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Treas.
HJ
10
•A13P4
v. 220
U. S. Dept. of the Treasury.
Press releases.,
LIBRARY
MAR 13198 n
TREASURY DEPAaiMENT
FOR IMMEDIATE RELEASE
EXPECTED AT 10:00 A.M., EST
TUESDAY, MARCH 20, 1979
STATEMENT OF THE HONORABLE W. MICHAEL BLUMENTHAL
SECRETARY OF THE TREASURY
BEFORE THE SUBCOMMITTEE ON FOREIGN OPERATIONS
COMMITTEE ON APPROPRIATIONS
UNITED STATES SENATE
Mr. Chairman. I am very pleased to appear before
this Subcommittee to present the Administration's appropriations request for the multilateral development banks.
U.S. participation in these banks serves a broad
range of foreign policy and national security interests.
It provides significant economic and financial returns to
the United States. It supports institutions which are
effective in promoting economic growth and development in
less developed countries. It permits us to share the burden
of furnishing foreign economic assistance with other donor
countries. These are the principal reasons why we believe
U.S. participation in the multilateral development banks is
both necessary and cost effective.
I have a comprehensive statement which discusses these
considerations and other issues in detail. I would like to
B-1466
- 2submit that statement for the record and begin today's
•A
•-••
discussion by summarizing its main points. This year we are
requesting budget authority of $3.6 billion for the development
banks. This consists of two parts: $1,842 million for paid-in
capital subscriptions and for contributions to the concessional
windows of the banks, which will eventually result in expenditure
and $1,782 million for callable capital subscriptions to the
banks, which will not result in actual expenditures.
The request breaks down as follows:
— $1*026 million for U.S. subscriptions to the World
Bank's capital. Ten percent of this amount, or $102.6 million
would be paid-in. With this subscription, and those of other
member countries, the Bank is able to borrow on private
markets and relend the funds for development assistance
projects at market rates of interest. The Bank has never had
a default on its loans and earns money each year.
— $ly092 million for U.S. contributions to the fourth
and fifth replenishments of the International Development
Association. IDA is the concessional loan facility of the
World Bank. It lends money only to the poorest countries of
the world. Of this total, $800 million is for this year's
installment to IDA V, and $292 million is needed to complete
the final installment of the U.S. contribution to the fourth
replenishment, which was negotiated by the previous
Administration. This year's total IDA request is $166 million
- 3 less than what Congress actually appropriated for this
institution last year.
— $33.4 million for the third and final installment of
U.S. contributions to the International Finance Corporation,
the World Eank affiliate that encourages the growth of productive private enterprise in developing countries.
— $687 million for the first installment of the U.S.
subscription to the capital of the Inter-American Development
Bank. Of this amount, 7.5 percent or $51.5 million is
paid-in. The Bank is a primary source of development
lending in the hemisphere and the United States is its
leading shareholder.
— $325 million for U.S. contributions to the Fund for
Special Operations of the IDB, the Bank's soft loan window.
$175 million is for the first of four annual installments
to the new replenishment, each of which calls for
a lower U.S. contribution than was pledged to the
previous replenishment. The remaining $150 million is for
the final part of our contribution to the prior replenishment, which was negotiated by the previous Administration.
— $248 million for subscriptions to the capital of
the Asian Development Bank. Ten percent, or $24.8 million
of this subscription will be paid-in. This Bank has established an excellent record and Japan has taken the lead
in providing for its financing. Furthermore, European
- 4 members have increased their proportionate share in
providing funds.
— $171 million for U.S. contributions to the Asian
Development Fund, the soft loan window of the Asian
Development Bank. $111 million is for the first installment of our contribution to the new replenishment and $60
million is for the final installment of our contribution
to the present replenishment, which was negotiated in 1975.
— $42 million for the first of three annual installments to the African Development Fund. This request will
enable the United States to provide a reasonable share of
funding for concessional lending to the poorest African
countries. It reflects our objective of taking a more active
role in encouraging economic and social development in Africa.
This request of $3.6 billion in budgetary authority for
the multilateral development banks is slightly more than
last year's request of $3.5 billion. However, putting
aside callable capital, the request would result in expenditures that would be $286 million less than the expenditures
which would have resulted from last year's request.
Compared to last year's appropriation, expenditures
resulting from this year's request would be up by $211
million, or 13 percent. This increase is the result
of unfunded requests from prior years, which account
for almost $500 million in expenditures (deriving from
- 5 almost $1 billion of total budget authority). If we could
clear up these unfunded amounts, the budgetary outlook for
U.S. contributions to the multilateral development banks
over the next few years would result in a fairly constant
level of expenditures in nominal terms and a reduction
in real terms.
Our request is for a substantial sum. I believe that
it is necessary and that it would be well spent for the
four reasons I cited earlier.
First, helping the developing countries through participation in the banks advances important U.S. foreign
policy and security interests. Our interests require
the successful social and economic development of these
countries. Many of these interests are shared by other
industrial countries, and most importantly by many
developing countries as well. These shared interests
are the foundation for effective multilateral cooperation
through the banks.
The United States has a great deal at stake in these
countries. As recent events have clearly demonstrated, some
occupy strategic geographic positions, and possibilities
exist for unrest and conflict, which could carry dangers for
many countries, including the United States. Furthermore,
we need the cooperation of the developing world if we are to
achieve such objectives as: halting the proliferation of
nuclear weapons, limiting conventional armaments, combatting
- 6 international terrorism, suppressing international drug traffic,
controlling illegal migration, promoting human rights and
protecting the global environment.
Our economic interests in the developing world are large
and growing. As a group, these countries were a market for
25 percent of our exports in 1977, including $6.7 billion in
agricultural commodities. They were the source for 24 percent of our imports in 1977, including tin, bauxite, rubber,
manganese, and other critically needed raw materials. To
ignore the developing countries is to ignore our own interests.
Second, we derive significant economic and financial
benefits from the activities of the multilateral banks,
which more than offset the budgetary burden of our contributions. In short we earn a good return on our investment.
These direct financial and economic benefits include
contracts awarded to U.S. firms resulting from development
projects financed by the banks, the purchase of other
goods and services in this country derived from bank
activities, and interest paid to U.S. holders of bank
bonds. On a cumulative basis, the banks have returned
in these kinds of benefits substantially more than the
amounts which have been paid in by the U.S. Government.
Thus our contributions to the banks have not been a problem
for the balance of payments or a source of trouble for the
dollar. Indeed, they have provided benefits for the U.S.
economy in terms of jobs and our economic growth.
- 7 Looked at more broadly, the multilateral development
banks have played a very constructive role in sustaining
a smoothly functioning and growing world economy which
in turn has helped our trade and employment. They
are a central part of the system for economic cooperation
which the United States worked hard to establish after
World War II and which we must continue to support
strongly today. We live in an economically interdependent
world, and we need to encourage and extend international
cooperation on development, as well as trade and finance,
if we are to deal successfully with our own economic
problems.
Third, the banks have been effective instruments for
promoting economic and social development and thus are
contributing to a more tolerable world environment for
this and coming generations.
Essentially these institutions apply banking
principles to the achievement of development purposes.
In this they are unique instruments in the annals of
economic change, and they work. The projects they finance
are soundly conceived, carefully supervised and well executed.
Of course there have been exceptions, but they are comparatively few and the average quality has been high indeed.
One of the principal U.S. objectives in the banks is
to encourage and expand the use of resources to assist
the poor — not to finance a welfare program, but to raise
- 8 productivity and increase employment opportunities. This
requires the financing of the right mixture of projects
to enlarge basic infrastructure, raise agricultural
productivity, provide the basis for expanded employment in
urban areas and provide the foundation for the extension
of essential social services.
The World Bank has been a leader in the effort to
reach the poor, and progress is continuing. During the
Bank's last fiscal year, 31 IDA projects amounting to
$867 million were approved for rural development lending
alone, with benefits going mostly to small farmers, tenants,
and landless laborers. Emphasis is being placed on helping
the urban poor through projects which provide sites
and services for housing and through the encouragement
of labor intensive industries.
This Committee has expressed concern about the use of
concessional resources from the Fund for Special Operations
of the Inter-American Development Bank. The recently
negotiated replenishment agreement explicitly provides
that 50 percent of all Bank lending — conventional and
concessional — will benefit low income groups. In addition,
the agreement requires that concessional resources from the
Fund for Special Operations be increasingly targeted at the
poorest countries and the poorest people of the hemisphere.
- 9 While we have devoted a great deal of effort to
encourage movement in this direction, we recognize that the
banks must maintain a balanced approach to growth and
development. Lending for transportation, communications
and electric power will continue to have high priority.
Infrastructure and basic needs projects depend on each
other.
We strongly support and give high priority to
the expansion of Bank lending for energy development.
In response to a request made at the Bonn Summit Meeting,
the World Bank explored new approaches to help solve the
growing energy problems of developing countries and
proposed an expanded lending program to do this. The
United States has endorsed the general provisions of
that program, including Bank financing for geological
and geophysical surveys and exploratory drilling, and
an acceleration in lending for projects to develop and
produce gas and oil. By 1983, the World Bank Group
expects to be lending $1.5 billion a year for this
program, which would amount to more than 10 percent
of its total lending. Over the next few years, the
Inter-American Development Bank will be devoting a large
proportion of its lending to help finance hydroelectric,
geothermal and other aspects of energy development in Latin
America, and the Asian Development Bank has also embarked
on a large lending program to finance the production of
- 10 primary energy fuels. These Bank funds, moreover, will
facilitate additional private investment in this critical
area, thus helping to meet urgent requirements in the
developing countries, and improving the oil supply and demand
balance for the world as a whole.
Fourth, the Banks are an unusually effective means
for sharing the development assistance burden among the
better-off countries.
Currently the United States provides one-fourth of
the total funding requirements for these institutions,
while other countries provide three-fourths. In contrast,
the United States, twenty-five years ago, provided
about two-thirds of total foreign economic assistance.
Countries that once received assistance are now major
sources of assistance, and this encouraging process
continues today.
Consequently, our participation in the multilateral
development banks has proven to be increasingly cost
effective. Our foreign assistance dollar is stretched
much further; it has greater impact and does more good
for us and the developing countries as a result of our
participation in the banks. These substantial benefits,
however, require that the United States contribute its fair
share of total resources. For example, if we do not contribute
$800 million to this year's installment for IDA V, other
countries' shares would not become available for commitment
- 11 and IDA lending would have to stop. In the case of the
remaining U.S. share of IDA IV, funds are needed to meet
disbursement requirements on past commitments.
Under the replenishment arrangements in the InterAmerican Development Bank, the Asian Development Fund
and the African Development Fund, other countries
may reduce their contributions if we do not provide
curs in full.
Direct budgetary costs are even more greatly
reduced by the banks' extensive use of callable capital
for subscribing to new shares. This type of capital
is not paid in to the banks. In the case of the United
States, it never leaves the Treasury Department and
does not result in any budgetary outlay. These
subscriptions, however, serve as backing that enables
the banks to borrow in the world's private
capital markets. Callable capital would result
in a budgetary outlay only in the event it were needed
to cover a bank default on an obligation to bondholders.
Such a call has never taken place in the past. In view
of the banks' excellent financial record, their paid-in
capital, and their large reserves from past earnings, the
possibility of a call taking place in the future is remote
Under typical capital replenishment arrangements,
nine out of ten dollars for conventional lending are
raisea by the banks in this way, enabling us to achieve
- 12
very large budgetary savings without restricting the flow
of needed resources to developing countries. In the case
of the World Bank, total U.S. paid-in capital contributions of $884 million have generated more than $45 billion
of lending, a leverage factor of 50 to 1. Moreover, the
value of our shares is not only still intact, but it has
been increased as a result of past earnings.
In the next subscription to the Inter-American
Development Bank, the paid-in portion will be reduced
from 10 percent to 7-1/2 percent. This will provide
additional leverage in the use of U.S. budgetary expenditures to help finance this Bank. It is our intention
to seek further reductions in the paid-in portions of
future capital subscriptions of other banks, consonant
with their growing financial strength.
Have domestic social programs suffered as a result
of our foreign assistance program? I do not believe so.
Only one-fourth of one percent of our Cross National
Proauct goes for foreign economic assistance, including
our participation in the multilateral development banks.
This figure has declined in recent years and is now lower
than the corresponding CNP shares for twelve of the
seventeen countries in the Development Assistance Committee
of the OLCD.
On the other hand, U.S. budgetary expenditures for
domestic social programs have risen rapidly over the past
-13decade. In 1965, expenditures for these programs amounted
to $6 for each dollar of foreign aid. By 1969, this multiple
had risen to $18 and by 1979 to $46. Funding for foreign
economic assistance has not taken place at the expense of
domestic social priorities. The question is not whether the
United States can afford to fund foreign assistance programs,
but rather can we afford not to. The answer clearly is no.
I turn now to report to you briefly on several matters
on which the Congress has expressed special interest or concern.
Salaries. A great deal of work has been done in
constructing a rational and objective system for determining
World Bank and IMF salaries. A set of recommendations
to this end has been made by a Joint Committee of these
two institutions after one and a half years of study, which
included the employment of professional compensation
firms. These proposals are now being considered by
the Boards of the two institutions, and we are working
with other member governments to resolve this issue.
Encouraging capital saving technology. There is
a growing emphasis in the banks on encouraging the use of
capital saving technologies. Use of such technologies is
stimulated in the first instance by efforts to induce
developing countries to adopt more realistic exchange rates
and interest rates, thus eliminating an artificial premium
on the use of capital rather than labor. What can be
done on the individual project level has to be adapted
-14to the differing circumstances in individual countries.
In many cases these technologies are closely linked to
the success of projects which are designed to benefit the
poor directly. One example is a recently approved IDB
loan to El Salvador for community development in the
economically deprived northwest region of the country.
Its objective is to increase incomes and improve living
conditions for 144,000 people in 300 small rural communities through self-help construction of small scale public
works. The cost per beneficiary is not expected to exceed
$80. Another example is an IDA credit to Upper Volta
which is directed at rural and urban artisans and small
scale entrepreneurs to encourage production of bricks,
farm implements, wooden utensils, and pottery. The
average cost per job is estimated to be less than $200.
Human Rights. We have sought to encourage greater
regard for human rights in bilateral discussions with other
countries, and in our actions in the multilateral banks. We
have consulted with other member countries on human rights
problems, and we have opposed, by voting against or abstaining
on 50 loans to 15 countries.
We have also taken steps to implement the provision of
last year's Appropriations Act which calls upon the Administration to seek adoption of human rights amendments to the banks'
charters. In order to generate support for such amendments,
we have consulted with countries that share our human rights
- 15 concerns. Thus far, their reaction to this proposal has
been negative. They believe that the introduction of such
amendments would be divisive, and that such amendments would
not obtain the broad support required for their adoption. We
are undertaking additional consultations to pursue this
approach and to achieve the objectives of the legislation.
I would like to stress that the human rights provisions in current law are being carried out conscientiously.
I see no need for change in the legislation. Indeed, as
I have stated in the past, legislation prohibiting the use of
U.S. contributions to the banks for loans to specific countries
would mean that the contributions would have to be rejected
by the institutions. This would jeopardize our continued
participation in the banks at the expense of our human rights
concerns and at enormous cost to our other foreign policy
objectives.
Accountability. We have greatly increased the flow
of information to the Congress on the activities of the
banks, and we have encouraged greater public dissemination
of bank documents. During the past year, the General
Accounting Office completed studies of evaluation and
review units within the banks and generally found them
to be effective.
Commodity Issues. Current law requires that the
United States oppose use of MDB funds for the production
of any commodity for export if it is in surplus on world
- 16 markets and if substantial injury would be caused to U.S.
producers of the same, similar or competing products.
It also provides that the President shall initiate
international consultations to develop standards governing
the allocation of development assistance for production
of commodities in surplus on world markets where increased
exports would cause substantial harm to other producers.
As a matter of fact, the banks have been making
very few loans that could fall under these provisions.
This is understandable because the banks themselves
believe that loans to finance commodities in prospective
world surplus would be a wasteful use of development
assistance resources. To carry out the legislative
requirements, we have established criteria to determine
the economic impact of commodity loans on the world
markets. No loan proposals thus far this year have
required special action. We have also raised
internationally the question of establishing standards
governing the use of development assistance resources
for commodity loans and will report to you further on
this matter.
I do not believe additional legislative action on
commodity issues is warranted. In particular, legislation
to prohibit the use of U.S. appropriations to the banks
to finance specific commodity projects would, as in the
case of country restrictions, not be legally acceptable
- 17 to the banks. Such a provision in U.S. law would seriously
damage U.S. interests.
I would like to conclude, Mr. Chairman, by asking
that we step back for a moment and consider these institutions
from still another vantage point. The evidence shows that
they are one of the great success stories of the entire
post-war period, stretching from Bretton Woods to the
present. Even now they are continuing to improve on this
impressive record. They give us good value for our money,
their net impact on the budget is small, and they bring
substantial economic and political benefits. I ask for
your support in making it possible for this good work to
continue.
FOR IMMEDIATE RELEASE
EXPECTED AT 10:00 A.M., EST
TUESDAY, MARCH 20, 1979
STATEMENT OF THE HONORABLE W. MICHAEL BLLJMENTHAL
SECRETARY OF THE TREASURY
BEFORE THE SUBCOMMITTEE ON FOREIGN OPERATIONS
COMMITTEE ON APPROPRIATIONS
UNITED STATES SENATE
Mr. Chairman. I am very pleased to appear before
this Subcommittee to present the Administration's appropriations request for the multilateral development banks.
U.S. participation in these banks serves a broad
range of foreign policy and national security interests.
It also provides significant economic and financial returns
to the United States. It supports institutions which are
effective in promoting economic growth and development in
less developed countries. It permits us to share the burden
of furnishing foreign economic assistance with other donor
countries. These are the principal reasons why we believe
U.S. participation in the multilateral development banks
is both necessary and cost effective.
In my statement, I will discuss these considerations
in detail. The Committee has expressed particular interest
in several other issues including bank lending to benefit
the poor, salaries and administrative costs. I will also
report to you on these matters. 1
Let me begin by summarizing the individual requests
and briefly discussing their budgetary effect.
B-1467
- 2 This year we are requesting budget authority of $3.6
billion for the development banks. This consists of two
parts: $1,842 million for paid-in capital subscriptions and
for contributions to the concessional windows of the banks,
which will eventually result in expenditures; and $1,782
million for callable capital subscriptions to the banks,
which will not result in actual expenditures.
The request breaks down as follows:
— $1,026 million for U.S. subscriptions to the
World Bank's capital. Ten percent of this amount, or
$102.6 million would be paid-in. With this subscription,
and those of other member countries, the Bank is able
to borrow on private markets and relend the funds
for development assistance projects at market rates
of interest. The Bank has never had a default on
its loans and earns money each year.
— $1,092 million for U.S. contributions to the fourth
and fifth replenishments of the International Development
Association. IDA is the concessional loan facility of the
World Bank. It lends money only to the poorest countries
of the world. Of this total, $800 million is for this
year's installment to IDA V, and $292 million is needed
to complete the final installment of U.S. contribution to
the fourth replenishment, which was negotiated by the
previous Administration. This year's total IDA
request is $166 million less than what Congress actually
appropriated for this institution last year.
— $33.4 million for the third and final installment
of U.S. contributions to the International Finance
Corporation, the World Bank affiliate that encourages
the growth of productive private enterprise in developing
countries.
— $687 million for the first installment of the U.S.
subscription to the capital of the Inter-American Development
Bank. Of this amount, 7.5 percent or $51.5 million is
paid-in. The Bank is a primary source of development
lending in the hemisphere and the United States is its
leading shareholder.
— $325 million for U.S. contributions to the Fund for
Special Operations of the IDB, the Bank's soft loan window.
$175 million is for the first of four annual installments
to the new replenishment, each of which calls for
a lower U.S. contribution than was pledged'to the
previous replenishment. The remaining $150 million is for
the final part of our contribution to the prior replenishment, which was negotiated by the previous Administration.
- 3 — $248 million for subscriptions to the capital of
the Asian Development Bank. Ten percent, or $24.8 million
of this subscription will be paid-in. This bank has established an excellent record and Japan has taken the lead
in providing for its financing. Furthermore, European
members have increased their proportionate share in
providing funds.
— $171 million for U.S. contributions to the Asian
Development Fund, the soft loan window of the Asian
Development Bank. $111 million is for the first installment of our contribution to the new replenishment and $60
million is for the final installment of our contribution
to the present replenishment, which was negotiated in 1975.
— $42 million for the first of three annual installments to the African Development Fund. This request will
enable the United States to provide a reasonable share of
funding for concessional lending to the poorest African
countries. It reflects our objective of taking a more active
role in encouraging economic and social development in Africa.
This request of $3.6 billion in budgetary authority for
the multilateral development banks is slightly more than
last year's request of $3.5 billion. However, putting
aside callable capital, the request would result in expenditures that would be $286 million less than the expenditures
called for in last year's request.
Compared to last year's appropriation, expenditures
resulting from this year's request would be up by $211
million, or 13 percent. This increase is the result
of unfunded requests from prior years, which account
for almost $500 million in expenditures (deriving from
almost $1 billion of total budget authority). If we could
clear up these unfunded amounts, the budgetary outlook for
U.S. contributions to the multilateral development banks
over the next few years would show a fairly constant
level of expenditures in nominal terms and a reduction
in real terms.
Our request is for a substantial sum. I believe
that it is necessary and that it would be well spent for
the reasons I cited earlier.
First, helping the developing countries through participation in the banks advances important JJ.S. foreign
policy and security interests. Our interests require
the successful social and economic development of these
countries. Many of these interests are shared by other
- 4 industrial countries, and most importantly by many
developing countries as well. These shared interests
are the foundation for effective multilateral cooperation
through the banks.
The U.S. has a great deal at stake in these countries.
Some occupy strategic geographic positions and possibilities
exist for unrest and conflict, which could carry dangers
for many countries, including the United States. Furthermore, we need the cooperation of the developing world if
we are to achieve such objectives as: halting the
proliferation of nuclear weapons, limiting conventional
armaments, combatting international terrorism, suppressing
international drug traffic, controlling illegal migration,
promoting human rights and protecting the global environment.
Our economic interests in the developing world are large
and growing. As a group, these countries were a market for
30 percent of our exports in 1977, including $6.7 billion
in agricultural commodities. They were the source for
24 percent of our imports in 1977, including tin, bauxite
rubber, manganese and other critically needed raw materials.
Second, we derive significant economic and financial
benefits from the activities of the multilateral banks,
which more than offset the budgetary burden of our contributions. In short we earn a good return on our investment.
These direct financial and economic benefits include
contracts awarded to U.S. firms resulting from development
projects financed by the banks, the purchase of other
goods and services in this country derived from bank
activities, and interest paid to U.S. holders of bank
bonds. On a cumulative basis, the banks have returned
in these kinds of benefits substantially more than the
amounts which have been paid in by the U.S. Government.
Thus our contributions to the banks have not been a problem
for the balance of payments or a source of trouble for the
dollar. Indeed, they have provided benefits for the U.S.
economy in terms of jobs and our economic growth.
Looked at more broadly, the multilateral development
banks have played a very constructive role in sustaining
a smoothly functioning and growing world economy which
in turn has helped our trade and employment. They
are a central part of the system for economic cooperation
which the United States worked hard to establish after
World War II and which we must continue to support
- 5 strongly today. We live in an economically interdependent
world, and we need to encourage and extend international
cooperation on development, as well as trade and finance,
if we are to deal successfully with our own economic
problems.
Third, the banks have been effective instruments for
promoting economic and social development and thus are
contributing to a more tolerable world environment for
this and coming generations.
Essentially these institutions apply banking
principles to the achievement of development purposes.
In this they are unique instruments in the annals of
economic change, and they work. The projects they finance
are soundly conceived, carefully supervised and well executed.
Of course there have been exceptions, but they are comparatively few and the average quality has been high indeed.
One of the principal U.S. objectives in the banks is
to encourage and expand the use of resources to assist
the poor — not to finance a welfare program, but to raise
productivity and increase employment opportunities. This
requires the financing of the right mixture of projects
to enlarge basic infrastructure, raise agricultural
productivity, provide the basis for wider employment in
urban areas and provide the foundation for expanding
essential social services.
The World Bank has been a leader in the effort to
reach the poor and progress is continuing. During the
Bank's last fiscal year, 31 IDA projects amounting to
$867 million were approved for rural development lending
alone, with benefits going mostly to small farmers, tenants,
and landless laborers. Emphasis is being placed on helping
the urban poor through projects which provide sites
and services for housing and through the encouragement
of labor intensive industries.
This Committee has expressed concern about the use
of concessional resources from'the Fund for Special
Operations of the Inter-American Development Bank. The
recently negotiated replenishment agreement explicitly
provides that 50 percent of all Bank lending — conventional
and concessional — will go to low income groups. In addition,
the agreement requires that concessional resources from the
Fund for Special Operations be increasingly targeted at the
poorest countries and the poorest people of the hemisphere.
- 6 While we have devoted a great deal of effort to
encourage movement in this direction, we recognize that the
banks roust maintain a balanced approach to growth and
development. Lending for transportation, communications
and electric power will continue to have high priority.
Infrastructure and basic needs projects depend on each
other.
Another high priority that we strongly support is
the expansion of Bank lending for energy development.
In response to a request made at the Bonn Summit Meeting,
the World Bank explored new approaches to help solve the
growing energy problems of developing countries and
proposed an expanded lending program to do this. The
United States has endorsed the general provisions of
that program, including Bank financing for geological
and geophysical surveys and exploratory drilling, and
an acceleration in lending for projects to develop and
produce gas and oil. By 1983, the World Bank Group
expects to be lending $1.5 billion a year for this
program, which would amount to more than 10 percent
of its total lending. Over the next few years, the
Inter-Araerican Development Bank will be devoting a large
proportion of its lending to develop geothermal and
hydroelectric potential in Latin America, and the Asian
Development Bank has also embarked on a large lending
program to finance the production of primary energy
fuels. These Bank funds, moreover, will facilitate
additional private investment in this critical area,
thus helping to meet urgent requirements in the developing
countries, and improving the oil supply and demand balance
for the world as a whole.
Fourth, the Banks are an unusually effective means
for sharing the development assistance burden among the
better-off countries.
Currently the United States provides one-fourth of
the total funding requirements /or these institutions,
while other countries provide three-fourths. In contrast,
the United States, twenty-five years ago, provided
about two-thirds of total foreign economic assistance.
Countries that once received assistance are now major
sources of assistance and this encouraging process
continues today.
Consequently, our participation in the multilateral
development banks has proven to be increasingly cost
effective, providing a multiplier effect to the use of
our development assistance appropriations. This
- 7 substantial benefit, however, requires that the United
States contribute its fair share of total resources.
For example, if we do not contribute $800 million
to this year's installment for IDA V, other countries'
shares would not become available for commitment and
IDA lending would have to stop. In the case of the remaining U.S. share of IDA IV, funds are needed to meet
disbursement requirements on past commitments.
Under the replenishment arrangements in the InterAmerican Development Bank, the Asian Development Fund
and the African Development Fund, other countries
may reduce their contributions if we do not provide
ours in full.
Direct budgetary costs are even more greatly
reduced by the banks' extensive use of callable
capital for subscribing to new shares. This type
of capital is not paid in to the banks. In the case
of the U.S., it never leaves the Treasury Department
and does not result in any budgetary outlay. These
subscriptions, however, serve as backing that enables
the banks to borrow in the world's private
capital markets. Callable capital would result
in a budgetary outlay only in the event it were needed
to cover a bank default on an obligation to bondholders.
Such a call has never taken place in the past. In view
of the banks' excellent financial record, their paid-in
capital, and their large reserves from past earnings, the
possibility of a call taking place in the future is remote.
Under typical capital replenishment arrangements,
nine out of ten dollars for conventional lending are
raised by the banks in this way, enabling us to achieve
very large budgetary savings without restricting the flow
of needed resources to developing countries. In the case
of the World Bank, total U.S. paid-in capital contributions of $884 million have generated more than $45 billion
of lending, a leverage factor of 50 to 1. Moreover, the
value of our shares is not only still intact, but it has
been increased as a result of past earnings.
In the next subscription to the Inter-American
Development Bank, the paid-in portion will be reduced
from 10 percent to 7-1/2 percent. This will provide
additional leverage in the use of U.S. budgetary expenditures to help finance this Bank. It is our intention
to seek further reductions in the paid-in portions of
future capital subscriptions of other banks, consonant
with their growing financial strength.
- 8 Have domestic social programs suffered as a result
of our foreign assistance program? I do not believe so.
Only one-fourth of one percent of our Gross National
Product goes for foreign economic assistance, including
our participation in the multilateral development banks.
This figure has declined in recent years and is now lower
than the corresponding GNP shares for twelve of the
seventeen countries in the Development Assistance Committee
of the OECD.
On the other hand, U.S. budgetary expenditures for
domestic social programs have risen rapidly over the
past decade. In 1965, expenditures for these programs
amounted to $6 for each dollar of foreign aid. By 1969,
this multiple had risen to $18 and by 1979 to $46. It is
clear from these figures that funding for foreign economic
assistance has not taken place at the expense of domestic
social priorities.
In justifying the appropriations request I have
emphasized four factors which constitute the rationale
for continued U.S. participation in the banks: foreign
policy and national security considerations, economic
and financial benefits, the overall effectiveness of the
banks in lending to promote growth and reach the poor,
and the cost effectiveness of our subscriptions
and contributions. At this time, I would like to
discuss each of these matters in more detail and then
report to you further on several other issues including
use of salaries, capital saving technologies, human
rights,
and commodities.
FOREIGNaccountability,
POLICY AND NATIONAL
SECURITY CONSIDERATIONS
The more than one hundred developing nations
contain the great majority of the world's population.
They differ greatly among themselves in terms of culture,
history, political systems and the level of economic
development that they have attained. Nevertheless,
they all share one major aspiration: economic growth
and development and material improvement in the lives
of their people.
The less developed countries have moved to the
forefront of world affairs. They are increasingly active
in international political and economic organizations and
more effective in pursuing their national and regional
interests. Collectively, and in some cases individually,
they have assumed a much greater importance in U.S.
foreign policy and national security considerations:
- 9 — They are an important source of raw materials which
are critical to the economies of the United States and other
industrial countries.
— They occupy strategic geographical positions.
— They are growing users of atomic energy for
peaceful purposes and a number of them have the
capability for developing nuclear weapons.
— They have military capabilities which can be
used to initiate military conflicts affecting U.S.
interests and having the potential of escalating
into great-power confrontation.
— Their growing populations and aspirations
place greater demands on the earth's resources and
environment on which we too must depend.
Negotiations toward the solutions to these problems
are complex and difficult, requiring a balancing of
interests and a sensitivity to the requirements of
developing countries. In implementing non-proliferation
policy, for example, it is necessary to recognize that
less developed countries have a legitimate and expanding
requirement for energy. In this particular respect,
the IBRD Report on Energy and the recommendations
it contained for project financing in this sector,
have been very helpful. In order to combat international
terrorism effectively, we must be able to count
on the support of less developed countries in multilateral
organizations such as the U.N. and in dealing directly
with individual situations as they may arise. The
Law of the Sea Conference now going on under the
auspices of the United Nations requires the cooperation
of less developed countries on a number of issues
if we are to reach agreement and still protect interests
of the United States relating to navigation, marine
research, protection of the environment and exploration
and exploitation of deep seabed mineral resources.
In this general context of competing and conflicting interests on major international issues, the
multilateral development banks provide the United
States with a practical and effective way to work
cooperatively with developing countries to help
them meet their most basic aspirations. However, our
relationships with less developed countries are also
important on an individual basis. The following four
examples illustrate how multilateral development bank
activity contributes to the achievement of U.S. policy
objectives in specific countries.
- 10 -
Thailand
Thailand has a central position in southeast Asia
and has maintained a close relationship with the United
States. It is in our national interest to support the
stability and independence of Thailand because it is a
key element of regional progress and balance in southeast
Asia. Thailand's cooperation is essential if we are to
have an effective narcotics suppression program. It has
also provided a country of first refuge for Indo-Chinese
refugees. Thailand is important as an expanding
market for U.S. exports including cotton, tobacco,
machinery, fertilizers, iron, and steel. It is also
a reliable supplier of critical raw material imports
such as tin, tungsten and rubber.
Economically, Thailand has grown at a rate matched
by few developing countries. From 1960 to 1976, GNP
growth averaged 7.6 percent a year. A high and rising
level of investment has been maintained, exceeding 20
percent of GNP and largely financed by domestic savings.
Per capita income doubled over the 1960-1976 period.
Inflation has been kept under control by conservative
fiscal policies, although price pressures have recently
intensified.
In the past, economic policies have tended to favor
Bangkok, other urban areas and the relatively better off
farmers of the central plains. A large proportion of
the rural population, particularly in the northeast, has
not shared equitably in the benefits of economic growth.
Failure to remedy the growing disparity has fostered
insurgency and hindered political stability.
The present government in Thailand is beginning to
reorient economic policy more in favor of these
elements of the rural population. The Prime Minister
has declared 1979 the "Year Qf the Farmer" and has
stated his government's intention to direct far greater
resources to rural areas. The revised Five-Year Development Plan for 1977-1981 calls for external borrowing of
about $1 billion per year to finance rural and infrastructure development to bring services and improved
agricultural technology to the rural poor.
For 1979, the proposed borrowing pcograra includes
$314 million from the IBRD and $324 million from the
ADB. It is in our interest that the flow of financing
- 11 -
continue to Thailand. Our participation in the
banks will help assure that the country will be
able to sustain its growth and carry out
needed changes in its overall economic policies.
Mexico
Mexico provides another example of how a country
which is critically important to the United States
benefits from multilateral development bank activities.
Mexico's importance to the U.S. stems primarily
from its geographical proximity to this country, and
the influence which this proximity can have on the
political, economic, social, environmental and security
aspects of American society. Two fundamental U.S.
policy objectives which flow from this basic fact
of life are:
— Political stability and economic growth in
a Mexico which is friendly to the United States.
— Control of migration which if not controlled,
has potentially disruptive effects for the United
States.
In addition, the development of Mexico's
hydrocarbon resources will increase the free world's
supply of oil and provide Mexico with the revenue
to increase domestic employment, thus reducing migration
pressures on the United States. Finally, cooperation
between our two countries is necessary for narcotics
control and other border issues including sanitation,
pollution control, and law enforcement.
Mexico does not receive .concessional lending
from either the IBRD or the TDB. It has become, in .
fact, a donor to the Fund for Special Operations of the
IDB. It continues, however, to receive substantial
amounts of market rate financing from the banks.
In their most recent fiscal years, World Bank loans to
Mexico amounted to $469 million while those of the
Inter-American Development Bank were $238 million.
President Carter, during a recent trip to Mexico,
visited an integrated rural development project which
is being financed jointly by the banks. The purpose
- 12 of the project is to increase incomes and employment
opportunities for poor people in rural areas of the
country. The banks thus play a very useful financial
intermediary role in Mexico, and they provide a
source of advice on investment plans which may help
Mexico to use petroleum revenues most effectively
to solve unemployment and under-employment and redress
social and economic imbalances.
Tanzania
Tanzania is one of the world's poorest countries.
However, it has taken a prominent position in regional
and international organizations and is recognized as a
leader in Africa and in the Non-Aligned Movement. .
President Nyerere is Chairman of the Front Line States
and U.S. officials have worked with him concerning
very sensitive problems relating to Rhodesia and Namibia.
President Nyerere and his government have advanced
a national development strategy which emphasizes "self
reliance". Their philosophy has entailed the organization of the rural population into "ujamaa" villages,
and attempting to provide education and other
services on a limited but equitable basis. The World
Bank has worked closely with Tanzania in devising
and implementing its rural development strategy which
is aimed at reaching the poor and helping to meet basic
human needs. On a cumulative basis, it has committed
$605 million to Tanzania, including $353 million
on concessional terms.
ECONOMIC AND FINANCIAL BENEFITS
U.S. participation in the multilateral development
banks is a long-term investment in the future of the
developing world. Although the most important benefits
to the United States are long-term, we clearly derive
short-term benefits as well.
Increased financing to the developing countries
permits them to increase their imports of investment
goods from the United States and other developed countries directly. As a result of the increased investment,
the developing countries are able to improve their
living standards more rapidly, providing a growing
market for the United States and other exporters.
- 13 -
This investment also helps developing countries
produce raw materials the United States roust import
in order to prosper.
Exports to developing countries resulting
directly from multilateral development bank loans
and from the more rapid expansion of living standards
are a growing source of demand for U.S. goods and
services. This provides jobs, income, profits, and
tax revenue in the United States.
From the time of the banks' inception in 1946 to
the middle of 1978, direct accumulated receipts by
all segments of the U.S. economy have exceeded outflows to the MDBs by $2.4 billion. In addition, an
econometric analysis which we have made shows that
real GNP increased annually between $1.2 billion and
$1.8 billion as a result of exports of U.S. goods
and services to markets directly created by MDB
financed projects in developing countries. This
means that every U.S. dollar paid into the MDBs
generated between $2.39 and $3.38 in real U.S.
economic growth annually over the period.
U.S. participation in the multilateral development banks is not motivated primarily by these kinds
of benefits. But it is a mistake to view outlays to
the multilateral development banks as an economic
loss to the United States.
A large proportion of the direct economic and
financial benefits that have accrued to the United
States have been in the form of contracts awarded
to U.S. firms for loan projects' financed by the banks
overseas. As a general matter, our cumulative procurement
shares from the banks have been in line with our share
of contributions: 25 percent in the World Bank, 50
percent in the Inter-American Development Bank and
8 percent in the Asian Development Bank.
In the case of the Asian Development Bank, procurement has been less than the level of our expectations.
Consequently, we established an inter-agency working
group to study the reasons for the disparity and to
take appropriate actions. The working group, consisting
of representatives from Treasury, Commerce and the
State Department's East Asia and Economic Bureaus,
took the following actions:
- 14 -
—
—
—
—
—
—
—
— Distributed a questionnaire to 300 U.S.
consulting firms eliciting information on
weaknesses in the system for providing
information about upcoming contracts
Conducted a bid-by-bid review of the award
of 1500 contracts let by the Asian Development
Bank. The review indicated that U.S. firms bid
on 300 of these contracts, a bid rate of 20
percent, and that they won 100 of the contract
awards for which they had bid, an award rate of
33 percent.
Arranged for a meeting of regional economic
and commercial counselors which is to take
place in Manila to be built around the theme
of increasing U.S. ADB procurement.
Promoted a series of ADB staff visits to
U.S. Chambers of Commerce, mainly on the
west coast, to advise U.S. firms of procurement
opportunities in the ADB.
Sought additional opportunities for U.S. Government officials to talk to business groups about
ADB activities. A Treasury official in recent
months has briefed both business and trade
groups in Georgia and Michigan on ADB
procurement.
Persuaded ADB Management to provide copies
of the Monthly Operations Report directly to
interested businesses on a subscription basis.
Persuaded ADB management to publish all
procurement notices in "Development Forum,"
published monthly by the U.N. as well as in
the individual trade publications.
Established pilot programs for Economic and
Commercial Counselors to monitor the preparation of specific project proposals.
As a result of the study, we have assured ourselves
that the lending procedures of the ADB are fair to U.S.
suppliers and that there is no institutional bias within
the Bank which limits the success of U.S. suppliers.
We see the problem as one of encouraging U.S. suppliers
to bid more aggressively. Our role in solving this
problem is making sure that potential U.S. suppliers
have enough information as early as possible.
- 15 -
A system has been established within the office of
the U.S. Director at the ADB to increase the flow of information to U.S. suppliers. Prior to Board consideration
of each loan, a cable incorporating procurement information
is sent to the U.S. Economic or Commercial Counselor in
the recipient country and to the Commerce Department in
Washington for dissemination to U.S. firms, including
publication in Commerce Department periodicals such as
Business America. We look forward to seeing improvement
in U.S. procurement from ADB-financed projects as a result
of the effort we are now making and as a result of
currency realignments which should make American exports
generally more competitive.
Within the Inter-American Development Bank,
we are now pursuing a parallel program to increase U.S.
procurement. A team of Commerce Department officials
has consulted with the U.S. Executive Director and arrangements are being made for establishing a reporting system
to advise U.S. Embassy economic counselors in Latin
America of upcoming bank contracts similar to that which
has been established for the Asian Development Bank. In
recent months, the U.S. Alternate Executive Director
of the IDB has participated in a number of meetings
to advise U.S. businesses of procurement opportunities
in Latin America through the Inter-American Development
Bank and to assist U.S. businessmen in doing business
through the bank.
A number of other actions have been taken which
should be helpful in promoting U.S. procurement in the
banks. A brochure outlining procurement opportunities
and procedures and practices in all the banks has recently
been revised and reissued. The banks themselves have prepared
and provided detailed information on their lending activities
and procurement eligibility requirements. This material
is available directly from the banks or through the U.S.
Executive Directors' offices.! The Monthly Operations.
Report is now available on a subscription basis
from the ADB as it has been for some time from
the World Bank Group and we are hopeful that the InterAmerican Development Bank will provide this material
on a similar basis in the near future. The offices of
the U.S. Executive Directors in all of the banks are
extremely active in assisting U.S. businessmen and we
have encouraged them to do more in this regard.
- 16 In the World Bank Group, recent examples of contracts
awarded to U.S. firms include: $4.6 million to Ingersoll
for miscellaneous goods and services in Korea, and
$1.2 million to Southwire for electrical equipment
in Brazil. Disbursements made between July 1, 1977
and June 30, 1978 on all World Bank Group contracts
awarded to U.S. firms amounted to $1,447 million.
Examples of contracts awarded from the Asian Development
Bank include $7.2 million to the Vinnell Corporation
for construction work in the Philippines, and $2.1
million to Phillips Brothers for copper wire. Examples
from the Inter-American Development Bank include:
$1.1 million to the Robins Company for equipment in
Brazil and $2.0 million to the R.J.L. Hoste Company
for construction in Guatemala. Smaller firms also
benefit from awards of contracts for bank-financed
projects.
REACHING THE POOR
The World Development Report, released by the
World Bank last August, estimated that more than 800
million people of the developing world continue to
live in conditions of absolute poverty — that they
are inadequately sheltered, malnourished, illiterate
and diseased, with infant mortality rates in low income
countries running far in excess of 100 for every thousand
live births and life expectancies estimated at less
than 44 years.
The very impressive growth rates of less developed
countries in the last 25 years have not resulted in
commensurate improvement in the lives of the absolutely
poor. There has been increasing concern that much
greater efforts must be made by the multilateral development banks and by other development assistance agencies
to reach these people more directly and to involve them
more productively in the development process. This
Administration supports greater efforts by all the
development assistance organizations to reach the
poor in recipient countries. We have urged the World
Bank and the regional development banks to take
a number of actions to improve appraisal, implementation and evaluation of projects designed to reach
the poor.
- 17 At the same time we recognize that a great deal
of progress has already been made. During the Annual
Meeting of the World Bank Group in Nairobi in 1973,
a number of objectives were established to change
the Bank's lending practices over the following five
year period: lending in the agricultural sector was
to be increased by 40 percent and a minimum of 70
percent of all agricultural loans were to benefit
small farmers. Both of these goals have been met
and surpassed. Agricultural lending in the five year
period 1974-78 was up 145 percent over the preceding
five year period. Of 363 agricultural projects approved
by the Bank in 1974-78, 75 percent contained a component
explicitly directed at assisting small farmers. In
more than 200 of these 363 projects, over half
of the direct beneficiaries were expected to be
members of the rural poor. Bank experts now
estimate that as a result of these loans the incomes
of over 10 million rural families will at least
double.
The World Bank has also established a set of
goals for addressing the problems of the urban poor
and a number of projects have already been approved
to provide sites and services for urban housing and
to create additional employment opportunities. For
the period 1976-80, the Bank intends to finance 50
urban projects and by 1981 to substantially increase
the proportion of its lending through industrial
development finance institutions which directly
benefits the urban poor. Additional emphasis is being
placed on labor intensive industries and finding ways
to encourage artisan and cottage industries. The use
of labor intensive methods and practices has been
mandated where appropriate in the implementation of
Bank projects and encouraged throughout the construction
industries of recipient countries.
In spite of the progress that has been made
and that which is programmed, there is no disagreement
that the problems of absolute poverty will be with
us far into the future. Indeed the World Bank
itself estimates that it would take a massive
effort to reduce the number of people in absolute
poverty to the level of 400 million by the year
2000. We are convinced, however, that much more
can be done to raise the productivity of poor people
to increase their incomes and to provide them
with improved access to public services.
- 18 We have worked along two basic tracks to
promote this result. We have sought basic changes
in the policies of the banks to ensure that they
will devote an increasing share of their loans to
help the poor directly. In the recently negotiated
replenishment of the Inter-American Development Bank
for example, it was agreed that one-half
of all lending over the next four years benefit
low income groups in recipient countries. It
was also agreed that the concessional resources
of the FSO should be better targeted toward poor
people and poor countries. In the first and second
years of the replenishment, 75 percent of these
scarce concessional foreign exchange resources
must go to the poorest countries in the
hemisphere. In the third and fourth years,
this figure must be increased to 80 percent.
Any of the remaining FSO funds which go to other
countries must be used only for projects which
demonstrably benefit low income groups.
To assure that these results are
achieved, the Board of Governors of the Bank has
directed that the Board of Executive Directors
prepare and submit by this June a report which will
define precisely the groups which are to be
benefitted with these resources. In addition,
it should be noted that Bank management has already
taken a number of steps to improve its capacity
to reach low income groups. A clear statement
of the intended beneficiaries of each project,
the justification for the use of FSO resources
and a description of land tenancy, in the case
of agricultural loans, is now required in all loan
documents. The Bank has also established a Small
Project Financing Program which will enable it
to respond to the needs of low income groups on
a pilot basis and in innovative ways outside the
regular lending program constraints.
In the Asian Development Bank, we took a very
active role in seeing that the Bank's Board of
Directors adopted an Agricultural Sector Paper
based on the results of the Second Agricultural
Survey which was carried out last year at Bank
initiative and expense. Among other things, the
paper provides the following guidance for future
lending in agriculture: improved design of projects
" 19 "
to assure more rural employment opportunities,
concentration on rural infrastructure including
feeder road networks; better support facilities
for rural credit programs and improved arrangements
for providing inputs and for marketing production;
establishment and upgrading of extension services
for rural women; strengthening small scale enterprises
and better provision for health, nutrition and
family planning assistance. In addition, it calls
for more of an orientation toward helping to meet
basic human needs of the rural poor, encourages
the participation of the under-employed in bank-financed
projects, and requires that projects emphasize
cost-reduction through calculations of project-cost
per beneficiary.
The banks have proceeded along three lines
toward the objective of further benefitting the
poor.
First, the banks are using their considerable
aid leverage to promote policy changes in the
borrowing countries to improve the lot of the poor.
As part of this approach, much greater effort is
currently being made to involve the poor themselves
in the planning and implementation of development
projects. Examples of these efforts exist in all
the multilateral development banks.
In February 1978, the International Development
Association approved an $8.5 million credit to Cameroon
for integrated rural development in the economically
deprived eastern province of the country. This loan,
which is to provide assistance through a provincial
development organization (ZAPI), places particular
importance on getting the full cooperation and participation of local farmers in all aspects of the
project. ZAPI itself has set a long-term objective
of eventually enabling the farmers to take charge
of local development actions and has adopted a
strategy aimed at creating a farmer controlled and
operated cooperative structure. To this end, a
system of farmer committees has been established
to organize village marketing and to oversee
disbursement and recovery of credits as well as to
provide the farmers with a mechanism for influencing
policy, planning and coordination of rural development activities in the province.
"20
"
In September 1978, the Asian Development Bank made
a loan of $18 million to Indonesia for an irrigation
project. This loan also emphasizes the need for active
involvement of farmers through local irrigation associations which are called Subaks. These organizations
are traditional in some rural areas of Indonesia and
include in their membership all cultivators who own,
sharecrop or rent land receiving water from a single
source. Each member of the Subak has an equal vote
and the leadership is democratically elected by
majority vote or consensus. The ADB loan agreement
specifically requires that the Subaks be directly
involved in the allocation of water between Subaks
and in the settlement of inter-Subak water rights
disputes.
A third example of involvement by the poor is
an IDB loan of $13.2 million to El Salvador for
community development. This loan, which was approved
in November 1978, has been designed to benefit
low income groups in the northwestern region of the
country. It includes a sub-program of credits for
production purposes to individuals or cooperative
organizations and a sub-program of small scale public
works such as school repairs and construction of
feeder roads, bridges, community halls, public baths,
washrooms and latrines. A central element of the
project is the provision for beneficiary participation in setting priorities for the small scale public
works and for giving the beneficiaries the opportunity
to work on the implementation of these works.
Second, the multilateral development banks have
shifted the sectoral composition of their lending
activity to favor projects which directly meet the
needs of the poor. For example, World Bank Group
lending for rural development increased over sevenfold from FY 1973 to FY 1978 from $247 million
to $1,728 million. Similar sectoral changes are
occuring in the regional banks as well.
In the Asian Development Bank, for the year 1977,
the percentage share of agricultural projects was
29 percent, up from 26 percent in 1976. In 1978 more
than 53 percent of the bank's concessional lending to
the poorest countries of the region was for agricultural purposes. In the IDB at the end of 1977,
bank lending going directly for agricultural
- 21 "
purposes accounted for 23 percent of the total
loan portfolio. In 1978, there was an increased
concentration on approval of integrated rural
development projects which are mandated to rise in
the period 1979-1982 since, under the upcoming
replenishment, between 30 and 35 percent of bank
lending has been expressly designated for rural
development projects. A further 10 to 15 percent
is targeted for urban development projects.
Third, the MDBs are changing the emphasis of
their more traditional projects to assure that their
benefits are shared by the rural and urban poor. In
the design of water supply, electrification and road
projects, for example, the benefits accruing to poorer
groups have been considerably expanded.
Two specific recent examples come to mind.
An IDB loan of $12.2 million to Ecuador for a rural
water supply system has been aimed at several communities in El Oro province where 90 percent of the
population have incomes less than the national
average income. An ADB loan of $24.0 million to
the Philippines has been designed to support construction of secondary and feeder roads in the island
of Mindanao, a particularly disadvantaged area of the
country. It has been estimated that, in addition
to net value added through incremental agricultural
production and user cost savings, the project will
also benefit 42,000 families with a population of
270,000 in the area of influence through improved
availability of governmental social and administrative services, a favorable effect on school enrollments and greater access to health services.
An important problem is how best to develop
a capacity to discover "who actually benefits"
from MDB projects. Considerable effort has been
made by the banks in the last several years to
improve the data gathering procedures and statistical
analysis capabilities of the borrowing countries.
This effort is a vital ingredient of the banks'
programs to know whether they are in fact better
reaching the poor, and how to assure that they will
do so in the future. These statistical and analytical
- 22 "
techniques are now receiving greater attention, along
with shifts in sectoral priorities and redesign of
traditional projects.
There is substantial evidence that the multilateral development banks have made considerable
progress in recent years in better reaching the poor.
The most recent statistics for IDA indicated
that during FY 1978 50 agricultural projects amounting
to $1,341 million were approved, accounting for
nearly 58 percent of total IDA lending. Of these
projects, 31 amounting to $867 million were for
rural development lending in which a majority of
the direct benefits go to small farmers, tenants and
landless laborers. Approximately 6.6 million rural
families are expected to benefit directly from these
50 agricultural and rural development loans and of
those families, two-thirds or 4.4 million, are either
absolutely poor or in the lower third of the income
levels for their particular countries. In addition
to the direct beneficiaries, the World Bank staff
estimated that 13 million other farm families
should benefit from the projects through advances
such as improved research, storage, seed supply,
and marketing facilities as well as from
increased employment opportunities or from the
provision of health and education services or improved transportation and other rural infrastructure.
These efforts to reach the poor are essential.
At the same time, we believe that the multilateral
development banks must also continue to pursue a
multiplicity of goals if they are to be effective
catalysts for development. The banks must preserve
their recognized strengths in project design,
sectoral and country programming, macro-policy
leverage and infrastructure support. We would
not want them to abandon these programs.
Infrastructure projects are still key in many less
developed countries because they provide the necessary
economic context for other assistance programs, including
those to benefit directly the poor. For example, feeder
roads serving small farmers in isolated parts of Africa
must lead eventually to a principal roadif inputs are to
get in and production is to get out. Adequate port facilities are needed if fertilizers and other inputs from abroad
- 23"
are to reach these smallholders and if their coffee or
cocoa or other production is to have an export market.
The smallholders themselves recognize that an
improved transportation infrastructure is essential
to reduce the disparities between farmgate and
market prices. Indeed, the success of projects
designed to meet basic human needs are often dependent
upon these kinds of infrastructure projects. Hydroelectric power projects provide another example of
projects which are critical if less developed countries are to meet expanding energy requirements
and reduce their reliance on expensive imported
fuels. The banks must combine projects such
as these with the new emphasis on reaching the
poor throughout the developing world in ways which
promote both productivity
and equity.
THE EFFECTIVENESS
OF THE BANKS
The banks are very effective in promoting
the economic growth and development of recipient
countries. They raise resources for both concessional
and near market lending operations from many donor
countries. As a consequence, they are able to operate
on a significant scale and across the range of economic
sectors. Supported by a well qualified and experienced
staff from more than 100 member countries, they have
established a reputation for rigorous and detailed
appraisal of project proposals and programs. The volume
and range of their operations, and the expertise they can
bring to bear, enable them to play a unique role in
promoting economic growth and development. They have
a capability and impact which is greater than that
which any individual donor country can muster.
The multilateral development banks have become
the leading institutions in the field of international
economic development. They are now the largest source
of official assistance to developing areas, last year
making commitments for approximately $11 billion for*"
over 400 projects in recipient countries. Actual disbursements exceeded $5.5 billion. This level of lending
gives the banks important influence in recipient countries.
Because of their apolitical character, and the fact
that they operate on the basis of economic and
financial criteria, the banks are able to encourage
the adoption of appropriate economic policies.
- 24 They finance programs of technical assistance,
to strengthen local institutions and provide training
for local officials. They encourage coordination of the
resource flow to developing countries and promote cooperation among official lenders by chairing aid coordination
groups for particular countries. They also support
research and development organizations, particularly
in agriculture, and sponsor seminars and research on
developmental problems, making the results available
to interested individuals and groups.
In its most recent fiscal year, the World Bank
Group approved total loans and investments amounting to
$8,749.1 million. Of that amount, $6,097 million were
for loans on near market terms, $2,313 million were for
loans on concessional terms and $338.4 million were for
investments by the International Finance Corporation.
Disbursements from the Bank and IDA made during the
year were $3,849 million. Technical assistance operations financed by the Bank included two loans amounting
to $20.3 million and components of 151 other operations
which amounted to an additional $230 million.
The Bank also maintained a leading role in the
organization and operations of various aid coordination
mechanisms. Under the auspices of the Bank, the Caribbean
Group for Cooperation in Economic Development was established and held its first meeting in 1978. Formal meetings
of ten other aid coordinating groups were held under
Bank auspices during the year including groups for
Bangladesh, Bolivia, Burma, Egypt, India, Nepal,
Pakistan, Philippines, Sri Lanka, and Zambia. In
addition the Bank participated in a meeting of the InterGovernmental Group on Indonesia and hosted a meeting
of donor agencies to discuss improving cofinancing and
coordination of operations in the population sector.
In order to promote better inter-agency coordination, the Bank also entered into a formal agreement with
the recently established International Fund for
Agricultural Development (IFAD) on a working arrangement
between the two organizations. The Inter-American Development Bank and the Asian Development Bank have entered
into similar agreements with IFAD.
In addition, the World Bank became a co-sponsor
for Research and Training in Tropical Diseases and IDA
agreed to administer the Special Action Account of $385
million for the European Economic Community to provide
-25 quick-disbursing assistance to the poorest developing
countries. A number of ongoing programs and relationships
were maintained with various U.N. agencies including the
Food and Agriculture Organization, the World Health Organization, United Nations Industrial Development Organization,
the International Labor Organization and the United
Nations Education, Scientific and Cultural Organization.
During 1978, the World Bank also continued its
support for eleven international agricultural research
organizations providing $8.7 million to help finance
the programs of organizations such as the International
Institute of Tropical Agriculture in Nigeria, the International Livestock Center for Africa in Ethiopia, and
the International Potato Center in Peru.
Eighty-seven economic research projects and studies
were also underway in the IBRD during 1978. The results
of these studies are available to the international
research community and the public as well as to policy
makers within the Bank and member countries. Examples of
studies currently in process include strategies for control
of tropical diseases such as schistosomiosis and the use
of low cost technologies to provide safe drinking water
and sanitation facilities. In addition, examinations
are being made of small scale enterprises in selected
countries and a number of surveys and studies are being
conducted to provide a better analytical framework for
providing rural development assistance.
The World Bank has also continued efforts to
improve its systems for evaluating loan operations.
In 1978, the Bank published an Operations Evaluation
Department review of project performance audit results.
The system for providing feedback to the operating
departments from the audit process was strengthened
through improvement in annual and semiannual procedures
for reviewing completed and qn-going projects. All Bank
loans now require the borrower to complete a project"*
completion report as a standard feature and in more
difficult sectors — such as agriculture, education
and urban development — the establishment of special
monitoring units is required. In 1978, the Bank also
sponsored a seminar on post-evaluation and review for
senior officials of several African countries. As a
result, discussions are continuing with .those countries
regarding establishing national agencies to evaluate
public investment projects and similar seminars are
planned for other regions.
- 26 Similar functions and activities are carried out by
the regional development banks. For example, during 1978,
the Presidents of these banks held one of their regular
meetings at the headquarters of the Inter-American Development Bank to discuss major economic and financial issues
facing developing countries. At this meeting they were
joined by representatives from the World Bank,
the International Monetary Fund, the European Economic
Community, the European Investment Bank, the OPEC
Special Fund and the Islamic Development Fund. During
1978, the IDB initiated joint financing with OPEC
countries and organizations for development projects
in Haiti, Bolivia, and Honduras. The Bank also
sponsored symposia on the application of capital
saving technologies and the prospects for greater
use of solar energy. Last year, the Asian Development
Bank held a seminar for regional development banks
promoting improved appraisal and implementation of
public and private investment projects. The Bank
also completed a survey on South Pacific agriculture
and sponsored a seminar on irrigation development and
COST-EFFECTIVENESS
management.
The cost-effectiveness of U.S. participation
in the multilateral development banks is based on
three factors:
(1) Equitable sharing of the burden for
providing economic assistance with
other donor countries;
(2) Leveraging paid-in capital contributions
to the banks by borrowings in private
capital markets, based on callable
or guarantee capital;
(3) Extending bank resources through
cofinancing arrangements made with
other official sources, including
OPEC countries, and with private banks.
As I indicated at the beginning of my testimony,
the United States has been able progressively to
reduce its share of subscriptions and contributions
to the banks and the shares of other participating
- 27 "
countries have been correspondingly increased.
This process is continuing today. It reflects
the growing economic strength of other countries
and their increased capability to provide more
resources for development. These countries include
industrial countries such as Germany and Japan, the
OPEC countries and some of the relatively more advanced
developing countries such as Brazil and Mexico which
have increased their convertible currency contributions
to the Inter-American Development Bank.
During the past two years, this Administration
has negotiated replenishment agreements for the
International Development Association, the InterAmerican Development Bank, the Asian Development
Fund and the African Development Fund. In all of
these agreements, except that for the African
Development Fund, where the United States had
hardly participated at all, the share of the United
States has declined and the shares of other countries
have increased.
As finally agreed in the spring of 1977, the
fifth replenishment of IDA provided for a reduction
in the U.S. share from 33.32 percent to 31.42 percent.
Countries which increased their contributions to IDA V
were Saudi Arabia, the United Arab Emirates and Kuwait.
Germany and Japan, which had substantially increased
the level of their contributions to the fourth
replenishment, maintained this increased level
during the fifth replenishment.
Subsequently, during the course of 1977 and 1978,
a number of countries announced increases in their
contributions to IDA V including Saudi Arabia, Kuwait,
the Netherlands, Norway, and the United Kingdom.
Altogether, these increased contributions amounted
to $145.5 million with the largest sums coming from
Saudi Arabia which contributed $100 million and Kuwait
which contributed $20 million". As a result of these *
additional increased contributions the U.S. share
of IDA V declined further to the level of 31.2 percent.
In preliminary discussions for the sixth replenishment
of resources, we are pursuing a sizable further reduction
in line with the Sense of the Congress Resolution
on shares contained in Title III of Public Law 95-481.
-28More equitable burden-sharing was one of the key
elements in the recently completed agreement to replenish the resources of the Inter-American Development
Bank, where our share is the largest because we are
the only sizable industrial country in the hemisphere.
Under the original terms of their entry into the bank
in 1974, the non-regional members of Western Europe
and Japan provided 4.4 percent of the Bank's total
capital. In the agreement just negotiated, they
raised the percentage share of their subscription to the
increase by more than two and one-half times to 11 percent,
pledging a total of $876 million in paid-in and callable
capital which serves as backing on the Bank's borrowing
operations. Under the agreement, Canada and Venezuela
are contributing $310 million and $467 million respectively
in paid-in capital and completely convertible backing
for the Bank's borrowing operations. In addition,
all of the recipient member countries of the Bank
are making two-thirds of their paid-in capital fully
convertible, thus mobilizing $178 million in convertible
resources, including $43.5 million from Argentina,
$43.5 million from Brazil and $28 million from Mexico,
or a total of nearly $115 million from these three
countries.
In the Fund for Special Operations, the Bank's
concessional lending facility, the non-regional member
countries maintained their entry share of 30 percent and
increased their contributions from $450 million
to $525 million. Canada, Venezuela and Trinidad and
Tobago agreed to make all of their contributions fully
convertible, providing $58.1 million, $70 million
and $3.9 million respectively for a total of $132
million to these resources which are lent to the poorest
countries in the hemisphere.
The three largest developing countries in the
hemisphere, Argentina, Brazil and Mexico, agreed to
make the equivalent of three-quarters of their FSO
contributions convertible; thus they are contributing*
$72 million, $72 million and $46.5 million respectively.
They have also agreed to continue not to borrow these
convertible FSO resources. These three countries and
Venezuela are all former recipients of FSO resources.
They are now making convertible contributions to those
resources of $260 million.
- 29 As a result of these contributions and those of
the non-regional countries, the U.S. share of convertible
FSO'resources has dropped from 57 percent in the last
replenishment to 45 percent in the new replenishment.
In terms of absolute amounts, the annual level of
U.S. contributions to the FSO will fall from $200
million under the last replenishment to $175 million
under the new one, a reduction of 12.5 percent or
$25 million per year in paid-in contributions to the
concessional lending fund of the IDB.
In the Asian Development Fund, negotiations
were completed last spring for a replenishment of
resources of $2.0 billion, with the United States
contributing $445 million, or 22.25 percent, and
meeting the share standard established in last year's
appropriations legislation. In addition, other donors
agreed to make supplemental contributions of
$150 million, thus effectively reducing the U.S.
share to 20.7 percent, significantly below the
standard set in last year's legislation.
Other donor countries have increased
their percentage shares of contributions to the
Fund. Japan, for example, originally on a par
with the United States in contributions to the
Fund, is contributing $673 million under the
basic agreement and a supplementary amount of
$118.3 million, for a total of $792 million or
36.8 percent of the total compared with our 20.7
percent. The Netherlands and Sweden also
made marginal increases in their previous
contributions and France, joining the Fund for the
first time, provided an additional $104.8 million.
The other replenishment agreement negotiated
by the Administration last year was for the African
Development Fund. This Fund is relatively small
and U.S. contributions in the past have been very
minor, amounting to $50 million or well under ten
percent of total Fund resources. In this particular
case, the Administration agreed to a very substantial
increase in the percentage share of our contributions
to somewhat under eighteen percent although it is
still a small amount in dollar terms ($125 million
over a 3 year period) because the AFDF is still quite
small itself.
- 30 We consider that this increase is fully justified
on the grounds that Africa is the least developed
continent, that it contains some of the poorest and
least advantaged countries in the world, and that
the African Development Fund has been steadily improving
its administrative and technical capabilities. In
the last two years, Africa has also assumed a much
greater importance than before in the overall foreign
policy of the United States. The announcement of the
$125 million for contributions to the Fund was made last
year at the time of President Carter's visit. It has
been widely publicized in Africa and favorably interpreted
as an indication of increasing U.S. interest.
USE OF CALLABLE CAPITAL
The second factor contributing to costeffectiveness is the ability of the banks to use
callable capital backing for bond issues, thereby
permitting them to raise private capital for
conventional lending, and avoiding budgetary
outlay by the United States or other member countries.
The ability of the banks to leverage limited paid-in
contributions in this way has grown to the point where
today, only one dollar in ten has to be paid-in and in
the case of the IDB it is even less, as a result of
the recent replenishment.
When the World Bank was first established in 1946,
20 percent of the capital was paid in and 80 percent
was callable. The higher proportion of paid-in capital
was necessary to cover start-up expenses, provide acceptable
financial ratios and to secure confidence and support
for the institution from private capital markets. As
the Bank developed, it established a record for prompt
collection and a reputation for financial prudence.
It was possible to reduce the paid-in portion
without damaging the Bank's ability to raise private
funds at an acceptable cost. On a cumulative basis,
the U.S. has paid in $884 million to the capital of
the World Bank and, as a result of burden-sharing
and leverage, supported a total lending program of
over $45 billion. On this basis, each dollar of U.S.
paid-in capital has been able to support approximately
$50 in Bank lending. This pattern has been followed
by the Inter-American Development Bank and the Asian
-31Development Bank, although because these institutions
were not established until 1959 and 1966, and have
different capital structures, the leverage factors
have been lower.
In the case of the World Bank, we are now at
the point when we can consider whether or not it is,
in fact, necessary to continue to have 10 percent of
the capital paid into the Bank under the next general
capital increase. The final answer to this question
depends, of course, on the views of all members and
on the attitudes of private capital markets to this
prospect. We ourselves would want to consider very
carefully the implications that such a step might
have for the Bank's financial strength, its cost of
capital and the lending rate policy that it will follow
in the 1980's. In any event, I am confident that
it will be possible to reduce the paid-in portion
of the next general capital increase below the ten
percent level.
In the recently negotiated increase in capital
of the Inter-American Development Bank, the financial
strength of the institution made it possible to reduce
the proportion of capital to be paid in. Under the
terms of the agreement reached last December, the
proportion of paid-in capital was reduced to seven
and one-half percent.
On a cumulative basis, the U.S. has paid in
$482 million to the IDB and supported a total capital
lending program of nearly $7.0 billion, a combined
leverage factor based on both burden-sharing and use
of callable capital of 14 to 1. This is much lower
than the multiple for the World Bank, but it reflects
the fact that the Bank was not established until 1959
and that the United States until the 1970's was the
only developed member country. The entry of the nonregionals and the increase in their capital shares
in combination with a reduced**paid-in portion will
cause this multiple to become even larger in the future.
In the Asian Development Bank, the cumulative
paid-in capital contributions of the United States
amount to $242 million and they support a total lending
program in excess of $3.8 billion, a leverage factor
of 15 to 1.
-32 -
COFINANCING
A third way in which our participation in the
multilateral development banks is cost effective is
through cofinancing or complementary financing arrangements made with private banks or other public and private
organizations. The banks have been able to sell to
commercial banks "participations" in the early maturities
of their individual loans. These sales have been made
without recourse and originally at the fixed interest
rate set in each individual bank loan contract. This
procedure had the advantage — since it was done without
recourse — of freeing up Bank resources for additional lending. However, with the general rise and
increased volatility of interest rates that has occurred
during the 1970's, it has not been possible to continue
these particular programs on the basis of a fixed rate.
As a result, the Inter-American Development Bank
modified its participation program, introducing a
variable.interest rate feature. In the case of the
World Bank, a parallel lending program was established
with a cross-default clause to provide additional
security for the commercial lender portion of the
loan. This clause permits but does not make mandatory
suspension of the entire loan, including the World
Bank portion, if there should be a default on the
portion of the loan held by the commercial bank. Under
its new program, the World Bank had mobilized a total
of $469 million in additional lending resources from
private banks as of the end of calendar year 1978.
The figure of $469 million does not include the
International Finance Corporation, which is also a
member of the World Bank Group and which, under its
mandate to encourage private enterprise in less developed
countries, is very active in pofinancing. As of
^
June 30, 1978, the IFC held investments amounting
*"
to more than $1,315 million of which $332 million
or 25 percent were held for private purchasers and
participants. On average, IFC financing in individual projects is held to 25 percent or less of
total project costs and other resources have
necessarily been mobilized including additional
private or public capital from developed.countries
or from the recipient country itself.
-
33"
IFC operations in the past have been most
successful in middle income countries and in companies that have been in operation for some time.
Following the recent increase in resources, however,
it has been planned that operations in the poorer
recipient countries will be increased. IFC will,
therefore, perform a very useful role in putting together
proposals which can attract additional private financing
to countries, particularly in Africa and Asia, which
have had difficulty in this respect in the past.
In the Inter-American Development Bank there is
a complementary or cofinancing program based on sales of
participations. There is no need for a cross-default
clause, since the Bank administers the commercial
bank portion of the loan, acting as disburser and
collector. The Bank has had no difficulty in attracting
commercial bank participation at interest rates which
are agreeable to the borrowing countries and marginally
lower than they would have received in the absence
of the program, i.e., on a straight commercial loan
basis. Since 1976, the Inter-American Development
Bank has mobilized $278 million in additional lending
resources through its complementary financing program.
In both the World Bank and the Inter-American Development
Bank, we anticipate that the amounts of money raised
in this manner will rise in the future.
Participation in the cofinancing programs
has not been limited to U.S. banks. Major banks from
Germany, Japan, Switzerland and Canada, among other
countries, have taken significant portions of individual
loans. In addition to the resource extending beoefit,
which is helpful to us for domestic budgetary reasons,
there are other very definite advantages to the cofinancing
programs. They provide a mechanism for introducing
commercial bank lending in developing countries whose.
international credit standing has not been firmly
established, thereby permitting these countries to
enter the world financial system and pave the way
for reducing still further, over time, the need for
public aid. They also enable the multilateral development
banks to lend in a larger number of sectors and for more
projects, permitting a greater concentration of
both conventional and concessional resources on
projects which reach the poor, without requiring
that critical infrastructure needs of recipient
countries be abandoned or left unmet.
-34-
The Asian Development Bank has made less
progress thus far than the World Bank and the InterAmerican Development Bank in revising and expanding
its private cofinancing program. At a recent Board
of Directors meeting which considered a management
proposal to take such action, the U.S. Director urged
that greater emphasis be placed by the Bank on this
cost-effective way of mobilizing additional resources
for its developing member countries.
The Asian Development Bank has been more
successful, however, in arranging cofinancing arrangements
with other official sources such as the OPEC Special
Fund, the Islamic Development Fund and individual
OPEC countries. As of the end of calendar year 1978,
the ADB had raised a total of $343 million in this
manner. The Inter-American Development Bank has also
helped the Venezuelan Government to establish a special
Venezuelan Trust Fund of $500 million which is
administered by the IDB for lending to other developing
countries in the hemisphere. This Fund is in addition
to Venezuela's regular contributions to the Bank's
capital and to the Fund for Special Operations. World
Bank figures show that cofinancing with OPEC countries
and agencies amounted to $1.4 billion at the end of
1977, the most recent period for which data are available.
Because its membership has been limited to the region,
the African Development Bank has not tapped the international
bond markets or sought to establish cofinancing relationships
with commercial banks. If non-regional countries join
the bank, which is a matter now under negotiation,
however, the AFDB in the fuuure should be able to
begin modest bond offerings based on the paid-in and
callable capital contributions of developed member
countries and may look toward the establishment
of cofinancing relationships with commercial banks.
*
m.
0
'
The United States has benefitted from increased
burden-sharing and the mobilization of additional
capital through bond offerings and cofinancing. As
other countries have increased their contributions
to the multilateral development banks, it has been
possible for our overall share of contributions to decline.
As the banks have established themselves in private
capital markets, it has been possible fof our overall
paid-in capital contributions to be reduced from
fifty percent in some cases to less than ten
percent.
- 35 In comparison, the use of cofinancing has been
more limited. I am hopeful that the World Bank and
the Inter-American Development Bank will continue to expand their operations during this year and
that the Asian Development Bank will be able to launch
a new cooperative financing program with private
banks as well as continue its relationships with
public entities in the OPEC countries.
SALARIES
A major issue that has been of concern
to both the Congress and the Administration is that
of salaries, benefits, and administrative costs
within the multilateral development banks. Of these
issues, the predominant one has been staff salaries.
With the strong support of the United States, the
management of the World Bank and the IMF formed a
Joint Committee of Executive Directors on Compensation
Issues. This Committee was given responsibility
to study the compensation situation of all IMF/IBRD
employees and to make appropriate recommendations
to the Executive Boards of the two institutions. The
Committee met on numerous occasions throughout 1977
and 1978, employed professional compensation firms to
obtain necessary data for comparative purposes and
finished its work in late December. Its final report
has been printed, and copies were sent to the Congress
on February first.
This report and its recommendations provide
the framework for an objective determination of salaries
based on public and private salary levels in member
countries.
It advances three basic recommendations:
— salaries in the main professional grades
will be determined as the average of those in the U.S.
private sector and the U.S. Civil Service, plus a premium
of ten percent. This premium is necessary to adjust
for regional differences of pay within the United
States and to make the salaries competitive on an
international as well as an East Coast basis. Data
from the U.S. private sector were used because the costs
involved are U.S. costs and the necessary data
were available.
- 36 — salaries in the management levels will
be determined by setting a moderate differential
for each successive grade over the preceeding grade,
to arrive at a rational management structure.
— tax reimbursement paid American staff will be
calculated from the net salaries, using the average
deduction for that income level, rather than the
standard deduction as heretofore.
The net effect of these recommendations would be
to bring Bank and Fund salaries more closely into line
with comparable public and private sector salaries, as
directed in Section 704 of Public Law 95-118.
We will be working with other countries to obtain
adoption of the new compensation system by the
Boards of the Bank and the IMF.
CAPITAL SAVING TECHNOLOGIES
Another U.S. objective in the banks has been to promote
projects which more directly and effectively reach the poor
within beneficiary countries. One important means to help
achieve this objective is to promote the utilization of
capital saving technology in order to increase the productivity and incomes of poor people to insure that the greatest
number of people benefit from bank projects, and to promote
the most efficient use of scarce development resources.
Capital saving technologies involve the productive and
often innovative use of small-scale and labor-intensive
processes, techniques, equipment and tools which are less
complex and costly than those usually employed in the
developed countries. As a result, their application promotes the efficient use of available resources by substituting
abundant unskilled labor for scarce investment funds. The
approaches, activities, and techniques they embody also
permit a focus on reaching the maximum number of beneficiaries at relatively modest assistance costs.
The United States has sought policy decisions through
which the banks will place increased emphasis on the'use of
capital saving technologies in their projects. In November
1976, the Inter-American Development Bank adopted a policy
to promote the use of light capital technology by making
it a significant component of development strategy.
In 1977, the Asian Development Bank incorporated
an enumeration and assessment of light capital technologies
into its project identification and evaluation procedures
so as to examine relevant technological alternatives
as an ongoing part of its project selection process.
- 37 The World Bank's policy guidelines on the use of
technologies are included in sector policy papers. For
example, one of the major recommendations of the Bank's
1978 paper, Employment and Development of Small Scale
Enterprises was that the Bank should urge recipient
governments to correct policies and regulatory measures
that have the effect of encouraging undue capital
intensity in investments. The paper points out that
larger firms may benefit more than smaller enterprises
from credit programs with artificially low interest
rates or from the subsidization of public services
such as power, transportation and water supply. It
concludes that these policies can be modified and
that additional incentives can be provided in other
ways such as reserving public procurement of certain
items to smaller firms, encouraging subcontracting, and
broadening the sectoral coverage of development finance
companies.
We have also sought to maximize the use
of capital saving technologies in our review of
individual loans. The Executive Directors in all of
the banks, backstopped by Treasury staff, examine all
loan proposals specifically to assure that this criterion
is properly taken into account. They endeavor to promote
the use of capital saving technologies in their contacts
with other Board members, in communications with bank
management and in discussions with technical staff.
The U.S. concern for the application of capital saving
technologies has been emphasized by our requesting
clarification on the technological aspects and implications
of individual projects presented to the Boards. For
example, in connection with a fisheries loan to Ecuador,
the United States Executive Director of the IDB sought
and received assurance from the Bank that the crafts
to be used in the project were the most appropriate,
least capital intensive alternative. In a feasibility
study for a dam in the Dominican Republic, the Executive
Director made sure that the guidance given to the consultants
by the Bank included instructions to specifically take
into account the possibilities for using light capital
technologies in designing the project.
The banks, with U.S. support, are making increased
efforts at the preinvestment stage to achieve a more
effective application of capital saving technologies.
By strengthening their project appraisal activities, the
banks facilitate the selection of projects incorporating
techniques that are most appropriate to the circumstances
and requirements of the borrowing countries. In a large
number of cases this leads to the utilization of light
capital technologies.
- 38 -
The results of efforts to introduce capital saving
technologies in appropriate instances can be seen in their
increasing use in individual bank projects. An example is
the recent IDB loan of $13.2 million mentioned earlier
to support community development in the economically
depressed northwest region of El Salvador. The objective
of the project is to help bring about an improvement
in the living conditions and incomes of approximately
144,000 people living in about 300 small rural communities
through self-help construction of small scale works
(roads, schools, bridges, potable water supply systems)
and the granting of credit to approximately 48,000
low income people to increase their agricultural, agroindustrial and crafts production, facilitate the marketing
of their products, and to meet other basic family needs.
The construction methods for the works subprogram
will be labor intensive and use a high proportion
of local materials. It is planned to limit the use
of construction equipment to the minimum amounts
necessary to assure a satisfactory output. In the
credit assistance subprogram, the use of machinery
will be limited to equipment that can be manually
or easily operated, such as knapsack pumps, manual
sprayers and sprinklers, and animal drawn plows. As
a result of making this extensive use of local labor
and materials in the works subprogram, the cost per
beneficiary will not exceed $80.
An IDA credit for artisan small and medium scale
enterprises in Upper Volta is an example of the
World Bank's efforts to create employment by working
through artisan groups and small scale enterprises.
The project has three major components and all are
expected to have important employment creation and
institution building effects. One of these is for
credit-in-kind and extension, services to artisans.
It amounts to $820,000 or 21 percent of the total
credit and is based wholly on the provision of
capital saving technology. The credit-in-kind will
be largely raw materials such as wood, metal, and
cement, and equipment such as wheelbarrows, shovels,
axes, saws, molds and other basic tools. The
average loan size is expected to be $400 with a range
from a few dollars for working capital .to a maximum
of $8,000 for artisans. Extension officers will distribute raw materials and assist in planning and
- 39 implementing investments as part of their regular
supervision visits to artisans. Artisan production
will be bricks, farm implements, wooden utensils and
probably pottery. Technical assistance to be provided
for the artisans will include basic skill training,
accounting for illiterates, general advice and direct
marketing. The target group of recipients are rural
and urban artisans with annual incomes of less than
$400. Since a total increase in direct employment
of 1,500 is projected, average investment cost per
job will be less than $200.
The El Salvador and Upper Volta projects are
two examples of efforts to reach the poor through
capital saving technologies. The information for
a detailed account of current efforts is presently
being collected and will be included in our 1979
report to the Congress on the use of light capital
technologies in MDB activities.
HUMAN RIGHTS
The Administration and the Congress share a firm
commitment to a foreign policy which gives high priority
to enhancing respect for human rights throughout the
world. In December of last year, President Carter
vigorously reaffirmed this commitment on the occasion of
the 30th anniversary of the Universal Declaration of
Human Rights.
Our policy in the banks has been aimed at inducing
improvements in specific problem situations. We
believe this objective can be achieved by demonstrating
to human rights violators that there are costs attached
to continued oppressive practices, and conversely
by demonstrating that there are benefits to those
governments which promote human rights.
In a report submitted to* the Congress in October. 1978,
the Secretary of State and I described in detail how this
policy has been implemented in the last 18 months. As
that report indicated, we have pursued our human rights
policy across the range of our relationships with other
countries. In the foreign assistance area, our bilateral
program has been governed by this principle and the
related concerns of reaching the poor and meeting basic
human needs. We define human rights to include, beyond
- 40 freedom from governmental violations of the person, basic
economic and social rights such as adequate food, housing,
clothing, health care and the opportunity to play a
productive role in society. The banks enhance respect
for human rights in the developing world by increasingly
shifting the emphasis of their lending programs toward
reaching the poor and meeting basic human needs.
We have encouraged the banks in this shift of emphasis
to projects which reach the poor and help meet basic human
needs, and we usually support projects for those countries
with human rights problems if they benefit the poor and
meet basic human needs, in order not to penalize the
people for the abusive policies of their governments.
We have undertaken consultations with other countries
on human rights problems, and we have raised human rights
concerns in the banks by opposing, through "no" votes or
abstentions, 50 loans to 15 countries where we considered
the human rights situations severe.
We have also taken steps to implement Section 611
of the FY 1979 Appropriations Act, which calls on the U.S.
Governor to "propose and seek adoption" of a charter
amendment in the banks that would establish human rights
standards to be taken into account in connection with each
loan. In an effort to generate support for such an amendment, and to ensure its best chances for adoption, we have
consulted other governments who share our human rights concerns and sought their views and agreement with this proposal.
Thus far, the reactions of other governments to the
proposal of an amendment have been negative. They believe
the introduction of such amendments would be unnecessarily
divisive and that they would not obtain the broad support
required for their adoption. In view of such reactions
we are undertaking additional consultations to pursue
this approach and to achieve the objectives of the
legislation.
«
In light of existing legislation which requires the
United States to vote against loans to countries that are
found to violate human rights consistently, I see no need
for special legislation aimed at restricting multilateral
development bank lending to particular countries. In
accordance with Section 701(f) of Public Law 95-118 and
the Administration's policy, we have voted against
or abstained on 50 loans to 15 countries. The present
legislation is being implemented conscientiously, and
I believe that no change is necessary at this time.
- 41 Indeed, as I have stated in the past, contributions
made under legislation prohibiting the use of U.S.
contributions to the banks for loans to specific countries would have to be rejected by the institutions.
Under their charters, the banks cannot accept funds from
the United States or from any other member which are
restricted on country grounds. Any provision in U.S.
law which would prohibit the use of appropriated funds
for multilateral development bank lending to selected
countries would seriously jeopardize continued U.S.
participation in the banks at the expense of our human
rights and other foreign policy objectives.
ACCOUNTABILITY
A number of steps have been taken during the
past two years to strengthen procedures for accountability
of the multilateral development banks and to increase
the flow of information on their activities which
is available to the Congress and to the public. We
are continuing to follow the activities of the banks
closely to assure ourselves that audit and evaluation
mechanisms within the banks are functioning
adequately.
Each of the banks is audited by well-known auditing
firms.
The results of these audits are published
in the annual reports. They are also required to file
specific financial information with the Securities
and Exchange Commission in order to issue bonds in
the U.S. capital market. This information is available
to the public. In addition, the banks have made available
to the public, on a subscription or referral basis,
their Monthly Operational Summaries which list all
projects under consideration for financing and show
their status, and statements of loans and press releases
on each loan which is approved. They also publish
many of their country economic reports, research
papers related directly or indirectly to their
operational lending programs, other occasional
papers, and a wide variety of statistical reports
on all aspects of their operations. The World Bank
makes available to the public its Catalogue of Publications
briefly describing its research and occasional papers
from which the public may order documents. Similarly,
the IDB makes available to the public papers prepared
for seminars and roundtable discussions as well as
many of their country economic reports. I might also
- 42 add that information from the loan documents is
available on request, after Board consideration,
to businessmen and other members of the public.
The Treasury Department routinely transmits
to the Congress and the General Accounting Office
numerous documents in compliance with various
legislative provisions as well as to meet special
requests. Included in the documentation which goes to
various offices are the Monthly Operational Summaries
listing loan proposals under consideration or appraisal
in the banks, Statements of Approved Loans for the
banks, statements of income and financial condition,
status of negotiation notices, brief loan analyses
prepared bi-weekly by Treasury Department staff, project
evaluation reports, and various sector and policy
papers and reports. In addition, the U.S. Executive
Directors and members of the Treasury staff are available
to talk with Congressional members and staff regarding
any other material they may wish to know about the
bank or its activities.
During the past year we have continued to
press the banks to review their classification systems
and to declassify as many documents as possible.
The World Bank has declassified the World Development
Report, the Energy Report and its Commodity Price
Report. It has also made public project performance
audit reports. In the IDB, the Monthly Operational
Summaries have been declassified during the past year.
All of the banks now make available to the public
Monthly Operational Summaries on the status of future
projects. It is now possible for businessmen and
other members of the public to subscribe to these
reports on a monthly basis from the World Bank
and the Asian Development Bank. In the case of the
IDB, the Monthly Operational Summaries are available
to businessmen and the public through the U.S. Commerce
Department, although we are working with the bank
to get it to provide this material directly and on the
same basis as the other banks.
With regard to the question of financial controls
and reporting requirements, the Articles of Agreement
for all of the Banks contain explicit provisions that
the Banks shall ensure that the proceeds' of any loan
are used only for the purpose for which the loan was
granted. To carry out this provision, the Banks include
- 43 a number of requirements either in the loan document itself or in other agreements made with the borrowers.
Each borrower is required to have his overall financial position audited by independent outside auditors
approved by the Banks. In addition, each project
in which the Banks participate is either subject to
independent audit or to a requirement that books
be kept open to the Banks for inspection.
Each of these banks has an independent operations evaluation unit whose personnel are responsible
to management and, in the case of the World Bank and
the Inter-American Development Bank, directly to
the respective Boards of Executive Directors. In
the Inter-American Development Bank, programs are
evaluated by a three-member "Group of Controllers"
and its staff. This group was established in 1968
and its members are appointed from outside the bank
for non-renewable three-year terms and report directly
to the Bank's Board of Executive Directors.
In the World Bank Group, projects are evaluated
by the Operations Evaluation Department. It is
headed by a Director-General who reports directly
to the Executive Directors. The Operations Evaluation
Department uses "Project Completion Reports" and
Project Performance Audits to evaluate the impact of
the Bank's development projects. In the Asian Development
Bank, selective project evaluations are conducted by
both the bank's own Economic Department and by independent
outside evaluators from various countries. The African
Development Fund is currently establishing a system
for evaluating projects.
During the past year, the General Accounting Office
completed studies of these independent review and
evaluation units and made a number of positive findings
with regard to their operations and effectiveness.
In the case of the IBRD,, the GAO auditors indicated
that the World Bank Group has' made considerable progr-ess
toward developing an independent and continuous selective
examination, review, and evaluation of the Bank's programs
and activities.
With regard to the IDB, they said that the effectiveness of the Group of Controllers has improved steadily
since its creation and that its reports -have contained
many recommendations for improving Bank operations.
They noted that most of the recommendations have been
adopted by the Board of Executive Directors and that Bank
management has taken specific actions to implement them.
- 44 With regard to the ADB, the auditors said that
some progress had been made in improving the review
and evaluation of projects assisted by Bank financing,
but that the expanding volume of Bank lending made
more independent and wider-range review and evaluation
necessary and desirable. They made several recommendations
in each report for improving the systems in the respective
banks. These recommendations cover, among other matters,
the scope of some of the individual reports and the need
for maintaining or strengthening the independence of the
evaluation units.
Specific requirements with regard to procurement
procedures and the disbursement of funds are set forth
in loan agreements with individual borrowers and in
operating manuals and instructions of the banks.
Procurement is either by international competitive
bidding, international shopping, or local procurement.
All of these procedures must meet detailed bank requirements. Depending on the exact disbursement procedure
followed, the borrower is required to present any
or several of the following types of supporting evidence
for substantiating withdrawals from the loan account:
the contract or confirmed purchase order and evidence
that the payment has been made, such as suppliers'
invoices and bills of lading, consultants' invoices
in case of consultancy services, contractors'
invoices and borrowers' certificate of work progress
in case of civil works, letters of credit against
which the banks' commitments are being sought,
and negotiating banks' reports of payment accompanied
by suppliers' invoices.
Each borrower is also obliged to meet a number of
other reporting requirements. He must keep records
relating to the progress of the project and the cost
of carrying it out. He must permit Bank representatives
to visit the project site, inspect the works being
carried out and the records related to it. He must
also be prepared to submit to the Bank on request any
additional information concerning the progress of the
project and his operational and financial conditions.
All of the banks maintain supervision systems
to oversee the fulfillment of the established
requirements. The IDB has a resident mission in
each recipient country which monitors the progress
of projects and checks for compliance with provisions
of the loan agreement. The World Bank and the ADB do
not have representatives in all recipient countries.
- 45 However, members of the staff visit the borrowers
and the project sites, generally once a year, but more
often if it is necessary. In addition, staff members
at the banks headquarters regularly review procurement documents and the recommendations for bid
awards. In the case of credit projects, they review
and approve subloans above certain minimal amounts.
They also review progress reports submitted by the
borrowers for all projects and correspond with them
on a wide range of project implementation issues.
We are working to carry out the recommendations
of the General Accounting Office. We are also
committed to strengthening the accountability of
the banks and to increasing the flow of information
on their activities. Complete disclosure of all bank
information, however, is neither feasible nor desirable.
We have to balance our oversight responsibilities with
the confidential nature of the banks relationships with
its borrowers, especially concerning economic policy
advice which may be sensitive in recipient countries.
COMMODITY LEGISLATION
Following passage of the appropriations legislation last October, procedures have been established to
implement two provisions in the legislation dealing
with commodities. The legislation requires that the
United States oppose use of MDB funds for the production
of any commodity for export if it is in surplus on
world markets and if substantial injury would be caused
to U.S. producers of the same, similar or competing
products. It also provides that the President shall
initiate international consultations designed to
develop standards governing the allocation of development
assistance for production of commodities in surplus
on world markets where increased efforts would cause
substantial harm to other producers.
As a matter of fact, however, the banks have been
making very few loans that could fall under these
provisions. To carry out the legislative requirements,
we have carefully analyzed these loans to determine
the economic impact of,production on the world markets.
No loan proposals thus far this year have required
special action because the commodities to be produced
either were for domestic production or would not be in
surplus or result in substantial injury to U.S. suppliers.
- 46 Essentially, our approach is based on the
principle that loans for projects that will result
in the increased production of commodities in
prospective world surplus will prove to be a wasteful
use of development assistance resources. Fortunately,
our approach is also followed by the banks in identifying
and appraising projects.
With regard to the second provision of the legislation, the United States has raised internationally
the issue of allocation of assistance for the increased
production of commodities in surplus. We are seeking
agreement among the OECD countries on general principles
that such an allocation of assistance can be disruptive
to producers in developed and developing countries
alike, that it may prove counter-productive to bilateral
and multilateral development efforts, that international
standards should be developed generally to avoid assistance
for surplus commodities while taking into account
world-wide comparative advantages in commodity production.
There is no need for additional legislation
aimed at restricting uses of U.S. funds by the
banks for the financing of special commodities on
products. As I have noted with regard to country
restrictions, the banks could not legally accept contributions on those terms. Any such provision in
U.S. law would seriously jeopardize continued U.S.
participation in the multilateral
CONCLUSION development banks.
In my testimony to this Subcommittee last year,
I expressed the hope that Congress and the Administration would work out a consensus or common view of our
objectives in the multilateral development banks. I
suggested that the consensus might include agreement
on our basic goals within the banks such as reaching
the poor more directly and effectively, promoting
human rights, assuring accountability, and rationalizing
administrative costs.
In my testimony today, I have dealt at some length
with these matters and with other issues which have
been of concern to the Congress and the Administration
including rationalizing salaries and other administrative
costs and limiting bank financing for production of certain
- 47 commodities. Over the past year, we have made
progress on these issues. We have not been able to
prevail in every instance or have every issue resolved
exactly as we might have wished. Other countries contribute to the banks and their views have to be taken
into account. That is a limitation of the multilateral
approach but it has been more than offset by the many
advantages we have derived from our participation
in these institutions.
I am hopeful, as a result of the progress that
has been made over the past year, that Congress
and the Administration will agree on providing our
share of subscriptions and contributions to the multilatral development banks for FY 1980 and that we can
continue to effectively pursue our interests in the
banks.
Transcript of the Remarks of
The Honorable W. Michael Blumenthal
Secretary of the Treasury
before the
Washington Press Club, Washington, D. C.
March 15, 1979
I am delighted to have this opportunity, really for the
first time since my return from China, to report to you about
my impressions and experiences. I do recognize that you may
wish to ask questions relating to other topics, and I'll be
happy to answer those to the extent that I can.
But I would like to just very briefly, in order to allow
you the maximum time for questions, say a few words about China.
As to what we did, apart from representing the President
and the elevation of the liaison office to full Embassy status,which
was in itself an important/ symbolic and historic effort, we did
manage to settle the claims assets issue. We settled it on
the basis of 41 cents on the dollar. That represents a fair and
equitable settlement, I believe, for both sides. It compares
favorably with similar settlements previously made with other
countries, with whom we had issues of this kind.
Moreover, the important things from the U.S. side is that
that settlement will be fully liquidated in cash over a five-year
period, beginning in October of this year. In other words, the
Chinese will make their first payment in October of this year,
and then pay us the remainder of it in five equal installments
thereafter. That is a good settlement, from our point of view.
Previous settlements with other countries have involved periods
as long as 20 years. And even when the amounts involved -- in
this case we agreed on $80.5 million -- were smaller than this.
Moreover, we do not have to go into the issues of litigating
on the assets of China that were blocked here, that are now going
to be unblocked. That is a responsibility for the Chinese.
So, clearly, from our point of view, that was a good
arrangement. I think it was a good arrangement from the point
of view of China too, because without the settlement of that
issue, it would rot have been possible to develop a full-blown
economic relationship between the United States and China, which
the Chinese hope and expect will manifest itself in the form of
expanded trade; in the form of providing technical advice,
technology transfer, assistance with management and know-how,
joint ventures; equity investments, a shipping agreement and
decisions in the context of a trade agreement on how to treat
such things as proprietary rights by Americans on patents, trademarks, things of that kind. All of that really would not have
been possible to move on without settling the question of claims
assets. So from the point of view of the Chinese, they removed
a major roadblock in the way of the full normalization of our
economic relations. We agreed we would move forward in the
B-1468
negotiation of a trade agreement and we have already begun that
process.
- 2 We've agreed on what it will cover, and agreed on a timetable for getting on with that job. The question of Most
Favored Nation treatment for China is going to be dealt with,
and we informed the Chinese it was the intention of the President
to recommend to the Congress, and in the context of a satisfactory
trade agreement, that that MFN status be granted. And, of course,
the Chinese also are interested in becoming eligible for ExportImport Bank credit. And that, too, is something we will consider.
That will require, again, different types of legislation
by Congress. So all that is now beginning to move forward.
Thirdly, we set up a U.S. - China joint economic committee,
chaired on the Chinese side by Vice Premier Yu Qiuli, and on the
U.S. side by myself, which will on both sides bring together
the principal senior government officials. In our case, it is
a number of Cabinet officers. On the Chinese side, it is the
analogous group of senior officials who will work together on
all of these different elements of the economic relationship that
now has to be established.
So much more of what we did in the climate that was created
was a good one, and I think we can move forward. Now, as to the
opportunities for a mutually beneficial economic relationship.
There are those who think of the billion or so people in China,
and who have visions of a huge market with tremendous potential
for the United States or other countries, like Japan, Western
Europe, a huge market to be tapped: those dreams are really no
different than they were 30 or 4 0 years ago. I remember when I
came to China in 1939 as a young boy, one of the books that I
read,maybe one of the first books I read in English, was a book
by a man named Carl Crow, an American, the title of which was
Four Hundred Million Customers. That's significant, because we
now are only 40 years later up to a billion. He had this vision
of 4 00 million eager customers lining up for whatever we had
to sell. And there are those who feel similarly today. There's
another school of thought, the cynics, who take the position
that that is really a lot of nonsense; that in fact the lack of
purchasing power, the low per capita income in China, and the
lack of foreign exchange make all that illusory, and that in fact
the Chinese have nothing to sell, and, therefore, nothing to buy
anything with, and, therefore, this is all a lot of hot air.
As in most matters, here, the truth and justice lie somewhere
in the middle. It is indeed true that we do not have a huge
market to be tapped. It is also equally true that there are
good opportunities, developed properly and gradually, good opportunities over a period of time for a mutually profitable and
growing economic relationship between China and the United States,
and of course, also between China and a number of other countries-
- 3 The Chinese do have some things to sell. They can develop
some of their raw materials - oil, tin, manganese, antimony,
coal, and metals of various kinds. They do have an opportunity
as light manufacturers to enter the world market. And even
though light manufacturing is a sector in which trade problems
appear most chronically in the developed countries, with such
things as textiles, there are many products and product groups
in which the Chinese can expand their share of the market that
is available. We visited a bicycle factory in Shanghai. I
went there for any number of reasons, but one of them was because
bicycles are a good case in point. The United States does not
produce bicycles any more in this country, except for some
specialty bikes. They are virtually all imported from Taiwan,
from Korea, and a number of other places.
Clearly, it is possible for China to begin to compete, and
to get into the American market with bicycles made in their
country. So I think one could identify a number of product areas
in which it is possible for the Chinese to develop exports.
Similarly, the Chinese have indicated that they have an attitude
of great flexibility with regard to the implementation of a basic
goal that they have decided on. And that is really a very, very
major change in their thinking.
They are determined to embark on a strategy of economic
development for their country, a strategy which is not too dissimilar from the kind of economic development efforts that have
been undertaken with varying degrees of success by any number
of developing countries throughout the world over the last 2 0 or
30 years. They have, of course, very special problems, great
problems to overcome, with the large number of people on a
limited land base, and a variable land base.
Nevertheless, they have said that's what they're going to do.
And they have indicated to me their great flexibility in the
methods they're willing to use to accomplish this, going all the
way from compensation deals where they make a contract with a
foreign government to come in to provide capital and to be paid
out of the resulting product or raw materials. Oil is a good
case in point that emerges from the product to actual joint
ventures with equity investments by foreign companies, up to 4 9
percent, which require, amongst other things, developing the
concept of profit, at least for that enterprise, a formula for
profit, the sharing of profit, paying for the technology that is
involved, paying for the management knowhow that would have to
be provided, and presumably an arrangement as to the division
of the production that goes to domestic and to export purposes.
Obviously, when you look at the potential for exports, when
you look at the flexibility that they're willing to employ, when
- 4 you look further at the opportunities that exist for certain
service-type activities in which the Chinese would capitalize
on the resource: that they have in greatest abundance, namely
people, I think one can see not a huge unlimited amount of
resources, but a growing amount of resources available to fund
a progressive development program.
In the service industry, two possibilities come to mind.
One.is the use of China as a base for the assembly of certain
products, where raw materials and various components get shipped
in, put together, and then re-exported as other countries —
Japan and later Iran, Singapore and Hong Kong have done many
years ago. There's no reason why the Chinese could not do that.
And, secondly, of course, such other service industries
as the tourist business. I would think that the pent-up demand
throughout the world to see the wonders of China is considerable.
The beauty, again, is that tourism is a service industry with
the emphasis on the word "service." You can provide very good
service if you have enough people. The Chinese have them.
Moreover, they are most gracious, polite, and happy people,
and do a great job in that area. And the capital requirements
to develop the necessary facilities are relatively small in
relation to the returns that can be earned.
So, clearly, when you add all this together, there are
opportunities, in my judgment. It's not an all or nothing
situation.
I could, of course, spend a lot of time discussing other
general impressions having to do with the changes that have
occurred compared to the period when I lived there, which are
tremendous, or as compared to 1973 when I first went back to
China, which are also considerable. I will not go into them in
detail except to say that there is a much more pragmatic attitude
on the part of the government, a sense of great diversity, of
hope and ferment among the people, and a great emphasis on raising
the level of consumption.
There is, in industrial enterprises, a growing emphasis on
rewarding effort, rather than looking at everything in egalitarian
terms. Bonuses have reappeared in many of the enterprises. And
all of that represents great change. You see it in the way the
people are dressed. You see it in the freedom with which they
approach you, and talk about some of those things. You see it
in many, many different ways.
The interest in the United States and in learning from
others, and the expectation of being able to do business with
- 5 the United States and learning from Americans is quite different
than it was five or six years ago. I was always surprised when
I first went there — and I went to a lot of factories in 1973 —
that the Chinese were always proud to show me what they had.
But even though they knew I came there as a chief executive
of a large corporation with many factories, whenever I commented
about what we did, even if I looked at the production of the
same kind of product, there was a polite nod. But there was an
apparent lack of interest. I remember going to look at a factory
that made grinding machines. After they gave me all the statistics
on how many grinding machines they produced and what the sizes
and what the problems were; I said, "You know, I make grinding
machines in my factories. Let me tell you, let's compare."
The interest level was very low. Today, they're willing to
compare and to ask questions and to ask opinions. And that, I
think, is a reflection of the different policy that the government
has enunciated. It reflects the basic desire of the people to
learn and develop their country in this way.
What are the prospects? None of us, of course, can tell
that. And, certainly, no one who has made a short trip such as
we did would really be wise to speculate about the future. It's
clear that there are tremendous problems. China remains a very
poor country, a country in which communication between the center
and the provinces is by no means perfect.
There is much heterogeneity among the different regions.
Orders which are laid down at the center are frequently carried
out imperfectly in the outlying regions and the provinces, where
the primary emphasis must always be on providing the bare essentials
in the way of food and clothing for that large a number of people.
Whether or not a process of development once underway could ever
be stopped; whether or not a political line of this basic nature
once embarked on can ever be reversed; whether or not the people
will have the patience to stay the course and to accept the
reverses that will be inevitable in this process without political
eruptions, no one, of course, knows.
I would say in conclusion that the opportunity for the
United States to develop a fruitful relation after so many years
of interrruption is considerable. It is made possible by the
breakthrough that the President achieved in the normalization
of the political relationship. It is, I think, in the interests
of both countries that that opportunity be pursued. It is equally,
it seems to me, in their interests and in our interests that we
do that with a sense of realism and with a sense of proportion
and in a gradual way, and that we do not hide difficulties that
we have, or problems that we see for ourselves or for the Chinese,
so that misunderstandings do not arise, and that we can counsel
them in their economic development efforts, based on the experience that we have had over the years in watching
- 6 -
that process take place, successfully and otherwise, in many
different situations and many different parts of the world.
I think I should stop here, and just take the next 30
minutes or so with questions on this, or any other topic.
QUESTION: Mr. Secretary, you also visited Japan on this
trip. And I wondered if you could brief us on the impressions
you got from the talks with the Japanese officials there.
I am particularly concerned as to whether Japan is going to
continue to run these large trade surpluses for apparently
as long as they wish, and whether or not they're going to allow
the United States to compete in their government procurement?
SECRETARY BLUMENTHAL: We had something like a 24-hour
stay in Japan. And I had an opportunity to meet with the Prime
Minister, Foreign Minister, and Finance Minister, and other
senior ministers responsible for Japan's international economic
relations. I detected a change, perhaps subtle, but nevertheless a clear change in the climate on this problem that you
referred to, and in the attitude of the political leaders that
I met with.
I think that there is a clear commitment on the part of
these leaders to bring about a better balance in their
external accounts. Japan will always have to run a trade
surplus, but certainly cannot and should not run a current
account surplus. The current account surplus has been too
large because the trade surplus has been very big.
So achieving balance in the current account and substantial reduction of the surplus in the trade account clearly
has to be an-important goal. We made it very clear that we
thought it was absolutely essential that this was going to
happen--not on an ad hoc, one-shot basis, but as a permanent
policy and that in the absence of that, the risk of unilateral
action by the Congress, whether the Administration wanted it
or not, was overwhelming. And I think the Japanese are aware
of this, and are very concerned about it. It is also true that
although they desire to actually effectuate a reduction of
this surplus, it is not easy for them in the very short run.
There are some short run things that can and must be done.
They have to continue to exercise great restraints, voluntary
restraints, on the volume of their exports. They can continue
and perhaps should continue their program of emergency imports,
simply to keep these numbers from getting totally out of hand
in the foreseeable and immediate future. And, clearly, the
Japanese have to make certain decisions that are still outstanding in the multilateral trade negotiations now being completed
- 7 with regard to the nature of their tariff cuts, and certain
other non-tariff agreements which are in the final throes
of negotiation.
But those are immediate issues. In addition, the longer
run goal of bringing a better balance into the current
account does involve structural adjustments in the Japanese
economy —structural adjustments which, essentially, tend to
bring about a larger domestic demand, shifting production
in Japan to servicing more the domestic market plus the export
market, and an opening up of the Japanese economy to foreign
competition, particularly manufactured products.
The Japanese have always been free, obviously, in the
import of raw materials and foodstuffs, but have continued
to be cautious and protectionist, more than we would like,
with regard to imports of manufactured products. A structural shift is needed there that, clearly, is not easy
for them politically.
We know in our own country such changes are not easily
made in a political setting where legislatures have to act
and interest groups have to be accommodated. But the
Japanese believe and know that it has to be done. I think,
therefore, they are working actively on that problem.
The key question is whether they will be able to move
fast enough. And I think certainly we left them with very
little doubt that speed is of the essence.
QUESTION: Not too long ago, there was a story in the
Washington Post that a $2.5 billion deal between Japan and
China had been suspended. And I believe it was for plant
manufacturing equipment. Do you know anything more about
that? And do you think there's any chance the U.S. would be
eligible to get that business?
SECRETARY BLUMENTHAL: I read in some of the Japanese
papers that there were rumors that the reason it was
suspended had to do with the fact I was visiting in China at
the time. That describes a degree of influence and power
which, even if we had it, and wanted to exercise it, it
probably would not work. Of course, it had nothing to do with
that visit.
I know only little more than that. The Chinese did
point out to me that it was not a cancellation—it was indeed
a suspension; that these agreements had been negotiated by
several ministries, subject to approval at the top;
- 8 -
that upon review at the top, it had been decided to seek a
renegotiation of those contracts with regard to some of t e
terms and conditions related thereto; that that's what was
going to happen, and that they simply didn't like some of
the terms.
So whether that is the actual story or not, whether the
process of coordination between the different ministries
perhaps has not yet been perfectly worked out, and that
something slipped between the cracks there, I really don't
know. But I'm satisfied that they had, as they put it, the
basis for doing so, subject to disapproval, and those negotiations will take place.
QUESTION: Mr. Secretary, in your remarks you implied
that the granting of Most Favored Nation treatment to China
would require legislation. Does this mean the Administration
of which you're a part is going to seek amendments, the JacksonVan ik Amendment?
SECRETARY BLUMENTHAL: No, we have not made the decision
on the Jackson-Vanik Amendment, and how we will deal with it.
It does not mean that. What is required is that an agreement
between the United States and China be approved by the
Chinese. And, of course, the trade agreement has to deal—
probably, in Article 1—with the reciprocal treatment of
discrimination and non-discrimination of each other's products
in each other's markets. And it is in that context that the
Congress will get a crack at it. But my statement does not
imply a decision one way or the other as to dealing with the
action.
QUESTION: Mr. Secretary, in what sense did you have
any fears, amongst either the Chinese people or their leaders,
about the Soviet Union militarily and in any sense that you
might have had of efforts to use us in that relationship?
SECRETARY BLUMENTHAL: I don't know about using us.
I really can't comment on that. I think it's clear to anyone
who talks to responsible Chinese officials and Chinese government leaders, that their attitude towards the Soviet Union is
not positive. They are concerned in a variety of. ways. And
they have no hesitation about expressing their views on that
to any of you who are going to China, I'm sure. That will be
made perfectly clear. I can't really go beyond that.
I think they are primarily concerned about establishing a
relationship with us which is a political and economic one and
that the economic component of it is critically important
- 9 -
QUESTION: Mostly, the economics would be involved in
science and technology. That's what they really want. There
was word about some 110 nations who had recognized China before
we did. Therefore, each nation wants to do business with China.
How will we fit into that setup, where they all want to do
business with China, and to what extent?
SECRETARY BLUMENTHAL: Well, we will fit into it in a way
we fit into it in any other foreign market. We will be competing
with all those other countries who are in the market for a
particular product. Those 110 nations include both large and
small, economically strong and not so strong. Obviously the
United States, given our size and our resources, is a formidable
competitor and probably ranks somewhat above the 110 in terms
of the possibilities for competition.
I would say, however, that the United States is interesting
to the Chinese for more than just science and technology.
QUESTION: What else do they want?
SECRETARY BLUMENTHAL: I think the United States is interesting
to the Chinese because of our management know-how, simply because
of our proven ability for knowing how to run things. And I think
you'll see Chinese students eventually in business schools in
the United States. I was in one meeting where the senior officials
got into a very interesting discussion on such questions as diecounted cash flow and similar esoteric subjects that are of
interest to businessmen, but that I'm not sure had been previously
discussed at that much length among officials within China. On
things of that kind, we can help them a lot. In addition, we're
interesting to the Chinese because we are a very large market.
Among those 110 countries, there are some that have a market
with a population the size of a fraction of just the municipality
of Shanghai.
That's different than when you're 220 million people, with
a very high per capita income. So that's very important to them.
QUESTION: Mr. Secretary, when you were away in China, there
were some disturbing crisis and economic indicators that came out.
I wonder if you could tell us, does this mean the Administration's
game plan for slowing the economy and checking and decelerating
inflation now has to be rethought: Is it not working?
SECRETARY BLUMENTHAL: It's clear that the statistics on
inflation are bad. It is equally true that the anti-inflation
program — the thrust of the anti-inflation program, as the
President announced it in late October and on November 1 -- is
such that one could not reasonably have expected that the inflation
statistics to reflect the impact of those programs by January
or February.
- 10 -
And the statistics we're talking about are the statistics
of January and February. Those programs involve a very stringent
fiscal policy, a commensurate tight monetary policy, a strong
effort to move the budget as close as possible toward balance
and as quickly as possible, and a program of voluntary wage and
price guidelines, rather than the institution of controls which
would not work, with a strong effort to induce business and
labor to cooperate and to comply with those guidelines.
That is the Administration's game plan. That game plan has
not been altered. The statistics are bad. They are worse in
some ways than we thought. There are reasons for that. Obviously, the food prices have been very high. Some of that has
to do with the weather that we've been having. Those things are
temporary. We expect them to improve. Obviously, the energy
situation is worse than anyone could have expected, given the
events in the Middle East and in Iran, and that has added to
the problems.
We expect those to be temporary. So I would not say at all
that the game plan has to be scrapped. I think it is correct.
I think the questions that the President faces have to do with
implementing it further in such a way as to bring about, as
quickly as possible and as fairly as possible for all the different groups in our country, the desired result, which is the
reduction of inflation while maintaining sufficient growth in
the economy to avoid high levels of unemployment.
We don't want to solve inflation with high unemployment.
QUESTION: Do you still expect to stay with — considering
the energy problems, the seven and a half inflation rate for
the year that was part of the game plan?
SECRETARY BLUMENTHAL: We have not changed our official
forecast.
QUESTION: Mr. Secretary, is China going to bring the
U. S. out of the recession in 1980?
SECRETARY BLUMENTHAL: No.
QUESTION: No?
SECRETARY BLUMENTHAL: Well, let me explain that. We are
not going to say there's going to be a recession in 19 80. So
when I say no, I say no because the assumption is incorrect,
and the conclusion is incorrect because the assumption is incorrect. We expect a slowdown in the economy. What we do not
expect is a recession.
- 11 -
Secondly, the development of economic relations and trade
relations with China, as I indicated, is going to be a gradual
process, and, clearly, will not have a major impact one way or
the other on the U. S. economy, whatever the level of economic
activity of the United States in 19 80.
QUESTION: Mr. Secretary, American businesses, both on the
export and import side, might be interested in doing business in
China. Of course, they are very interested in opening offices
in China. Could you give us your impression on how willing the
Chinese will be to permit U. S. companies to open up offices?
And what kind of a timetable do you see?
SECRETARY BLUMENTHAL: That's part of the trade agreement
that has to be negotiated under the heading of "business facilitation." And we will know a lot more specifically on the
subject as the negotiation is pursued. That is a very important
element which I expect Secretary Kreps, who is the next Cabinet
officer to go to China, to hopefully, or possibly, be able to
agree on in the time she has set out. It's obviously very important in order to facilitate the kinds of contracts I have
discussed.
My impression from talking to the Chinese is that they are
prepared and willing to allow American businessmen to locate
there, where that is needed; that the limitations, in my judgment,
are not really political; that the limitations, where they exist,
are essentially logistic in nature. The Chinese simply do not
have facilities in the major places where U. S. businesses would
have to locate to put up and accommodate a lot of people. And
a lot of preparation will have to be done.
So I suspect it will be a gradual process. If you turn to
the press, for example, I gather they have now allowed some of
the wire services in, and told them they have to work out of
their hotel rooms. There simply is no place for them. And all
of that has to be developed and built. It takes time and money.
QUESTION: Did you get the feeling they were working on that;
that this is something they're —
SECRETARY BLUMENTHAL: It's on their minds. How actively
they've begun implementing it, I don't know.
QUESTION: Mr. Secretary, is there any significance in the
fact that the claims agreement you initialed about two years ago
is not available in Washington, the text?
SECRETARY BLUMENTHAL: There's no significance to that. That
will be made public when it's signed, and we expect it to be
signed very shortly.
- 12 -
QUESTION: You mentioned, in terms of trade with China,
two sets of possibilities. One, the development of their natural
resources in the country: manganese, zinc, and things of this
sort. And secondly, light industry such as textiles. So the
two points of my question are with regard to the development of
natural resources. Is the government prepared to support the
investment, the money that would be required to bring the
Chinese metals to the market? And, secondly, with regard to textiles and other light industries, I tend to think there was
considerable concern for the present trade and the disproportion
that the impact that they might have on some segments of the
population, on account of the fact you do have countries such as
China that can only furnish us goods in certain categories which
happen to be the areas in which minorities and women are disproportionate to employees.
I wonder to exactly what extent the Administration has a
program that will be effective in terms of lifting the harm in
that area, and what do you propose to be done?
SECRETARY BLUMENTHAL: Let me deal with both of those questions. In the first one, you asked if the government was willing
to support these investments. You mean, the U. S. government?
QUESTION: Yes, guarantees or whatnot, because it's a considerable amount of money.
SECRETARY BLUMENTHAL: At the moment, the U. S. government
has no legal authority to provide any of those resources. The
only way we could — and that would be in a very limited way —
would be through Ex-Im Bank credits. Essentially, the raw material
resources would have to be done through private arrangements.
The obvious and most immediate case is oil. I do not have the
impression from talking to the large number of oil companies with
whom the Chinese have had preliminary discussions, all of whom
have been in to see me, that that's going to be a problem. The
question is, what kind of a contract is negotiated. But the large
oil companies are quite willing to make arrangements to provide
the resources, providing they can get a kind of contract that
allows them to have access to the product that emerges. They're
willing to take the risks inherent in this.
So the answer is, don't look for the U.S. government to
provide a lot of resources. And, beyond that, I don't think it
will be necessary anyway.
As to the second question, I'll try to address myself a
little bit to that. Obviously, we have to be very honest with
them, and let me tell you, we are being very honest with them._
Certainly, Ambassador Strauss, in his negotiations on the textile
problem, is being honest and saying we have bilateral agreements
under the Multi-Fiber Arrangement in effect with many countries
under which the amounts, or the quantities of textiles, imported
- 13 into the United States, are limited by import ceilings on many
categories of textile and apparel products.
I don't know how many controlled categories there are now.
Years ago there used to be 64 controlled cotton categories. Now
there are over 100 such categories covering cotton, wool and
man-made fibers products. We have told the Chinese that they're
going to have to fit into this structure. The amount of square
yard equivalent lengths imported into the United States has risen
steadily over the past 2 0 years. As the total market in the
United States for textiles has risen, so has the percentage of
imports to the domestic market. There is no reason, however,
why it is not possible to develop a scheme — even for textiles
which are in a most sensitive category -- that would provide
reasonable opportunity for Chinese textile exports. It's not
going to be large. That's not what is going to fund the development
requirements of China. But there's no reason why China has to
be excluded from the U.S. textile market.
The problem of textiles is really an overall problem of the
U.S. economy. Providing reasonable Chinese entry into this
market is not going to affect it one way or another, because we
have some global notions in mind of what we can accept. To
answer the second part of that question, we have, of course, a
variety of programs other than the MFA which provide adjustment
assistance to workers, minorities, women, or other workers, such
as older workers, who are adversely affected by shifts away from
the production of such products.
But basically, it has been, I think, the policy of the U.S.
government over the years, under various Administrations, to
insure that the U.S. market for domestically produced textiles
remains at appropriate levels within the United States. There
are similar cases for other labor-intensive goods.
On the other hand, I picked out the example of bicycles
earlier, because I thought here was a good case where we don't
have that problem, because for all practical purposes there
isn't a production base in the United States at this point.
QUESTION: Can you indicate the amount of progress that
China has made on drafting a commercial code?
SECRETARY BLUMENTHAL: Really, I don't know. I think they
have begun. They're working on it, but I don't know the details
of that, or just how far along they are.
QUESTION: Isn't it true that in order to grant China these
export-import loans that they need so badly, we must first give
them Most Favored Nation status, which requires Congressional
action? I wanted to ask you really what your candid assessment
is, as to whether Congress will give them the Most Favored Nation
status. And if they do not get it, do you have any plans to
- 14 suggest any other ways, legislatively perhaps, that they can
get these export-import loans?
SECRETARY BLUMENTHAL: The granting of Export-Import Bank
credits is restricted by two pieces of legislation. One is
the Jackson-Vanik Amendment. The other one is the Stephenson
Amendment. We have to deal with both of those in an effort
to extend official credit. Credits will not be part of a trade
agreement, but there will be a subsequent consideration of that,
I'm sure.
What the chances of success are, I cannot tell you, candidly
or otherwise. I really don't know. I think that there is a
general recognition from Congress that it is logical and proper
for us to try to work out a way to do that now that political
normalization has been achieved. And I am not pessimistic about
the possibility that something can be worked out. I'm optimistic.
That's why I thought it was proper for me to indicate to them
that was our intention to do so. And I think one can optimistical]
expect that it can be worked out. But I can't guarantee it.
QUESTION: You haven't talked at all about your visit to
Shanghai. I'm interested in hearing how you compare it to the
40's, when you left, and to 1973, when you went.
SECRETARY BLUMENTHAL: I could take a long time to talk
about that. Obviously, apart from the fact it was a very important!
personal experience for me, in comparing it to the period which
I lived there I would say all the obvious things, only perhaps
I would say them with a lot of feeling. Shanghai was truly a
city in which there were not laws. It was completely an open
city. It was a place in which anything could be secured if you
had the price for it, and a place in which the injustices of man
toward fellow man were more graphically evident for all to see,
than any other place that I've ever visited.
It was a place that was rampant with disease. Hundreds of
people were dying every day and there was no money for the
relatives to bury them. Infants were abandoned at birth. All
manners of disease; cats, dogs; rabies; prostitution; drugs;
gambling; you name it. I think you get the general pictureBeing "shanghaied" really has some meaning. It was a refuge. It
was the last refuge for adventurers, crooks, and all manner of
odd types from all over the world. That's all gone.
If there are adventurers or crooks, they're not out in the
open for anyone to see. There are not cats and dogs for anyone
to see. There is not evidence of hunger. I did not see anywhere
this time or in 1973 any evidence of any person who was not
reasonable well fed. I did not literally see anyone in rags, in
tattered clothes. This was wintertime when I was there; in 1973
it was summer. People had decent clothes to wear. They
- 15 -
were much more colorful now than they were in 19 73, but they
were adequate and comfortable in both instances. I think the
people living in the streets, the people living in shacks, are
gone. The people live poorly by our standards. They live in
very crowded circumstances and in what clearly would be substandard housing. The housing in our slums in the worst areas
of our cities is pretty good housing by the standards of Shanghai
and other cities in China.
But people have a roof over their heads. And although it's
very inadequate for them, for many of them, it is an improvement.
One great sense that I had, particularly this time, is of tremendous overpopulation — a sense of people, people, people
everywhere, and not a place to step. You literally can't walk
on the sidewalks. You have to walk out in the middle of the
streets. The sidewalks are so crowded.
Now, I'm told that some of that is due to people coming
into the city to do their shopping. But whatever the reason is,
you just can't get away from people. If you want to know what
overcrowding is and what a population problem really is, or what
it's going to be like, walk around the streets of Shanghai. So
you have that sense of 400 million people having gone to a
billion, and you feel it in China today. There's a sense of
orderliness and civic obedience. People line up. People line
up for buses. It's incredible for anyone who grew up in China
to see that — people getting into lines to climb onto buses,
where before they'd kill each other to get on buses. So at that
level, obviously, it's a place which for virtually all of the
Chinese people is a much better place to live.
QUESTION: Mr. Secretary, this is due to the tremendous
discipline that has been instilled through the past 30 years
under the Mao regime. Do you see anything slipping there as we
go along?
SECRETARY BLUMENTHAL: It's still there, and I can't really
tell whether it will change. At the moment, it's there.
QUESTION: There are great number of students coming in
huge numbers and will come to study here. What are the implications that that will have for controls?
SECRETARY BLUMENTHAL: My impression is that the number of
students that will come here is not huge. I heard yesterday at
the Chinese Embassy that the expected some 500. So it's going
to be in the hundreds or maybe low thousands, but not a very
large number. Obviously, one of the great problems is that
there has been a tremendous gap in China with the universities
and colleges not functioning for practical purposes for quite a
while. And they have to catch up with that, and that's another
great problem in pursuing their development program. These
- 16 -
people will work hard, as Chinese students tend to do, and try
to learn a lot. They'll be very busy. Obviously, it will
^
impact, because they will come back with new ideas. But I don t
think it will have a vast impact on China as a country. The
numbers are much too few.
MS.SULLIVAN: I think we have time for one more question.
QUESTION: Mr. Secretary, there seems to be a growing
interest in Congress about the creation of a Department of Trade.
Do you foresee this as a possibility? And what do you think of
that?
SECRETARY BLUMENTHAL: It's certainly a possibility, because
there is considerable interest in it in Congress. It's not a
new question. It's been considered over the years. There is no
Administration position on this. So I am somewhat restricted in
what I could say to you. I have wrestled with this problem on
and off and on in a previous incarnation — the last time I was
in government. I think it's not easy in our system in the United
States to set up a separate Department of Trade.
And one has to be clear as to what one is trying to establish. If you want a Department of Trade for the purpose of
centralizing and promoting the development of exports, that's
one thing. If you want to set up a Department of Trade, that
is analogous to what the Japanese have under their MITI, Ministry
of International Trade and Industries, you have a different kind
of thing. And generally speaking, it has been felt that that
kind of department would not fit into the American structure
very well. So I see some problems.
I don't know what position we will take on it. It's still
being discussed. And I think the question of goals and definition MS.
is aSULLIVAN:
very important
Thankone.
you very much.
FOR RELEASE AT 4:00 P.M.
March 20
1979
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling
approximately $6,000 million, to be issued March 29, 1979.
This offering will result in a pay-down for the Treasury of about
$200
million as the maturing bills are outstanding in the
amount of $6,208 million. The two series offered are as follows:
91-day bills (to maturity date) for approximately $3,000
million, representing an additional amount of bills dated
December 28, 1978, and to mature June 28, 1979
(CUSIP No.
912793 Z3 3 ) , originally issued in the amount of $2,909 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $3,000 million to be dated
March 29, 1979,
and to mature September 27, 1979 (CUSIP No.
912793 2N 5) .
Both series of bills will be issued for cash and in
exchange for Treasury bills maturing March 29, 1979.
Federal Reserve Banks, for themselves and as agents of foreign
and international monetary authorities, presently hold $3,362
million of the maturing bills. These accounts may exchange bills
they hold for the bills now being offered at the weighted average
prices of accepted competitive tenders.
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any? higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington,
D. C. 20226, up to 1:30 p.m., Eastern Standard time,
Monday, March 26, 1979.
Form PD 4632-2 (for 26-week series)
or Form PD 4632-3 (for 13-week series) should be used to submit
tenders for bills to be maintained on the book-entry records of
the Department of the Treasury.
B-1469
-2Banking institutions and dealers who make primary markets in
Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such
securities may submit tenders for account of customers, if the
names of the customers and the amount for each customer are
furnished. Others are only permitted to submit tenders for their
own account.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury. A
cash adjustment will be made on all accepted tenders for the
difference between the par payment submitted and the actual issue
price as determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit
of 2 percent of the par amount of the bills applied for must
accompany tenders for such bills from others, unless an express
guaranty of payment by an incorporated bank or trust company
accompanies the tenders.
Public announcement will be made by the Department of the
Treasury of the amount and price range of accepted bids.
Competitive bidders will be advised of the acceptance or
rejection of their tenders. The Secretary of the Treasury
expressly reserves the right to accept or reject any or all
tenders, in whole or in part, and the Secretary's action 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 weighted average price (in three
decimals) of accepted competitive bids.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on March 29, 1979,
, in cash or other immediately available
funds or in Treasury bills maturing March 29, 1979.
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.
-3Under Sections 454(b) and 1221(5) of the Internal Revenue
Code of 1954 the amount of discount at which these bills 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 these
bills (other than life insurance companies) must include in his
or her 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 Circulars, Public Debt Series Nos. 26-76 and 27-76, and this notice, prescribe the terms of
these Treasury bills and govern the conditions of their issue.
Copies of the circulars and tender forms may be obtained from any
Federal Reserve Bank or Branch, or from the Bureau of the Public
Debt.
FOR RELEASE AT 1:30 P.M.
MARCH 20, 1979
TREASURY POSTPONES AUCTION OF
TWO YEAR NOTES
The Treasury today announced it was postponing the
auction of $2,880 million of 2-year notes originally
scheduled for Wednesday, March 21, 1979. This postponement
is necessary because Congressional action on legislation
to raise the temporary debt limit to allow delivery of
the new 2-year notes is not at this time assured.
Interested investors are advised to look for notice of
any rescheduling of this auction in the financial press or
to contact their local Federal Reserve Bank for such information.
oOo
B-1470
FOR RELEASE UPON DELIVERY
Expected at 10:00 a.m.
Thursday, March 22, 1979
STATEMENT OF EMIL M. SUNLEY,
DEPUTY ASSISTANT SECRETARY OF THE TREASURY FOR TAX POLICY,
BEFORE THE SUBCOMMITTEE ON OVERSIGHT OF THE
HOUSE WAYS AND MEANS COMMITTEE
ON THE INVESTMENT TAX CREDIT
Mr. Chairman and Members of this Distinguished Committee:
I am pleased to appear before you today to discuss the
investment tax credit. This credit, which will reduce
Federal receipts by over $15 billion in fiscal year 1980, is
one of the largest tax expenditures of the Federal Government.
It is, therefore, important that Congress periodically
reexamine its impact on the economy and consider how its
efficiency and fairness might be improved. I am not today
going to recommend changes in the credit. A major thrust of
my testimony is that the credit should not be turned on and
off as a countercyclical policy but should be viewed as a
stable feature of our tax law. I will, however, discuss
some of the pros and cons of making several changes in the
structure of the credit.
The investment credit is equal to 10 percent of qualified
investment. Assets eligible for the investment credit
include most machinery and equipment, but generally do not
include structures. Eligible equipment is restricted to
depreciable property with a useful life of 3 years or more.
The investment credit can be regarded as similar to a
cash grant tc purchasers of certain capital equipment, with
certain peculiar rules related to the fact that it is
B-1471
- 2 cleared — that is, paid and distributed — through the tax
system. The credit, however, differs in significant ways
from an across-the-board 10 percent subsidy for new machinery
and equipment.
° The credit is not refundable. If tax liability exceeds
$25,000, the credit is limited to $25,000 plus 60
percent of tax liability in excess of $25,000. In
1982, after a transition period, the tax liability
limitation will be increased to 90 percent. Prior to
1978, the credit beyond the first $25,000 was limited
to 50 percent of tax liability. Unused credits may be
carried back 3 years against prior tax liability and
carried over for 7 years. Treasury estimates that
credits claimed by corporations were about 68 percent
of the tentative credits earned in any year when the 50
percent limit was in effect. The carryback and carryover provisions enabled about 85 percent of these
tentative credits ultimately to be used. The 90 percent limit will increase to about 78 percent the fraction
of credits claimed by corporations in the year they are
earned.
° The credit is reduced for short-lived assets. Investment qualified for the credit is two-thirds of the cost
of the asset if the useful life is at least 5 but less
than 7 years and is one-third of the cost of the asset
if the useful life is at least 3 but less than 5 years.
On the average, the short-lived property rules reduce
the allowable amount of the investment credit by 10 to
15 percent.
° When an asset is purchased, its expected life is used
in determining the fraction of the asset cost for the
credit. Upon disposition of the asset, if actual life
is less than the expected useful life any excess
investment credits claimed in a prior year are recaptured
° The investment credit claimed does not reduce the cost
basis used for depreciation. Even though the Government
has, in effect, paid for 10 percent of the investment,
100 percent of the purchase price may be depreciated.
The tax savings from this additional depreciation to a
corporation in the 46 percent bracket is equivalent,
for an asset of average life (12 years) to a 29 percent
increase in the investment credit from 10 percent to
12.9 percent.
- 3 -
In evaluating the investment credit, some fundamental
questions should be asked:
° Should we subsidize the purchase of machinery and
equipment?
° Does the investment credit substantially increase
investment in machinery and equipment? Does it increase
total investment?
° Are there more effective ways of providing the same
subsidy?
° Does the investment credit create unintended or undesirable
side effects? Some that have been mentioned are: 1)
discrimination against small firms and rapidly growing
firms because credit is limited to 90 percent of tax
liability, 2) encouragement of leasing, 3) discrimination
among investments with different useful lives, and 4)
increased opportunities for tax shelters.
The main purpose of the investment credit is to increase
permanently the fraction of GNP allocated to savings and
investment. To the extent it accomplishes this, it increases
the rate of growth immediately, and provides a permanent
increase in the amount of capital per worker, productivity,
and real wages.
A second objective of the investment credit is to
increase the proportion of total private savings allocated
to investment in machinery and equipment. The credit
stimulates capital formation in major manufacturing industries
and also furthers innovation by accelerating the installation
of new capital embodying the most recent technological
advances. The credit has not been extended to most real
estate since this industry benefits from other significant
tax preferences.
Impact on Investment
Any evaluation of the investment credit must consider
how much it promotes these two objectives — increasing the
overall rate of capital formation and allocating a larger
share of national savings to investment in machinery and
equipment.
- 4 The investment credit operates by providing an incentive
for firms to purchase new machinery and equipment. To
finance these increased purchases, firms must acquire more
funds, either through higher retained earnings, new equity
issues, or increased borrowing. As firms bid for the scarce
supply of savings generated in the economy, the return on
savings is increased. This encourages an increased flow of
savings at any level of income. In order for the rate of
capital formation to increase, these increased savings must
be forthcoming to match the increase in investment demand.
The net effect on total investment, therefore, depends
not only on the stimulus to investment demand but also on
the responsiveness of private savings to increased rates of
return. It also matters how the revenue cost of the credit
is financed, by the Federal Government. If it is financed
by a larger deficit, the resulting increase in government
borrowing will reduce savings elsewhere; if it is financed
by increases in taxes on labor income or consumption or by a
reduction in Government spending on current period goods and
services, there will be an increase in savings at the expense
of current consumption.
Economic theory strongly supports a conclusion that the
investment credit increases the rate of capital formation.
However, the size of its impact relative to the revenue loss
is in dispute. A review of econometric studies reveals
considerable uncertainty about the impact of the investment
credit and of other capital formation incentives on total
savings and investment.
A number of econometric studies have estimated the
impact of the investment credit, and of other tax incentives
to capital formation, on investment. The findings of this
research are highly varied because investigators have used
different methods and assumptions.
Early research by Professors Robert Hall and Dale
Jorgenson found that enactment of the investment tax credit
in 1962 had a powerful effect on investment demand in the
1960s. The Hall and Jorgenson study focused on the role of
the credit in increasing the demand for capital by lowering
the price of capital services. Their theoretical model used
a formulation of the demand for capital that assumed that a
10 percent reduction in the price of capital services —
which could be achieved by a 10 percent refundable investment
- 5 credit with a basis adjustment for depreciation — would
increase in the long run the stock of capital demanded by 10
percent. Subsequent investigators used more flexible
assumptions that allowed them to estimate the impact of the
investment credit on the long-run demand for capital and
that, to varying degrees, stressed other factors as determinants of investment, such as corporate cash flow, expected
future sales and financial market variables. The estimated
long-run impact of the investment credit on the demand for
capital in these studies is highly variable. Professor
Charles Bischoff, for example, estimated that a 10 percent
reduction in the cost of capital would also raise the demand
for capital by 10 percent, while Professor Robert Coen
estimated that such a reduction in the cost of capital would
increase the demand for capital by only 3 percent. Professor
Robert Eisner's estimates of the impact on capital formation
of the investment credit are even smaller.
Studies that focus on investment demand alone ignore an
important potential constraint on the effects of the investment credit — the need for additional private savings to
finance increased investment. If more private savings are
forthcoming only if the after-tax yield from savings increases,
then the resulting increase in interst rates will choke off
some of the potential increase in investment demand.
Professors Paul Taubman and Terence Wales have explored this
issue, estimating that the need for higher interest rates to
bring forth additional savings, reduces the impact of the
investment credit to about one-fourth of the estimated
increase in demand for capital. This issue —
the extent
to which additional savings will be forthcoming to finance
an increased demand for capital — remains an important
source of differences in estimating the impact of capital
formation incentives such as the investment credit.
While the effect on total capital formation of the
investment credit is uncertain, available evidence shows
that the sectoral impact is strong. By changing the relative
rewards to different uses of savings, the investment credit
increases the share of total investment allocated to qualified
machinery and equipment and reduces the share allocated to
other sectors, especially real estate. The relatively
strong impact of the credit on investment in machinery and
equipment has been shown in many studies, beginning with the
original paper by Professors Hall and Jorgenson. In a 1971
paper, Henry Aaron, Frank Russek and Neil Singer provided
evidence from econometric simulations that removal of the
- 6 investment credit in 1969 caused a significant shift of new
investment from machinery and equipment to real estate, more
than offsetting the effects of tightening real estate
depreciation and recapture rules. Their findings are
consistent with what we would expect in an economy where
investors are seeking the highest after-tax return on their
dollars and efficient financial markets facilitate movements
of funds between different sectors.
Countercyclical Policy
One frequently used argument that is not an appropriate
goal for the investment credit is short-run economic stimulation.
It is true that an increase in the investment credit by
itself increases the demand for investment and therefore
could increase employment and promote recovery at a time
when the economy is depressed. However, it should be recognized
that any increase in the deficit can increase total demand
in the economy and, if there is unemployment, create additional
jobs. If fiscal stimulus is needed, individual tax cuts may
well be superior to business tax cuts or changes in the
investment credit or other expenditure programs because the
individual tax cuts are probably translated into additional
spending with shorter lags and less leakage into savings.
Moreover, changes in the investment credit are a very
poor tool of countercyclical policy. Econometric studies
have found a strong effect on aggregate demand from the
investment credit. However, because capital spending plans
are frequently made well in advance of actual expenditures
and are difficult to change once set in motion, the investment credit impacts with a very long time lag. In the past,
changes in the credit have often been poorly timed. The
credit was temporarily suspended in 1966 — just before the
1966-67 pause in economic growth. It was restored in 1967 —
just prior to the inflationary boom of the late 1960's. It
was removed in 1969 — just before the 1970 recession. It
was restored again in 1971 — shortly preceeding the overheating of the economy in 1972 and 1973. In all of these
cases, the change in the investment credit had its strongest
effect on aggregate demand at the wrong time; it was expansionary
during an upswing and contractionary during a slump. Of
course, this need not always result from a change in the
credit, but the long-time lag between enactment of a change
and its effect on investment demand make the investment tax
credit an imprecise and uncertain tool of countercyclical
policy.
- 7 Also, changes in the credit raise problems of determining
appropriate transitional rules. For example, when the
credit is suspended or reinstated, should the credit remain
available for machinery and equipment placed in service
before the effective date or to machinery and equipment
ordered before the effective date? In the past, determination
of how new rules should apply has been different for suspension of the credit than for reinstatement. When the
credit was repealed in 1969, taxpayers could still receive
credit for eligible property subject to a binding commitment
before the change was first proposed by the Administration,
as long as the actual delivery of the property occurred
before the end of 1975. In contrast, the restoration of the
credit in 1971 was made effective for property acquired or
completed after the announcement date, August 15, 1971, or
for property on which construction was begun or an order
placed between March 31, 1971 and August 15, 1971. Further
changes in the credit would require additional detailed
rules relating timing of different stages of the acquisition
process.
In summary, changes in the investment credit rate
should not be considered in terms of short-run stabilization
objectives, but for its long-run effect on capital formation
and on promotion of the best use of available private
savings. It is worthwhile for Congress to review periodically
the effectiveness of the credit in achieving these long-run
objectives; future changes in the investment credit should
be based on these considerations and not, as has sometimes
occurred in the past, on short-run economic forecasts.
Structural Issues
Introduction. Having reviewed the reasons for subsidizing
the purchase of machinery and equipment by private firms, I
now want to turn to the consequences of using the tax system as
the mechanism for paying the subsidy, and what structural
changes in the credit might be considered.
It is useful first to consider the simplest form of a
subsidy to machinery and equipment: a direct grant program.
Congress could encourage the purchase of machinery and
equipment by allocating funds to the Department of Commerce,
which would make payments to firms equal to 10 percent of
the value of any qualified equipment purchased, or placed on
order, after a specified effective date. Commerce would do
this without regard to the tax posture of the recipient. If
- 8 this type of subsidy were enacted, the normal method of tax
treatment would be to regard the grant as a Government
contribution to capital. The recipient's depreciable basis
would not include the Government's contribution. The subsidy
rate could be adjusted to make this type of cash grant
program provide the same total subsidy to business firms as
the investment credit. However, the distribution among
firms of benefits received would be different than under
current law. Firms that currently are not able to make full
use of the credit or that invest heavily in short-lived
property would be net gainers.
The investment tax credit could be altered to conform
exactly to this direct subsidy program. This equivalence
could be achieved by making the investment credit refundable,
requiring a downward basis adjustment, for the amount of
credit received, and repealing the short-lived property
rules. The only major difference between this type of
investment credit and a direct expenditure program is that
the tax credit would be under the jurisdiction of the
congressional tax committees rather than appropriation and
authorization committees and would not appear in the budget
of any agency. Thus, with a tax credit, total Federal
expenditures appear to be smaller. However, the effect on
the deficit and on the amount of incentive provided for
investment in machinery and equipment would be the same as
an equivalent direct subsidy program.
This comparison illustrates that the present credit can
be viewed as a direct expenditure program which is distributed
through the income tax system, and which has some peculiar
features because the income tax system is used. These
special features create complexities in administration,
anomalies for tax policy, and some unintended side effects.
For this reason, their rationale and consequences deserve
examination.
Nonrefundability
The most important of these provisions is the nonrefundability of the credit and its limit to 90 percent of all tax
liability in excess of $25,000. This provision is important
not only for its direct effects, but because it creates a
need for other provisions — the carryover and carryback
rules and the inclusion of the credit in the depreciable
basis — that would not be likely features of an expenditure
program to promote investment.
- 9 There are two rationales for nonrefundability of the
investment credit — one cosmetic and one substantive. The
cosmetic reason is that, without the tax liability limit, it
would appear that some large corporations are paying no tax
or, in some cases, negative taxes. This issue of providing
special tax relief for corporations would not arise if
direct subsidies were used. Data on farm subsidy payments,
for example, are not used to show that wealthy farmers pay
no tax, and people do not consider linking eligibility to
receive farm subsidies to a farmer's tax liability.
The substantive justification for the tax liability
limitation relates to the numerous other subsidies being
cleared through the tax system. These other tax subsidies
should be taken into account. An example, as noted before,
is offsetting the highly favorable tax treatment of real
estate by restricting the investment credit to machinery and
equipment. Restricting the credit by tax liability tends
to limit its availability to other sectors receiving other
tax subsidies — for example, mining — and thus tends to
even out the total level of subsidies distributed in
connection with any particular kind of activity. But the
levelling out effect is haphazard because it depends in each
case upon the mix of business in a particular company. As
a result, it may encourage business combinations and mergers
that are otherwise undesirable.
The denial of a portion of the investment tax credit to
firms with low tax liability may have adverse consequences.
Low tax liability is not necessarily the result of an
abundance of tax subsidies. Companies experiencing temporary
losses, companies making large expansions in capacity, and
companies generally experiencing rapid growth frequently may
not have sufficient tax liability to claim the full credit
in the current period even though the income that will be
earned from current period investment will generate high tax
liability in the future. There is no reason to limit or
deny the credit received by these companies.
The adverse consequences of nonrefundability are
mitigated to some extent by provisions for the carryback and
carryover of excess credits. In addition, firms with low
current period tax liability can lease machinery and equipment from firms with sufficient tax liability to utilize
fully the investment credit. By charging lower rental
payments the benefits of the investment credit may be passed
through by the lessor to the lessee. The lessor, however,
usually has to be paid a "commission," and this commission
represents an economic cost. There is no particular reason
- 10 why the tax law should encourage leasing transactions where
private parties, not influenced by tax considerations, would
not consider leasing a convenient and low cost method of
financing assets.
Carryback and Carryover Rules
Provisions allowing tentative investment credits to be
carried back 3 years and carried forward 7 years to offset
past and future taxes mitigate the most severe consequences
of nonrefundability by permitting new and growing firms and
firms with temporarily depressed earnings to use the credit.
But they are not complete remedies for those consequences
because a credit received today is worth substantially more
than one which will not be received until 7 years from today.
Equally seriously, these provisions, increase the complexity
of the law. Their most serious consequence is to make it
much more difficult to write a simple law — however desirable
which would exclude the credit from depreciable basis.
Because of the tax liability limitations on the credit, even
with carryovers we do not generally know if and when the
credit will be used. Therefore, a basis adjustment for
depreciation would necessitate recomputing the depreciable
basis when credits expire at the end of the carryover period.
This type of computation is possible, but would severely
complicate depreciation accounting.
Basis Adjustment for Depreciation
Normally, firms would not be permitted to depreciate
against taxable income the value of a cash subsidy received
from the Government. However, under present law, the tax
credit is included in the basis for tax depreciation even
though it represents the portion of the asset's cost paid
for by the Government, not the firm.
Including the credit in allowable depreciation raises
the effective rate of investment credit by providing firms
with extra tax deductions. In effect, the benefit of a $100
investment credit received by a taxpayer who purchases a
$1,000 machine can be viewed as divided into two pieces.
The first piece — the credit itself — reduces the cost of
the asset by 10 percent for all taxpayers. The second piece
is the $100 of additional tax depreciation in excess of the
taxpayers' investment over the life of the asset. This
piece is worth more to taxpayers in high tax brackets and is
more valuable for short-lived assets because the benefits of
tax depreciation for those assets are received sooner.
- 11 Because the extra depreciation is worth more to high
bracket taxpayers, such taxpayers receive more encouragement
to invest in qualified machinery and equipment than low
bracket taxpayers. As in other situations where income is
improperly measured, encouragement is provided for tax
shelter formation. One way this has been manifested in the
past is through leasing transactions that enable high
bracket individual investors not actually using the qualified
equipment to benefit from the credit. However, a 1971
provision limiting investment credits available to noncorporate
lessors has substantially curbed this source of tax shelter
abuse.
Reduction of Credit for Short-lived Assets
The extra benefit to short-lived assets provided by
additional depreciation is offset by allowing only one-third
of the credit for assets with a life of 3 to 5 years and
two-thirds of the credit for assets with a life of 5 to 7
years. The combined effect of these two provisions — the
absence of a basis adjustment and the statutory limit on the
credit for short-lived assets — is that the investment
credit provides the greatest subsidy for assets with lives
of 7 years. Longer lived assets and shorter lived assets
receive smaller effective subsidy rates. Requiring a basis
adjustment for the investment credit would reduce the
discrimination against long-lived assets and therefore
reduce the necessity for statutory restrictions for shortlived assets. It would also permit repeal of the recapture
rules and permit a uniform credit for both short and longlived assets.
Recapture
The determination of asset life for the purpose of
computing creditable investment is generally performed when
the asset is placed in service. In the event of early
disposition, the credit is recomputed if the limitations on
short-lived assets apply to the actual asset life.
Any
difference between the investment credit claimed and the
investment credit that would have been claimed if the actual
life were used is recaptured.
Recapture provisions are an additional source of
complexity in the investment credit. (Commissioner Kurtz
will describe this complexity in his testimony.) Recapture
would not be an issue if the investment credit were not
limited for short-lived assets; but this requires a basis
adjustment.
- 12 The 1974 Treasury Proposals
This discussion has illustrated some of the complexities
and problems that have arisen from subsidizing the purchase
of capital equipment through the tax system. I have mentioned
how it is possible to design an investment tax credit
exactly equivalent to a cash grant subsidy that would reduce
these complexities and make the subsidy more neutral. The
Treasury Department's 1974 proposal for restructuring the
investment credit would have accomplished this objective.
Along with increasing the rate of investment credit from its
then 7 percent rate to the current 10 percent rate, the
Treasury proposed to:
° Eliminate the limitations based on useful life, so that
all property with useful life of more than 3 years
would qualify for the credit.
° Provide for full refundability of the investment credit
with a 3-year phase-in.
0
Require the taxpayer to reduce the cost basis of
qualifying property for depreciation by the amount of
the investment tax credit.
Pros and Cons of Restructuring
Restructuring the credit, as proposed by the Treasury
in 1974, would eliminate many of the problems of the current
law. It would provide for an equal reduction in the cost to
private firms of all assets with a life over 3 years. By
not providing any tax-exempt income, it would be equally
valuable to taxpayers in all income brackets. It would
eliminate the need for complex carryover and carryback
provisions and for recapture. Taxpayers would not engage in
leasing transactions solely for tax purposes. In conjunction
with the other changes, the credit rate could be altered to
provide the same overall incentive to investment.
Although this type of restructuring has advantages and
may indicate how the investment credit should have been
designed originally, there are problems in changing current
law. First, while the credit rate could be adjusted to
maintain the same overall incentive, the benefits to some
firms would increase and to others would decrease. Raising
the credit rate to prevent major losses to any industry from
the change would require a significant increase in the
- 13 average investment incentive and would result in a large
revenue loss to the Treasury. In addition, even if the
average incentive to investment is unchanged, the restructuring
proposed in 1974 would cause a significant immediate revenue
loss to the Treasury. The revenue loss from increasing the
rate of the credit would be incurred immediately while the
revenue gains from requiring a basis adjustment would accrue
over the life of the asset. Thus, even if the present value
of revenue to Treasury is unchanged — the higher future
revenue offsetting the immediate lost revenue — the deficit
would be increased in the short run from the restructuring
proposals.
Conclusion
The investment tax credit is a major tax expenditure
program designed to increase investment, particularly in
machinery and equipment. Available econometric research
shows that it does promote increased investment, but its
cost effectiveness at achieving this objective is still in
dispute.
The investment credit is not a reliable tool of countercyclical policy. Changes in the investment credit should be
considered only in the context of overall policies to
stimulate long-run capital formation, and not to offset a
temporarily overheated or depressed economy.
The investment credit could be made more similar to a
direct expenditure program by allowing refundability, requiring
a basis adjustment, and permitting the same credit rate for
all asset lives. These changes if adopted as a package,
would reduce the bias against short-lived and very longlived assets in the present credit, reduce tax shelter
problems, end the artificial encouragement to leasing, and
eliminate the necessity for complex carryover rules. On the
other hand, such a restructuring of the investment credit
would be difficult to accomplish without large short run, or
even permanent revenue losses.
o 0 o
FOR IMMEDIATE RELEASE
NA W S
1
WASHINGTON, D.C. 20220
Press inquiries:
i.eral financing b a n k
March 20, 1979
FEDERAL FINANCING BANK ACTIVITY
Roland H. Cook,.Secretary, Federal Financing Bank (FFB),
announced the following activity for February 1-28, 1979.
New Program
On February 7, the FFB entered into an agreement with the
Secretary of Housing and Urban Development (HUD) whereby HUD
agrees to guarantee and the FFB agrees to purchase obligations
issued by local government units pursuant to Section 108 of the
Housing and Community Development Act of 19 74, as amended.
Proceeds from the sale of these obligations are used to finance
the purchase of real property by local governments, or the
rehabilitation of real property already owned by local governments. The FFB commitment is in the amount of $500 million and
expires September 30, 1979.
Guaranteed Lending
FFB provided Western UniQn Space Communications, Inc., with
$18,675,000 on February 1, and $7,700,000 on February 20 at
annual interest rates of 9.3781 and 9.553%, respectively. These
advances mature October 1, 1989, and are part of FFB's $687
million financing of a satellite tracking system to be constructed
by Western Union and used by the National Aeronautics and Space
Administration, which guarantees repayment of th§ advances.
Under notes' guaranteed by the Rural Electrification Administration, FFB advanced a total of $55,211,000.00 to 19 rural
electric and telephone systems.
FFB made 27 advances on existing loans to 15 foreign governments totalling $28,156,519.61. These advances are guaranteed
by the Department of Defense under the Arms Export Control Act.
During February, FFB purchased the following General Services
Administration participation certificates;
Interest
Series
Date
Amount
Maturity
Rate
7/15/04
9 057%
K--016
$1,565,679.00
2/1
M--042
2/13
7/31/03
9 223%
4,159,479.58
L--051
2/16
11/15/04
9 226%
750,521.25
B-1472
- 2 On February 21, FFB purchased a total of $2,315,000 in
debentures issued by 8 small business investment companies.
These debentures are guaranteed by the Small Business Administration, mature in 3, 5, 7 and 10 years, and carry interest
rates of 9.465%, 9.315%, 9.295% and 9.285%, respectively.
Department of Transportation Guarantees
On February 16, FFB entered into two agreements with the
Secretary of the Department of Transportation (DOT) acting
through the Administrator of the Federal Railroad Administration
(FRA), whereby FFB agrees to advance funds to the Chicago and
North Western Transportation Company (C$NW). The agreement
committing $6,192,406 (511-78-2) will mature May 1, 1986, and
the agreement committing $21,193,315 (511-78-3) will mature
November 1, 1990. These are the second and third agreements
under which FFB has committed to lend funds to C§NW. On
March 8, 1978, FFB agreed to lend $17.6 million to C$NW. This
agreement (511-78-1) will mature March 1, 1989. Funds advanced
under these agreements are guaranteed by DOT under Section 511
of the
Railroad
andguaranteed
Regulatory
Act of 1976.
Under
theseRevitalization
and other notes
by Reform
DOT pursuant
to
Section 511, FFB lent funds to the following railroads during
February:
Interest
Date
Amount
Maturity
Rate
9.345% an.
$2,112,393.00
12/10/93
Trustee of Chicago, Rock Island
2/2
9.539% an.
499,727.00
3/1/89
Chicago § North Western 511-78-1 2/13
9.508"0 an.
3,756,422.00
11/15/91
Trustee of The Milwaukee Road
2/14
an.
9.668% s/a
876,118.00
5/1/86
Chicago § North Western 511-78-2 2/23
9.403%
534,935.00
11/1/90
Chicago $ North Western 511-78-3 2/27
On February 1, FFB lent $5.1 million to the Trustee of The
Milwaukee Road. The advance matures April 20, 1988, and carries
an interest rate of 9.115%. This sum represents the total amount
committed by FFB'to The Milwaukee Road under an April 20, 1978
Guarantee Agreement between FFB and DOT. The repayment of these
funds is guaranteed by DOT pursuant to Section 3 of the Emergency
Rail Services Act of 1970.
On February 23, FFB lent $468,400.00 to the United States
Railway Association under their Note #8. This advance is
guaranteed by the Department of Transportation, matures April 30,
1979, and carries an interest rate of 9.874%.
- 3On February 16, the National Railroad Passenger Corp.
(Amtrak) extended the maturity on the $66 million outstanding
under their Note #17 until April 2, 1979. This maturity
extension is provided for under the terms of the Note, and
carries an interest rate of 9.725%. During February, Amtrak
also borrowed the following amounts from FFB under Notes
guaranteed by DOT:
Interest
ote #
Date
Amount
Maturity
Rate
17
17
17
17
17
17
18
18
2/1
2/6
2/14
2/15
2/16
2/21
2/21
2/22
$ 8,000,000.00
10,000,000.00
7,500,000.00
6,000,000.00
5,000,000.00
6,608,801.00
3,391,199.00
5,000,000.00
2/16/79
2/16/79
2/16/79
2/16/79
4/2/79
4/2/79
3/30/79
3/30/79
9.749%
9.66%
9.76%
9.728%
9.725%
9.856%
9.856%
9.888%
Agency Issuers
The Tennessee Valley Authority (TVA) sold FFB a $15 million
Note on February 14 and a $740 million Note on February 28.
Both notes mature May 31, 1979, and carry interest rates of
9.811% and 9.957%, respectively. Of the total $755 million
financed, $685 million refunded maturing securities, and $70
million raised new cash.
On February 2, FFB purchased a $715 million Certificate of
Beneficial Ownership (CBO) from the Farmers Home Administration.
This CBO will mature February 2, 1984, and carries an annual
interest rate of 9.333%.
In its weekly short-term FFB borrowings, the Student Loan
Marketing Association (SLMA), a federally-chartered private
corporation which borrows under a Department of Health, Education
and Welfare guarantee, refunded $300 million in maturing securities and raised $65 million in new cash. FFB holdings of
SLMA notes total $980 million.
FFB Holdings
As of February 28, 1979, FFB holdings totalled $53.2 billion.
FFB Holdings and Activity Tables are attached.
# 0 #
FEDERAL FINANCING BANK HOLDINGS
(in millions of dollars)
February 1979
Program
February 28. 1979
January 31. 1979
On-Budget Agency Debt
Tennessee Valley Authority
Export-Import Bank
$ 5,865.0
6,898.3
$ 5,795.0
6,898.3
2,114.0
345.9
Net Change
(2/1/79-2/28/79)
Net Change-FY 1979
(10/1/78-2/28/79)
-0-
645.0
330.0
2,114.0
345.4
-00.5
-10.9
25,160.0
57.0
163.7
38.0
637.7
104.6
24,445.0
57.0
163.7
38.0
637.7
105.9
715.0
2,885.0
22.4
61.2
4,447.1
312.3
36.0
38.5
17.3
53.5
4,384.4
305.8
36.0
38.5
5.1
7.7
402.8
321.3
4,735.4
281.3
980.0
21.6
177.0
351.3
294.9
4,680.1
279.0
915.0
21.6
177.0
$
70.0
$
Off-Budget Agency Debt
U.S. Postal Service
U.S. Railway Association
-0-
Agency Assets
.Farmers Home Administration
DHEW-Health Maintenance Org. Loans
DHEW-Medical Facility Loans
Overseas Private Investment Corp.
Rural Electrification Admin.-CBO
Small Business Administration
-0-0-0-0-
-0-0-2.2
-0-
-1.3
-7.6
Government Guaranteed Loans
DOT-Emergency Rail Services Act
DOT-Title V, RRRR Act
DOD-Foreign Military Sales
General Services Administration
Guam
DHUD-New Communities Admin.
Nat'l. Railroad Passenger Corp.
(AMTRAK)
NASA
Rural Electrification Administration
Small Business Investment Companies
Student Loan Marketing Association
Virgin Islands
ViWiTA
TOTALS
Federal Financing Bank
$53,220.9*
$52,154.2*
62.8
6.5
-0-051.5
26.4
55.2
2.3
65.0
-0-0$1,066.6*
4.9
25.4
469.2
42.2
-0-0-131.6
84.7
543.8
30.7
235.0
-0.2
-0$5,143.4*
March 13, 1979
*Totals do not add due to rounding.
FEDERAL FINANCING
BANK
February 1979 Activity
BORROWER
AMOUNT
OF ADVANCE
PATE
: INTEREST: INTEREST
MATURITY : RATE : .2AXASLEL
(other than s/a)
Department of Defense
Taiwan #8
Jordan #3
Greece #9
Jordan #2
Greece #10
Korea #8
Spain #2
Honduras #2
Colombia #2
Ecuador #2
Israel #7
Jordan #3
Spain #1
Taiwan #3
Thailand #3
Tunisia #4
Colombia #2
Costa Rica #1
Costa Rica #1
Indonesia #3
Taiwan #9
Israel #7
Colombia #2
Jordan #2
Jordan #3
Malaysia #3
Tunisia #5
Farmers Home Administration
2/1
2/1
2/1
2/5
2/7
2/7
2/7
2/8
$
67,480.00
6,090.50
1,109,807.22
31,865.52
26,350,142.78
48,743.48
1,423,414.00
66,500.00
79,974.00
98,744.00
1,000,000.00
419,340.00
1,636,314.95
79,890.46
162,282.00
1,022.00
463,829.25
12,806.00
5,621.43
31,607.30
1,100,000.00
21,597,674.07
1,135,596.00
6,785,851.77
107,394.00
263,304.88
71,224.00
7/1/85
12/31/86
5/3/88
11/26/85
2/1/89
12/31/86
9/15/88
10/7/82
9/20/84
8/1/85
12/15/08
12/31/86
6/10/87
12/31/82
9/20/84
10/1/85
9/20/84
4/10/83
4/10/83
9/20/86
7/1/86
12/15/08
9/20/84
11/26/85
12/31/86
3/20/84
6/1/86
9.289%
9.234%
9.193%
9.149%
9.208%
9.252%
9.223%
9.645%
9.478%
9.435%
9.232%
9.387%
9.377%
9.641%
9.478%
9.426%
9.47%
9.59%
9.585%
9.465%
9.472%
9.297%
9.658%
9.591%
9.547%
9.695%
9.571%
715,000,000.00
2/2/84
9.125%
1,565,679.00
4,159,479.58
750,521.25
7/15/04
7/31/03
11/15/04
9.057%
9.223%
9.226%
2/1
2/6
2/14
2/15
2/16
2/21
2/21
2/22
8,000,000.00
10,000,000.00
7,500,000.00
6,000,000.00
71,000,000.00
6,608,801.00
3,391,199.00
5,000,000.00
2/16/79
2/16/79
2/16/79
2/16/79
4/2/79
4/2/79
3/30/79
3/30/79
9.749%
9.66%
9.76%
9.728%
9.725%
9.856%
9.856%
9.888%
2/1
2/1
2/1
2/2
2/5
2/5
2/9
2/13
2/13
2/13
2/13
2/13
2,123,000.00
3,000,000.00
3,337,000.00
1,500,000.00
1,794,000.00
205,000.00
4,736,000.00
1,624,000.00
983,000.00
1,438,000.00
415,000.00
2,812,000.00
2/15/81
12/31/13
12/31/13
12/31/13
12/31/13
12/31/13
12/31/13
2/13/81
2/13/81
2/13/82
12/31/13
12/31/13
9.785%
9.044%
9.044%
9.043%
9.023%
9.023%
9.19%
9.875%
9.875%
9.465%
9.211%
9.211%
2/13
2/13
2/13
2/13
2/13
2/13
2/13
2/13
2/14
2/14
2/15
2/22
2/22
2/27
2/28
2/28
2/28
2/28
2/28
2/2
9.333% annuallv
General Services Administration
Series K-016
Series M-042
Series L-051
2/1
2/13
2/16
National Railroad Passenger Corporation
(Amtrak)
Note
Note
Note
Note
Note
Note
Note
Note
#17
#17
#17
#17
#17
#17
#18
#18
Rural Electrification Administration
Corn Belt Power #94
United Power #6
Arkansas Electric #97
Sugar Land Telephone #69
United Power #86
United Power #122
Wabash Valley Power #104
Western Illinois Power #99
Wolverine Electric #100
Northern Michigan Electric #101
Gulf Telephone #50
Allegheny Electric #93
9.668% quarterly
8.944%
8.944%
8.943%
8.923%
8.923%
9.087%
9.756%
9.756%
9.356%
9.107%
9.107%
FEDERAL FINANCING BANK
February 1979 Activity
Page 2
BORROWER
AMOUNT
OF ADVANCE
DATE
.: INTEREST: INTEREST
MATURITY : RATE : PAYABLE
(other than s/a)
Rural Electrification Administration
(cont.)
Tri-State Gen. $ Trans. #79
East Kentucky Power #73
Northwest Iowa Power #95
Big River Electric #58
Big River Electric #91
United Power #6
Pacific Northwest Generating # 118
South Mississippi Electric #3
South Mississippi Electric #90
United Power #86
Westco Telephone #112
Southern Illinois Power #38
Tri-State Gen. § Trans. #79
2/14
2/16
2/21
2/22
2/22
2/22
2/22
2/26
2/26
2/27
2/28
2/28
2/28
$
1,726 ,000.00
8,134 ,000.00
7,442,000.00
2,224,000.00
3,071 ,000.00
1,000 ,000.00
1,807 ,000.00
1,886 ,000.00
514,000.00
1,100 ,000.00
1,000 ,000.00
500,000.00
840,000.00
9.275%
12/31/85
9.855%
2/16/81
2/21/82 9.475%
9.885%
2/22/81
2/22/81 9.885%
9.227%
12/31/13
9.227%
12/31/13
2/27/81 10.095%
2/27/81 10.095%
9.273%
12/31/13
2/28/81 10.065%
2/28/82 9.635%
9.415%
1/31/86
9.17% quarterly
9.737%
9.365%
9.766%
9.766%
9.123%
9.123%
9.971%
9.971%
9.168%
9.941%
9.522%
9.307%
Small Business Investment Companies
500,000.00
50,000.00
50,000.00
500,000.00
165,000.00
50,000.00
300,000.00
700,000.00
2/1/82
2/1/82
2/1/84
2/1/84
2/1/84
2/1/86
2/1/89
2/1/89
9.465%
9.465%
9.315%
9.315%
9.315%
9.295%
9.285%
9.285%
2/13
2/20
2/27
85,000,000.00
90,000,000.00
105,000,000.00
85,000,000.00
5/8/79
5/15/79
5/22/79
5/29/79
9.66%
9.736%
9.773%
9.969%
2/14
2/28
15,000,000.00
740,000,000.00
5/31/79
5/31/79
9.811%
9.957%
5,100,000.00
4/20/88
9.115%
2,112,393.00
499,727.00
3,756,422.00
876,118.00
534,935.00
12/10/93
3/1/89
11/15/91
5/1/86
11/1/90
9.136%
9.322%
9.292%
9.445%
9.403%
468,400.00
4/30/79
9.874^
18,675,000.00
7,700,000.00
10/1/89
10/1/89
9.168%
9.335%
Capital Resource Co. of Conn. 2/21
Central New York SBIC, Inc.
2/21
Central New York SBIC, Inc.
2/21
Funder Capital Corp.
2/21
Multi-Purpose Capital Corp.
2/21
Central New York SBIC, Inc.
2/21
Fourth St. Capital Corp.
2/21
Mid-Atlantic Fund, Inc.
2/21
Student Loan Marketing Association
Note #182 2/6
Note #183
Note #184
Note #185
Tennessee Valley Authority
Note #93
Note #94
Department of Transportation
Emergency Rail Services Act
Trustee of The Milwaukee Road
2/1
Department of Transportation
Section 511
Trustee of Chicago, Rock Island 2/2
Chicago 5 North Western 511-78-1 2/13
Trustee of The Milwaukee Road
2/14
Chicago $ North Western 511-78-2 2/23
Chicago $ North Western 511-78-3 2/27
9.345%
9.539%
9.508%
9.668%
annually
annually
annually
annually
United States Railway Association
Note #8 2/23
Western Union Space Communications, Inc.
(NASA)
2/1
2/20
9.378% annually
9.553%
FOR IMMEDIATE RELEASE
EXPECTED AT 10:00 A.M. EST
WEDNESDAY, MARCH 21, 1979
STATEMENT 3Y THE HONORABLE C. FRED BERGSTEN
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE SUBCOMMITTEE ON INTERNATIONAL
DEVELOPMENT INSTITUTIONS AND FINANCE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
Mr. Chairman. I am pleased to appear before you
today to present the Administration's proposals for
authorization of U.S. participation in replenishments
of resources for the Inter-American Development Bank,
the Asian Development Fund and the African Development
Fund .
The authorization requests for these three institutions total $4,019 million, including $2,543 million
for callable capital subscriptions which do not entail
budgetary outlays and $1,476 million for paid-in capital
subscriptions and concessional funding which will
lead to budgetary outlays over an eight to ten year period.
They cover the U.S. share of the financing necessary to
sustain the lending operations of the institutions during
the period 1979-1982. These requests require annual
appropriations over a three to four year period beginning
B~£3*±-
/17JL
- 2 next year and provision has been made for the first of these
appropriations in the FY 1980 Budget.
Prior to concluding the negotiations on these three replenishment agreements, we consulted actively with the Congress
regarding U.S. objectives and positions on all the key
issues. You will recall that I came before this Subcommittee
in formal hearings last April prior to the final negotiating
sessions for the replenishments of the Asian Development Fund
and the African Development Fund and, in December, just before
the final negotiations for the increase in resources of the
Inter-American Development Bank. On both those occasions, I
explained our aim in the negotiations and our view of their
likely outcomes, and obtained your helpful guidance. These
consultations were very helpful to us in carrying out and
completing the negotiations. We hope they have laid the foundation for a common view between the Administration and Congress
on these replenishments.
U.S. POLICY TOWARDS THE MULTILATERAL DEVELOPMENT BANKS
Before turning to the details of the individual replenishment proposals, I would like to set out the policy perspectives
within which we view U.S. participation in the multilateral
development banks, participation which we think is particularly
important for the conduct of U.S. relations with both developed
and developing countries. In discussing each of the replenishment proposals, I would like to relate our participation to
-3speountries and to the achievement of specific foreign
poliectives on a regional basis.
jlationships with the developing countries encompass
majotical, security, economic and humanitarian concerns.
U.S.rt for economic growth and development in poorer
counis directly linked to meeting these fundamental
cone* Maintenance of the U.S. commitment to a constructive
and ative program of international economic assistance is
esseif we are to continue to provide that support effective
:imary objective of U.S. foreign policy is to promote
peacsperity, and cooperation among nations because the
exisDf these conditions in other countries contributes
to tL-being of the United States itself.
All of our
foreLicy programs, including those for the multilateral
devet banks, have been designed to contribute to these
obje.
ore than one hundred developing nations contain the
grearity of the world's population.
They differ greatly
amonselves in terms of culture, history, political
systd the level of economic development that they have
atta Nevertheless, they all share one major aspiration:
econrowth and development and material improvement in the
liveheir people.
ess developed countries have moved to the forefront
of wffairs.
As increasingly active and effective
-4participants in international political and economic organizations, they have assumed a much greater importance in U.S.
foreign policy and national security considerations:
— They occupy strategic geographical positions.
— They are growing users of atomic energy for
peaceful purposes and a number of them have
the capability for developing nuclear weapons.
— They have military capabilities which can be used
to initiate conflicts affecting U.S. interests and
having the potential of escalating into great-power
confrontation.
— They are an important source of critical raw materials
for the United States and other industrial countries.
— Their growing populations and aspirations place increasing demands on the earth's resources and
environment.
Thus, in implementing U.S. non-proliferation policy,
for example, we must recognize that less developed countries
have a legitimate and expanding requirement for energy. In
order to combat international terrorism effectively, we must
be able to count on the support of less developed countries
in multilateral organizations such as the United Nations and
in dealing directly with individual situations as they may
arise. The Law of the Sea Conference now going on under the
auspices of the United Nations requires the cooperation of
less developed countries on a number of issues if we are to
reach agreement and still protect interests of the United
- 5 States relating to navigation, marine research, protection
of the environment and exploration and exploitation of deep
seabed mineral resources.
Negotiations toward the solutions to these global problems
are complex and difficult, requiring a balancing of interests
and a sensitivity to the requirements of developing countries.
In the context of these competing and conflicting interests on
major international issues, the multilateral development banks
provide the United States with a practical and effective way
to work cooperatively with developing countries to help them
meet their most basic aspirations.
Another major objective of U.S. policy is to encourage
the integration of the developing countries into the international economic system. The United States was instrumental in
the establishment of this system shortly after the end of World
War II, and we have worked hard to maintain its effectiveness.
The system is based on the principles of free flows of trade
and investment, and it has well served the United States and
the world. Its continuation is necessary for our own progress
and, we believe, for fulfilling the aspirations of the
developing countries.
The multilateral development banks are an integral part
of the international economic system. Through their assistance
to the economic and social progress of the developing countries,
the banks foster a structure of cooperation between developing
and developed countries characterized by mutual responsibilities
and joint contributions to the health of the international
economic and political system.
-6Over the longer run, the health of the U.S. economy will
depend to a considerable degree on the reliable growth in
supply of the products we need from the LDCs and LDC markets
for our exports, as well as the flow of investment between
us.
In 1977, non-oil developing countries purchased 25 percent
of our total exports. In the agriculture sector, these exports
amounted to $6.7 billion and included large components of wheat,
rice and cotton. In the same year, our imports from these
countries totalled $36 billion, one fourth of total imports.
Our reliance on the developing countries for supplies of
necessary and, in some instances, vital raw materials is
striking. It includes tin, natural rubber, bauxite, manganese
and other raw materials.
DEVELOPMENT EFFECTIVENESS
One of the most effective means through which we can
promote rapid and equitable growth and stability in the
developing countries are the multilateral development banks.
The banks have become the leading institutions in the
field of international economic development. They raise
resources for both concessional and near market lending
operations from many donor countries. As a consequence, they
are able to operate on a significant scale and across the
range of economic sectors. They are today the primary source
of official development assistance. Their loan commitments
-7in 1979 are expected to reach $12.5 billion, and their
disbursements last year amounted to more than $5.5 billion.
The banks have also come to represent a significant
share of U.S. foreign assistance in recent years, as a result
of both Executive Branch and Congressional decisions. Including
callable capital, appropriations for the banks have exceeded
appropriations for AID bilateral development assistance since
FY 1977.
Excluding callable, the two have been roughly
equal for the past year or so.
As a share of all U.S. foreign
assistance, including security supporting assistance and
P.L. 480, our contributions to the banks still represent
a distinct minority of the total.
I have appended to
my testimony several charts which illustrate this trend.
The high level of their lending gives the MDBs important
influence in recipient countries.
Because of their apolitical
character, and the fact that they operate on the basis of
economic and financial criteria, the banks are able to
encourage, in their continuous policy dialogue with borrowers,
the adoption of appropriate economic policies so as to ensure
good use of our money.
They do this by analyzing individual projects in the context of both the recipient's development program and priorities
and trends in the world economy, selecting for funding only
the soundest projects which are proposed.
They also assist
in the diversification of developing countries' economies
-8by providing additional capital to sectors requiring it.
Their policy advice is generally consistent with U.S. views
and stresses the importance of market forces and an open
international economic system.
Their examination of projects within the context of
the world economy is designed to assure that they do not
finance projects which include production of any commodity
in surplus on world markets.
There have been complaints
from domestic producers that the banks have been financing
commodities in competition with U.S. products.
The United
States would vigorously oppose MDB financing of projects
for the production and export of a commodity which could
be deemed in surplus in the world market and could injure
U.S. producers.
All the banks have implicit or explicit
policies against financing such projects.
These loans would
represent an inefficient use of the resources of the MDBs,
in that they would be of questionable quality and unproductive
nature.
Within the economic systems which developing countries
have chosen for themselves, the banks stress the role of
market forces in the effective allocation of resources,
the development of outward looking trading economies and
the spreading of development resources to poorer people.
In conjunction with their financial assistance, the banks
strengthen local institutions and provide training for
local officials through extensive programs of technical
assistance.
-9It is clearly in the interest of the United States that
the MDBs should lend to countries with differing economic and
even political systems, as long as there is assurance that the
funds will be used effectively to advance the living standards
of the people of such countries. Their relationship with the
banks will result in their integration into the international
economic system which we support and will contribute to the
stability and growth of the international economy as their
stake in it becomes more firmly rooted. The banks should
not lend to countries with gross mismanagement or demonstrated unwillingness to benefit their populations, of course,
whatever their economic or political systems.
The Administration is especially concerned, as the
Congress is, that there should be costs to repressive governments for their human rights behavior. W e have expressed
this view to the managements of the banks and to the other
member countries. We have demonstrated the seriousness of
our concern by opposing through "no" votes or abstentions,
in satisfaction of Section 701(f) of PL 95-118, and for
policy reasons, 50 loans to fifteen countries. The Secretary
of the Treasury and the Secretary of State submitted, in
October 1978, a Report to the Congress on the implementation
of the various provisions of PL 95-118, which reviews in
detail our efforts in the banks to address human rights and
basic human needs.
The competence and international character of the staff
-10of the banks have established their reputation for rigorous
and detailed appraisal of project proposals and programs.
Therefore, their advice is often much more effective than that
of individual bilateral donors, where political sensitivities
may be involved.
The banks have also shown themselves able to respond to
changing circumstances and new developmental initiatives.
For example, they are now targeting a more substantial proportion of their assistance to projects which directly reach
the poor — responding to needs for broadening the growth
process, helping to satisfy basic income, increase agricultural productivity and reduce rates of unemployment.
In response to our desire that they assist in increasing
the productivity of the poor, the banks are placing increasing
emphasis on employment creating projects, in connection with
their efforts in both the agriculture and rural development
sectors and in urban-oriented industrialization efforts.
One important means to help achieve the objective of
effectively reaching the poor is to promote the utilization
of capital saving technologies in order to increase the
productivity and incomes of poor people. We have urged and
supported the creation of units or groups within the MDBs
to focus on the appropriateness of technologies incorporated
into the banks' projects. Such groups have been established
in the World Bank, the IDB and the ADB. We have sought, and
obtained, policy decisions by the banks placing increased
emphasis on the use of capital saving technologies in their
-11projects.
As a result of our initiatives, the banks are
making increased efforts, at the preinvestment stage, to
achieve a more effective application of appropriate technologies.
Efforts by the banks to reach the poor are essential.
At the same time the multilateral development banks
must also continue to pursue a multiplicity of goals if
they are to be effective catalysts for development.
The
banks must preserve their recognized strengths in project
design, sectoral and country analysis and programming,
macro-policy leverage and infrastructure support.
In many
less developed countries, infrastructure projects are
still key because they provide the necessary economic
context for other assistance programs, including those
developed to benefit the poor.
Hydroelectric projects provide an example of projects
which are necessary if the developing countries are to meet
their expanding energy requirements and reduce their reliance
on expensive imported energy.
Feeder roads serving small
farmers in isolated areas of Africa for example, must lead
to a main road eventually if production is to get out and
inputs are to get in to assist in increasing production.
Adequate port facilities are needed if fertilizers and other
inputs from abroad are to reach the smallholders and if
their coffee or cocoa or other production is to get out.
Indeed, the success of products designed to meet basic human
-12needs and to incorporate capital saving technologies is
often dependent on these kinds of infrastructure projects.
Another high priority that we strongly support is the
expansion of bank lending for energy development. In
response to a request made at the Bonn Summit meeting, the
World Bank has proposed a program which we have strongly
endorsed to help solve the growing energy problems of
developing countries. The Bank had already planned to start
spending about $500 million per year on energy projects
by 1979 — that amount will now be tripled by 1983 to cover
an expanded lending program to finance geological and geophysical surveys and exploratory drilling, and more lending
for projects to develop and produce gas and oil. Over the
next few years, the Inter-American Development Bank will
be devoting a large proportion of its lending to developing
hydroelectric and geothermal potential in Latin America.
The Asian Development Bank has also embarked on a large
lending program to finance the production of primary energy
fuels. These MDB funds will facilitate additional private
investment in the energy area, thus helping to meet urgent
requirements in the developing countries and improving the
world energy supply and demand balance.
The banks also contribute to the efficient use of scarce
development assistance coming from many sources through
their leadership and participation in the consultative groups
and consortia which coordinate bilateral assistance efforts
on behalf of numerous countries.
- 13 COST EFFECTIVENESS
The MDBs are a particularly cost-effective mechanism for
providing economic assistance because they permit us to share
the burden for providing this assistance with other countries,
and because they mobilize private capital through bond offerings
and cofinancing.
What was once a predominantly U.S. foreign economic
assistance effort has been transformed today into a much more
broadly shared one. The overall U.S. share of subscriptions and
contributions to the MDBs has declined to 25 percent, as other
countries have increased their capacity to provide more resources
for development. These include industrialized countries such
as Germany and Japan, OPEC nations, and some of the relatively
more advanced developing countries such as Mexico and Brazil.
For every dollar we contribute to the banks, they now contribute
three dollars.
Participation in a multilateral framework means that
the interests,of donor countries are collectively represented.
No one country can dictate the policies of the multilateral
development banks. Because we share the same view of the
objectives of the banks with most other member governments,
however, and because we play a major role in each of the
banks, their operations and policies have almost always
responded to our policy priorities.
- 14 The banks rely on the callable capital subscriptions
of their members as backing for their bond issues in private
capital markets, and use these borrowed funds for their
harder term operations. Because of their solid record
of financing economically sound and feasible projects,
the MDBs have been able to increase the leverage of
their callable capital to the point where only one out
of every ten dollars of capital subscriptions is in
fact paid-in.
In the case of the World Bank, for example,
each dollar the U.S. subscribed has generated some $50
in Bank lending. The Bank has made $45 billion of loans
over its lifetime while the United States has paid in only
$884 million. This tremendous leverage means that, particularly in a period of budget stringency, the banks are
an extremely cost-effective channel for the U.S. foreign
assistance dollar.
The banks also engage in co-financing operations with the
private commercial banks. These have involved the purchase
of shares in individual MDB loans as well as complementary
financing arrangements for MDB financed projects. These
operations are very desirable, not only because they
mobilize additional resources but particularly because
they provide a mechanism for the introduction of commercial
-15bank lending in the developing countries for development
projects. Some of these countries have not yet established
a firm international credit standing, and the involvement
of private commercial banks will permit these countries
to enter the world financial system, paving the way for
future decreases in their reliance on official assistance
to meet external capital requirements.
BENEFITS TO THE UNITED STATES
The operations of the MDBs provide direct and indirect
benefits to the U.S. economy substantially above our contributions. These benefits stem from project-related procurement of goods and services, bank administrative expenditures
in the United States, net interest paid to U.S. holders
of bank bonds, and faster LDC growth resulting in rapidly
growing markets for U.S. exports. The total value of U.S.
procurement alone since the inception of the banks has
been over $8.3 billion, which exceeds U.S. subscriptions
and contributions paid into the banks by $2.1 billion.
As a result of their increased investment financed by the
MDBs, the developing countries are able to improve their
living standards more rapidly, providing a growing market
for the United States and other exporters. This investment
also helps developing countries produce raw materials the
United States must import in order to prosper.
From the time of the banks' inception in 1946 to the
-16middle of 1978, direct accumulated receipts by all segments
of the U.S. economy have exceeded outflows to the MDBs by
$2.4 billion. In addition, an econometric analysis which
we have made shows that real GNP increased annually between
$1.2 billion and $1.8 billion as a result of exports of
U.S. goods and services to markets directly created by MDB
financed projects in developing countries. This means
that every U.S. dollar paid into the MDBs generated between
$2.39 and $3.38 in real U.S. economic growth annually
over the period. This also means that the banks' activities
created between 50,000 and 100,000 jobs a year.
U.S. participation in the multilateral development
banks is not motivated primarily by these kinds of
benefits. However, it is clearly a mistake to view
our contributions to the banks as giveaways or economic
losses to the United States. To the contrary, they bring
us net economic gains in both GNP and balance-of-payments
terms.
ROLE IN THE INTERNATIONAL ECONOMIC SYSTEM
The multilateral development banks provide a
practical and effective way for us to collaborate with
the developing countries in helping them achieve their
basic aspiration: economic growth and equity. Our
participation in the MDBs and the overall levels of
our foreign assistance are judged as a signal of the
-17seriousness of our response to their problems.
The banks are also a forum for cooperation with
industrialized countries. I mentioned earlier the increased
role which these countries are playing in the banks, by
shouldering large shares of the costs of their activities.
We participate with these countries in discussions within
the banks on all issues of development policy, and alternative approaches to the use of development assistance funds.
We have recognized for many years that cooperation with
other industrial countries is to the well-being of the
United States. Our collaboration with them on these development questions positively affects our overall relationships
with these countries and our dealings with them in other fora.
LATIN AMERICA
The bulk of the financing contained in the proposal
before you today is to replenish the capital and concesssional
windows of the IDB for the four-year period 1979-82. Our
approach to this replenishment was based on the twin realities of Latin America's position in the world economy for
the 1980s: impressive overall economic progress in most
countries, but continued great needs in most of them.
During the past decade, Latin America's rate of economic
progress has outstripped that of other developing regions:
— Between 1965 and 1977, the gross domestic product of
-18the region more than doubled in real terms to nearly
$400 billion. This represents an annual growth rate
of 6.1 percent — compared with 5.1 percent for
all developing countries, and about 3.9 percent
for the developed countries. It maintained impressive
growth even through the world recession, cushioning
the impact of the recession on the industrialized
countries-particularly the United States.
— Real per capita GNP in the region has increased by
more than half since 1965. It now stands at $1100,
as compared with a per capita GNP of $450 for the
rest of the developing countries.
As a result, Latin America has made the transition to a
region with a global role of its own. Individual Latin American
nations have become advanced developing countries (ADCs) with a
vital stake in the future of the world economy, in the sucessful
operation of the international trade and monetary systems, in
ensuring adequate rates of production and demand, and in
assisting the poorest countries of the world in eradicating
extreme poverty.
Mexico is one example of how a country which is critically
important to the United States benefits from MDB activities.
Its importance to the United States stems primarily from geographical proximity to this country and the influence which
this proximity can have on the political, economic, social,
-19environmental and security aspects of American society.
U.S.
relations with Mexico are governed by two fundamental U.S.
policy objectives:
— Political stability and economic growth in a Mexico
which is friendly to the United States.
— Control of migration flows which could have potentially
disruptive effects for the United States.
In addition, development of Mexico's hydrocarbon resources
will increase the free world's supply of oil and provide Mexico
with the revenue to increase domestic employment, thus reducing
migration pressures on the United States. Finally, cooperation
between our two countries is necessary for narcotics control
and other border issues including sanitation, pollution control,
and law enforcement.
Mexico doe»s not receive concessional lending from the IDB.
It has become, in fact,, a donor to the FSO
It continues,
however, to receive substantial amounts of market rate financing
from the MDBs.
In its most recent fiscal year, Inter-American
Development Bank loans to Mexico totaled $238 mill.ion.
Loans
from the World Bank totalled $469 million.
The multilateral development banks play a financial
intermediary role in Mexico. They are also able to provide
advice on investment plans which may help Mexico to use
-20its petroleum revenues most effectively to attack unemployment
and under-employment and redress social and economic imbalances. And they advise the Mexican Government on how to
approach the problems of equitable economic growth. During
his recent trip to Mexico, President Carter visited an
integrated rural development project which is being financed
jointly by the World Bank and the IDB. The purpose of this
project is to increase incomes and employment opportunities
for poor people in rural areas of the country.
Brazil is another example. It is important to the
United States simply by the weight of its size and strategic
position. Brazil is the world's seventh most populous nation,
the tenth largest economy, and has a resource endowment and
agricultural capacity rivalling those of the United States.
The U.S. and Brazil share major global interests:
the maintenance of Western security, a healthy world
economy, the avoidance of North-South confrontation, and
Brazil's successful completion of the transition to
developed country status along with peaceful evolution
toward a more equitable and politically open, pluralistic
society, setting an example for other developing countries.
Brazil's challenge for the future will be to maintain adequate
growth to create the estimated 1.3 million jobs needed each
year to keep pace with its rising population, while devoting
-21more resources and attention to improving the productivity
and well-being of its poor.
The multilateral development banks play the role of
policy advisor as well as that of financial intermediary in
Brazil as they do in Mexico. In calendar year 1978, the IDB
made loans to Brazil totaling more than $282 million. In its
most recent fiscal year, World Bank loans totaled $705 million
Like Mexico, Brazil is a donor to the convertible currency
resources of the concessional lending fund of the IDB and
has agreed not to borrow from those funds.
However, Latin America is not a homogeneous region.
Despite the progress of recent years, Latin America
contains some of the poorest and least developed areas
in the world. For example, the level of protein intake
in Haiti is the lowest in the world, and its caloric
intake is next to the lowest. Infant mortality rates
throughout the region are three times as high as those
in the United States. Forty percent of primary school-age
children and sixty percent of secondary school age children
do not attend classes. Population increases outpaced
agricultural growth in 1975 and 1976 although a moderate
improvement occurred in 1977. The labor force is increasing
at a rate of 2.8 percent a year, exacerbating an already difficult
-22unemployment problem.
Although the growth in average per
capita income in the region has been remarkable, there are
now more people, perhaps as many as 150 million, living in
absolute poverty than there were a decade ago.
And, notwithstanding the progress that has been made by
the region as a whole, there are countries which have
not shared in Latin America's overall progress and which
continue to need concessional resources. These countries have
little access to private capital markets and a limited ability
to assume debt at market rates. Their per capita incomes
remain low by Latin American and global standards as well.
Continuing self-help and structural change is
crucial to development, but Latin America also requires a
continuing flow of external financial resources to sustain
the momentum of its economic and social development.
The United States has a keen interest in fostering
the development and ensuring the stability of Latin America
and the Caribbean. In economic terms, the importance of the
region to the United States is obvious by the large flow of
goods and services, technology and capital in both directions.
In 1977, our exports to the Latin American region nearly reached
the $20 billion mark, more than our exports to Japan and almost
as much as those to the European Common Market. This export
-23volume is projected to grow by 10 to 15 percent per year.
Since 1960 U.S. direct investment in Latin America and
the Caribbean has doubled with a restructuring of that
investment away from enclave investments in mining and
petroleum toward manufacturing, trading and finance.
These
investments now exceed $20 billion, approximately two-thirds
of all U.S. investment in the developing world.
In 1977,
Latin America and the Caribbean provided the following
shares of U.S. mineral imports:
petroleum, 26 percent;
iron ore, 23 percent; bauxite, 88 percent; copper, 40
percent.
In addition, we obtain about 50 percent of our
sugar imports, 80 percent of our bananas, and 70 percent
of our coffee from Latin America.
THE INTER-AMERICAN DEVELOPMENT BANK
With U.S. support, the IDB has contributed significantly
to the economic development of the region.
In its nineteen
year history the IDB has proven itself an innovative leader,
continually finding new ways to strengthen the development
impact of its activities, through its project financing and
through its technical assistance in developing planning and
programming.
By December of 1978, the IDB had provided
$13.0 billion of assistance from its own resources of which
$7.1 billion came from capital and $5.9 billion from the FSO.
For the IDB to continue to play its important role in assisting
- 24 Latin America's development efforts, the resources of both
the Bank's capital and the Bank's concessional window, the
Fund for Special Operations (FSO) must be increased as their
current convertible currency loan commitment authority will
be depleted by mid-1979.
Economic development is the highest priority objective
of almost every one of the countries of Latin America.
Our participation in the IDB in support of the region's
development efforts is a key element in our efforts to win
their cooperation on matters of common concern such as narcotics,
migration, and obtaining needed energy and raw materials.
The IDB also provides an institutional setting where we can
encourage the advanced developing countries to undertake a
larger part of the responsibility for the functioning of the
international economic system.
The increased contributions
of these countries in this replenishment demonstrate their
recognition of their increased strength and responsibility as
participants in the system.
Because of the joint gains to Latin America and to us
of a free, liberal international economic system, we both stand
to benefit from the process of shared participation and responsibility.
Over the long-term there has been a decline in the
level of our bilateral grant and loan assistance to the
-25region from the peak in the mid-60s, reflecting both
Latin America's rapid economic growth and a deliberate
shift in the emphasis of our bilateral concessional assistance
program toward the poorer regions of Africa and South Asia.
The proposed FY 80 AID budget for Latin America, however,
actually represents a slightly higher level of bilateral
assistance than the budget allocations in fiscal years 1977-79
—
$230 million versus $218 million.
We can demonstrate our continued strong interest in
furthering the development of Latin America through our
participation in this IDB replenishment.
In line with our
development finance policy, we have broadened our economic
ties with Latin American countries through other avenues of
bilateral economic cooperation which are more consistent
with their individual levels of development. They have
increasingly become larger recipients of Eximbank credits
and guarantees as well as export credits for U.S. agricultural
products through the Commodity Credit Corporation. The OPIC
program of insurance and finance for private investors has
also been active in the region.
The leveling off of U.S. bilateral assistance to Latin
America at around $200 million a year does not, however, suggest
a U.S. move away from the region.
It is the result of our
global policy in development finance.
The application of this
global policy to Latin America means that the region should,
-26because of its development progress, be moving gradually but
deliberately from concessional assistance as provided by AID
and the soft windows of the multilateral development banks
(MDBs) to the non-concessional windows of the banks and private
capital markets.
The replenishment before you conforms to
this policy.
The U.S. approach to the IDB replenishment negotiations
had the following objectives:
to focus lending on the poorer countries in the region
and to the poor people in all recipient countries;
to increase burden-sharing by both developed and
developing member countries;
to reduce the paid-in portion of the United States
and other donors' subscriptions, consistent with maintaining the financial soundness of the bank.
With respect to the first objective, these replenishment negotiations significantly restructure the lending program
of the IDB for the 1979-1982 period. In response to the economic
realities of Latin America the number of countries which will
tap the FSO for convertible currency loans will be reduced.
Several borrowers have progressed sufficiently that they no
longer need to turn to the FSO at all as a source of external
capital.
In addition to the five countries which had already
volunteered not to borrow convertible currencies from the
-27FSO during the last replenishment period, 1976-1978 (Argentina,
Brazil, Mexico, Trinidad and Tobago and Venezuela), Chile
and Uruguay will now no longer do so.
IDB lending for the
Bahamas and perhaps one other Caribbean country might also
now be wholly from capital resources.
As a result, the annual size of the FSO lending program
can now be smaller than during the last replenishment.
We believe this to be a most appropriate step in the evolution
of development finance whereby, as countries make economic
progress and no longer need concessional resources, they can
graduate to harder lending terms and the level of concessional
assistance they receive can fall.
The FSO replenishment will
allow for $468 million in convertible currency loans per year,
down from an average level for the 1976-1978 replenishment
of $540 million per year.
In addition, these concessional funds will be concentrated
even more on the poorest and least developed countries in
the hemisphere.
During 1979-80, the initial years of this
replenishment, at least 75 percent of convertible FSO resources
would go to them.
During the second half of the replenishment
period, this minimum allocation would increase to 80 percent.
Because of their broad access to private capital markets,
and their own recognition of the greater needs of their poorer
neighbors, the largest and more prosperous Latin countries
-28—
Argentina, Brazil and Mexico —
borrowing to present levels.
will restrict their capital
They will thereby reduce sharply
their percentage share of total IDB capital lending although
retaining sizable amounts in absolute terms.
The Bank will
help them adjust to this change by assisting in arranging
an increased amount of cofinancing for their IDB projects,
improving still further their access to private capital.
As
has been the case since 1975, Venezuela and Trinidad and Tobago
will not borrow at all from the Bank during this replenishment
period.
These constructive steps by the more advanced developing
countries of Latin America will permit the middle level and
poorer countries to attain substantial annual increases in
their real rate of total borrowing from the Bank.
This will
in turn help cushion their move from the concessional funds
of the FSO to the harder lending terms of the capital window,
and round out the three-step approach which recognizes the
economic maturing of the region: (a) fewer borrowers from the
concessional FSO's convertible currencies, (b) more capital
lending for the countries shifting from the FSO to the capital
window made possible by (c) increased reliance on private
sector borrowing by the most advanced countries of the
Hemisphere.
This replenishment also involves agreement to target IDB
lending to poorer people in
recipient countries.
Those
countries, outside the group of poorest and least developed,
-29who retain some access to FSO resources have agreed to limit
their FSO borrowing wholly to those projects which directly
benefit their poor people.
As far as the Bank's total resources
are concerned, it has been agreed that 50 percent of 1979-1982
lending will benefit low-income groups, primarily through
the creation of productive employment opportunities in the
rural and urban areas.
The IDB replenishment proposal before you also contains
major advances in terms of burden-sharing by non-regional
countries and advanced developing member countries.
The non-regional members of the Bank will contribute
a share of the capital increase (11 percent) which is two and
one half times larger than their current share of 4.4 percent.
In addition, the non-regional members will contribute 30
percent of the FSO replenishment, the high level which they
had agreed to as part of their entry into the IDB.
The subscriptions of the Latin American members (except
Venezuela) to paid-in capital will be two-thirds in convertible currency —
an increase from the 50 percent previously
subscribed in convertible currency by these members.
As in the 1976-1978 replenishment, Venezuela will make its
paid-in subscriptions entirely in convertible currency.
In continuation of the practice instituted during the
1976-78 replenishment, Venezuela and Trinidad and Tobago have
again agreed to make all their contributions to the FSO in
convertible currency.
Moreover, as an indication of their
-30growing financial and economic strength, Argentina, Brazil
and Mexico have agreed to increase the freely usable portion
of their FSO contributions from 25 percent to 75 percent —
raising the level of resources fully usable by the FSO
by $191 million.
As a result of these contributions and those of the
non-regional countries, the U.S. share of convertible FSO
resources has dropped from 57 percent in the last replenishment to 45 percent in the proposed replenishment.
Because of these changes in the Bank's lending
program and in the burden-sharing arrangements, this
replenishment (in comparison to the previous replenishment)
allows a reduction in the annual contribution to be paid in by
the United States. To fulfill the proposed lending program of
the IDB, the increase in capital resources for 1979-82
amounts- to $7,969 million of which 7.5 percent or $598 million
would be paid-in. The United States share of this increase
would be $2,749 million — 34.5 percent of the total —
comprising $2,543 million of callable capital and $206 million
of paid-in capital. For the FSO, the increase proposed for
1979-82 would amount to $1,750 million of which the United
States share would be 40 percent of the total or $700
million. The U.S. shares are those called for in the Sense
of the Congress Resolution in the FY 1979 Foreign Assistance
Appropriations Act, and they have been accepted by the Bank's
other members as appropriate levels of U.S. participation.
- 31 Also, under this replenishment only seven and one half
percent of the capital will be paid-in, down from the typical
10 percent paid in during previous replenishments.
The annual
U.S. capital subscription of $687.3 million thus involves
$635.8 million of callable capital - which does not entail
any budget outlay.
The paid-in portion of the U.S. subscrip-
tion would be $51.5 million annually.
The U.S. contribution to the FSO will decline absolutely
from $200 million a year to $175 million a year.
This
is a twelve and one half percent reduction.
While the budget outlay commitments for the 1976-78
replenishment, as negotiated, were $240 million per year,
the proposed 1979-82 replenishment would result in annual
budget outlays of only $226.5 million —
of $13.5 million.
an absolute reduction
The reduction in real terms is, of course,
much more substantial.
For both capital and concessional
funds, the budgetary outlays would as always be spread
over a number of years because drawdowns are made only as
needed to cover actual disbursements by the Bank or on the
basis of an agreed schedule.
In the last two years, the Administration and the
Congress have been carefully reviewing the appropriate
budgetary and appropriations treatment of callable capital.
In 1977, authorizing legislation was enacted for U.S. participation in a selective capital increase of the IBRD and
-32a general capital increase of the ADB.
That legislation
—
Public Law 95-118 — required that U.S. subscriptions to callable
capital be made only after the amounts to fund the subscriptions
had been appropriated. The Administration indicated its
willingness to go along with this approach, immediately upon
taking office.
The bill which we have submitted proposes language relating
to the appropriation of callable capital for the new IDB replenishment different from that contained in Public Law 95-118
for the IBRD and ADB. The language provides that the commitment
to subscribe to callable capital stock is to be effective
"only to such extent or in such amounts as are provided in
advance in appropriation Acts." The difference in language
is for the purpose of allowing the Congress and the Administration maximum flexibility in determining the future treatment
of callable capital in the context of the review of budgetary
controls over all Federal credit and guarantee programs proposed
for this year by the President in the budget documents for
FY 1980. The Administration's proposals envisage the
possibility of different forms of budget limitations in annual
appropriations Acts, and — while fully protecting the role
of the Appropriations and Budget Committees — we simply wish
to avoid precluding, for application to the new IDB replenishment,
any of the possible outcomes of that process.
-33The Administration strongly recommends this replenishment
proposal.
The increase in the Bank's resources will provide
funds to support projects which build on the major economic
successes of the past decade in Latin America, and continue
the development momentum which will lead one day to the
establishment of dynamic economies able to finance their
own continued development.
United States participation in the proposed increase
in resources would constitute a positive and concrete
expression of United States interest in, and concern for,
the development of Latin America and the Caribbean.
A
continuing flow of resources through the IDB will help the
region to further improve its economic situation and that
of the millions of Latin Americans who still live in poverty.
It is a cooperative effort in which the more advanced
Latin American countries are joining the industrial countries
in providing a part of the convertible currency resources
for IDB lending to the poorest countries in the region.
ASIA
As recent weeks have shown, conflict and instability
remain problems in Asia, and are of continuing concern
to the United States. From the standpoint of security,
a strategic balance now exists in the region.
It is clearly
in our interest that this balance be maintained. Our policies
are designed to preserve balance and stability in the region,
prevent expansion of existing conflicts and maintain our
-34commitments to our friends and allies.
They obviously
do not entail a return to our earlier deep involvement
in the internal affairs of the region.
We have concentrated instead on the development of
long term sustainable policies that emphasize national
self-reliance, supplemented by continued U.S. support.
In
this regard, we have been especially encouraged by the
emergence of the Association of Southeast Asian Nations
(ASEAN) which is a successful example of the regional
economic cooperation we believe will contribute to stability
in the area.
We continue to place high priority on the region.
We cannot afford to do otherwise.
Viewed in this light, U.S. participation in the
Asian Development Bank offers an effective way to
demonstrate continued U.S. concern in the area and its
stability and to show our willingness to provide financial
support for the economic aspirations of its people.
Indeed, Asia contains the overwhelming majority of the
world's poorest people.
On the basis of strategic con-
siderations alone, it is in our interest to support effective
actions to improve the conditions of their lives and to
promote greater stability in the area.
Thailand is one example of how the work of the Asian
Development Bank can advance U.S. foreign policy objectives
in individual countries.
Thailand has a central position
in southeast Asia, and it has maintained a close relationship
-35with the United States. It is in our national interest to
support the stability and independence of Thailand because
it is a key element of regional progress and balance in southeast Asia. We also have other important interests in Thailand.
For example, Thailand's cooperation is essential if we are
to have an effective narcotics suppression program. It has
also provided a country of first refuge for Indo-Chinese
refugees. Thailand is important as an expanding market for U.S.
exports including cotton, tobacco, machinery, fertilizers, iron,
and steel. It is also a reliable supplier of critical raw
material imports such as tin, tungsten and rubber.
Economically, Thailand has grown at a rate matched by few
developing countries. From 1960 to 1976, GNP growth averaged
7.6 percent a year. A high and rising level of investment has
been maintained, exceeding 20 percent of GNP and largely
financed by domestic savings. Per capita income doubled over
the 1960-1976 period. Inflation has been kept under control
by conservative fiscal policies, although price pressures
have recently intensified.
In the past, economic policies have tended to favor
Bangkok, other urban areas and the relatively better off
farmers of the central plains. A large proportion of
the rural population, particularly in the northeast, has
not shared equitably in the benefits of economic growth.
The present government in Thailand is beginning to
reorient economic policy in favor of these elements
- 36 of the rural population. The Prime Minister has declared
1979 the "Year of the Farmer" and has stated his government's
intention to direct far greater resources to rural areas.
The revised Five-Year Development Plan for 1977-1981 calls
for external borrowing of about $1 billion per year to finance
rural and infrastructure development to bring services and
improved agricultural technology to the rural poor.
For 1979, the proposed borrowing program includes $324
million from the ADB. Under the proposed ADF replenishment,
Thailand will become eligible for concessional financing
of projects addressing the needs of its poor citizens. It is
in our interest that the flow of MDB financing continue to
Thailand. Our participation in the Asian Development Bank
and Fund will help assure that the country will be able to
sustain its growth and carry out needed changes in its overall
economic policies.
A second example is Pakistan. The turmoil in neighboring
countries underscores U.S. interest in the security and
stability of this Persian Gulf rim nation.
Pakistan suffers from political instability and a growing
sense of isolation, and recently the economy has stagnated.
The most important contribution the United States can make
to Pakistan's stability and long-term development is to
assist it in putting its economic house in order and, thereby,
induce stability while political problems are resolved.
- 37 Pakistan is a poor agricultural country and its best
prospects for growth lie in that sector of the economy.
With one of the world's largest irrigation systems, Pakistan
could become a major exporter of agricultural commodities
while meeting the food requirements of its own population.
It has a well-developed infrastructure in terms of railroads
and roads, and there is a sound industrial base upon which to
expand. The ADF can, and is, helping Pakistan to develop
this potential. Its assistance, totalling $290 million
at the end of 1978, has been focused on the improvement of
agriculture through the support of irrigation projects, the
production of fertilizer inputs, of power for rural electrification, and cement for use in civil works in agriculture.
THE ASIAN DEVELOPMENT FUND
Recently, there has been a significant increase
in cooperation among the nations of Asia. This is exemplified
by the efforts of the ASEAN to work together among themselves,
and with the rest of Asia and the industrialized world,
in an effort to increase regional stability and prosperity.
The Asian Development Bank and Fund, as visible, technically
qualified, moderate and respected regional institutions
both aid and are aided by this move to increased regional
self-reliance. Our participation in the Bank and Fund
constitutes a clear, demonstrable statement of our interest
in the region and associate the United States with the
region's goals and aspirations.
- 38 The Asian Development Fund (ADF) was established in
1974 to mobilize concessional resources, on an organized
and regular basis, to consolidate and standardize the
Asian Development Bank's lending to the smaller and
poorer, developing member countries in Asia.
Six member countries account for the major share of
these concessional loans: Pakistan, Burma, Nepal,
Afghanistan, Bangladesh and Sri Lanka. These six are
among the poorest countries in the world, and several
of them are of central importance to U.S. foreign policy.
Several Pacific islands which are of importance to U.S.
policy toward the region (particularly the Solomons and
Western Samoa) receive ADF funds — our primary channel
for providing assistance to them. In addition, under the
proposed replenishment, the Fund will resume modest amounts
of lending for basic human needs projects in Indonesia,
the Philippines and Thailand. India has voluntarily refrained
from receiving funds from the ADF, relying instead on IDA
as its principal source of concessional aid.
Our goal in the replenishment negotiations was to
ensure that substantial resources were provided for the
ADF's activities, and that these resources should be more
sharply focused on the poor. We were able to achieve an
agreement that agricultural investment and rural development
programs would continue to be the primary lending sectors
of the ADF, and that these projects would increasingly
- 39 focus on benefitting the poorer segments of the population.
We also achieved a resumption of lending to the "marginally
eligible" countries —
Indonesia —
Thailand, the Philippines and
for projects which meet basic human needs.
The U.S. share of the total replenishment of $2.15
billion for the 1979-1982 period amounts to $445 million.
This represents a substantial degree of burden-sharing.
It is 20.69 percent of the total, below the level
suggested by the Congress (22.24 percent) in the FY 79
Foreign Assistance Appropriations Act and consistent with
the Sense of the Congress provision in Public Law 95-118.
This share will require annual appropriations for the 1979-1982
period of $111 million.
Authorization of the proposed
U.S. contribution is required in 1979, and appropriation
of the first tranche in FY 80 to prevent ADF commitments
ceasing in December 1979.
I would like to briefly address the issue of Chinese
membership in the Asian Development Bank.
The situation
in the ADB is different from that in the International
Monetary Fund and the World Bank in that Taiwan was an
original member of the ADB, joining in 1966.
Taiwan
is a full member of the Bank, although it ceased to rely
on the ADB for external financing in 1971.
The People's Republic of China has not indicated an
interest in membership in the ADB.
Participation by the
- 40 People's Republic in the 3ank raises a number of complex
issues, such as the possible effects on the lending
program, and legal mechanisms for their participation.
We believe the PRC is aware of the complexities involved
in their joining the banks, and that their entry will
take time. As Secretary Blumenthal said while testifying
before the House Appropriations Subcommittee on Foreign
Operations on March 14, it would be premature to state a
U.S. Government position on the question of their participation.
AFRICA
We are proposing an increase in U. S. contributions
to the African Development Fund. The African continent
has assumed a much greater foreign policy importance for
the United States which stems from the following factors:
— Africa is a growing locus of power both politically
and economically.
— It commands vital economic resources which are
essential to the United States and the industrialized
nations of the West.
— It occupies a strategically important geographic
position.
— It continues to experience instability and political
and military weakness which could draw in larger,
non-African powers for the resolution of local
wars and pose risks for elevating and broadening
regional conflicts.
-41—
Further, the persistence of racial injustice in
southern Africa threatens the stability of the area.
— It has acute problems of poverty and economic underdevelopment which have the potential to cause growing
resentment against the United States and other
developed countries.
In addition, African countries now play a prominent
role in international politics and in the conduct of world
diplomacy. By themselves, they comprise almost one-third
of the membership of the United Nations. Together with
other developing countries, they account for two-thirds
of the membership of that organization. We need the cooperation of African countries to resolve the kinds of
international problems which I have already mentioned.
In terms of the individual countries, Nigeria is
the largest U.S. trading partner on the continent. Annual
U.S. exports to that country currently exceed $1 billion,
and Nigeria supplies us with almost 20 percent of our petroleum
imports. After Saudi Arabia, it is our second largest
source of foreign crude oil. Nigeria has taken a constructive
leadership role and consistently opposed outside intervention
in African conflicts.
In both economic and humanitarian terms, Africa
represents the world's greatest development challenge.
It is the least developed continent, containing two-thirds
-42of the world's 30 poorest nations and some of the world's
most deprived and disadvantaged people. In most countries
of the region the numbers of individuals living in absolute
poverty amount to more than one-third of the population.
Seventy five percent of Africa's population is engaged
in subsistence agriculture. Life expectancies in Africa
average 43 years — 10 years less than those in other
developing countries and 30 years less than those in the
United States. Less than 20 percent of the population
of sub-Saharan Africa has access to safe drinking water.
Growth rates in Sub-Saharan Africa remain well below
those in other developing regions. Per capita incomes
expanded at a rate of less than 2 percent per annum in
1960-75. Although a large percentage of African labor
works in the agriculture sector, agricultural production
has also grown slowly, increasing at an annual rate of
about 1.5 percent since 1960. This rate of growth has not
been sufficient to keep up with the increase in population.
THE AFRICAN DEVELOPMENT FUND
The African Development Fund (AFDF) represents an
important means to help these countries break out of the
vicious cycle of poverty. It was created in 1973
as the concessional lending affiliate of the African
Development Bank (AFD3). The Bank itself was established
in 1964 to make loans to African nations on near-market
terms; it has no non-African members.
-43The Fund makes concessional loans to the poorest
countries in Africa.
Except under the most unusual circum-
stances, loans are not granted to countries with 1976
per capita GNP above $550. Absolute priority is given
to nations with per capita GNP below $280.
The African
Development Fund has concentrated its efforts on those
most in need:
in 1977, 64 percent of its lending went
to countries with a per capita income of less than $280.
In that same year, loans targeted to assisting the poor
accounted for approximately 60 percent of total lending.
In the replenishment negotiations, it was agreed
that the Fund's efforts to reach the poor should be
continued and intensified.
During 1979-1981, 80 percent
of the Fund's resources will be lent to the poorest countries —
with a per capita GNP below $280.
With respect
to sectors, it was agreed the AFDF would focus particular
attention on projects aimed at meeting basic food and
health requirements and at increasing the effective
utilization of human potential through training in such
areas as agriculture.
The AFDF is reaching those whom
the United States believes should receive top priority for
development assistance.
The AFDF donors agreed to a second replenishment
which will permit the African Development Fund to expand
its efforts to aid Africa's poor in the 1979-1981 period.
-44Th e U.S. contribution of $125 million to the second replenishment would be 17.5 percent of the total of $713.5 million
of pledged resources.
This U.S. share represents an increase
in our position in the Fund.
Recently, our share of
Fund resources has been under 6 percent —
to Norway.
which was equal
We believe that a much more substantial
U.S. share in this institution is consistent with both
our objectives of increased burdensharing and the high
priority we place on strengthening U.S. relations with the
countries of Africa.
The resulting 17.5 percent is still
substantially less than our share in any of the other MDB
windows.
It is consistent with the Sense of the Congress
Resolution, and we believe it is essential to demonstrate
our interest in assisting growth and development in Africa.
We believe that the African Development Fund is an
increasingly effective regional institution which can
help address Africa's enormous prolbmes of proverty and
underdevelopment.
It is the kind of cooperative organization
that we want to encourage because it provides us with
a practical way to assist African development without
unwarranted and direct involvement in the affairs of
individual countries.
I would like to mention briefly the opening of membership in the African Development Bank (AFDB) to non-regional
members.
This Bank is unique among the MDBs in that its
membership has been drawn entirely from regional developing
-45nations since its establishment in 1964. As a result,
its subscribed capital after 15-years is currently only
$957 million and its cumulative loans total $620 million.
In order to strengthen the Bank's resource base and lending
program, negotiations have now been undertaken, pursuant
to a 1978 authorization by the African Governors, to begin
the participation of non-regional members in the Bank.
The Administration strongly supports the efforts
of the African Development Bank to expand its base of
resources. We have participated constructively in discussions
with other non-African countries considering membership,
and are now envisaging a U.S. capital subscription on the
order of $360 to $400 million (to be contributed over a five
year period FY 81-85) which would also represent a U.S. share
of about 17-18 percent. This would provide us with our
own Executive Director at the Bank, and make us the largest
single shareholder. We will be consulting with you
on details of U.S. participation in the Bank, looking
toward the submission of legislation next year.
Africa's critical importance to the management of
international political and economic affairs is now wellestablished. Our proposed support for this replenishment of the African Development Fund, as well as our
prospective entry into the African Development Bank
itself, reflect the strong commitment which the
-46Administration and the Congress share to support the
aspirations of African peoples for a better life.
CONCLUSION
The Administration strongly supports the replenishments I have proposed today.
The multilateral development banks are a practical
and effective way for the United States to cooperate
with the developing countries in achieving their basic
goal of equitable economic growth. Our participation
in the banks and the overall levels of our foreign
assistance are judged as an indication of the seriousness
of the U.S. response to the problems of the developing
countries.
As I have emphasized, the United States has important
foreign policy interests in the developing countries.
We will be more successful in obtaining the cooperation
of these countries in our search for world economic and
political stability if they see us to be willing to assist
them in their development efforts. This basic reciprocity
is at the heart of our relations with the developing countries.
For all the reasons I have given, we strongly support
the recommended U.S. participation in the multilateral
-47development banks.
The proposals before you today deal
only with the regional banks, which play a special role
in the international economic system.
Their operations
reflect the assessments made by regional members of thier
own needs, and they have an expertise and understanding
of local conditions and problems.
The regional development
banks serve as useful complements to the global programs
of the World Bank Group.
Most importantly, U.S. support
for these regional banks especially manifests our interest
in the development and progress of the countries in each
region and thus has particular political as well as economic
significance.
U.S. Foreign Development Assistance
FY 1969-1979
($ Millions)
MDB Appropriations
Fiscal
Year
1969
19 70
1971
1972
1973
1974
1975
1976
1977
1978
1979
1/
MDB
Appropriations
Less Callable
Total
Capital 1/
686
686
455
335
738
788
619
696
141
1,r
1,,926
2,,515
480
480
255
88
570
620
522
600
404
1,104
1,632
AID
Appropriations 2/
1,207
870
989
986
910
820
691
-999
1,121
1,294
1,544
Foreign Assistance
as Share of Foreign
Appropriations
Assistance Appropriations
Less Callable
Le ss Callable
i
Total
Total
Capital
Capital
1,893
1,556
1,444
1,321
1,648
1,608
1,310
1,695
2,262
3,220
4,059
1,687
1,350
1,244
1,074
1,480
1,440
1,213
1,599
1,525
2,398
3,176
36
44
32
25
45
49
47
41
50
60
62
Indicating magnitude of budgetary expenditures that would eventually result in outlays
2/ AID assistance, excluding Security Supporting Assistance and PL-480.
28
36
20
8
39
43
43
38
26
46
51
U.S. Foreign Development Assistance
FY 1969-1979
Constant 1978 Dollars
($ Millions)
Fiscal Year
MDB Appropriations
Less
Total
Callable Capital
AID
Appropriations
1969
1,203
842
2,117
19 70
1,142
799
1,448
1971
721
404
1,566
1972
510
134
1,500
1973
1,061
819
1,308
1974
1,033
813
1,075
1975
740
624
827
1976
791
682
1,136
1977
1,225
434
1,204
1978
1,926
1,104
1,294
1979
2,331
1,513
1,431
THE PRESIDENT'S 198 0 BUDGET REQUEST
FOREIGN ECONOMIC AND FINANCIAL ASSISTANCE
BUDGET AUTHORITY
(in millions of dollars)
FOREIGN ECONOMIC AND FINANCIAL
ASSISTANCE:
FY 1978
Actual
FY 1979
Estimate
FY 1980
Proposed
Multilateral development
assistance:
Multilateral development
banks
1,926
2,515
3,625
International organizations
240
260
277
1,294
1,544
1,762
International Fund for AgriCultural Development
Agency for International
Development
Proposed legislation
Food Aid
25
923
806
719
2,219
1,921
1,995
79
164
152
127
149
162
SUBTOTAL, Foreign economic and
6,808
financial assistance
7,359
8,718
-336
-346
-370
6,472
7,013
8,348
35.9
43.4
Security supporting
assistance (AID)
Refugee assistance
Other foreign economic and
financial assistance
Offsetting receipts
TOTAL, net of receipts
MDBS AS PERCENT OF TOTAL
29.8
The President's FY 198 0 Budget Request
Foreign Economic and Financial Assistance
Program Level
(in millions of dollars)
FY 1978
Actual
FY 1979
Estimated
FY 1980
Proposed
FOREIGN ECONOMIC AND FINANCIAL
ASSISTANCE:
Multilateral development
assistance:
1,104
1,630
1,842
Multilateral development banks
1,926
2,515
3,625
International organizations
241
260
277
International Fund for
Agricultural Development
200
1,545
1,479
——_
25
1,438
1,399
1,921
1,995
164
152
155
171
7,113
7,340
-346
-370
6,767
6,970
24.1
26.4
Agency for International
Development
1,369
Proposed Legislation
Food Aid 1,192
Security Supporting
Assistance (AID)
2,224
Refugee Assistance 7 9
Other Foreign Economic and
Financial Assistance
138
SUBTOTAL 6,547
Offsetting Receipts -336
TOTAL, Foreign Economic
and Financial Assistance
MDBS AS PERCENT OF TOTAL 17.8
6,211
THE PRESIDENT'S FY 198 0 BUDGET REQUEST
FOREIGN ECONOMIC AND FINANCIAL ASSISTANCE
OUTLAYS
(In millions of dollars)
1978
Actual
1979
Estimate
1980
Proposed
FOREIGN ECONOMIC AND FINANCIAL
ASSISTANCE:
Multilateral development
assistance:
Multilateral development
banks:
858
858
1,023
International organizations
210
251
272
20
40
International Fund for Agricultural Development.
Agency for International
Development
20
1 ,007
1,007
1,175
Proposed legislation
Food aid
1,316
6
808
1,055
993
1,908
2,061
1,950
Refugee assistance
75
111
173
Other foreign economic and
financial assistance
78
118
119
4,965
5,649
5,893
-336
-346
-370
4,629
5,303
5,523
18.5
16.2
18.5
Security Supporting
Assistance (AID)
SUBTOTAL, Foreign Economic
and Financial Assistance
Offsetting receipts
TOTAL, Net of Receipts
^DBS AS PERCENT OF TOTAL
FOR IMMEDIATE RELEASE
March 21, 1979
Conta' : Alvin M. Hattal
202/566-8381
TREASURY RELEASES REPORT ON THE
NATIONAL SECURITY EFFECTS OF OIL IMPORTS
The Treasury Department today released its report
of an investigation under Section 2 32 of the Trade Expansion Act of 1962 into the national security effects
of oil* imports.
The report consists of a memorandum from Secretary
W. Michael Blumenthal to the President and the Treasury
General Counsel's report of the investigation. The
result of a year-long investigation initiated on March
15, 1978, the report concludes that oil imports are
entering the United States in such quantities and
under such circumstances as to threaten to impair the
national security. Accordingly, the Secretary's memorandum to the President recommends that action be taken
to reduce domestic oil consumption and increase domestic
production of oil and other sources of energy by providing
appropriate incentives and eliminating programs and regulations that inhibit the achievement of these goals.
The report notes that specific recommendations
on achieving conservation and production objectives
are being evaluated in an interagency group charged
with presenting the President with policy options for
his consideration.
*
The Secretary's report to the President is based
on the investigation conducted by the General Counsel
of the Treasury Department. The General Counsel's report of that investigation examines in considerable
detail the causes and consequences of the nation's
* As used in the report, "oil" includes crude oil,
crude oil derivatives and products, and related products derived from natural gas and coal tar.
R 1474
(MORE)
-2growing dependence on imported oil, particularly since
1975, when Secretary of the Treasury William E. Simon
reported to President Ford that oil imports threatened
to impair the national security.
The General Counsel's report concludes that the
threat to the national security is greater now than before because:
- U.S. dependence on imported oil to satisfy domestic oil needs and overall energy demands has increased;
- The amount and cost of these oil imports have
increased dramatically since 1975;
- Oil imports increasingly originate in a small
number of distant foreign countries;
- The risk that oil imports will be interrupted by
civil disturbances, terrorist acts, war and a
variety of other causes has not diminished since
1975.
The report finds that, even apart from the possibility
of supply interruptions, the monetary repercussions
accompanying the growing dependency on imported oil
constitute a threat to the national security.
The Secretary initiated the oil import investigation in March of 1978 to update the 19 75 finding
that oil imports threatened to impair the national
security. The statute requires that the investigation
be concluded within one year of the date it is initiated.
During his investigation, the General Counsel
solicited and considered comments from the public
as well as from a number of agencies. The agencies'
comments, which were appended to the General Counsel's
report transmitted to the President, and public comments received in the course of this investigation are
available for public reading and copying at the Library
of the Treasury Department, Room 5030, Main Treasury,
15th St. and Pennsylvania Ave. N.W., Washington, D.C.
o
0
o
THE SECRETARY OF THE TREASURY
WASHINGTON 20220
MAR 14 1979
MEMORANDUM FOR THE PRESIDENT
Subject: Report of Section 232 Investigation on Oil Imports
I have completed the investigation I initiated last year
pursuant to Section 232 of the Trade Expansion Act of 1962 to
determine whether oil* imports are entering the United States
in such quantities or under Buch circumstances as to threaten
to impair the national security. I am transmitting herewith
a detailed report of our investigation.
On January 14, 1975, acting pursuant to the same Section
232 authority, Treasury Secretary Simon found that the
nation's dependence on imported oil was so great as to
threaten to impair the national security and recommended to
President Ford that action be taken to remove the threat.
That conclusion is, unfortunately, even more valid today.
The nation's dependence on imported oil has increased
dramatically since the 1975 finding. At the time of
Secretary Simon's finding, 37 percent of United States demand
for oil was supplied from foreign sources. In 1978, oil
imports accounted for 45 percent of oil consumed in the
United States. During that same period, the nation became
more dependent on oil to meet overall energy demand, and oil
imports increasingly originated in a small number of distant
foreign countries. The increasing dependence on foreign
sources of oil is a consequence of both rising levels of
consumption and declining domestic production.
This growing reliance on oil imports has important consequences for the nation's defense and economic welfare. because so much of the oil used in the United States originates
have dramatized the consequences of this excessive
?pei
on foreign sources of petroleum. Furthermore, the rising
level of oil imports adversely affects our balance of trade
* The term "oil", as used in this report, means crude oil,
crude oil derivatives and products, and related products
derived from natural gas and coal tar.
-2and our efforts to strengthen the dollar; in 1978, outflows
of dollars for our oil imports amounted to $42 billion, $15
billion more than in 1975 and offsetting much of,the rise in
our exports of industrial and farm products.
•
The continuing threat to the national security which
our investigation has identified requires that we take
vigorous action at this time to reduce consumption and increase domestic production of oil and other sources of
energy. To the extent feasible without impairing other
national objectives, we must encourage additional domestic
production of oil and other sources of energy, and the
efficient use of our energy supplies, by providing appropriate incentives and eliminating programs and regulations
which inhibit the achievement of these important goals.
Specific recommendations on achieving these conservation
and production objectives are being evaluated by an interagency group in which Treasury is participating. The committee's work will be finished shortly and specific policy
options will be formulated for your consideration.
W. Michael Blumenthal
-1REPORT OF INVESTIGATION PNDER SECTION 232
OF THE TRADE EXPANSION ACT,
19 U.S.C. 1862, AS AMENDED
I. INTRODUCTION
1. Background.
Section 232(b) of the Trade Expansion Act of 1962 authorizes the President to take action to adjust imports of
crude oil, crude oil derivatives and products and related
similar products derived from natural gas and coal tar (hereinafter referred to collectively as "oil") if the Secretary
of the Treasury finds that such commodities are being imported into the United States in such quantities or under such
circumstances as to threaten to impair the national security.
Previous findings that oil imports threaten to impair
the national security were made in 1959 and 1975.1/ Those
findings have served as the basis for programs to~control oil
imports, first by means of quotas and later through use of
license fees.2/ The use of license fees was upheld by the
United States Supreme Court in an opinion which emphasized
the breadth of the remedies permitted under Section 232(b).3/
On its face, Section 232(b) authorizes any remedy reasonably
related to the adjustment in the importation of a particular
article.
This investigation was initiated by the Secretary of the
Treasury on March 15, 1978 (see Appendix A) to examine developments since 1975 and to determine:
1. whether increased reliance (since 1975) on oil
imports from a small number of distant foreign
suppliers continues to threaten to impair the
national security;
2. whether the monetary repercussions accompanying continued large payments outflows for oil
imports threaten to impair the national
security.
At the time he initiated the investigation, the Secretary of the Treasury stated that the investigation was to be
undertaken for contingency purposes only and that it should
be conducted on a confidential basis. Initially, in the Secre
u f 5 y , B 3ud9ment, national security interests required that
public comments not be invited. Accordingly, the Secretary
-2requested the General Counsel to proceed immediately with the
investigation. Information and advice were solicited from
the following agencies in the course of the investigation:
Central Intelligence Agency, Department of Defense, Department of Energy, National Security Council, Federal
Reserve Board, Department of State, Council of Economic Advisers, Department of Commerce, Department of Labor, Department of the Interior, and Department of Transportation. On
February 2, 1979, the Secretary invited comments from the
public, having reviewed his earlier determination and concluded that it was then appropriate to issue the invitation.
None of the agency submissions or public comments challenged
the proposition that oil imports threaten to impair the
national security. The overwhelming conclusion of these submissions and comments is that such a threat continues to
exist.
2. Conclusion
The conclusion of this report is that oil continues to
be imported in such quantities and under such circumstances
as to threaten to impair the national security. This threat
arises both from increased reliance on a small number of
foreign oil suppliers and the monetary repercussions accompanying continued large payments outflows for imported oil.
Unlike temporary crises in the nation's ability to satisfy
its oil import needs, the national security threat arising
from growing reliance on imported oil has its gravest implications in the long-term.
II: INCREASED RELIANCE ON OIL IMPORTS FROM A RELATIVELY
SMALL NUMBER OF FOREIGN SUPPLIERS THREATENS TO IMPAIR
THE NATIONAL SECURITY
1. A threat to the national security has previously
been established.
The 1959 finding.
In 1959, the President's Special Committee to Investigate Crude Oil Imports determined that oil imports constituted a threat to the national security.4/ The Committee
concluded that, in order to have enough oil to meet the nation's security needs, "there must be a limitation on imports
that will insure a proper balance between imports and domestic production.... [Absent that balance,] in an emergency
the nation would be confronted with all of the liabililites
inherent in a static, as contrasted with a dynamic, mobilisation base, including the delays, waste and inefficiency
-3tbat accompany efforts to strengthen any part of the aobilisation base on a 'crash' basis."5/
The 1975 finding.
In 1975 the Secretary of the Treasury found that oil imports threatened to impair the national security. That investigation considered all factors relevant to a finding under Section 232(b), including the relationship of the nation's economic welfare to its national security. The Treasury report concluded that oil imports should be reduced in
order to "wean ourselves away from a dependence upon imported
oil, conserve our use of petroleum, promote the use of alternative sources of energy, and at least in part, stanch the
outflow of payments resulting from our purchases of this
commodity."6/
Congressional declarations.
In August 1977, Congress, in enacting Title I of the
Department of Energy Organization Act, declared that the
"energy shortage and our increasing dependence on foreign
energy supplies present a serious threat to the national
security of the United States."2/ This declaration echoed an
earlier Congressional finding in section 2 of the Emergency
Petroleum Allocation Act of 1973 that oil shortages will
create severe economic dislocations and hardships which
constitute a national energy crisis threatening the public
health, safety and welfare. 8/ More recently, section 102 of
the National Energy Conservation Policy Act of 1978 emphasized the need to stem the nation's increasing reliance on
imported oil and the vulnerability which accompanies such
reliance.9/
2. The nation has increased its dependency on a small
number of distant foreign oil suppliers.
Since 1975, United States oil imports have increased as
a share of oil consumed and of all energy consumed in the
United States. In addition, because oil imports increasingly
originate from a small number of foreign and mostly distant
sources, they have become more vulnerable to interruption.
Level of oil imports.
Oil imports have risen steadily over the past 20
years.10/
-41959
1*8 mmbpd (million
barrels per.day)
1975
6.5 mmbpd
•
1978
8.7 mmbpd (including
the Strategic
Petroleum Reserve)
Over the same period, oil imports have increased both as a
share of domestic demand for oil 11/
1959 18%
1975
1976
39%
45%
and as a share of demand for energy of all types.12/
1959 9%
1975
1978
19%
23%
A growing share of our oil imports come from OPEC
nations:13/
1959 70%
1975
1978
78%
83%
Oil imports averaged 8.7 mmbpd during 1978—down 6 percent from 1977.14/ However, this decline resulted from a
rundown of domestic inventories and a one-time buildup of
Alaskan production which more than offset the 1.6 percent
rise in domestic oil demand and the 4 percent decline from
1977 in the crude oil production of the lower 48 states.15/
Alaskan oil, which began to flow in June 1977, approachecPthe
capacity pipeline flow of 1.2 mmbpd in the second quarter of
1978.16/
Sources of oil imports.
In the early 1960's, Venezuela was the largest external
supplier of oil to the United States, providing about 46
percent of total oil imports.17/ Later Canada (non-OPEC)
became a large supplier, accounting for about 22 percent of
imports by 1970.18/ However, imports from Venezuela have declined sharply as a percentage of total imports, and Canada
has adopted procedures which could virtually phase out all
light crude oil exports to the United States by 1981.19/ As
imports from these traditional Western Hemisphere suppliers
have receded in significance, there has been a corresponding
-5rise of the nation's reliance on Eastern Hemisphere sources,
particularly those in the Middle East. The proportion of oil
imports originating in Middle Eastern countries wafe:20/
1959 21%
1975
27%
1978
34%
For the next decade, the United States will probably
continue to rely heavily on Middle Eastern supply sources.
Although recent developments in Iran have diminished expectations for continuing the previous levels of production in
that country, in all likelihood, U.S. dependence on other
Middle Eastern producers will increase further.21/
As oil production in the United Kingdom and Norwegian
sectors of the North Sea develops, some demand for Middle
Eastern oil will shift to North Sea oil. However, the
changeover is likely to have its greastest effect on the
European markets, with substantial U.S. reliance on Middle
Eastern oil remaining relatively undiminished. The expanding
production in Mexico, for which the United States forms a
natural market,22/ offers another alternative to imported
Middle Eastern oil. Nevertheless, through 1985, U.S. dependence on Middle Eastern producers is not expected to be reduced significantly because of the development lead time
required. -v *
Value of oil imports.
Not only has the volume of U.S. oil imports expanded,
but the landed price of foreign petroleum has jumped sharply
as well. For example, the average unit value (f.a.s.) of
U.S. petroleum imports has risen as follows:23/
1959 $ 2.26 pb (per
barrel)
1975
$11.45 pb
1978
$13.28 pb
As a consequence, the nation's annual oil import bill has
grown dramatically over the past 20 years:24/
1959 $ 1.5 billion
1975
$27.0 billion
1978
$42.3 billion
The cost of oil imports may be expected to increase
further in 1979 as a result of the OPEC price increase of
-614.5 percent—fourth quarter to fourth quarter—agreed upon
at the meeting of OPEC ministers in December. Recent
interruptions in Iranian production have put upward^pressure
on market prices and have prompted many oil producer's to seek
to obtain price increases beyond those scheduled in the
December OPEC price decision.
3. The risk of detrimental interruption has not
lessened.
Risk of interruption.
As noted above, the U.S. is heavily dependent for its
imported oil on a small number of distant countries. These
countries are a diverse group of nations with different resources and goals. While, in the main, the U.S. shares common
interests with them, there are also some areas of political
disagreement. In 1973, some of these countries demonstrated
their willingness to use oil as a political weapon. For the
first time in history, this country's access to major petroleum supplies was cut off by an embargo, as a result of dissatisfaction with our foreign policy. This action was
prompted by a major military conflict in the Middle East.
Although hostilities have generally subsided, the underlying
political dispute has not yet been resolved. Despite the intervening years and strengthened relations with Middle Eastern nations, the United- States cannot discount the possibility of another political disagreement with the nations on
which it depends for its oil supplies.
In addition, recent developments in Iran have highlighted the potential for internal domestic upheavals to
disrupt oil supplies. As a result of the events beginning
with a strike in October 1978, Iranian exports until very
recently have been limited to small amounts of heavy residual
oil not usable within Iran. Although Iranian oil exports
have been renewed, the Iranian government has stated its
intention to limit oil exports to 3 mmbpd, well below the 5
mmbpd level that prevailed before the interruptions. Even
though Iranian oil accounted for only 5 percent of U.S. oil
consumption prior to December 1978, Secretary Schlesinger
recently indicated that the continued interruption of even
this relatively less important U.S. supply source could
require the U.S. to consider mandatory conservation measures.
This assertion serves to emphasize, as the Central
Intelligence Agency has noted, the vulnerability of the U.S.
economy to supply disruption. See Appendix B.
Furthermore, other types of supply interruption are possible. For example, six of the Middle Eastern nations which
are major suppliers of oil to the U.S. ship their oil through
the narrow Strait of Hormuz at the southern end of the Ara-
-7bian Gulf.25/ This geographical situation alone renders this
oil supplyToute vulnerable. Moreover, the producing nations
themselves face a risk of terrorist action with attendant
harm to oil production and shipment facilities. Indeed, the
Central Intelligence Agency has stated:
There i6 a high probability that acts of nature, human error, or deliberately targeted terrorist attack will interrupt the flow of oil in one
or more of the oil exporting nations during the
next several years.
Interruptions of oil supply owing to guerrilla
operations, acts of terrorism, or acts of nature are not
likely, by themselves, to be of a magnitude and duration
which would result in severe economic disruption of Free
World economies, though they could exert strong upward
pressure on prices in a tight world oil market. Extensive terrorist action against key oil storage and transportation facilities in the Persian Gulf could, in particular, significantly affect the market by substantially reducing oil supplies for the time required to put
those facilities back into operation, which could be
several months.
See Appendix B.
According to the Defense Department:
The concentration of oil production facilities in
the area presents the major physical risk. Tnis creates
a risk of interdiction, or even the risk of natural or
accidental disturbances. The extensive damage in the
Abqayq fires in May and June 1977, caused by accident,
highlights the fragility of these facilities. Destruction of key facilities could cause major interruptions
of oil deliveries to the U.S. and to our NATO and
Japanese allies which would adversely affect U.S. and
Western World political, economic and military security.
See Appendix B.
In short, the overall potential for an embargo or other
interruption has not decreased since the embargo of 1973, nor
since the 1975 finding by the Secretary of the Treasury that
such a risk threatened to impair the national security. On
the contrary, developments in Iran demonstrate that U.S. oil
imports can be seriously affected by internal disruptions in
-8a country even if it is not a primary supplier of the U.S.
oil imports. Disruption in any source of supply serves to
concentrate U.S. reliance on the other supply sources and, at
a minimum, leads to unscheduled price increases, thereby
increasing the nation's vulnerability.
Strategic petroleum reserve only recently initiated.
Congress has ordered the establishment of a Strategic
Petroleum Reserve (SPR)26/ to reduce the impact of a potential interruption. However, the reserve currently contains
only about 77 million barrels, or 7.7 percent of the one
billion barrel goal proposed by the Department of Energy for
1985.27/
International Energy Agency Sharing Plan gives limited
protection.
To minimize the effect on member countries of oil
shortages created by an embargo or other circumstances, the
United States and the 19 other International Energy Agency
(IEA) member countries have agreed to an International Energy
Program under which allocation of oil and mandatory demand
and restraint measures can be triggered when the group as a
whole sustains a 7 percent reduction in oil import supplies
or when any one country (or group of countries) sustains a 7
percent reduction in its oil supplies.28/ Each country is
required to have demand restraint mechanisms in place that
are capable of reducing its oil consumption by 7 percent-about three and one half mmbpd for the IEA countries as a
group based on IEA estimates of probable 1980 consumption.
The supply sharing mechanism is coupled to the activation of
the demand restraint program. In addition, countries have
the obligation to build stocks equivalent to 60 days of
imports.
The interruption of Iranian oil exports has not led to
activation of the IEA oil-sharing agreement. Nevertheless,
IEA member countries are greatly concerned regarding the
current situation in the oil market, which has brought severe
pressure on prices. Accordingly, the IEA Governing Board,
meeting on March 1-2, 1979, agreed that IEA countries would
promptly reduce their demand for oil on the world market by
about 2 mmbpd. This amount corresponds to about 5 percent of
IEA consumption. The share of the U.S. in this reduction
would be just under one mmbpd.
The degree of protection afforded by the combined SPR
and IEA sharing plans depends on a number of variables,
including the amount of oil stored at the time of any inter-
-9ruption, as well as the magnitude and length of the interruption. The current level of protection afforded by the existing SPR and contingency conservation plans is limited.
Because of the relatively small inventory in the SPP> at the
present time, conservation contingency plans take on added
significance as a means of meeting our March 2 commitment to
the IEA or, more generally, our potential commitment under
the provisions of the IEA. Besides measures to reduce oil
consumption by encouraging the use of natural gas, which is
temporarily in surplus, and by shifting to non-oil generated
electric power, the Administration has submitted to Congress
for approval three contingency conservation plans. These
three conservation plans, which were submitted on March 1,
are estimated to save as much as 614,000 bpd. It is anticipated that these demand restraint plans will play a significant part in achieving the consumption reduction agreed upon
on March 2 or in meeting our obligations in case of activation of the international sharing plans.
Impact of the National Energy Act on oil imports
It is estimated the National Energy Act will save between 2.4 and 3.0 mmbpd of oil imports by 1985. Sizeable
savings will occur from the displacement of imported oil by
additional supplies of domestically produced natural gas.
This potential displacement is estimated to be in excess of
one mmbpd. Increased gas supplies are anticipated to result
primarily from provisions in the National Energy Act which
raise the prices of natural gas and permit tapping supplies,
formerly available only to the intrastate market, for the
interstate market.
At the beginning of 1979 there were variously estimated
to be between 1 and 1.4 trillion cubic feet of additional
natural gas supplies immediately available as a result of the
National Energy Act.29/ If these supplies were promptly put
to use, they could displace over 500,000 bpd of imported oil
for the next two or three years. However, there is uncertainty as to how much oil consuming equipment can be
physically converted to use the additional gas and whether or
not such conversion will be practical for the short term.
In summary, while the provisions of the National Energy
Act are estimated to reduce oil imports by about 2.5 mmbpd by
1985, for the immediate future, reductions in oil use will be
modest and will not significantly lessen U.S. vulnerability
to disruptions in foreign supply.
Limited possibilities for the development of alternative
energy sources.
-10Despite national programs to encourage use of alternative energy sources, immediate savings from conversion to
other fuels are limited by the time required to change
existing energy-using capital stock, i.e., industrial equipment, buildings, and transportation vehicles. For example,
the conversion of industrial plants and electric utilities
from oil and gas use to coal is slow, costly and constrained
by environmental considerations. Thus, despite the recent
emphasis on shifting the source of energy in major oilburning
installations, the use of oil in utility plants increased
from 396 mmb in 1971 to 624 mmb in 1977.30/
In the last decade, nuclear generating capability has
grown, but nuclear power's share of domestic energy production remains small. The power generated from nuclear plants
increased from 38.1 billion kilowatt hours in 1971 to 250.9
billion kilowatt hours in 1977.31/ Even so, nuclear sources provide only about 4 percent of total energy production.32/ As the United States' nuclear capability increases,
demancPfor oil and gas by utilities may decline, but at a
slow rate. In addition, the lead time currently required for
placing a nuclear power plant in operation is 10-12 years.33/
Overall, the provisions of the National Energy Plan anticipated that nuclear power would reach an oil equivalent of 3.8
mmbpd by 1985, up from 1.0 mmbpd oil equivalent in 1976.34/
However, more recent projections of nuclear power generation
provided by the Energy Information Administration to Congress
are somewhat lower.35/
To date, renewable sources of energy, such as solar,
wind, and geothermal, have not made significant contributions
as substitutes for oil and gas. The 1977 National Energy
Plan forecasts that these domestic energy supplies will increase from 1.5 mmbpd of oil equivalent in 1976 to 1.7 mmbpd
oil equivalent in 1985.36/ This increase of only 200,000 bpd
of oil equivalent indicates that any significant energy contribution from such new sources will not take place until
after 1985.
Expanded domestic production hampered under current
conditions.
Domestic production of crude oil has declined, from a
peak of 9.6 mmbpd in 1970 to 8.7 mmbpd in 1978, despite the
addition of production from the Alaskan North Slope.37/
Production from Alaska began in 1977 and by 1978 reacHed the
current design capacity of the Alaskan pipeline of 1.2 mmbpd.
Absent further incentives for the sale of Alaskan crude, pro-
-11duction is estimated to remain at this level offering no further offset to the decline in production in the lower 48
states.
Of particular concern is the rapid decline of lower tier
"old" oil production under the current pricing structure.
The production of old oil is important because it constituted
over 50 percent of domestic production at the beginning of
1977.38/
Production of old oil was projected to decline from 3.5
mmbpd in 1978 to 1.95 mmbpd by 1985, an annual decline rate
of 8 percent over the seven year period.39/ However, Treasury studies have placed the actual annualPdecline rate for
old oil at over 16 percent for the 12 month period beginning
in December 1977. Decline rates are greatly influenced by
the economics of production which may account for the
abnormally high rates experienced in recent months.
Proven domestic reserves of crude oil have declined
steadily from 39 billion barrels in 1970 (at the time of the
Alaskan North Slope discovery) to an estimated 29.5 billion
barrels at the end of 1977.40/ Moreover, subsequent to the
discovery of oil at Prudhoe Bay, the new reserves added each
year have not equaled annual production. The outlook for
discovering significant quantities of new domestic petroleum
reserves is uncertain from a geological standpoint.41/ Undiscovered oil resources in the U.S. are estimated To range
from 46 to 143 billion barrels with a median amount of
roughly three times the current proven reserves.42/ New
reserves can only be proven by drillings. In adaTtion, there
is a significant potential for enhanced recovery from known
deposits of oil.
Domestic production from existing wells has been
hampered by price regulations that discourage some categories
of marginal production. There are indications that at $15
per barrel (1976 $ ) , enhanced production may amount to as
much as 1.5 mmbpd by 1990.43/
In addition, the entitlements
program, designed to equalize the price of imported and
domestic crude oil to domestic refiners, has in fact encouraged oil consumption by indirectly subsidizing purchasers of
foreign oil.44/
Under the current pricing structure, there appears
little prospect for substantially increasing oil production
or even stemming the natural decline of old oil. On the
other side of the supply-demand system, conservation measures
taken to date have not been sufficient to slow the rise in
-12demand adequately. Thus, the nation's current prospects of
reducing its vulnerability to interruptions in oil imports
are not promising.
4. The impression of vulnerability created by the
nation's seeming inability to control its increasing
dependence on oil imports directly affects the
nation's defense and foreign policy.
The United States' increasing reliance on foreign oil is
perceived by its industrialized allies, the developing world,
the Soviet bloc and the oil exporting countries themselves
both as a sign of weakness and of a lack of internationally
cooperative behavior. This perception works to the nations
disadvantage in terms of its national defense and its foreign
policy.
National Defense.
The Department of Defense has described the national
defense impact of the nation's dependence on imported oil:
The threatened impairment of the national
security must be assessed not only in terms of the
domestic capability to support national defense
needs ... but also in terms of international perceptions. Other countries make decisions on foreign relations and defense matters based upon their
perception of our strengths. The impact of petroleum import ...(dependency] on the United States
could alter these perceptions significantly causing
them to misjudge U.S. intentions. Such decisions
would affect directly the security of the United
States.
See Appendix B.
The State Department concurred that dependence impairs
the national defense:
Our treaty obligations, particularly those
that relate to mutual security, require the United
States to be able to conduct an effective defense
of its own interest and to make an effective contribution to the defense of its allies. Heavy dependence on imported oil can create doubts about
our ability to sustain prolonged conflicts and
assist our allies in an optimum way.
See Appendix B.
-13Foreign policy.
The dependence of the nation on imported oil a£so adversely affects its ability to achieve its foreign policy
objectives and fulfill its international obligations. Other
countries may doubt this country's resolve to fulfill political commitments or respond to challenges when the contingencies to which it may have to respond could affect the availability of oil. Respect for the United States' ability to
take charge of its energy problem is critical to maintaining
a position of world leadership. The State Department
reported:
It is our view that the current oil import situation impairs our ability to achieve our foreign
policy objectives, both economic and political...
Moreover, the way in which we deal with this situation is widely regarded by other countries as a
test of United States leadership and determination
to play a constructive role in international relations .
See Appendix B.
5. Conclusion
The nation's current and projected dependence on forei';
oil is appreciably greater than when past findings determine
that dependence on foreign oil threatened the national security. The risk of interruption has not significantly lessened, and measures to reduce substantially the impact of interruption are not yet in place. The threat to the national
security is thus greater now than at any time in the past.
III. THE MONETARY REPERCUSSIONS OF EXCESSIVE DEPENDENCE ON
IMPORTED OIL THREATEN TO IMPAIR THE NATIONAL SECURITY^/
1 . The efforts of the U.S. to strengthen the dollar at
home and abroad are being hampered by the excessive
dependence on imported oil.
Efforts to strengthen the dollar.
Although the United States is pursuing a broad array of
policies to establish the fundamental economic conditions for
a strong dollar, these efforts are being hampered by excessive dependence on imported oil. A program of monetary and
fiscal restraint, supplemented by voluntary wage-price programs, is being implemented to bring inflation down and
achieve a more sustainable economic expansion. This will
-14contribute to a substantial reduction in the U.S. trade and
current account deficits, which is a prerequisite ,for the
maintenance of a strong and stable dollar. A new-export
promotion program is expected to help increase exports further. However, curbing this country's reliance on imported
oil is essential to any major and lasting improvement. As
pointed out in a previous section, the actual cost of annual
oil imports increased nearly thirty-fold from 1959 to 1978,
from $1.5 billion to about $42 billion. In 1978, oil imports
represented roughly 25 percent of the total imports of the
United States and amounted to about one and a quarter times
the total merchandise trade deficit.
In 1979, oil import costs are expected to rise substantially. The December 1978 OPEC price hike alone will add
about $4 billion to the cost of U.S. oil imports during 1979
and even more in 1980. The disruption in world supply patterns due to political developments in Iran has already led
to some further price rises and created the risk of substantial increases.
The continuing excessive dependence on imported oil is
making it more difficult to achieve U.S. economic objectives.
The rising price o£ imported oil increases inflationary pressures by directly raising costs and by heightening inflationary expectations. Uncertainties about supplies and costs
hamper confidence and inhibit investment required for noninflationary growth. The growth of oil imports puts greater
adjustment burdens on other elements of the U.S. balance of
payments since it greatly increases the need for expansion of
exports or decreases in other imports. With reduced dependence on oil imports, the U.S. economy could maintain
appropriate levels of growth and grow faster with a lower
inflation rate and a stronger dollar.
Exchange market perceptions.
Because of its impact on the U.S. trade and current
account deficits, excessive and growing U.S. dependence on
oil imports increases the danger of reduced confidence in the
dollar and makes the dollar more vulnerable to downward
pressures in the foreign exchange market.
If downward pressures on the dollar were to become so
servere as to damage world confidence in the dollar, the
national security of the United States would be impaired.
The dollar serves as the principal international currency for
the world economy. The dominant share of world trade is denominated in dollars. About three-fourths of all medium and
-15long-term borrowing in international capital markets is in
dollars. The IMF indicates that nearly 80 percent of
official foreign currency reserves held by foreign central
banks is in dollars. Thus, loss of confidence in trte dollar
if widespread, would be likely to precipitate sudden and
large-scale international capital flows in ways which would
be disruptive to the banking system and world financial
markets. The danger of resort to restrictive measures which
would jeopardize the open trade and payments system would be
greatly increased.
As the Federal Reserve Board has indicated:
Concern about the U.S. deficit and the international value of the dollar could lead holders of
dollars to undertake reductions in their dollar
assets. Exchange market uncertainties would thereby be heightened and instability increased. It is,
therefore, necessary to demonstrate our resolve to
contain our oil imports and to help avoid the economic disruption that could follow from such portfolio shifts.
See Appendix B.
Chairman Miller of the Federal Reserve Board has noted
the relationship between the exchange value of the dollar anc"
the health of the U.S. economy:
At current quantity and price levels, imported
petroleum is a major factor in the large U.S. trade
and current account deficits. This has contributed
to the substantial depreciation of the dollar in
relation to other major currencies. Such depreciation adds to domestic inflation, fosters higher
U.S. interest rates, creates instability in the international financial markets, and threatens further increases in international oil prices. These
in turn foster conditions that could lead to lower
domestic economic activity and higher unemployment.
See Appendix B.
Moreover, the world associates a strong currency with a
strong country. The United States' relations with other
nations and its ability to exercise leadership in political
and military affairs are closely linked to confidence in the
dollar.
According to the Department of State:
-16-
dollar. This in turn has created difficulties in
achieving the maximum degree of international cooperation to further our objective of promoting a
stable, balanced recovery of the world economy...
See Appendix B.
2. Conclusion
A perception of continued inability of the nation to
resolve its oil import problem could have significant consequences for the value of its currency and could thus seriously harm the nation's economic welfare. Such a perception,
therefore, threatens to impair the national security.
IV. FINDINGS
This investigation has established that
U.S. dependence on foreign oil has increased
since 1975 and there has been no change in the
risks of interruption, resulting in a greater
threat to the national security than before;
the monetary repercussions accompanying the
growing dependency on imported oil constitute a
threat to the national security, even apart from
the possibility of supply intejye-uptions.
'H. Mundheim
General Counsel
Department of Treasury
MAR 1 4 1979
-17FOOTNOTES
1/ The 1959 finding was announced in Presidential "Proclamation 3279, on March 10, 1959, 24 Fed. Reg. 1781 (1959). The
1975 Treasury finding appeared as U.S. Dep't of Treasury,
Report on Investigation of Effect of Petroleum Products on
the National Security pursuant to Section 232 of the Trade
Expansion Act, as amended, 40 Fed. Reg. 4457 (1975).
2/ See Presidential Proclamation 3279, 24 Fed. Reg. 1781
Tl959) as amended (quotas), modified by Presidential
Proclamation 4210, 38 Fed. Reg. 9645 (1973) (license fees).
The supplemental license fees imposed by President Ford
following the 1975 finding were subsequently revoked.
3/ FEA v. Algonquin SNG Inc., 426 U.S. 548 (1976).
4/ President's Special Committee to Investigate Crude Oil
Imports, Report to the President, March 6, 1959.
5/ President's Special Committee to Investigate Crude Oil
Imports, Report to the President, July 29, 1957.
6/ U.S. Dep't of Treasury, Report, supra note 1.
7/ Department of Energy Organization Act, Pub. L. No. 95-91,
sec. 101, 91 Stat. 567 (to be codified at 42 U.S.C. sec. 7112
(1977)).
8/ Emergency Petroleum Allocation Act of 1973, sec. 2, 15
U.S.C. sec. 751 (1973).
9/ National Energy Conservation Policy Act of 1978, Pub. L.
No. 95-619, sec. 102, 92 Stat. 3206, (to be codified at 42
U.S.C. 820 (1978)).
10/ 3 [ 1977J Energy Information Adm. Ann. Rep. to Cong. 23
Thereinafter cited as EIA Annual Report]. Imports for 1975
and 1978 are on balance of payments basis, derived from
Bureau of Census statistics and covering imports from foreign
countries into U.S. Customs territory plus the Virgin Islands
and Guam; data obtained from Balance of Payments Division,
Bureau of Economic Analysis, Department of Commerce.
11/ Data from Monthly Energy Review, Feb. 1979, at 30,
adjusted to a balance of payments basis.
12/ For 1959, see 3 EIA Annual Report, supra note 10 at 5,
71. For 1978, see Monthly Energy Review, Feb. 1979, at 4,
30, adjusted to a balance of payments basis.
13/ Data by source are from Department of Energy and differ
slightly from balance of payments data. For 1978 data, see
-lft
Letter from Deputy Secretary of Energy John O'Leary to
Secretary of Treasury W. Michael Blumenthal (March 9, 1979).
For 1975 data, see Monthly Energy Review, May 1978, at 12,
14. For 1959 data, see Independent Petroleum Association of
America, United States""Petroleum Statistics 1978 preliminary). The 1959 data are for countries which are Jiow OPEC
members. Estimated indirect imports for all years have been
included.
14/ Monthly Energy Review, Feb. 1979, at 30, adjusted to a
Balance of payments basis.
15/ Production data based on first 9 months of 1977 and 1978.
See U.S. Dep't of Energy, Energy Data Reports, Petroleum
Statement, Monthly, Sept. 1978, at 7.
16/ American Petroleum Institute, Estimated U.S. Supply/Demand Situation, June 1978, at 2.
17/ U.S. Dep't of the Interior, Energy Perspectives II, June
1T76, at 191.
18/ Ich at 194.
19/ Canadian National Energy Board, Report, "In the Matter of
Exportation of Oil," October 1974, 4-7.
20/ Data are Department of the Treasury estimates, based on
information supplied by Department of Energy and the Central
Intelligence Agency. Includes both direct and indirect
imports.
21/ An indication of productive capacity can generally be
estimated from the proven reserves. It should be noted that
the Middle East contains approximately 385 billion barrels of
proven crude oil reserves. This is almost 60% of the entire
world's reserves. Within the Middle East, Saudi Arabia,
Kuwait and Iran have 281 billion barrels. These three
countries dwarf the rest of the world in their current
reserves. By contrast, the reserves of Indonesia are only 14
billion barrels; Nigeria, 19 billion barrels; and Venezuela,
14 billion barrels. See "Estimated Proved and Provable
Petroleum Reserves," in Central Intelligence Agency,
International Energy Statistical Review, Feb. 7, 1979 at 4.
22/ Mexican exports to the U.S. constituted 0.3 percent of
U7S. oil imports in 1973, about 2 percent in 1977, and are
expected to continue to rise in the future. See Monthly
Energy Review, May 1978, at 12, 14.
23/ Unit value for 1959 is for crude oil only; those for 1975
and 1978 cover crude and products. Data are based on Bureau
of Census import statistics, and were obtained from Balance
of Payments Division, Bureau of Economic Analysis, Department
-19of Commerce.
24/ Balance of Payments basis. Represents Bureau d£ Census
statistics covering imports from foreign countries into U.S.
Customs territory plus the Virgin Islands and Guam.
25/ Iran, Iraq, Kuwait, Qatar, Saudi Arabia, and United Arab
fmirates.
26/ Energy Policy and Conservation Act, sees. 151-166, 42
U7S.C. sees. 6231-46 (1976).
27/ The Department of Energy's Strategic Petroleum Reserve
plan, amendment no. 2 to increase the size to one billion
barrels became effective June 13, 1978.
28/ Agreement on an International Energy Program, Brussels,
September 27, 1974, ch. IV.
29/ See, e.g., Section 232 Investigation Comment of American
Gas Association dated February 21, 1979 (on file at U.S.
Dep't of Treasury) .
30/ Monthly Energy Review, May 1978, at 38.
31/ see 3 EIA Annual Report, supra note 10, at 5.
32/ Monthly Energy Review, Feb. 1979 at 6.
33/ The Administration supported a nuclear siting and licensing bill in Congress which would reduce lead time to 6 - 7
years. H.R. 11704, 124 Cong. Rec. H.2,298 (daily ed. March
21, 1978). The Administration anticipates introducing a
similar bill in the near future.
34/ Executive Office of the President, National Energy Plan,
April 29, 1977, at 95 [hereinafter cited as the NEP].
35/ According to the NEP, nuclear power will equal 24.5 percent of total electricity generated in 1985. NEP, supra note
32, at 95. The EIA forecasts 19 percent nuclear power for
slightly less electricity generated in 1985. 2 EIA Annual
Report, supra note 10, at 215.
36/ NEP, supra note 35, at 96.
37/ For 1970 data, see 3 EIA Annual Report, supra note 10, at
23; includes lease EoTdensate. For 1978 data, see Monthly
Energy Review, Feb. 1979, at 28.
38/ Monthly Energy Review, Feb. 1979, at 76.
39/ 2 EIA Annual Report, supra note 10, at 139 (table 6.9).
-2040/ American Petroleum Institute, Reserves of Cru$e Oil,
Natural Gas Liquids and Natural Gas in the United -States and
Canada as of Dec. 31, 1977 24 (1978).
41/ 2 EIA Annual Report, supra note 10, at 149 (figure 6.3).
42/ 2 EIA Annual Report, supra note 10, at 149 (table 6.14).
43/ National Petroleum Council, Enhanced Oil Recovery, Dec.
T?76, at 6 (figure 2).
44/ Entitlements essentially average the cost of crude oil to
refiners. Higher priced imported oil is averaged in with
lower priced, price-controlled domestic oil. The cost to
refiners of a composite barrel is approximately $2/bbl. less
than the cost of imported oil.
45/ The data in this section were developed by the Office of
International Monetary Affairs, Department of Treasury.
FOR IMMEDIATE RELEASE
March 21, 1979
Contact: Robert E. Nipp
202/566-5328
TREASURY ANNOUNCES RESULTS OF GOLD SALE
The Department of the Treasury announced that 1,500,100
troy ounces of fine gold were sold yesterday to 20 firms and
individuals who bid successfully at a sealed bid sale.
Awards of 1,000,000 troy ounces of gold in 400 ounce bars
whose fine gold content is 99.5 to 99.94 percent were made to
16 successful bidders at prices from $240.00 to $244.00 per
ounce, yielding an average price of $2 41.30-per ounce. Bids
for this gold were submitted by 20 bidders for a total amount
of 2.1 mi-l-lion ounces at prices ranging from $234.75 to
$244.00 per ounce.
Awards of 500,100 troy ounces of gold in 300 ounce bars
whose-fine-gold content is 89.9 to 9 0.1 percent were made to
12 successful bidders at prices from $238.74 to $242.03 per
ounceT" yielding an average price of $240.09 per ounce. Bids
for this gold were submitted by 19 bidders for a total amount
of 0.8 million ounces at prices ranging from $233.17 to $242.03
pex~ounce.
Gross proceeds from today's sale were $361.4 million.
Of the proceeds, $63.3 million will be used to retire Gold
Certificates held by Federal Reserve Banks. The remaining
$298.0 million will be deposited into the Treasury as a
miscellaneous receipt.
The list of the successful bidders and the amount of gold
awarded to each is attached. The General Services Administration
will release details on the individual awards later.
The current sale was the eleventh in a series of monthly
auctions being conducted by the General Services Administration
on behalf of the Department of the Treasury. The next sale,
at which 1,500,100 ounces will be offered, will be held on
April 17, 1979. At this sale, 1,000,000 fine troy ounces
will be offered in bars whose fine gold content is 99.50 to
99.94 percent. The minimum bid for these bars will be for
400 fine troy ounces. A total of 500,100 ounces will be
offered in bars whose fine gold content is 89.9 to 91.7 per
cent. The minimum bid for these bars will be 300 fine troy
ounces. Bids for bars in each fineness category will be
evaluated separately.
B-1475
(over)
Firm
Fine Troy Ounces
Amax Copper Inc
New York, N.Y.
50,700
Bank Leu
New York, N.Y.
13,200
Credit Suisse
Zurich, Switzerland
23,100
Derby & Co LTD
London, England
10,000
Deutsche Bank
Frankfurt, Germany
200,000
Dowdex Corporation
Chicago, 111.
1,600
Dresdner Bank
New York, N.Y.
274,000
Englehard Minerals and Chem
New York, N.Y.
72,000
Gerald Metals Inc
New York, N.Y.
30,000
Gold Standard Corp
Kansas City, Mo.
400
J. Aron & Company
New York, N.Y.
76,400
Metals Quality Corp.
New York, N.Y.
27,600
Mocatta Metals Corp.
New York, N.Y.
80,000
Noranda Sales Corp. LTD.
Toronto, Ontario, Canada
18,300
Republic National Bank of N.Y,
New York, N.Y.
143,500
Samuel Montagu Inc.
New York, N.Y.
28,000
Sharps, Pixley Inc.
New York, N.Y.
66,200
Swiss Bank Corporation
Zurich, Switzerland
107,100
Union Bank of Switzerland
Zurich, Switzerland
256,000
Westway Metals Corp.
Englewood CI, N.J.
22,000
FOR IMMEDIATE RELEASE
March 21, 1979
Contact:
Alvin M. Hattal
202/566-8381
TREASURY ANNOUNCES FINAL DETERMINATION
IN COUNTERVAILING DUTY INVESTIGATION OF
AMPICILLIN TRIHYDRATE AND ITS SALTS
The Treasury Department today announced a final
determination that exports to the United States of
ampicillin trihydrate and its salts from Spain are
being subsidized.
The Countervailing Duty Law requires the Secretary
of the Treasury to collect an additional duty equal to"
the subsidy paid on merchandise exported to the United
States.
As a result of its investigation, Treasury found
that Spanish manufacturers of this merchandise received
subsidies.
Notice of this action will appear in the Federal
Register of March 22, 19 79.
Imports of this merchandise from Spain during 19 78
were valued at about $5.4 million.
o
B-1476
0
o
FOR IMMEDIATE RELEASE
March 21, 1979
Contact:
Alvin M. Hattal
202/566-8381
TREASURY REVOKES COUNTERVAILING DUTIES
ON CERTAIN PRODUCTS FROM URUGUAY
The Treasury Department today announced its decision
to revoke countervailing duties on imports of Uruguayan
leather handbags, non-rubber footwear, leather wearing
apparel and a number of textile products. Countervailing
duties will not be collected with respect to any of the
products covered which were exported from Uruguay on or
after February 16, 19 79.
The decision was based on a finding that the export
of these goods is no longer being subsidized. The
Treasury Department found that the Government of Uruguay
had totally eliminated the net subsidy each product was
receiving when it was exported to the United States by
the imposition of a tax on all exports of the affected
products to the United States on or after February 16, 19 79,
in amounts equal to the subsidy applicable to that product.
The Government of Uruguay will also inform the Treasury of
any instances in which the tax was not properly imposed on
any goods destined for the United States.
With respect to leather handbags, non-rubber footwear,
and leather wearing apparel, the Treasury had determined
in early 19 78 that Uruguayan exports of these products to
the United States were subsidized but that, based on actions
undertaken by the Government of Uruguay to eliminate those
subsidies, the imposition of countervailing duties was
waived. In November 1978, however, it was determined that
the conditions on which the waiver was based were no longer
applicable and the waiver was revoked. The posting of
estimated countervailing duties on all imports of those
items from Uruguay has been required since that time.
In the case of certain textiles and textile products,
the Treasury determined in November 19 78 that exports of
those products to the United States were being subsidized,
and countervailing duties have been imposed since that time.
B-147T
(MORE)
- 2 -
Notice of these actions will appear in the Federal
Register of March 22, 19 79.
Imports of leather handbags, leather wearing apparel
and non-rubber footwear were valued at about the following
amounts for 1978: leather handbags, $6.3 million; leather
wearing apparel, $27.8 million; non-rubber footwear, $18.7
million. No import statistics were available on Uruguayan
textile products.
o
0
o
FOR RELEASE AT 4:00 P.M.
March 22, 1979
TREASURY'S 52-WEEK BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for approximately $3,340 million, of 364-day
Treasury bills to be dated April 3, 1979, and to mature
April 1, 1980,
(CUSIP No. 912793 3F 1 ) . This issue will not
provide new cash for the Treasury as the maturing issue is
outstanding in the amount of $3,346 million.
Without assurance, before the auction date of March 28, of
Congressional action on legislation to raise the temporary debt
ceiling, the Treasury will postpone this auction.
The bills will be issued for cash and in exchange for
Treasury bills maturing April 3, 1979. The public holds $1,666
million of the maturing issue and $1,680 million is held by
Federal Reserve Banks for themselves and as agents of foreign and
international monetary authorities. Tenders from Federal Reserve
Banks for themselves and as agents of foreign and international
monetary authorities will be accepted at the weighted average
price of accepted competitive tenders. Additional amounts of
the bills may be issued to Federal Reserve Banks, as agents of
foreign and international monetary authorities, to the extent
that the aggregate amount of tenders for such accounts exceeds
the aggregate amount of maturing bills held by them.
The bills will be issued on a discount basis under
competitive and noncompetitive bidding, and at maturity their par
amount will be payable without interest. This series of bills
will be issued entirely in book-entry form in a minimum amount of
$10,000 and in any higher $5,000 multiple, on the records either
of the Federal Reserve Banks and Branches, or of the Department
of the Treasury.
Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington,
D. C. 20226, up to 1:30 p.m., Eastern Standard time,
Wednesday, March 28, 1979. Form PD 4632-1 should be used to
submit tenders for bills to be maintained on the book-entry
records of the Department of the Treasury.
Each tender must be for a minimum of $10,000. 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.
B-1478
-2Banking institutions and dealers who make primary markets in
Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such
securities may submit tenders for account of customers, if the
names of the customers and the amount for each customer are
furnished. Others are only permitted to submit tenders for their
own account.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury. A
cash adjustment will be made on all accepted tenders for the
difference between the par payment submitted and the actual issue
price as determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit
of 2 percent of the par amount of the bills applied for must
accompany tenders for such bills from others, unless an express
guaranty of payment by an incorporated bank or trust company
accompanies the tenders.
Public announcement will be made by the Department of the
Treasury of the amount and price range of accepted bids.
Competitive bidders will be advised of the acceptance or
rejection of their tenders. The Secretary of the Treasury
expressly reserves the right to accept or reject any or all
tenders, in whole or in part, and the Secretary's action 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 weighted average price (in three
decimals) of accepted competitive bids.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on April 3, 1979,
in cash or other immediately available
funds or in Treasury bills maturing April 3, 1979.
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.
-3Under Sections 454(b) and 1221(5) of the Internal Revenue
Code of 1954 the amount of discount at which these bills 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 these
bills (other than life insurance companies) must include in his
or her 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 Circulars, Public Debt Series Nos, 26-76 and 27-76, and this notice, prescribe the terms of
these Treasury bills and govern the conditions of their issue.
Copies of the circulars and tender forms may be obtained from any
Federal Reserve Bank or Branch, or from the Bureau of the Public
Debt.
FOR RELEASE AT 4:00 P.M.
March 22, 1979
TREASURY TO AUCTION $1,500 MILLION OF 14-YEAR 10-MONTH BONDS
The Department of the Treasury will auction $1,500
million of 14-year 10-month bonds to raise new cash. They
will be an addition to bonds which are currently outstanding.
Additional amounts of the bonds may be issued to Federal
Reserve Banks as agents for foreign and international
monetary authorities at the average price of accepted
competitive tenders.
Without assurance, before the auction date of March 29,
of Congressional action on legislation to raise the temporary
debt ceiling, the Treasury will postpone this auction.
Details about the new security are given in the
attached highlights of the offering and in the official
offering circular.
oOo
Attachment
B-1479
HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 14-YEAR 10-MONTH BONDS
TO BE ISSUED APRIL 5, 1979
March 22, 1979
Amount Offered:
To the public
Description of Security:
Term and type of security
Series and CUSIP designation
Maturity date February 15, 1994
Call date
Interest coupon rate
$1,500 million
14-year 10-month bonds
9% Bonds of 1994
(CUSIP No. 912810 CF 3)
No provision
9%
Investment yield To be determined at auction
Premium or discount
To be determined after auction
Interest payment dates
August 15 and February 15
Minimum denomination available $1,000
Terms of Sale:
Method of sale
Accrued interest payable by
investor
Preferred allotment
Deposit requirement 5% of face amount
Deposit guarantee by designated
institutions
Key Dates:
Deadline for receipt of tenders
Settlement date (final payment due)
a) cash or Federal funds
b) check drawn on bank
within FRB district where
submitted
c) check drawn on bank outside
FRB district where
submitted
Delivery date for coupon securities.
Price auction
$20.74210 per $1,000
Noncompetitive bid for
$1,000,000 or less
Acceptable
Thursday, March 29, 1979,
by 1:30 p.m., EST
Thursday, April 5, 1979
Tuesday, April 3, 1979
Monday, April 2, 1979
Thursday, April 5, 1979
FOR RELEASE AT 4:00 P.M.
March 23, 1979
TREASURY TO AUCTION TWO CASH MANAGEMENT BILLS
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills, as follows:
24-day bills (to maturity date) to be issued April 2, 1979,
representing an additional amount of bills dated October 26, 1978,
and to mature April 26, 1979 (CUSIP No. 912793 Y2 6 ) . The
amount of the offering will be announced March 28.
78-day bills (to maturity date) for approximately $3,000
million, to be issued April 4, 1979, representing an additional
amount of bills dated December 21, 1978, and to mature June 21,
1979 (CUSIP No. 912793 Z2 5 ) .
Without assurance, before the auction dates for the bills,
of Congressional action on legislation to raise the temporary
debt ceiling, the Treasury will postpone the auctions.
Competitive tenders will be received at all Federal Reserve
Banks and Branches, up to 12:30 p.m., Eastern Standard time, on
the auction dates. The 24-day bills will be auctioned Thursday,
March 29, 1979. The 78-day bills will be auctioned Friday,
March 30, 1979.
Noncompetitive tenders will not be accepted. 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. Each
tender for each issue must be for a minimum amount of $1,000,000.
Tenders over $1,000,000 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.
The bills will be issued on a discount basis under
competitive bidding, and at maturity their par amount will
be payable without interest. Except for definitive bills in
the $100,000 denomination, which will be available only to
investors who are able to show that they are required by law
or regulation to hold securities in physical form, this
series of bills will be issued entirely in book-entry form
in a minimum denomination of $10,000 and in any higher
$5,000 multiple, on the records of the Federal Reserve Banks
and Branches.
B-1480
2.
Banking institutions and dealers who make primary
markets in Government securities and report daily to the
Federal Reserve Bank of New York their positions in and
borrowings on such securities may submit tenders for account
of customers, if the names of the customers and the amount
for each customer are furnished. Others are only permitted
to submit tenders for their own account.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the
book-entry records of Federal Reserve Banks and Branches, or for
bills issued in bearer form, where authorized. A deposit of 2
percent of the par amount of the bills applied for must
accompany tenders for such bills from others, unless an express
guaranty of payment by an incorporated bank or trust company
accompanies the tenders.
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 of their tenders. The Secretary of the
Treasury expressly reserves the right to accept or reject
any or all tenders, in whole or in part, and the Secretary's
action shall be final. Settlement for accepted tenders in
accordance with the bids must be made or completed at the
Federal Reserve Bank or Branch in cash or other immediately
available funds on Monday, April 2, 1979, for the 24-day
bills, and on Wednesday, April 4, 1979, for the 78-day bills.
Under Sections 454(b) and 1221(5) of the Internal
Revenue Code of 1954 the amount of discount at which these
bills 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 these bills (other than life insurance
companies) must include in his or her Federal income tax
return, as ordinary gain or loss, the difference between the
price paid for the bills 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 Circulars, No. 418 (current
revision), Public Debt Series - Nos. 26-76 and 27-76, and
this notice, prescribe the terms of these Treasury bills and
govern the conditions of their issue. Copies of the
circulars may be obtained from any Federal Reserve Bank or
Branch.
FOR RELEASE ON DELIVERY
Expected at 10:00 a.m.
March 27, 1979
TESTIMONY OF THE HONORABLE ROBERT CARSWELL
DEPUTY SECRETARY OF THE TREASURY
BEFORE THE
SENATE COMMITTEE ON 'BANKING, HOUSING AND URBAN AFFAIRS
I am pleased to present the views of the Administration
on S. 85 and S. 353. We support the efforts of the Congress
to deal with the question of appropriate reserve requirements
for depository institutions at this time. The Administration
has endorsed several approaches to this question, including
H.R. 7, which is presently under consideration in the House
of Representatives. We hope the Congress will be able to
act on this matter expeditiously.
Many plans have been put forward to deal with this
problem. Rather than discussing them in detail, I would
like to reiterate the principles that we believe should
govern this undertaking.
They are:
— improvement of the tools available to the
Federal Reserve in the implementation of
monetary policy.
B-1481
- 2 - reducing competitive inequities among depository institutions engaged in the same
or similar lines of business.
- restraining the negative impact of any changes
on the Federal Budget in this period when the
Administration and the Congress are striving to
squeeze down the deficit.
Universal and Uniform Required Reserves
These objectives are best served by imposing mandatory
reserve requirements on all institutions holding similar
deposit balances. Since reserve requirements are important
to the effective formulation and implementation of monetary
policy, their coverage should not be contingent upon voluntary or induced membership in the Federal Reserve System.
They should be regarded as a price and a necessary component
of participation in the monetary system rather than a result
of decisions about the choice of a regulator, the value of
access to- the discount window or a nice balancing of the costs
of maintaining reserves against the benefits of membership.
Moreover, to the extent that all institutions maintaining:
transaction balances have the same level of reserves, the
link between the aggregate amount of reserves and the money
supply is made more firm.
For these reasons, S. 85 like H.R. 7 takes a constructive
step in severing the connection between reserves and Federal
Reserve membership, and by focusing instead on the'type of
balance involved. Extending reserve requirements to thrifts
for transaction accounts is a timely shift toward competitive
equality and a more equitable distribution of the reserve
burden. The adverse impact on thrifts is relatively small
because their transaction balances are small at this time.
Of course, it is not possible to achieve full equality
of treatment with this step. There are many small depository institutions that with some justification will resist
a reserve obligation on the ground that the adverse impact
on earnings is too great, and their participation, while
theoretically correct, may not in practice be necessary to
the effective conduct of monetary policy. Reserves in excess of vault cash of the smaller banks would in any event
constitute only a small proportion of total reserves.
- 3 Accordingly, some exemption from universal reserves
for small institutions may therefore be appropriate, but we
would hope that the exemption would be as small as possible.
In this regard S. 85 goes a step beyond H.R. 7.
The reporting requirements contained in the bill provide
important supplementary monetary coverage of all depository
institutions not required to hold reserves. The report forms
and statistics should be brief and rely as much as possible
on existing information flows. The paperwork burden of all
institutions, particularly the smaller, should be kept to a
minimum.
Finally, we do not think that the concept of universal
reserves is inconsistent with the principles of the dual
banking system. That system recognizes that when there
is an overriding Federal interest in an issue, the groundrules should be established by the Federal government. That
is the case, for example, with, international banking. It
is also the case with monetary policy. So long as reserves
have a role to play in this process, all banks similarly
situated should have the same burden to the extent practicable.
Surely the Federal Government has no responsibility to insure
the viability of state supervision by making it financially
unattractive for a bank to be a member of the Federal Reserve.
The strength of the system comes from the choice it offers .
on supervision and examination. That choice remains unchanged
by this bill. Moreover, the availability of Federal Reserve
services to all banks at nondiscriminatory rates will make
Interest
Reserves
it. easieronfor
a larger bank to be a nonmember.
In the last Congress, the Administration indicated that
if the Congress decided that the holding of reserves should
continue to be voluntary, then the Administration would
support legislation to reduce the financial burden of membership through the payment of interest on reserves. For
all the reasons I have noted, we very much prefer the approach
of required reserves embodied in this bill.
- 4 Revenue Loss Projections
In testimony before this Committee last June and August
and in a letter to the House Banking Committee in September
1977, the Administration stated that it would accept a revenue
loss of $200-300 million, after tax recoveries, to deal with
this problem. Then, in an October letter to this Committee,
with the budget outlook tightening, we indicated that a
revenue loss at the lower end of that range was preferable.
In the current budget environment, a solution to the membership
problem involving a revenue loss under $200 million, net of
tax recoveries, is essential. That figure is based on 1977
data and assumes full implementation. We understand that the
Federal Reserve staff estimates that the pretax cost of
fully implementing S. 85 on that basis would be approximately
$133. million or $73 million after tax. The comparable cost
figures for S. 353 would be $1,299 million and $714 million,
respectively.
I have attached to my written statement a table showing
the projected revenue impact of the changes contemplated by
S. 85 over the next five years.
In any calculation of the total annual cost of a membership solution, the Congress should focus particular attention
on the fiscal 1980 budget impact. There are several elements
in the revenue and cost figures that make the near term
financial results of the various membership solutions a special
concern. In determining the after-tax revenue loss for most
proposals, estimates of tax recaptures that may take several
years are used. These deferred tax effects might leave a
disproportionate after-tax shortfall in the first year of
most annual loss projections.
Similarly, most proposals assume income of about $410 million from the explicit pricing of Federal Reserve services to
reduce the annual net revenue loss the proposals will generate.
Yet, not all the revenue will be available in fiscal 1980.
It will take time to develop and institute prices on some
services.
Accordingly, our support of S. 85 is premised on the
assumption that the Federal Reserve will fully offset any
revenue loss during the transition years. Chairman Miller
has advised me that the Board of Governors has agreed to
this approach.
- 5 Other Issues
Section 6 of S. 85 would require the Federal Reserve to
price its services and make them available to all depository
institutions, whether or not they are members or hold reserves. Once access to System services is no longer required
as an inducement to membership, the more general availability
of Federal Reserve services should benefit the banking system
as a whole. Moreover, requiring that the Federal Reserve
price services on a basis involving full allocation of cost,
with appropriate allowances for costs unique to private
organizations such as capital.and taxes, should allow other
vendors to compete with the System more effectively. Hopefully,
market mechanisms will then become important in establishing
the prices of these services and the relative roles of the
competing vendors.
*
*
*
This concludes my formal testimony, Mr. Chairman. I
would be pleased to answer any questions the Committee may
have.
Estimated Revenue Effects of S. 85
Fiscal Years 1980-84
($ millions)
1980
Fiscal Years
1981
1932
1983
1984
-373
-787
-831
-879
-929
icrease in Federal Reserve earnings from
extension of reserve requirements to
nonmembers, phased in over 4 years
beginning October 1979
55
120
197
289
319
crease in Federal Reserve earnings from
charges for Federal Reserve services,
phased in over 2 years beginning
October 1979
1
271
535
579
630
682
Net change in Federal Reserve earnings •
before tax recovery
-47
-132
-55
40
72
35
31
-3
-28
-31
-97
-24
37
44
29
92
149
206
268
-5
125
243
312
sduction in Federal Reserve earnings due
to reduction in reserve requirements for
member banks, at October 1979 projected
membership levels* phased in over 2 years
beginning October 1979
come tax offset 16
Net revenue effect before offset for
membership attrition under present
Federal Reserve requirements
'set due to loss in Federal Reserve
earnings caused by membership attrition
mder present Federal Reserve requirements
adjusted for tax offset)
Net revenue effect -2
ice of the Secretary of the Treasury
Office of Tax Analysis
.•
March 26, 1979
Assumptions Underlying Revenue Estimates of
1.
S, 85
Reduction in Federal Reserve earnings due to attrition in
member bank reserves:
(a) between December 1977 and September 1979 member bank
deposit attrition continues at the average of the
nation for the period 1974-77 (i.e., the member bank
share of total commercial bank deposits declines
1.4 percentage points per year);
(b) total commercial bank deposits increase at an average
annual rate of 8.5 percent each year after 1977; and
(c) the average return on the Federal Reserve portfolio
is 6.5 percent per year from October 1979 through
September 1984.
2. Increase in Federal Reserve earnings from charges for
services:
(a) full charging for Federal Reserve services, if fully
implemented at the end of 1977, would have generated
$410 million; and
(b) Federal Reserve revenue from such charges grows
proportionally to the growth in deposits.
3. Recovery of the loss of Treasury revenue from the decline
-in Federal Reserve earnings:
(a) additional commercial bank earnings are taxed at-an
average marginal rate of 35 percent;
(b) the lagged additional dividends paid to commercial
bank stockholders from the higher commercial bank
after-tax earnings increases total tax recovery
2-1/2 percentage points per year until the total
tax recovery reaches 45 percent of the additional
commercial bank earnings in four years.
4. Offset due to loss in Federal Reserve earnings caused by
membership attrition under present Federal Reserve
requirements:
(a) if S. 85 is not enactecr, the attrition of member
bank deposits after 1979 would accelerate to a rate
midway between that experienced in New England (4.6%)
and that of the nation (1.4%);
- 2
(b) total commercial bank deposit growth and Federal
Reserve portfolio return are as indicated in
assumption 1; and
(c) the tax offset to higher earnings of member banks
no longer subject to required reserves is as indicated
in assumption 3.
Office of the Secretary of the Treasury
Office of Tax Analysis
March 27, 1979
FOR IMMEDIATE RELEASE
EXPECTED AT 2:00 P.M., EST
TUESDAY, MARCH 27, 1979
STATEMENT OF THE HONORABLE C. FRED BERGSTEN
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE SUBCOMMITTEE ON FOREIGN OPERATIONS
COMMITTEE ON APPROPRIATIONS
HOUSE OF REPRESENTATIVES
Introduction
Treasury has reviewed the Report on the International
Financial Institutions prepared for the House Appropriations
Committee by the Committee's Surveys and Investigations Staff.
We welcome this effort to add to the state of knowledge on
the operation of the Multilateral Development Banks (MDBs).
We also welcome the opportunity to assess fully and on the .
record the merits and shortcomings of these institutions.
We note at the outset that the Report records both a number
of positive conclusions about the banks — around fifty, by our
count — and a number of criticisms. Of these shortcomings, many
have been identified by the banks themselves — indeed, internal
bank documents are the source of most of the criticisms noted by
the investigators — and corrective action is already underway.
Some of the other criticisms are simply based on misconceptions,
which we will try to clarify during these hearings. But some of
the criticisms clearly call for additional responses; we will seek
B-1482
-2to implement remedial measures in the banks as rapidly as
possible, and report back to the Congress on our progress within
three months.
In general, we regard the Report as a useful aid in the
consultation process between the Administration and the Congress
on U.S. participation in the development banks.
I should
note for the record that the Survey and Investigations staff was
granted complete access on an unrestricted, open-door basis to
Treasury personnel and to the office of our Executive Directors
at the Banks throughout the course of their work.
Indeed, they
were housed at Treasury for over a year to do the Report. We
recognized the importance of the study from its initiation and
were open, accessible and forthcoming in collaborating with
the staff.
Today I will respond to the recommendations contained
in the; Report and, with my colleagues, will be prepared to
respond to specific criticisms cited in it.
An Overview of the Report
Let me summarize quickly our overview of the Report.
Of its seven substantive chapters (II-VIII), the first
("Operational Mechanisms and Interrelationships of the
International Finance Institutions") is a summary of how
the banks function.
In terms of attention and concern, the heart
-3of the Report is contained in Chapters III.-Y-: Oversight
Procedures of the U.S. Executive Branch, Accountability of
the International Financial Institutions, and Administrative
Practices, Staffing and Remuneration. These three chapters
account for over two-thirds of the analytical material in
the Report. Chapters VI-VIII represent the other concerns
spelled out in the Committee's directive to the investigators:
Commodities, Human Rights and Reaching the Poor.
Virtually the entire Report is thus devoted to an examination
of MDB processes rather than results. Process is important.
But the Report does not address the question of whether the
poorer countries have been successful in achieving development,
whether the banks have been successful in promoting development,
or whether supporting the banks represents an effective way
to pursue the U.S. national interest in development. In assessing
the Report, we should not lose sight of the fact that in no way
does it question the fundamental contribution which the
multilateral banks have made to development and improved living
conditions in the poor countries of the world.
In addition, the Report does not question the cost-effectiveness
of providing U.S. foreign assistance through the MDBs: that
every dollar we put into the banks is matched by three dollars
from other donor countries, and that the World Bank over its
lifetime has made $50 of loans for every $1 we have paid into it.
Nor does the Report question that the banks bring clear economic bene
-4to the United States:
that every dollar we have paid into them
has directly generaged $2.40-$3.40 of
additional U.S. GNP and created 50-100,000 jobs annually, and
that our balance of payments has gained about $2.5 billion from
the operations of the banks throughout their histories. In short,
the Report deals with an important but narrow set of issues — bu
some of the most central features of the banks and of U.S. polic
What is_ the record? What has been achieved? The
excellent study prepared last year by the Congressional
Research Service concluded that:
... there has been spectacular growth of GNP in the last
25 years... per capita income in the LDCs increased
3.4 percent /over this peridd/. This was faster than
today's developed countries grew during the initial
phases of their development, faster than the LDCs
had ever grown before, and faster than anyone expected
them to grow. (p. 37)
This economic growth has been accompanied by dramatic advances
in literacy, education, nutrition, health, family planning and
life expectancy — in sum, in the central indicators of the
quality of life.
The matter can be brought closer to home. Many countries
that were heavily dependent on U.S. bilateral economic aid or
grants in the early 1960's no longer need such aid. They
now rely entirely on MDB loans at market rates and on loans
from private commercial banks.
This outstanding performance was achieved during the
period in which .the World Bank and its sister institutions,
-5-
the regional development banks, were being formed and reaching
maturity. The banks have increasingly become the base of
external support for the development process, and have
contributed importantly to the development results just cited.
We believe that they have become the most efficient and costeffective international agents for economic and social progress
in the developing world. Nothing in the Report suggests
otherwise.
Why is this so?
The answer cannot be found solely in the size of the
lending programs of these banks — important as they are.
They now supply about 10-15 percent of the total external
capital moving to the developing world. The proportion is
much higher for the poorest countries who do not have the
credit standing to borrow on international capital markets.
Nonetheless, the main contribution of the banks lies in the
catalytic effect of their operations on the flow of capital from
other sources, and in the manifold ways in which they encourage
efficient economic policies in the borrowing countries and
thus increase domestic savings and investment.
Their catalytic role is widely demonstrated. The MDBs
have guided the development of new international assistance
efforts such as the Caribbean Development Group, the Islamic
Development Bank, the OPEC Special Fund and the International
Fund for Agricultural Development. They help to coordinate
-6the bilateral assistance programs of the OECD countries.
Key development strategies used in the poorer countries have
been formulated with the help of the MDBs: growth with equity,
project design to reach the poor, appropriate technology,
integrated rural development, and energy development.
Furthermore, the major commercial banks in the United States
and other industrial countries depend heavily on the World Bank's
assessment of conditions in developing countries to determine
their own country risk profiles. The existence of lending
programs by the Multilateral Development Banks is an important
element in determining the availability and size of loans
from the commercial banks. The MDBs have done
much to open the door of international capital markets to
creditworthy developing countries.
The contribution of these Banks to promoting economic
efficiency is also a matter of record. This is accomplished
by assisting the developing countries in:
— the preparation of national development plans;
— the formulation of economic policies;
— the identification and design of individual projects;
— the supervision and control of project costs and
execution;
— the development of human capital; and,
— the strengthening of local administration and institutions.
What do these general statements mean? Some specific
examples may help to bring them to life.
-7In 1971, the World Bank ceased lending to Argentina
until that country took steps to implement needed economic
policy changes. In 1972 Pakistan responded to the World Bankchaired donor consortium by liberalizing its imports and
rationalizing its foreign exchange system. The World Bank's
basic economic report on the Philippines in 1976 advanced
an overall policy framework which served as a basis for the
country's current five-year development plan.
Examples of constructive influence on Tanzania include
improving electrical and water supply tariff structures,
improved budgetary control and import liberalization. The
Inter-American Development Bank required the Government of Brazil
to prepare and present a five-year sector program prior to
its approval of a specific loan. Also in Brazil, the World
Bank has built up through technical assistance the institution
in charge of many of the rural development programs in the
impoverished northeastern part of the country — POLONQRDESTE, some
of whose projects I have visited personally and found to be of excep
high quality. The World Bank has improved the operating
efficiency of rural credit institutions in India by insisting
on tough organizational changes to promote greater loan recovery.
In Bangladesh, World Bank recommendations led to reduced
governmental subsidies for wheat and rice and increasing the
price paid to the farmer. The Asian Development Bank has
insisted on revised water-user charges prior to approving
a number of urban water supply projects.
-8In Kenya, World Bank recommendations which were incorporated
in the national development plan included higher producer
prices for farmers, exchange rate changes and wage
restraint in the high wage urban areas — all of which served
to channel a greater share of total income to rural areas.
In Indonesia, technical assistance from the World Bank increased
the management capabilities of the irrigation authority of
western Java, now considered to be among the most capable
public works agencies in Indonesia. In Bolivia, the IDB
recognized the need to expand the agricultural frontier
into virgin territories and underdeveloped areas; its
projects in the transportation, communication and agricultural
sectors were designed with the goal of national economic
integration in mind.
In the Dominican Republic, the IDB has decided on a plan
of action which will focus on the key sectors of agriculture
and energy. With respect to the energy sector there, the plan
calls for developing the nation's hydroelectric potential. In
Morocco the World Bank has, through its policy discussions and
project preparation activities, had a major influence on
urban development policy — a policy that is now much more
responsive to the needs of the poorest population at a cost
which is widely replicable.
In almost every single project financed by the banks, there
are specific requirements which must be met in terms of pricing
-9policy, cost recovery, project implementation monitoring,
institution building, and evaluation. In a very real sense,
each project thus becomes a vehicle for improving the
economic policies of the borrowing country. This is the
influence exercised by the banks. It is what lies behind
the statement which appears on page 45 of the Investigators
Report:
Multilateral lending embraces a subtle influence
throughout the Third World of encouragement of
beneficial adherence to economic patterns of the
Free World rather than embracing the communist
patterns of development with the assistance offered
by the IFIs being insulated from policy variations
of any one member country.
This, however, is only one of many positive statements
about the banks in the report under review today. From
press coverage to date, and indeed from a cursory reading
of the Summary and Observation section of the Report, one
might be led to conclude that the Report had nothing positive
to say about the banks. This is far from true, and it might
help right the balance to cite some of the more
important of these comments:
1. ...at the World Bank and the ADB operational
efficiency is clearly recognizable in the quality
of professional staff and the procedural controls
and systems. (p. 10)
2. The IFIs are interested in aspects of a country's
economy wherein the most influence might be expressed
in altering or emphasizing broad economic policies
and in building institutions within the country... (p.
-103. In its field visits, the Investigative Staff observed
a number of uses of light capital technology in
agricultural, rural development, urban development
irrigation, and road projects in Latin America, Asia,
and Africa. All were being effectively used and local
project managers and government officials were highly
pleased with the inclusion of such approach in the
design of the projects. (p. 42)
4. Multilateral institutions enjoy a political
assistance (sic) frequently more effective, staffs
trained in a variety of disciplines to provide technical
assistance, leverage of capital with borrowing in private
markets, equitable burden-sharing among donors, and
freedom to employ infrastructure and industrial
development which generate employment that are outside
the scope of USAID. (p. 45)
5. The United States has considerably greater day-to-day
review of matters coming before the Executive Directors
than does any member country ... (p. 62)
6. Generally effective systems of management control
are operative in all of the IFIs, with the World Bank's
being perhaps the most sophisticated. (p. 71)
7. From a management viewpoint, the World Bank is
tightly controlled in the areas of program planning,
budget, finances and operations. (p. 77)
8. The internal audit reports issued in FY 1978 appear
to be meaningful, necessary and consistent with IBRD
Internal Audit Department functional responsibilities.
The Investigative Staff examined a representative sample
of audit reports of its own selection and found them
to be of good quality. (p. 80)
9. The United States was instrumental in obtaining
a study of compensation principles and structure
of the IMF and World Bank by private consultants which
resulted in a January 1978 report to the Governments
of France, Germany, Japan, the United Kingdom and the
United States. (p. 113)
10. The Investigative Staff reviewed an abundance of
evidence reflecting a clear awareness within the IFIs
of the plight of the poor as well as efforts to shift
their lending not only toward the poorer developing
countries but also toward reaching the poor elements
in all the LDCs. (p. 165)
-1111. In general, the 36 projects which were designed
mainly to assist the poor or had substantial segments
so designed were being diligently pursued by local
project managers and staff toward objectives
set, and the failures encountered in meeting objectives...were
outweighed by the accomplishments being achieved. (p. 167)
However, many criticisms of the banks are also presented
in the Report. We do believe that a number of its findings
are simply wrong, that others reflect a misunderstanding of
the ways in which the institutions operate, and that still
others represent problems which the banks or the U.S.
Government are already addressing. Nevertheless, we have
examined all these criticisms with an open mind and, as
you will see, are prepared to adopt new policy measures to
respond to a number of them.
A great many specific criticisms are made, and we are
prepared to respond to all of them during the course of
these hearings. It seems to us, however, that there
are three areas in which the Report is most critical:
— The auditing and evaluation efforts of the banks;
— The flow of information to member countries;
— The ability of the United States to effectively
influence the management of the institutions.
- 12 Audits and Evaluations
A major theme of the Report is that the MDBs should
do a much better job in auditing and evaluating their own
activities.
The Report (p. 70) addresses the confusing and
interchangeable use of the words "audit" and "evaluation" and
comes to essentially the right conclusion:
"In this
Report, traditional definitions are adhered to in that audit
refers to the methodical review and verification of records
of account, and evaluation refers to the study and appraisal
of the worth of a function or of its product."
I would add
to the latter"... and the achievement of the aims originally
intended within cost and time factors originally set forth."
In these terms, the audit requirements of the
banks are well established.
There are many internal checks.
One principal check is the requirement for tendering foreign
procurement through international competitive bidding.
This is the basic procedure used internationally and, of course,
by the U.S. Government, to ensure that the best quality goods
and services are procured at the best price.
Winning suppliers
- 13 and contractors are held to account for their performance and
the proper use of funds. Where there are lapses, the MDBs
take corrective action.
Each MDB's charter contains provisions requiring the
institutions to ensure that the funds made available to
borrowers are used only for the purpose for which the loan
was made. In pursuance thereof, borrowers are required to
substantiate their expenditures of MDB funds by submitting
contracts or confirmed purchase orders, evidence of payment,
suppliers' invoices and bills of lading, contractors' and
consultants' invoices and certificates of work progress,
letters of credit, commercial banks' reports of payment and
whatever other documentation is appropriate in a given
circumstance.
Evaluation is carried out by normal implementation,
supervisory, and financial procedures. In addition, I would
like to call attention to a relatively new system instituted
by the World Bank. It is called "built-in project monitoring
evaluation." This procedure builds into project implementation
a continued surveillance by special units. Their goal is to
evaluate project performance to assess its economic impact,
measure project management efficiency, and get a better
understanding of the motivations and constraints of the project
beneficiaries.
This system also can, and does, bring to light instances
of financial or other irregularities. In FY 1976 and
-14FY 1977 about 60 percent of the agricultural projects had
built-in M&E units, costing an average of 2 percent of total
project costs. This is a relatively new mechanism, and the
Bank is still actively engaged in improving its effectiveness
and utility.
We also believe that the report fails to credit the banks
for the extensive efforts they already make in this area.
Last year's study by the Congressional Research Service,
conducted for this committee, referred as follows
to the World Bank:
In reading the reports of the Operations
Evaluation staff, one is struck by the
extremely critical analyses of Bank projects
contained therein. The harshest analyses we have.
read of the Bank's operations come from its own
Operations Evaluation unit. The criticism was
more well informed than that found in the popular
press and academic journals.
and:
Among the bilateral and multilateral development
agencies the World Bank is probably the most selfcritical. The Bank staff appears to be making
a genuine effort to learn from experience and to
alter future policies in light of what can be learned
from past successes and failures.
In connection with the auditing and evaluation
procedures employed by the banks, I would like to bring
to the attention of the Committee a number of studies
conducted by the General Accounting Office. The GAO has been
monitoring the banks' review and evaluation procedures since
1973. This was in response to the will of the Congress as
-15expressed in PL93-18 9, which amended the Foreign Assistance
Act of 1961 and provided that the U.S. Executive Director to the
IBRD shall "actively seek the establishment by the governing
authorities" of an independent program of "review and
evaluation of the programs and activities" of the Bank.
The law further provided that the reports prepared under such
an independent program shall be transmitted to Congress and
to the Comptroller General. Furthermore, the Comptroller
General is charged with reviewing these reports and reporting
to the Congress "any suggestions the Comptroller General may
deem appropriate concerning auditing and reporting standards...,
the recommendations made and actions taken as a result of
such recommendations." All of the foregoing is being
complied with fully.
In 1974, in response to U.S. urging, the World Bank
created a new post of Director General, Operations Evaluation.
The incumbent is appointed by the Board, holds office for
renewable terms of five years, is removable only by the Board
and reporting directly to the Board. The Director General's
operating arm is the Operations Evaluations Department. OED's
independence has been advocated by the GAO, and applauded by
the GAO. The Department is charged with preparing the project
performance audits on each completed project, and other
evaluation studies and operational policy reviews. All OED
reports go to the Board and to the Congress.
-16The GAO reviewed the IBRD's evaluation system in June
of 1978 and issued a report entitled, Effectiveness of the World
Bank's Independent Review and Evaluation System. Its
principal conclusion was: "The World Bank Group...has made
considerable progress toward developing an independent and
continuous selective examination, review, and evaluation
of the Bank's programs and activities."
Regarding the ADB, the U.S. Director, in
response to the 1973 legislation, recommended that the
Bank establish an independent evaluation system. The ADB
system was established in 1973 and a special post-evaluation
unit was created in 1974. In response to GAO suggestions,
and the recommendations of the U.S. Director, the
recent ADB reorganization (July 1978) upgraded this unit
to an office, added staff, altered reporting responsibility
to the President, and broadened its mandate. The GAO held
discussions with ADB management and expressed the hop© this
office would eventually report directly to the Board.
In June 1977 the ADB Board established a three-member
Audit Committee, again largely in response to concerns
expressed by the U.S. Executive Director. The Audit Committee
is charged with reviewing the adequacy and efficiency of the
bank's internal audit and post-evaluation activities. Quoting
from the Investigators' Report:
The Audit Committee has been active and
successful in the recent strengthening of
^/^ ln^ernal au<*it function and the post
evaluation function.
-17.Moreover, in assessing the committee, the Report concludes:
Accountability of management to the Board within ADB is
enhanced subtly by ...the informal and free interchange
of activity and bank documents between the Board
and Management....
In the case of the IDB, Congressional interest in the
evaluation function pre-dated the 1973 legislation. In 1967
(PL 90-88), Congress advocated that a review unit be
established. At U.S. urging, a three-member Group of
Controllers was established in 1968. Appointed from outside
the Bank, they report directly to the Board. An American has
always been one of the three members of this Group. The
Group has concentrated primarily on internal administrative
and policy making procedures.
The GAO in a June 1978 study concluded:
The effectiveness of the Group has improved
steadily since its creation.
It went on to state:
"...of 150 recommendations the Board has approved,
122 had been fully or substantially implemented...the
fact that Management has implemented so many of the
Group's recommendations indicates that the Group is
contributing to improving the Bank operations."
The IDB Board, after some months of consideration, has
acted to reorganize the Group of Controllers. As of
July l, 1979 the present Group of (three) Controllers
*ill be replaced by a single Director of External Review
nd Evaluation. The broad authority to look into any and
-18all activities of Bank activity will be continued, as will
previous policy of selecting the Director from outside
Bank staff and proscribing service on Bank staff after
expiration of his term. The reorganization also
establishes a standing Committee of the Board to guide and
supervise the work of the, Director and staff. This
reorganization was strongly supported by the U.S. Executive
Director and follows GAO suggestions.
This brief summary of the comments of the GAO regarding
its review of the MDB auditing and evaluation systems indicates
that, over the years, substantial improvements have been
made in these systems — largely in response to U.S.
recommendations. Indeed, the Report itself points to one or
two instances where these systems have achieved their purposes
quite effectively by detecting and correcting behavior
inconsistent with their rules. Contrary to what is
stated in the Report, deviation from prescribed practices
leads to effective counteraction, including requiring the
borrower to issue a new tender for bids or, in extreme
cases, cancellation of a portion of the loan contract or
the entire contract.
Let me cite some recent examples for the Committee's benefit:
1. In an education project in Africa, the Ministry of
Education purchased building materials in excess of the
agreed quantities and by negotiations instead of
international competitive bidding as required by the Bank.
The Bank refused to finance the additional quantities and
-19-
cancelled $130,000 from the credit —
of those building materials.
the amount
2. On a railway loan in a Mid-Eastern country,
bidding was undertaken for carrier telephone
equipment and the borrower awarded the contract
to a local supplier, who was the second-lowest
bidder, instead of to the lowest responsive
bidder, who was foreign. As a result
the Bank cancelled the amount in question —
$300,000 — from the loan.
3. In a Middle Eastern country a road
construction contract was awarded to a state
controlled construction company rather than
to the lowest evaluated bidder. As a result,
a supplemental loan for the highway program
amounting to some $15 million for this country
was dropped by the World Bank.
-20However, further improvements can be made.
In this
regard, a number of suggestions made in the Investigators'
Report will be quite useful, and we will pursue them.
Specifically, we share the Investigators' opinion
that, to the maximum feasible extent, the banks' auditing
systems must be independent and detached from the operational
side of the institution. There we support, and will promote,
suggestions that:
1. The World Bank's Internal Audit Department
should report directly to the President (p.79)
2. In the IDB, the Auditor General should not
report to an official with operating
responsibilities (p.89).
We also agree with the Investigators* recommendation
that regular monitoring of all internal bank functions should
be instituted by the auditing arms of the respective banks.
No internal management system is fault-free; all can be
improved.
We therefore also support the following recommendations
and will press for their adoption within the MDBs:
3. The ADB's evaluation unit should not limit
itself to project evaluations; it should
also evaluate Bank operations (p.98).
4. The World Bank's OED should devote more time
and resources to broad review of how well
management performs its responsibilities (p.83).
5. The IDB should establish an Audit Committee
composed of Executive Directors similar to
the ones in the World Bank and the ADB (p.89).
6- The IDB Group of Controllers should evaluate
the work of the Auditor General's office (p.89).
-217.
The IDB Operations Evaluations Office reports
should be made available to the EDs (p.90).
We will report back to Congress on our progress in
promoting these changes in the MDBs in three months'
time.
The Flow of Information
The flow of information is obviously critical to the
effective functioning of any institution, public or private.
We thus take extremely seriously the concerns expressed in
the Report that there is excessive classification of MDB
documents, that some documents are not available to the
Executive Directors and that some which are available are
not, but should be, circulated routinely.
We agree that more bank documents should be available
to the public and that the number of bank documents with
a limited distribution can be further reduced. The
United States has already made a great deal of progress
in achieving such a reduction. We will persevere, in the
interest of maximum openness of the operations of the banks.
-22-
However, as noted by Secretary Blumenthal in his
testimony before this Committee last year:
"Complete disclosure of all documents is neither
desirable nor feasible. Each IFI's policy on
disclosure must balance the oversight responsibilities of its member governments with the
confidential nature of normal bank/client
relationships. This last consideration
deserves additional explanation. In the course
of their economic policy advisory role, the
IFIs often recommend politically unpopular
measures. If these recommendations become
public information through extremely liberal
public disclosure policies, domestic political
opposition would impede the effectiveness of
the IFIs' role. So we cannot achieve, nor
do we want, complete disclosure."
Despite this important caveat, let me state clearly
that Executive Directors in the MDBs have access, on
request, to all bank documents necessary to carry out
their responsibilities. We are exploring whether more
documents should be routinely available to the Executive
Directors.
We also believe that documents distributed to the
Executive Directors and available to concerned government
departments should be available to appropriate Congressional
Committees under suitable arrangements to protect, where
necessary, their confidentiality. We understand that such
arrangements have been worked out in other policy areas and
look forward to working out satisfactory understandings in
this area as well.
I must also take this occasion, Mr. Chairman, to remind
the Committee that — while we can, and will, seek changes in
-23the classification system of the banks —
the United States,
like all member countries, is required to observe the rules
governing disclosure of bank documents. The Surveys and
Investigation Staff acknowledged this requirement, and
clearly indicated in its Memorandum for the Chairman (of
the Committee) which transmitted the Report that it had
obtained internal bank documents with a limited distribution
with the understanding they would be afforded the same
protection as required by the institutions. We regard
it as extremely unfortunate that, despite repeated
discussions and my letter of March 20, the Committee publicly
released the Report without deleting specific references
drawn from internal bank documents with a limited distribution. I request that my letter of March 20 be inserted
in the record to make clear the views of the Administration
on this issue.
The Report points out that U.S. influence in the banks
is reduced when we fail to fulfill our financial pledges,
or inject extraneous political issues into bank policy
discussions. A failure to observe the normal standards of
conduct pertaining to the treatment of bank documents can
only risk a similar result. Treasury neither had, nor has,
any desire to suppress one iota of substance in the Report,
but we cannot lightly disregard a clear obligation of
membership in the banks.
-24U.S. Influence on the Banks
This reference to U.S. influence in the banks reminds
us that, in numerous places, the Report suggests that the
United States lacks influence on bank policy.
one, the Report is simply wrong.
On this
In fact, this criticism
is somewhat ironic because a frequent charge levied at
the United States by other donor and borrower countries —
and often by the banks' managements and staffs themselves —
is that the banks, far from independently dominating the
member nations, are completely under the thumb of the
United States.
To be sure, the United States cannot dictate its
every wish to the banks on every issue.
These are multilateral
institutions where others contribute 75 percent of the funds.
If we (or any other country) stray far from the charters, or
the purpose of the banks, our views will be poorly received.
But whenever our own efforts are seen as promoting internationally
acceptable goals or the objectives of the institutions themselves,
we can generally gain the support of other members required to
assure success.
To a large extent, the charge of "no U.S. influence"
is contradicted by the Report itself.
It remarks favorably
on the influence of the U.S. Executive Directors in advancing
appropriate technology as a consideration in bank
lending.
it cites the success of the United States in
-25initiating a review of World Bank salaries; indeed, it
rightly says that the force of the United States in
advocating the salary review has created strong pro and
anti-United States factions within the banks.
It comments
on how United States views are taken into account in general
development issues.
It describes the major shift in the
banks' lending priorities to better reach the poor, a
major development assistance objective of the United States.
It points out the success the United States has had in reducing
the paid-in component in the periodic capital increases of
all the MDBs.
These are hardly the signs of "no influence."
But there are many other examples of effective U.S.
influence on the banks, usually taken in cooperation with
other member countries in reflection of the realities of
multilateralism:
The World Bank
—
The United States has advocated increased
MDB lending for energy development; the
World Bank has recently announced a major
program of energy lending.
—
The United States has recommended shifts in
the Bank's sectoral lending composition; the
World Bank is lending much more in the
agricultural and rural development sectors.
-26-
—
The United States has urged the World Bank
to adopt an interest formula which relates
interest charges to costs of borrowing; the
Bank has adopted such a formula.
— The United States along with other members
recommended that IDA lending for basic needs
projects be resumed to certain eligible
countries; IDA resumed such lending.
— The United States supported the creation of
an independent Operations Evaluation Department;
the OED is now an important arm of the World Bank.
The United States has encouraged the World Bank
to act as an international financial catalyst;
the Bank has increased considerably its cofinancing
of projects.
The United States has suggested that the Bank's
graduation policy be reviewed; the Bank
is undertaking a major review of its graduation
policy.
Inter-American Development Bank
— The United States has urged the IDB's Group
of Controllers be strengthened; such changes
have been implemented.
— The United States has sought the declassification
of the Bank's reports on loans in process and bid
-27-
awards; such reports are now routinely
available.
— The United States has urged improved IDB
budget control and limits on staffing; the
IDB has adopted a functional budget system
and a lid has been placed on staffing, in
spite of an 83 percent increase in lending
volume.
The United States has continuously stressed
the importance of appropriate technology; the
IDB formed an internal management committee
on appropriate technology.
But it has been the recently concluded replenishment
of IDB resources which gives us the best examples of U.S.
influence in the IDB. The objectives we sought and achieved
in the replenishment negotiations include:
Increased concentration of FSO resources on the
poorest countries; more countries have agreed not
to borrow FSO convertible resources.
— All FSO loans not destined for the poorest
countries will directly benefit low income
groups.
— 50 percent of total Bank lending will benefit
low-income groups.
-28-
—
The less developed countries will be able
to borrow moderately increasing amounts
because the advanced countries agreed to a
stable rate of borrowing.
—
The regional borrowing countries will make
a larger portion of their paid-in subscriptions
convertible.
—
The more advanced borrowing countries agree
to make more of their FSO contributions
convertible to assist their less fortunate
neighbors.
The non-regional members will increase their
share of capital and maintain their already high
contributions to the FSO.
The U.S. share of capital and FSO is within the
guidelines established in the Sense of the Congress
resolution.
Asian Development Bank
The Asian Development Bank is an interesting case
to study regarding U.S. influence because, unlike the World
Bank and the IDB, we are not the largest contributor.
Japan is.
Yet even here the record of positive U.S.
influence on the Bank is clear.
-29-
The United States took the lead in advocating the
creation of a post-evaluation unit in 1973. As a recent
GAO report attests, at U.S. urging the unit was expanded
into a full office, its mandate was widened to include
elements of project auditing in addition to project
evaluation, and it was made responsible directly to the
President to increase its independence. It is expected
that within a few years the office will report directly
to the Board, as the GAO has suggested. At U.S. urging,
the ADB Board of Directors committee reviews the internal
auditing and project evaluation functions of the ADB and
makes recommendations for expanding those functions.
The ADB, with consistent U.S. support, has kept tight
control over its administrative costs. In fact, it is
described in the Report as the most cost-conscious of all
the banks. The ADB has, at U.S. urging, declassified its
project pipeline document and has undertaken distribution
on a modest subscription cost basis. This is to improve
the information flow to potential suppliers under bankfinanced projects.
Last year, as part of the reorganization of the ADB,
the United States supported creation of a second vice president'
position in order to rationalize internal management along
more modern lines. The person selected for this position
is a U.S. national. The ADB has, at the suggestion of the
-30-
th e United States, agreed to send its senior procurement officer
on a tour of the United States to speak to business groups
about ADB procurement requirements and opportunities.
The ADB has been responsive to U.S. concerns in
financial policy matters as well. The ADB lending rate
is regularly reviewed to insure that it fully reflects and
covers the Bank's borrowing and administrative costs. Also,
the United States sought and obtained an increase in the commitment
fee charged by the Bank. Partly as a consequence of
these changes, the bond market stature of ADB has been
further enhanced.
In the most recent ADB replenishment of its concessional
loan window, the Asian Development Fund (ADF), the United
States advocated, and it was ultimately agreed, that three
important Southeast Asian countries would gain become eligible
for some ADF loans to help meet basic human needs.
The United States also urged greater burden-sharing, and as part of
that exercise succeeded in reducing the U.S. share on the
ADF replenishment to a figure below that contained in the
Sense of the Congress resolution. In addition, the ADB
has been responsive to U.S. initiatives regarding capital
saving technology, agricultural and rural development lending/
graduation and maturation and local cost financing.
-31The problem in the Report is that it fails to understand
the decision-making process in the banks. It seems to look
solely to the formal meetings of the Executive Boards to see
whether the U.S. Executive Director prevailed on a given vote,
or was overriden. It seems to be based on the assumption
that the Directors rather than management shbuld be responsible
for many of the details of preparing, administering and
auditing or evaluating individual loans.
The actual situation is, and should be, quite different.
The member governments provide the policy framework for the
banks — and, as I have indicated, the United States has
done quite well in achieving its goals in so doing. It is
the job of the banks' managements to execute that policy,
under the daily guidance of the Executive Board. We, and
other member countries, exercise our policy function through
formal and informal meetings of the Governors of the
institutions, through numerous bilateral and multilateral
meetings at every level and, importantly, through the
periodic replenishment negotiations as outlined above.
The record is clear over 35 years: these institutions
have successfully advanced U.S. policy objectives in the
developing nations while the burden of financing has been met
increasingly by other donors. It is a record which bears the
mark of effective U.S. influence in the MDBs.
- 32 Conclusion
In conclusion, I would note again that the Report
does not challenge the funadmental•premises of
U.S. participation in the development banks:
that the development of the poorer countries is a U.S.
national objective of high priority, that the banks are
an extremely cost-effective way through which we can
pursue that objective and that United States policy goals
are effectively advanced.
As I also noted at the outset, the Report—unlike
the summary—also notes the steps which are being taken
by the Bank and the United States to address some of the problems
identified in the report.
I have highlighted in my
statement information on additional measures which have
been taken or planned by the MDBs.
Many of the findings
in this Report are based upon assessments and evaluations
made by Bank managements precisely for the purpose of
improving the effectiveness of their loans and operations.
In addition, the Report points the way toward
further strengthening of the banks in several areas, most
notably the audit and evaluation functions, and the flow
of information.
We have profited from the work of the
Surveys and Investigation staff in these areas, and we are
initiating additional steps to implement several of their
recommendations in the near future.
- 33 Finally, let me reiterate that we view the Report as representing
one more step in the close collaboration and consultation
if not always uniformity of views—which have marked
relations between the Administration and the Congress
on these issues for the past two years.
We are pleased
to have the opportunity to appear before you so promptly
after the filing of the Report, and stand ready to try
to answer any questions you may have.
—
MmentoftheTREASURY
NGTON, D.C. 20220
TELEPHONE 566-2041
For Release Upon Delivery
Expected at 10:00 a.m.
March 27, 1979
Statement of The Honorable Donald C. Lubick,
Assistant Secretary of the Treasury for Tax Policy,
before the Committee on Ways and Means,
Subcommittee on Select Revenue Measures
Mr. Chairman and Members of this Subcommittee:
I am pleased to have the opportunity to present the
views of the Treasury Department on E.R. 2797, the "Technical
Corrections A.ct of 1979." The Technical Corrections Act is
the first of many important bills the Subcommittee will
consider this year, and I look forward to working with you
on a wide range of tax issues.
H.R. 2797 would effect technical changes in four tax
acts adopted in the 95th Congress: the Revenue Act of 1978,
the Foreign Earned Income Act of 1978, the Energy Tax Act of
1978, and'the Black Lung Benefits Revenue Act of 1977. The
staff of the Joint Committee on Taxation has drafted H.R.
2797 in an effort to reflect more accurately and clearly the
Congressional intent underlying these four tax measures.
Treasury staff has had substantial involvement in the
drafting process, and we agree with nearly all the proposed
amendments. In the appendix to this statement, I discuss
the few revisions Treasury recommends. My testimony will
focus on the importance of the technical corrections process
itself and on some of the most significant provisions in the
bill.
Most of us remember vividly the hectic tax legislative
activity in the final days of the 95th Congress. The
conference reports on three major tax bills — the Revenue
Act, the Energy Tax Act, and the Foreign Earned Income
Act — were adopted on October 15, 1978. The Revenue Act
alone comprises about 200 pages of statutory language and
over 100 provisions, with many significant issues being
resolved by the House-Senate conferees during the waning
hours of the session. The draftsmen performed remarkably
well under the severe time pressures; but as expected, there
are some technical problems that need to be corrected this
Congress.
B-1483
- 2 Although the time constraints last fall made the
drafting task especially difficult, the need for technical
corrections is not an isolated phenomenon. Regardless of
the time devoted to consideration and drafting of statutory
language, technical errors are inevitably discovered in
major tax legislation. Problems range from clerical oversights, to ambiguous wording, to unforeseen and unintended
implications of an amendment. These problems become apparent
as Treasury and IRS begin to prepare regulations interpreting
the Code and as taxpayers and practitioners seek to apply
the new provisions to specific fact situations.
Prior to 1977, there was no established mechanism to
correct the errors in tax legislation. Taxpayers and tax
administrators simply had to deal with the statutes as
originally drafted, and to accept many tax results that
Congress did not intend. However, with the introduction of
the Technical Corrections Act of 1977, a formal procedure
was implemented to make technical modifications to the Tax
Reform Act of 1976. The 1977 Corrections Act, like the bill
you are now considering, was drafted initially by the Joint
Committee staff with the aid of comments from Treasury, IRS
and private tax practitioners.
Our experience with the 1977 Corrections A.ct is instructive. Once Congress has made a substantive decision on tax
policy, both taxpayers and the Government have a strong
interest in assuring that the policy is implemented by
proper statutory language; the 1977 Act advanced this
objective, and I believe the effort was well received by all
individuals concerned with the tax system. At the same
time, the process suffered last Congress from undue delay;
technical corrections for the Tax Reform Act of 1976 were
not adopted until passage of the Revenue Act of 1978.
The protracted legislative course of the 1977 Corrections
Act created a number of problems. For example, the delay
affected IRS efforts to make timely and accurate changes in
tax forms. A number of changes were made in the 1977 tax
forms on the assumption that the pending 1977 Corrections
Act would be enacted in 1977. When enactment was postponed
until late 1978, the effective date of one of the corrections
relating to community property laws and to the credit for
the elderly was changed from January 1, 1977 to January 1,
1978 — a change that required corrective action by the IRS
to assure that affected taxpayers did not overpay their 1977
taxes.
- 3 The 1977 Corrections Act was stalled in Congress
because it became encumbered with major substantive amendments. We hope that this problem can be avoided in connection with the consideration of H.R. 2797. Mr. Chairman,
your announcement of March 14, 1979 states that, "Issues
that involve modification of the policy decisions underlying
these acts are beyond the scope of this particular hearing."
Treasury has carefully adhered to this standard, and we urge
other witnesses to do likewise.
Discussion of Specific Provisions
H.R. 2797 contains 66 amendments, not including changes
that are purely clerical in nature. To keep my testimony
brief, I will not discuss all of the proposed amendments;
detailed descriptions are contained in the pamphlet prepared
by the Joint Committee staff. However, I would like to
mention some of the most important provisions in H.R. 2797.
Three amendments are necessary to coordinate properly
the investment credit provisions contained in the Revenue
Act and the Energy Act.
o The Revenue Act was designed to make the investment
credit permanent at a 10-percent rate, rather than
reverting after 1980 to a 7-percent rate as scheduled
under prior law. However, the Energy Act restated the
investment credit provisions of old law and was formally
enacted after the Revenue Act. As a result, the Code
may still technically retain a December 31, 198 0
expiration date for the 10-percent credit. The Technical
Corrections bill would clarify Congressional intent to
make the 10-percent rate permanent.
Certain equipment may qualify for both the regular 10percent investment credit and an additional 10-percent
credit for energy property acquired after September 30,
1978 and before January 1, 1983. Under the Revenue
Act, only one-half of the otherwise qualified investment
is eligible for the regular investment credit where the
taxpayer uses the special 5-year amortization provision
for pollution control facilities and also finances the
facilities with tax-exempt bonds. Congress intended
also to reduce the special energy investment credit to
5-percent in the case of energy property, including
certain pollution control equipment, financed by taxexempt bonds. But through interaction of the two
- 4 provisions, the energy credit is effectively only 2.5
percent with respect to pollution control equipment
subject to the limitations on the regular investment
credit. This result was not intended, and the bill
would amend the Code to provide a 5 percent energy
investment credit to this property.
° The Revenue Act extends the regular investment credit
to certain rehabilitation expenditures attributable to
buildings that are at least 20 years old. To preclude
the claiming of a double regular investment credit,
the credit for rehabilitation expenditures is denied
for property qualifying under other investment credit
rules. As now drafted, the Code also prohibits a
taxpayer from claiming both the energy investment
credit and the regular investment credit for rehabilitation expenditures that qualify as expenditures for
energy property. The bill would correct this unintended
result.
Under the Revenue Act, no deduction is generally
allowed for expenses incurred with respect to entertainment
facilities. The Act specifically excepts "country club
dues" from the new deduction disallowance rule. Congress
did not intend the exception to be so restricted, and the
bill would reflect the Congressional intent by deleting the
word "country" from the exception for club dues.
The Revenue Act increased the capital gains deduction
from 50 percent to 60 percent for individuals (so that 40
percent of individual capital gains would be subject to tax)
and also reduced the alternative capital gains tax rate for
corporations from 30 percent to 28 percent. H.R. 2797
contains several technical amendments to correct drafting
errors and to clarify the application of these capital gains
changes. Among the technical corrections are the following:
° Prior to the Revenue Act, an individual in a high rate
bracket could elect to have the first $50,000 of
capital gains taxed at a 25 percent rate in lieu of
deducting one-half of capital gains from gross income.
This special "alternative tax" for individuals was
repealed for taxable years beginning after December 31,
1978. Through inadvertence, the rules for calculating
the alternative tax for taxable years prior to repeal
were not altered to reflect the increase in the capital
aains deduction from 50 percent to 60 percent. After
- 5 consulting with Treasury staff and the Joint Committee
staff, the Internal Revenue Service prepared its 1978
tax forms and instructions as though the conforming
change were properly made, and the Technical Corrections
bill would now formally correct this oversight in the
Revenue Act.
° The increase in the capital gains deduction for individuals was made effective for sales or exchanges after
October 31, 1978. The reduced alternative capital
gains rate for corporations was made effective for
sales or exchanges after December 31, 1978. Left
unclear was the treatment of payments received after
the respective effective dates for sales or exchanges
occurring before the effective dates. Under the
Technical Corrections bill, the capital gains tax
reductions would apply in instances where the income is
properly taken into account by the seller during a
period after October 31, 1978 (in the case of individuals) or after December 31, 1978 (in the case of
corporations).
Another important change relates to the effective date
of the targeted jobs credit. The Revenue Act was drafted to
make the- targeted jobs credit effective for wages paid or
incurred through December 31, 1980. The statement of
conference managers indicates that the expiration date is to
be December 31, 1981. The statement of managers reflects
the correct Congressional intent, and the Technical Corrections
bill would rectify the clerical error in the Act.
In the appendix to this statement, I list several
suggested amendments to the Technical Corrections bill.
Most of these amendments are minor. But there is one item
that deserves special mention; we believe that the Subcommittee
should delete section 103 (a)(3)(A) of the bill, which would
permit passive net lessors to claim the investment credit
for building rehabilitation.
Since the reinstitution of the investment tax credit in
1971, section 46(e)(3) of the Code has denied the credit to
an individual owner who is merely a passive lessor of the
property. The purpose of this rule is to discourage tax
shelter activities. It has been applied to all property
eligible for the investment credit. Some persons may
advance policy considerations for creating a special exception
- 6 -
in the case of building rehabilitation; however, this issue
is clearly one of substance. Regardless of the relative
merits of the arguments for or against a special exception,
this substantive provision should not be included as part of
a Technical Corrections bill.
Mr. Chairman, with the exception of the "net lease"
provision, H.R. 2797 is limited to technical revisions in
the tax legislation passed last Congress. The bill is an
important effort to relieve confusion and unintended hardship
for taxpayers, but it is not designed to reopen substantive
policy debate on the scores of tax issues considered in 1977
and 1978. To fulfill its purpose, prompt passage is critical.
We join with you in urging that the bill not become a
vehicle for the presentation of controversial, substantive
changes in tax policy.
° 0 °
APPENDIX
TREASURY COMMENTS REGARDING CURRENT PROVISIONS
OF THE TECHNICAL CORRECTIONS BILL
(1) Election for Application of New ESOP "Put" Option
(Section 101(a)(5)(B) of the bill and section 141(g)(5)
of the Revenue Act of 1978).
Employees who receive a distribution of employee stock
from an ESOP must under certain circumstances be given a put
option to dispose of the stock. The Revenue Act of 1978
established new put option conditions with respect to stock
acquired by an ESOP after December 31, 1978. H.R. 2797
would allow an employer to elect to have the new put option
provisions apply to securities acquired by a tax credit ESOP
before January 1, 1979. In effect, this election would
allow an employer to avoid tracing with respect to which
securities were subject to the old or new put option rules.
The bill would also allow an employer to revoke the election
with the consent of the Treasury.
Treasury is opposed to the provision which allows
revocation of an election. The statute provides no guidance
with respect to the standards to be applied in the revocation
process. In the absence of guidance, it is likely that
whatever standards are adopted would be challenged as being
arbitrary. Further, it is likely that there would be
significant administrative problems in dealing with the
revocation process, both in the determination of whether
consent should be granted and in the number of requests for
consent in the absence of statutory guidelines.
If it is intended that revocation is to be allowed only
in very narrowly defined circumstances such as where the
employer was precluded by law from making the election,
there would appear to be ample regulatory authority to
provide relief; if an employer's election were ineffective,
it could be treated by regulations as not having been made.
(2) Antidiscrimination Requirement for Certain Employee
Contributions to an ESOP (Section 101(a)(5)(G)(ii) of
the bill and section 141 of the Revenue Act of 1978).
Prior law relating to ESOPs allowed employers up to an
additional 1/2 percent'investment credit for employer
contributions which matched employee contributions to the
- 2 ESOP. One of the requirements for eligibility to claim the
additional credit was that the employee contributions must
satisfy the antidiscrimination requirements of the Code
applied to qualified plans. This would require actual
contributions from a cross-section of employees and not
merely an opportunity to contribute. Section 101(a)(5)(G)(ii)
of H.R. 2797 would delete the specific reference to the
antidiscrimination requirement with respect to employee
contributions. We understand that the requirement is
believed to be redundant because, under the 1978 Act, ESOPs
must meet all the requirements applied to qualified plans.
If in fact the revision made by this section of the
Technical Corrections bill does not change prior law relating
to employee contributions to a tax credit ESOP, we have no
objection to the change. However, if our understanding is
not correct and if the Technical Corrections bill is intended
to exempt employee contributions to a tax credit ESOP from
the antidiscrimination rules, then we object to the provision
both on the grounds that it is not a technical correction
and on the grounds that such a change would not be sound tax
policy.
(3) Deduction for Estate Tax Attributable to the Noncapital Gain Portion of a Lump Sum Distribution
(Section 101(a)(6) of the bill and section 142 of the
Revenue Act of 1978).
This provision would reduce the amount of. a lump sum
plan distribution, subject to 10-year averaging, by the
amount of estate tax attributable to the lump sum distribution. The revision would be applicable to estates of
decedents dying after the date the bill is enacted.
We agree with the need for a technical amendment, but
we recommend a language change to clarify the intent that
the estate tax deduction in question refers to the estate
tax attributable to the portion of the distribution currently
included in gross income. Under our proposed modification,
paragraph (6) of section 101(a) of the bill would be amended
by striking out "lump sum distribution" at the end of that
paragraph and inserting in lieu thereof "total taxable
amount."
- 3 (4)
Period of Excess Contributions to an Individual Retirement Account (Section 101(a) (12) (E) (iii) of the bill
and section 157 of the Revenue Act of 1978).
The Revenue Act of 1978 added provisions which allow an
excess contribution to an IRA to be withdrawn without income
or penalty tax consequences under certain circumstances.
As included in the Revenue Act, the withdrawal is allowed
for "any contribution paid during a taxable year" if the
conditions are met (Code section 408(d) (4)). The Technical
Corrections bill would revise this provision to apply to
"any contribution paid for a taxable year" (emphasis added).
The proposed technical amendment creates a problem
because the excise tax applied to excess contributions is
based on excess contributions made during a year. The
difficulty is illustrated in the following example:
Assume Employee X is an active participant in a
qualified plan for 1979 and 1980 and that X makes a
contribution to an IRA on January 15, 1980. It is
clear that a contribution made in either year will be
an excess contribution. However, has X made his excess
contribution for 1979 or for 1980? The determination
is significant since the deadline for taking advantage
of the Code section 408(d)(4) withdrawal provision is
determined by reference to the deadline for filing X's
tax return "for such taxable year." If X made the
contribution for 1979, the withdrawal uncTer section
408(d)(4) must take place before he files his 1979
income tax return on April 15, 1980; if the contribution was for 1980, he has until April 15, 1981 to made
the withdrawal.
To avoid confusion, we recommend that section 101(a)
(12)(E)(iii) be deleted from H.R. 2797.
(5) Availability of the Rehabilitation Investment Credit
to Net Lessors (Section 103(a)(3)(A) of the bill and
section 315 of the Revenue Act of 1978) .
Section 103(a)(3)(A) of the bill would permit passive
net lessors to claim the investment credit for expenditures
incurred to rehabilitate certain buildings. Since the
reinstitution of the investment tax credit in 1971, section 46(e)(3) of the Code has denied the credit to an
individual owner who is merely a passive lessor of the
property. The purpose of this rule is to discourage tax
- 4 shelter activities. It has been applied to all property
eligible for the investment credit. Some persons may advance
policy considerations for creating a special exception in
the case of building rehabilitation; however, this issue is
clearly one of substance. Regardless of the relative merits
of the arguments for or against a special exception, this
substantive provision should not be included as part of a
Technical Corrections bill.
(6) Tires Used in the Manufacture of Buses (Section 108(c)(3)
of the bill relating to the Energy Tax Act of 1978).
This section of the bill was intended to provide a
credit or refund of the excise tax on tires and tubes purchased by a manufacturer and placed on a new bus chassis in
view of the fact that the law exempts new buses completely
from tax. However, as now drafted, the amendment applies
only to tires and tubes placed on a "qualified bus." Thus,
there is no credit or refund for a few buses sold for use by
churches, by manufacturers to pick up employees, and by some
charter operations. To extend "exemption" coveraqe to these
buses, sections 6416(b)(3)(C) and 6416(b)(4)(B) of the Code
should be amended as follows:
Paragraph (3)(C) is amended by inserting "is an automobile bus chassis or automobile bus body, or" after
"and such other article". Paragraph (4)(B) is amended
by inserting "is an automobile bus chassis or automobile bus body, or" after "such other article".
New buses are exempted from the excise tax, whether the
buses are domestically manufactured or imported. Therefore,
the bill should also contain an amendment to Code section
4071 (e) to exempt tires and tubes placed on the chassis of
a new imported bus. The exemption could be achieved by
inserting ", or such article is an automobile bus chassis or
automobile bus body" after "4061" in the last sentence of
Code section 4071 (e).
- 5 SUGGESTED ADDITIONS TO THE
TECHNICAL CORRECTIONS BILL
(1) Simplified Employee Pensions (Section 152(g)(2) of the
Revenue Act of 1978).
Section 152(g)(2) of the Revenue Act of 1978 requires
insertion of a cross reference "in the material immediately
following subparagraph (G) of section 415(b)(2)." However,
there is no subparagraph (G) in section 415(b)(2). The
reference should be to "the material immediately following
subparagraph (G) in section 415(a)(2)."
(2) Certain Powers of an Independent Trustee Not Treated
as a Power for Purposes of the Tax on GenerationSkipping Transfers (Section 702(n)(2) of the Revenue
Act of 1978 and section 2613(e) of the Internal Revenue
Code).
The Tax Reform Act of 1976 imposed a tax on certain
generation-skipping transfers. Under the generation-skipping
provisions, an individual is a beneficiary of a trust if he
has a present or future power or interest in it. "Power"
means "any power to establish or alter beneficial enjoyment
of the corpus or income of the trust." A person has an
"interest" if the person has either "a right to receive
income or corpus from the trust" or "is a permissible
recipient of such income or corpus." Thus, one can be a
beneficiary by satisfying either or both of the tests.
In the 1976 Act, Congress sought to exclude certain
independent trustees from being treated as beneficiaries
solely because of powers which they held to distribute trust
corpus and income. The original language in section 2613(e)
of the Code was found too restrictive and section 702(n)(2)
of the Revenue Act of 1978 expanded the categories of
individuals to whom independent trustees could make distributions without being treated as beneficiaries. However,
since the time of enactment of the original generationskipping provisions, there has been a question whether an
individual trustee who was the permissible appointee of
trust assets under an unexercised power of appointment held
by another would be deemed to have an interest in the trust
and therefore be treated as a beneficiary under that test.
- 6 Congress clearly intended to carve out an exception for
independent trustees. The draftsmen did not focus on the
question of whether a contingent future interest, such as
that of a permissible appointee, should be treated as an
interest for purposes of beneficiary determination. We
recommend that, solely for purposes of the independent
trustee exemption, a trustee will not be treated as having
an interest in the trust if his only interest is as a
permissible appointee under a power of appointment held by
another.
The General Explanation of the Revenue Act of 1978
states that an individual trustee will not be treated as a
beneficiary if "he has no interest in the trust other than
as a potential appointee under a power of appointment held
by another." The purpose of this amendment is simply to
codify the intent of Congress, as expressed in the General
Explanation.
(3) Meals or Lodging Furnished for the Convenience of
tne Employer (Section 205 of the Foreign Earned Income
Act of 1978 and section 119 of the Internal Revenue
Code).
Section 4 of P.L. 95-427, which was enacted October 7,
1978, effective for tax years after 1953, redesignated most
of the existing Code section 119 as subsection (a) and added
a new subsection (b). The new subsection (a) began as
follows: "(a) GENERAL RULE.—There shall be excluded. . . ."
Section 205 of P.L. 95-615, the Foreign Earned Income Act of
1978, then amended Code section 119 as follows:
Section 119 ... is amended ... by striking out
"There shall" and inserting in lieu thereof "(a) MEALS
AND LODGING FURNISHED TO EMPLOYEE, HIS SPOUSE, AND HIS
DEPENDENTS, PURSUANT TO EMPLOYMENT. — There shall".
Section 205 of P.L. 95-615 should also have struck out "(a)
GENERAL RULE.—". This clerical chanqe should be included
in the bill.
(4) Gasoline Used in Commercial Fishing (Section 222 of
the Energy Tax Act of 1978 and section 6421(d)(2) of
the Internal Revenue Code).
Section 6421(d)(2)(C) of the Code contains three cross
references relating to refund of fuel and oil taxes for
commercial fishermen. The cross references are not complete.
Two additions are suggested to read as follows:
- 7 "(iv) section 6424 (relating to payments for qualified
business use of lubricating oil), and
(v) section 6427 (relating to payments for special
fuels used other than for the use for which sold)."
(5) Chassis or Bodies Converted to Buses (Section 231 of
the Energy Tax Act of 1978 and section 6416(b)(3)(A) of
the Internal Revenue Code).
While section 231 of the Energy Act exempts from excise
tax sales by manufacturers or importers of bus chassis and
bus bodies, there is no explicit credit or refund provision
if a truck chassis or truck body is sold tax-paid and then
modified to form a bus. This could be rectified with an
amendment to Code section 6416(b)(3)(A) by inserting after
"him" the phrase ", or such other article is an automobile
bus chassis or an automobile bus body". This amendment
would permit the person who modifies the truck into a bus to
apply for credit or refund of the tax on the truck chassis
or body.
(6) Lubricating Oil (Section 404 of the Energy Tax Act of
1978 and section 6416 of the Internal Revenue Code).
Section 404 of the Energy Act provides an exemption
from the tax on lubricating oil with respect to lubricating
oil sold for use in mixing with rerefined used oil; the
exemption is available to the extent that the new oil does
not exceed 55 percent of the mixture and the rerefined oil
constitutes at least 25 percent of the mixture. No provision
was made for credit or refund of tax if tax-paid lubricating
oil is mixed with rerefined oil. To provide for a credit or
refund, a new Code section 6416(b)(2)(N) should be added by
deleting "or" after subparagraph "(L)", by changing the
period at the end of subparagraph "(M)" to a semicolon, and
by adding the following new subparagraph:
11
(N) in the case of lubricating oil taxable under
section 4091, mixed with rerefined oil (as defined in
section 4093(b)(3) and the lubricating oil does not
exceed 55 percent of such rerefined oil."
WASHINGTON, D.C. 20220
TELEPHONE 566-2041
9^
FOR RELEASE UPON DELIVERY
Expected At 9:30 a.m.
STATEMENT OF
THE HONORABLE DONALD C. LUBICK
ASSISTANT SECRETARY OF THE TREASURY (TAX POLICY)
BEFORE THE
SUBCOMMITTEE ON SELECT REVENUE MEASURES
COMMITTEE ON WAYS AND MEANS
March 28, 1979
Mr. Chairman and Members of the Subcommittee:
I am pleased to appear before you today to present the *
Treasury's views on H.R. 2550, a bill dealing with the
deductibility of travel expenses by Federal and State
legislators.
H.R. 2550 would extend for one year, through tax year
1978, the temporary rules on State legislators' travel
expenses which were enacted by section 604 of the Tax Reform
Act of 1976. The Ways and Means Committee approved such an
extension on March 21, 1979. Treasury supports this one-year
extension.
In addition, H.R. 2550 would enact permanent rules on
travel deductions for both State and Federal legislators.
Treasury supports these rules with certain modifications.
B-1484
2
Present Law and H.R. 2550
Section 162 of the Internal Revenue Code allows a
deduction for ordinary and necessary business expenses,
including meal and lodging expenses incurred while travelling
away from home in the pursuit of a trade or business.
For purposes of determining whether travel expenses are
incurred away from home, Code section 162 provides that the
"home" of a Member of' Congress will be his place of residence
within the State, Congressional district, or possession which
he represents in Congress. Section 162 also imposes a $3,000
annual limitation on the amounts which a Member of Congress
may deduct for living expenses incurred away from home.
Transportation fares are deductible without regard to the
$3,000 limit.
Under the temporary rules for State legislators which
were enacted in 1976, a State legislator may elect as his tax
home his place of residence within the legislative district
which he represents. He may deduct for living expenses away
from home, without substantiating those expenses, the amount
computed by multiplying the legislator's total number of
"legislative days" for the year by the per diem amount
generally allowable to Federal employees for travel away from
home. For this purpose, "legislative days" include (1) days
in which the legislature was in session (including any day in
which the legislature was not in session for 4 consecutive
days or less, i.e., weekends) and (2) days in which the
legislature was not in session but the legislator attended a
meeting of a legislative committee.
Revenue Ruling 79-16, 1979-3 I.R.B. 6, holds that for
purposes of these rules the "generally allowable" Federal per
diem is the maximum Federal per diem authorized for the seat
of the legislature. The Federal per diem travel allowance is
$35 for most areas of the United States but is higher for
certain high cost areas, including a number of State
capitals. For example, the Federal per diem for Juneau is
$60; for Honolulu, $58; for Boston, $49; and for Albany, $39.
H.R. 2550 would make permanent these temporary rules for
State legislators. In addition, H.R. 2550 would repeal the
$3,000 limitation on amounts deductible as living expenses by
Members of Congress. The bill would allow Federal
legislators (like State legislators) to deduct, without
substantiating the expenditure, an amount equal to the number
of "legislative days" for the year times the Federal per diem
for Washington, D.C. (which is currently $50).
3
Comments on Permanent Rules Proposed in H.R. 2550
To understand the impact of H.R. 2550, it is necessary
first to understand the travel expense deduction rules which
would apply to legislators in the absence of special
statutory rules. Under the rules applicable to taxpayers
generally, a taxpayer's "home" for purposes of section 162 is
his principal place of business. A legislator's principal
place of business would be determined annually on the basis
of factors involving the total time ordinarily spent by the
legislator at each of his business posts, the degree of
business activity at each location, the amount of income
derived from each location, and other significant contacts.
Thus, under the generally applicable rules, the Washington
metropolitan area would be the tax home for Members of
Congress, regardless of the fact that they maintain their
legal residence elsewhere. With the increasing lengths of
State legislative sessions, the tax home for some State
legislators might well be the State capital.
Thus, under the generally applicable rules for
determining tax home, Members of Congress and some State
legislators would be restricted to deductions for business
travel away from the seat of the legislature (essentially,
deductions for travel to their legislative district).
However, because of the nature of the legislator's job, it
might not be fair to restrict legislators to a deduction for
some expenses of living in their legislative district.
Legislators, unlike most other taxpayers, often have business
reasons to maintain two residences, one near the seat of the
legislature and one in their legislative district. Moreover,
in many cases it is reasonable for the legislator's family to
continue to reside in the legislative district.
Deductions for lodging expenses incurred away from home
are appropriate to reflect a duplication or increased level
of expense which the taxpayer would not incur in the absence
of business necessity. Similarly, deductions for meal
expenses incurred away from home are appropriate to reflect
an additional expense (of eating outside the home) which the
taxpayer incurs for business reasons.
For these reasons, it is appropriate to have a special
statutory rule allowing legislators to deduct a portion of
their living expenses incurred at the seat of the
legislature. Such a rule cannot provide perfect results in
all circumstances, but it can be fair and neither overly
harsh nor overly generous.
4
One approach to providing such a rule is to allow
legislators to elect their residence in their legislative
district as their tax home. (H.R. 2550 takes this approach
for State legislators but not Federal.) In cases where the
legislature is in session for a substantial portion of the
year, providing such an election without limitation could
have the effect of permitting legislators to choose as their
tax home the location at which the lesser portion of living
expenses was incurred and hence to deduct the full amount of
expenses incurred at the location where the greater portion
was incurred. Thus, the election could provide overly
generous results in many cases.
Another approach to providing a statutory rule for
legislators is to designate the legislative district as the
legislator's tax home and allow substantiated living expenses
incurred at the seat of the legislature to be deducted
without limit. However, in cases where the legislator
maintains only minimal permanent quarters in his legislative
district, this rule would place legislators in a uniquely
favorable tax position.
We believe therefore that the type of rule currently
provided by Code section 162 for Members of Congress
(designating the legislative district as the Member's tax
home and imposing a ceiling on the deductible amount of
living expenses) is a reasonable approach toward providing a
statutory rule. This type of rule has been in effect since
1952, and there appears to be no reason to change, except of
course to increase by some means the $3,000 ceiling to
reflect the substantial price changes of the past 27 years.
To achieve this result, we suggest that H.R. 2550 be
modified in two ways. First, limit to 180 days a year the
number of "legislative days" allowable in computing
deductible amount for both State and Federal legislators.
Allowing deductions for living expenses incurred at one
business location during more than half the year may
contradict the idea of being "away from home." Limiting the
deduction to an amount based on a maximum of 180 legislative
days per year would allow a deduction of $9,000 a year for
living expenses incurred by Members of Congress ($50 a day
for 180 days) and would allow comparable amounts for State
legislators. If the $3,000 limitation were increased simply
to reflect rises in the consumer price index which have
occurred since the limitation was enacted in 1952, the
limitation would be increased to about $8,000.
5
Second, designate the residence in the legislative
district as the tax home for both State and Federal
legislators. H.R. 2550 would permit State legislators to
elect the residence in the legislative district as their tax
home; the tax home of those who did not so elect would be
determined on the basis of the circumstances in the
individual case. Allowing an election could foster
uncertainty and lead to annual shifts in a legislator's tax
home. Designating the legislative district as the tax home
for both State and Federal legislators would provide
certainty.
It should also be understood that under H.R. 2550, as
under existing law for taxpayers generally and for
legislators, deductions would be allowable only for
legislative days on which the legislator is "away from home"
in the traditional sense (i.e., overnight). Legislators who
are not away from home overnight do not incur lodging
expenses other than in their principal residence. Nor do
they incur any meal expenses which other taxpayers are
allowed to deduct.
In summary, we believe that it is reasonable to provide
a special statutory rule for away-from-home living expense
deductions of State and Federal legislators. We also believe
that, if modified in the two ways we have suggested, H.R.
2550 provides an appropriate rule.
FOR RELEASE ON DELIVERY
Expected at 9:00 a.m.
March 28, 1979
STATEMENT OF
EMIL M. SUNLEY
DEPUTY ASSISTANT SECRETARY (TAX ANALYSIS)
BEFORE THE
OVERSIGHT SUBCOMMITTEE OF THE
COMMITTEE ON WAYS AND MEANS
Mr. Chairman and members of the Subcommittee:
I welcome this opportunity to appear before you to discuss several important issues involving the distribution of
subsidies through the tax system to regulated utilities.
This subject is not only of great interest to the Congress
and the Administration, but also to regulators, ratepayers
and utilities throughout the country.
Let me begin by recalling for the Subcommittee why it
is that a tax policy official is testifying before a tax
committee on a subject of fundamental importance to regulated
utilities, ratepayers and regulators. The issues before the
Subcommittee involve two general subsidies to capital formation provided through the Internal Revenue Code: accelerated
tax depreciation and the investment tax credit.
When tax depreciation rules permit write-offs at a
faster rate than the actual physical deterioration of capital
assets, the economic effect is the deferral of tax liability.
The result is the same as if the Treasury were to extend a
series of interest-free loans to the taxpayer during the
early years of the asset's life, which are repayable in the
later years.
B-1485
- 2 The other subsidy — the investment credit — was the
subject of extensive testimony before the Subcommittee this
past week. This credit is roughly equivalent to a direct
cash grant paid by the Treasury to purchasers of certain
capital assets. The grant is paid by allowing taxpayers to
reduce their tax liabilities otherwise payable.
Thus, we are talking about two forms of Federal subsidies — interest-free loans and cash grants — which are
"cleared" — that is, paid and distributed — through the
Federal income tax system.
If these subsidies had been enacted as direct grant and
loan programs administered by the Commerce Department, then
not only would we be before a different committee, but most
of the issues before us would never have arisen. This is
because under a direct loan or grant program, the real
character of the payments to assist private capital formation
would be obvious to all concerned.
The accounting treatment for government grant and loan assistance is simply not
controversial in the private sector. Consequently, there
would be no need to prescribe accounting rules by Federal
law and, therefore, no need to exercise oversight review of
such rules.
That we are here at all may be the most persuasive
reason for exercising greater restraint in the future when
we are tempted to use the tax system as a mechanism to
finance Federal subsidy programs. Programs whose objectives
and costs are obscured by the method chosen to finance them
and whose administration becomes intertwined with administratioi
of the income tax laws impose unnecessary social and political
costs we can ill-afford to bear.
Why Provide These Subsidies to Regulated Utilities?
The investment credit, as originally proposed by the
Treasury Department in 1962, would have completely excluded
public utilities from the credit. The Treasury argued that,
"Investments by these regulated monopoly industries are
largely governed by determined public requirements and are
subject to regulated consumer service charges designed to
provide a prescribed after-tax rate of return on investment"
The House Ways and Means Committee compromised by giving
the public utilities one-half the credit allowed other
industries. The Committee justified the decision as follows:
- 3 The smaller credit [for public utilities] is
provided ... because much of its benefit in these
regulated industries is likely to be passed on in
lower rates to consumers, thereby negating much of
the stimulative effect on investments. Moreover,
the size of the investment in regulated public
utilities ... will in large part be determined by
the growth of other industries, rather than their own.
The reasoning reflected in the Treasury and Ways and
Means statements prevailed until 1975 when Congress placed
regulated companies on the same footing as all other companies
for investment credit purposes. It is clear today that the
earlier reasoning is essentially wrong. In both the regulated
and unregulated sectors of the economy, technology and
consumer preferences operate to determine which particular
forms of capital will be employed and which kinds of output
will be increased. If the full beneficial effect of an
investment tax credit for machinery and equipment is to be
achieved, it should be made generally available, on the same
terms, to all sectors of the private economy — to the
regulated as well as to the unregulated. Only in this way
can the structure of product prices and the output mix of
the private sector fully reflect technological possibilities
and consumer preferences. The capital cost of goods produced
by the regulated sector should not be made arbitrarily
higher or lower than the capital cost of goods produced by
the unregulated sector.
A second argument often made for denying the full
investment credit to regulated utilities is that the
regulatory process inherently biases public utilities to
excessive use of capital. As a purely abstract principle,
a case can be made that as long as the average "fair rate
of return" allowed by the regulators exceeds the marginal
cost of funds, the management of regulated utilities will
have an incentive to utilize more capital intensive
production methods. However, there are several factors in
the real world which tend to reduce this effect.
First, the familiar regulatory lag in adjusting the
prices of utility services to rising costs will operate to
prevent the realization of higher returns from marginal
investments. Related to this, is the fact that the
regulatory authorities themselves may adjust downward the
fair rate of return thus offsetting the tendency toward
excessive capital intensity.
- 4 Similar checks are provided by competition among
utilities (e.g., gas or electric power) and between utilities
and large companies able to produce their own utility
services. Finally, to the extent that utilities are
interested in maximizing sales rather than profits there
would be no pressure for excessive capital intensity.
Attempts at empirically estimating the degree of
excessive use of capital in the utility sector have not
adequately come to grips with the difficulties in measuring
the marginal cost of funds relative to the average "fair"
rate of return or with the ability of regulators to adjust
the fair rate of return as conditions warrant. Indeed,
throughout the history of regulation, we have seen large
variations in the profits of utilities and in their ability
to attract funds in capital markets, all while a "fair"
return was presumably being earned.
Thus, we would conclude that it would be unwise policy
to offset a theoretically possible excessive use of capital
by utilities by denying to them an instrument designed
generally to stimulate capital formation.
Phantom Taxes
Let us now turn to the question of "phantom taxes".
This is an issue of perception, not of economics, financial
accounting, or fairness. The phantom tax problem evolves
from the natural response of a utility ratepayer who is told
that he is being charged a greater amount for utility income
tax liability — a part of his cost of service — than the
utility actually pays as taxes. Of course, what the ratepayer does not see and is not told is that part of the
utility's tax liability is offset by Federal subsidy payments
to the utility, and that there subsidies will lower his
cost of service. This portion of the utility's taxes are by
no means phantom or fictitious. They are simply being
offset by Federal subsidies.
The phantom tax problem would not arise if the Federal
subsidies in question — the investment credit and accelerated
depreciation — were paid directly in cash grants or as
interest-free loans, rather than cleared through the tax
system. If the Commerce Department, instead of the Treasury
Department, were in the business of providing these subsidies,
ratepayers would see that they were being charged the same
amount for utility taxes as the utility actually paid in
- 5 discharging its liability. Ratepayers would also see a
series of checks being written by the Commerce Department to
the utilities. Since utility taxes paid to the Treasury
would then equal utility taxes paid by ratepayers, the
phantom tax issue would have disappeared. And yet, this
hypothetical arrangement involving the Commerce Department
is the economic equivalent of the system we have today. No
one — not the ratepayers, not the utilities — is any
better or worse off in the hypothetical. Thus, as I said
before, the phantom tax problem is one of perception, and
not of economics or fairness.
Since this point is essential to understanding the
issues before the Subcommittee, let me provide a simple
illustration. Suppose a company owes the Treasury $1
million in income taxes, and Congress has decided to pay
that company a subsidy of $100,000. Congress could pay the
subsidy by having Treasury write a check for $100,000.
Alternatively, instead of having the company write a check
to Treasury and Treasury write a check to the company, the
two payments can be folded together. In effect, this is
what happens when subsidies are paid through the tax system.
In our example, the company has indeed paid $1 million in
tax, and the Treasury has paid $100,000 in subsidies. Of
course, an outsider will observe only that a net payment of
$900,000 is remitted to the Treasury.
By using the tax system to clear Federal subsidies, we
naturally end up with some tax liabilities being less than
they otherwise would be. The reduction in tax does not mean
that the taxes were never paid. It simply means that two
offsetting payments — a tax payment to the Treasury, and a
subsidy payment to the taxpayer — have cancelled out. The
appropriate accounting for subsidies cleared through the tax
system is discussed below.
Let me emphasize the important policy lesson contained
in the phantom tax issue. We must realize that when the
Federal tax system is used for a purpose other than simply
raising revenues — such as for paying capital subsidies —
unexpected and undesirable consequences may follow. In the
case before the Subcommittee, the fact that the Federal tax
system — rather than a direct aid system — is being used
to pay capital subsidies to regulated companies is responsible
for some ratepayers believing that they are being charged
for taxes that the utilities never pay. While there is no
economic or financial substance to the ratepayers' view,
their annoyance is quite understandable. Moreover, their
respect for the basic fairness of the Federal tax system may
well be diminished.
- 6 The lesson is an important one. When we run subsidies
through the Federal tax system, we risk creating significant
problems of misperception. These problems may well impinge
on the ability of the Federal tax system to function properly,
and create problems elsewhere.
How Should Tax Subsidies to Capital be Accounted For?
The next issue is how regulated utilities should
account for tax subsidies to capital, such as accelerated
depreciation and the investment credit. I would like to
offer for the record an analysis of the accounting rules
prepared by Treasury, which is attached to my testimony.
Utility regulators have two basic goals: (1) to
establish prices that cover the cost of providing utility
services, and (2) to minimize the costs of providing those
services.
The amount utilities charge for services must be sufficient to cover current expenses such as labor, fuel, and
taxes, and the costs of capital used to provide those services.
The total costs attributable to the use of capital include
depreciation, interest, and a sufficient after-tax return to
shareholders to maintain and attract equity capital. The
amount charged for utility services must, therefore, be set
so that after current expenses, including income taxes, as
well as interest and depreciation, shareholders receive an
adequate after-tax rate of return.
Consequently, the size of the rate base — that is, the
total capital contributed by lenders and shareholders —
determines all components of the cost of using capital. The
rate of return to lenders and shareholders is some "fair
return" as a percentage of the rate base. Depreciation
represents the fraction of the rate base used up in each
year's production.
If part of the rate base is financed by a source other
than shareholders and lenders, such as a government subsidy,
the charge for utility services should reflect this fact. If
the Federal Government provides a 10 percent purchase
subsidy with respect to plant and equipment, the rate base
should be reduced accordingly, thereby properly recognizing
the Federal contributions. By reducing rate base, cost of
service elements that are determined by rate base ~ both
depreciation and fair rate of return — are also reduced in
- 7 proportion to the Federal subsidy. If the government
furnishes $10 and private lenders and equity owners provide
$90, only $90 has to be regarded as the base for depreciation
and a fair rate of return.
The term "normalization" refers to the modifications of
utility rate base which reflect the investment credit in the
manner I have just described. What this means is that the
rate base is reduced by the amount of the subsidy to reflect
the fact that private financing is not required for a
portion of the assets acquired by the firm. If this is
done, the cost of service charged to ratepayers will be
precisely the same as if the subsidy had been paid by the
Commerce Department in cash. At tfle same time, the utility's
tax expense is the tax liability for the year without
reduction for the subsidy. The smaller cash payment to the
Treasury is the method by which the government's contribution
to the purchase of machinery and equipment has been provided.
Section 46(f) of the Code is intended to incorporate this
result. For reasons I will explain later, section 46(f) is
somewhat deficient.
The analysis for accelerated depreciation is similar to
that for the investment credit, except that we are now
dealing with interest-free loans rather than cash grants.
By providing accelerated tax depreciation to regulated
companies, part of the rate base is being financed by
interest-free loans from the Treasury. Proceeds of the
Treasury loans cannot directly reduce rate base since the
loans must be repaid. However, the cost of service is
reduced since no rate of return need be paid with respect to
the portion of the rate base financed by Treasury's interestfree loans.
Some have suggested that Treasury's interest-free loan
is never repaid, that is, the deferred taxes are forever
deferred. This is not the case. For any given asset, the
loan is repaid as the tax depreciation allowances are
reduced in later years of the asset's life. It is true that
as new assets are acquired to maintain productive capacity,
new loans are extended which, in effect, repay the expiring
ones. Thus, a permanent supply of borrowing from the Treasury
may be maintained. The "permanency" of the Treasury loan
supply is, however, no differnet from the supply of longterm debt provided by private lenders, which is also being
replenished on a continuing basis.
- 8 The proper accounting treatment for these interest-free
loans is also referred to as "normalization". This treatment, which again is consistent with the Congressional
intent and with cost of service ratemaking objectives, is
the treatment generally required by section 167(1) of the
Code.
If a procedure other than normalization is applied to
the investment credit or accelerated depreciation, the
result will be inconsistent with both the Congressional
intent and the objectives of cost of service regulation. If
the income tax expense for which ratepayers are charged is
reduced by the capital subsidy — a procedure commonly
called "flow-through" — current ratepayers are being undercharged for their cost of service while future ratepayers
will more than make up the difference. Under flow-through,
only the current tax expense is reduced. On the other hand,
under normalization, all capital costs associated with rate
base — depreciation, interest, taxes, and after-tax returns
to stockholders — may be reduced since the rate base is
reduced. These reductions are realized over the life of the
asset.
Thus, under flow-through, only the tax expense is
reduced. Under flow-through, regulated companies are in
effect told that there has been no cost reduction in the
qualified property. This plainly defeats the purpose of
providing the subsidy in the first place. Likewise, the
objective of cost of service ratemaking is defeated since
current year customers have cost of service reduced by the
full amount of a reduction in capital cost when that reduction
should have" been spread over the life of the asset for the
benefit of future ratepayers.
Let me illustrate these principles with a simple
example. A utility buys some machinery with a 30-year life
for $30 million. No one would suggest that in the year of
acquisition, ratepayers be required to furnish the full $30
million. Instead, assuming straight-line depreciation of
the machinery for cost-of-service rate regulation, ratepayers
will be charged $1 million per year for depreciation over
the life of the machinery, and they will pay a fair rate of
return on the undepreciated remainder, financed by lenders
and stockholders. Suppose the manufacturer has a "10percent-off" special. The utility rushes to the store, and
the $30 million item instead has a cost of $27 million. No
one would suggest that the full amount of the savings be
- 9 passed on immediately by reducing current rates by $3 million.
What happens instead is that annual depreciation charges are
reduced from $1 million to $0.9 million. This has the
effect of spreading the benefits of the 10-percent discount
to ratepayers over the life of the machinery. Additionally,
the fair rate of return charges will be reduced by 10 percent over each year of the asset's life.
The investment credit is no different. The "10percent discount" provided by the credit should not be
flowed-through immediately. Instead, as in the example, the
rate base must be adjusted to reflect the fact that assets
in the rate base cost 10-percent less. A similar analysis
follows for accelerated depreciation except that the tax
deferrals — interest-free loans — reduceithe "finance
charge" to lenders and stockholders whose financing is no
longer needed.
To summarize then, we must evaluate accounting rules
here on the bases of how Congress intended these subsidies
to be treated and the objectives of cost-of-service ratemaking. Flow-through of the tax subsidies defeats the
Congressional objectives by greatly reducing the capital
subsidy nature of the provisions.
Should Normalization be Enforced Through the Internal Revenue
Code?
At this point, We have told you that the two subsidies
in question, accelerated depreciation and the investment
credit, should be made available to regulated companies on
the same basis as unregulated companies. We have also
described how regulators should account for these subsidies.
We must next turn to what is the most difficult issue before
the Subcommittee — whether the proper accounting treatment
of the subsidies should be enforced through the Internal
Revenue Code.
Sections 46(f) and 167(1) do two things. They describe
how the subsidies should be accounted for in utility ratemaking, and they prescribe penalties for failure to do so.
The penalties are quite severe. If the wrong accounting
method is chosen, the subsidies are completely disallowed.
No middle position is available. It is worthwhile to
explore the reasons for imposing such severe penalties.
- 10 Initially, the issue involved only accelerated depreciation. Congress first provided accelerated depreciation in
the Code in 1954. By the mid- to late 1960's, certain
problems had developed with regulated utilities. Some
regulators were immediately flowing through the benefits of
accelerated depreciation, thereby reducing greatly its
capital-subsidy effects. In certain cases, where utilities
resisted flow-through, regulators set rates as i£ flowthrough had been elected. At this point, Congress intervened. The Tax Reform Act of 1969 enacted section 167(1) of
the Code. These rules provide generally that accelerated
depreciation is available to regulated utilities only if
normalization is followed for ratemaking purposes. In 1971,
when the investment credit was restored, Congress provided
the credit to regulated utilities only if a set of rules
based upon normalization was followed. These rules are now
found in section 46(f) of the Code. The Congressional
concern was that absent such rules, regulators would flowthrough the credit, thereby defeating its capital subsidy
impact.
In the unregulated sector there need be no such concern
that company managements may willfully misconstrue a capital
purchase subsidy by the accounting procedures they adopt.
The management that behaves as if the capital purchase
subsidy is a mere reduction in its tax bill will be disciplined
by competitors who adopt production and marketing strategies
based on the lower cost of production made possible by the
subsidy. Regardless of how the subsidy is presented in an
unregulated company's financial books of accounts, market
prices and output will respond to the real underlying changes
in private costs. Prices and costs are equilibrated in
unregulated markets independently of accounting formalities.
In the regulated sector, on the other hand, the regulatory
authorities influence prices and outputs by their interpretation
of the "rules for cost measurement. By misconstruing the
real nature of subsidies cleared through tax accounts, they
may misdirect public subsidies.
Further, although flow-through accounting is clearly
contrary to the Congressional intent in enacting capital
subsidies, it can be extremely attractive. First, it
corresponds to the popular misperception that receipts of
these subsidies are "phantom taxes". Second, by converting
a potential stream of lowered capital charges into a misconstrued
reduction in current cost of service, flow-through provides
current ratepayers rate reductions that can be quite substantial. In periods of high inflation, there is great impetus
to keep rates low currently.
- 11 Thus, regulators are subject to intense pressure, both
economic and political, to keep rates as low as possible.
Under such circumstances, flow-through may be irresistible.
In order to offset this pressure, it is suggested, stringent
rules such as those found in sections 46(f) and 167(1) are
required. Regulators are thereby furnished with the means
to counteract pressure to reduce rates currently.
On the other hand, these provisions of the Code no
doubt preempt some element of discretion that would otherwise be left to ratemaking authorities. However correct the
normalization rules may be, it is argued, they constitute
Federal intervention in ratemaking policies. Moreover,
since utilities receive enormous quantities of these tax
subsidies, ratepayers perceive that they are paying far more
for utility taxes than the utilities ever pay. Although, as
we have said before, phantom taxes are a problem of perception and not of substance, the perception creates real
political problems. Regulators are hard pressed to explain
satisfactorily why more taxes are charged for than are
actually paid. Furthermore, as some have pointed out, while
the tax rules prescribe accounting rules, they do not
authorize an inquiry into the motivation for regulators
choosing a particular rate of return. This means there are
limits as to how far the tax rules can be enforced in the
regulatory process.
We cannot be oblivious to the significant problems
arising from enforcement of normalization through the Code
and from clearing the subsidies through the tax system. If
the identical subsidies were provided directly by the
Commerce Department in the form of grants and interest-free
loans, phantom tax and similar issues would disappear, and
the question of whether or not to normalize the subsidies
would never arise. Since we believe that (1) normalization
is the appropriate accounting technique, (2) the Congressional
intent is well served by normalization, and (3) enforcement
through the Code has generally been effective, we are
constrained to conclude that sections 46(f) and 167(1) are
useful and that the policies underlying their enactment
continue to have validity.
Administration of Sections 46(f) and 167(1)
The penalties for failure to comply with sections 46(f)
and 167(1) are severe. In addition, affected taxpayers are
regulated and for the most part, publicly owned. In view of
- 12 these constraints, we believe that there has been general
compliance with these requirements. In some cases, where
utilities have doubts about whether a proposed rate order
will comply with the requirements of the Code, they have
requested a ruling from the Internal Revenue Service. Due
to the severe penalties imposed in the event of noncompliance,
we assume that in most cases, these provisions are reasonably
self-enforcing.
It is, therefore, not surprising that there have been
very few administrative problems involving the IRS. Few
ruling requests or requests for technical advice have been
received. We understand there are presently two or three
normalization issues being considered on audit. No tax
liability litigation has as yet involved a normalization
issue.
On the other hand, as recent events in California have
shown, the current tax rules are not very well equipped to
handle controversy. The basic problem is that two different
parties, the utility and the regulator, have a say in determining the facts on which the tax subsidies are based. One
process — ratemaking — exists to handle the relationship
between the regulator and the utility, A second process —
tax administration — exists to handle the relationship
between the utility and the IRS. The two processes are
independent, and as a result, a problem in one cannot as yet
be handled easily in the other.
In view of recent events, we are currently exploring
both with regulators and utilities whether a separate tax
proceeding can be devised to resolve quickly any questions
involving sections 46(f) and 167(1). We hope to know soon
whether a satisfactory procedure can be developed.
A Technical Problem With Section 46(f)
The accounting rules prescribed for the investment
credit in section 46(f) do not adequately reflect the
principles of normalization and cost of service ratemaking.
Since we believe that if any rules are to be enforced, they
should be normalization rules, we would like to discuss with
you the problems with section 46(f) and how these problems
should be remedied.
1. Section 46(f)(1). This section provides that the
credit shall not be allowed if
"... the taxpayer's cost of service for ratemaking
purposes is reduced by reason of any portion of the
credit allowable ... or
- 13 "... the base to which the taxpayer's rate of return
for ratemaking purposes is applied is reduced by reason
of any portion of the credit allowable ... [unless] the
reduction in rate base is restored not less rapidly
than ratably."
Current investment credit rules permit taxpayers to
claim depreciation for the portion of the asset financed
by the credit. Section 46(f)(1) is ambiguous because it
does not provide guidance as to how to account for depreciation
attributable to the portion of the asset financed by the
investment credit.
The correct set of rules should provide that (1) tax
expense in any year may not be reduced by the allowable
investment credit or by the tax savings from depreciation
attributable to the portion of the asset financed by the
investment credit, and (2) the rate base used for both
depreciation charge computation and to which the fair rate
of return is applied must be reduced by the allowable
investment credit and by the tax savings from depreciation
attributable to the portion of the asset financed by the
investment credit.
2. Section 46(f)(2). Here, an alternative procedure
is prescribed. The cost of service may be reduced by no
more than a ratable portion of the allowable credit over the
life of the asset. But the rate base may not be reduced "by
reason of any portion" of the credit. In effect, the
depreciation charge is reduced in recognition of the government capital purchase subsidy, but ratepayers are expected
to pay stockholders the entire fair rate of return on the
government's contribution to the rate base assets.
Not surprisingly, utilities elect section 46(f)(2), for
it seems to ensure them of a greater than fair rate of
return on their own funds.
We believe that section 46(f) (1) should be rewritten to
reflect more accurately the correct accounting procedure for
normalization of the investment credit. In addition, we
believe that section 46(f)(2) should be deleted, since it
does not accurately reflect normalization accounting,
procedures.
14 Should an Excise Tax be Substituted for the Income Tax
on Utilities?
In response to controversies involving phantom taxes
and flow-through, it has occasionally been suggested that
these issues be resolved by substituting an excise tax on
utility services for the corporate income tax now levied on
utilities. We believe that any such change in the law would
be a serious mistake.
We believe that the motivation for such proposals is
misplaced. As we discussed before, the only reason utility
taxes actually paid vary so much from utility taxes that
ratepayers are charged for is that capital subsidies are
being cleared through the Federal tax system, and utilities
use enormous amounts of capital. Once this is recognized,
there is no further reason for suggesting that an excise tax
be substituted for the income tax on utilities.
In addition, we would note the following:
° Sound principles of public finance policy disfavor
specific excise taxes except for (1) control purposes,
and (2) overcoming "market failure", as in the case of
an excise tax serving as a substitute for price controls,
and pollution taxes, which internalize externalities.
° The proposal implies that an excise tax may, in fact,
be substituted for an income tax. This is not true.
An excise tax is, in effect, imposed on all inputs:
labor, materials, and services provided by other firms,
as well as capital. An income tax falls on earnings
only.
0
Either an ad valorem or a specific excise tax would
impose wideTy varying tax burdens on consumers. An ad
valorem tax would penalize consumers of high cost
companies dependent on expensive fuel or burdened by
high local taxes. A specific excise tax would penalize
consumers served by low-cost companies, largely comprised
of publicly-owned entities.
° Most public utilities do more than sell electric
energy. Construction and supply of gas services are
common. As a result, segregation of exempt income from
taxable income will be an administrative nightmare.
o 0 o
Accounting for Tax Subsidies with Special Reference to Cost
of Service, or "Fair Rate of Return", Utility Regulation
An Annex to the Statement of
Emil M. Sunley
Deputy Assistant Secretary (Tax Analysis)
Department of the Treasury
Before the
Oversight Committee of
The Committee on Ways and Means
March 28, 1979
Table of Contents
Page
Introduction
1
I. Accounting for the "cost of service." 3
Three classes of transactions
Assumptions underlying the base case
Description of the "base case."
A note on the base case replacement of plant
3
4
6
and equ ipment
A note on the meaning of net book-value
8
9
II. Accounting for a subsidy for the acquisition
of capital
A cash subsidy for the purchase of qualified
property
The importance of correctly accounting for
a capital subsidy
The mischief caused by accounting for a capital
subsidy as "income" in the year received
A capital subsidy paid as a credit against
income tax
Differ-ences between capital0 subsidies paid
in cash and as credits against income tax
Accounting for the "extra" subsidy inherent
in the investment tax credit
III. Accounting for a subsidy for the financing
of capital
A "zero interest" Federal loan for financing
the purchase of qualified property
Accounting for the specified "zero interest"
loan subsidy
Clearing the interest-free loan program
through the income tax
10
12
17
18
22
26
30
32
34
35
38
ii
Mischief caused by regarding the proceeds of
interest free loans as additions to equity
"income" for the year
,
The combined effect of the two tax subsidies
42
45
IV. Consistency of Tax Subsidy Normalization Rules
46
with Dynamic Change
Relaxing the no-growth assumption:
investment tax credit
Deferred taxes
Effects of unforeseen changes
the
-
V. Extension of the regulated company analysis
to unregulated companies
Deferred taxes in the unregulated sector
Tables:
Table A-l Base Case Financial Statements
Table A-2 Illustrating Maintenance of a Constant
Capital Stock, When The Regulatory Depreciation
Imputation Rule is Straight-Line
Table A-3 Financial Statements, with 10 Percent
46
48
50
51
53
56
57
Capital Subsidy
58
Table A-4 Net Rate Base, Income from Sales, and
Cost of 'Service Elements, with 10 Percent Capital
Subsidy, when Tax and Regulatory Measurement
Rules are Identical
59
Table A-5 Financial Statements, When a Capital
Subsidy is " Flowed-Through" to Equity
60
Table A-6 Schedule of Interest-Free Loans Extended
and Repaid: 1979 Vintage of Plant and Equipment.. 61
Table A-7 Privately Financed Rate Base, Income
from Sales, and Cost of Service Elements, With
Federal Interest-Free Loan Program
62
Table A-8 Financial Statements, First Year of a
Federal Interest-free Loan Program Financed
Through the Tax System
63
Ill
Table A-9 Comparison of Income from Sales, When
Proceeds of Interest-Free Loans Are so Accounted
For and When They Are "Flowed-Through" to Equity
Income in the Year Rece ived
Table A-10 Combined Effect of Investment Tax
Credit and Interest-Free Loan Program on Cost
of Service (millions)
,
6
6
Introduction
The prices of goods and services exchanged
voluntarily
in markets, when there are no barriers to entry, tend to
approximate "cost of production."
Conventionally, cost of
production comprises two elements, payments for labor
services and materials embodied in the goods and services
produced for sale and payments for the services of capital—
plant, equipment, inventories, etc.—similarly embodied in
the output.
In the unregulated sector, where freedom of
entry and exit by individual enterprises is presumed to
exist, prices "automatically" equilibrate with costs:
if a
seller receives prices in excess of labor, material and
normal capital costs, his abnormal return, conventionally
expressed as a return to his equity capital, attracts
competition; if the prices he receives fall short of his
total costs, he exits. In the regulated sector, where it is
presumed that technological conditions preclude freedom of
entry
and
exit,
regulatory
commissions
function
to
equilibrate prices and costs.1/
1/ Another function performed in unregulated markets is the
assurance that the costs of production to which prices are
equilibrated are minima.
capital both function to
employments
Since markets for labor and
allocate these resources to
in which the value product
is a maximum, it
follows that least-cost technologies will tend to be
employed. Neither workers nor capital owners will accept
returns for productive services that are lower than might
be earned elsewhere either because the products they
produce fail to fetch sufficiently high prices or because
the technology being employed is obsolete. In the case of
regulated industries, it is presumed the regulators will
exercise vigilance to ensure that prices received are no
higher
than
costs,
technology permits.
and
that
the
costs
are
as
low
as
-2Because regulatory agencies must replace impersonal
market forces in establishing both quality of service and
schedules of allowable maximum rates to be charged for
services, their responsibilities are varied and complex.
Given a specification of "quality of service", the "cost of
service" must be measured so that revenues generated by the
schedule of allowable rates will not be "excessive."
To
carry out this responsibility, regulatory commissions
establish procedures by which the varied transactions of
regulated companies are recorded so that the outcome of the
operations of the companies may be reviewed and made subject
to control by the commissions.
An understanding of these standard procedures, commonly
known as standard accounts, is critical to an understanding
of the logically consistent way in which tax subsidies should
be accounted for, in both the regulated and unregulated
sector of the economy. Therefore, the first section of this
annex .sets out the elements of an accounting system, and
defines the terms relevant to an accounting for "cost of
service" and for the subsidies which affect this cost. The
next section introduces a capital grant subsidy, the class to
which the investment tax credit belongs, and demonstrates how
this public support of capital formation operates to reduce
the "cost of service." The following section introduces a
capital subsidy in the form of an "interest-free loan," the
class to which "artificially accelerated tax depreciation"
allowances belong, and contrasts this with a capital grant
form of subsidy. The subsidy accounting procedure commonly
called "normalization" is shown to be the only technique that
correctly portrays the intended effect of both capital subsidies on the cost of service. The fourth section demonstrates
that "normalization" accounting also effectively portrays the
results of capital subsidies under dynamic conditions; the
last section comments on the extension of these subsidy
accounting techniques to the unregulated sector.
-3-
I.
Accounting for the "cost of service."
Three classes of transactions
Any enterprise, whether regulated or unregulated,
engages in a myriad of transactions involving the employment
of labor, procurement of materials, the acquisition and
maintenance of plant and equipment, and the payment of taxes
in the course of producing and selling goods.
Organizing
these transactions in a structure that is both comprehensive
and analytically useful is the subject matter of accounting,
both for financial reporting and income tax compliance.
Three sets of transactions must be dealt with:
First those
involving
the
purchases
of
goods
and
services
which
are
directly embodied in the goods and services sold within an
accounting period, usually a year.
In principle, purchase
transactions are cumulated, or "inventoried" over the course
of the year and subtracted from the sales transactions as
"cost of goods sold"; the excess of sales proceeds over cost
of goods sold is "operating income" of the enterprise.
The second set of transactions to be dealt with are
those pertaining to the acquisition and use of plant and
equipment items, the services of which are embodied in the
enterprise output over a long span of accounting periods.
For this class of transactions, in addition to accounting for
acquisition of the assets encompassed in market exchanges, it
is also necessary to account for the using-up of these
assets; and since this cost of output is normally not
observable in a set of market transactions, a procedure for
imputing the value of the capital consumed during a period is
required.
-4Finally, there is the class of transactions concerned
with financing operations, particularly the acquisition of
plant and equipment items. These include the extension of
trade credit to finance sales, the receipt of trade credit to
finance purchases, and the issuance of long-term debt instruments or issuance of stock to obtain additional equity.
Unlike the other two sets of transactions which are concerned
with measuring the cost of producing goods and services for
sale, and the net outcome of an enterprise' economic activity, these transactions involve only the recording and
assignment of claims against the assets of the enterprise.
Assumptions underlying the base case.
We will not concern outselves here with the problems of
maintaining surveillance over the classifications of transactions in order to derive reliable measures of income,
whether for financial or tax purposes. This is a tremendous
burden of auditing borne by regulatory, financial, and income
tax personnel which we will assume is satisfactorily accomplished in the real world. Instead, we will concentrate our
attention on the statements which summarize the outcome of
accounting for the economic performance of an enterprise.
To do this most expeditiously, and to facilitate the
later discussion of accounting for the introduction of tax
subsidies, we will make
the
following
simplifying
assumptions:
(1) The enterprise, a regulated utility, has financed
its operations in such a way that its "current
assets" equal its "current liabilities."
That is,
the amount of its cash on hand, accounts receivable,
and inventories of materials and supplies is exactly
equal to its accounts payable (including accrued
-5taxes). This means that the net value of its plant
and equipment is eactly equal to outstanding
interest-bearing debt and the claims of its equity,
or share, owners. Plant and equipment is therefore
the "rate base."
(2) All plant and equipment is depreciable.
(3) The acquisition cost of plant and equipment is the
same for both regulatory (financial) and tax
accounting purposes.
(4) The regulatory life of plant and equipment is 30
years; and the total plant and equipment account is
comprised of 30 equal units, one of which must be
replaced each year.
(5) There is no growth and no inflation; the state of
technology does not change.
(6) Sixty percent of the rate base is financed by debt,
40 percent by equity; the interest payable to bondholders is 10 percent, the after-corporate-tax
return to equity is 15 percent.
(7) All interest is paid at the end of the year; corporate income after taxes is also distributed at that
time.
(8) Plant and equipment acquisitions are made at the
beginning of each year.
These assumptions generally define the case of a "going
concern" in what is technically described as "stationary
equilibrium." However, as will be noted below, this model of
-6an enterprise may also be used to describe dynamic adjustment
to changes in the size of the enterprise or in the terms on
which its assets are acquired or financed.
Description of the "base case."
In the base case, we assume that income tax accounting
perfectly matches regulatory accounting, and there are no
subsidies.
Then, for
the year
income statement summarizing
actions noted above.
1979, Table
A-l shows the
the first two classes of trans-
Sales of utility
services aggregated
$274.6 million, of which $165 million (60 percent of sales)
consisted in cost of goods sold, leaving an operating income
of $109.6 million.
This operating
income is allocable into
$30 million for depreciation, $27.9 million paid in interest,
$23.8
million
in
corporation
income
tax,
and
an
after-
corporate-tax return to shareholders of $27.9 million.
Operating income is therefore no more, or less, than the
capital cost portion (40 percent in this example) of total
cost and sales:
it includes provision for recovery of
capital consumed during the year, a return to bondholders,
corporation income tax—a tax on the income attributable to
equity capital, the incomes attributable to labor, suppliers,
and creditors having been allocated to them—and a return to
shareholders.
The 40 percent of total cost (sales) allocable
to capital is approximately typical of electric utilities.
Since we are assuming that interest and shareholder
earnings are paid out at year end, the beginning and ending
balance sheet, summarizing
dealing with claims against
the third
class of
the assets, also
transactions
in Table A-l,
shows that, net, no change in total assets or claims against
them have occurred.
-7On the asset side, cash and other current accounts are
up by $30 million, representing the cash-flow resulting from
the allowance for 1979 depreciation included in cost of
service (sales); but net plant and equipment has been reduced
by that same $30 million.
As claims against the total of
$565 million of assets, current liabilities remain at $100,
and the $465 million of plant and equipment continues to be
financed by $279 million in long-term debt, the basis for an
interest charge of $27.9 million, at 10 percent, and by $186
million of shareholder equity, the basis
-corporate-tax return of $27.9 million.
for
an
after-
If we assume there are 10 million shares outstanding,
they will sell at $18.60 a share, for they will receive $2.79
a year in dividends, a 15 percent return, which is sufficient
to warrant their being held, under the assumption we are
operating with.
So long as the prices of utility services
yield $274.6 million in total revenue, and costs, including
market
rates
of
return
to capital,
remain
unchanged,
the
combined return to capital of $55.8 million, representing a
12 percent return to the $465 million of privately furnished
funds to operate the utility, is a "fair return" and the 12
percent a "fair rate of return."
In fair rate of return regulation, then, a regulatory
commission forecasts the net plant and equipment (rate base)
that will be required
to furnish
a postulated
quantity
of
service, multiplies this by the "fair rate of return", adds
to this an income tax quantity which is functionally determined by the equity return, and finally adds to this estimate
of the cost of capital services a forecast of labor, fuel,
and materials costs of production.
This forecast total cost
of service becomes the required
sales revenue, and given a
forecast of the service produced
and distributed, rates per
unit of services fall-out. This is "cost of service" utility
regulation, including a "fair rate of return", on rate base.
-8A_note_on_the_base_case_£e£1^
equipment.
By our assumptions of no growth, inflation, or change in
state of technology, it follows that each year, our illustrative company will have to acquire $30 million of plant and
equipment items in order to maintain its service capacity at
unchanged prices (and cost of service) .
Thus at the begin-
ning of 1980 (end of 1979), the illustrative utility will
have to buy $30 million of replacement capital goods. Therefore, at the beginning of 1980, the $30 million increment of
cash
and
other
current
assets
accumulated
during
1979 is
exchanged for the plant and equipment, and the balance sheet
reverts to its beginning-of-1979 appearance. Under plant and
equipment, $30 million of assets that had been acquired in
1950 are removed
from the account
million of new items.
depreciation
with
and
are replaced
by $30
Similarly, the $30 million of accrued
respect
to
the
1950-vintage
assets
is
removed from the accrued depreciation account; this restores
the net plant and equipment account to $465 million, the rate
base required to produce the utility company services for
1980.
Table A-2 may be helpful in comprehending the process of
maintaining a capital stock. There a partial array of each
vintage
shown.
of
assets
Under
in service
the
regulatory
at
the beginning
rules
of
1979 is
for measuring
cost of
service, each vintage is "depreciated" l/30th each year; an
imputation
method
called
"straight-line."
Thus,
at
the
beginning of 1979, the 1950 vintage, the oldest in use during
1979, has a net book-value of $1 million, $29 million having
been recovered in costs of service over the prior 29 years of
its use, whereas the 1979 vintage, being just acquired has a
net book-value of $30 million.
acquisition
cost
of
$900
Altogether, of the original
million,
$435
recovered by the private suppliers of
leaving a net rate base of $465 million.
million
financial
has
been
capital,
-9At the beginning of 1980, the 1950 vintage drops out,
its position at a $1 million net book value being assumed by
the 1951 vintage; likewise, the 1979 vintage eases down a
notch to a net book-value of $29 million, being replaced by
the new 1980 vintage with a net book-value of $30 million.
Thus, at the beginning of 1980, the original cost of all 30
vintages in use is still $900 million, of which $435 million
has been recovered in depreciation charges embedded in the
cost of service for years prior to 1980.
A note on the meaning of net book-value.
Clearly, the allowance for depreciation is an imputation
of the decline in value of depreciable assets. In the regulated company case, since regulatory commissions establish
rates based on their rule for imputing depreciation, so long
as the fair rate of return applied to the rate base (original
cost less previously imputed depreciation) matches the opportunity cost of financial capital for the utility, the market
value of stock will equal the book-value of that stock. That
is, the regulatory commission's valuation of plant and equipment, $465 million, less the claims of bondholders, $279
million, equals the book-value of equity. Then book-value ^s
the market value of plant and equipment as well; by its ratemaking power the commission establishes a market value of
regulated company plant.
For what follows, this is a critical point. Regardless
of the "quality" of regulatory ratemaking rules, commission
rules for imputing depreciation as a cost of service must be
taken as the "norm" against which tax depreciation rules will
be compared. For example, it might be demonstrated that, if
utiliity commissions tried harder to account for obsolescence
due to technical change in production and distribution facilities used by the utility and/or to changes in the relative
-10costs of fuels or other inputs used, they would find a set of
depreciation
realistic.
imputation
rules other
than straight-line more
Applying these more realistic rules would permit
more timely introduction of improved plant and equipment, and
these "better" depreciation imputation rules would ultimately
result in a lower total cost of service as more efficient
combinations of labor and materials were thereby put into
use.2/ But, since
the
logic
of
fair
rate of
return price
setting validates whatever depreciation imputation rule that
is used
by
a
regulatory
commission,
whether
the
rule is
optimal or not it is the norm to measure income of the
regulated company, both for financial and tax accounting
purposes.
II. Accounting for a subsidy for the acquisition of capital
So long as a replacement module costs $30 million and
the entire $30 million must be financed with funds obtained
in private capital markets, the capital portion of cost of
service will be $109.6 million in the example we have
postulated as the base case.
During 1979, 1980, and every
succeeding year, this cost of service will recur and have to
be recovered in the charges permitted the regulated company.
2/ The FCC staff has recently suggested that depreciation
imputation rules used by that agency may have retarded
technical
progress
and
communications industry.
depreciation
patterns
cost
reduction
in
the
tele-
Virtually every investigation of
for
machinery
and
equipment
has
concluded that "straight-line" patterns are poor approximations for asset value decline, the phenomenon depreciation is supposed to describe.
-11Let us now examine the consequence of a 10 percent subsidy
for the purchase of depreciable property, when tax accounting
rules match regulatory accounting rules.3/
Since the
3/ Those familiar with the analysis of excise taxes and subsidies will be aware that whether the subsidy is conferred
on the purchaser, or the seller of a commodity, the net
effect will be the same. If the subsidy is given to the
seller, and if entry into the production of the subsidized
article is free, selling prices will be competed down by
the amount of the subsidy. If the subsidy is given to the
buyer, offer prices will be bid up_ by the amount of the
subsidy. But, if the article in question can be produced
at constant prices, then the selling price (net to the
producer) cannot be more than the cost of production, and
the whole amount of the subsidy will be "passed through"
to buyers in the form of lower net purchase prices. The
government will be paying that fraction of the cost represented by the subsidy; buyers will be paying for the
remainder with their own disposable resources.
In the present case, a subsidy for the purchase or sale of
capital goods, a subsidy paid to the buyer rather than the
seller is preferable on administrative grounds. Whether a
"qualified" article is a capital good or not depends on
the use to which a buyer will put it. A vehicle used by
the purchaser in a productive enterprise ("trade or
business") is obviously a capital good; the same vehicle
used for recreation or personal transportation is not.
Since qualification of an article for a capital subsidy
can be more easily determined after its purchase by
whether the purchaser must "capitalize" the acquisition
cost and recover his capital through depreciation imputations as he uses it to produce salable output, it is more
convenient to pay a capital subsidy to the purchaser.
-12"proper" regulatory accounting rules for a form of this subsidy conveyed as a credit against income tax otherwise due is
the subject of controversy, we shall here simply develop the
"regulatory rule" that reflects the logic of cost of service,
or fair rate of return, utility rate regulation.
As will
become apparent, this rule for accounting
generally that called "normalization."
for a subsidy is
A cash subsidy for the purchase of qualified property.
Suppose that, effective January 1, 1979, Congress
authorizes the Secretary of Commerce to pay each purchaser of
depreciable property with an expected life of 7 or more
years, on the submission of evidence that such property has
been acquired, an amount equal to 10 percent of the purchase
price of the property.
Since the regulated company buys and
uses depreciable property with an expected life of more than
7 years, its 1979 purchase of $30 million will be eligible
for the subsidy when company officials duly present invoices
or contracts and similar documentation of the purchase.
was
shown
in Table
A-l,
in
any
year,
the
result
As
of the
regulated company's operations was to increase its cash and
other current assets by $30 million which was then available
to acquire that amount of replacement items for its plant and
equipment account. Thus, at the end of 1978, the company had
$30 million, amassed as a recovery of capital consumed during
1978 from its sales revenue, with which to buy property that
would now only cost it $27 million,
contribution of the Commerce Department.
net
of
the
cash
The remaining $3 million of cash and other current
assets at the beginning
taining
of 1979
is now redundant for main-
the constant stock of company
plant
and
equipment.
The $3 million excess therefore should be used to reduce debt
and outstanding equity so that utility customers will not be
-13burdened with providing a return to the now displaced private
financing; customers should pay only for returns to privately
financed capital used to produce the output they buy. Since
there is no reason to alter the debt-equity ratio of the
company, $1.8 million of outstanding bonds will be retired
along with $1.2 million of shareholder equity. The bonds may
be retired either by not "rolling over" that amount of debt
maturing on January 1, 1979, or by buying back that amount of
outstanding bonds. Similarly, the $1.2 million of redundant
equity might be paid back as a "return of capital" to all
existing share-holders, or $1.2 million of outstanding stock
might be purchased in the market and cancelled.
The effect on net rate base of the utility therefore has
been a reduction of $3 million at the beginning of 1979 as
compared with the pre-subsidy case discussed above:
total
net acquisition cost of the property is now $897 million
because the 1979 vintage cost only $27 million rather than
$30 million, while accumulated depreciation is still $435
million, leaving a net rate base of $462 million rather than
$465 million; and this reduced rate base is financed with
$277.2 million of debt, and
equity.
$184.8 million of
shareholder
The subsidy also has two effects on the cost of service
for 1979. First, only $0.9 million of depreciation, recovery
of private capital, need be provided for the 1979 vintage
addition to the capital stock.
Thus, since the other 29
vintages in use during the year each require $1 million, the
total depreciation charge entered into cost of service for
1979 need only be $29.9 million instead of $30 million.
Second, interest paid bond holders is reduced to $27.72
million and the after-corporate-tax return to equity is also
reduced to $27.72 million. The reduction in required return
to equity has a related effect on the Federal income tax.
-14Altogether, the cost of service will have been
virtue
of
the
subsidy
authority acts promptly
in
1979,
assuming
reduced by
the
to reflect the subsidy
regulatory
in the rate
charges it approves.
But before tracing the net effect of the subsidy in 1979
and future years as each additional replacement vintage
ben-
efits from the 10 percent subsidy, an accounting convention
needs to be introduced and explained.
Because the market
price of the equipment items acquired in 1979 is still $30
million, accountants feel constrained to show $30 million as
the
acquisition
cost
in
balance
sheets.
But,
since
$3
million was contributed by government subsidy, they initially
offset
the
"unamortized
$30
million
subsidy".
by
a
$3
million
account
labelled
Thus, at the beginning of 1979, the
balance sheet entry for the 1979 vintage, in isolation, would
be:
Plant and equipment (beginning of 1979):
Acquisition cost $30
less: Unamortized subsidy....$3
Accrued depreciation... 0
Net rate base
3'
$27
For the 1979 vintage, still in isolation, the end of 1979
balance sheet entry would be:
Plant and equipment (end of 1979) :
Acquisition cost $30
less: Unamortized subsidy....$2.9
Accrued depreciation... 1.0
Net rate base
3.9
$26.1
-15In effect, this esoteric accounting treatment, in which the
subsidy is amortized over the life of the property, shows the
net book-value of the subsidized asset at private cost. Also
under this accounting treatment, while the $30 million is
apparently "depreciated" over 30 years, this is offset by
annual amortization of the subsidy so that the net reduction
in book-value, at private cost is, in fact, $0.9 million,
l/30th of the $27 million. "Net depreciation" of subsidized
assets entering cost of service is of private cost only.
With this in mind, we may now assemble the 1979
financial statements incorporating the cost of service impact
of the $3 million capital subsidy received with respec4- to
the 1979 vintage of capital; these are shown in Table A-i.
Instead of the base case required total revenue of $274.57
million, after one vintage of capital has been subsidized,
the required revenue shrinks to $273.95 million. This saving
to utility customers of $0.62 million in 1979 results from
the following reductions:
Private capital recovery $0.10 million
Interest payment
$0.18 million
Federal tax
$0.16 million
Return to equity
$0.18 million
Total $0.62 million
We have already noted the reduction in rate base, from
$465 to $462 million, at the beginning of 1979, also shown in
the beginning and end of year balance sheets in Table A-3.
It will be observed that, at the end of 1979, the book-value
of plant and equipment has diminished by only $29.9 million,
for the "depreciation" of the $30 million market price of the
1979 vintage is offset by a $0.1 million reduction in
unamortized subsidy. By the same token, cash and other current assets have increased by only $29.9 million, instead of
-16$30 million as in the base case because only this amount of
cash-flow has been provided
in the reduced cost of service
charges.
Thus, at the beginning of 1980, after one year of
operation under the subsidy, the regulated company has $29.9
million to finance the acquisition of a new vintage of equipment
items.
Again, with
a 10 percent
cash
subsidy, the
market price of $30 million will require only a $27 million
drain
on
the
company's
cash
resources.
Thus,
at
the
beginning of 1980, $2.9 million of excess private debt and
equity develops, resulting in a retirement of $1.74 million
of debt and $1.16 million of shareholder equity.
For the
year 1980, cost of service will be further reduced, and the
process
of
reducing
annual
net
(of
subsidy
amortization)
charges for depreciation and returns to creditors and equity
holders will continue until all 30 vintages have been
replaced by property subsidized by the Commerce Department.
The annual net rate base, total revenue required, and cost of
service elements comprising the revenue requirement 1979 to
2009, are arrayed in Table A-4. Each year, a little more of
the privately financed net rate base is displaced by public
subsidy so that, by 2008, the net rate base has shrunk by
$46.5 million
since
from
the capital
its unsubsidized
subsidy
level of $465 million;
is 10 percent,
so
long
as the
subsidy remains in effect for at least thirty years, 10 percent of privately
financed
capital
in a regulated
company
will be replaced by publicly financed capital.
Taxpayers generally will assume the cost of maintaining
10 percent of the qualified capital stock, and since they do
not require a return for supplying this capital used in the
private sector, for both these reasons the capital cost
portion of total cost of service shrinks by 10 percent.
In
the year 2008, gross revenues need cover only $27 million of
-17the cost of $30 million of equipment items required to maintain the company's capital stock; the other
supplied by Federal taxpayers through the
$3 million is
Department of
Commerce. Interest coverage in sales revenue becomes $25.11
million, as does the after-corporate-tax return to shareholders, 10 percent less than the unsubsidized levels of
$27.9 million.
Finally, the Federal income tax coverage in
revenues becomes $21.39 million, also 10 percent less than
.the base case level of $23.77 million. Because capital costs
comprise 40 percent of the base case total cost of service,
the subsidy induced 10 percent reduction of capital cost of
service becomes a 4 percent reduction in total cost of
service; in 2008, customers would need to pay only $263.61
million for the capital-subsidy-assisted output of a plant
costing $30 million in resources annually to maintain instead
of $274.57 million.
The importance of correctly accounting for a capital
subsidy.
The foregoing step-by-step analysis of a procedure for
accounting for a capital subsidy has an inherent economic
logic worth exploring. As noted earlier, the function of an
accounting system is to portray the outcome of transactions,
economic decisions, involved in the production and sale of
goods and services.
The names one attaches to the procedures, or to the transactions, are unimportant; rather, the
test of validity of the accounting procedures is whether they
produce accurate measures of underlying phenomena.
To demonstrate that the foregoing procedure, popularly
called "normalization," is the only acceptable way to account
for a capital subsidy, because it alone provides an accurate
measure of the underlying phenomena, let us substitute a real
10 percent reduction in the cost of acquiring the regulated
-18company's plant and equipment items.
That is, suppose that,
at the beginning of 1979, some unspecified change in the cost
of producing this plant and equipment occurs so that what had
formerly cost $30 million now costs $27 million to purchase.
Referring to Table A-3, we would observe that the only
changes in the income statement and the beginning and ending
1979 balance sheets would be elimination of references to
"unamortized subsidy" and "subsidy amortization."
The rate
base would have shrunk by $3 million, assuming the regulatory
authority is vigilant; the excess $3 million would have been
returned to creditors and shareholders to dispose of however
they chose; and the cost of service would have been shrunk
accordingly. Similarly, at the end of 1979, $29.9 million of
cash-flow would have been generated, $2.9 million in excess
of the $27 million capital expenditure requirement at the
beginning of 1980.
Then Table A-4 might simply be recaptioned to refer to the effect on rate base, income from
sales, and cost of service in the event capital goods prices
are reduced by 10 percent.
Since the. economics of a 10 per-
cent capital subsidy are exactly the same as the economics of
a 10 percent goods price reduction, the proper way to account
for the latter
former.
is also
the proper
way
to account
for the
The mischief caused by accounting for a capital subsidy
as "income" in the year received.
Note has been taken earlier of the self-fulfilling
character of rate regulation.
Because entry into regulated
markets is restricted, and regulatory commissions prescribe
accounting procedures on which they base maximum rates, the
depreciation and other income accounting rules they prescribe
produce the rates which, in the end, will validate the rules.
If, in a particular year the rules produce too low revenues,
market prices of regulated company shares will tend to fall,
-19destroying
the relationship to book-value.
Such an occur-
rence indicates the commitment to creditors and shareholders
is being abrogated. This condition will induce some change
in regulatory commission rules, such as formulation of the
"fair rate of return", which will restore the .relationship
between book and market value, and this will "validate" the
commissions's ratemaking rules. Thus, one further test of
the rationality of the "normalization" rule is to examine
what happens when a capital subsidy, or real reduction in the
price of plant and equipment is arbitrarily accounted for by
a regulatory commission as an increase, or source of, aftercorporate-tax income of regulated company shareholders. This
is popularly called "flow-through" accounting for a subsidy.
In terms of our illustrative example, Table A-5 presents
the 1979 "flow-through" outcome as it would appear in the
financial statements of the regulated company.
"Flowingthrough" the $3 million capital subsidy permits a $5.56
million reduction -in required 1979 revenues, as compared with
the base case.
This "amplification" of the $3 million
flow-through to equity income, after-tax, results from the
fact that tax-exempt compensation, to equity holders in this
case, obviously substitutes for a much larger pre-tax payment, as would be included in the required sales revenue to
cover cost of service, and the higher the tax rate, the
larger is the pre-tax payment eliminated by each dollar of
after-tax payment.4/ As compared with the 1979 results under
proper accounting for the subsidy, or normalization, shown in
4/ The reader should note that, for expositional simplicity,
we have extended equality of tax and regulatory accounting
to treatment of the subsidy, presumed to be in cash, as a
tax-exempt income payment to shareholders. In fact, the
tax accounting for a cash capital subsidy would be to
exclude the subsidy from the depreciable basis of the
property and this would increase the tax due as well as
increase the required revenues.
-20Tables A-3 and A-4, 1979 rates are lowered by $4.94 million
through this incorrect accounting for the capital subsidy.
But, since "flow-through" procedures maintain the $465
million rate base, and hence the equivalent amount of private
financing, as the balance sheets in Table A-5 show, the
lowered "flow-through" rates, which are permanently sustained
so long as the subsidy remains in effect, merely borrow from
the future-
As may be seen in Table A-4, in 1989 and every
year thereafter, a proper accounting for the capital cost of
service
will
yield
a
through" procedures.
lower
required
revenue
than
"flow-
In 1989, the properly measured cost of
service is $268.76 million
and declining
while the
"flow-through" cost of service is still $269.01 million, its
permanent level.
"Flow-through" procedures never approach the cost of
service reduction measured by the appropriate accounting for
a capital subsidy because they, in effect, finance a larger
first-year reduction in required revenues (and reductions for
9 more years, in our example) with the proceeds of additional
borrowing and equity financing, for which rates of return
will have to be paid.
erroneous
treatment
Since the rate base to finance this
of a capital subsidy
is permanent, its
recovery through depreciation and its interest and after-tax
return to equity
(plus income tax) will be permanently paid
by the regulated utility's customers.
There is no way to
interpret cost of service rate regulation theory in a way
which authorizes a regulatory authority to permanently impose
a burden
in excess of their real cost of service on future
users of utility services in order to provide current users
rates below their real cost of service.
This characteristic of "flow-through" accounting of a
capital subsidy appears clearly when that procedure
is
applied to a real reduction in the price of plant and equipment items. Suppose again that on January 1, 1979, the $30
million vintage of equipment drops in price to $27 million.
As we have noted before, this event should result in a $0.62
-21million reduction in the real cost of service, with the $3
million saving in equipment cost utilized to reduce the rate
base. However, if a regulatory commission designates the $3
million saving in equipment cost an addition to "net income"
attributable to shareholders' equity, while treating the $27
million of equipment purchased as if it cost $30 million, the
current year cost of service could be reduced by $5.56
million; the $3 million saving is "flowed-through".5/ Thus,
the rate base remains at $465 million, supported by that
amount of debt and equity, rather than falling to $462
million, reducing the required amount of debt and equity.
Clearly, to manipulate a lower current charge for service, $3
million of additional private funds are utilized in the
regulated company, the unnecessary cost of which will
ultimately have to be paid by utility customers.
Happily, this "flow-through" of savings in the cost of
acquiring capital would never be tolerated by regulatory
commissions: They would note that, for the same reason they
did not "flow-through" to current cost of service the $30
million of equipment cost, nor the reduced $27 million cost
(since neither expenditure was embodied fully in the service
sold in the year of acquisition) , it would be improper to
consider the $3 million difference an addition to net income
of the regulated company.
Transactions involving the
purchase of assets to be used for a period of years affect
current year cost of service only to the extent the assets
are used-up that year, as estimated by the depreciation
imputation rule, and as the net investment of creditors and
shareholders is changed by virtue of those transactions.
5/ Again, for simplicity, we assume that $30 million will be
permitted as the tax basis for depreciation purposes. If
only $27 million is paid, under the tax laws and all the
normal rules of financial accounting, only $27 million of
the taxpayer's (enterprise's) capital is recoverable
through imputed depreciation allowances.
-22In view of the conclusion reached by this discussion of
procedures for accounting for capital subsidies, the 17 years
of controversy over the accounting treatment of the investment tax credit, the most general capital subsidy paid by the
Federal government, is indeed perplexing. That there is any
lingering question about the merits of "normalization" versus
"flow-through" of the investment credit is probably attributable to the (originally) unconventional way in which the
subsidy is conveyed. We now turn to the issues peculiar to
the tax credit.
A capital subsidy paid as a credit against income tax.
To this point we have dealt with a 10 percent subsidy
payable
by
the
Commerce
Department
on
the
submission of
evidence that a depreciable asset with an expected life of
more than 7 years has been acquired for productive use. In
the examples we have detailed above, the regulated company
annually acquires $30 million of assets eligible for the
subsidy, hence receives a cash payment on this account of $3
million so that the net cost to it is $27 million.
Also,
each year, the company pays income taxes, in amounts depending on the rate, base and, consequently, on the amount of
private equity invested, given the after-corporate-tax return
required
to maintain the value of the company's
the corporation income tax rate.
shares and
The $27 million expenditure
enters cost of service as depreciation allowances, returns to
financiers of the (reduced) rate base and as taxes attributable to the equity share of those returns.
subsidized
reduction
in
acquisition
cost
The
is
$3 million
reflected
in
reductions in each of these elements of cost of service.
Suppose that Congress, in order to reduce the volume of
checks
capital
being
written
subsidy
by
payments
the
in
government
the
following
decides
way:
to
make
Companies
-23qualifying
for the subsidy will be permitted to simply sub-
tract from the taxes otherwise payable by them the amount of
the
subsidy
owed
them;
eligibility
for
the
subsidy
would
still be documented by invoices, contracts and other evidences of purchase, as in the case of the subsidy payable by
the Commerce
Department.
This
mode
of payment
will
save
check-writing expense for the government; it will also save
administrative expenses because the capital goods qualifying
for the credit are already accounted for in the tax books-ofaccount reviewed by the IRS.
Under this mode of payment, i.e., as a credit against
tax otherwise due, the illustrative regulated company, at the
beginning of 1979 still has $30 million in additional cash
and other current assets with which to purchase a replacement
vintage of plant and equipment items.
But now, when it buys
the items, it will automatically reduce the cash requirement
for paying taxes (included among the current liabilities in
its end of 1979 balance sheet) by $3 million.
Thus, the
financial statements shown in Table A-3 still correctly portray the results of its Subsidized acquisition of plant: The
$3 million of redundant cash would be used to reduce outstanding debt and equity to correspond with the $3 million
reduction in rate base; the 1979 income statement would show
exactly the same entries, including $23.61 million as provision for Federal income taxes,
included in cost of service.
an
amount
that
must
be
This latter figure, the $23.61 million provision for
Federal income tax when $3 million less will actually be
paid, is the source of continuing confusion as to the proper
way to account for the capital subsidy.
Many argue that the
$3 million is not "paid" and, hence ought not to be included
in the 1979 cost of service, i.e., that the "reduction in
tax" be "flowed-through" and accounted
for as in Table A-5.
24Th«ce oersons regard the $3 million of investment credit not
subtracted from the $23.61 million of 1979 tax expense and
therefore included in cost of service as a "phantom tax" that
inflates the cost of service and thereby enriches regulated
company stockholders.
The confusion results from a common tendency of laymen
to regard the clearance of payments through a single account
as destroying the basic transactions which gave rise to the
net payment.
That is, while these same persons would agree
that
a Federal
subsidy
of
$3
million
paid
in
cash
to a
regulated company on the purchase of plant and equipment is
perfectly consistent with a tax expense of $23.61 million
that year; nonpayment of $3 million in tax liability in oi
to get the same subsidy as additional cash is inconsistent
with the same tax expense of $23.61.
Since these persons are not persuaded of the analytical
error they are committing by a demonstration that the dollar
magnitudes resulting from a transaction in which $30 million
of assets are purchased at a net private cost of $27 million
are the same whether the subsidy is paid in cash, accompanied
by a full payment of tax liability, or not paid in cash but
cleared as a credit against tax liability, the following
example may be helpful. Suppose that, included in the cost
of goods sold for 1979, is $5 million of fuel purchased from
company A and that included in the regulated company's 1979
sales is $1 million of services sold to A. Suppose further,
that A and the regulated company have agreed that, in view of
their reciprocal seller-customer relations, the regulated
company will remit to A only the net amount owed
it.
The
regulated company will therefore use its account payable to A
to clear amounts owed it by A.
Thus, in the year in question, the $5 million of fuel purchases are recorded as an
expense (debit) and as an equivalent account payable
-25(credit);
(credit)
and
the $1 million
and an equivalent
sales
to A
as gross
account receivable
income
(debit).
At
the end of the year, the regulated company clears its account
receivable from A of $1 million against the $5 million
account payable, and closes its account payable by remitting
a check for $4 million.6/ Clearly, the fact that the regulated company paid only $4 million in cash in settlement of
the reciprocal obligations of it to A and from A to it does
not mean that the $1 million in sales to A have been obliterated or that its cost of goods sold has been reduced from
$5 million to $4 million, because this is the net cash
remittance to the fuel supplier.
Similarly, when a capital subsidy, such as the investment credit, is cleared against the tax account of the
regulated company, the clearing operation does not obliterate
the tax liability generated by the company's operation, nor
does it obscure the conveyance of a subsidy to the company in
respect of its acquisition of property qualified for the
subsidy.
Thus, the accounting procedure that properly analyzes a cash subsidy for the acquisition of capital is also
appropriate for a capital subsidy paid by permitting a credit
6/ The accounting entries to reflect this clearing transaction are:
Debit: Accounts payable $1 million
Credit:
Accounts receivable
Debit: Accounts receivable $4 million
Credit: Cash
$1 million
$4 million
Note that none of these entries affect entries for sales
of $1 million to A or of cost of goods sold of $5 million
(purchases of fuel from A ) .
-26against income tax. The "phantom tax" issue raised in
connection with capital subsidies cleared through the tax
system is a false issue: It arises from incomplete analysis
of the transactions involved. Moreover, any careless consideration of "tax paid" net of subsidies, or other payments,
cleared through the tax accounts of a given year as a measure
of tax liability generated by a taxpayer's economic performance during a year will lead to a grossly misleading
indication of the taxability of that taxpayer's income, or
what is popularly called his "effective tax rate."7/
Differences between capital subsidies paid in cash and
as credits against income tax.
Although the accounting for capital subsidies, when
paid, is independent of the form in which they are paid—
whether as cash or as credits against income tax otherwise
due—there are three notable differences between cash capital
subsidies and the present investment credit. First, because
capital subsidies cleared through tax accounts are regarded
as "reductions in tax," the amount of the subsidy payable
during a year is limited to the first $25,000 of tax
liability plus (ultimately) 90 percent of the tax liability
in excess of $25,000.8/ Although attachment of conditions
7/ See U.S. Treasury Department, Effective Tax Rates Paid by
Corporations, 1972, May, 1978.
8/ Prior to 1979, the annual limitation on the amount of
investment credit that might be taken by a single taxpayer
was the first $25,000 of tax liability that year plus 50
percent of the tax liability in excess of $25,000. In
1979, the annual maximum is the first $25,000 plus 60 percent of any additional tax liability, the percentage
increasing by 10 points in 1980 and each succeeding year
until it becomes 90 percent in 1982. Amounts of credit
earned in any y ear but not taken by reason of this
limitation may be carried back 3 years and forward 7.
-27to the granting of cash capital subsidies is not unusual,
imposition of a requirement that the private investor have
current tax liability is not a normal condition. The effect
of this limitation on effective receipt of the capital
subsidy is frequently a delay in its conveyance to the
investor, and in some cases, partial denial of the subsidy.
The second difference between a normal cash subsidy for
the purchase of qualified capital goods and the present
investment credit is that the credit is payable in advance of
the legal acquisition of the asset, under certain circumstances. If the asset in question takes more than two years
to construct, then if the purchase contract calls for advance
payments, popularly called "progress payments", then the
investment credit may be taken as these payments are made.9/
This is a curious, and asymmetrical, intrusion of "cash
accounting" procedures in a tax accounting system that,
except for its general reliance on the occurrence of an
exchange event to trigger "recognition" (measurement) of
gross and net taxable income, applies accrual procedures.
The event that signifies entitlement to .a purchase
subsidy is the legal acquisition of the qualified property;
the basis for the subsidy is the value of the property at the
time acquisition occurs.
If the terms are C.O.D., the
exchange price covers all costs—including capital costs—
incurred prior to the exchange; if the terms call for predelivery, "progress," payments, then part of the capital
costs—interest on working capital—are assumed by the buyer;
if the terms call for deferred payment, then two transactions
are involved, an exchange of property, and a loan.
In
9"/ Internal Revenue Code, section 46(d).
-28principle, the subsidizable basis of the property should be
the same in all these cases, because the value of the
property is the same when the property exchanges.
If, in the
progress payment case, an explicit imputation of the contribution by the purchaser to the value of the property in the
form of interest on loans he has made were recognized, and
that interest income attributed (and taxed) to him as lender,
it would be clear that the "progress" payment should not
trigger
interest
a "purchase"
paid,
like
subsidy.
that
paid
The
to
any
implicit
creditor,
amount
of
would
be
incorporated in the selling price of the property, and that
selling price, when paid on delivery, would constitute the
basis for the purchase subsidy.
Under present tax law conventions, no interest is
imputed with respect to progress payments; it neither appears
in the
taxable
income
of
the
implicit
lender,
nor
is it
accumulated as part of the cost of the property.
It therefore follows that, when delivery has occurred and the
property financed by progress payments has been placed in
service, the amount of subsidy payable is less than it would
be under a C.O.D. contract.
But, this is as it should be,
for part of the acquisition price has been paid with untaxed
funds—the implicit interest on the advance of funds. To
allow an acceleration of subsidy payments therefore provides
an
unwarranted
enhancement
of
the
subsidy
that
encourages
this form of project financing.10/
10/To appreciate the illogic of allowing purchase subsidies
when prepayments of the purchase price are made, consider
whether purchase subsidies should be delayed as repayments
of principal are made over the life of a deferred payment
plan to finance
devalue
the
the same purchase.
purchase
subsidy.
This
There
structure a purchase (or sale) -subsidy
favor particular payment schedules.
is
in
would
no
clearly
reason to
a manner
to
-29As
regulated
it
happens,
companies
"progress"
payments
are
so that this unusual
common
among
characteristic
of
the investment tax credit is particularly valuable to this
sector of the economy. We shall not attempt to demonstrate
here how this further reduces the cost of service for, to do
so, we would have to introduce an additional set of accounts
relating to "construction work in progress", an activity of
regulated companies that is separate from its normal activities of producing and distributing services, which is of
major concern here.
Rather we will simply observe that, in
terms of real resource costs, the $30 million expenditure for
rate base assets we have been recording
are already subsi-
dized by some amount, the amount depending on the length of
time the utility has taken to construct the $30 million unit
it places in service each year.
The third difference between a cash capital subsidy and
the investment tax credit derives from the tax treatment of
the subsidy
itself.
Whereas a government
grant
(or other
nonshareholder "contribution to capital") for the purpose of
acquiring an asset is treated under the tax laws as not
recoverable
by
the
beneficiary
of
the
grant,
the
subsidy
conveyed as an investment tax credit is.
That is, if the
Commerce Department had paid $3 million toward the purchase
of $30 million of equipment, the purchaser of the equipment
would be treated under the tax laws, as under the normal
rules of financial accounting followed in the balance sheet
presentation above, as having only $27 million in private
resources recoverable as depreciation.11/ However, when that
same subsidy is conveyed as a credit against income tax, the
investor is permitted to take tax depreciation deductions
with respect to the $3 million of subsidy as well as the $27
million paid with his own (or borrowed) funds. Clearly, a 10
percent
investment
tax credit
so structured
is worth more,
i.e., displaces more privately financed rate base, than a 10
percent cash subsidy.
11/Section 362(c).
-30Accounting for the "extra" subsidy
investment tax credit.12/
inherent_in the
Just as it was convenient to develop rules for accounting for a subsidy by first examining it when paid in cash, so
it will be illuminating to translate the additional subsidy
element conveyed by tax depreciation of a capital subsidy
into cash grant equivalents.
To do this, we modify the
original 10 percent subsidy paid by the Commerce Department
in the following way: To enhance the capital subsidy while
not initially paying the full amount, the Secretary of
Commerce offers to add to the 10 percent subsidy, which is
payable on submission of evidence that qualified property has
been acquired, an additional subsidy in subsequent years,
provided the purchaser retains and uses the property. Thus,
the additional subsidy is formulated as an amount, payable at
the end of each period of use, equal to the reduction in
income tax payable had the government's grant been included
in the investor's tax depreciation basis. The rationale for
such a subsidy might be that the government believes that,
first, by delaying the payment of the additional subsidy to
the purchaser he will be disciplined into making fewer
frivolous investments since he initially will have to pay the
90 percent unsubsidized portion of the asset's cost and wait
for the remainder for the full life of the asset. Secondly,
it might be thought that stringing out part of the subsidy
12/ We do not here account for the enhancement of the investment credit resulting from its availability as "progress
payments" are made. To do so would require complicating
the presentation to separately account for the regulated
company's construction activity.
Since this is not
related to current cost of service, it is better ignored
in the exposition.
-31over the life of the investment will serve to induce the
investor to squeeze out•the full productivity of the asset.
Gearing the amount of additional subsidy to the tax rate of
the subsidized investor is questionable. There would appear
to be no economic policy objective served by making the
additional subsidy worth more to high-income investors. The
basic 10 percent subsidy, of course, is equal-valued to all
investors.
Under this revised formulation of the 10 percent capital
subsidy, still assuming that tax depreciation imputation
rules match those used by the regulatory authority, at the
end of 1979, the first year of the subsidy program, the
Commerce Department will pay an additional subsidy of $46,000
to the utility company.
This is equal to 46 percent (the
income tax rate) of $100,000, the annual depreciation of the
subsidy ($3 million/30 years) for the 1979 vintage. At the
end of 1980, both the 1979 and 1980 $3 million subsidies will
qualify for an additional $46,000 payment from Commerce.
Ultimately, after all 30 vintages have been brought within
the scope of this modified subsidy, each year the regulated
company will realize a cash subsidy of $4.38 million for each
$30 million of plant and equipment it purchases: $3 million
representing 10 percent of the purchase price of the qualified property, $1.38 million as supplementary subsidy for 30
vintages in use, at $46,000 per vintage. The annual subsidy
per $30 million investment in qualified property is, therefore, effectively 14.6 percent ($4.38 million divided by $30
million).
Altogether, the revised "10 percent" cash subsidy will
ultimately reduce the unsubsidized rate base of our regulated
company from $465 million to $397.11 million, the remaining
$67.89 million of capital having been furnished by the
Federal government. Thus, the enhanced "10 percent" subsidy
brings about the following cost of service:
-32Cost of goods sold
Net depreciation
Interest paid
Income taxes
After-corporate-tax return
to equity
$165.00 million
25.62
23.83
20.30
23. 83
Total cost of service....$258.58 million
By reducing the capital cost elements by 14.6 percent, the
"10 percent" subsidy supplemented by future subsidies equal
to the value of private tax depreciation of the initial
subsidy succeeds in reducing total cost of service by 5.8
percent.
The present investment tax credit possesses exactly the
characteristics just described for an enhanced "10 percent"
capital subsidy. It therefore follows that the proper procedure for accounting for the investment credit is that also
just described:
While the tax expense entering cost of
service is $20.30 million each yeaf after full adjustment to
the enhanced subsidy, a total capital subsidy of $4.38
million is cleared against this accrued liability, resulting
in a payment of $15.92 million in cash to the Treasury and
leaving $4.38 million as an addition to "unamortized subsidy"
which will exactly offset the amortization of the balance in
that account and sustain a net rate base of $397.11 million
financed by $238.27 million of bonds and $158.84 million of
equity.
III. Accounting for a subsidy for the fina_ncinc[_of
capital.
Subsidies to private capital formation may either be in
the form of grants, or the investment tax credit, discussed
-33above, or in the form of financing.
In the case of grants,
the government assumes some part of the cost of acquiring the
eligible property, thereby relieving the customers who purchase the product of this capital of a part of the costs of
replacing the capital as well as the return thereon (and the
income tax attributable to that income).
in the case of
financing subsidies, loans to displace private financing are
either
made
directly
by
the
government,
or
the
terms of
private loans are subsidized, i ^ , by government guarantees
to lenders which reduce loan rates of interest, or by governmental assumption of all or part of the interest payments to
lenders. Thus, in the case of subsidies pertaining to the
financing of private capital, customers are relieved only of
the subsidized capital return costs; they must still pay
prices which will permit recovery of the capital used-up in
production.
Normally, the accounting for interest subsidies raises
no issues.
However, the formulation of Federal financing
subsidies commonly described
elements that confuse analysts
accounting for these subsidies
troversy, again centered on
as "tax deferral" contains
and laymen alike, making the
a continuing source of condebate over the merits of
"normalization" or "flow-through". To clarify analysis of a
proper accounting for such subsidies, we shall again first
specify
the
administered
present
by
"tax
deferral"
the Commerce
subsidy
Department
as
a
program
to derive from its
structure and functions a set of accounting procedures
capable of measuring the impact of the subsidies. These will
again be found transferable exactly to an accounting for the
same subsidies cleared through the tax system.
And once
more, these procedures
"normalization."
will
be
found
to
be
those
called
-34A _ ^ z e r o _ i n t e r_e s t ^ _ F e d e £ a 1 __1 o a n__ f o r __ f i^n a n c i n £ _ t h e
purchase of qualified property.
Suppose that, beginning on January 1, 1979, Congress
authorizes
the Secretary of Commerce
to make loans, at zero
rates of interest, to any purchasers of depreciable property
in order to assist them with the financing of this form of
capital
which
formation.
would
be
The Secretary,
easy
to
after
administer,
seeking
avoid
a
100
formula
percent
financing, and could be flexibly adapted to the varying life
characteristics of depreciable property, devises this formulation:
At
the
end
of
each
year
after
the
purchase
of
depreciable property, the Commerce Department will lend a sum
to the owner, at zero interest, equal to the product of his
tax
rate
times the difference between a proclaimed
depreci-
ation imputation schedule for that property and one which
describes the real economic decay of that property.
The
proclaimed schedule will simply be that produced by the sumof-years 1
digits
formula
computed
for
a
life .equal
to
80
percent of the real life. The "real" life and depreciation
imputation
s c h e d u l e will be that used
for
financial
reporting.
This is an extremely clever formulation of the terms of
a loan to achieve
the objectives of Congress
in authorizing
the program to encourage private capital formation:
1. The timing of loans and their repayment are automatically determined.
to be recovered
or
the
real
Since the total basis of the asset
under either
underlying
the proclaimed
schedule
automatically will be extended
the ownership
years.
of
the property,
is
the
schedule
same,
loans
in the early years of
repaid
in
the
later
-352. The amount of the loans will be greater the more
durable the asset, i.e., the longer lived and/or
decelerated the pattern of real underlying depreciation.
This is desirable because the private
financing needed to "carry" assets is roughly
correlated with durability.13/
On the other hand, because the amount of the financing subsidy thus provided is directly proportional to the investor's
tax rate, the program formula lends more to high income
investors than others. Again, this seems to serve no useful
economic policy objectives.
Accounting for the specified "zero interest" loan
subsidy.
In tracing out the effects of this Federal lending program, it is helpful to ignore any subsidies for purchasing
the assets. Considering only the loan, since the regulated
company's 1979 investment qualifies for the zero interest, or
interest-free, Federal lending program, we may easily determine the schedule of such loans and repayments this vintage
of investment will generate.
This is shown in Table A-6.
The proclaimed schedule of "depreciation" amounts in this
12/ In the limit of non-durability, an asset which is used-up
and requires replacement each year will require a cost of
service charge for depreciation equal to replacement cost
and no private financing of its acquisition is required;
the beginning balance sheet will show $X for such an
asset, the ending balance sheet zero, with cash and other
current assets increased by $X, available for purchasing
a replacement. Virtually no capital is required to carry
such an asset.
At the opposite extreme, an infinitely
durable asset costing X will require permanent financing
of X.
-36case will distribute the $30 million cost of the qualified
property over 24 years (80 percent of 30) by the sum-of-years' digits formula. Thus, in the first year, the proclaimed schedular amount for the regulated company is $2.4
million.
Since its norm for depreciation that year is $1
million, it can borrow from the Commerce Department $644,000
at the end of 1979 ($2.4 million, less $1 million, times the
46 percent tax rate equal $644,000). At the end of 1980, the
1979 vintage will qualify the regulated company for an
additional $598,000 of interest-free borrowing, and so on,
through 1992 for, in 1993, the proclaimed schedular amount is
equal to the depreciation norm.of $1 million. Through 1992,
$4.8 million of interest-free borrowings will have been generated by the 1979 vintage. Then, beginning in 1994, under
this lending program, repayments begin so that, when the 1979
vintage is retired at the end of 2008, all $4.8 million of
outstanding loans generated by the 1979 vintage will have
been repaid.
However, at the beginning of 1980, the regulated company
will acquire another $30 million of qualified property, and
this, too, will generate qualification for interest free
loans.
Indeed, at the end of 1980, the $598,000 of loan
eligibility of the 1979 vintage just noted will be added to
by the $644,000 first-year contribution of the 1980 vintage,
providing a total of $1,242 million in new interest-free
loans.
Continuing with the assumption of no growth or inflation, Table A-7 arrays the annual results of this lending
program over the next 30 years. In columns (2) and (3) are
shown the annual loan proceeds to which qualified property in
service entitles the regulated company.
For 1979, the
$644,000 generated by that vintage is shown in column (2), as
is the combined $1,242 million the 1979 and 1980 vintages
generated at the end of 1980. Returning our attention to the
end of 1979, it is obvious that the $644,000 of interest-free
-37loans may be used to eliminate that amount of private financing of the $465 million of rate base; thus, at the beginning
of 1980, $644,000 of debt and equity has been retired,
leaving only $464,356 million of private financing for the
$465 million of rate base. Then the additional loan eligibility of $1,242 million generated during 1980 enables the
retirement of that additional amount of private financing so
that, at the beginning of 1981, private debt and equity to
support the $465 million rate base has been reduced to
$463,114 million.
Until 1992, the addition of each vintage of assets
increases the regulated company's loan eligibility each year
by an amount greater than the preceding year. The reason why
increases in the annual increment to loan eligibility peaks
in 1992 is that, after that year, as we saw in Table A-6,
loans with respect to the 1979 vintage have to be repaid.
Thus, in 1993, the combined increment to loan eligibility
provided that year by the 1993 vintage and others is offset
in part by repayment of $46,000 with respect to the 1979
vintage assets. Beginning in 1994, the annual increment to
loan eligibility declines, reaching zero in 2008, after all
vintages in use have become eligible for interest-free loans
to the regulated company.
By the beginning of 2008, outstanding interest-free
loans to the regulated company have increased to $94.3
million, a total which will remain constant so long as the
regulated company maintains its stock of subsidy-financed
plant and equipment (rate base). Should it fail to spend $30
million some year, it will have to reduce its interest-free
loans outstanding, pay-off $644,000 that year, the amount of
expiring loans with respect to all its vintages not offset by
"new" lending for the vintage not acquired.
But, since we
have no reason to suppose that the regulated company will not
-38continue to maintain its rate base, the $94.3 million of
interest-free loans will be sustained by the equivalent of
"rolling-over" outstanding private bonds:
Loan repayments
will be covered by new borrowing.
The ultimate effect of the Commerce Department lending
program has been to reduce the unsubsidized financing of $465
million required to sustain a $465 million rate base to only
$370.7 million, with consequent reductions in the cost of
service. The effects on cost of service resulting from the
subsidized financing program are tabulated in columns (5)-(9)
of Table A-7. Since the subsidy does not reduce the private
cost of purchasing plant and equipment, the $30 million
annual depreciation cost of service remains unaffected.
However, the interest paid, income tax, and after-corporatetax return to equity steadily declines as Federal interestfree financing grows.
Ultimately, since the private
financing required is reduced by 20.3 percent, the portions
of cost of service relating to returns to private capital
similarly decline, and this brings about a 5.9 percent
reduction in total cost of service, from $274.57 million to
$258.43 million.
Clearing the interest-free loan program through the
income tax.
The lending program just described required the Commerce
Department to write checks in exchange for private firms'
notes agreeing to the terms of the loan, including repayments.
Once again, the necessity for writing checks to
implement the financing subsidy program can be avoided by
clearing the government lending through the income tax
accounts of investors. Indeed, this has been done. In 1954,
all taxpayers were allowed to use formulas for determining
annual depreciation allowances that include the sum-of-years'
-39digits method and others consistent with it, whether or not
this matched the real depreciation pattern of assets.
Beginning in 1971, taxpayers have been allowed to use 80
percent of the guideline life for such assets published by
the Treasury Department, regardless of the economic lives of
their assets.
In certain other cases, Congress has
explicitly introduced 5-year write-offs and immediate
expensing privileges that are the functional equivalents of
interest-free lending programs described above.
It will be recalled that the magnitude of the interestfree loans is dependent on the- difference between the
"proclaimed" schedule of depreciation allowances and that
which would be used for actual income measurement.
This
characteristic of the lending program raises certain issues
concerning the "norm" of depreciation imputation that should
be used for "actual" income measurement, a matter to which we
will turn below. However, in the regulated company case, as
has been noted above, the depreciation imputation norm is
specified and validated by regulatory commission rate making
rules.
Thus, to the extent that taxable income of utilities is
measured with the use of depreciation imputation rules that
depart from those used by regulatory commissions, the Federal
government is implementing an interest-free lending program
of the type just described.
Prior to the modifications of
the tax laws beginning in 1954, there was reasonably close
correspondence between the regulatory and tax rules governing
depreciation imputation. In regulated industries, therefore,
the post-1954 deviations of tax rules for income measurement
from regulatory norms marked the introduction of a subsidy
program that may only be correctly accounted for as a source
of interest-free loans.
-40We may translate the discussion above of an accounting
for the effect of interest free Federal financing into the
terminology of regulatory accounting for tax expense as
follows:
Attendant on investment in depreciable assets is
the need to measure pre-tax income flowing from their use,
after making allowance for the ultimate worthlessness of
those assets due to wear-and-tear and to obsolescence- Whatever formula is used for imputing the occurrence of this
decline in value over the life of the assets in order to
measure taxable income, the same total imputation will be
made for regulatory purposes.
If the tax rules result in
larger depreciation imputations early in the lives of assets
than is imputed under regulatory rules, then tax depreciation
imputations for the same assets wiil be smaller later in the
assets' lives. In effect, the entries in Table A-6 measure
the time-displacement of tax payments—"tax deferral"—not a
"forgiveness" of tax. Since income tax is a statutory percentage of income, and income is a function of the privately
financed capital used to produce service by the regulated
company, then if, and only if, the regulatory commission
computes tax expense—an element of cost of service—by using
its own depreciation imputation rules will it measure and
fairly distribute the cost of capital services over time.
"Tax deferral" represents interest free borrowing, the benefits of which will be distributable to customers as the
loans, generally called "deferred taxes", displace private
financing.
This accounting procedure is called "normalization" of
the difference between income tax liability, the current year
tax expense, using the company's depreciation imputation
rules (the regulatory commission's rules in the case of a
regulated company) and that using the tax depreciation
imputation rules.
The tax liability computed using the
regulated company's own rules, since it is purely a function
-41of the tax rate applied to an income measure based on the
value of assets employed, and which are privately financed,
is the correct measure of income tax expense for the period;
the difference, "deferred taxes" is a source of financial
funds available (and used) to displace private financing.
The financial statements for 1979 that reflect this
procedure are shown in Table A-8.
The only difference
between these statements and those of the base case for the
same year (Table A-l) is the $0.64 million ($644,000,
rounded) of deferred tax: In the income statement reflecting
the first-year lending program, tax expense of $23.77 million
is presented in two parts, the net $23.13 million payable
after netting the $0.64 million of interest free loan plus
the loan proceeds for the year itself, labelled "deferred
tax"; in the end of 1979 balance sheet, deferred tax appears
on the liability side, offset on the asset side by an
equivalent $0.64 million of cash and other current assets.
This raises total assets and liabilities to $565.64 million
at the end of 1979. When the $0.64 million is used to reduce
debt and equity, at the beginning of 1980, the asset and
liability totals will revert to $565 million. This process
of displacing private financing of the rate base shown in
Table A-7 to reflect the accumulation of interest- free loans
can occur, of course, only if the regulatory commission
properly regards the total tax expense, computed on the basis
of its own depreciation imputation rules and also shown in
Table A-7, as a cost of service. Assuming prompt regulatory
response, this normalization procedure to account for the
effects of an interest-free lending program charges each
year's customers their true (private) cost of service, as
this has been reduced by the volume of interest-free lending
by Federal taxpayers.
-42Mischief caused by regarding the proceeds of interest
free loans as additions to equity "income" for the year.
The fundamental accuracy with which "normalization" of
subsidies cleared through the tax system accounts for the
underlying phenomena can be demonstrated again by considering
the outcome of "flow-through" procedures applied to proceeds
of interest-free loans cleared through income tax accounts.
In Table A-7, column (2) arrays the annual amount of
interest-free loans, or "deferred taxes", generated by the
volume of subsidy-qualified property then in service.
If
these loan proceeds, payable to the regulated company in
exchange for notes labelled "deferred taxes", are simply
regarded as "reductions in tax" for the years in question,
then they make possible a reduction in required revenues that
is a multiple of the deferred taxes. As noted in connection
with "flow-through" of the investment credit, since these
payments are tax-exempt, at a tax rate of 46 percent each
dollar of loan proceeds can displace $1,851 of pre-tax—
customer-paid—income from sales. For example, in 1980, as
shown in column (2) of Table A-7, the 1979 and 1980 vintages
generate $1,242 million of interest-free loan proceeds that
year. This makes possible a reduction in required revenues
of $2.3 million ($1,242 times $1,851) as compared with the
base case level of $274.57 million, or a required 1980 revenue of $272.27 million. If that is the 1980 revenue, after
deducting $165 million (cost of goods sold), $27.9 million
(interest paid), and a tax depreciation deduction of $32.7
million (28 vintages @ $1 million each plus $2.3 million for
the 1979 vintage and $2.4 million for the 1980 vintage),
taxable income is $46.67 million, and the tax liability
payable is $21.47 million.
This amount is treated as tax
expense for the year, "deferred tax" not being recorded; the
interest-free loan is therefore not accounted for by the
regulatory authority. The required 1980 revenue of $272.27
is decomposed in that year's income statement as follows:
-43Cost of goods sold
Depreciation
Interest paid
Federal income tax
Paid
$165.00
30.00
27.90
Net return to equity..
million
21.47
27.90
Total $272.27 million
Table A-9 shows this annual required revenue from sales,
along with those for 1979 and other years through 2009, under
a regulatory procedure which "flows-through" to net income of
equity the proceeds of interest-free loans made available for
depreciable assets acquired after January 1, 1979. To compare this result with a proper accounting of the effects of
interest free loans, the required revenues from sales under
"normalization" accounting for each year, transcribed from
Table A-7, are also shown. Under the "flow-through" procedure costs of service assessed steadily drop until 1992, and
after 1993 steadily rise. This pattern mirrors the pattern
of interest-free loans generated, shown in column (2) of
Table A-7.
Thus, by 2008, when no additional interest-free
loans are generated to clear through the tax accounts, the
"flow-through" required revenue from sales that year has
returned to the base case level, where it will remain so long
as there is no change in the rate baseGiven the nature of the underlying phenomena, a shifting
in time of tax liabilities, and hence the generation
of
interest-free loans, the "flow-through" pattern is indeed
curious:
until 1992, "flow-through" procedures afford
customers lower rates than if the loan proceeds were properly
accounted for, as interest-free loans; thereafter, they are
assessed higher charges, and by 2008, they are paying rates
as if the Federal loan program had never existed or continued
-44in effect!
Any technique for accounting for the effects of
tax deferral which produces such results must be defective:
so long as tax deferral is in effect, and the calculations
here assume the subsidy program is permanent, it should be
reflected in lower costs of service. Though the conditions
in 2009 include the interest-free loan program while the base
case does not, revenues required in the two instances are the
same. If this is the result of "flow-through" accounting for
the loan program, it must be an improper regulatory accounting technique.
The inherent error of "flow-through" techniques is their
failure to account for the cumulative effect (a growing
stock) of interest-free loans provided by artificially
accelerated tax depreciation imputation methods. It therefore misallocates the proceeds of interest-free loans to
current year consumers as a cost of service reduction; this
deprives future years' consumers of the benefit of
interest-free financing of plant and equipment. As noted in
the previous section dealing with the accounting for a
capital purchase subsidy, forcing future generations to pay
the price of unnecessary private financing of rate base is a
policy inconsistent with the objective of cost of service
rate regulation.
Under that regulatory procedure, each
year's customers ought to pay the cost of their service; they
should neither be forced to bear a burden to benefit future
generations of customers, nor be given price breaks that will
be a burden to other generations.
Moreover, in the (improbable) event that replacement
does not continue so that loans will have to be repaid, the
generation of customers in that year will experience an
increase in cost of service. For example, if in 2009 the $30
million is not spent on replacement, $644,000 of the deferred
tax will have to be repaid. But, in order to "repay" this,
income from sales will have to be increased by $1,193 million
-45above the base case, which has no subsidy!
Had the subsidy
been accounted for properly, the increase in tax payable due
to a net repayment of deferred taxes would have been so
accounted for:
of outstanding
service.
as a reduction in deferred taxes, a repayment
loans, not an increase in current cost of
The combined effect of the two tax subsidies.
The previous section showed how the investment tax
credit, if properly accounted for in the
would ultimately reduce the rate base
required, absent* a subsidy, to $397.11
private financing.
In this section we
cost of service,
of $465 million
million requiring
have shown how a
properly accounted for interest-free lending program financed
through the income tax accounts would reduce the required
private financing of rate base assets by 20.3 percent. Table
A-10 summarizes the combined effect of these two subsidies on
the cost of service, when the assumed static stock of assets
required to produce the established level and quality
service have all come under the cover of the subsidies.
of
As noted, the investment credit, by providing complete
Federal financing and replacement of 14.6 percent of the $465
million worth of plant and equipment, reduces the financing
requirement to $397.11 million. Then, the interest-free loan
program provides $80.53 million of financing, leaving only
$316.58 million to be financed with long-term debt and shareholder equity.
The net effect of these two subsidies is,
then, a reduction in all the capital cost elements: the net
depreciation charge is reduced by the investment tax credit,
and the interest, income tax and return to equity are reduced
by both the investment credit and the loan program.
Altogether, the capital cost elements have been
30.6
percent,
from
$109.57
to
$76.06
million,
reduced by
and
this
translates into a total reduction in cost of service of 12.2
-46percent, from $274.57 to $241.06 million. Depending on the
responsiveness of service demand to this reduction in cost of
service, expansion of service capacity, and hence plant, will
ensue.
It is worth noting in conclusion that the indicated
reduction in tax liability shown in Table A-10 does not imply
some net reduction in Treasury revenues. We are here examining only the outcome of Federal subsidies for a unit of
capital employed by a regulated company to provide utility
services. The reduction in income tax revenues generated by
these subsidies to private capital formation, which are
translated into reductions in prices paid by customers, are
regenerated when the purchasing power released in lowered
prices is spent for other goods and services. Whether these
tax subsidies to private capital formation result in net
changes in Treasury revenue flows depends largely on whether
the response to the subsidy programs in the aggregate stimulates a net change in the tax base, i.e., GNP originating in
the private sector. This is an empirical question for which
there is as yet no definitive answer.
IV. Consistency of Tax Subsidy Normalization Rules with
Dynamic Change
Relaxing the no-growth assumption: the investment tax
credit
The foregoing accounting of the way in which subsidies
to private capital operate to reduce the private cost of,
charges for, service in the context of fair rate of return
utility regulation was intentionally presented with the aid
of a model of a regulated company in "stationary equilibrium." Assuming the regulated company merely operates a fixed
stock of plant and equipment items incorporating an unchanging state of technology and using labor and materials with
-47similarly unchanging costs makes it possible to clearly trace
out the effects of a subsidy.
The accounting of these
effects, however, is not dependent on the model's assumptions.
For example, suppose that, as a result of the subsidyinduced decline in service charges, or for any other reason,
the amount of service demanded in the regulated company's
market increases.
Then, in addition to the $30 million
annual investment in plant, some additional
be made
to expand
capacity.
Suppose
that
investment will
a one
percent
increase in capacity is called for in 1979, and approved by
the regulatory commission.
If the book-value of the existing plant is $465 million, a one percent expansion would
require an additional expenditure of $4.65 million, if the
entire expansion is made at the beginning of 1979. Absent a
purchase subsidy, $4.65 million of additional financing,
$2.79 million of new issues of bonds, $1.86 million of stock
(or retention of that amount from 1978 after-corporate-tax
income of the company), would be required.
In 1979, this
addition would add $0,155 million of depreciation to cost of
service, $0,279 million for interest, a like amount for
return to equity, and $.238 million to income tax expense.
If, in 1979, a 10 percent investment credit is introduced,
the
combined
purchase
of
$34.65 million
that
year
would generate a subsidy of $3,465 million (plus $1,594
million later).
Then, just as we saw above, the subsidy
would ultimately decrease capital costs of service of both
the initial rate base and the 1979 increment by the relative
size of the subsidy, 14.6 percent in the case of the present
investment credit.
million in cash due
Moreover, the availability of $3,465
to the subsidy means that only $1,185
million of new financing will be required at the beginning of
1979 to finance the additional $4.65 million acquisition.
-48Thus, introducing growth changes nothing in the accounting for the investment subsidy. However, it is worth noting
that because the dollar magnitude of the investment subsidy
each year is determined by the sum of "replacement" plus "new
investment", the net new financing required for the addition
to capacity (rate base) is greatly reduced; the redundant
private financing with respect to "replacement" rate base is
available to help finance the increment to rate base. In
inflationary times, when mere "replacement" prices rise, the
additional current dollar investment called for which would
also have to be financed with additions to debt and equity,
equally benefits from the subsidy as if it represented real
growth.
Thus it can be seen that in any period in which
regulated companies are both growing in a real sense and
plant and equipment costs are inflating, the existence of a
subsidy program greatly reduces the search for additional
private financing.
This is probably why regulated company
managements have come to regard the investment credit as
essential "means" of financing their annual outlays for plant
and equipment.
Again, the use of cash or other accounts
through which to clear a multitude of transactions may cause
careless observers to accept this fallacious interpretation
of the function of a capital subsidy.
Deferred taxes
In a similar fashion, interest-free loans generated by
additions to capacity provide the same pattern of future
reductions in cost of service associated with additions as
was observed above in connection with the gradual qualification of all the vintages of plant for deferred taxes.
Continued growth, or inflation, by generating larger combined loan eligibility for each vintage of "replacement" and
the "new" investment, provides a larger fraction of each
year's new financing requirements and again creates the
-49illusion that the current year's subsidy is mainly an expansion financing device.
Of course, in terms of the underlying
economics of the transactions, while the aggregate displacement of private financing of the rate base may be large
relative to any current year's purchases of plant and equipment, the distinction between the two elements of the
displacement—that pertaining to additional loans for which
previously acquired property become eligible and the other
pertaining to the first-year eligiblity of the increment—
should not be obscured simply because both elements are
cleared through the current year's tax account.
It is worth noting in passing that, if the rate of
growth of annual outlays for rate base assets rises at a high
enough rate, the point at which annual required revenues
determined by "flow-through" of interest-free loan proceeds
exceeds the revenue required under a proper accounting of
these loans is delayed, as compared with the no growth case
we have examined in detail above. So long as growth and/or
inflation cause the rate base to increase, the cumulation of
deferred taxes increases. Thus as compared with the U-shaped
cost of service decline from 1979 to 1992 and
to 2008 shown in column (2) of Table A-9,
regarded as a cost per unit of output because
capacity remains constant, had annual outlays
rise from 1993
which may be
it is assumed
grown at some
constant rate, the cost curve would have been stretched over
time, the minimum cost of service would have occurred after
1992, and so long as the annual rate of growth had persisted,
the annual cost per unit of service would never quite return
to the unsubsidized level.
However, even under these circumstances, the cost of service established under "flowthrough" accounting procedures would never reach the levels
of
correct
cost
of
service
calculation.
If
properly
accounted for, the continued increase in interest-free
financing of the growing rate base would bring about steadily
declining costs of service.
-50In sum, the appropriate accounting for subsidies cleared
through tax accounts in no-growth situations is also appropriate for a growth situation. In either case the technique
called "normalization" distributes the benefit of the subsidies to customers over time in accordance with the terms of
the subsidies: the investment credit as an initial reduction
in the acquisition cost of the qualified property, plus subsequent supplements earned as the asset is held in use; the
interest-free loan program, with the proceeds in the form of
deferred taxes determined by the loan and repayment schedule
implied by the divergence between tax and regulatory rules
for imputing the occurrence of depreciation, as a displacement of private financing.
Effects of unforeseen changes.
Suppose that an investment error has been made: The
"wrong" facilities were acquired at the "wrong" time. That
is, facilities were built to embody a technology that later
proves to be inefficient, or the plant is located on a site
that later appears to have been badly selected, or anticipated demand for utility services has failed to materialize.
These investments that subsequent events prove to have been
made in error are incorporated in the rate base. Under the
logic of fair rate of return regulation, since the regulatory
commission has tacitly approved inclusion of the "excess"
investment in the rate base, the costs of these "mistakes"
are distributed to customers over time in the form of charges
for depreciation, rate of return, and income taxes.14/
14/ Footnote 1 indicated that surveillance over the quality
of regulated company decision making is one of the
responsibilities of regulation.. In unregulated markets,
commission of investment errors results in losses to
equity owners.
As a consequence, rates of return to
equity in the unregulated sector tend to be higher than
rates of return in the regulated sector.
-51The accounting for subsidies cleared through the tax
system is, of course not affected by this; the subsidies
generated by the mistaken investment should be distributed in
the same way as the mistaken costs themselves. It is also
probably the case that, if there are subsidies which have the
effect of reducing private costs of acquiring and using
capital, more "mistakes" will be made pari passu with the
increase in investment that may be induced by the lower cost
of service made possible by the subsidies. However, given a
quality of regulatory vigilance over the investment planning
of regulated companies, there is no reason to suspect they
will relax their vigilance because subsidies are available.
The relative cost of "mistakes" is not altered by the subsidies, which apply equally to "good" and "bad" decisions.
V. Extension of the regulated company analysis to
unregulated companies.
The phenomena associated with the provision of subsidiees for the acquisition, or financing, of private capital
are the same in both the regulated and unregulated sectors.
It therefore follows that the proper accounting of tax subsidies described above for regulated companies applies
equally to unregulated companies. In the unregulated sector,
however, the economic import of the company's own accounting
system is much less.
Because entry into markets in the
unregulated sector is more or less free, and because there is
also inter-product competition in the unregulated sector,
selling prices, and hence revenue from sales, does not
annually track changes in cost of goods sold and the several
elements of capital cost. "Required revenues" to cover all
costs, including a "fair rate of return", cannot simply be
obtained in unregulated markets by the mere posting of such
prices.
-52In the regulated case described above, capital cost
changes were "rolled-in" over 30 years, the average life of
the plant. This is one example of average cost pricing: The
annual charge for depreciation, interest, and return to
equity is derived from the costs of the 30 prior years.
Thus, when a subsidy,, or any other cause for a reduction in
private cost of acquiring capital, reduced the purchase price
of capital by 10 percent, 30 years had to elapse before the
full change in cost, the lower marginal cost, was finally
realized by customers.
And with perfect cost of service
regulation over this period, the regulated company's bookvalue of rate base was kept equilibrated to the market value
of the company's bonds and shares.
In the unregulated company case, however, where market
prices are freer to vary as cost conditions change, revenues
more quickly adjust to cost changes. For example, after a 10
percent capital purchase subsidy has been introduced, in an
industry which replaces its capital in, say, 15 years, it
will not take 15 years for the effect of the subsidy to work
its way through to prices and revenue.
New firms, for
example, or divisions of firms in other industries, that
equip themselves after the introduction of the subsidy will
be able to install a plant at 90 percent of the cost of
plants built before the subsidy. These firms will be able to
price their output lower to capture larger shares of the
market, and this will force older firms to more rapidly
adjust prices downward to reflect the lower costs or be
forced out of business. For an unregulated company, therefore, the historic book-value of assets acquired before the
subsidy, and the corresponding book-value of equity, may be
overstated as compared with the valuation placed on these
assets in the market, after a subsidy has been introduced.
For example, if market prices of products adjusted instantaneously to the change in marginal capital costs, then the
-53earnings of pre-subsidy assets, and the corresponding equity,
would immediately shrink.
These lower "earnings per share"
of "old" firms would cause market prices of these shares to
decline,
which
assets carried
value .
is
to
say
the market value
of
pre-subsidy
in balance sheets would be lower than book-
In the unregulated sector, then, the response to a
capital subsidy is much more rapid than in the
regulated
sector. A 10 percent purchase subsidy will more quickly lead
to a higher rate of investment to expand capacity.
Of
course, after adjustment to the reduction in capital costs
has been made, the only effect of the subsidy will be to sustain the higher
replacement
investment
required
to sustain
the larger capital stock it has induced.
Deferred taxes in the unregulated sector.
The foregoing remarks on the looser ties between bookvalue and market value of unregulated company assets and
equity than is found in the regulated sector apply also to
the substantive content of unregulated companies' imputations
of depreciation for financial reporting purposes.
For an
unregulated company, its depreciation imputation rules do not
determine a "cost of service
"claim" in prices it charges.
(production)" element it can
Rather, it is an accounting
convention employed to derive a financial measure of pre-tax
income, and to correspondingly revalue depreciable assets in
its balance sheet.
If the company's depreciation imputation
rule produces too low an annual depreciation "expense", as
compared with real depreciation, this simply means that pretax income for the period is overstated, and "net income"
(after-tax) likewise.
But, since dividend payouts need not
correspond to this measure of book-income, there is no
financial or other penalty to overstatement of book-income.
-54On the other hand, if the depreciation imputation rule used
by an unregulated company aims to rapidly write-off assets,
regardless of the real rate of depreciation, its book-pre-tax
income will be understated, and its "net income" correspondingly. Again there is no penalty for not measuring income in
a manner such that the amount so measured could actually be
paid out and permit the company to carry on its operations,
as in the regulated company case.
Of course, "quality" of reported earnings is an important dimension of a company's performance that is carefully
assessed by investment analysts. Shares of companies that
employ depreciation imputation methods calculated to overstate "net income" will naturally sell for prices that are
smaller "multiples" of reported earnings per share in recognition of this source of "low quality" earnings; companies
that use more accelerated depreciation imputation methods
will sell for a higher multiple, all other things being
equal. Since too slow a method of imputing depreciation also
results in a higher book-value of depreciable assets, bookvalue per share of companies employing such depreciation
methods will tend to exceed market value on this account, as
well. Conversely, the consistent use of too rapid depreciation imputation rules for financial reporting will be
associated with a market value in excess of book-value.15/
15/ Cf., Solomon, Ezra, "Alternative Rate of Return Concepts
and Their Implications for Utility Regulation," Bell
Journal of Economics and Management Science, Vol. 1, No.
1, (Spring, 1970), pp. 65-81.
-55Since the depreciation imputation method employed by an
unregulated company has no normative value, the divergence
between it and tax depreciation imputation methods also has
no normative implications. However, the logic of accounting
in the unregulated company case nevertheless requires recognition of "deferred taxes" for, whether the book imputation
really measures depreciation, timing differences between it
and tax depreciation must be accounted for if only to provide
a record of the degree to which assets employed in the business have less "tax basis" to be recovered than the assets*
reported book-value and, therefore, how much extra income tax
liability might be owed in the event assets are not replaced.
Thus in the case of unregulated companies, due to the uncertain content of the company's reported (book) depreciation,
reported accrual of "deferred taxes" during a year is not
normally a satisfactory measure of interest-free loans
extended.
To obtain a measure of interest-free loans
extended to unregulated companies requires that a real
measure of depreciation for the year be computed and this
compared to the tax depreciation imputation allowed for the
same year. The corrected figure, less the tax depreciation
amount times the corporate tax rate yields the measure of
interest-free loans qualified for during the year, the proper
"deferred tax amount" to add to the net income tax payment to
derive tax expense for the year.
-56Table A-l
Base Case Financial Statements
Income Statement
for year, 1979
(millions)
Income from sales
less: Cost of goods sold
equals : Operating income
$274. 57
165.0
$109.57
less: Depreciation. 4 $30.00
Interest paid
27.90
equals: Pre-tax income
$
less: Provision for Federal income tax (§46 percent,
equals: After-tax ("net") corporate income
$
less : Distribution to stockholders
equals: Addition to retained earnings.....
57.90
51. 67
23.77
27.90
27.90
0.00
Balance Sheets
1979
(millions)
Cash and other
current assets
Assets
"Beginning;
$100
End
$130
:
:
Liabilities
Beginning :Enc
Accounts payable
(including taxes) $100 $10(
Plant and equipment Long-term debt 279 275
original cost
$900
$900
less: accrued
Net worth:
depreciation 435 $465 465 $435
Capital stock
Total assets $565 $565 Total liabilities $565 §565
186
..,
J5S
-57-
Table A-2
Illustrating Maintenance of A Constant Capital Stock, When
The Regulatory Depreciation Imputation Rule is Straight-Line
Assets in use, at beginning of
Year asset
vintage was acquired Original
cost
(Jan. 1)
T979~~
Accumulated
depreciation
Net
bookvalue
7
h
£
Original
cost
I9S0"
Net
Accumulated : book
depreciation: value
1950
$ 30
$ 29
1951
30
28
$ 30
$ 29
1952
30
27
30
28
1959
30
20
10
30
21
1960
30
19
11
30
20
•
•
•
•
•
•
•
$
1
$
1
9
10
•
•
•
•
•
•
•
•
•
1978
30
1
29
*30
2
*28
1979
30
0
30
30
1
29
30
0
30
$900
$435
$465
1980
Total
$900
$435
$465
-58-
Table A-3
Financial Statements, With 10 Percent Capital Subsidy
Income Statement
for year, 1979
(millions)
Income from sales $273.95
less: Cost of goods sold
equals: Operating income
165.00
$108.95
less: Depreciation $30
Subsidy amortization
(0.1)
Interest paid
27.72
57.62
Pre-tax corporate income $51. 33
less: Provision for Federal income tax
23.61
equals: after-tax ("net") corporate income...$27.72
less: Distributions to stockholders
27.72
equals: To retained earnings
0.0
Balance Sheets
1979
(millions)
Assets
Beginning
Cash and other
current assets
Liabilities
~
End
:
Beginning: End
Accounts payable $100
?ID0
$129.9
Long-term debt
277.2 277.
;
$100
;
Plant and equipment
original cost
$900
$900
Net worth:
less: unamortized
Capital stock
subsidy
3
2.9
accrued
depreciation 435 $462
465 $432.1
Total assets $562 $562.0 Total'liabilities$562.0 $562.
184.8
184J
Table A-4
Net Rate Base, Income from Sales, and Cost of Service Elements,
with 10 Percent Capital Subsidy; when Tax and Regulatory Income
Measurement Rules are Identical
Year
Net
rate base
(beginning
of year)
(D
Base case
$465.00
with subsidy
1979
$462.00
1980
459.10
1981
456.30
1982
453.60
1983
451.00
Income
from sales
(2)
Cost of
goods sold
(3) .,
Net
depreciation
(millions)
Cost of service
Interest
paid
(5J_
Federal
income tax
i§l
Return
to equity
(7)
$274.57
$165.00
$30,00
$27.90
$23.77
$273.95
273.36
272.78
272.22
271.67
$165.00
165.00
165.00
165.00
165.00
$29.90
29.80
29.70
29.60
29.50
$27.72
27.55
27.38
27.22
27.06
$23 .61
23.47
23.32
23.18
23.05
$27.90.
$27.72
27.55
27.38
27.22
27.06
1984
1985
1986
1987
1988
448.50
446.10
443.80
441.60
439.50
271.14
270.63
270.14
269.66
269.20
165.00
165.00
165.00
165.00
165.00
29.40
29.30
29.20
29.10
29.10
26.91
26.77
26.63
26.50
26.37
22.92
22.80
22.68
22.57
22.46
26.91
26.77
26.63
26.50
26.37
1989
1990
1991
1992
1993
437.50
435.60
433.80
432.10
430.50
268.76
268.34
267.93
267.54
267.16
165.00
165.00
165.00
165.00
165.00
28.90
28.80
28.70
28.60
28.50
26.25
26.14
26.03
25.93
25.83
22.36
22.26
22.17
22.09
22.00
26.25
26.14
26.03
25.93
25.83
1994
1995
1996
1997
1998
429.00
427.60
426.30
425.10
424.00
266.81
266.47
266.14
265.84
265.55
165.00
165.00
165.00
165.00
165.00
28.40
28.30
28.20
28.10
28.00
25.74
25.66
, 25.58
25.51
25.44
21.93
21.86
21.79
21.73
21.67
25.74
25.66
25.58
25.51
25.44
1999
2000
2001
2002
2003
423.00
422.10
421.30
420.60
420.00
265.28
265.03
264.79
264.57
264.37
165.00
165.00
165.00
165.00
165.00
27.90
27.80
27.70
27.60
27.50
25.38
25.33
25.28
25.24
25.20
21.62
21.57
21.53
21.50
21.47
25.38
25.33
25.28
25.24
25.20
2004
2005
2006
2007
2008
419.50
419.10
418.80
418.60
418.50
264.18
264.01
263.86
263.73
263.61
165.00
165-00
165.00
165.00
165.00
27.40
27.30
27.20
27.10
27.00
25.17
25.15
25.13
25.12
25.11
21.44
21.42
21.41
21.40
21.39
25.17
25.15
25.13
25.12
25.11
2009
2010
418.50
263.61
165.00
27.00
25.11
21.39
25.11
l
&
M
-60-
Table A-5
Financial Statements, When a Capital Subsidy
Is "Flowed-Through" to Equity
Income Statement
for year, 1979
(millions)
Income from sales $269.01
less: Cost of goods sold
165.00
equals: Operating income
104.01
less : Depreciation $30.0
Interest paid
27.9
57.90
equals: Pre-tax income
$ 46.11
less: Provision for Federal income tax
21.21*
equals : After-tax corporate income
$ 24.90
plus : Capital subsidy
3.00
"Net" income
? 27.90
less: Distribution to stockholders
27.90
equals : Addition to retained earnings
0.00
^Assumes tax accounting will ignore nonshareholder contribution to capital.
Balance Sheets
1979
(millions)
Assets
Beginning:
Cash and other
current assets
$100
End
$130
Plant and equipment
original cost
$900
$900
less: accrued
depreciation 435 $465 465 $435
Total assets
$565
$565
:
:
Liabilities
"
Beginning:End .
Current liabilities
(including taxes
payable)
$100
$100
Long-term debt
Net worth:
Capital
stock
Total
liabilities
279
$565
279
Table A-6
Schedule of Interest-free Loans Extended and Repaid:
1979 Vintage of Plant and Equipment
End of
year
. Depreciation Schedule
Proclaimed 1/
Norm 2/
(2) ~
(1)
"
Loan
extended
:/(l)-(2)/x.46
(3)
End of
Proclaimed 1/
year
(4)
(5)
"
(millions)
1994
$0.9
0.8
1995
1996
0.7
1997
0.6
1998
0.5
1979
1980
1981
1982
1983
$ 2.4
2.3
2.2
2.1
2.0
$ 1.0
1.0
1.0
1.0
1.0
$0,644
0.598
0.552
0.506
0.460
1984
1985
1986
1987
1988
1.9
1.8
1.7
1.6
1.5
1.0
1.0
1.0
1.0
1.0
0.414
0.368
0.322
0.276
0.230
1999
2000
2001
2002
2003
1989
1990
1991
1992
1993
1.4
1.3
1.2
1.1
1.0
1.0
1.0
1.0
1.0
1.0
0.184
0.138
0.092
0.046
0.0
2004
2005
2006
2007
2008
Totals
$25.5
$15
$4,830
Ortlce or the Secretary or the Treasury
Office of Tax Analysis
Loan repaid
/(6)-(5)/x.46
Norm2/
(6T
(7)
$ 1.0
1.0
1.0
1.0
1.0
$0,046
0.092
0.138
0.184
0.230
0.4
0.3
0.2
0.1
0.0
1.0
1.0
1.0
1.0
1.0
0.276
0.322
0.368
0.414
0.460
0.0
0.0
0.0
0.0
0.0
1.0
1.0
1.0
1.0
1.0
0.460
0.460
0.460
0.460
0.460
$4.5
$15
$4,830
March :>. 19/*
1/ The proclaimed schedule is based on sum-of-years' digits, for 24 years. Thus, the denominator
"~ for each year's fractional depreciation is 300. Then for 1979, the fraction for determining
the schedular amount is 24/300, and this multiplied by $30 million yields $2.4 million. The
amount for 1980 is 23/300 times $30 million, and so on through 24 years.
2/ The depreciation norm is based on 1/30 of $30 million each year.
Table A-7
Privately Financed Rate Base, Income from Sales,
and Cost of Service Elements,
With Federal Interest-Free Loan Program
Base case
Financing of rate base
Zero interest loans
Beginning
at end of year:
For
of year
given
private
Cumulative
year
funds
(3)
(2)
(1)
$465,000
$274.57
With lending
subsidy:
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
$465,000
464,356
463.114
461.320
459.020
456.260
453.086
449.544
445.680
441.540
437.170
432.616
427.924
423.140
418.310
413.480
408.696
404.004
399.450
395.080
390.940
387.076
383.534
380.360
377.600
375.300
373.460
372.080
371.160
370.700
370.700
$274.57
274.46
274.24
273.94
273.54
273.07
272.53
271.92
271.26
270.55
269.80
269.03
268.22
267.40
266.58
265.75
264.93
264.13
263.35
262.60
261.89
261.23
260.63
260.08
259.61
259.22
258.90
258.67
258.51
258.43
258.43
Year
$0,644
1.242
1.794
2.300
2.760
3.174
3.542
3.864
4.140
4.370
4.554
4.692
4.784
4.830
4.830
4.784
4.692
4. 554
4. 370
4. 140
3.864
3. 542
3. 174
2. 760
2. 300
1.840
1.380
0.920
0.460
0.000
0.000
$0,644
1.886
3.680
5.980
8.740
11.914
15.456
19.320
23.460
27.830
32.384
37.076
41.860
46.690
51.520
56.304
60.996
65.550
69.920
74.060
77.924
81.466
84.640
87.400
89.700
91.540
92.920
93.840
94.300
94. 300
94.300
Income
from
sales
(*)
Cost of service
Cost
of
Income
goods DepreInterest
ciation
taxes
sold
(7)
(6)
(«)
<5)
$165.00 $30.00 $27.90
$23.77
$165.00
$165.00
$30.00
$30.00
$27.90
27.86
27.79
27.68
27.54
27.38
27.19
26.97
26.74
26.49
26.23
25.96
25.68
25.39
25.10
24.81
24.52
24.24
23.97
23.70
23.46
23.22
23.01
22.82
22.66
22.52
22.41
22.32
22.27
22.24
22.24
$23.77
23.73
23.67
23.58
23.46
23.32
23.16
22.98
22.78
22.57
22.34
22.11
21.87
21.63
21.38
21.13
20.89
20.65
20.42
20.19
19.98
19.78
19.60
19.44
19.30
19.18
19.09
19.02
18.97
18.95
18.95
After-tax
return to
equity
(9)
$27.90
$27.90
27.86
27.79
27.68
27.54
27.38
27.19
26.97
26.74
26.49
26.23
25.96
25.68
25.39
25.10
24.81
24.52
24.24
23.97
23.70
23.46
23.22
23.01
22.82
22.66
22.52
22.41
22.32
22.27
22.24
22.24
t
roi
-63-
Table A-8
Financial Statements, First Year of a
Federal Interest-free Loan Program Financed
Through the Tax System
Income Statement
for year 1979
(millions)
Income from sales
$274.57
less: Cost of goods sold
165.00
equals : Operating income
$109.57
less: Depreciation
$30
Interest paid
27.90
57.90
equals: Pre-tax income
$ 51.67
less: Provision for Federal income tax:
Accrued taxes payable..$23.13
Deferred tax
0.64
23.77
equals: After-tax ("net") corporate income...$ 27.90
less : Distribution to stockholders . .
27.90
equals: Addition to retained earnings
lj> 0.00
Balance Sheets
1979
(millions)
Assets : Liabilities
Beginning:
End
:
uash and other
current assets
$100
$130.64
Plant and equipment
acquisition cost
$900
$900
less: accrued
depreciation 435 $465 465 $435
Total assets
$565
$565.64
Beginning:End
Current liabilities $100 $100.00
Long-term debt
279 279.00
Deferred taxes
0
0.64
Capital
Net
worth stock
186
186.00
$565 $565.64
Table A-9
Comparison of Income from Sales, When Proceeds of Interest-Free Loans Are So Accounted For
and When They Are "Flowed-Through" to Equity Income in the Year Received
Income
Interest-free loans "flowed-through" to income
from sales:
Costs of service
loan benefits
Income
Income
distributed
Cost of
from
taxes
as earned:
Interest
goods sold Depreciation
sales
"paid"
Year
"normalize"
(3)
(2)
(6)
_J5)
(millions)
(1)
&>
Base case
$274.57
$165.00
$274.57
$30.00
$27 .90
$23.77
With loan
subsidies:
1979
1980
1981
1982
1983
$274.57
274.46
274.24
273.94
273.54
$273.37
272.27
271.24
270.31
269.46
1984
1985
1986
1987
1988
273.07
272.53
271.92
271.26
270.55
268.69
268.01
267.41
266.90
266.47
17.89
17.21
16.61
16.10
15.67
1989
1990
1991
1992
1993
269.80
269.03
268.22
267.40
266.58
266.13
265.88
265.71
265.62
265.62
15.33
15.08
14.91
14.82
14.82
1994
1995
1996
1997
1998
265.75
264.93
264.13
263.35
262.60
265.71
265.88
266.13
266.47
266.90
14.91
15.08
15.33
15.67
16.10
1999
2000
2001
2002
2003
261.89
261.23
260.63
260.08
259.61
267.41
268.01
268.69
269.46
270.31
16.61
17.21
17.89
18.66
19.51
2004
2005
2006
2007
2008
259.22
258.90
258.67
258.51
258.43
271.16
272.01
272.86
273.71
274.57
20.36
21.21
22.06
22.91
23.77
2009
258.43
274.57
Office of the Secretary of the Treasury
o(fi cc < > f T.ix Analysis
$165.00
V
$165.00
$30.00
'1
$30.00
$27 .90
$22.57
21.47
20.44
19.51
18.66
,
$27. 90
23.77
Net return
to equity
(7)
$27 .90
$27.90
v
$27.90
March 6,
1979
Table A-10
Combined Effect of Investment Tax Credit
and Interest-Free Loan Program on Cost of Service
(millions)
Plant and equipment required to produce specified quantity
and quality of service; "rate base," at market prices
Rate base assets to be financed:
Base case (without subsidies)
After 10 percent investment credit fully effective
Financing of rate base assets:
Base case: Interest-bearing debt
$279.00
Capital stock
186.00
After investment credit and interestfree loan program effective:
Interest-bearing debt
Capital stock
Interest-free loans,
"deferred taxes"
Cost of Service
$465.00
$465.00
$397.11
$465.00
•
S
•
$189.95
$126.63 316. 58
80.53
397.11
Base case
Subsidies
fully effective
Total cost of service $274.57 $241.06
Cost of goods sold 165.00 165.00
Capital costs: Depreciation
30.00
25.62
Interest paid
27.90
18.99
Provision for Federal
income tax
23.77
12.45*
After-corporate tax return
to equity
27.90
18.99
^Includes coverage of $4.38 million in initial and supplementary
investment credit, but no addition to "deferred taxes."
TREASURY
LEPHONE 566-2041
, D.C. 20220
FOR IMMEDIATE RELEASE
March 26, 1979
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $3,000 million of 13-week Treasury bills and for $3,001 million
of 26-week Treasury bills, both series to be issued on March 29 1979
were accepted at the Federal Reserve Banks and Treasury today. The details are
as follows:
RANGE OF ACCEPTED
COMPETITIVE BIDS:
High
Low
Average
13-week bills
maturing June 28, 1979
26-week bills
maturing September 27t 1979
Price
Discount
Rate
Investment
Rate 1/
Price
97.608
97.593
97.599
9.463%
9.522%
9.498%
9.86%
9.92%
9.89%
95.250 9.396%
95.221
9.453%
95.229
9.437%
Discount
Rate
Investment
Rate 1/
10.03%
10.09%
10.08%
Tenders at the low price for the 13-week bills were allotted 97%.
Tenders at the low price for the 26-week bills were allotted 13%.
TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS AND TREASURY:
Location
Received
Boston
$
44,680,000
New York
4,307,190,000
Philadelphia
34,900,000
Cleveland
28,510,000
Richmond
19,815,000
Atlanta
40,840,000
Chicago
390,660,000
St. Louis
34,775,000
Minneapolis
27,175,000
Kansas City
23,480,000
Dallas
9,575,000
San Francisco
391,370,000
Treasury
10,170,000
TOTALS
$5,363,140,000
Accepted
Received
Accepted
$
39,665,000
2,301,405,000
34,900,000
28,510,000
19,815,000
40,840,000
305,660,000
12,775,000
7,175,000
23,480,000
9,575,000
166,280,000
10,170,000
$
37,890,000
4,491,860,000
37,360,000
38,755,000
12,580,000
23,485,000
161,370,000
32,260,000
23,085,000
20,790,000
7,815,000
212,430,000
16,270,000
$
22,890,000
2,680,460,000
37,360,000
38,755,000
12,580,000
23,485,000
86,370,000
13,260,000
3,085,000
20,790,000
7,815,000
37,430,000
16,270,000
$3,000,250, OOOa/i $5,115,950,000
includes $370,870,000 noncompetitive tenders from the public.
includes $223,795,000 noncompetitive tenders from the public.
Equivalent coupon-issue yield.
I486
$3,000,550,000b/
FOR RELEASE AT 4:00 P.M.
March 27, 1979
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling
approximately $6,000 million, to be issued April 5, 1979.
This offering will result in a pay-down for the Treasury of about
$200 million as the maturing bills are outstanding in the amount
of $6,214 million. The two series offered are as follows:
91-day bills (to maturity date) for approximately $3,000
million, representing an additional amount of bills dated
January 4, 1979, and to mature July 5, 1979
(CUSIP No.
912793 2A 3), originally issued in the amount of $2,910 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $3,000 million to be dated
April 5, 1979,
and to mature October 4, 1979
(CUSIP No.
912793 2P 0) .
Without assurance, before the auction date of April 2, of
Congressional action on legislation to raise the temporary debt
ceiling, the Treasury will postpone this auction.
Both series of bills will be issued for cash and in exchange
for Treasury bills maturing April 5, 1979. Federal Reserve
Banks, for themselves and as agents of foreign and international
monetary authorities, presently hold $3,321 million of the
maturing bills. These accounts may exchange bills they hold for
the bills now being offered at the weighted average prices of
accepted competitive tenders.
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington,
D. C. 20226, up to 1:30 p.m., Eastern Standard time,
Monday, April 2, 1979.
Form PD 4632-2 (for 26-week series) or
Form PD 4632-3 (for 13-week series) should be used to submit
tenders for bills to be maintained on the book-entry records of
the Department of the Treasury.
B-1487
-2Each tender must be for a minimum of $10,000. 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 in and borrowings on such
securities may submit tenders for account of customers, if the
names of the customers and the amount for each customer are
furnished. Others are only permitted to submit tenders for
their own account.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury. A
cash adjustment will be made on all accepted tenders for the
difference between the par payment submitted and the actual issue
price as determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit
of 2 percent of the par amount of the bills applied for must
accompany tenders for such bills from others, unless an express
guaranty of payment by an incorporated bank or trust company
accompanies the tenders.
Public announcement will be made by the Department of the
Treasury of the amount and price range of accepted bids. Competitive bidders will be advised of the acceptance or rejection
of their tenders. The Secretary of the Treasury expressly
reserves the right to accept or reject any or all tenders, in
whole or in part, and the Secretary's action 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 weighted average price
(in three decimals) of accepted competitive bids for the
respective issues.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
or at the Bureau of the Public Debt on April 5, 1979,
in cash
or other immediately available funds or in Treasury bills maturing
April 5, 1979.
Cash adjustments will be made for differences
between the par value of the maturing bills accepted in exchange
and the issue price of the new bills.
-3Under Sections 454(b) and 1221(5) of the Internal Revenue
Code of 1954 the amount of discount at which these bills 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 these
bills (other than life insurance companies) must include in his
or her 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 Circulars, Public Debt Series flos. 26-76 and 27-76, and this notice, prescribe the terms of
these Treasury bills and govern the conditions of their issue.
Copies of the circulars and tender forms may be obtained from any
federal Reserve Bank or Branch, or from the Bureau of the Public
Debt.
FOR RELEASE AT 4:00 P.M.
March 27, 19 79
TREASURY POSTPONES AUCTION OF
52-Week BILLS
The Treasury today announced it was postponing the
auction of $3,340 million of 52-week bills originally
scheduled for Wednesday, March 28, 1979. This postponement
is necessary because Congressional action on legislation
to raise the temporary debt limit to allow delivery of
the 52-week bills is not at this time assured.
Interested investors are advised to look for notice of
any rescheduling of this auction in the financial press or
to contact their local Federal Reserve Bank for such information.
oOo
B-1488
FOR IMMEDIATE RELEASE
March 28, 1979
Contact:
Alvin M. Hattal
202/566-8381
TREASURY ANNOUNCES COUNTERVAILING
DUTY INVESTIGATION ON CERTAIN SCALE
AND WEIGHING MACHINES FROM JAPAN
The Treasury Department has started an investigation
into whether imports of certain scale and weighing machines from Japan are being subsidized.
A preliminary determination in this case must be
made by August 15, 1979, and a final determination by
February 15, 19 80.
Imports of this merchandise during 19 78 were valued
at about $4 million.
The investigation follows receipt of a petition
alleging that manufacturers and/or exporters of this
merchandise receive benefits from the Government of Japan.
The Countervailing Duty Law requires the Secretary
of the Treasury to collect an additional customs duty
equal to the subsidy paid on merchandise exported to the
United States.
Notice of this investigation will be published in
the Federal Register of March 29, 19 79.
o
B-1489
0
o
FOR IMMEDIATE RELEASE
March 28, 1979
Contact:
Alvin M. Hattal
202/566-8381
TREASURY TO START ANTIDUMPING
INVESTIGATION ON SODIUM ACETATE
FROM CANADA
The Treasury Department today said it will start
an antidumping investigation of imports of sodium
acetate from Canada.
Treasury's announcement followed summary investigations conducted by the U. S. Customs Service after
receipt of a petition filed by the Niacet Corp., Niagara
Falls, N.Y., alleging that firms in Canada are dumping
sodium acetate in the United States.
The petition alleges that imports of this merchandise are being sold in the United States at "less than
fair value." (Sales at less than fair value generally
occur when imported merchandise is sold in the United
States for less than in the home market.) The Customs
Service will investigate the matter and make a tentative
determination by September 29, 1979.
If sales at less than fair value are determined by
Treasury, the U. S. International Trade Commission will
subsequently decide whether they are injuring or likely
to injure a domestic industry. (Both sales at less than
fair value and injury must be determined before a dumping
finding is reached. If dumping is found, a special
antidumping duty is imposed equal to the difference
between the price of the merchandise at home or in
third countries and the price to the United States.)
Notice of the start of this investigation will
appear in the Federal Register of March 29, 19 79.
Imports of this merchandise in 19 7 8 were valued
at $381,000.
o
B-1490
0
o
FOR IMMEDIATE RELEASE
March 28, 1979
Contact:
Alvin M. Hattal
202/566-8381
TREASURY ANNOUNCES COUNTERVAILING
DUTY INVESTIGATION ON CERTAIN VALVES
AND PARTS THEREOF FROM JAPAN
The Treasury Department has started an investigation into whether imports of certain valves and parts
thereof from Japan are being subsidized.
A preliminary determination in this case must be
made by August 16, 1979, and a final determination by
February 16, 19 80.
Imports of this merchandise during 1978 were
valued at about $4 3.9 million.
The investigation follows receipt of a petition
alleging that manufacturers and/or exporters of this
merchandise receive benefits from the Government of
Japan.
The Countervailing Duty Law requires the Secretary
of the Treasury to collect an additional customs duty
equal to the subsidy paid on merchandise exported to
the United States.
Notice of this investigation will be published in
the Federal Register of March 29, 19 79.
o
B-1491
0
o
FOR IMMEDIATE RELEASE
EXPECTED AT 9:00 A.M. EST
WEDNESDAY, MARCH 28, 1979
_.
J o h n Ra
¥ ' Director of International
Trade, delivered the speech for
Assistant Secretary Bergsten.
REMARKS BY THE HONORABLE C. FRED BERGSTEN
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE
AMERICAN FOOTWEAR INDUSTRIES ASSOCIATION
KEY BISCAYNE, FLORIDA
Trade and the U.S. Economy
International trade is more important to the U.S.
economy than most Americans realize. And it is becoming
increasingly more important.
In 1970 our combined exports and imports accounted
for 8-1/2 percent of our Gross National Product (GNP).
By 1978 the share of total trade in our GNP had nearly
doubled to 15 percent — with a bit more than a 6-1/2
percent share for exports and slightly-less than an
8-1/2 percent share for imports. This difference of
almost 2 percent in our import and export shares — and
the rapid growth of U.S. imports of both oil and non-oil
products in recent years, as compared to a much slower
growth in total U.S. exports — is at the root of our
present trade deficit problem.
B-1492
- 2 In 1977 and 1978 we ran record trade deficits of
$31 billion and $34 billion, respectively.
We expect
to see some improvement in these figures in 1979, as
our trade deficit moves closer to $27 billion.
basic problem remains.
But the
We cannot continue to run deficits
of these magnitudes and expect to maintain confidence in
the dollar, or combat inflation, or enjoy continued solid
growth of our own economy.
An increasing number of Americans unfortunately would
have us close our doors to imports in response to our
deficit problem, especially in areas where domestic
industries are finding it increasingly difficult to compete
with foreign production.
We do not rule out the selective use of import
restraints in certain cases.
It is important, for example,
to protect our manufacturers against unfair dumping or
subsidy practices of other nations which cause or threaten
injury.
And it may be necessary in critical or emergency
situations to temper dramatic surges in imports which can
radically disrupt domestic markets.
For example, in June 1977 as you are well aware, we
entered into Orderly Marketing Arrangements (OMA's) with
Korea and Taiwan to restrict their exports of nonrubber
footwear to the U.S. market.
We did so with great
reluctance, as contrary to our general philosophy of open
markets, but as a necessary step to deal with the rapid
- 3 surge of footwear imports which came almost entirely
from these two nations. The OMA's were part of an overall
package of assistance to the domestic footwear industry
which was designed to help provide a breathing space for U.S.
shoe producers to adjust to increasing import competition.
Such restraints should not be the norm.
intended to be permanent.
They are not
And they must take into consid-
eration the impact of restraints on the domestic economy
as a whole.
I would like to focus my comments today on the following
issues:
first, the general importance of open markets to
the U.S. economy;
second, the importance of adjusting to increased
import competition from the developing nations;
third, the problem of unfair trade competition
(especially as regards government subsidies); and
fourth, the problems of the footwear industry in
particular, and what we have done to help ease the
adverse impact of import competition in this area.
The Importance of Open Markets
Imports are a vital component of U.S. production and
consumption.
We depend on imports for essential raw materials;
for a wide range of choice in consumer goods; for needed
domestic competition and a spur to more efficient production;
- 4 as an important rein on domestic inflation; as necessary
inputs for domestic production; and as a source of jobs
in import-dependent industries.
Some, I know, will argue that we don't need import
competition in order to produce for the American market.
Given our high standard of living, they contend, we can
afford slightly higher prices - and obtain better quality
products, to boot. Imports don't provide jobs they say,
but rather cause us to lose jobs in import-competing
industries. And they would equally contend that imports
have no direct effect on prices charged by domestic
industries — import competition doesn't cause U.S.
producers to reduce the prices they would otherwise charge,
and import restraints don't cause them to charge more.
I can't agree with any of these arguments. Inflation
is the most important problem facing the United States
today. Imports are an essential part of our fight against
inflation.
There are basically three categories of U.S. imports:
non-competitive, competitive, and supplementary goods:
— Nearly half of all U.S. merchandise imports
consists of noncompetitive, and in many cases
essential supplies and materials, including oil.
These products are either not available in the
domestic market, or not available in sufficient
amounts to meet domestic demand. Tin, chromium,
- 5 iron ore, and natural rubber are good examples,
as are more than 50 percent of our agricultural
imports.
— Many other imports are supplementary to domestic
production. They fill gaps in domestic supplies,
or offer alternatives in terms of style, quality,
and technological advancement. Italian shoes and
small, fuel-efficient cars are examples, although
the U.S. auto industry is learning to produce small
and more efficient cars as well.
The remainder of our imports compete directly
with U.S. production, and affect prices to the
same extent that domestic competition does: that
is, the larger the number of competing firms and
the lower the concentration ratios, the more direct
impact on price competition. Shoe imports from the
developing nations of Asia and Latin America are an
example of directly competitive imports.
The fundamental point is that import competition
stimulates innovation and efficiency. The competitive
environment nourished by the relatively open trade posture
of the United States over the past forty years has spurred
American industries to make steady improvements in the
range and quality of available goods. Import barriers, by
contrast, permit protected industries to raise prices and
reduce incentives to improve the quality of their output.
- 6 They promote an inefficient allocation of resources and
detract from our ability to produce the things we make best.
Imports hold down prices and stimulate the discovery of
cost-saving technology and other innovations. Trade barriers,
by contrast, raise prices to consumers and push up the cost
of living. When import penetration raises serious problems
for a domestic industry, it is always sensible for the
Government to consider helping that industry to improve
its competitive ability directly as an alternative to
providing insulation from the forces of the marketplace.
The burden of import restrictions falls particularly
heavily on low-income consumers, who tend to spend a greater
share of their budgets on protected items such as low-cost
shoes and meat. In some cases, foreign suppliers respond
to trade barriers by discontinuing lower-priced items in
favor of those with higher unit prices. This tendency
also hurts poorer Americans more than others.
U.S. industries which compete most directly with
imports have voiced considerable concern in recent years
about two major problem areas: (1) imports of low-cost
goods from the developing countries and (2) unfair trade
practices of other nations, including both price-cutting
and government subsidies which serve to distort trade flows.
I would like to discuss U.S. policy toward each of these
problems in the context of the growing importance of U.S.
exports to the developing nations, our global efforts to
- 7 work more closely with them to resolve trade problems,
and the new rules of fair trade which we have agreed
upon as part of the recently concluded Multilateral Trade
Negotiations.
Trade With the Developing Nations
The developing countries are becoming increasingly
important markets for U.S. exports. They accounted for
more U.S. export sales in 1978 than Western Europe and
Japan combined, representing 37 percent of all our exports
— or $53 billion. Furthermore, they are the fastestgrowing markets for our goods. Between 1970 and 1978,
our exports to the developing countries grew by 340 percent,
compared with a growth of 180 percent in our exports to
developed countries. Even excluding the OPEC countries,
U.S. exports to the developing countries grew by 270 percent
— still far faster than those to the developed countries.
We expect these trends to continue into the future.
The World Bank's World Development Report projects LDC
imports of goods and services of $900 billion in 1985,
compared with their actual 1975 imports of $270 billion.
The reasons for this are not hard to find.
First, the developing countries are growing more
rapidly than the rest of the world. Between 1960 and 1975,
total production in these countries grew at an average
annual rate of 5.6 percent compared with 4.2 percent for
the developed countries.
- 8 Second, these countries have an enormous need for
the goods and services that will allow them to provide
an acceptable standard of living for their populations.
Particularly for machinery and other capital goods
—
the kinds of manufactured goods in which the United
States has its clearest international advantage
—
the appetite of the developing countries over the longer
term is potentially insatiable.
Nevertheless, the future of the developing countries
and the extent of our exports to them depend crucially
on their ability to export to us those products where
they have a comparative cost advantage.
Trade must be
a two-way street.
As you are well aware, exports from the developing
countries have become quantitatively important in some
sectors, such as shoes and textiles.
Some have implied
that, because of our high-wage economy, U.S. industry
cannot compete with producers in these countries.
This
is not the case, for high-wage workers in the United
States are also high-productivity workers.
For manu-
factured goods as a whole, the LDCs import much more
than they export.
In 1976, we and the other industrial
countries imported $36 billion in manufactured goods
from the developing countries, but we exported $124
billion worth of manufactures.
Thus, the industrial
countries had a trade surplus for manufactures of
nearly $90 billion with developing nations.
- 9 In the case of the United States individually, we
exported $2 worth of American manufactures to developing
countries for every dollar we imported.
Unquestionably, the capacity of the developing
countries to export manufactures will continue to grow.
The World Bank projects an annual growth rate for export
volume of 12 percent through 1985.
Even at that time,
however, developing countries will still be a relatively
small force in comparison to imports from all sources
—
accounting for less than 14 percent of industrial country
imports of manufactures and less than 3 percent of total
domestic sales.
Those who call for generalized protection from imports
must not ignore these realities.
Efforts to artificially
reduce imports from such countries will have two effects.
First, it will invite retaliation against U.S. exports,
putting at risk the millions of jobs now producing for the
LDC market.
Second, it would reduce the capacity of these
countries to import, thereby slowing the growth of potential
markets for American goods and costing American jobs.
Both would adversely impact on our prosperity and standard
of living.
Thus, continued access to our markets by the developing
countries is essential both to our own interests and those of
the world economy.
Nevertheless, I want to assure you of our
unyielding belief that such international trade needs to be
conducted on a basis of fairness to all participants.
- 10 Fairness requires two main elements:
First, all countries must accept responsibilities consistent with the benefits they receive
from a liberal international trading system. A few
developing countries, notably including Hong Kong,
South Korea, Taiwan and Brazil, have emerged very
rapidly as serious competitors to the industrial
countries for a wide range of products. We have
taken a strong stand in urging these Advanced
Developing Countries (ADCs) to liberalize their
import systems and to assure that they accept the
responsibilities consistent with their increasing
role in world trade. We believe we have had a large
measure of success, both in the Multilateral Trade
Negotiations (MTN) and in bilateral discussions.
Second, the use of subsidies to promote
export-led growth must be controlled. Clear limits
on subsidies that influence international trade are
essential particularly to assure that countries
do not use them in a way that harms other countries.
Again, we have made a major effort in the MTN to
assure consistent principles that would assure
producers in all countries that they will not be
hurt by unfair competition.
- 11 The New Subsidy/CVD Code
The new subsidy/countervailing duty code which
we have negotiated as our top priority item in the
MTN includes important provisions for the assumption
of obligations by the developing countries. Developing
countries which join the code can fulfill the general
obligation to refrain from the use of industrial and
mineral export subsidies by assuming obligations
regarding the use of these subsidies commensurate with
their competitive needs. This provision specifically
recognizes that export subsidies are an integral part of
many development programs, but that they become less
necessary as nations develop. The requirement is designed
to encourage the phase-out of export subsidies as nations
become more advanced, and hence have less need for such
practices. Nations which accept these reponsibilities
under the code receive an assurance that, as their
subsidies are phased out, their exports will not be
countervailed unless injury is shown.
Brazil, for example, has already announced the
phase-out of its major export subsidies over a period
of approximately four and a half years within the context
of the code. Reductions in its export incentives began
in January, and will continue at quarterly intervals.
This is a significant contribution to improved discipline
in the subsidies area, since Brazil has for some years
- 12 maintained perhaps the largest subsidy program of any
major trading country. It is particularly significant
for the United States, since Brazil is our eighth largest
trading partner. We regard the Brazilian action as a
statesmanlike assumption of the increased responsibilities
attaching to its sharply increased role in the world
economy, and enormously important in assuring cordial
U.S.-Brazilian economic and overall relations in the
years ahead.
Brazil's adherence to the code offers real benefits
to U.S. industry, which has long been concerned about
the very high level of subsidization offered by Brazil
to competing industries exporting to our market. Brazilian
non-rubber footwear exports have benefitted from federal
and state export subsidies ranging from 5 to 12 percent
of the value of the product in recent years. U.S.
industries should experience more equitable competition
from Brazil in these and other industrial products in
the years ahead.
Beyond Brazil, we expect other advanced developing
nations to undertake similar phase-out commitments,
tailored to their own situation, and negotiations are
actively underway with a number of them.
As a result of implementing the subsidy/countervail
code domestically, we will adopt the first genuine overhaul
of the U.S. countervailing duty law in 80 years. Consistent
- 13 with our international commitments, we should now have
a law that provides, first, for prompt consideration of
the twin tests of subsidy and injury; second, for
provisional measures within four months of the filing
of a petition —
cutting by two-thirds the time now
usually taken before the law "bites"; third, an expanded
and much more transparent procedure allowing all interested
parties to participate and review information collected;
fourth, assured periodic review to update the basis on
which CVDs are collected; and, fifth, a system under
which we can quickly accept undertakings from foreign
governments or exporters to end the injurious effects
of subsidies to achieve the aims of the law without going
through all of its elaborate procedures.
Retroactive
countermeasures will be available to ensure that such
undertakings are not violated.
All in all, the new
procedures will provide for the open and expeditious
resolution of subsidy complaints, which should be welcome
news for the U.S. footwear industry, and other industries,
as well.
Trade and the U.S. Footwear Industry
The U.S. footwear industry is an excellent example
of a competitive domestic industry in which imports have
a clear impact on domestic shoe prices, with substantial
benefits for U.S consumers.
Indeed, a recent Brookings
study has shown that imports of nonrubber footwear from
- 14 Latin America and Asia (which account for 72 percent
of all U.S. imports of these shoes) are, on average,
24 percent less expensive than comparable domestic
products. Nonrubber shoe imports from Europe, Japan,
and Canada - in contrast - are 20 percent more expensive
on average than domestic shoes — a strong indication
of the influence of fashion and brand attraction for
these shoes.
The footwear industry has indeed been faced with
severe import competition. Between 1975 and 1976,
for example, imports of nonrubber footwear from Taiwan
and Korea increased by a dramatic 80 million pairs,
as compared to total U.S. production of 422.5 million
pairs of nonrubber shoes. Any restraint on imports,
however, must clearly take into account both the
industry's need for government intervention and the
potential cost of restraints to U.S. consumers.
Although the President recognized that the cost
could be significant, he also believed that temporary
relief was necessary to permit the domestic shoe industry
to adjust to the sudden increase in imports which had
occurred during this period.
As a result of the OMAs which we negotiated and which
became effective in July 1977, a recent Brimmer study
has shown that by June 1978:
- 15 —
U.S. production of nonrubber footwear actually
increased by 2 percent, a sharp reversal of the
previous downward trend; and
the rise in imports of nonrubber footwear was
clearly halted.
These are major improvements for the U.S. shoe
industry. There have also been costs, however, especially
for low-income consumers.
Our OMA's have concentrated on the low-cost producers
— Korea and Taiwan — which supplied 75 to 100 percent
of total U.S. imports of the kinds of nonrubber footwear
bought by low-income groups in 1976-77: women's plastic
dress and casual shoes under $5.00, men's plastic work
shoes under $12.00, leather work shoes, and athletic shoes.
The quotas have therefore fallen most heavily on low-income
Americans, while permitting higher prices to be charged by
European and Japanese suppliers.
Trade restrictions clearly are not the long-run
solution to the industry's problems. If the industry
is to survive and prosper, it is essential that this
period of restraint be used to enhance competitiveness,
to become more innovative, and to adjust to the realities
of international competition. By directing that a major
new trade adjustment effort be undertaken in conjunction
with a program of limited import restraints, the President
has underlined the need for adjustment. These two programs
- 16 are complementary: one providing breathing space during
which the other can begin to yield positive results.
The Footwear Industry Revitalization Program is a
comprehensive $56 million, 3-year effort to meet the
needs of both individual firms and the footwear industry
as a whole, emphasizing technical and financial assistance
to firms as well as broader programs to confront industrywide structural problems. Since the program's inception,
the Commerce Department has certified 77 footwear manufacturers for trade adjustment assistance; in the previous
15 years only 31 manufacturers had been certified.
Because many of the certified firms are small to
medium-sized firms lacking the resources to identify
weaknesses and implement the innovative marketing,
manufacturing and management techniques necessary to
revitalize the industry, special assistance from teams
of private consultants with industry expertise has been
a key element of the program.
Recent reports from the Footwear Specialist Teams
indicate that the footwear industry has both inherent
strengths and potential advantages upon which to capitalize,
as well as serious weaknesses which will require considerable
effort to overcome. With new marketing strategies, more
efficient methods of production, and greater fashion awareness, there is no inherent reason that the U.S. footwear
industry cannot be a pacesetter both here and abroad.
- 17 In fact, one of the more successful aspects of the
footwear program has been the export promotion program.
In the last quarter of 1978 exports totalled 2.7 percent
of U.S. production. If exports continue at this pace
they will exceed our goals of 3 percent of annual production in 1981 and 5 percent of production in 1983.
Current export promotion efforts include participation
by 24 U.S. firms in the Dusseldorf Trade Show, a U.S.
Trade Mission to Holland and Denmark, and a comprehensive
"in store" promotion effort in major retail stores in
nine principle European cities.
The footwear industry is not unique in its failure to
exploit potential export markets. However the industry's
response to export promotion efforts has been gratifying.
There appear to be excellent opportunities for profitable
ventures. Data drawn from the returns of Domestic International Sales Corporations indicate that the profit per
unit on export sales has been twice the level of profit
per unit on domestic sales for a number of years across
a range of products.
The Interagency Footwear Group has also been in
contact with the AFIA and has demonstrated the Administration's commitment to ensure that the effectiveness
of the OMA's is not being undermined. At the most recent
meeting on March 7 the Interagency Group outlined our
present concerns about the effectiveness of the OMA's as
well as actions we have already taken.
- 18 For example, when imports from Hong Kong increased
sharply in 1978, threatening the effectiveness of the
OMA's, we consulted with the Government of Hong Kong
and determined that a large portion of the surge in
trade resulted from imports into Hong Kong of components
and subsequent shipment of finished footwear to the
United States.
Hong Kong agreed to institute a licensing system
whereby only footwear made from components manufactured
in Hong Kong would be issued a Hong Kong certificate of
origin. The United States will deny entry to nonrubber
footwear from Hong Kong which does not have a valid
certificate of origin.
This system went into effect in the United States
on November 28, 1978. Although we should expect some
temporary lag before the impact of the new arrangements
shows up in actual trade figures, if it becomes evident
that the arrangements are not working effectively, we
will again meet with the Government of Hong Kong in
order to negotiate a more effective agreement. We
have been working with the Government of the Philippines
to resolve a similar problem.
We have also consulted with the Koreans, in response
to a recent surge in their exports of leather work shoes to
our market. They have agreed to limit exports of leather
work shoes to the United States to a maximum of 3.7 million
pairs yearly for the duration of the restraint period. We
have raised this issue with Czechoslovakia and Romania, as
- 19 well.
We have received a favorable initial response from
Czechoslovakia that they do not plan to exceed their 1978
level of 800,000 pairs in 1979 and 1980. We are continuing
to discuss this problem with Romania and are hopeful of a
satisfactory resolution of the problem.
Other areas of mutual concern are:
(1) Increasing imports from a few other countries.
(2) The surge in rubber fabric imports from Taiwan
and Korea which competes directly with nonrubber.
(3) Upgrading by Taiwan and Korea and the resultant
disappearance of the most inexpensive shoes.
(4) Imports of lasted shoe uppers as a means of
circumventing the OMA's.
The Administration is committed to do all that we
can within the framework of the existing agreements
to ensure that Taiwan and Korea live up to their
commitments and that other suppliers do not increase
their exports to the extent that they undermine the
effectiveness of the restraint on the part of Taiwan
and Korea.
However, there are realistic limits on what we can do.
For example, rubber footwear was not included in the
original injury determination and therefore we cannot
impose unilateral restraints on rubber footwear imports
without a separate 201 investigation.
- 20 In spite of these factors, however, I am gratified
to note that the U.S. shoe industry has in fact done quite
well during 1978, in comparison with the persistent decline
in the previous decade:
(1)
Production was off by less than 0.5 percent
last year.
(2)
Imports rose by only 1 percent, the smallest
rise in 10 years.
(3)
Exports, although still a modest 6.8 million
pairs, rose by 28 percent to the highest level
in ten years.
(4)
Employment in the footwear industry remained
exceptionally stable, with a decline of less
than 0.5 percent (about 600 employees) during
1978.
These figures speak well for our overall efforts to
assist the domestic footwear industry.
have worked.
The agreements
They have clearly turned the import situation
in non-rubber footwear around.
There are a few new
problems which we can handle within the framework of the
present agreements.
But the basic challenge now is for
our own industry to devote its efforts to using its
resources in the most efficient manner and to stay
one step ahead of our foreign competitors in meeting
the demand and taste preferences in our own market.
FOR RELEASE AT 4:00 P.M. EST
March 28, 1979
TREASURY POSTPONES AUCTIONS OF 14-YEAR 10-MONTH BONDS
AND 24-DAY BILLS
The Treasury today announced it was postponing the
auctions of $1,500 million of 14-year 10-month bonds and the
24-day bills originally scheduled for Thursday, March 29,
1979. This postponement is necessary because Congressional
action on legislation to raise the temporary debt limit to
allow delivery of the securities is not at this time assured.
Interested investors are advised to look for notice of
any rescheduling of these auctions in the financial press or
to contact their local Federal Reserve Bank for such information.
oOo
B-1493
FOR RELEASE ON DELIVERY
March 30, 1979 — 9:30 a.m. EST
STATEMENT OF THE HONORABLE RICHARD J. DAVIS
ASSISTANT SECRETARY OF THE TREASURY
(ENFORCEMENT & OPERATIONS)
BEFORE THE
COMMITTEE ON GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ON
S. 333
"THE OMNIBUS ANTITERRORISM ACT OF 1979"
I very much appreciate the opportunity to appear
before this Committee in order to discuss the explosives tagging provisions of S. 333, the "Omnibus Antiterrorism Act of 1979." As you know, Mr. Chairman, in
the Ninety-Fifth Congress we testified before other
committees of both the House and the Senate concerning
the Treasury Department's reasons for supporting the
adoption of explosives tagging legislation; and recently
we have again testified in the House in support of tagging legislation.
Today, I will present an overview of what the explosives tagging program is intended to accomplish, why
Federal legislation is needed, what kind of legislation
is most desirable and what our answers are to criticisms
of this program raised in other hearings. In addition
to my remarks, Mr. G. Robert Dickerson, the Director of
the Bureau of Alcohol, Tobacco & Firearms, will submit
a detailed statement and supporting materials for the
record.
As an attorney and former Federal prosecutor, my
primary experience has involved dealing with how to
investigate and prosecute crimes after they have been
committed. But my responsibilities for the protective
B-1494
- 2 as well as the investigative enforcement activities of
the Treasury Department demand a perspective which
gives at least equal weight to the ability of government to prevent criminal activities, especially those
employing violence.
Consequently, I have followed closely the development, under BATF and Aerospace auspices, of capabilities for introducing into non-military explosives those
unique elements — taggants — which would permit identification and detection of explosives. Very simply,
the explosives tagging system would work as follows.
Identification tagging involves the insertion of a
number of tiny particles — the taggants — in an explosive material which would survive intact after an explosion and be recovered by bomb scene investigators. The
identification taggant which is presently ready for commercial use involves several color-coded layers identifiable under a microscope. At the bomb scene, it would
first be found in the debris through use of a long-wave
ultra-violet light which causes the taggants to fluoresce.
Since one side of most taggants will be magnetic, a
magnet will be used to extract the taggants from the
debris. The taggant itself would reveal the type of explosive involved, its manufacturer, and the date and
shift when it was made. From this, the explosive could
be traced through the distribution chain from manufacturers, to retailers and, in many instances, to the
last, or a group of possible last, legal owners of the
explosive.
Detection taggants — which are microscopic capsules
containing an inert material — would emit a vapor which
could be detected by specially developed equipment and
animals before the explosive containing them was detonated. The presence of bombs could, thus be detected
and lives and property saved.
These techniques, some of which could be implemented nationally in 1979 if we had the authority, offer
law enforcement and security authorities an opportunity
to use science and technology not only to solve more
bombing crimes but also to prevent their occurrence.
In this manner, a comprehensive explosive tagging program can significantly enhance the public safety.
The extent to which tagging will help counter
bombing crimes will be largely influenced by how quickly and how many forms of explosives are tagged. It is
- 3 very important therefore, that as soon as technology
allows, the requirement that a particular class of explosives be tagged should go into effect. One class
of explosives — dynamites, water gels and slurries —
is ready for identification tagging now; black powder
will be shortly. Tagging for the other types is expected to be ready at different times throughout the
next three years. Following is a chart reflecting the
status of development for tagging the various categories of explosives. It describes the dates we expect
tagging could begin to be implemented if legislation
is passed in this session and if sufficient taggants
are then available. These estimates are those of
BATF technical experts and the Aerospace Corporation,
the technical managers of this program.
IDENTIFICATION TAGGING
— Black Powder, June 1979
— Smokeless Powder, July 1981
— Dynamites, water gels & Slurries, June 1979
— Fuse and Detonating Cord, November 1979
— Boosters, March 1980
— Detonators, June 1981 (label method)
October 1981 (double plug method)
DETECTION TAGGING
— Black Powder, October 1980
— Smokeless Powder, October 1980
— Dynamites, water gels & slurries, October 1980
— Fuse and Detonating Cord, October 1980
— Boosters, January 1981
— Detonators, January 1981 (both single plug methods)
June 1981 (label method)
October 1981 (double plug method)
— Detection Taggant Sensors, April 1981 through
March 1982 (implementation of different devices)
Changes, both positive and negative, from the schedule
projected last summer are due to various factors, including scientific developments, the lack of legislation, and delays in securing testing agreements with
some manufacturers.
We urge that legislation be passed during this
session which provides the Secretary with the necessary
authority to require tagging of all types of non-military explosives in order that we can minimize the delay
in getting tagged explosives into the marketplace and
maximize our ability to apprehend those who use bombs
- 4 and to save the lives of their intended victims at the
earliest possible time. Elimination of particular
classes of explosives from this legislation will, we
fear, provide a disincentive for the producers of those
explosives to cooperate with the development and testing
of tagging. The passage of comprehensive legislation,
on the other hand, will provide a stimulus which would
accelerate the process by which tagging of all explosives used in crimes could be accomplished.
The enactment of tagging legislation in a piecemeal fashion also will minimize and, likely, defeat
the timely impact on bombing crimes which tagging might
have. For example, if we were to achieve legislative
authority that permits us to institute identification
tagging for the dynamites, water gels and slurries
(which are ready for national identification tagging)
but not for other explosives, we would not be able to
respond rapidly to the expected shift from dynamites
to other forms of explosives; and that shift will receive impetus because of these exclusions. Instead,
we will have to: (1) continue to perfect tagging of
those categories of explosives not ready today, (2)
submit additional legislation to authorize the tagging
requirement for those types, (3) go through additional
sets of hearings to cover again the testimony already
given on this, and (4) if the additional legislation
then passes, wait for the taggant manufacturers and
explosive manufacturers to gear up for production and
use of the taggants in these other types of explosives.
This will be a very lengthy process giving bombers
years of immunity from the tagging of what are already
commonly used explosives in bombs, such as black and
smokeless powders.
On the other hand, if we have a single, comprehensive bill — with the requirements that all taggants be safe, suitable, non-damaging, and available,
and with the discretionary authority to make exemptions or delays when needed — the only step remaining
once taggants for these other types of explosives are
ready will be to institute the tagging requirement.
This approach will not authorize the inclusion of taggants before it is safe to do so; tagging will happen
only after tests, participated in by the manufacturers,
have been completed successfully.
- 5 Passage of a comprehensive bill is also necessary
so that the manufacturers of taggants and explosives
will be prepared to invest willingly the resources
needed to have production and distribution facilities
ready. They will do so only if they know that there
is a legal requirement for compliance and that the
tagging requirement will be implemented on a certain
date. This certainly can only be achieved through a
comprehensive tagging bill.
The Department recognizes that some have urged
that black and smokeless powders be excluded from this
program because they are used lawfully by sportsmen.
We cannot endorse such an exclusion. All explosives
have both lawful and unlawful uses. Black and smokeless powders are not only used by the law-abiding;
they are also used by the bombers. For example, among
all bombings in 1978 recorded by ATF — including unidentifiables and incendiaries — black and smokeless
powders were used in 18.5 percent of the total bombings.
FBI figures for this period attribute 22.1 percent to
the powders. A chart presenting a statistical analysis
of the various explosives used in crime is attached
to my testimony. Together, those powders comprise a
tiny portion of the commercially available cap-sensitive
explosives, yet their frequency of occurrence in bombings is several magnitudes greater than their proportional availability.
Given this situation, a program that excludes
these powders will clearly have serious deficiencies.
Initially, such an exclusion would encourage the increased
use of powders in bombs. We are especially concerned
about excluding powders from the detection tagging program. Given the relative frequency of their use in
bombings, the use of taggant detectors would be of questionable value if they could not detect black and smokeless powder bombs. This exclusion would also reduce
the cost benefits of identification tagging.
We have recently heard charges that the safety
testing for identification-tagged dynamites, water
gels, and slurries is not sufficient. That is not
true. In our charge to Aerospace we have placed,
and continue to place, the highest priority on the
safety of taggants. Dynamites, water gels, and
slurries tagged with the finally selected identification taggants have met every safety test. These tests
were established and conducted by the explosives manufacturers themselves.
Based on these tests, the
- 6 manufacturers were confident enough to market their
own tagged explosives. The explosives manufacturersV
have produced and sold seven million pounds of tagged
explosives. These are undisputed facts attesting to
the safety of identification taggants in this class
of explosives. Further information supporting the
safety testing is submitted as an exhibit to
Mr. Dickerson's prepared statement. Safety tests
are now being pursued on all other classes of explosives with participating manufacturers, and under our
approach no tagging would be required until these
tests have been passed.
From Treasury's perspective another vital issue
for tagging has been whether the crimes solved and
the deterrence established are worth the effort and
costs of requiring the taggants. In order to assess
this as objectively as possible, Management Science
Associates was asked to study this question. While
acknowledging the difficulty in assessing the impact
of any program before it begins, the study concluded,
and we believe, that the value and cost effectiveness
of identification tagging is clear.
Identification tagging will not, of course, serve
as an instantaneous means of finding bombers. We do
not expect to solve crimes and obtain convictions on
the basis of tagging evidence alone. Identification
taggants will instead provide initial leads and supply
an additional specific connection between the manufacturer of an explosive, the category of last legal
purchasers of a particular lot, and other evidence
found at a bomb scene such as package fragments, wires,
clockworks. In addition, evidence extrinsic to the
bomb scene, such as employees with grievances against
a bombed business, can be compared with the list of
purchasers of an identified lot of tagged explosives
in order to reduce further the list of suspects. The
additional speed with which taggants will help investigators make these initial links will provide an increased possibility of focusing on a class of suspects
while the criminal among them is still likely to have
some incriminating evidence in his possession.
The identification taggant is analogous to the
date/shift code already required to be printed on
high explosives. We know that date/shift data permits
speedier traces and that ATF has analyzed those cases
- 7 where date/shift code information has been retrieved
from dynamite wrappers that survive explosions or
were found before detonation. Their study shows that
cases forwarded for prosecution where a date/shift
code was found were nearly twice the number of cases
without date/shift information. We expect at least
a comparable result from the use of indentification
taggants.
Furthermore, this analogy should apply equally
in terrorist bombings or bombings by professional
criminals, where link analysis will be greatly enhanced
through the taggants providing a clear means of showing connections and patterns common to several bombings
even if perpetrated in several different parts of the
country. Focus on the individual or group of extremists connected to multiple bombings will not only
increase the likelihood of solution of several bombings
through one overall investigation but will also save
immense expenditures of manpower on bombings which
might otherwise appear as unconnected events.
Detection tagging is, in a way, the part of the
tagging program from which the greatest direct benefits to the public safety can be expected. With detection devices placed at high target value locations, we
can go beyond solving bombing crimes only after the
destruction has happened and begin, through pre-detonation discovery, to prevent bombings from occurring.
The MSA study suggests that the cost-benefit of this
form of tagging is less certain than that for identification tagging. Its analysis makes clear, however,
that if one considers just the high risk, potential
targets of catastrophic bombings — airports, planes,
public buildings — then the benefits are clear. In
addition, when one considers what detection tagging
can do — save life and limb — the essentiality of
going forward with this program becomes clearer.
While additional information on costs is contained in Mr. Dickerson's statement, I would like to
note that the costs of tagged high explosives have
been calculated at two cents per pound of tagged explosives. We do not believe this to be an unreasonable burden on either manufacturers or purchasers of
explosives.
- 8 We have also heard claims that complex and costly regulatory schemes will be initiated as part of
the tagging program. Treasury and ATF have asked for
no new recordkeeping legislation. Records are now
required under existing laws, including those applicable to black and smokeless powders. The only additional requirement would be to show the taggant1s code
in existing records. This small additional bit of information could not possibly be a serious burden.
We also do not seek to tag those types of explosives seldom found in any bombings. We have no desire
to impose burdens on commercial enterprises or private pursuits that do not have a clear public benefit.
For example, we are not seeking to require the tagging
of those smokeless powders inserted in commercially
manufactured, fixed ammunition. Only powders for sale
in bulk quantities should be tagged. We take this
position because there is no measurable public benefit
to achieve by tagging individual rounds of ammunition.
Furthermore, we will not require the tagging of
blasting agents which are very rarely used in crimes.
The greatest portion (80 percent) of the materials
produced for use in commercial blasting is made up of
blasting agents, the most common of which is a mixture
of ammonium nitrate and fuel oil known as ANFO. The
components of ANFO are not explosives until compounded
at the blasting site. Then they nearly always require
a booster and detonator in order to be exploded successfully. Both boosters and detonators are going to
be tagged under this program since they nearly always
occur in criminal use of high explosives. Thus, in
the event that blasting agents are used in a particular crime, booster and detonation tagging will provide
the tracing mechanism, and we will not have to undertake the massive and costly job of requiring that
blasting agents themselves be tagged. Tagging of the
boosters and detonators is cheaper, more readily applicable, and will have a much greater impact on bombings than tagging of the blasting agents.
The explosives tagging program is designed to
help significantly in defeating the bomber, whether
he is a terrorist or any other form of criminal. And
because we believe in the overall value of tagging,
we think that it would be appropriate, in addition to
the specific safety and other protections which
- 9 Mr. Dickerson and I describe in our statements, to
have an obligation placed on Treasury and the Bureau
of Alcohol, Tobacco and Firearms to report to Congress
at least annually on the results of the tagging program. Such a report will enable Congress to continue
to evaluate this program and, we believe, recognize
its worth. We will be happy to work with the Committee
in developing this and other proposals designed to
assure the proper implementation of this program.
We recognize that many Americans have been touched
by acts of terrorism and other bombing crimes. The
victims — or their survivors — know that bombing is
a particularly vicious and indiscriminate crime. It
is a clearly deliberate act of violence in which the
bomber has to acquire the knowledge of how to make a
bomb; he has to fabricate the explosive device; and he
has to plant it. This is a calculated, planned and indisputably intentional process with severe consequences:
death, injury and the destruction of property. For
these reasons we believe that we should do all that we
legitimately can to meet this problem.
Mr. Chairman, we have never offered tagging as a
panacea to bombing crimes. It will not be. All bombings will not be stopped or prevented. In addition,
we know that it will take time for the effectiveness
of tagging to have an impact that gives a clear measure
of its worth. We are confident, however, that identification tagging will help solve more bombings and that
detection tagging will cause the discovery of more bombs
before they detonate. Together, these two forms of
tagging will meaningfully advance our ability to deal
with the bombing problem and deter some criminals from
using this deadly instrument. We believe that ;this is
a contribution to the general welfare to which the
American public is entitled.
February 26, 1979
Department of the Treasury Statement
March 30, 1979, Committee on
Governmental Affairs,
United States Senate
1978
Distribution of Explosives in Crime
ATF
FBI
Number
Percent
Known
Percent
w/Unknown
Number
Percent
Known
Percent
w/Unknown
Incendiary
636
39,30
34.60
468
36.10
26.50
Black Powder
196
12.10
10.70
171
13.20
9.70
Smokeless Powder
209
13.00
11.40
157
12.10
8.80
Military
133
8.20
7.20
55
4.20
3.10
Dynamite
173
10.70
9.40
251
19.40
14.20
Other
271
16.70
14.70
194
15.00
11.00
1618
.100.00
1296
100.00
Subtotals
Unknown
219
Totals 1837
Black & Smokeless
(Shown as percentage
of known)
Black & Smokeless
12.00
471
26.70
100.00
1767
100.00
25.30
25.10
18.50
22.10
(Percentage
including unknowns)
B l a c k km S m o k e l e s s
(Percentage excluding
40.8
39.6
The Treasury Department today said it has determined that methyl alcohol imported from Canada is
being sold in the United States at "less than fair
value."
The case is being referred to the U. S. International
Trade Commission, which must decide within 90 days
whether a U. S. industry is being, or is likely to be,
injured by these sales.
If the decision of the Commission is affirmative,
dumping duties will be collected on sales found to be
at less than fair value.
Appraisement has been withheld since the tentative
decision issued on December 19, 19 78. The weighted average margin of sales at less than fair value in this case
was 59.2 percent, computed on all sales.
Interested persons were offered the opportunity
to present oral and written views before this determination.
(Sales at less than fair value generally occur when
imported merchandise is sold in the United States for
less than in the home market.)
Imports of this merchandise during 19 7 8 were
valued at about $18,000.
Notice of this determination will appear in the
Federal Register of March 30, 1979.
o
B-1495
0
o
For Release on Delivery
March 29, 1979
Remarks by the Honorable Anthony M. Solomon
Under Secretary of the Treasury
Before the Foreign Exchange Association of North America
Thursday, March 29, 1979 7:00 P.M.
I am pleased to have the opportunity -- and the challenge -of reviewing recent developments in the foreign exchange
markets with the men and women who represent the professional
trading community in the United States. The exchange markets
have enormous importance for the international financial
system and for the world economy at large„ From a practical
perspective, they serve as a catalyst for the expansion of
international trade and investment, which is essential for
raising living standards here and abroad. But in addition,
the exchange markets play a special economic role„ They form
the arena in which exchange rates are determined. Out of that
process flow critical price signals influencing what is
produced, where it is produced, and where it is soldo It is
for these reasons that exchange market stability is of such
utmost importance0 Only when conditions are orderly can the
markets effectively perform their basic function, that of
generating a pattern of exchange rates which is consistent
with fundamental economic trends and at the same time helps
shape international adjustment
As professionals, however, you know full well that on a
daily basis there are many more influences on the exchange
markets than just the fundamentals„ Rightly or wrongly, any
piece of news -- economic, political, social -- can affect
people's expectations about where an exchange rate may go
next0 That means virtually anything can set off buying
or selling of a currency, and on occasion in very large
amounts0 But traders don't have the luxury of disengaging
B-1496
from the market simply because they personally feel that the
- 2trading factor of the moment is unimportant or transitory0
They must serve their customers and make markets. And they
must perform their responsibilities without exposing their
banks to undue risks. So while we all might hope otherwise,
the internal dynamics of the exchange markets cannot always
be relied upon to produce stability„ In times of great
uncertainty, the markets may need firm support from the
authorities0
'
Last fall was a time when uncertainties ran unusually
deepo The dollar had moved a long way against most other
major currencies0 Yet selling persisted and in fact
broadened, despite frequent official intervention by the
UoS0 and other authorities. To many thoughtful market
participants, there was a sense of unreality to it all0
But there was little confidence that the sequence of sharp
declines in the dollar almost every day would be halted or
reversed by the market itself„ And few were bold enough
to be the first to try.
To those of us responsible for the international
financial policy of the United States, the situation
became intolerable„ In our view, exchange rate movements
for the dollar had clearly gone beyond what could be justified
by fundamental economic trends „ The consequences were serious.
Excessive exchange rate movements threatened to make it more
difficult to bring inflation under control by subjecting our
economy to new upward pressures on prices.
Faced with that grim scenario, we sought to design a
response to accomplish two objectives. The basic aim was to
lay the foundation for a gradual improvement in confidence
that could take hold more firmly as fundamental adjustments
in the world and our national economy proceeded.. But the
immediate objective was to jolt market psychology out of the
extreme bearishness that seemed to have taken over. That
meant dealing with the market's concerns explicitly and
convincingly0
The market's concerns had coalesced around three central
themes0 First was the problem of the United States inflation
rate, which had increased during 1978, while inflation in
other major countries had declinedo What were the prospects
for slowing and then reversing our performance, which was a
source of dismay to all? Second was the problem of large
current account imbalances -- here and abroad„ Would those
- 3-
imbalances narrow enough and would improvement be sustained?
Third was perhaps a more intangible but nevertheless deepseated concern about the coherence of U„S» economic policy.
Would there be a determined, comprehensive, and effective
approach to the difficult choices we faced, choices imposed
by domestic inflation, external imbalances, energy needs,
and foreign exchange market disorder?
We recognized the validity of these concerns and
appreciated their importance. Even so, the intensity of the
pessimism manifested in the exchange markets seemed to us
exaggerated.
First on the inflation problem: The President had stated
unequivocally that arresting inflation in the United States
was our major economic objective. A series of steps covering
a wide range of policies to achieve that goal had been
initiated. A gradual move to monetary restraint was under
way. Fiscal policy actions were being planned to reinforce
this restraint. Governmental sources of inflation were being
attacked. Stricter wage-price standards were set down. In
short, we had committed ourselves to deal with inflation and
that commitment was being systematically implemented -- not
in one grand, comprehensive package, but by individual actions
taken as rapidly as possible. We recognized that results
would not come overnight, and there would be setbacks along
the way. There was full recognition that a moderation of
economic growth, which was clearly advisable, and public
support for the anti-inflation initiative together would
strengthen the chances for success.
Second, on the balance of payments problem: Our current
account deficit had peaked by early 1978. In subsequent
months, the wide divergences between U.S. and foreign
economic growth had started to narrow, and previous exchange
rate movements were reinforcing the balance-of-payments
impact of that narrowing. As a result, the U 0 S 0 current
account deficit was declining significantly and there was
progress toward reducing some of the major surpluses abroad.
As it turned out, by the second half of 1978 the U 0 S 0 deficit
was less than half what it had been the year before, and every
indication was pointing toward further improvement.
To be sure, increases in oil prices will offset a part
of the full improvement that would otherwise have occurred.
How much, we don't know, because OPEC has essentially given
producing countries a license to charge what the traffic will
bear.
Some will
probably
do oil
just
that.
Others
may with
take
a
as
longer
you know,
view
of
the
the
United
impact
States
of
is
prices
committed,
on
thealong
world.
But
other
- 4countries participating in the International Energy Agency,
to a 5 percent reduction in oil consumption this year. Conservation efforts are essential, and as they take hold,
petroleum imports should slacken. If we and other major
consumers succeed in these conservation efforts, the surcharges
which some OPEC countries hope to collect may not hold.
In any case, the oil situation is one factor that
complicates the balance-of-payments outlook. Decisions of
the new Iranian government to curtail military purchases
are another,, But U„S0 exports of goods and services continue
to grow strongly, and there are signs that the public is
grasping the pressing need to save energy. Going through
the exercise of estimating the net effect of these various
influences is more difficult than usual, and I think it is
premature to cite any particular forecast today. But based
on preliminary findings, we still anticipate a substantial
reduction in our current account deficit this year0 At the
same time, we expect further adjustment abroad by countries
in surplus as economic growth there is maintained and in
some cases expanded.
Third, on the problem of policy coherence. It is
imperative for government to pursue appropriate policies.
But sometimes that is not enough. There must also be an
unmistakable signal of commitment. In the circumstances
confronting us last October -- extreme disorder in the exchange
markets and worsening inflation in domestic markets -decisive action on many fronts was needed to dramatize a new
thrust to policy. On the monetary side, the Federal Reserve
acted forcefully to stiffen the degree of restraint. The
discount rate was increased by a full percent and reserve
requirements were raised. Those actions were important.
They helped lay a firm domestic basis from which to launch
a major attack against foreign exchange market disorder.
To implement it, we mobilized a very large amount of resources,
using a variety of financing techniques, new and old, and
working in close cooperation with the Germans, Japanese, and
Swiss authorities. We wanted to leave no doubt that we
were fully prepared to back up our commitment to restore
stability to the markets0 You know the details of the
November 1 financing package and how we proceeded to use it —
whenever and on whatever scale necessary to dispel any residue
of skepticism about our intentions.
- 5-
The results so far have been gratifying. By any
standard, market conditions have been better since November 1
than before. That is not primarily because of a stream of
what might be called "good news". I'd say the recent news
has been mixed. Some of the numbers have been disturbing -such as the latest wholesale and consumer price statistics. I
draw little comfort from the fact that faster price rises have
been recorded abroad as well as in the United States. However,
other numbers have been reassuring -- for instance, the continued
deceleration in the growth of the money supply in reaction to
the Fed's policy of restraint. Moreover, while I avoid placing
too much emphasis on one month's figures, the trade statistics
for February announced yesterday do tend to reconfirm the
improving trend that began last year. Still other events,
inherently complex and with implications not only for the
United States but for all countries, have had diverse effects
on the exchange markets. The Iranian situation is a good
.illustration of that kind of complex development, and so is
the oil supply and price situation more generally. All
countries are affected, but in different ways, and the differential impact is hard to determine with any degree of certainty.
I think most participants in the exchange markets appreciate
rthat point, and have responded accordingly.
What I conclude, and take some satisfaction from, is that
the underlying tone in the exchange markets has vastly improved„
:By itself, this has promoted a more judicious assessment by
market participants of new trading factors as they come along.
No longer is there a knee-jerk reaction to sell the dollar on
most every item carried over the wire services. Certainly,
dollar exchange rates have showed some daily variation. That
is to be expected in a normal, orderly market. But rate
movements are not cumulating. There is a counterweight,
stemming from the market itself but occasionally reinforced by
operations of the authorities, tending to restore balance. As
a result, the average daily movement in most major currencies
is just a fraction of what it was last October. In recent
weeks, the only currency that has fluctuated fairly sharply
has been the Japanese yen. In large part, that reflects shifting
market perceptions of Japan's relative vulnerability to the
oil situation. But I think that a firm official response is
helping to reduce the erratic movements in the yen market.
- 6 There are other concrete signs of an improvement in
exchange market conditions. Some of last year's leads and
lags in commercial payments have been unwound. The pace of
diversification has slowed noticeably and may even have been
reversed in some cases. Borrowing, of dollars to finance
•"
exchange positions has diminished. Investors are responding
to relative interest rate incentives and are acquiring
dollar assets. And perhaps most concretely, we have
substantially improved our own net position in foreign
currencies. Factoring in the proceeds of our foreign
currency note issues and other acquisitions of currency, the
United States now has more resources immediately available
for current operations than we did just after November 1.
Looking to the future, I don't pretend to know with
any precision how the markets will develop. From what I
hear in the Street, opinions naturally differ about the
possible course of rate movements over the rest of the year.
But I am intrigued as much by the flavor of the comments as
by the predictions themselves., Expectations do not seem
to be held with any great conviction, perhaps because the past
few months have been a chastening experience for a number of '
people. I'm encouraged by this greater sense of two-way
risk in the market. It helps keep market conditions more
orderly. Consequently, unless there is some major shock to the
world economy, I would foresee a continuation of the generally
balanced trading conditions we have now.
Whatever your own personal views on the outlook, I want ,
you to bear in mind these final thoughts. We remain committed
to the underlying principles embodied in the measures taken
last fall. We will not hesitate to use our ample resources
to meet our objectives. And above all, we will continue to
pursue a coordinated policy of restraint to ensure that progress
is made in curbing inflation, lowering payments imbalances,
and achieving more moderate but sustainable growth in our
economy. Surely, those are the essential ingredients for
a strong and stable dollar over the long haul.
oo 00 oo
For Release on Delivery
Expected at 2:00 p.m.
March 29, 1979
DEPARTMENT OF THE TREASURY
OFFICE OF THE SECRETARY
NATIONAL CONSUMER COOPERATIVE BANK
STATEMENT OF THE HONORABLE ROGER C. ALTMAN
ASSISTANT SECRETARY OF THE TREASURY (DOMESTIC FINANCE)
BEFORE THE H.U.D.-INDEPENDENT AGENCIES SUBCOMMITTEE
OF THE HOUSE COMMITTEE ON APPROPRIATIONS
Mr. Chairman and Members of this Distinguished Subcommittee:
I am pleased to present the Administration's initial
budget request for the National Consumer Cooperative Bank.
The National Consumer Cooperative Bank Act was signed
into law by the President on August 20, 1978. The Act
establishes a bank to make sound loans at market rates of
interest to cooperatives in a variety of fields. It also
creates an Office of Self-Help Development and Technical
Assistance within the Bank to extend capital advances and
to make management and technical assistance available to
cooperatives with special needs.
Last September the Administration established an Interagency Task Force, which I chair, to expedite implementation
of the Act. The Task Force held 19 public meetings on the
Bank in Washington and around the nation. At these meetings,
people who are members of cooperatives or who are interested
in forming cooperatives voiced deep interest in the Bank.
The Bank
The Bank is modeled on the highly successful Banks for
Cooperatives, which make credit available to agricultural
cooperatives. It was established to satisfy the unmet credit
needs of other cooperatives, particularly consumer cooperatives.
The Bank represents an effort by Congress and the Administration to achieve increased growth and stability for cooperaB-1497
- 2 tives in order to secure lower consumer prices, enhanced
power for consumers in the market place, and a fair share
in the benefits of cooperatives for low income people. The
request that I present today will allow the Bank to begin
moviny toward these goals.
Like the Banks for Cooperatives, the Bank will initially
be financed with a government investment that will be redeemed
over time. And like them, it is intended to operate on a
sound and self-sustaining financial basis.
The Bank's Self-Help Development Office will be separate
from its lending operation. It's Self-Help Development Fund
will make capital advances, or soft loans, to cooperatives
which cannot secure adequate financing from hard loan sources.
These capital advances will help satisfy cooperatives' need
for equity and junior debt. The advances will increase
cooperatives' financial soundness and will help them qualify
for conventional loans from the Bank and other sources.
This is particularly important for new cooperatives and
for cooperatives serving low income people. The Office's
technical assistance program will offer management and
technical assistance to cooperatives, including low-income
credit unions that are not eligible to become borrowers.
Budget Summary
Our budget request can be summarized as follows: For
FY 1979, we seek a $40 million appropriation for capitalizing
the Bank (purchasing its Class A stock); $10 million for
capitalizing the Self-Help Development Fund; and $2 million
each for the Bank's administrative expenses and of the SelfHelp Office, which include the expenses of its technical
assistance program. For FY 1980, we seek an additional
$60 million for Class A stock, $20 million for the Self-Help
Fund, $2,459 million for the Bank's expenses, and $6,441
million for the expenses of the Self-Help Office.
Capitalizing the Bank
The moderate capital investment that we have requested
is necessary to establish the Bank as a sound, independent
entity capable of generating sufficient earnings from its
nation-wide business to repay the government's investment
over a reasonable length of time. Our FY 1979 request for
funds for purchasing Class A stock is significantly below
- 3 the $100 million authorized by Congress for that year.
However, our fiscal year 1979 and 1980 requests together
should satisfy the Bank's capital needs in those years and
firmly establish it as a self-sufficient, independent entity.
The Bank's Class A stock is preferred stock yielding
cumulative dividends. The dividend rate will be determined
by the Secretary of the Treasury, who will take into consideration the market rate for Treasury securities of comparable maturity. Until October 1, 1990, however, dividends
are limited to 25% of the Bank's net income.
The government's investment will be repaid out of the
Bank's retained earnings and the proceeds of required purchases of stock by cooperative borrowers. As I noted before,
the model for this procedure is the highly successful Banks
for Cooperatives in the Farm Credit System. The statute
requires that the Bank retire the Class A stock as soon as
possible consistent with the Act's purposes. It also requires
that the proceeds of all sales of Class B and C stock after
October 1, 1990 be used for this purpose.
Until all the Class A stock is redeemed, the President
of the United States will appoint at least six members of
the Bank's thirteen member board of directors. Thereafter,
he will appoint only one. I expect that after its initial
organizational phase, the Bank will place a high priority
on retiring the Class A stock. In this way the Bank will
be independent and wholly controlled by cooperatives as
soon as possible.
Lending Policies
The Bank's objective is to make sound loans at market
rates of interest. The statute requires that every loan
be fully repayable in accordance with its terms and conditions. It also requires that as long as the Bank is making
loans from government capital, it must charge interest rates
that are at least equal to rates prevailing in the local area
for loans from other sources for similar purposes and maturities.
The loan program will thus be a hard loan program.
By the end of FY 1980, the Bank should have nearly
$100 million in loans outstanding if the requested appropriations are granted. This would constitute a significant step
toward meeting the needs of cooperatives for conventional
credit. Among the types of cooperatives assisted would be
food coops, housing coops, low-income agricultural coops,
energy coops, health care coops and handicraft coops. By
- 4 statutory mandate, the Bank must use its best efforts to
see that 35% of the total goes to cooperatives serving lowincome people. Low-income people will thus share substantially
in the benefits from increased growth in cooperatives. In
order to assure that existing small businesses are not unfairly
harmed, the Bank will assess the impact of its loans on small
business.
The Bank is authorized to leverage its resources by borrowing in the credit markets. However, we assume that the
Bank will do no borrowing in fiscal years 1979 or 1980. We
also assume that the Bank will implement its guarantee program
on no more than a demonstration basis in those years. We feel
that the lack of a substantial track record would make it
difficult for the Bank to sell debt on advantageous terms in
these years. Sound business practice would thus lead it to
look solely to its equity capital as a source of funds. We
therefore ask that the Bank's authority to make or guarantee
loans be limited to $40 million in FY 1979 and $100 million
in FY 1980. The requested ceiling will allow the Bank to lend
its capital while keeping a reasonable reserve for losses
and for continuity of operations into FY 1981.
Salaries and Expenses of the Bank
The statute authorizes funds for the Bank's administrative
expenses. Our request would chiefly cover the costs of establishing and operating the Bank's direct loan program. Such
costs include hiring and training personnel, designing and
implementing loan procedures, acquiring and remodeling office
space, and the like.
Let me stress here that our request for administrative
expenses reflects assumptions about the Bank's structure upon
which its Board of Directors will ultimately decide. We
have assumed, for example, that the Bank and its Self-Help
Office will share many overhead services in order to secure
cost efficiencies and that the bulk of these shared services
(performed by roughly fifty full-time employees) would best
be located in the Bank proper. We have also assumed that
the Bank and the Self-Help Office will each maintain a separate
field staff of credit analysts.
The bank will have no funds at all until it receives a
FY 1979 appropriation. I therefore urge that you expedite
treatment of the FY 1979 request.
- 5 Capitalizing the Self-Help Development Fund
The Self-Help Development Fund is designed to promote
the growth and development of cooperatives that cannot obtain
sufficient funds from other sources, particularly cooperatives
that serve low-income people. The Fund's capital advances
are well suited for achieving this objective. They will
satisfy the need of many cooperatives for capital infusions
that are subordinated to ordinary debt.
The statute requires that applicants present an acceptable
plan for replacing capital advances with equity within thirty
years. It also requires that advances bear interest at a
rate determined by the Bank's Board of Directors. All
interest income and repayments of principal will be redeposited in the Fund's capital account. The requested capital
appropriations will enable the Fund to assist cooperatives
on a significant scale in fiscal years 1979 and 1980.
Salaries and Expenses of the Self-Help Office and the Technical
Assistance Program
Our request for the expenses of this Office is separate
from our request for the expenses of the rest of the Bank. It
covers the cost of setting up and operating both the Office's
capital advance program and its technical assistance program.
It also covers the Office's share of the cost of services
provided to it by the Bank.
The Office's technical assistance program will aid cooperatives with special needs, particularly those serving low-income
people. For many cooperatives, technical assistance is the
most important type of aid. Such assistance could include
training in management, bookkeeping, financial planning, contracting, serving on a board of directors, and membership
education. It could also include training in skills relevant
to a cooperative's particular line of business, such as produce
buying for food cooperatives, retail marketing for retail
cooperatives, or health care management for health care cooperatives. In many cases the Office may recover all or part
of the cost of assistance by charging fees.
Personnel
Let us turn briefly to the question of personnel. We
believe that the Bank will be able to operate effectively
and economically in fiscal years 1979 and 1980 with the
authority to hire 166 full-time employees. We have assumed
that roughly 101 of these employees will work under the
direction of the Bank's president and that roughly 65 will
work under the direction of the Self-Help Office's Director.
Bank on a shared-cost basis.
- 6 We have further assumed that roughly fifty of the employees
working for the President and roughly eight of the employees
working for the Director will perform services for the entire
Bank on a shared-cost basis.
This arrangement would help secure the cost savings
sought by Congress in consolidating the Office within the Bank.
I suggest, however, that the Bank should have discretion to
modify this structure within the overall personnel limit of
166 full-time employees.
*
*
*
Thank you, Mr. Chairman and members of the Subcommittee
for your attention. I will be happy to answer any questions
you may have.
FOR IMMEDIATE RELEASE
March 30, 1979
Contact:
George G. Ross
202/566-2356
TREASURY RELEASES FIRST REPORT ON
THE INTERNATIONAL BOYCOTT PROVISIONS OF
THE INTERNAL REVENUE CODE
The Treasury Department today released its first
annual report on the international boycott provisions,
titled, "The Operation and Effect of the International
Boycott Provisions of the Internal Revenue Code."
The international boycott provisions, added to the
Code by the Tax Reform Act of 1976, deny certain tax
benefits to persons who participate in or cooperate with
an international boycott. The tax benefits affected by
the international boycott provisions are the foreign tax
credit, the deferral of tax on the earnings of controlled
foreign corporations, and the deferral of tax on the
earnings of Domestic International Sales Corporations
(DISCs).
The international boycott provisions are generally
effective for operations after November 3, 19 76.
The Report covers the period November 4, 19 76,
through December 31, 1976. It provides an estimate of
the tax benefits lost and information on the number and
type of boycott requests received and agreements entered
into.
o
B-1498
0
o
FOR RELEASE AT 4:00 P.M. EST
March 29, 1979
TREASURY POSTPONES AUCTION OF
7 8-DAY BILLS
The Treasury today announced it was postponing the
auction of $3,000 million of 78-day cash management bills
originally scheduled for Friday, March 30, 1979. This
postponement is necessary because Congressional action on
legislation to raise the temporary debt limit to allow
delivery of the 78-day bills is not at this time assured.
Interested investors are advised to look for notice
of any rescheduling of this auction in the financial press
or to contact their local Federal Reserve Bank for such
information.
oOo
B-1499
FOR IMMEDIATE RELEASE
EXPECTED AT 10:30 A.M. EST
MARCH 30, 1979
REMARKS BY THE HONORABLE C. FRED BERGSTEN
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE CANADIAN-AMERICAN COMMITTEE
NEW YORK, NEW YORK
U.S.-Canadian Economic Cooperation:
Harbinger of Global Accords
The United States and Canada share a special
relationship across a broad spectrum of mutual interests
and concerns. As neighboring nations, we share the
world's longest open border, a common heritage, similar
endowments of natural resources, and a history of strong
independence. Canada and the United States have joined
hands in addressing problems in a number of crucial
areas in our bilateral relations, ranging from trade
in automobiles and agricultural products to environmental
issues and national security. As industrialized nations
with a strong stcke in the global economy, the United
States and Canada have worked closely together
B - 1500
- 2 in multilateral forums, as well, to address mutual
problems and to create and maintain a framework
for beneficial economic exchange with all nations.
The need for continued cooperation is especially
critical in the area of international trade and
investment.
The magnitude of trade and investment
flows between the United States and Canada gives each
country a distinct and almost unsurpassed importance
in the other's economy:
We are each other's largest trading partner,
and indeed we carry out by far the largest
bilateral trading relationship in the world.
U.S.-Canadian trade accounted for one-fifth
of total U.S. trade in 1977, and 70 percent
of total Canadian trade.
—
The total value of U.S. trade with Canada
($62 billion in 1978) is slightly more than
U.S. trade with all nine members of the European
Community and exceeds U.S. trade with the
OPEC nations as a group.
—
The United States is the largest foreign
investor in Canada, and Canada is the third
largest foreign investor in the United States.
Canada's private direct investment in the
United States now totals $6 billion.
U.S.
investment in Canada is more than $35 billion.
- 3 New flows of capital for direct investment
from Canada to the United States have exceeded
U.S. flows to Canada for the past few years.
The size of these flows, and the relative ease
with which goods and capital cross our shared border,
make it inevitable that problems and tensions will
arise. Indeed, problems in U.S.-Canadian economic
relations have often served as harbingers of later,
global issues of a similar nature. This was true for
a number of international monetary issues during the
1960s. Today the use of domestic and export subsidies
which affect trade flows, export controls, conditional
duty remissions, responses to the operations of multinational corporations, investment incentives, and
procurement or offset requirements are clear cases in
point.
The ability of the United States and Canada to
deal with such problems, and our efforts to assure
that new problems will not arise, is critical for
maintaining effective bilateral relations between
our two countries. Beyond this, however, U.S.-Canadian
ingenuity in dealing with bilateral economic issues
can help provide a framework for shaping international
solutions to global concerns of a similar nature.
Indeed, there would seem to be little hope of reaching
successful global accomodations on such difficult
matters if the United States and Canada, with their
- 4 long history of cooperation and strong mutual interest
in peaceful settlement of economic disputes, cannot do
so.
I would therefore like to take this opportunity
to discuss a few of the areas where cooperation between
the United States and Canada is critical, both to
our bilateral relations and to the future of global
economic cooperation.
Investment Incentives
The proliferation of investment incentives,
frequently coupled with such measures as domestic
or export performance requirements and offsets, is
becoming a potential irritant in U.S. relations with
Canada and other countries.
These measures are becoming
more widespread throughout the world.
However, cases
involving the use of incentives in North America are
more likely to cause tensions, primarily because of
the geographical proximity of our two countries.
We in the United States are fully cognizant of
the economic problems facing Canada at this point in
time, and thus sympathize with the desires of Canadian
authorities to adopt policies to deal with them.
However, we too have serious economic problems.
And,
as a longer run proposition, we cannot condone efforts
by one country to shift its economic burdens to another.
These issues are of concern not only to the Administration
but to the Congress, as indicated most recently by
Senator Javits on the floor of the Senate on March 22.
- 5 Several recent cases illustrate the practices
I am referring to and the problems they can cause from
the U.S. point of view.
I am sure that Canadians
could cite cases of their own.
Indeed, Canadians
have commented widely on their own practices in this
area; today I would like to add our viewpoint on them.
(1) Six years ago the U.S. Treasury Department
determined that the assistance grants and loans
extended by the Governments of Canada and Nova Scotia
to the Michelin Tire Corporation constituted a bounty
or grant under the U.S. countervailing duty law.
The
determination was based on a decision that the investment
incentives, while designed to promote the development
of an economically depressed area, actually had the
effect of assisting tire exports to the United States.
The case is still in litigation in the U.S. Customs
court.
(2)
Last year the Canadian Government, in
conjunction with the Province of Ontario, offered
the Ford Motor Company an inducement of $68 million
to build a new plant in Ontario rather than Ohio.
In August, Ford announced its decision to build its
plant in Ontario.
The U.S. Government has strongly
objected to the use of such incentives, which distort
the economically efficient allocation of resources
and can result in the loss of U.S. export opportunities
and U.S. jobs,
- 6 (3)
The use of offset requirements in connection
with procurement of goods from foreign firms is also
increasing in Canada.
The purchase of goods from
a firm is conditioned on agreement by that firm to
enter into licensing or co-production arrangements
in Canada.
This practice was concentrated at first
in the area of defense procurement, but its use by
the Canadian and other governments is becoming a
common practice in large commercial transactions as
well.
(4)
The Canadian Government has also recently
announced new government investment incentives for
the forest products industry, which could serve to
stimulate exports in this area.
Roughly half of
Canadian production of forestry products is now
exported, principally to the United States.
Further
stimulation of exports could be a sensitive issue,
and might run afoul of the U.S. countervailing
duty statute or the proposed international Subsidy/
Countervailing Duty Code.
I understand that the
Canadian Government has similar reviews of some
20 other industrial sectors underway, as potential
beneficiaries of government assistance.
(5)
In January of this year Treasury determined
that Canadian Government grants to Honeywell in 1975
for optic liquid level sensing systems also involved
- 7 a countervailable subsidy. This conclusion was reached
after Treasury concluded a detailed examination of
the uses to which the funds were put and, consistent
with the Michelin decision, determined that the ad
valorem subsidy was significant and a preponderance
of the production was exported. Treasury did not,
by extension, decide that research and development
grants per se are a bounty or grant under the U.S.
countervailing duty law. Rather, the decision rests
on the particular use of the funds in the specific
cases and its potential impact on trade.
Policy Responses
A number of U.S.-Canada trade and investment
problems are therefore on the table. Fortunately,
steps are being taken on both sides of the border
to help deal with them.
For one thing, some of the new international
arrangements worked out in the Multilateral Trade
Negotiations will limit the use of such incentives
as export and other subsidy practices. The major
provisions of the new Subsidy/Countervailing Duty
Code, which I will discuss later, are particularly
relevant.
In addition, the development of disciplines over
government policies toward investment flows is an
important element of the U.S. Government's approach
- 8 to international economic policy.
My colleagues
in other agencies and I have recently discussed these
problems bilaterally with Canada, with other key
industrialized countries, and multilaterally in the
OECD.
Our talks with Canada focused initially on the
Canadian incentives offered to Ford, but have broadened
to cover the use of investment incentives in general.
There is general agreement that the use of public
funds for these purposes on both sides of the border
is, as our Canadian colleagues put it, "a mug's game".
We are continuing to meet bilaterally to discuss the
issues in this area in greater depth.
The United States is encouraged by a statement made
earlier this month by the Canadian Government that Canada
is anxious to pursue an agreement with the United States
on the use of incentives in the automobile sector.
In
announcing new measures to promote the Canadian auto
industry, Jack H. Horner, the Canadian Industry, Trade
and Commerce Minister, said: "The Government's position
is that its involvement in competitive subsidization
with U.S. federal, state or municipal governments
is a costly, no-win proposition for the governments.
Such intervention in the investment decision-making
process will lead to uneconomic decisions."
- 9 He went on to add that "The Government will
pursue, on an urgent basis, discussions with U.S.
authorities on the question.
The objective of the
discussions will be to reach agreement to contain
such investment incentives."
The United States welcomes this initiative by
the Canadian Government and hopes that our continued
discussions will help improve cooperation in this
area.
Any bilateral resolution will give us a head
start in moving toward multilateral arrangements as
well.
Mr. Horner indicated, however, that pending
negotiation of such an agreement his government
"will not stand by while investment is lost as a
result of incentives available in other countries."
To this end, it will offer special assistance to the
provinces when they lack the resources to compete.
A key aspect of U.S. discussions with the
Canadians will thus be participation by the U.S.
states.
Canadians obviously regard them as competitors
for investments and will be anxious to have at least
some of them involved in any understandings we might
reach on the incentives question.
One idea is for
the leaders of selected states and provinces to begin
a dialogue in this area among themselves.
Our
governments will be considering this and other
- 10 approaches in the months to come, while continuing
to discuss the substantive issues involved in the
incentives problem.
The United States is also raising the problem
with other countries on a multilateral basis,
primarily in the Organization for Economic Cooperation
and Development (OECD).
Progress on this front has
been slower, but is now proceeding.
We face some formidable difficulties in trying
to promote agreement on the need to curb governments'
use of investment incentives.
One stems from the
fact that investment is relatively new as a major
vehicle for international economic exchange.
As a
result, most governments have not yet recognized the
need for international cooperation on investment,
even though they long ago recognized the need for
rules in the other major spheres of international
economic activity —
trade and international monetary
relations.
Some governments recognize the dangers inherent
in competition with others for investments and are
uncomfortable about it.
However, they find it
politically impossible to de-esc.alate unilaterally
and are pessimistic about the chances of persuading
others to join in a general reduction in the use of
incentives.
- 11 Yet, situations are developing abroad which
have the potential for generating the same sort of
international tensions that have occurred in U.S.Canadian bilateral relations. Many governments are
striving vigorously to attract foreign investments
as a solution to their economic and social ills. The
firms being courted are in a position of being able
to benefit handsomely at the taxpayer's expense by
pitting one country — or political subdivision —
against others. A case in point is the incentives
competition that is developing among a number of
European countries seeking to win a prospective
investment by the Ford Motor Company.
To the U.S. Government, the need for international
cooperation to head off the further development and
sharpening of this competition is obvious. It will
not be achieved overnight at a simple stroke; rather
it will emerge from a long process of discussion and
negotiation. We hope that our discussions with Canada
will prove to be a significant step in that direction.
U.S.-Canadian Trade
Bilateral trade between the United States and
Canada almost doubled between 1973 and 1978, from
a level of approximately $32 billion to nearly $62
billion. In 1978 the United States exported $28
billion in merchandise trade to Canada, and imported
- 12 $34 billion in goods from Canada. Canada is our single
largest partner for both imports and exports.
About two-thirds of total U.S.-Canadian bilateral
trade is in manufactured goods. The United States
exports more engineering products and machinery for
specialized industries to Canada than we import from
Canada, while importing more motor vehicles, raw
materials, and fuels. Total primary products account
for nearly one-third of U.S. imports from Canada.
Aside from these areas, however, U.S.-Canadian import
and export trade is evenly dispersed across a broad
spectrum of products.
This complementarity of U.S.-Canadian trade,
and our strong dependence upon one another for primary
goods, semi-manufactures and manufactured products
alike, emphasizes the importance of cooperation in
the trade area — and the need to avoid artificial
incentives or restraints which distort normal trading
patterns. It is inevitable that the proximity of our
markets and the competitive nature of U.S. and Canadian
production of a number of goods can at times cause
problems, if sharp rises in exports threaten employment
and production in the importing nation. But Government
intervention has also been the source of a number
of trade problems in recent years. We have worked
together in helping to resolve such problems in the
past, and must continue to do so in the future.
- 13 The U.S.-Canadian Automotive Agreement represents
the most comprehensive effort to deal with bilateral
trade problems in a constructive and mutually beneficial
manner. Negotiated in 1964 and implemented in 1965,
the Agreement set forth these objectives:
1. Creation of a broader market for
automotive products within which the
full benefits of specialization and
large-scale production can be achieved;
2. Liberalization of U.S. and Canadian
automotive trade in respect to tariff
barriers and other factors tending to
impede it, with a view to enabling the
industries of both countries to participate
on a fair and equitable basis in the expanding
total market of the two countries; and
3. Development of conditions in which market
forces may operate effectively to attain the
most economic patterns of investment,
production, and trade.
The Auto Pact was also designed to head off
potential conflicts over Canada's efforts to improve
the performance of its automotive industry. The
catalyst for negotiation of the Agreement was the
possible imposition of countervailing duties by the
United States against a Canadian scheme for subsidizing
exports of automotive products by means of conditional
- 14 duty remissions on imports.
Canada had a deficit of
$560 million in automotive products trade with the
United States in 1964 and expected the deficit to
grow over the next few years.
As a result of the Agreement, Canada did not
introduce export subsidies and did not impose additional restrictions on imports of U.S. automobiles.
In effect, the Agreement permitted Canada to develop
a more efficient automotive industry without damaging
the long-term interests of the auto industry, workers,
and consumers on the U.S. side of the border. Free
trade in specified new motor vehicles and original
equipment automotive parts helped to create an
integrated North American industry and market with
the benefits of specialization and large-scale
production for both nations. As a result of the
Agreement, total bilateral automotive trade grew
from $720 million in 1964 to over $20 billion in 1977.
Canada in particular has gained an efficient
automobile industry, lower prices to consumers and
improved wages and employment. The United States
has maintained a substantial market for automobiles
in Canada and has experienced increasing export
opportunities in automotive products.
The Auto Agreement offers a clear example of
the mutual benefits which can be gained from duty-free
trade in a given sector. Even so, there are lingering
- 15 problems.
Canada remains concerned about its deficit
in automotive products, particularly automotive parts
trade with the United States.
However, the overall
Canadian deficit on automotive products declined from
$1 billion in 1977 to $473 million in 1978, and recent
exchange rate changes should help reduce the deficit
further in the future.
In an effort to help Canadian parts manufacturers,
the Canadian Government announced a duty remission
agreement with Volkswagen Canada, Ltd., in June of
last year.
The purpose of the plan is to increase
sourcing of Canadian parts through duty reduction
on VW auto imports from Pennsylvania and other
locations.
The duty reduction is determined by the
value of Canadian automotive components exports
purchased by Volkswagen. Additional schemes are now
planned with Nissan and other firms.
We have expressed
our deep concern to the Canadian Government about
them.
Multilateral Trade Negotiations
While individual instances of measures taken in
possible violation of the GATT can be dealt with on
a case-by-case basis, as in U.S. dealings with Canada
on the Michelin case and the auto duty remission plans,
a broader approach is required.
- 16 The MTN affords a major opportunity for broader
cooperation. One of the U.S. Government's most
important objectives in the MTN was the negotiation
of a code regulating the use of subsidies and countervailing measures. Canada is one of the most important
participants in that process. Negotiation of a code
is essentially completed. We believe that the code
will promote the smooth unfolding of future U.S. trade
relations with Canada and other code signatories in
this critical area.
In particular, the code provides new guidelines regarding the use of subsidies in the following
areas:
(1) There is a much stronger prohibition of
industrial export subsidies, complemented by an
updated list of prohibited export subsidy practices.
This new list includes practices such as export
inflation insurance, exchange risk guarantees, and
duty drawbacks in addition to items carried over from
the previous GATT list.
(2) There is an explicit recognition that
countr ies must accept responsibility for the trade
effects of their domestic subsidy programs, and
commit themselves to avoid granting such subsidies
that adversely affect the trade interest of other
countr ies.
- 17 (3)
Domestic subsidies which impair GATT tariff
bindings through import substitution are subject to
countermeasures as a violation of GATT commitments.
Such subsidies may include, but are not limited to,
regional development grants, research and development
grants, government provision of infrastructure services
and government financing of commercial enterprises,
including provisions of loans and guarantees on noncommercial terms.
(4) Export subsidies on industrial products to
third markets are subject to countermeasures, as are
export subsidies on agricultural products which displace
the exports of others or involve material price undercutting in a particular market.
(5) Developing countries for the first time are
agreeing to phase out the use of export subsidies
as part of their obligations, commensurate with their
competitive needs, under the new code.
(6) These provisions are complemented by new
rules regarding the use of countervailing duties,
and by the adoption of an injury test in U.S. law.
We have also made substantial progress in other
MTN codes. The United States is pleased that one
of the most difficult elements in the U,S.-Canadian
phase of the MTN talks has been resolved favorably,
with Canada's tentative decision to sign the Customs
- 18 Valuation Agreement. This is a welcome sign that Canada
is willing to take even very difficult steps to reduce
barriers to trade between our two countries.
Canada's
adherence to this code will greatly help to eliminate
a significant nontariff barrier to trade among all
developed, and some developing, countries.
Future of U.S.-Canadian Economic Relations
The agreements worked out multilaterally in the
MTN, and which the United States and Canada are seeking
on a bilateral level, will promote a continuation of
positive trade and investment relations between our
two countries as trade and investment flows continue
to grow.
It is clear that both countries are anxious to
obtain the greatest possible economic benefit from
international trade and investment.
Hence, we must
not lessen our attempts to eliminate obstacles to them.
This is true not only because of the resulting benefits
to our bilateral relationship, but because it is also
clear that any bilateral actions we take —
such as
an agreement to regulate investment incentives
—
may well set a pattern for broader, perhaps even
global, arrangements at a later time.
This is not an easy task.
But the U.S. Government
firmly believes that heightened cooperation between
the United States and Canada in the area of trade and
- 19 investment will provide benefits that will reach beyond
our own borders.
It could set the stage for more
effective international approaches to problems that
beset all nations, and could pave the way for greater
international economic cooperation in the future.
IMMEDIATE RELEASE
March 30, 1979
CONTACT:
Charles Arnold
202/566-2041
STATEMENT BY DEPARTMENT OF THE TREASURY
As a consequence of the failure to raise the Nation's debt limit
this week, the following actions have been taken:
1. The auction of $6.0 billion of 91-day and 182-day bills
originally scheduled for Monday, April 2, 1979, was postponed.
In addition to this auction postponement, the Treasury Department has postponed five offerings of bills, notes and bonds
since March 20, 1979. These postponements were necessary
because without legislation to raise the temporary debt limit
the Treasury could not assure delivery of the securities.
After March 31, 1979, the Treasury Department cannot issue any
Treasury obligations until final Congressional action is completed on the debt limit legislation, and it is signed into
law.
2. Effective Monday, April 2, all sales of U.S. Savings bonds are
suspended because bonds cannot be issued.
3. All of the Treasury's funds in tax and loan investment
accounts with commercial banks have been called in order to
maximize operating balances at Federal Reserve Banks.
4. All available securities in the Exchange Stabilization Fund
have been redeemed in order to allow the Treasury to borrow
approximately $3 billion from the Federal Reserve without
exceeding the current debt ceiling.
5. The Federal Reserve Board has been requested to accelerate
from April 3 to April 2 its regular monthly payment of
earnings of approximately $700 million to Treasury.
6. Beginning Monday, April 2, cash inflows into the Social
Security, Civil Service and other trust funds will not earn
interest.
Present cash projections confirm Secretary Blumenthal's statement
March 12 that without an increase in the temporary debt ceiling, the
easury will be unable to meet its obligations on Tuesday, April 3.
o00o
1501
FOR TMMHDTATF RELEASE
March 30, 1979
TREASURY POSTPONES WEEKLY BILL AUCTIONS
The Treasury today announced it was postponing the
weekly bill auctions totaling $6,000 million originally
scheduled for Monday, April 2, 1979. This postponement
is necessary because Congressional action on legislation
to raise the temporary debt limit to allow delivery of
the bills is not at this time assured.
If feasible, these auctions will be held on Tuesday,
April 3. 1979. Interested investors are advised to look
for notice of any rescheduling of these auctions in the
financial press or to contact their local Federal Reserve
Banx for such information.
oOc
B i 502
FOR IMMEDIATE RELEASE
March 30, 1979
TREASURY TO SUSPEND SAVINGS BONDS SALES
As a result of the inaction of the Congress to increase
the debt limit, the Department of the Treasury today
announced that the sale of U. S. Savings Bonds, Retirement
Plan Bonds and Individual Retirement Bonds would be suspended
effective April 2, 1979, until further notice. Without new
legislation to increase the public debt limit, the Government
lacks authority to issue new debt obligations.
Until the debt ceiling is raised, the Treasury Department
will also be unable to complete transactions involving special
nonmarketable securities which are issued in connection with
the financing of tax-exempt bond issues by state and local
governments.
oOo
B 1503
For Release Upon Delivery
Expected at 10:00 a.m. ^
April 3, 1979
STATEMENT OF
DANIEL I. HALPERIN
DEPUTY ASSISTANT SECRETARY OF
THE TREASURY (TAX LEGISLATION)
BEFORE THE SENATE FINANCE COMMITTEE
SUBCOMMITTEE ON PRIVATE PENSION PLANS
AND EMPLOYEE FRINGE BENEFITS
Mr. Chairman and Members of the Subcommittee:
I am pleased to have the opportunity to appear before
you today to present the Treasury Department's views regarding additional tax incentives for savings by individuals as
well as certain other retirement plan issues. It is our
understanding that the Subcommittee is interested in the
Department's reaction to four areas: tax deductions for
employee contributions to qualified plans or for contributions to IRAs by those participating in such plans, deductible
IRA contributions by spouses, revisions to the income tax
treatment of lump sum distributions from plans and tax
credits for small employers who establish qualified plans.
DEDUCTIBLE CONTRIBUTIONS BY ACTIVE PARTICIPANTS
S. 75, introduced by Senators Dole and Nelson, Section
203 of S. 209, introduced by Senators Williams and Javits,
and S. 557, introduced by Senator Bentsen, would allow a
deduction for employee contributions by active participants
in employer-sponsored plans. Both S. 75 and S. 209 allow
deductible contributions to be made by any participant earning below a specific level, with contributions by those
earning above the safe harbor amount deductible only if the
plan is nondiscriminatory.
B-1504
- 2 S. 557 would allow deductible contributions by any
participant without regard to satisfaction of a nondiscrimination test.
We would first like to examine the basic objectives of
these bills and to discuss certain general tax policy issues
involved in achieving these objectives.
Present law allows employees who are not active participants in qualified plans to deduct up to $1,500 annually
for contributions to an Individual Retirement Account (IRA).
Denial of a deduction for IRA contributions by an employee
who is an active participant in a qualified plan is based on
the assumption that such employees do not need an IRA to
provide for retirement. This assumption may not be in
accord with the facts.
Some participants in an employer-sponsored plan will
receive little or no benefit from the plan at retirement.
These participants are in plans which provide minimal
benefits either to all participants or to those in lower
wage brackets; they are also in plans which provide deferred
vesting which does not generate benefits for them because of
frequent job changes. These employees will tend to oppose
the establishment of qualified plans or will seek to opt out
of such plans in favor of individual IRAs. We believe this
interferes with the long-run goal of retirement security for
all workers which can be better achieved through employersponsored plans. Thus, we are sympathetic to one of the
objectives of these bills — to reduce the attractiveness of
IRAs to those who have an option to participate in an employer
plan.
We agree that any narrowly targeted solution to this
dilemma will be either intolerably complex or inequitable.
For example, the small benefit problem could be alleviated
by allowing participants to "make up" the difference between
the employer contribution on their behalf and the maximum
deductible IRA contribution they could make. The difficulty
here is that any attempt to determine the amount an employer
contributes on behalf of an employee under many types of
defined benefit plans either will be extremely complex or
will involve rough approximations which may not be equitable.
While it is less burdensome to determine the amounts allocated
to a participant under a defined contribution plan, limiting
the availability of "make up" IRAs only to participants in
defined
plans
would
an unacceptable
tinction contribution
on grounds of
equity
and be
would
be a furtherdisprefer-
- 3 ence for defined contribution plans which we believe to be
less able to provide adequately for retirement.
Further, any attempt to provide for deductible contributions while a participant has no vested interest could
lead to pressure from long service employees for a slower
vesting schedule, which is obviously contrary to the goals
of ERISA.
Since it is not feasible to narrowly focus on those
participants who will eventually receive little or no benefit
from the qualified plan, we need to examine a more farreaching approach: encouragement and broadening of retirement savings in general.
We support the objective of broadening retirement
savings, but we continue to insist that there must be
adequate assurance of nondiscriminatory coverage and benefits.
Nondiscrimination in the enjoyment of tax benefits associated
with savings for retirement is essential.
Under an income tax, income is subject to tax when
earned, whether it is consumed immediately or put aside for
a rainier day. Tax incentives for retirement savings work
to defer tax until income is spent, presumably after retirement.
This departure from the goal of a progressive income tax
system can only be justified as a means of furthering nontax
social policy goals. In this case, we believe the goal is
the assurance that employees at all levels of compensation
will be provided with retirement protection, protection
which is particularly difficult to plan and save for at low
income levels. As evidence of this goal, favorable tax
treatment is generally allowed only if contributions or
benefits provided by employer contributions do not discriminate
in favor of officers, shareholders and highly compensated
employees.
Without this nondiscrminiation requirement the tax
system is ill-equipped to provide for those with low or
moderate income. The higher a taxpayer's income, the greater
the benefits of favorable tax treatment. Thus, the absence
of a requirement that low-income employees receive benefits
under a tax-favored program leads, quite logically, to
unequal utilization of the tax benefit. This result is
dramatically illustrated by the most recent figures available regarding the utilization of the current IRA deduction.
Treasury estimates that of employees able to utilize an IRA
m 1977, over 52 percent of those with adjusted gross income
- 4 of $50,000 or more did so, while the average utilization
rate was was under five percent for those with $20,000 or
less of adjusted gross income. (Tables 1 and 2".)
In turning now to the specific proposals to be considered today, we will approach each bill on the assumption
that it will be acceptable only if low paid workers—those
who are most in need of retirement savings as well as least
able to plan and save for retirement—actually participate
in substantial numbers.
S. 557 - Deductions by Any Active Participant
As noted above, S. 557 allows an active participant to
make a deductible contribution to a qualified plan or to an
IRA. The deductible limit is the lesser of 15 percent of
compensation or $1,500, the same as the current limits on
contributions to IRAs. S. 557 would not apply to participants
in government plans or to employees of tax-exempt organizations who participate in salary reduction tax sheltered
annuity plans.
Although we acknowledge that S. 557 would probably
encourage some additional retirement savings, we believe it
does not pass the test set out above that it be designed to
assure or encourage savings by relatively low-paid workers.
As noted above, utilization of tax benefits increases
at higher income levels since the benefit of a deduction is
greater as income increases. Since the tax benefit for high
paid employees is not predicated on substantial savings by
other employees, we believe the effect of S. 557 will be
much like that of the current IRA—utilization at
income levels above $50,000 will be more than 10 times
higher than utilization at levels of $20,000 or less. Moreover, there are proportionally more active participants than
nonparticipants among those at high income levels. Therefore,
we oppose S. 557.
S. 75 and Section 203 of S. 209: Deductions by All Active
Participants, Subiect to an Antidiscrimination Test for High
Paid Employees
S. 75 and Section 203 of S. 209 would allow active
participants earning below a specified level to make deductible
contributions of up to $1,000 to their employer's plan or to
an IRA, while participants above the specified income level
will be allowed a deduction for contributions only if contributions are also made, on a nondiscriminatory basis, by
employees earning lesser amounts.
- 5Under S. 75, the specified pay level is Step 1 of GS14, which is currently $32,442; under S. 209, the level is
Step 1 of GS-12, currently $23,087. In addition, each bill
allows into the safe harbor those earning above the specified
income level if their compensation is within the lower twothirds of all participants.
This approach raises the following issues:
(i) Assuming a nondiscrimination test is to be
applied to the allowance of deductions for high-income
individuals, does it make sense to waive the test for
those at lower income levels?
(ii) If so, how should the cut-off point be
determined?
(iii) What criteria should be utilized in developing
a staisfactory test of nondiscrimination?
Determining the Cut-off Point
As indicated above, a tax deduction for retirement
savings is much more likely to impact on those at highincome levels who have both the ability to save and significant tax savings from doing so. The lower income group
will be covered in qualified plans not necessarily in
response to the tax savings offered to them alone but
because it is essential to do so in order for the highincome group to obtain their tax savings.
The non-discrimination test is thus aimed at the
behavior of high income employees and there may be no need
to apply it to the lower paid. Withholding tax benefits
from the top one-third, unless there is nondiscriminatory
coverage, may be sufficient incentive to assure the widespread
participation we seek.
Setting the cut-off point based
upon income level can only be acceptable if this type of
incentive remains.
We estimate that over 96 percent of all employees in
the United States have salaries and wages of $32,000 or
less, and that over 94 percent have salaries and wages of
$23,000 or less.* Based on these statistics, we believe
the presently proposed safe harbors are too high. Since
most of the population would be able to take advantage of
the tax break without regard to participation by others
there will be little encouragement of savings by workers in
These figures include government employees.
- 6 the lowest paid group which is the goal of the favorable tax
treatment. Moreover, we are concerned with the effect on
tax equity if the safe harbor level is as high as $32,000.
Our experience with IRA utilization levels indicates that
the preponderance of use will be among those at the top of
the eligible group. While people at that income level are
certainly not rich they are in the top 4 percent of all
earners and it is difficult to support what amounts to a tax
deduction for this group and not to those earning less.
Thus, we are not willing to support a safe harbor
unless it is targeted to a much smaller group; those
employees who are most in need of encouragement to save for
retirement. Our statistics show that over 75 percent of
all workers (including government employees) would be covered
by a safe harbor of $15,000, We believe a safe harbor in
this general area would allow significant numbers of employees
to take advantage of favorable tax treatment for retirement
savings while maintaining the incentive for widespread
coverage and limiting the disproportionate utilization of
the tax benefit by higher paid employees.
With respect to those above this level, an antid.iscrm-i niation test is essential to permit them to deduct their
contributions. If such a test is believed to be difficult
to administer, we could limit the deductibility of contributions to only those earning at or below the safe harbor
level. However, if we assume that allowing deductible contributions by higher paid employees when an antidiscrimination test is met will have the effect of giving these
employees an incentive to encourage savings by low-paid
employees, then an antidiscrimination test should be included
in the bill in order to achieve a wider breadth of savings.
Testing for Discrimination
Under current law and administrative practice, an equal
dollar for dollar comparison is not necessary to satisfy the
antidiscrimination requirements of qualified pension plans.
For example, in defined contribution plans, the rule is that
employer contributions which are allocated to participants'
accounts are acceptable if they are equivalent as a percentage of compensation. S. 75 and S. 209 test for discrimination by comparing the level of contributions for all highly
compensated employees as a group with the contribution level
- 7 of all other employees. However, even within this approach,
S. 75 and S. 209 depart from the general standard of equality
and allow greater percentage contributions for highly
compensated employees than are made by the remaining individuals.
We recognize that some exceptions are allowed from the equal
percentage test of equality as, for example, under the
provisions allowing a defined contribution plan to be
"integrated" with the employer's Social Security contributions.
We also note that the. antidiscrimination tests reflected in
-S. 75 and S. 209 are adopted from the test for cash or
deferred profit sharing plans added to the Code by the
Revenue Act of 1978. However, we do not believe it is
necessarily appropriate to incorporate these tests in the
area of deductible employee contributions to qualified
plans.
The tests adopted for cash or deferred profit-sharing
plans reflect in part the historical background of such
plans. Under Internal Revenue Service rulings, cash or
deferred plans were deemed acceptable if one-half of the
contributions to the plan come from the bottom two-thirds of
employees. This allowed the top one-third of employees to
contribute twice as much as the average contribution from
the bottom two-thirds. In order to revise these rules, it
was necessary to effect a compromise measurement of discrimination, and this compromise is reflected in the 1978
Act provision.
Furthermore, we believe it is clearly inappropriate to
measure limited contributions made by an employee as a
percentage of his or her total compensation. Limiting
deductible employee contributions to the lesser of 10
percent of compensation or $1,000 reflects an intent to
focus on replacement of the first $10,000 of earnings. A
substantial limit on contributions without a limit on the
salary taken into account for the computation is inconsistent
with this purpose since it results in high-paid employees
making the maximum deductible contribution without generating
a significant contribution for low-paid employees. For
example, a $100 contribution for an individual earning
$10,000 would permit the maximum $1,000 contribution for an
individual earning $100,000.
If an antidiscrimination test based on compensation is
used, the appropriate measurement is one which limits the
compensation taken into account to the level which permits
- 8 the maximum dollar amount of contributions. Therefore, in
S. 75 and S. 209, the deferral should be determined on the
basis of an employee's compensation up to $10,000.
Contributory Plans
Once the approprate safe harbor level and antidiscrimination test are determined, the most significant remaining
issue is the treatment of employee contributions to plans
under which employer contributions, or benefits derived from
employer contributions, are geared to contributions by
employees. We refer to these plans as "contributory."
Under Section 203 of S. 209, deductibility of employee
contributions to contributory plans would be limited to
plans in effect on January 1, 1978; under S. 75, all contributory plans, including those established after enactment,
would be acceptable vehicles for deductible employee
contributions.
We have a number of concerns relating to allowing
deductible contributions to contributory plans.
First, there will be a substantial revenue loss attributable
to contributory plan deductions without a corresponding
increase in savings. For example, of the $1.1 billion revenue
loss we estimate for S. 557 in the current calendar year,
the largest portion—about $850 million—will be for employee
contributions which are currently made on a nondeductible
basis.
We are also concerned that allowing deductions for
contributions to these plans will encourage their establishment, and that this may lead to a potential loss of retirement security for low paid workers. While we know of no
detailed study, it is reasonable to believe that the level
of participation in contributory plans among eligible
employees increases as income rises. We do not believe that
any of the arguments advanced in favor of contributory plans
are forceful enough to justify them if, in fact, they
deviate from the overall goal of retirement security.
In this connection, we would like to review four areas
of the Internal Revenue Code applicable to contributory
plans, which we believe should be considered.
- 9 First, a contributory plan may take advantage of a
special safe harbor arithmetical test available for determining whether its coverage meets the minimum requirements
of the Code. This test allows a plan to meet the coverage
requirements if at least 70 percent of all employees who
have met the plan's minimum age and service requirements are
eligible to participate and 80 percent of the employees who
are eligible do participate. For example, if 100 employees
have met a plan's age and service requirements for eligibility,
then only 70 employees actually must be eligible to participate,
and only 80 percent of those employees—or 56 individuals—
need to participate to satisfy this test.
If a plan does not meet the arithmetical safe harbor
coverage tests, then it may still satisfy the minimum
participation requirements by satisfying what is referred to
as a.fair cross section test. Under this test, the employer
may show that the plan covers employees in all compensation
ranges and that those in the middle and lower brackets are
covered in more than nominal numbers. We believe that a
plan which covers only the top 55 percent of employees would
not satisfy the fair cross section test; thus it seems
incongrous that a plan which covers only one more percent
may satisfy the arithmetical test.
Second, the Code requires that a plan must provide for
vesting in employer contributions at a rate or rates which
satisfy certain tests based on an employee's years of
service (or a combination of age and years of service.)
However, service with an employer during a period in which
an employee was eligible to make contributions to a contributory plan but did not contribute may be excluded in
determining an employee's years of service for vesting
purposes. Thus, to the extent an employee is prevented by
outside economic pressures from participating in a plan, he
or she will lose not only the employer derived benefits
attributable to his or her contributions for that period but
also vesting credit for service with the employer which may
affect the employee's entitlement to employer benefits for
those periods he or she is able to contribute.
>
Third, the rules relating to the allocation of a
participant's accrued benefit between the portion derived
from employee contributions and the portion derived from
employer contributions in a contributory plan are often
extremely unfair to younger participants. The Code generally
- 10 requires that an employee's accrued benefit must grow at an
equal or near equal rate for each year he or she is credited
with service under a plan. However, ratable accrual focuses
on the total accrued benefit of the participant under the
plan. In effect, allocation of employer- and employee^derived
benefits based on a participant's total benefit defeats the
equal accrual rate requirement since the employer derived
portion of a benefit may not be significant until a participant
nears retirement age. A younger employee may be entitled
merely to the return of his or her own contributions.
Fourth, a plan may provide that a participant who
withdraws his or her contributions from a contributory plan
will forfeit the employer benefit attributable to those
contributions. Although ERISA denies this forfeiture once a
participant has a 50 percent vested interest in employer
contributions, the forfeiture provision may still work a
substantial hardship on the withdrawing employee.
These rules lead us to two conclusions. First, it
seems that contributory plans may be suspect as a means of
avoiding many of the participant protections provided by
ERISA. Second, since low-paid employees are most likely to
be subject to significant outside economic pressures which
will interfere with their ability to make contributions to a
plan, we believe these employees are most likely to be
adversely affected by the encouragement and continuation of
contributory plans. Accordingly, we would prefer to limit
the deductibility of employee contributions to those made on
a voluntary basis, that is, employee contributions which do
not generate employer contributions or benefits.
Mechanism for Employee Contributions
Finally, we would also like to comment on the issue of
how employee contributions should be handled. Under S. 75
and Section 203 of S. 209, an employee may contribute
either to an IRA or to his or her employer's qualified plan.
It is not clear whether it is intended that an employee's
contributions to an IRA may be taken into account in determining
whether the employer's plan satisfies the nondiscrimination
tests.
If an approach to the general issue of deductible
contributions is adopted which does not involve an antidiscrimination test, we have no objection to allowing
- 11 employees to contribute directly to IRAs without employer
involvement. However, if an antidiscrimination test is
adopted, then we believe that employee-established IRAs
should not be counted in determining whether the antidiscrimination test is met, unless there is some way of
checking on the IRAs both by the employer and by the IRS.
If an acceptable mechanism can be established for certifying
and verifying "outside IRAs" we would have no objection to
.this approach.
DEDUCTIBLE IRA CONTRIBUTIONS BY SPOUSES
S. 94 is concerned with a different aspect of retirement
security than S. 75, Section 203 of S. 209 or S. 557. S. 94
is concerned with the security of a spouse who either does
not work outside the home or earns less than $10,000 per
year from such work. It would allow the spouse of an
employee to make deductible contributions to an IRA based
upon compensation equal to his or her spouse's compensation.
The bill would also repeal the current spousal IRA
provisions of the Internal Revenue Code which allow up to a
$1,750 deduction by an employee if equal contributions are
made on behalf of the employee and his or her nonemployee
spouse.
Treasury estimates the revenue loss of S. 94 would
be $336 million for the current calendar year, rising to
over $1 billion by 1984.
Although we recognize the goal of extending tax favored
retirement savings to spouses, we believe the utilization of
these IRA deductions would be similar to the utilization
under current law which, as noted above, is over 52 percent
for employees with more than $50,000 of adjusted gross
income and less than 5 percent where adjusted gross income
is below $20,000. In addition, there are many who believe
that the two-worker family is overtaxed as compared to the
one-worker family or unmarrieds living together. Therefore,
we do not feel tax equity necessarily would be served by
allowing up to a $3,000 IRA deduction for married persons in
one-worker families outside the context of an overall solution
to the relative tax burden of married and single persons.
For these reasons, we oppose S. 94.
- 12 REVISIONS TO LUMP SUM DISTRIBUTION RULES
Section 201 of S. 209 modifies the aggregation rules
contained in the Internal Revenue Code relating to the
special tax treatment given lump sum payments from qualified
plans. In general, the aggregation rules reguire that the
balance to the credit of an employee must be paid from all
deferred compensation plans required to be aggregated, or no
.lump sum treatment is possible. Generally, the present law
requires the aggregation of all pension type plans and the
separate aggregation of all profit sharing type plans. In
the case of multiemployer plans, the bill would divide the
various plan forms into defined benefit plans and defined
contribtuion plans. In all other cases, the bill retains
the present law, i.e., a division between pension types and
profit sharing types. The significant change under the
rules contained in the bill is that a defined contribution
money purchase pension plan will not have to be aggregated
with a defined benefit pension plan if they are both multiemployer plans.
Treasury is not opposed to this change. However, we
believe that lump sum treatment should depend upon an
aggregation of qualified plans of all types. Thus, we would
favor the computation of tax, in the case of a lump sum
distribution from one class of plan, as if the value of
benefits hold in all other classes had already been distributed.
The effect of this would be to apply a higher rate of tax to
a lump sum distribution if a benefit is being held in another
type of plan for later distribution.
Section 202 of S. 209 addresses the question of the
status of an employee covered by a multiemployer plan who
terminates his service for one of the contributing employers.
The bill provides that when the employee has not worked (for
any employer) in service covered by the plan for six months
after severing his employment relationship with a participating
Treasury
supports
the amendment.
employer,
he will
be deemed
to have separated from service,
and thus be eligible for a lump sum distribution.
- 13 TAX CREDITS FOR ESTABLISHING PLANS
Section 204 of S. 209 provides a tax credit for "small
business employers," both corporations and unincorporated
businesses or partnerships, equal to a portion of the
deductible contributions they make to newly established
qualified retirement plans. The credit begins at 5 percent
of the deductible plan contribution, and ends at 1 percent
in the fifth year after the plan is established. No credit
is allowed for contributions of employer securities to the
plan, or apparently for cash contributions to the extent the
cash is used to acquire employer securities.
For purposes of qualifying for the credit, a "small
business employer" is an incorporated or unincorporated
business with a monthly average of fewer than 100 employees
in the year before the first credit year, and with earnings
and profits (or in the unincorporated case, net profits) not
greater than $50,000 in the year before the first credit
year. Although no credit is allowable under the bill for
any taxable year in which a qualified plan is terminated,
there is no limitation on the credit if a qualified plan is
terminated and a "new" plan is established in the next
taxable year.
As we have previously testified,* we share the desire
reflected in this provision of S. 209 to expand the coverage
of the private pension system. Based on currently available
statistics, we estimate that not much more than one-half of
the nation's labor force is now covered under the private
pension system, and we believe that employees working for
small employers tend to be among those who are least likely
to be covered. However, there is not to our knowledge
sufficient information regarding both the numbers of employees
who are not covered by plans and the reasons for their
exclusion from the private pension system to determine if an
additional tax incentive can be targeted so that it will
increase coverage without providing a windfall to employers
or an unreasonably large revenue cost.
We are currently working with the Internal Revenue
Service in an effort to analyze the group of taxpayers who
neither maintain an IRA or participate in a qualified plan.
* February 6, 1979, before the Senate Human Resources Committee.
We are, in addition, soliciting the information which may be
available at national accounting and consulting firms regarding
- 14 coverage and exclusions from coverage as well as demographic
information concerning the American work force. We also
understand that the President's Commission on Pension Policy
and the Office of Planning Policy and Research in the
Department of Labor will be studying the coverage and
noncoverage of employees during 1979 and 1980.
Without clearer information as to the gap in coverage
of employees and the portions of the gap which could be
affected by new incentives, we cannot evaluate the appropriateness of Section 204 of S. 209. We feel it is premature to
act now on such a proposal. With the information our studies
and those being conducted by other agencies and Congressional
staffs will provide, perhaps an efficient system of incentives
which is narrowly targeted to expand coverage under the
private pension system will be possible.
Mr. Chairman, that concludes my formal testimony. I
would be pleased to answer any questions the Subcommittee
may have.
o
0
o
Table 1
Individual Retirement Accounts, 1977:
Estimate of Utilization Rate by Income Class
Number of
returns
with
salaries
and
wapes 1/
Adjusted
gross
Income
class
($000)
(
Estimated
Estimated
number of
number of
taxpayers
taxpayers
with
: eligible
: salaries and :
to use
wages 2/
IRAs 3/
Estimated
number
of
IRAs 4/
Numbers in millions
Utilization
rate
) (.. percent .)
0- 5
20.1
20.7
17.6
0.04
5 - 10
16.5
19.0
13.3
0.18
1.4
10- 15
13.0
17.5
10.5
0.35
3.3
15 - 20
10.7
16.3
7.4
0.40
5.4
20 - 50
15.8
24.9
6.2
1.35
21.8
and over
1.1
1.4
0.4
0.21
52.5
Tottl
7772
99.8
55^4
2.53
"4767.
ce of the Secretary of the Treasury
fice of Tax Analysis
^published data from 1977 tax returns.
icludes 2 spouses when both have salaries and wages.
eludes persons covered by public or private retirement systems.
lows for 2 individual retirement accounts on some returns.
sed on number of Forms 5329 filed. Some of these accounts
-eived no deductible contributions during 1977.
0.27.
March 27, 1979
Table 2
Individual Retirement Accounts, 1976:
Estimate of Utilization Rate by Income Class
Adjusted
gross
income
class
($000)
Number of
returns vith
salaries
and
wages 1/
(
Estimated
: ' Estimated
number of
number of taxtaxpayers
: payers with
eligible
: salaries and
to use IRAs 3/
: wages 2/
Number in millions
Estimated
number
of D U U 4/
TJtilizttlOD
rate
) (.. percent
0 - 5
20.3
21.2
17.1
•04
0.3
5-10
17.3
20.6
13.5
.19
1.4
10-15
13.4
19.1
11.6
•30
2.5
15-20
10.6
15.7
6.5
•34
5.2
20 - 50
12.9
18.6
6.1
.90
14.8
50 and over
0.9
1.2
0.4
_1£
&£
Total
75.4
96.4
55.4
1.95
3.5
Office of the Secretary of the Treasury
Office of Tax Analysis
February 16, 1978
1/ Unpublished data from 1976 tax returns.
_2/ Includes 2 spouses when both have salaries and wages.
3/ Excludes persons covered by public or private retirement systems.
kj Allows for 2 individual retirement accounts on some returns. Based on
number of Forms 5329 filed.
FOR IMMEDIATE RELEASE
EXPECTED AT 10:00 A.M. EST
TUESDAY, APRIL 3, 1979
STATEMENT BY THE HONORABLE C. FRED BERGSTEN
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS
COMMITTEE ON APPROPRIATIONS
HOUSE OF REPRESENTATIVES
STATEMENT: WORLD BANK GROUP
I. Amounts Requested
Mr. Chairman and Committee members, I am honored to
appear before you today to seek your support for the
Administration's FY 1980 appropriations request for the
World Bank Group. The total request is for $2,151.2 million,
broken down as follows:
A. International Bank for Reconstruction and Development
(IBRD)
The Administration is requesting $1,025.8 million
for the IBRD to complete the second installment of the
Selective Capital Increase and to make the third and
final installment. The Administration will not request
any funding for the IBRD for FY 1981 if this request
B-1505
- 2 receives favorable treatment.
$502.8 million, or half
of the total, represents an unfunded but authorized past pledge
— half of the request is for new money. Further, only 10 percent
of the request, $102.6 million, is for paid-in capital. The
$923.2 million balance is for callable capital.
B. International Development Association (IDA).
The Administration is requesting $1,092 million for IDA.
$292 million of the request will complete the last payment
of the fourth replenishment of IDA (IDA IV). The $800
million balance is for the third and final installment
of IDA V. Note that this year's IDA request is $166 million
smaller than the amount actually appropriated by the Congress
last year.
C. International Finance Corporation (IFC).
The Administration's request for the IFC is for $33.4
million to complete the third and final installment of the
IFC's capital increase.
Mr. Chairman, I wish to submit a table summarizing these
amounts:
IBRD
IDA
IFC
Total
$ 33.4
$1,356.4
($ million)
New Request
$523.0
$800.0
Unfunded Past Pledge
502.8
292.0 794.8
Total Request
1,025.8
Of Which Paid-in
102.6 1,092.0
Of Which Callable
923.2
1,092.0
33.4
2,151.2
33.4
1,228.0
923.2
- 3 -
II.
The Importance of the Developing Nations
The less developed countries (LDCs) are of vital
importance to the United States. They are important
sources of raw materials and growing users of the earth's
limited resources and environment upon which we all depend.
They occupy strategic geography and their military concerns
and conflicts can seriously affect U.S. interests and could
potentially involve the great powers. Some LDCs even have
nuclear military capability. Moreover the LDCs have tremendous
potential as a market for U.S. exports, provided they
are able to attain sufficiently high standards of living.
Secretary Blumenthal devoted considerable attention to
the importance of the LDCs to the U.S. in the statement he
submitted when he appeared before this Subcommittee on March 14,
three weeks ago. I shall not attempt to improve on the points
he made; rather I commend his statement to your further attention.
III. The Record of the World Bank Group
The multilateral development banks in general and the
World Bank Group in particular have performed well in
serving U.S. interests. The IBRD was conceived in 1944 and
began operations in 1946. The IBRD contributed significantly
to the reconstruction of post-War Europe and Asia, but by
the early 1950s the emphasis had already begun to shift to
development projects in the LDCs.
- 4 The IFC was created in 1956 as a financially independent
affiliate of the IBRD. Its purpose is to strengthen the
role of the private sector in LDCs by taking non-guaranteed
debt and equity positions in commercial enterprises.
In 1960 IDA was created as a second financially independent affiliate of the IBRD, with the purpose of providing
development resources on a concessional basis to countries
too poor to afford the IBRD's commercial lending terms.
The accomplishments of the World Bank Group are impressive. The IBRD had extended loans totaling $44.7 billion
by June, 1978, and IDA credits totaled $13.7 billion. Both
the IBRD and IDA have perfect repayment records — neither
has ever lost a penny on any loan or credit. Cumulative
IFC gross commitments reached $2.0 billion by June, 1978.
The MDBs have become the leading institutions in the
field of international economic development, and the World
Bank Group is pre-eminent among the MDBs. In FY 1978 the
World Bank Group made commitments in nearly 80 countries
totaling over $8.7 billion — nearly four times the regional
banks combined. Disbursements rose to $3.8 billion.
But the World Bank Group is far more than a highly
successful financier. Because of its pre-eminent position
in the field of international economic development, the
World Bank Group is able to exert considerable influence for
- 5 policy improvements in borrowing members.
It provides
technical assistance as a component of some of the projects it
finances or makes separate technical assistance loans. It
chairs or otherwise participates in over 20 aid coordination
mechanisms, and contributes importantly to the harmonization
of programs of international organizations including the
regional banks, UNDP, WHO, IFAD, and many others. The World
Bank conducts or funds research on development problems and its
reports are available to member governments and international
organizations. The World Bank's Economic Development
Institute conducts courses in Washington and abroad on
development policy issues and management for officials
of member governments.
Each of the three institutions deserves U.S. support
for its specialized role in the development effort.
A. IBRD
The IBRD directs its loans to developing countries which
can afford to borrow at commercial rates by virtue of per
capita GNP or balance of payments strength but which are not
in a position to rely entirely on commercial banks or other
lenders. These countries tend to be the developing countries
of greatest economic importance to the United States such as
Mexico, Brazil and Korea. The IBRD also lends significant
sums to very poor countries who cannot meet their development
needs fully from concessional resources such as IDA,
e.g. Egypt and India.
- 6 The IBRD is project-oriented.
It lends to governments
for specific development projects and activities, except
in very unusual circumstances. But it is not an implementing
agency, despite the fact that its loans are project specific.
It offers counselling and advice on what policies are
necessary for project effectiveness and how projects can
best be implemented. Actual project implementation must
be performed by the borrower. This permits the IBRD to
economize on its own personnel, and strengthens government
and other institutions in borrowing countries. The borrower
is deeply involved in the project from start to finish
so that the new facilities or programs will be adequately
managed after the last dollar of IBRD money is disbursed.
The Bank's first industrial forestry project is a good
illustration. It is a successful project that was carried
out in Zambia over an 8-year period. The goal of planting
16,000 hectares was met one year early despite a slow
start, 600 jobs were created instead of the estimated
400, conservation measures were taken, and economic and
financial rates of return are above the original estimates.
The demand from the mining sector is not growing as fast
as expected but, in combination with other government
programs, the project has stimulated interest in establishing
local forest industries. The Government succeeded in
- 7 implementing the project within its own framework and
as part of a well defined forestry program. The substantial
cost overrun due to inflation was covered by the government.
A follow-on Bank project has been approved to expand
plantings, increase logging and sawmilling capacity, and
conduct research on more efficient plantation management
techniques.
In FY 1978 IBRD lending reached $6.1 billion. As I
shall discuss momentarily, IBRD lending is increasingly
directed to sectors having the greatest impact on reaching
the poor. It also has an important role in the oil and
gas areas. But a great deal of IBRD lending is still
for critically important infrastructure such as roads
and railways, telecommunications facilities, hydroelectric
installations and so on, which require significant amounts
of foreign exchange.
B. IDA
IDA lends to the world's poorest countries on extremely
concessional terms. In FY 1978, 90 percent of all IDA credits
went to countries with per capita GNP lower than $280. These
credits are interest-free but with a service charge of 3/4
percent per year. The credits have 50 year maturities with
10 years graceIDA spends most of its money in the rural areas of
its borrowing countries because that is where the majority
- 8 of all the people, and of the poorest people, live.
As one
would expect, agriculture typically supplies over half of
the national income and local industry is built around its
production.
Increasing agricultural output will, therefore,
increase the supply of food and raw materials for the country
as a whole and will increase the income of the majority
of the poorest people.
There are many kinds of agricultural projects.
designed to increase production of a single crop.
Some are
Some are
designed to train farmers in all aspects of management.
Some
include building farm-to-market access roads and credit
programs; these are "integrated" projects.
Some are directed
toward research on crops and soils of particular regions.
New style rural development projects expand the integrated
project concept outward to include improvements in all aspects
of rural life.
In addition to increasing agricultural produc-
tion, they aim to create employment in a variety of activities,
improve health and education, expand transportation and
communication, and improve housing.
IDA estimates that its FY 78 agricultural projects will
result in an increase in production of agricultural goods
worth about $1,186 million and that about 6.6 million rural
families will benefit directly from training and new or expanded facilities.
Most of these families are in the
lowest income level.
In addition, about twice as many
families will benefit indirectly as a result of investments
- 9 in farm related research and facilities and in social
services. Increasing employment opportunities go hand in hand
with all of these activities.
Some examples of IDA projects can best illustrate the
approach and its impact.
In India, a series of projects involving research and
farm extension services aimed at small farms has increased
wheat yields by almost one ton per hectare to 2.0-2.3 tons
per hectare.
In Senegal farmers are being helped to increase livestock production through animal health and husbandry improvements. Another livestock project in Somalia includes building
market places, establishing feedlots, developing water supplies,
and constructing veterinary centers.
A more comprehensive agricultural project is underway
in the Yemen Arab Republic. Irrigation systems are being
constructed to control seasonal flooding. High-yielding seeds
have been made available to the farmers through improved
research and extension services. Farm credit has been
increased. Access roads have been built to ensure that
produce reaches the market, which in turn encourages the
farmer to grow more. IDA estimates that these improvements
will eventually help to double the area's output.
IDA reaches the poor through its agriculture and rural
development projects, but it has also increased its efforts
- 10 to help those living in the slums of the overcrowded cities.
Urban development programs support construction of low-income
housing and public facilities in new areas, as well as improvement
of existing slums and encouragement of small-scale and
cottage industries which provide employment.
For example, in El Salvador, IDA is helping to finance
a low-income housing project which will serve as a model
for the country. A local private organization is the executing
agency and is also providing capital. The project will
construct 7,000 dwellings and provide extension of electricity,
water, sewerage, education and community facilities.
Two sectors receiving increasing attention are education
and energy. Lending in energy other than power development
is a new activity that is part of the World Bank's overall
program to increase energy development in the LDCs, including
support for geologic surveys and exploratory drilling.
Education projects have been funded for many years but will
be expanded; they attempt to introduce classwork that
directly relates to the conditions and needs of the local
region and the country.
C_L
IFC
I have already outlined the role of the World Bank and
IDA in helping to meet the needs of the LDCs through loans
and concessional credits. The International Finance Corporation
complements the IBRD and IDA by identifying and developing
- 11 economic opportunities requiring a commercially oriented
approach.
IFC is a kind of investment bank with development
goals. It makes loans as well as equity investments in
LDC enterprises that will contribute to overall development
efforts. IFC also provides assistance to local firms and
government agencies on financial, legal and other technical
matters.
IFC's most important function, however, is its ability to play
a catalytic role in increasing the number of investors interested
in funding LDC enterprises. IFC never finances the entire
cost of a project. Instead it seeks to mobilize and supplement
private capital. Therefore it looks for projects that cannot
attract sufficient capital on reasonable terms from other source?.
Of the new investments approved during FY 78, the IFC provided
$338 million to projects whose overall cost was $1,872 million
— a ratio of less than 20 percent. The difference was made
up by other investors, mostly in the LDCs themselves.
As a result of the role of matching private capital
with development needs, the IFC has come to be an important,
neutral third party to negotiations between the private
sector and national governments. These negotiations are
often fraught with misunderstandings and distrust. Especially
in natural resource development sectors like mining and energy,
equity participation by IFC has been important in bringing
- 12 together capital and management to meet the appropriate investment opportunity.
IFC does not accept a government guarantee of repayment
but will not make an investment without the agreement of
the government of the country where the venture is located.
An investment is undertaken only when IFC is assured
of repatriation of its payments and earnings on its money.
The IFC now invests in some government owned enterprises since
in many LDCs the private sector is still very limited and
the highest priority projects may be in the public sector.
While the Corporation does not take active part in management
even when it has made an equity investment, -it does review an
enterprise's activities through field visits and consultations
with management as well as by regular monitoring of reports.
IFC's operations have been very successful.
The write-
off rate is very low and would be a good showing for any
venture capital enterprise, but is outstanding when one
considers the difficulties involved in many of the poor
countries where management skills are scarce and physical and
capital infrastructure are inadequate.
IFC chooses its invest-
ments with great care and then helps them to succeed through
effective technical assistance and policy advice as necessary.
But if IFC took no losses, it would not be doing its job.
Thus the World Bank is much more than a bank —
it is
a well-rounded, broadly-based development institution capable
- 13 of providing a wide range of services to its members.
It
is fundamental to world development efforts.
IV. The Need for Funds
A^ IBRD
The IBRD's loanable funds derive primarily from bond
sales on world financial markets, paid-in capital from
member governments, loan repayments, and retained earnings.
Bond sales are overwhelmingly the most important.
By the mid-1970s it was evident that the IBRD would
require a capital increase in order to expand its borrowing
and hence lending power. Without a capital increase, it
was clear that the IBRD would hit its statutory lending
limit by 1982 — to avoid the disruption of an abrupt drop
in lending at that time, lending would have had to level
off starting in 1977 or 1978.
In 1976, the United States and other members concluded
negotiations for a Selective Capital Increase (SCI) of $8.3
billion. Of this sum, 90 percent or $7.5 billion is
callable or guarantee capital. The paid-in portion is
about $830 million.
The SCI had two purposes: 1) to provide a
small amount of capital to the IBRD pending agreement on a
General Capital Increase, and 2) to adjust relative country
shares to parallel changes in the IMF and thereby better
spread the burden of providing financial resources to
the Bank. The issue of relative country shares is an
- 14 important one, and I shall return to it presently. The
negotiated U.S. share was only 19 percent, compared with
a cumulative U.S. share of 25 percent before the SCI was
negotiated. When the SCI is concluded, the U.S. capital
share of the IBRD will be 23 percent and U.S. voting power
will decline to 21 percent. This decrease in the U.S.
share is consistent with the U.S. desire for other members
to expand burdensharing but, the United States will then
have only a narrow margin of safety protecting its effective
veto over charter amendments and Board expansion.
The U.S. share of $1,569 million ($157 million paid-in
and $1,412 million callable or guarantee capital) was to
be subscribed in three equal installments. Unfortunately the
United States fell behind on the first installment and
even further behind on the second. These unfunded past
pledges account for the apparent gap between last year's
appropriation and this year's request. Only $523 million —
about half of the present request — is before you for the
first time this year.
The leverage provided by this capital increase is
enormous. In the SCI now before you, each dollar paid-in
by the United States is matched by four dollars from other donors
and 45 dollars borrowed in capital markets — each U.S. taxpayer's
dollar paid into the SCI supports 50 dollars of IBRD lending.
fact, over its entire history, the IBRD has made more than
In
- 15 $45 billion worth of loans but U.S. taxpayers have paid-in only
about $820 million, a ratio of over 50 to 1. This leverage makes
the IBRD an excellent investment in world development for the
U.S. taxpayer.
B. IDA
IDA IV dates from 1973. Despite the critical needs
of the world's poorest countries, member governments had
permitted IDA's resources at that time to dwindle to the
point that lending had to be trimmed. In 1974, IDA lending
dropped nearly twenty percent in nominal terms. IDA IV
permitted a resumption of lending growth and has been
a vital factor in helping the poorest LDCs adjust to the
1974 oil price increases and ensuing world recession.
The last commitments from IDA IV were made in mid-1977.
IDA V, agreed in 1977, provided IDA with continued real
lending growth. The last commitment from IDA V will come
in 1980.
There is great need to fully appropriate both the full
$292 million for IDA IV and the full $800 million for IDA V.
In the case of IDA IV, appropriating the requested funds would
end a continuing U.S. default on a legally binding international obligation. The commitment undertaken by the previous
Administration to contribute $1.5 billion to IDA IV was not
conditioned on obtaining the necessary appropriations. Other
IDA donors made their unqualified commitments in full reliance
that the U.S. commitment was also unqualified. It was based
- 16 on this understanding that IDA IV became effective in
January of 1975 when the United States agreed to make its
contribution.
Loan commitments have already been made
and the U.S. is the only government in arrears.
The U.S.
doesn't make unqualified commitments like this any
longer, but we must make good on pledges that were made in
this way.
In the case of IDA V, the entire lending program would halt
if the U.S. payment of $800 million is not made.
We agreed
to this condition in IDA V in order to assure the other donors
that equitable burdensharing of the replenishment would be
maintained, despite our —
at that time, new —
policy of making
all U.S. pledges to the banks, "subject to appropriation."
Therefore, failure to provide our share of the last installment
of $800 million would stop the lending program of the
largest concessional loan institution in the world.
This
would seriously hurt the less developed countries as it would
also hurt us badly in the eyes of the rest of the world.
C.
IFC
The IFC replenishment, which became effective in
November 1977, is the first since the original capitalization of the Corporation in 1956.
It will enable the
Corporation to undertake a greater variety of projects
and to establish a presence in a greater number of countries,
including many of the poorest LDCs.
- 17 The entire U.S. subscription to the replenishment is
$111.5 million out of a total of $469 million allocated to
members for subscription.
As a result of the replenishment,
the U.S. share in the IFC has declined from 32 percent
to about 25 percent.
This year's request, $33.4 million, will complete our
share of the current replenishment.
V.
Policy Concerns
A.
Reaching the Poor.
1.
IBRD and IDA
It became increasingly apparent in the 1960s that rapid
overall growth in the LDCs could bypass their poorest
people unless a special effort was made to reach directly
those in
absolute poverty.
Many Americans have little idea
what absolute poverty means!
It means that one will probably not live longer
than age forty-five.
It means that one will probably suffer from
malnutrition or some untreatable disease most
of those forty-five years because there is often
only one doctor per 20,000 people.
It means that one will probably not have safe
or adequate drinking water or a clean place to
bathe.
It means that one will probably never learn to
read or write.
- 18 That is what absolute poverty means to the individual
human being. What it means to the country is that the country's
greatest resource — its population — is wasted by disease
and ignorance.
Starting in about 1972 the IBRD and IDA began to dramatically alter the nature of their lending. Activities were
designed to reach directly the poorest and to insure that
the poorest were not systematically excluded from the
benefits of more traditional projects. In FY 1978, over
45 percent of IBRD lending went for agriculture and rural
development, education, population and nutrition, urban
development, and water supply and sewerage, compared with
only 16 percent for those same sectors in FY 1972.
The change in IDA has been just as dramatic. In 1972,
40 percent of IDA credits were in agriculture, education,
population and health, urbanization, and water supply and
sewerage. By FY 1978 the fraction was around 65 percent.
The Congressional Research Service study which this
Committee released last year was very clear on this point:
"...one is struck by the shift that has taken
place in sectoral allocations between fiscal
year 1972 and fiscal year 1977." (page 73)
The change in emphasis by sector has been accompanied
by increasing emphasis within sectors on reaching the poor.
To quote the CRS study once more:
"There has obviously been a shift in intended
beneficiaries of projects in the agriculture, urban,
and education sectors ... there is also an obvious
- 19 poverty focus in the Bank's urban development projects ... Education projects were also being directed
toward the poor ... Population and water projects
were also being designed so as to directly benefit
poor people." (page 89)
The U.S. Government strongly influenced this change
in direction, and the Congress played a major part in so doing.
The U.S. was able to attract wide support within the Bank and
among member countries for the reaching-the-poor thrust,
and the progress made is inarguable. The impact of this shift
on benefits reaching the poorest appears to be substantial,
although it is too early to measure results in detail.
2. IFC
The U.S. spearheaded the action to increase the
Corporation's capital from $110 million to $650 million,
to enable the IFC to greatly expand the geographical
distribution of its activity and to reorient it more
toward meeting the needs of the poorest countries
and the poorest peoples.
The IFC Five Year Program for FY 79-83 accordingly has
the following major objectives:
a more than doubling of its investment level
and expansion to a greater number of countries.
greater involvement in the least developed
countries.
a greater variety of co-financing arrangements
in order to increase its catalytic effect and
- 20 to maintain the one to four historical ratio of
IFC investments to other investment resources.
—
an increase in the level of its equity financing,
particularly in the poorer countries where it is
very difficult for ventures to raise equity money.
—
investment in a greater number of sectors, with
more emphasis on development of natural resources
and the support of commercial agriculture and
service sectors.
—
expansion of its financial markets development
program with special attention to finding new
ways to fill the financial needs of small and
medium scale enterprises.
strengthening of its ongoing promotional and
project related technical assistance programs
including non-project related policy assistance
to improve the environment for private enterprise.
B.
U.S. Infuence
It is no easy task to maintain U.S. influence in the
MDBs while simultaneously reducing the U.S. share in these
institutions, particularly while we have fallen so far
behind in making our payments on these reduced obligations.
Nevertheless, U.S. influence so far remains strong.
Let me give just two examples of how World Bank Group
activities are helpful to U.S. interests just as they are
for the interests of most countries.
Last week President
- 21 -
Sadat and Prime Minister Begin met here in Washington
for what must be one of the most historic moments in this
generation — the signing of the Egypt/Israel Peace Treaty.
As a result of this accord, the capacity of poor countries
in the entire region to make good use of development resources
will increase. The United States will respond with large
bilateral flows of various kinds. Peace will also make it
possible for the World Bank Group to expand its activities
in the region.
Another example is how the World Bank is trying to
stimulate increased energy production in the world. The
1974 oil price jump and subsequent increases gave rise
to re-evaluation of the world energy situation. It was
clear that, at the new higher prices, many countries might
be able to produce oil economically which had not been
able to do so at lower prices.
If this oil (and other energy sources as well, such
as coal and hydro) could be exploited, it would bring
world supply in better balance with world demand to the
advantage of all countries.
The United States and other countries saw a role for
the World Bank in expanding energy exploitation in the
non-OPEC LDCs, and discussed the possibilities with other
donors at the London Summit and CIEC Ministerial in 1977.
In July 1977, the World Bank Board approved a lending
- 22 program of $400-$450 million in fuel minerals for FY 1980.
The United States then joined with other major donors
at the Bonn Summit (1978) in asking the Bank to re-evaluate
its energy prospects.
As a result, the Board approved an
expanded program to accelerate petroleum production in
developing countries.
The Bank is now aiming for an FY 1983
energy lending level of $1.5 billion which will make it a
major catalyst for expanding LDC energy production.
C.
Salaries
A major issue that has been of concern to both the
Congress and the Administration is that of salaries, benefits,
and administrative costs within the multilateral development
banks.
Of these issues, the predominant one has been staff
salaries.
With the strong support of the United States, the
management of the World Bank and the IMF formed a Joint
Committee of Executive Directors on Compensation Issues.
This
Committee was given responsibility to study the compensation
situation of all IMF/IBRD employees and to make appropriate
recommendations to the Executive Boards of the two institutions.
The Committee met on numerous occasions through 1977 and 1978,
employed professional compensation firms to obtain necessary
data for comparative purposes and finished its work in
late December.
Its final report has been printed, and copies
were sent to the Congress on February first.
- 23 This report and its recommendations provide the framework
for an objective determination of salaries based on public
and private salary levels in member countries.
It advances three basic recommendations:
—salaries in the main professional grades will be
determined as the average of those in the U.S. private sector
and the U.S. Civil Service, plus a premium of ten percent.
This premium is necessary to adjust for regional differences
of pay within the United States and to make the salaries
competitive on an international as well as an East Coast
basis. Data from the U.S. private sector were used because
the costs involved are U.S. costs and the necessary data
were available.
—salaries in the management levels will be determined
by setting a moderate differential for each successive grade
over the preceding grade, to arrive at a rational management
structure.
—tax reimbursement paid American staff will be
calculated from the net salaries, using the average deduction
for that income level, rather than the standard deduction
as heretofore.
The net effect of these recommendations would be to
bring Bank and Fund salaries into line with comparable
public and private sector salaries, as directed in Section
704 of Public Law 95-118. We are cooperating with other
countries to complete this work.
- 24 D.
Accountability
This topic was discussed at length during last week's
oversight hearings.
Here I would only add that every IBRD
and IDA project is reviewed a year or so after the loan
has been completely disbursed.
and economic —
ones.
All the benefits —
social
are re-estimated and compared with the projected
Projects are reviewed first by the staff who shepherd
the project through its implementation, and then by the
Operations Evaluation Department.
The final reports are
circulated through the Bank and to the Executive Directors
and used as the basis for revisions in project design and
implementation methods.
Experience with past projects are leading the staff
to place greater emphasis on analysis of broad sectoral
policies and of socio-economic aspects of the local areas
where the projects are to have their impact.
Borrower
governments are being brought into the full process of planning,
monitoring and evaluation to a much greater extent than
before to ensure full understanding and cooperation by them.
Training and institution building have become much more
important goals in recent projects.
This is especially true
of the new style projects which attempt to bring social
and economic benefits directly to the very poor.
One hundred nine projects were covered in the last
review.
They accounted for loans and credits of $2.2 billion.
Ninety percent of the projects were proving themselves worth-
- 25 while and more than half showed economic re-estimates that
were equal to or better than what had originally been estimated.
Congress played a major role in enhancing the independence
and quality of the Operations Evaluations system, since it
was partly as a result of legislation that the Department
was created as an independent unit that reports directly
to the Board of Directors.
Now that it is beginning a major expansion, IFC is
setting up an evaluation system similar to the
Operations Evaluation Department of the IBRD and IDA. It
will produce project completion reports on a country or
sector basis to gain insights into the problems and successes
peculiar to certain types of projects or countries. The
first reports are expected to be given to the Executive
Directors for review during this year.
E. Capital Saving Technology
The World Bank tries to make maximum use of local talent,
material and technologies in its projects. Where available
technology is not appropriate for the task, a new or different
technology is developed or applied to local conditions.
Several of the rural development projects in particular have
funds to support research in new technologies and to find
existing technologies that would apply to local projects.
For example, a project in Sri Lanka developed a method
of pumping water from existing canals to irrigate 2,600
hectares of land in the island's dry area. Farmers could
- 26 then enlarge their small plots by more than 60 percent.
This
enabled them not only to grow more crops but to grow a variety
of crops which would increase their surplus.
Another example of IDA'S support of capital saving
technology is an education project in Guyana which established a program to study use of local materials for
construction.
All of the agricultural and rural development projects
that are aimed at increasing the small farmer's production
are capital saving technology projects.
The farmers are
not given sophisticated tractors, sprinklers and other equipment.
Instead they are trained in how to use more efficiently
what they have.
Western technology is applied when
appropriate, for such purposes as increasing the availability of
water, eradicating the diseases which affect the people
and the animals, and providing better seeds.
Pilot projects
are used to demonstrate what can be done on the land with more
water, healthy animals and better seeds, and the farmers are
then taught how to improve their own production.
IFC too selects its investment projects on the basis of its
potential contribution to the development needs of the country.
Therefore, it supports ventures that encourage the use of local
labor, materials and technologies.
Mr. Chairman, I believe that you are to be personally
congratulated on the role you have played in increasing
- 27 sensitivities to capital saving technologies both in aid
organizations and in developing countries throughout the world.
F.
IBRD Veto
The IBRD charter provides that charter amendments
and expansion of the number of seats on the Board of
Directors must pass by 80 percent of the vote.
Because
the United States has always had more than 20 percent of
the vote, it has power of veto.
The United States has never
had to use this muscle, but simply having it available has
been an important element in U.S. influence.
At the outset of this statement, I alluded to the problem
of relative country shares.
While the United States has fallen
behind in subscribing to only a fraction of the capital we
agreed to take, other nations are seeking larger shares.
In the past month, fourteen countries have requested
special capital increases in the IBRD above and beyond
amounts agreed in the SCI.
Eleven countries asked for
subscription increases costing $254 million to parallel
their increases in the IMF resulting from the Seventh
Quota negotiations.
Yugoslavia complained that it had
not been able to take up as much capital as it would have
been permitted when it joined the IBRD, and now wished to correct
this old shortage with a special increase of $91 million.
Japan asked for and received increased shares worth $483
million in order to reflect its increased importance in the
- 28 world economy and the strength of its support for the entire
World Bank Group. $229 million of additional capital has
been made available for France so that it may maintain parity
with Germany and Japan. The increases I have discussed so
far total $1,057 million beyond the SCI. Our appropriations
request is for $1,026 million within the SCI.
Eight other countries have also requested special
increases, but too few unallocated shares remain. Any other
special capital increases must be deferred to a future time.
With or without these special increases, the U.S. veto
would be in jeopardy if the United States subscribes no more
shares. Moreover it would not be prudent to merely assure
ourselves of 20.01 percent of the vote — we must leave
at least a small cushion of safety against future developments.
VII. Summary
I would like to conclude by re-emphasizing the commitment
to the less developed countries which this Administration is
carrying on from past Administrations. An improved standard
of living for the peoples of these countries will contribute
to the overall growth and stability of our international systems.
The World Bank Group with its three pronged approach is the primary
international institution for achieving this. It is therefore in
the U.S. interest that the Group be able to maintain its leadership role in channeling money from the developed to the developing
countries, guiding LDC governments in rational policy making and
conducting valuable research in economic development problems.
- 29 Through the Group, the U.S. can share responsibility
in the financing of development work and in exerting influence
on LDC government policy.
We hope that this request for $2,151.2 million will
receive your careful, serious attention both in terms of the
needs of the LDCs and the importance of the Bank Group as a
means to meeting these needs.
o P O 938 763
EXECUTIVE OFFICE O F T H E PRESIDENT
C O U N C I L O N W A G E A N D PRICE STABILITY
W A S H I N G T O N , D.C. 20506
OFFICIAL BUSINESS
P E N A L T Y F O R PRIVATE USE $300
R E T U R N THIS SHEET TO COUNCIL O N W A G E
A N D PRICE STABILITY, OFFICE O F INFORMATION, 726 JACKSON PLACE, N.W., R O O M 4013,
W A S H I N G T O N , D.C. 20506, IF Y O U D O N O T WISH
T O RECEIVE THIS M A T E R I A L Q . O R IF C H A N G E
O F A D D R E S S IS N E E D E D Q (INDICATE C H A N G E ,
INCLUDING STOP N U M B E R O R ZIP C O D E AS APPROPRIATE).
FIRST CLASS
FOR IMMEDIATE RELEASE
EXPECTED AT 2:00 P.M. EST
TUESDAY, APRIL 3, 1979
STATEMENT OF THE HONORABLE C. FRED BERGSTEN
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS
OF THE
COMMITTEE ON APPROPRIATIONS
HOUSE OF REPRESENTATIVES
African Development Fund
Mr. Chairman, I would like to turn now to our
appropriations request for the African Development Fund.
For FY 1980 we are seeking $41.7 million as the
first of three installments of a $125 million U.S.
contribution to the second replenishment of the Fund,
which will cover AFDF lending in the calendar year
1979-81 period. The U.S. share of the $713.5 million
total pledged to the second replenishment is 17.5 percent
— well below the level of our contributions to the
soft loan windows of the other development banks.
The Administration's appropriation request for the
African Development Fund for FY 1980 reflects the growing
importance of Africa to the United States:
B-1506
- 2 —
The United States has a strong humanitarian
interest in aiding the 400 million people who live in
Africa.
Africa lags far behind other developing regions,
let alone the developed world, on almost all indicators
of development.
Not only do many countries have per
capita incomes below $280; they also have growth rates
well below those of developing countries in other regions
of the world.
—
The United States also has increasingly important
economic interests in Africa.
U.S. investment in Africa has
more than quadrupled since 1965.
During the past decade,
U.S. exports to Africa have grown from $1 billion to
over $5 billion, and this trend will continue as incomes
and consumer demand increase in the future.
U.S.
imports from Africa also are increasing rapidly and
include many important raw materials.
In recent
years, almost 70 percent of our manganese ore and cobalt
imports have come from Africa, and Nigeria is now the
second largest source of U.S. oil imports.
—
Finally, Africa is of growing political interest
to the United States.
Recent developments in the horn
of Africa and in southern Africa have underscored the
need to strengthen our ties with African nations.
The African Development Fund and the FY 1980
Appropriations Request
The African Development Fund (AFDF) was established
- 3 in 1973 as the concessional loan affiliate of the African
Development Bank. The Bank itself was founded on September
24, 1964, with the governments of twenty-two independent
African states as members, to promote investment of
public and private capital in Africa. It had initial
capital resources of $300 million and a staff of 45.
During its fifteen years of operations, the authorized
capital stock of the Bank has increased to $960 million,
its membership to 48 African nations and its staff to
well over 400 persons.
Over the years, the African Development Bank has
made a considerable effort to increase its effectiveness,
and that of the Fund, through cooperation with other international organizations and bilateral agencies. The African
Bank and Fund have frequently cooperated with the World Bank
in the development and financing of projects and programs.
Other organizations with which the AFDB has worked closely
include the United Nations Development Program, the
World Health Organization and the Food and Agriculture
Organization.
I would like to briefly mention at this point
that, after fifteen years during which the membership
in the African Development Bank has been restricted
to African countries, negotiations are now underway on
the membership of the United States and other non-African
countries in the Bank. We will be consulting with the
- 4 -
Congress later on the details of participation in the
Bank, looking toward the submission of legislation next
year.
We are now envisaging a U.S. capital subscription
on the order of $360 to $400 million (of which seventy-five
percent would represent callable capital) to be contributed
over a five-year period beginning perhaps in FY 1981.
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.
About 75 percent of the
African population is engaged in subsistence agriculture.
Africa's average per capita GNP in 1975 was only $390
and over a third of the continent's nations have a per
capita GNP of $200 or less.
In few African countries
do the numbers of individuals in absolute poverty number
less than one-third of the population.
in Africa average 43 years —
Life expectancies
almost 10 years less than
in other developing countries and 30 years less than in
the U.S.
Because of the serious problems facing Africa,
many African countries need concessional aid in
addition to the loans of the Bank offered at marketrelated interest rates.
To meet the need of many countries
for softer lending terms, the Bank decided to establish
a source of concessional funds.
- 5 The Bank undertook discussions with developed
countries to establish a concessional facility associated
with the Bank in 1966. After six years of negotiations,
and with U.S. assistance in drafting the Charter, the
African Development Fund was inaugurated in July 1973.
Members of the Fund currently include the Bank itself —
representing all of its member countries — the United
States, Canada, Brazil, Japan, Kuwait, Saudia Arabia,
and thirteen European donors.
The Fund's total initial resources, consisting of
contributions by fourteen non-African donor countries
and the African Development Bank, amounted to $89
million. Adding subsequent subscriptions received by
acceding countries and resources from two replenishments, total ratified contributions to the Fund amounted
to $463.3 million as of September 30, 1978.
Congress authorized U.S. membership in the
AFDF in May 1976 with a contribution of $25 million.
It appropriated $5 million of this amount in the FY
1976 Foreign Assistance Appropriations Act and $10 million
in the FY 1977 Act. Thus the United States joined the Fund
on November 18, 1976 with a $15 million contribution.
The remaining $10 million authorized by the Congress
- 6 -
in May 1976 was appropriated in the FY 1978 Appropriations
Act.
This $10 million contribution raised the U.S. share
of Fund resources to somewhat under 6 percent, tying the
United States with Norway as the sixth largest donor.
A U.S. contribution to the first general replenishment
of the Fund was authorized by the Congress in October,
1977 and $25 million was appropriated in the FY 1979
Appropriations Act.
As a result of this contribution,
the United States has now become the third largest donor
in the Fund with 9 percent of AFDF resources behind
Japan (17 percent) and Canada (14 percent).
Fund lending has increased from $47 million in 1974
to over $172 million in 1978.
Since its establishment
the Fund has made 111 loans totaling $533 million in
31 countries.
On a cumulative basis, agriculture
accounts for 33 percent of all loans, transportation—
30 percent, public utilities—18 percent and health and
education—19 percent.
Since the African Development Fund, at its present
lending rate, would exhaust its commitment authority
by the end of 1978, discussions of a second general
replenishment of the Fund to finance its 1979-81 lending
program began in December, 1977 and were completed in
May 1978.
- 7 -
Donors have agreed to a $780 million target for the
replenishment to which $713.5 million has been pledged
to date.
The Administration's $41.7 million appropriations
request for FY 1980 represents the first of three installments of a $125 million U.S. contribution to the second
replenishment for which authorizing legislation has
been submitted to Congress.
The proposed $125 million
contribution is 17.5 percent of total resources pledged to
the second replenishment —
a substantial increase in
our contributions to the Fund, but well below our share
in the soft loan windows of the other development banks.
Moreover, on a cumulative basis, the U.S. will remain
considerably below Japan which will continue to be
the largest donor in the Fund.
This contribution reflects
both the increased priority placed on Africa in U.S.
foreign policy and the Administration's commitment
to equitable burdensharing among donors.
Appropriation of the full $41.7 million requested for
the African Development Fund for FY 1980 is particularly
important because the contributions of other donors are
linked to that of the United States.
Appropriation of
our first installment to the second AFDF replenishment is
needed to trigger the full amount of the second installment
- 8 -
of other donors.
Any reduction in the FY 1980 appropria-
tions request could lead to a proportional reduction in the
contributions of other donors, thereby reducing the Fund's
ability to contribute effectively to Africa's
development.
Key Policy Issues
Mr. Chairman, I would now like to turn to
several key policy issues of interest to the Congress
concerning the activities of the African Development Fund.
Reaching the Poor
The U.S representative to the African Development
Fund participated in a working group of the Board of
Directors which drafted new lending guidelines for the
Fund during the second replenishment period.
These
guidelines will serve to intensify the AFDF's efforts
to focus on the poorest countries and poorest peoples.
With respect to the countries which will be
eligible for AFDF loans, it was agreed that, except
under the most unusual circumstances, loans will not be
given to countries with a 1976 per capita GNP above
$580.
Moreover, in recognition of the fact that
scarce concessional resources should be allocated to
those countries most in need, it was agreed that not
- 9 less than 80 percent of the Fund's resources will be
targeted to countries with a 1976 per capita income
of $280 or less during the second replenishment.
In terms of the types of projects which the Fund
will finance, preference will be given to projects which
directly help meet basic human needs and increase the
productivity of poor people. These include:
—
integrated rural development projects;
—
projects aimed at meeting basic food
requirements which include such elements
as production, storage, marketing, distribution
and transportation;
—
projects aimed at the effective utilization of
human resources by deploying them to meet the
real needs of a region, including projects
focused on training at a basic level In areas
like agriculture and cottage industry;
—
projects aimed at basic health requirements
including health services, infrastructure and
training;
—
projects aimed at developing institutions
such as co-operatives, agricultural banks,
and rural financing funds.
The nature of the Fund's efforts to reach the
poor can best be shown, however, by a concrete example
- 10 -
of its activities. A representative African Development
Fund project is a $7.8 million loan to finance a rural
primary health care project in Sudan.
Sudan suffers from a severe lack of proper health
care services.
It has a high infant mortality rate
and limited number of physicians to meet the needs of
its 16 million people.
average 49 years —
Life expectancies in the Sudan
compared to 72 years in industrialized
countries.
Sudan's Primary Health Care Program, a priority
element in the National Health Plan, is designed to
bring health services, suitably integrated with other
community services, to rural populations who do not
presently have access to health care.
The aim is to
make available simple medical care and health prevention
and promotion activities such as safe water, human waste
disposal, adequate nutrition, and immunizations.
Major
endemic diseases (malaria, schistosomiasis, tuberculosis
and leprosy) which afflict rural residents will also
be brought under control through the network of primary
health care services to be created under this project.
Health education in rural communities, carried out
through close and frequent contact by the health
workers, is expected to produce important attitudinal
- 11 -
changes towards disease and health and encourage villagers
to adopt better hygiene, cooking and eating habits.
Children and adults, once freed from poor nutrition and
disabling and debilitating endemic diseases, should
materially improve, qualitatively and quantitatively, the
manpower resources needed for the socio-economic development
of Sudan.
The African Development Fund loan will assist
Sudan's effort to improve health care by building
the dispensaries needed to reach the poor, and by
financing necessary equipment and vehicles. The project
will provide all of the dispensaries needed in the three
provinces of the Blue Nile and North and South Darfur,
and almost half of the dispensaries needed in the White
Nile Province.
It is thus designed to bring primary health
care to 28 percent of Sudan's population.
Capital Saving Technology
The Agreement establishing the African Development
Fund requires the institution to ensure that its lending
operations make the most effective contributions to the
economic and social advancement of its member countries.
In this connection, the management ensures that the techniques used in the formulation and implementation of projects
are appropriate to the development needs and local conditions
- 12 -
of the member countries.
Most African countries are
characterized by a relative scarcity of investment capital
and abundance of unskilled labor. The management of
the Fund, therefore, as a matter of policy, views the
choice of technologies which involve the use of small-scale
labor intensive processes, and equipment and tools
which are less complex and costly than those usually
used in the developed world, as most desirable.
In the two-and-a-half years that the United
States has been a member of the African Development
Fund, the United States has intervened in meetings of
the Board of Directors, consulted with Fund management
and staff and urged other member countries at annual
meetings to promote the concept of the appropriate use
and application of capital saving technology through
Fund activities.
The U.S. representative to the Fund
has actively contributed to increasing the flow of
information on capital saving technology and the policies
and publications on the subject from the other development
institutions.
An excellent example of a project designed to increase
agricultural productivity on a wide scale through the use
of capital saving technology is found in the Somalia
Agricultural and Farm Management project.
The total
- 13 cost of the project is $22 million, of which $8.8
million will be financed by an AFDF loan. The project
will develop a functioning and dynamic extension service
through the establishment of several training centers,
demonstration farms, fellowships abroad, expatriate
technical assistance, research capabilities, and management
support.
The revitalized extension service will concentrate
on the introduction of basic methods and technologies.
Changes introduced will be simple without involving
any initial increases in cash expenditure by the farmer.
Moisture conservation, row planting, increased and
homogeneous plant population will be stressed.
Farmers will be progressively introduced to seed dressing,
plant protection, alternative cropping systems and animal
traction.
Introduction of animal traction will bring
the average size of cropped holdings from five to seven
hectares.
As yields rise, producing a marketable surplus,
purchased inputs such as insecticides, improved seeds,
and, where applicable, fertilizers will be introduced.
On the average rainfed farm of 5 hectares income will
increase from the present $242 to $341 with extension as the
only additional input; to $389 with the introduction of animal
traction; and to $576 with the introduction of marketed
inputs.
These benefits will be realized by 180 thousand
farm families at an average project cost of $122 per family.
- 14 Evaluation/Auditing at the African Development Fund
At the May, 1978 annual meeting of the African
Development Fund, the U.S. representative stressed
the importance of strengthening the Fund's evaluation
and auditing of projects.
Since that time, the
Fund has taken steps to improve the quality of its
evaluation and auditing functions.
Since August, 1978
a Price Waterhouse consultant has been working with
Fund management to establish an internal auditing unit
within the Fund's organizational structure. We are encouraged
by these initiatives and we will continue to emphasize the
vital role which strong evaluation and auditing procedures
have to play in improving the effectiveness and efficiency
of Fund operations.
We fully recognize that development
is a learning experience, in which insights gained from
earlier projects can lead to improvements in the design
of future programs.
Conclusions
Mr. Chairman, we have strong humanitarian, political
and economic interests in Africa which require us to
strengthen our relationships with African countries.
U.S. participation in the African Development Fund is an
important way of strengthening these ties by demonstrating
- 15 our willingness to join with African nations in
an African institution to further their development.
I therefore strongly recommend appropriation of
the $41.7 million requested for the African Development
Fund for FY 1980.
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TUESDAY APRIL 3, 1979
STATEMENT OF THE HONORABLE C. FRED BERGSTEN
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS
OF THE
COMMITTEE ON APPROPRIATIONS
HOUSE OF REPRESENTATIVES
Inter-American Development Bank
Mr. Chairman, I am pleased to testify on the request
for funding of U.S. participation in the Inter-American
Development Bank. This year, we are making a new request
for $687.3 million for capital subscriptions and $175 million
for the Fund for Special Operations.
Of the $687.3 million capital, $51.5 million (7.5 percent)
will be paid-in and $635.8 million is for callable capital.
Both of these amounts represent the first of four years'
subscriptions and contributions which were agreed to in
the replenishment negotiations concluded late last year.
In addition, $150.3 million is needed to fund requests for
the Fund for Special Operations which have been authorized
but not approved in prior years. Appropriation of these
funds will enable the Bank to meet the needs of its members
and to continue its innovative approach to development in
the hemisphere.
B-1507
- 2 Importance of Latin America and the Caribbean to the U.S.
Latin America and the Caribbean have achieved significant
growth and economic transformation during the last fifteen
years.
This growth has enabled the region to assume a much
more significant role in the world economy.
Many of the
economic indicators demonstrate the area's progress —
economic
growth rates, GNP, international trade expansion and investment.
Some countries have achieved the status of advanced developing
countries with a vital and growing stake in the future of
the world economy; others have not shared fully in the region's
progress.
Economic growth rates in the region, after averaging
6.2 percent during the 1970-76 period, fell to 4.5 percent
in 1977 and an estimated 4.1 percent in 1978.
Real per capita
GNP has increased by more than half since 1965 to $1,100,
substantially higher than most of the developing areas of
the world.
The growing importance of the region to the U.S. is
demonstrated by the fact that since 1965 it has tripled
its exports to the U.S. to $25 billion in 1977, while the
region's imports of our products increased to almost $20
billion.
Latin America and the Caribbean provide 26 percent
of the petroleum, 23 percent of the iron ore, 88 percent
of the bauxite, 40 percent of the copper and 50 percent
of the sugar which we import.
The area also provides about
- 3 70 percent and 80 percent of our total supplies of coffee
and bananas respectively.
U.S. investment in the area has
more than doubled since 1960 and now exceeds $20 billion.
The character of this investment has changed during this period
away from mining and petroleum toward manufacturing, trading
and finance.
All these figures show that Latin America has
assumed an important place in the economic relationships of
the United States.
Prospects are that its economic relation-
ship with the United States and with the rest of the world
will continue to expand.
This visible progress helps to mask the fact that there
is much unfinished business before the region reaches maturity.
Per capita GNP is only one-sixth that of the United States.
Income distribution patterns remain unbalanced.
Urban problems
have grown with the inflow of people to the cities —
nearly
one of every four people live in cities of one million inhabitants
or more, compared with one-in-ten in 1950.
The region has
the fastest growing labor force in the world and must be
able to generate about 3 million jobs annually merely to
absorb the projected increase in the labor force.
Lending Activities and Resources
The year 1978 marked the close of the 1975-78 programming
cycle provided for in the IDB's fourth replenishment.
The
lending targets agreed to for that period, as well as the
sectoral distribution, were met —
with 21 percent of lending
- 4 going for agriculture, 20 percent for industry and mining,
28 percent for energy, 12 percent for transportation and
communications, 16 percent for social infrastructure and
3 percent destined to other sectors.
In 1978, the IDB approved a total of almost $1.9 billion
in new loans, raising the cumulative net lending as of December
31, 1978 to almost $14 billion.
This lending has been devoted
to financing projects with a total value of more than $57
billion, with the Latin American countries themselves providing
most of the additional resources.
Of the total amount loaned
by the Bank, over $7.1 billion has been from capital resources,
about $5.9 billion from the FSO and nearly a billion dollars
from other funds which the Bank administers, including the
Social Progress Trust Fund and the Venezuelan Trust Fund.
The Bank meets the needs of its members principally from
its capital window, which lends on near-market terms, and from
its soft window (the FSO) which lends on concessional terms.
In addition, the Bank administers a variety of special funds.
In recent years, it has performed an important intermediary
role in attracting and associating private lending with its
own to channel greater amounts of funds to its borrowers.
Lending through the capital window is financed primarily
from the proceeds of borrowings in the international capital
markets and the paid-in capital subscriptions of the Bank's
- 5 members.
The borrowings are backed by members' callable
capital subscriptions which have never resulted in budgetary
outlays, and are virtually certain never to be needed to
meet Bank obligations to bondholders.
Therefore only the
paid-in amount of $51.5 million in the FY 1980 capital request
truly represents a budgetary obligation.
Complementary financing is a means of mobilizing private
capital for development by associating it with IDB lending.
It requires no appropriations from member governments or
use of the IDB's own funds since the funds are all provided
by private lenders.
These loans complement Bank loans and
help borrowers by assisting countries to enter directly the
international credit system.
The Bank was able to mobilize
$133 million for its borrowers through this mechanism in 1978.
FSO loans are extended entirely from resources contributed by the members of the Bank.
The FSO enables
the Bank to provide concessional resources to its podrest
member countries and for projects which benefit low income
groups.
The IDB also serves as administrator for thirteen
special funds totaling nearly $1.2 billion, which are
provided by both member and non-member countries.
Of these,
the two largest are the $525 million Social Progress Trust
Fund placed under the Bank's administration in 1961 by the
United States and the $500 million Venezuelan Trust Fund
established in 1975.
- 6 In 1978, the Bank began a new program which enables it
to provide financing to small projects and to individuals
in; "productive pursuits who have previously lacked access to
credit.
Non-profit intermediary institutions or associations
of producers channel the resources to sub-borrowers engaged
in small productive projects.
The Replenishment
The lending cycle covered by the previous replenishment
ended in 1978.
The Bank's convertible resources in both
capital and FSO available for lending are now nearly exhausted.
At the annual meeting of the Bank last April, negotiations to
replenish the Bank's resources and to chart the course of the
Bank for the next four years, 1979-1982, began.
The negotia-
tions, which were protracted and difficult, were finally
concluded last December when the Governors agreed to forward
the replenishment arrangements to the member governments
for approval.
In my view, the terms of the replenishment
represent a very significant and favorable shift in the
Bank's mobilization and use of resources for lending in
the region.
The replenishment is characterized by three important
advances —
increased devotion of lending to the poorest
countries in the Hemisphere and to poor people in all recipient
countries, increased burden-sharing by the non-regional and
advanced developing member countries, and a further shift
- 7 in emphasis from the concessional FSO to the capital resources
of the Bank.
The improved burden-sharing, and shift toward
greater emphasis on capital lending, markedly reduce-the
impact of the replenishment on the U.S. budget.
As a result,
the United States will provide 80 percent of its contribution
in the form of capital subscriptions as compared to 73
percent in the 1976 replenishment and to 45 percent in the
1970 replenishment.
Let me review briefly the progress we were able to
make in these three areas.
The increased emphasis on lending to the poor is
characterized by a number of changes, the cumulative effect
of which will be quite significant.
First, the replenishment
embodies the understanding that the Bank will further concentrate its concessional FSO resources on the poorest developing
countries of the region.
During 1979-1980, at least 75 percent
of the FSO convertible resources will go to the countries
which are the poorest in the region.
This share for the poorest
will rise to 80 percent during the last two years.
These
targets will continue to assure that these countries receive
the lion's share of FSO.
In 1973 these countries received
only 50 percent of the FSO convertible resources.
Furthermore,
all convertible FSO resources destined to countries other
than the poorest shall directly benefit low income groups.
- 8 Second, it has been agreed that the IDB will devote
one-half of total Bank lending over the replenishment period
to projects which provide benefits directly to low income groups.
The Board of Executive Directors is working hard to develop
an implementation plan to assure that this target is met.
We are working closely with the Bank and its other members to
ensure that the implementation plan developed is satisfactory
and will provide a concrete operative program to guide
the Bank.
Third, during prior replenishments five countries —
Argentina, Brazil, Mexico, Trinidad and Tobago and
Venezuela —
agreed to cease borrowing convertible cur-
rencies from the FSO.
For the 1979-82 period Chile and
Uruguay have agreed to join this group.
In addition, the
financing requirements of the Bahamas may be served by
requesting only the Bank's conventional resources, except
for small amounts of technical assistance.
This voluntary
withdrawal from FSO financing will permit its scarce
concessional resources to be concentrated even more on
the poorest countries.
Fourth, the replenishment will permit the growth
rate of the Bank's lending to increase in real terms in
1979-1982 but at a somewhat slower rate than in recent
years.
However, that growth will be concentrated in the
less developed countries of the region because annual
- 9 lending for the more developed borrowing countries (Argentina,
Brazil and Mexico) will remain constant over the period.
The total lending program for the other countries, from
both capital and concessional funds, will thus be permitted
to continue the real increases of the last few years
—
although FSO lending in convertible currency, taken by
itself, will decline from $556 million in 1978 to an average
of about $500 million in 1979-82 because fewer Latin American
countries now need its concessional terms.
As regards increased burden sharing, both non-regional
and regional members have agreed to carry a larger share
of the load.
The non-regional members will subscribe
11 percent of the IDB capital increase, almost two and
one-half times larger than their current aggregate share.
The non-regional members have also agreed to take a 30 percent
share of the FSO replenishment, maintaining their original
high level for that window.
All the borrowing member countries will pay two-thirds
of their paid-in subscriptions to the capital window in con—
vertible currency, whereas in the 1976-78 replenishment one-half
was convertible.
In addition, the more advanced countries
of Latin America (Argentina, Brazil and Mexico), in recognition
of their greater level of development, have agreed to enlarge
their support for the less developed countries of the region
by increasing the convertible proportion of their contributions
- 10 to the FSO from 25 percent in the 1976-78 replenishment
to the equivalent of 75 percent during 1979-82.
As in the
past, Venezuela and Trinidad and Tobago will make their
entire FSO contributions convertible.
These major changes in the IDB lending program and
burden-sharing arrangements will permit a reduction in
United States' paid-in and FSO contributions from $240 million
annually in the 1976-78 replenishment to $226.5 million
in the 1979-82 replenishment, while enabling the Bank to
continue to play its proper role in the development of
Latin America.
This is an absolute reduction of $13.5 million
from the annual obligations of the last replenishment, which
was negotiated in 1975.
The reduction in real terms is,
of course, much more substantial.
For both capital and
concessional funds, the actual budgetary outlays would as
always be spread over a number of years because drawdowns
are made only as needed to cover disbursements by the Bank
on the basis of an agreed schedule.
In the FSO, the United States will contribute $175
million per year, an absolute reduction of twelve and one-half
percent from the $200 million annual contribution which
the United States agreed to make under the previous
replenishment.
Only seven and one-half percent of the U.S. subscription to capital is to be paid-in, down from ten percent
- 11 under the current replenishment. This means that $635.8
million of our annual capital subscription of $687.3 million
will be in callable capital, requiring no actual outlays.
The amount paid in for each year's capital subscription
will be $51.5 million.
Overall replenishment levels amount to $1,750 million for
the FSO and slightly more than $8 billion for the increase
in authorized capital for the four-year period 1979-1982.
The U.S. shares are within the ceilings set by the Sense
of the Congress resolution included in the FY 1979 appropriations
act —
40 percent for the FSO and 34.5 percent for IDB capital.
We believe that the 1979-82 replenishment agreement
represents substantial progress in meeting United States
goals to increase lending to the poor, achieve more equitable
burden sharing and place greater emphasis on lending from the
capital windows which consequently reduces U.S. budget outlays.
This package is a prime example of the way in which we have
exercised great leverage in influencing the course of the
banks' development.
These changes will cause a significant
shift in activity and emphasis —
we believe for the better
—
within the IDB for many years to come.
Discussion of Bank Requests
As of December 31, 1978, the subscribed Ordinary Capital
of the Bank was $9.7 billion —
$1.2 billion of paid-in
capital and $8.5 billion of callable capital.
The initial
- 12 capital of $850 million in 1959 was successively expanded
in 1964, 1967, 1970 and 1976 to reach its present size.
To accommodate the entry of non-regionals in 1976,
a new series of capital stock, Inter-regional Capital, was
created.
Both regional and non-regional members may subscribe
to this stock.
Since this type of capital is free of the
restrictive covenant that applies to the Bank's Ordinary
Capital, which permits borrowing only against callable capital
of the United States, the IDB is now able to raise funds
in the private capital markets of the world backed by
callable capital subscribed by other members with strong
credit ratings.
As of December 31, 1978, subscriptions to
Inter-regional Capital stock totaled $1.9 billion consisting
of $242 million of paid-in capital and $1.7 billion of callable
capital.
The Fund for Special Operations was established
under the Bank's Charter for making loans "on terms and
conditions appropriate for dealing with special circumstances
arising in specific countries or with respect to specific
projects".
Most of these resources are loaned for the benefit
of poor people and poor countries of the region.
The amorti-
zation periods for loans from the Fund have usually been
longer, and the interest rates lower, than for loans from
the Bank's capital resources.
The Fund for Special Operations
was initially established with contributions of $146.3 million.
- 13 A series of subsequent contributions raised the value of
the FSO to $6.2 billion as of December 31, 1978.
The U.S. contribution we are requesting is required
to enable the Bank to restore its depleted resources and
complete its 1979 lending program, the first year covered
by the replenishment.
Available funds will not cover the
Bank's lending beyond the second quarter of this year.
Our request can be summarized as follow:
—
Total request —
$1,012.6 million of which $150.3
million for the FSO was previously requested but
unfunded.
The new money breaks down as:
-
$687.3 million for callable capital
-
$51.5 million for paid-in capital
-
$175 million for FSO
If the United States does not subscribe to capital,
other countries will be unable to subscribe because the
U.S. voting power is near the limit in the charter.
The
U.S. could waive its right to maintain its voting power
but the result would be a loss of our veto in the FSO,
and we do not intend to use the waiver.
Hence the practical
effect of a failure to appropriate the full amount of capital
requested would be to back out roughly $2 of other countries
subscriptions for every $1 we failed to subscribe.
I believe
that the Congress took this consideration very much into
- 14 account when it appropriated the full amount of IDB capital
requested by the Administration for FY 1979 and I hope that
it will do so again.
The FSO funds are urgently needed so that the poorest
countries will be able to moderate the cost of their increased
reliance on hard lending.
In addition under the terms of
the replenishment and to assure faithful implementation of
the agreed burden-sharing formula, other donors can reduce
their FSO contributions proportionately to any reduction
in ours.
A failure to appropriate the full amount could
thus have a multiple negative effect on the FSO lending
program.
Let me turn now to a review of some of the major concerns
of Congress and this Administration with regard to the Bank —
in particular reaching the poor, capital saving technology,
and salaries and administrative costs.
We have already had
an extensive discussion of the accountability issue during
last week's oversight hearing.
Reaching the Poor
I have already enumerated the principal elements agreed
to during the replenishment negotiations to make the Bank's
program more effective in assisting the poorest people in
Latin America.
These include agreement that 50 percent of the
Bank's total lending from its own resources be directed to
- 15 the benefit of low income groups, a further concentration
of concessional assistance on the poorest countries and
use of concessional assistance in other countries only if
it directly benefits low income groups.
The Bank's efforts to target increasingly large amounts
of IDB funds to the poor are continuing.
Treasury officials
and the U.S. Executive Director and Alternate traveled
extensively in the region in 1978 to inspect, first hand,
projects which are helping to improve the lot of the region's
poor people.
An interesting example of the Bank's innovative
efforts is the small project financing program established
in 1978 to provide credit to low income groups engaged
in productive activities.
In 1978, the IDB made a loan of $16.9 million to Ecuador
to help finance an integrated rural development program
in the Province of Zamora-Chinchipe in Ecuador designed
to benefit some 42,000 low income persons.
Ecuador is one
of the few developing countries in Latin America with sufficient
fertile land and appropriate climate to increase agricultural
production at reasonable cost.
The project area covers
some 509,000 acres in southeastern Ecuador.
The project
will provide credit to farmers, carry out a study to exploit
forests, give land property titles to farmers, establish
research and extension services, set up marketing services,
build local roads, provide support services, build schools
and provide basic sanitation facilities.
- 16 Also in 1978, the IDB made a $32.6 million loan to
finance a project to help improve the water system of La
Paz and the sewerage system of Cochabamba in Bolivia.
conditions in Bolivia are seriously deficient.
Sanitary
As a conse-
quence, the nation suffers a high incidence of water-borne
diseases and an infant mortality rate which is almost double
the average for Latin America as a whole.
About 40 percent of
the population of La Paz gets its water through public taps,
independent systems or tank cars.
This population includes
the city's poorest people who reside mostly in outlying
areas.
In Cochabamba only about 40 percent of the population
is served by a sanitary sewerage system and this system has
deteriorated badly.
Capital Saving Technology
In November 1976, the Inter-American Development Bank
adopted a policy to promote the use of light capital technology by making it a significant component of development
strategy.
The U.S. Executive Director has actively promoted,
in Board meetings and in more informal discussions, increased
attention to the use of capital saving technology in project
development and implementation.
These efforts have resulted
in the incorporation of capital saving technologies into a
number of projects.
In 1978 the Bank made a $35 million loan to Haiti for
storm drainage in Port-au-Prince.
This project will consist
- 17 of a series of subprojects which include: a) erosion control;
b) collection and disposal of solid wastes; c) cleaning,
repairing and realignment of the waste system and; d) expansion
of the
drainage system.
The execution of the project will
be characterized by appropriate labor intensive technology.
The works will be carried out through small labor contracts
under the direct supervision of an Executing Unit —
a
special group set up through the Ministry of Public Works,
Transporation and Communications.
The materials to be
used will be acquired by the Unit itself and will come,
as much as possible, from the project area.
These materials
include sand, gravel, stone, cement and reinforcing bar.
Most equipment will be elementary; some advanced equipment,
such as trucks, loaders and concrete will be used only
in certain activities which would be impossible or too
costly to do without.
As another example, the Bank made a $13.2 million loan to
El Salvador in 1978 for community development.
This project
will involve the construction of approximately 970 small
scale public works and the granting of credit to low income
persons in the northwestern region.
The public works will
include roads, schools, bridges, potable water, parks and
other services.
Their construction will be highly labor
intensive and primarily local material will be used.
The
earth movement will be completely manual and only picks,
- 18 shovels, and wheelbarrows will be used.
include:
Other elements
a) maximum use of stone in construction; b)
maximum use of arch bridges, which entail use of stone
and manpower; and c) maximum use of baked dry bricks,
manufactured by hand in small brickworks, and concrete
blocks made by hand at the worksite.
In the credit assistance
program, attention will be given to the provision of credit
for activities which take into account the abundant labor
resource.
Therefore, only machinery that can be manually
operated or very easily operated (knapsack pumps, manual
sprinklers, and animal-drawn plows) will be financed.
In addition, in order to increase productivity and employment,
and to reduce soil erosion, the provision of credit will
aim at reducing the area sown to annual crops.
Salaries and Administrative Costs
As in the other MDBs, salaries and administrative costs
in the IDB continue to be a major concern of this administration.
The IDB has formed a committee to study the future
levels of compensation appropriate to the institution and
action within the IDB is expected to closely parallel actions
taken in the World Bank in response to the Kafka Committee
report.
On other administrative costs the IDB continues to make
good progress.
In the last year the IDB eliminated first
- 19 class travel for all staff except the President and Executive
Vice President.
This policy was adopted in response to U.S.
initiatives and resulted in administrative savings in 1978
of $50,000.
As a further measure of savings, the IDB has
also eliminated its spouse travel program.
Furthermore, partly in response to U.S. urging, the
IDB has maintained its personnel levels essentially constant
over the past three years while the volume of work has increased
substantially, thus bringing IDB staffing ratios more in
line with other MDBs.
Conclusion
The U.S. has achieved a number of very important objectives
in the latest replenishment negotiation at the IDB.
In order
to carry out these improvements, we now need to come up with
our negotiated contribution.
The benefits we secured from
these negotiations could be lost if we should be unable
to fulfill our responsibilities to the institution and to
the other member countries.
The support of the Congress in appropriating these funds
will strengthen our hand in carrying out the understandings
negotiated and in seeking further improvements in the Bank's
management and operations.
They are one of the most important
components of our overall budget proposals for the MDBs for
FY 1980.
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STATEMENT OF THE HONORABLE C. FRED BERGSTEN
ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS
OF THE
COMMITTEE ON APPROPRIATIONS
HOUSE OF REPRESENTATIVES
Asian Development Bank
Mr. Chairman, I would now like to testify in support of
our requests totaling $419.5 million for the Asian Development
Bank (ADB), and its concessional loan window—the Asian
Development Fund (ADF). The total includes $248.2
million for the ordinary capital operations of the ADB and
$171.3 million for the ADF. The request for ordinary capital
contributions includes $203.6 million for our third contribution
to the second general capital increase and $44.6 million in
unfunded pledges from the FY 1979 request. The request for the
ADF consists of two elements—$60 million for our third and
final contribution to the first replenishment, authorized in
1977, and $111.3 million as the first of four equal annual
installments to the second replenishment of the ADF, for which
we are seeking authorization this year.
B-1508
- 2 Of the total $419.5 million, $223.4 million consists
of callable capital and is virtually certain never to result
in a budget outlay.
Of this year's total requests, less
than $15 million are expected to result in budget outlays
during FY 1980.
The Asian Development Bank was created in 1966 to
foster economic growth and cooperation in the developing
countries of Asia and the Pacific.
The Bank which is
headquartered in Manila, has 43 member countries — 26
developing countries and 17 developed.
Besides the United
States and Canada, the developed member countries include
three regional members and twelve Western European members.
The United States was a major factor in the creation
of the Bank, and has participated actively throughout its
existence.
The United States has subscribed to slightly more
than $1 billion, or 11.9 percent of the Bank's capital,
providing the U.S. with a 10.0 percent voting share. This
compares with Japanese subscriptions of 17.5 percent of the
capital, providing them with a voting share of 14.5 percent.
We will restore the U.S. voting share to full equality with
that of Japan,'at 13.4 percent, by the end of FY 1981, if
the Congress grants us full appropriation of our requests to
the second general capital increase.
The United States has contributed $270 million to the ADF,
15.2 percent of the total resources, compared with Japanese
contributions of $893.3 million or 50.3 percent of total
- 3 resources.
All countries, except Australia and the
United States, have completed their contributions to
the first replenishment. In the second replenishment the
United States1 share will total 20.7 percent, down from the
22.25 percent of the first replenishment and our 28.6 percent
share of the original resource mobilization of the ADF, while
Japan's share will increase from its 33.6 percent of the
first replenishment to 36.8 percent.
We believe that the Asian and Pacific region is of great
importance to the security and prosperity of the United
States and the developed world.
The region has a diverse
mixture of countries, including some of the fastest growing,
most successful developing nations with whom our trade
and investment links continue to expand rapidly; along
with some of the most populous and poorest nations in
the world, needing all the capital and technical assistance
that we can provide if they are to break out of their
cycle of poverty. It also includes some small island nations
in the Pacific having no multilateral source of external
aid other than the ADB.
The successful partnership of
regional and non-regional, developed and developing countries,
represented in the ADB is one that warrants our continued
support.
- 4 Bank Lending Activities
The Asian Development Bank made its first loan in 1968.
The Bank has now become an important contributor to the
economic development of Asia and the Pacific.
It is
a major source of capital in the region and has played a
vital role in mobilizing self-help resources in its developing.
member countries.
As of December 31, 1978, total loan funds committed
by the Bank had reached over $5 billion for 359 individual
development projects.
Nearly $4 billion or over 70%
came from the Bank's ordinary capital resources.
These
loans were financed at near market rates of interest at
maturities from thirteen to thirty years, including from
two to seven year grace periods.
The remaining $1.5 billion
in total lending consisted of concessional loans financed
from the Asian Development Fund.
These loans carry an
interest rate of 1 percent with maturities of forty years.
Countries receiving these loans are among the world's
poorest.
Almost ninety percent of the Bank's concessional
funds have gone to countries having a per capita income
of $200 or less.
In calendar year 1978, the Bank made new loans totaling
over $1.1 billion.
Of this amount, loans from ordinary
capital amounted to $778 million with concessional loans
- 5 accounting for the remainder.
These loans went to eighteen
of the Bank's developing member countries with five receiving
loans exclusively from concessional resources.
Over its history, twenty-three developing countries
have borrowed from the Asian Development Bank.
The major
recipients have been those countries in Asia which are
important to the military, political and economic interests
of the United States.
For example, the largest borrowers
from the Bank have been Korea ($836 million), the Philippines
($730 million), Pakistan ($713 million), Indonesia ($710
million), and Thailand ($517 million).
These and other
countries whose economic and social progress is significant
to stability in Asia have benefitted from the Bank's resources
at a relatively small cost to the United States.
Bank Financial Resources
The Bank's ordinary capital lending is financed primarily
from the paid-in capital subscriptions of members and, to
a much greater extent, the proceeds of borrowings in international
capital markets.
Members' callable capital subscriptions are
used exclusively to guarantee these borrowings and are virtually
certain never to be needed to meet the obligations to bondholders
and thus to result in budgetary outlays.
The Bank's cumulative subscribed capital stock now
amounts to $8.7 billion, consisting of 20 percent paid-in
- 6 capital and 80 percent callable capital.
This total stock
results from the original subscriptions and the two general
capital increases —
in 1971 and in 1976 —
along with
special capital increases subscribed by various member
governments during the Bank's lifetime.
The U.S. subscription
of slightly over $1 billion represents 11.9 percent of
the total, as compared to Japan's 17.5 percent share.
The Bank has become an increasingly familiar and
respected name in the world's capital markets.
It has
a triple A rating and can now borrow on virtually the
same terms as the World Bank.
Gross borrowings amounted
to $350.3 million in 1978 and $112 million in 1977, none
of which was raised in the United States.
The Bank's funded
debt now totals $1.6 billion, of which $295 million
or 18.3 percent was raised in the U.S. capital markets.
The corresponding figures for Japan and Western Europe
were 26 percent and 45 percent respectively.
Additional
amounts were raised from foreign central banks and in
the Middle East.
Of the $1.2 billion in U.S. resources already contributed
to the Asian Development Bank and Asian Development Fund
only $499 million will result in budgetary outlays.
remaining $736 million is callable capital —
The
a highly
contingent liability virtually certain never to be used.
These U.S. contributions have a multiplier effect for
- 7 financing development projects in Asia by attracting private
capital and by inducing burden sharing contributions from
other developed countries.
Funds that the ADB lends are augmented by co-financing
with other public and private institutions, together with the
local costs provided by the recipient developing country itself.
The amount of lending financed directly by the Bank's ordinary
capital is some fifteen times greater than the United States'
direct budgetary cost, with a smaller multiple in the ADF.
However, since the Bank acts as a catalyst in mobilizing
other funds, the total project costs financed by the
Bank's ordinary capital and ADF windows have amounted to over
$10.8 billion, at a total U.S. budgetary cost of less than
$500 million.
Therefore, every dollar of U.S. budgetary outlays
has provided over twenty dollars in ADB developmental
project funding. This ratio will increase in the future as
the Bank's capital structure matures, and begins to lend reflows.
The second general capital increase, adopted by the
Board of Governors in 1976, provides the Bank with
some $3.8 billion in lendable resources, sufficient to
increase the Bank's lending program from $625 million
in 1977 to $975 million in 1981.
Appropriation of the
U.S. request will be required for the Bank to complete
- 8 its planned 1980 and 1981 lending programs of about $1.9
billion.
Any shortfall in U.S. appropriations will eventually
be reflected in reduced Bank lending commitments.
Asian Development Fund
When the Bank was established, it was recognized that it
should provide financing on commercial terms to meet the
needs of the poorest developing member countries.
Prior to
1973, special funds were contributed to the Bank's soft loan
window on an unscheduled basis through bilateral arrangements
between donor countries and the Bank.
In 1973, the Bank's
Board of Governors, with United States support, adopted a
resolution creating a new multilateral special fund, the
Asian Development Fund, to which contributions would be
made and used on the same terms and conditions.
The U.S. share of the initial ADF mobilization was
$150 million, or 28.6 percent of the $525 million total,
to finance concessional lending over the period 1973-1975.
These U.S. contributions were made in FYs 1974, 1975
and 1977.
The first replenishment of the ADF was negotiated in
1975 for lending in the 1976-78 period.
The United States,
following consultations with Congress, was eventually
able to agree to a $180 million share of a $809 million
replenishment, a 22.2 percent share, which resulted in
a considerable reduction from our share in the original
resource mobilization.
Congress authorized these funds
- 9 in 1977 and appropriated $49.5 million and $70.5 million
in FY 1978 and FY 1979, respectively, for the Fund.
All
participating donor countries, except the United States
and Australia, had completed their contributions to the
first replenishment of ADF by the end of 1978. The United
States is requesting appropriation of its final $60 million
contribution to the first replenishment in FY 1980. At
the end of calendar year 1978 the ADF had only $228 million
left in uncommitted funds.
Accordingly, a replenishment
of ADF resources is needed if ADF lending is not to cease
by mid-1979.
The second replenishment of the Asian Development Fund
During late 1977 and early 1978, international
negotiations were conducted on the amount and conditions
of the second replenishment of the ADB.
The Bank's proposal
was for a replenishment of $2.15 billion, to be committed
over four instead of three years as for earlier ADF resource
mobilizations.
The four-year cycle allows for greater
stability and forward planning of the Bank's activities.
Following a Presidential decision and Congressional
consultations, the United States indicated it could not
provide more than a $445 million contribution to the
replenishment.
It was eventually agreed that the
replenishment would total $2 billion, but countries
could make supplementary contributions sufficient
- 10 to raise the total another $150 million.
This goal
was eventually reached when six countries offered to
contribute the supplemental amounts.
Of the total $2.15
billion for the second replenishment, the U.S. share of
$445 million represents 20.7 percent, which is less than
the 22.25 percent ceiling specified in last year's Foreign
Assistance Appropriations Act.
The replenishment arrangements reflected to a considerable
extent the goals the United States had sought.
The Fund
will give increased emphasis to the pressing needs of the
poorest countries in the region, and will resume lending
to certain important "marginally eligible" countries
for projects which address basic human needs, through
greater lending for agriculture and rural development.
These countries still have large sections of their
populations living in rural poverty.
The United States had urged throughout the negotiations
that additional countries join in the replenishment. This
was achieved when France agreed to contribute for the
first time.
Finally, the United States sought to have the
Bank be more aggressive in obtaining cofinancing agreements,
especially with the Middle Eastern countries, which the
Bank agreed to do.
- 11 Appropriations requests for FY 1980 - Ordinary Capital
Under the terms of the second general capital increase
adopted in 1976, the United States was to provide $814.3
million, or 16.3 percent of the total capital increase of
slightly over $5 billion, 10 percent in the form of paid-in
shares and the remaining 90 percent in callable capital.
Appropriations were received in FY 1978 and FY 1979 for
$168 million and $194.5 million, respectively.
In FY 1980,
we are requesting a total of $ 248.2 million ($24.8 million
paid-in capital and $223.4 million callable capital).
Under the agreed arrangements, payment for the paid-in
shares may be made in four equal installments over 1978 - 1981.
The capital increase was designed to cover the needs of
the Bank sufficiently to increase the annual lending from
ordinary capital resources from $625 million in 1977 to
$975 million in 1981.
The request for FY 1980 comprises our third tranche to
the second general capital increase of $203.6 million,
and $44.6 million in funds authorized but unappropriated in
previous years.
Of the U.S. paid-in portion, 40 percent
($9.92 million) would be in cash and 60 percent ($14.89
million) in non-interest bearing letters of credit to
be drawn down as needed to meet the disbursement needs of
the Bank.
The callable capital portion does not increase
Treasury outlays, but enables the Bank to raise funds in
the world's capital markets on far better terms than
- 12 it otherwise could at no real cost to the United States.
Consequently, of the $248.2 million FY 1980 request for the
Bank, less than $10 million or 4 percent will leave the
Treasury during FY 1980 and only $25 million or 10 percent
is ever expected to leave the Treasury.
The U.S. subscriptions are leveraged with the subscriptions
from other members and borrowings from the capital markets to
finance Bank lending.
Since it began lending in 1968, the Bank
has lent $3.9 billion from its ordinary capital window,
over fifteen times the direct United States budgetary
outlay for paid-in capital.
However, the true developmental
impact of the Bank's lending is much greater since Bank
funds will generally be accompanied by co-financing from
other official and unofficial sources, plus resources
mobilized by the developing countries themselves.
As the Bank's capital structure matures, we expect
this ratio to increase still further, as it has in
the IBRD. Furthermore, the amount requested for paid-in
capital in FY 1980 - $24.8 million - is about the same
level in nominal terms, and twenty-five percent lower
in real terms, than the amount the Congress appropriated for the Bank as far back as FY 1975.
- 13 If Congress appropriates the full request in FY 1980,
our request for paid-in-capital in FY 1981 will fall
to $20.4 million.
Appropriation of the requested funds will permit the
United States to maintain and increase its influence in
the Bank.
The United States as a key founding member, and
the second largest shareholder, has been able to substantially
influence the directions of the Bank over the years, which
has also accounted in part for the Bank's success to date.
Continuation of that influence requires the United States
to adhere to its burden-sharing arrangements, that have
been negotiated with other member countries.
Appropriations requests for FY 1980 - Asian Development Fund
The United States is seeking the first of four annual
installments of $111.25 million to the second replenishment
of the ADF in FY 1980, together with our third and final
installment of $60 million to the first replenishment.
This results in a total request in FY 1980 of $171.25
million for the ADF, a one-time doubling up of the
contributions to the first and second replenishments
and the first contribution to the second replenishment.
Full appropriation will reduce the lag in U.S. contributions, as compared to other donors, from two
years to one year, and future appropriations requests
will fall to $111.25 million per year in FYs 1981-83.
- 14 Appropriation of the full $111.25 million requested
for FY 1980 is particularly important because the
contributions of other donors are linked to that of
the United States.
Appropriation of our first installment
is needed to trigger the full amount of the second
installment of other donors.
Any reduction in the FY 1980
appropriations request could lead to a proportional reduction
in the contributions of other donors, thereby reducing the
Fund's ability to play its full role in the development
of Asia.
Payment of the U.S. contributions will be made by
letters of credit to be drawn down as required to
meet disbursements.
Consequently, actual U.S. budgetary
outlays during FY 1980 from the ADF appropriations
request are estimated to be approximately $4 million,
or 2 percent of the requested amount.
The remaining
amounts will be drawn down over the following ten or so
years.
Reaching the poor
The Bank has historically been strong in basic
infrastructure lending in such traditional sectors as
electric power, transportation and communication, but
- 15 in the last several years has moved towards increasing
the share of lending going to agriculture and benefiting
the poorest within developing member countries. The traditional
areas of power and transportation have taken almost 47
percent of ordinary capital and 40 percent of total lending
up through 1978.
Meanwhile, 25 percent of the total and
50 percent of concessional lending has been channeled
into agriculture.
With the scheduled adoption of a new agricultural sector
policy and the larger share of concessional lending
as a result of the new replenishment, there will be increased
emphasis on lending to the agricultural sector both in
dollar amounts and in effectiveness.
This trend is already
evident in 1978, when 55 percent of concessional lending
and 27 percent of total lending went to the agricultural
sector.
The Bank's new agricultural policy provides the
following guidance for future lending:
improved design
of projects to assure more rural employment opportunities;
concentration on rural infrastructure including feeder
road networks; better support facilities for rural credit
programs and improved arrangements for providing inputs
and for marketing production; establishment and upgrading
of extension services for rural women; strengthening
- 16 small scale enterprises and better provision for health,
nutrition and family planning assistance.
In addition,
it calls for greater emphasis on basic human needs of
the rural poor, participation of the under-employed in
bank-financed projects, and cost-reduction of projects
through calculations of cost per beneficiary.
The increased emphasis on reaching the poor through agriculture is demonstrated by the Bali Irrigation Loan made by the
Bank in September 1978. This $18 million irrigation loan
emphasizes the need for active involvement of farmers through
local irrigation associations which are called Subaks.
These organizations are traditional in some rural areas of
Indonesia and include in their membership all cultivators
who own, sharecrop or rent land receiving water from
a single source. Each member of the Subak has an equal
vote and the leadership is democratically elected by
majority vote or consensus.
The ADB loan agreement
specifically requires that the Subaks be directly
involved in the allocation of water between Subaks and in the
settlement of inter-Subak water rights disputes.
Capital saving technology
The United States, along with some other developed and
developing member countries, has continued to promote
the adoption of capital saving technologies.
We believe there
are very real and encouraging signs of success for our efforts.
- 17 The Bank's commitment to the use of capital savings technology
in agriculture and aquaculture is noteworthy.
This is
important because of its potential impact in reducing
rural poverty. The Bank is now making a concentrated effort
to increase rural incomes and expand agricultural output
through programs that take advantage of the large unused
stock of human capital in rural Asia.
A good example of capital saving technology is an
aquaculture development project in Thailand.
This project
is designed to increase the income and employment opportunities
of small fish farmers through the production of fish and
shrimp species easily adaptable to local conditions, using
simple techniques.
Those techniques chosen have been
the most appropriate for the existing human and physical
resources of the country.
The project is expected to provide direct benefits to
2,532 fishermen living at subsistence level or belonging
to low-income groups, and to increase their incomes severalfold while providing the fish consumption requirements
for 320,000 people.
The Bank also promotes capital saving techniques
in its civil works wherever possible, particularly for
secondary feeder road construction and maintenance.
For
- 18 example, the Mindanao Secondary and Feeder Road Project
in the Philippines was specifically designed to maximize
use of rural labor.
Accountability
Last year the ADB management took several steps to
increase the accountability of its work to its member
countries and increase its internal efficiency.
The first
was the expansion and strengthening of the Office of the
Internal Auditor, and the second was the establishment of a
Post Evaluation Office which reports solely to the President
of the Bank.
The Internal Auditor's Office, which concerns itself
primarily with the areas of loan disbursements and repayments
and administrative expenses, has undergone a major
strengthening in staff-. We will monitor the results of
this expansion.
At the same time we propose to
consider other areas that should be audited, such as
broad program audits of the operational activities of
the Bank.
The Post Evaluation Office performs independent post
evaluations of bank-financed projects, and reports
directly to the President.
Until now the Bank has only
performed post-evaluation reviews on a sample of completed
projects.
This practice will be expanded considerably
as a result of the reorganization and strengthening of the PC
Evaluation Office.
All evaluation reports are available
to the Executive Directors.
- 19 -
Salaries and administrative costs
The Bank's record on administrative costs is well
known and needs little repeating. The Bank has the lowest
administrative costs of any of the MDBs.
The ADB operates
with fewer professionals per project undertaken and at lower
salaries, than in the other MDBs.
We believe it is to
the credit of Bank management, and an indicator of its
responsiveness to U.S. concerns, that only 2.5 cents of
every dollar lent is absorbed in administrative expenses.
On the question of salaries I would like to mention that
U.S. nationals on the ADB staff are at a distinct disadvantage
vis a vis expatriates from other developed member
countries whose salaries are not subject to national taxation.
Consequently, the after-tax incomes of Americans turn out
to be well below those of other Bank employees and of United
States Government employees in Manila, earning the same base pay.
The situation has worsened, with recent changes in U.S. tax
legislation, which heightens the prospect of a severe depletion
in the number and quality of senior U.S. nationals on
the Bank's staff.
We are investigating possible solutions and
hope that a remedy can be found before American presence in the
Bank is severely eroded.
The costs of an equitable resolution
would not be large and Bank salaries and administative costs
would remain the lowest of all the MDBs.
- 20 Procurement
The level of U.S. procurement from the Bank has been
below our expectations.
Consequently, we established
an inter-agency working group to study the reasons for
the disparity and recommend appropriate actions.
The working group has solicited the views of a large
number of U.S. business firms about improving the flow of
contract information.
Bank management has taken measures
including promotion of a forthcoming staff visit to selected
U.S. Chambers of Commerce to advise U.S. firms of procurement
opportunities with the Bank, and making available copies of its
Monthly Operations Report to interested businessmen.
This
information on future business opportunities is also being
published in Commerce Department publications for businessmen, and is being provided to U.S. embassies around the world.
As in other U.S. policy questions the Bank has been
responsive to U.S. procurement concerns.
We are confident
that the lending procedures of the Bank are fair to U.S.
suppliers and there is no institutional bias which limits
the success of U.S. suppliers.
The problem, as we see
it, lies with increasing the awareness of the opportunities
for U.S. firms.
With the additional flow of information,
there should be more aggressive bidding by U.S. firms.
We are attempting to assure that such information is made
available to them as quickly as possible.
- 21 Conclusion
The Asian Development Bank has become a key
instrument in U.S. policy toward Asia.
It is an
effective and efficient institution that has shown
responsiveness to U.S. concerns particularly through
the sectoral and country distribution of its lending
programs.
The Bank has successfully leveraged U.S. contributions
employing the funds of other regional and non-regional developed
countries, raising funds in world capital markets and
co-financing projects with public and private institutions from the developed countries and the capital surplus
countries of the Middle East.
The Bank's programs have been
implemented in a highly cost-effective manner, thereby contributing
to the growth and stability of an area of the world of
fundamental importance to U.S. economic and strategic
interests.
The ADB is a successful example of a diverse mixture
of developed and developing countries striving cooperatively
to achieve development for the world's most populous region.
Its efforts and continued accomplishments deserve our wholehearted support.
The Administration recommends appropriation of
the requested amounts.
GPO 938 766
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)epartmentoftheTREA$URY
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TELEPHONE 566-2041
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FOR IMMEDIATE FFT.F.ARF
April 2, 1979
Charles Arnold
566-2041
SALE OF SAVINGS BONDS AND MAILING OF TAX REFUND CHECKS RESUMED
Following completion of Congressional action to raise the
nation's debt limit today, the Treasury authorized all Federal
Reserve Banks and some 40,000 other issuing agents to resume
sales of U.S. Savings Bonds. Sales had been suspended because,
in the absence of action to raise the debt limit, new bonds could
not be issued.
The Treasury also resumed the distribution of Federal income
tax refund checks. Because of the lack of action to increase the
debt ceiling, the scheduled mailing on March 29 of $2.6 billion in
refund checks dated March 30 had been withheld.
0O0O0
B-1509
KpamentCtheTRWURY
WASHINGTON, OX. 2Q220
||f §
TELEPHONE 566-2041
FOR IMMEDIATE RELEASE
April 2, 1979
TREASURY RESCHEDULES AUCTION OF $3,000 MILLION OF CASH
MANAGEMENT BILLS ORIGINALLY ANNOUNCED MARCH 23, 1979
The Department of the Treasury, by this public notice,
invites tenders for approximately $3,000 million of 76-day
Treasury bills to be issued April 6, 1979, representing an
additional amount of bills dated December 21, 1978, maturing
June 21, 1979 (CUSIP No. 912793 Z2 5 ) .
Competitive tenders will be received at all Federal
Reserve Banks and Branches up to 12:30 p.m., Eastern
Standard time, Thursday, April 5, 1979. Noncompetitive
tenders will not be accepted. 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. Each tender for the issue
must be for a minimum amount of $1,000,000. Tenders over
$1,000,000 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.
The bills will be issued on a discount basis under
competitive bidding, and at maturity their par amount will
be payable without interest. Except for definitive bills in
the $100,000 denomination, which will be available only to
investors who are able to show that they are required by law
or regulation to hold securities in physical form, this
series of bills will be issued entirely in book-entry form
in a minimum amount of $10,000 and in any higher $5,000
multiple, on the records of the Federal Reserve Banks and
Branches.
Banking institutions and dealers who make primary
markets in Government securities and report daily to the
Federal Reserve Bank of New York their positions in and
borrowings on such securities may submit tenders for account
of customers, if the names of the customers and the amount
for each customer are furnished. Others are only permitted
to submit tenders for their own account.
B
-1510
-2No deposit need accompany tenders from incorporated
banks and trust companies and from responsible and
recognized dealers in investment securities for bills to be
maintained on the book-entry records of Federal Reserve
Banks and Branches, or for bills issued in bearer form,
where authorized. A deposit of 2 percent of the par amount
of the bills applied for must accompany tenders for such
bills from others, unless an express guaranty of payment by
an incorporated bank or trust company accompanies the
tenders.
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 of their tenders. The Secretary of the
Treasury expressly reserves the right to accept or reject
any or all tenders, in whole or in part, and the Secretary's
action shall be final. Settlement for accepted tenders in
accordance with the bids must be made or completed at the
Federal Reserve Bank or Branch in cash or other immediately
available funds on Friday, April 6, 1979.
Under Sections 454(b) and 1221(5) of the Internal
Revenue Code of 1954 the amount of discount at which these
bills 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 these bills (other than life insurance
companies) must include in his or her Federal income tax
return, as ordinary gain or loss, the difference between the
price paid for the bills 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 Circulars, No. 418 (current
revision), Public Debt Series - Nos. 26-76 and 27-76, and
this notice, prescribe the terms of these Treasury bills and
govern the conditions of their issue. Copies of the
circulars may be obtained from any Federal Reserve Bank or
Branch.
tpartmentoftheTREASURY
ASHWGTON, OX. 20220
TELEPHONE 500-2011
FOR IMMEDIATE RELEASE
April 2, 1979
TREASURY RESCHEDULES OFFERING OF $1,500 MILLION
9% 14-YEAR 10-MONTH BONDS
In its original offering of March 22, the Department of
the Treasury announced that the bonds would be auctioned
Thursday, March 29, 1979, and issued Thursday, April 5, 1979.
The Treasury hereby amends its original offering announcement
by providing that the bonds will be auctioned Tuesday, April 10,
1979, and issued Wednesday, April 18, 1979.
As stated in the original announcement, the Treasury will
auction $1,500 million of the 9% 14-year 10-month bonds to
raise new cash. They will be an addition to 9% bonds, due
February 15, 1994, which are currently outstanding. Additional
amounts of the bonds may be issued to Federal Reserve Banks as
agents for foreign and international monetary authorities at
the average price of accepted competitive tenders.
Details about the offering, as amended, are given in the
attached highlights of the offering and in the official
offering circular.
oOo
' Attachment
5-1511
(over)
HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF RESCHEDULED 14-YEAR 10-MONTH BONDS
TO BE ISSUED APRIL 18, 1979
April 2, 1979
Amount Offered:
To the public
Description of Security:
Term and type of security
Series and CUSIP designation
Maturity date February 15, 1994
Call date. .
Interest coupon rate
$1,500 million
14-year 10-month bonds
9% Bonds of 1994
(CUSIP No. 912810 CF 3)
No provision
9%
Investment yield To be determined at auction
Premium or discount
To be determined after auction
Interest payment dates
August 15 and February 15
Minimum denomination available $1,000
Terms of Sale:
Method of sale
Accrued interest payable by
investor
Preferred allotment
Deposit requirement 5% of face amount
Deposit guarantee by designated
institutions
Key Dates:
Deadline for receipt of tenders
Settlement date (final payment due)
a) cash or Federal funds
b) check drawn on bank
within FRB district where
submitted
c) check drawn on bank outside
FRB district where
submitted
Delivery date for coupon securities.
Price auction
$23.97415 per $1,000
Noncompetitive bid for
$1,000,000 or less
Acceptable
Tuesday, April 10, 1979,
by 1:30 p.m., EST
Wednesday, April 18, 1979
Tuesday, April 17, 1979
Tuesday, April 17, 1979
Wednesday, April 18, 1979
FOR IMMEDIATE RELEASE
April 2, 1979
TREASURY RESCHEDULES OFFERING OF $2,880 MILLION
OF 2-YEAR NOTES
In its original offering of March 14, the Department of
the Treasury announced that the notes would be auctioned
Wednesday, March 21, 1979, and issued Monday, April 2, 1979.
The Treasury hereby amends its original offering announcement
by providing that the notes will be auctioned Thursday, April
5, 1979, and issued Monday, April 9, 1979.
As stated in the original announcement, the Treasury will
auction $2,880 million of the 2-year notes. These notes had
been intended to refund approximately the same amount of notes
which matured March 31, 1979.
In addition to the public holdings, Federal Reserve Banks,
for their own account, held $640 million of the maturing
securities. These securities were refunded by issuing shortterm Treasury bills. These Treasury bills will then be exchanged by the Federal Reserve for additional amounts of the
new notes at the average price of accepted competitive tenders.
Additional amounts of the new securities may also be issued
at the average price to Federal Reserve Banks, as agents for
foreign and international monetary authorities, to the extent
that the aggregate amount of tenders for such accounts exceeds
the aggregate amount of maturing securities held by them.
Details about the new security, as amended, are given in
the attached highlights of the offering and in the official
offering circular.
oOo
Attachment
B-1512
(over)
HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF RESCHEDULED 2-YEAR NOTES
TO BE ISSUED APRIL 9, 1979
April 2, 1979
Amount Offered:
To the public
Description of Security:
Term and type of security
Series and CUSIP designation
Maturity date March 31, 1981
Call date
Interest coupon rate
Investment yield
Premium or discount
Interest payment dates
Minimum denomination available
Terms of Sale:
Method of sale
Accrued interest payable by
investor.
Preferred allotment
Deposit requirement 5% of face amount
Deposit guarantee by designated
institutions
Key Dates:
Deadline for receipt of tenders
Settlement date (final payment due)
a) cash or Federal funds
b) check drawn on bank
within FRB district where
submitted
c) check drawn on bank outside
FRB district where
submitted
Delivery date for coupon securities.
$2,880 million
2-year notes
Series R-1981
(CUSIP No. 912827 JN 3)
No provision
,To be determined based on
'the average of accepted bids;
To be determined at auction;
To be determined after aucti
September 30 and March 31
$5,000
Yield auction
None
Noncompetitive bid for
$1,000,000 or less
Acceptable
Thursday, April 5, 1979,
by 1:30 p.m. , EST _.,<,
Monday, April 9, 1979
Friday, April 6, 1979
Friday, April 6, 1979
Friday, April 20, 1979
FOR IMMEDIATE RELEASE
April 2, 1979
TREASURY RESCHEDULES 52-WEEK BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for approximately $3,340 million, of 362-day
Treasury bills to be dated April 5, 1979, and to mature
April 1, 1980 (CUSIP No. 912793 3F 1 ) . This issue will not
provide new cash for the Treasury as the maturing issue is
outstanding in the amount of $3,346 million.
The bills will be issued for cash, and if desired by
investors, in exchange for Treasury bills which will mature
April 3, 1979. The public holds $1,666 million of the
maturing issue and $1,680 million is held by Federal Reserve
Banks for themselves and as agents of foreign and international
monetary authorities. The Federal Reserve's holding of such
bills will be exchanged on April 3 for short-term Treasury
bills. These bills will then be exchanged for the new annual
bills at the weighted average price of accepted competitive
tenders. Additional amounts of the bills may be issued to
Federal Reserve Banks, as agents of foreign and international
monetary authorities, to the extent that the aggregate amount
of tenders for such accounts exceeds the aggregate amount of
maturing bills held by them.
The bills will be issued on a discount basis under
competitive and noncompetitive bidding, and at maturity their par
amount will be payable without interest. This series of bills
will be issued entirely in book-entry form in a minimum amount of
$10,000 and in any higher $5,000 multiple, on the records either
of the Federal Reserve Banks and Branches, or of the Department
of the Treasury.
Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington,
D. C. 20226, up to 12:30 p.m., Eastern Standard time,
Wednesday, April 4, 1979. Form PD 4632-1 should be used to
submit tenders for bills to be maintained on the book-entry
records of the Department of the Treasury.
Each tender must be for a minimum of $10,000. 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.
B-1513
-2Banking institutions and dealers who make primary markets in
Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such
securities may submit tenders for account of customers, if the
names of the customers and the amount for each customer are
furnished. Others are only permitted to submit tenders for their
own account.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury. A
cash adjustment will be made on all accepted tenders for the
difference between the par payment submitted and the actual issue
price as determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit
of 2 percent of the par amount of the bills applied for must
accompany tenders for such bills from others, unless an express
guaranty of payment by an incorporated bank or trust company
accompanies the tenders.
Public announcement will be made by the Department of the
Treasury of the amount and price range of accepted bids.
Competitive bidders will be advised of the acceptance or
rejection of their tenders. The Secretary of the Treasury
expressly reserves the right to accept or reject any or all
tenders, in whole or in part, and the Secretary's action 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 weighted average price (in three
decimals) of accepted competitive bids.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on April 5, 1979,
in cash or other immediately available
funds or in Treasury bills maturing
April 3, 1979.
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.
-3Under Sections 454(b) and 1221(5) of the Internal Revenue
Code of 1954 the amount of discount at which these bills 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 these
bills (other than life insurance companies) must include in his
or her 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 Circulars, Public Debt Series Nos. 26-76 and 27-76, and this notice, prescribe the terms of
these Treasury bills and govern the conditions of their issue.
Copies of the circulars and tender forms may be obtained from any
Federal Reserve Bank or Branch, or from the Bureau of the Public
Debt.
FOR IMMEDIATE RELEASE
April 2, 1979
TREASURY ANNOUNCES $6,000 MILLION OF CASH MANAGEMENT BILLS
FOR AUCTION AND ISSUE TUESDAY, APRIL 3, 1979
(Additional Announcements to Follow)
The Department of the Treasury, by this public notice,
invites tenders for approximately $6,000 million of 23-day
Treasury bills to be issued April 3, 1979, representing an
additional amount-of bills dated October 26 ,1978, maturing
April 26, 1979 (CUSIP No. 912793 Y2 6).
-
J
Competitive,--tenders will be received only at the
Federal Reserve Bank of New York up to 10:30 a.m., Eastern
Standard time, -Tuesday, April 3, 1979. Noncompetitive
tenders will not be accepted. Tenders will not be received
at the Department tof the. Treasury, Washington.^ Wire and
telephone tenders -may'Khe received at the discretion of the
Federal Reserve Bank of New York. Each tender for the issue
must be for a minimum amount 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.
%^
_jt*
The bills will be issued on a discount basis under
competitive bidding, and at maturity their par amount will
be payable without interest. Except for definitive bills in
the $100,000 denomination, which will be available only to
investors who are able to show that they are required by law
or regulation to hold securities in physical form, this
series of bills will be issued entirely in book-entry form
in a minimum denomination of $10,000 and in any higher
$5,000 multiple, on the records of the Federal Reserve Banks
and Branches.
Banking institutions and dealers who make primary
markets in Government securities and report daily to the
Federal Reserve Bank of New York their positions in and
borrowings on such securities may submit tenders for account
of customers, if the names of the customers and the amount
for each customer are furnished. Others are only permitted
to submit tenders for their own account.
B-1514
-2No deposit need accompany tenders from incorporated
banks and trust companies and from responsible and
recognized dealers in investment securities for bills to be
maintained on the book-entry records of Federal Reserve
Banks and Branches, or for bills issued in bearer form,
where authorized. A deposit of 2 percent of the par amount
of the bills applied for must accompany tenders for such
bills from others, unless an express guaranty of payment by
an incorporated bank or trust company accompanies the
s
tenders.
<-r
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 of their tenders. The Secretary of the
Treasury expressly reserves the right to accept or reject
any or all tenders, in whole'or in part, and the Secretary's
action shall be final. Settlement for-'accepted tenders in
accordance with the bids'1 murst"-be made or'completed at the
Federal Reserve Bank of New York in castf or other
immediately available furids by close of business Tuesday, April
1979.
-.
^..
if/
:'
r ,'
Under Sections 454(b) and 1221(5) off the Internal
Revenue Code of 1954 the:amount of discount at which these
bills are sold is considered to accrue1 when the bills are
sold, redeemed or otherwise disposed of, and the bills are
excluded from consideration as capital assets. Accordingly,
the owner of these bills (other than life insurance
companies) must include in his or her Federal income tax
return, as ordinary gain or loss, the difference between the
price paid for the bills 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 Circulars, No. 418 (current
revision), Public Debt Series - Nos. 26-76 and 27-76, and
this notice, prescribe the terms of these Treasury bills and
govern the conditions of their issue. Copies of the
circulars may be obtained from any Federal Reserve Bank or
Branch.
VartmentoftheTREASURY
ON, OX. 20220
TELEPHONE 566-2041
FOR IMMEDIATE RELEASE
April 2, 1979
.,« TREASURY ANNOUNCES
REVISED FINANCING SCHEDULE
TJ
As a result, of final action by the Congress on legislation to raise and extend the tempdrary debt ceiling, the
Department of Treasury announced the following revised 1
schedule of offerings:
... $6.0 billion of l23 day cash'management bills,
maturing April 26) to be auctioned at 10:30 a.m.,
Tuesday, lApril 3 for settlement-also on April 3.
Bids for these cash management bilisrwill' be
accepted only at the New York Federal Reserve
Bank in minimum amoiints of $10 million.
... $4.0 billion of 15 day cash management bills,
maturing April 19, to.be auctioned at 12:00
noon on Tuesday, April 3 for settlement on •
Wednesday, April 4. Bids for these cash
management bills will be accepted at any
Federal Reserve bank in minimum amounts of
$10 million.
... $6.0 billion of weekly Treasury bills ($3.0
billion of 3 month bills to mature on July 5,
1979, and $3.0 billion 6 month Treasury bills
to mature October 4, 1979) to be auctioned at
1:30 p.m. Tuesday, April 3, for settlement
Thursday, April 5. This represents a rescheduling
of the auction of these bills originally scheduled
for Monday, April 2.
... $3.3 billion of annual bills maturing April 1,
1980, for auction at 12:30 p.m., Wednesday,
April 4 for settlement Thursday, April 5.
This offering substitutes for the offering
of the 52 week bills which the Treasury was
unable to auction on Wednesday, March 28. The
Federal Reserve will exchange its holdings of
B 1515
- 2 -
... $3.0
... $2.9
... $1.5
Separate
issued.
maturing annual bills for short term Treasury
bills. These Treasury bills will then be
exchanged by the Federal Reserve for new
annual bills to be issued by the Treasury on
April 5.
billion of 76 day cash management bills
to mature June 21, to be auctioned at 12:30 p.m.
Thursday, April 5 for settlement Friday, April 6.
This represents a rescheduling of the previously
announced June cash management bill originally
scheduled to be auctioned on Friday, March 30.
billion of 2 year notes maturing March 31,
1981 to<be auctioned at 1:30 p.m., Thursday,
April 5 for settlement Monday, April 9. This
represents the rescheduling of the previously
announced 2 year note which was to have been
auctioned Wednesday, March 21. The Federal
Reserve will exchange its holdings of
approximately $640 million of maturing 2 year
notes for short term Treasury bills. These
Treasury bills will then t>e exchanged by the
Federal Reserve for new 2 year notes issued by
the Treasury on April 9.
billion of reopened 14 year 10 month
Treasury bonds, maturing February 15, 1994,
to be auctioned at 1:30 p.m. on Tuesday,
April 10 for settlement Wednesday, April 18.
The auction of these bonds was originally
scheduled for Thursday, March 29.
announcements on each of the above will be
department of theTREASURY
IN6T0N, OX. 20220
TELEPHONE 566-2041
FOR RELEASE AT 11:50 P.M.
April 3, 1979
RESULTS OF AUCTION OF $6,005 MILLION
OF 23-DAY TREASURY BILLS
The Treasury has accepted $6,005 million of the
$15,073 million of tenders received at the Federal Reserve
Bank of New York for the 2 3-day Treasury bills to be
issued April 3, 1979, and to mature April 26, 1979, auctioned
today. The range of accepted bids was as follows:
Price
Discount Rate
Investment Rate
10.00%
9.783%
99.375
High
10.12%
9.892%
99.368
Low
10.09%
9.861%
Average 99.370
Tenders at the low price were allotted 31%
B-1516
FOR RELEASE AT 4:00 P.M.
April 3, 197 9
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling
approximately $6,000 million, to be issued April 12, 1979.
This offering will result in a pay-down for the Treasury of about
$200
million as the maturing bills are outstanding in the
amount of $6,215 million. The two series offered are as follows:
91-day bills (to maturity date) for approximately $3,000
million, representing an additional amount of bills dated
January 11, 1979,
and to mature July 12, 1979
(CUSIP No.
912793 2B 1), originally issued in the amount of $2,916 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $3,000 million to be dated
April 12, 1979,
and to mature October 11, 1979
(CUSIP No.
912793 2Q 8 ) .
Both series of bills will be issued for cash and in
exchange for Treasury bills maturing April 12, 1979.
Federal Reserve Banks, for themselves and as agents of foreign
and international monetary authorities, presently hold $3,071
million of the maturing bills. These accounts may exchange bills
they hold for the bills now being offered at the weighted average
prices of accepted competitive tenders.
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington,
D. C. 20226, up to 1:30 p.m., Eastern Standard time,
Monday, April 9, 1979.
Form PD 4632-2 (for 26-week series)
or Form PD 4632-3 (for 13-week series) should be used to submit
tenders for bills to be maintained on the book-entry records of
the Department of the Treasury.
B-1517
-2Each tender must be for a minimum of $10,000. 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 in and borrowings on such
securities may submit tenders for account of customers, if the
names of the customers and the amount for each customer are
furnished. Others are only permitted to submit tenders for
their own account.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury. A
cash adjustment will be made on all accepted tenders for the
difference between the par payment submitted and the actual issue
price as determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit
of 2 percent of the par amount of the bills applied for must
accompany tenders for such bills from others, unless an express
guaranty of payment by an incorporated bank or trust company
accompanies the tenders.
Public announcement will be made by the Department of the
Treasury of the amount and price range of accepted bids. Competitive bidders will be advised of the acceptance or rejection
of their tenders. The Secretary of the Treasury expressly
reserves the right to accept or reject any or all tenders, in
whole or in part, and the Secretary's action 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 weighted average price
(in three decimals) of accepted competitive bids for the
respective issues.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
or at the Bureau of the Public Debt on April 12, 1979,
in cas!
or other immediately available funds or in Treasury bills maturii
April 12, 1979.
cash adjustments will be made for differed
between the par value of the maturing bills accepted in exchange
and the issue price of the new bills.
-3Under Sections 454(b) and 1221(5) of the Internal Revenue
Code of 1954 the amount of discount at which these bills 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 these
bills (other than life insurance companies) must include in his
or her 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 Circulars, Public Debt Series Nos. 26-76 and 27-76, and this notice, prescribe the terms of
these Treasury bills and govern the conditions of their issue.
Copies of the circulars and tender forms may be obtained from any
Federal Reserve Bank or Branch, or from the Bureau of the Public
Debt.
tpartmentoftheJREASURY
TELEPHONE 566*2041
(6HINGT0N, OX. 20220
April 3, 1979
FOR IMMEDIATE RELEASE
RESULTS OF TREASURY'S 15-DAY BILL AUCTION
Tenders for $4,001 million of 15-day Treasury bills to be issued
on April 4, 1979, and to mature April 19, 1979, were accepted at the
Federal Reserve Banks today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
High
Low
Average -
Price
Discount Rate
99.593
99.585
99.587
9.768%
9.960%
9.912%
Investment Rate
(Equivalent Coupon Issue Yield)
9.97%
10.17%
10.12%
Tenders at the low price were allotted 76%.
TOTAL TENDERS RECEIVED AND ACCEPTED BY
FEDERAL RESERVE DISTRICTS:
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
TOTAL
B-1518
Received
Accepted
$ 100,000,000
7,765,000,000
$ 72,800,000
3,301,600,000
60,000,000
10,000,000
1,045,000,000
10,000,000
55,200,000
10,000,000
521,600,000
10,000,000
10,000,000
465,000,000
$9,465,000,000
30,000,000
$4,001,200,000
1
E^IJJTT
mmf f\? ^-r
Mi
_-_*•
• >l
_5SL
__v>^
^E_" "V^J mcr.lm
A
FOR IMMEDIATE RELEASE
April 4, 1979
Contact: Alvin M. Hattal
202/566-8381
TREASURY ANNOUNCES COUNTERVAILING
DUTY INVESTIGATION ON CERTAIN
FIREARMS AND PARTS FROM BRAZIL
The Treasury Department has started an investigation into whether imports of firearms and parts from
Brazil are being subsidized.
A preliminary determination in this case must be
made by August 22, 1979, and a final determination by
February 22, 1980.
Imports of this merchandise during the first ten
months of 1978 were valued at $8 million.
The investigation follows receipt of a petition
alleging that manufacturers and/or exporters of this
merchandise receive benefits from the Government of
Brazil.
The Countervailing Duty Law requires the Secretary
of the Treasury to collect an additional customs duty
equal to the subsidy paid on merchandise exported to
the United States.
Notice of this investigation will be published in
the Federal Register of April 5, 19 79.
o
B-1519
0
o
^^H
__^_HBB^^^^^^^^^^
tpartmentoftheJREASURY
TELEPHONE 566-2041
HSHINGTONfDX. 20220
FOR IMMEDIATE RELEASE
April 3, 1979
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $ 3,001 million of 13-week Treasury bills and for $3,003 million
of 26-week Treasury bills, both series to be issued on April 5, 1979,
were accepted at the Federal Reserve Banks and Treasury today. The details are
as follows:
RANGE OF ACCEPTED
COMPETITIVE BIDS:
High
Low
Average
13-week bills
maturing July 5, 1979
Price
D iscount
Rate
97.589
97.568
97.575
9.538%
9.621%
9.593%
Investment
Rate 1/
9.94%
10.03%
10.00%
26-week bills
maturing October 4, 1979
Price
Discount
Rate
: 95.202
: 95.198
: 95.199
9.491%
9.498%
9.496%
Investment
Rate 1/
10.14%
10.14%
10.14%
Tenders at the low price for the 13-week bills were allotted 47%
Tenders at the low price for the 26-week bills were allotted
TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS AND TREASURY:
Location
Received
Boston
$
75,765,000
New York
5,018,040,000
Philadelphia
19,705,000
Cleveland
34,365,000
Richmond
29,670,000
Atlanta
36,290,000
Chicago
192,220,000
St. Louis
59,080,000
Minneapolis
15,895,000
Kansas City
27,630,000
Dallas
25,330,000
San Francisco
378,125,000
Treasury
15,265,000
TOTALS
$5,927,380,000
Accepted
$
52,350,000
2,555,340,000
19,705,000
34,365,000
29,670,000
36,290,000
61,620,000
37,020,000
14,305,000
27,630,000
20,030,000
97,065,000
15,265,000
Received
69,925,000
160,330,000
58,390,000
144,210,000
31,075,000
24,420,000
601,465,000
66,990,000
20,555,000
21,090,000
9,595,000
498,160,000
20,805,000
$3,000,655,000a/* $7,727,010,000
i/Includes $ 438,725,000 noncompetitive tenders from the public.
^Includes $ 289,270,000 noncompetitive tenders from the public.
L_/Equivalent coupon-issue yield.
B-1520
Accepted
$
19,925,000
2,573,145,000
13,360,000
16,210,000
19,575,000
20,920,000
223,965,000
12,890,000
5,555,000
20,270,000
9,595,000
47,060,000
20,805,000
$3,003,275,0001
FOR RELEASE ON DELIVERY
EXPECTED AT 10:00 A.M.
APRIL 5, 1979
STATEMENT OF PAUL H. TAYLOR
FISCAL ASSISTANT SECRETARY OF THE TREASURY
BEFORE THE SUBCOMMITTEE ON
PUBLIC BUILDINGS AND GROUNDS OF THE
HOUSE COMMITTEE ON PUBLIC WORKS AND TRANSPORTATION
Mr. Chairman and Members of the Subcommittee:
I am glad to be here this morning to discuss fiscal aspects
of the John F. Kennedy Center revenue bonds, which were purchased by the Secretary of the Treasury pursuant to section 9
of the Kennedy Center Act.
That provision authorized the Center's Board of Trustees
to issue revenue bonds to the Secretary in an amount not exceeding $20.4 million. The proceeds were to be used to finance
the Center's parking facilities and the bonds were to be repaid
from revenues accruing to the Center. Interest was required
to be computed to reflect the cost of market borrowings by the
Treasury. The Act permits deferral of payment of the interest
B-1521
- 2 with the approval of the Secretary of the Treasury, but stipu-.
lates that interest so deferred will bear interest after
June 30, 1972. Deferred interest was not, however, to be
considered a reduction of the borrowing limitation. The first
bond was issued on July 1, 1968 in the amount of $1.5 million
and carried a maturity date of December 31, 2017. Attachment
A to my statement shows the obligations, their interest rates
and maturity dates.
The bonds provide that principal and interest are to be
paid from parking revenues. However, because these revenues
were insufficient to meet the current interest on the bonds
(partially because a substantial portion was diverted to repay
a $3.5 million loan from the parking concessioner), the Center's
Board, in December 1968, and annually thereafter, requested and
was granted a deferral of the interest by the Secretary of the
Treasury. Attachment B shows the computation of deferred interest from December 31, 1968 through December 31, 1978. In
February 1979 the Department granted a further one-year deferral
after the Center indicated its intent to seek a legislative
solution to their financial problem. In this connection, H.R.
13579 of the 95th Congress would have provided for an accommodation between the Center and the Treasury whereby the Board
would undertake to repay, in equal annual installments, the
$20.4 mill on principal on the bonds and the Secretary would
- 3 release the Board from its obligation to pay deferred and
future interest thereon. The proposed legislation was not
considered, however, and we understand that your Committee is
now reviewing ways to provide some relief for the Center's
financial dilemma.
Apropos this point, on December 20, 1977, the Comptroller
General transmitted to the Secretary of the Treasury a report
on the financial operations of the Center. The report pointed
out that one of the Center's largest financial obligations is
the $15 million in interest and deferred interest owed to the
Treasury on the revenue bonds. The report concluded that only
the Congress can determine the "future financial course" of
the John F. Kennedy Center for the Performing Arts. We concur
in that assessment, recognizing that that determination will
require an accommodation between the Center and the Treasury.
We believe the Center's status as a national memorial and
cultural center requires us to view their financial impairment
in a different light than would be the case with respect to
normal business-type operations of the Government. Therefore,
the Department supports the write-off of the Center's interest
obligation to the Treasury. We also believe that a firm schedule for repayment of the principal should be adopted.
That concludes my prepared statement, Mr. Chairman. I
will be glad to respond to any questions.
Attachments
oOo
Attachment A
John F. Kennedy Center for the Performing Arts
Loans, John F. Kennedy Center, Parking Facilities
Revenue Bonds - 12/31/78
Calendar
Year
Advanced
Accrued
Face
Amount
Interest to December 31, 1978
No . of Days
Interest
From
To
Rate
Bond
No.
Due Date
5-1/8%
2-5
12/31/2017
1968
3,800,000
12/31/77
1 yr
194,750.00
5-1/4%
1-6
12/31/2017
1968
2,900,000
12/31/77
1 yr
152,250.00
5-3/8%
7 & 8
12/31/2017
1968
1,200,000
12/31/77
1 yr
64,500.00
5-3/4%
9 & 10
12/31/2018
1968
2,200,000
12/31/77
1 yr
126,500.00
5-7/8% 11 & 14
12/31/2018
1969
4,300,000
12/31/77
1 yr
252,625.00
12/31/2018
1969
1,000,000
12/31/77
1 yr
60,000.00
>-l/4% 16 & 17
12/31/2018
1969
1,300,000
12/31/77
1 yr
81,250.00
i-1/2% 18 & 19
12/31/2018
1969
1,900,000
12/31/77
1 yr
123,500.00
12/31/2018
12/31/2019
1969
1970
800,000
1,000,000
1,800,000
12/31/77
12/31/77
1 yr
1 yr
\l
.-5/8%
15
20
21
GRAND TOTAL
20,400,000
119,250.00
L,174,625.00
John F. Kennedy - Deferred Interest
Revenue Bonds - 12/31/78
Year
Deferred
Interest Deferred
12/31/68
12/31/69
12/31/70
12/31/71
12/31/72
12/31/73
12/31/74
12/31/75
12/31/76
12/31/77
114,176.57
775,852.06
1,152,844.18
1,174,625.00
1,174,625.00
1,174,625.00
1,174,625.00
1,174,625.00
1,174,625.00
1,174,625.00
10,265,247.81
Interest on Deferred Interest Deferred 12/31/72
it
12/31/73
M
ti
12/31/74
n
ti
12/31/75
•i
••
••
12/31/76
II
It
M
12/31/77
H
II
II
II
Deferred
Rate
Interest on Deferred
Interest
5-1/2%
7-1/8%
6-5/8%
5-7/8%
6-1/8%
6-7/8%
7-3/4%
7-1/2%
6-1/8%
7%
6,279.71
55,279.46
76,375.93
69,009.22
71,945.78
80,755.47
91,033.43
88,096.88
71,945.78
82,223.75
692,945.41
6-1/8%
6-7/8%
7-3/4%
7-1/2%
6-1/8%
7%
103,472.16
285,227.76
385,592.64
506,509.50
632,594.59
743,286.79
2,656,683.44
Int. on Deferred
Interest Deferred
Total Int.
Deferred
6,337.66
19,609.41
29,883.43
37,988.21
38,746.42
52,030.08
184,595.21
877,540.62
SUMMARY
Interest
Deferred
Interest
Interest
12/31/78 1,174,625.00
Interest to date
on Deferred Interest
on Deferred Interest Deferred . . .
Principal owed 20,400,000.00
Total Interest owed
Total owed 12/31/78 35,374,096.87
10,265,247.81
3,349,628.85
184,595.21
14,974,096.87
14,974,096.87
o
=r
9
3
w
FOR RELEASE UPON DELIVERY
Expected at 10:00 A.M.
Wednesday, April 4, 1979
TESTIMONY OF THE HONORABLE W. MICHAEL BLUMENTHAL
SECRETARY OF THE TREASURY
BEFORE THE
HOUSE APPROPRIATIONS SUBCOMMITTEE ON TREASURY,
POSTAL SERVICE AND GENERAL GOVERNMENT
Mr. Chairman and Members of this Subcommittee:
I appreciate this opportunity to discuss the current
state of the economy and the prospects for the dollar at
home and abroad.
As I pointed out when I appeared before the full Appropriations Committee earlier this year, the American economy
is at a critical juncture. Since the deep recession of
1974-7 5, we have enjoyed an impressive recovery of employment
and production. We have had less success in maintaining the
value of our currency at home and abroad.
This imbalance in our achievements cannot persist.
Either we shall right the balance ourselves by bringing inflation under orderly control, or events will reassert equilibrium
for us, by bringing the economic recovery itself to a disorderly close. There is no doubt which alternative best serves the
public interest.
Recent Economic Developments
The events of recent months have made it even
clearer that the program of fiscal and monetary
restraint announced last January was the appropriate
and necessary course. Recent economic statistics show
B-1522
-2-
that real growth in the fourth quarter of 1978 was almost
7 percent at an annual rate, much higher than anticipated
in January, more than double our estimate of the economy's
long-term growth potential, and well above the 5 percent
average rate of real growth during the current expansion.
Coming as it did in the fourth year of cyclical recovery,
with only very narrow margins of unutilized skilled labor
and industrial capacity remaining, this unexpected upsurge
in real growth was reflected in a more rapid rise in costs
and prices. In combination, real growth and inflation
added up to more than a 15 percent annual rate of increase
in gross national product at current prices—a rate exceeded only twice before in the current expansion.
The pace of economic activity has slowed somewhat in
the early months of this year. Some of this slowing has
reflected adverse weather, some has reflected a normal let up
in consumer spending following the surge in buying in late
1978. At the same time, we have seen a scramble by businesses
to rebuild inventories, to accelerate ordering as delivery times
lengthen, to borrow more heavily to finance outlays. Worst of
all, we have seen an acceleration in inflation. With worldwide demand for industrial materials quickening, with costs
rising, with capacity limits being reached in some key
-3industries, prices of some commodities are again rising at
a double-digit rate.
The emergence of excess demand pressures after four
years of cyclical expansion threatens to disrupt the
orderly and generally well-balanced nature of the recovery.
The Recent Inflation Record
The rate of advance in prices in recent months is running
far above acceptable levels. Consumer prices rose
0.9 percent in January and 1.2 percent in February.
Over the two-month span, the index was up at an annual
rate of about 13 percent. This compares with a 9 percent
rise in 1978 and just under 7 percent during 1977.
In part, the recent bad news on the inflation front
reflects special unfavorable developments in farm and food
prices. Part of the sharp January rise in food prices was
due to severe weather in the Midwest and strikes in California.
Meat prices rose nearly 5 percent in February alone. Some
of these and other special factors will not be present later
in the year.
But acceleration has also been taking place across
a broad range of other prices. Clearly, the recent acceleration is not all due to special factors.
-4The recent wholesale price statistics have been
particularly disappointing.
The price index for finished
goods rose at a 15 percent annual rate in January and
February, and at a 12-1/2 percent annual rate with foods excluded.
Farther down the production chain at the intermediate
and crude materials levels, rates of increase have been even
faster.
This has built up pressures which will push up
retail prices for the next few months.
With delivery times
slowing and rates of capacity utilization relatively high,
particularly in the materials producing sectors, demand
pressures are clearly a major factor behind the recent deterioration in price performance.
Late last summer, there were some early warning signs
that the economy was entering a zone of excess demand which
could make the control of inflation an even more difficult
task.
Since then, I regret to say, the signs of excess
demand are even more apparent.
The index of crude nonfood
materials prices is often used as a sensitive measure of
demand pressures.
It rose at more than 30 percent, annual
rate, in the.first two months of this year, on top of nearly
a 20 percent annual advance in the final three months of 1978.
More bad price news is possible in the months to come.
Hopefully, however, the policy actions already put in train
will result in some moderation as the year progresses.
-5—
Business firms will have used up a large
part of the price increases that are
allowable under the wage-price program and
the program has been tightened so
as to spread allowable price increases more
evenly throughout the program year.
— The steps taken to moderate the use of six-month
money market certificates should contribute to
a gradual easing of activity in the homebuilding sector where demand and cost pressures have
been intense.
— The most severe feedback effects on domestic
prices from last year's depreciation of the
dollar have already been felt, and the stabilization of the dollar since our November 1 actions
will alleviate some of the pressure on domestic
prices induced by a weakening dollar.
As these measures take hold and some of the special
factors fade from the picture, the latest upsurge in
inflation should begin to moderate. In addition, the
policies of restraint already embarked upon—a reduced budget deficit and tighter monetary policy—will
contribute to a gradual reduction of aggregate
demand pressures. Real growth is expected to taper off
-6during the course of the year.
Indeed, some economists
in the private sector are projecting an actual recession.
We do not expect a recession, but we do expect—and the
economy badly needs—some relief from excess demand.
The Policy of Restraint
While some abatement in inflation is expected, we
have to recognize that significant and enduring abatement
requires persistent application of restraint.
There is no
quick cure for an inflation that has been building for over
a decade.
And there are no easy ways out.
Unless the growth
of aggregate demand is reduced, demand-pull inflation will
merge with cost-push, and inflation will accelerate even
further.
Incomes policies, such as the voluntary wage/price
deceleration program, can play an important part in containing inflationary pressures.
But they can be effective only
in the context of macro economic policies that limit growth
in aggregate demand to our resource availability.
While the inflation rate will be coming down later this
year, there is a real risk that the current temporary burst
of inflation will greatly complicate our task.
If the recent
burst of inflation is built into current wage demands, the
wage-price spiral will be ratcheted upwards another notch.
-7Wage restraint in upcoming negotiations will be crucial
if we are to achieve the progress toward lower rates of
inflation that the situation demands.
Profits grew very rapidly in the fourth quarter
after virtually no growth in the third quarter. But
profits typically show large increases in periods of
sharply rising activity. The Council on Wage and Price
Stability is intensifying its monitoring efforts to insure
business compliance with the standards of the price deceleration program.
The Need for a Strong and Stable Dollar
The dollar's value cannot be protected at home if it
is weak abroad, and we cannot maintain its integrity abroad
if it is shrinking at home. Last year, that maxim received
a sharp and painful illustration. The acceleration in
domestic inflation served to weaken the dollar on the foreign
exchange markets, and this in turn raised the domestic price
level even further--as the cost of imported goods rose and
provided an umbrella for domestic price increases.
The President moved forcefully on November 1st to put
an end to this vicious cycle. He endorsed the imposition of
greater monetary restraint domestically and arranged with
Germany, Switzerland and Japan a program of closely coordinated
intervention in the foreign exchange markets. The U.S. has
mobilized most of the $30 billion in foreign exchange resources being used to finance our share of this effort.
-8-
These funds have been obtained partly through use of U.S.
reserves and partly by borrowing, including the issuance of
foreign currency denominated securities.
Conditions in the foreign exchange market have
clearly improved since November 1.
The severe and per-
sistent disturbances which characterized the markets last
fall have been overcome.
From its low point on October 31,
the dollar has recovered on a trade-weighted basis by about
10 percent.
Against the DM, the Swiss franc, and the
yen, the dollar has appreciated by 9 to 21 percent.
Uncertainties regarding oil supplies and prices are the
principal source of concern in the foreign exchange market
at this time.
These uncertainties have created some nervous-
ness as market participants attempt to assess the potential
consequences for various currencies.
While the dollar has
been quite firm during this period of uncertainty, the continued
long-run health of both our currency and our economy requires
a clear, firm and constructive energy policy.
The Treasury Department has recently concluded an investigation under Section 232 cf- the Trade Expansion Act of 13G2 lo
determine whether crude oil and products are entering the U.S.
in such quantities or under such circumstances as to threaten
to impair the national security.
In 1975, acting under the same Section 232 authority/
Treasury Secretary Simon found that at that time the nation's
-9dependence on imported oil was so great as to threaten
to impair the national security. That conclusion is,
unfortunately, even more valid today.
The nation's dependence on imported oil has increased
dramatically since the 1975 finding. At that time, 37 percent of the United States demand for oil was supplied from
foreign sources. In 1978, oil imports accounted for 45
percent of oil consumed in the United States.
The rising level of oil imports adversely affects our
balance of trade and our efforts to strengthen the dollar;
in 1978, outflows of dollars for our oil imports amounted to
$42 billion, $15 billion more than in 1975 and offsetting
much of the rise in our exports of industrial and farm
products.
Our growing reliance on oil imports has important consequences for the nation's welfare. Recent developments in Iran
have dramatized the consequences of this excessive dependence
on foreign sources of petroleum.
The continuing threat to the national security which our
investigation has identified requires that we take vigorous
action at this time to reduce consumption and increase domestic
production of oil and other sources of energy. To the extent
feasible without seriously impairing other national objectives,
we must encourage additional domestic production of oil and
other sources of energy, and the efficient use of our energy
-10supplies, by providing appropriate incentives and
eliminating programs and regulations which inhibit the
achievement of these important goals. The President
will shortly be announcing additional steps this
nation must take to solve our energy problem. All of
us must unite behind him in support of a program that
will liberate our economy from the continuing threat
to our economic welfare and security posed by our over
dependence on foreign oil.
0O0
FOR IMMEDIATE RELEASE
April 3, 19 79
DAVID J. SHAKOW APPOINTED
ASSOCIATE TAX LEGISLATIVE COUNSEL AT TREASURY
Secretary of the Treasury W. Michael Blumenthal
today announced the appointment of David J. Shakow of
New York City as Associate Tax Legislative Counsel.
Mr. Shakow, 33, has been attorney-advisor to the
Tax Legislative Counsel in the Treasury Department since
August 1977. Before joining Treasury, he was an associate
at the New York law firm of Davis Polk & Wardwell.
Mr. Shakow also served as a law clerk to the Honorable
William H. Hastie, late Chief Judge of the Third Circuit
Court of Appeals.
As Associate Tax Legislative Counsel, Mr. Shakow
will assist the Tax Legislative Counsel in heading a
staff of lawyers and accountants who provide assistance
and advice to the Assistant Secretary of the Treasury
for Tax Policy. The Office of Tax Legislative Counsel
participates in the preparation of Treasury Department
recommendations for Federal tax legislation and also
helps develop and review tax regulations and rulings.
Mr. Shakow was graduated from Harvard College in
1967 with a B.A. degree. He received a J.D. degree
from Harvard Law School in 1970. In 1976, he received
an LL.M. (in Taxation) degree from New York University
School of Law.
o
B-1523
0
o
FOR IMMEDIATE RELEASE
April 5, 1979
Contact:
Alvin M. Hattal
202/566-8381
TREASURY ANNOUNCES FINAL DETERMINATION
IN COUNTERVAILING DUTY INVESTIGATION
ON OLEORESINS FROM INDIA
The Treasury Department today announced a final
determination that exports to the United States of
oleoresins from India are being subsidized.
The Countervailing Duty Law requires the Secretary
of the Treasury to collect an additional duty equal to
the subsidy paid on merchandise exported to the United
States. However, because this merchandise is eligible
for duty-free entry into the United States, the U. S.
International Trade Commission must make an injury determination before countervailing duties can be collected.
As a result of its investigation, Treasury found
that manufacturers of this merchandise received subsidies
consisting of a rebate under the "Export Cash Assistance
Program." The amount of the subsidy has been determined
to be 4.23 percent of the f.o.b. price of oleoresins
exported to the United States.
Notice of this action will appear in the Federal
Register of April 9, 19 79.
Imports of this merchandise from India during 19 78
were valued at about $1.5 million.
o
B-1524
0
o
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION
Tenders for $3,344 million of 52-week Treasury bills to be dated
April 5, 1979,
and to mature April 1, 1980,
were accepted at the
Federal Reserve Banks and Treasury today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS: (Excepting 1 tender of $500,000)
Investment Rate
Price
Discount Rate
High - 90.719 9.230% 10.09%
Low
90.719
9.230%
Average 90.719
9.230%
(Equivalent Coupon-Issue Yield)
10.09%
10.09%
Tenders were allotted 91%.
TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS AND TREASURY:
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Received
Accepted
$
56,235,000
6,155,695,000
8,725,000
50,935,000
9,635,000
22,320,000
284,965,000
45,370,000
14,505,000
34,555,000
5,270,000
273,555,000
$
11,235,000
3,197,595,000
3,725,000
9,935,000
9,635,000
20,870,000
25,245,000
15,430,000
4,505,000
19,910,000
5,270,000
13,195,000
Treasury
7,195,000
7,195,000
TOTAL
$6,968,960,000
$3,343,745,000
The $3,344 million of accepted tenders includes $197 million of
noncompetitive tenders from the public and $ 1,5 99 million of tenders from
Federal Reserve Banks for themselves and as agents of foreign and
international monetary authorities accepted at the average price.
B-1525
For Release
Friday, AMs, April 6, 1979
THE HONORABLE W. MICHAEL BLUMENTHAL
SECRETARY OF THE U.S. TREASURY
ADDRESS BEFORE
THE UNIVERSITY OF CALIFORNIA (BERKELEY)
APRIL 5, 1979
Nothing has given me greater pleasure than being named alumnus
of the year by my alma mater.
ftith the dollar emerging from an all time low, with the
national debt at an all time high, with the nation confronted by
double-digit inflation, it was perfect timing for the University
Fathers to call to the world's attention that it was here at
Berkeley that the Secretary of the United States Treasury received
his training in banking and international finance.
In 1947, right here in San Francisco, I first set foot in this
country. I had $60 in my pocket, a tenth grade education and all
the wisdom a young man could pick up on the streets of Shanghai.
I had learned quite a bit of English and Chinese during my
eight years in Shanghai, not as an intellectual pursuit but as a
matter of sheer survival.
My English helped me survive when the U.S. Navy arrived at the
Vvhangpoo River and then, two years later, it naturally was of great
help when 1^ arrived at the Golden Gate. But it wasn't until a few
weeks ago that my Chinese came in handy.
In the banquet room of the Great Hall of the People, I was
called upon to deliver the toast. The first few minutes were
devoted to the traditional bland pleasantries expected at
international affairs. I decided to make those pleasant opening
remarks in Chinese. Much to my chagrin, the interpreter immediately
translated my Chinese into English so that, as he explained, the
officials at the banquet could understand it.
It was the only lapse of Oriental tact that I ever encountered.
Vvhen I landed in San Francisco, 32 years ago at the age of 21,
the last thing on my mind was a college education. I was more
concerned about where my next meal was coming from. I consulted the
help wanted ads, and hustled up a job at the National Biscuit
Company where I was assigned the task of adding up the cookies that
drivers would take out on their morning rounds. I excelled at it.
iet somehow it left me with a vague feeling that I was capable of
greater achievement! But I went through quite a few jobs before I
h
^t the jackpot.
B-1526
-2-
That vvas at Lake Tahoe, toward the end of my final semester at
Berkeley.
I landed a job handling the stage lights for a famous
striptease dancer.
It was there, in the saloons of Lake Tahoe, that I learned the
difference between appearance and reality.
The stripteaser's name would be immediately recognizable to you
but let gallantry prevail -- she had seen better days.
She came out
on the stage fully dressed and as she discarded each article of
clothing, my job was to change the color of the spotlight. The less
she wore, the darker it became.
It was glamorous and the audience
1ov ed it.
Eetween the acts, I was the bus boy at the club. I had to run
out with the dishes and bring in the new glasses of water. My only
problem was that on the way to the kitchen I would see this famous
stripteaser leaving the stage and walking toward her dressing room.
While the spectators were still wildly applauding her glamorous
stage appearance — I had a direct and unobstructed view of the real
thing.
That was how I learned the difference between appearance and
reality.
Ladies and gentlemen, I got my degree at Eerkeley but T got my
education at Harold's.
In preparing for this occasion, my thoughts went back to the
time I arrived in this country in 1947. Today, the world is beset
by a multitude of seemingly insoluble problems, the energy shortaqe,
inflation, the menace of nuclear power plant failure, pollution, the
rising cost of health care and the threat it all means to our way of
life and standard of living.
It is tempting to look back on the good old days when I arrived
in this country as a lad of 21.
A piece of paper I carried instead of a passport said I was a
displaced person.
I set foot on American soil, after years in Nazi
Germany and war time China. This was the land of milk and honey and
unlimited opportunity.
When I got my first job two days after I
landed, I recall that I felt all was right with the world.
It was a
good world.
Or was it?
I checked the front page of the New York
'limes for that day I arrived in America in 1947.
It w asn't a very go od day for a man named Mikola Petkov in
Eulgaria.
he was hanged that morning by the C ommunist government
for uefus ing to cooperat e.
The head of the Un ited Nations was
plead ing, without too mu ch success, for unity. General MacArthur,
the head of the Allied o ccupying force in Japa n, was telling the
Japanese they could expe ct less food from the United States that
yea., bee a use of world co nditions? President Tr uman was urging
Am e clc a n s to eat less so there'd be enough to go around, the White
house was concerned abou t an Arab Threat of th e Jewish homeland.. ••
in fact, the only bright little bit of news I saw on the front page
:
of the Nc w York Times in 1947 was the price... . it was selling f°
three cents a copy!
-3The day I was graduated from Berkeley in June 1951, things
hadn't changed all that much. There was a national cry to raise the
cultural level of TV, consumer groups were threatening a boycott of
beef, there was national concern over the use of drugs on campus,
the war in Korea, and the H Bomb was tested for the first time.
Income taxes were going up and General MacArthur was saying that our
foreign policy was being set by other countries. That all sounds
familiar. The only thing that had changed between the time I
arrived in the United States and the time I left here with a diploma
is that the price of the New York Times had gone up to five cents a
copy and the incidental fee had gone up from $35 to $42.50.
But the nation and the world have changed greatly since then.
The Gross National Product of the United States was only $290
billion in 1950; today we are a two trillion dollar economy. The
population has increased by 66 million. American women have been
liberated from their traditional place in society and now make up
fully half of the work force. Our music, our art, our literature
. . . all have gone through mutations of sorts. Even the role and
the conduct of the nation's highest office -- the Presidency -- have
changed radically.
Internationally, the difference is equally remarkable. Western
Europe is not only on its feet, but is strong and moving further
toward political, economic and monetary integration. The Cold War
has given way to "competitive coexistence" and detente. China has
shaken off the dogmatism of Chairman Mao to embark on a course of
economic modernization and political adjustment. What once was a
disparate collection of nomadic desert sheikdoms has become a
stronghold of economic power known as OPEC.
We cannot today review the panoply of all the changes of the
last two and a half decades. But here are two which I would like to
share with you. Not only because both are timely, but also because
they are important tests of America's ability to adapt to change.
The first is the problem of inflation. The second relates to the
normalization of our relations with China.
Inflation
There is no question that inflation poses the most serious
threat to America's prosperity. Inflation reduces the living
standards of all people, especially of the poor, the unemployed, the
retired. It distorts business planning and capital formation. It
generates unproductive forms of economic activity. It impairs the
international competitiveness of our industry. It weakens the
dollar and undermines our leadership in world affairs.
We all know this. We know we cannot have growth, we cannot
have reduced unemployment, indeed we cannot sustain a free
enterprise system, if inflation is allowed to continue on its
Present course. The question is: What can we, what are we doing
about it?
-4When President Sadat was in Washington two weeks ago, he
reported to the Chamber of Commerce that World Bank officials had
told him that the Egyptian economy had to be cleaned up. Sadat was
reminded of the old business adage that it takes as long to undo a
mess as it took to make it. To which he replied, "Well, the
Egyptian economy has been in the making 7,000 years!"
Fortunately the history of our inflation has not been that long
in the making. But the problem is nevertheless a deeply rooted one
and has been around long enough to breed a novel psychology of
expectations: Prices which increase in one sector of the economy
are not offset elsewhere, for prices and wages throughout the
economy are flexible only in an upward direction. Rising prices in
turn erode profits and the purchasing power of wages. Higher prices
and enlarged wage demands ensue.
The process became noticeable in the mid-50's and a whole
generation of buyers, sellers and elected officials have come to
expect and accept it. Inflation has become a pattern of behavior, a
way of thinking. Thus labor simply assumes that, try as the
President may, the prices workers pay at the counter will continue
to rise. So they demand still higher wages. Industry raises prices
in anticipation of inflation in order to preserve real profit
margins. In the same way, government budgets for greater
expenditures. Private borrowers expect that inflation will bail
them out regardless of debt levels, so they borrow more. Similarly,
sellers of dollars in the foreign exchange markets take for granted
that inflation wil continue to erode the value of our currency.
Together, these practices become self-fulfilling prophesies.
Add to this the inflationary impact of the Vietnam War, the oil
crisis, the uncontrolled spread of regulatory interference and
costly growth of government bureaucracy and you have a pretty good
picture of what our inflation is all about.
The dilemma we face today is that of exorcising a deeply
engrained psychology of inflation. This is a monumental task. It
will require action on all fronts. In my view, this effort must
respect at least five key principles:
First, it must be a voluntary effort. There must be no
controls, for we cannot afford the distortions and damage
controls have on a free enterprise system;
Second, we must continue to work on the fundamentals. The
size of government must be reduced. Unnecessary regulation
must be eliminated. The energy economy must be rationalized
We must find ways to restore productivity. We must find new
incentives to capital formation;
— Third, we must think ahead and invest in the future. The
President's efforts in the energy area are a case in point;
-5--
Fourth, the burden of wringing inflation from our system must
be shared equally. Sacrifices will have to be made by labor,
by business, by government;
Eifth, the sacrifices must be made over time. It will not
take 7,000 years to do the job well, but it may take five, or
seven, or ten.
The President is striving to provide the leadership needed on all
these fronts. He has outlined in clear relief his anti-inflation
program. It calls for a tight budget and tight money. For reducing
the growth of government. For bringing and end to needless
regulation. For eliminating the existing system of inefficiencies and
disincentives in energy production. And for voluntary wage and price
restraint. This is not an easy job. This surely is a change from the
1940's and 1950's when Presidents waged war on tangible enemies. It
is infinitely more difficult to rouse the people to fight something so
invisible and complex. Yet it must be done.
China
The other change I wish to touch on is that which has taken place
in our relationship with China. It is now easy to forget that thirty
years ago we were arguing over who lost China. Today we are working
hard to develop a new relationship with her.
The process of change begun by President Nixon in the famous
Shanghai Communique of 1972 culminated on March 1 of this year when
the united States joined over 100 other nations in officially
cecognizing the existence of the People's Republic of China. The
opening up of an American Embassy in Beijing now provides us with a
formal diplomatic framework within which to develop our political
relations, promote increased trade and insure the protection of U.S.
citizens and interests.
What are the economic opportunities presented by rapprochement
with China?
There are those who think of China in terms of a huge market with
unlimited potential. Those dreams are really no different than they
were 30 or 40 years ago. One of the first books I read in China in
1^39 was a book by an American named Carl Crow. The title of the book
was
Ipur Hundred Million Customers. Crow had a vision of 400 million
eager customers lining up for whatever we had to sell. Now there are
a billion or so Chinese and there are those who feel similarly today.
There is another school of thought -- which holds that the lack
°f purchasing power, the low per capita income in China, and the lack
of foreign exchange make for no market at all; that the Chinese have
nothing to sell and nothing to buy anything with.
As in most matters, reality lies somewhere between these
' xtremes. There are opportunities which developed properly could
'y^11a mutually profitable economic relationship between our two
untries. But they are certainly not unlimited.
-6The Chinese do have things to sell. They can develop some of
their raw materials — oil, tin, manganese, coal and metals. They can
draw on the skill and intelligence of the people to assemble and
export products from raw materials and components imported from other
countries. They can develop a tourist industry.
Finally, the Chinese have an opportunity to enter the world
market for light manufacturing. I visited a factory in Shanghai last
month which is a case in point: The Forever Bicycle Factory. That
factory is a veritable rabbit warren of small, dank buildings and
bamboo huts where bike parts are made on home made machines and
carried from building to building by hand to be made into bicycles.
Ey American standards the production technology there is turn of the
century. But Forever Bicycle turns out 1,700,000 high quality
bicycles a year. It takes 3,900 people to do so, but it turns them
out. With a little technology and management know-how the Forever
Bicycle Factory could easily export to the United States or anywhere
else.
For our part there is the potential to sell the Chinese the
plants, equipment and technology that they will need to succeed in
their modernization effort. They clearly need and are eager for
American managerial, financial and technical know-how. But though
they need much, they clearly are limited in resources. They will
first have to turn their high hopes and hard work into cash and credit.:
to finance purchases of things they wish to buy from abroad.
To succeed, great obstacles will have to be overcome. China is
still a very poor country, which has lost a whole generation of
teachers, of scientists, of technocrats and which remains difficult to
coorcinate and manage. Whether or not the process of development now
underway can ever be stopped; whether or not a political change of so
fundamental a nature can ever be reversed; whether or not the Chinese
people will have the patience to stay the course and to accept the
inevitable setbacks nobody knows.
But it is clear that the United States has an opportunity to
develop a fruitful relationship after so many years of interruption.
It is, I think, in the interests of both countries that the
opportunity be pursued.
Tonight, I talked about two challenges imposed on us by changes
in our country and in the world. There are many others. But these
two — one in domestic and the other in foreign policy — have special
meaning for this audience. Inflation is the most pervasive and the
most pernicious threat to our economy and to our way of life. The nev
relationship with China, of course, has special significance, not only
to me, but also to the University and to this region of our countryWill we have the courage, the ingenuity and the wisdom to meet
these challenges — and the many others we must face, now and in the
years to come?
-7I have unbounded optimism that we will. For one thing has
remained unchanged: we still have the same precious assets we have
marshalled so successfully in the past in the pursuit of great tasks.
In the world, the United States still stands as the single
strongest and most dynamic power. Our natural resources are vast.
Cur technology remains second to none. The optimism and pragmatism of
our people are unimpaired. And while not perfect, we are still looked
upon by others as the example to follow in maintaining a free society
and a productive free market economy.
Again and again we have shown that the drive and dynamism of
Americans can be harnessed to deal with our critical problems, once we
put our minds to the job. We did it when we sent a man to the moon
and we are doing it in reordering our civil rights. We are doing it
in opening up equal opportunity to women and to our minorities to
share equally in a better life, and we showed that we can stand
together and support our government in providing leadership on such
difficult international problems as promoting the peace process in the
Middle East.
We have the resources and we can harness them to meet the other
challenges of a changing world. So we can lick inflation, solve our
energy problems and establish a new relationship with China, if we
face up squarely to the task.
On the Eerkeley campus today, I sense the same gratifying
preservation of the best things I found the first day I arrived in
this country and at this University. There remains the opportunity
for the highest qualtiy education for all citizens regardless of race,
religion or origin. And although the incidental fee is no longer $35,
it is still being provided at bargain rates.
The University today, as when I first came, is still the meeting
place for students and scholars from all parts of the world, and it
remains an outstanding center of learning and scholarship, as it has
been for so long. It must never be otherwise.
At a critical point in my career, I had the privilege of studying
under Robert Aaron Gordon, an international authority of business
cycles and manpower policy who, as a champion of strong policies to
achieve full employment, gave me much of the background and insight
which I was able to use in business and in the government. And, of
course, there were others equally eminent, like Howard Ellis, still
writing and researching at the age of 81, not to speak of Jack Letiche
who, I understand, is still teaching international economics and
economic development, much as he taught me about these areas in which
I worked ever since.
These, and others like Andrew Jaszi, who introduced me to the
pleasures of German literature and poetry, or Hans Kelsen, the eminent
scholar of international law, or Eob Scalapino, who today, as then, is
still influencing scholars and students with his work on China and the
F
ar East — are what make Eerkeley a great University.
-8In these important ways our alma mater has not changed. Nothing
gave me greater pleasure today than to see that these things have
remained the same. The University still is a place that exudes
vibrancy and excitement, and where all manner of students are welcome
to study.
How this would have pleased George Berkeley for whom the town wa
named, I do not know. For a bit of checking tells us that is was his
aim to find, as he put it, "an educational institution for the
evangelization and education of aboriginal Americans." Happily, that
stricture is being interpreted as liberally today as it was in my day
Obviously, I am glad and proud that this is so and equally pleased
that so many of my fellow "aboriginal Americans" are here with me thi
evening. This diversity has been one of the great strengths of the
University of California and I hope that it will always remain so.
0OO0
Apartment of theTREASURY
TELEPHONE 566-2041
WASHINGTON, D.C. 20220
FOR IMMEDIATE RELEASE
April 5, 1979
RESULTS OF TREASURY'S 76-DAY BILL AUCTION
Tenders for $3,001 million of 76-day Treasury bills to be issued
on April 6, 1979, and to mature June 21, 1979, were accepted at the
Federal Reserve Banks today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Price
High
Low
Average -
Discount Rate
97.974 9.597%
97.968
9.625%
97.970
9.616%
Investment Rate
(Equivalent Coupon Issue Yield)
9.96%
9.99%
9.98%
Tenders at the low price were allotted 71%.
TOTAL TENDERS RECEIVED AND ACCEPTED BY
FEDERAL RESERVE DISTRICTS:
Location
Received
Accepted
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
$
90,000,000
6,954,000,000
$
42,100,000
2,649,650,000
25,000,000
4,000,000
TOTAL
B-1527
477,000,000
5,000,000
60,000,000
193,750,000
1,000,000
20,000,000
495,000,000
90,000,000
$8,106,000,000
$3,000,500,000
CONTACT:
ROBERT W. CHILDERS
(202) 634-5248
FOR IMMEDIATE RELEASE April 6, 1979
REVENUE SHARING FUNDS DISTRIBUTED
The Department of Treasury's Office of Revenue
Sharing (ORS) distributed more than $1.7 billion in
general revenue sharing payments today to nearly 36,500
State and local governments.
Currently legislation authorizes the Office of Revenue
Sharing to provide quarterly revenue sharing payments to
State and local governments through the end of Federal
fiscal year 1980.
- 30 B-1528
FOR IMMEDIATE RELEASE
CONTACT:
ROBERT W. CHILDERS
(202) 634-5248
April 6, 1979
REVENUE SHARING DATA RELEASED TODAY
The Office of Revenue Sharing today released the
data to be used to allocate funds for Entitlement Period
Eleven of the General Revenue Sharing Program.
The U.S. Department of the Treasury's Office of
Revenue Sharing is sending the latest available figures
on population, per capita income, local adjusted tax
collections and intergovernmental transfers to each
eligible unit of local government.
State governments are being provided their most
recent data for population, urbanized population, per
capita income, state and local taxes, general tax
effort, state individual income tax collections and
Federal individual income tax liabilities.
All recipient governments may review the figures
and notify the Office of Revenue Sharing if they
believe the figures are inaccurate.
Data correction
proposals should be received by the Office of Revenue
Sharing by May 15, 1979.
B-1529
-2-
General revenue sharing funds are allocated
according to formulas set by the revenue sharing law.
These formulas use data provided primarily by the Bureau
Census, the Bureau of Economic Analysis, the Internal
Revenue Service and the Bureau of Indian Affairs.
Quarterly payments for Entitlement Period Eleven
will be made in January, April, July and October 1980,
to approximately 39,000 units of State and local government.
Approximately $6.85 billion will be distributed
during the eleventh entitlement period.
Since the General Revenue Sharing Program was
authorized in 1972, more than $45 billion has been
distributed.
-30-
FOR IMMEDIATE RELEASE
April 5, 1979
RESULTS OF AUCTION OF 2-YEAR NOTES
The Department of the Treasury has accepted $2,881 million of
$5,951 million of tenders received from the public for the 2-year
notes, Series R-1981, auctioned today.
The range of accepted competitive bids was as follows:
Lowest yield 9.66%_
Highest yield
Average yield
9.70%
9.68%
The interest rate on the notes will be 9-5/8%. At the 9-5/8% rate,
the above yields result in the following prices:
Low-yield price 99.938
High-yield price
Average-yield price
99.868
99.903
The $2,881 million of accepted tenders includes $730 million of
noncompetitive tenders and $1,408 million of competitive tenders from
private investors, including 18% of the amount of notes bid for at the
high yield. It also includes $743 million of tenders at the average
price from Federal Reserve Banks as agents for foreign and international
monetary authorities. The $743 million for foreign and international
monetary authorities is equal to the aggregate amount of their holdings
of notes that matured March 31, 1979.
In addition to the $2,881 million of tenders accepted in the
auction process, $640 million of tenders were accepted at the average
price from Federal Reserve Banks for their own account in exchange for
maturing short-term bills, and $9 million of tenders were accepted at
the average price from Federal Reserve Banks as agents for foreign and
international monetary authorities. The $9 million is new cash and
represents the amount by which the aggregate tenders from foreign and
international monetary authorities exceeded the aggregate amount of
their holdings of notes that matured March 31, 1979.
1/ Excepting one tender of $25,000
B-1530
-2-
General revenue sharing funds are allocated
according to formulas set by the revenue sharing law.
These formulas use data provided primarily by the Bureau
Census, the Bureau of Economic Analysis, the Internal
Revenue Service and the Bureau of Indian Affairs.
Quarterly payments for Entitlement Period Eleven
will be made in January, April, July and October 1980,
to approximately 39,000 units of State and local government.
Approximately $6.85 billion will be distributed
during the eleventh entitlement period.
Since the General Revenue Sharing Program was
authorized in 1972, more than $45 billion has been
distributed.
-30-
V
/?)' ^0 TREASURY NOTES OF SERIES
DATE
HIGHEST SINCE:
J
LOWEST SINCE: TODAY:
R-1981
April 5, 1979
LAST ISSUE:
Department of theTREASURY
TELEPHONE 566-2041
IN6T0N, DX. 20220
FOR IMMEDIATE RELEASE
April 9, 1979
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $3,000 million of 13-week Treasury bills and for $3,001 million
of 26-week Treasury bills, both series to be issued on April 12, 1979,
were accepted at the Federal Reserve Banks and Treasury today. The details are
as follows:
RANGE OF ACCEPTED
COMPETITIVE BIDS:
13-week bills
maturing July 12. 1979
Price
High
Low
Average
Discount
Rate
97.576a/9.589%
97.550
9.692%
97.561
9.649%
26-week bills
maturing October 11r 1979
Investment
Rate 1/
Price
9.99%
10.10%
10.05%
95.171 9.552%
9.580%
95.157
9.572%
95.161
Discount
Rate
Investment
Rate 1/
10.20%
10.23%
10.23%
a/ Excepting 2 tenders totaling $770,000
Tenders at the low price for the 13-week bills were allotted
%.
Tenders at the low price for the 26-week bills were allotted 83%.
TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS AND TREASURY:
Location
Received
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
$
Treasury
TOTALS
40,470,000
4 ,134,385,000
23,955,000
39,110,000
33,570,000
45,255,000
218,835,000
43,970,000
28,315,000
49,185,000
19,640,000
261,600,000
26,390,000
$4 ,964,680,000
Ac cepted
$
: Received
40,470,000
2 ,394,985,000
23,955,000
39,110,000
33,570,000
45,255,000
148,835,000
29,970,000
28,315,000
49,185,000
19,640,000
120,360,000
< $
60,965,000
. 5,263,050,000
:
21,325,000
86,025,000
:
23,600,000
:
36,240,000
:
271,590,000
:
39,520,000
:
27,650,000
:
21,260,000
:
16,805,000
421,875,000
$
25,105,000
2,550,800,000
11,325,000
25,025,000
21,600,000
36,240,000
95,240,000
15,520,000
17,650,000
20,930,000
12,805,000
143,185,000
26,390,000
25,690,000
25,690,000
$3 ,000,040,000b/- $6,315,595,000
b/tncludes $524,310,000 noncompetitive tenders from the public.
_£ncludes $339,280,000 noncompetitive tenders from the public.
/Equivalent coupon-issue yield.
B-1531
Accepted
$3,001,115,000c
il
FOR R E L E A S E U P O N DELIVERY
EXPECTJd-J A T 10 :00 A. M.
W E D N E S D A Y , APRIL 11, 1979
S T A T E M E N T O F JOHN R. KARLIK
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
F O R INTERNATIONAL E C O N O M I C ANALYSIS
BEFORE THE
SENATE C O M M I T T E E O N C O M M E R C E , SCIENCE A N D TRANSPORTATION
Mr. Chairman and Members of the Committee:
It is a pleasure for m e to testify today regarding the proposed
amendment of the International Investment Survey Act of 1976.
In order for the Department of the Treasury to continue to carry out
the provisions of the Act mandating portfolio investment surveys, we
that Section 9 needs amending. We are currently conducting a survey o
foreign portfolio investment in domestic securities and a feasibilit
of alternative approaches to surveying U. S. residents' portfolio inv
abroad. In order to continue this work during fiscal year 1980,
expenditures for these purposes must be authorized and appropriated.
A year ago when I testified before this Committee I explained our plans
to conduct portfolio investment surveys mandated by the Act. During
the last year we made significant progress. I would like to briefly
summarize this work before presenting our budgetary requirements.
B-1532
-2O n August 9, 1978, the Office of Management and Budget approved our
survey of foreign portfolio investment in domestic securities. The survey
will measure foreigners' holdings as of December 31, 1978. In November
we mailed 10,600 survey questionnaires to banks, brokers, and corporations
in the United States. We also completed a separate mailing to associations
and other interested organizations, so that the survey would receive
maximum publicity. We conducted these mailings well in advance of the
December "as-of-date" to give prospective respondents an opportunity
to organize their data information systems to provide the requested
information at a minimum cost.
Firms were asked to return the completed questionnaire by March 31,
1979. To date over 3,000 completed questionnaires and 2,000 valid
exemptions have been received. A follow-up letter has been printed and
will be mailed to firms who have not responded. We are currently in
the process of identifying these firms and will conduct the follow-up
campaign within a few days.
While we were temporarily delayed by the hiring freeze last fall, our
staffing for the survey is on schedule. All of the permanent staff and
approximately one half of the temporary personnel needed for processing
the questionnaires, analyzing them and writing the report to Congress
have been hired. Installation of the computer facilities required for
entering responses, editing for accuracy and compiling a final data base
is complete. With the completion of necessary software forthcoming,
we plan to begin data processing in a few weeks.
-3The 1976 Act also requires a survey of U. S. portfolio investment
abroad. No such survey has been conducted since 1943. Given changes
in the volume and structure of international financial investment flows,
there is a lot to learn about conducting an outward survey. We have
initiated an analysis of how to best go about surveying U. S. residents'
portfolio investment abroad. Since the Act defines portfolio investment
to mean any international investment other than direct investment, this
is a most difficult, although challenging, technical task. Therefore,
the feasibility analysis must carefully cover all aspects of conducting
such a survey -- information requirements, existing data collection
mechanisms, current data deficiencies, survey coverage and methodology, resource requirements, public reporting burden, and
questionnaire design.
The Act requires that a balance between costs, burden to the public, and
the need for information must be fully considered before implementing any
data collection program. We consider this a sound principle, and each
possible approach will fully take into account those considerations. In th
regard, diverse and responsible views from qualified persons representing
business, labor, academia, and other Federal user agencies will be
actively solicited. We would also appreciate the views of this Committee
regarding the uses to which data resulting from a survey of outward
portfolio investment would be put. Such knowledge is essential to
balancing the costs and benefits of collecting information on U.S.
residents' holdings of foreign securities.
-4Conclusions and recommendations derived from the feasibility study
will not be available for several months. However, a decision to undertake
an outward survey and its particular design will be adopted only after
consultation with the Members and staff of this Committee.
We anticipate that the same staff will be able to simultaneously complete
the survey of foreigners' portfolio investment now under way, analyze the
survey results, and complete the study of the options for conducting a surv
of U. S. portfolio investment abroad. Therefore, the estimated expenditures
for fiscal year 1980, compared to 1979, include no personnel increases, but
additional amounts needed for data processing and for expert advice and
consultation. A firm estimate of expenditures for fiscal year 1981 cannot
be made until the decisions regarding an outward survey are reached.
We, therefore, request that to fulfill Treasury's responsibilities for
conducting portfolio investment surveys, expenditure authorization be
granted in the amount of $1. 6 million for the fiscal year ending
September 30, 1980.
topartmentoftheTREA$URY
WASHINGTON, OX. 20220
TELEPHONE 566-2041
RSCK 595
RELEASE ON DELIVERY
Expected 2 P.M. EST
RCAS^.VI
Dhr:ARTh£iiT
REMARKS OF
THE HONORABLE W. MICHAEL BLUMENTHAL
SECRETARY OF THE TREASURY
AT THE
SIXTH ANNUAL INTERNATIONAL TRADE CONFERENCE
DALLAS, TEXAS
APRIL 10, 1979
Studying the agenda for this conference aroused some twinges
of nostalgia. It was not many years ago when I too attended
conferences on the problems of multinational management in an
interdependent world, when I too was concerned with revising
corporate strategy following a major round of tariff adjustments,
when I too concerned myself with the difficulties of launching
business activities in Socialist countries.
My views on these matters, of course, have broadened since I
moved from the private world of the Bendix Corporation to the
Treasury. But the change in my per spective does not result in
major differences in the concerns o r considerations that go into
policy formulation. The unknown is as much unknown for the
government official as it is for th e business executive. The
frustrations with bureaucratic dela ys in planning and in
implementation of plans is certainl y no less in government than
in a large business organization. And the difficulties of
reconciling disparate views is cert ainly no less when one is
dealing with the Congress and a mul titude of government agencies
and departments than it is when rec onciling employee and
shareholder interests.
What is strikingl y different is the difficulty, in
government policy maki ng, of measuring success. There is, in
government, no single "bottom line" that provides an unequivocal
measure of the perform ance of management. Instead, there are
multiple objectives to be achieved, and no one can be satisfied
with anything less tha n a passing grade in every aspect of
policy. And too, the entire system in Washington is constructed
so as to force decisio n-makers to emphasize the politically
expedient. Just as in flation forces businessmen to concentrate
investment on projects offering quick payouts rather than on
longer-term capital ou tlays needed to enhance productivity, so
too does Washington fo rce policy makers to concentrate their
efforts on projects wi th two to four year returns.
B-1533
-2-
Success in Two Critical Areas . . .
How, then, do we mea.Jire up in managing those areas of
immediate concern to this conference: Inflation, trade and the
dollar? As a summary report card, I would suggest that we've
achieved a remarkable degree of success in two of the three, but
are still failing in the third.
Two successes out of throe would be a good batting average
in most leagues. But it isn't good enough in economic policy.
This is not to denigrate our successes. We have onjoyed a
significant improvement in our trade balance, and the dollar ban
strengthened significantly.
Over the past year, our trade deficit has been reduced by
almost 40 percent. Indeed, between the first quarter and fourth
quarters of 1978, the physical volume of U.P. exports grew at r
22 percent annual rate. The volume of imports rose at only a 1
percent rate. U.S. exports of goods and services continue to
grow strongly. And the recently announced energy program will
significantly reduce oil imports. Thus even taking into account
the recent actions taken by OPEC and the decisions of the new
Iranian government to curtail military purchases, a substantial
reduction in our current account deficit to about $10 to $12
billion can be expected in 1979.
Longer term, the prospect for an improved trade performance
has been enhanced by the President's commitment to trade, despite
considerable political costs. For example, despite the political
capital that he could accrue by giving in to protectionist forces
in the Congress, the President has remained steadfast in his
commitment to a successful MTN. The benefits that that agreement
will bring to the United States through reductions in trade
barriers and the interventionist practices of foreign governments
will continue to assure a vital free trading system.
On the foreign exchange front we have met with striking
success in the dollar's sharp recovery from last year's lows. Cn
a trade-weighted basis, the dollar now stands 11 percent above the
levels reached just before the November 1 action. Since November
1, the dollar has risen by 21 percent against the Japanese yen, by
16 percent against the Swiss franc and 10 percent against the
German mark. We have in place the resolve and the tools to
assure that the strength of the dollar is maintained.
. . . Failure in the Third
Thus, on the trade and foreign exchange fronts, we have
clearly made progress. But continued progress in our
international economic affairs is threatened (as is the domestic
progress we have made in creating new jobs and in reducing
unemployment) by insufficient progress in the third vital a r e a inflation. The modest abatement in inflation that we enjoyed in
late 1978 has been succeeded by a reacceleration in prices this
year. The increase in consumer prices thus far this year — at
an annual rate of 13 percent — has been one and a half times its
rate during 1978. The increase in February alone was the largest
monthly rise in 4-1/2 years. Worse yet, the course of wholesale
prices does not offer much hope of an early reversal of inflation
trends. Sharp increases recorded in materials prices and for
goods at intermediate stages of processing are yet to carry
through to the retail level.
What is most alarming about the recent burst in inflation is
that it comes on the heels of a sharp rise in prices last year.
A sporadic surge in inflation reflecting transient factors that
push prices up from a base of reasonable stability is annoying
but not alarming. But the 9 percent Increase in prices last
year, and the even more rapid rise so far this year, come after a
decade of inflation, a decade in which each successive wave of
demand pressures brought the rate of inflation to new crests.
Moreover, even when market pressures abated, each cyclical trough
in inflation was higher than the preceeding one.
The generation which has recently entered the labor market
as full-time participants in our economic life has grown up in an
environment of ever upward-trending inflation.
Is it any wonder that this generation prefers to spend,
rather than save?
Is it any wonder that this generation is willing to incur
record debt-repayment burdens in order to acquire the houses and
other tangible assets that seem to offer the best insulation
against inflation?
business
Is it any wonder that today's generation of
on quick pay-out
executives increasingly focuses investment plans
outlays we need
projects, rather than on the longer-term capital
to restore productivity growth?
Is it any wonder that businesses have begun to scramble for
inventories, to over-order to guard against the prospect of
higher prices?
Is it any wonder that our export performance is lagging
others?
Inflation is distorting our economic behavior and thwarting
us, individually and collectively, in achieving our legitimate
and otherwise attainable goals. We must not, and cannot
reconcile ourselves to living with inflation.
What Must Be Done?
So what do we do? First, with your cooperation, and with
the full range of government policies all directed to the same
end, we must contain inflationary pressures without putting the
economy through the wringer of a severe recession. For those who
-4are skeptical that anything short of a recession will prove
futile in ending the spiral of costs and prices — and I
recognize that there are many skeptics in the business community
— I would remind you that the last effort to cure inflation by
recession achieved only limited success and that at great
economic cost. The 1974-75 recession, the worst economic
downturn since the Great Depression of the 1930's, did cut the
inflation rate in half, but it still left us with an underlying
rate of inflation double that of the mid-1960's. Six is better
than twelve, but it is still not an acceptable inflation rate for
the long term.
Our objective must not be, and is not, only to bring the
rate of inflation down from the double-digit range.- It is to set
in place a complex of policies dedicated to continued, persistent
reduction in inflation over time.
This is why the President is pursuing a policy of
continued reduction in the share of the nation's
output absorbed by Government spending.
This is why the President has submitted the first
proposal ever to the Congress to begin a longoverdue process of evaluating the costs of
regulatory interference.
This is why we are continually reviewing our tax
structure to seek ways to encourage investment in
more .efficient capital equipment.
This is why the President has taken action to
deregulate the price of oil.
With inflation and inflationary expectations so deeply
embedded in our society, success in containing inflation will not
come easily or rapidly. There is no "quick-fix" to a problem
that has been festering so long. We must summon the resources of
character that.will support persistent pursuit of the objective.
We must develop priorities and stick to them. And we must
develop the patience to stay with the long cure.
We must learn to avoid grasping for new policies with every
jiggle of an economic curve. The current situation is a case in
point. After racing at an unsustainable 7 percent pace in late
1978 economic activity has moderated in the early months of this
year.
But almost all of the moderation has been in consumer
spending for homes and goods and, consequently, in industries
directly serving the consumer. This is not an unusual
development; frequently after a buying surge the consumer has
wisely retrenched to catch up on the bills that come rolling in a
month or so after a spending spree. Business spending for
materials and ordering of new capital goods continues apace.
-5Because of the slowdown in consumer spending,and the drop in
housing starts — both in part weather related — the voices of
alarm are beginning to sound. Concern is expressed £hat the
economy is too fragile to withstand fiscal austerity and monetary
restraint* Myopic monetarists, guided only by the monetary
aggregates, are widely predicting recession, despite the evident
ability of the banking system to obtain funds in sufficient
quantity to support a very rapid rate of expansion in bank
credit.
This is typical of the obstacles we will face in maintaining
policies appropriate to the longer-run eradication of inflation.
We must not panic and reverse course at the first signs of a
pause in the pace of economic activity, however attractive this
might be in political terms. The inflation problem won't be
solved unless we persevere with our policies of fiscal and
monetary restraint.
This is not to deny that austere policies run the risk of
recession. But we can be sure that there is no viable
alternative: encouraging inflationary forces, or passively
accepting them, will assuredly lead to recession.
We therefore must take the risks entailed in maintaining
and, if necessary, intensifying our anti-inflation measures. And
we must demonstrate patience in waiting for these measures to
yield the desired results.
It is somewhat out of character for roe to be counseling
patience. I have not been known among my colleagues — either at
Bendix or at the Treasury — for that quality. Indeed, like most
CEO's I have constantly prodded for a faster pace of progress,
criticized efforts that seemed too timid, pushed for success that
is always so slow in coming. But I do recognize that we are in a
long-term struggle, that success will come only if we exercise
patience and persistence.
Is It All Bad News?
While I am not renowned for my patience, neither am I
identified with gloom and despair. I see some evidence to
support my optimism that inflation wi}J. indeed be' brought under
control.
One neartening factor is the reduction in domestic price
pressures stemming from the renewed strength of the dollar. The
decline in the exchange value of the dollar last year was costly
to us in terms of the impact on our price levels, for it directly
raised the costs of imported goods, and provided an umbrella
permitting increases in the prices of import-competing goods
produced here. Estimates of the price effects of depreciation
vary, but most analysts conclude that the decline in the dollar's
value contributed about one percentage point of the 9 percent
inflation from which we suffered in 1978.
This influence on our price structure should be reversed
this year as the dollar strengthens. Exchange markets have,
belatedly, recognized the major improvement that has .taken place
in our international trade balance and that the improvement has
been real, not just a reflection of inflated values.
Similarly, the exchange markets now know that the
President's commitment to a national energy economy is real and
not just rhetorical. There is no doubt in my mind that the
markets agree with the President that the program he announced
last week will make a significant contribution to curbing long
run inflation, improving our trade balance and, through this, to
sustaining the strength of the dollar.
Oil Policy is Key
As many of you know, the Treasury Department recently
concluded an intensive year-long study of the effects on our
economy and on our national security of our heavy dependence on
imported oil. The results of this investigation are summarized
in this excerpt from my report and recommendations to the
President:
"The continuing threat to the national
security which our investigation has
identified requires that we take vigorous
action at this time to reduce consumption
and increase domestic production of oil and
other sources of energy. To the extent
feasible without impairing other national
objectives, we must encourage additional
domestic production of oil and other
sources of energy, and the efficient use of
our energy supplies, by providing
appropriate incentives and eliminating
programs and regulations which inhibit the
achievement of these important goals."
The President's program will achieve these goals. We are
ending the subsidization of oil imports which, by keeping
domestic oil prices artificially low, has encouraged excessive
use of imported oil and been a deterrent to increased domestic
output. We will be dismantling the existing system of
entitlements that has saddled us with channeling huge sums of
money under rules and regulations so intricate that it takes a
hoard of lawyers, accountants and bureaucrats to administer.
The phased decontrol path — with complete abolition of
controls by September 30, 1981 — provides major incentives to
encourage higher domestic oil production, even after taking
account of the windfall profits tax proposed by the President.
The program recognizes the additional costs associated with new
exploration for oil, and will immediately permit the price of
newly discovered oil to rise to the world level. Incremental
-7production resulting from enhanced recovery methods will also be
permitted to receive the world price. In addition, production
from marginal wells will enjoy a much higher price than under
present conditions. These substantial incentives for increased
domestic production should -result in significant savings in our
oil import bill*
At the same time, by raising the price of domestic oil to
its true replacement cost, we will be encouraging more prudent
use of the important national asset represented by our domestic
oil reserves. The conservation benefits flowing from the gradual
rise in oil prices will be supplemented by a number of specific
measures, both mandatory and voluntary, to reduce energy use.
Finally, the program provides major incentives to encourage
greater use of alternative energy sources, and will provide the
funding for development of new energy sources and technologies.
While decontrol will provide the incentive to increase
production, the President's program calls for a windfall profits
tax to make sure the American people recover some part of the
additional oil company revenue* I know well that the business of
taxing is a controversial one. Let me comment on it briefly. We
anticipate that the tax proposed by the President will result in
a net increase of $1*6 billion in tax receipts in FY 81 and $3.0
billion in FY 82. Those tax receipts will be placed in an Energy
Security Fund. The Fund will be used to give financial assistance to people hit hardest by energy price increses, to help
finance additional energy-saving mass transit and to help pay for
an increased commitment to finding and developing alternative
energy sources. I feel as the President does that this is a
reasonable and just approach.
I can assure you that within the Congress what is considered
Texas' gain in this program is considered with equal vehemence to
be New England's loss. Not everyone is pleased; nor can they be
when they focus only on their own immediate interests. But the
implications for our trade balance and for the dollar are clear.
We expect that import savings in the first full year of the
program's operation (1980) will be over a million barrels a day.
And these savings will mount steadily and sharply in the years
beyond.
In the short-run, to be sure,, the effect of decontrol will
be a modest upward push to the inflation rate. There is no way,
in our market-based economy, to provide production and
conservation incentives without permitting prices to adjust to
clear the market. There is no free lunch.
In the longer-term, by encouraging domestic production, by
encouraging domestic conservation and alternative energy source
use, by investing the recaptured "economic rents" in research on
new energy technologies, and by freeing ourselves from the
inflationary results of dependence on a cartel's pricing
-8decisions, we will be reducing the rate of inflation in this
country. The cost of phased decontrol is trivial relative to the
costs we are already paying for excessive dependence on imported
oil, and the even higher costs to which we would remain exposed
unless we reduce this dependence.
This program deserves — a,nd needB — your full support.
Our efforts to curb inflation deserve — and need — your full
support. The President has made some tough decisions. He will
stick to them. Cattle raiser or oil producer, investment banker
or industrialist, labor leader or management executive, your
interests will best be served by the success of these programs.
0OO0
FOR RELEASE AT 4:00 P.M.
April 10, 1979
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling
approximately $6,000 million, to be issued April 19, 1979.
This offering will result in a pay-down for the Treasury of about
$8,207 million as the maturing bills are outstanding in the
amount of $14,207 million ($8,002 million of which represents two
issues of cash management bills; $4,001 million of 48-day bills
issued March 2, and $4,001 million of 15-day bills issued April 4 ) .
The two series offered are as follows:
91-day bills (to maturity date) for approximately $3,000
million, representing an additional amount of bills dated
January 18, 1979, and to mature July 19, 1979 (CUSIP No.
912793 2C 9 ) , originally issued in the amount of $2,911 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $3,000 million to be dated
April 19, 1979, and to mature October 18, 1979
(CUSIP No.
912793 2R 6 ) .
Both series of bills will be issued for cash and in
exchange for Treasury bills maturing April 19, 1979.
Federal Reserve Banks, for themselves and as agents of foreign
and international monetary authorities, presently hold $3,429
million of the maturing bills. These accounts may exchange bills
they hold for the bills now being offered at the weighted average
prices of accepted competitive tenders.
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington,
0. C. 2U226, up to 1:30 p.m., Eastern Standard time,
Monday, April 16, 1979.
Form PD 4632-2 (for 26-week series) or
Form PD 4632-3 (for 13-week series) should be used to submit
tenders for bills to be maintained on the book-entry records of
the Department of the Treasury.
B-1534
-2Each tender must be for a minimum of $10,000. 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 in and borrowings on such
securities may submit tenders for account of customers, if the
names of the customers and the amount for each customer are
furnished. Others are only permitted to submit tenders for
their own account.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury. A
cash adjustment will be made on all accepted tenders for the
difference between the par payment submitted and the actual issue
price as determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit
of 2 percent of the par amount of the bills applied for must
accompany tenders for such bills from others, unless an express
guaranty of payment by an incorporated bank or trust company
accompanies the tenders.
Public announcement will be made by the Department of the
Treasury of the amount and price range of accepted bids. Competitive bidders will be advised of the acceptance or rejection
of their tenders. The Secretary of the Treasury expressly
reserves the right to accept or reject any or all tenders, in
whole or in part, and the Secretary's action 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 weighted average price
(in three decimals) of accepted competitive bids for the
respective issues.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
or at the Bureau of the Public Debt on April 19, 1979,
in cash
or other immediately available funds or in Treasury bills maturing
April 19, 1979.
Cash adjustments will be made for differences
between the par value of the maturing bills accepted in exchange
and the issue price of the new bills.
-3Under Sections 454(b) and 1221(5) of the Internal Revenue
Code of 1954 the amount of discount at which these bills 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 these
bills (other than life insurance companies) must include in his
or her 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 Circulars, Public Debt Series Nos. 26-76 and 27-76, and this notice, prescribe the terms of
these Treasury bills and govern the conditions of their issue.
Copies of the circulars and tender forms may be obtained from any
Federal Reserve Bank or Branch, or from the Bureau of the Public
Debt.
department of theTREASURY
NGTON, D.C. 20220
TELEPHONE 566-2041
FOR IMMEDIATE RELEASE
April 10, 1979
RESULTS OF AUCTION OF 14-YEAR 10-MONTH 9% BONDS
The Department of the Treasury, has accepted $1,500 million of
the $2,649 million of tenders received from the public for the
14-year 10-month 9% bonds maturing February 15, 1994, auctioned today.
The range of accepted competitive bids was as follows:
High
Low
Average -
Price
Approximate Yield
99.09
98.69
98.79
9.10%1/
9.15%
9.14%
The $1,500 million of accepted tenders includes $107
million of
noncompetitive tenders and $1,393 million of competitive tenders from
private investors, including 65% of the amount of bonds bid for at the
low price.
1/ Excepting two tenders totaling $7,000.
B-I535
)epartmentoftheJREA$l\RY
\\mm\WML\D.C.
20220
TELEPHONE 566-2041
ASHINGT0N,D
FOR RELEASE ON DELIVERY
EXPECTED AT 11:00 A.M.
April 12, 1979
DEPARTMENT OF THE TREASURE
OFFICE OF THE SECRETARY
NEW YORK CITY LOAN GUARANTEE PROGRAM
INTRODUCTORY STATEMENT OF THE HONORABLE ROGER C. ALTMAN
ASSISTANT SECRETARY OF THE TREASURY (DOMESTIC FINANCE)
BEFORE THE SENATE SUBCOMMITTEE ON HUD - INDEPENDENT AGENCIES
OF THE SENATE APPROPRIATIONS COMMITTEE
Mr.
Chairman and MemDers of this distinguished
Subcommittee:
I appear oerore you today to discuss the activities ana
plans of tne Treasury Department as they relate to the
administrative expenses of its Office of New York Finance.
iviy testimony this morning will cover three major areas:
— A brief history of the New York City Loan Guarantee
Act and its administration oy Treasury's Office of
New York Finance;
-- A review of Treasury's additional responsibilities
imposed by P.L. 95-497 in monitoring pension fund
participation in the City's Four Year Financial Plan;
and
-- The level of appropriations Treasury believes necessary
to enable it to effectively carry out its statutory
responsibilities in the 1980 fiscal year.
B-1536
- 2 The Guarantee Act
The New York City Loan Guarantee Act of 1978 (P.L. 95-339),
authorizes the Secretary of the Treasury, during the 1979 - 1982
period, to issue up to $1.65 billion of Federal guarantees of
City long-term debt. These Federal guarantees are the core of
an overall four-year $4.5 billion long-term borrowing plan.
Only ^750 million of the Secretary's guarantee authority is
actually scheduled to be used as part of the $4.5 billion plan.
The balance of $3.75 billion in long-term financing will be
provided on an unguaranteed basis by the local clearinghouse
banKs, City and State employee pension funds, local savings
banks and insurance companies, and by the public markets.
Tue remaining $900 million of guarantee authority, therefore,
is on a standby basis in 1981 and 1982, to be used only if the
public markets are net available to tne City or tiAC long-term
bonds in those years. Table I presents this four year borrowing Plan in detail:
Table I
Bond Issues per Four Year Plan ,
($ in millions)
1979
Guaranteed
City:
$
500
1980
$
1982
250
Unguaranteed
City:
NAC Private
Placements:
401
537
MAC Public
Issues :
500
500
$1,401
$>i,237
Total
1981
!
Total
$
750
$300
$650
950
537
325
1,800
1,000
$837
.*•
4~.
—'
I—
:?9 / 5
$4,500
Backed up by standby guarantee authority up to $900 million
if City and/or MAC bonds cannot oe sold puolicly.
- 3On November 17, 1978 Treasury issued the first $200 million
of guarantees and issued the next $150 million on February 15,
1979. Prior to the extension of each round of Federal guarantees,
the Guarantee Act requires that the Secretary make a series of
fourteen findings the most important of which are as follows:
— the City has the capacity to repay the Federally
guaranteed City indebtedness;
— the City is unable to obtain credit elsewhere in
sufficient amounts and on reasonable terms;
— that a financing plan satisfying the City's shortand long-term needs exists and is sound; and
— that the City is making substantial progress towards
truly balancing its budget in accordance with generally
accepted accounting principles (GAAP) by its fiscal year
1982.
The Guarantee Act also requires the City to obtain both its
long- and short-term financing in the public credit markets as
soon as practicable. In January, 1979 the City re-entered the
puolic credit markets for the first time in four years by
successfully selling $125 million of its short-term notes. A
puolic sale of another $150 million in notes took place on
March 1, 1979, at an interest rate more favorable to the City
than its initial public issue. Both' issues were oversubscribed.
Treasury has provided the staff of the Subcommittee with
copies of the Secretary's findings, and supporting documentation,
prepared in connection with the most recent issuance of $150
million of Federal guarantees on February 15, 1979. The same
determinations must be made anew in Hay when another $150
million in guarantees are scheduled to be issued, and thereafter
whenever the Federal guarantees are requested pursuant to the
Guarantee Act.
In order to carry out these responsibilities, the staff
of the Office of New York Finance must monitor, on a continuous
basis, the fiscal activities of the City, the State and Federal
governments as tney relate to the City. This involves:
review and analysis of monthly and quarterly City
financial statements and related reports;
tracking the City's daily cash flow requirements and
assessing the time schedule and amounts required for
seasonal financing;
- 4 —
studying the effects of urban legislation enacted by
the 95th Congress and proposed to the 96th Congress;
— contact with (1) credit rating services with respect
to investment grade rating of City securities, and (2)
the financial community and the City's financial
advisor with respect to receptivity of the public
markets to the City's deot securities;
— meeting with the City and agencies assigned to monitor
the City, e.g., Financial Control Board, Office of the
Special Deputy Comptroller (State), MAC and GAO; and
— liaison with New York State officials with regard to
the State's commitment of continued support for New
York City, along with other cash flow and budgetary
matters.
The Secretary's November 9, 1978 report to Congress covering
Treasury's activities under the Guarantee Act is included as
Exhibit I. The next such report is due to be submitted to
Congress on May 8, 1979.
Companion Legislation
The companion legislation to the Guarantee Act is P.L.
95-497. This affords certain City, and State pension funds with
protection in purchasing City and MAC indebtedness pursuant to
the City's Four Year Financing Plan. The funds' tax exempt
status for failure to satisfy certain sections of the Internal
Revenue Code is assured, provided they comply with the requirement of P.L. 95-497. Without this legislation, the pension
funds would not have committed to purchase securities as part
of the City's $4.5 billion of the Four Year Financial Plan.
Treasury's responsibilities under P.L. 95-497 are several.
Initially, the Secretary was required to not disapprove the
purchase agreements entered into by each of the participating
City and State pension funds for the purchase of City or MAC
indebtedness. P.L. 95-497 imposes standards that must oe
satisfied in order for the Secretary to make that determination.
Ine two most significant are:
-- that the issuance of indebtedness by the City will not
jeopardize their aoility to make future pension fund
contributions; and
- 5—
that the purchase of City indebtedness will not endanger
the ability of the pension funds to pay future pension
benefits.
The staff of the Subcommittee has been provided with
copies of the determinations made by the Secretary in regard
to the Guaranteed Bond Purchase Agreement, the Bond Purchase
Agreement, and the Loan Agreement. These agreements put
into place the City's $4.5 billion Four Year Financial Plan.
In addition, the Treasury has an ongoing monitoring
function under P.L. 95-497. Whenever an acquisition of City or
MAC indeotedness is made pursuant to one of the purchase
agreements, the Secretary must find that the acquiring fund
does not hold more than 50 percent of its assets in City and
MAC indebtedness, and does not have a negative cash flow.
This, too, requires extensive monitoring by Treasury's Office
of New York Finance.
Structure of the Office of New York Finance
In order to carry out its responsibilities, Treasury's
Office of New York Finance maintains two offices-one in
Washington and one in New York City. In addition, the services
of an accounting consultant—currently Arthur Andersen & Co.
are used, although reliance upon such outside services, has
decreased and will continue to do so.
The Washington office has several responsibilities:
— Analysis of Federal aid to New York City;
-- Economic forecasting and impact of national economic
trends on New York City's economy;
-- Preparation of tne Secretary's determinations with
respect to the Guarantee Act and P.L. 95-497;
-- Preparation of testimony and background materials in
conjunction with Congressional oversight and requests;
and
— Administration of the office, e.g., budget, contracts,
procurement.
- 6 The staff located in New York City has primary responsibility for Treasury's day-to-day dealings with the City,
State, and State agencies monitoring the City's finances.
In addition, the New York Office conducts reviews of the City's
budget and programs, audits and verifies the reports received
from the City and its monitors and, if necessary, recommends
changes and improvements to the reports. In addition, the
office inspects accounts, books, records and other financial
documents of the City or any financing agency participating
in the financing needs of the City.
Administrative Expenses
Our appropriation under the New York City Loan Guarantee
Act of 1978, in fiscal year 1979, is $1,050 million. In
addition, we are requesting a supplemental of $34,000 to
accommodate the FY 1979 civilian pay increase as authorized
oy Executive Order 12087 dated October 7, 1978. This increase,
coupled with a $50,000 reduction, amounts to a request
for $1,034 million for fiscal year 1980.
The fiscal year 1979 budget is on track. Even with several
large obligations yet to be incurred such as an upgrading
of communications equipment, involuntary relocation of both
Wasnington and New York offices and additional consulting
contracts, the Office will be able to operate within its budget.
Presently, our professional, secretarial and clerical staff
totals 16.
The administration is requesting that you appropriate only
$1,034 million to fund 1980 requirements. Of this amount,
approximately 66 percent, $683,000, is allocated for personnel
compensation and benefits, $25,000 for travel, $20,000 for rent,
utilities, communication, supplies, equipment and $306,000 for
services provided to the Office by Treasury oudget and personnel
offices, and consultants.
Last year, before this Subcommittee, I committed to
decrease Treasury's dependence upon outside experts while
increasing the internal capabilities of its Office of New
York Finance. Thus far, consulting expenditures contracted to
date have been reduced. We project that approximately 32 percent
of our FY 1979 appropriations will be spent on outside consultants
versus 55 percent in FY 1978. Our FY 1980 budget allocates only
rougnly 25 percent of the requested appropriation for consulting.
- 7 Finally, let me note that the Guarantee Act requires the
City to pay to the Treasury a guarantee fee of .5 percent per
annum on the outstanding principal amount of Federally
guaranteed City bonds. Over the maximum period during which
guarantees will be outstanding - Fiscal years 1979 - 1993 approximately $25 million in guarantee fees may be paid by the
City to the Federal Government. This should offset by a more than
3 to 1 ratio the Treasury's administrative expenses under the Act
over that same period. In fiscal year 1980, for example, we expect
to receive $3,618 million in guarantee fees compared to the $1,034
administrative budget. To date, we have received approximately
$462,000 in guarantee fees from the City.
This concludes the prepared portion of my testimony. I
will be pleased to respond to any questions.
Thank you.
EXHIBIT 1
THE SECRETARY OF THE TREASURY
WASHINGTON 20220
NOV 91978
Dear Mr. Chairman:
On August 8, 1978, President Carter signed the
New York City Loan Guarantee Act of 1978 (Public Law
95-339). Section 108 of the Guarantee Act entitled
"Reports to Congress" requires that "within three months
after the date of enactment of this title, ... the
Secretary shall transmit to the Committee on Banking,
Housing and Urban Affairs of the Senate and the Committee
on Banking, Finance, and Urban Affairs of the House of
Representatives a report containing a detailed statement
of his activities under this title."
I welcome this opportunity to relate the efforts of
the Department of the Treasury in connection with the
Guarantee Act over the past three months.
Background
In the spring of 1978 the Administration requested
Congressional authority, subsequently granted in the
form of the Guarantee Act, to provide Federal guarantees
for New York City indebtedness based on the following
principles:
— Preserving New York City's Solvency: We were
convinced that the effects of a bankruptcy would be
extremely serious for the residents of the City and
State, the market for all municipal securities, and for
foreign confidence in the United States. A concerted
effort in the form of the City's $4.5 billion Pour-Year
Financial Plan, the cornerstone of which was the availability of Federal guarantees up to $1.65 billion of City
indebtedness, was generated to prevent bankruptcy and to
allow the City to achieve financial self sufficiency
within a reasonable time.
Maximum Budget and Financing Efforts by the
Local Parties: Primary responsibility for New York City's
financing rests with the local elected officials and the
relevant private parties at the City level. Beyond that,
the City is the responsibility of New York State. The
Federal financing assistance in the form of guarantees
was provided only under extraordinary circumstances and
was limited to issuance over a four-year period.
- 2 — A Truly Balanced City Budget is a Prerequisite
to Ending this Crisis: New York City lost access to conventional borrowing sources because it incurred large budget
deficits, financed operating expenses with capital borrowings, could not control its chaotic record keeping
systems and otherwise lost control of its finances. In the
past three years, these deficits have been reduced significantly. The City has also installed an integrated, databased financial reporting and record keeping system. We
believe that achievement of true budget balance is the key
to restoring the City's access to the credit markets. The
financing plan is conditioned upon achievement of a budget
balanced in accordance with Generally Accepted Accounting
Principles ("GAAP") by 1982.
— The New York City Financing Crisis Should be
Resolved Once and For All: The only acceptable plan for
future financing of the City is one which will restore
permanently the ability of New York City to finance itself.
Four-Year Plan - Financing
The overall objective of the Four-Year Financing Plan
is to enable the City to return fully to the credit markets
for seasonal and long-term needs after Guarantee Act authority
expires on June 30, 1982. In order for this to occur, it was
necessary for the City to take several fundamental steps to
reform its finances. These include:
— An accelerated phase-out of the "capitalized
expense items" over a period of three years instead of the
eight permitted under State law. This would enable the City
to return to the capital markets that much earlier by reducing
the time the City would be operating at a deficit, according
to GAAP. This is one of the key factors restricting market
access.
Elimination of the need for the State to advance
$800 million in aid in the last quarter of each City fiscal
year (which, in fact, was the rolling over of prior years'
deficits). This action would also reduce to below $1 billion
annually the amount of City seasonal borrowing. The
exceedingly high level of short-term borrowing is another
element blocking market access.
In addition to these basic reforms, the City needed
sufficient long-term funds during the Plan period in order
to maintain its physical plant and to make needed investments
for future economic development. Funds were also needed by
MAC in order to issue refunding bonds so as to lower MAC debt
service in the later years of the Plan and, thus, reduce the
City's overall debt service burden during FY 1979-1982.
- 3The Four-Year Financing Plan, covering FY 1979-1982,
has evolved to include the following elements:
Amount
Purpose
City expenditures for bricks
and mortar
Phase-out of capitalized
expense items
($ in millions)
$2,300
900
MAC Refunding bonds 600
Bonding out the State advance 400
Bonding the MAC capital reserve
fund
300
Total City Financing Plan $4,500
Most significantly, the participants reflect the overwhelming involvement of local parties. In fact, over 80
percent of the $4.5 billion will be privately placed with
or underwritten by New York institutions. The components
of the $4.5 billion in financing will be supplied in the
following approximate amounts:
Amount
Sources
($ in millions)
MAC Bonds
New York Financial Institutions:
City & State Pension Funds $625
Clearinghouse Banks 625
Savings Banks 300
Insurance Companies 250
1,800
Public Issues 1,000
City Bonds
Public Issues 950
Guarantee Bonds purchased by City
and State Pension Funds
Total $4,500
750
- 4 Last week, agreement was reached on the remaining
major open issues in the Four-Year Financing Plan. All
parties are proceeding to complete the formal documentation as soon as possible and the first closing is
expected during the next two weeks. Copies of all the
final documents will be forwarded to you when available.
Finally, a discussion of the City's short-term,
seasonal financing is appropriate. The City's seasonal
financing is no longer of the large dimension ($3 billion)
it was in the recent past. The reduced seasonal needs of
the City are now estimated to peak at $800 million for
FY 1979.
Four-Year Plan - Budget
The Treasury's Office of New York Finance commenced
its review of the City's FY 1979 Budget and Budget Plan
for the subsequent three years with the submission of the
initial Plan to me on January 20, 1978. My staff and our
consultants, Arthur Andersen & Co., reviewed both the
assumptions underlying the projections of baseline estimates and the estimates, themselves. Reports prepared by
the New York State Financial Control Board and by the
Special Deputy State Comptroller for New York City were
also analyzed. Similar studies have been conducted of the
Executive Budget and Budget Plan, issued by the City on
April 25, 1978, as well as the major updates to that Plan
issued on August 24, September 25 and on October 6, 1978.
The latter two modifications were in response to
my requests for the formulation of detailed, recurring
programs for City initiated actions to close projected
budget gaps instead of reliance on third party actions,
such as Federal or State aid. The Financial Control Board
has scheduled a meeting for November 9, 1978 to review the
last two plan revisions.
In conducting budget reviews our staff assesses the
reasonableness of the budget gaps presented and the City's
plans to close those gaps. Our consultants have confirmed
to us that the plans and modifications were developed on
a consistent basis especially as related to assumptions
made by the City and methodologies used.
Our staff has participated in many meetings with
key City internal accountants, staff of the City's
independent auditors and staff from the various other
monitoring agencies to discuss and resolve accounting
- 5 issues raised relative to the City's budget and treatment of items therein. Most of these issues have been
resolved and are reflected either in the City's Audited
Financial Statements for its fiscal year ended June 30,
1978 (appended hereto) or in the revised Plans.
Current General Activities
During the past three months, the Treasury has been
especially active in assisting efforts to formally implement the City's Four-Year Financing Plan in conformity
with the requirements of the Guarantee Act.
The Deputy Secretary, the General Counsel and the
Assistant Secretary for Domestic Finance have been actively
lion mas:
has regu
__ ___,
many of the most seniorTreasury officials.
A Special Assistant to the General Counsel has
devoted all of his time to the drafting, preparation and
review of the various financing documents, certifications,
legal opinions and other corrollary instruments. He also
participated on numerous occasions in key stages of negotiation, tracked the enactment of relevant local, State and
Federal legislation and had discussions with members of the
underwriting industry and the fating agencies. Among the
parties to this negotiation are the following:
1. New York City
2. Municipal Assistance Corporation
3. 11 Commercial Banks
4. 36 Savings Banks
5. 10 Insurance Companies
6. 6 Pension Systems
7. Financial Control Board
8. New York State
9. Advisors and counsel to all parties
The Acting Assistant General Counsel for Domestic Finance
is now working full time on final arrangements for the
closing of the financial agreements.
The professional staff of the Office of New York
Finance also has been actively monitoring the progress „ .of the negotiations and participating in them as its
own market access, economic or budgetary analysis was
required. It is performing the following tasks on a
- 6 continuing basis, all of which involve responsibilities
of the Treasury under the Guarantee Act:
(a) liaison with committees of the Congress;
(b) review and analysis of the City financial
statements and related reports;
(c) assistance in completion of the City's audited
financials for FY 1978 and review of relevant
municipal accounting issues for the FY 1979
audit;
(d) compliance determinations concerning the
conditions of eligibility under the Guarantee
Act;
(e) contact with (1) credit rating services with
respect to investment grade rating of City
securities and (2) the financial community
and the City's financial advisor with respect
to accessibility of the City's debt instruments to the public markets;
(f) liaison with New York State officials with
regard to the State's commitment of continued
support for New York City, along with other
cash flow and budgetary matters;
(g) study the impact of urban legislation enacted
by the 95th Congress; and
(h) tracking the City's daily cash flow requirements and assessing the time schedule and
amounts required for seasonal financing.
The Director of the Office of New York Finance, and
other senior members of my staff will be delighted to
meet with your staff at their mutual convenience to
amplify information contained in this report.
Sincerely,
W. Michael Blumenthal
The Honorable
William Proxmire
Chairman, Committee on Banking,
Housing and Urban Affairs
United States Senate
Washington, D. C. 20510
Department of theJREASURY
WASHINGTON, O.C. 20220
TELEPHONE 566-2041
FOR IMMEDIATE RELEASE
April 13, 1979
Contact
Del Dobbins
202/566-5211
TREASURY ISSUES SIXTH DISC ANNUAL REPORT
The Treasury Department today released its sixth Annual
Report on the "Operation and Effect of the Domestic International Sales Corporation Legislation" (DISC). This report
covers income tax returns for DISCs with accounting periods
ending between July 1, 19 76, and June 30, 19 77, referred to
as DISC year 1977.
Highlights of the report are:
— The revenue cost to the Treasury was $750 million
for DISC year 19 77, compared to $1.2 billion for
DISC year 19 76. The reduction in the revenue cost
in DISC year 19 77 was due to the curtailment of
DISC benefits required by the Tax Reform Act of
1976.
— Total U. S. exports are estimated to have been
$3.9 billion higher in DISC year 19 77 than they
would have been without the DISC program. The
reduced incentive to export under the Tax Reform
Act may not be reflected in the $3.9 billion DISC
effect because of the delayed reactions to a
reduction in export incentives. Moreover, the Tax
Reform Act was not passed until October 19 76, but
was made effective retroactively to January 19 76.
This $3.9 billion estimate has not been adjusted
to take account of either flexible exchange rates
or the possible displacement of non-DISC exports
by DISC exports, both of which tend to diminish
the ultimate impact of DISC.
— The ten largest beneficiaries of the DISC program
realized 21 percent of the total tax saving.
The DISC report examines foreign export tax practices,
the Multilateral Trade Negotiations (MTN) Subsidies/Countervailing Measures Agreement, and the General Agreement on
Tariffs and Trade (GATT) prohibition against rebating corporate income and ohter direct taxes to exporters. Because
(MORE)
B-1537
- 2 -
direct tax burdens are generally higher in foreign countries
than they are in the United States, the report notes that
allowing all countries to rebate direct taxes to exporters
would have the initial effect of worsening the U. S. competitive position.
Copies of the sixth DISC Annual Report are available
for purchase from the Superintendent of Documents, U. S.
Government Printing Office, Washington, D. C. 20401. When
ordering, use Stock No. 048-044-01608-7.
o
0
o
DepartmentoftheTREASURY
TELEPHONE 566-2041
WASHINGTON, D.C. 20220
April 16, 1979
FOR IMMEDIATE RELEASE
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $3,000 million of 13-week Treasury bills and for $3,001 million
of 26-week Treasury bills, both series to be issued on April 19, 1979,
were accepted at the Federal Reserve Banks and Treasury today. The details are
as follows:
RANGE OF ACCEPTED
COMPETITIVE BIDS:
13-week bills
maturing July 19, 1979
Price
High
Low
Average
a/ Excepting
b/ Excepting
Discount
Rate
Investment
Rate 1/
,*/
97.578^'
9.582%
9.98%
97.564
9.637%
10.04%
97.570
9.613%
10.02%
tenders totaling $80,000
tender of $250,000
26-week bills
maturing October 18. 1979
Price
Discount
Rate
95.147-^ 9.599%
95.123
9.647%
95.133
9.627%
Investment
Rate 1/
10.26%
10.31%
10.29%
Tenders at the low price for the 13-week bills were allotted 63%.
Tenders at the low price for the 26-week bills were allotted
TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS AND TREASURY:
Location
Received
Boston
$
36,085,000
New York
4,727,610,000
Philadelphia
29,060,000
Cleveland
41,250,000
Richmond
34,285,000
Atlanta
34,430,000
Chicago
454,705,000
St. Louis
41,540,000
Minneapolis
5,500,000
Kansas City
35,895,000
Dallas
29,495,000
San Francisco
403,520,000
Treasury
28,500,000
TOTALS
$5,901,875,000
Accepted
Received
Accepted
$
34,975,000
2,325,210,000
29, 060,000
36, 000,000
31, 025,000
34, 430,000
119, 705,000
28, 800,000
5,500,000
34, 795,000
29, 495,000
262, 520,000
28,490,000
$
22,375,000
4,902,615,000
12,185,000
28,685,000
21,460,000
25,235,000
268,615,000
34,865,000
5,770,000
17,655,000
14,940,000
302,745,000
28,885,000
$
22,375,000
2,542,615,000
12,185,000
28,685,000
21,460,000
25,235,000
73,615,000
24,865,000
5,770,000 1
17,655,000 '
14,940,000,
182,745,000,
28,885,000f
$3,000,005,000c/: $5,686,030,000
./includes $547,855,000 noncompetitive tenders from the public.
'/Includes $321,925,000 noncompetitive tenders from the public.
^Equivalent coupon-issue yield.
1-1538
$3,001,030,000d/
DATE:
April 16, 1979
13-WEEK
26-WEEK
TODAY: % G / 3 7* 9,CZ7 >r
LAST WEEK: ?. &¥? 7* ? , S' 7 Z. %
HIGHEST SINCE:
LOWEST SINCE:
\
- 2 -
direct tax burdens are generally higher in foreign countries
than they are in the United States, the report notes that
allowing all countries to rebate direct taxes to exporters
would have the initial effect of worsening the U. S. competitive position.
Copies of the sixth DISC Annual Report are available
for purchase from the Superintendent of Documents, U. S.
Government Printing Office, Washington, D. C. 20401. When
ordering, use Stock No. 048-044-01608-7.
o
0
o
FOR IMMEDIATE RELEASE
April 17, 1979
Contact: Jack Plum
202/566-2615
STUDY OF GEOGRAPHIC RESTRICTIONS ON BANKING
The Treasury Department today released an outline of work and a
background paper prepared for the study of geographic restrictions on
banking required by the International Banking Act of 1978.
The work outline presents a framework for evaluating the major
policy options for governing the power of despository institutions
and their holding companies to establish and acquire branches and
subsidiary banks.
#
B1539
COMMERCIAL BANKING UNDER
THE MCFADDEN ACT
A Summary of Issues and Findings
March 2, 1979
Mark G. Bender
Office of Capital Markets Legislati
;
Contents
Pag
Introduction
1
National Branching Policy 3
The McFadden Act of 1927 5
The Banking Act of 1933
The 1956 Douglas Amendment
6
7
Previous Policy Recommendations 9
Commission on Money and Credit 9
Advisory Committee to the Comptroller
Committee on Financial Institutions
The Hunt Commission
FINE "Discussion Principles"
The EFT Commission
Nader's Concentration Limit
Major Issues and Findings 16
Operating Efficiency 16
Credit Allocation
Concentration
Safety and Soundness
Convenience and Needs
Small Banks
Branch Office Alternatives
Non-Bank Branching
Dual Banking
10
11
12
13
13
14
18
20
24
25
27
28
30
31
I.
introduction
At the national level, policy regarding the ability of
commercial banks to expand geographically through branching
is specified in the McFadden Act of 1927, as amended by the
Banking Act of 1933.
These statutues provide that the branches
of national banks are to be limited to the same geographic
areas as permitted to state banks by the various state laws.
The net result of this policy of over forty years duration
has been the current heterogeneous banking structure of the
nation: unit banking in some states; statewide branching in
other states; and limited branching in the remainder.
in recent years the pressures to reassess and revise
McFadden have risen measurably.
The Hunt Commission, for one,
explicitly recommended in 1971 that "the power of commercial
banks to branch, both de novo and by merger, be extended to
a statewide basis, and that all statutory restrictions on
branch or home office locations based on geographic or population factors or on proximity to other banks or other branches
thereof be eliminated."
Liberalized branching was again the
subject of various financial reform proposals of the Congress
in the 1970's.
Also, in its analysis of electronic banking
terminals the EFT Commission in 1978 recommended that "State
and federally chartered depository institutions should have
the power to offer debit services anywhere in the country
through terminal-based EFT systems," while "deposit-taking
^
- 2 -
through EFT terminals should be gradually expanded." Finally,
the gradual growth of the service powers of nonbank depository
institutions which are not limited in branching by McFadden
has introduced additional pressures for the realization of
"competitive parity" for commercial banks.
Many of the issues surrounding McFadden are as much
political as economic in nature and pertain to the "dual
banking system" rubric. Such issues include: (1) to what
extent federally chartered institutions ought to be restricted
by state laws governing state-chartered institutions; (2)
whether state boundaries should constitute the ultimate limit
on branching by banks; (3) how the competitive balance of
different classes of federally-chartered institutions can be
maintained within particular states; and (4) how the competitive
balance between federally-chartered and state-chartered institutions can be maintained within particular states.
Other McFadden issues are more directly related to the
overall comparative economic performance of commercial banks
in the different branching environments. Among others,
these issues include: (1) whether or not bank safety and
soundness is significantly different by branching environment; (2) whether the convenience and needs of the public are
better met in liberal as opposed to restrictive branching
states; (3) how concentration and monopoly power vary by
branching statutues; (4) whether bank operating economies
- 3 vary significantly by branching or nonbranching status; (5)
how other forms of multi-office banking are related to variations in banking statutes; (6) how the urban-rural allocation
of credit is impacted by branching; and (7) what are the
implications of new banking technology for traditional bank
branching policy.
Most of the foregoing McFadden issues have been the subject of extensive debate and investigation for a good many
years, resulting in a substantial literature.
The most recent
major effort at reassessing McFadden was undertaken in 1976
by the Subcommittee on Financial Institutions of the Committee
on Banking, Housing and Urban Affairs of the United States
Senate.
That Compendium and other source materials provide
the background upon which this summary of McFadden issues and
findings is based.
II. National Branching Policy
For the greatest part of the nineteenth century branch
banking was of little or no concern as a national policy issue.
Most banking markets were highly localized and only required
a single head office; communication and transportation systems
were not yet highly developed; bank notes could be widely
dispersed geographically from any single location; and the
widespread adoption of "free banking laws" provided a model
for single-establishment banking.
- 4 It was not until the onset of the Civil War that the
structure of commercial banking became a national policy concern.
Even then, however, the concern was more one of financing
the War and also of restoring the public's confidence in circulating currency than it was of other attributes of the
banking system.
In fact, neither the National Currency Act
of 1863 nor the National Banking Act of 1864 —
which together
laid the foundations for the national banking system —
bothered to address branch banking per se.
ever
Still, the National
Banking Act has been interpreted as preventing branch banking
by national banks.
This is so because in two critical pro-
visions where location was referenced it was done so in the
singular.
With the passage of time branch banking grew in importance
as an issue.
By the early 1900s large urban areas presented
new incentives for bank expansion; communication and transportation facilities had improved measurably; and deposit
banking, which was amenable to the geographic extension of
banking facilities, had clearly displaced bank notes in
importance.
Furthermore, following the lead of California
in 1909, many states passed favorable branching legislation
for state-chartered banks.
As a consequence, national banks,
which perceived themselves to be at a competitive disadvantage
relative to state banks, sought redress with respect to
branching as well as other restrictions.
- 5 The McFadden Act of 1927
The McFadden Act of 1927 was the first major effort at
the formulation of a national policy regarding the issue of
branching by commercial banks.
The Act followed upon the
1922 "teller's windows" ruling of the Comptroller of the
Currency which allowed national banks to set up and operate
limited service offices and agencies in those places where
they were already permitted to conduct business.
On balance
McFadden was favorable to city-wide branching as opposed to
out-of-town branching.
For example, Section 7(c) states
that "A national banking association may, after the date of
the approval of this Act, establish and operate new branches
within the limits of the city, town, or village in which
said association is situated if such establishment and operation
are at the time permitted to State banks by the law of the
State in question."
Also, in Section 7(f) the term "branch"
was held "to include any branch office, branch agency, additional office, or any branch place of business located in
any State or Territory of the United States or in the District
of Columbia at which deposits are received, or checks paid,
or money lent."
McFadden also addressed the problems of national bank
competition with state banks which might have numerous outof-town branches (as in California) by trying to curb the
capacity of state banks to acquire or establish additional
out-of-town branches.
Furthermore, the Act provided that no
- 6 Federal Reserve member bank, national or state, could establish
out-of-town branches after February 25, 1927, nor absorb other
(nonmember) banks having out-of-town branches established after
that date without relinquishing such branches. Also, state
banks seeking Federal Reserve membership were required to
relinquish all out-of-town branches established after the
25 February, 1927 date. However, no restriction on out-of-town
branching by state nonmember banks was attempted. Finally,
Section 7(a) of McFadden served to ligitimize the heretofore
legally dubious status of national bank "teller's windows."
Whether or not McFadden intended to confer complete competitive equality between types of institutions, or whether
or not it intended to confer relative supremacy over branching
policy to state or federal authorities has been long debated.
From their own review and analysis of the literature Fischer
and Golembe concluded that, "the McFadden Act was never intended to establish complete branching equality between state
and national banks. It was also not aimed at giving the states
control over Federal branching policy... The object was not
to limit just national bank branching but to limit branching."
The Banking Act of 1933
The anti-branching sentiment manifest in the McFadden
Act receded somewhat during the economic difficulties and
the banking collapse of the late 1920s and early 1930s. To
many observers the better record with respect to failure
- 7 demonstrated by branch banks was viewed as proof positive
that unit banking was inherently less sound (although others
pointed out that unit banking was largely carried on in
agricultural-oriented regions and the failure rate of unit
banks was a natural by-product of the disproportionately
large burden of depression visited on those regions). The
growth in sentiment favorable to more liberalized branching
was not sufficient to carry the day, however, once the "bank
soundness" argument was pre-empted by proposals for deposit
insurance.
The Banking Act of 1933 (Glass-Steagall) which was
finally passed in response to the "bank crisis" is most
notable for its provision of a federal system of deposit
insurance, credited by some observers with not only "saving"
the dual banking system but with also "unifying" commercial
banking to an unprecedented degree under federal supervision.
The Glass-Steagall Act also broadened the branching power of
national banks moderately by de-emphasizing city-wide branching
in favor of branching anywhere in a state as authorized by
that state for its own state-chartered banks.
The 1956 Douglas Amendment
Efforts to circumvent restrictions on bank expansion
through branching led to a renewed interest in group banking
as the economy recovered from the economic distress of the
- 8 late 1920s and early 1930s.
Bank holding companies, rather
than bank chains, had by now become the most popular and the
economically most significant form of group banking.
The Banking Act of 1933 did take a first step in the
direction of Federal regulation of bank holding companies by
requiring the latter to solicit the permission of the Federal
Reserve Board before voting in the selection of the directors
of affiliated banks.
But major shortcomings of the 1933
legislation were that (1) companies holding only one bank
were excluded from coverage; (2) BHC systems consisting of
state banks only were not required to register with the Federal
Reserve and could therefore expand within and beyond state
borders; and (3) the effect on competition was not a condition to be considered by the Federal Reserve in the
registration of BHCs.
By 1956 substantial pressures had grown for the enactment
of more restrictive bank holding company legislation, due
especially to concerns about concentration of resources and
the statewide and interstate expansion of some multi-bank
holding companies.
The Bank Holding Company Act of 1956 was
the first Federal legislation to focus exclusively on the
holding company form of organization.
More specifically,
Section 3(d) of the Act, known as the Douglas Amendment,
prohibited multi-bank holding companies from chartering or
acquiring a bank in another state.
In 1970 the legislation
was extended to cover one-bank holding companies.
Currently,
therefore, other than for those domestic and foreign holding
companies which have received "grandfather" privileges, the
interstate expansion of banking is effectively prohibited.
III. Previous Policy Recommendations
Commercial bank branching policy at the national level
has remained virtually unchanged in the four-and-a-half decades
since Glass-Steagall; and, in the wake of substantial economic
and technological advances, this has only served to increase
the intensity of the branching debate. In recent years, for
example, the Commission on Money and Credit (1961), the
Advisory Committee on Banking to the Comptroller of the Currency
(1962), the Hunt Commission (1971), the FINE Discussion
Principles of the House Banking Committee (1975), and the EFT
Commission (1977) have all, in one form or another, recommended
more liberalized branching.
Commission on Money and Credit
In its 1961 Report the Commission on Money and Credit
recommended that:
• the provisions of the National Banking Act should
be revised so as to enable national banks to establish branches within trading areas irrespective
of state laws;
• state laws should be revised to provide corresponding
privileges to state-chartered banks;
- 10 t
•
branching privileges recommended for national banks
should be made available to federally-chartered mutual
savings banks and savings and loan associations, and
• state laws should be liberalized to conform.
The Commission nevertheless qualified its recommendations
by observing that the chartering authority should adopt a
number of practices in the exercise of its power. These were
(1) that it should avoid undue concentration in the local
market; (2) that it should give new entrants a chance to
compete even if their business must be partially bid away from
existing competitors, and should place considerable reliance
on the applicant's integrity, managerial competence, and his
judgment in regard to earnings prospects of the new branch;
and (3) that it should treat the applications for new branches
on a par with new unit bank applications.
Advisory Committee to the Comptroller
The Report of the Advisory Committee to the Comptroller
in 1962 found that "the expanding needs of our economy for
banking facilities and services requires a re-examination of
both Federal and State laws with respect to the branching
privileges of banks." The basic question according to the
Committee was whether or not, on the national level, the public
interest would be best served if Congress authorized the establishment of branches by National Banks under Federal standards irrespective of the law of the State in which the National
Bank is located." The Advisory Committee recommended that:
- 11 I
•
the law should be amended so that any national
bank, in addition to its present right to branch
in accordance with state law, may be permitted,
2 years after the amendatory bill is effective,
to establish branches within a limited area
within the state in which the principal office
of the particular national bank is located; and
• initially, branching within a fixed radius of
25 miles from the principal office ought to be
permitted.
Committee on Financial Institutions
The 1963 Report of the President's Committee on Financial
Institutions expressed strong support for bringing legislative
uniformity to the federal statutory standards which govern all
significant types of structural change in banking — charters,
branches, mergers, holding company acquisitions and any other
form of affiliation which might be regulated.
More specifically, with respect to the branching issue,
the Committee found that "extreme limitations on branching...
may impede the provision of banking services and effective
competition" although "it is important to avoid excessive
concentration of banking (and other financial) facilities
through branching." The Committee concluded that:
• the federal and state governments, within their
respective authorities, should review present
restrictions on branching with a view to developing
a more rational pattern, subject to safeguards to
avoid excessive concentration and preserve competition;
• the statutory standards applicable to granting
of charters and approval of new branches should
explicitly include "the effect on competition";
- 12 •
in the case of each application for charter,
branch, membership in the Federal Reserve
System, and admission to deposit insurance,
the banking agencies not directly concerned
and the Justice Department should have the opportunity to submit an advisory opinion on the
effect of the proposed action on competition;
• federally supervised savings and loan associations
should be subject to federal standards regarding
charters, branches, mergers and holding company
supervision similar to those applicable to
banks; and
• the Federal Savings and Loan Insurance Corporation
should be given authority to pass on branching
applications of state-chartered insured associations
in a manner parallel to the authority of the FDIC
over insured state banks.
The Hunt Commission
The Hunt Commission reported its findings in 1972. With
respect to branching, the Commission "rejected proposals to
permit interstate branching or metropolitan area banking by
federal legislation" although it urged the states to be
"progressive in changing their laws." The Commission felt
that the failure of states to act "could encourage the use of
inferior organizational and technological means for extending
markets." It was specifically recommended that:
• by state laws, the power of commercial banks to
branch, both de novo and by merger, be extended
to a statewide basis; and
• all statutory restrictions on branch or home
office locations based on geographic or population factors or on proximity to other banks or
branches thereof be eliminated.
- 13 FINE "Discussion Principles"
In 1975 Congressional efforts to advance comprehensive
financial institution restructuring resulted in the "discussion
principles" of the Financial Institutions and the Nation's
Economy study of the House. With respect to the branching of
depository institutions, the FINE study recommended that:
• all federally insured depository institutions
should be allowed to branch across state lines
if not in conflict with state law;
• where a conflict with state law exists, branches
should be allowed in SMSAs of two million persons
or more for both out-of-state and intrastate
institutions;
• where branching is prohibited, depository institutions would be allowed branches in all SMSAs
with populations of two million or more; and
• depository institutions would be prohibited from
branching across state lines via mergers.
The EFT Commission
In its 1977 Report, the National Commission on Electronic
Fund Transfers found reason to regulate the hardware of
electronic banking services — the EFT terminal — differently
than the hardware of traditional banking services — the brick
and mortar branch. The Commission also found reason to regulate
the different classes of EFT services differently. Thus the
traditional "information services" such as check authorization,
check guarantee and file look-up would not require new regulation.
But the "funds transfer services" such as the various types of
debit functions, credit functions and deposits would require
regulation.
- 14 The Commission found that "the rules governing the
deployment of off-premise EFT terminals should be separate
and distinct from and less restrictive than the rules regarding
the establishment of conventional branches," and these rules
"should be no more restrictive than the rules governing that
institution's ability to offer EFT services." Regarding EFT
services, the Commission recommended that:
• no restrictions be imposed on the availability of
the EFT based credit services of debit overdraft,
point of sale credit purchase, and cash advance;
• state and federally chartered depository institutions should have the power to offer the debit
services of cash withdrawal, bill or loan payment,
and point of sale purchases anywhere in the country
through terminal-based EFT systems;
• state and federally chartered depository institutions should be free to deploy EFT terminals on a
statewide basis for deposit taking;
• state and federally chartered depository institutions should be allowed to cross contiguous state
lines for the deployment of deposit-taking terminals
in "natural market areas" following reciprocal approving legislation by the states; and
• the Congress should establish a date after which
federally-chartered institutions may cross state
lines in natural market areas for deposit taking
irrespective of state legislation.
Nader's Concentration Limit
In contrast to the series of liberalizing branching policy
options reviewed above, Ralph Nader has proposed a much more
cautious approach, in his 1975 testimony on the FINE study
Nader expressed concern over the potential for greater deposit
- 15 concentration in large banking organizations if branching were
allowed on an interstate basis. For example, many large
banking organizations already have extensive interstate networks
of nonbank offices which could rapidly assume all banking
functions. As of 1975 Bank of America had 336 nonbank offices
in 32 states, Citicorp had 284 nonbank offices in 34 states,
Manufacturers Hanover Corp. had 151 nonbank offices in 15
states, and Chemical New York Corp. had 121 nonbank offices
in 15 states.
Potentially, the interstate deployment of EFT terminal
networks in combination with existing nonbank office networks
could lead to "nationwide networks of control [that] would
result in the McDonaldization of the banking industry...and a
cartelized banking structure." This "unhealthy concentration
of power undermines competitive financial markets, distorts
the market allocation of credit, and thereby infects the entire
economy." Nader specifically recommended that:
• interstate acquisitions be prohibited under
Section 4 of the Bank Holding Company Act
unless expressly authorized by state law;
• interstate EFTS terminal deployment be prohibited
unless expressly authorized by state law; and
• limit commercial banks to 10% of total nationwide
commercial bank deposits.
- 16 IV. Major Issues and Findings
Efforts to treat the McFadden issue in a more systematic
manner have been assisted in recent years by the growing body
of literature pertaining to important subissues.
The latter
include the relationships of branching/nonbranching to
operating efficiency, the convenience and needs of the public,
bank safety and soundness, alternate forms of multi-office
banking, competition with nonbank depositories, and the
nature of the dual banking system, among others.
These
major subissues are discussed below.
Operating Efficiency
The hypothesis to be tested is that branch banking organizations are more efficient in terms of costs per unit of
output than are unit banking organizations.
If the hypothesis
can be accepted on the basis of empirical findings it follows
that the position of pro-branching advocates would be strengthened
and vice-versa.
According to Guttentag, the relevant question
in this respect "is whether a branch bank has lower costs than
a group of unit banks of the same aggregate size which provide
the same number of offices and other outputs."
A large number of studies of bank operating efficiency
have been done in recent years, during the course of which
earlier differences regarding the appropriate definitions of
inputs, outputs, type and size of samples, and so on have
- 17 tended to diminish.
Longbrake has probably done the most
recent comprehensive analysis of bank operating efficiency
by branching structure. He finds that unit banks of less
than $15 million in deposits are more efficient than branch
banks with branch offices of the same average ($15 million)
size. However, as the number of branches increases, the cost
disadvantage of the branch banking organization decreases.
Thus, a branch bank with five $10 million offices has costs
8.7% above those of five $10 million unit banks, while a
branch bank of twenty-five $10 million offices has costs only
1.9% above those of twenty-five $10 million unit banks.
Longbrake also finds that for offices with deposits more
than $15 million, branch banks are the more efficient and
their advantage increases with the number of offices. Accordingly, a branch bank with five $50 million offices is
shown to have costs 1.6 to 2.9% lower than five $50 million
unit banks; a branch bank with 25 such offices has costs 7.6
to 9.0% lower than 25 comparable unit banks.
The net result of these findings on overall bank efficienc
however, may still be indeterminate. The outcome would seem to
hinge on whether or not the typical branch bank in a liberalize
branching environment could achieve an average office size of
$15 million or more. New banking technology, on the other
hand, may well bring that average office size requirement down.
- 18 V
It is Guttentag's opinion that "[I]f growth prospects are sufficiently favorable to allow branch banks to reach a size where
costs are below those of unit banks, allowing such growth
obviously will promote efficiency."
Credit Allocation
Another major point of departure in the evaluation of
the desirability of branch banking relative to unit banking
is that of credit allocation. Here, a number of hypotheses
are generally introduced for testing: First, that branch banks
provide a relatively more economical means of transferring
funds from surplus to deficit areas than unit banks. Second,
that branch banks make a greater proportion of their resources
available to meet local credit needs. Third, that branch
banks pursue a loan policy more favorable to large customers
than to smaller ones. Finally, that branch banks tend to
favor their head-office cities at the expense of their branchoffice locations.
A survey of the empirical evidence by Guttentag and
Herman strongly supports the hypothesis that branch banking
more economically transfers funds between areas. Apparently,
this is because such transfers occur "within firms, whereas
comparable transfers between unit banks are market transactions
subject to transaction costs and other 'frictions'." Unit
banks' correspondent relationships do not seem to shift funds
to deficit areas as readily as branch banking, and other interbank credit flows entail institutional frictions.
_ As regards the proportion of resources branch banks tend
to allocate to local credit needs, Guttentag and Herman again
find that the available evidence tends to support the hypothesis
in favor of branch banking.^ It seems that "branch banks made
more loans in relation to assets than unit banks and that this
applies as well to business loans, consumer installment loans,
and mortgage loans." In an even more specific analysis of
business loans only, Eisenbeis finds that "statewide branching
has resulted in a greater proportion of business loans to
locally limited business than either unit banking or limited
branching."
Empirical evidence does seem to support the hypothesis
that branch banks favor the large business customer over the
smaller one by allocating relatively more of their business
loan portfolio to the former. But, even given this fact, it
may nevertheless be true that large banks are as good a source
of credit to small business as small banks since, overall,
they place a larger proportion of their resources into loans.
The final hypothesis holds that branch banks will discriminate in favor of the head-office location to the detriment
of branch-office locations. Studies by Johnson and Kohn and
Kaye have not found this to be true. Rather than simply using
outlying branches as a source of funds, the evidence seems to
indicate that branch banks have higher loan ratios than unit
banks in the same areas, while unit banks acquired by branch
banks generally tended to increase their loan ratios.
Concentration
In many ways the single most important economic issue
pertaining to the McFadden controversy is that of the concentration of resources. Two hypotheses are of relevance here:
first, that branching tends to increase concentration in banking;
and, second, that increased concentration in banking will manifest itself in higher service prices.
For the most part, concentration is measured in terms of
the share of deposits held by the largest one, three, or five
banking organizations in the market. On occasion variables
other than deposits may be used; for example, the share of
specific credit granting product lines held by the dominant
firms. Also, to appropriately define the relevant market
can itself be a significant problem: is it highly localized,
statewide, or geographically larger? Should the market be
defined in terms of all bank services, or specific product
lines? Should it be defined in terms of inter-bank competition
only, or should it be extended to include non-bank competitors?
Numerous studies of the concentration and pricing
hypotheses have been done in recent years. The hypothesis
that bank performance in terms of prices and profits is
positively related to concentration has found widespread
empirical support, in 1977 Rhoades published a paper which
summarized and evaluated those major structure-performance studies
done since 1959 which utilized price or profit as an indicator
- 21 of performance.
Thirty of some 39 studies established a
statistically significant relationship between measures of bank
performance and market structure. This is to say that higher
prices and/or profit levels were found to coincide with higher
levels of concentration, as has almost always been the case
in studies of the industrial sector of the economy.
A recent study by Beighly and McCall was unique in that
it focused solely on commercial bank installment lending and
made use of the Lerner index as a measure of the degree of
market power. According to the authors, "Bank market power,
as measured by the Lerner price-marginal cost index, tends to
be greater: (1) the greater the inequalities among individual
bank shares; (2) the larger the market share held by the leading
bank group; and (3) the fewer the number of commercial banks."
It is concluded somewhat more tenuously that the market power
of banks "tends to be greater in large, local markets where
branch banking is permitted and where the loan interest rate
ceilings are lower," and that "there are in general greater
inequalities among individual bank market shares, larger
shares held by the leading bank group, and fewer banks in
markets where branch banking and lower loan interest rate
ceilings exist."
While Beighley and McCall defined their relevant market
in terms of metropolitan areas, Greer arrived at similar conclusions in his state-by-state analysis of installment lending
_
- 22 -
done for the National Commission on Consumer Finance in 1974.
In this case statistically significant relationships were found
with respect to personal loan rates, automobile loan rates,
and other consumer credit rates and a four-bank concentration
ratio.
Whereas the concentration-pricing hypothesis has received
significant support in the literature, the concentrationbranching hypothesis has not garnered the same degree of
consensus. The difference in viewpoints tends to revolve
around (1) whether the analysis emphasizes established branching
status or changing branching status as being most relevant to
competition, and (2) whether the most appropriate market is
defined in terms of larger metropolitan or statewide areas as
opposed to much smaller highly localized areas.
Studies of statewide and large metropolitan area concentration in banking have almost universally found significantly
higher levels of concentration in states which permitted statewide branching than in either limited branching or unit banking
states. For example, in a 1972 examination of the effects of
branching on competition and performance Gilbert and Longbrake
found that the concentration of commercial bank deposits was
greater and the number of banks smaller in statewide branching
states. More specifically, "Between 1961 and 1969, the
average proportion of deposits held by the five largest banking
organizations increased from 72.1% to 74.2% in statewide
- 23 -
••
branching states, decreased from 41.6% to 39.0% in limited
branching states, and decreased from 37.2% to 33.8% in unit
banking states."
Guttentag, also,-found, that "banking concentration is
higher on both a state basis and a metropolitan area basis
under branching." For example, "at the end of 1974 the five
largest banks in each state on average held 75% of deposits
in state-wide branching states compared to 41% in limited
branching states and 34% in unit banking states." And in 1976
Heggestad and Rhoades reported on a study of changes in bank
market structure in 228 major SMSAs. The authors found that
"markets in unit banking states experience less increase or
more decrease in concentration than markets in statewide
branching states -- and by inference, than markets in limited
branching states." It is suggested that this result may be
attributable to the fact that "unit banking markets generally
have significantly more firms and thus a larger competitive
fringe."
It is often argued, nevertheless, that bank markets are
highly localized and that large-area concentration ratios are
relatively unimportant. Rather, it is held that the local
market, protected through regulation from the entry of new
competitors, is the appropriate focal-point for concern, and
that new entry is easier under branching than under unit
banking. In this respect, a recent study by McCall and
- 24 Peterson did find that prior to new bank entry into markets
in restricted branching states, the existing banks rendered ""
relatively poorer service to the community than was the case
in liberal branching states. Accordingly, it was concluded
that the greater threat of entry in the branching environment
served to deter existing banks from as great a degree of
exploitation as was the case in unit banking states.
Safety and Soundness
From the initial days of the dual banking system it has
been argued frequently that branch banking is inherently more
stable than unit banking. The correctness of this hypothesis
hinges largely on whether or not branching can be shown to
erode profitability, increase or decrease deposit variability,
or alter the number and size of bank failures.
In a recent review of the empirical evidence available,
Gilbert found that branching does not appear to "adversely affect the profitability of an institution or of its competitors."
Furthermore, it is concluded that "competition may be increased
substantially without endangering profitability by permitting
branch institutions to open de novo offices in local markets."
As suggested here, the maintenance of profitability in a
branching environment would serve to support the branchingstability hypothesis. Also, an analysis of the evidence with
respect to deposit variability by Lauch and Murphy found that
branching was favorable to lessened deposit variability and,
hence, to bank stability.
With respect to the number and size of bank failures,
Gilbert found that in the period-1960-1975 "the percentage of
total banks that failed...was highest in unit banking states,
although not much higher than in the other categories;" but
"Unit-banking states had the lowest deposit volume of failed
banks, both in terms of percentage of deposits of all failed
banks (11%) and percentage of deposits of all banks in that
category (.02%)." On the surface at least, the lower number
of bank failures in branching states would tend to support the
branching-stability hypothesis while the larger size of failures
in branching states would undermine the hypothesis. Nevertheless,
Gilbert and others argue that any systematic relationship between
recent bank failures in branching states and branching per se is
tenuous at best. Rather, the explanation seems to be more
related to the activities associated with larger banks in recent
years and the latter, by chance, are more frequently located in
branching states.
Convenience and Needs
The question of whether or not the public's convenience
and needs are better served with branch banking than with unit
banking generally involves the examination of a two-part
hypothesis. First, that branching brings a wider range of
- 26 bank services to the public; and, second, that branching makes
more banking facilities available to the public. Branch banking,
for example, is conducive to larger institutions, and it is
argued that larger institutions can efficiently offer a
wider range of services as well as provide more banking
facilities to the public.
According to Guttentag and Herman, the available evidence
supports the hypothesis that the range of services offered to
the public is greater under branch banking than it is under
unit banking. Typical large-institution services include
•revolving credit, trust services, special checking accounts,
payroll services to business customers, and foreign exchange
transactions." Still, it is recognized that the offering of
such services may be just as much a function of demand as it
is institutional capability, since unit banks can normally
meet requests for special services through the correspondent
system.
There has been much less doubt, especially in the light
of recent empirical evidence, that branch banking makes more
facilities (offices) available relative to population than
does unit banking. In a survey of the data Guttentag found
clear evidence "that in metropolitan areas branch banks provide
many more offices relative to population than unit banks," in
fact, roughly twice as many on average. Even where small towns
- 27 or nonmetropolitan areas are concerned, "more recent (and improved) studies indicate a larger margin for branch banks."
The availability of a greater number of more convenient facilities
has generally been considered to be a significant benefit to
the public and, apparently, this is favored by branching.
Small Banks
Almost by definition alone the liberalization of branching
would be expected to result in a lesser number of relatively
larger banking organizations. Accordingly, the survival capabilities of small unit banks under liberalized branching has
become a major subissue of McFadden. The hypothesis to
be examined is that branching denies small unit banks the
economic capability to compete.
A number of relatively recent studies have considered
the ability of small unit banks to successfully compete in a
branching environment. Kohn concluded that the small bank
can compete due to the facts that (1) economies of scale in
branching organizations are not so great as to overwhelm the
cost competitiveness of the small bank; (2) many customers
are not so interest-rate sensitive as to rapidly substitute
institutions for reason of rate differentials; (3) many customers do not demand the wider range of services offered by
large institutions and will not shift accordingly; and (4)
many small banks are well established in terms of convenient
locations, knowledge of the local market, and highly personalized customer relationships. Also, Gilbert and Longbrake
found that the profitability of unit banks was not necessarily
adversely impacted by the entry of branch banks into their
markets. Finally, McCall and Peterson, in their study of
de novo market entry, found that established unit banks could
not only compete, but that their performance in terms of loans
made and rates charged improved to the benefit of the local
community.
According to Guttentag, "the available evidence indicates
that the declining number of unit banks associated with branch
banking stems largely from increased opportunities to merge
and reduced incentives to charter new banks, as well as from
a tendency for some unit banks to become branch banks." And,
"There is no evidence that unit banks are driven out by predatory competition from large branch systems."
Branch Office Alternatives
Students of banking have long recognized that branching
is but one of a number of ways to achieve multi-office banking
networks. Chain banking, for example, was a significant form
of multi-office banking up to the time of the Depression.
Group banking, in the form of holding companies, has grown
steadily in importance. And more recently, the development of
electronic banking terminals has provided another alternative
for the realization of multi-office banking.
- 29 An examination of the hypothesis that limitations on
branching lead to a relatively greater emphasis on alternate
forms of multi-office banking was undertaken by White in 1976.
He found that most states which took restrictive legislative
action with respect to bank holding companies did so following
the Bank Holding Company Acts of 1956 and 1970. Furthermore,
it was found that currently the majority of the states with
restrictive legislation relative to bank holding companies pertain to that group of 31 states which had little or no holding
company activity in 1957. In fact, within these states "polici
on branching and multi-bank holding companies are clearly
correlated" and "Restrictions or privileges for one form of
banking organization are generally accompanied by similar
policies regarding the other multi-office form."
Still, White notes that not all of the states which had
very little holding company activity prior to the 1956 Act
followed up with their own restrictive legislation, and he
finds that this "may be regarded as a step toward liberalizing
multi-office opportunities." Also, viewed from a different
perspective, it is interesting to note that "States which
have liberalized branching statutues since 1956 have usually
allowed for multi-office banking through the formation of
holding company groups for a number of years prior to making
branching status changes effective."
- 30 In the case of electronic banking terminals, the intention
of states with respect to liberalizing or restricting multioffice banking can generally be found in whether or not terminals
are defined as branches for deployment purposes.
In short, if
an electronic banking terminal were to be considered equivalent
to a bank office then that terminal's location would be governed
by the existing branching statute of a given state.
In this
respect, current data suggest a somewhat more liberal policy
overall for multi-office banking through EFT than would be
apparent from branching statutues only.
For example, as of
early 1978 Krabill found that: (1) of twenty-two states (and
the District of Columbia) that permitted statewide branching,
statewide terminal deployment was also permitted; (2) of
seventeen limited branching states three allowed statewide
terminal deployment while the remainder restricted terminals
as they did branches; and (3) of twelve unit banking states
one-half allowed statewide terminal deployment, one allowed
limited terminal deployment, and five prohibited any off-site
terminal deployment.
Non-Bank Branching
Another concern of commercial banks faced with limitations
on branching is their competitive status relative to other
depository institutions which may have greater actual or
potential branching freedom.
In this respect, White reported
- 31 that in many states the branching privileges of savings and
loans, for example, are more generous than those for commercial
banks.
Currently, only West Virginia and Montana appear to
seriously restrict branches or other off-site limited facilites
for savings and loans.
The other states allow branching either
statewide or within limited geographic areas.
The difference in treatment of thrifts and commercial banks
also occurs with respect to federally-chartered institutions.
National banks must abide by the branching statutes of those
states in which they operate; but federally-chartered thrift
institutions need only abide by the branching regulations
imposed by the Federal Home Loan Bank Board which generally
coincide with state policies.
Technically, federally-chartered
savings and loan associations have been afforded a more
liberal branching policy than have been federally-chartered
commercial banks.
Dual Banking
Perhaps the final, but by no means the least debated, of
the McFadden issues involves the nature of the dual banking
system itself.
The hypothesis is frequently put forth, for
example, that any major change in the McFadden principle would
serve to severely damage the dual banking system.
Any judgment
to be made with respect to this hypothesis, therefore, requires
a better understanding of exactly what is meant by the "dual
banking system."
- 32 According to Brown, "dual banking refers to a system
under which states and the Federal Government have approximately equal rights regarding chartering, supervision, and
examination of privately operated commercial banks." And the
core of dual banking amounts to the provision of "more than
one route of entry into the commercial banking business with
the chartering authority supervising operations of banks
authorized by it." Inherent to dual banking is the freedom
existing banks have to switch from one chartering authority
to another and thereby to switch supervisory frameworks.
Brown points out, however, that the maintenance of
different terms of market entry, which was a major objective
of dual banking, has already been compromised somewhat by
the virtual necessity of a new bank's acquiring FDIC deposit
insurance. Accordingly, the FDIC has gained "a potential
veto over entry into banking by new state-chartered institutions not members of the Federal Reserve," while "the
Federal Reserve can veto deposit insurance for banks which
seek it through the Federal Reserve membership route."
Yet even though federal deposit insurance effectively
deprived the dual banking system of one of its objectives —
control over new bank entry — the system still provides
bank organizers a choice in terms of applications for charters and their supervisory and regulatory framework. But,
argues Brown, "if regulation were uniformly applied by all
three Federal agencies, or if all policy making was concentrated in one agency...all escape routes could be closed to
commercial banks."
In either of these cases, "dual banking
would cease to exist."
Although the states have lost considerable control over
market entry via new bank chartering, they still retain
authority over entry via branching.
This is most evident
in the authority of the states to determine the geographic
limitations on all banks operating within their boundaries,
per the McFadden principle.
In this respect, one of the
primary characteristics of dual banking —
of banking structure —
state determination
appears to remain intact.
But even
within the context of their own branching laws, notes Brown,
"the authority of the states to decide on individual branching
applications is far more restricted than that of the Federal
Government."
This is so because as long as federal deposit
insurance is involved the federal agencies can veto state bank
applications, but the states cannot veto national bank applications under any circumstance.
The result is that while
states can determine the nature of branching inside their
boundaries the federal agencies can significantly affect the
actual composition or pattern of branching.
Federal antitrust
activities and federal regulation of bank holding companies
have further contributed to an erosion of state primacy with
respect to structure.
Bibliography
Beighley, H. Prescott and Alan S. McCall, Market Power and
Structure and Commercial Bank Installment Lending,"
Working Paper No. 72-18 (revised), Federal Deposit
insurance Corporation/
Benston, George J., "The Optimal Banking Structure: Theory
and Evidence," Journal of Bank Research, III (Winter 1973),
220-237.
Brown, William J. "American Bankers Association", "The Dual
Banking System in the United States," Compendium of Issues
Relating to Branching by Financial Institutions, U.S. Senate,
Subcommittee on Financial Institutions, 1976.
Budzeika, George and Rocco Magnotta, Effect of the 1969
Liberalization of the Banking Law in New Jersey, Banking
Studies Department, Federal Reserve Bank of New York, 1973.
Eisenbeis, Robert A., "The Allocative Effects of Branch
Banking Restrictions on Business Loan Markets," Journal
of Bank Research, II (Spring 1975), 43-45
Fischer, Gerald C. and Carter H. Golembe, "The Branch Banking
Provisions of the McFadden Act as Amended: Their Rationale
and Rationality," Compendium of Issues Relating to Branching
by Financial Institutions, U.S. Senate, Subcommittee on Financial
Institutions, 1976.
Gady, Richard L. and Richard D. Carter, "Change in Banking
Structure in Ohio: Impact on Farm Credit," Improved Fund
Availability at Rural Banks, Board of Governors of the
Federal Reserve System, 1975.
Gilbert, Gary A., "Branch Banking and the Safety and Soundness
of Commercial Banks," Compendium of Issues Relating to
Branching by Financial Institutions, U.S. Senate, Subcommittee
on Financial Institutions, 1976.
Gilbert, Gary G. and William A. Longbrake, "The Effects
of Branching by Financial Institutions on Competition,
Productive Efficiency, and Stability - An Examination of
the Evidence," (Published in two parts), Journal of Bank
Research, IV (Autumn 1973), 154-67, and (Winter 1974),
298-307.
Guttentag, Jack, "Branch Banking: A Summary of the Issues
and Evidence," Compendium of Issues Relating to Branching
by Financial Institutions, U.S. Senate, Subcommittee on
Financial Institutions, 1976.
Guttentag, Jack M. and Edward S. Herman, "Banking Structure
and Performance," Bulletin, Nos. 41-43 (February 1967),
New York University Graduate School of Business Administration,
Institute of Finance.
Heggestad, Arnold A. and Stephen A. Rhoades, "An Analysis
of Changes in Bank Market Strucutre," Atlantic Economic
journal, (Fall 1976).
Kohn, Ernest, Branch Banking Bank Mergers and the Public
Interest, New York State Banking Department, 1964.
Kohn, Ernest, The Future of Small Banks, New York State
Banking Department, 1966.
Kohn, Ernest and Carmen J. Carlo, The Competitive Impact
of New Branches, New York State Banking Department, 1969.
Kohn, Ernest, Carmen J. Carlo, and Bernard Kay, Meeting
Local Credit Needs, New York State Banking Department, 1973.
Kunreuther, Judith B., "Banking Structure in New York State:
Progress and Prospects," Monthly Review, Federal Reserve
Bank of New York (April 1976), 107-115.
Lauch, Louis H. and Neil B. Murphy, "A Test of the Impact of
Branching on Deposit Variability," Journal of Financial and
Quantitative Analysis, September 1970.
Longbrake, A. William, "Productive Efficiency in
Commercial Banking: The Impact of Bank Organizational
Structure and Bank Size on the Cost of Demand Deposit
Services," Working Paper No. 72-10. Federal Deposit
Insurance Corporation.
Longbrake, William A. and John A. Haslem, "Commercial
Banking Structure in the United States: Its Development
and Future," Working Paper No. 74-16. Federal Deposit
Insurance Corporation.
Mote, Larry R., "The Perennial Issue: Branch Banking,"
Business Conditions, Federal Reserve Bank of Chicago
(February 1974), 3-23.
Rhoades, Stephen A., "Changes in the Structure of Bank
Holding Companies Since 1970", The Magazine of Bank
Administration
(October 1976).
Rhoades, Stephen A., "Structure-Performance Studies
In Banking: A Summary and Evaluation," Staff Economic
Studies No. 92, Board of Governors of the Federal Reserve
Board, 1977.
Rhoades, Stephen A. and Gregory E. Boczar, "The Performance
of Bank Holding Company - Affiliated Finance Companies",
Staff Economic Studies No. 90, Board of Governors of the
Federal Reserve Board, 197 7.
Rosenblum, Harvey, "The Impact of Limited Branch Banking on
Agricultural Lending by Banks in Wisconsin," Improved
Fund Availability at Rural Banks. Board of Governors of
the Federal Reserve System, 1975.
Shull, Bernard, "Multiple-Office Banking and Competition:
A Review of the Literature." Compendium of Issues Relating
to Branching by Financial Institutions, U.S. Senate,
Subcommittee on Financial Institutions, October 1978.
Shull, Bernard and Paul M. Horvitz, "Branch Banking and the
Structure of Competition," Studies in Banking Competition
and the Banking Structure. The Administration of National
Banks, 1966.
Snider, Thomas E., "Branch Banking and Loan Portfolio
Changes: The Virginia Experience," Improved Fund
Availability at Rural Banks. Board of Governors of the
Federal Reserve System, 1975.
White, Roger S., "The Evolution of State Policies in
Multi-Office Banking From the 1930's to the Present,"
Compendium of Issues Relating to Branching by Financial
Institutions, U.S. Senate, Subcommittee on Financial
Institutions, October 1978.
COMMERCIAL BANKING UNDER THE
MCFADDEN ACT
A Proposed Work Plan
March 20, 1979
Revised April 10, 1979
Department of the Treasury
Office of Capital Markets Legislation
This paper outlines a framework for evaluating the
major policy options in the system of rules which govern the
power of depository institutions and their holding companies
to establish and acquire branches and subsidiary banks. In
general, we believe that the debate in this area has been of
sufficiently long standing that the current need is for the
intelligent assessment of various policy options rather than
additional extensive background analysis.
The policy options ultimately chosen must be closely
linked to the degree to which they advance the purposes of
the commercial banking system and the commonly accepted
objectives of financial system reform. The Administration's
approach should
(1) avoid excessive concentration of economic resources;
(2) promote economically optimum price, profit and
output levels;
(3) assure a continued major role for small banks and
preserve the vitality of the dual banking system;
(4) promote diversity of approach and responsiveness to
local economic and social conditions;
(5) improve the overall efficiency of the banking
system;
(6) minimize regulatory inconsistencies between bank
and nonbank financial institutions;
(7) preserve the liquidity and solvency of financial
institutions so as to protect their safety and
soundness;
- 2 (8) decrease the cost and increase the availability
._ of services to consumers to enhance the convenience
and needs requirements of the public;
(9) strengthen the effectiveness of Government
stabilization policies in the financial area; and
(10) assure a steady and adequate flow of funds to
housing and preserve the stability of specialized
lenders serving the mortgage markets.
Each policy option under serious consideration by the
task force should be assessed in terms of its overall impact
on the objectives of financial reform, over both the short
and long term.
Current Policy Options
Conceptually, the policy options open for consideration
run the gamut of merely maintaining the status quo to permitting
unrestricted deposit taking and lending on a nationwide basis
on the one hand, or "McFaddenizing" all types of financial
services by banks on the other. The range of options currently
includes, but is by no means limited to, the following:
1- Maintain the status quo:
— the states should continue to have the final
word regarding the geographic location of the
banking offices of both state and federallychartered banks within their boundaries.
2. Establish a state-federal advisory committee
for further study:
— an advisory committee made up of the appropriate
state and federal banking authorities should be
established to review the inconsistencies in
current policies in this area and, within a
specified time period, should report on mutually
acceptable ways to rationalize geographical
restrictions on bank operations.
- 3 3.
Banks should be permitted to operate within
specified and limited "trading areas". For example:
banks should be permitted to have branches
or subsidiaries anywhere within a specified
radius of their head office (e.g., 25-50 miles)
irrespective of state laws, or
banks should be permitted to have branches
or subsidiaries anywhere within the state of
their head office irrespective of state laws,
or
banks should be permitted to have branches
or subsidiaries within their "natural market
areas", such as SMSAs, and to cross contiguous
state lines within natural market areas
irrespective of state laws.
4. Geographical restrictions on bank operations ought
to vary according to "product line" or functional
criteria. For example:
banks should be allowed to have branches or
subsidiaries without regard to geographic
location for the provision of all wholesale
banking services irrespective of state laws, or
banks should be allowed to have branches or
subsidiaries without regard to geographic
location for the provision of all non-deposittaking wholesale and retail banking services
irrespective of state laws.
5. The expansion of banking organizations through
branching or subsidiaries should be restricted
only by limits on concentration and/or by the
need to otherwise maintain competition. For
example:
banks should be permitted to have branches or
subsidiaries without geographic restrictions
within a state, provided that the group does
not possess more than a fixed percentage of
statewide banking deposits; or
- 4 *
—
branches and subsidiaries should be permitted
nationwide, subject to such restrictions as
o general antitrust standards, or
o a fixed percentage of nationwide bank
deposits, or
o a maximum asset size, or
o subject to a regulatory determination that
the establishment of a branch or a subsidiary
is not anticompetitive, or
o such expansion may be done only on a de novo
basis.
Banks should be allowed to expand by the
liberalized establishment and deployment
of EFT terminals and systems. For example:
banks should be permitted to deploy off-premise
EFT terminals under rules less restrictive than
those regarding the establishment of conventional
branches.
Bank organizations should be allowed to expand
only through subsidiaries, either newly established
or acquired:
bank holding companies should be permitted to
establish or acquire additional banks and banking
offices without regard to geographic location
irrespective of state laws, or
bank holding companies should be permitted to
establish or acquire additional banks and banking
offices subject to one or more of the limitations
referred to in other options.
No restrictions should be placed on the geographic
expansion of banks through branches or subsidiaries.
- 5 9.
All bank financial services should be subjected to
the McFadden principle:
the statewide or interstate expansion of banking
and bank-related activites by banks or bank
holding companies should be governed by state
rules applicable to bank branching.
Suggested outlines for the analysis of the impact of
the alternative policy options considered above on each of the
major objectives of financial reform follow.
1.
Bank Concentration
i
Content Requirements
1. Review and analyze the ^evidence:
a. What is the roost appropriate measure of
competition and/or concentration?
— share of deposits
— share of wholesale/retail service lines
— presence of other bank competitors
— presence of nonbank competitors
— degree of capital market integration
b. What is the most relevant definition of the
market?
— local — natural trading areas
— metropolitan
— nationwide
— statewide
c. What is the current status and degree of
concentration in banking?
— state by state concentration ratios
— other market concentration ratios
— concentration by state branching statute
— concentration by type of banking
organization (unit, branch, holding company)
d. How and why have concentration ratios changed
recently?
— due to changes in state policies
— due to changes in bank organizational form
e. How important or effective are alternative
barriers to entry?
— geographical restrictions
- — capitalization/other requirements
— home office protection laws
— currently dominated markets/entrenched
institutions
- 2 Paper
(Cont.)
f. How does the McFadden Act of 1927 relate
in terms of legislative history to the
creation and/or maintenance of the dual
banking system?
g. What is meant by the dual banking system in
terms of its major attributes or characteristics?
h. In what specific ways has the dual banking
system contributed to a more efficient commercial banking structure in the U.S.?
i. Can the dual banking system be effectively
maintained in the absence of the McFadden
Act?
j. If the McFadden Act is necessary to sustain
the dual banking system should it be allowed
also to govern bank expansion through "proxy"
branching such as EFT terminal deployment
and/or other multi-office forms?
2. Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. Differentiate the impact of policy options
according to the near-term (2-5 years) and
the long-term (10-20 years).
1,
2.
Bank Prices, Profits and Output Levels
Content Requirements
1. Review and analyze the evidence:
a. How has banking structure affected the price, profit,
and output performance of banking organizations?
— unit banks — wholesale services
— branch banks
— retail services
— holding companies
b. How has the degree of competition affected
price, profit, and output performance?
— presence of other bank competitors
— presence of nonbank competitors
c. How have recent changes in state statutes
or the form of banking organizations affected
performance?
— liberalization of branching laws
— liberalization of holding company laws
~ formation of multi-bank holding companies
— formation of one-bank holding companies
2. Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. Differentiate the impact of policy options
according to the near-term (2-5 years) and the
long-term (10-20 years).
3.
Diversity of Approach and
Responsiveness to Local
Economic and Social Problems
Content Requirements
1. Review and analyze the evidence:
a. What is the current status of small banks
in the United States?
— number
—
—
—
—
location
"typical" community served
extent of small bank "monopolies"
presence of other bank/nonbank
competitors
b. How well have small banks performed in
recent years?
— price levels — deposit rate paid
— profit levels
— output levels
c. How have recent changes in state statutes
or the form of banking organizations affected
the performance of small banks?
— liberalization of branching laws
— acquisition of multi-bank holding companies
— conversion to one-bank holding companies
d. What lessons can be drawn about the potential
structure and performance of small banks in
the U.S. from other experiments in financial
structure?
— price deregulation in U.S. securities
industry
— nationwide branching in Canada
e. What are the qualitative attributes or the
"social values" of the maintenance of a
vigorous small bank community?
Paper
2.
(Cont.)
Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. Differentiate the impact of policy options
according to the near-term (2-5 years) and
the long-term (10-20 years).
4.
Bank Credit Allocation Practices %
Content Requirements
1. Review and analyze the evidence:
a. How does the distribution of bank loans/prices
by class of borrower differ according to bank
structure?
— low income borrowers
— farmers
— small businessmen
— state and local government
b. How does banking structure affect overall
loan-to-asset or loan-to-deposit ratios?
c. Does the allocation of bank credit to the
financial institution competitors of banks
differ according to bank structure?
— bank loans to consumer finance companies
— bank loans to commercial finance companies
— bank loans to affiliated companies with
competitive product lines
d. How does bank structure affect the overall
sources and uses of funds?
— the flow of aggregate savings
— the composition of savings between deposits
and other instruments
— competition for the savings dollar
— funds for capital formation
— funds for "new" enterprises
— funds for consumption purposes
2. Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. -Differentiate the impact of policy options according
to the near-term (2-5 years) and the long-term
(10-20 years).
5.
Bank Operating Efficiency
Content Requirements
1. Review and analyze the evidence:
a. How do bank economies of scale and operating
efficiencies differ according to bank structure?
— unit banks — multi-bank holding
— branching
— limited branching
company
— one-bank holding
company
b. Are the production costs of certain bank
services more sensitive to banking structure
than other bank services?
— deposit services — trust services
— third party payments — mortgage loans
— commercial loans
— other
— consumer loans
c. What externally imposed restrictions might
have as significant an influence on bank
operating efficiency as the particular form
of bank organization?
— capitalization requirements
— liquidity requirements
— other bank regulations
— required reserves
— monetary policy
d. Are there significant cost differences between
transfers of capital "internal" to a multioffice banking organization as opposed to
through "external" correspondent relationships?
2. - Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. Differentiate the impact of policy options according
to the near-term (2-5 years) and the long-term
(10-20 years).
6.
The Regulation of Bank and
Nonbank Financial Institutions
Content Requirements
1. Review and analyze the evidence:
a. In what major ways do state banking statutes
differ from one another and from the National
Banking Act? In what major ways are they
similar?
b. How do state statutes and the National Banking
Act confer competitive advantages and/or
disadvantages on their respective institutions?
c. In what significant ways are banking organizations handicapped by state and national
regulations relative to their major nonbank
competitors? What are the reasons for differences in treatment?
d. In what ways are the operations of domestic
banking organizations and foreign banking
organizations in the U.S. differentially
impacted by statutes such as the McFadden Act,
the Douglas Act, the Edge Act, or others?
2. Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. Differentiate the impact of policy options
according to the near-term (2-5 years) and the
long-term (10-20 years).
7,
Bank Safety and Soundness
»
11
Content Requirements
1. Review and analyze the evidence:
a. How has banking structure impacted on the
safety and soundness of bank operations?
— unit banks — multi-bank holding
— limited branching
— branching
—
company
one-bank holding
company
b. Have there been significant differences in
bank failure rates associated with regulatory
factors other than branching or other multioffice restrictions?
— state or national capitalization requirements
— state or national reserve requirements
— state or national liquidity requirements
— state or national portfolio restrictions
c. Has federal deposit insurance virtually
eliminated concern with the impact of bank
structure on the safety and soundness of
bank operations?
2. Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. Differentiate the impact of policy options
according to the near-term (2-5 years) and
the long-term (10-20 years).
8. Convenience and Needs/Services Availability
Content Requirements
1* Review and analyze the evidence:
a. How have different bank branching restrictions
affected the availability of bank financial
services to the public?
— by type of financial service
— by number of branches per capita
— by size of market
— by consumer income distribution
b. How have different bank brancning restrictions
affected the relative status of banks and
nonbank financial intermediaries as providers
of financial services to the public?
c. On balance, after bank and nonbank financial
service providers are taken into consideration,
is there evidence that bank branching restrictions have resulted in a net deficit of services
to the public when compared against liberal
branching?
2. Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. Differentiate the impact of policy options
according to the near-term (2-5 years) and the
long-term (10-20 years).
%'
9.
Government Stabilization Policies
Content Requirements
1. Review and analyze the evidence:
a. In what ways might banking structure
impact on the effectiveness of monetary
and credit allocation policies?
b. Are there currently any discernible differences with respect to the efficiency
and the institutional burdens of monetary
policy depending upon the bank branching
environment?
c. How may alternative forms of multi-office
banking other than branching, such as
holding companies or EFT terminal deployment, affect government stabilization
policies?
d. If liberalized branching leads to greater
concentration in banking how will the
monetary policy responsibilities of the
Federal Reserve be affected?
2. Estimate the net benefit or the net cost to be
attributed to the alternative policy options.
3. Differentiate the impact of policy options
according to the near-term (2-5 years) and
the long-term (10-20 years).
10.
Housing Credit
Content Requirements
1. Review and analyze the evidence:
a. How do differences in bank branching
restrictions impact on the mortgage lending
operations of thrift institutions?
— unit banking
— limited branching
— statewide branching
b. Do branch banks or other multi-office forms
of bank organizations (such as holding
companies) divert relatively more or less
deposit funds from their thrift competitors
than do unit banks?
c. If a general liberalization of restrictions
on bank branching were implemented would
thrift institutions require compensating
powers in order to remain competitive? If
so, what types of compensating powers would
be required?
2. Estimate the net benefit or the net cost to be
attributed to the alterna
@FedFRASER