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LIBRARY
POOM 5030
OCT 1 6 1985
TREASUKY U£PAK[MENT
Treas.
HJ
10
•A13P4
v. 265
U.S. Dept. of the Treasury
1; PRESS RELEASES
LIBRARY
ROOM 5030
OCT 1 6 1985
\ TREASURY DEPAH [MENT
rREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone 566-2041
For Release Upon Delivery
March 26, 1985
STATEMENT OF THE HONORABLE JAMES A. BAKER, III
SECRETARY OF THE TREASURY
COMMITTEE ON APPROPRIATIONS
SUBCOMMITTEE FOR TREASURY, POSTAL SERVICE,
AND GENERAL GOVERNMENT
MR. CHAIRMAN, MEMEERS OF THE SUBCOMMITTEE:
I am pleased to appear before this Subcommittee for the
first time to discuss the operating budget for the Treasury
Department for Fiscal Year 1986.
As this Subcommittee is well aware, and as I have come to
understand better during the past several weeks, the Treasury
Department carries out functions that are truly essential to the
existence of our Federal system of government.
We administer the
Nation's tax system, and collect the government's revenues.
We
manage the government's fiscal affairs, including paying its
bills and financing the nation's public debt.
We manufacture the
currency and coin that are essential to the nation's commerce and
economic well-being.
institutions.
B-57
We help regulate our country's financial
We process passengers and cargo coming into the
-2-
country, enforcing import and export laws.
We carry out basic
federal law enforcement responsibilities, including protecting
the President, Vice-President, as well as other dignitaries. We
participate in the effort to combat illegal drug smuggling, and
administer firearms and explosives laws.
Finally, we advise the
President on monetary, economic, and tax policies.
To continue to carry out the functions of the Treasury
Department in Fiscal Year 1986, we are requesting a total budget
of $5.3 billion and 121,006 positions. These funding and
staffing totals include $6 million and 75 positions for the
administration of the revenue sharing program; that request is
reviewed by the Appropriations Subcommittee for Housing and Urban
Development and Independent Agencies.
Our budget request for FY 1986 represents a decrease of $45
million, or 0.8%, below the comparable Fiscal Year 1985 levels.
In addition to these funding and staffing requests for the
operations of the Treasury Department, our Fiscal Year 1986
budget reflects a proposed transfer of certain responsibilities
of the Small Business Administration to the Treasury Department.
-3Our budget includes $74 million and 1,650 positions for the
administrative costs of servicing existing direct loans and
monitoring the servicing of guaranteed loans.
The budget also
includes $2.6 billion for expenses directly associated with the
portfolio, including writing off defaulted loans.
Our
understanding is that this request concerning the transfer of the
Small Business Administration will not be taken up by the
Treasury Appropriations Subcommittee, but will be covered by the
Commerce, Justice, State and Judiciary Subcommittee.
The Fiscal Year 1986 budget for the Treasury Department has
several major objectives.
First, the overall budget request
reflects our participation in the governmentwide 1-year freeze in
total spending other than debt service.
Specifically, we have
maintained spending levels appropriated in the Fiscal Year 1985
Continuing Resolution plus critical supplemental requests.
Second, our budget reflects two specific governmentwide
proposals included in the President's budget —
a reduction of 5%
in Federal civilian pay effective January, 1986, and a 10%
reduction in administrative and overhead costs.
The 5% pay reduction will produce savings of approximately
$135 million in the Treasury Department's budget for Fiscal Year
1986.
-4-
To accomplish the 10% reduction in administrative costs, we
will streamline administrative and support operations. Every
Treasury organization will participate in this effort; the
estimated savings in Fiscal Year 1986 is $64 million. The
majority of these savings will be accomplished in the Internal
Revenue Service and the U.S. Customs Service. The IRS reduction
reflects cuts in personnel, printing, and general support
operations. The reduction in the U.S. Customs Service reflects
the centralization of administrative functions, certain
organizational realignments, and various operational and
management efficiencies.
Strengthening law enforcement capabilities is a third
objective of this budget.
We will increase our participation in the President's
Organized Crime Drug Enforcement Task Forces. We are requesting
supplemental funding of $6.5 million in Fiscal Year 1985 to
support Treasury's participation in the 13th City Task Force in
Miami. These Task Forces have achieved dramatic results. Since
October of 1982, the Task Forces have initiated over 800 cases,
which have resulted in over 4,300 indictments and more than 1,600
convictions. Over two-thirds of these cases have been the direct
result of financial investigations. These efforts have focused
on the criminal leadership in this country; this has resulted in
the breakup of many formerly well-financed and tightly-controlled
organized crime operations.
-5-
We are moving to strengthen our drug interdiction efforts.
We will acquire three additional P-3A aircraft this summer for
surveillance.
We have recently completed the installation of a
third air-to-air surveillance aerostat in the Bahamas.
Further,
we will acquire eight new, high endurance, tracking aircraft this
year with funds appropriated in FY 1984.
Our Fiscal Year 1986 budget for air interdiction represents
an increase of $16 million, or 36%.
These funds will be used to
operate the P-3A aircraft to be acquired this summer, to install
radars and night vision devices in certain interception aircraft,
to operate up to two additional helicopters, and to begin
developmental work on a 360 degree search radar system.
The Treasury Department is most appreciative of the
assistance we have received from the Defense Department over the
past several years in our efforts to stem the flow of illegal
drugs into the country.
As I am sure you are all aware, the drug
traffic from Central and South America, through the Caribbean, is
an increasingly serious problem.
Treasury must do everything
that we can to work together with all Federal agencies who can
aid in this war on drugs.
To this end, I am asking the Assistant
Secretary of the Treasury for Enforcement and Operations to meet
-6-
with the Defense Department to develop a joint plan for
strengthening our anti-smuggling capabilities in the Caribbean
Basin.
Our budget contains a proposed Fiscal Year 1985 supplemental
of $4.1 million to provide security and related equipment for the
perimeter of the White House, Naval Observatory, and Main
Treasury.
We believe that these improvements are critical due to
the recent events world-wide and the increased threat of
terrorist activity in this country.
In order to provide improved handling of seized property, we
are requesting $6 million in Fiscal Year 1985 and $8 million in
Fiscal Year 1986 for a new Customs Forfeiture Fund.
This Fund
was authorized by Congress last year in both the Trade and Tariff
Act of 1984 and the FY 1985 Continuing Resolution.
The Fund
operates using the net proceeds from the disposition of seized
and forfeited merchandise and currency.
We will use the Fund
primarily to pay for expenses related to seizures and to equip
forfeited vessels, vehicles, and aircraft for use in narcotics
interdiction.
We believe that this Fund not only will enable us
to increase significantly the profits from the sale of seized
assets, but also will increase the equipment available to us for
drug interdiction.
-7-
A fourth major objective of this budget is to continue major
efforts to modernize Treasury systems and equipment.
Even within
an overall spending freeze, we cannot postpone the introduction
of new technology and modern equipment.
These investments are
essential to the Department's ability to handle growing workloads
and to relieve future pressures for growth in personnel.
To help modernize the tax administration system, our budget
includes resources to continue two major projects now under
development —
the Automated Examination System and the Tax
System Redesign Project.
The Automated Examination System will
equip IRS enforcement personnel with modern equipment to help
them in the auditing of tax returns.
When this system is fully
implemented, productivity is expected to increase by as much as
25%.
The Tax System Redesign Project is a longer-term effort to
enable IRS to create an overall modernized system that will meet
the requirements of the 1990's.
The U.S. Customs Service is seeking an additional $14
million to automate its major commercial processing procedures,
to develop an integrated data telecommunications network, to
replace the current 15 year old Treasury Enforcement
Communications System, and to apply new technology to drug
interdiction efforts.
Customs' Automated Commercial System will
-8-
involve automated processing of entries from the trade community,
eliminate redundancies, reduce paper, and enhance selectivity
procedures in the cargo review process.
The Department's fiscal bureaus will continue to improve the
government's financial systems, the means by which we collect,
manage, and disburse federal funds and finance the public debt.
The Financial Management Service is requesting an additional $14
million to complete replacement of the Service's headquarters
computer, continue efforts to upgrade the government's collection
and payment systems, and enhance the financial telecommunications
network.
The Bureau of the Public Debt is requesting $3.5
million for funding for the first phase of a project to replace
the Bureau's mainframe computer and to purchase new equipment for
the processing of Savings Bonds issue stubs.
A fifth major objective of this budget is to strengthen the
tax administration system to collect additional revenues that are
owed by taxpayers.
Beginning in FY 1987, we will add 2,500
positions for Examinations in each of three fiscal years, for a
total of 7,500 positions.
This initiative will produce an
estimated $4.6 billion in additional revenue during Fiscal Years
1987-1989.
This proposal is recommended by the President's
-9-
Private Sector Survey on Cost Control, and involves the
collection of taxes that are legitimately owed.
It is only
equitable that we not ask the vast majority of American
taxpayers, who pay their fair share of taxes, to have to
subsidize those who do not contribute.
To implement this
initiative, we will conduct some advance hiring at the end of
Fiscal Year 1986.
Our budget also provides, within existing resource levels,
for implementation of certain provisions of the Deficit Reduction
Act of 1984.
Specifically, we will enforce the new tax shelter
registration requirements, as well as provisions which will
provide additional information to IRS.
The tax shelter
requirements are especially important as they will provide IRS
with the ability to identify and target abusive shelters for
enforcement action.
A sixth major objective of this budget is to accomplish
productivity savings through improved management and automated
systems.
Specifically, our budget identifies savings of $23
million and 748 positions.
The majority of these savings will
result from efficiencies in the processing of tax returns and
automation of the collection field function.
-10-
In addition to the major objectives that we have identified,
our budget anticipates a large and growing workload.
Some
examples include:
— IRS will process 178.7 million tax returns, an increase of
3% above the previous year.
— We expect to audit or contact over 2.7 million taxpayers,
close an estimated 3.3 million delinquent tax accounts,
and provide some form of assistance to over 55 million
taxpayers.
— We anticipate that 311 million passengers will arrive at
U.S. borders; this represents a growth of 4.3%.
We will
process 7.1 million formal entries of merchandise —
6%
more than in FY 1985.
— Treasury will issue over 80 million savings-type securities
and redeem more than 82 million.
We will make over 731
million payments, an increase of 2% above the prior year.
— We will print 6.6 billion pieces of currency, an increase
of 6.5%, and 35.8 billion postage stamps, an increase of
3%.
We will manufacture approximately 16.2 billion coins.
-11-
In summary, in terms of the major overall changes to the
budget, we are seeking:
— $67.1 million for program enhancements, related primarily
to the objectives that I have described;
— $14.6 million for increased workload, especially in the
area of tax administration;
— $262.4 million for price increases in such areas as
communications, office space, travel, and utilities; and
— an offset of $387.3 million in program reductions. These
include the 5% pay cut, the 10% savings in administrative
areas, and various productivity and one-time savings
throughout the Department.
FISCAL YEAR 1985 PROPOSALS
Our budget contains supplementals totalling $77.1 million
and rescissions totalling $9.5 million for Fiscal Year 1985.
The supplemental requests include $44.9 million to cover 50% of
the pay increase effective this past January and program
supplementals of $32.2 million.
-12-
The program supplementals include funds to cover the recent
postage rate increase for the Financial Management Service; to
establish the 13th Organized Crime Drug Enforcement Task Force in
Miami; to make certain security improvements to the White House,
Naval Observatory, and Main Treasury; to provide a one-time
capitalization increase to the IRS' Tax Lien Revolving Fund; to
support the Customs Seizure Fund; and to establish User Fees at
Certain Small Airports.
The proposed rescissions of $9.5 million are in response to
Section 2901 of the Deficit Reduction Act of 1985.
That Section
requires executive branch agencies to achieve savings in costs
associated with motor vehicles, travel, consulting services,
printing, and public affairs.
Mr. Chairman, that summarizes the major proposals of the
Treasury Department.
I shall be happy to answer any questions
that the Subcommittee may have.
rREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone 566-2041
fOR RELEASE AT 4:00 P.M. March 26, 1985
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling approximately $13,100 million, to be issued April 4, 1985.
This
offering will result in a paydown for the Treasury of about $25
million, as the maturing bills are outstanding in the amount of
$13,115 million, including $1,207 million currently held by Federal Reserve Banks as agents for foreign and international monetary
authorities and $2,453 million currently held by Federal Reserve
Banks for their own account. The two series offered are as follows:
92-day bills (to maturity date) for approximately $6,550
million, representing an additional amount of bills dated
January 3, 1985,
and to mature July 5, 1985
(CUSIP
No. 912794 HR 8 ) , currently outstanding in the amount of $7,065
million, the additional and original bills to be freely
interchangeable.
182-day bills (to maturity date) for approximately $6,550
million, representing an additional amount of bills dated
October 4, 1984,
and to mature October 3, 1985
(CUSIP
No. 912794 HM 9 ) , currently outstanding in the amount of $8,311
million, the additional and original bills to be freely
interchangeable.
Both series of bills will be issued for cash and in exchange
for Treasury bills maturing April 4, 1985.
Tenders from
Federal Reserve Banks for themselves and as agents for foreign and
international monetary authorities will be accepted at the weighted
average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued 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 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. 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.
B-58
- 2 Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington, D. C.
20239, prior to 1:00 p.m., Eastern Standard time, Monday,
April 1, 1985.
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.
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
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. Each
tender must state the amount of any net long position in the bills
being offered if such position is in excess of $200 million. This
information should reflect positions held as of 12:30 p.m. Eastern
time on the day of the auction. Such positions would include bills
acquired through "when issued" trading, and futures and forward
transactions as well as holdings of outstanding bills with the same
maturity date as the new offering, e.g., bills with three months to
maturity previously offered as six-month bills. 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, when submitting tenders for customers, must
submit a separate tender for each customer whose net long position
in the bill being offered exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
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
- 3 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 yield 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 $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to three
decimal places on the basis of price per hundred, e.g., 99.923, and
the determinations of the Secretary of the Treasury shall be final.
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 4, 1985,
in cash or other immediately-available funds
or in Treasury bills maturing April 4, 1985.
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.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
In general, if a bill is purchased at issue after July 18,
1984, and held to maturity, the amount of discount is reportable
as ordinary income in the Federal income tax return of the owner
at the time of redemption. Accrual-basis taxpayers, banks, and
other persons designated in section 1281 of the Internal Revenue
Code must include in income the portion of the discount for the
period during the taxable year such holder held the bill. If the
bill is sold or otherwise disposed of before maturity, the portion
of the gain equal to the accrued discount will be treated as ordinary income. Any excess may be treated as capital gain.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76 and 27-76, Treasury's single bidder guidelines, and this
notice prescribe the terms of these Treasury bills and govern the
conditions of their issue. Copies of the circulars, guidelines,
and tender forms may be obtained from any Federal Reserve Bank or
Branch, or from the Bureau of the Public Debt.
rREASURY NEWS
partment of the Treasury • Washington, D.C. • Telephone
FOR IMMEDIATE RELEASE
March 26, 1985
RESULTS OF AUCTION OF 4-YEAR NOTES
The Department of the Treasury has accepted $ 6,255 million of
$ 21,807 million of tenders received from the public for the 4-year
notes, Series L-1989, auctioned today. The notes will be issued
April 1, 1985, and mature March 31, 1989.
The interest rate on the notes will be 11-1/4%. The range of
accepted competitive bids, and the corresponding prices at the 11-1/4%
interest rate are as follows:
Price
Yield
99.843
Low
11.30%
99.780
High
11.32%
99.843
Average
11.30%
Tenders at the high yield were allotted 20%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
238,264
45,264
$
$
New York
19 ,379,904
5,r532,844
Philadelphia
27,300
26,800
Cleveland
174,449
64,449
Richmond
85,823
51,223
Atlanta
52,091
37,091
Chicago
737,876
177,476
St. Louis
120,358
116,358
Minneapolis
79,497
25,097
Kansas City
94,716
89,216
Dallas
16,850
13,250
793,918
70,518
San Francisco
5,517
5,517
Treasury
Totals
$21 ,806,563
$6,,255,103
The $ 6,255 million of accepted tenders includes $914
million
of noncompetitive tenders and $ 5,341 million of competitive tenders
from the public.
In addition to the $ 6,255 million of tenders accepted in the
auction process, $300 million of tenders was awarded at the average
price to Federal Reserve Banks as agents for foreign and international
monetary authorities. An additional $365 million of tenders was also
accepted at the average price from Government accounts and Federal
Reserve Banks for their own account in exchange for maturing securities.
B-59
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
For Release Upon Delivery
Expected at 10:00 a.m. E.S.T.
March 27, 1985
STATEMENT OF
DENNIS E. ROSS
ACTING DEPUTY TAX LEGISLATIVE COUNSEL
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON JUDICIARY
UNITED STATES SENATE
Mr. Chairman and Members of the Committee:
I am pleased to have the opportunity to present the views of
the Treasury Department on the Federal income tax policy issues
raised by the proposed sale by the Federal government of its
interest in the Consolidated Rail Corporation ("Conrail") to
Norfolk Southern Corporation ("Norfolk" or "Norfolk Southern").
I have attached to my statement a letter that we have sent to
Senator Danforth, Chairman of the Senate Commerce Committee's
Subcommittee on Surface Transportation, containing a more
detailed analysis of these tax policy issues.
Section 401 of the Regional Rail Reorganization Act of 1973
enacted by the Northeast Rail Service Act of 1981 directed the
Secretary of Transportation to submit to the Congress a plan for
the sale of the Federal government's interest in approximately 85
percent of Conrail's common stock to (1) ensure continued rail
service; (2) promote competitive bidding for the stock; and (3)
maximize the government's return on its investment in Conrail.
After careful review of a number of purchase proposals, the
Secretary of Transportation has recommended sale of Conrail to
Norfolk Southern.
The Treasury Department has consulted closely with the
Department of Transportation with regard to the tax policy
aspects of the sale of Conrail. Our advice to the Transportation
B-60
- 2 Department has been guided by two basic policy objectives: (1)
that the sale of Conrail should not provide the purchaser with
Federal income tax benefits that would not be available in an
analogous transaction between private parties; and (2) that the
internal Revenue Service ("IRS"), in its role as administrator of
the Federal income tax laws, should not be prevented by the sales
agreement or enabling legislation from treating Conrail in the
same manner as it would any other taxpayer.
Treatment of Conrail's Tax Benefits
Under current law there are significant differences in the
Federal income tax treatment of a sale of stock and a sale of the
assets of a corporation. In general, a purchaser of the stock of
a corporation receives a tax basis in the stock purchased equal
in amount to the consideration paid for such stock. Other than
this change in tax basis for the stock purchased, the sale of
stock of a corporation generally does not trigger tax
consequences either to the purchaser or to the corporation whose
stock is sold. Accordingly, the existing tax attributes of the
acquired corporation generally remain intact even though the
corporation is owned by different persons.
Given the treatment of stock purchase transactions under
current law, if the proposed sale of Conrail stock occurred
between private parties the tax attributes of Conrail, such as
its net operating loss carryforwards, investment tax credit
carryforwards, and asset tax basis (including the so-called
"frozen asset base"), would remain intact following the sale.
The tax consequences of the proposed sale of Conrail to Norfolk
Southern would depart from this private transaction model in that
certain of Conrail's tax attributes would not survive the sale
transaction. Thus, pursuant to a closing agreement to be entered
into between Conrail and the IRS, Conrail's net operating loss,
investment tax credit and other carryforwards would, with certain
exceptions, not be available for carryforward to taxable years
beginning after the date of sale (hereinafter, the "Closing").*
At the same time, other Conrail tax attributes, in particular,
Conrail's asset basis, would, as in a private party transaction,
carry over to taxable years after the Closing.
We believe the different treatment of Conrail's tax
carryforwards on the one hand and its asset basis on the other is
appropriate for a number of reasons. Conrail's existing
carryforwards arose during the period of the Federal government's
•
The closing
agreement
also attributable
provide that to
Conrail's
ownership
and are
for the would
most part
monies
taxable
year
would
terminate
as
of
the
Closing.
invested in Conrail by the Federal government. The same is not
- 3 -
true of Conrail's asset basis. Although the assets held by
Conrail have changed substantially since its formation in 1976,
data provided to us by the Department of Transportation indicates
that the aggregate tax basis of its assets (as of December 31,
1983) is roughly equal to what it was at that time. Thus, the
proposed transaction would return Conrail to the private sector
with substantially the same asset basis as at the time the
Federal government acquired it.*
We, of course, recognize that the purchase price in a sale
transaction will reflect the extent to which advantageous tax
attributes carry over in an acquisition. Where the Federal
government is the seller, however, any gain in purchase price
from a carry over of favorable tax attributes must be weighed
against future revenue losses attributable to the purchaser's
utilization of the tax attributes. This weighing is more
difficult to the extent the purchaser's ability to use the
attributes is uncertain. In this respect, the value of Conrail's
carryforwards is inherently more speculative than the value of
its asset basis, since the carryforwards would be of future value
only to the extent that annual depreciation deductions generated
by Conrail's asset basis had already been fully utilized. It
would thus appear reasonable for the Federal government to
require the termination of Conrail's carryforwards rather than
speculate as to their value, while, in accord with the model of a
private transaction, permitting Conrail to return to the private
sector with its asset basis intact.
It should also be noted that the treatment of Conrail's tax
attributes in the proposed sale is similar to what was approved
by Congress at the time of Conrail's formation. Thus,
legislation adopted in connection with Conrail's formation, now
reflected in section 374(c) of the Internal Revenue Code (the
"Code"), provided that the net operating loss carryforwards of
Conrail's predecessors would not carry over to Conrail whereas
Conrail would inherit its predecessors' asset basis. The tax
consequences of the proposed sale of Conrail to Norfolk Southern
would generally conform to that legislative precedent.
If thethe
effects
inflation
are accounted
for, Conrail's
Finally,
carry of
over
of Conrail's
asset basis
should not
current
asset
basis
is,
of
course,
much
less
than
at the
time
cause a reduction in Federal income tax revenues collected
from
of
its
formation.
Moreover,
since
the
value
of
Conrail's
Conrail. Although Conrail is a taxable entity, it has not
assets today likely exceeds their value at the time of
Conrail's formation, the built-in loss in Conrail's assets
(i.e., the excess of their basis over value) is likely
smaller today than it was at Conrail's formation.
- 4 -
previously paid Federal income tax, nor would it in the
foreseeable future given its substantial carryforwards and the
high basis in its assets. Because Conrail's carryforwards would
not survive the proposed sale to Norfolk Southern, the
transaction would, if anything, accelerate the point at which
Conrail would become a taxpaying corporation.
Separation of Government Roles
The IRS is charged with administration and enforcement of the
Federal income tax laws. In order to effectively carry out this
mission, no preference or special rules can be adopted for any
taxpayer.
We believe the Department of Transportation's plan for the
sale of Conrail is consistent with the IRS' special
responsibilities as administrator of the Federal income tax laws.
Most importantly, the plan does not restrict the IRS from
auditing or assessing tax liabilities against Norfolk Southern or
Conrail after the sale. To the extent Norfolk Southern would be
protected in the proposed transaction against possible tax
liabilities of Conrail or of Norfolk, such protection would be
provided in the form of a warranty, rather than covenant by the
IRS, in order that the IRS be able to fulfill its mission of
evenly administering and enforcing the Federal income tax laws.
Certain legislation, which is included in the proposal submitted
by the Department of Transportation, would be necessary to
implement a procedure for Norfolk Southern to enforce such tax
warranties against the Federal government.
Special Legislation for Conrail's Employee Stock Ownership Plan
Certain legislation is also required to qualify for tax
purposes Conrail's employee stock ownership plan that was created
by earlier legislation. This legislation, which is included in
the proposal submitted by the Department of Transportation, is
necessary because of the possibly unique form of Norfolk
Southern's arrangements with Conrail's labor unions and employees
and the unusual structure of Conrail's employee stock ownership
plan.
This concludes my prepared remarks. I would be happy to
respond to your questions.
DEPARTMENT OF THE TREASURY
WASHINGTON, D.C. 20220
ASSISTANT SECRETARY
March 27, 1985
Dear Mr. Chairman:
This is in response to your request for our views of the
Federal income tax policy issues raised by the proposed sale of
the Federal government's interest in the Consolidated Rail
Corporation ("Conrail") to Norfolk Southern Corporation
("Norfolk"). In preparing this response, we have not
comprehensively examined all potential Federal income tax
consequences of the proposed sale, but have limited our analysis
to certain issues of tax policy raised by the Federal
government's ownership of Conrail and the form of the proposed
transaction. In addition, our analysis has assumed that the
details of the proposed transaction are accurately reflected in
the Memorandum of Intent signed February 8, 1985 by Norfolk and
the Department of Transportation, and in H.R. 1449 and S. 638,
the pending legislation that would authorize and establish terms
for the sale of Conrail.
We have previously consulted with the Department of
Transportation with regard to its Congressionally mandated plan
for the return of Conrail to the private sector. We thus have
advised the Department of Transportation as to Federal income tax
aspects of the sale of Conrail and have reviewed the tax
implications of the bids for Conrail and of draft language for
the Memorandum of Intent and enabling legislation. Our prior
advice and the conclusions set forth in this response have been
guided by two basic policy objectives: 1) that the sale of
Conrail should not provide the purchaser with Federal income tax
benefits that would not be available in an analogous transaction
between private parties; and 2) that the Internal Revenue Service
(the "IRS"), in its role as administrator of the Federal income
tax laws, should not be prevented by the sales agreement or
enabling legislation from treating Conrail in the same manner as
it would any other taxpayer. Based on our analysis of the
Memorandum of Intent and the enabling legislation, we believe
that the proposed sale is basically consistent with these policy
objectives.
Background
Section 401 of the Regional Rail Reorganization Act of 1973
enacted by the Northeast Rail Service Act of 1981 directed the
Department of Transportation to devise a plan for returning
Conrail to the private sector, preferably by sale of common stock
rather than by a sale of its assets. Under current law there are
significant differences in the Federal income tax treatment of a
sale of stock and a sale of the assets of a corporation. In
general, a purchaser of the stock of a corporation receives a tax
- 2 basis in the stock purchased equal in amount to the consideration
paid for such stock. Other than this change in tax basis for the
stock purchased, the sale of stock of a corporation generally
does not trigger tax consequences either to the purchaser or to
the corporation whose stock is sold. Accordingly, the existing
tax attributes of the acquired corporation generally remain
intact even though the corporation is owned by different persons.
Carry Over of Tax Attributes
Given the treatment of stock purchase transactions under
current law, if the proposed sale of Conrail stock occurred
between private parties the tax attributes of Conrail, such as
its net operating loss carryforwards, investment tax credit
carryforwards, and asset tax basis (including the so-called
"frozen asset base"), would remain intact following the sale.
The tax consequences of the proposed sale of Conrail to Norfolk
would depart from this private transaction model in that certain
of Conrail's tax attributes would not survive the sale
transaction. Thus, pursuant to a closing agreement to be entered
into between Conrail and the IRS, Conrail's net operating loss,
investment tax credit and other carryforwards would, with certain
exceptions, not be available for carryforward to taxable years
beginning after the date of sale (hereinafter, the "Closing").*
At the same time, other Conrail tax attributes, in particular,
Conrail's asset oasis, would, as in a private party transaction,
carry over to taxable years after the Closing.
We believe the different treatment of Conrail's tax
carryforwards on the one hand and its asset basis on the other
is appropriate for a number of reasons. Conrail's existing
carryforwards arose during the period of the Federal government's
ownership and are for the most part attributable to monies
invested in Conrail by the Federal government. The same is not
true of Conrail's asset basis. Although the assets held by
Conrail have changed substantially since its formation in 1976,
data provided to us by the Department of Transportation indicates
that the aggregate tax basis of its assets (as of December 31,
1983) is roughly equal to what it was at that time. Thus, the
proposed
transaction
would would
returnalso
Conrail
to the
sector
*
The closing
agreement
provide
thatprivate
Conrail's
with taxable
substantially
the same
asset as
basis
as at
the time the
year would
terminate
of the
Closing.
Federal government acquired it.**
** If the effects of inflation are accounted for, Conrail's
current asset basis is, of course, much less than at the time
of its formation. Moreover, since the value of Conrail's
assets today likely exceeds their value at the time of
Conrail's formation, the built-in loss in its assets (i.e.,
the excess of their basis over value) is likely smaller * today
than it was at Conrail's formation.
- 3 We, of course, recognize that the purchase price in a sale
transaction will reflect the extent to which advantageous tax
attributes carry over in an acquisition. Where the Federal
government is the seller, however, any gain in purchase price
from a carry over of favorable tax attributes must be weighed
against future revenue losses attributable to the purchaser's
utilization of the tax attributes. This weighing is more
difficult to the extent the purchaser's ability to use the
attributes is uncertain. In this respect, the value of Conrail's
carryforwards is inherently more speculative than the value of
its asset basis, since the carryforwards would be of future value
only to the extent that annual depreciation deductions generated
by Conrail's asset basis had already been fully utilized. It
would thus appear reasonable for the Federal government to
require the termination of Conrail's carryforwards rather than
speculate as to their value, while, in accord with the model of a
private transaction, permitting Conrail to return to the private
sector with its asset basis intact.
It should also be noted that the treatment of Conrail's tax
attributes in the proposed sale is similar to what was approved
by Congress at the time of Conrail's formation. Thus,
legislation adopted in connection with Conrail's formation, now
reflected in section 374(c) of the Internal Revenue Code (the
"Code"), provided that the net operating loss carryforwards of
Conrail's predecessors would not carry over to Conrail whereas
Conrail would inherit its predecessors' asset basis. The tax
consequences of the proposed sale of Conrail would generally
conform to that legislative precedent.
Finally, the carry over of Conrail's asset basis should not
cause a reduction in Federal income tax revenues collected from
Conrail. Although Conrail is a taxable entity, it has not
previously paid Federal income tax, nor would it in the
foreseeable future given its substantial carryforwards and the
high basis in its assets. Because Conrail's carryforwards would
not survive the proposed sale to Norfolk, the transaction would,
if anything, accelerate the point at which Conrail would become a
taxpaying corporation.
Utilization of Conrail Deductions By Norfolk
The proposed sale transaction could adversely affect Federal
income tax revenues if future deductions generated by Conrail's
asset basis could be utilized to offset otherwise taxable income
of Norfolk. As an includible member in Norfolk's consolidated
return, tax losses of Conrail could currently offset taxable
income of any other member in the consolidated return unless such
losses were limited under the separate return limitation year
- 4 ("SRLY") and the built-in deduction rules of the consolidated
return regulations. These rules, in general, prevent the
utilization of an acquired corporation's pre-acquisition losses
(including losses attributable to assets with tax basis in excess
of fair market value, so-called "built-in deductions") against
income of any member of the acquiring group. It is conceivable
that Norfolk would seek to avoid these restrictions through any
of the following strategies: by satisfying the so-called de
minimis exception to the SRLY and built-in deduction rules, by
transferring assets to Conrail, the income from which would be
absorbed by Conrail losses, or by merging Conrail into Norfolk
(or an affiliated corporation) in a transaction in which
Conrail's tax attributes would carry over.
The consolidated return regulations would provide an
exception to the SRLY and built-in deduction rules, if, on the
acquisition date, the aggregate of the adjusted tax basis of all
assets of Conrail (other than cash, marketable securities, and
goodwill) do not exceed the fair market value of such assets by
more than 15 percent. See Treas. Reg. § 1.1502-15(a)(4 ) (i ) (b).
A review of Conrail's tax data, provided to us by the Department
of Transportation, suggests that Conrail would not satisfy the de
minimis exception, since its aggregate tax basis appears to
exceed $3 billion, and Norfolk is paying only $1.2 billion for 85
percent of Conrail's common stock. The de minimis exception,
however, is based on the fair market value of Conrail's assets
rather than the value of Conrail's stock. Since we do not have
appraisals or other direct information concerning the fair market
Paragraph
12(e)assets,
of the Memorandum
of Intent
provides
as
value
of Conrail's
it is not certain
that
Conrail that
would
a
condition
to
Norfolk
buying
Conrail
from
the
Federal
not satisfy the de minimis exception.*
government, Norfolk shall have received (at the Federal
government's sole election) either a ruling or a warranty
that amounts paid to employees of Conrail for services
rendered after Closing in order to increase their
post-Closing wages to industry standard and the costs paid or
incurred for certain routing concessions which are otherwise
ordinary and necessary business expenses shall not be treated
as built-in deductions and can be deducted when accrued or
paid. Although the SRLY and built-in deduction rules apply
to amounts economically accrued but not yet deducted, the
above expenses do not appear to constitute built-in
nfh.rwtc2SA B e ^ u s e o f * h e condition that such expenses must
otherwise be ordinary and necessary business expenses, the
w ^ r ? n h ° ^ r H ^ n t ? . ^ ? V i r e d x b y the above condition does not
warrant the deductibility of such amounts; only that such
amounts are not built-in deductions.
- 5 -
Norfolk's ability to avoid the SRLY and built-in deduction
rules by either transferring assets to Conrail or by merging
Conrail into Norfolk or an affiliate would be constrained by
Norfolk's contractual obligations, by practical business
considerations and by the provisions of the tax law. Paragraph
12(b)(iii) of the Memorandum of Intent appears to prohibit a
merger of Conrail into Norfolk (or an affiliated corporation) for
at least five years after the Closing. In addition, it is
questionable whether Norfolk would transfer significant income
producing assets to Conrail given that, as reflected in Paragraph
12(b) of the Memorandum of Intent, there would be significant
restrictions on Norfolk's ability to withdraw assets from
Conrail. With regard to tax law limitations, a transfer of
significant assets to Conrail or a merger of Conrail into Norfolk
(or an affiliated corporation) could subject future use of
Conrail deductions to challenge under section 269 of the Code.
See Treas. Reg. § 1.269-3(b)(1).
Warranty of Asset Basis
As provided in Paragraph 6(e)(ii) of the Memorandum of
Intent, the Federal government would warrant to Norfolk that the
asset basis reflected on Conrail's tax return for the year ending
on the Closing would not be decreased as a result of an audit
adjustment for a taxable year ending on or before the Closing.
We believe this warranty is appropriate for a variety of reasons.
Most importantly, the warranty protection extended to Norfolk is
consistent with the allocation of risks that could be expected in
an analogous private party transaction. Conrail has not been
audited since its formation and its tax basis in many assets
would have to be traced to its predecessors. As a consequence,
Norfolk has no effective means of determining whether Conrail's
asset basis is accurately reflected on its tax returns. In
circumstances where the accuracy of the selling party's tax
accounting cannot be established, it is reasonable to expect the
seller to retain the risk of audit.
Consistent with the above warranty, Paragraph 6(e) (iii) and
(iv) of the Memorandum of Intent require the Federal government
to warrant that the adjusted tax basis of Conrail's assets would
not be reduced and no gain or loss or income would be recognized
by Conrail or Norfolk as a result of the sale of Conrail's stock
to Norfolk, except in the event Norfolk makes, or is deemed to
have made, an election under section 338 of the Code. If a
section 338 election were made (or deemed made) by Norfolk in
connection with its purchase of the stock of Conrail, Conrail
would be treated as if it sold all of its assets to itself in a
liquidating sale, and the tax basis of its assets would be
adjusted to an amount based upon the amount Norfolk paid for
Conrail's stock (grossed-up to reflect a purchase of 100 percent
of Conrail's stock). The Memorandum of Intent further provides
- 6 that', for purposes of the warranty, Norfolk would not be deemed to
make a section 338 election as a result of any asset acquisition
provided that Norfolk (and its affiliates) elect either to treat
such assets acquired in accordance with regulations promulgated
under section 338 or elect under conditions to be agreed upon that
the basis of such assets would not exceed the transferor's basis in
the assets immediately before the acquisition. This warranty was
provided because, as of the date the Memorandum of Intent was
signed, the regulations providing for a carryover basis to avoid a
deemed election under section 338, contemplated by Congress in the
Tax Reform Act of 1984, had not been issued.
It should be noted that the warranty protection that Norfolk
receives is not a guarantee that the IRS will not audit Conrail for
pre-Closing years or that if it does so that it will not be entitled
to require a reduction in Conrail's asset basis. In the event of an
IRS audit and resultant reduction in basis, the warranty procedure
contemplated in the Memorandum of Intent and enabling legislation
entitles Conrail to sue in Federal court and to obtain a judgment
which could be applied to offset any increase in tax liability
attributable to the basis reduction. Although this procedure leaves
Conrail economically protected from the risk of audit, it does not
otherwise impair the IRS' ability to conduct an audit of Conrail.
Retention of the IRS' audit authority with respect to Conrail's
pre-Closing years could be significant to the extent substantive tax
issues relating to those years have relevance to issues arising in
other tax years of Conrail or to the administration of the Federal
income tax system generally.
Change in Methods of Depreciation
The potential value of any built-in loss in Conrail's assets
also depends on the period of time over which those assets would be
depreciated. The warranty as to asset basis provided in Paragraph
6(e)(ii) of the Memorandum of Intent contains a condition that the
depreciation of such assets should be determined without extraordinary departures from the methods of prior years. In general,
since a depreciation method is considered a method of accounting, a
taxpayer cannot change its method of depreciation with respect to a
particular asset without first obtaining permission from the
Commissioner
of the
In thisRecovery
regard, Conrail
Norfolk
would
Section 203(c)
of IRS.*
the Economic
Tax Act and
of 1981
permitted
be taxpayers
treated the
as any
taxpayer
if, after the
sale of
to same
change
theirother
method
of depreciating
railroad
track
Conrail,
a
change
in
depreciation
method
were
requested.
without having such change treated as a change in method of
accounting, it does not appear that this provision applies to a
C
5f n9e iio-, the m e t h o d o f depreciating railroad track initiated
after 1981. Thus, Conrail should not be able to change its
present method of depreciating its "frozen asset base" without
securing the prior approval of the IRS.
- 7 -
Carry Over of Earnings & Profits
At present, Conrail may have a deficit earnings and profit
account reflecting its substantial net losses over the period of
its operation.* The Memorandum of Intent does not directly state
whether the earnings and profits history of Conrail would carry
over to post-Closing taxable years. Since earnings and profits
ordinarily would carry over in a stock acquisition, the failure
to state a contrary result suggests that Conrail's earnings and
profits account would survive the transaction. Since earnings
and profits are a measure of a corporation's income or loss, it
would seem that Conrail's earnings and profits should be treated
consistently with Conrail's net operating losses, and thus should
not carry over to post-Closing years. We thus believe that a
definitive sale agreement should clarify the treatment of
Conrail's earnings and profits by providing that they .not carry
over in the sale transaction.
The value to Norfolk of a carryover of Conrail's earnings and
profits is uncertain. Earnings and profits determine the extent
to which a corporation's distributions to its shareholders are
dividends rather than a return of capital. Although a deficit
earnings and profits account would permit a corporation to make
nontaxable return of capital distributions to its shareholders,**
Conrail will be a wholly-owned member of Norfolk's consolidated
group and thus its distributions will be nontaxable whether
characterized as dividends or as a return of capital. We
understand that Norfolk itself has a substantial surplus in its
earnings and profits, and thus any distributions by Norfolk to
its shareholders would be fully taxable dividends even if they
were attributable to distributions from Conrail. Moreover,
Norfolk's surplus in earnings and profits would not be offset by
any deficit of Conrail even if Conrail were to merge with
Norfolk. See section 381(c)(2) of the Code.
Cancellation of Conrail Debt and Preferred Stock
The Northeast Rail Service Act, which directed the Department
* Transportation
We have not been
provided
any data
on Conrail's
earningsalso
and
of
to devise
a plan
for the
sale of Conrail,
profits.
may
uncertainty
as "Federal
to the exact
amount
directed
that There
Conrail
bebe
sold
free of the
government's
because of the uncertain effects of prior law.
** A carryover of any Conrail deficit in earnings and profits
could well be disadvantageous to Norfolk, since it would
limit Conrail's ability to issue new preferred stock to
outside interests. The market for such preferred stock is
predominantly among corporations, for whom dividend
distributions are more advantageous than returns of capital.
- 8 -
existing debt or preferred stock interests. The apparent intent
of the legislation was that Conrail be returned to the private
sector with a sound capital structure. This intention is
reflected in Paragraph 3 of the Memorandum of Intent, which
provides that prior to the sale, approximately $850 million of
outstanding Conrail debt, including accrued interest thereon, and
approximately $2.3 billion par value of Conrail preferred stock,
including accrued and unpaid dividends thereon, held by the
Federal government would be "cancelled or retired, and
contributed to the capital of Conrail." In addition, under
Paragraph 6(e)(i) of the Memorandum of Intent, the Federal
government would warrant that Conrail will not recognize income
on account of the cancellation of Conrail preferred stock or
debt.
Under general tax law principles, reflected in section
61(a)(12) of the Code, a corporation may recognize income where
it retires outstanding indebtedness at a cost that is less than
the face amount of the indebtedness. This discharge of
indebtedness principle recognizes that a taxpayer has an economic
profit where it borrows money which it is not required to repay
in full. Certain exceptions to the discharge of indebtedness
principle are enumerated in section 108 of the Code, including
that a corporation does not recognize income where a shareholder
contributes indebtedness to the corporation's capital (provided
that the shareholder's basis in the debt is not less than the
face amount of the debt). This exception, stated in section
108(e)(6), effectively recognizes that any excess of the amount
borrowed from a shareholder over the amount repaid might have
been directly contributed to the corporation without causing the
corporation to recognize income.
Under the substantive principles described above, Conrail
would not recognize income from the cancellation of its debt if
such cancellation were treated as a contribution to its capital
by the Federal government. Although there is little authority
addressing whether a shareholder's cancellation of corporate debt
is a contribution to capital, characterization of the
cancellation of Conrail's debt as a contribution to its capital
would seem probable. The cancellation of Conrail's debt would be
structured
in this
form, theowns
cancellation
was directed
by common
*
The Federal
government
approximately
85% of the
Congress,
andConrail,
the practical
effect
of the 15%
cancellation
stock of
with the
remaining
being heldwould
by
simply
be
to
enhance
the
value
of
Conrail
common
stock
owned
or
Conrail Equity Corporation ("CEC"), a subsidiary of Conrail
controlled
by the Federal
(see discussion
below government.*
under Transactions Involving Conrail's
- 9 -
Even if the cancellation of Conrail's debt were not treated
as a contribution to its capital by the Federal government,
Conrail's carryforwards would remain available to offset any
discharge of indebtedness income to Conrail for a pre-Closing
year. Given the size of Conrail's carryforwards in comparison to
the amount of its outstanding debt, the warranty that Conrail
would not recognize discharge income offers additional protection
to Conrail only to the extent such income might be recognized
after the Closing, i.e., in a year in which the carryforwards
would not be available to absorb the income. Although it may be
conceivable that the debt cancellation and sale of Conrail could
be recharacterized so as to cause Conrail to recognize discharge
of indebtedness income after the Closing, any such income would
as a practical matter be attributable to the period in which
Conrail was owned by the Federal government. We thus believe it
is consistent with the other tax consequences of the proposed •
sale that Conrail be held harmless from any tax liability arising
from the cancellation of its indebtedness. A warranty providing
for this result is additionally appropriate given that the
cancellation is directed by legislation.
The proposed sale agreement also warrants that Conrail will
not recognize income from the cancellation of its outstanding
preferred stock. Under general tax law principles, a corporation
does not recognize income upon a reacquisition or cancellation of
its own stock. Thus, absent a recharacterization of the
transaction, Conrail should not recognize income from the
cancellation of its preferred stock.
Although we are uncertain as to why this warranty was
requested, it might conceivably be out of a concern that
Conrail's preferred stock could be characterized for tax purposes
as indebtedness, and thus that Conrail may recognize income from
its cancellation. There is little authority indicating under
what circumstances an investment denominated as preferred stock
could be recharacterized as debt for tax purposes. We
nevertheless view the possibility of such recharacterization in
Conrail's circumstances as remote. Recharacterization of any
substantial portion of Conrail's preferred stock as debt could
push Conrail near or into insolvency.
Transactions Involving Conrail's ESOP
Approximately 15 percent of Conrail's common stock is
beneficially owned by Conrail's employee stock ownership plan
- 10 ("ESOP").* Paragraph 2 of the Memorandum of Intent provides
that, ator prior to the Closing, Norfolk or Conrail shall have
made appropriate arrangements with respect to the employees of
Conrail to accomplish the acquisition by Norfolk of such
employees' 15 percent beneficial interest in Conrail. While we
understand that separate negotiations between Norfolk and
Conrail's employees are still pending, Exhibit A to the
Memorandum of Intent indicates that Norfolk proposes to transfer
$375 million in cash or Norfolk common stock to Conrail's ESOP.
To the extent that Norfolk's transfer to Conrail's ESOP is in
exchange for the ESOP's beneficial interest in Conrail's stock,
such amounts would not be deductible contributions by Norfolk but
rather costs incurred in acquiring Conrail's stock. On the other
hand, to the extent that the amount of Norfolk's transfer to
Conrail's ESOP exceeds the value of the ESOP's beneficial
interest in Conrail's stock, such amount could be a 'deductible
contribution by Norfolk, subject to the deduction timing rules of
Code section 404 (including section 404(j)) and the continued
qualification of Conrail's ESOP. The enabling legislation
specifically provides that no inference is to be drawn from the
provisions of that legislation regarding either the allocation of
Norfolk's $375 million transfer between the purchase of Conrail's
stock and deductible contributions to the ESOP or the
deductibility of any portion of such transfer by Norfolk to
Conrail's ESOP.
If the form of Norfolk's arrangements with Conrail's
employees were to cause disqualification of Conrail's ESOP, such
employees generally would be currently taxable on the value of
CEC, all of the common stock and approximately 50 percent of *
their beneficial interest in the trust. In this regard,
the preferred stock of which is owned by Conrail, currently
owns approximately 15 percent of the common stock of Conrail.
The other 50 percent of CEC's preferred stock is owned by
Conrail's ESOP. Under existing agreements, Conrail's ESOP by
1991 would own 100 percent of CEC's preferred stock which
would then be exchanged for the 15 percent of Conrail's
common stock held by CEC.
**
It should be noted that under Paragraph 12(b)(viii) of the
Memorandum of Intent Norfolk and Conrail are prohibited for
at least five years from obtaining a reversion of any excess
assets held in connection with Conrail's Supplemental Pension
Plan. A reversion of plan assets to either Norfolk or
Conrail would not be permissible unless and until the plan is
terminated and all liabilities of the plan to the employees
r
J
are fully satisfied.
- 11 section 132 of the enabling legislation provides that Conrail's
ESOP and related trusts maintained, amended, or adopted in
implementing the Secretary of Transportation's plan for the sale
of Conrail shall be deemed to meet the qualification requirements
of sections 401 and 501, notwithstanding that such plans may not
meet the requirements of Code section 415 (which relate to
limitations on contributions and other additions with respect to
participants in a qualified plan) or that participants in such
plans may be entitled to withdraw a portion of the shares
allocated to their accounts prior to the expiration of the
two-year period generally imposed by the IRS for qualified plans
(see Treas. Regs. § 1.401-l(b)(1)(ii)). Although Norfolk's
arrangements with Conrail's employees have not been finalized, we
believe it appropriate, given the possibly unique form of such
arrangements and the unusual structure of Conrail's ESOP, to
waive by legislation these two possible technical violations in
order that Conrail's ESOP maintain its qualification.
Sincerely,
jiuotoi fcUo-A,—,
Ronald A. Pearlman
Assistant Secretary
(Tax Policy)
The Honorable
John C. Danforth, Chairman
Subcommittee on Surface Transportation
Committee on Commerce, Science
and Transportation
United States Senate
Washington, D.C. 20510
rREASURY NEWS
partment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
March 27, 1985
RESULTS OF AUCTION OF 7-YEAR NOTES
The Department of the Treasury has accepted $5,752 million of
$16,006 million of tenders received from the public for the 7-year
notes, Series E-1992, auctioned today. The notes will be issued
April 2, 1985, and mature April 15, 1992.
The interest rate on the notes will be 11-3/4%. The range of
accepted competitive bids, and the corresponding prices at the 11-3/4%
interest rate are as follows:
Yield
Price
Low
11.82%1_/
99.648
High
11.85%
99.508
Average
11.85%
99.508
Tenders at the high yield were allotted 97%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Received
Accepted
Location
Boston
$
18,688
$
233,838
New York
14,097,960
5,137,060
Philadelphia
11,960
11,960
Cleveland
77,718
55,388
Richmond
30,596
19,446
Atlanta
23,839
12,789
Chicago
795,574
262,534
St. Louis
94,815
92,815
Minneapolis
6,941
6,941
Kansas City
38,695
38,682
Dallas
9,131
7,131
San Francisco
579,901
83,561
Treasury
4,995
4,995
Totals
$16,005,963
$5,751,990
The $5 752 million of accepted tenders includes $560
million
of noncompetitive tenders and $5,192 million of competitive tenders
from the public.
In addition to the $5,752 million of tenders accepted in the
auction process, $100 million of tenders was awarded at the average
price to Federal Reserve Banks as agents for foreign and international monetary authorities.
1/ Excepting 1 tender of $2,000.
B-61
rREASURY NEWS
sartment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
March 27, 1985
STATEMENT BY
THE HONORABLE THOMAS J. HEALEY
ASSISTANT SECRETARY OF THE TREASURY
FOR DOMESTIC FINANCE
BEFORE THE
COMMERCE, CONSUMER, AND MONETARY AFFAIRS SUBCOMMITTEE
OF THE HOUSE COMMITTEE ON GOVERNMENT OPERATIONS
Mr. Chairman and members of the Subcommittee:
I am glad to have this opportunity to discuss with you
the findings of the "Blueprint for Reform: The Report of the
Task Group on Regulation of Financial Services". The
recommended reforms, which are based on the principle of
regulation by function, are a first step to assigning regulatory
responsibility for similar functions to one regulatory entity
in order to eliminate overlapping authority. The Task Group's
unanimously adopted recommendations were carefully negotiated
by the 13 member group and represent a balanced and workable
program that is a definite improvement over the current system.
Many of the proposals that implement greater functional
regulation, especially those that generate little or no
controversy such as the centralization of antitrust and
securities responsibilities, should be adopted as soon as
possible.
As you know, the "Blueprint" does not offer a solution
to all the problems in the financial services industry but
attempts to strengthen the regulatory system by simplifying
it and improving accountability.
B-62
- 2 Congress found in the late 1970s that depository
institutions could not compete for funds with less restricted
financial services firms'and'thus passed the Depository
Institutions Deregulation and Monetary Control Act of 1980.
This Act and the Garn-St Germain Act of 1982 authorized
the elimination of the federally imposed interest rate ceilings
on deposits in commercial banks, savings and loan associations
and mutual savings banks. In addition, these Acts increased
the asset powers of depository institutions so that they
could invest their market rate deposits at a profit.
In order to maintain safety and soundness and consumer
protection in our new deregulated environment, the regulatory
structure must provide even more effective examination and
enforcement than was necessary when the activities of these
institutions were more strictly limited.
The current regulatory structure is exceedingly complex.
Seven primary federal regulatory agencies, hundreds of state
agencies, and many special purpose organizations share
regulatory authority over depository institutions. The
regulatory system, which has evolved over the past hundred
years, needs some significant restructuring. Currently,
there is notable overlapping and duplication in the
responsibilities of agencies. For example, two different
federal agencies regulate state chartered banks and five
different federal agencies handle the antitrust issues and the
securities matters involving banks and thrifts. In addition,
a single business organization which includes a national bank
and a parent holding company is supervised by the Office of
the Comptroller of Currency (OCC), the Federal Reserve Board
(FRB), and the Securities and Exchange Commission (SEC).
B cau e
® ^ _t^e financial regulatory agencies are "independent"
's an
these
. ., .
--jgulatory
system which in the past has been accused of creating
"competition in laxity".
The "Blueprint" recommends major changes in the structure
of federal bank regulation to increase efficiency and improve
the reliability and flexibility of the system. The major
proposals which are listed in the Appendix to this testimony,
are Resigned to lead the regulatory system toward one that will
' l n u J l y b e organized predominantly along functional lines.
Under the proposals adopted by the Task Group no agency would
in ! J ? H n n l^Ut agenCY
responsibilities would be restructured.
In addition, there are recommendations to reform the deposit
insurance system, transfer more responsibility to state
cont ^fL^M-ieS ^at meSt Certain qualifications, streamline
legislation 8 l l m i n a t e ° r r e P e a l unnecessary regulations and
- 3 The Vice President's Task Group worked for many months
to develop a plan that all the participating agencies could
support. In your letter asking Treasury to testify on
this matter, you point out that the recommendations involve
"trades" of regulatory responsibilities which must be executed
in their entirety for the arrangement to remain acceptable
to the signatories. Consequently, you feel it important for
Congress to have a record of those "trades" whose failure to
be executed would make it necessary for the Treasury
Department and other agencies to remove endorsement of other
recommendations and general principles in the report.
Designating such proposals that we find essential is not
possible at this time. We would have to evaluate any changes
in the recommendations to determine how they would alter the
overall effectiveness of the regulatory structure before we
could make any comment.
We feel that it would be counterproductive to indicate
any recommendations with which Treasury might not agree or
finds "improvable". The whole process of working out a
comprehensive restructuring of the system required compromises,
give and take among the participating agencies. Any proposed
changes in these recommendations would have to be carefully
studied to make sure they were acceptable.
The Task Group made no recommendations to change the
regulation of credit unions or the structure of the Federal
Home Loan Bank system and made no proposals for combining
the deposit insurance funds. The Task Group found that
banks, savings and loan associations and credit unions still
have very different balance sheets and business goals.
Legislated deregulation has tended to make the activities
available to these institutions similar but overall they
are still more dissimilar than similar. Therefore, the
recommendations concentrate on restructuring the bank
regulatory agencies and addressing the overlapping and
duplicating activities of these agencies. Even though the
recommendations are somewhat limited in this respect there
are about 50 recommendations for legislation that the Task
Group believes would strengthen the regulatory structure and
make it more efficient. At the same time, however, prudent
checks and balances would be maintained to help insure a
consistently safe and sound financial system.
The Task Group's recommendations were unanimously adopted.
They form a balanced and workable program for reorganizing
and streamlining the existing federal financial regulatory
system. Therefore, we would prefer-that the proposals be
considered as a whole.
- 4 »v m Ne , vert heless, i£ it appears to be necessary to implement
the Task Group's recommendations in stages, there are anv
number of proposals which might be taken as subgroups to be
b ? ? t S * w whenever feasible. For example, there could be a
eals
S J J I - J u f!?
outmoded legislation such as the Public
Utility Holding Company Act or that eliminates overburdenina
"cations? 8U 3S re<Juirin^ fede"l approval for branch 9
D6r»rJ!^!Sy0U-f0r allowfn9 me to present the Treasury
£?££? S VleWS' X WU1 be glad t0 answer ^estioL you
Attachment
Appendix
The Major Proposals of the Blueprint for Reform
The three existing federal bank regulators would be
reduced to two by eliminating the FDIC's role in
examining, supervising and regulating state non-member
banks. A new "Federal Banking Agency" ("FBA") would be
created within the Treasury Department, incorporating
and upgrading the existing OCC. This agency would
regulate all national banks, while the FRB would be
responsible for federal regulation of all state-chartered
banks.
The regulation of bank holding companies would be
substantially reorganized. At present, the FRB regulates
all bank holding companies, even though a different
agency usually regulates the subsidiary bank(s) of the
holding company. Under the new system in almost all
cases the agency that regulates a bank would also
supervise its parent holding company. This would make
it possible for most banking organizations to have a
single federal regulator rather than two.
The FRB would transfer its authority to establish the
permissible activities of bank holding companies to the
new FBA, although it would maintain a limited veto right
over new activities.
The FRB would continue to supervise the holding companies
of the very largest domestic banks, as well as those with
significant international activities and foreign-owned
institutions.
The FDIC would be refocused exclusively on providing
deposit insurance and administering the deposit insurance
system. All its current responsibilities for environmental,
consumer, antitrust and other laws not directly related
to the solvency of insured banks would be transferred to
other agencies, as would its responsibilities for routine
examination, supervision and regulation of state non-member
banks. At the same time, the FDIC would assume new
authority to review issuance of insurance to all institutions, as well as to examine all troubled institutions
and a sample of non-troubled firms in conjunction with
the primary supervisor. The FDIC would also have new
authority to take enforcement action against violations
of federal law concerning unsafe banking practices in
any bank examined by it where the primary regulator failed
to take such action upon prior request of the FDIC.
- 2 A new program would transfer current federal supervision
of many state-chartered banks and S&Ls (and their holding
companies) to the better state regulatory agencies,
creating new incentives for states to assume a stronger
role in supervision.
The special regulatory system for thrifts would be
maintained, but eligibility would be based on whether an
institution is actually competing as a thrift, rather
than on its type of charter.
The FDIC and FSLIC would be required to establish common
minimum capital requirements and accounting standards for
insurance purposes.
Antitrust and securities matters would each be handled by
a single agency rather than five different agencies at
present.
Some specific regulatory provisions would be simplified
to eliminate unnecessary burden. These include existing
legislative provisions that encourage wasteful litigation,
as well as outdated application requirements in various
areas.
•t
i ^r
federal financing bank
i
—11
A T^
\
/ \
/
\ /\ /
WW
March 27, 1985
FOR IMMEDIATE RELEASE
FEDERAL FINANCING BANK ACTIVITY
Francis X. Cavanaugh, Secretary, Federal Financing
Bank (FFB), announced the following activity for the
month of February 1985.
FFB holdings of obligations issued, sold or guaranteed by other Federal agencies totaled $146.6
billion on February 28, 1985, posting an increase of
$0.6 billion from the level on January 31, 1985. This
net change was the result of increases in holdings of
agency debt issues of $0.1 billion and holdings of
agency-guaranteed debt of $0.5 billion. FFB made 253
disbursements during February.
Attached to this release are tables presenting FFB
February loan activity, new FFB commitments to lend
during February and FFB holdings as of February 28,
1985.
# 0 #
B-63
^—^ .
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\ A / ( ^v
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WASHINGTON, DC. 20220
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Page 2 of 7
FEDERAL FINANCING BANK
FEBRUARY 1985 ACTIVITY
DATE
BORROWER
FINAL
MATURITY
INTEREST
RATE
(semiannual )
$ 200,000,000.00
435,000,000.00
385,000,000.00
40,000,000.00
375,000,000.00
20,000,000.00
375,000,000.00
375,000,000.00
120,000,000.00
2/8/85
2/15/85
2/21/85
2/19/85
2/25/85
2/25/85
3/1/85
3/4/85
3/7/85
8.455%
8.595%
8.585%
8.605%
8.605%
8.595%
8.655%
8.805%
8.875%
10,000,000.00
2,100,000.00
15,000,000.00
650,000.00
1,369,000.00
7,205,000.00
15,000,000.00
610,000.00
15,000,000.00
10,000,000.00
5/3/85
5/6/85
5/9/85
4/18/85
5/13/85
5/16/85
5/20/85
5/20/85
5/24/85
5/24/85
8.605%
8.535%
8.585%
8.585%
8.635%
8.605%
8.605%
8.605%
8.775%
8.875%
50,000,000.00
25,000,000.00
20,000,000.00
645,000,000.00
120,000,000.00
25,000,000.00
10,000,000.00
2/1/00
2/1/05
2/1/05
2/1/90
2/1/95
2/1/00
2/1/05
11.515%
11.565%
11.755%
11.465%
11.885%
12.025%
12.115%
3/10/91
6/30/96
6/15/12
9/10/87
7/31/91
7/31/91
4/10/96
6/15/91
2/4/96
3/25/96
3/24/12
6/15/12
2/5/95
5/15/95
7/15/92
9/12/94
4/15/14
11.075%
11.055%
11.445%
10.465%
11.275%
8.875%
11.360%
11.125%
11.415%
10.453%
11.575%
11.545%
11.125%
11.525%
10.884%
11.205%
10.653%
AMOUNT
OF ADVANCE
INTEREST
RATE
(other than
semi-annual)
ON-BUDGET AGENCY DEBT
TENNESSEE VALLEY AUTHORITY
Advance #431
Advance 1432
Advance #434
Advance #435
Advance #436
Advance #437
Advance #438
Advance #439
Advance #440
2/1
2/4
2/8
2/15
2/15
2/18
2/21
2/25
2/28
NATIONAL CREDIT UNION ADMINISTRATION
Central Liquidity Facility
+Note
Note
+Note
Note
•Note
•Note
+Note
Note
+Note
•Note
#300
#301
#302
#303
#304
#305
#306
#307
#308
#309
2/4
2/7
2/8
2/8
2/13
2/15
2/19
2/19
2/27
2/28
AGENCY ASSETS
FARMERS HOME ADMINISTRATION
Certificates of Beneficial Ownership
2/4
2/4
2/19
2/25
2/25
2/25
2/25
GOVERNMENT - GUARANTEED LOANS
DEPARTMENT OF DEFENSE
Foreign Military Sales
Botswana 3
Korea 19
Greece 15
Malaysia 6
Malaysia 7
Malaysia 8
Peru 10
Spain 5
Tunisia 16
Spain 8
Turkey 13
Greece 15
Jordan 12
Liberia 10
Philippines 10
Portugal 1
Egypt 6
•rollover
2/1
2/4
2/4
2/4
2/4
2/4
2/4
2/4
2/4
2/5
2/5
2/7
2/7
2/7
2/7
2/8
2/11
39,952.20
306 ,922.00
3,374 ,519.20
113 ,457.75
259,800.00
702 ,013.25
635 ,595.00
1,202 ,314.00
5,323 ,668.19
16,344 ,919.76
7,480 ,432.33
1,003 ,408.00
9,476 ,221.64
187,449.07
1,433 ,873.04
641 ,165.00
21,000 ,000.00
11.846%
11.899%
12.JL00%
11.794%
12.238%
12.387%
12.482%
ann.
ann.
ann.
ann.
ann.
ann.
ann.
Page 3 of 7
FEDERAL FINANCING BANK
FEBRUARY 1985 ACTIVITY
BORROWER
DATE
AMOUNT
OF ADVANCE
FINAL
MATURITY
INTEREST
RATE
(semiannual
INTEREST
RATE
(other than
semi-annual)
Foreign Military Sales (Cont'd)
Jordan 12
Egypt 6
Spain 5
Spain 7
Turkey 13
Peru 8
Peru 9
Philippines 10
Somalia 4
Morocco 13
Korea 19
Jordan 11
Greece 14
Greece 15
El Salvador 7
Ecuador 6
Botswana 3
Egypt 6
Egypt 6
Turkey 13
Ecuador 8
Morocco 12
Jordan 12
Jordan 10
Greece 14
2/11
2/13
2/13
2/13
2/13
2/13
2/13
2/13
2/14
2/14
2/14
2/14
2/14
2/14
2/14
2/14
2/15
2/15
2/21
2/21
2/22
2/22
2/25
2/28
2/28
$ 6,809,868.00
3,241,949.70
822,704.74
17,592.00
548,090.88
266,578.33
65,822.40
369,730.82
53,560.65
173,701.68
555,935.00
400,000.00
3,757,801.48
869,996.06
393,886.80
17,240.65
296,382.47
5,674,408.00
1,808,869.50
12,782,242.24
291,591.00
36,115.00
4,690,907.11
81,600.00
775,934.81
2/5/95
4/15/14
6/15/91
7/15/95
3/24/12
12/15/88
9/15/95
7/15/92
11/30/12
5/31/96
6/30/96
11/15/92
4/30/11
6/15/12
6/10/96
6/20/89
3/10/91
4/15/14
4/15/14
3/24/12
7/31/96
9/21/95
2/5/95
3/10/92
4/30/11
11.262%
11.725%
11.235%
11.555%
11.665%
10.625%
11.105%
10.965%
11.565%
11.295%
11.135%
10.045%
11.616%
11.555%
11.515%
11.045%
11.235%
11.615%
11.875%
11.839%
11.315%
11.755%
11.673%
9.805%
12.195%
DEPARTMENT OF ENERGY
Synthetic Fuels - Non-Nuclear Act
Great Plains
Gasification Assoc. #131
8,000,000.00
1/2/86
2/13
2/15
2/20
2/20
2/20
2/22
2/26
2/26
2/26
3,831,500.00
4,330,000.00
500,000.00
5,431,118.53
296,078.50
124,500.00
104,713.75
1,213,451.58
651,210.19
2,000,000.00
222,000.00
200,000.00
750,000.00
190,000.00
624,700.00
2/1/90
2/1/91
2/1/92
2/1/88
8/1/86
8/15/86
8/15/85
2/15/91
8/1/86
8/1/85
8/15/86
9/1/85
2/15/86
12/1/85
8/15/86
10.606%
10.720%
10.904%
10.050%
9.695%
9.735%
8.935%
10.845%
9.725%
8.795%
9.745%
9.185%
9.505%
9.345%
10.065%
2/14
2/15
177,137,000.00
2,063,688.62
4/15/85
4/15/85
8.655%
8.605%
2/11
9.975%
DEPARTMENT OF HOUSING & URBAN DEVELOPMENT
Community Development
*Indianapolis, IN
•Louisville, KY
Sacramento, CA
Peoria, IL
Inglewcod, CA
Santa Ana, CA
Lynn, MA
•South Bend, IN
Inglewcod, CA
Long Beach, CA
Santa Ana, CA
Waukegan, IL
St. Louis, MO
St. Petersburg, FL
Santa Ana, CA
2/1
2/1
2/1
2/1
2/6
2/6
DEPARTMENT OF THE NAVY
Ship Lease Financing
Bobo
•Obregon
•maturity extention
•rollover
10.887%
11.007%
11.201%
10.303%
9.930%
9.972%
8.939%
11.139%
9.961%
ann.
ann.
ann.
arin.
ann.
ann.
ann.
ann.
ann.
9.982%
9.201%
9.724%
9.495%
10.318%
ann.
ann.
ann.
ann.
ann.
Page 4 of 7
FEDERAL FINANCING BANK
FEBRUARY 1985 ACTIVITY
BORROWER
DATE
AMOUNT
OF ADVANCE
FINAL
MATURITY
INTEREST
RATE
(semiannual)
$ 6,000.00
4,720,000.00
15,000,000.00
55,000.00
2,279,000.00
3,687,000.00
3,175,000.00
602,000.00
40,000.00
1,045,000.00
294,000.00
4,915,000.00
653,000.00
858,000.00
1,101,000.00
378,000.00
2,026,000.00
983,000.00
453,000.00
551,000.00
2,802,000.00
70,000,000.00
1,106,000.00
915,000.00
112,000.00
15,000,000.00
1,960,000.00
4,000,000.00
500,000.00
1,959,000.00
300,000.00
1,333,000.00
2,633,000.00
6,212.00
1,211,000.00
16,105,000.00
9,655,000.00
20,000,000.00
1,720,000.00
1,675,000.00
4,950,000.00
56,000,000.00
592,000.00
1,110,000.00
3,622,000.00
4,234,000.00
24,822,000.00
106,000.00
670,000.00
7,054,000.00
6,552,000.00
750,000.00
247,000.00
7,000.00
2/4/87
2/5/87
1/2/18
3/31/87
3/31/87
2/11/87
2/11/87
2/11/87
2/11/87
12/31/15
2/11/87
2/11/87
2/11/87
2/10/88
2/10/88
2/13/87
1/2/18
3/31/87
3/31/87
3/31/87
3/31/87
3/31/87
2/15/87
2/16/87
3/31/87
2/19/87
2/19/87
2/17/88
2/20/87
2/20/87
2/20/87
2/21/87
2/21/87
2/23/87
3/31/87
1/2/18
2/25/87
2/25/87
2/25/87
2/25/87
1/2/18
12/31/12
3/31/87
3/2/87
3/31/87
3/2/87
3/2/87
3/2/87
1/2/18
3/31/87
3/31/87
3/2/87
3/31/87
3/31/87
10.175%
10.155%
11.465%
10.242%
10.234%
10.165%
10.165%
10.165%
10.165%
11.515%
10.165%
10.165%
10.165%
10.535%
10.535%
10.195%
11.550%
10.478%
10.255%
10.167%
10.175%
10.175%
10.115%
10.115%
10.154%
10.155%
10.155%
10.505%
10.135%
10.135%
10.135%
10.265%
10.265%
10.265%
10.471%
11.799%
10.465%
10.465%
10.465%
10.465%
11.932%
12.008%
10.550%
10.685%
10.732%
10.685%
10.685%
10.685%
12.088%
10.735%
10.747%
10.685%
10.755%
10.740%
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
11.431%
11.431%
11.431%
11.431%
11.431%
INTEREST
RATE
(other than
semi-annual)
RURAL ELECTRIFICATION ADMINISTRATION
•Western Farmers Electric #64 2/4
Western Farmers Electric #196 2/5
Western Illinois Rjwer #294
2/6
Basin Electric #272
2/8
Tri-County Electric #284
2/8
•Wabash Valley Powsr #104
2/11
•Wabash Valley tomr #104
2/11
•Wabash Valley fomr #206
2/11
Central Electric #131
2/11
Kansas Electric #282
2/11
Deseret GAT #170
2/11
Deseret GfcT #211
2/11
•Wolverine Power #101
2/11
•Wolverine Power #182
2/11
•Wolverine Power #183
2/11
Tex-La Electric #206
2/13
Vermont Electric #303
2/13
•Wolverine Power #100
2/13
New Hampshire Electric #270
2/13
N.E. Texas Electric #280
2/15
Allegheny Electric #255
2/15
Cajun Electric #263
2/15
•Wabash Valey Power #252
2/15
•New Hampshire Electric #192
2/15
•S. Mississippi Electric #3
2/15
•Basin Electric #137
2/19
•Dairyland Power #54
2/19
•San Miguel Electric #110
2/19
United Power #159
2/20
United Power #212
2/20
United Power #222
2/20
Brazos Electric #108
2/21
Brazos Electric #230
2/21
Colorado Ute Electric #168
2/21
Old Dominion Electric #267
2/22
•Soyland Power #226
2/22
•Dairyland Power #54
2/25
•Basin Electric #137
2/25
•Colorado Ute Electric #71
2/25
•Colorado Ute Electric #203
2/25
*Tex-La Electric #208
2/25
•Cajun Electric #76
2/26
Central Power Electric #278
2/27
San Miguel Electric #110
2/28
•Allegheny Electric #93
2/28
•Basin Electric #232
2/28
•Oglethorpe Power #246
2/28
Plains Electric #158
2/28
*Tex-La Electric #208
2/28
Plains Electric #300
2/28
Kamo Electric #2(6
2/28
Sho-Me Power #164
2/28
New Hampshire Electric #270
2/28
Basin Electric #272
2/28
SMALL BUSINESS ADMINISTRATION
State & Local Development Company Debentures
The St. Louis Local Dsv. Co.
The St. Louis Local Dsv. Co.
D v. Corp. of Mid. Qsorgia
Region Nine Dsv. Corp.
The St. Louis Local Dtv. Co.
•maturity extension
2/6
2/6
2/6
2/6
2/6
26,000.00
26,000.00
30,000.00
37,000.00
38,000.00
10.049% qtr.
10.029% qtr.
11.305% qtr.
10.114% qtr.
10.106% qtr.
10.039% qtr.
10.039% <jtr.
10.039% qtr.
10.039% qtr.
11.354% qtr.
10.039% qtr.
10.039% qtr.
10.039% qtr.
10.400% qtr.
10.400% qtr.
10.068% qtr.
11.388% qtr.
10.344% qtr.
10.127% qtr.
10.041% qtr.
10.049% qtr.
10.049% qtr.
9.990% qtr.
9.990% qtr.
10.028% qtr.
10.029% qtr.
10.029% qtr.
10.371% qtr.
10.010% qtr.
10.010% qtr.
10.010% qtr.
10.137% qtr.
10.137% qtr.
10.137% qtr.
10.337% qtr.
11.630% qtr.
10.332% qtr.
10.332% qtr.
10.332% qtr.
10.332% qtr.
11.759% qtr.
11.833% qtr.
10.414% qtr.
10.546% qtr.
10.592% qtr.
10.546% qtr.
10.546% qtr.
10.546% qtr.
11.911% qtr.
10.595% qtr.
10.606% qtr.
10.546% qtr.
10.614% qtr.
10.600% qtr.
Page 5 of 7
FEDERAL FINANCING BANK
FEBRUARY 1985 ACTIVITY
BORROWER
DATE
AMOUNT
OF ADVANCE
FINAL
MATURITY
INTEREST
RATE
(semiannual)
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/00
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/05
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.431%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.518%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
State & Local Development Company Debentures (Cont'd)
The St. Louis Local Dev. Co.
2/6
ES.BDC of Montgomery County, MD 2/6
The St. Louis Local Dev. Co.
2/6
Metro Sm. Bus. Asst. Corp.
2/6
San Diego County L.D.C.
2/6
Detroit Economic Growth Corp. 2/6
Texas Certified Dev. Co., Inc. 2/6
Columbus Countywide Dev. Corp. 2/6
Kisatchie-Delta Reg. P&D Dis. 2/6
Wisconsin Bus. Dev. Fin. Corp. 2/6
Texas Panhandle Reg. Dev. Corp.2/6
Cascades West Fin. Srvs, Inc. 2/6
Bus. Dev. Corp. of Nebraska
2/6
Concord Regional Dev. Corp.
2/6
Rural Missouri, Inc.
2/6
Toledo Econ. Plan. Cn., Inc.
2/6
Springfield Cert. Dev. Co.
2/6
Detroit Econ. Gr. Corp. L.D.C. 2/6
Cumberland County Bus Dev Corp 2/6
Phoenix Local Dev. Corp.
2/6
Region Eight Dev. Corp.
2/6
The St. Louis County L.D.C.
2/6
Birmingham City Wide L.D.C.
2/6
The St. Louis County L.D.C.
2/6
NGCDC, Inc.
2/6
Cleveland Area Dev. Fin. Corp. 2/6
Texas Cert. Dev. Co., Inc.
2/6
Region Nine Dev- Corp.
2/6
Cen. Ozarks Dev., Inc.
2/6
Evergreen Ccmm. Dev. Assoc.
2/6
E.C.I.A. Business Gr., Inc.
2/6
New Haven Ccmm. Inv. Corp.
2/6
Iowa Business Growth Co.
2/6
Ocean State Bus. Dev. Auth, Inc2/6
C.D.C. of Mississippi, Inc.
2/6
Nine County Development, Inc. 2/6
Wilmington Ind. Dev., Inc.
2/6
Phoenix Local Dev. Corp.
2/6
Prince George's C.F.S.C.
2/6
Hamilton County Dev. Co., Inc. 2/6
Alabama Community Dev. Corp.
2/6
Hamilton County Dev. Co., Inc. 2/6
Long Island Development Corp. 2/6
South Shore Econ. Dev. Corp.
2/6
Central Ozarks Dev., Inc.
2/6
Long Island Development Corp. 2/6
Forward Development Corp.
2/6
Greater Salt Lake Bus. Dis.
2/6
Greater Salt Lake Bus. Dis.
2/6
Greater Salt Lake Bus. Dis.
2/6
Purchase Area Dev. Dis., Inc. 2/6
Long Island Development Corp. 2/6
Empire State Cert. Dev. Corp. 2/6
S.W. 111. Areawide Bus. D.F.C. 2/6
Virginia Economic Dev. Corp.
2/6
Evergreen Ccmm. Dev. Assoc.
2/6
Massachusetts Cert. Dev. Corp. 2/6
CANDO Citywide Dev. Corp.
2/6
Nine County Development, Inc. 2/6
River East Progress, Inc.
2/6
Bridgeport Economic Dev. Corp. 2/6
The St. Louis County L.D.J.
2/6
Chester County S.B.A. Corp.
2/6
San Diego County L.D.C.
2/6
$ 70,000.00
84,000.00
99,000.00
101,000.00
103,000.00
140,000.00
155,000.00
168,000.00
168,000.00
179,000.00
191,000.00
193,000.00
225,000.00
268,000.00
280,000.00
500,000.00
44,000.00
56,000.00
58,000.00
65,000.00
68,000.00
79,000.00
84,000.00
84,000.00
86,000.00
95,000.00
95,000.00
103,000.00
105,000.00
111,000.00
122,000.00
126,000.00
133,000.00
137,000.00
137,000.00
151,000.00
153,000.00
155,000.00
166,000.00
179,000.00
191,000.00
205,000.00
248,000.00
252,000.00
265,000.00
285,000.00
290,000.00
290,000.00
315,000.00
315,000.00
317,000.00
340,000.00
340,000.00
364,000.00
401,000.00
426,000.00
500,000.00
500,000.00
30,000.00
61,000.00
76,000.00
83,000.00
87,000.00
97,000.00
INTEREST
RATE
(other than
semi-annual)
page 6 of 7
FEDERAL FINANCING BANK
FEBRUARY 1985 ACTIVITY
DATE
BORROWER
AMOUNT
OF ADVANCE
FINAL
MATURITY
INTEREST
RATE
(semi-annual)
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
2/1/10
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
11.545%
2/1/90
2/1/90
2/1/90
2/1/90
2/1/92
2/1/92
2/1/92
2/1/95
2/1/95
2/1/95
2/1/95
2/1/95
2/1/95
2/1/95
2/1/95
2/1/95
2/1/95
2/1/95
2/1/95
11.105%
11.105%
11.105%
11.105%
11.445%
11.445%
11.445%
11.505%
11.505%
11.505%
11.505%
11.505%
11.505%
11.505%
11.505%
11.505%
11.505%
11.505%
11.505%
INTEREST
RATE
(other than
semi-annual)
State & Local Development Company Debentures (Cont'd)
$ 99,000.00
116,000.00
131,000.00
137,000.00
151,000.00
168,000.00
168,000.00
184,000.00
197,000.00
200,000.00
202,000.00
215,000.00
224,000.00
233,000.00
267,000.00
334,000.00
382,000.00
428,000.00
473,000.00
500,000.00
500,000.00
500,000.00
500,000.00
500,000.00
Bay Colony Development Corp. 2/6
Covington First Dev. Corp.
2/6
The Gr. Stark Cty. Gr. Assoc. 2/6
Opportunities Minnesota, Inc. 2/6
Ocean State Bus Dsv Auth, Inc 2/6
Warren Redev. & Planning Corp. 2/6
San Diego County L.D.C.
2/6
Evergreen Community Dev. Assoc.2/6
San Diego County L.D.C.
2/6
Ark-Tex Regional Dev. Co., Inc.2/6
Wisconsin Bus. Dev. Fin. Corp. 2/6
Opportunities Minnesota, Inc. 2/6
Neuse River Dev. Auth., Inc.
2/6
Advancement, Inc.
2/6
Opportunities Minnesota, Inc. 2/6
Bay Area Bus. Dev. Co.
2/6
Tuscon Local Development Corp. 2/6
Wisconsin Bus. Dev. Fin. Corp. 2/6
C.D.C. of N.E. Georgia
2/6
Bay Area Business Dev. Co.
2/6
Cen California Cert Dev Corp
2/6
Los Angeles LDC, Inc.
2/6
Empire State Cert. Dev. Corp. 2/6
Railbelt Caim. Dev. Corp.
2/6
Small Business Investment Company Debentures
Crocker Capital Corp.
First Oklahoma Inv. Cap. Corp.
Marwit Capital Corporation
Western Financial Cap. Corp.
Advent Industrial Cap. Co., LP
Advent V Capital Company, LP
NYBDC Capital Corp.
BT Capital Corporation
Cap. Corp. of Wyoming, Inc.
Clinton Capital Corporation
Edwards Capital Company
Fundex Capital Corporation
MVenture Corporation
Metropolitan Venture Co, Inc.
NYBDC Capital Corporation
TLC Funding Corporation
UST Capital Corporation
Unicorn Ventures, Ltd.
Walnut Street Capital Corp.
200 ,000.00
1,500 ,000.00
1,000 ,000.00
1,000 ,000.00
2,500 ,000.00
20,000 ,000.00
150 ,000.00
5,000 ,000.00
200 ,000.00
3,000 ,000.00
1,500 ,000.00
480 ,000.00
4,200 ,000.00
1,000 ,000.00
350 ,000.00
1,044 ,000.00
1,500 ,000.00
2,500 ,000.00
1,500 ,000.00
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
2/20
TENNESSEE VALLEY AUTHORITY
Seven States Energy Corporation
Note A-85-05 2/28
549,301,538.81
5/31/85
8.785%
FEDERAL FINANCING BANK
FEBRUARY 1985 Commitment
BORROWER
Jersey City, N.J.
GUARANTOR
AMOUNT
EXPIRES
MATURITY
HUD
$25,000,000.00
10/1/86
10/1/91
Page 7 of 7
FEDERAL FINANCING BANK HOLDINGS
(in millions)
Program
February 28, 1985
January 31, 1985
$ 13,950.0
15,852.2
288.6
$ 13,810.0
15,852.2
286.2
1,087.0
51.3
Net Change
2/1/85-2/28/85
Net Change—FY 1985
10/1/84-2/28/85
Cn-Budget Agency Debt
Tennessee Valley Authority
Export-Import Rank
NCUA-Central Liquidity Facility
$
-02.4
$ 515.0
162.3
19.7
1,087.0
51.3
-0-0-
-0-0-
59,041.0
112.9
132.0
59,066.0
115.7
132.0
-25.0
-2.8
-470.0
-3.2
8.3
8.3
-2.7
3,536.7
37.0
3,536.7
37.6
-0-0-0-0.6
-3.1
17,506.6
5,000.0
11.8
1,436.0
243.2
33.5
2,146.2
411.3
36.0
28.3
902.3
643.5
17,404.8
5,000.0
11.8
1,428.0
239.2
33.5
2,146.2
411.3
36.0
28.3
902.3
521.3
101.8
395.7
-0-08.0
4.0
-0-0-0-0-0-0-
-05.6
4.0
4.0
-0-
0.9
20,804.1
920.3
466.3
1,588.2
155.5
177.0
20,652.5
880.7
448.4
1,570.5
155.6
177.0
151.6
39.6
17.9
17.7
217.0
60.0
111.7
32.7
-4.1
$ 146,611.1
$ 146,034.3
140.0
Off-Budget Agency Debt
U.S. Postal Service
U.S. Railway Association
Agency Assets
Farmers Home Administration
DHHS-Health Maintenance Org.
DHHS-Medical Facilities
Overseas Private Investment Corp.
Rural Electrification Admin.-CBO
Small Business Administration
-0-0-
Government-Guaranteed Lending
DOD-Foreign Military Sales
DEd.-Student Loan Marketing Assn.
DOe-Geothermal Loan Guarantees
DOE-Non-Nuclear Act (Great Plains)
DHUD-Ccnmunity Dev. Block Grant
DHUD-New Communities
DHUD-Public Housing Notes
General Services Administration
DOI-Guam Power Authority
DOI-Virgin Islands
NASA-Space Communications Co.
DON-Ship Lease Financing
DON-Defense Production Act
Rural Electrification Admin.
SBA-Small Business Investment Cos.
SBA-State/Local Development Cos.
TVA-Seven States Energy Corp.
DDT-Section 511
DOTMiMATA
TOTALS*
•figures may not total due to rounding
122.2
-0-0-
$
576.8
146.0
35.0
-O-32.3
-2.0
-0-0.4
-52.3
643.5
-0$ 1,775.0
rREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone
ADDRESS BY
THE HONORABLE DAVID C. MULFORD
ASSISTANT SECRETARY OF THE
U.S. DEPARTMENT OF THE TREASURY
BEFORE
THE TWENTY-SIXTH ANNUAL MEETING
OF THE INTER-AMERICAN DEVELOPMENT BANK
VIENNA, AUSTRIA
MARCH Ortiz-Mena,
26, 1985
Mr. Chairman, President
Fellow Governors,
Ladies and Gentlemen, I would like to begin by expressing
on behalf of the entire United States delegation our pleasure these past few days in accepting the warm and very
gracious hospitality of beautiful and historic Vienna. A
year ago we met in lovely Punta Del Este, where the focus
was on the international debt crisis. Today, we meet in a
different hemisphere, but also in a changed atmosphere,
joined together by our common interest in economic growth
and development. I hope in our present discussions on the
role of the Bank in a rapidly changing global economic
environment, we can draw creatively on our past experiences
in order to forge a better understanding of how we can
jointly achieve our growth and development objectives for
the future.
Before turning to my remarks, I would like to extend
the best wishes of Secretary of the Treasury, James A. Baker
who will soon become the new U.S. Governor of the InterAmerican Development Bank. Secretary Baker has asked me to
congratulate you on the progress made towards establishing
the Inter-American Investment Corporation. This important
cooperative effort to encourage investment within our
hemisphere has now very nearly become a reality.
Much has changed since Punta Del Este to alter the
focus of our attention. At last year's IDB annual meeting,
many of us here participated in a special session to discuss
the international debt issue.
In October, at the IMF/World
Bank meetings, the United Sates took the initiative in proposing another special meeting — this time at the Interim and
Development Committee meetings next month in Washington -- to
continue and to expand this dialogue. The focus in April will
be on the wide range of elements which are involved in the
restoration of sustained growth, including of course problems
of indebtedness.
We in the United States are confident and optimistic
about the prospects for world growth. President Reagan
expressed the essence of our present view in his speech at
the World Bank meeting in September. He said that three
years earlier he had asked, "that we examine the terrible
shocks inflicted upon the world economy during the 1970s,
that all of us face up to the origins of those problems, and
also recognize our ability to withstand and surmount them."
j'6-64
-2He went on to say, "one conclusion seemed both undeniable
and universally true. The societies whose economies had fared
best during these tumultuous times were not the most tightly
controlled, not necessarily the biggest in size, nor even the
wealthiest in natural resources. What united the leaders
for growth was a willingness to trust the people — to believe
in rewarding hard work and legitimate risk."
Progress in the Industrial Countries
All of our nations have been living through a prolonged
period of major change in the world economy, marked by a
difficult but essential transition from inflationary domestic
policies to more sustainable growth for the longer term. Many
countries, including my own, are now emerging from their most
severe economic contraction in two decades. Others, while
maintaining modest economic growth, have nevertheless been
forced to adjust domestic economic policies and to adapt to
external developments in order to sustain growth for the future.
Some of us have been able to make considerable progress
toward our objectives. Others are still in the early stages
of adjusting to external change. But we all have more work
ahead of us.
Through major domestic policy changes, the industrial
countries of Europe, Japan, and North America, have sought
to quell inflation and to put in place the foundations for
stable growth — a challenge at any time, but especially in
the wake of the radically altered economic environment of
the 1970s.
In Europe, efforts to reduce the role of government
in the economy are coinciding with accelerating and more
widely shared growth, nurtured by a sharp recovery in export
markets, particularly that of the United States. Collective
GNP growth for Europe should approach 3 percent this year —
and perhaps more, if capital and labor become more mobile.
For the longer term, however, Europe appears to be recognizing increasingly that it needs to address a number of what
we refer to as domestic structural rigidities, including
those designed to benefit individual workers, which in the
aggregate unfortunately hamper economic growth and reduce
the common welfare.
The Japanese economy continues its solid record of
sustained advances. Its growth rate of nearly 6 percent
in 1984 has been led primarily by increased exports.
Growth in 1985 is expected to continue at a more sustainable level of 5 percent and should be more balanced, with
better growth in domestic sectors of the economy. The
international economy should benefit from this improvement,
but would benefit more if access to Japanese markets were
also to improve.
-3Canada, after enduring protracted inflation and
stagnation, has achieved a strong recovery with lower
inflation last year and is beginning efforts to allow
private business greater opportunities to harness the
bountiful potential of that country.
But it is the United States that has provided the
major impetus for growth worldwide. In a marked departure from more than a decade of disappointing economic
performance, and the widespread perception that we could
not anticipate any early return to the rapid rates of
growth experienced in the 1960s, U.S. growth has, in fact,
been sustained at a strong rate of 6 percent since the low
point of our recession in 1982. We have sharply reduced
the rate of inflation to a current rate of less than 4
percent. Interest rates have been cut nearly in half from
their previous high of about 20 percent, and the recent
decline in real rates. In short, a new dynamism has been
restored to the private sector.
Since 1982, the U.S. economy has created over 7.5
million jobs — almost all in the private sector. We
now anticipate a more sustainable four percent growth
rate for 1985 and beyond, with a well-founded expectation of further declines in inflation.
In this environment, we may forget too easily what
appeared in the 1970's to be an attitude of resignation
to low growth and a high "embedded rate of inflation."
President Reagan has provided confident leadership and a
firm commitment to the removal of regulatory restrictions
on the private sector, as well as policies to reduce
taxation. Money supply growth has been steadier. These
policies, taken together, have transformed our performance, as well as our expectations. Our success in
reducing inflation and in restoring strong economic
growth have inspired widespread confidence and optimism
in the U.S. economy, both within the United States and
abroad.
I readily acknowledge that there are still potential
risks in the U.S. economic outlook. Interest rates still
remain high by historical standards. Our large budget
deficit is a matter of considerable concern, and growing
trade deficits have spurred protectionist pressures which
are becoming increasingly difficult to withstand. We still
have much work ahead of us, and are now engaged in a major
struggle to reduce federal deficits. To demonstrate his
commitment to this effort, President Reagan recently vetoed
politically sensitive farm legislation which would have
significantly increased Government expenditures. We are
fully prepared to put our own trade restrictions on the
line as part of a multilateral commitment to new trade
negotiations in order to liberalize trade in the interest
of all nations.
-4The lesson of these developments is clear: adjustment can
be, and often is painful, but concentrated efforts can produce
dramatic results in a very short time. Failure to address the
need for adjustment, on the other hand, will not alleviate the
pain, but merely make it more pronounced and disruptive over
the longer term.
Latin America and the Caribbean
The experiences in Latin America and the Caribbean over
the last four years may portend a similar evolution. Some
difficulties have been surmounted, but many remain.
We are all very much aware of the painful shock forced
upon the people of our hemisphere after years of seemingly
inexhaustible foreign credit. Adjustment to that shock is
at least partially behind us.
Now, we see that for Latin America as a whole, a growth
rate of 2.5 percent emerged last year. This is a welcome
contrast to the two previous years of decline and, I believe,
a harbinger of better growth in the years to come.
Looked at from the external standpoint, the decline in
the regional current account deficit from $42 billion in
1982 to about $6 billion last year, clearly means the overall
financial situation is now more manageable.
Aggregate figures for the region, however, disguise
individual country situations. Here, we are sensitive to
the fact that so far only a few have done well, many more
are midway along the path of resumed growth, and some are
still in the early phase of establishing sustained growth.
We all clearly have much work to do.
The industrial countries — especially, in Europe and
Japan — must concentrate on opening their markets and we
must all move together toward more liberal trade. I have
already referred to the task we face in the United States.
Economic adjustment and renewed confidence are the
essential underpinnings for revived flows of direct investment and for the return of capital from abroad.
Commercial banks must give greater consideration to
their role in providing new credit to countries which are
performing well under economic adjustment programs. This
is a critical feature of the international debt strategy
embraced by the Summit countries. We are concerned about
a pattern of bank commitments which suggests that where
smaller countries are making the necessary adjustments
leading to re-establishment of growth, certain banks
appear not to recognize this progress and are unwilling
to provide new financing.
-5The Multilateral Development Banks — especially,
the IDB, our central concern today — must measure their
effectiveness in terms of the contribution they make to
helping countries lay the foundation for long term economic
growth.
Inter-American Development Bank
Let us now turn to look more closely at the IDB. This
year marks the end of the first quarter century of IDB
operations throughout Latin America and the Caribbean. The
IDB has an impressive record of accomplishments. It is a
milestone that deserves our attention and applause- It is
also an ideal opportunity to reappraise the efforts we have
made over the years.
Budgetary resources are scarce. This is a fact of life
that the IDB must face. It therefore has a special obligation to refocus its programs to make efficient use of limited
resources. We are doing this in the United States in our
current budgetary process and I can personally attest to the
fact that it is no easy enterprise. Among the many areas
being scrutinized in our budget, we have sought a more efficient use of resources in all the MDBs.
Indeed, this effort began in 1981, when the Reagan
Administration first took office. At that time, we made
a comprehensive assessment of U.S. participation in the
Multilateral Development Banks. The resulting assessment,
published in February, 1982, was regarded by the U.S.
Government as a blueprint for action — a summary, if you
will, of what we believed must be accomplished in the MDBs
over the next few years.
The report expressed the Administration's strong support
for the MDBs — including the IDB — as effective institutions
through which the United States seeks to foster efficient
development for the people of the borrowing member countries.
The Reagan Administration continues to hold that view.
However, the report also found too much emphasis on the
quantity of funding instead of on the quality of the projects
being funded. In practice, this focus on quantity has been
found wanting. I think every one here understands that now.
The principal change embodied in the assessment was
the decision to place more emphasis on market forces,
policy reform and sectoral allocation than had been the
case previously. In general, it recommended that MDB lending policies provide larger incentives to private sector
development. It urged greater selectivity in projects and
programs financed by the MDBs, with commensurate flexibility
in setting annual lending levels. It called for closer links
between lending levels and specific policy reforms that would
relate each project to overall development strategy.
-6In the intervening period, there has been noticeable
progress toward these goals in all of the MDBs. Two
important changes have been made in the IDB, one in subloan interest rates and the other in public utility tariffs.
These changes in the IDB policies are encouraging similar
changes in these areas in borrowing member countries.
One could say that the process we undertook to adopt
these policies has been a confidence building exercise,
demonstrating that we are able to make a commitment among
ourselves to act on the basis of economic principles. We
must build on this base for a more productive future. And
we need to begin planning now for that building process to
continue.
The United States wants to place greater emphasis on
the IDB and the role that it plays in our hemisphere. As
members of the IDB, we have an important obligation to the
people of the hemisphere to use our resources more
effectively. This is not simply a matter of an obsessive
attachment to the notion of so-called "conditionally;"
rather, it is a matter of vision, good management and
results for the people for whom this organization was
created.
We might take a further step by making two simple
but extremely important reforms in the principles on which
we conduct bank business. First, every project that is
brought to the Executive Board should be fully justified
in economic terms. Regretfully, this has not always been
the case. Over the past year, a number of projects were
brought forward that we were forced to oppose on purely
economic grounds. In some instances, the projects were
not well designed. In others, they contravened established
policy. Clearly, the Bank's internal project review must be
rigorous enough to ensure that such projects do not come to
the Executive Board.
Second, we need to help borrowing countries create the
economic environment and sectoral policies most conducive for
growth and development. Transfer of resources is not enough.
Every loan must fit into an appropriate economic policy
setting. The IDB must thoroughly analyze the policies of its
borrowers and, where necessary, encourage reform before committing its resources. In this respect, the IDB should work
to improve its policy coordination and cooperation with
other international lenders.
The U.S. Exeuctive Director has already circulated a
paper on the advantages to be gained from strengthening the
country-programming process. We believe the loan review
process can be strengthened by giving greater involvement to
offices within the Bank that have sectoral or macro-economic
expertise. We may want to require assessments of each
-7country's sectoral and macro-economic policies in all loan
documents and make changes in the organizational structure
of the Bank to improve loan quality.
We are not wedded to these specific proposals. Other
measures might work as well. What is important, however, is
that we work to achieve both the objectives I have identified.
This is essential if the IDB is to have a more effective role
in encouraging Latin American economic lrowth and development.
Frankly, until we make progress in these two areas, it would
not be productive for us to discuss financial parameters for
future Bank activities.
In the IDB some may suggest that we should simply rewrite
the rules or create new or special ways of lending more money.
These are not answers to the underlying problems we face.
In policy terms, as applied to the IDB, this means we
believe the Industrial Recovery Program and the Special
Operating Program have served their purposes and should end,
as agreed, in 1985.. Similarly, at this point, we are not
convinced that either changes in the so-called matrix or Bank
financing of non-IDB projects is a solution. Also, while we
are willing to discuss the concerns raised by the Central
American Governors, we cannot support any modification of the
Sixth Replenishment guidelines.
In sum, I appeal to you, as shareholders to evaluate our
Bank's performance, retain the policies which are working,
reform the policies which are not, avoid the temptation of the
easy road and instead take up the challenge I have put before
you today. Each of us — whether donor or borrower, should
recognize our own self-interest, as well as the mutuality of
our interests within the IDB.
Like all of you, I look forward to the next year's annual
meeting. In the meantime, we will stay closely involved with
the Bank and hope that a year from now we shall all be able to
survey the year with the satisfaction that we have made the IDB
a more effective Bank for development in Latin America. We owe
that to the people for whom the Bank was created.
TREASURY NEWS
ipartment of the Treasury • Washington, D.c. • Telephone 566-2041
March 28, 1985
FOR IMMEDIATE RELEASE
RESULTS OF AUCTION OF 20-YEAR 1-MONTH TREASURY BONDS
The Department of the Treasury has accepted $4,261 million
of $10,699 million of tenders received from the public for the
20-year 1-month bonds auctioned today. The bonds will be issued
April 2, 1985, and mature May 15, 2005.
The interest rate on the bonds will be 12%. The range of
accepted competitive bids, and the corresponding prices at the 12%
interest rate are as follows:
Price
Yield
99.920
Low
12.00%
High
12.05%
99.545
Average
12.04%
99.620
Tenders at the high yield were allotted 98%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
Totals
Received
290,524
9,170,478
890
24,513
5,889
10,391
625,204
64,644
4,020
15,252
458
485,849
404
$10,698,516
$
Accepted
$
524
3,889,418
890
14,513
5,889
4,391
172,204
64,639
4,000
15,252
458
88,109
404
$4,260,691
The $4,261 million of accepted tenders includes $329
million of noncompetitive tenders and $3,932 million of competitive tenders from the public.
B-65
TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-204
For Release 10:15 a.m.
March 29, 1985
Contact:
Brien Benson (566-2041)
Ken Butler (Bureau of
Public Debt) 376-4306
SECRETARY BAKER ANNOUNCES SAVINGS BOND REDESIGN
Treasury Secretary James A. Baker, III, today announced a
newly designed face for the popular Series EE Savings Bond as part
of a gradual shift from punch card to paper bond stock. The design
change, which does not affect the terms and conditions of Savings
Bonds, will speed up the processing of Savings Bonds, deter
counterfeiters, and save over a million dollars a year in printing
costs. Additional savings will come from using state-of-the-art
equipment in processing bonds.
The Bond face will contain magnetic ink and optical character
data that the financial community and Treasury will be able to
process and record at high speed with great accuracy.
To deter counterfeiting, the new Bond face will be much more
complex. Features will include a gradation of pastel colons from
yellow to brown, portraits of Founding Fathers, engraved borders,
and a patterned background containing a picture of Independence
Hall in Philadelphia.
Lighter paper stock will save $1 million annually once the
changeover is fully implemented.
The new format will be introduced in stages during the next
two years. Starting in May, all Series EE Savings Bonds produced
by Treasury will have the new faces. The change from card to paper
will be more gradual. Between May and September, the 96 large
payroll agents which inscribe Bonds with computers and report their
sales to Treasury using magnetic tape, will convert to paper bonds.
These 96 agents issue about half of all Bonds sold each year.
The remaining agents, including over-the-counter and payroll
issuers which report sales using hard-copy registration stubs, will
receive the newly-designed Bonds in card form until 1987.
B-66
-2By then, the Treasury expects to have equipment that can
optically record sales data at high speeds. This capability will
allow the completion of the transition to paper. Then the benefits
of the design change will come into full force - reduced weight and
space requirements, lower shipping costs, and lower stock
acquisition costs.
Treasury does not plan to recall Bonds of the old design now
held by agents. As the agents use up their old stock, it will be
replaced by stock of the new design.
More than 9.5 million Americans buy U. S. Savings Bonds each
year, 60 percent of them through payroll savings plans offered by
their employers. In 1984, Bond sales totaled $4 billion; nearly
$75 billion worth of Bonds are now held by Americans.
To facilitate the introduction of the newly designed bond,
Treasury will conduct an awareness program to inform issuing agents
and the public about the change.
M#
PORTRAITS APPEARING ON NEW DESIGN
SERIES EE U.S. SAVINGS BONDS
DENOMINATION
PORTRAIT
$50.00
George Washington
$75.00
John Adams
$100.00
Thomas Jefferson
$200.00
James Madison
$500.00
Alexander Hamilton
$1,000.00
Benjamin Franklin
$5,000.00
Paul Revere
$10,000.00
James Wilson
TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-204
FOR RELEASE UPON DELIVERY
Prepared Remarks by
Secretary of Treasury
James A. Baker, III
at a Press Conference announcing
the new Savings Bond design
Friday, March 29, 1985
Washington, D-C.
Good morning. I'm pleased to announce another step forward
in our efforts to modernize Treasury operations and save taxpayer
money.
It's a new design for the most commonly used Savings Bond,
the Series EE, and the beginning of a shift from card to paper
stock. I emphasize that what we are announcing involves no
changes in the terms and conditions of the Savings Bond.
The new format will speed up the processing of Savings
Bonds, deter counterfeiters, and save over a million dollars a
year in printing costs. Additional savings will come from using
state-of-the-art equipment in processing bonds.
Although not directly affecting Americans who now hold
Bonds, the change will benefit those who buy the $4 billion of
new Bonds sold each year.
It will benefit the nore than 40,000 U.S. Savings Bonds
issuing agents. And it will benefit a Savings Bonds program that
has been extremely cost-etfective to the U.S. government.
Our design change is similar to the recently announced shift
to paper government checks.
•
By 1987 all Series EE Savings Bonds will be made of
multicolored paper, replacing the punched cards used for the last
28 years.
B-67
-2The new Bonds will be more efficient. The Bond face
contains magnetic ink and optical character data that the
financial community and Treasury will be able to process and
record at high speed and with great accuracy.
To deter counterfeiting, the new Bond face will be much more
complex. This will include a gradation of pastel colors from
yellow to brown, portraits of Founding Fathers, engraved borders,
and a patterned background containing a picture of Independence
Hall in Philadelphia.
These changes in Savings Bond design are part of Treasury's
ongoing effort to increase efficiency and cut costs. In addition
to the paper government checks announced earlier this year,
Treasury recently introduced the innovative STRIPS program, which
not only reduces the cost of debt financing to the government,
but offers the public a greater variety of securities.
In addition, Treasury has the lead role in the President's
Cash Management reforms, which realized savings of $1.4 billion
in fiscal year 1984.
All this was accomplished while reducing staff by 3,000 *
employees, with a simultaneous increase in productivity.
Now, I want to introduce those who will be involved in the
change-over to the new type of Savings Bond.
Fiscal Assistant Secretary Carole J. Dineen, who has overall
responsibility for the development and distribution of the new
Bond;
Treasurer of the United States Katherine D. Ortega, wfcio is
responsible for the public awareness effort and promoting the
sale of Savings Bonds;
William M. Gregg, Commissioner of the Public Debt, whose
agency will administer the transition;
And Martin French, Assistant Commissioner of the Savings
Bond Operations Office, the office that designed the new Bond and
which will implement the new design.
PORTRAITS APPEARING ON NEW DESIGN
SERIES EE U.S. SAVINGS BONDS
DENOMINATION
PORTRAIT
$50.00
George Washington
$75.00
John Adams
$100.00
Thomas Jefferson
$200.00
James Madison
$500.00
Alexander Hamilton
$1,000.00
Benjamin Franklin
$5,000.00
Paul Revere
$10,000.00
James Wilson
The United States and Japan;
Their Ad Hoc Agreement and Its Implications
Remarks by Dr. David C. Mulford, Assistant Secretary
for International Affairs, U.S. Treasury Department
Euromarkets Conference, London, April 1, 1985
It is a pleasure to be back in London to speak before this
distinguished group. April 1 is an auspicious day to discuss the
Yen/Dollar Agreement, as today marks the beginning of the next
round of liberalization of the Euroyen market. For some of you,
April 1st may have other connotations, but I am advised that
there is nothing in Japanese history, philosophy, or indeed in
MOF regulations, which indicates that April Fool's Day, like
other U.S. products, has yet gained access to Japan.
In my remarks today I wish to explain the objectives of the
U.S. Treasury in initiating the yen/dollar talks, to touch upon
several of their more important results and to close by commenting on some of the Yen/Dollar Agreement's implications for world
capital markets.
The United States' concern about the role of the yen in the
international financial system was the most important motivation
for the yen/dollar discussions. Although it seemed clear to us
that the Japanese authorities were not directly depressing the
value of their currency, it was equally apparent that the role of
the yen in the international financial system did not fully
reflect the underlying strength of the Japanese economy.
Japan has become an economic giant, the world's second
largest market economy. But the yen has remained the least
utilized internationally of all the major industrial nations'
currencies. Last year, for example, only some 3-1/2 percent of
the world'1 s official reserves were denominated in yen. In trade,
Japan uses yen to a much lesser extent than the United States and
most European countries use their national currencies. Only
about 40 percent of Japan's exports are denominated in domestic
currency, compared to 90 percent for U.S. exports and 60-85
percent for the exports of major European countries. On the
import side, the figures are a mere 3 percent for Japanese
imports denominated in yen, versus 70-85 percent for the United
States and 30-45 percent respectively for the currencies of the
major European countries. Likewise, in international finance,
despite interest in yen assets on the part of many international
investors, the yen has been a difficult currency to deploy, and
of course, as you all know, there has never been a Euroyen market
remotely comparable to other Eurocurrency markets.
-2We concluded that Japan's financial policies were having an
important influence on the value of its currency in international
markets. We were also concerned about the broader impact of
Japan's policies on the efficiency of the international economic
system. If interest rates are not permitted to move freely, or
capital flows are discouraged, funds will not be allocated
efficiently. This is not simply a matter of domestic concern.
In today's highly interdependent world, the policies of one
government can be transmitted quickly to the rest of the world,
thus influencing the allocation of resources worldwide.
Our general objective, then, was to begin to change the
environment in which the exchange rate is determined from one
based on government regulation and administrative "guidance" to
one governed by market forces. To do this, we believed it was
necessary first, to seek full deregulation of Japan's domestic
capital market; second, to increase the range and availability
of yen-denominated instruments to international borrowers and
investors; and third, to improve access to the Japanese market
for foreign financial institutions.
The principle objective of domestic deregulation is to allow
interest rates to be determined by market forces. This will
increase the range and appeal of yen instruments to Japanese and
foreign investors alike and help improve efficiency of the
resource allocation, both within Japan and between Japan and the
rest of the world.
',
Increasing the access of foreign financial institutions to
the Japanese market will ensure not only that foreign investors
have access to Japanese assets and that Japan's market becomes
more competitive, efficient and innovative, but also that foreign
firms actually receive the benefits of "national treatment" in
Japan. To accomplish this, there was a need to increase the
"transparency" of Ministry of Finance policies, and to improve
competitive opportunities for foreign firms (not just U.S. firms)
in such areas as trust banking, dealing in Government of Japan
securities, and membership on the Tokyo Stock Exchange.
Our chief avenue for near-term progress was the Euroyen
'market which, though founded in 1971, remained in its infancy.
It was, however, a market less encrusted with regulation,
compared even to the Samurai market. Hence, the relative lack of
legal and market precedents, and the obvious merits of observing
established Euromarket formats, caused us to believe that the
Euroyen market, and not the Samurai market, offered both the most
desirable area for change, as well as the path of least
resistance in Japan. Dismantling regulations and controls in
Japan's highly structured domestic market, on the other hand,
will take more time, but once the process is begun on a
sufficient scale, we hope the momentum of change will be to some
degree self-perpetuating.
-3As you know, a major feature of the expanded Euroyen market
is the development of a larger and more broadly-based Euroyen
bond market. One of the major achievements in our discussions
was MOF's decision to open this market in stages to a much
greater number of potential issuers. As of today, non-Japanese
corporations with ratings of AA or better, and about half of all
A-rated firms, will be able to issue Euroyen bonds.
The goal, of course, was and remains to have no restraints
or controls on who may issue, but to let the market determine
creditworthiness. For AAA, AA and A-rated firms with net worth
of ¥600 million or more, the highly restrictive credit criteria
imposed by the Ministry of Finance are being replaced this month
by internationally accepted credit ratings. We hope MOF will
soon abandon the use of credit criteria entirely and allow all
potential issuers to issue on the basis of independent ratings.
Japanese corporations, though eligible to issue, have yet
to tap the Euroyen market due to the existence of Japanese
withholding tax on Euroyen bonds issued by resident companies.
However, last week the Diet passed legislation abolishing this
tax on bonds held by non-residents, effective today. We are
pleased with this important change, which will now allow for
greater Japanese sponsorship in the market, but I cannot help
but note in passing that just at the time when the United States
and other countries have abolished withholding tax on foreign
investors, Japan has tightened withholding on the overseas
investments of Japanese residents, thereby collecting for itself
the revenues formerly collected by the countries which have
repealed withholding. Their aim is to discourage the reflow to
Japan of Euroyen instruments and, I suppose, to place a damper
on capital outflows. While this will not be detrimental to the
development of the Euroyen market, it is clearly a backward step
for international capital flows and Japan's full integration into
world capital markets.
In setting up the Euroyen market, we felt strongly .that
non-Japanese firms should be allowed to lead and co-lead manage
Euroyen issues. This will promote the development of the market
by giving foreign investors better access to Euroyen paper and
bringing many major Euromarket firms into the important marketmaking function they perform in other currencies. More competition may also help keep borrowing costs low, a feature of the
early rush of Euroyen issues that some of you would probably
like to forget. Euroyen certificates of deposits and syndicated
Euroyen lending represent two other important beachheads for
the market's development.
No summary of the activity in the Euroyen note market is
necessary here, as I know you have all been deeply engrossed in
the cut and thrust activity of its early months. For the record,
however, I would note that there have been 15 Euroyen issues by
non-resident corporations since December 1, three of which have
had non-Japanese lead managers. In addition, the vast majority
-4of all Euroyen issues since December 1st have had non-Japanese
co-lead managers. I believe most Japanese banks with overseas
branches and a number of non-Japanese banks have issued Euroyen
CDs. Syndicated lending has been relatively slow, but activity
should pick up as the supply of Euroyen funds increases and MOF
lifts the one-year maturity limit.
In appraising the implications for the Euroyen market, one
must remember it is still at a very early stage of development.
For example, it is still subject to some undesirable and, we
believe, unnecessary regulation, much of which stems from Japan's
Foreign Exchange Control Law. The Ministry of Finance still
checks the qualifications of each potential issuer in the Euroyen
bond market and requires banks to obtain approval for their first
Euroyen CD issue. Various maturity restrictions limit flexibility in funding and lending, and floating rate instruments are
not yet available. The lack of Japanese corporate issuers to
date and the current inadequacy of Euroyen funding sources are
other indications that the market still needs time to develop.
The question is, how long will the Euroyen market remain at
this stage of development? Not very long, would be my view.
There are simply too many pressures for change. But change does
not come quickly in Japan, since there is always the threat of
renewed intervention by a government bureaucracy whose penchant
is for regulation instead of free markets. Therefore, althopgh I
believe the effects of domestic and international financial }
liberalization in Japan are inexorable, they are also, if you
will pardon the expression, inscrutable.
Once some restrictions are lifted, the remaining ones are
apt to become more vulnerable. Liberalization in some areas is
likely to spawn further change in others. At the moment, for
example, the criteria for Japanese residents to issue Euroyen
bonds are very restrictive. However, the more liberal criteria
for non-residents, plus the ability to swap, allows Japanese
corporations to raise Euroyen, even though they may not be able
to issue directly. Likewise, Euroyen CDs currently bear fixed
rates of interest and must have maturities of six months or less.
Nevertheless, the possibility of rollovers makes these Euroyen
CDs akin to longer term, adjustable rate instruments.
In addition, official attitudes in Japan are changing.
More and more, Japanese officialdom appears to be coming to the
conclusion that financial liberalization is inevitable, and even
desirable. They are realizing that unless Japan is prepared to
cut Japanese corporations off,from Eurocurrency borrowing and
restrict Japanese foreign investment, it is no longer possible
to isolate Japan from international markets. On the contrary,
exposure to international financial markets is forcing change on
the domestic market through the need for more competitive
instruments. Japan's recent capital outflows are simple
confirmation of this fact.
-5-
Finally, the market opening that has occurred so far has
unleashed new competitive pressures for further deregulation.
The more aggressive Japanese financial institutions are eager
to develop new business. They see some natural advantage in yen
transactions and want opportunities in yen that foreign firms
have enjoyed in their own markets. Meanwhile, Japanese residents
want the same fund-raising possibilities as non-residents, and
Japanese investors want investment instruments more accurately
reflective of market rates.
As a result, I think it is just a matter of time before
we will see more changes in the Euroyen market. Some are already
underway. For example, the Ministry of Finance has recently
authorized medium and long-term syndicated Euroyen lending to
non-residents and is reportedly studying Euroyen bonds with
floating rates and shorter maturities. Plans are also afoot to
establish an International Banking Facility in Tokyo. This
obviously raises the possibility that more Euroyen activity will
take place in Japan, but given Japan's regulatory inclinations,
I expect that a substantial portion of an expanding Euroyen
market will remain offshore. Meanwhile, non-residents' transactions will probably continue to be liberalized more rapidly
than residents', but both are likely to continue developing
fairly steadily.
So far, I have concentrated on the development of the
Euroyen market, but I would like to say a few words about the
bearing this has on domestic deregulation in Japan. In many
respects, the development of the Euroyen market facilitates the
process of domestic deregulation. One reason for this is that,
to a large extent, the separation between the two markets is
artificial. Japanese residents already have access to other
Eurocurrency markets, and companies which cannot issue Euroyen
bonds directly have access to yen funds through an active swap
market. The removal of the "real demand rule" in April 1984 has
also facilitated foreign financial transactions, and competitive
arbitrage between the domestic and foreign markets will help
integrate the domestic and Euroyen markets.
While the development of the Euroyen market will create
strong pressures for deregulation in Japan, there may be a still
more effective force for change: Japan's massive capital outflows. In 1984, net recorded capital outflows from Japan were a
record $30 billion. Next year, with Japan's growing current
account surplus, they will be still higher. Although Japan, with
its high savings rate, appears awash in capital, its large public
sector budget deficit — expressed as a share of GNP — is
approximately as large as that of the United States. Japan's
high savings rate suggests a potential for higher growth if
domestic investment of these savings in Japan were made more
attractive.
-6Meanwhile, to judge by the magnitude of these capital flows,
it appears that Japanese investors are behaving like rational
investors everywhere, investing, when possible, where the returns
to capital are highest. In Japan, it is said that, "The frog in
the well knows nothing of the great ocean." It would seem that
Japanese investors are now clambering out of the well, and the
ocean looks pretty good. Until returns in the domestic market
are comparable to those overseas, Japanese investors will
probably continue to channel a substantial portion of their
savings abroad.
Parenthetically, I might add, these capital outflows suggest
that at least in the financial market, Japanese do not necessarily "buy Japan" when alternatives exist. I wonder, then, whether
we should accept Japan's protestations, or the views of many
foreign businessmen, about the deep-seated desire of Japan's
citizens to buy only Japanese goods as an explanation of why
Japan's imports of manufactured goods from the outside world are
so low. I believe we are correct to look to regulations, formal
and informal, as the reason for inadequate access, and I hope
Japan will follow in other areas the example it has set in the
Yen/Dollar Agreement before irreparable damage is done to the
world trading system.
Returning to the capital account, I think the Japanese
authorities are likely to have one of two reactions to these,
developments. One possibility is that they could become sufficiently alarmed by the volume of these outflows to reimpose some
form of capital controls. However, such a move would be
politically unpalatable for Japan, since it would clearly outrage
the rest of the world and certainly violate the spirit, if not
the letter, of its understandings with the United States.
I think Japan is more likely to maintain or to increase the
pace of domestic deregulation, checking the outflows by improving
the returns on investment in Japan. In fact, Japan may already
be on this second course. Steps are being considered today that
were discussed in our talks last year, but at that time were
unacceptable. MOF should be commended for its constructive
attitude, for in all our discussions with the Japanese, they have
clearly taken steps they perceive to be in their own long-term
interests. New steps might include establishing a Treasury bill
market, which would provide an attractive short-term instrument
for investors and set a market-rate basis for Japan's financial
markets. This would also be an important tool for debt management and the execution of monetary policy. Another possibility
might be to eliminate withholding taxes on foreign investment in
Japan, so as to make investment in Japan more competitive with
investment in other markets.
Having said earlier that exchange rate concerns were an
important motivation for the yen/dollar discussions, let me
say a few words about exchange rate movements since the
Yen/Dollar Report was issued last May. At that time, the press,
-7not perhaps having understood the fundamental nature of the
exercise, seeemed to expect that success should be measured by an
immediate strengthening of the yen against the dollar. It is
true that in the balance of 1984 and early 1985 the yen weakened
against the dollar, but we must remember that it has remained
stronger against the dollar than any other major currency. As of
Friday's New York close, the yen had declined about 7-1/2 percent
against the dollar since last May. Over the same period, the DM,
French franc and Sterling were all down about 10 to 11 percent
against the dollar, while the yen was up some 3 to 3-1/2 percent
against these European currencies.
In some respects, the yen's strong performance is not
surprising. Japan's economic performance and its sound macroeconomic policies surely play an important role. Japan's capital
outflows are, of course, a reflection of its large current
account surplus. Nevertheless, I think it is very significant
that the yen has remained relatively strong in the face of the
capital outflows which result from the disparity between the
greater freedom to lend or invest abroad and the restrictions in
the domestic market. A large portion of these outflows appear to
be going into the Euromarket. It may well be that a substantial
amount is going into the Euroyen market and remaining in yendenominated claims, thereby neutralizing, to some extent, the
exchange rate effect of Japan's capital outflows. Over time,
however, as the domestic and Euroyen markets develop more fuj.ly,
I think we will be able to state more confidently that Japan's
financial market liberalization has helped the yen to reflect
more fully the underlying strength of the Japanese economy. And
this is what the yen/dollar talks were really all about1
In conclusion, considerable change has occurred in the ten
months since the the U.S. Treasury and the Japanese Ministry of
Finance released their Yen/Dollar Report. In fact, I think we
will look back on this Report as a cornerstone of change, marking
the beginning of the internationalization of Japan's financial
system. My view, however, is that progress is just beginning.
The future pace of Euromarket development depends on a number
of factors: the reaction of market participants, including
borrowers, intermediaries and most important, investors; conditions in other markets; and internal pressures for further
change. However, taking the recent past as a guide, one may
safely conclude that the competition in the Euroyen market will
be brisk, and the opportunities, great. On the domestic side,
growth in the Euroyen market, along with increasing competitive
pressures internally and the desire to attract more of Japan's
savings for domestic investment, will combine to force more rapid
deregulation inside Japan.
I would welcome your comments on my remarks and your
suggestions on areas where further liberalization is needed.
rREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 1, 1985
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $ 6,564 Billion of 13-week bills and for $6,557 million
of 26-week bills, both to be issued on April 4, 1985,
were accepted today.
RANGE OF ACCEPTED
13-week bills
COMPETITIVE BIDS: maturing
July 5, 1985
Discount Investment
Rate
Price
Rate 1/
Low
High
Average
8.11%
8.20%
8.18%
8.40%
8.49%
8.47%
26-week bills
maturing October 3, 1985
Discount Investment
Rate
Rate 1/
Price
97.927
97.904
97.910
8.52% 9.03% 95.693
8.56%
9.07%
95.672
8.55%
9.06%
95.678
Tenders at the high discount rate for the 13-week bills were allotted 21%.
Tenders at the high discount rate for the 26-week bills were allotted 60%.
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
:
Received
Received
:
$
401,410
13,913,380
:
23,785
'42,070
:
72,485
:i
58,105
J
1,046,095
:
95,020
;
40,930
:
67,295
35,540
:
.
1,137,570
392,640
Accepted
$
410,245
14,169,120
32,545
67,855
51,680
49,080
1,092,690
107,995
34,390
59,730
50,195
1,156,940
333,825
$
60,245
4,630,970
32,545
67,855
51,680
49,080
357,390
82,995
34,390
59,730
50,195
752,700
333,825
$17,616,290
$6,563,600
:
$17,326,325
$6,557,025
$14,716,645
1,258,535
$15,975,180
$3,663,955
1,258,535
$4,922,490
:
:
:
$14,379,920
1,137,105
$15,517,025
$3,610,620
1,137,105
$4,747,725
1,321,110
1,321,110
:
1,250,000
1,250,000
320,000
320,000
559,300
559,300
$17,616,290
$6,563,600
$17,326,325
$6,557,025
:
$ 100,710
5,107,380
23,785
42,070
67,685
55,305
294,095
61,020
40,930
67,295
28,540
275,570
392,640
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS
II Equivalent coupon-issue yield*
B-68
:
rREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 8:30 p.m., E.S.T.
April 1, 1985
REMARKS BY
SECRETARY OF THE TREASURY
JAMES A. BAKER, III
AT THE
ECONOMIC CLUB OF NEW YORK
APRIL 1, 1985
Thank you very much.
This is my second attempt to speak to the Economic Club of
New York. I was invited back in 1982, but budget matters forced
me to cancel at the last minute. So I thank you for this
raincheck. It's a pleasure to be here this evening, and an honor
to address such a distinguished group.
In case you haven't noticed, today is April Fools Day — when
everything's a joke. This contrasts with April 15th — when
nobody's laughing. And, like any well-prepared speaker, that
reminds me of a story.
An income tax collector died and arrived at the pearly gates.
Just ahead of him were two clergymen, but St. Peter motioned them
aside and took the tax collector right in. "Why him ahead of us?"
the surprised clergymen asked. "Haven't we done everything
possible to spread the good word?"
"Yes," said St. Peter, "but that guy scared the hell out of
more people than you ever did."
A lot has happened in the time between that first invitation
to speak here and today. Back in 1982, the country was in
recession. But, with honest optimism, I still would have told you
that the future looked bright.
Today is that future. We're in the 29th month of recovery
and growth. Our economy has been shining — with real growth last
year the highest since 1951.
Hundreds of thousands of jobs are being created every month
— over 7-1/2 million during this expansion. Capital spending has
outpaced gains during any previous postwar recovery.
And inflation has been held at bay — dramatically below the
double-digit levels that were crushing our spirit and ruining our
economy only a few years ago.
B-69
- 2 The reason for all this success, and the reason that even in
1982 I could have spoken here with optimism, has been the
unyielding belief of this Administration in sound, commonsense
economic policy and the unwillingness to buckle under pressure for
traditional, quick-fix "solutions."
We held on doggedly to our faith in the power of free
markets, incentive-spurring tax cuts, and the creativity of the
individual. We pushed hard to control federal spending, cut
needless or out-of-date regulation, and restore economic power to
the people.
The result? America's economy has been catapulted out of the
stagflation and morass of the 1970s. And more important, we have
restored confidence in market-oriented economic policies; we have
renewed our faith in America's power to produce jobs and
well-being through growth; and in so doing, we have begun to lay a
firm foundation for sustained economic development without
inflation.
We have returned to a position of strength in the
world economy, as well. And this American economic might is
helping to pull other nations up off the mat. Most haven't
recovered to the extent we have and this, along with the
international debt problem, has kept the relative attractiveness
of U.S. investment strong, and thus kept the dollar strong —
stronger than some would like.
But even those who find fault with the dollar's strength are
realizing that the United States cannot go back to the
traditional, quick-fix mentality.
Rather than artificially lowering the dollar, others are
coming to see that sound, convergent, market-oriented economic
policies are the best means to assure long-term stability.
With the international debt problem, we've seen a similar
acceptance of work, dedication and patience as the proper means to
overcome a serious threat to the worldwide financial system.
At the 1983 Williamsburg Summit, we adopted a five-point
strategy for managing the debt problem. Its basic elements were,
and are: economic adjustment by debtor countries; growth and open
TMP
tn
! industrialized nations; adequate resources for the
IMF; continued bank lending to those countries who are making
lne
adjustment efforts; and emergency bridge loans by
governments to aid adjustment programs. That strategy is working.
difficultPfore,S?iiS
n0t SlWayS eas
*'
cutticult for all concerned.
In fact
'
ifc is often
But it is effective.
- 3 We're encouraged by the progress of Mexico, the nation that
led off a wave of debt problems in Latin America and elsewhere two
and a half years ago. Mexico has battled back and is now held up
as a model for other debtor nations to follow.
The battle is far from over, but in Mexico and throughout the
international community, if we stick by our basic strategy, if the
debtor countries, the IMF, the lenders and industrial nations
continue to work together, then the debt problem will continue to
be manageable in the short-term and even solvable in the long-run.
In the meantime, we've got more to do right here at home. It
would be a serious mistake to let this recovery breed complacency.
Our domestic economy is growing and thriving as a direct result of
economic policies implemented in 1981. We must build on what
we've started; extend those policies and philosophies that have
brought us this far, for they promise to carry us much farther.
I want to interject here that I am not troubled by the first
quarter flash for growth and inflation. The early data suggest
that GNP is rising at only a little over 2 percent, while the GNP
deflator is projected at above 5 percent. However, most private
economists believe that this flash estimate reflects a number of
aberrant technical influences and that real growth has been
understated, while inflation has been overstated. In addition,
February's leading indicators suggest that we'll continue to see
moderate growth.
And I believe we will see growth continue for a long while
yet — if we continue what we started four years ago, and if the
Congress acts responsibly to implement the President's program.
Our efforts right now center on the control of federal spending
and on tax reform. These are the top two domestic economic issues
we face.
On spending control, we are encouraged by the way the terms
of the debate have been framed. No longer is the question "should
we cut spending?", it is now "how should we cut spending?"
On tax reform, we are undertaking an historic challenge. And
because, at the President's direction, I am leading the
Administration's efforts to refine our proposal, I will devote the
balance of my remarks tonight to that topic.
I remember my first briefing on the subject as Treasury
Secretary. One of my advisors told me: "Mr. Secretary, I know
you think coming up with passable tax reform legislation is going
to be very tough. But if you look at it this way, it doesn't seem
all so monumental. There's only two types of people complaining
about the tax system," he said. "Men and women."
- 4 Well that about sums it up, I think. A lot of people are
complaining. In fact, recent studies find that:
— 4 out of 5 taxpayers believe the present tax system
benefits the rich and is unfair to the ordinary working
man or woman;
a majority of taxpayers believe the federal income tax
system is too complicated; and
a majority of respondents perceive that cheating on
income tax is rampant.
I think it's clear that, where our tax system
is concerned, there is a widespread populist sentiment in favor of
major reform. And more importantly, this sentiment is rooted in
legitimate concerns.
Now, of course, there is substantial resistance to some of
the particular changes that would be brought by a comprehensive
tax overhaul. But we firmly believe that the majority of
Americans would forego some aspects of the system which benefit
them individually, for a simpler and fairer system with lower tax
rates.
More than 70 years of piece-meal changes in the tax code has
culminated in a system that has fundamental shortcomings.
It is riddled with inequities. It has grown unacceptably
complex. It requires high tax rates to provide sufficient
revenue. And it is adversely affecting what should be economic
decisions by businesses, investors, and yes, even average
individual taxpayers.
And perhaps most importantly, the present situation has led
to a loss of respect for the tax system, which translates into a
loss of respect for government generally. To the extent that we
can improve our tax system, we will be improving government and
the public's perception of government. To the extent that we fail
to do so, we will be allowing a regrettable and corrosive tendency
toward alienation and cynicism to persist.
I know that problems with the tax code aren't news to you.
h e a r d t h e com
^Ln6ar\Wu
Plaints. And Washington has often
fc X
reform
Pr^L? D
?
- B ^t it's only recently, since
dlrected a f
Addr^! t f ^ r
u U study in his State of the Union
0
a year a
has hlrnL I
w^.
9 ° ' t h a t r e * l ' comprehensive reform
nas become a possibility.
- 5 He reconfirmed his concern in the most recent State of the
Union two months ago. He spoke of a "Second American Revolution"
— a revolution of hope and opportunity for all Americans. Tax
reform is most definitely one of the means to lead us to, and
assure the continuance of, a successful revolution.
It's not an easy task. We don't underestimate the difficulty
involved, nor minimize the importance of our actions. In fact,
tax reform is among the most ambitious undertakings of this
Administration. But the time for such bold action hasn't been
better in many years. We've got a thriving, strong economy, and
believe me, that makes our efforts a lot less difficult.
We've also got something of a consensus among the leading
proponents of tax reform. All of them agree that our present
system is flawed and that some kind of comprehensive reform is
needed. And among the major reform proposals, the same basic
philosophies are shared, even if all the same specifics are not.
We've been meeting almost daily with members of Congress,
representatives of the business community, and other affected
parties. And we're entering these discussions with open minds, a
willingness to listen and a willingness to examine all aspects of
reform.
There's not too much, for our part, that's already etched in
stone. But there are several important, general guidelines that
we think should shape the dialogue.
First of all, we believe that tax rates are still too high
and must be reduced. High tax rates stifle incentives to work,
save, and invest. They discourage invention, innovation, and risk
taking. They encourage wasteful tax shelter investment and they
stimulate underground economic activities.
It is far better to levy a low rate of tax on all income than
to tax only some income at extremely high rates. By bringing
untaxed income into the tax base we can reduce high marginal tax
rates for both individuals and corporations without any loss of
revenues in the short run.
In the longer run, those lower rates should lead to even
higher revenues through sustained growth of the tax base.
Secondly, any tax reform proposal must be revenue neutral.
The Administration is adamantly opposed to reform being a tax
increase in disguise.
Now this means grappling with two forces that we know are
lurking in the shadows — those who will attempt to combine tax
reform with deficit reduction; and those who will lobby hard to
have their special tax treatment retained in any new law.
- 6 We can't give in to either pressure. Tax reform and deficit
reduction each has its own singular importance. Both are economic
priorities. But they must remain separate issues.
Similarly, the special interests must understand that we
can't exempt every preferential treatment, deduction and credit
that has a constituency and at the same time bring down tax rates.
that families be treated fairly and assigned the importance they
deserve as the foundation of American society.
Widespread home ownership provides a sense of well-being and
social stability that we believe strengthens the family and,
through that, all of society. The deduction for mortgage interest
makes homeownership easier and more likely and warrants special
consideration.
Even more important under our fairness to families guideline
is that people living in or near poverty pay no income tax. I
don't think too many would argue that those applying everything
towards bare necessities of life should not have the added burden
of income tax.
A fourth criterion is formally called "economic neutrality."
Simply put, this means all sources and uses of income should be
taxed equally. And this requires, again, that most special
exclusions, adjustments, credits and deferrals that favor certain
sources and uses of income be eliminated.
We believe that a free market is the best method for
allocating resources in the most efficient manner. It provides
the best data and best signals for investors, consumers, savers
and businesses.
But right now, our economy in some respects can be severely
distorted because what should be economic decisions are decisions
driven instead by tax considerations. While a pure, economically
neutral system may be unattainable, we should make every effort to
devise a system as unbiased and economically efficient as
J
possible.
k
W this as ec
. P t of tax reform is of great importance to
m*n<, * ?u
Tn fho\
alienee. There's been a concern on the part of many
mav S L ^ ! l n e S S . a ? d , i n d u s t r i a l sectors that some reform proposals
lookino 2!r«5Pi?al f o r m a t i ° n . Let me assure you that we will be
kin t L arl
ll S t t h 9 S e e l e ^ n t s of any plan. We don't want to
kill the goose that lays the golden egg.
- 7 Our overall economic objective is and has been stronger
economic growth. There is no contradiction between tax
simplification and economic growth. They can and should go hand
in hand .
We|re well aware of the integral part capital formation has
in providing and sustaining growth in an economy. And we're well
aware that economic risk and investment are functions of potential
gain. We obviously need to find a balance. We need the
entrepreneurs, innovators and risk-takers.
The complexity of our tax code seems to be the federal
government's unintended method of adding insult to injury. And
because of ever-changing statutory provisions, I don't see the
system growing any simpler on its own. Simplifying the tax code
must be among our objectives.
Within this framework lies a good foundation for tax reform.
We won't abandon the guidelines I've gone through today, but we
are receptive to sound suggestions and alternatives that may
benefit taxpayers and the economy.
One alternative we don't have is inaction. What our tax
system has developed into is contrary to so much of what has
powered our nation for two centuries that we must achieve
comprehensive reform.
To let the present system of piece-meal change and
debilitating complexity continue would be to risk a lot.
Eventually, a flawed tax system would catch up with us. And the
price would be less growth, less opportunity and less hope.
Perhaps you've heard it said that destiny is not a matter of
chance, it is a matter of choice. It is not a thing to be waited
for, it is a thing to be achieved.
Well, the way I see it, we can take a chance and wait. Or we
can make a choice and achieve. It's clearly up to us. I think
our decision should be evident.
Thank you.
TREASURY NEWS
spartment of the Treasury • Washington, D.c. • Telephone 566-2041
For Release Upon Delivery
Expected at 10:00 A.M., E.S.T.
April 1, 1985
STATEMENT OF
RONALD A. PEARLMAN
ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
AND THE
SUBCOMMITTEE ON SELECT REVENUE MEASURES
OF THE
HOUSE WAYS AND MEANS COMMITTEE
Mr. Chairmen and Members of the Subcommittees:
I am pleased to appear before you today to discuss some of
the more significant Federal income tax aspects of corporate
acquisitions. The. recent surge in merger activity and the
publicity surrounding recent acquisitions (and attempted
takeovers) of large, publicly held corporations has renewed
concern that our tax laws inappropriately encourage these
transactions. We do not know all of the economic and other
reasons behind the recent flurry of activity. However, we doubt
that tax considerations are the driving force. We suspect that
other market forces precipitate these transactions; forces that
reallocate resources to higher valued uses, promote economies of
scale, increase shareholders' return on investment, replace
inefficient management, and free up capital for new investment
opportunities. Only those persons responsible for the merger
activity know for certain the forces that drive their decisions;
I will not today speculate on their decision making process,
instead I will concentrate on the principal tax aspects of
mergers and acquisitions and defer to the expertise of others on
the effect of these corporate acquisitions on the economy as a
whole.
B-70
- 2 While it is doubtful that our tax laws are primarily
responsible for the recent merger upswing, they play an important
role in these transactions, just as they do in virtually every
business transaction corporations conduct. The subject of the
hearing today concerns those aspects of our current tax laws that
exert the greatest influence on merger activity. The first part
of my testimony summarizes the different types of corporate
acquisitions and describes the divergent tax consequences that
may be obtained. The second part of my testimony discusses
certain structural features of our tax system that appear to
encourage corporate acquisitions and takeovers. The third part
of my testimony describes recent trends in merger activity that
raise significant tax policy issues. Included among these are
the use of ESOPs in leveraged buyouts, the use of asset
reversions from overfunded defined benefit plans to finance
mergers and acquisitions and the carryover of tax attributes in
mergers and acquisitions of thrift institutions. Finally, I will
discuss certain legislative proposals that are inspired by the
current wave of mergers and acquisitions.
I. Taxing Corporate Acquisitions - An Overview
In general, for tax purposes, corporate acquisitions are
categorized into two basic forms — taxable and tax-free. While
this categorization vastly oversimplifies how the tax law applies
to these transactions, it is useful in analyzing the important
tax policy questions in this area to think of the transactions as
coming within one of these two categories; for it is this
categorization that will trigger the most significant tax
consequences. This first part of my testimony summarizes the
types of mergers and acquisitions that come within each category
and their principal tax consequences.
A. Tax-Free Acquisitions
The distinctive characteristic of a wholly tax-free
acquisition is that no gain or loss is recognized by the target
corporation or its shareholders. The target shareholders are
permitted to roll over their investment position in the target
corporation for an investment position in the acquiring
corporation without paying current tax. This tax-free rollover,
however, is generally available only to the extent the target
shareholders receive stock of the acquiring corporation or
certain related corporations. Other consideration received by
the target shareholders is taxable either as dividend income or
S5 P i«27^?!i n :J e p ! n ? 1 2 9 u P O I \ t n e application of a complicated set
S M ? « , ? i Ji;??« 8 J* t U t 0 r y n i l e s t h a t s t r i v e t 0 m a k « this ever
difficult distinction.
- 3 A tax-free acquisition generally will not generate taxable
income to the target corporation, even if that corporation has
appreciated assets. The corollary of this tax-free treatment is
that the target corporation's historic tax basis for its assets
"carry over" to the acquiring corporation and are not
"stepped-up" (or down) to fair market value. Moreover, with
certain limitations discussed below, tax attributes of the target
corporation, such as net operating losses and unused credits and
accumulated earnings and profits, will also carry over to the
acquiring corporation.
To qualify as a tax-free acquisition, the transaction
generally must qualify as a "reorganization" as defined in
section 368 of the Code.jy Although the statutory definition and
judicial interpretations place significant constraints on how a
reorganization can be structured, significant flexibility does
exist. Thus, a tax-free acquisition can take the form of a
direct acquisition of the target corporation's assets, the
acquisition of the target corporation's stock, or a combination
of the target and the acquiring corporation pursuant to statutory
merger or consolidation.
B. Taxable Acquisitions
The principal characteristic of a taxable acquisition that
sets it apart from a tax-free acquisition is that the seller in a
taxable acquisition cannot receive a tax-free rollover of his
investment. The seller in a taxable acquisition can be either
the target corporation (a taxable asset acquisition) or the
target shareholders (a taxable stock acquisition). The
collateral consequences of a taxable asset acquisition and a
taxable stock acquisition differ in so many respects that each
will
discussed separately.
V
A be"reorganization"
is defined in section 368(a) as including
four basic types of acquisitions: statutory mergers (type "A"
reorganizations), stock-for-stock exchanges (type "B"
reorganizations), asset-for-stock exchanges (type "C"
reorganizations), and bankruptcy reorganizations (type "G"
reorganizations). Tax-free acquisitions can also be effected
through compliance with section 351. In addition to
satisfying the statutory definition, a reorganization must
meet certain other regulatory and common law tests (such as
the "continuity of interest" and "continuity of business
enterprise" tests) in order to qualify as a reorganization".
Although there is some uncertainty regarding application of
these statutory and judicial tests to particular fact
patterns, there is a substantial body of case law and
Internal Revenue Service rulings and past history that
provide guidance to taxpayers.
- 4 1. Taxable Asset Acquisitions
In a taxable asset acquisition, gain or loss is recognized by
the target corporation, unless, as discussed below, the target
corporation is completely liquidated within a statutorily
prescribed time. The sale may be reported on the installment
method, however, in which case any cap'ital gain is deferred and
reported as the installment payments are received. In any case,
the tax basis of the assets acquired are adjusted to reflect the
purchase price paid for those assets. In a taxable asset
acquisition, the acquiring corporation does not succeed to any of
the target corporation's tax attributes, such as net operating
losses and unused credits and accumulated earnings and profits.
These tax attributes, however, will be available to offset the
target corporation's income and tax liability resulting from the
sale.
If a transaction is a taxable asset acquisition from a
corporation that has adopted a plan for complete liquidation
within a 12-month period, generally no gain or loss is recognized
by the selling corporation (except to the extent of recapture
and other tax benefit items). Gain or loss is recognized,
however, by the shareholders of the liquidating corporation based
upon the difference between the amount of the liquidation
proceeds received and their stock basis. If the target
corporation sells its assets for installment notes that are
distributed in liquidation, the target shareholders can report
their gain on the installment basis to the extent they receive
the notes.
2. Taxable Stock Acquisitions
In General. If a transaction is a taxable stock
acquisition, gain or loss generally will be recognized by the
selling shareholders, but may be reported on the installment
method if installment notes are received. The tax consequences
to the target corporation and the acquiring corporation depend
upon whether the acquiring corporation makes a section 338
election.
The immediate effect of a taxable stock acquisition is that
the target corporation becomes a subsidiary of the purchasing
corporation. If no section 338 election is made for the target
corporation, no gain or loss is recognized with respect to
target's assets and its corporate tax attributes are preserved,
subject to certain limitations discussed below. If a section 338
election is made, the taxable stock acquisition takes on most of
the characteristics of a taxable asset acquisition from a
liquidating target corporation.
wh—f 2;l0n 338 E^ectio"s. A section 338 election is available
where one corporation purchases at least 80 percent of the stock
of a target corporation over a 12-month period. In such case,
- 5 the purchasing corporation may elect to adjust the basis of the
assets of the target corporation as though the target corporation
sold all of its assets to a new corporation in connection with a
plan for complete liquidation within a 12-month period. The
price at which the assets are deemed sold by the target
corporation and purchased by the new corporation is generally the
purchasing corporation's basis in the target's stock at the
acquisition date.*/ A section 338 election requires that the
target corporation generally recognize its recapture and other
tax benefit items as if it had sold its assets pursuant to a plan
of complete liquidation.
Section 338 also contains consistency rules designed to
prevent a purchasing corporation from obtaining a step-up in
basis for some of the target's assets, while preserving target's
corporate tax attributes and historic tax basis for other assets.
The typical case addressed by these rules is one where target has
one group of high value, low basis assets with respect to which
the purchaser wants to take depreciation, amortization, and
depletion deductions on a stepped-up basis, and another group of
assets which may carry either a significant recapture or other
tax liability or valuable tax attributes (such as net operating
loss or credit carryforwards). If the purchasing corporation
were to acquire all of target's assets, all assets would receive
a stepped-up basis, target (assuming target liquidated within a
12-month period) would be taxed only on the recapture and tax
benefit items on all assets, and the corporate tax attributes of
target would be extinguished. From a tax planning perspective,
the purchasing corporation would like to step-up the basis of the
\/ Section 338(a)(1) provides that the target corporation is
first group of assets (for instance, by a direct asset purchase),
deemed to sell its assets at their fair market value on the
yet avoid the recapture tax and maintain a carryover of basis for
acquisition date. Alternatively, in the case of a bargain
stock purchase, an election may be made under section
338(h)(11) to determine the aggregate deemed sale price on
the basis of a formula that takes into account the price paid
for the target corporation's stock during the acquisition
period (grossed-up to 100 percent) plus liabilities
(including taxes on recapture and other tax benefit items
generated in the deemed sale) and other relevant items.
Section 338(b) provides that the new corporation is deemed to
purchase the target corporation's assets at an aggregate
price equal to the grossed-up basis of recently purchased
stock plus the basis of nonrecently purchased stock (subject
to an election under section 338(b)(3) to step-up the basis
of such nonrecently purchased stock) plus liabilities
(including taxes on recapture and other tax benefit items
generated in the deemed sale) and other relevant items.
- 6 the second group of assets and the valuable corporate tax
attributes of target (by acquiring all of the target stock and
not making a section 338 election).
To prevent this type of tax motivated tailoring acquisitions,
the consistency rules require that the purchasing corporation
must elect either to step-up the basis of all acquired assets
(with the associated recapture and loss of corporate tax
attributes) or to carry over the basis of all acquired assets
(generally with the continuation of tax attributes). Section 338
generally provides that a step-up in basis (and attendant
recapture and other tax consequences) will be triggered
automatically if, within the period beginning one year before the
beginning of the acquisition and ending one year after control is
acquired, any member of the purchasing group acquires the stock
of any corporation affiliated with the target corporation (target
group) or an asset from any member of the target group, other
than in certain defined transactions.*/
C. Carry Over of Corporate Tax Attributes
1. In General
Under current law, a corporation that incurs a net operating
loss in one year generally is permitted to carry back the loss to
offset income earned in the three taxable years preceding the
year in which the loss is incurred and to carry forward any
excess to offset income earned in the 15 years after the loss is
incurred. A net capital loss generally may be carried back to
the three taxable years preceding the loss and then carried
forward to the five taxable years succeeding the loss. The
underlying premise of allowing a corporation to deduct a net
operating loss or a net capital loss incurred in one year against
taxable income earned in another year is to ameliorate the unduly
harsh consequences of an annual accounting system. In other
*/ The excepted transactions included transactions in the
ordinary course of business, carryover basis transactions,
pre-effective date transactions, and other transactions to
the extent provided in regulations. In some cases, the
consistency rules can operate to require taxpayers to take a
step-up in basis and pay recapture taxes or suffer other tax
detriments where no manipulative scheme exists. As
contemplated by Congress in the Tax Reform Act of 1984,
Treasury is considering allowing taxpayers to elect carryover
basis (or cost basis when less than carryover basis in a
particular asset) in all assets that a corporation acquires
during the consistency period. We do not believe that the
providing of this "carryover basis election" would create any
significant new tax incentives for corporate acquisitions
provided there are appropriate safeguards.
- 7 words, the ability to carry losses back and forward is intended
as an averaging device. For similar reasons, corporations that
are unable to use all their credits against tax in the year in
which the credits are earned may use such excess credits to
offset tax liability in the three prior taxable years and the 15
succeeding taxable years.
The ability to carry over net operating losses, unused
credits, and other tax attributes following certain corporate
acquisitions, as described briefly above, may affect such
acquisitions in a variety of ways. The ability to carry over
corporate tax attributes, for example, may affect both the form
of acquisitive transactions and the price paid or the value of
other consideration used in such transactions. Moreover, the
ability to carry over tax attributes may in certain instances
influence whether an acquisition will be undertaken. The ability
to carry over tax attributes after a corporate acquisition,
however, is limited under current law in several respects.
As mentioned above, the tax attributes of a target
corporation generally survive a tax-free reorganization and carry
over to the acquiring corporation. In addition, if a corporation
acquires the stock of another corporation in a taxable
transaction, the tax attributes of the target corporation also
survive the acquisition, unless a section 338 election is made
for the target corporation. Moreover, although a purchasing
corporation that does not make a section 338 election will not
succeed directly to the tax attributes of the target corporation,
it may benefit from the target corporation's net operating
losses, net capital losses, unused credits, and other tax
attributes, if the target and purchasing corporations join to
file a consolidated income tax return. Alternatively, a
purchasing corporation that does not make a section 338 election
may inherit the tax attributes of the target corporation if the
target is liquidated or merged into the purchasing corporation.
2. Limitations on the Carry Over of Tax Attributes
Under sections 382 and 383, V the ability of an acquiring or
*/ Sectionscorporation
382 and 383
substantially
amended
the Tax
purchasing
towere
use or
benefit from
the netinoperating
"~ Reform Act of 1976, but the effective date of those amendments
has been delayed several times. Most recently, section 61 of
the Tax Reform Act of 1984 extended the effective date of the
1976 Act amendments until December 31, 1985. The 1976 Act
rules, as well as current law, have been criticized and a number
of reform proposals have been made. Although we understand that
the Subcommittees are not examining sections 382 and 383 in
detail at this hearing, we believe that it is important that
Congress address these provisions this year and we look forward
to working with the Congress in developing reasonable rules
governing the carry over of corporate tax attributes.
- 8 losses and other tax attributes of a target corporation following
a taxable stock acquisition or a tax-free reorganization may be
limited. Sections 382 and 383 were enacted to establish
objective tests that would curh "trafficking" in corporations
with unused net operating losses and other favorable tax
attributes. In the case of net operating loss carryovers,
Congress was particularly concerned that profitable, operating
corporations were acquiring shell corporations whose principal
assets were unused net operating losses that could be applied
against income of the acquiring corporations that was unrelated
to the business activity of the acquired corporations.
In addition to the specific objective limitations provided by
sections 382 and 383, the carry over of net operating losses and
other favorable tax attributes may be disallowed under section
269, whenever the principal purpose of an acquisition of stock or
assets is to obtain the benefit of losses, deductions, or
credits. Thus, section 269 may be applied to deter misuse of the
general carryover limitation provisions.
Finally, the ability of an acquiring corporation to benefit
from the tax attributes of a target corporation by joining with
the target to file a consolidated income tax return is limited by
the "separate return limitation year" and "consolidated return
change of ownership" rules provided in applicable Treasury
regulations. In addition to limiting use of net operating loss
and credit carryovers, the consolidated return regulations under
certain circumstances also limit the ability to benefit from
"built-in" losses following an acquisition.
II. Structural Aspects of the Income Tax That May Encourage
Corporate Acquisitions and Takeovers
While we believe economic as opposed to tax considerations
typically drive a corporation's decision to acquire another
corporation, we recognize that there are a number of structural
features of our current income tax system that may encourage
corporate acquisitions. The Committees may wish to consider
removing or modifying some of the current law provisions that
encourage merger activity. As the discussion below will
indicate, however, some of the incentives in current law are
rooted in the basic structure of how we tax corporations and
their shareholders and could not be altered without fundamentally
changing the present income tax system.
A. Double Taxation of Corporate Earnings
Our current income tax system generally treats corporations
as taxpaying entities separate from their shareholders. A
corporation separately computes and reports its taxable income,
and in making this calculation it is not entitled to a deduction
for dividends paid to shareholders. Moreover, these dividends
- 9 are taxed to individual shareholders as ordinary income (except
for a $100 per year exclusion). Consequently, corporate taxable
income paid as dividends to individual shareholders generally
bears two taxes, the corporate income tax and the individual
income tax.
The double taxation of corporate earnings that are
distributed as dividends to shareholders affects dividend
distribution policies in ways that may encourage merger activity.
In particular, corporations,, especially those with shareholders
in relatively high income tax brackets, are encouraged to retain
earnings in order to allow the shareholders to defer imposition
of the second tax.*/ This pressure to accumulate corporate
earnings not only Tnterferes with ordinary market incentives to
place funds in the hands of the most efficient users, but also
stimulates corporate acquisitions in at least two ways.
First, corporations that accumulate cash funds in excess of
their needs for working capital must reinvest those funds;
acquiring the stock or assets of other corporations is an
investment alternative that must be considered by any corporation
with excess funds to invest. Second, a corporation with large
amounts of funds invested in nonoperating assets may become an
attractive target, because the market may not immediately reflect
the value of those nonoperating assets (which may not generate
financial reported earnings commensurate with their values).
Because of this potential undervaluation of the target's
nonoperating assets, a potential acquiring corporation may view
the nonoperating assets as cheap funds available to finance the
acquisition of the underlying business operations of the target.
The mitigation or elimination of the double tax on corporate
dividends, through any form of integration of the corporate and
individual income taxes, would reduce or eliminate these effects.
In contrast to the taxation of corporate earnings distributed
as dividends, corporate income distributed to creditors as
interest is deductible by the corporation and thus taxed only
once, to the creditors. The disparate tax treatment of debt and
equity in the corporate sector distorts decisions regarding a
corporation's capitalization, making corporations more vulnerable
to takeover during economic downturns, and also may encourage
*/
Indeed,
in some
cases the
shareholder-level
taxdebt
can be
leveraged
buyouts,
because
interest
payments on the
incurred
~in
" such
permanently
avoidedoffset
if the
retained
earnings
distributed
a transaction
income
earned
by the are
target
in liquidation following the death of the shareholder, which
corporation.
occasions a tax-free increase in the stock's basis to its
fair market value. The double taxation of dividends and the
tax-free basis step-up at death operate in tandem to place
extreme pressure on closely-held corporations to retain
rather than distribute earnings.
- 10 Since interest payments on debt financing are deductible and
dividends paid on equity are not, corporations are encouraged by
the tax law to utilize debt rather than equity to finance their
ongoing operations. This may result in an increased debt to
equity ratio that increases the risk of bankruptcy and
vulnerability to downturns in the business cycle; and any
corporation that is temporarily crippled by an economic downturn
becomes a likely takeover candidate. The incentive for leveraged
buyouts conferred by the more favorable tax treatment of interest
payments is discussed further in part III.A.l., below.
B. Capital Gain - Ordinary Income Distinction
Currently, corporations are subject to tax on ordinary income
at a maximum rate of 46 percent and on capital gains at a maximum
rate of 28 percent. Individuals are subject to tax on ordinary
income at a maximum rate of 50 percent and on capital gains at a
maximum rate of 20 percent. While corporate taxable income
distributed to individual shareholders as dividends generally
bears two ordinary income taxes, the shareholder's receipt of
cash or property in exchange for his stock in a purchase of the
corporation results in a significant lessening of the double tax
burden when compared with the receipt of such cash or property as
dividend income. Even though corporate earnings distributed as
dividends would be taxed to the shareholders at ordinary income
tax rates, the gain attributable to retained earnings is taxed at
preferential capital gains rates if the shareholders sell their
stock. This capital gain opportunity results in an incentive for
the corporations to retain income in corporate solution and for
corporate acquisitions.
C. Underutilization of Capital Subsidies
Capital subsidies (such as certain credits and accelerated
depreciation) provided through the tax system may have an
unintended ancillary effect of encouraging mergers and
acquisitions. In some cases the amount of these tax subsidies
have outstripped the recipient corporation's ability to use them
effectively by investing in operating assets. To the extent that
a corporation cannot effectively reinvest the tax subsidies in
operating assets, such amounts are invested in nonoperating
assets, which stimulate merger activity as detailed in part
II.A., above.
In addition, whenever a company does not have enough income
and tax liability to benefit from the accelerated depreciation
and tax credit capital subsidies, an incentive for mergers is
created. As summarized earlier, there are limitations on the use
of tax attributes of an acquired corporation, but these
limitations do not apply to certain forms of mergers or
acquisitions. And even in cases in which the limitations apply,
the acquiring corporation may nevertheless benefit to some extent
from the target corporation's tax attributes.
- 11 For example, the limitations provided in sections 382 and 383
generally would not apply if a corporation with substantial
unused net operating losses and excess credits acquired a
profitable target corporation's stock or assets in either a
tax-free or taxable acquisition. Accordingly, income and tax
liability generated by the target corporation or its assets could
be offset in future years by the acquiring corporation's unused
tax attributes. Similarly, if an acquiring corporation purchased
the stock of a target corporation in a taxable acquisition and
did not make a section 338 election, the acquiring corporation
could use the target corporation's net operating losses to offset
future income of the target corporation. If, on the other hand,
the acquiring corporation made a section 338 election, although
it would not succeed to the target corporation's tax attributes,
any income realized by the target corporation by virtue of the
section 338 election and the accompanying tax liability could be
offset by the target corporation's net operating loss and credit
carryforwards.
The ability to benefit from net operating loss and other
carryforwards following the acquisition of a corporation is not
necessarily inconsistent with sound tax policy. As discussed
earlier, a corporation is allowed to carry back and carry forward
its unused net operating losses and credits without limitation
(other than on the number of carryback and carryforward years).
These unused net operating losses and credits may result from
capital subsidies to which the corporation is entitled, but is
unable to utilize currently. The carry over of net operating
losses and other tax attributes following a corporate acquisition
may properly allow the target corporation to effectively benefit
from the capital subsidies in the same manner as if no
acquisition had occurred. Nevertheless, the tax rules governing
the carry over of tax attributes should not encourage corporate
acquisitions that would not be undertaken on purely economic
grounds. Moreover, those rules should not result in tax
attributes becoming more valuable in the hands of an acquiring
corporation than they would have been in the hands of a target
corporation.
In general, we believe that the existing limitations on the
carry over of corporate tax attributes do not work well in some
respects and improperly allow the carry over of tax attributes in
some cases. We do not believe, however, that either the ability
to carry over tax attributes in a corporate acquisition or the
imperfections in the existing statutory and regulatory
limitations on such carryovers is the fuel driving the recent
surge of corporate acquisitions. Nevertheless, we do look
forward to working with the Congress in reforming those rules
this year.
We want to point out, however, that the existence of unused
tax attributes and the ability to benefit from such attributes by
acquiring control of a corporation would be of much less concern
- 12 if corporate taxable income were measured correctly and, for
example, the existence of unused net operating losses meant that
a corporation had realized actual economic losses. Under current
law, however, a corporation that earns a significant profit may
nevertheless have substantial net operating losses and other
unused tax attributes. Current law does not provide for direct
reimbursement of net operating losses or refundability of credits
by the Federal government and does not permit corporations with
unused tax attributes to transfer those attributes freely to
other corporations that can benefit from them. The consequence
of such a system is the existence of an increased volume of tax
attributes that can not be used by the corporations to which they
are made available. The lack of refundability or free
transferability and the resulting increase in the volume of
unused tax attributes place significant pressure on the rules
that are designed to limit the use of net operating losses and
excess tax credits following an acquisition and provide an
incentive to acquire corporations with such unused tax
attributes.
Moreover, the mismeasurement of income for tax purposes and
the resulting increased volume of unused tax attributes may favor
conglomeration by encouraging corporations that are engaged in
business activities that generate "tax losses" and excess tax
credits to combine with other corporations that are engaged in
activities with fewer tax attributes. The tax laws should not
create such a bias between diversified and non-diversified
entities.
The adoption of a system that correctly measures economic
income would eliminate the possibility that profitable
corporations could have unused net operating losses or excess tax
credits and would ensure that companies with loss carryforwards
had suffered equivalent economic losses. The importance of rules
limiting the use of tax attributes following corporate
acquisition would thus be decreased. The proper measurement of
corporate income also would greatly diminish the volume of unused
favorable tax attributes, and correspondingly reduce the
importance of tax attributes in decisions regarding corporate
acquisitions and conglomeration.
D. General Utilities Doctrine
Some have argued that the section 338 rules and the
liquidation rules conflict with the general scheme for taxing a
corporation and its shareholders and may encourage corporate
acquisitions. Generally, as described above, a corporation is
subject to tax on the profits derived from its operations and its
shareholders are subject to a second level of tax on the
distributions of those profits as dividends. In a liquidating
sale of assets or sale of stock with a section 338 election,
there is a step-up in basis of assets with only a partial
corporate level tax; recapture and tax benefit items are taxed,
but other potential gains are not. This result stems from the
- 13 rule attributed to General Utilities & Operating Co. v.
Helvering, 296 U.S. 200 (1935), that is now codified in sections
311(a), 336, and 337. Under those provisions, a corporation
recognizes no gain (other than recapture and tax benefit items)
on distributions, including liquidating distributions, made to
its shareholders. These rules may give an additional incentive
to a corporation to sell assets in some cases because it
increases the likelihood that the present value of the tax
benefits that accompany property ownership (e.g., depreciation
and depletion deductions) may exceed the seller's tax detriment
incurred on the sale. Thus, the same assets may be more valuable
to a buyer than to the current owner.
Congress has reduced this incentive to sell corporate
properties by limiting the scope of the General Utilities rule.
For example, TEFRA made distributions of appreciated property in
a partial liquidation taxable to the distributing corporation.
In addition, the Tax Reform Act of 1984 (the "1984 Act") imposed
the same treatment on dividend distributions of appreciated
property. One major aspect of the General Utilities doctrine
remains, however. Nonrecognition of gain by the selling
corporation continues to be the general rule in connection with a complete liquidation and a deemed asset sale in connection with a
section 338 election (although recapture and tax benefit items
are taxed). While repeal of this last major exception would
simplify the tax laws, we do not believe that the failure of the
corporate tax regime to impose two levels of tax on liquidation
transactions is primarily motivating corporate acquisitions.
Further, as we have indicated in prior testimony before the
Senate Finance Committee, we believe that in considering the
repeal of General Utilities in liquidation transactions, relief
from double taxation of liquidation proceeds must also be
considered.
E. Inadequate Recapture Taxes
1. In General
Some have suggested that the imperfections in the current
recapture rules may be a factor encouraging corporate mergers and
acquisitions. If the General Utilities rule were fully repealed
and a corporation were required to recognize gain to the extent
the amount realized exceeds its basis in assets, the
effectiveness of the recapture rules would not be as important.
Short of a complete repeal of the General Utilities rule in a
liquidation context, it may be appropriate to tighten current
recapture rules. For example, under current law, a liquidating
corporation that used the .last-in first-out ("LIFO") method of
accounting for inventories is required to recognize income
attributable to the difference between the value of inventory
determined on the LIFO basis and that determined on a first-in
first-out ("FIFO") basis (commonly called LIFO reserve). This
rule could be expanded to include all inventory profit (not just
- 14 the difference between LIFO and FIFO) and all other ordinary
income. In addition, the recapture rules on section 1250
property (including residential real estate) could be conformed
to the section 1245 recapture rules applicable to personal
property to require the liquidating corporation to recapture
ordinary income to the extent of the full amount of prior
depreciation allowed. These changes would be premised on the
notion that the corporation claiming tax benefits should return
those benefits at the time of sale (whether by actual sale or in
liquidation) if the sale shows that the earlier granted benefits
were excessive.*/ Any strengthening of the recapture rules,
however, magnifies the potential double taxation of corporate
earnings and any change in the recapture rules should be
coordinated with proposals to relieve that double tax burden.
2. Mineral Property
Under current law, gain on the disposition of mineral
property is recaptured as ordinary income under section 1254 to
the extent of intangible drilling costs that were deducted after
December 31, 1975. There is no recapture, however, with respect
to gains from the sale of mineral property for which intangible
drilling costs were deducted prior to that date. Consequently,
on the sale or exchange of mineral properties, gain attributable
to expenses deductible against ordinary income as intangible
drilling costs prior to 1976 is taxable at capital gain rates
even though the drilling expenses were deducted against ordinary
income.
*/ It should be noted that recapture and tax benefit items
generally are not recognized upon the sale of a subsidiary.
However, such a result may be inconsistent with the basic
principles of the recapture rules where the selling
corporation and its subsidiary joined in filing a
consolidated return for all years in which the deductions (or
credits) were claimed. The consolidated return regulations
provide for an annual basis increase (or decrease) in the
parent's stock in the subsidiary based on the annual increase
(or decrease) in earnings and profits, rather than taxable
income, of the subsidiary for such year. Some have suggested
that these rules may permit the selling parent corporation to
understate its gain (as well as avoid recapture income)
because the basis of. the subsidiary's stock is
inappropriately increased whenever the earnings and profits
increase in an amount greater than taxable income. This
disparity between earnings and profits and taxable income
typically is due to certain tax subsidies, such as
accelerated depreciation. The Internal Revenue Service takes
the position that allowing this basis increase would result
in impermissible double deductions to the selling affiliated
group and is currently litigating this issue.
- 15 Prior to 1975 integrated oil companies could deduct
percentage depletion at a rate of 22 percent with respect to
mineral property. Percentage depletion deductions are not
limited to the taxpayer's basis in the mineral property; so that,
with respect to pre-1975 properties, the adjusted depletable
basis (investment costs other than intangible drilling costs) for
most taxpayers is zero. Since 1975, however, integrated oil
companies have been required to use cost depletion. Thus, in
effect, most integrated oil companies receive no depletion
allowances if they continue to produce from pre-1975 properties.
Upon a disposition of mineral property to another who would be
allowed cost depletion for the same property, current law does
not require recapture of either cost or percentage depletion
allowances; this rule applies whether or not percentage depletion
allowances were taken in excess of the taxpayer's basis.
Some have suggested that recapture rules should be applied to
intangible drilling costs deducted in respect of mineral
properties regardless of when the deductions were taken. We
cannot support such a change. The recapture of intangible
drilling costs was considered extensively by Congress in
connection with legislation in 1976. Congress enacted a
recapture provision at that time and settled upon what it
considered to be a fair transition rule. We do not believe that
it is appropriate to change that transition rule retroactively.
Suggestions also have been put forth to apply recapture rules
to percentage and cost depletion allowances. Normally, as in the
case of depreciable personal property, recapture of depreciation
is provided when the property is sold or exchanged; only the
excess of the selling price over original basis is eligible for
capital gains rates (and nonrecognition at the corporate level in
a liquidating sale). The lack of adequate recapture rules
creates an incentive to sell to a buyer who will obtain the
benefit of a step-up in basis (and therefore larger deductions
against ordinary income) at the cost of only a capital gains tax
to the seller. The failure to recapture cost depletion
allowances thus may provide some incentive for acquisitions of
companies with mineral properties. We do not believe the
recapture rules applicable to mineral property should differ from
the current recapture rules applicable to personal property. In
either case, full recapture is needed to minimize inefficient
churning of such property solely for tax reasons.
Although we would support full recapture of cost depletion,
we would not support the application of recapture rules to
percentage depletion. The percentage depletion allowance is, in
effect, a negative excise tax on the production of minerals which
results in a lower effective income tax rate for those eligible
for its benefits. While it may be appropriate to consider
reducing or eliminating future allowances for percentage
depletion, we do not believe the special rate of tax on mineral
properties that Congress provided by way of the percentage
- 16 depletion allowance should be retroactively repealed by extending
the recapture rules. Congress dealt with the policy
considerations involving the availability of this special tax
incentive to integrated oil companies by limiting -such taxpayers
to cost depletion for taxable years ending after December 31,
1974.
III. Recent Developments in Corporate Acquisitions that Raise
Significant Tax Policy Issue's
~
'
The structural aspects of the current income tax law
discussed above may encourage merger and acquisition activity to
some degree, but as stated at the outset, we do not believe they
are the driving force behind the current flurry of activity. A
number of the publicized acquisitions that are of interest to the
Committees involve tax techniques that have only recently
evolved, and to some extent these techniques are based upon
recently enacted tax incentives. We are concerned that these tax
incentives are being employed in mergers and acquisitions in ways
that Congress did not intend. Principal among our concerns are
the use of ESOPs in leveraged buyouts and the carryover of tax
attributes in mergers and acquisitions of thrift institutions. I
would also like to comment upon the growing use of asset
reversions from overfunded defined benefit plans to finance
mergers and acquisitions.
A
« Leveraged Buyouts and the,Growing Use of ESOPs
1. Leveraged Buyouts
The prototypical leveraged buyout involves the conversion of
a publicly held company into a private company pursuant to an
acquisition by a newly organized private company of all of the
target company's stock. The acquiring company usually is
organized and controlled by the senior management of the target
iS"?!!?X:i„ S e K? r i? a t e c<?mPanY's acquisition of the target stock
hi ;!f?!iX «*£* 5 i n * n c e d ' W l th the expectation that the debt will
be retired out of future earnings of the company.
thatAl*vfr!;«LCa.Se With 0ther mer9ers and acquisitions, we expect
factor!
Slvfr?h^?UtS a f2 *?tivated primarily by economic
encoSraie l E I ™ ! ^ 1 ' *$* i * C O m e t a x l a w t o s o * e e x t ent may
tax ?reltmint n ? 9 ? l b U y ° ? t S ° f corP°*ations by the more favorable
- 17 The. deductibility of interest incurred in connection with
debt-financed acquisitions also encourages these acquisitions to
the extent that our tax system does not take account of inflation
properly. Nominal interest rates typically include an inflation
component which compensates the lender for the anticipated future
reduction in the real value of a fixed dollar amount debt
obligation and acts as an offsetting charge to the borrower for
the inflationary reduction in the value of the principal amount
of the borrowing, where borrowed funds are invested in assets
that also increase in value by virtue of inflation, the tax law
permits a current deduction for interest expenses but no
realization of the increase in value of the asset until its sale
or disposition. In such cases the interest deduction can be used
to offset income that otherwise would be taxed currently.
The use of installment debt in acquisitions leads to
significant mismatching of the gain that is deferred by the
seller and the allowance to the purchaser of depreciation,
amortization, or depletion deductions determined by reference to
asset values that have been stepped-up to fair market value as a
result of the acquisition. This asymmetrical treatment of a
sale, under which the buyer is treated as acquiring full
ownership of the asset while the seller is treated as making only
partial sales each year over the term of the contract may create
a tax bias for installment debt-financed acquisitions. In a
taxable corporate acquisition (an asset acquisition or a stock
acquisition with a section 338 election), this mismatching is
reduced to some extent if the target corporation's assets are
subject to recapture tax since the recapture income is recognized
immediately. The asymmetrical treatment arising from installment
sales debt is a problem that should concern these Committees, but
the problem exists in every installment sale of a depreciable
asset and is by no means unique to corporate acquisitions.
The tax arbitrage from debt financing generally is available
for all debt-financed assets, not just those acquired in a
corporate merger or acquisition. The only special limitation on
the deductibility of interest on debt incurred in acquisitions is
found in section 279 which applies only under very limited
circumstances. Although it may be appropriate to give
consideration to revising the general rules regarding the
deductibility of interest we see no justification for a further
limitation on the deductibility of interest expense that is aimed
specifically at debt incurred in connection with corporate
acquisitions.
2. Leveraged Employee Stock Ownership Plans
While every leveraged buyout raises the concerns just noted,
we have particular concerns about the use of leveraged employee
stock ownership plans (ESOPs) to effectuate leveraged buyouts and
to defend against attempted takeovers. Since Congress first
- 18 established special tax incentives for ESOPs, these plans have
been used frequently in leveraged buyouts, but the 1984 Act makes
ESOPs an even more attractive vehicle for purchasing shares in a
leveraged buyout.
In a leveraged ESOP, the ESOP borrows to purchase stock of
the company that establishes the ESOP, and the company obligates
itself to contribute amounts to the ESOP sufficient to enable it
to service the debt. The employer may deduct these contributions
to the ESOP currently without regard to the restrictive limits on
employer contributions to other types of employee benefit plans.
Because the ESOP is a qualified plan, an employee participating
in the ESOP is not required to include these contributions in
income until he or she receives a distribution from the plan.
Under the terms of a typical leveraged ESOP, employees are
not entitled to distributions from the plan until separation from
service. When the ESOP distributes stock to a participant, the
employee is taxed on the value of the stock (determined with
reference to the price paid by the ESOP) and accumulated income
which has been allocated to the participant's account. A
participant has the right to require the employer to purchase the
stock from the participant at fair market value, unless the stock
is readily marketable and traded on an established securities
market.
An ESOP is required to give covered employees the right to
vote publicly traded shares held by the ESOP. But employees can
vote shares held by the ESOP that are not publicly traded, only
with respect to actions (such as mergers or liquidations) which
require an affirmative vote of more than a majority of the
corporation's shares.
It is possible that the nominal beneficiaries of the ESOP,
the corporation's employees, will obtain little current benefit
from the arrangement. This is true because, while the ESOP may
own a significant percentage of the outstanding employer
securities, a participant employee will not realize the value of
the securities originally purchased by the ESOP until separation
from service. Finally, because leveraged buyouts involve
privately held corporations, the employees generally are entitled
to only very limited voting rights with respect to ESOP stock.
Despite the uncertainty of the benefits that an ESOP confers
on covered employees, in the 1984 Act Congress expanded the
incentives for employee stock ownership through ESOPs in four
ways: (1) banks, insurance companies, and other commercial
lenders may exclude one-half of the interest paid or accrued on a
loan the proceeds of which are used by a leveraged ESOP to
purchase qualified stock; (2) taxpayers are permitted to defer
gain from the sale of stock to an ESOP if the proceeds are used
5 L ? U f C 5 a S ? ^ 2 C 1 " J a s e c o n d corporation; (3) corporations may
?!?f
dividends paid to employees with respect to stock of the
Y e h e l d in an E S P
!«5^ L
? °r stock bonus plan; and (4) an ESOP may
2lE!T v hlliS 1 ^- t S X 4 a b i l i t Y with respect to stock of a
closely held business which is transferred to the ESOP.
- 19 Historically, the employer's right to deduct ESOP
contributions while the employees participating in the ESOP defer
income has been a significant subsidy which has made the use of
ESOPs a favored vehicle for leveraged buyouts. The 1984 Act,
however, so enhanced the tax benefits available to leveraged
ESOPs that we believe not .only will the use of ESOPs in leveraged
buyouts increase, but the total number of leveraged buyouts may
actually increase. In addition, we expect that these new
incentives will greatly increase the use of leveraged ESOPs to
defend against potential takeovers.
The most significant of the new incentives for the use of
ESOPs in leveraged buyouts is section 133 of the Code which
permits banks, insurance companies, and other commercial lenders
to exclude one-half of the interest paid or accrued on a loan the
proceeds of which are used by a leveraged ESOP to purchase
qualified stock. This permits lenders to charge a lower interest
rate and thus lower the costs of acquiring employer securities
through an ESOP.
We understand that the subsidy provided under
section 133 allows qualifying lenders to provide financing to an
ESOP at approximately 80 percent of the otherwise available
interest rate. For example, if the rate available to the ESOP
would be 10 percent without regard to section 133, the ESOP could
save approximately $140,000 in interest charges on a ten-year,
level payment, $1,000,000 obligation, assuming an actual interest
rate of 8 percent. Such a significant reduction in the cash flow
required to finance an acquisition is certain to stimulate
leveraged buyouts.
The 1984 Act provisions also created an incentive for owners
of businesses to sell to their ESOPs rather than to others. New
section 1042 allows a shareholder to defer the gain on the sale
of shares in the corporation to an ESOP if certain requirements
are met. Presumably, the availability of deferral for a
shareholder selling to an ESOP will result in a lower purchase
price for the shares to the ESOP. Although our limited
experience with this provision makes it impossible to know to
what extent the special tax benefit to the selling shareholder
will be reflected in the price to the ESOP, any reduction in the
cost of acquiring a corporation through an ESOP will obviously
create a further incentive for leveraged buyouts through ESOPs.
The cumulative effect of these subsidies is to create
substantial tax incentives for leveraged buyouts through ESOPs.
These benefits inure to those in a position to establish an ESOP
and through that device to take a public company private. It
also appears that ESOPs are frequently employed as a defensive
takeover tactic. These tactics may have an unnecessary dampening
effect upon otherwise advisable mergers and acquisitions.
Although the goal of encouraging employee ownership may be
worthwhile, we believe that any examination of mergers and
acquisitions should include an examination of the effects on
mergers and acquisitions of the indirect subsidies provided
through the current tax provisions relating to ESOPs.
- 20 C. Overfunded Defined Benefit Plans
Concern also has been expressed recently about the
involvement of overfunded qualified defined benefit plans in
corporate mergers and acquisitions. Under current law, a company
may terminate its defined benefit plan and receive any assets
that are in excess of the present value of the participants'
accrued benefits as of such termination. There are no
restrictions on the company's use of such excess assets.
Because overfunded defined benefit plans thus constitute
relatively attractive sources of cash, companies with
significantly overfunded plans are thereby made more attractive
partially fund the acquu
other companies have terminated their own overfunded plans to
reduce the readily available pool of assets to which the
companies have access and thereby to make themselves less
attractive to other companies. These companies generally have
used the excess assets to make less liquid investments (such as
equipment purchases), to finance "going private" transactions, or
to take defensive actions (such as establishing an ESOP to hold
company stock) against potential takeover attempts. Finally,
some companies have terminated their overfunded plans to use the
assets offensively in their own takeover initiatives or to retire
debt incurred in completed takeover transactions.
In assessing the role of defined benefit plans in mergers and
acquisitions, one should understand the essential features of
such plans and why and in what sense they are overfunded. The
law grants favorable tax treatment to employer-maintained
retirement plans that satisfy various qualification requirements.
There are two types of qualified retirement planss defined
contribution plans and defined benefit plans. Under a defined
contribution plan, a participant's accrued benefit is equal to
the value of the assets allocated to such participant's account
and all plan assets are allocated to participants' accounts.
Thus, no assets are available for employer recoupment.
Under a defined benefit plan, however, the participant's
accrued benefit is determined under a benefit formula, which
generally is based on the participant's compensation and years of
participation in the plan. The company maintaining the plan (the
sponsor) has the responsibility to make sufficient contributions
to the plan to maintain a pool of funds sufficient to provide the
participants' promised retirement benefits as they come due.
Accordingly, unlike a company maintaining a defined contribution
plan, the sponsor of a defined benefit plan bears the full risk
of investment gains and losses in the plan's assets.
- 21 There are numerous reasons why a defined benefit plan may, at
any particular time, hold assets in excess of the present value
of participants' accrued benefits at such time. The most basic
reason is the inherent nature of the sponsor's obligation to fund
a defined benefit plan, as reflected in the minimum funding
standards of section 412 of the Code. These standards generally
require that a sponsor fund the plan on a "going concern," rather
than a "termination," basis. This means that sponsors must
currently fund not merely accrued benefits, but also some portion
of participants' projected benefits at normal retirement age. In
projecting future benefits, future salary increases and inflation
ordinarily are considered. In addition, in order to avoid an
ever-increasing funding obligation as its workforce ages, a
sponsor may choose to fund its plan in accordance with a
level-funding actuarial funding method that tends to accelerate
contributions relative to the rate of benefit accrual. As a
consequence of the natural operation of the funding rules, a
defined benefit plan that is not fully funded on a going concern
basis may well be overfunded on a termination basis.
The actuarial methods commonly used in determining sponsors'
defined benefit funding obligations rely on long-term assumptions
regarding such items as investment returns and salary increases.
To the extent that plan investments earn more than anticipated or
salaries increase less than expected, overfunding will tend to be
greater. For example, during recent years, the rates of return
on equity investments have exceeded most actuarial assumptions,
which themselves tend to be quite conservative, and salary
increases have generally been less than expected.
Furthermore, in determining a defined benefit plan's excess
assets, it is necessary to calculate the present value of
participants' accrued benefits. The higher the interest rate
assumption used in this calculation, the fewer assets are
necessary to provide participants' accrued benefits. During
recent years, insurance companies have been pricing both
immediate and deferred annuity contracts for terminating defined
benefit plans using recent high interest rates. By reducing the
current cost of providing for participants' accrued benefits upon
plan termination, this has contributed significantly to the
excess termination-basis funding of many defined benefit plans.
Finally, within certain limits (section 404 of the Code), a
sponsor is permitted to deduct defined benefit plan contributions
in excess of the required contribution under the minimum funding
standards. This may of course encourage further employer
contributions to a plan, particularly in profitable years, and
consequently larger overfunding.
The tax law requires a defined benefit plan to be maintained
for the exclusive benefit of the participants and their
beneficiaries. In addition, it must be impossible at any time
- 22 prior to the satisfaction of all liabilities with respect to the
sponsor's employees and their beneficiaries under the plan, for
any part of the plan's assets to be used for, or diverted to,
purposes other than the exclusive benefit of the employees and
their beneficiaries. Because it is not possible to satisfy all
plan liabilities before plan termination, a sponsor may recoup
plan assets only by terminating its plan. And, in this regard,
because a sponsor may voluntarily establish a qualified plan and
may voluntarily terminate its plan as it desires, this particular
restriction rarely poses a practical obstacle.
A significantly overfunded defined benefit plan thus may be
seen, both from the sponsor's perspective and from the
perspectives of other companies that may be interested in
attempting to take over the sponsor, as a relatively accessible
and attractive pool of liquid assets. Of course, the desire to
recoup excess plan assets is not limited to companies involved in
merger and acquisition transactions. Any business need that
requires significant financing—e.g., diversification, expansion
of capacity, modernization, advertising—may be sufficient
motivation. Nevertheless, due to the substantial cash
requirements of acquisitions and acquisition-related
transactions, it is natural that companies involved in such
transactions will look to defined benefit plans as a potential
source of ready funds.
While any assets received upon plan termination must be
included in income, the sponsor is entitled to offset this
inclusion by any available deductions and credits (including
interest deductions and loss carryovers). Thus, because the
decision to terminate is in the hands of the plan sponsor, it
frequently is possible to time the termination so that none or
only a small portion of the assets is subject to tax. To the
extent a sponsor is able to achieve this result, terminating an
overfunded defined benefit plan becomes more attractive.
One of the primary concerns expressed about the terminations
of defined benefit plans to recoup plan assets is the security of
the participants' benefits. Under current law, there is no
requirement that participants continue to accrue benefits after a
plan has terminated. It is thus inevitable that where a sponsor
terminates a defined benefit plan and does not establish any
other plan in its place, participants will not receive the
benefits at retirement that they would have received—and may
well have expected to receive—if the plan had not been
terminated. In a voluntary pension system, there is very little
that the government can do to prevent such terminations beyond
assuring that all of the participants' benefits as of the
termination are adequately provided.
Of greater recent concern, however, have been reversion
transactions under which a sponsor receives plan assets while
effectively continuing to maintain the defined benefit plan.
- 23 These transactions generally have taken two forms: (1) the
termination of the defined benefit plan and the establishment of
a new defined benefit plan, often identical to the terminated
plan (reestablishment transaction); and (2) the spinoff of a
defined benefit plan into two plans, one for active employees and
one for retirees, the allocation of the excess assets to the
retirees' plan, the termination of the retirees' plan, and the
continuation of the defined benefit plan for the active employees
(spinoff transaction).
In May 1983, the ERISA agencies (the Department of Treasury,
the Internal Revenue Service, the Department of Labor, and the
Pension Benefit Guaranty Corporation) issued enforcement
guidelines (the Guidelines) for purposes of processing
reestablishment and spinoff transactions. By requiring the full
vesting of all benefits and the purchase of annuity contracts
from insurance companies guaranteeing participants' accrued
benefits, the Guidelines assure that the security of
participants' benefits accrued before the transaction is not
adversely affected. In addition, the Guidelines attempt to
impose substantive parity between reestablishment transactions
and spinoff transactions by requiring the continuing plan in the
spinoff transaction to satisfy all of the substantive
requirements of a formal termination—e.g., full vesting of
benefits, formal notice to participants, and third-party
annuitization of benefits. Moreover, the Guidelines extend
additional security to plan participants in the continuing plans
with respect to benefits accrued after the transactions by
strengthening the funding requirements under such plans.
Finally, the Guidelines prevent a sponsor from undertaking
reestablishment and spinoff transactions on a regular basis by
specifying that such transactions may not be undertaken more than
once every fifteen years.
We believe that, within the confines of existing
administrative authority, the Guidelines appropriately protect
the interests of participants in plans that are involved in
reestablishment or spinoff transactions. We recognize that some
believe that additional protections are necessary, but we are
comfortable that the Guidelines strike the proper balance between
assuring the security of participants' benefits and not
encouraging defined benefit plan sponsors to terminate their
plans without establishing a successor plan. We do not believe
that legislation with respect to these specific transactions is
necessary.
Similarly, it is our view that the recent involvement of
overfunded defined benefit plans in acquisitions and acquisitionrelated transactions does not warrant specific legislation to
limit the rights of plan sponsors to terminate their defined
benefit plans as they desire. We are concerned that any such
legislative action to curb the termination of plans may
- 24 unnecessarily discourage employers from maintaining or properly
funding defined benefit plans. We must be careful not to
undermine the voluntary nature of the pension system in an
attempt to dampen related merger and acquisition activity.
We recognize, however, that, in the context of a broader
examination of pension and tax policy, it is appropriate to
consider action to reduce the general incentive for plan sponsors
to terminate plans and extract assets for nonretirement purposes.
The impetus for any such action should not, however, be the
involvement of overfunded plans in acquisition
transactions—although this certainly would a factor to be
considered—but rather should be based only on a full
consideration of the applicable pension and tax policies. Thus,
any proposal to reduce the incentive to terminate defined benefit
plans should apply on an across-the-board basis, without regard
to either the reason the sponsor is terminating the plan or the
intent of the sponsor to establish a successor plan. For
example, after further deliberations, it may be appropriate on
pension and tax policy grounds to apply a special excise or
minimum tax to asset reversions. This or similar action would
reduce the attractiveness of terminating overfunded defined
benefit plans in all circumstances.
D. Special Problems With Respect To Carry Over of Tax
Attributes of Thrift Institutions
In the Economic Recovery Tax Act of 1981 ("ERTA"), Congress
amended Section 368 of the Code to provide rules relating to
bankruptcy reorganizations of thrift institutions (i.e., savings
and loan associations and savings banks). These changes,
proposed by the Federal Home Loan Bank Board (the "Bank Board"),
were designed to resolve the issue of how the continuity of
interest requirement applies in reorganizations involving thrift
institutions.
Prior to ERTA, the Internal Revenue Service took the position
that a merger of a stock association into a mutual association
could not qualify as a tax-free reorganization. The Service
reasoned that the exchange of the shareholders' stock for
deposits in the mutual fails to satisfy the continuity of
interest requirement because the deposits are cash equivalents.
The courts generally rejected the Service's position, but without
*/
Supreme of
Court
the Service's
position
the The
concurrence
the recently
Internal sustained
Revenue Service,
combinations
of
S e
J
?
J
?
?
V
Commissioner.
y.g.
§ 1 0 5 sstatus.*/
# ct627
stocks and mutuals
could
not
be
assured
tax-free
AWI « * rUJ, i? 9 * tna 5 t h e m e r 9 e r of a stock into a mutual
sat sf
?£?! ™
J y the continuity of interest requirement. In
ini!rS!!!' * 11 2 r 0 S e p r i o r t 0 E R T A ' the Court held that the
for
An III \° i
*er shareholders of the stock association
a
e
th. t r a n c ^ - ^ ^ . ? S ? e n 5 i a l l y c a s h equivalents and, thus,
the transaction failed the continuity of interest test.
- 25 There was also uncertainty as to the application of the
continuity of interest requirement in reoganizations involving
thrifts under section 368(a)(1)(G) ("G reorganizations"). In
many reorganizations involving thrifts, the transferor's solvency
was in question and the Internal Revenue Service took the
position that the transaction could qualify as a tax-free
acquisition only if it satisfied the G reorganization
requirements. However, it was not clear how the continuity of
interest requirement applied in a G reorganization involving
thrifts. In the case of a mutual association there are no
stockholders and the principal creditors are depositors whose
interests generally are insured and who are not likely to
exchange those claims for stock. Further, stock associations
were unwilling to issue stock to those depositors. Consequently,
it appeared that the continuity of interest requirement generally
barred the reorganization of a thrift from qualifying as a
tax-free G reorganization.
To resolve these issues, Congress lifted the continuity of
interest requirement in G reorganizations involving a transferor
thrift if certain requirements are met. Generally, under these
rules, a transaction otherwise qualifying as a G reorganization,
in which the transferor is a financial institution to which
section 593 applies, will not be disqualified merely because no
stock or securities of the transferee are issued, provided: (i)
the transferee acquires substantially all of the assets of the
thrift and the thrift distributes any remaining assets pursuant
to the plan; (ii) substantially all of the liabilities of the
thrift (including deposits) become liabilities of the transferee;
and (iii) the appropriate agency certifies that, under 12 U.S.C.
S1464(d)(6)(A)(i), (ii) or (iii), either that the transferee
thrift is insolvent, the assets of the thrift are substantially
dissipated, or the thrift is in an unsafe and unsound condition
to conduct business. The Bank Board, the Federal Savings and
Loan Insurance Corporation ("FSLIC") or, if neither has
supervisory authority over the thrift, the equivalent state
authority may certify that one of the grounds specified in 12
U.S.C. 51464(d)(6)(A) exists. In addition, section 382(b)(7)(B)
was added to provide that the transferee's and transferor's
depositors are taken into account in determining the level of
continuity of interest for purposes of section 381.
In these acquisitions a profitable financial institution
typically agrees to assume the transferor thrift's obligations in
consideration for payments from a regulatory body, such as the
FSLIC, and the right to succeed to the transferor's tax
attributes. The tax attributes which the acquiring corporation
seeks to preserve are the thrift's accumulated net operating
- 26 losses and other carryforwards and the transferor thrift's basis
in its assets (typically residential mortgages with basis
significantly above fair market value).*/
In tax-free reorganizations the continuity of interest
requirement limits tax-free treatment to those transactions in
which the owners of the target corporation receive a meaningful
ownership interest in the acquiring corporation. The transfer of
stock in the target corporation for stock in the acquiring
corporation is tax-free because the owners of the target
corporation are deemed to have merely changed the form of their
investment. Moreover, the notion that tax attributes carry over
in a tax-free reorganization hinges on the continuity of interest
doctrine. The tax law considers it appropriate for tax
attributes to be used to offset income earned after the
acquisition whenever the historic shareholders who incurred the
unused attributes continue to hold a sufficient equity position
after the reorganization.
Under the revised rules for thrifts, neither the stockholders
nor the creditors (i.e., the depositors) of the troubled thrift
receive a continuing ownership interest in the acquiring
corporation. To permit tax attributes to carry over in these
transactions thus departs from the traditional principles
underlying the tax-free reorganization provisions, and provides a
tax subsidy for private acquisitions of thrift institutions. In
effect, this subsidy may operate to shift some or all of the
burden of thrift losses from FSLIC, the private insurance agency
funded by the thrift industry, to the Federal government.
Congress thus should consider carefully whether subsidies for the
thrift industry are necessary, and whether they should be made
through direct appropriations or through the tax laws,
recognizing that the latter route may be less efficient and more
costly in the long run. We recognize, however, that the thrift
industry
is undergoing
a would
period leave
of restructuring
and with
there may be
\/ This carryover
basis
the transferee
nontax
considerations
for
encouraging
the
flow
of
capital
into by
substantial built-in losses which could be realized merely
the thrift
selling industry.
the loans. Alternatively, if the transferee does not
sell the loans, the carryover basis permits the transferee to
treat payments other than stated interest as repayments of
principal; if the transferee took a fair market value basis
in the loans, a portion of the "principal" repayments would
constitute market discount under section 1277 and thus be
treated as ordinary income.
- 27 If the thrift reorganization rules are retained, we also
suggest that these Committees examine whether the special thrift
reorganization rules should be limited to acquisitions of a
thrift by a bank or another thrift. These provisions were
enacted to facilitate the rehabilitation of a thrift through its
acquisition by another thrift under the supervisory powers of a
certifying agency. Although the statutory language and the
legislative history do not explicitly suggest that these
provisions are limited to acquisitions of troubled thrifts by
other depository institutions, strong concerns existed in 1981
that these special rules not be used to permit the ready transfer
of realized and built-in losses of a troubled thrift to a
corporation other than a depository institution. Indeed, the
Bank Board, in seeking this legislation, assured the staffs of
the tax-writing committees and the Treasury Department that the
principal purpose of the legislation was to remove the technical
obstacles to supervised mergers involving troubled thrift
institutions.
We have become aware that these special rules are being used
increasingly to facilitate mergers of troubled thrifts and
corporations outside the banking sector. Though these
acquisitions may technically satisfy the statutory requirements,
the potential transfer of tax losses of troubled thrift
institutions to corporations other than banks or other thrifts
goes beyond the intended scope of the ERTA provisions. To date,
the Internal Revenue Service has not issued rulings involving
troubled thrifts where the principal trade or business of the
IV. Current
Legislative
Proposals to banking. Thus, if thrift
acquiring
corporation
is unrelated
reorganizations
are current
to be continued,
urge that
Congress
In
response to the
flurry ofwemerger
and acquisition
clarify
the
scope
of
these
provisions.
activity, a number of bills have been introduced in Congress that
would use the tax laws to discourage these transactions. I will
comment on several of these bills, but will not discuss any of
them in detail.
It has been proposed that more stringent tax consequences
attach to a stock acquisition that is effected pursuant to a
hostile takeover (generally, one disapproved by a majority of the
independent members of the board of directors of the target
corporation). An automatic section 338 election would be deemed
made, and all gain on the target corporation's assets, not just
recapture and tax benefit items, would be recognized. We do not
believe that the tax laws should be used to discourage hostile
takeovers. If it is concluded that hostile takeovers harm
shareholders or the economy, Congress should address its concerns
directly. As a matter of tax policy we do not believe "hostile"
acquisitions should be treated differently under the tax laws
than "friendly" acquisitions.
- 28 It has also been suggested that so-called "greenmail" profits
be subject to a 50 percent excise tax, and that no deductions be
allowed for "greenmail payments" or interest on indebtedness
incurred to acquire stock or assets acquired pursuant to certain
hostile acquisitions. While we would not object to a statutory
confirmation that under current law "greenmail payments" are not
deductible, we do not believe, that there is a need for special
tax provisions to curtail greenmail payments.
V. Summary
In conclusion, the current tax rules would not appear to be
propelling the recent surge of corporate acquisitions and
takeovers. We have set out in this testimony, however, certain
aspects of current tax law that may encourage corporate
acquisitions and that may be the proper subject of legislative
reforms in this area. In particular, we look forward to working
with your Committees this year to modify the rules relating to
the carry over of corporate tax attributes in mergers and
acquisitions. We do not believe, however, that Congress should
amend the tax laws for the purpose of generally discouraging
merger and acquisition transactions.
*
*
*
This concludes my prepared remarks.
respond to your questions.
I would be happy to
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
For Release Upon Delivery
Expected at 8:30 A.M.
STATEMENT OF BERYL W. SPRINKEL
BEFORE THE
SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
WASHINGTON, D.C.
Tuesday, April 2, 1985
Mr. Chairman, distinguished members of the Committee, it is
an honor for me to appear before you today as the President's
nominee to be Chairman of the Council of Economic Advisers.
During the past four years, it has been my privilege to serve
as the Under Secretary of the Treasury for Monetary Affairs. In
that capacity, I have been involved in a wide range of domestic and
international economic issues and have worked closely with officials
from other Executive agencies, the Congress, foreign governments
and international agencies. The experiences I have had and the
personal relations that have evolved have resulted in a most rewarding and satisfying four years. In particular, I have appreciated
and enjoyed the opportunity to participate on many occasions in
this Committee's semi-annual review of monetary policy.
When President Reagan came to office in 1981, a primary goal
was to revitalize the U.S. economy which was overburdened by the
effects of record high inflation and interest rates, rising tax
rates and proliferating government regulations. The President's
economic recovery program did not seek cosmetic, short-run relief
to our economic ills. Rather, it was designed to put in place
prudent, long-term economic policies designed to reduce inflation
and provide for sustainable real economic expansion. We are now
enjoying the fruits of those long-term policies.
Inflation in the past three years has been lower than during
any time since the mid 1960's. Interest rates are well below where
they were in January 1981. We are into the third year of an economic
expansion which to date has been the strongest in 30 years. Business
investment is booming, productivity is up, and the proportion of
the adult population that is at work is at a peacetime high. In
contrast to the late 1970's, the U.S. economy is again the envy of
the world.
B-71
-2-
Our efforts to restore sound, noninflationary growth m the
U.S. have provided an important stimulus to growth in other countries.
We believe we have learned some important lessons about the effects
of providing positive incentives and allowing free markets to work.
These same principles can help other nations improve the dynamism
and flexibility of their economies. Other Administration officials
and I have worked closely with our foreign counterparts to encourage
the design of policies that will promote noninflationary economic
growth on a global scale.
The restoration of a strong U.S. economy has been reflected
internationally in both a strong dollar and a growing trade and
current account deficit. At the same time, the strong recovery in
the U.S. and the strength of the dollar have provided considerable
stimulus to European economic recovery and the growth in LDC exports.
We anticipate that efforts to restore growth in other countries
— with our encouragement — will also help to strengthen foreign
currencies relative to the dollar and improve our trade position.
We have also emphasized that increased international access to
markets plays an important role in contributing to global growth.
Another key international economic issue has been the debt
crisis and the stability of the international financial system.
The restoration of economic growth in the industrialized countries
and sound adjustment efforts by the developing countries themselves ,
have been two key elements of our approach to these problems. The
economic situation in the developing countries has improved in the
past two years, although we still have some way to go before this
problem can be put behind us.
Another key area of responsibility for me at Treasury has been
debt management. We have pursued debt management policies which,
while achieving the immediate objective of providing necessary
funds, also served to balance the Treasury's financing activities
in the market and contribute to the liquidity and breadth of the
government securities market. We introduced rather innovative
financing techniques which we believe have expanded the investor
base for Treasury securities, while minimizing the cost of financing
to the government and the taxpayer. In addition, our efforts are
ongoing to modernize cash management and processing procedures
within Treasury and throughout the Federal government. By 1988,
annual interest savings will have grown to $3.5 billion. In total,
co8f l^*-years t h e s e e f f o r t s a r e expected to save the taxpayer
$9.1 billion.
nv^JhlS ^ua S?lid record of accomplishment for us all and the
f
" u ' £e s h a r e d a m o n 9 the Administration, the Congress and
the Federal Reserve. Obviously, problems and challenges remain.
a downwL^n^^ bi?7?!ut challen9es is to get the Federal deficit on
h k h 1
hi ? l t h ° U K l a ? S a n d t a x "venues still close to
accomplish tn^ll
' T b e i l e v e ifc is best for the economy if we
s endin
economic arow
^
?
9 restraint, along with sustained
economic growth. This will enable us to reduce outlays gradually
-3-
as a share of GNP, until they are brought more nearly into line
with the rising revenues which economic growth will generate. I
know that all of you, along with your colleagues, are working hard
to restrain spending growth and reduce the budget deficit in a way
that is fair to all Americans. We in the Administration appreciate
your commitment and are confident that with perseverance an acceptable, bipartisan solution can be found.
The Administration is also committed to working with the
Congress on a fundamental and comprehensive tax reform plan. Our
goal is a simpler, fairer system, one more conducive to economic
growth, and one which will eliminate the tax burden on taxpayers at
or below the poverty level.
It is critically important that monetary policy be designed to
protect the progress on inflation and ultimately to reduce the
inflation rate further. Inflation is a pervasive deterrent to a
healthy and prosperous economy. Our commitment to restoring price
stability must not waiver and it is important that our monetary
actions consistently convey that commitment to the financial markets.
Monetary policy at the same time should provide sufficient money
growth to support sustained economic growth and avoid any undue
monetary restriction of the economy.
These and other issues are the tough decisions and challenges;
the President and all of us will face in the months and years
ahead. I know the members of this Committee share our desire to
formulate economic policies that provide price stability and enhance
economic growth and opportunity. If confirmed as CEA Chairman, I
look forward to working closely with this Committee and the Congress
in that economic policymaking process.
0O0
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
.. „
, _
April 2, 1985
w
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling approximately $13,300 million, to be issued April 11, 1985.
This
offering will result in a paydown for the Treasury of about $50
million, as the maturing bills are outstanding in the amount of
$13,338 million, including $625
million currently held by Federal Reserve Banks as agents for foreign and international monetary
authorities and $2,285 million currently held by Federal Reserve
Banks for their own account. The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,650
million, representing an additional amount of bills dated
July 12, 1984,
and to mature July 11, 1985
(CUSIP
No. 912794 HJ 6) , currently outstanding in the amount of $15,650
million, the additional and original bills to be freely
interchangeable.
182-day bills for approximately $6,650 million, to be dated
April 11, .1985,
and to mature October 10, 1985
(CUSIP
No. 912794 JB 1 ) .
Both series of bills will be issued for cash and in exchange
for Treasury bills maturing April 11, 1985.
Tenders from Federal Reserve Banks for themselves and as agents for foreign and
international monetary authorities will be accepted at the weiqhted
average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued 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 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. 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.
B-72
- 2 Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington, D. C.
20239, prior to 1:00 p.m., Eastern Standard time, Monday,
April 8, 1985.
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.
Each tender must state the par amount of bills bid for,
which must be a minimum of $10„000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
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, df the names of the
customers and the amount for each customer are furnished. Others
are only permitted to submit tenders for their own account. Each
tender must state the amount of any net long position in the bills
being offered if such position is in excess of $200 million. This
information should reflect positions held as of 12:30 p.m. Eastern
time on the day of the auction. Such positions would include bills
acquired through "when issued" trading, and futures and forward
transactions as well as holdings of outstanding bills with the same
maturity date as the new offering, e.g., bills with three months to
maturity previously offered as six-month bills. 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, when submitting tenders for customers, must
submit a separate tender for each customer whose net long position
in the bill being offered exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
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
ana 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
- 3 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 yield 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 $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to three
decimal places on the basis of price per hundred, e.g., 99.923, and
the determinations of the Secretary of the Treasury shall be final.
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 11, 1985,
in cash or other immediately-available funds
or in Treasury bills maturing April 11, 1985.
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.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
In general, if a bill is purchased at issue after July 18,
1984, and held to maturity, the amount of discount is reportable
as ordinary income in the Federal income tax return of the owner
at the time of redemption. Accrual-basis taxpayers, banks, and
other persons designated in section 1281 of the Internal Revenue
Code must include in income the portion of the discount for the
period during the taxable year such holder held the bill. If the
bill is sold or otherwise disposed of before maturity, the portion
of the gain equal to the accrued discount will be treated as ordinary income. Any excess may be treated as capital gain.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76 and 27-76, Treasury's single bidder guidelines, and this
notice prescribe the terms of these Treasury bills and govern the
conditions of their issue. Copies of the circulars, guidelines,
and tender forms may be obtained from any Federal Reserve Bank or
Branch, or from the Bureau of the Public Debt.
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
STATEMENT OF
THE HONORABLE
JAMES A. BAKER, III
SECRETARY OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS OF THE
COMMITTEE ON APPROPRIATIONS
U.S. SENATE
• APRIL 4, 1985
Mr. Chairman and members of the committee:
It is a pleasure to meet with you today to discuss the
policies we are pursuing with the Multilateral Development
Banks (MDBs); the President's budget proposals for the MDBs;
and the compelling need for this Committee to support the
replenishments recently negotiated which reflect full consultation with the Congress, and in particular, this Committee.
The Administration firmly supports the MDBs and their vital
role in preserving and enlarging the international economy by
providing technical and financial assistance to developing
countries. Mr. Chairman, I agree with your remarks to Secretary
of State Shultz two weeks ago: the United States has a long-term
self-interest in nurturing, these institutions.
You and the members of your committee played a key role in
securing Congressional approval for the Seventh Replenishment of the International Development Association (IDA VII)
and the newly created Inter-American Investment Corporation
(IIC). The Administration deeply appreciates your invaluable
help in implementing the President's program.
Successful United States leadership in these institutions
depends on firm backing by the Congress for international
commitments — commitments made on the basis of extensive
congressional consultations. The President — indeed, our
country — stands behind those commitments. Having played a
part in the preparations for these negotiations, you now bear
responsibility for following through on these replenishment
commitments so that the MDBs may more fully serve the people
for whom they were created.
The basis for our participation and policy direction will
continue to be the 1982 Treasury assessment of the MDBs which
this Committee helped to shape. As you will recall, the
assessment
concluded that the MDBs have been most useful to
B-73
- 2 i_ «««.*.ihnhina to the achievement of our
the United States Jy contributing to tn
helping us
global economic and | ^ n « j J t ^ C ^ d strategic interests.
Thi^ 1 : " : ^ trir'tod'ay than in 1982. The situation in SubSanaran Srica'for instance, has steadily deteriorated since
1982
There is a need for major programs of policy reform
and on getting better value from both internal and external
Resources. The economies of Latin America are striving to
get back on their feet from the debt crisis that struck in
1982. In both these geographic regions, as well as Asia, the
MDBs are playing an important role in enhancing developing
country growth and stability:
— as catalysts for mobilizing private sector
resources;
— as sources of sound economic policy advice
and technical assistance; and
— as providers of inputs that the private sector
would not or could not provide.
The Administration's specific objectives,. also in keeping with
the assessment, are to hold down the budgetary impact of the
MDBs, promote better quality loans, and enhance the role of the
private sector. We want to stop the practice of viewing the
quantity of lending as a mark of success in these institutions
by refocusing our attention to the issue of the quality of MDB
lending.
Reducing Budgetary Impact of the MDBs
As a fiscal year 1985 supplemental we are requesting $236.7
million in budget authority and $1,219.0 million for callable
capital, which as you know, is provided in the form of program
limitations. The fiscal year 1986 request is for $1,347.6
million in budget authority and $3,641.7 million for cailable
capital.
In the past, members of this committee have supported the
Administration in its efforts to scrutinize the budgetary
effects of the MDB programs consistent with U.S. interests
and the realities of our domestic budget environment.
In fact, our current fiscal year 1986 budget request for paidin capital and concessional funding is $130*5 million or 8.8
percent less than was provided in fiscal year 1980. Since
taking office this Administration has negotiated replenishments
that have reduced the proportion of paid-in capital for subscriptions to the hard-loan windows of the MDBs. In the
Inter-American Development Bank (IDB), paid-in capital is now
4.5 percent of the total, down from 7.5 percent in the previous
capital increase, m the Asian Development Bank (ADB),
d™nni2 ? a p i t a l d r °PP e d f r o ™ 10 to 5 percent. The IBRD
dropped the amount of paid-in capital from 10 to 7.5 percent.
- 3 Because of their greater budgetary impact, the reduction in
the budget request has come from a decrease in the MDBs' soft
loan programs; these programs have been reduced some $570
million, or 40.5 percent in real terms, in our FY 1986 request
compared to the FY 1981 programmed levels. The current
experience of the MDB soft windows in processing loan commitments indicates that the replenishments the Administration
negotiated were adequate, including the three-year $750 million
per year IDA VII replenishment. However, even after the reductions that have taken place the programs remain sufficiently
substantial to fulfill their objectives.
I would like to take a few minutes to address the single
largest component of our budget request for the MDBs—the
International Development Association (IDA). We are pleased
that the World Bank has moved swiftly to strenghthen the administration and management of its African operations with the
object of supporting policy reform efforts in this region.
IDA, with its enhanced efforts to increase effectiveness of
its lending to Sub-Saharan Africa, will be focusing its
program on the need for appropriate policies that are essential
to achieve self-sustaining growth. The share of IDA's resources
going to Sub-Saharan Africa has increased from an average of
27.5 percent in 1980 through 1982 to 35.2 percent in the
Subsequent years.
This Committee has been most outspoken on the subject of India
borrowing from IDA. India had been receiving a full 40 percent
of all IDA credits. India's share dropped to 28.0 percent by
fiscal year 1984 and is expected to decline further during
IDA VII.
Because of the scope and effectiveness of its lending operations
IDA is the single most important multilateral development
institution for the World's poorest countries, many of which
are in Sub-Saharan Africa. The Administration — after extensive
consultation with this Committee — made a commitment to the
institution and the developing countries to contribute $750
million in FY 1986. We must honor this commitment, along
with the other commitments that have been made to the MDBs in
consultation with Congress.
Consistency with Bilateral Assistance
We sometimes hear the argument that bilateral assistance is a
better vehicle for advancing U.S. foreign policy interests in
developing countries. We believe the programs are interrelated
and that both are effective channels for assisting developing
countries. U.S. financial support of the MDBs is matched by
substantial amounts from other donor countries and private
capital markets; U.S. bilateral programs engender close
cooperation that enhance our national interest and increase
political, economic, and military stability in the.third
world.
- 4 £i~A ^y inh^rest that out of 37 countries
S a t ^ e i v e d allocations* JS'SS! fro. the State Deparfnenfs
that receivea <axx^
fc
32
of
them#
SKrCtgSr= ^rte^'l^l^Va Spain -have per capita
GNPs too high to qualify as MDB borrowers. Among these 3 2
countries receiving MDB assistance, the United States provided
tei biUion In foreign aid in 1984, while the MDBs provided
$4.9 billion to these same countries - - a t a cost to the
United States of approximately $1.3 billion because of the
unique cost sharing features of these institutions. In short,
the MDBs are cost effective in assisting countries of particular
importance to the United States.
Improved Loan Quality
We have also achieved better quality loans. This is evidenced
in several areas. First, we have had success in the MDBs with
our efforts to strengthen the. quality of loans. Occasionally
this may require the United States to oppose a loan based on
an assessment of the economic viability of the project.
I think it is fair to say that there has been some improvement
in the overall quality of MDB lending as a result of our
continuing emphasis on this subject. We have been particularly
concerned about MDB lending for projects which are likely to
achieve high financial rates of return, and which could be
undertaken by the private sector or with commercial finance.
An example of our success in strengthening MDB lending policy
is the change in World Bank project lending for oil and gas
projects. Early in this Administration we successfully
opposed the creation of a special World Bank Energy Affiliate
because we believed it to be unnecessary. In addition, we
have opposed a number of loans in this sector because we
believed the World Bank was displacing private capital available for this purpose. Our concerns did not go unnoticed.
Recently the World Bank issued new operating guidelines that
should significantly improve the quality of their lending in
this sector.
Another example of improved loan quality is the continuing
priority given to economic policy adjustment issues in the
face of declining loan demand. The World Bank's lending in
its current fiscal year is now projected at $11 billion —
roughly $2 billion less than the IBRD anticipated. We fully
support the World Bank's recently increased emphasis on
maintaining lending standards rather than pursuing aggregate
lending targets.
nMT^i jllustration of improved loan quality concerns public
th
whiii L S "
! Inter-American Development Bank (IDB),
chance
with > h ' f S S f U l i n G a i n i n g a significant policy
loan!^ I
• t h l f P° llc y m place the IDB can only now make
loans to public utilities that have a rate structure which
- 5 enables the utility to meet full operating and maintenance
costs. This policy will result in a reduction in government
budget subsidies for those countries receiving loans in these
sectors.
Environmental Impact of MDB Projects
An area where we are now trying to influence MDB policy to be
more constructive is the impact of MDB projects on the environment. I am well aware, Mr. Chairman, of your deep concern on
this issue, particularly regarding some MDB projects in Brazil.
I share your concerns. Your public expressions have very usefully focused attention on this issue. Our own examination of
MDB projects indicates a mixed performance by the Banks in
adhering to their own, current standards regarding environmental safeguards on the design and implementation of their
projects. There have been some very well designed projects;
there has also been a number of environmentally questionable
projects.
To address this situation Treasury is undertaking a policy of
bringing questionable projects to the attention of senior
Management of the various MDBs. The impact of accumulating
evidence will bring home the conclusion that policy implementation has to be strengthened.
' <
As we all become more aware of the environmental impact of
MDB projects — donors, recipients, and the institutions themselves — we will have to become more careful in analyzing
this factor.
In the meantime, Mr. Chairman, the U.S. Treasury welcomes
hearing from you and other members of your Committee regarding
the adverse environmental impact of any MDB projects that
might come to your attention.
Support for the Private Sector
We also have as a general goal to increase MDB support for
the private sector.
Your Committee, Mr. Chairman, has already contributed much
toward support for the private sector by lending a firm hand
in enacting legislation to enable U.S. participation in the
Inter-American Investment Corporation (IIC).
Most IDB members have joined together to create the IIC which
will be linked with the IDB. The IIC will focus on strengthening the capitalization of small- to medium-sized firms in Latin
America and the Caribbean by providing equity participations
and loans.
Other MDBs have also taken some positive steps in this
direction. As I will mention in more detail later, the
International Finance Corporation (IFC) is about to embark
- 6 on a five-year plan to boost their support for the private
sector. About two years ago the ADB began equity operations
on a small scale. In addition, the ADB recently held a
seminar on "privatizing" - i.e., having the private sector
perform certain functions now performed by the public sector,
often through state-owned enterprises (SOEs). We are looking
forward to reviewing the seminar's final results, and for ADB
management to carry them forward in a policy paper.
We are carefully examining the MDBs' past practices in lending
to state-owned enterprises, particularly to ascertain the
extent of private sector alternatives. We do so because we
believe State-owned enterprises are frequently plagued by
management deficiencies, and political pressures to sustain
artificial levels of employment and subsidized prices. There-
U.S. Unfunded Replenishment Commitments
The Administration's FY 1985 Supplemental Request reflects our
determination to honor United States' commitments to the institutions, the other donor countries, and most importantly, to
the people of the developing countries themselves — commitments
for the most part negotiated by this Administration.
I believe our unfunded replenishment commitments are truly
creating a very difficult situation for MDB lending programs.
Currently, the United States' funding shortfall of $91 million
in the Asian Development Fund (ADF) has, because of a cost
sharing mechanism, led to total reductions of about $250 million,
Without our requested funds, the ADF will be forced to make
contingent loan commitments, which prevents the institution
from finalizing their loan agreements.
The Inter-American Development Bank (IDB) is in a worse situation. Because charter provisions grant the United States
34.5 percent of the IDB voting power, the Bank cannot accept
subscriptions from others that would push us below this
Me e l "u B a ? e d o n t h i s 3 4 - 5 Percent criterion, the current
U.S. shortfall in subscriptions of $40 million paid-in capital and $849 million in callable capital compels the IDB to
refuse to accept subscriptions from other members of more
rpmnfi"? 5 l l l l o n : T ? i s h a s forced the IDB to stop its
regular lending and only make contingent commitments until
we provide our subscription shortfall.
FuL1^ ^ple^is*ment of the IDB's soft loan window, the
sharinrmechan a ^° Pe n ati °" S ( F S 0 ) ' a l s o contains a cost
resumed !nfJo^'i ° ^ s * ort fall of $72.5 million has
The inlunded JSSl shortfall of around $175 million.
Increase f c c n ^ T n t S t 0 - t h e W o r l d B a n k ' s General Capital
increase (GCI) has temporarily pushed our voting power to
- 7 below 20 percent. The first installment for the Inter-American
Investment Corporation (IIC) remains incomplete and detracts
from our efforts to urge others to join up.
I strongly believe that consistent shortfalls can cause
serious damage to our relations with other member countries,
the institutions themselves, and more importantly, have a
negative impact on the people of the developing countries
who are the beneficiaries of these institutions. On the
basis of our extensive consultations with the Congress,
including this Committee, we entered into commitments we
believed the United States would be able to honor. We now
find ourselves unable to fulfill the obligations we agreed to.
Frankly, this is not good government, and, does not speak
well for the United States.
The Fiscal Year 1985 and 1986 Budget Request
With the exception of a small number of capital shares in the
World Bank dating back to 1970 which the United States did
not purchase, and capital shares for the IBRD's 1981 General
Capital Increase (GCI), the entire MDB fiscal year 1986
request comprises replenishment agreements negotiated by this
Administration in close consultation with this Committee.
Treasury officials kept in close touch with the Committee and
these funding proposals reflect both the need for budgetary
restraint and the financial requirements for effective development programs. We are requesting $236.7 million in budget
authority and $1,219.0 million under program limitations for
callable capital subscriptions as a fiscal year 1985 supplemental. The fiscal year 1986 request is for $1,347.6 million
in budget authority and $3,641.7 million under program limitations for callable capital.
Many of the countries in Sub-Saharan Africa are in serious
economic difficulty. It is worth noting, therefore, that
many of the programs included in this request are oriented
toward this region. An increased share of IDA resources go
to Sub-Saharan Africa; the African Development Bank and Fund
are devoted entirely to promoting the region's development;
and the International Finance Corporation's new five-year
plan features increased emphasis on the region.
International Bank for Reconstruction and Development (IBRD)
For the IBRD, the Administration is seeking a fiscal year 1985 •
supplemental request of $30.0 million in budget authority for
paid-in capital and $370.0 million under program limitations
for callable capital to complete the fourth of six installments
for the U.S. share of the 1981 GCI of the Bank. For fiscal
year 1986, the'Administration is requesting: 1) $109.7 million
in budget authority and $1,353.2 million under program limitations for subscriptions to the fifth installment of the 1981
- 8 nrr o\ sfi«5 7 million in budget authority and $685.3 million
GCI; 2) $65.7 mjJ-iion i
y s u b s c r i p t i o n s to the first of
m
a
n
under program i* £* ?J° !B|2TsS1984 Selective Capital Increase
^ n " n 3 ? 1 • milliof for paid-in capital subscriptions
and $66?9 million in program limitation for callable capital
subscriptions to the 1970 SCI.
The 1984 SCI totals $8.4 billion and was unanimously approved
by the IBRD Executive Board in May 1984. This SCI ad:usts
members' relative shares to reflect their relative position
in the world economy. U.S. participation is an important
demonstration of U.S. support for the World Bank and our
willingness to work cooperatively with other donor countries
to strengthen the World Bank's financial position and ensure
improved cost-sharing.
The Administration continues to believe that the IBRD should
play a prominent role in the longer-term development programs
of its borrowers and regards "equitable cost-sharing" among
donors to be a key element of our participation in all of the
MDBs. An important consideration for the United States in
negotiating the SCI was the general understanding to maintain
a conservative interpretation of the IBRD's "sustainable
level of lending" (SLL).
Subscription to all IBRD shares — the GCI and both SCIs —
is essential in order to maintain the U.S. veto over amendments to the Articles of Agreement of the Bank.
International Development Association (IDA)
For fiscal year 1986, the Administration is requesting $750
million for the second of three installments for the $2.25
billion U.S. share of the $9 billion seventh replenishment.
We are pleased at the speed with which the World Bank has
moved, with full support of the Executive Board, to strengthen
the administration and management of its African operations,
with the object of supporting policy reform efforts in this
region. We continue to believe the countries of Sub-Saharan
Africa and other least developed countries should have first
claim on available IDA resources as long as these countries
are able to make effective use of these resources.
International Finance Corporation (IFC)
For fiscal year 1986, the Administration is seeking $35.0
million for the first of five installments on the U.S. subscription to a $650 million IFC capital increase unanimously
approved by the IFC Executive Board in June, 1984.
This capital increase is needed to support an IFC five-year
plan for the period FY 1985-1989 that features four initiatives
1]
Jh!r!f!d.?haSis °n ^Pital market development to build
the institutions necessary to mobilize capital;
- 9 2) implementation of a corporate restructuring program to
assist enterprises adapt to changing economic conditions
brought about by adjustment programs and adverse or
changing market conditions;
3) allocation of a larger share of IFC's resources to
Sub-Saharan Africa for a program which contains four
main components:
° provide investment analysis and advisory
services through expanded venture capital
companies;
° take a larger investment share where it proves
difficult to mobilize resources for otherwise
worthwhile projects;
° more and smaller projects to take advantage of
the region's relatively larger number of smaller
scale investments; and
° more intensive use of development finance
corporations.
4) establishment of an energy exploration and development
program that will attract foreign private resources
to developing countries.
This investment program is consistent with the direction and
emphasis the United States has encouraged the IFC to take.
Inter-American Development Bank (IDB)
In a supplemental request for fiscal year 1985, the Administration is seeking $40.0 million in budget authority and
$849.0 million under program limitations for subscriptions
to complete the second of four installments to the 1983 capital
increase of the IDB. For fiscal year 1986, the Administration
is requesting $58.0 million in budget authority and $1,231.0
million under program limitations for the third installment.
The lending program based on the 1983 capital increase is
designed to continue strong support for the long term development of the countries in Latin America and the Caribbean.
Fund for Special Operations (FSO)
In a supplemental request for fiscal year 1985, the Administration is seeking $72.5 million for the second of four
installments for the 1983 replenishment. For fiscal year
1986, the Administration is requesting $72.5 million for the
third installment.
The FSO replenishment is designed to address the long term
development needs of the poorest countries, primarily in
Central America and the Caribbean. As a result of U.S.
- 10 •._ ..>,= p<?n. other countries are also
unfunded commitments to the FSO, ocner
holding back on their payments.
m^r-American '—^ Corporation (IIC)
I. a supplemental ^uest for fiscal year 1985 the^mini-
^'^nmentslofthe nTtlai S.S? subscription to the IIC.
For fiscaf yea°ri986, She Administration is seeking $13
million for the second installment.
The Administration strongly supported establishing the IIC
as a practical means of enhancing the capacity of the IDB
to aid the private sector in borrowing countries. The
investment program will provide loans and equity participation for small- to medium-sized privately controlled firms
in Latin America and the Caribbean.
Asian Development Bank (ADB)
For fiscal year 1986, the Administration is seeking $13.2
million in budget authority and $251.4 million under program
limitations for the third of five installments for the 1983
General Capital Increase.
The ADB is a key institution in one of the most economically '
dynamic and politically sensitive regions of the world.
Active and positive U.S. participation has served U.S.
interests.
Asian Development Fund (ADF)
In a supplemental request for fiscal year 1985, the Administration is seeking $28.2 million to complete U.S. contributions to the first replenishment and $63 million to complete
the second of four installments to the third replenishment.
For fiscal year 1986, the Administration is requesting $130
million for the third installment to the third replenishment.
The ADF has supported well designed and effective development
projects in some of the poorest countries in the world. U.S.
support benefits the people of such countries as Pakistan and
Sri Lanka as well as many of the strategic island countries
in the Southern Pacific.
African Development Bank (AFDB)
For fiscal year 1986, the Administration is requesting $18.0
million in budget authority for subscriptions to paid-in capital
and $54.0 million under program limitations for callable capital
for the fourth of five installments for the initial U.S. subscription to the AFDB.
The AFDB is visible evidence of U.S. commitment to work with
^™CS
? 1 S S ° f A f r i c a f o r fche achievement of their long
term development objectives.
- 11 African Development Fund (AFDF)
For fiscal year 1986, the Administration is seeking $75 million
in budget authority for the first of three installments for
the U.S. contribution to the fourth replenishment.
During the period of the fourth replenishment, 85 percent of
AFDF lending will go to the poorest African countries. Fund
lending will continue to be focused on agriculture with 40
percent of the replenishment resources going to this sector.
The remainder of AFDF lending will go to high priority projects
for transportation, health, education and water supply.
The substantial increase in the U.S. contribution to the AFDF
is a reflection of the Administration's belief that concessional
development assistance should be focused on the poorest countries,
particularly those of Sub-Saharan Africa.
Upcoming Replenishment Negotiations
It may be useful to briefly comment on upcoming replenishment
negotiations. In light of the current severe fiscal pressures,
the Administration has not budgeted at this time for all future
replenishments. Because of the budget stringency all current • ,
programs — domestic and international — are being thoroughly
scrutinized for possible budgetary cuts. In this context we
decided- to defer any decisions on future participation until
later in the year.
The replenishment negotiations that will begin this year are
for the ADF, IDB/FSO and AFDB. Negotiations for IDA VIII
will commence in late 1985 or early 1986 and should be
completed in time for IDA to begin making commitments in July
1987. We plan to consult with this Committee, as well as
others, to inform you about these upcoming replenishment
negotiations in more detail.
Conclusion
In conclusion, Mr. Chairman, I want to emphasize this
Administration's commitment and full support for the MDBs.
.In this context, I reiterate the importance of the supplemental
request for contributions and subscriptions that we have
requested previously, and to urge your full support for the
entire FY. 1986 budget request.
The supplemental request is, for the most part, to complete
installments for agreements negotiated by this Administration.
Failure to provide previous amounts requested has significantly
curtailed the lending programs of the ADF and FSO. The IDB
lending program is essentially stopped. Obviously the FY 1986
budget request must be appropriated in full to prevent a
continuation of these shortfalls.
- 12 As you know, Mr. Chairman, the Administration made an earnest
effort to consult closely with the concerned members of the
Congress in conducting our 1982 Assessment of the MDBs and
the replenishments negotiated on the basis of the Assessment's
guidelines. Moreover, President Reagan, in various international fora, has repeatedly stressed U.S. commitment to
these institutions. Now, we urge your support for the
Administration's MDB request so that the people for whom
these institutions were created to serve will benefit.
TREASURY NEWS
FOR RELEASE
UPON
DELIVERY • Washington, D.C. • Telephone 566-2041
epartment
of the
Treasury
Expected at 2:00 P.M.
April 3,//1985
E7S.T.
STATEMENT OF THE HONORABLE JAMES A. BAKER, III
SECRETARY OF THE TREASURY
COMMITTEE ON APPROPRIATIONS
^ SUBCOMMITTEE FOR TREASURY, POSTAL SERVICE,
AND GENERAL GOVERNMENT
MR. CHAIRMAN, MEMBERS OF THE SUBCOMMITTEE:
I am pleased to appear before this Subcommittee for the
first time to discuss the operating budget for the Treasury '
Department for Fiscal Year 1986.
As this Subcommittee is well aware, and as I have come to
understand better during the past several weeks, the Treasury
Department carries out functions that are truly essential to the
existence of our Federal system of government.
We administer the
Nation's tax system, and collect the government's revenues.
We
manage the government's fiscal affairs, including paying its
bills and financing the nation's public debt.
We manufacture the
currency and coin that are essential to the nation's commerce and
economic well-being.
institutions.
B-74
We help regulate our country's financial
We process passengers and cargo coming into the
-2-
country, enforcing import and export laws.
We carry out basic
federal law enforcement responsibilities, including protecting
the President, Vice-President, as well as other dignitaries.
We
participate in the effort to combat illegal drug smuggling, and
administer firearms and explosives laws.
Finally, we advise the
President on monetary, economic, and tax policies.
To continue to carry out the functions of the Treasury
Department in Fiscal Year 1986, we are requesting a total budget
of $5.3 billion and 121,006 positions.
These funding and
staffing totals include $6 million and 75 positions for the
administration of the revenue sharing program; that request is
reviewed by the Appropriations Subcommittee for Bousing and Urban
Development and Independent Agencies.
Our budget request for FY 1986 represents a decrease of $45
million, or 0.8%, below the comparable Fiscal Year 1985 levels.
In addition to these funding and staffing requests for the
operations of the Treasury Department, our Fiscal Year 1986
budget reflects a proposed transfer of certain responsibilities
of the Small Business Administration to the Treasury Department.
-3Our budget includes $74 million and 1,650 positions for the
administrative costs of servicing existing direct loans and
sonitoring the servicing of guaranteed loans.
The budget also
includes $2.6 billion for expenses directly associated with the
portfolio, including writing off defaulted loans.
Our
understanding is that this request concerning the transfer of the
Small Business Administration will not be taken up by the
Treasury Appropriations Subcommittee, but will be covered by the
Commerce, Justice, State and Judiciary Subcommittee.
The Fiscal Year 1986 budget for the Treasury Department has
several major objectives.
First, the overall budget request
reflects our participation in the governmentwide 1-year freeze in
total spending other than debt service.
Specifically, we have
maintained spending levels appropriated in the Fiscal Year 1985
Continuing Resolution plus critical supplemental requests.
Second, our budget reflects two specific governmentwide
proposals included in the President's budget —
a reduction of 5%
in Federal civilian pay effective January, 1986, and a 10%
reduction in administrative and overhead costs.
The 5% pay reduction will produce savings of approximately
$135 million in the Treasury Department's budget for Fiscal Year
1966.
-4-
To accomplish the 10% reduction in administrative costs, we
will streamline administrative and support operations. Every
Treasury organization will participate in this effort; the
estimated savings in Fiscal Year 1986 is $64 million. The
majority of these savings will be accomplished in the Internal
Revenue Service and the U.S. Customs Service. The IRS reduction
reflects cuts in personnel, printing, and general support
operations. The reduction in the U.S. Customs Service reflects
the centralization of administrative functions, certain
organizational realignments, and various operational and
management efficiencies.
Strengthening law enforcement capabilities is a third
objective of this budget.
We will increase our participation in the President's
Organized Crime Drug Enforcement Task Forces. We are requesting
supplemental funding of $6.5 million in Fiscal Year 1985 to
support Treasury's participation in the 13th City Task Force in
Miami. These Task Forces have achieved dramatic results. Since
October of 1982, the Task Forces have initiated over 800 cases,
which have resulted in over 4,300 indictments and more than 1,600
convictions. Over two-thirds of these cases have been the direct
result of financial investigations. These efforts have focused
on the criminal leadership in this country; this has resulted in
the breakup of many formerly well-financed and tightly-controlled
organized crime operations.
-5-
We are moving to strengthen our drug interdiction efforts.
We will acquire three additional P-3A aircraft this summer for
surveillance.
We have recently completed the installation of a
third air-to-air surveillance aerostat in the Bahamas.
Further,
we will acquire eight new, high endurance, tracking aircraft this
year with funds appropriated in FY 1984.
Our Fiscal Year 1986 budget for air interdiction represents
an increase of $16 million, or 36%.
These funds will be used to
operate the P-3A aircraft to be acquired this summer, to install
radars and night vision devices in certain interception aircraft,
to operate up to two additional helicopters, and to begin
developmental work on a 360 degree search radar system.
The Treasury Department is most appreciative of the
assistance we have received from the Defense Department over the
past several years in our efforts to stem the flow of illegal
drugs into the country.
As I am sure you are all aware, the drug
traffic from Central and South America, through the Caribbean, is
an increasingly serious problem.
Treasury must do everything
that we can to work together with all Federal agencies who can
aid in this war on drugs.
To this end, I am asking the Assistant
Secretary of the Treasury for Enforcement and Operations to meet
-6-
with the Defense Department to develop a joint plan for
strengthening our anti-smuggling capabilities in the Caribbean
Basin.
Our budget contains a proposed Fiscal Year 1985 supplemental
of $4.1 million to provide security and related equipment for the
perimeter of the White House, Naval Observatory, and Main
Treasury. We believe that these improvements are critical due to
the recent events world-wide and the increased threat of
terrorist activity in this country.
In order to provide improved handling of seized property, we
are requesting $6 million in Fiscal Year 1985 and $8 million in
Fiscal Year 1986 for a new Customs Forfeiture Fund. This Fund
was authorized by Congress last year in both the Trade and Tariff
Act of 1984 and the FY 1985 Continuing Resolution. The Fund
operates using the net proceeds from the disposition of seized
and forfeited merchandise and currency. We will use the Fund
primarily to pay for expenses related to seizures and to equip
forfeited vessels, vehicles, and aircraft for use in narcotics
interdiction. We believe that this Fund not only will enable us
to increase significantly the profits from the sale of seized
assets, but also will increase the equipment available to us for
drug interdiction.
-7-
A fourth major objective of this budget is to continue major
efforts to modernize Treasury systems and equipment.
Even within
an overall spending freeze, we cannot postpone the introduction
of new technology and modern equipment.
These investments are
essential to the Department's ability to handle growing workloads
and to relieve future pressures for growth in personnel.
To help modernize the tax administration system, our budget
includes resources to continue two major projects now under
development —
the Automated Examination System and the Tax
System Redesign Project.
The Automated Examination System will
equip IRS enforcement personnel with modern equipment to help
them in the auditing of tax returns.
When this system is fully
implemented, productivity is expected to increase by as much as
25%.
The Tax System Redesign Project is a longer-term effort to
enable IRS to create an overall modernized system that will meet
the requirements of the 1990'8.
The U.S. Customs Service is seeking an additional $14
million to automate its major commercial processing procedures,
to develop an integrated data telecommunications network, to
replace the current 15 year old Treasury Enforcement
Communications System, and to apply new technology to drug
interdiction efforts.
Customs' Automated Commercial System will
-8-
involve automated processing of entries from the trade community,
eliminate redundancies, reduce paper, and enhance selectivity
procedures in the cargo review process.
The Department's fiscal bureaus will continue to improve the
government's financial systems, the means by which we collect,
manage, and disburse federal funds and finance the public debt.
The Financial Management Service is requesting an additional $14
million to complete replacement of the Service's headquarters
computer, continue efforts to upgrade the government's collection
and payment systems, and enhance the financial telecommunications
network.
The Bureau of the Public Debt is requesting $3.5
million for funding for the first phase of a project to replace
the Bureau's mainframe computer and to purchase new equipment for
the processing of Savings Bonds issue stubs.
A fifth major objective of this budget is to strengthen the
tax administration system to collect additional revenues that are
owed by taxpayers.
Beginning in FY 1987, we will add 2,500
positions for Examinations in each of three fiscal years, for a
total of 7,500 positions.
This initiative will produce an
estimated $4.6 billion in additional revenue during Fiscal Years
1987-1989.
This proposal is recommended by the President's
-9-
Private Sector Survey on Cost Control, and involves the
collection of taxes that are legitimately owed.
It is only
equitable that we not ask the vast majority of American
taxpayers, who pay their fair share of taxes, to have to
subsidize those who do not contribute.
To implement this
initiative, we will conduct some advance hiring at the end of
Fiscal Year 1986.
Our budget also provides, within existing resource levels,
for implementation of certain provisions of the Deficit Reduction
Act of 1984.
Specifically, we will enforce the new tax shelter
registration requirements, as well as provisions which will
provide additional information to IRS.
The tax shelter
-•
requirements are especially important as they will provide IRS
with the ability to identify and target abusive shelters for
enforcement action.
A sixth major objective of this budget is to accomplish
productivity savings through improved management and automated
systems.
Specifically, our budget identifies savings of $23
million and 748 positions.
The majority of these savings will
result from efficiencies in the processing of tax returns and
automation of the collection field function.
-10-
In addition to the major objectives that we have identified,
our budget anticipates a large and growing workload.
Some
examples include:
— IRS will process 178.7 million tax returns, an increase of
3% above the previous year.
— We expect to audit or contact over 2.7 million taxpayers,
close an estimated 3.3 million delinquent tax accounts,
and provide some form of assistance to over 55 million
taxpayers.
— We anticipate that 311 million passengers will arrive at
U.S. borders; this represents a growth of 4.3%.
We will
process 7.1 million formal entries of merchandise —
6%
more than in FY 1985.
— Treasury will issue over 80 million savings-type securities
and redeem more than 82 million.
We will make over 731
million payments, an increase of 2% above the prior year.
— We will print 6.6 billion pieces of currency, an increase
of 6.5%, and 35.8 billion postage stamps, an increase of
3%.
We will manufacture approximately 16.2 billion coins.
-11-
In summary, in terms of the major overall changes to the
budget, we are seeking:
— $67.1 million for program enhancements, related primarily
to the objectives that I have described;
— $14.6 million for increased workload, especially in the
area of tax administration;
— $262.4 million for price increases in such areas as
communications, office space, travel, and utilities; and
— an offset of $387.3 million in program reductions. These
include the 5% pay cut, the 10% savings in administrative
areas, and various productivity and one-time savings
throughout the Department.
FISCAL YEAR 1985 PROPOSALS
Our budget contains supplementals totalling $77.1 million
and rescissions totalling $9.5 million for Fiscal Year 1985.
The supplemental requests include $44.9 million to cover 50% of
the pay increase effective this past January and program
supplementals of $32.2 million.
The program supplementals include funds to cover the recent
postage rate increase for the Financial Management Service; to
establish the 13th Organized Crime Drug Enforcement Task Force in
Miami; to make certain security improvements to the White Bouse,
Naval Observatory, and Main Treasury; to provide a one-time
capitalization increase to the IRS' Tax Lien Revolving Fund; to
support the Customs Seizure Fund; and to establish User Fees at
Certain Small Airports.
The proposed rescissions of $9.5 million are in response to
Section 2901 of the Deficit Reduction Act of 1985.
That Section
requires executive branch agencies to achieve savings in costs
associated with motor vehicles, travel, consulting services,
printing, and public affairs.
Mr. Chairman, that summarizes the major proposals of the
Treasury Department.
I shall be happy to answer any questions
that the Subcommittee may have.
TREASURY NEWS
department of the Treasury • Washington, D.e. • Telephone 566-2041
Statement of the Honorable
Dr. David C. Mulford
Assistant Secretary for International Affairs
Department of the Treasury
before the
Foreign Operations Subcommittee
of the
House Appropriations Committee
on
Wednesday, April 3, 1985
Thank you, Mr. Chairman for this opportunity to share with
you and your committee members my thoughts on the economic
situation in Israel. All of us share a strong interest in and
commitment to the stability and vibrancy of Israel's economy.
President Reagan told visiting Prime Minister Peres last October
9 that the Administration would work closely with his government
to avert balance of payments problems. It is in this spirit of
cooperation that the Administration has been holding talks with
Israeli officials over the past six months on their plans to lay
the foundation for a sustainable economic recovery. These talks
have been frank and constructive and are continuing.
Over the past decade or so Israel's economy has lost the
vitality it so clearly demonstrated in the 1950s and 1960s. Israel,
like most nations', had to face the many sharp changes in the
international economic environment of the 1970s, such as higher
oil prices, deeper than usual trade slumps, and generally higher
annual rates of inflation. In the case of Israel, these changes
were complicated by unique circumstances such as the 1973 War
and the loss of the oil fields in the Sinai. The economic adjustment required of Israel by these events was substantial. In
recognition of this special hardship and to ease the pain of
adjustment, U.S. economic and military assistance was increased
and the terms were eased.
Nonetheless, Israel has not fully adjusted to the new external
environment. As a result, its economy has reached an unsustainable
position with high rates of inflation, large balance of payments
deficits and anemic growth rates.
What we see today is an economy gripped by an increasingly
inflexible'1 system that has stifled its economic dynamism. The
Government's role in the economy and the size of its work force
B-75
- 2have expanded to the point where the budget deficit is no longer
supportable by existing resources. The ratio of central governmen t expenditure to GDP has been increasing along with the budget
icit.sectors
In addition,
real
wagehave
increases
in productivity
both the public and
def
private
in recent
years
exceeded
increases. Total demand for goods and services has thus been
outstripping supply and resulting in ever increasing price rises,
growing external imbalances and more recently declining foreign
exchange reserves.
The government's attempts to stabilize the economy generally
have been through administrative measures. For example, it has
tried to hold down prices and promote exports through subsidies.
However, the beneficial impact on prices and exports has been
temporary. These measures, on the other hand, have added to
government expenditures and increased the need for higher taxes.
Israel already has one of the highest marginal tax rates in the
world, so many Israeli citizens go to great lengths to avoid
paying taxes.
Meanwhile, the Central Bank's role in financing the budget
deficit has been increasing. Until recently the government was
able to finance a major portion of its deficit by selling debt
instruments. At present, however, Israeli citizens are less
willing to hold government debt instruments because of high
inflation and economic uncertainty. As a result, to finance the
deficit the Central Bank has been expanding the money base,
which brought inflation to over 1000% just prior to the wage/price
controls which were launched last November. While the wage/price
agreements have reduced the monthly rate of price rises, inflationary pressures remain very strong under the surface.
Israel's inflationary environment, previous stop-go policies
and very high marginal tax rates have hurt the investment climate.
As a result, the investment/GDP ratio has dropped from above
30 in the 1960's to around 20 in recent years. Investment in
plant and equipment, which is so essential for future growth and
employment, has suffered an even greater decline. More recently,
there also has been a loss in foreign investors' confidence.
P
!f- ? ?S a r e f l e c t i °n of this diminished confidence, Israel's
official reserves have been decreasing since last June.
If Israel is to regain the confidence of domestic and foreign
iHnrnn?J!;.ltaiaU^h0fitle8 m U S t r e s t o r * market incentives to their
Mine?
L r ' ° e / ; t h e e c o n o m Y- We are encouraged by Prime
"
*err*s' ^termination to correct the country's difficult
economic problems and desire to give market forces greater
intended a Lfl^" ***** taken a number of measures
aSree lith hit lalt* ^
P r o b l e m s. While I would not necessarily
111" s^ v iry S itivf te^Ho^' * ^" that ** *",
b
to date, more needs to be done' L T ' ' ^ ^
Y the results p
this fact and are working ^further m ^ a s u r e s t ^ 0 ^ 1 6 3
^ ^
- 3 A sharp reduction in government expenditures is key to
Israel's economic adjustment efforts. Last week the Knesset
approved the FY 85/86 budget which reflects a major cutback from
the expected level of expenditures for the fiscal year that
ended on Sunday, March 31. In the past, however, Knesset approved
budgets were routinely increased during the course of the year.
We hope that the recently passed legislation to improve expenditure
discipline will minimize this kind of deviation in the future.
To be truly effective in the Israeli environment, fiscal
restraint must be complemented by appropriate monetary policy.
The Israeli authorities need to find a way to reduce the amount
of money creation connected with the financing of the budget
deficit. In this regard, we believe that the authorities need
to devise a plan that would enable the government to finance its
deficits in a non-inflationary manner.
We expect to continue our dialogue with Finance Minister
Modai and his collegues as they develop additional measures that
will lay the foundation for a return to non-inflationary growth.
In these discussions, we will be reaffirming President Reagan's
commitment to provide financial support and we will be exploring
ways in which this support can be of maximum benefit to the
Israeli economy.
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 12:00 NOON
April 4, 1985
TREASURY'S 52-WEEK BJLL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for approximately $8,300 million of 364-day
Treasury bills to be dated
April 18, 1985,
and to mature
April 17, 1986
(CUSIP No. 912794 KB 9 ) . This issue will not
provide new cash for the Treasury, as the maturing 52-week bill
is outstanding in the amount of $8,282 million.
The bills will be issued for cash and in exchange for
Treasury bills maturing April 18, 1985.
In addition to the
maturing 52-week bills, there are $13,696 million of maturing
bills which were originally issued as 13-week and 26-week bills.
The disposition of this latter amount will be announced next week.
Federal Reserve Banks as agents for foreign and international
monetary authorities currently hold $2,138 million, and Federal
Reserve Banks for their own account hold $3,811 million of the
maturing bills. These amounts represent the combined holdings of
such accounts for the three issues of maturing bills. Tenders from
Federal Reserve Banks for themselves and as agents for foreign and
international monetary authorities will be accepted at the weighted
average bank discount rate of accepted competitive tenders. Additional amounts of the bills may be issued 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 bills held by them. For
purposes of determining such additional amounts, foreign and international monetary authorities are considered to hold $275
million
of the original 52-week issue.
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.
20239, prior to 1:00 p.m., Eastern Standard time, Thursday,
April 11, 1985Form 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.
B^-J6
- 2 Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. .Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
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. Each
tender must state the amount of any net long position in the bills
being offered if such position is in excess of $200 million. This
information should reflect positions held as of 12:30 p.m. Eastern
time on the day of the auction. Such positions would include bills
acquired through "when issued" trading, and futures and forward
,
transactions. 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, when
submitting tenders for customers, must submit a separate tender
for each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement, nor make an agreement to purchase or sell or otherwise dispose of any noncompetitive awards of this issue being auctioned
prior to the designated closing time for receipt of tenders.
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 yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
- 3 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 $1,000,000 or less without
stated yield from any one bidder will be accepted in full at the
weighted average bank discount rate (in two decimals) of accepted
competitive bids. The calculation of purchase prices for accepted
bids will be carried to three decimal places on the basis of price
per hundred, e.g., 99.923, and the determinations of the Secretary
of the Treasury shall be final.
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 18, 1985,
in cash or other immediately-available funds
or in Treasury bills maturing April 18, 1985.
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.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
In general, if a bill is purchased at issue after July 18,
1984, and held to maturity, the amount of discount is reportable
as ordinary income in the Federal income tax return of the owner
at the time of redemption. Accrual-basis taxpayers, banks, and
other persons designated in section 1281 of the Internal Revenue
Code must include i*i income the portion of the discount for the
period during the taxable year such holder held the bill. If the
bill is sold or otherwise disposed of before maturity, the portion
of the gain equal to the accrued discount will be treated as ordinary income. Any excess may be treated as capital gain.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76 and 27-76, Treasury's single bidder guidelines, and this
notice prescribe the terms of these Treasury bills and govern the
conditions of their issue. Copies of the circulars, guidelines,
and tender forms may be obtained from any Federal Reserve Bank or
Branch, or from the Bureau of the Public Debt.
TREASURY NEWS
iportment of the Treasury • Washington, D.c. • Telephone 566-2041
April 8, 1985
J. Roger Mentz Appointed
Deputy Assistant Secretary of the Treasury for Tax Policy
Secretary of the Treasury James A. Baker, III, today
announced the appointment of J. Roger Mentz, a partner in the New
York City law firm of Mudge Rose Guthrie Alexander & Ferdon, as
Deputy Assistant Secretary of the Treasury for Tax Policy,
effective April 15, 1985.
Mr. Mentz, 43, will serve as Deputy to Assistant Secretary
Ronald A. Pearlman, who has principal responsibility for
formulation and execution of United States domestic and
international tax policies.
Mr. Mentz earned a B.S.E. degree with honors in chemical
engineering from Princeton University in 1963. He received his
L.L.B. degree from the University of Virginia Law School in 1966,
where he served on the editorial board of the Virginia Law Review
and was a member of the Order of the Coif. Mr. Mentz has
practiced law with Mudge Rose since his graduation from law
school.
Mr. Mentz has served on the Executive Committee of the New
York State Bar Association Tax Section since 1973 and served as
Chairman of the Tax Section from 1982-83. He is also a member of
the American Bar Association Section of Taxation. Mr. Mentz was
an Adjunct Associate Professor at the New York University Law
School L.L.M. Program from 1979-80, where he taught a course in
international taxation. He has also written extensively on a
variety of tax issues.
Mr. Mentz and his wife Marilyn have two children, Steven and
Tanna.
# # #
B-77
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 8, 1985
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,673 million of 13-week bills and for $6,666 million
of 26-week bills, both to be issued on April 11, 1985,
were accepted todayRANGE OF ACCEPTED
COMPETITIVE BIDS:
Low
High
Average
13-week bills
maturing July 11, 1985
Discount Investment
Rate *
Rate 1/
Price
8.13%
8.14%
8.14%
8.42%
8.43%
8.43%
97.945
97.942
97.942
:
26--week bills
maturing October 10, 1985
Discount Investment
Price
Rate
Rate 1/
.
.
8.54%
8.57%
8.56%
9.05%
9.08%
9.07%
95.683
95.667
95.672
Tenders at the high discount rate for the 13-week bills were allotted 80%.
Tenders at the high discount rate for the 26-week bills were allotted 76%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Received
Accepted
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Accepted
399,950
17,439,850
25,550
68,555
41,160
45,830
1,167,265
73,285
38,370
65,730
41,680
3,635,050
390,800
$
44,500
4,415,105
23,550
43,555
41,160
44,830
101,090
53,285
33,370
62,730
31,680
1,387,050
390,800
: $
395,435
14,245,565
23,030
50,105
50,870
40,835
1,518,505
59,430
33,655
78,265
39,115
1,605,075
477,330
$
45,435
5,356,885
23,030
50,105
50,630
39,835
356,545
44,550
33,655
75,785
32,915
79,195
477,330
$23,433,075
$6,672,705
• $18,617,215
$6,665,895
$20,880,330
1,283,955
$22,164,285
$4,119,960
1,283,955
$5,403,915
: $15,792,065
:
1,183,405
: $16,975,470
$3,840,745
1,183,405
$5,024,150
1,201,835
1,201,835
:
1,100,000
1,100,000
66,955
66,955
:
541,745
541,745
$23,433,075
$6,672,705
: $18,617,215
$6,665,895
$
Izpe
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS
An additional $8,345 thousand of 13-week bills and an additional $47,255
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
y Equivalent coupon-issue yield.
B-78
TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2
FOR RELEASE AT 4:00 P.M.
April 9, 1985
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling approximately $13,700 million, to be issued April 18, 1985.
This offering will not provide new cash for the Treasury, as the maturing bills
are outstanding in the amount of $13,696 million. Tenders will be
received at Federal Reserve Banks and Branches and at the Bureau of
the Public Debt, Washington, D. C. 20239, prior to 1:00 p.m., Eastern
Standard time, Monday, April 15, 1985.
The two series
offered are as follows:
91-day bills (to maturity date) for approximately $6,850
million, representing an additional amount of bills dated
January 17, 1985,
and to mature
July 18, 1985
(CUSIP No.
912794 HS 6 ) , currently outstanding in the amount of $7,026 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,850 million, to be dated
April 18, 1985
and to mature October 17, 1985 (CUSIP No.
912794 JC 9 ) .
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.
The bills will be issued for cash and in exchange for Treasury
bills maturing April 18, 1985.
In addition to the maturing
13-week and 26-week bills, there are $8,282
million of maturing
52-week bills. The disposition of this latter amount was announced
last week. Tenders from Federal Reserve Banks for their own account
and as agents for foreign and international monetary authorities will
be accepted at the weighted average bank discount rates of accepted
competitive tenders. Additional amounts of the bills may be issued
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
bills held by them. For purposes of determining such additional
amounts, foreign and international monetary authorities are considered to hold $1,833 million of the original 13-week and 26-week
issues. $2,108 million is currently held by Federal Reserve Banks
as agents for foreign and international monetary authorities, and
$3,914 million is held by Federal Reserve Banks for their own
account. These amounts represent the combined holdings of such
accounts for the three issues of maturing bills. Tenders for bills
to be maintained on the book-entry records of the Department of the
Treasury
should be submitted on Form PD 4632-2 (for 26-week series)
B-79
or Form PD 4632-3 (for 13-week series).
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
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. Each
tender must state the amount of any net long position in the bills
being offered if such position is in excess of $200 million. This
information should reflect positions held as of 12:30 p.m. Eastern
time on the day of the auction. Such positions would include bills
acquired through "when issued" trading, and futures and forward
transactions as well as holdings of outstanding bills with the same
maturity date as the new offering, e.g., bills with three months to
maturity previously offered as six-month bills. 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, when submitting tenders for customers, must
submit a separate tender for each customer whose net long position
in the bill being offered exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
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 book-entry
records of Federal Reserve Banks and Branches. A deposit of 2 perS n L r f f p a r a m o u n t °J t h e bills applied for must accompany
SU h blllS from other
Itltt I K
?
s , unless an express guaranty of
lenders
" l n c o r P ° r a t e d ba *k or trust company accompanies the
PAGE 3
Public announcement will be made by the Department of the
Treasury of the amount and yield 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 $1,000,000 or less without
stated yield from any one bidder will be accepted in full at the
weighted average bank discount rate (in two decimals) of accepted
competitive bids for the respective issues. The calculation of
purchase prices for accepted bids will be carried to three decimal
places on the basis of price per hundred, e.g., 99.923, and the
determinations of the Secretary of the Treasury shall be final.
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 the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. 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. In addition, Treasury Tax and Loan Note Option Depositaries may make payment for allotments of bills for their own accounts and for account
of customers by credit to their Treasury Tax and Loan Note Accounts
on the settlement date.
In general, if a bill is purchased at issue after July 18,
1984, and held to maturity, the amount of discount is reportable
as ordinary income in the Federal income tax return of the owner
at the time of redemption. Accrual-basis taxpayers, banks, and
other persons designated in section 1281 of the Internal Revenue
Code must include in income the portion of the discount for the
period during the taxable year such holder held the bill. If the
bill is sold or otherwise disposed of before maturity, the portion
of the gain equal to the accrued discount will be treated as ordinary income. Any excess may be treated as capital gain.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76 and 27-76, Treasury's single bidder guidelines, and this
notice prescribe the terms of these Treasury bills and govern the
conditions of their issue. Copies of the circulars, guidelines,
and tender forms may be obtained from any Federal Reserve Bank or
Branch, or from the Bureau of the Public Debt.
TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2
FOR IMMEDIATE RELEASE
April 11, 1985
TREASURY OFFERS $4,000 MILLION OF 3-DAY
CASH MANAGEMENT BILLS
The Department of the Treasury, by this public notice,
invites tenders for approximately $4,000 million of 3-day Treasury bills to be issued April 15, 1985, representing an additional
amount of bills dated April 19, 1984, maturing April 18, 1985
(CUSIP No. 912794 GK 4) .
Competitive tenders will be received only at the Federal
Reserve Bank of New York up to 1:00 p.m. Eastern Standard time,
Friday, April 12, 1985. Wire and telephone tenders may be
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. Tenders must show the yield desired, expressed
on a bank discount rate basis with two decimals, e.g., 7.15%.
Fractions must not be used.
Noncompetitive tenders from the public will not be accepted.
Tenders will not be received at the Department of the Treasury,
Washington, or at any Federal Reserve Bank or Branch other than
the Federal Reserve Bank of New York.
The bills will be issued on a discount basis under competitive bidding, and at maturity their par amount will be payable
without interest. The bills will be issued entirely in book-entry
form in a minimum denomination of S10,000 and in any higher S5,000
multiple, on the records of the Federal Reserve Banks and Branches.
Additional amounts of the bills may be issued to Federal Reserve
Banks as agents for foreign and international monetary authorities
at the average price of accepted competitive tenders.
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.
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million.
This information should reflect positions held as of 12:30 p.m.,
Eastern time, on the day of the auction. Such positions would
include bills acquired through "when issued" trading, futures,
B-80
- 2 and forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e. g., bills with
three months to maturity previously offered as six-month bills.
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, when submitting tenders for
customers, must submit a separate tender for each customer whose
net long position in the bill being offered exceeds $200 million.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities. 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 yield 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. The calculation
of purchase prices for accepted bids will be carried to three
decimal places on the basis of price per hundred, e.g., 99.923.
Settlement for accepted tenders in accordance with the bids must
be made or completed at the Federal Reserve Bank of New York in cash
or other immediately-available funds on Monday, April 15, 1985.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
In general, if a bill is purchased at issue after July 18,
1984, and held to maturity, the amount of discount is reportable
as ordinary income in the Federal income tax return of the owner
at the time of redemption. Accrual-basis taxpayers, banks, and
other persons designated in section 1281 of the Internal Revenue
Code must include in income the portion of the discount for the
period during the taxable year such holder held the bill. If the
bill is sold or otherwise disposed of before maturity, the portion
of the gain equal to the accrued discount will be treated as ordinary income. Any excess may be treated as capital gain.
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 may be obtained from any Federal Reserve
2
Bank or Branch.
TREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April ll, 1985
CONTACT:
CHARLES POWERS
(202) 566-2041
UNITED STATES AND SRI LANKA SIGN NEW INCOME TAX TREATY
The Treasury Department today announced that a new income tax
treaty was signed with Sri Lanka in Colombo on March 14, 1985.
The proposed treaty will be sent to the Senate for its advice and
consent to ratification.
The treaty covers the U.S. Federal income tax and certain
Federal excise taxes, and the Sri Lanka income tax, including the
income tax based on the turnover of enterprises licensed by the
Greater Colombo Economic Commission.
The proposed treaty
provides for maximum rates of tax at source of 15 percent on
dividends. Interest and royalties will be subject, in general,
to a maximum tax at source of 10 percent.
Interest, however,
will be exempt at source if paid by the Government of the United
States or Sri Lanka or by a political subdivision or local
authority of one of the Governments, or if received by one of the
Governments or a Government agency. Rental payments for the use
of tangible personal property are subject to a maximum tax at
source of 5 percent.
The treaty contains provisions dealing with the taxation of
business profits, personal service income, capital gains and
other types of income, as well as provisions relating to the
administration of the treaty and the taxes to which it applies.
The treaty provides for the exchange of information relating to
income and certain other taxes.
The treaty contains provisions, similar to those found in
other U.S. tax treaties, designed to prevent abuse of the treaty
by limiting its benefits to persons properly entitled to those
benefits.
The proposed treaty contains an article relating to grants
which may be made by the Government of Sri Lanka for purposes of
economic development.
The article simply confirms current U.S.
B-81
-2law by providing that in appropriate circumstances such grants
will be treated for U.S. tax purposes as contributions to capital
and not as income.
The treaty is subject to ratification. It will enter into
force upon the exchange of instruments of ratification. The
provisions of the treaty will have effect in respect of taxes
withheld at source on the first day of the second month following
entry into force; in respect of other taxes, it will have effect
for taxable periods beginning on or after the first day of
January of the year in which the treaty enters into force.
A limited number of copies of the treaty are available from
the Public Affairs Office, Treasury Department, Main Treasury
Building, Room 2315, Washington, D.C.
20220, telephone (202)
566-2041.
o 0 o
TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 11, 1985
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION
Tenders for $8,337 million of 52-week bills to be issued
April 18, 1985,
and to mature
April 17, 1986, were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Low
High
Average -
Discount
Rate
8.43%
8.44%
8.44%
Investment Rate
(Equivalent Coupon-Issue Yield)
9.14%
9.15%
9.15%
Tenders at the high discount rate were allotted 56
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Location
Received
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS
B-82
Price
91.476
91.466
91.466
Accepted
$
378,680
21,224,795
17,105
25,955
61,645
26,315
1,145,525
80,270
19,430
51,660
8,560
2,020,325
163,440
$25,223,705
$
28,680
7,574,570
17,105
25,955
30,645
26,295
106,585
60,270
19,430
47,960
8,560
227,325
163,440
$8,336,820
$22,957,830
740,875
$23,698,705
1,400,000
$6,070,945
740,875
$6,811,820
1,400,000
125,000
$25,223,705
125,000
$8,336,820
TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 12, 1985
RESULTS OF TREASURY'S AUCTION OF 3-DAY CASH MANAGEMENT BILLS
The Treasury has accepted $4,001 million of the $28,858
million of tenders received at the Federal Reserve Bank of New
York for the 3-day Treasury bills to be issued April 15, 1985,
and to mature April 18, 1985, auctioned today. The range of
accepted bids was as follows:
Discount Investment Rate
Rate
(Equivalent Coupon-Issue Yield)
Price
Low 8.39% 8.52% 99.930
High
8.46%
Average
8.43%
8.52%
8.52%
Tenders at the high discount rate were allotted 30%.
B-83
99.930
99.930
rREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone 566-2041
Statement of the Honorable
James A. Baker, III
of the United States of America
Concerning the Problem
of Mixed or Tied Aid Credits
Before the Meeting of the
OECD Council at Ministerial Level
April 11, 1985
Paris, France
Over the course of the last four years, the OECD export
credits group has made remarkable.progress in eliminating export
credit subsidies. Unfortunately, the proliferation of tied aid
credits designed for commercial advantage threatens to undermine
this progress.
The United States deeply regrets that the trade and
development assistance committees were unable to fulfill the 1984
ministerial mandate to take "prompt action" to improve both
discipline and transparency over tied aid credits. While the
export credits group has made progress improving transparency, and
the Development Assistance Committee has made technical
improvements in both transparency and discipline, neither
committee has moved in any meaningful way to install the
discipline necessary to eliminate the trade- and aid-distorting
effects of using low grant element tied aid credits. As a result,
the use of tied aid or mixed credits to promote exports and
penetrate markets at the expense of real development continues
unabated and — even more disturbingly — may be expanding.
The United States has proposed several ways to improve
discipline and thus elimate the commercial abuse of tied aid
credits. The clearest, simplest, and most direct solution is the
U.S. proposal to ban tied aid credits with a grant element below
50 percent.
By significantly raising the grant element, this approach
helps ensure that tied aid credits are used for sound development
purpose by raising the cost of using them for export promotion.
It is an objective test. It can be administered and enforced. It
reduces the temptation, whatever a country's official aid policy
or motivation, to misuse its foreign aid for commercial ends. The
average grant element for all official development assistant (ODA)
loans was 56-58 percent compared to 25 percent for tied or mixed
aid credits.
B-84
- 2 Let us keep the distinction between development assistance
and commercial credits that is so important not only to
industrialized countries but to the developing countries as well.
The United States recommends again that all OECD ministers agree
to improve discipline by substantially increasing the minimum
permissible grant element and commensurately raising the grant
element in the definition of official development assistance.
If that cannot be achieved immediately, I would propose the
following package as an interim solution:
A commitment for OECD ministers to improve discipline and
elimate the commercial use of tied aid credits.
As a first step, a significant increase in the minimum
permissible grant element.
General acceptance of the European Community's transparency
proposal on definition, prior notification, and prior
consultation, with the details-to be worked out by the
appropriate OECD committees.
New instructions to appropriate OECD committees to develop,
and to implement by a date certain, specific measures to
improve discipline further. (At a minimum, a study of
alternatives should be completed by September 30, 1985, and
the specific measures should be fully in force by the next
OECD ministerial.)
If progress on an adequate alternative for further improving
discipline is not possible and fully in force by the next
ministerial review, a ministerial committee that a further
increase in the permissible grant element will automatically
come into force.
We have an opportunity at this ministerial to move to
eliminate this unfair practice and resolve this increasingly
troublesome issue. I urge, therefore, that we set a substantial
increase in the grant element as our goal. I think we can and
should move to that goal now. if we are unable to agree to
increasing the discipline in one step, then I urge we adopt this
compromise package as an interim approach to resolving the vexing
problem of tied aid credits.
The U.S. has been exercising restraint in the use of mixed
credits because we view the practice as unfair. If, however, the
continued refusal of a few to agree continues to prevent progress
2?Mnh^S,fUn * ?* m o s t view as particularly troublesome, the U.S.
will have no alternative but to follow the advice of many in our
o n r ^ i L f 0 u U " e f t 0 U S t h a t w e " f i 9 h t " " with fire" and
ourselves
wide like
use of
this device.
This make
we would
to avoid.
TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2041
Statement by the Honorable James A. Baker III
Secretary of the Treasury
of the United States of America
Concerning
Progress In Implementing the Debt Strategy
Before The
Meeting of the OECD Council
at Ministerial Level
April 11, 1985
Paris, France
Mr. Chairman, Secretary General Paye, distinguished
colleagues. It seems appropriate that the first international
meeting I attend as Secretary of the Treasury should be at the
OECD. In its early days, as the Organization for European
Economic Cooperation, and in its present, broader configuration,
this organization has exemplified international cooperation. The
progress made over the years in improving the living standards of
our nations in indicative of the value of our working together.
I look forward to being a part of the long, productive
relationship the U.S. has had with the OECD and to building
close, working ties with my colleagues in this room.
The Debt Strategy
International debt problems in the developing countries
emerged clearly, as we all know, about two and a half years ago.
Initially, there were calls for generalized solutions to the
financing needs of the debtor countries. Many of these proposals
entailed quite dramatic departures from traditional practices and
would have involved generalized debt relief for all debtors,
regardless of their particular need or circumstances.
Fortunately, these proposals did not find widespread favor in
either developed or developing countries — for, had they been
adopted, they would have proved counter-productive. More
appropriately, a five-point strategy was devised, based on a
case-by-case approach to debt problems.
B-85
-2-
This case-by-case approach, still in force, involves the
following key elements:
1) Adjustment by debtor countries to restore balance of payments
equilibrium and growth;
2) Sustained noninflationary growth and open markets in
industrial countries to provide export opportunities for LDCS;
3) Provision of adequate resources for the international
financial institutions, with a central role for the IMF;
4) Continued commercial bank lending to countries making
determined adjustment efforts;
5) Selective bridge financing by the financial authorities of
industrial countries.
This strategy has envolved over time and been strengthened as
needed. For example, at last year's London Summit it was
recognized that year-by-year rescheduling might not be necessary
or appropriate for all debtors. Banks and governments were
encouraged to consider multi-year rescheduling agreements for
certain countries which have undertaken successful, sustainable
efforts to improve their performance and external payments
position.
Progress in Implementation
Reviewing actual performance over the past year in light of
these debt strategy elements suggests that clear progress has
been achieved. Developments to date have been consistent with
the eventual resolution of the problem. Let's look at where we
stand .
Last year we saw a strong acceleration of LDC real growth.
We estimate LDC real GNP rose almost 4.5 percent in 1984, and
expect a continuation near this rate in 1985 and 1986. This
average does, however, conceal a wide range of variation in
performance among LDCS. The best performance has been in some of
the dynamic Asian countries, most of which avoided serious debt
problems by adjusting within a few years to the 1979-80 oil price
shock. For 1985 and 1986, we expect real growth in the 6-8
percent range in the Asian region.
-3-
These last figures suggest that the industrial nations have
also worked hard at fulfilling their role in the strategy.
Improved average real growth in OECD economies — 3.5 percent in
1984 excluding the U.S. — and particularly strong U.S. growth —
6.8 percent in 1984 — has expanded markets for LDC exports
considerably. We will focus more heavily on the OECD economic
situation tomorrow, but it is clear that by providing increased
export opportunities for the LDCS, some OECD countries have
played an important role in their adjustment efforts.
The IMF has played a central and constructive role in
implementing the debt strategy. The quota increase, the
expansion and modification of the GAB, and other borrowing
arrangements have provided the IMF with sufficient resources to
meet foreseeable needs for temporary balance of payments
financing over the next few years. The IMF'S effectiveness in
promoting economic adjustment has helped catalyze countries.
Two years ago skeptics questioned whether the case-by-case
approach would provide adequate financial assistance. In
practice, this approach generally has resulted in sufficient
levels of financial flows. Private banks have reduced their
net new lending from earlier unsustainably high rates but have
remained a significant factor in support of the adjustment
process, providing some $18 billion to non-oil developing
countries in 1983. And from the beginning of 1983 through 1984,
agreements have been concluded, or reached in principle, for
rescheduling of debt to commercial banks for 30 countries
amounting to about $144 billion.
While we have made some progress, much remains to be done to
restore fully the conditions for sustainable growth. Developed
and developing countries, commercial banks and the international
financial institutions must all continue to share the
responsibility for ensuring a successful outcome.
There is a clear willingness among many debtor governments to
take the measures needed to restore balance to their economies.
But in some cases, there have been problems in keeping countries
moving in the right direction. Some of the major debtors have
only recently adopted, or still need to implement, effective
adjustment measures. Others have seen marked improvement in
external positions, but the sustainability of this improvement
depends heavily on the successful reduction of internal
imbalances, and the creation of an environment more conducive to
growth. In many cases, both domestic and external adjustment
efforts should be reinforced, including the adoption of more
realistic exchange rates, improving the functioning of domestic
markets, reducing fiscal imbalances, and liberalizing trade and
investment regimes. There is a pressing need to reduce
inflation, both through the standard macroeconomic policy tools
and through complementary measures such as wage policy and
financial reform. These are often politically difficult
measures, yet they are crucial for the restoration of sustainable
growth and creditworthiness.
-4OECD growth is likely to be slower this year, as the U.S.
moves to a somewhat lower but more sustainable growth rate. Many
observers feel that average OECD growth of 3-1/2 percent is
required to expand LDC export markets. I think OECD growth of
3-1/2 percent is sustainable and hopefully the minimum we will
experience over the medium term if all OECD countries take
necessary action to implement domestic policies that address our
respective barriers to stronger economic performance. We can
thus provide open, growing markets in support of developing
countries' adjustment efforts. It is particularly important that
Europe and Japan do this as the U.S. economic expansion moderates
in 1985.
Recently, net new lending to less developed debtors by
commercial banks has slowed. To some degree this was expected.
It reflects in part lower current account deficits in the
countries concerned as well as prudential concerns. Most of this
new lending is occurring only under commitments which are part of
IMF supported packages of policy reform and debt restructuring.
There is, perhaps, a natural tendency to look only at past
problems rather than at present adjustment efforts and the future
beneficial impact of policy changes that have occurred both in
developing and developed countries. Decisions to lend should be
considered not only in the context of traditional calculation of
expected profits compared to expected risks, but against the risk
of not taking action to help solve the current debt problem. I
believe that a moderate but regular increment of new credit for
countries that are adjusting their economies is essential for
the resumption of growth and creditworthiness. Bankers must see
themselves as an important part of the equation to resolve the
debt problem over the medium term.
Some have looked to the debt strategy for a quick-fix or
simple solution. But the debt situation is the accumulation of
years of problems and will not be improved overnight. I think it
is useful to view the strategy as a road map. It shows us the
unique route to our destination — sustainable growth and the
restoration of creditworthiness in troubled debtor nations. We
have already traveled many miles down the road and successfully
hurdled some obstacles in our path. Yet some distance remains,
and it will take time to arrive at the end of our journey. While
the general situation continues to improve, we will be faced with
country problems of varying degrees of seriousness from time to
time. Unrelenting efforts by developed and developing countries,
###
commercial banks and the international
financial institutions to
U
^
responsibility
outlined
in
the debt strategy will, I
h
think, help ensure that we arrive safely at our destination.
TREASURY NEWS
ipartment of the Treasury • Washington, D.c. • Telephone 566-2041
(Corrected Copy)
STATEMENT BY
JAMES W. CONROW
DEPUTY ASSISTANT SECRETARY FOR INTERNATIONAL AFFAIRS
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON INTERNATIONAL DEVELOPMENT INSTITUTIONS
AND FINANCE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
U.S. HOUSE OF REPRESENTATIVES
APRIL 16, 1985
Mr. Chairman, it is a pleasure to appear before the
Committee to present the Administration's legislative
proposals for the multilateral development banks, or "MDBs.
In negotiating these proposals, the Treasury Department
made every effort to keep the Committee informed and to
take its views into account. We trust that the results of
our negotiations will have your support.
African Development Fund
The first program which I would like to address today
is the replenishment of the African Development Fund, or
"AFDF". This particular institution is designed to help
advance our humanitarian objectives. In recent months, we
have all been struck by the-plight of hungry people in
Africa and by the bleak economic prospects for the region.
However, it is generally acknowledged that the longterm food problem can only be solved by putting Africa in c
position where it can produce more food for itself, and
this cannot be done without development assistance.
B-86
- 2 The African Development Fund replenishment is in large
part targeted to precisely that purpose. The proposal is
to participate in the $1.5 billion Fourth Replenishment of
the African Development Fund with a U.S. contribution of
$225 million dollars over three years. The United States
would be the largest single donor, providing 15.4 percent
of the total — followed by Japan with 14 percent and Canada
with 9.5 percent.
In the negotiations, we succeeded in obtaining a commitment that ninety percent of replenishment resources would
be allocated to countries with per capita GNPs of less than
$510 per year. The remainder is to go to countries with
per capita GNPs of less than $990. This will help meet the
developmental needs of the poorest African countries, whose
per capita incomes are low and whose capacity to repay
external debt is limited.
During the replenishment, 40 percent of the lending
will be given to projects aimed at meeting basic food
requirements (including food production, processing,
storage, marketing, and distribution). Human resource
development and maintenance through educacation and health
projects will also be emphasized and are slated to receive
15 percent of AFDF lending. The Fund will lend 10 percent
of its resources for basic infrastructure (water supply and'
sewage, telecommunications, and electricity) which provide
services to the urban or rural poor. Twenty-five percent
of Fund lending will go for transportation projects which
would provide market outlets for agricultural produce or
private trade or would better integrate transport systems to
improve the delivery of food or other priority commodities.
We succeeded in limiting the level ,of non-project lending
to five percent of the total replenishment.
The United States has a strong humanitarian interest,
in aiding Sub-Saharan Africa, as well as important political
and security interests.
Economic development has been particularly slow in Africa
over the past decade. Part of this poor performance can be
attributed to inappropriate economic policies. In addition, •
Sub-Saharan Africa has had to cope with an extensive drought,
adverse external economic conditions, such as world-wide
recession and falling commodity prices, and civil conflict.
Recently there has been a growing awareness among African
countries of the need to reassess their development strategies
to make better use of available resources. While Africa
continues to face a difficult development challenge, more
African governments now agree that properly valued exchange
rates, incentive prices for farmers, and a better allocation
in investment resources are important preconditions to
economic growth. Whether this new realism will result in
more effective economic policies and better results depends
on how quickly African Governments act and how much support
the international community will provide.
-3The economic crisis in Africa is especially evident
in agriculture. Few countries have seen their agricultural output increase by as much as 3 percent a year
during the 1970s and early 1980s. In a number of countries, agricultural production has either stagnated or
actually fallen during this period. At the same time,
population has been increasing by an annual average of
2.5 percent in the 1960s, 2.7 percent in the 1970s and
about 3 percent in more recent years. Per capita food
production is currently less than 80 percent of the level
which prevailed during the period of 1961-65. Not surprisingly the result has been an increasing dependence
on imported food for consumption — using scarce foreign
exchange resources that are then unavailable for investment.
The problems facing African countries reinforce the
need for major adjustment in economic policies, especially
the removal of the economic policy bias against agricultural
production. In instances where countries have undertaken
appropriate economic adjustment measures, there has been
an encouraging increase in the production of agriculture.
While more countries are determined to alter policies to
improve the outlook for economic revival, concessional
assistance is an essential complement in support of their ,
efforts.
The African Development Fund, with its emphasis on
lending for agriculture, water supply, health and transportation can be an effective channel for responding to
the key development problems of Africa.
The nations of Africa view the African Development
Bank and Fund as their regional development institutions.
While other development agencies may supply more funds,
the African Development Bank and Fund are particularly '
important as regional forums for discussing continentwide financial and economic issues. The level of U.S.
participation in the Bank and Fund is viewed by many
in Africa as a gauge of U.S support for the development
objectives of African countries.
I hope the Committee will support the Administration's
proposal for the African Development Fund.
International Finance Corporation
A fundamental component of the Administration's
approach to development assistance is the conviction
that the private sector holds the key to economic growth
in developing countries. Treasury's 1982 assessment found
that those nations that have encouraged private sector
development, both domestic and from abroad, have generally
achieved more rapid and sustainable growth than those which
- 4 have not. Put simply, market-oriented private enterprise -by responding to profitable opportunities — produces jobs,
earns foreign exchange and builds a technical and managerial
base in the labor force.
The proposal to participate in the capital increase
for IFC is our third — and most important — step toward
strengthening MDB support for the private sector in developing countries. In many respects, Treasury's 1982 assessment
found that direct support from the MDBs for the private
sector had lagged in recent years. Since taking office,
the Administration has joined with other member countries
to support:
— the start-up of a small but well-targetted equity
investment program in the Asian Development Bank.
— the creation of the Inter-American Investment
Corporation, and
— now, a significant redirection and capitalization
of IFC.
The Administration's proposal is for a $175 million
U.S. share in a five year $650 million dollar IFC capital
increase, that would double IFC's authorized capital to $1.3
billion.
Specifically, the Administration's legislative proposal
would authorize the U.S. Governor to vote in favor of the
proposed capital increase, to subscribe subject to appropriations to IFC shares valued at $175 million and to authorize
the appropriation of $175 million to pay for these shares.
The previous capital increase for IFC was approved in
1977. The final U.S. subscriptions were provided by the.
Congress in 1981. The 27 percent U.S. share of IFC capital
is being maintained in the proposed replenishment.
IFC has made valuable contributions to the economies
of developing countries through a broad spectrum of industries, including agrobusiness, building materials, chemicals, wood products, tourism, energy and financial services.
Since its establishment in 1956, IFC has invested $5.2
billion in 83 countries.
IFC is also doing pioneering work to improve the environment for direct foreign investment and to increase the
flow of international equity capital. IFC has provided
technical assistance to help developing country governments
write legislation to attract foreign direct investment. It
has supported the formation of several new equity investment
funds designed to foster more rapid development of emerging
capital markets in some of the developing countries. We
commend this initiative and are encouraging IFC to expand
its efforts in this area.
-5The proposed capital increase is designed to mobilize
foreign and domestic sources of capital at a commendable
ratio of six to one to be used in support of a five year
investment program totalling $4.4 billion. The program
feature major investment initiatives in the following
areas:
— For an Expanded Capital Market Development Program:
IFC is the principal — and in many countries, the
only — multilateral development institution providing technical assistance to develop new financial
instruments and to establish stock markets. In
addition, IFC is the main multilateral development
institution funding private financial firms. The
five year program would earmark 14 percent, or
roughly $500 million, for financial market and
institutional development.
— For Corporate Restructuring: The economic adjustment process which many developing countries are
going through has placed severe constraints on the
growth of the private sector and the availability
of credit. To help private firms adapt to these
constraints and become leaner, more efficient economic endeavors, IFC anticipates providing technical
assistance and investing about $210 million to support firms that can restructure their businesses
into more' promising/ areas. Financial resources will'
be provided for working capital loans, for long-term
capital or for equity, as circumstances may suggest.
— For Energy Exploration and Developments IFC contemplates investing about $100 million in exploration
activities with the participation of small independent
oil service or production companies, which have thus
far invested in developing countries only to a limited
extent. The IFC share of such ventures would normally
be limited to ten percent in order to maximize the
catalytic role of the Corporation. In addition, up
to $400 million more would be invested in other energy
ventures, including energy development and production,
through loans or equity.
— For Sub-Saharan Africa: Tradeoffs between sound and
creditworthy investment and sometimes risky developmental objectives are necessary in Sub-Saharan AFrica
where the national economic policies and the availability
of entrepreneurial talent are least favorable. To
enhance the chances for successful private sector
development, IFC has fashioned a $478 million, fourpronged strategy for Sub-Saharan Africa:
* More intensive promotional activities. IFC will
offer investment analysis and advisory services
through expanded venture capital companies. These
services will earn appropriate fees whenever possible.
-6* Taking a larger investment share. In circumstances
where it proves difficult to mobilize resources
for otherwise worthwhile projects in Africa
the IFC may waive its usual practice of limiting
participation to 25 percent of total capital.
* More and smaller projects. In full knowledge
that project preparation costs per unit of
investment will be higher, IFC will invest
in projects in the $1 million to $5 million
range to take advantage of the relatively
larger number of opportunities for smaller
scale investments in the region.
* More intensive use of development finance
corporations. To reach the many investment
opportunities below the $1 million level in
Africa IFC will make more intensive use of
well-run development finance corporations,
even if government owned.
The Administration believes that the proposal to
increase IFC capital — together with companion activities in the other MDBs — will give a strong impetus to
a private sector development effort that holds real
potential for long term growth.
The IBRD Selective Capital Increase
'
The IBRD — an estimated $11 billion lending program
in fiscal year 1985 — is the world's preeminent multilateral financial intermediary operating in developing
countries.
v^
The Administration strongly supports the IBRD and is
committed to working constructively with management and
other members to increase the Bank's effectiveness. In
addition to its proven expertise as an investment project
lender, we value highly the Bank's ability to provide
essential policy guidance and technical assistance, and
to act as a catalyst in encouraging private enterprise and
investment capital. The importance of the IBRD to recipient
countries is underscored by the very difficult adjustment
problems now faced by many developing countries and by the
Bank's very considerable efforts to encourage and facilitate
such adjustment.
The United States has regarded "equitable cost-sharing"
among donors to be a key element of our participation in
the MDBs and has over time gradually reduced the U.S. share
in all the MDBs, including the World Bank. To this end, the
United States has traditionally been a strong supporter
of "parallelism" insofar as it suggests that countries
which, by virtue of their economic growth, have taken a
larger quota in the International Monetary Fund (IMF),
-7should take up increased shares in the capital stock of
the IBRD. This is accomplished by Selective Capital
Increases, with the United States and other Bank members
supporting the practice of timing such SCIs to follow
closely IMF quota reviews.
In April, 1983, World Bank management proposed
initiating consultations with Bank members regarding
an SCI to "parallel" the increase in IMF quotas, which
had been adopted. The Bank's position was that an
increase of 141,800 shares — amounting to about $17
billion — would be necessary to parallel fully the
IMF's quota increases.
The U.S. position in subsequent SCI negotiations
had three key elements:
(a) to focus an SCI specifically on the need to
adjust shares and not as a means of supporting
increased Bank lending,
(b) to get the cost of the SCI to the United States
as low as possible, and
(c) to provide the United States with the option of
subscribing a level of shares sufficient to retain
a U.S. veto (i.e., 20 percent of the voting power)
over any amendment of the Bank's Charter.
After more than a year of negotiations, the Bank's
Executive Directors agreed on an SCI in May 1984 which
would increase the IBRD's capital stock by 70,000 shares
valued at $8.4 billion, of which 8.75 percent would
consist of paid-in capital. The proposed allocation
for the United States was 12,453 shares or 17.8 percent
of the total, valued at $1.5 billion. Following the SCI,
the United States would still retain a 20 percent share
of IBRD allocated shares — and thus, our veto over
amendments to the Charter.
The most significant adjustment in country shares
related to Japan. As a result of the SCI, Japan's ranking in the share capital of the IBRD — i.e., potential
voting power — changed from fifth to second position.
This.change, while logical in terms of Japan's relative
economic position in the world eocnomy, required a
prolonged period of difficult negotiations among the
Japanese and the three affected European countries
(Germany, Britain and France) for whom "ranking" was
sensitive from both a political and economic standpoint.
-8-
Japan's position as the second largest IBRD shareholder is in keeping with the size and importance of
the Japanese economy and the need for Japan to assume
greater responsibilities in the international financial
system, commensurate with its economic strength and
political importance.
U.S. subscription to the shares allocated by the 1984
SCI would cost $1,502 million of which 8.75 percent or
$131.4 million, would be paid-in. The Administration
has requested authorization for the full subscription
in FY 1986, with the necessary appropriations provided
in two equal installments in FY 1986 and FY 1987.
U.S. support for the SCI was conditioned on the
understanding that the IBRD's lending program will not
exceed a conservatively defined sustainable level of
lending (SLL). This is defined as the level of IBRD
lending to countries which can be sustained indefinitely
(in nominal terms) without any further increase in Bank
capital under current lending policies. A conservatively
defined SLL is important to insure we do not come under
pressure to subscribe to a new General Capital Increase
on the grounds that the Bank's lending volume would decline
without a GCI.
The SCI proposal shares the cost of IBRD membership
more equitably. As a measure of support for an effective
institution, we urge the Committee's favorable action.
Conclusion
The proposed legislation for the African Development
Fund, International Finance Corporation and the World
Bank is the result of three extended negotiations carried on over the last two years. I know you are aware,
Mr. Chairman, of the course of those discussions.
Appropriations to fund these programs are included
in the President's FY 1986 budget request. Thus, timely
enactment of this legislation is essential.
I hope the Committee will conclude that these
proposals are positive contributions to the U.S foreign
assistance program and that the legislation merits your
support.
iREASURY NEWS
lartment of the Treasury • Washington, D.c. • Telephone
FOR IMMEDIATE RELEASE
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
April 15,- 1985
Tenders for $6,863 million of X3-week bills and for $6,851 million
of 26-week bills, both to be issued on April 18, 1985,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:
Low
High
Average
13-week bills
maturing July 18, 1985
Discount Investment
Rate
Rate 1/
Price
26-week bills
maturing October 17, 1985
Discount Investment
Rate
Rate 1/
Price
8.00%a/
8.05%
8.04%
8.23%
8.27%
8.27%
8.28%
8.33%
8.32%
97,978
97.965
97.968
8.71%
8.75%
8.75%
95.839
95.819
95.819
a/ Excepting 2 tenders totaling $690,000.
Tenders at the high discount rate for the 13-week bills were allotted 99%,
Tenders at the high discount rate for the 26-week bills were allotted 76%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
:
Received
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Tjrpe
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS
$
388,540
14,591,640
27,225
60,985
60,005
47,650
1,080,280
82,505
17,345
67,565
43,015
1,614,395
396,065
:
$
:
:
:
'>
:
:
1
:
385,185
16,758,995
23,205
36,870
64,260
48,675
1,069,090
64,695
16,270
51,895
33,595
1,513,720
426,520
$
35,185
5,787,875
23,205
36,870
60,960
47,475
207,950
28,495
16,270
51,675
23,595
104,720
426,520
$18,477,215
$6,862,855
:
$20,492,975
$6,850,795
$15,607,990
1,308,195
$16,916,185
$3,993,630
1,308,195
$5,301,825
:
$17,190,150
1,127,925
$18,318,075
$3,547,970
1,127,925
$4,675,895
1,304,630
1,304,630
:
1,250,000
1,250,000
256,400
256,400
:
924,900
924,900
:
$20,492,975
$6,850,795
$18,477,215
U Equivalent coupon-issue yield.
B-87
$
38,540
4,895,540
27,225
60,985
60,005
47,650
324,080
47,455
17,345
67,565
38,015
842,385
396,065
Accepted
$6,862,855
:
:
2041
rREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone 566-2041
"HISTORIC" TAX REFORM:
THE POPULIST CORRECTION
REMARKS BY
RICHARD G. DARMAN
DEPUTY SECRETARY OF THE TREASURY
BEFORE THE
INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION
WASHINGTON, D.C.
APRIL 15, 1985
Today, of course, is tax day. I wish I could brighten the
day by describing in detail the new tax system that the President
soon will be recommending to the Congress. But I cannot. The
Treasury consultations have not yet been completed, and the
President has not yet made decisions.
So I hope you will not mind if, rather than focusing on
particular reform proposals, I offer a perspective on the reform
movement which is giving rise to them.
The perspective is, as you will see, somewhat idiosyncratic.
It gives greater weight to the political and sociological impetus
for reform than it does to the power of economic theory. But in
so doing, I think it makes a more persuasive case that reform
clearly must come. (This perspective may give offense to some
economic theorists. But I hope they may find some consolation in
the greater confidence that reform is coming -- and that they
may, therefore, take full credit one day.)
"Historic" Tax Reform
In each of the past two State of the Union messages, in
countless campaign speeches, and most recently in his Saturday
radio talk, the President of the United States has referred to
the next stage in tax reform as "historic." That is a dramatic
characterization.
But, of course, one must be skeptical of political rhetoric.
In a media world that seems to have little time for the
ordinary, politicians often seek to distinguish themselves with
rhetorical excess — even when (or especially when) their
substantive material is not quite up to distinction.
Particularly since Viet Nam, Presidential rhetoric has had to
hear a special burden of suspicion. The light that President
Johnson claimed to see was at the end of too long a tunnel. And
President Nixon's rhetoric compounded the problem. He showed too
strong an attraction toward the false superlative and the
hackneyed use of words like "historic." (One of my Nixonian
favorites
his
statement
announcing
Smithsonian
agreement
of
B-88
history
1971.ofwas
He
the
termed
world.
it the
It then
greatest
lasted
monetary
athe
little
agreement
over a year!)
in the
Page 2
Even in understatement
^ ^ / ^ i M U t ^ ^ n f r e c a l l s
formulations that somehow strained "edibi
Y
^ ^
rather vividly his reported remark "P° n
,.y A n d o f c o u r
China. "You aotta admit that s a great » a ^
'
po:
of the term "historic."
, _
. . . ,
One might understandably ask whether the President's
characterization is apt. Is comprehensive tax reform even likely
to be enacted? (It has, in one form or another, been talked
about for vears — without finding its way into law.) And if
bold reform is to be enacted this year, as the President
suggests, is it "historic" merely in the obvious sense? Or does
its possible enactment reflect some deeper historical force —
which may be movinq us toward action now? What is that force?
And are those who would resist it likely to be successful?
I shall try to suggest answers to these questions as I touch
upon the narrower subject of our tax reform program and its
prospects.
Business As Usual?
From one perspective, this talk of bold reform might all be
construed as business as usual. A President has proposed a
study. But more than a year after the President's call for
reform, he has not yet endorsed a specific legislative proposal,
and the Treasury Department is still developing options.
At an abstract level, there is widespread public support for
change. Indeed, it is said that there are only two categories of
people with views about the current tax system — and both sets
of views are negative: those of men and those of women. Yet
when it comes to particulars, there are at least as many
categories of people who oppose reform as there are provisions in
the tax code.
The prospects for stalemate — or for degeneration into
conventional incrementalism — would seem to be dominant.
From another perspective, however — the correct one in my
view — there is obvious reason to think there is more here than
mere political puffery.
It is true that the President has not yet introduced
his own detailed proposals. Those will be advanced in
about a month. But he has established certain clear
parameters. Among these, we take as given the
following firm commitments:
o
we must reduce personal income tax rates
substantially, bringing the top rate down to
35 percent, or lower if possible;
o
we must raise the personal exemption in order to
provide greater fairness for families, and allow
most families at or near the poverty line to be
freed from income taxation altogether;
o
we
increase
must curtail
the perceived
unproductive
fairness
taxofshelters,
the tax system;
and
Page 3
o
we must reduce corporate rates in a manner that is
consistent with overall interests in capital
formation;
o
we must preserve incentives for homeownership by
preserving a home mortgage interest deduction; and
o
we must achieve reform on a basis that is revenue
neutral (in static terms) — that is, overall tax
"reform" must produce greater fairness,
simplicity, and growth, and not a tax increase in
disguise.
Those who know the figures will appreciate that to
be bound by these few basic parameters is inescapably
to be driven toward major reform. Whatever number of
options and refinements one may consider, in the end
one is forced toward significant reform if one is to
meet the President's basic tests.
It is true, as one would expect, that there is
substantial resistance among those who seek to protect
one special interest or another. That resistance is
clearly visible. But it seems worth nothing that, in
due course, representatives of the general interest —
the people — can, and will, be mobilized. In this
respect, it seems not insignificant to recall that the
President was reelected with a 49-State electoral vote
majority in a campaign that had only one clear and
consistent substantive focus: The President said he
wanted to bring personal income tax rates further down,
not up.
It is true that because the President's specific reform
proposals are still being developed, mobilization of
public support — the general interest — has not vet
begun in earnest. But that hardly means that the
electoral mandate has been forgotten. And the time
that has been devoted to refinement of options is time
that has also been given to exploration of a basis for
bipartisan consensus. I should emphasize that the
quest for possible bipartisan consensus is not a
deviation from the President's basic reform guidelines.
It is, rather, an examination of options and
refinements that are consistent with those reformist
guidelines. So, when mobilization does begin, it will
do so on a basis that has a better chance of growing
and being sustained.
Strange Bedfellows
Even without full mobilization of potential popular support,
there are already remarkable signs that something unusual may be
happening here. The reform movement is quietly gathering
momentum.
Public opinion polls show overwhelming popular support for
tax simplification and tax fairness in the abstract. Some polls
are also beginnina to show substantial popular support even in
negatively
the light
And the
of
inclined,
business
public exposure
is
community,
beginning
to less
which
to popular
show
mostsigns
presumed
particulars.
of support
to be —
Page 4
especially among those who pay high effective tax rates relative
t0 0t
But th^mo^rinteresting phenomenon is the composition of
the leadership contingent for the emerging tax reform movement.
It includes some strange bedfellows:
.**.*_
A "conservative" Republican President who associates
himself with President John F. Kennedy;
Ra lph Nader and the Chairman of General Motors, who
independently agree on the merit of "Treasury I"-type
reforms; and
so _ C alled "neo-liberal" and "neo-conservative" leaders
in the House and Senate, as well as supposedly more
"moderate" chairmen of the respective tax committees.
(Indeed, it appears that the tax reform movement may even
bring the leaders of the Wall Street Journal's Washington bureau
and its New York editorial page closer together!)
The Rise of Market-Oriented Populism
But what accounts for this emerging phenomenon?
Is it merely an intellectual recognition of the merit of
so-called "supply-side" economic theory — or any economic theory
for that matter? I think not.
One of the most politically powerful of the reformist ideas
is that marginal income tax rates must be reduced
across-the-board. Yet this is arguably as much a "demand-side"
idea as it is "supply-side." The matter can be argued round or
flat, as sophistic geographers used to say.
One of the less politically powerful — and much more
politically contentious — reform ideas is that the tax code
should be neutral in its treatment of differing types of income
and neutral in its effect upon different categories of
investment. Insofar as this may be understood at all by the
general public, I suspect it is not understood as an economic
matter. Rather, it is understood as a matter of "fairness" (in
its application to tax shelters, for example) and as a matter of
Government's proper role — involving the general questions of
Governmental power to direct, influence, control, and intrude.
In any case, it seems implausible to suggest that economic
^science" could be driving the reform movement. That so-called
"science" is still in a primitive stage of development.
Admittedly, it gained sufficient status in the sixties to become
the subject of the Nobel prize. But in some ways that has proved
embarrassing: The prize is given to economists who hold
diametrically opposed views about the same empirical phenomena.
This is understandable — for, as Niels Bohr reportedly said,
Economics is harder than physics." But it is not onlv
understandable, it seems increasingly to be understood'. There is
a widespread recognition of the now-obvious fallibility of
economic science," in its current condition. A healthy,
correcting skepticism has arisen. And in the absence of
tll^
T G s c l e n c e ' P*°Ple have regained a degree of faith in
et h U
tuisctarlcommon
ation
practical
experience
sense
new
new-found
fonnS
^ft' ^
satisfaction
^5 P °,if irand
with
force
economic
with
for the
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status
seems
quotothan
be rooted
in-
Page 5
But what is the nature of that frustration? I suggest it is
basically populist.
It is not a destructive form of populism, as has sometimes
been known. Rather is seems, at this stage, to be a more benign
and potentially constructive form. It is anti-elitist, opposed
to excessive concentrations of power, oriented toward fairness
and toward a degree of levelling.
It is also increasingly market-oriented. That, of course,
has not been characteristic of past, American populist movements.
But it is a natural corollary of the populists' distaste for
concentrated power — in a world where the concentration of power
has shifted from private elites to governmental elites.
The focus of frustration ranges from the ridiculous to the
sublime.
At the level of the ridiculous, one thinks of the recently
mandated and soon-to-be-eliminated "contemporaneous logging
requirements" (as they are known in Washington) — that is, the
paperwork required of farmers, salesmen, firemen, and others who
use vehicles for both business and personal purposes. Intended
in part to get at tax abuses by proverbial Mercedes-drivers —
abuses that populists might have condemned — the regulations
promulgated by the world of Washington somehow went awry, and
created a populist backfire. The same was true of the failed
effort to withhold taxes on interest and dividends.
These abortive efforts are symptoms of a tax system in
trouble. Driven toward increasing complexity in the pursuit of
compliance and a broader revenue base, the system is eroding its
base of popular support. It seems almost to be bent on
self-destruction.
At a more rarified level, the rising populist reaction is
against the general phenomenon of governmental elitism gone awry.
It is against the pseudo-sophistication of the "policy sciences."
It is disappointed by the frustration of what proved to be the
false hopes of the sixties. It is disenchanted by the
v/ell-intentioned failures of the "best and the brightest."
In this sense, it is represented intellectually by the rise
of the political neo-ists — the "neo-conservatives" and the
"neo-liberals" — both sets of which reflect a disenchantment
with the liberalism of the recent past and an increasing
appreciation of market-oriented policies. But fundamentally, the
populist reaction is just that. It is not an intellectual
movement.
The Rise of White-Collar Populism
This is not to say that the populist movement is not deep.
In my view it is, but along a heavily emotional dimension. And
it is, I think, broader than may conventionally be recognized.
It extends beyond stereotypical "blue-collar" and "red-neck"
America — well into the vast world of the white-collars. I do
not mean merely to refer to the recently fashionable "Yuppies."
Indeed, I mean particularly to focus on what often seem to be the
forgotten white collar workers: the non-Yuppies, the ones who
have made so
position,
collars"
the
itto
to"Rinso-blue
speak.
white collar
collars"
clothes
orbut
thenot
"pass-for-whiteto Yuppie power or
Page 6
Here, I think, are legions of quiet populists. We tend t o
forget how many "workers" are now "white-collar -- that is
people, who dress more like professionals than like hard-hats.
Excludina service workers, there are about 55 million white
collar workers in America today — double the number in 1960.
They represent almost 55 percent of the workforce (compared to
less than 30 percent for blue collars) . Only a small fraction of
these have "made it." Many of the rest are living out lives of
frustrated hopes.
Thev are caught in what might seem a quiet con game. Many
have worked their way "up" from blue-collar backgrounds. They
have charged clothes; yet, in many respects, they have not
significantly changed their place. And although it may not be
clear on the outside, they know on the inside.
Joseph Heller captured one sense of this plight in his
novel, Something Happened. Slocum, the white-collar anti-hero,
reports on his worklife:
In the office in which I work there are five people of
whom I am afraid. Each of these five people is afraid
of four people (excluding overlaps), for a total of
twenty, and each of these twenty people is afraid of
six people, making a total of one hundred and twenty
people who are feared by at least one person. Each of
these one hundred and twenty people is afraid of the
other one hundred and nineteen, and all of these one
hundred and forty-five people are afraid of the twelve
men at the top. . . .
At work, where I am doing so well now, the sight
of a closed door is sometimes enough to make me dread
that something horrible is happening behind it,
something that is going to affect me adversely.
Something must have happened to me sometime.
In Malamud's and Redford's The Natural, the hero's vouthful
professional hopes and promise are cut short. When asked to
explain what happened, he can only say, "Things didn't turn out
as I expected." In less heroic ways, that is what has happened
to millions of white-collar workers: things haven't turned out
as expected.
The Rise of Flat-Tax Populism
But what, one might ask, has the disappointment,
frustration, and alienation of white-collar workers to do with
tax reform? Presumably, they, like most, would welcome a tax
rate reduction. But what would give such a conventional
preference the emotional force to support a major reform
movement?
«.,•»* I s " g g ( , s t t h a t the latent emotional impetus for reform is
1 £J£ t h * s , r n s e t h a t somehow the white collar world is a bit of
„ ' • ,1fc " , a = e n s e n o t ^rely that the white-collar social
of thill ™iTi!leading; but also that, for millions and millions
Th^v ,11 LW+ r k e r s ' . t h e V have somehow been victims of a con.
faC
dl
rl
eBls tsmlleThey
gsh t t
tn 0k WoOfr k
a si n o f f i c e
clean
^
ca„i
brokers
percent
^";
Jl
, h?ah-techf^f
?of
„
or
^f2 all
e?*?eT*American
£^ ?
T
--.
^households
"-^ hgMih°ain
nv
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like
are
their
now
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make-believe
homeowner
own or
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homes.
lawyers
households.)
65
or
or
Page 7
Many own shares of stock. (There are more than 42 million direct
and 130 million indirect American shareholders now.) Most have
checking accounts (88 percent of Americans do); credit cards (81
percent of Americans do); and savings accounts (71 percent of
Americans do). Many have money market accounts and/or IPAs.
They are sensitive to interest rates and have some basis for
interest in financial markets. But — and this is a big "but" —
they do not have much capital.
Indeed, they do not have much income from which to develop a
store of capital. The median income for all male white collar
workers — including the real capitalists and the Yuppies — is
less than $25,000 per year. For female white collar workers it
is about half that. Obviously, millions and millions of white
collar workers must struggle just to make ends meet. It is no
wonder that more than half of all white-collar workers seek
professional tax-paying advice, and that an overwhelming majority
(77 percent) feel they are paying too much to the Government.
Yet to achieve the implicit promise of the "rise" from
blue-collar to white-collar, the capital-poor imitation
capitalists know they need more than rate reduction. They need
the benefits of strong economic growth as well. Those who people
the worlds of Silicon Valley and Route 128 know the indirect
value to them of incentives for entrepreneurship and risk-taking.
But the overwhelming majority of white-collar workers don't work
in high-risk environments. They live in risk-averse
bureaucracies, which they know could be more daring and more
efficient.
So it is easy enough to see how the white-collar majority
would favor tax rate reduction and incentives for growth. Still,
it is not quite so obvious why they would favor flattening the
tax rate structure — and why this should be construed as
populist.
The reason would seem to be that flatter seems fairer. But
why?
Of course, there is an easy claim of equity that can be made
for a flat rate system. That, no doubt, appeals to some. But
populists are supposed to be anti-elitists. And the question
naturally presents itself: Why wouldn't they like a highly
progressive tax system.
The answer, I think, is partly to be found in a point made
earlier: The offensive elite in today's world is less a private
elite and more a governmental elite. Further, many white-collar
workers still aspire to join the private elite. But there is
another element to the explanation: Larger numbers of people
sense that the progressive tax system, in actual operation, is
often not progressive — and, somewhat ironically, in practice it
seems unfair.
There may be a natural politico-economic law that
excessively progressive tax systems must degenerate. They will
either stifle incentive and have to be changed. Or, perhaps more
likelv, they will create a powerful incentive for the7 development
of
our
since
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and
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Page 8
percent in 1980. And as it has done so, resistance in various
forms has mounted.
But be a possible law of likely degeneration as it may,
there are obvious unsettling aspects in the current system. The
overwhelming majority of taxpayers eat lunch without being able
to deduct their meals as business expenses. They buy baseball or
hockey tickets without being able to enjoy the luxury of
business-related sky-boxes. They talk on fishing boats, but
don't take the tax deduction for ocean-cruise seminars. They
strain to pay interest on their home mortgages and may take the
tax deduction for their payments, but they can't quite figure out
how others can invest in real estate shelters and get more back
in tax benefits than is put at risk. They read that of those
with gross incomes of over $250,000 before "loss," more than a
fifth pay less than 10 percent in taxes; and of those with gross
incomes over $1,000,000 before "loss," a quarter pay 10 percent
or less in taxes.
From this perspective, it is little wonder than flatter
would seem fairer.
And it is this perspective, too, which helps explain why
there is popular interest in simplification, although .the
majority of lower- and middle-income taxpayers already have a
rather simple tax system. What they want is simplicity for
others as well. This is not a matter of altruism. Their
interest in simplification is driven by resentment of the present
system's unfairness — their sense that others benefit from
complexity, whereas they do not.
The Populist-Growth Connection
Populist resentment and the quest for fairness are powerful
motive forces for reform. Without them, I doubt that
"supply-side" and "neo-liberal" intellectual movements would have
much practical effect. But with them, it seems clear to me that
there is the grassroots political basis for reform.
That reform can rightly be viewed as "historic" — as an
outgrowth of rising market-oriented populism, and as a valuable
correction on America's special path toward pioneering growth.
Pioneering growth will be advanced bv a reformed tax system
that reduces unproductive sheltering and encourages productive
investment; and by a system that reduces marginal tax rates to
stimulate work, savings, and productivity. But growth will also
be advanced through the psychological contribution that tax
reform can make to the overall sense of the system's fairness.
Populist resentment is not healthy — except to the extent
that it forces correction. But as it does, it may help unleash
^ r ^ ^ Q P ^ d u c t l V e ^ f r c ^ s of millions and millions of
Americans who are now living lives of cyuiet frustration,
alienation, and underproductivity.
'
Prospects
tax reform^l,^ th" int«U««*ual underpinnings of the current
n
r
T " 6
basically common-sensical
and basicallv
wouldVsuff'icie-nt
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Page 9
In a democracy, large-scale, non-incremental reform requires
a broadly-based, emotionally-driven, popular appeal. Populist
resentment, the new populist appreciation of market-oriented
growth, and the populist quest for fairness are the basis for
just such an appeal. Their convergence with "supply-side" and
"neo-liberal" ideology is fortuitous. I doubt that" thev — and
the historic reform movement of which they are a part -- can be
denied).
While I may not have fully demonstrated this point in these
remarks, perhaps there is significance in the very fact that a
retrograde Harvard elitist and confessed pragmatist would appear
before this distinguished and sophisticated audience to sing the
praises of populism!
Thank you very much.
rREASURY NEWS
portment of the Treasury • Washington, D.c. • Telephone 566-2041
Statement of the
Honorable James A. Baker, III
of the United States of America
Concerning Partnership for Growth
Before the Meeting of the
OECD Council
at Ministerial Level
April 12, 1985
Paris, France
Chairman Wilson, Secretary General Paye, Distinguished
Colleagues.
Partnerships for Growth
Yesterday our discussions focused on issues relating to
economic growth and adjustment in developing countries, and on
problems and prospects in the world trading system. In many
respects today's topic -- the OECD economies in the 1980's — is a
discussion of ways in which our policies, macroeconomic and
structural, can help lay the basis for progress in both of these
areas. The choice we make to secure sustained, non-inflationary
growth for the rest of the decade will help shape the economic
environment in which the LDCs operate. The policies we choose
will also affect the capability of our economies to adjust to
economic change and will help determine our ability to resist
trade protectionist pressures.
Our primary economic goal must be to establish the best
possible climate for sustained, non-inflationary, job-creating
growth — to maximize the opportunities for our people to find
jobs, to increase their standards of living, and to realize their
full potential. We must choose policies which unleash the
strength of the free enterprise system so that our economies can
regain their vitality and flexibility to adapt to changing
conditions.
B - 89
- 2 We need a new commitment to growth throughout the OECD area,
not the temporary kind of growth brought about by government "pump
priming" but the durable, sustainable growth created by private
sector investment and production, in a free, market-oriented
environment. Each of us faces individual problems that only we
ourselves can solve. But we have a common interest in their
solution. Acting constructively on our individual problems, we
can create an environment in which the whole is greater than the
sum of its parts — and in which we become true partners for
growth.
Current Situation
The OECD economies are in their strongest position in many
years. The widely accepted view of the seventies was that
industrial country inflation rates near the double-digit range
were the best that we could expect. But over the past four years,
we have fundamentally altered our inflation outlook. The average
inflation rate in the OECD area is the lowest since 1972,
immediately preceding the first oil shock.
In addition to these inflation gains, the recovery in our
economies has solidified. Led by the strong recovery and
expansion in the United States, the OECD is now in its third year
of expansion. Further, the disparities in growth among our
countries are narrowing significantly. Last year's average growth
was the strongest since 1976. Projections indicate that solid
real growth will be recorded this year and next. And importantly,
inflation rates will stay at low levels so long as we continue to
pursue sound and stable monetary and fiscal policies. This could
be the only period since the early sixties when inflation rates
four years into a recovery are lower than at the beginning of the
recovery.
We should be proud of these important improvements in the
economic climate. We have, working together, laid the foundation
for a sustained, non-inflationary expansion. We now need to build
on that foundation the basis for continuing growth and for sharing
the benefits of expansion.
Challenges/Opportunities
nnnnr?nn?^Lthe imP^ssive gains, all of us face challenges and
P
n
? H e V h e n 6 X t f e w y e a r s - A s Policy-makers, each of
bld
the
domestic support needed to tackle serious
n?
ffle
r
S
our c o u n t r ^ % h ' f ^ e t h e e r o b 1 ^ are not the same in all
c ren
o n ^ n e - S O l U t i ° n S a r e a3L1 a i m e d at assuring that the
current expansion is sustained in a manner which creates new jobs.
- 3 I see three broad areas in which all of us need to improve
oar performance: fiscal policy, trade liberalization, and
structural adjustment. Only a few OECD members have successfully
reduced their level of government expenditures and budget deficits
significantly. The rest of us must follow through on our
commitments to reduce the size of government to free up needed
resources for the private sector.
There is no question that we must all move forward on trade
liberalization. Our economies will all benefit from the more
efficient allocation of resources brought about through free trade
flows. The ability of the LDCs to continue their adjustment
programs depends importantly on open market in our countries.
Increased economic flexibility will also result from efforts
to reduce the structural rigidities which all of our economies
face. Structural barriers need to be removed to allow market
signals to determine business decisions such as hiring, firing,
investment choices, interest rate determination, and the like. We
do not see structural adjustment as a way to increase government's
role in our economies. Instead, we view it as a process that
removes government interference from the marketplace and returns
economic choice to private citizens.
While all of us need to redouble our efforts in these basic
areas, I believe that troublesome areas are of different
importance among our countries.
For the United States, the major challenge is to reduce the
budget deficit in a way consistent with sustained real growth. I
have worked closely with President Reagan for four years. I can
assure you that he is deeply committed to reducing the budget
deficit. This commitment was very clear in early March when the
Congress passed farm legislation that exceeded the President's
budget proposals. All of you understand the political power of
farmers. And you have read about the serious financial
difficulties American farmers are experiencing. So you would
appreciate the political risks of rejecting farm legislation. Yet
President Reagan did just that. He vetoed the farm spending bill.
I am certain that the President will continue to show that same
degree of courage throughout his second term.
I am optimistic that the President and the Congress will
reach an agreement on a budget package that will reduce the
projected deficit substantially. The Senate leadership and the
Administration have recently worked out a package of budget cuts
that would reduce our projected deficits by $52 billion in the
next fiscal year and by $300 billion over the next three years.
If enacted, this package would result in a deficit of less than
two percent of the GNP by 1988.
- 4 Spending cuts are the best course of action to reduce the
deficit. They are the only way to reduce the size of government
and to release funds to the private sector. And only cuts achieve
lasting reductions in the presence of government in our economies.
Raising taxes is not a satisfactory approach. Indeed, we also
intend to enact a comprehensive reform of our tax system that will
bring tax rates further down, not up. This is consistent with our
general interest in increasing incentives for work, saving, and
investment.
We accept the responsibility for reducing our budget deficit.
But at the same time we should all recognize the contributions the
United States has made to the global economy.
Our European colleagues have experienced a major boost in
demand through our rapidly expanding imports. European
exports to the United States rose 32 percent last year. The
U.S. expansion has accounted for nearly one-half of the real
growth of the major European countries.
And the LDCs would not have survived their recent financial
problems without the rapid 37 percent growth of exports to
the United States.
I hesitate to speculate on where we would all be if the U.S.
economy had not provided that growth. We intend to assure that
our growth continues.
Let me suggest areas in which policy action by others would
also help the global economies.
If the European and Japanese economies are to supplement the
United States in supporting LDC adjustment efforts, their imports
from LDCs will have to increase significantly. Their combined
imports from LDCs would have to rise by $25 billion to equal the
growth stimulus ignited by the U.S. expansion. This would
represent a growth of some 25 percent in the level of Japanese and
European imports from LDCs.
Our Japanese colleagues face difficult challenges and
opportunities. For more than a decade Japan has been the second
iffneKt.^onomy in the OECD. Its solid growth performance has
been built upon the ability of Japanese firms to reap the
advantages of the free liberal trading system. All of us can
success
marketplac
stories of the Japanese firms in the world
radi
^ J ^ v.wv.
L f ! ^?c!c.a?atii?lvu* .x ai1 o1e^r"a i1 ttrading
system is based on the
tollow ?n =°™P"
!. ^antage. It
It assumes
assumes that
that trade
trade is
is :free
to tiow in both directions — that' s what comparative advantage is
- 5 all about. No country has a comparative advantage in all it
produces. A country's openness to imports is the cost of gaining
the benefits from exporting opportunities. The gains from free
trade come from the balance of costs and benefits of imports and
exports. All countries need market access to pay for their own
imports.
It is time for Japan to accept the responsibilities of free
trade that coincide with the benefits.
In Europe, the current expansion has not succeeded in
reducing unemployment rates. You are unhappy with this result and
so am I. It is our view that the ability of European economies to
create jobs will not improve unless you address fundamental
structural rigities in your economies. I believe that it is
critical that you remove impediments to hiring and firing of
workers so that firms possess flexibility and economic incentives
to create new jobs. Firms need to be able to raise capital in the
most efficient way possible.
Removing capital market controls
and rigidities would produce a better allocation of capital within
economies. Increasing competition in domestic capital markets
will provide important gains in financial markets flexibility.
And in labor markets, disincentives to job search must be removed
and marginal tax rates must be lowered so that workers have an
economic reason for seeking new jobs.
Without substantially increased flexibility and
market-oriented decision making in Europe, job creation will
remain disturbingly low. This hurts the U.S. economy as well as
European economies. It reduces demand for our exports and adds to
our trade and current account deficits. And, a low-growth,
high-unemployment European economy increases trade protectionist
pressures in America and Europe.
Because of the importance of structural adjustments, we need
a heightened effort in the OECD throughout 1985 and early 1986 to
bring about a fuller understanding of the relationship between
structural adjustment measures and improved economic performance.
On one track, we would ask the secretariat to start work
immediately on an analytical paper on the linkages between
structural adjustment and economic performance. The paper should
be designed to inform the policy debate and improve public
understanding of the issues. This work could be monitored by the
Economic Policy Committee, with review by other committees as
appropriate, and forwarded to the 1986 ministerial.
On a second track, we would ask the various committees to •
exchange views on national experiences with structural adjustment
measures. This should lead to a progress report to ministers next
year based on actual experience.
- 6 -
This approach will enable the OECD to break new ground in
analyzing an extremely relevant issue. Our efforts would provide
solid evidence to the public that OECD governments are seriously
tackling the obstacles of employment creation and stronger
economic growth.
Before concluding, Mr. Chairman, I would like to say a few
words concerning a matter of interest to all members of the OECD
as well as to developing countries. I am speaking of the
operation of the international monetary system.
As many are aware, the Group of 10 has been conducting a
major review of the international monetary system for almost two
years. The G-10 studies are not yet completed, and it is
therefore not possible to know at this stage exactly what the
conclusions may be. The current system has served us well in many
respects over the last turbulent decade, but this is not to say
that the system is without weaknesses. We understand the G-10
studies will conclude that a major reform is not necessary, but
that a number of concrete, pragmatic steps should be taken to
strengthen the current system.
The G-10 Finance Ministers and Central Bank Governors will
review the results of these studies in June. The United States
attaches considerable importance to this work, which we expect
will represent a sound basis for improving the monetary system.
Therefore the United States is prepared to consider the possible
value of hosting a high-level meeting of the major industrial
countries, following the conclusion of the G-10 studies, in order
to review the various issues involved in transforming the findings
of the G-10 into appropriate action.
The meeting could center around one of the major conclusions
that appears to be emerging from the studies — that the key to
greater external stability is internal policies that promote
convergence toward non-inflationary growth. Such stability can
only be achieved in a lasting way by strengthening our cooperative
efforts to promote sound underlying policies and performance. The
studies point toward the need to strengthen IMF surveillance as a
means of encouraging such policies and performance.
h„ ™nJrClal meetin9 co"ld, therefore, build on the G-10 studies
L
^ ^ ' ^ 3 c o o P e r a t i v * fashion, the policies and
be fmoroved Jn nr« "V™ l n d u s t r i a l countries, and how these can
m
in J M « ZLt,^
°lt c o n v e r ^ n c e toward non-inflationary growth.
In this connection, the implementation of concrete soecific
arrangements to strengthen IMF surveil lanno ?!!i 1 • S p e C l £ 1 C
multilateral surveillance, c o u i r b r d l s c u s s e d " 0 1 ^ 1 1 1 9
- 7 The G-10 studies are not limited only to matters of
underlying policy and convergence of performance — they also
cover such issues as international liquidity, the role of the IMF,
and certain aspects of the debt problem. Each of these areas
could be considered at the special meeting.
Such a meeting would not in any way be linked to negotiations
to liberalize the international trading system. As we said
yesterday, trade negotiations can and must proceed on their own
merits. It is clear that discussions on international monetary
issues are in fact, already well advanced. We should build on the
work already done in the monetary area. We should also move
quickly and independently to assure that trade liberalization is
not left behind.
Conclusion
In concluding, Mr. Chairman, I would like to reemphasize that
assuring a durable non-inflationary expansion is the fundamental
task. Progress in all of the areas I have discusses is essential
to accomplishing that task.
In the highly interdependent world of the eighties we must
move forward together. As each of us makes our best effort to
solve our respective problems, we can become true partners for
growth.
TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
April 17, 1985 9:00 A.M., E.S.T.
Statement by
Robert A. Cornell
Deputy Assistant Secretary
for Trade and Investment Policy
Department of the Treasury
Before
Subcommittees on Africa and
International Economic Policy and
Trade Committee on Foreign Affairs
House of Representatives
April 17, 1985
Chairmen and Members of the Subcommittees:
I appreciate the opportunity to present the Treasury
Department's views on legislation recently introduced in
the Congress on South Africa.-^ Officials of the Department
believe the apartheid policies of the South African Government are repugnant and we, like members of the Congress,would like to see their total abolition. We also recognize
that there is a strong and apparently growing desire in
America to express our opposition to South African racial
discrimination.
We view legislation proposed by members of Congress as
a sincere attempt to respond to this desire and to develop
a statement of opposition to South Africa's apartheid
policies. However, the Treasury Department cannot support,
B-90
- 2 -
and must oppose, the types of punitive economic measures
proposed in the legislation for several reasons.
First, we believe the proposed measures will not produce
the desired changes in South Africa's system of apartheid.
Moreover, they would have unintended but adverse effects on
the non-white South African population we wish to help, and
would harm, perhaps significantly, U.S. commercial interests.
Second, the proposed measures contradict basic objectives
and tenets of this Administration and would undermine the
Administration's efforts to minimize government intervention
in markets and government controls on firms, and in the international area to promote free and open capital markets.
Since the statements of Assistant Secretary of State
Crocker and Deputy Assistant Secretary of Commerce Kelly
cover in detail foreign policy considerations, embargoes on
trade and services, codes of conduct and federal contracts, I
would like to concentrate my remarks on five specific areas
of particular interest to the Treasury. They are:
— ban on bank loans;
-- disinvestment and ban on new investment;
— ban on imports of krugerrands;
— denial of tax credits to U.S. firms operating in
South Africa; and
— requirement that U.S. Executive Director of the IMF
vote against loans to South Africa.
My coverage of these fives areas will include responses
to specific questions raised by the Subcommittees in their
letter inviting Treasury's views.
Ban on Bank Loans
loanSTbv ^T^J„De?a"raent strongly objects to a ban on
a d
}?ne1udTnn"?;=
" ° t h e r fi"ancial institutions
a r o r e i a ^ b ^ n ^ 3 " 0 6 C ° m ^ n i e s ) ' d i ^ t l y or indirectly through
or to anv
™ „ H subsidiary, to the South African Government
y
owned
c
°K' P a r t n e " h i p , or other organization
prohibitionsln errere w U h ' t h f f " r i < D a n G ° v - n m e n t . These
e r e W l t n tn
e free movement of capital, in
- 3 -
effect imposing discriminatory exchange controls, which the
Administration opposes except in situations involving national
emergencies. Adoption of prohibitions on bank lending would
undermine the Administration policy that international capital
markets should remain free of government interference and
that lending decisions should be based on market rather than
political considerations.
Restrictions on U.S. bank lending to South Africa could
be viewed both at home and abroad as evidence of the U.S.
readiness to use capital controls routinely for political
ends. Their imposition could erode international confidence
in the security of foreign investments in this country and
thus impair the implementation of our monetary and financial
policies. Restrictions on foreign subsidiaries of U.S. firms
might place these firms in conflict with laws of third countries—
creating resentment about and inviting retaliation against—what
would be considered an extraterritorial reach of U.S. law.
Bans on U.S. bank lending to South Africa could set a
dangerous precedent for imposing politically-motivated restrictions
on lending to a variety of other countries. For example, such
restrictions could also be extended to Eastern European or
sub-Saharan African countries which have adopted political or
economic policies that are not congruent with our own.
As a practical matter a ban on bank lending is likely to
be ineffective. It is likely that other countries' banks
would replace U.S. banks as lenders. U.S. banks only account
for about twenty-five percent of total bank claims on South
Africa as reported by the Bank for International Settlements
(BIS), and only a small portion of U.S. bank claims (under
seven percent as of end September 1984) represent lending to
the South African public sector.
Since capital is fungible, some perverse results could
emerge with a ban on U.S. lending. An increase in loans by
other countries' banks could be indirectly funded by borrowing
from U.S. banks. Attempts to establish a surveillance
system to prevent such occurrences would be extremely difficult
if not impossible to administer, and would be very costly.
Any such attempts would also create further distortions
in international capital markets with the ultimate result
of harming U.S. financial interests.
- 4 -
Much U.S. bank lending to South Africa finances U.S.
exports. A ban on lending would reduce U.S. exports, domestic
production and employment, and have a negative effect on our
balance of trade.
Bans on U.S. bank loans to South Africa might also limit
the availability of foreign exchange for financing of South
Africa's reexports of food and other supplies to other African
countries.
Disinvestment and Ban on New Investment
The Treasury opposes legislation banning new U.S. investments in South Africa or requiring disinvestment by established
U.S. investors, for much the same reasons that we oppose a
ban on bank lending:
— it would conflict with our longstanding market-oriented
policy towards investment, and would undermine our
efforts to extend that policy internationally; and
— it would set a precedent for banning U.S. investments
in other countries whose policies are strongly opposed
in the United States.
Like a ban on bank lending, a ban on new investments in
South Africa and/or a requirement that U.S. firms disinvest
could produce rather perverse results for non-whites in South
Africa and for U.S. firms with operations in South Africa.
U.S. firms operating in South Africa are a major employer
of non-whites and a major source of pressure for change in
South Africa's policies. Limiting the ability of these firms
to bring in new capital, to grow or to adjust to market,
conditions, or requiring that they leave South Africa, would
reduce job opportunities for non-whites and limit or, in all '
probability, remove the many improvements enjoyed by non-white
employees of U.S. firms on the job and off the job in areas
such as housing, education and health. Recent polls indicate
that the majority of non-white South Africans recognize the
investmen,ntn^1V^C^SeqUenCeS f°r them of ba"s on U.S.
" ^ ^ n m f ° u t h A f r i c a °r of U.S. disinvestment-they
oppose these measures.
these sectors there are
- 5 -
numerous competitors, both foreign and local South African.
A ban on new investments would limit established U.S. firms'
capacity to adjust to market changes—such as the current
economic stagnation in South Africa—and may force many to
withdraw. Depending upon the nature of the firm's business
and the prevailing economic conditions, a withdrawal, prompted
by limits on new investment or by required disinvestment,
could be extremely costly to the firm, both at the point of
withdrawal and subsequently. Firms might be forced to sell
their assets at a price well below real value. In addition,
potential host countries to and potential customers of foreign
subsidiaries of U.S. firms would not miss the fact that U.S.
firms were forced, because of political judgements in the
United States, to leave South Africa. They would likely take
this into account in deciding whether to permit U.S. investment
in their countries or whether to buy from U.S. firms.
Even if a ban on new investments did not lead to closure
of U.S. operations in South Africa, it would preclude investments by U.S. firms not there now. This would create a
segmented and discriminatory grouping of U.S. firms—those
with operations in South Africa and others. This is clearly,
not acceptable.
Finally, while the U.S. is the third largest source of
direct investment in South Africa ($2.3 billion year-end 1983;
17 percent of total foreign direct investment in South Africa),
an ending of new U.S. investment flows or the sale of existing
capital assets is not likely to create serious problems for
South Africa. Other countries (Japan, the United Kingdom,
West Germany) have significant commercial interests in South
Africa, and their firms would quickly fill gaps left by
departing U.S. firms. South Africa also has demonstrated its
ability to develop efficient indigenous production in the
face of international sanctions, such as in its arms industry.
Ban on Imports of Krugerrands
Treasury opposes a prohibition on the importation of
South African krugerrands. While the prohibition would be
a symbolic gesture it would be an ineffective gesture, and
it may place the United States in violation of our international obligations under the General Agreement on Tariffs
and Trade (GATT).
- 6 -
A prohibition of imports from an individual country,
such as South Africa, would normally be considered a discriminatory trade measure under the GATT. It could leave the
United States open to a complaint in the GATT from South
Africa, and the possibility of GATT sanctioned countermeasures
by South Africa.
The proposed ban on imports of South African gold coins
would probably not result in a corresponding reduction in
U.S. gold demand or imports of foreign gold. Americans would
still be able to purchase and hold krugerrands abroad, and
new marketing efforts would undoubtedly be developed in an
effort to get Americans to do so. Americans could also
switch from buying krugerrands to purchasing coins and gold
pieces of other countries, such as Canadian maple leafs.
South Africa would still benefit after such switching, since
gold for the production of most foreign coins is purchased in
the market to which South Africa supplies about 60 percent of
newly mined non-Soviet gold. South Africa has not allowed
changes in demand for krugerrands to affect the amount of
its gold production that is sold, as it views bullion
and coin sales as interchangeable.
In the final analysis, a ban on U.S. krugerrand imports
would affect South African earnings from gold sales only
to the extent that such a ban would have a negative impact on
gold prices. If Americans switched to buying krugerrands
abroad or to foreign coins produced by gold purchased in the
world market, the overall demand for gold would not be changed
and the price would not be affected. However, if Americans
were to switch to purchasing xsoins minted from gold in official
reserves, the price of gold would tend to decline because of
the increase in supply to the world market.
Any downward pressure on gold prices consequent to a
U.S. ban on krugerrand imports is not likely to be strong.
extremel
c^v, 1 ?,
y unlikely event that the demand for
fnnn^i n r c C a n 9 ° l d C ° i n S f e l 1 b v t h e f u l i equivalent of 1984
be Zl^ rL^0rtt
°f a b o u t L 3 million ounces, this would
aol2 2imn??iS\1Ve..K0 t h e 3 6 m i l l i o n ounces of newly mined
gold supplied to the market last year.
U.S. Vote Against IMF Loans
Fund
- 7 -
to South Africa. This requirement would be both damaging
to important U.S. interests in the IMF and an ineffective
tool against apartheid.
The IMF was created to promote global economic and
financial stability, an objective that is in the broadest
U.S. economic and foreign policy interest. The Fund's
success in achieving this objective is due in large measure
to its strict focus on economic and financial issues, and to
its consistently even-handed treatment of its members despite
the fact that its membership comprises countries with widely
divergent economic and social systems. The United States
has strongly supported this approach through Democratic and
Republican administrations alike.
Each IMF member has certain rights in the Fund (such
as the right to make use of IMF financing) and each must
fulfill certain obligations (such as the obligation to cooperate
with the Fund in connection with IMF loans). Efforts to
limit selectively the rights of certain members in the Fund
would rapidly undermine their willingness—and the willingness
of other members as well—to meet their important obligations
to the Fund. This would seriously impair the Fund's ability
to play its crucial role in the international system. Moreover,
steps by the United States to tamper with the IMF's basic
apolitical character would certainly trigger similar actions
by other countries, with potentially damaging implications
for U.S. friends and allies. Ultimately, the IMF could
degenerate into just another highly politicized and ineffective
international institution.
The special concerns of Congress on the question of
apartheid, as well as the need to protect the IMF's essentially
technical economic character, are reflected in the recently
enacted legislation approving U.S. participation in an increase
in the resources of the IMF. This legislation establishes
special criteria which must be considered by the United States
prior to approval of any proposed IMF loan for South Africa,
but specifies these criteria strictly in economic terms.
Thus, the U.S. Executive Director to the IMF may support a
proposed IMF loan to South Africa only after making a determination that the loan will improve the balance of payments
situation by reducing constraints on labor and capital mobility,
and benefit economically the majority of the population.
The United States has, consistent with the spirit of
this legislation, urged the South Africans to reduce constraints on labor and capital mobility which contribute to
- 8 -
balance of payments deficits and to expand education and
job training programs. In our view this approach is a
sound one and offers the best prospects for an IMF role in
reducing apartheid that is both influential and consistent
with the other important objectives I have outlined.
Denial of U.S. Tax Credits
The Treasury Department opposes the proposed denial
of foreign tax credits for South African taxes because it
violates both U.S. treaty obligations and sound tax policy.
The United States taxes U.S. citizens and residents,
including U.S. corporations, on their worldwide income.
When a portion of that income is earned in a foreign country,
the foreign country will generally also tax the income.
As a result, the same items of income may be subject to
double taxation. To avoid such international double taxation,
the United States permits foreign taxes paid on income
earned outside the United States to be credited against
U.S. tax. To preserve the U.S. tax on U.S. income, the
foreign tax that may be claimed as a credit is limited to
,
the U.S. tax that would otherwise be due on the foreign
income.
For a U.S. company with excess foreign tax credit
limitation, the proposed denial of credits would result in
the double taxation of income earned in and taxed by the
Republic of South Africa. The combined U.S. and South
African tax rate on this income could be as high as 85-90
percent as a result of the proposal.
The United States foreign tax credit is based on sound
tax policy. It conforms with accepted international practice _
by according to host countries the primary right to tax
income earned in that country. The United States obligation
to relieve international double taxation of income earned by
citizens, residents and corporations in South Africa is
confirmed m our income tax treaty with South Africa which
would be directly violated by the proposed legislation.
Conclusion
y c IruS!f?marY: We reco9nize the pressures to respond strongly
to South Africa s policies, and the Congress's genuine attempts
to develop a response. However, when the Treasury examines
the types of measures proposed in legislation, largely punitive
- 9 -
economic actions, in terms of their potential for promoting
change and their effects on U.S. interests and the interests
of non-whites in South Africa, we cannot support, and must
oppose, them. We believe the proposed measures would not
produce the changes we all seek, but would further disadvantage
the non-white population in South Africa and would have
adverse effects, perhaps significant and long-standing, on
U.S. commercial interests.
#####
TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566FOR RELEASE AT 4:00 P.M. April 16, 1985
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$13,000 million, to be issued April 25, 1985.
This offering
will result in a paydown for the Treasury of about $50
million, as
the maturing bills are outstanding in the amount of $13,042 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m., Eastern Standard time, Monday, April 22,
1985. The two series offered are as follows:
91-day bills (to maturity date) for approximately.$6,500
million, representing an additional amount of bills dated
January 24, 1985,
and to mature
July 25, 1985
(CUSIP No.
912794 HT 4 ) , currently outstanding in the amount»of $7,073 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,500 million, to be dated
April 25, 1985,
and to mature October 24, 1985
(CUSIP No.
912794 JD 7 ) .
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.
The bills will be issued for cash and in exchange for Treasury
bills maturing April 25, 1985.
Tenders from Federal Reserve"
Banks for their own account and as agents for foreign and international monetary authorities will be accepted at the weighted
average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued 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 bills held by them. Federal Reserve
Banks currently hold $ 1,266 million as agents for foreign and international monetary authorities, and $1,829 million for their own account.
Tenders for bills to be maintained on the book-entry records of the
Department of the Treasury should be submitted on Form PD 4632-2 (for
26-week series) or Form PD 4632-3 (for 13-week series).
B-91
2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
x? in multiples of $5;000. Competitive tenders must also show
tie yield desired, expressed on a bank discount rate basis with
tv;o decimals, e.g., 7.15%. Fractions may not be used. A single
udder, as defined in Treasury's single bidder guidelines, shall
.iot submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets in
Government securities and report daily to the Federal Reserve Bank
:" New York their positions in and borrowings on such securities
jrtay submit tenders for account of customers, if the names of the
customers and the amount for each customer are furnished. Others
a.:e only permitted to submit tenders for their own account. Each
tender must state the amount of any net long position in the bills
•vung offered if such position is in excess of $200 million. This
information should reflect positions held as of 12:30 p.m. Eastern
time on the day of the auction. Such positions would include bills
acquired through "when issued" trading, and futures and forward
transactions as well as holdings of outstanding bills with the same
iiidturity date as the new offering, e.g., bills with three months to
n-iturity previously offered as six-month bills. Dealers, who make
.;-••-,'jiary markets in Government securities and report daily to the
federal Reserve Bank of New York their positions in and borrowings
an such securities, when submitting tenders for customers, must
submit a separate tender for each customer whose net long position
li\ the bill being offered exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
ixo: make an agreement to purchase or sell or otherwise dispose of
'i.iy noncompetitive awards of this issue being auctioned prior to
tne designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for must
accompany all tenders submitted for bills to be maintained on the
fc>A-entry records of the Department of the Treasury. A cash
rdjustment will be made on all accepted tenders for the difference
b=j' v-een the par payment submitted and the actual issue price as
•jjvermined 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 book-entry
records of Federal Reserve Banks and Branches. A deposit of 2 percs.rc. of the par amount of the bills applied for must accompany
terriers for such bills from others, unless an express guaranty of
r.avuent by an incorporated bank or trust company accompanies the
readers.
785
Public announcement will be made by the Department of the
Treasury of the amount and yield 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 $1,000,000 or less without
stated yield from any one bidder will be accepted in full at the
weighted average bank discount rate (in two decimals) of accepted
competitive bids for the respective issues. The calculation of
purchase prices for accepted bids will be carried to three decimal
places on the basis of price per hundred, e.g., 99.923, and the
determinations of the Secretary of the Treasury shall be final.
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 the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. 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. In addition, Treasury Tax and Loan Note Option Depositaries may make payment for allotments of bills for their own accounts and for account
of customers by credit to their Treasury Tax and Loan Note Accounts
on the settlement date.
In general, if a bill is purchased at issue after July 18,
1984, and held to maturity, the amount of discount is reportable
as ordinary income in the Federal income tax return of the owner
at the time of redemption. Accrual-basis taxpayers, banks, and
other persons designated in section 1281 of the Internal Revenue
Code must include in income the portion of the discount for the
period during the taxable year such holder held the bill. If the
bill is sold or otherwise disposed of before maturity, the portion
of the gain equal to the accrued discount will be treated as ordinary income. Any excess may be treated as capital gain.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76 and 27-76, Treasury's single bidder guidelines, and this
notice prescribe the terms of these Treasury bills and govern the
conditions of their issue. Copies of the circulars, guidelines,
and tender forms may be obtained from any Federal Reserve Bank or
Branch, or from the Bureau of the Public Debt.
4/85
[REASURY NEWS
lartment of the Treasury • Washington, D.C. • Telephone 566-2041
April 17, 1985
Ronald A. Pearlman Confirmed
Assistant Secretary of the Treasury for Tax Policy
Ronald A. Pearlman was confirmed by the United States Senate
as Assistant Secretary of the Treasury for Tax Policy on January
31, 1985. He signed the oath of office on February 22, 1985.
Prior to his nomination, Mr. Pearlman served as the Deputy
Assistant Secretary of the Treasury for Tax Policy from July 1,
1983, until his swearing in as the Assistant Secretary.
Mr. Pearlman has the principal responsibility for the
formulation and execution of United States domestic and
international tax policies.
Prior to joining the Treasury, Mr. Pearlman was a partner in
the St. Louis law firm of Thompson & Mitchell and served as 'an
adjunct professor of law at Washington University School of Law,
St. Louis.
Prior to joining the St. Louis law firm, Mr. Pearlman served
in the Office of the Chief Counsel of the Internal Revenue Service
from 1965-69.
Mr. Pearlman earned a B^A. degree from Northwestern
University in 1962, and received his J.D. degree from
Northwestern's Law School in 1965 where he was on the Board of
Editors of the Northwestern University Law Review. In 1967, he
earned an LL.M. degree in Taxation from Georgetown University*Law
Center.
A frequent lecturer at various tax institutes, he has also
written a number of articles on tax subjects.
Mr. Pearlman served as the Chairman of the Missouri Bar
Taxation Committee from 1976-78, and Chairman of the Advisory
Committee, Director of Revenue, State of Missouri from 1978-79.
Chairman, 1979 Mid-America Tax Conference.
Mr. Pearlman is a member of the American Bar Association, the
American Law Institute, and The Missouri Bar.
Mr. Pearlman and his wife Hedy have two children, Steven and
Leslie.
###
B-92
TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
ORAL STATEMENT BY THE HONORABLE JAMES A. BAKER
SECRETARY OF THE TREASURY
OF THE UNITED STATES
CONCERNING
A BLUEPRINT FOR GLOBAL GROWTH
BEFORE THE
MEETING OF THE INTERIM COMMITTEE
APRIL 17, 1985
WASHINGTON, D.C.
Chairman Ruding, Managing Director de Larosiere, fellow
Governors:
I welcome this opportunity to participate in this special
meeting of the Interim Committee.
I must admit that when I first
came to Treasury I wondered if Don Regan had left roe a golden
opportunity or an impossible task when he proposed that the
Interim and Development Committees engage in an informal dialogue
on medium-term growth, adjustment, and development.
But as I have dealt regularly over the past two and a Half
months with the need to ensure continued low inflation growth in
the U.S. economy, I've become convinced that an informal dialogue
is precisely what we need to understand better how each of us can
contribute to achieving stronger and more balanced global growth.
We all want growth for our economies —
not stop-go spurts of
growth arid recession punctuated by periods of high inflation, but
sustained growth.
°n.
Markets we can depend
Creditworthiness that can be maintained so that credit is
there when needed.
B-93
Jobs we can count on.
- 2 -
Those aren't such impossible goals.
But they require
considerable thought and medium-term planning.
And that's what
these meetings are designed to permit us to do:
To talk to one another — frankly and off the record — about
the progress achieved in recent years in the face of very
difficult problems.
More importantly, to listen to one another, and thereby to
understand better the underlying economic situation in each
of our economies, as well as our fundamental interdependence.
To review the prospects for the rest of the decade, '
considering what policies might help assure sustained, low
inflation growth.
And to help build a consensus about what each of us can and
will contribute to that common objective.
Our task, in sum, is to develop a "blueprint" of policies for
global growth to which each of us can contribute and from which
all of us will benefit.
all countries.
This does not mean identical policies in
Our economies vary immensely, have different
needs, and can draw on unique strengths.
But we all can and must
Play a role in assuring that growth spreads and is sustained.
- 3 -
Sustained growth among the industrial countries is clearly
the cornerstone for global growth.
It is more important to the
developing countries than any conceivable rise in development
assistance or lending by the international institutions.
The United States and other industrial countries have already
made substantial efforts which are reaping benefits in reducing
inflation, cutting government spending, and allowing markets
a greater role in our economies.
U.S. expansion alone since 1982
has directly increased non-oil LDC exports by $25 billion.
U.S.
growth also created a 32 percent increase in European exports to
the United States last year, and has accounted for nearly
one-half of the real economic growth of the major European
countries.
A number of developing countries have also made considerable
efforts to correct their payments imbalances.
Through the use of
a range of policies, particularly sound monetary, fiscal/ and
exchange rate policies, these countries have in most cases
restored growth, slowed inflation, and reduced sharply their
balance of payments deficits.
I find it particularly encouraging
that output in non-oil developing countries rose by 4.5 percent
in 1984, while their exports grew by 12 percent and their imports
by nearly 6 percent.
- 4 -
Our task now is to assess the progress that we've made, and
to determine how to direct our efforts to consolidate
and build on that progress.
The United States will do its part. We must follow a steady,
anti-inflationary monetary policy.
And we are determined to
reduce substantially the U.S. budget deficit.
The President has
recently secured an agreement with the Senate leadership on a
deficit reduction program that, if implemented, will ensure a
$300 billion reduction in our deficit over three years.
We are
also fully prepared to put current U.S. trade restrictions on the
table as part of a new round of trade negotiations, provided
others will do the same, as a means of reducing protectionist
pressures and benefitting global growth.
But as U.S. growth slows somewhat to a more sustainable level
in the years ahead, economic developments in Europe and Japan
will become even more crucial in supporting the adjustment
efforts of the developing countries.
Efforts to reduce further
government expenditures, to maintain anti-inflationary monetary
policies, and to free up and open up their economies can and must
make a significant contribution to LDC and global growth in the
medium term.
While sustained growth in the industrial world can facilitate
growth elsewhere, it obviously cannot make growth happen.
The
- 5 -
policy choices of individual developing countries will determine
whether or not they can take advantage of the opportunities that
are presented.
In addition to sound monetary, fiscal, and
exchange rate policies, more active use needs to be made of
pricing, marketing, and wage policies; trade and financial market
liberalization; and efforts to improve the environment for
foreign direct investment.
All of these can contribute
importantly to LDC growth and adjustment.
Turning to the question of an SDR allocation, the United
States continues to oppose an allocation.
We frankly don't see
that international liquidity and reserve developments demonstrate
a need for it.
Our discussions this afternoon will include consideration of
ways to strengthen IMF surveillance generally and to develop
"enhanced" surveillance for certain debtor countries.
We firmly
believe that IMF surveillance can play a key role in encouraging
the adoption of sound economic policies in all of our countries,
through both regular and special consultations with individual
countries, as well as through multilateral surveillance.
I hope
others will join us in supporting measures to strengthen IMF
surveillance.
The studies regarding the international monetary system which
have been underway within the Group of Ten recognize the need for
- 6 -
more effective IMF surveillance, and are likely to emphasize
specific proposals toward that end.
As I indicated last week,
the United States attaches considerable importance to these
studies of possible improvements in the international monetary
system.
We are therefore prepared to consider the possible value
of hosting a high-level meeting of the major industrial
countries, following the conclusion of the studies, in order to
review the various issues involved in transforming their findings
into appropriate action.
Such a meeting could provide further impetus to strengthening
the international monetary system through the IMF, in particular
through the upcoming review of the G-10 studies by the IMF's
Interim Committee.
For while the major industrial countries must
do their part to strengthen the system, we cannot do it alone.
It will be necessary for each of us, industrial and developing
countries alike, to accept our ^responsibilities to improve the
system.
This is reflected in the fact that it is the Interim Committee, representing the entire membership of the IMF, that has
the responsibility, among others, to advise and report to the
Board of Governors with respect to "the management and adaptation
of the international monetary system...."
It is this Committee,
then, that will have the basic task of considering how the G-10
studies can best be implemented to strengthen the international
monetary system.
- 7 -
I look forward to this afternoon's informal session as an
opportunity to discuss frankly the key policy issues for the
medium-term.
I intend to approach these discussions positively
and constructively, and I trust each of you will do the same.
Being positive and constructive does not necessarily mean
agreeing to this or that financial concession.
A focus on such
concessions can distract us from the real issues and from what
this meeting is about —
listening, learning, and understanding
better what each of us can do to establish a firm basis for
sustained growth.
Through such understanding, we can develop a
blueprint for global growth that can help ensure a more
productive and prosperous future for us all.
fREASURY NEWS
lartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
April 17, 1985
TREASURY TO AUCTION $9,000 MILLION OF 2-YEAR NOTES
The Department of the Treasury will auction $9,000 million
of 2-year notes to refund $8,225 million of 2-year notes maturing
April 30, 1985, and to raise about $775 million new cash. The
$8,225 million of maturing 2-year notes are those held by the
public, including $360 million currently held by Federal Reserve
Banks as agents for foreign and international monetary authorities.
The $9,000 million is being offered to the public, and any
amounts tendered by Federal Reserve Banks as agents for foreign and
international monetary authorities will be added to that amount.
Tenders for such accounts will be accepted at the average price of
accepted competitive tenders.
In addition to the public holdings, Government accounts and
Federal Reserve Banks, for their own accounts, hold $347 million of
the maturing securities that may be refunded by issuing additional
amounts of the new notes at the average price of accepted
competitive tenders.
Details about the new security are given in the attached
highlights of the offering and in the official offering circular.
oOo
Attachment
B-94
HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF. 2-YEAR NOTES
TO BE ISSUED APRIL 30, 1985
April 17, 1985
Amount Offered:
To the public
Description of Security:
Term and type of security
Series and CUSIP designation .
Maturity date
Call date
Interest rate
Investment yield
Premium or discount
Interest payment dates
Minimum denomination available
Terms of Sale:
Method of sale
Competitive tenders
Noncompetitive tenders
Accrued interest payable
by investor
Payment by non-institutional
investors
Payment through Treasury Tax and
Loan (TT&L) Note Accounts
Deposit guarantee by
designated institutions
Key Dates:
Receipt of tenders
Settlement (final payment
due from institutions)
a) cash or Federal funds
b) readily collectible check !
$9,000 million
2-year notes
Series U-1987
(CUSIP No. 912827 SC 7)
April 30, 1987
No provision
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
October 31 and April 30
$5,000
Yield Auction
Must be expressed as an
annual yield, with two
decimals, e.g., 7.10%
Accepted in,full at the average price up to $1,000,000
None
Full payment to be
submitted with tender
Acceptable for TT&L Note
Option Depositaries
Acceptable
Wednesday, April 24, 1985,
prior to 1:00 p.m., EST
Tuesday, April 30, 1985
Friday, April 26, 1985
REASURY NEWS
iortment of the Treasury • Washington, D.c. • Telephone 566-2041
For Release Upon Delivery
Expected at 10:00 a.m. EVS.T.
April 30, 1985
STATEMENT OF
DENNIS E. ROSS
ACTING DEPUTY TAX LEGISLATIVE COUNSEL
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON ENERGY AND COMMERCE
SUBCOMMITTEE ON COMMERCE, TRANSPORTATION, AND TOURISM
UNITED STATES HOUSE OF REPRESENTATIVES
Mr. Chairman and Members of the Committee:
I am pleased to have the opportunity to present the views of
the Treasury Department on the Federal income tax policy issues
raised by the proposed sale by the Federal government of its
interest in the Consolidated Rail Corporation ("Conrail") to
Norfolk Southern Corporation ("Norfolk Southern"). We have not
comprehensively examined all potential Federal income tax consequences of the proposed sale, but have limited our analysis to
certain issues of tax policy raised by the Federal government's
ownership of Conrail and the form of the proposed transaction.
In addition, our analysis is based on the details of the proposed
transaction reflected in the Memorandum of Intent signed February
8, 1985 by Norfolk Southern and the Department of Transportation,
and in H.R. 1449 and S. 638, pending legislation that would
authorize and establish terms for the sale of Conrail.
Background /
Section 401 of the Regional Rail Reorganization Act of 1973
enacted by the Northeast Rail Service Act of 1981 directed the
Secretary of Transportation to submit to the Congress a plan for
B-95
- 2 the sale of the Federal government's interest in approximately 85
percent of Conrail's common stock to (1) ensure continued rail
service; (2) promote competitive bidding for the stock; and (3)
maximize the government's return on its investment in Conrail.
After careful review of a number of purchase proposals, the
Secretary of Transportation has recommended sale of Conrail to
Norfolk Southern.
The Treasury Department has consulted closely with the
Department of Transportation with regard to the tax policy
aspects of the sale of Conrail. Our advice to the Transportation
Department has been guided by two basic policy objectives: (1)
that the sale of Conrail should not provide the purchaser with
Federal income tax benefits that would not be available in an
analogous transaction between private parties; and (2) that the
Internal Revenue Service ("IRS"), in its role as administrator of
the Federal income tax laws, should not be prevented by the sales
agreement or enabling legislation from treating Conrail in the
same manner as any other taxpayer.
Treatment of Conrail's Tax Benefits
Under current law, there are significant differences in the
Federal income tax treatment of a sale of stock and a sale of the
assets of a corporation. In general, a purchaser of the stock of
a corporation receives a tax basis in the stock purchased equal
in amount to the consideration paid for such stock. Other than
this change in tax basis for the stock purchased, the sale of
stock of a corporation generally does not trigger tax consequences either to the purchaser or to the corporation whose stock
is sold. Accordingly, the existing tax attributes of the
acquired corporation generally remain intact even though the
corporation is owned by different persons.
Given the treatment of stock purchase transactions under
current law, if the proposed sale of Conrail stock occurred
between private parties, the tax attributes of Conrail, such as
its net operating loss carryforwards, investment tax credit
carryforwards, and asset tax basis (including the so-called
"frozen asset base"), would remain intact following the sale.
The tax consequences of the proposed sale of Conrail to Norfolk
Southern would depart from this private transaction model in that
certain of Conrail's tax attributes would not survive the sale
transaction. Thus, pursuant to a closing agreement to be entered
into between Conrail and the IRS, as reflected in paragraph 4 of
the Memorandum of Intent, Conrail's net operating loss,
investment tax credit, and other carryforwards would, with
.certain exceptions, not carry over to taxable years beginning
- 3 after the date of sale (hereafter, the "Closing").* At the same
time, other Conrail tax attributes, in particular, Conrail's
asset basis, would, as in a private party transaction, survive
the Closing.
We believe the different treatment of Conrail's tax carryforwards on the one hand and its asset basis on the other is
appropriate for a number of reasons. Conrail's existing carryforwards arose during the period of the Federal government's
ownership and are for the most part attributable to the Federal
government's investment in Conrail. The same is not true of
Conrail's asset basis. Although the assets held by Conrail have
changed substantially since its formation in 1976, data provided
to us by the Department of Transportation indicate that the
aggregate tax basis of its assets as of December 31, 1983 is
roughly equal to what it was in 1976. Thus, the proposed transaction would return Conrail to the private sector with
substantially the same asset basis as at the time the Federal
government acquired it.**
We recognize, of course, that the purchase price in a sale
transaction will reflect the extent to which advantageous tax
attributes carry over in the acquisition. Where the Federal
government is the seller, however, any gain in purchase price
from a carry over of favorable tax attributes must be weighed
against future revenue losses attributable to the purchaser's
utilization of the tax attributes. This weighing is more
difficult to the extent the purchaser's ability to use the
attributes is uncertain. In this respect, the value of Conrail's
carryforwards is inherently more speculative than the value of
its asset basis, because the carryforwards would be of future
value only to the extent that annual depreciation deductions
generated by Conrail's asset basis had already been fully
utilized. It would thus appear reasonable for the Federal
government to require the termination of Conrail's carryforwards
rather than speculate as to their value, while, in accord with
*
The closing agreement also would provide that Conrail's
the model of a private transaction, permitting Conrail to return
taxable year would terminate as of the Closing.
to the private sector with its asset basis intact.
** If the effects of inflation are accounted for, Conrail's
current asset basis is, of course, much less than at the time
of its formation. Moreover, since the value of Conrail's
assets today likely exceeds their value at the time of
Conrail's formation, the built-in loss in Conrail's assets
(i.e., the excess of their basis over value) is likely
smaller today than it was at Conrail's formation.
- 4 It should also be noted that the treatment of Conrail's tax
attributes in the proposed sale is similar to what was approved
by Congress at the time of Conrail's formation. Legislation
adopted in connection with Conrail's formation, now reflected in
section 374(c) of the Internal Revenue Code (the "Code"),
provided that the net operating loss carryforwards of Conrail's
predecessors would not carry over to Conrail, whereas Conrail
would inherit its predecessors' asset basis. The tax consequences of the proposed sale of Conrail to Norfolk Southern would
generally conform to that legislative precedent.
Finally, the carry over of Conrail's asset basis should not
cause a reduction in Federal income tax revenues collected from
Conrail. Although Conrail is a taxable entity, it has not
previously paid Federal income tax, nor would it in the foreseeable future given its substantial carryforwards and the high
basis in its assets. Because Conrail's carryforwards would not
survive the proposed sale to Norfolk Southern, the transaction
would, if anything, accelerate the point at which Conrail would
become a taxpaying corporation.
Utilization of Conrail Deductions By Norfolk Southern
While we believe that the carry over of Conrail's asset basis
is appropriate, we recognize that the proposed sale transaction
would reduce Federal income tax revenues if future deductions
generated by Conrail's asset basis could be utilized to offset
otherwise taxable income of Norfolk Southern. As an includible
member in Norfolk Southern's consolidated return, tax losses of
Conrail could currently offset taxable income of any other member
of the consolidated group to the extent such losses were not
limited under the separate return limitation year ("SRLY") and
the built-in deduction rules of the consolidated return regulations. These rules, in general, prevent the utilization of an
acquired corporation's pre-acquisition losses (including losses
or deductions attributable to assets with tax basis in excess of
fair market value, so-called "built-in deductions") against
income of any other member of the acquiring group. It is
conceivable that Norfolk Southern could seek to mitigate the
effect of these restrictions through any of the following
strategies: by satisfying the so-called de minimis exception to
the SRLY and built-in deduction rules, by transferring assets to
Conrail, the income from which would be absorbed by Conrail
losses, by diverting income opportunities to Norfolk Southern, or
by merging Conrail into Norfolk Southern (or an affiliated
corporation) in a transaction in which Conrail's tax attributes
would carry over.
The consolidated return regulations provide an exception to
the SRLY and built-in deduction rules, if, on the acquisition
date, the aggregate of the adjusted tax basis of all assets of
Conrail (other than cash, marketable securities, and goodwill) do
not exceed the fair market value of such assets by more than 15
- 5 percent. See Treas. Reg. § 1.1502-15(a)(4)(i)(b). A review of
Conrail's tax data, provided to us by the Department of Transportation, suggests that Conrail would not satisfy this de
minimis exception, since its aggregate tax basis appears to
exceed $3 billion, and Norfolk Southern is paying only $1.2
billion for 85 percent of Conrail's common stock. The de minimis
exception, however, is based on the fair market value o"F~
Conrail's assets, rather than the value of Conrail's stock. The
cash price paid by Norfolk Southern for Conrail stock need not
correspond to the value of Conrail's assets, since it would not
reflect other costs incurred by Norfolk Southern as a result of
the transaction or liabilities burdening the assets of Conrail.
Therefore, since we do not have appraisals or other direct
information concerning the fair market value of Conrail's assets,
we cannot conclude with certainty that Conrail would fail to
satisfy the de minimis exception.*
Norfolk Southern's ability to avoid the effects of the SRLY
and built-in deduction rules either by transferring assets or
income opportunities to Conrail or by merging Conrail into
Norfolk Southern or an affiliate would be constrained by Norfolk
Southern's contractual obligations, by practical business
considerations, and by the provisions of the tax law. Paragraph
12(b)(iii) of the Memorandum of Intent appears to prohibit a
merger of Conrail into Norfolk Southern (or an affiliated
corporation) for at least five years after the Closing. In
addition, it is questionable whether Norfolk Southern would
transfer significant income producing assets to Conrail given
that, as reflected in Paragraph 12(b) of the Memorandum of
Intent, there would be significant restrictions on Norfolk
Southern's ability to withdraw assets from Conrail. With regard
to tax law limitations, a transfer of significant assets or
income
opportunities
tothe
Conrail
or a merger
of Conrail
Paragraph
12(e) of
Memorandum
of Intent
providesinto
that as
Norfolk
Southern
(or
an
affiliated
corporation)
could
subject
a condition to Norfolk Southern buying Conrail
from
the
future
use of
Conrail deductions
to challenge
Federal
government,
Norfolk Southern
shallunder
have section
received 269
(at
of the
Code.
See
Treas.
Reg.
§
1.
269-3(b)(1).
the Federal government's sole election) either a ruling or a
warranty that amounts paid to employees of Conrail for
services rendered after Closing in order to increase their
post-Closing wages to industry standard and the costs paid or
incurred for certain routing concessions which are otherwise
ordinary and necessary business expenses shall not be treated
as built-in deductions and can be deducted when accrued or
paid. Although the SRLY and built-in deduction rules apply
to amounts economically accrued but not yet deducted, the
above expenses do not appear to constitute built-in
deductions. Because of the condition that such expenses must
otherwise be ordinary and necessary business expenses, the
ruling or warranty required by the above condition does not
warrant the deductibility of such amounts; only that such
amounts are not built-in deductions.
- 6 Warranty of Asset Basis
As provided in Paragraph 6(e)(ii) of the Memorandum of
Intent, the Federal government would warrant to Norfolk Southern
that the asset basis reflected on Conrail's tax return for the
year ending on the Closing would not be decreased as a result of
an audit adjustment for a taxable year ending on or before the
Closing. We believe this warranty is appropriate for a variety
of reasons. Most importantly, the warranty protection extended
to Norfolk Southern is consistent with the allocation of risks
that could be expected in an analogous private party transaction.
Conrail has not been audited since its formation and its tax
basis in many assets would have to be traced to its predecessors.
As a consequence, Norfolk Southern has no effective means of
determining whether Conrail's asset basis is accurately reflected
on its tax returns. In circumstances where the accuracy of the
selling party's tax accounting cannot be established, it is
reasonable to expect the seller to retain the risk of audit.
Consistent with the above warranty, Paragraph 6(e)(iii) and
(iv) of the Memorandum of Intent requires the Federal government
to warrant that the adjusted tax basis of Conrail's assets would
not be reduced and no gain or loss or income would be recognized
by Conrail or Norfolk Southern as a result of the sale of
Conrail's stock to Norfolk Southern, except in the event Norfolk
Southern makes, or is deemed to have made, an election under
section 338 of the Code. If a section 338 election were made (or
deemed made) by Norfolk Southern in connection with its purchase
of the stock of Conrail, Conrail would be treated as if it sold
all of its assets to itself in a liquidating sale, and the tax
basis of its assets would be adjusted to an amount based upon the
amount Norfolk Southern paid for Conrail's stock (grossed-up to
reflect a purchase of 100 percent of Conrail's stock). The
Memorandum of Intent further provides that, for purposes of the
warranty, Norfolk Southern would not be deemed to make a section
338 election as a result of any asset acquisition provided that
Norfolk Southern (and its affiliates) elect either to treat such
assets acquired in accordance with regulations promulgated under
section 338 or elect under conditions to be agreed upon that the
basis of such assets would not exceed the transferor's basis in
the assets immediately before the acquisition. This warranty was
provided because, as of the date the Memorandum of Intent was
signed, the regulations providing for a carryover basis to avoid
a deemed election under section 338, contemplated by Congress in
the Tax Reform Act of 1984, had not been issued.
It should be noted that the warranty protection that Norfolk
Southern receives is not a guarantee that the IRS will not audit
Conrail for pre-Closing years or that, if it does so, it will not
be entitled to require a reduction in Conrail's asset basis.
- 7 Rather, in the event of an IRS audit and any reduction in basis,
the warranty procedure contemplated in the Memorandum of Intent
and enabling legislation entitles Conrail to sue in Federal court
and to obtain a judgment that could be applied to offset any
increase in tax liability attributable to the basis reduction.
Although this procedure leaves Conrail economically protected
from the risk of audit, it does not otherwise impair the ability
of the IRS to conduct an audit of Conrail. Retention of the
audit authority of the IRS with respect to Conrail's pre-Closing
years could be significant to the extent substantive tax issues
relating to those years have relevance to issues arising in other
tax years of Conrail or to the administration of the Federal
income tax system generally.
Change in Methods of Depreciation
The potential value of any built-in loss or built-in
deductions attributable to Conrail's assets also depends on the
period of time over which those assets would be depreciated. The
warranty as to asset basis provided in Paragraph 6(e) (ii) of the
Memorandum of Intent contains a condition that the depreciation
of such assets should be determined without extraordinary
departures from the methods of prior years. In general, since a
depreciation method is considered a method of accounting, a
taxpayer cannot change its method of depreciation with respect to
a particular asset without first obtaining permission from the
Commissioner of the IRS.* In this regard, Conrail and Norfolk
Southern would be treated the same as any other taxpayer if,
after the sale of Conrail, a change in depreciation method were
requested.
Carry Over of Earnings and Profits
At present, Conrail may have a deficit earnings and profit
account reflecting its substantial net losses over the period of
* Section 203(c) of the Economic Recovery Tax Act of 1981 permitted
taxpayers to change their method of depreciating railroad track
without having such change treated as a change in method of
accounting. It does not appear that this provision applies to a
change in the method of depreciating railroad track initiated
after 1981. Thus, Conrail should not be able to change its
present method of depreciating its "frozen asset base" without
securing the prior approval of the IRS.
- 8 its operation.* The Memorandum of Intent does not directly state
whether the earnings and profits history of Conrail would carry
over to post-Closing taxable years. Since earnings and profits
ordinarily would carry over in a stock acquisition, the failure
to state a contrary result suggests that Conrail's earnings and
profits account would survive the transaction. Since earnings
would
seem that
Conrail's
earnings
and profitsincome
shouldorbe
treated
and profits
are a
measure of
a corporation's
loss,
it
Conrail's earnings and profits by providing that they not carry
over in the sale transaction.
The value to Norfolk Southern of a carry over of Conrail's
earnings and profits is uncertain. Earnings and profits
determine the extent to which a corporation's distributions to
its shareholders are dividends rather than a return of capital.
Although a deficit earnings and profits account would permit a
corporation to make nontaxable return of capital distributions to
its shareholders,** Conrail will be a wholly-owned member of
Norfolk Southern's consolidated group and thus its distributions
will be nontaxable whether characterized as dividends or as a
return of capital. We understand that Norfolk Southern itself
has a substantial surplus in its earnings and profits, and thus
any distributions by Norfolk Southern to its shareholders would
be fully taxable dividends even if they were attributable to
distributions from Conrail. Moreover, Norfolk Southern's surplus
in earnings and profits would not be offset by any deficit of
Conrail even if Conrail were to merge with Norfolk Southern. See
section 381(c)(2) of the Code.
Cancellation of Conrail Debt and Preferred Stock
The Northeast Rail Service Act, which directed the Department
of Transportation to devise a plan for the sale of Conrail, also
directed that Conrail be sold essentially free of the Federal
**
We have not been provided any data on Conrail's earnings and
profits. There may be uncertainty as to the exact amount
because of the uncertain effects of prior law.
A carry over of any Conrail deficit in earnings and profits
could be disadvantageous to Norfolk Southern, because it
would limit Conrail's ability to issue new preferred stock to
outside interests. The market for such preferred stock is
predominantly among corporations, for whom dividend
distributions are ordinarily more advantageous than returns
of capital.
^
- 9 government's existing debt or preferred stock interests. The
apparent intent of the legislation was that Conrail be returned
to the private sector with a sound capital structure. This
intention is reflected in Paragraph 3 of the Memorandum of
Intent, which provides that prior to the sale approximately $850
million of outstanding Conrail debt, including accrued interest
thereon, and approximately $2.3 billion par value of Conrail
preferred stock, including accrued and unpaid dividends thereon,
held by the Federal government would be "cancelled or retired,
and contributed to the capital of Conrail." In addition, under
Paragraph 6(e) (i) of the Memorandum of Intent, the Federal
government would warrant that Conrail will not recognize income
on account of the cancellation of Conrail preferred stock or
debt.
Under general tax law principles, reflected in section
61(a)(12) of the Code, a corporation may recognize income where
it retires outstanding indebtedness at a cost that is less than
the face amount of the indebtedness. This discharge of
indebtedness principle recognizes that a taxpayer has an economic
profit when it borrows money that it is not required to repay in
full. Certain exceptions to the discharge of indebtedness
principle are enumerated in section 108 of the Code, including
that a corporation does not recognize income where a shareholder
contributes indebtedness to the corporation's capital (provided
that the shareholder's basis in the debt is not less than the
face amount of the debt). This exception, stated in section
108(e)(6), effectively recognizes that any excess of the amount
borrowed from a shareholder over the amount repaid might have
been directly contributed to the corporation without causing the
corporation to recognize income.
Under the substantive principles described above, Conrail
would not recognize income from the cancellation of its debt if
such cancellation were treated as a contribution to its capital
by the Federal government. Although there is little authority
addressing whether a shareholder's cancellation of corporate debt
is a contribution to capital, characterization of the
cancellation of Conrail's debt as a contribution to its capital
would seem probable. The cancellation of Conrail's debt would be
*
The Federal
government
approximately
85 percent of the
structured
in this
form, theowns
cancellation
was effectively
common
stock
of
Conrail,
with
the
remaining
percent being
directed by Congress, and the practical effect of15the
held by Conrail
Equity be
Corporation
subsidiary
cancellation
would simply
to enhance ("CEC"),
the valuea of
Conrail of
Conrail
(see
discussion
below
under
Transactions
Involving
common stock owned or controlled by the Federal government.*
Conrail's ESOP).
- 10 Even if the cancellation of Conrail's debt were not treated
as a contribution to its capital by the Federal government,
Conrail's carryforwards would remain available to offset any
discharge of indebtedness income to Conrail for a pre-Closing
year. Given the size of Conrail's carryforwards in comparison to
the amount of its outstanding debt, the warranty that Conrail
would not recognize discharge income offers additional protection
to Conrail only to the extent such income might be recognized
after the Closing, i.e., in a year in which the carryforwards
would not be available to absorb the income. Although it may be
conceivable that the debt cancellation and sale of Conrail could
be recharacterized so as to cause Conrail to recognize discharge
of indebtedness income after the Closing, any such income would
as a practical matter be attributable to the period in which
Conrail was owned by the Federal government. We thus believe it
is consistent with the other tax consequences of the proposed
sale that Conrail be held harmless from any tax liability arising
from the cancellation of its indebtedness. A warranty providing
for this result is additionally appropriate given that the
cancellation is effectively directed by legislation.
The proposed sale agreement also warrants that Conrail will
not recognize income from the cancellation of its outstanding
preferred stock. Under general tax law principles, a corporation
does not recognize income upon a reacquisition or cancellation of
its own stock. Thus, absent a recharacterization of the
transaction, Conrail should not recognize income from the
cancellation of its preferred stock.
Although we are uncertain as to why this warranty was
requested, it might conceivably be out of a concern that
Conrail's preferred stock could be characterized for tax purposes
as indebtedness, and thus that Conrail may recognize income from
its cancellation. There is little authority indicating under
what circumstances an investment denominated as preferred stock
could be recharacterized as debt for tax purposes. We
nevertheless view the possibility of such recharacterization in
Conrail's circumstances as remote. Recharacterization of any
substantial portion of Conrail's preferred stock as debt could
push Conrail near or into insolvency.
- 11 Transactions Involving Conrail's ESOP
Approximately 15 percent of Conrail's common stock is
beneficially owned by Conrail's employee stock ownership plan
("ESOP").* Paragraph 2 of the Memorandum of Intent provides
that, at or prior to the Closing, Norfolk Southern or Conrail
shall have made appropriate arrangements with respect to the
employees of Conrail to accomplish the acquisition by Norfolk
Southern of such employees' 15 percent beneficial interest in the
common stock of Conrail. while we understand that separate
negotiations between Norfolk Southern and Conrail's employees are
still pending, Exhibit A to the Memorandum of Intent indicates
that Norfolk Southern proposes to transfer $375 million in cash
or Norfolk Southern common stock to Conrail's ESOP.**
To the extent that Norfolk Southern's transfer to Conrail's
ESOP is in exchange for the ESOP's beneficial interest in
Conrail's stock, such amounts would not be deductible
contributions by Norfolk Southern, but rather costs incurred in
acquiring Conrail's stock. On the other hand, to the extent that
the amount of Norfolk Southern's transfer to Conrail's ESOP
exceeds the value of the ESOP's beneficial interest in Conrail's
stock, such amount could be a deductible contribution by Norfolk
Southern, subject to the deduction timing rules of Code section
404 (including section 404(j)) and the continued qualification of
Conrail's ESOP. The enabling legislation specifically provides
that no inference is to be drawn from the provisions of that
legislation regarding either the allocation of Norfolk Southern's
$375 million transfer between the purchase of Conrail's stock and
deductible
contributions
to stock
the ESOP
the deductibility
of any
*
CEC, all
of the common
and or
approximately
50 percent
of
portion
of such transfer
bywhich
Norfolk
to Conrail's
ESOP.
the preferred
stock of
is Southern
owned by Conrail,
currently
owns approximately 15 percent of the common stock of Conrail.
The other 50 percent of CEC's preferred stock is owned by
Conrail's ESOP. Under existing agreements, Conrail's ESOP by
1991 would own 100 percent of CEC's preferred stock which
would then be exchanged for the 15 percent of Conrail's
common stock held by CEC.
** It should be noted that under Paragraph 12(b)(viii) of the
Memorandum of Intent Norfolk Southern and Conrail are
prohibited for at least five years from obtaining a reversion
of any excess assets held in connection with Conrail's
Supplemental Pension Plan. A reversion of plan assets to
either Norfolk Southern or Conrail would not be permissible
unless and until the plan is terminated and all liabilities
of the plan to the employees are fully satisfied.
- 12 If the form of Norfolk Southern's arrangements with Conrail's
employees were to cause disqualification of Conrail's ESOP, such
employees generally would be currently taxable on the value of
their beneficial interest in the trust. In this regard, section
132 of the enabling legislation provides that Conrail's ESOP and
related trusts maintained, amended, or adopted in implementing
the Secretary of Transportation's plan for the sale of Conrail
shall be deemed to meet the qualification requirements of
sections 401 and 501, notwithstanding that such plans may not
meet the requirements of Code section 415 (which relate to
limitations on contributions and other additions with respect to
participants in a qualified plan) or that participants in such
plans may be entitled to withdraw a portion of the shares
allocated to their accounts prior to the expiration of the
two-year period generally imposed by the IRS for qualified plans
(see Treas. Reg. § 1.401-l(b)(1)(ii)). Although Norfolk
Southern's arrangements with Conrail's employees have not been
finalized, we believe it appropriate, given the possibly unique
form of such arrangements and the unusual structure of Conrail's
ESOP, to waive by legislation these two possible technical
violations in order that Conrail's ESOP would maintain its
qualification.
Separation of Government Roles
The IRS is charged with administration and enforcement of the
Federal income tax laws. In order to carry out this mission
effectively, no preference or special rules can be adopted for
any taxpayer.
We believe the Department of Transportation's plan for the
sale of Conrail is consistent with the special responsibilities
of the IRS as administrator of the Federal income tax laws. Most
importantly, the plan does not restrict the IRS from auditing or
assessing tax liabilities against Norfolk Southern or Conrail
after the sale. To the extent Norfolk Southern would be
protected in the proposed transaction against possible tax
liabilities of Conrail or of Norfolk Southern, such protection
would be provided in the form of a warranty, rather than covenant
by the IRS, in order that the IRS be able to fulfill its mission
of evenly administering and enforcing the Federal income tax
laws. Certain legislation, which is included in the proposal
submitted by the Department of Transportation, would be necessary
to implement a procedure for Norfolk Southern to enforce such tax
warranties against the Federal government.
* * *
This concludes my prepared remarks. I would be happy to
respond to your questions.
rREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
STATEMENT OF THE HONORABLE JOHN M. WALKFR, JR.
ASSISTANT SECRETARY (ENFORCEMENT AND OPERATIONS)
U.S. DEPARTMENT OF THE TREASURY
BEFORE THE ST7RC0MMImmEE ON CRIME
COMMITTEE ON THE JUDICIARY
U.S. HOUSE OF REPRESENTATIVES
APRIL 16, 1985
Progress in the Fight Against Monev Laundering
Mr. Chairman and Members of the Committee:
I am pleased to have the opportunity to apnear before
vou today to discuss the problem of money laundering. As
this Committee is fully aware, money laundering is a serious
challenge to law enforcement and a clear danger to the soundness and integrity of our financial system. In my testimony
today, I will discuss the scope of the money laundering
problem and some of the reasons why it is so pervasive. I
will explain whv Treasury believes that an attack on money
laundering is essential to a successful fight aqainst organized
crime and drug trafficking. I will then summarize the progress
we have made and discuss initiatives with the potential to
further our progress.
The Treasury Department sincerely welcomes the interest
that you, Chairman Hughes, and this committee have expressed
in this critical topic, and we look forward to assisting you
as you consider possible legislative measures to enhance our
country's efforts against money laundering and other organized
crime.
Why Money Laundering Poses a Difficult Challenge to
Lav/ Enforcement
Mr. Chairman, for a number of reasons, money launderinq
is a major challenge for law enforcement. First, the scope of
the problem is staggering. While no one knows with certainty
how much money is laundered in the United States every year,
estimates point to anywhere between S50 and $65 billion in
laundered crime proceeds from drug trafficking alone. From
money launderinq cases Treasury has investigated, we know
that a sinqle money laundering enterprise can wash $300
million or more in crime proceeds in less than a year's
time.
B-96
Suppressing money laundering is enormously difficult fen
another reason: there are seemingly infinite ways for
criminals to accomplish it. Treasury's investigators have
uncovered money laundering schemes that are as varied as the
human imagination will allow. They can be conducted domestically
or internationally, and they can exploit various types of
financial institutions. Because all organized crime depends
on skilled money launderers for its very existence, there is
a continuous incentive for criminals to develop new methods
for circumventing Federal reporting requirements and for
concealing cash and pools of assets from the eyes of law
enforcement.
Money laundering has seen unprecedented growth over the
last decade for another basic reason: it is an extremely
lucrative criminal enterprise. Treasury's investigations
have uncovered members of an emerging criminal class: They
are the professional money launderers who aid and abet other
criminals through financial activities. These individuals
do not fit the stereotype of an underworld criminal. They
are accountants, attorneys, money brokers, and members of
other legitimate professions. They need not become involved
with the underlying criminal activity except to conceal and
transfer the proceeds that result from it. They are drawn to
their illicit activity for the same reason that drug trafficking
attracts new criminals to replace those who are convicted and
imprisoned; and that reason is greed. Money laundering, for
them, is an easy route to almost limitless wealth.
Our free society and our diverse economy, with its ready
access to international financial networks, provide the
setting for the money launderer's operations. We must
recognize that while our law enforcement tools—chiefly the
Bank Secrecy Act—allow us the means to obtain reporting that
can disclose suspicious transactions, there are limitations
on the amount and type of information that law enforcement
may obtain. Later in my testimony, I will describe how
Treasury is seeking to overcome some of these limitations.
I will also address the subject of possible legislative
changes that have the potential to strengthen the tools at
law enforcement's disposal for use against the money laundering
problem.
- 3 An Attack on Money Launderinq is Essential
to the Fight Against Organized Crime and
Drug Trafficking
Mr. Chairman, the difficulties I have mentioned should not
cause anyone to believe that our fight against money laundering
is a hopeless one. Quite to the contrary: in the past four
years, we have recorded substantial and remarkable progress.
I will give some examples of this progress in a moment. But
for now, let me stress a principle that our financial investigations have demonstrated time and time again: that we can
never hope to control drug trafficking and other forms of
organized crime in our society unless we continue our efforts
to go after the money that is at the heart of every criminal
enterprise. The reasons behind this conclusion are fundamental
ones.
Money, of course, is the motivation behind every organized
crime transaction and the thread that ties together the
components of a criminal enterprise. If we can trace the
money, the trail will often lead to high-level criminals.
The leaders in any criminal enterprise usually take great
pains to distance themselves from the illegal source of their
income. But they can usually be found close to the money.
The money, if seized, is potentially devastating
evidence at a criminal trial. A jury can yet lost in the
technical details of a white collar crime. But if jurors can
be shown the illicit proceeds, they can more readily understand
the full impact of the crime.
Also, through seizure and forfeiture, we can deprive
a criminal enterprise of its lifeblood. For instance, drugs
can be readily replaced by a drug trafficking organization,
but its cash reserves are essential to its functioning.
It is this cash that finances new drug importing ventures,
and is the means of corrupting justice. Large monetary
seizures can cripple the organization and possibly put it
out of business altogether.
Finally, the Bank Secrecy Act is itself the authority
for criminal and civil penalties. As an independent basis
for prosecution, it can be the statutory weapon that breaks
up a criminal enterprise and imprisons its members.
Treasury's investigative successes under the Bank Secrecy
Act demonstrate the validity of this approach. In 1980,
Treasury, with the support of the Justice Department, organized
Operation Greenback in Miami to conduct financial investigations
using the reporting information provided by the Bank Secrecy
Act. The Treasury task forces modeled after Greenback now
total forty in number, located in cities across the nation.
- 4 Since 1980:
• They have produced over 1300 indictments and over
460 convictions;
• They have resulted in $81.8 million in currency
seizures and $34.3 million in property seizures; and
° They have destroyed eighteen major money launderinq
enterprises, which laundered a documented total
of $2.8 billion. (Chart on Monev Laundering)
Greenback itself has become a component in one of the
President's Organized Crime Druq Enforcement Task Forces,
which now number thirteen. These Task Forces have initiated
over 880 cases, even thouqh they have been fullv operational
for only 21 months. They have produced indictments of more
than 4600 individuals and have resulted in more than 1,860
convictions. Two out of three Task Force cases have a
financial component.
Treasury has contributed approximately 480 special aqents
to work full-time on the OCDE ^ask Forces, 400 of which are
IRS and Customs agents who are investigatinq money launderinq.
^he other 80 aqents are ATF agents who are investigatinq the
firearms violators who participate in and support the druq
trade and orqanized crime.
Our Attack on Money Laundering Requires the Full
Participation and Cooperation of the Financial Community
Mr. Chairman, while mreasury's financial investigations
have made considerable progress, it is no secret that money
launderinq remains an enormous challenge.
When the Rank Secrecy Act was passed, Congress contemplated
that it would strenqthen law enforcement's ability to combat
white collar and orqanized crime. Over the fifteen years
since enactment of this landmark leqislation, there is no
question that the Act has succeeded in this regard. But as a
society, it is essential that we set a higher goal: if we are
to strike a telling blow aqainst druqs and crime, we must go
further, and strive to deny criminals access to our financial
system.
m
his, of course, is a task that law enforcement cannot
accomplish alone. Ranks and other financial institutions must
do more to ensure that their employees do not become, wittingly
or unwittingly, the prey of the criminal operative with cash
to launder.
- 5 Certainly, full compliance with the reporting requirements
is essential. Treasury depends on the reporting data generated
by these requirements for its own financial investigations and
the analytical support it provides other law enforcement agencies
The Treasury Financial Law Enforcement Center, or TFLEC,
combines these data with other sources of intelligence to generate financial intelligence reports, currency flow charts, and
link analyses, which probe the financial connections inside and
among illicit enterprises. TFLEC provides vital support to ongoing investigations, including those of the OCDE and Treasury
Task Forces, and it generates leads for the development of new
cases.
It is fair to say that were it not for the reporting information Treasury receives as a result of the Bank Secrecy Act,
the major money laundering enterprises I mentioned earlier would
all be thriving today. To ensure the availability of reports,
we must continue to improve the level of compliance by financial
institutions. Recent cases involving banks that have violated
the reporting requirements illustrate that there are instances
in which currency transaction reports and currency and monetary
instrument reports are not being filed. We have also seen misuse of the exempt lists, under which specified bank customers
may make cash deposits without the filing of CTR's.
We have begun a number of initiatives to effect further
improvements in compliance:
° We are working with the bank regulatory agencies to improve the application of the examination procedures;
° We have worked with the President's Commission on Organized Crime, which has developed a series of regulatory,
administrative, and legislative recommendations. Some
of the regulatory and administrative recommendations
have already been implemented, and the remaining ones
are under serious consideration.
° We are giving assistance to banking industry associations
to foster the development of improved training for bank
employees. Regarding the banking industry, there is a
further point I would like to make: we must not confine
our thinking to the bank's legal obligations. Every
financial institution has a moral and ethical obligation
not to be used to further criminal activity. This obligation extends both to the community served by the bank
and to our financial system as a whole. For it is certain that when criminal operatives can use a financial
institution at will for their own purposes, the overall
trust in our banking system is eroded. Thus banks must
be vigilant to spot instances of money laundering and
must report suspicious transactions to the law enforcement authorities.
- 6 The Growing Problem of Offshore Money Laundering
Mr. Chairman, I would like to turn to another aspect of
the problem facing us: offshore money laundering. Even as
we improve compliance with the Bank Secrecy Act, we must recognize that the expanded Federal enforcement effort will cause
a shift to offshore money launderinq. The Milian-Rodriguez
case, in 1983, exemplified this trend, and involved the
international transportation of over $300 million in cash to
offshore accounts.
Our government has responded to this trend by seeking
international agreements providing for access to evidence
relevant to U.S. criminal investigations. On July 26, 1984,
Great Britain and the United States exchanged diplomatic correspondence establishinq our access to documentary information
located in the Cayman Islands that is material to investiqations
related to drug traffickinq. The aqreement became effective
on August 29, 1984, and since that time has resulted in the
obtaininq of valuable information for prosecutions in the
United States.
The Departments of Justice and Treasury have been seeking
a similar agreement with the Republic of Panama and will
resume negotiations with Panamanian officials later this month.
In further response to the trend of offshore money
laundering, Treasury published proposed regulations last
year that would establish procedures under which the Secretary
could require specified U.S. banks to report financial transactions with foreiqn financial institutions. These regulations, which will be promulqated in final form in the near
future, will provide a mechanism to help identify money transfers related to druq traffickinq or other organized crime
that occur between U.S. and foreiqn financial institutions.
In exercising the authority under this regulation,
Treasury will select classes of transactions with foreiqn
financial institutions as the subject of reportinq on the
basis of available information indicatinq unusual financial
activity. Treasury will strive to impose reportinq requirements
in the least burdensome manner consistent with our need for
the information. The Act is quite specific in requirinq that
Treasury carefullv consider how its international transaction
reporting requirements affect financial institutions.
- 7 Initiatives to Strengthen Our Attack on Money Launderinq
Mr. Chairman, as I mentioned earlier, the President's
Commission on Organized Crime has developed legislative
recommendations as well as suggested requlatory changes
and improvements for the administration of the Bank Secrecy
Act. Some of these legislative recommendations have been
incorporated in various bills now pending before the Congress,
and I would be remiss if I did not express my appreciation
for the efforts that vou, Chairman Hughes, have put forth
to develop and introduce legislation to combat money launderinq.
I would also like to express my appreciation to Congressman
McCollum, for his leadership and initiative in this area.
With regard to the entire body of proposed legislation
now pending before both houses of Congress, I would like to
offer a few observations. First, an area of leqislative
inquiry that we consider worthy of close examination is the
Right to Financial Privacy Act. While Treasury recoqnizes
the rationale for preserving the confidentiality of banking
records, we strongly suggest that the Congress re-examine
the current balance between the maintaining of this confidentiality and the legitimate interest of law enforcement in
receiving usable information concerning potential violations.
Another topic that certainlv deserves examination is the
matter of an administrative summons power that Treasury could
use in ensuring compliance with Title 31. Administrative
summons authority is quite common amonq Federal aqencies, yet
Treasury lacks any such authority that could be applied to
determine whether a financial institution is complying with
applicable Title 31 reportinq requirements. This authority
would be of great benefit to Treasury in fulfillinq its
civil enforcement responsibility and its oversight responsibility regarding bank requlatory aqencies.
Mr, Chairman, this concludes my formal statement. I
would be pleased to answer any questions that you and other
members of the Committee may have.
Attachment
Attachment
SIGNIFICANT MONEY LAUNDERING CASES
Convicted
Isaac Kattan
Beno Ghitis
?rozco
Armenteros et.al.
Great American Bank
Zapata et.al.
Dollars Laundered
$500,000,000
268,000,000
145,000,000
130,000,000
95,000,000
17,000,000
12,000,000
Subtotal $1,167,000,000
Plnt0
Pending
A
B
$300,000,000
300,000,000
S.
2io'6ooIooo
~
£
F
JGJ
j
230,000,000
180,000,000
140,000,000
70,000,000
65,000,000
60,000,000
t
20,000,000
Subtotal $l,b24,000.0QQ
Tot
al $2,791,000.000
T
Time Frame
36' monthsS months
13 months
36 months
13 months
8 months
13 months
24 months
36 months
20 months
36 months
24 months
8 months
8 months
12 months
12 months
18 months
3 months
TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2041
STATEMENT OF THE HONORABLE
JAMES W. CON ROW
DEPUTY ASSISTANT SECRETARY
FOR DEVELOPING NATIONS
BEFORE THE
HOUSE SUBCOMMITTEE ON INTERNATIONAL
DEVELOPMENT INSTITUTIONS AND FINANCE
OF THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
APRIL 18, 1985
Mr. Chairman and Members of the Subcommittee:
The Administration is seriously concerned by the extremely
difficult development problems confronting the countries of
Sub-Saharan Africa. We attach major importance to an effective
United States development role in the region. I therefore welcome
the increased attention being focused on Sub-Saharan Africa by the
Subcommittee, reflected in the Chairman's proposed bill, H.R. 1949,
as well as the opportunity you have provided for me to meet with
you to discuss our shared goal of strengthening the ability of
our bilateral and multilateral programs to promote sustainable
economic growth in the countries of the region.
Overview:
A general consensus has emerged that policy reform is the
key to long-term progress in Sub-Saharan Africa. There is also
widespread recognition that improving the quality of external
assistance is as important as the volume. We also want a
program which maximizes its impact on Africa yet realistically
recognizes the limitations posed by the region's relatively
new institutions, limited technical manpower, and overall
absorptive capacity. These have been paramount considerations
in formulating an effective U.S. response to Africa's development needs. The result of these considerations is a very
substantial U.S. effort comprised of an expanding bilateral
program, a concerted effort in the World Bank to focus IDA and
IFC resources on Sub-Saharan Africa, and growing support for
the African Development Bank and Fund.
B-97
- 2 Economic Situation:
Approximately 400 million people liye in the 45 countries
of Sub-Iaharan Africa. While the current tragedy of widespread
famine and drought has attracted worldwide concern and renewed
interest in the region, Sub-Saharan Africa s problems are not
a sudden development. Rather, they are the result of a process
of economic deterioration which began in the late 1960s. A
number of inter-related factors have contributed to Africa s
economic decline. However, the roots of the current problem
are largely based on past policies — such as inappropriate
investments, misaligned exchange rates, and skewed product
pricing. These have compounded existing structural deficiencies, discouraged efficient use of resources, and
significantly reduced the productivity of investment.
There is still great diversity among the economic situations
of individual African countries. In general, however, the
region's overall situation in recent years has been characterized by declining per capita agricultural output, a high level
of idle industrial capacity, a deteriorating physical infrastructure, and inefficient institutions. Sub-Saharan Africa's
external position has also weakened significantly — in part
due to the international economic environment — with declines
in both export volumes and overall terms of trade, and a
major build-up of external indebtedness.
Nonetheless, favorable developments in a number of
countries have taken place over the past year. A return to
more normal rainfall patterns in several key areas appears
to be taking place, with an immediate, positive impact on
agricultural production. Significant policy-re form programs
are under way in a growing number of countries, and prospects
are promising for real GDP growth in 1985 for the first time
in four years.
World Bank Sub-Saharan Africa Report:
As a result of its extensive experience in Africa, the World
Bank has accumulated an impressive and internationally respected
store of development expertise on the region. In August 1984,
the Bank issued its third report on Sub-Saharan Africa analyzing
development prospects and outlining an action program to help
restore economic recovery. In our view, this report was a frank
and objective analysis. The key themes in the report are the
urgent need for policy reform and getting better value from both
internal and external resources.
With respect to domestic policy environment, the report
criticizes continued policy distortions, places major stress on
market incentives — particularly in agriculture and including
realistic exchange rates — and identifies the need for major
^ J } * ^ C t ° y r e ^ o r m s < reductions in public expenditure, and
Pfl^n,
° r m 9 e a r e d t 0 ****« coordinated and more
mana
hf«£!*
? f m e n t ' Africa's population growth, the world's
highest, as well as environmental destruction and the lack of
human infrastructure are also highlighted.
- 3 With regard to external assistance, the key emphasis is on
improving the quality of donor support for African countries
implementing major policy reform. The need for better aid
coordination to improve project selection and more emphasis on
the rehabilitation and maintenance of existing facilities —
rather than new infrastructure — is also stressed. In addition,
the report outlines a program to increase the effectiveness of
the Bank's own assistance efforts in Africa.
U.S. Views:
The Administration agrees that policy reform is the key to
sustained economic progress in Sub-Saharan Africa. We also
recognize the importance of adequate donor support for those
countries implementing such reform. In this context, we are
working hard to increase the effectiveness of both our bilateral
and multilateral assistance efforts. At the same time, the
difficulties of putting together effective projects in Africa
should not be underestimated.
There are major absorptive
capacity constraints, with the weaknesses in the region's
institutional infrastructure providing a particularly difficult
obstacle to effective project implementation.
Bilateral Program;
The United States has a very considerable and expanding
bilateral assistance program for Sub-Saharan Africa, including
food aid, project specific assistance, and non-project support
funds. Total U.S. bilateral assistance to Sub-Saharan Africa
rose from $708 million in FY 1980 to $843 million in FY 1983.
It is projected to total over $1.8 billion in FY 1985; more than
$1.0 billion in commitments of food aid and $789 million in
assistance excluding food.
The main objectives of bur bilateral assistance strategy are
economic stabilization, increased agricultural production, and
human resources development. To achieve these objectives, our
bilateral programs are supporting economic policy reforms to
create incentives for growth and to enable the indigenous private
sector to play a more dynamic role while helping to develop the
technologies and institutions required for sustained growth.
The African Development Bank and Fund:
On Tuesday, I discussed with you the Administration's support
for the efforts of the African Development Bank and Fund to play
more important roles in addressing the fundamental problems facing
Africa. In the FY 1980-84 period, lending commitments from the
Bank and Fund totaled $3.7 billion.
The proposed U.S. contribution for the Fourth Replenishment
of the AFDF is $225 million, an increase of 50 percent over the
previous U.S. commitment level. The United States is the largest
contributor to the replenishment, and our 15.4 percent share is an
increase over the previous replenishment's 13.1 percent share.
- 4The market related lending of the AFDB goes to the relatively
higher income countries of Africa for public utility, transport and
agricultural projects. The Bank has begun work on formulating its
operational plan for the 1987-91 period. We intend to help the
AFDB fashion a plan to guide the institution into the next decade
while strengthening its financial and technical capacity.
World Bank Operations:
The operations of the World Bank are specifically designed
to encourage appropriate policies and thereby assist in the
economic growth of its developing country members. The Bank has
significantly expanded its operations in Africa and, in addition
to its proven expertise as an investment project lender, provides
helpful policy guidance and technical assistance, and acts as a
catalyst in encouraging private enterprise and investment capital.
In the FY 19 80-84 period, IBRD commitments to African
countries totaled $4.1 billion. Given the near-market terms of
IBRD loans, this assistance has concentrated on the relatively
higher-income countries; with Nigeria, the Ivory Coast and Kenya
accounting for about two-thirds of the total. Over the same
five-year period, concessional IDA commitments to Africa totaled
$5.2 billion with the five largest recipients (Sudan, Uganda,
Kenya, Tanzania, and Zaire) accounting for almost 40 percent
of the total. In addition to IBRD/IDA commitments, gross IFC
investments totaled $417 million over the FY 1980-84 period.
+*> irhe United States remains the largest single contributor to
the world Bank, and we are working with Management and other
members to improve the effectiveness of the Bank's assistance
liZ
^
lriZ*\ I n t h i s - context < we are pleased at the
t 1
J*|ich ^ e Bank has recently moved, with the full
P
f n d ° n ° L ! E * e c u t l v e Bo *rd, to strengthen the administration
suoDort a nrnoT
^l A f r l C a n o p t i o n s with the objective of
supporting policy reform efforts in the region.
resoc^sibnt/T ^V*1* t0 continue emphasizing its mandated
so1
ItlTes has a l L
^ investment project lending, the United
SUpP rted
to the chano.no
°
**** efforts to respond effectively
indivtduaTme^
realities o f *
nrooram i = * orw.
7 b t r u c t u r a l Adjustment Lending SAL
williner to f0™„i»t. f * • "^"rsing support for countries
a d j u s t L n ^ ^ n c f r t e i r i n ^ r o T ^ .P r o ? r a r a s <* structural
been 10 SALs (tiling ?841 6 ™n?-°"^ ^ F Y . 1 9 8 0 ' t h e r e h a v e
We also support secto? lit t railll°"> to six African countries.
for encouraging adjustmentaiT* l 0 3 n S *' a P P r ° P r ^ t e instruments
conditionally. such sector J f 9 . a S t h e r e i s "ffective
appropriate for Sub-Saharan A f r ^ v ^ l 0 a " S m a y b e Particularly •
hinder the desian and i„„i A f r i c a w h e n institutional weaknesses
I
based lending or when m a c r o T f - 0 " ° f m ° r e comprehensive policy '
wnen macro-policies are generally adequate.
- 5 Concessional IDA resources are of particular importance to
Africa. In the international negotiations which preceeded agreement on the Seventh Replenishment, the United States took a
leadership role in urging that on the basis of need, lack of
alternative financing, and limited opportunities for improving
terms of trade, Sub-Saharan Africa should have first claim on
available resources to the extent that they can be used effectively. While the share of annual IDA lending going to Africa
has increased significantly — from about 26 percent in FY 1980-81
to 34 percent in FY 1982-84 — we view the 35 percent share of
IDA VII currently programmed for Sub-Saharan Africa as still too
modest and not fully responsive to the IDA Deputies' recommendation
to accord "highest priority" to this region.
Within the last year, a new five-year program has been
designed for the IFC. The United States took an active role
in the construction of this plan, and successfully encouraged
agreement to allocate a larger share of IFC's resources to
Sub-Saharan Africa with an approach that reflects the economic
circumstances of the region, i.e., a focus on promotional
activities and smaller scale projects. Twenty-four percent of
IFC projects in the new program will go to Sub-Saharan Africa.
The United States and other member countries support an increased
and even accelerated IFC investment program because of the
firm belief that a strengthened private sector is a sine qua
non to sustained, balanced economic development.
World Bank Special Facility for Sub-Saharan Africa:
In January, 14 governments and the World Bank agreed to
establish a Special Facility for Sub-Saharan Africa. This
Facility will finance fast disbursing assistance including
structural adjustment, sector policy reform, and rehabilitation
in countries committed to monitorable stabilization and adjustment programs.
The emphasis placed on encouraging policy
reform is consistent with the policy based thrust we support
for the Bank's other operations.
In our view, donors must have the flexibility to respond
to Africa's needs in ways of their own choosing. Such responses
should of course be coordinated with the World Bank and other
donors in order to ensure resources are being utilized in the
most effective and rational manner. Thus rather than participating in the Special Facility, we preferred instead to concentrate
on improving the impact of our bilateral program and enhancing
the effective use of existing multilateral resources. Given the
substantial effort we are already making, we do not believe U.S.
participation in the Special Facility as provided for in H.R. 1949
is warranted. However, the Administration fully supports the
Special Facility's objectives which are very similar to that of
AID's targeted assistance for selected African countries pursuing
reform.
- 6 Conclusion:
We view the U.S. response to the current difficulties of
Sub-Saharan Africa as constructive and forthcoming. In the
final analysis, the pursuit of appropriate domestic policies
by individual countries will be the key element in reversing
the alarming economic trends in Africa and restoring sustained
growth. For those committed to do so, we remain ready to lend
our support and will work hard to increase the effectiveness
of our very considerable bilateral and multilateral assistance.
Thank you, Mr. Chairman.
TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
April 18, 1985
RICHARD G. DARMAN
DEPUTY SECRETARY OF THE TREASURY
Richard G. Darman was confirmed as Deputy Secretary of
the Treasury on January 31, 1985.
From 1981 to 1985, Mr. Darman served as Assistant to the
President of the United States and Deputy to the Chief of Staff
Prior to joining the White House staff, Mr. Darman was
a member of the faculty of Harvard's Graduate School of
Government and a partner in ICF Incorporated, a management
and economic consulting company. He served previously in
government from 19.70 to 19/77, in policy positions in 5 Cabinett
Departments (HEW, Defense," Justice, Commerce and State).
His
prior "service included service as Assistant Secretary of
Commerce for Policy, a position for which he was nominated by
President Ford and confirmed by the Senate.
Mr. Darman, 41, is an honors graduate of Harvard College
and Harvard Business School. He is married to Kathleen Emmet
(Darman), Ph.D. They have two sons, and reside in Virginia.
B-98
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
For Immediate Release
April 18, 1985
Contact:
Phone:
Bob Levine
(202) 566-2041
U.S. and Saudi Arabia to Hold Joint Economic Meetings
Secretary of the Treasury James A. Baker, III will host the
Ninth Session of the United States - Saudi Arabian Joint Economic
Commission on April 22-23, 1985. The Commission, established in
1974, is co-chaired by Secretary Baker and Saudi Minister of
Finance and National Economy, Mohammed Abalkhail.
The two day series of meetings will be held at the Treasury
Department. The participants will review the ongoing Joint
Commission technical cooperation projects, which include joint
activities in such fields as transportation planning and
development, supply management, and a cooperative arrangement with
Faisal University involving five leading U.S. universities. To
date, there are 21 ongoing and five complete Joint Commission
projects.
At 9 a.m. Monday, April 22nd, at the start of the Joint
Commission meeting, there will be a five-minute photo opportunity
in the Cash Room of the Main Treasury Building.
Concurrently with the Joint Commission Session, the
U.S. - Saudi Arabian Businessmen's Dialogue will also meet. The
Dialogue, a forum for representatives of the Saudi and American
business communities to discuss issues of mutual interest, is
co-chaired by Mr. T. A. Wilson, Chairman and Chief Executive
Officer of the Boeing Company and Mr. Suliman S. Olayan, Chairman
of the Olayan Group.
###
B-99
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
Oral Statement by
The Honorable James A. Baker, III
Secretary of the Treasury of the United States
Concerning a Blueprint for Global Growth
Before the Development Committee
Washington, DC
April 18-19, 1985
Chairman Khan, President Clausen, Managing Director
de Larosiere, and Fellow Governors:
It is a distinct pleasure for me to sit with you as a member of this
Committee. I believe that these special meetings of the Interim and
Development Committees provide a unique opportunity for all members of
the World Bank and International Monetary Fund to discuss, in a frank and
open manner, issues of concern to all of us.
Mr. Chairman, your personal contribution in arranging these meetings
has been most welcome and you have our continued respect and gratitude
for your strong leadership. We also thank the staffs of the Bank and the
Fund for the excellent analysis which will facilitate our discussions.
Six months ago, my predecessor joined with you in calling for these
special sessions in order that we might examine in a comprehensive way
the policy approach necessary to move toward a sustained pattern of
global growth. In yesterday's meetings we discussed the progress that
B - 100
2
has been made to reduce external imbalances and to improve growth prospects in the world economy in the second half of the 1980s.
We recognize the important gains already realized and the necessity
for undertaking efforts to assure continued progress toward sustained
global growth. We began to develop a blueprint for global growth in the
next few years.
Today we will examine a range of policy issues that will determine
the prospects for growth and development over the longer term. We will,
I hope, work to complete our blueprint in order to ensure that our
actions are part of a long-term strategy for sustained growth. I will
not dwell on these individual issues in my opening statement today. I am
submitting detailed comments for the record.
In reviewing our economic progress, we should all recognize that it
has entailed extraordinary acts of courage among nations, both singularly
and collectively. Significant economic adjustment, some of it painful,
has taken place. But our work is not yet finished.
Many countries still face fundamental problems. Despite expanding
world trade, debt service obligations in many cases are high in relation
to export incomes. We can all agree that adjustment efforts must be
continued. In addition, the environment for trade and investment flows
must be liberalized.
Our experience since 1982 indicates that we are on the correct path.
We firmly believe that sustained and widely shared growth is possible.
But we also recognize that together we will continue to face some difficult choices as we implement our policy blueprint. The need for mutual
understanding will certainly increase.
3
In calling for these special sessions, the United States emphasized
a desire for informality which would permit true dialogue—a full and
frank exchange of views. We spoke not of negotiation, but of the need to
achieve understanding. And we remain fully committed to achieving those
objectives today.
These talks should not be a debate between industrial and developing
countries. They, require that all participants help to identify policies
that will encourage new global growth and development. In this vein, I
would hope that those developing countries among us who have identified
and implemented successful policy approaches would share the benefit of
their experience with others.
I look forward to working with each of you to identify fresh approaches to the issues and the problems we face. My hope is that at the
end of our discussions, we will have reached a new level of understanding
and a renewed determination to work together toward a global environment
which provides the basis for sustained growth and future prosperity for
all nations.
Thank you, Mr. Chairman
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
STATEMENT OF THE HONORABLE JAMES A. BAKER
SECRETARY OF THE TREASURY
OF THE UNITED STATES
CONCERNING
A BLUEPRINT FOR GLOBAL GROWTH
BEFORE THE
MEETINGS OF THE
INTERIM COMMITTEE OF THE INTERNATIONAL MONETARY FUND (IMF)
AND DEVELOPMENT COMMITTEE OF THE WORLD BANK AND THE IMF
APRIL 17-19, 1985
WASHINGTON, D.C.
I welcome the opportunity to participate in these special
meetings of the Interim and Development Committees. The United
States proposed these meetings last fall to permit a frank and
informal dialogue on the prospects and policies for growth,
adjustment, and development over the medium term.
I am convinced that an informal dialogue is precisely what
we need to understand better how each of us can contribute to
achieving stronger and more balanced global growth. We all want
growth for our economies — not stop-go spurts of recession and
growth punctuated by periods of high inflation, but sustained
growth. Jobs we can count on. Markets we can depend on.
Creditworthiness that can be maintained so that credit will be
there when it is needed.
Those are not such impossible goals. But they are ones that
require considerable thought and medium-term planning, rather
than just looking at the problems of the moment. And that's what
these meetings are designed to do:
To give us a chance to talk — frankly and off the record —
about the important progress achieved in recent years in
the face of very difficult problems.
More importantly, to give each of us an opportunity to
listen to one another, and thereby to improve our
understanding of the underlying economic situation in our
economies, as well as our fundamental dependence on each
other .
To review the outlook for the rest of the 1980s and to
consider together what policies might improve the prospects
for sustained, low inflation growth.
B-101
-2-
And to help build a consensus on what each of us can and
will contribute to that common objective.
Our task, in sum, is to develop a "blueprint" of policies
for global growth, to which each of us can contribute" and from
which all of us will benefit. This does not mean identical
policies in all countries. Our economies vary immensely, have
different needs, and can draw on unique strengths. But we all
can and must play a role in following policies that will promote
growth.
Considerable progress has already been made in restoring
growth, reducing inflation, allowing markets a greater role in
our economies, and addressing international debt problems.
Yet much still remains to be done to assure sustainable, noninflationary growth and job creation over the medium term.
Our job now is to assess the progress that we've made and
to determine how to direct our efforts to consolidate and build
on that progress.
Recent Progress
The industrial economies are in their strongest position
in many years. This progress derives, in large part, from our
success in dealing with inflation. The widely accepted view
of the late 1970's was that industrial country inflation rates
near the double-digit range were the best that could be expected
But over the past four years, we have fundamentally altered
our inflation performance and outlook. The average inflation
rate in the industrial countries in 1984 was 5.1 percent, the
lowest since 1972, immediately preceding the first oil shock.
Inflation rates have stayed at low levels during the
recovery, and can stay low as long as we continue to pursue
sound and stable monetary and fiscal policies. This could be
the only period since the early sixties when inflation rates
four years into a recovery are lower than at the beginning of
the recovery!
In addition to these inflation gains, the recovery in our
economies has solidified. Last year's average growth in the
industrial countries was the strongest since 1976. Strong U.S.
growth has led the way, accounting for nearly one half of the
real economic growth of the major European countries since
1982, with a 32 percent increase in European exports to the
United States last year. In addition, the disparities in
growth among our countries are narrowing significantly. In
1983-84, the average annual rate of U.S. real GNP growth of
5,3 percent was more than three times the rate of European
growth. In 1985-86, it is projected that this differential
will narrow to less than 1 percent as U.S. growth declines to a
more sustainable 4 percent range and European recovery moves
the growth rate there above 3 percent.
-3-
This low inflation recovery in the industrial countries
has given a substantial boost to growth and adjustment in the
developing countries. U.S. expansion alone since 1982 has
directly increased non-oil LDC exports by $25 billion, accounting for more than half of the total growth in LDC exports
during that period.
But, as important as industrial country growth has been
for the LDCs, the recovery that has begun to broaden among
developing countries is critically dependent on their own
policies. Through the use of a range of policies, particularly
sound monetary, fiscal, and exchange rate policies, a number
of developing countries have been able to take advantage of
the expanding world economy to restore growth, slow inflation
and reduce sharply their balance of payments deficits.
Real economic growth rates in the LDCs have, in fact, been
better than many had anticipated. Few expected, for example,
the non-oil LDCs to grow at 4.5 percent last year. In addition,
just as in the industrial world, growth is becoming increasingly
more balanced geographically among developing countries, an
important development in the medium-term outlook.
One must be generally impressed by the substantial improvement in the aggregate current account deficit of the indebted
LDCs, from $113 billion in 1981 to $38 billion last year. The
turnaround in the position of the "market borrowers" category
from a peak deficit in 1982 of $74 billion to only $8 billion
last year was striking. These adjustments reflect the progress
that has been made generally in dealing with debt problems
during the last few years. Adjustment in these countries was
particularly welcome and necessary in light of the need to
reestablish their access to private credit.
Some countries clearly still have a way to go in reducing
current account deficits. However, the indebted developing
countries' aggregate current account position is approaching
a level which should be sustainable over the medium-term,
depending, of course, on policy implementation in individual
developing countries, as well as policies and performance in
the industrial world.
For many developing countries, the initial phases of
adjustment should be over. This is reflected not only in the
resumption of real economic activity but also by the fact
that last year non-oil LDC exports rose by 12 percent, while
their imports rose by nearly 6 percent. Indeed, external
adjustment now seems sufficiently advanced in some cases to
permit further adjustment efforts in many countries to be
directed increasingly toward improving domestic savings and
investment, along with continued implementation of those
policies which have enabled the adjustment in the external
sector to be achieved.
-4-
Medium-Term Prospects and Policies
The papers and medium-term scenario developed for us
suggest that we can build on the progress achieved to ensure a
bright future if all countries, developing and industrial
alike, make serious, determined efforts to improve their
economic situation.
On the other hand, failure to deal adequately with our
economic problems could lead to outcomes that would be unsatisfactory, with slow growth, higher inflation, and a reversal of
the progress made in overcoming external debt problems. Thus,
tne fundamental message is that a favorable outcome will not
be handed to us on a silver platter. We must all work diligently
to achieve it.
I can assure you that the United States will do its share.
We recognize that many of you are concerned about the size of the
U.S. budget deficit. Frankly, I am concerned, too, and I can
assure you that we view the need to reduce our budget deficit as
a matter of the highest priority. President Reagan is determined
to reduce the budget deficit substantially. The President has
recently secured an agreement with the Senate leadership on
the most ambitious deficit reduction program we have ever
embarked upon. If approved and fully implemented, this program
will ensure a $300 billion reduction in our deficit over three
years.
Reducing our deficit will be part of our broader effort
to sustain strong, non-inflationary growth in the world economy
and to maintain an open trading system. We should not be surprised to see U.S. real GNP growth slowing from its nearly 7
percent pace in 1984. But all the signs indicate that conditions
in the United States have been put in place for sustained noninflationary growth in the 4 percent range.
Our continued strong stance against inflation has contributed
to a fall in U.S. interest rates since last summer. We view firm
anti-inflation policies as the surest way to reduce inflation
expectations, and thereby reduce the inflation premia that are
built into interest rates. The lags in inflation expectations
have been long. But we believe people are beginning to accept
lower inflation as sustainable, and are adjusting expectations
accordingly.
As U.S. growth slows, economic policies and developments
in Europe and Japan in particular will become increasingly
important. Recent growth in Europe, however, has not reduced
unemployment. In fact, unemployment rates in France have risen
by nearly two percentage points since the end of 1982, by one
percentage point in Italy, and by 0.6 percentage point in
Germany and the U.K. This is a worrisome problem.
-5It is our view that the ability of European economies to
restore sustainable growth and job creation will not be accomplished through attempts to stimulate demand through more
government spending. Prompt, comprehensive measures are
needed to address structural rigidities, particularly in labor
and capital markets. I believe that it is critical, for example,
that Europe remove impediments to hiring and firing of workers
so that firms possess flexibility and have economic incentives
to create new jobs. Disincentives to the job search must be
removed and marginal tax rates must be lowered so that workers
have an economic reason for seeking new jobs. Firms also need
to be able to raise capital in the most efficient way possible.
This requires removing capital market controls and rigidities,
and allowing for increased competition in capital markets.
Such steps could also encourage repatriations of capital.
Providing for more attractive investment opportunities would
produce a better allocation of capital within economies.
The very high ratios to GDP of public expenditure and
public revenue in many European countries demonstrate the
existence of both macroeconomic and structural problems which
are a hindrance to stable growth over the medium term. Many
European expenditure-to-GNP ratios are in the range of 50-60
percent. These ratios clearly need to be reduced. Policies
to cut expenditures must, of course, be accompanied by prudent
anti-inflationary monetary policy.
In Japan, remaining impediments to open markets, particularly for goods, services and capital, also seriously affect
that country's economic performance, including the exchange
rate of the yen. They also contribute to world economic
imbalances. For example, at a time when the LDCs have been
working to reduce their trade deficits, Japan added to its
trade surplus with the LDCs.
Japan has made significant strides in liberalizing its
capital markets and stabilizing the yen, although further
progress is needed in this area, particularly with regard to
domestic financial market liberalization. What is needed now
is determined and forceful action by Japan to complement these
measures by opening up its markets for goods and other services.
If the European and Japanese economies are to supplement the
United States in supporting LDC adjustment efforts, their imports
from LDCs will have to increase significantly. Their combined
imports from LDCs would have to rise by $25 billion over the
next couple of years to duplicate the growth stimulus ignited
by the U.S. expansion. This would represent a growth of some
25 percent in the current level of Japanese and European imports
from LDCs.
If all of the industrial countries do their part in
addressing their own problems, I believe that the chances are
good for industrial country growth higher than the Fund staff
-6expect: perhaps in excess of 3 1/2 percent per year as a base
case rather than the roughly 3 percent the staff assumes.
Even 4 percent would not be out of the question if we are
willing to act and not let our sights be lowered by the experience
of the 1970s. But even a 4 percent growth rate in the industrial
world can only facilitate growth elsewhere; it cannot make
growth happen.
The policy choices of individual developing countries will
continue to determine whether or not they can take advantage
of the growth opportunities that are available. In addition
to sound monetary, fiscal and exchange rate policies, more
active use needs to be made of pricing, marketing, and wage
policies; trade and financial market liberalization; and efforts
to improve the environment for foreign direct investment. All
of these can contribute importantly to LDC growth and adjustment.
Countries which have been undertaking adjustment efforts over a
number of years but are not yet on a clear path to steady growth
and sustainable balance of payments positions must in particular
reinforce their efforts with prompt structural measures.
LDC dependence on foreign savings is still too high,
especially in light of the likely limits on the availability
of foreign portfolio financing and taking into account the
existing debt burden. The ratio of investment to GDP in many
developing countries has also fallen at a time when higher and
more efficient investment levels are needed in order to attain
an acceptable growth path. Mobilization of domestic savings
is, therefore, crucially important to sustainable economic
growth and external positions.
Much better performance on inflation in some developing
countries is also essential if domestic savings are to grow and
be employed efficiently in productive investment, rather than
being diverted to speculative or defensive uses, or to capital
flight. Unfortunately, traditional fiscal, monetary, and other
macroeconomic policies have not yet been fully employed to
combat inflation in some high-inflation countries. Beyond
that, taking into account the deficiencies and lags in
effectiveness of these standard tools, they will probably need
to be complemented and reinforced by other measures, such as
specific plans for revising inflationary expectations, wage
policies, import liberalization, and reforming financial
institutions and instruments.
In sum, if all of us — industrial and developing countries
alike — take the steps we can, we can look forward to a
still brighter future, measured not just by higher growth rates,
lower debt and debt service ratios, but also by higher standards
of living for all our people.
The Role of the IMF
During the last few years, the IMF has demonstrated why it
continues to be the world's central international monetary
-7institution. The Fund has responded in a timely and effective
manner to the international debt problem. Since 1981, more
than 100 countries have received over $40 billion in temporary balance of payments financing in support of their adjustment efforts. The IMF's policy advice has helped in the formulation and implementation of the sound domestic policies
necessary for restoration of growth and sustainable external
positions. Furthermore, the Fund has served importantly as a
catalyst for encouraging other lenders to reschedule existing
debt. This is particularly important since the IMF has not
provided and cannot provide the bulk of external financing
needs for developing countries.
As the pace of global recovery increases and adjustment
efforts succeed, it is to be expected that new IMF financing
would diminish and that members would repay outstanding loans
so that the resources would be available for new IMF lending.
The United States has become increasingly concerned, however,
that the prolonged use of IMF resources is undermining the
revolving character of IMF financing and creating undesirable
pressures for borrowing and quota increases. Moreover, the
failure of certain countries to meet their payment obligations
to the Fund in a timely manner weakens the IMF's financial
integrity and its credibility as a sound, prudent institution.
Despite difficult economic problems, the vast majority of
members meet fully their IMF obligations and all should be
expected to do so.
The IMF's raison d'etre as a financial institution is to
provide conditional lending in support of effective economic
adjustment to deal with temporary balance of payments difficulties. The flexible application of appropriate conditionality
is critical to the Fund's efforts to provide the sound world
economy and stable international monetary system on which all
of us depend and from which we all benefit. Measures that
would weaken the Fund's ability to promote sound policies would
result in less total financing and a poorer world economy. In
the final analysis, all of us would be worse off, particularly
the weakest among us.
The IMF's ability to encourage sound policies extends
beyond its function as a source of conditional financing. The
IMF's surveillance responsibilities are designed to assure that
those countries which do not need IMF financing, including the
largest members, fulfill their obligations to pursue policies
that will provide orderly underlying economic and financial
conditions that are the prerequisite for external stability.
IMF Surveillance
The United States has attached considerable importance to
the strengthening of IMF surveillance as a key means of encouraging sound economic policies in member countries. More effective
surveillance can thereby contribute to a more effective functioning
-8-
of the international monetary system and an expanding world
economy. Current surveillance principles and procedures are
based on the principles agreed upon in 1977, and subsequently
revised to a modest extent. However, the evolution of surveillance has, frankly, lagged behind world economic developments
in recent years. We must take concrete steps to ensure that
surveillance mechanisms meet today's needs. Indeed, many of
the problems which have plagued the world economy during the
1980s might have been avoided, or at least might have been less
serious, if IMF surveillance had been more effective during
the period when underlying difficulties were initially emerging.
In our view it is essential to develop further both the
content and procedures of IMF surveillance in order to foster
greater mutual understanding of our individual situations
and to enable the IMF to support and influence positively
member governments in their efforts to develop sound underlying
policies that will promote non-inflationary growth. IMF surveillance should encompass the full range of economic policies
affecting exchange rates and economic performance, including
monetary, fiscal, structural, pricing, and trade policies.
Any approach which focuses primarily on exchange rates per se,
and exchange rate policies narrowly defined, will not permit the kind of comprehensive and balanced judgment of a country's
policies and performance which is necessary for effective
surveillance.
The IMF staff paper prepared for the Interim Committee
discussion of surveillance includes a number of the specific
proposals which could provide a sound basis for a strengthening
of surveillance. Included are such steps as higher-level
participation in IMF Article IV consultations, special or
supplemental consultations where appropriate, greater focus on
the interaction of members' policies, and follow-up reports
on measures implemented since the last round of annual consultations. We also believe that increased public awareness of
IMF consultations is important, and that the public release of
an abbreviated version of the Managing Director's summing up
of Board discussions at the conclusion of Article IV consultations could be very useful. Such a statement could provide a
brief assessment of a member country's policies and prospects
as a complementary means of encouraging sound policies.
Finally, we believe that "enhanced" surveillance is a
potentially important part of the Fund's activities, in particular where additional IMF financing may not be appropriate or
desired, but where a continued Fund presence may be important to
hn%£2 lltt
"ember, to its potential creditors, and possibly
to the system as a whole. The Fund has already accepted a
ln c o n n e c t i o n
r^hPHnfU
*ith some private sector multi-year
1 3
We believe
v ^ o f ^
'
that enhanced surveillance
can also play a role m connection with certain cases involving
prolonged use of IMF resources, where continued Fund policy
advice and support may be helpful to both the member and its
-9creditors, but where further IMF financing may not be consistent
with the temporary nature of IMF financing. In such cases,
cooperation between the IMF and the World Bank is particularly
important.
The Fund should continue to proceed cautiously, aware of
both the risks and benefits of enhanced surveillance. Such
arrangements should be used selectively and should be associated
with sound, comprehensive adjustment programs. They should in
no way be substituted for sound policies. Furthermore, they
should generally involve quantified economic targets. Such
targets will be particularly important if countries with good
performance records wish to seek enhanced surveillance in
conjunction with possible multi-year rescheduling arrangements.
Such enhanced arrangements also should not implicate the Fund
in any way as a guarantor for other financing.
The studies regarding the international monetary system
which have been underway within the Group of Ten recognize the
need for more effective IMF surveillance, and are likely to
emphasize specific proposals toward that end. As I indicated
last week, the United States attaches considerable importance
to these studies of possible improvements in the international
monetary system. We are therefore prepared to consider the
possible value of hosting a high-level meeting of the major
industrial countries, following the conclusion of the studies,
in order to review the various issues involved in transforming
their findings into appropriate action.
Such a meeting could provide further impetus to strengthening the international monetary system through the IMF, in
particular through the upcoming review of the G-10 studies by
the IMF's Interim Committee. For while the major industrial
countries must do their part to strengthen the system, we
cannot do it alone. It will be necessary for each of us,
industrial and developing countries alike, to accept our
responsibilities to improve the system.
This is reflected in the fact that it is the Interim
Committee, representing the entire membership of the IMF, that
has the responsibility, among others, to advise and report to
the Board of Governors with respect to the "management and
adaptation of the international monetary system." It is this
Committee, then, that will have the basic task of considering
how the G-10 studies can best be implemented to strengthen the
international monetary system.
SDR Allocation
I'd like to turn briefly now to the question of a new
allocation of SDRs. The United States continues to oppose an
allocation.
-10Th e IMF's Articles of Agreement require that there be a
"long-term global need" for new reserves prior to a decision to
allocate. However, the data indicate that global reserves have
grown an average of 10 percent per year since 1982. In fact,
during the same period, reserves of the non-oil producing LDCs
have grown even faster, at an average annual rate of 16 percent.
Taking these and other factors into account, we do not
believe that the case has been made for an allocation.
The key to resolving the liquidity problems of individual
countries lies with effective economic adjustment policies.
Experience suggests that even countries in very difficult
positions today could conceivably restore their creditworthiness
in private capital markets through implementation of appropriate
adjustment measures.
We also remain concerned that creation of a large amount of
unconditional liquidity could send the wrong signals about the
need to continue to fight inflation as well as detract from
the necessary focus on adjustment efforts.
Finally, I would point out that because new SDRs would be
distributed on the basis of IMF quota shares, an allocation would
be of very little benefit to either the major debtors or the
poorest LDCs.
Trade
The excellent papers on trade prepared for our meetings by
the Bank and Fund staff convincingly demonstrate the benefits to
developed and developing economies of maintaining economies open
to world competition. The studies make clear the costs of
inward-oriented policies, such as import substitution programs,
in terms of growth potential, job creation, and overall performance.
Nonetheless, because of lower than desired global growth, persistent
high levels of unemployment, structural changes in demand and
supply, strains arising from the debt situation, and many other
reasons familiar to us all, protectionism has spread. Efforts
to strengthen the open multilateral trading system have been
insufficient.
Meeting here, we can contribute to trade liberalization by
agreeing on basic policy approaches and then working within each
of our governments to implement them.
First, we should recommit ourselves to resist protectionism.
In my country, the sharp increase in imports over the last few
years has led to strong pressures for protection. Nonetheless,
we have generally succeeded in keeping our market open. The
United States now accounts for 60 percent of developing country
exports of manufactured goods to the industrial countries.
Mindful of the benefits of our open market to the developing
countries, to the industrial countries, and to ourselves, my
-11government will continue to resist pressures to close our market.
We urge other countries to do the same.
Second, we must begin to dismantle existing trade restrictions when possible. The United States took a significant
step in this regard by deciding not to ask Japan to continue
its voluntary export restraint on automobiles.
Third, we should support a new round of trade negotiations.
We can accomplish far more in fighting protectionism and rolling
back barriers by working together than by trying to accomplish
these goals unilaterally. Multilateral trade negotiations permit us to counterbalance powerful groups in our economies that
benefit from protection with those sectors in our economies
that would benefit directly by a decrease in barriers and a
more stable and comprehensive set of trading rules.
Such negotiations should be broad. All barriers to trade
in goods and services should be on the negotiating table, whether
tariffs, non-tariff barriers, or newer forms of protection.
Crucial for the success of the negotiations is that both
industrial and developing countries participate fully. Developing
countries should become full partners in this enterprise. By
becoming actively involved in trade negotiations, the developing
countries can obtain greater access to other markets and appropriately open their own markets. Only by actively participating
in negotiations to reduce barriers can countries obtain these
twin benefits: better access for exports and a more open
economy.
The Bank and Fund have played an important role in encouraging
trade liberalization through their lending programs and through
consultations with member countries. We applaud these efforts,
and encourage these institutions to continue and even strengthen
their liberalization role, while maintaining close ties with the
main international trade organization — the GATT.
At the just concluded OECD Ministerial the industrial
countries agreed that a round of negotiations should begin as
soon as possible. The broader membership of this Committee should
give impetus to such a round by endorsing it and urging that it
begin in early 1986. In order to prepare for such negotiations,
we encourage our GATT partners to join us in a meeting of
senior officials in the GATT on July 22 of this year.
Capital Flows, Debt and Creditworthiness
As we meet, a chief concern of many developing countries is
« e a legacy of the debt crisis that emerged in many countries
fn 1982. The accompanying loss of creditor confidence resulted
in substantial flight of domestic capital, and had a deeply
-12inhibiting effect on commercial bank lending, and to some
extent, on the export credit agencies.
Because the crisis took years to develop, it will take some
time for debt burdens to be reduced to more manageable proportions. Fortunately, a good beginning has been made. As is clear
from the review of recent economic experience, growth in industrial country export markets and the decline of interest rates
have markedly improved the environment in which the developing
countries are operating. Many of them have tackled their problems vigorously through IMF-supported programs. A number of
countries undergoing these difficult adjustment efforts have
started to grow again while meeting their debt obligations.
Even as the general situation improves, we will continue
to be faced with country problems of varying degrees of gravity
from countries that either have not adjusted sufficiently or
have not shared in the growth of export markets. These lingering
problems do not detract from the essential success of the
present approach to debt problems.
The debt strategy is a flexible, case-by-case approach that
calls for continued debtor country adjustment efforts and noninflationary industrial country growth. Commercial banks
have an important role to play in the process, and continued
prudent commercial lending is essential. This approach has
proven adaptable to a changing international situation.
At the same time, we must recognize that in the financial
environment of the 1980s neither commercial bank lending nor
official development assistance will grow as rapidly as in the
past. As a result, attracting capital for development will
require developing countries to implement policies which will
increase domestic savings and make investment attractive to
private investors, both domestic and foreign. It is clear that
most successful developing countries have relatively higher
savings rates and therefore increased investment rates.
There is no magic to these policies. Increasing domestic
savings rates, attracting domestic and foreign capital into
investment, and reattracting flight capital all require the
same commitment to stable, non-inflationary growth policies.
Capital controls are not the solution; they do not address
underlying causes of the problem. Policies that create a
healthy investment climate are those that promote sustained
growth, adjustment and development.
For the more advanced developing countries, private bank
lending continues to play a dominant role in external financing.
™ e P a c ? . o f n e t n e w commercial bank lending has slowed from the
$45 billion pace m 1981-82 to roughly $14 billion last year.
It still remains a key ingredient in total external financing
flows, but it is an element over which industrial country
governments can have only limited influence. The key to improved
-13relations with commercial banks is improving creditworthiness
of borrowers. It is the borrowers' own policy actions which
determine this perception.
Our governments must avoid specific intervention in the
commercial decision making process of our private institutions.
Nevertheless, the industrial countries have a strong interest
in encouraging commercial banks to avoid actions that could be
counterproductive. In fact, the banking community reacted
to the emergency of widespread financing problems two years
ago in a generally constructive manner. They have played an
important role in helping to work out difficult financial
problems. Banks have been supportive of adjustment programs,
both in rescheduling packages and in providing net new lending,
where appropriate, and have negotiated multiyear reschedulings
in some cases, in order to facilitate longer term adjustment
efforts.
Looking ahead, it is important that private banks maintain
a broad view of their role, beyond the initial response to the
debt problems of the larger developing countries. They should
continue to support all countries — including smaller countries
— that are performing well under economic adjustment programs.
Net new flows can help strengthen the adjustment process and
improve the quality of outstanding credit. Our Bank regulatory
authorities recognize the importance of this policy.
Export Credit
Export credit agencies also play a key role in supporting
individual country adjustment efforts by maintaining critical
imports during periods of constrained external financing.
Decisions of export credit and insurance agencies regarding
provision of credit ("cover") are generally determined caseby-case on the basis of competitive factors and commercial
prudence. This mix of considerations has sometimes resulted
in a tendency to maintain cover during the build-up of a debt
problem and then to terminate cover abruptly when the problem
becomes overt. In some cases, resumption of cover has been
delayed well after agreement upon an IMF adjustment program
and conclusion of the initial debt rescheduling agreement in
the Paris Club.
The first step in addressing this problem is closer coordination in identifying potential debtor problems as they develop.
In this context, it may be appropriate to tighten cover during
the early phases of a troublesome debt situation.
The critical requirement in restoring access to credit must
be the adoption of a sound economic adjustment program. Such
a
program may involve rescheduling official and private debt
and new credit may be required. Official export credit agencies
have a responsibility to support such adjustment efforts by
-14joining with private financial institutions and the IMF in
providing new credits, consistent with their requirements for
assurance of repayment.
Turning to another facet of export credit agency operations, we believe export credits can and should contribute to
the development process in a way which is compatible with
their commercial focus, by supporting financially and economically sound projects. The background documents prepared for
this meeting suggest we explore the appropriate role of the
World Bank in improving the development impact of export credits.
We believe countries should welcome IBRD technical advice in
assessing the financial and development merits of a particular
project. Such a role for the Bank would be useful to credit
agencies and borrowers. However, given the range of commercial
and financial considerations in export credit transactions, it
would be difficult to structure and agree upon a more formal
role for the IBRD which would allow some form of direct influence
on export credit agency activities.
Official Development Assistance
We firmly believe that official development assistance is
an essential source of external financing for many of the poorer
countries. If used properly, in a supportive policy environment,
it can be especially critical to the future growth prospects of
the poorest countries. There are compelling humanitarian and
economic reasons to continue to improve the effectiveness of ODA
to developing countries. The United States remains committed to
this goal and is the largest provider of ODA with about $9 billion budgeted for U.S. fiscal year 1985.
All of us understand that the flow of concessional resources
has been constrained in recent years. Given today's budgetary
environment and the recognized need to constrain budgetary expenditures, available financial resources must be used wisely and
effectively. Resources must be channeled increasingly to the
poorest countries — those which have the least access to
private market financing.
The economic policy framework and the incentive system in
which ODA can be used is the single most important contribution
that potential recipient governments can make in the partnership
working for their own development. Careful and improved coordination of policy advice among the IMF, IBRD, regional development banks, bilateral donors and consultative fora remains a
fundamental responsibility of all.
f;
Th
and
* —7*"y "flys to improve aid effectiveness
a n d .._ *,~i~eZ-7.:~^ 7" *
-15Foreign Investment
Foreign direct and portfolio investments are especially
productive forms of capital inflow, with several characteristics
that make them attractive alternatives to commercial bank
lending. While commercial debts involve interest payments
that must be made regardless of economic conditions or the
performance of the borrowing entity, profit remittances from
foreign investments depend on the economic performance of the
investments themselves. With regard to foreign direct investment, LDCs can also gain transfers of technology, managerial
and marketing skills. Direct investments create employment
and contribute to diversification of the host economy, and
often result in export expansion.
However, foreign investment is obviously being underutilized. In 1975, foreign direct investment accounted for
20.4 percent of external finance for developing countries. In
1983 the share of foreign direct investment in external financing
dropped to 8.6 percent. Countries should review their policies
that restrict foreign investment and conflict with their need
for capital.
Capital market development is an important factor in
facilitating investment levels by improving intermediation
between savings and investment. In this context, we support the
work of the International Finance Corporation (IFC) in providing
technical assistance to create new financial institutions and
improve the functioning of existing domestic capital markets.
In seeking ways to facilitate direct investment, the United
States has firmly supported World Bank efforts to develop a
multilateral investment insurance scheme. We believe a multilateral investment guaranty agency (MIGA) which will stimulate
flows of additional foreign direct investment to developing
countries and encourage a policy environment which can attract
investment will be an important part of the development process.
We welcome the progress the Bank has made in developing a
sound proposal. We urge other governments to join us in an
effort to finalize the draft convention for establishing the
MIGA.
World Bank
Assuring that all countries, especially the poorest ones,
participate fully in the process of growth and development is a
challenge of overriding importance. Looking at the world economy
I am convinced that economic policies providing the incentive for
a free market which rewards hard work and legitimate risk are the
most likely to produce development successes. It is critically
important that foreign assistance programs, both bilateral and
multilateral, complement and encourage viable domestic marketoriented policies.
-16Th e operations of the World Bank and the regional development banks were specifically designed to encourage appropriate
policies and thereby assist in the economic growth of their
developing country members. As President Reagan stated at
last September's Annual meetings, we value highly the Bank's
proven expertise as an investment project lender, and its
ability to provide helpful policy guidance and technical assistance, and to act as a catalyst in encouraging private enterprise and investment capital.
I believe that the World Bank should continue to play a
prominent role in the longer-term development programs of its
borrowers and, as appropriate, in their medium-term adjustment
efforts. I also recognize the complexities and scale of the
diverse economic situations which developing countries are likely
to confront for the remainder of the 1980s. During this period
of immense challenge — which also poses great opportunities —
it is important that all of us work constructively to ensure
that the Bank's very considerable financial and technical resources are employed in the most effective possible way.
I therefore welcome the opportunities which the Future Role
of the Bank review provides for charting a comprehensive and
realistic medium-term strategy for future Bank operations. In
this context, I am particularly pleased at the increased recognition accorded to the vital link between the effectiveness
of Bank programs and the extent to which they are successful
in strengthening economic policies in borrowing countries.
More effective use of development resources in support of
policy reform is central to the task ahead.
In looking to the future, we want the Bank to continue
emphasizing its mandated responsibility for solid investment
project lending. This is where the Bank can play its most
valuable role. Its unique expertise provides a comparative
advantage to leverage its resources in support of appropriate
domestic adjustment policies. At the same time, we recognize
that the Bank must remain flexible to adapt effectively to the
changing circumstances of individual member countries.
The Structural Adjustment Lending (SAL) program is a good
example of such pragmatic and financially responsible flexibility.
We believe the Bank has used its experience with SALs to good
effect and that, on the strength of their record in facilitating
policy adjustment, the SAL program is a valuable instrument
for supporting member countries willing to formulate and implement programs of structural adjustment. In sum, the program
oSon ™ V " e c t i V e a U d „ W e b e l i e v e ^ should be retained and
even prudently expanded, as long as there is a serious need
and desire for more SALs linked to appropriate policy reforms.
^n^JiVfitl0n t0uthe SAL Pr°9ram' w* recognize that sector
adjustment loans can be instrumental in encouraging adjustment
as long as there is effective policy reform. Such sector
-17adjustment loans may be particularly appropriate in low-income
member countries where institutional weaknesses hinder the design
and implementation of more comprehensive policy-based lending.
The current Bank approach to lending, in effect, builds
upon the Bank's traditional strength and employs selective use
of existing non-traditional lending instruments in support of
policy reform.
We view this as a sound basis for future
operations, particularly since a strengthening of the world
economic recovery and a lessening of structural imbalances
should over time reinforce the Bank's traditional role as a
project-based investment institution.
This flexible response of the Bank, in parallel with the
efforts undertaken by the Fund, represents successful adaptation
by these institutions to an unprecedented set of difficult
developing country adjustment problems. However, the pragmatic
response of the institutions has in some cases led to overlapping responsibilities and a heightened need for cooperation.
The United States supports concrete, practical steps to strengthen Fund/Bank cooperation and ensure that Fund and Bank policy
advice and technical assistance are complementary. We therefore
welcome the priority attention both the Fund and Bank are
giving to this issue and, for our part, intend to continue
working actively with our colleagues in these institutions to
secure meaningful results.
While we applaud prudent flexibility in the World Bank
lending program, we would oppose efforts to enhance the Bank's
balance of payments role in ways which would lead to an increase
in lending without a constructive policy response by the borrower.
The benefits of such lending would have little lasting impact
on recipient countries. It would also jeopardize financial
market perceptions of the quality of the IBRD's loan portfolio.
We also believe that Bank efforts to strengthen domestic
institutions, rationalize public sector investment programs —
including sound sector pricing — and improve the environment
for private investment merit renewed support. In addition,
financially prudent efforts to enhance the Bank's catalytic
role by generating increased commercial bank and other cofinancing — without offering the umbrella of the Bank's preferred creditor status — should continue to be encouraged.
Both IDA and the IFC have unique and special roles; IDA in
encouraging policy reform and development in the Bank's poorest
member countries, and the IFC in promoting private enterprise.
The United States remains the largest single contributor to
these affiliates, and we are committed to working with other
members to increase their operational effectiveness. In the
case of IDA, we believe that the countries of Sub-Saharan
Africa, and other countries whose lack of creditworthiness
precludes access to alternative financing, should have first
claim on available resources as long as they can be used
effectively.
-18Resource availability has an important bearing on both the
operational aspects and the scale of future Bank lending. IDA
is in the first year of a new replenishment; IFC has a capital
increase proposal pending before its Governors; and a Selective
Capital Increase was approved for the IBRD last year. The
President's Report now seeks agreement to move forward on the
negotiation of a new IBRD General Capital Increase.
While
the issue of resource availability must be kept under close
review, I believe it is both unnecessary and unwise to be
focusing on the issue of a new GCI at this time.
The IBRD can lend up to $13 billion annually indefinitely
without a capital increase.
This is a substantial sum.
As
we are well aware, demand for lending has dropped significantly
and this year's IBRD commitments could well be below $11 billion. It is not clear to us how the Bank can increase its
lending program significantly at this time, without weakening
lending standards or displacing alternative sources of finance
in creditworthy countries. A further consideration, as suggested in President Clausen's report, is the need to consider
the Bank's capacity to borrow prudently the additional resources
implied by another general capital increase.
The Problem of Sub-Saharan Africa
There is no question that the economic situation in SubSaharan Africa remains the most critical of any region in the
world. The devastating effects of the prolonged drought in
the region will continue to be with us for an extended period,
even if more normal patterns of rainfall resume in the near
future. Nonetheless, as the World Bank has indicated in its
progress report on the Joint Program of Action, favorable
developments in a number of countries have taken place over
the past year. A return to more normal rainfall patterns in
several key areas appears to be taking place, with an immediate,
positive impact on agricultural production. Significant policy
reform programs are underway in a growing number of countries,
and prospects are good for real GDP growth in 1985 — although
still distressingly low — for the first time in four years.
In this region, as elsewhere, the importance of government
policies in creating a secure environment in which individuals
™ V V ? / 2 C e ? t u V e S t 0 S a v e ' i n v e s t a n d *ork, is paramount.
The World Bank has a major role in this effort through its
on-going project work and policy dialogue, and in its key role
in preparing for an expanded number of Consultative Groups.
rmp^tant^r^a"6 "° '^ "°
the Bank f
°' leadership in tSi.
emainS Very serio
situation^n'Afrirf ^n/
.
^ly concerned by the
situation m Africa and recognizes the continued need for a
?h^ r ?n^ r " P ? 5 S e 1 b y t h e W O r l d d o n o r community. We believe
and we are ^
Sub-Saharan Africa,
and we are directing a larger share of our own bilateral
-19-
resources to the region. We estimate our assistance program in
U.S. fiscal year 1985 at $775 million in addition to $900
million in food aid. We intend to use our bilateral resources
to support policy reform, and to coordinate these efforts
closely with the Bank's Special Facility and other donors. We
continue to support the African Development Bank and Fund,
where our contribution to the most recent Fund replenishment
represents a 50 percent increase over our previous commitment
level.
With diligent and continued efforts we can help Sub-Saharan
Africa put itself back on the road to economic growth.
Conclusion
These special meetings of the Interim and Development
Committees to consider critical economic issues constitute a
new commitment to international dialogue by the members of
these bodies.
Six months ago, my predecessor joined with you in calling
for these special sessions in order that we might examine in a
comprehensive way the policy approach necessary to move toward
a sustained pattern of global growth. At these meetings, we
will review the progress that has been made to reduce external
imbalances and to improve growth prospects in the world economy
in the second half of the 1980's.
In reviewing our economic progress, we should all recognize
that it has entailed extraordinary acts of courage among nations,
both singularly and collectively. Significant economic adjustment, some of it painful, has taken place. But our work is
not yet finished.
Many countries still face fundamental problems. Despite
expanding world trade, debt service obligations in many cases
are high in relation to export incomes. We can all agree that
adjustment efforts must be continued. The environment for
trade and investment flows must be liberalized and development
assistance and other capital flows should be used efficiently
to help those countries that are making determined adjustment
efforts.
Our experience indicates that we are on the correct path.
We firmly believe that sustained and widely shared growth is
possible. But we also recognize that together we will continue
to face some difficult policy choices. The need for continued
discussions and mutual understanding only increases as we seek
to design a policy blueprint for growth.
-20-
I look forward to working with you to identify fresh
approaches to the issues and problems we face. My hope is
that we can reach new levels of understanding and a renewed
determination to work together toward a global environment
which provides the basis for sustained growth and future
prosperity for all nations.
Thank you.
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 22, 1985
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,510 million of 13-week bills and for $6,508 million
of 26-week bills, both to be issued on April 25, 1985,
were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:
13-week bills
maturing July 25, 1985
Discount Investment
Rate
Rate 1/
Price
Low
7.56%
High
7.65%
Average
7.62%
a/ Excepting 3 tenders totaling
7.81%
98.089
7.91%
98.066
7.88%
98.074
$20,040,000.
26-week bills
maturing October 24, 1985
Discount Investment
Rate
Rate 1/
Price
7.83%£/
7.90%
7.87%
8.26%
8.34%
8.31%
96.042
96.006
96.021
Tenders at the high discount rate for the 13-week bills were allotted 60%
Tenders at the high discount rate for the 26-week bills were allotted 4%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
:
Received
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
$
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Accepted
147,150
3,990,480
35,675
59,010
51,875
53,105
368,880
62,465
37,210
64,510
31,865
1,246,125
361,470
389,240
15,071,250
20,775
37,745
71,615
43,565
1,014,615
84,725
41,930
45,610
17,965
1,657,995
419,125
$ 39,240
4,619,250
20,775
37,745
51,815
43,565
274,615
60,125
41,930
44,650
17,965
837,195
419,125
$18,612,620
$6,509,820
$18,916,155
$6,507,995
$16,211,395
1,259,390
$17,470,785
$4,108,595
1,259,390
$5,367,985
$16,194,435
1,050,920
$17,245,355
$3,786,275
1,050,920
$4,837,195
1,000,135
893,000
893,000
407,150
14,285,280
35,675
62,010
51,875
53,105
1,073,880
77,465
37,210
65,510
31,865
2,070,125
361,470
1,000., 135
$
Federal Reserve
Foreign Official
Institutions
141,700
141,700
777,800
777,800
TOTALS
$18,612,620
$6,509,820
$18,916,155
$6,507,995
y
Equivalent coupon-issue yield
B-102
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
Not Reviewed by the Office of Management and Budget
Due to Time Constraints
For Release Upon Delivery
Expected at 9:30 A.M., E.S.T.
April 22, 1985
STATEMENT OF
RONALD A. PEARLMAN
ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON TAXATION AND DEBT MANAGEMENT
OF THE
SENATE FINANCE COMMITTEE
Mr. Chairman and Members of the Subcommittee:
I am pleased to appear before you today to present the views
of the Treasury Department on three bills (S. 476, S. 420, and
S. 632) relating to corporate acquisitions. These bills appear
to be prompted by the recent surge in merger activity generally,
but are particularly directed at hostile merger activity. The
bills would substantially penalize, if not render economically
impossible, mergers and acquisitions that are considered
"hostile."
We do not believe that Congress should enact special tax
provisions aimed only at hostile as opposed to friendly
acquisitions. Indeed, we do not believe that Congress should
amend the tax laws for the purpose of discouraging mergers and
acquisition activity generally. *
We do not know all of the economic and other reasons behind
the recent flurry of activity. We doubt, however, that the tax
laws are the driving force, but rather suspect that other market
forces precipitate these transactions; forces that reallocate
resources to higher valued uses, promote economies of scale,
- 2 increase shareholders' return on investment, replace inefficient
management, and free up capital for new investment opportunities.
Only those persons responsible for the merger activity know for
certain the forces that drive their decisions.
The bills that are the subject of today's hearing would
discourage hostile takeovers by disallowing interest deductions
with respect to certain indebtedness and mandating a section 338
election for certain stock purchases. In addition, the bills
would discourage attempted takeovers by imposing an excise tax on
certain profits realized by persons who take substantial
investment positions in companies that are the subject of an
attempted takeover. These profits have recently been referred to
as greenmail profits. The bills also would clarify that under
current law no deduction is available with respect to any
greenmail payments.
The Treasury Department opposes these bills. As a matter of
tax policy, we do not believe hostile acquisitions should be
treated differently under the tax laws than friendly
acquisitions, nor do we believe that a clear distinction can be
drawn. Thus, we believe that interest deductions and section 338
elections should be equally available for hostile and friendly
acquisitions. Further, we do not believe that certain gains from
sales or exchanges of stock, labeled greenmail profits, should be
subject to an excise tax. Finally, while greenmail payments are
not deductible under current law, we would not be opposed to a
statutory confirmation of this point.
Hostile Versus Friendly Acquisitions
All of the bills that are the subject of today's hearing
would limit interest deductions, and both S. 632 and S. 420 would
mandate section 338 elections, for all hostile acquisitions.
Hostile acquisitions are defined in two different ways, however.
S. 476 defines the term "hostile acquisition" generally as an
acquisition of corporate property or stock by persons who have
acquired a 20 percent or greater interest in the target
corporation within the preceding year, if the transaction, before
consummation, is not formally approved by a majority (consisting
of at least two members) of the independent members of the board
of directors of the target corporation. No member of the board
would be treated as independent if such member is an officer or
employee of the corporation or was nominated by the persons
making the acquisition.
Both S. 632 and S. 420, framed more broadly than S. 476,
apply to acquisitions by any persons, if the acquisition is
pursuant to a "hostile offer." The term "hostile offer" turns on
the same factor as S. 476 — disapproval by a majority
(consisting of at least two members) of the independent members
of the board of directors of the target corporation. The
- 3 definition of an independent director is more restrictive under
S. 632 and S. 420 than S. 476, as it not only excludes from the
definition a person that is an officer or employee of the target
corporation, but also any person that has substantial financial
or commercial ties to that corporation, except for ownership of
stock.
We do not believe the tax consequences of corporate
acquisitions should turn on whether a corporation's independent
directors approve or disapprove of the acquisition. Moreover,
the effect of these bills would be to bring new and extreme
pressure to bear on the decision making processes of independent
directors. Because of .the harsh tax consequences resulting from
characterization of an acquisition as hostile, independent
directors would in effect have a veto over corporate acquisition
decisions. On the other hand, there may be substantial enough
pressures on the independent directors that would, under certain
circumstances, tend to make them vote for, rather than against, a
proposed acquisition. For only by their favorable votes could
the sanctions imposed by these bills be avoided. Such pressures
would seem to undermine the very rationale for independent
directors.
Further, many closely held corporations do not have
independent members on their boards of directors. In such cases,
the tax penalties could not come into play no matter how
vigorously a takeover is resisted. The bills do not suggest any
rationale for this arbitrary distinction. If these tax penalty
provisions were enacted, however, companies would have an
incentive not to have independent directors. We doubt that the
sponsors of the bills intend such a result.
We believe very strongly that the market place (i.e.,
shareholders rather than independent directors) should determine
whether a proposed acquisition is economically beneficial. The
tax laws should not bias this decision towards friendly or
against hostile acquisitions, as a hostile acquisition may turn
out to be an economically beneficiary acquisition. Only a free
market can make the optimal economic decision.
Disallowance of Interest Deductions on Certain Hostile
Acquisitions
All of the bills before the Subcommittee limit the
deductibility of interest incurred in connection with "hostile"
takeovers. The genesis of these bills apparently stems from the
publicity received by a number of recent acquisitions financed by
the use of so-called junk bonds (i.e., high risk, high yield
subordinated debt) and a concern that the current tax treatment
of interest may encourage mergers, especially hostile
acquisitions. The basic structure of our current income tax
system may encourage corporations to utilize debt rather than
- 4 equity in financing operations or acquisitions because of the
more favorable tax treatment of interest compared to dividends
and the arbitrage potential from debt financing.
S. 476 would disallow a deduction for any interest paid or
accrued during the taxable year with respect to "hostile
acquisition indebtedness." Hostile acquisition indebtedness is
defined as any "junior obligation" issued after February 18,
1985, in connection with a hostile acquisition. A "junior
obligation" is any obligation evidenced by a bond, debenture,
note or certificate, or other evidence of indebtedness issued by
any person which, upon issuance, bears any one or more of the
following characteristics: (1) the indebtedness is expressly
subordinated to the payment of any substantial amount of
unsecured indebtedness of the issuer or the corporation that is
the target of the hostile acquisition, (2) the indebtedness is
issued by a person whose assets are (or following the hostile
acquisition would be) comprised predominantly of the stock of the
target corporation, cash, and cash equivalents, or (3) the
indebtedness bears a rating from any nationally recognized rating
agency which is at least two ratings inferior to the rating from
such agency in respect of any other substantial class of
indebtedness of the issuer or the target corporation. S. 476 is
effective with respect to interest paid or accrued with respect
to obligations issued after February 18, 1985.
S. 632 differs slightly from S. 476 in that it disallows a
deduction for any interest paid or accrued on indebtedness
incurred or continued to acquire (or carry) stock or assets
acquired pursuant to a "hostile offer." The definition of
"hostile offer" differs only slightly from the definition of
"hostile acquisition" in S. 476 as discussed above. S. 632 is
effective with respect to indebtedness incurred or continued to
acquire (or carry) stock acquired after March 6, 1985. For
assets acquired pursuant to a "hostile offer," S. 632 fails to
provide a specific effective date for its application to
indebtedness incurred or continued to acquire (or carry) such
assets.
S. 420 is identical to S. 632 with respect to the
disallowance of interest deductions, except that it does not
apply
indebtedness
or generally
continued to
acquire
(or carry)
Ourtocurrent
income incurred
tax system
treats
corporations
assets;
it
is
limited
to
acquisitions
of
stock.
S.
420
as taxpaying entities separate from their shareholders. is
A
effective with
respect to
indebtedness
incurred
continued
to
corporation
separately
computes
and reports
its or
taxable
income,
acquire (or carry) stock which is acquired after February 6,
- 5 and in making this calculation it is not entitled to a deduction
for dividends paid to shareholders. Moreover, these dividends
are taxed to individual shareholders as ordinary income (except
for a $100 per year exclusion). Consequently, corporate taxable
income paid as dividends to individual shareholders generally
bears two taxes, the corporate income tax and the individual
income tax.
The double taxation of corporate earnings that are
distributed as dividends to shareholders affects dividend
distribution policies in ways that may encourage merger activity.
In particular, corporations, especially those with shareholders
in relatively high income tax brackets, are encouraged to retain
earnings in order to allow the shareholders to defer imposition
of the second tax.*/ This pressure to accumulate corporate
earnings not only Interferes with ordinary market incentives to
place funds in the hands of the most efficient users, but also
stimulates corporate acquisitions in at least two ways.
First, corporations that accumulate cash funds in excess of
their needs for working capital must reinvest those funds;
acquiring the stock or assets of other corporations is an
investment alternative that must be considered by any corporation
with excess funds to invest. Second, a corporation with large
amounts of funds invested in nonoperating assets may itself
become an attractive target, because the market may not
immediately reflect the value of those nonoperating assets (which
may not generate financial reported earnings commensurate with
their values). Because of this potential undervaluation of the
target's nonoperating assets, a potential acquiring corporation
may view the nonoperating asset as cheap funds available to
finance the acquisition of the underlying business operations of
the target. The mitigation or elimination of the double tax on
corporate dividends, through any form of integration of the
*/ Indeed,
some cases income
the shareholder-level
tax or
caneliminate
be
corporate
andinindividual
taxes, would reduce
permanently
avoided
if
the
retained
earnings
are
distributed
these effects.
in liquidation following the death of the shareholder, which
occasions a tax-free increase in the stock's basis to its
fair market value. However, if the corporation is formed or
availed of for the purpose of avoiding the second
shareholder-level tax by permitting earnings and profits to
accumulate instead of being distributed, there is imposed on
the corporation a penalty accumulated earnings tax.
- 6 In contrast to the taxation of corporate earnings distributed
as dividends, corporate income distributed to creditors as
interest is deductible by the corporation and thus taxed only
once, to the creditors. The disparate tax treatment of debt and
equity in the corporate sector distorts decisions regarding a
corporation's capitalization, making corporations more vulnerable
to takeover during economic downturns, and also may encourage
leveraged buyouts, because interest payments on the debt incurred
in such a transaction offset income earned by the target
corporation.
Since interest payments on debt financing are deductible and
dividends paid on equity are not, corporations are encouraged by
the tax law to utilize debt rather than equity to finance their
ongoing operations. This may result in an increased
debt-to-equity ratio that increases the risk of bankruptcy and
vulnerability to downturns in the business cycle; and any
corporation that is temporarily crippled by an economic downturn
becomes a likely takeover candidate.
The deductibility of interest incurred in connection with
debt-financed acquisitions also encourages acquisitions to the
extent that our tax system does not take account of inflation
properly. Nominal interest rates typically include an inflation
component which compensates the lender for the anticipated future
reduction in the real value of a fixed dollar amount debt
obligation and acts as an offsetting charge to the borrower for
the inflationary reduction in the value of the principal amount
of the borrowing. Where borrowed funds are invested in assets
that also increase in value by virtue of inflation, the tax law
permits a current deduction for interest expense but no
realization of the increase in value of the asset until its sale
or disposition. In such cases, the interest deduction can be
used to offset income that otherwise would be taxed currently.
The use of installment debt in acquisitions also leads to
significant mismatching of the gain that is deferred by the
seller and the allowance to the purchaser of depreciation,
amortization, or depletion deductions determined by reference to
asset values that have been stepped-up to fair market value as a
result of the acquisition. This asymmetrical treatment of a
sale, under which the buyer is treated as acquiring full
ownership of the asset while the seller is treated as making only
partial sales each year over the term of the contract may create
a tax bias for installment debt-financed acquisitions. In a
taxable corporate acquisition (an asset acquisition or a stock
acquisition with a section 338 election), this mismatching is
reduced to some extent if the target corporation's assets are
subject to recapture tax since the recapture income is recognized
immediately. The asymmetrical treatment arising from installment
sales debt is a problem that should concern this Subcommittee,
but the
asset
and
problem
is by no
exists
meansm unique
every to
installment
corporate sale
acquisitions.
of a depreciable
- 7 -
One of the bills, S. 476, would deny deductions for interest
paid on high yield, subordinated bonds used to finance hostile
acquisitions. The concern generating the bill may have been that
a number of these bonds, referred to as "junk bonds," have been
used in connection with recent highly leveraged acquisitions.
There is a substantial argument that some of these bonds would be
more appropriately classified as equity rather than debt.
Although there are significant differences in the tax treatment
of debt versus equity, it is extremely difficult to develop
general rules to differentiate a debt interest from an equity
interest. Section 385 lists certain factors that are to be taken
into account in distinguishing debt from equity interests.
Although section 385 was enacted in 1969, to date no satisfactory
general rules have been developed. The Internal Revenue Service
has administered this area, and will continue to differentiate
instruments including junk bonds, on a case by case basis.
S. 476 does not consider any facts and circumstances other than
those enumerated in its definition of junior obligation and,
therefore, may inappropriately characterize some junior
obligations as equity.
Two of the bills before the Subcommittee, S. 632 and S. 420,
address the disparate treatment of debt and equity and the
potential arbitrage from debt financing by limiting interest
deductions on all indebtedness incurred or continued in
connection with hostile acquisitions. The tax arbitrage from
debt financing generally is available, however, for all
debt-financed corporate assets, not just those acquired in a
corporate merger or acquisition. The only special limitation on
the deductibility of interest on debt incurred in acquisitions is
found in section 279 which applies only under very limited
circumstances. Although it may be appropriate to give
consideration to revising the general rules regarding the
deductibility of interest, we see no justification for a further
limitation on the deductibility of interest expense that is aimed
specifically at debt incurred in connection with hostile
acquisitions. Any tax advantage to utilizing debt in a corporate
acquisition is available both to hostile as well as friendly
acquisitions. We believe that any remedy to limit the advantage
to utilizing debt rather than equity to finance corporate
acquisitions should be done in a neutral manner.
Mandatory Section 338 Election in the Case of Hostile Stock
Purchases"
Two of the bills before the Subcommittee mandate that in a
hostile stock acquisition, the acquiring company is deemed to
have made a section 338 election for the target corporation, and
that certain other provisions of the tax law that generally apply
when a section 338 election is made, do not apply.
- 8 Generally, as described above, a corporation is subject to
tax on the profits derived from its operations and its
shareholders are subject to a second level of tax on the
distributions of those profits as dividends. In a liquidating
sale of assets or sale of stock subject to a a section 338
election, the acquiring company obtains the benefits of a step-up
in basis of the acquired assets with only a partial corporate
level tax; recapture and tax benefit items are taxed, but other
potential gains are not. This result stems from the rule
attributed to General Utilities & Operating Co. v. Helvering, 296
U.S. 200 (1935), that is now codified in sections 311(a), 336 and
337. Under those provisions, a corporation does not recognize
gain (other than recapture and tax benefit items) on certain
distributions, including liquidating distributions, made to its
shareholders.
The General Utilities rule applies when a section 338
election is made. The election is available generally whenever
one corporation purchases at least 80 percent of the stock of a
target corporation over a 12-month period. If such election is
made, the basis of the assets of the target corporation is
adjusted in a manner similar to the adjustments that would occur
if the target corporation had sold all of its assets to the
acquiring corporation in connection with a plan for complete
liquidation. The target corporation does not recognize gain (or
loss) on such deemed sale (except for recapture and tax benefit
items). The price at which the assets are deemed sold by the
target corporation and purchased by the new corporation is
V
Section
provides
that thebasis
target
generally
the338(a)(1)
purchasing
corporation's
in corporation
the target'sis
deemed
toacquisition
sell its assets
at their fair market value on the
stock
at the
date.*/
acquisition date. Alternatively, in the case of a bargain
stock purchase, an election may be made under section
338(h)(11) to determine the aggregate deemed sale price on
the basis of a formula that takes into account the price paid
for the target corporation's stock during the acquisition
period (grossed-up to 100 percent) plus liabilities
(including taxes on recapture and other tax benefit items
generated in the deemed sale) and other relevant items.
Section 338(b) provides that the new corporation is deemed to
purchase the target corporation's assets at an aggregate
lr.nl ^ ? U * ,K° K ^ • 9«ssed-up basis of recently purchased
0
E J " V h e b a * l s o f nonrecently purchased stock (subject
of tnrh nnni°n ^ ^ s e c t i o n 338(b)(3) to step-up the basis
?Lcludin« ^ " n t l y ? u r c h a s e d stock) plus liabilities
Generatedn rlt T r e S a P t u " an<* other tax benefit items
generated in the deemed sale) and other relevant items.
- 9 There is generally no requirement that a purchasing
corporation make a section 338 election for the target
corporation. If no section 338 election is made for the target,
no gain or loss is recognized with respect to target's assets and
its corporate tax attributes are preserved, subject to certain
limitations.
S. 632 provides that in the case of any hostile qualified
stock purchase, the purchasing corporation will be treated as
having made a section 338 election with respect to such purchase.
In addition, all gain, not just recapture and tax benefit items,
will be recognized on the deemed sale of assets. Moreover, the
basis of the target's assets deemed purchased will be reduced by
the amount of tax imposed on the target corporation as a result
of the deemed sale. S. 632 is effective for hostile qualified
stock purchases after March 6, 1985.
S. 420 is identical to S. 632, except that there is no
requirement that the basis of target's assets deemed purchased be
reduced by the amount of the tax imposed on the target
corporation on the deemed sale. S. 420 is effective for hostile
qualified stock purchases after February 6, 1985.
The availability of the section 338 election does not create
any significant tax incentives for either hostile or friendly
acquisitions. The provision was intended to facilitate mergers
and acquisitions by permitting the acquiring corporation to
replicate the tax consequences that would follow from an asset
acquisition without requiring an actual sale and transfer of
those assets. In many cases, however, the tax consequences of an
actual asset acquisition or a deemed asset acquisition under
section 338 will be adverse. Acquiring corporations have always
been able to avoid such consequences by acquiring the stock of
the target corporation and forgoing any adjustment in the basis
of the assets of the target company. There are no tax policy
considerations that suggest this latter alternative should be
foreclosed to hostile takeovers. If a mandatory section 338
election were imposed, there would be a substantial bias in the
tax law against hostile acquisitions of certain companies,
.especially those with large recapture and tax benefit items. We
do not believe there is a sound tax policy reason for imposing
that bias.
Similarly, we do not believe that there is any sound basis
for imposing the additional tax penalties on hostile stock
acquisitions that are proposed by S. 420 and S. 632. Whether all
gains, not just recapture and tax benefit items, should be
recognized on an actual liquidating sale of corporate assets or a
deemed sale pursuant to a section 338 election, is not an issue
that should turn on whether the acquisition is hostile or
friendly. Finally, the reduction in basis for the tax liability
generated on the deemed sale in a mandatory section 338 election
- 10 prescribed by S. 632 is contrary to fundamental tax concepts, and
amounts to an awkward and ill-conceived penalty on hostile
acquisitions.
Excise Tax on Greenmail Profits and Deductibility of Greenmail
Payments
Although the bills, as discussed above, generally attempt to
distinguish between hostile and friendly acquisitions, they also
deal with so-called "greenmail" paid and received in either
hostile or friendly situations. As the term is commonly used,
greenmail refers to a payment made by a corporation to a
particular shareholder, often referred to as a "raider," who has
purchased a substantial amount of the corporation's stock as part
of a plan to acquire the corporation.*/ The offer to purchase
the raider's stock is usually not made to all shareholders and is
thus known as "greenmail." In exchange for the payment, the
raider sells his stock to the target corporation and agrees to
refrain from further attempts to acquire the corporation (a
standstill agreement"). Although the payment is made in
exchange for the stock surrendered by the raider, it also may
include reimbursement for expenses incurred by the raider in the
takeover attempt.
c /on an attemPt fc° eliminate greenmail payments, S. 476 and
whn rlt mP ° Se .. a n o n d e d u c t i b l e 5 0 Percent excise tax on any person
who realizes "greenmail profits." Although greenmail, as
orooJ t 0 n e fn r 3 a l l y ab°r^ c o m m o n l Y ref *rs to payments made by a
more broad?v
?n ^ T * 6 ? share holder, both bills would sweep
more
broadly, m particular, greenmail profits are defined under
V
readUv 2v2flL?f f ^ 1 ^ * t r a d e d t a r 9 e t corporation are
rS?Hir4« «
?i f o r P u r c h a s e on a stock exchange and the
until he h i n c a u ^ e r f = r e q U i r e d
ac
t0 d i s c l
uired
°*e his'inSeStiSSs
stork tv!L I ?
f^e percent of the corporation's
no? be knownXbv t h e % a n d i d e n t i t y ° f a Potential raider may
acquired ?he thr^SoM ??* corporation until the raider has
S
f' v
o r V m 0 ^ r C f n t - " ^ t h e ^ ^ ^ Act,
substantial amount of rtock. "
haS ac< uiced a
3
- 11 S. 420 to include any gain realized by a "4-percent
shareholder"*/ on the sale or exchange of any stock in the
corporation Tf (1) the shareholder held such stock for a period
of less than two years, and (2) there was a public tender offer
for stock in the corporation at any time during the two-year
period ending on the date of such sale or exchange. Under
S. 476, greenmail profits also arise from a sale or exchange if,
at any time during the two-year period, any 4-percent shareholder
submitted a written proposal to such corporation which suggests
or sets forth a plan involving a public tender offer, regardless
of whether a public tender offer is actually made.**/
The tax would not apply, however, to a gain realized by any
person on the sale or exchange of stock in any corporation if,
throughout the 12-month period ending on the date of such sale or
exchange, such person had been an officer, director, or employee
of the corporation or a 4-percent shareholder. Under the bills,
therefore, the 50 percent excise tax would generally apply to
gains realized by relatively large, short-term shareholders.
Both bills would be effective for sales and exchanges made after
February 6, 1985, except for sales or exchanges made pursuant to
a written agreement in existence on February 5, 1985.
The 50 percent excise tax proposed by both bills is deficient
in several respects. First, the Treasury Department does not
believe that any valid tax policy is served by subjecting
greenmail profits to an additional tax. If greenmail payments
are determined to be contrary to the public interest, they should
be deterred directly, rather than through use of the tax laws.
For example, state corporate laws could be amended to prohibit
greenmail payments. Moreover, if such payments are judged by
shareholders to be generally unacceptable, direct action may be
taken.
particular,
many corporations
havemeans
done,any
corporate
*/ UnderInboth
bills, aas"4-percent
shareholder"
person
charters
may
be
amended
to
proscribe
such
payments.
who owns stock possessing four percent or more of the total
combined voting power of all classes of stock entitled to
vote. For purposes of determining whether a person is a
4-percent shareholder, stock owned both directly and
indirectly (through the application of section 318) is
considered.
^*/ The term public tender offer is defined under both bills to
mean any offer to purchase (or otherwise acquire) stock if
the offer is required to be filed or registered with any
Federal or state agency regulating securities.
- 12 -
in addition to the fact that the tax law is an inappropriate
tool to deter greenmail payments, the technique adopted by the
bills seems overly harsh and imprecise. Under current law, gams
realized on a sale or exchange of stock are generally treated as
capital gains. Assuming the shareholder had no capital losses,
gains from the sale or exchange of stock held for six months or
less are taxed as ordinary income at a maximum rate of 50
percent, while gains from stock held for more than six months
receive preferential tax treatment. In particular, individuals
and other noncorporate taxpayers may exclude 60 percent of the
gain from income, and corporations are subject to a maximum rate
of 28 percent on such gain. Under the bills, therefore, an
individual shareholder who owned four percent of a corporation's
stock for six months or less at the time of the sale could be
subject to a 100 percent tax on any gain, a 50 percent ordinary
income tax and the 50 percent excise tax.*/
The Treasury
Department does not believe that such a confiscatory rate of tax
is appropriate under any circumstances.
Moreover, we believe that a 4-percent shareholder, like any
other investor, is subject to the vagaries of the market and
should be taxed as any other investor. We perceive no tax policy
rationale for taxing a larger shareholder at a higher rate than a
smaller shareholder on an identical economic gain.
In addition, although the bills are styled as imposing an
excise tax on "greenmail," their reach is much broader. In
particular, the excise tax would apply to any investor who
purchased more than four percent of a corporation's stock,
regardless of whether the shareholder purchased the stock with an
intent to acquire the entire corporation. Such large
shareholders could include a variety of institutional investors,
such as pension plans, college and museum endowment funds, and
large private investors. While such investors normally hold
stock for periods of longer than one year, and would thus be
excluded from the excise tax under both bills, situations would
arise in which such investors, who had recently purchased stock,
V
Even
shareholder
had held the
stock
at the
time of of
the
would
wantiftothe
sell.
These situations
would
include
a variety
sale for more
sixinstitutions
months, but may
lessbethan
one year,
the
circumstances
underthan
which
forced
to liquidate
g a m could for
be external
taxed at 70
percent.
Corporate
an investment
reasons,
as well
as theshareholders,
simple desire
depending on the length of their holding periods, would be
subject to maximum effective rate of either 96 percent or 78
c
percent.
- 13 -
to take advantage of appreciation caused by an actual or
anticipated public tender offer. We do not believe that such
investors should be subject to the punitive tax proposed by the
bills.*/ While such large shareholders could avoid application
of the excise tax by holding their stock for more than one year,
such potentially noneconomic behavior should not be required by
the tax laws.**/
The final class of persons who might be subject to the
greenmail excise tax are so-called "arbitrageurs." Such
investors often take relatively large positions in a
corporation's stock in anticipation of a tender offer at a price
in excess of the prevailing market price. While such an investor
may seek to benefit directly from a raider's attempt to acquire
control of a corporation, we do not believe that any tax policy
justifies taxing such person at exorbitant rates.
In summary, the Treasury Department believes that S. 420 and
S. 476 represent an imprecise and overly harsh response to a
perceived problem that may not be a problem at all. In any
event, the solution does not reside in the tax laws.
Consequently, we oppose the excise tax provisions in both bills.
Focusing narrowly on the tax treatment of "greenmail" by the
corporation, S. 632 provides expressly for the disallowance of a
deduction for any "greenmail payment." A greenmail payment is
defined by S. 632 as any payment made by a corporation in
redemption of its stock from a 4-percent shareholder if (1) such
shareholder held such stock for a period of less than two years,
and (2) there was a public tender offer for stock in the
corporation at any time during the two-year period ending on the
date of such sale or exchange. A greenmail payment also would
include any payment to a 4-percent shareholder or other person
for any expenses paid or incurred in connection with a redemption
or public tender offer. Like S. 476 and S. 420, the term
4-percent shareholder does not include a person who holds at
least four percent of the total voting power of the corporation's
stock throughout the one-year period preceding the redemption or
who was an officer, director, or employee of the corporation
*/
Even ifthat
institutions
that are
exempt
from effective
the incomedate
tax for
also
throughout
period. There
is no
specific
were
exempted in
from
the excise tax, it would still fall
these
provisions
S. 632.
inappropriately on some large taxable investors.
**/ The one year exception in the bill would permit a raider to
avoid the excise tax simply by holding a four percent
interest for one year. While business and other factors
might preclude the use of such a tactic, the exception will
diminish the effectiveness of the provision.
- 14 -
Under current law, the repurchase of stock by a corporation,
regardless of the amount of stock owned by the shareholder from
whom the stock is redeemed, is a capital transaction that can not
give rise to a deductible loss and payments made by a corporation
in such a transaction are not deductible.*/ Consequently, the
Treasury Department believes that the provision of S. 632 denying
a deduction for redemption payments made to a 4-percent
shareholder under certain circumstances represents a limited
restatement of current law principles.
S. 632, however, contains an exception for redemption
payments made to a shareholder who, throughout the one-year
period preceding the redemption, was an officer, director, or
employee of the corporation or a 4-percent shareholder.
Moreover, S. 632 does not apply to redemption payments made to a
shareholder who owns stock possessing less than four percent of
the voting power of all the corporation's stock. Because
redemption payments are not generally deductible under existing
law regardless of the size or identity of the redeemed
shareholder, we believe that S. 632 is defective to the extent
that it suggests that redemption payments made to such
*/ The courts have held repeatedly that an amount paid by a
shareholders could be deducted by a corporation.
corporation to redeem its stock is a nondeductible capital
transaction. See H. and G. Industries, Inc. v. Commissioner,
495 F.2d 653 (TcTcir. 1974); Jim Walter Corp. v. United
States, 498 F.2d 638 (5th Cir. 1974); Richmond,
Fredericksburg and Potomac Railroad Co. v. Commissioner, 528
F.2d 917 (4th Cir. 1975); Markham & Brown, Inc. v. United
States, 648 F.2d 1043 (5th Cir. 1981); Harder Services, Inc.
v. Commissioner, 67 T.C. 584 (1976); Proskauer v.
Commissioner, 46 T.C.M. 679 (1983). In one isolated case,
Five Star Manufacturing Co. v. Commissioner, 355 F.2d 724
(5th Cir. 1966), a court held that an amount paid by a
corporation to repurchase its own stock was a deductible
business expense in light of a showing that liquidation of
the corporation was imminent in the absence of the
redemption, no value would have been realized by the
shareholders upon such a liquidation, and the redemption
represented the only chance for the corporation's survival.
Regardless of whether Five Star Manufacturing was correctly
decided, it has since B¥en strictly limited to its unusual
facts, see_j_ e^g. , Jim Walter Corp, supra, and its continuing
vitality, even on those unusual factiTTs unclear, see
Woodward v. Commissioner, 397 U.S. 572 (1970).
- 15 -
Despite the clarity of existing law and repeated losses in
litigation, some corporations engaged in takeover fights have
apparently taken the position that redemption payments may be
deductible for Federal income tax purposes on the theory that
they are made to "save" the corporation. We believe that
treating redemption payments as deductible expenses under the
circumstances contemplated by S. 632 is inconsistent with
existing law. Nevertheless, we would not object to an express
statutory confirmation that existing law bars the deductibility
of redemption payments. If such an amendment were adopted,
however, it should expressly deny deductibility for all
redemption payments, regardless of the size or status of the
shareholder, and the accompanying legislative history should
state clearly that the amendment does not create any inference
that the Congress believes such payments are deductible under
existing law.
• * *
This concludes my prepared remarks.
respond to your questions.
I would be happy to
[REASURY NEWS
•ortment of the Treasury • Washington, D.c. • Telephone
TREASURY ADVISORY
April 23f 1985
CONTACT:
Brien Benson
(202) 566-2041
Paul Allan Schott Resigns
Paul Allan Schott has resigned as Treasury Department
Assistant General Counsel for Banking and Finance, to take a
position with the Washington, DC law firm of Barnett, Yingling
and Shay, where he will concentrate on banking and financial
services law.
During his 1979-1985 tenure at Treasury Schott specialized in
deregulation of the banking industry, including drafting the
Administration's banking bill. His other responsibilities
included phase out of deposit interest rate ceilings, thrift
industry problems, securities activities of banks, interstate
branching and bank holding company acquisitions, and
consolidation of bank regulatory agencies.
Schott served as a Senior Attorney at the Federal Reserve
Board from 1973 to 1979, a„nd holds an L.L.M. from Georgetown
University Law Center and- a J.D. from Boston University School of
Law.
Walter T. Eccard will serve as Acting Assistant Counsel for
Banking and Finance until a permanent replacement is found.
###
R-104
TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
April 23, 1985
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling approximately $13,700 million, to be issued May 2, 1985.
This offering will not provide new cash for the Treasury, as the maturing bills
are outstanding in the amount of $13,655 million. Tenders will be
received at Federal Reserve Banks and Branches and at the Bureau of
the Public Debt, Washington, D. C. 20239, prior to 1:00 p.m., Eastern
Daylight Saving time, Monday, April 29, 1985.
The two series
offered are as follows:
91-day bills (to maturity date) for approximately $6,850
million, representing an additional amount of bills dated
January 31, 1985,
and to mature August 1, 1985
(CUSIP No.
912794 HU 1), currently outstanding in the amount of $7,025 million,
the additional and original bills to be freely interchangeable.
182-day bills (to maturity date) for approximately $6,850
million, representing an additional amount of bills dated
November 1, 1984,
and to mature October 31, 1985
(CUSIP No.
912794 HN 7) , currently outstanding in the amount of $8,259 million,
the additional and original bills to be freely interchangeable.
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.
The bills will be issued for cash and in exchange for Treasury
bills maturing May 2, 1985.
Tenders from Federal Reserve
Banks for their own account and as agents for foreign and international monetary authorities will be accepted at the weighted
average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued 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 bills held by them. Federal Reserve
Banks currently hold $1,493 million as agents for foreign and international monetary authorities, and $2,417 million for their own
account. Tenders for bills to be maintained on the book-entry
records of the Department of the Treasury should be submitted on Form
PD 4632-2 (for 26-week series) or Form PD 4632-3 (for 13-week series).
B-105
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
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. Each
tender must state the amount of any net long position in the bills
being offered if such position is in excess of $200 million. This
information should reflect positions held as of 12:30 p.m. Eastern
time on the day of the auction. Such positions would include bills
acquired through "when issued" trading, and futures and forward
transactions as well as holdings of outstanding bills with the same
maturity date as the new offering, e.g., bills with three months to
maturity previously offered as six-month bills. 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, when submitting tenders for customers, must
submit a separate tender for each customer whose net long position
in the bill being offered exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
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 book-entry
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
PAGE 3
Public announcement will be made by the Department of the
Treasury of the amount and yield 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 $1,000,000 or less without
stated yield from any one bidder will be accepted in full at the
weighted average bank discount rate (in two decimals) of accepted
competitive bids for the respective issues. The calculation of
purchase prices for accepted bids will be carried to three decimal
places on the basis of price per hundred, e.g., 99.923, and the
determinations of the Secretary of the Treasury shall be final.
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 the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. 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. In addition, Treasury Tax and Loan Note Option Depositaries may make payment for allotments of bills for their own accounts and for account
of customers by credit to their Treasury Tax and Loan Note Accounts
on the settlement date.
In general, if a bill is purchased at issue after July 18,
1984, and held to maturity, the amount of discount is reportable
as ordinary income in the Federal income tax return of the owner
at the time of redemption. Accrual-basis taxpayers, banks, and
other persons designated in section 1281 of the Internal Revenue
Code must include in income the portion of the discount for the
period during the taxable year such holder held the bill. If the
bill is sold or otherwise disposed of before maturity, the portion
of the gain equal to the accrued discount will be treated as ordinary income. Any excess may be treated as capital gain.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76 and 27-76, Treasury's single bidder guidelines, and this
notice prescribe the terms of these Treasury bills and govern the
conditions of their issue. Copies of the circulars, guidelines,
and tender forms may be obtained from any Federal Reserve Bank or
Branch, or from the Bureau of the Public Debt.
TREASURY NEWS
department of the Treasury • Washington, D.c. • Telephone 566-2041
STATEMENT OF
THE HONORABLE
JAMES W. CONROW
ACTING ASSISTANT SECRETARY OF THE TREASURY
FOR INTERNATIONAL AFFAIRS
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS OF THE
COMMITTEE ON APPROPRIATIONS
U.S. HOUSE OF REPRESENTATIVES
APRIL 25, 1985
Mr. Chairman and Members of the Committee:
Thank you for the invitation to appear before your
Committee today. I realize the difficulty in scheduling
Treasury's testimony this year, and I sincerely appreciate
your willingness to allow Treasury to present testimony
today on the President's supplemental budget request for
the Multilateral Development Banks (MDBs) for fiscal year
1985. As you know, Secretary Baker will discuss the
Administration's fiscal year 1986 budget request on May 16.
U.S. Unfunded Replenishment Commitments
The Administration's FY 1985 supplemental request reflects
our determination to honor United States' commitments to the
institutions, the other donor countries, and most importantly,
to the people of the developing countries themselves — commitments for the most part negotiated by this Administration.
I am well aware, Mr. Chairman, of your views on budgetary
supplementals in the absence of an emergency. But I believe
our unfunded replenishment commitments are truly creating a
very difficult situation for MDB lending programs. Currently,
the United States' funding shortfall of $91 million in the
Asian Development Fund (ADF) has, because of a cost sharing
mechanism, led- to total reductions in donor contributions of
about $250 million. Without our requested funds, the ADF
will be forced to make contingent loan commitments, which
prevent the institution from finalizing its loan agreements.
B-106
- 2 The Inter-American Development Bank (IDB) is in a worse
situation. Because charter provisions provide the United
States with 34.5 percent of the IDB voting power, the Bank
cannot accept subscriptions from others that would push us
below this level. The current U.S. shortfall in subscriptions is $40 million paid-in capital and $849 million in
callable capital. Based on the 34.5 percent criterion, the
IDB now has a cumulative shortfall in convertible currencies
of close to $1.2 billion in lending authority — and it could
increase to nearly $2 billion if the U.S. shortfall continues
until October. This has forced the IDB to stop its lending
program. It can only make contingent commitments until we
provide our subscription shortfall.
The replenishment of the IDB's soft loan window, the
Fund for Special Operations (FSO), also contains a cost
sharing mechanism. Our shortfall of $72.5 million has
resulted in a total shortfall of around $175 million.
The first installment for the Inter-American Investment
Corporation (IIC) remains incomplete and detracts from our
efforts to urge others to accelerate ratification. To continue
to demonstrate the leadership exercised previously in helping
to establish the IIC, the United States needs to quickly
eliminate the $3 million shortage.
The $400 million shortfall in subscription's to the World
Bank's 1981-86 General Capital Increase (GCI) has already
stretched out the U.S. contribution over a seven-year period.
Failure to meet even this extended schedule could further
erode U.S. credibility in this important institution. The
difficult development and adjustment problems now facing the
developing countries underscores the importance of the efforts
being made by the World Bank.
I believe that consistent shortfalls can cause serious
damage to our relations with other member countries, and with
the institutions themselves. More importantly, they have a
negative impact on the people of the developing countries who
are the beneficiaries of these institutions. On the basis of
our extensive consultations with the Congress, including this
Committee, we entered into commitments we believed the United
States would be able to honor. We now find ourselves unable
to fulfill the obligations we agreed to. Frankly, this is
not good government, and, does not speak well for the United
States. Secretary Baker has stated that it is totally unbecoming and unreasonable for the world's most powerful nation
to refuse to honor international commitments made in good
faith, and after full consultation between the Executive
and the Legislative Branches of government.
- 3 The Fiscal Year 1985 Supplemental Budget Request
We are requesting $236.7 million in budget authority and
$1,219.0 million under program limitations for callable
capital subscriptions as a fiscal year 1985 supplemental.
International Bank for Reconstruction and Development (IBRD)
The Administration is seeking a fiscal year 1985 supplemental request of $30.0 million in budget authority for
paid-in capital and $370.0 million under program limitations
for callable capital to complete the fourth of six installments
for the U.S. share of the 1981 GCI of the World Bank.
The Administration continues to believe that the IBRD
should play a prominent role in the longer-term development
programs of its borrowers. Eliminating the U.S. shortfall to
the World Bank is the most concrete way to demonstrate our
support.
Inter-American Development Bank (IDB)
For the IDB, the Administration is seeking $40.0 million
in budget authority and $849.0 million under program limitations
for subscriptions to complete the second of four installments
to the 1983 capital increase of the IDB.
Fund for Special Operations (FSO)
The Administration is seeking $72.5 million for the
second of four installments for the 1983 replenishment.
The FSO replenishment is designed to address the long
term development needs of the poorest countries, primarily
in Central America and the Caribbean. As a result of U.S.
unfunded commitments to the FSO, other countries are also
holding back on their payments.
Inter-American Investment Corporation (IIC)
For the IIC, the Administration is requesting $3 million
to complete the first of four installments for the initial
U.S. subscription to the IIC.
The Administration strongly supported establishing the
IIC as a practical means of enhancing the capacity of the IDB
to aid the private sector in borrowing countries.
Asian Development Fund (ADF)
The Administration is seeking $28.2 million to complete
U.S. contributions to the first replenishment and $63 million
to complete the second of four installments to the third
replenishment.
- 4 The ADF has supported well designed and effective development projects in some of the poorest countries in the world.
u!s. support benefits the people of such countries as Pakistan,
Bangladesh, and Sri Lanka as well as many of the strategic
island countries in the Southern Pacific.
Conclusion
In conclusion, Mr. Chairman, I want to emphasize this
Administration's commitment and full support for the MDBs.
In this context, I reiterate the importance of the supplemental request for contributions and subscriptions that we
have requested.
As you know, Mr. Chairman, the Administration made an
earnest effort to consult closely with the concerned members
of the Congress in conducting our 1982 Assessment of the MDBs
and in negotiating the replenishments on the basis of the
Assessment's guidelines. Moreover, President Reagan, in
various international fora, has repeatedly stressed U.S.
commitment to these institutions.
Our inability to honor commitments seriously damages
the Administration's negotiating position for future MDB
replenishments. This inability also tends to fragment all
our cooperative endeavors, such as influencing the MDBs to
push for policy reforms geared to increasing economic efficiency, and fostering broad opportunities which will enable
all strata of the population to benefit from economic development. Now, we urge your support for the Administration's MDB
request so that the people for whom these institutions were
created to serve will benefit.
TREASURY NEWS
pepartment of the Treasury • Washington, D.c. • Telephone 566-2041
for Release Upon Delivery
Expected at 10:00 a.m., E.S.T.
April 24, 1985
STATEMENT OF
RONALD A. PEARLMAN
ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
WAYS AND MEANS COMMITTEE
OF THE HOUSE OF REPRESENTATIVES
Mr. Chairman and Members of the Co mm it; free:
I am pleased to present the views of the Treasury Department
on the application of the imputed interest and original issue
discount ("OID") rules to seller-financed sales of property. We
are pleased to participate in the Committee's reexamination of
these provisions in light of the expiration at the end of June of
temporary rules contained in P.L. 98-612.
The Tax Reform Act of 1984 (the "1984 Act") refined the
imputed interest rules of prior law to require that taxpayers (i)
determine whether adequate interest is stated in a contract for
the sale of property by testing against interest rates which more
closely approximate market interest rates, and (ii) allocate
interest (including imputed interest) to the periods to which it
relates and take the interest into account for that period.
Taken together, these changes provide for the proper economic
treatment of deferred payment obligations arising in connection
with the sale or exchange of property. The "new rules will
largely prevent the abuses which arose prior to the 1984 Act,
including mismatching of income and deduction, overstatement of
tax basis and investment tax credit ("ITC") and accelerated cost
recovery system ("ACRS") allowances and the conversion of
ordinary income into capital gain taxed on a deferred basis.
B-107
- 2 Although the Treasury Department believes the 1984 Act rules
provide the proper tax treatment for sales and exchanges of
property, we support efforts to provide simpler rules for "smalltransactions. In view of the expiration of the temporary rules
contained in P.L. 98-612, i will discuss the application of the
imputed interest and OID rules to transactions involving
relatively small amounts. I will then address certain
improvements that we believe can be made in these rules for
larger transactions. Finally, I will comment on the rules
relating to transactions where an existing debt obligation is
assumed or property is taken subject to an obligation.
BACKGROUND
Congress substantially modified the imputed interest and OID
rules in the 1984 Act. As this Committee considers the
appropriate permanent rules for seller-financed sales of
property, it is important to review both the prior law rules and
the reasons for the 1984 Act amendments.
1. Rules Prior to the 1984 Act
Beginning in 1969, holders of publicly-traded discount
obligations or obligations issued for publicly traded property
were required to include and issuers were able to deduct OID over
the term of the obligation, without regard to whether the parties
were on the cash or accrual method for other items of income and
deduction. This treatment of original issue discount is based on
two premises. First, the rules recognize that original issue
discount represents interest that will accrue, but not be paid
currently during the term of the obligation; this deferral is the
economic equivalent of the borrower paying the interest which
accrues currently with additional funds borrowed from the lender.
Second, the requirement that the issuer and holder of an original
issue discount obligation report original discount obligation on
the accrual method ensures consistent accounting. Without such a
rule, the parties could mismatch income and deductions.
The prior law OID rules, however, did not apply to
obligations issued by individuals or to obligations issued in
exchange for non-publicly traded property. Thus, transactions
involving the purchase of real estate or non-publicly traded
personal property in which there was seller financing were
outside the scope of the original issue discount rules even if
the financing permitted interest to accrue without being paid
currently.
Deferred payment obligations issued in exchange for
non-publicly traded property, including obligations issued by
individuals, however, were subject to section 483. Section 483
- 3 required the parties to state a minimum rate of interest (under
prior law, 9 percent simple interest) or interest would be
imputed at a higher rate (10 percent compounded semiannually).
Section 483 provided a maximum test rate of 6 percent and an
imputation rate of 7 percent for related party real estate
transactions involving $500,000 or less.
2. Reasons for Change"
Limited Scope of OID Rules
Under prior law, the OID rules did not apply to deferred
interest obligations issued in connection with the purchase of
real estate or non-publicly traded personal property (such as
machinery), or to such obligations issued by individuals. In
these situations, tax avoidance opportunities resulted from the
fact that interest would accrue each year, but would not be paid
until maturity. The issuer of the obligation, if using the
accrual method of accounting, could claim annual interest
deductions while cash method holders deferred inclusion of the
discount until maturity.
The ability to mismatch income and deductions for OID formed
the basis for numerous real estate and other tax shelter
offerings. The revenue loss from these>tax shelter offerings was
significant and increasing dramatically as this structuring
technique became known and used widely in transactions involving
seller-financing. An example illustrates the magnitude of the
revenue loss from a typical transaction: A $5 million obligation
bearing interest at 12<5 percent, compounded annually, and
payable in a lump sum'after 20 years is exchanged for property.
An accrual method obligor in the 50 percent tax bracket would
claim interest deductions over the term of the obligation having
a present-value of $5.6 million. Because the cash method obligee
would defer recognition of interest income until maturity, the
present value of the tax paid by the obligee in the 50 percent
tax bracket is $2.3 million. Thus, the revenue loss from one
$5 million transaction from the mismatching of interest income
and deduction is approximately $3.3 million on a present value
basis. Of course, for larger transactions, the revenue loss
would be proportionately larger (e.g., $13.1 million for a $20
million transaction).
In addition to the asymmetrical treatment of issuers and
holders, discount bonds issued in tax shelter transactions of the
type described above frequently embodied a noneconomic
computation of interest (i.e., simple interest payable on a
deferred basis). Reporting interest on a simple interest basis
accelerates interest deductions by ignoring the compounding of
interest on deferred but unpaid interest; thus, interest is not
properly allocated to the period in which it actually accrues.
Cash method holders of the obligations are, of course,
- 4 indifferent to these timing concerns because they defer inclusion
until maturity. Although the use of noneconomic interest
calculations was largely proscribed by Rev. Rul. 83-84, 1983-1
C.B. 97, we understand that several tax shelter offerings made
prior to the 1984 Act took/positions inconsistent with this
ruling.
Deficiencies of Section 483
The tax law provides for different treatment of interest and
principal of debt obligations given in exchange for property. In
addition, other tax consequences flow from the characterization
of payments as either interest or principal, such as the seller's
amount realized and the buyer's tax basis in the acquired
property. Section 483 was originally enacted to ensure that
parties properly characterized as interest or principal amounts
paid pursuant to obligations given in exchange for property.
Without interest imputation rules such as those provided in
section 483, whenever a debt obligation is given in exchange for
property, the parties would have the flexibility to adjust the
rate of interest charged and the principal amount of the
obligation so as to produce an optimal tax result without
altering the underlying economic transaction. If these
distortions were permitted, a seller cbuld convert ordinary
interest income into capital gain (taxable on a deferred basis
under the installment sale rules) or gain that might be deferred
indefinitely where a residence is sold. In the case of a buyer,
the tax basis of the acquired asset would be overstated and
excess ACRS allowances^ and ITC would be claimed.
An overstatement of principal and understatement of interest
may also occur, and often does occur, even when the parties are
not purposefully attempting to avoid taxes. For example, suppose
a taxpayer has a piece of property which he genuinely believes is
worth $1 million. He wishes to sell the property at this price
but is unable to find a willing buyer. In order to move the
property, the taxpayer decides (for nontax reasons) not to lower
the purchase price but to offer seller financing at a
below-market rate for a portion of the purchase price. This
enables the taxpayer to close the sale transaction.
In this situation, the fact that the seller had to offer
below-market financing to sell the property indicates that the
property was not worth $1 million. Thus, even if tax avoidance
was not the goal of either party to the sale, the seller has
converted ordinary interest income into capital gain and the
buyer has obtained an overstated basis.
This tax advantage is never available where a third-party
lender finances the purchase of property (unless the seller makes
a payment to the lender to "buy down" the buyer's interest rate).
- 5 In such cases, the interest rate for the borrowing and the
purchase price for the property are independently fixed at arm's
length.
Historically, the section 483 test rates have been adjusted
only infrequently, and have often been at rates considerably
below market interest rates. To the extent that the test rate
provided under section 483 is less than a market rate of
interest, the buyer and seller may improperly characterize a
portion of deferred payments as principal and understate their
tax liability. Thus, a below-market test rate effectively
provides a tax subsidy for seller-financed sales of property.
Prior to the 1984 Act, we became aware of a substantial —
and rapidly increasing — number of transactions that exploited
the below-market interest test rate and the noneconomic simple
interest computation provided under section 483. In one case
brought to our attention, a tax basis of more than five times the
established fair market value of the property was claimed. Under
a proper economic analysis, the "excess basis" — i.e., the
amounts payable under the obligation in excess of the fair market
value of the acquired property — represents interest and should
be deductible only as it accrues over the life of the obligation.
However, by virtue of the defective operation of section 483,
taxpayers claimed that the excess was transformed into inflated
ITC and ACRS allowances which had a materially higher present
value than the interest deductions.
3. 1984 Act Changes
These abuses promp'ted the Treasury Department to propose a
number of changes to section 483 and the OID rules. Congress
adopted these proposed changes as part of the 1984 Act.
Section 1274
For transactions involving deferred payments for the sale of
non-publicly traded property, the 1984 Act establishes safe
harbor interest rates based on the term of the obligation to test
whether the obligation states adequate interest. If the parties
to a sale or exchange of non-publicly traded property involving
deferred payments fail to state adequate interest, interest is
imputed at a higher rate. The safe harbor test rate is 110
percent of the "applicable Federal rate" and the rate at which
interest is imputed is 120 percent of the applicable Federal
rate. The applicable Federal rates ("AFR") are based on average
market yields on outstanding Treasury obligations of comparable
maturity. The Treasury is to determine the rates for Treasury
obligations with maturities of 3 years or less (the "Federal
short-term rate"), over 3 years but less than 9 years (the
"Federal mid-term rate") and over 9 years (the "Federal long-term
rate").
- 6 -
The 1984 Act also expands the scope of the OID rules. After
December 31, 1984, obligations issued by individuals and
obligations issued for non-publicly traded property which provide
for deferred interest or which fail to state adequate interest
are subject to the OID rules.
The section 1274 rules embody two concepts: (i) a test rate
designed to approximate a market rate of interest and (ii) OID
rules requiring the parties to take into account, on the accrual
method, imputed interest (where adequate interest is not stated)
or stated interest (where adequate interest is stated, but is not
paid currently).
In recognition that the new rules impose a greater degree of
complexity than the prior law rules, Congress provided several
exceptions for routine transactions and transactions not
involving large amounts of money. Thus, sales of principal
residences, certain sales of farms for less than $1 million and
any sales involving total payments of $250,000 or less are not
subject to section 1274.
Changes to Section 483
The application of section 483 was'-limited to deferred
payment transactions involving sales or exchanges of property
falling within one of the exceptions to the OID rules. The
existence of unstated interest is tested with reference to the
applicable Federal rates established under the OID rules. Where
imputed interest is pfesent, however, it will be taken into
account only as payments are made (rather than under an accrual
method, as provided in section 1274). Thus, under section 483,
"principal" payments are recharacterized as interest to the
extent that imputed interest has accrued but has not been paid
through the time of payment.
In cases involving the sale or exchange of a principal
residence (to the extent of the first $250,000 of the cost of the
residence) or farmland costing less than $1 million, the 1984 Act
provided that the test rate previously applicable under section
483 would apply. Thus, the existence of unstated interest would
be determined by reference to a 9 percent test rate.
4. Public Law 98-612
After passage of the 1984 Act, a number of concerns were
raised regarding the impact of the changes described above on
relatively small transactions. To address some of these concerns
temporarily and permit the Congress to reexamine the OID and
imputed interest rules in this session, Congress passed P.L.
98-612 in October 1984 which contained temporary and permanent
rules relating to seller-financed sales of property. Most
- 7 importantly, P.L. 98-612 provided that for sales or exchanges of
property (other than new section 38 property) occurring prior to
July 1, 1985, the test rate is 9 percent (compounded
semiannually) on up to the first $2 million of seller financing.
For transactions involving more than $2 million of total
financing, the test rate is a weighted average of 9 percent and
110 percent of the applicable Federal rate.
P.L. 98-612 also provided that sections 1274 and 483
generally apply to assumptions of existing obligations in
connection with sales or exchanges of property or taking property
subject to an existing obligation. Congress, however,
specifically exempted from the scope of sections 483 and 1274
assumptions of obligations originally issued on or before October
15, 1984, in transactions where the sales price does not exceed
$100 million. P.L. 98-612 also provided exemptions from the
rule on assumptions generally for transactions involving (i)
personal residences, (ii) property used in the active conduct of
the trade or business of farming, and (iii) property (other than
new section 38 property) used in an active trade or business.
II
SMALL TRANSACTIONS
Although the principles underlying the OID and imputed
interest rules are equally applicable to all seller-financing
transactions, we recognize that these rules impose additional
burdens in planning sales transactions and that these burdens
weigh proportionately"more heavily on small transactions.
Therefore, we agree it is appropriate to consider rules that
would simplify the system for small transactions.
We feel obliged to point out to the Committee, however, that
any system that provides different rules for small and large
transactions must also describe in what circumstances
transactions will be aggregated for purposes of ascertaining
whether the small transaction rules should apply. Without
clearly defined aggregation rules, the large transaction rules
could easily be avoided. For example, a seller of a single piece
of property worth $5 million cannot be permitted to benefit from
the small transaction rules by selling five separate 20%
interests in the property to the same buyer in five transactions
taking place at substantially the same time. While this type of
abuse can be dealt with easily enough, other cases involving a
single seller and multiple buyers or multiple sellers and a
single buyer will present significant problems. While the
difficulties of formulating fair and workable aggregation rules
are not insubstantial, we believe that these problems are
outweighed by the need to provide simpler rules for small
transactions.
- 8 -
1.
Fixed Test Rate
Prior to the 1984 Act, the prevailing test rate was widely
knowS and individuals could' structure routine transactions
without consulting tax periodicals or a tax professional to
d i a m i n e the current applicable Federal rates. To continue this
systeTflr relative^ small transactions, we would support the
amplication of a fixed lower test rate. This rate would be
adjusted only to reflect significant long-term shifts in market
interest rates.
We suggest that the lower rate be fixed initially at 9
percent, based on compounding at least annually. This fixed rate
would provide a degree of certainty and simplicity for small
transactions by removing the need to refer to the applicable
Federal rate, which changes frequently. To give some effect to
shifts in market rates, however, this fixed rate might
automatically adjust when the applicable Federal rates shift very
substantially and remain at the new levels for a relatively long
time period. At the end of this time period, the small
transaction rate could be adjusted to, for example, the nearest
whole percentage to 80 percent of the current monthly Federal
aid-term rate. Of course, if the test rate applicable to large
transactions actually fell below the fixed small transaction
rate, the parties would be permitted to use the lower test rate.
A fixed rate for small transactions, adjusted infrequently is
far preferable to a floating rate, such as a fixed percentage of
the applicable Federal''rate. Although such a system would always
result in a below-market test rate for small transactions, the
floating rate would do nothing to eliminate the uncertainty for
transactions involving relatively small amounts of money since
the parties would still be required to consult current market
interest rates simply to structure such transactions.
2. Definition of Small Transaction
The distinction between large and small transactions can be
based on either the purchase price of the property or on the
amount of seller financing involved. If the purchase price of
the property is the basis for the distinction, we suggest that
the special rule for small transactions be limited to
transactions with a purchase price of $2 million or less. For
this purpose, purchase price would include cash and the fair
market value of any property transferred to the seller, as well
as the stated principal amount of any financing. Alternatively,
if the Committee prefers to continue to base the distinction
between large and small transactions on the amount of seller
financing, we suggest that the special rule for small
transactions be limited to transactions where the amount of
seller financing does not exceed $1 million.
- 9 -
For transactions above whichever of these thresholds is
chosen, the parties generally are sufficiently sophisticated to
be aware of current market interest rates, and we are not
persuaded that the additional complexity involved in consulting
current applicable Federal rates is burdensome when compared to
the other complexities that inevitably accompany a sale of an
expensive property. When ..a below-market interest rate is charged
in such large transactions, the parties should be fully aware of
the relationship between the purchase price and the interest rate
charged, as well as the resulting tax consequences.
3. Application of OID Rules to Small Transactions
Some have suggested that parties to a small transaction
should have the option to elect cash accounting for both parties
in lieu of the OID rules. In evaluating this option, it is
important to bear in mind that the OID rules apply only if the
parties to a sales transaction do not provide adequate stated
interest or if the transaction does not call for interest to be
paid currently. Since virtually all taxpayers will provide at
least the 9 percent interest required to avoid imputed interest,
this option is important only in situations where the parties
provide for deferred interest.
i»
We acknowledge that an election to report deferred payments
on the cash method may be simpler for the parties than the OID
rules. However, the existence of two separate accounting systems
for small and large transactions also would create new
complexities. For example, assume that property is sold under
the small transaction* rule and the parties elect the cash method;
subsequently, the property is resold in a transaction which is
subject to the OID rules and the original obligation is assumed.
In this situation, may the subsequent purchaser accrue interest
deductions currently while the original seller continues to
report interest income only as received? Alternatively, assume
the seller of the property disposes of the buyer's obligation to
an accrual basis taxpayer. Is the subsequent holder entitled to
use the seller's cash matching election? Rules that would have
to be provided to deal with such problems would make the cash
method election potentially very complicated.
A cash-matching election also involves potential for abuse.
For example, an owner of property could sell to a tax-exempt
intermediary for a note calling for deferred interest payments,
with the parties electing the cash method. The tax-exempt
intermediary could then sell to the intended buyer on the same
terms, with the buyer and the intermediary not electing the cash
method. The buyer could then report current interest deductions
under the OID rules, while the seller would have no current
interest income inclusion. The intermediary would use its tax
exemption to insulate itself from adverse consequences of the OID
interest inclusions.
- 10 -
Although a rule could be designed to address this particular
arrangement, we are not optimistic that every type of transaction
which is similar to this arrangement and exploits differences in
marginal tax rates could be stopped. If effective anti-abuse
rules are not developed to address all schemes structured to
avoid the requirement .that the parties to a deferred payment sale
of property account consistently for the interest element in the
transaction, one of the major abuses addressed in the 1984 Act,
the potential for mismatching income and deductions, will remain.
In view of the inevitable complexity involved with separate
accounting systems for small and large transactions and the
potential for abuse, we would urge the Committee not to adopt a
special accounting rule for small transactions.
4. Application of Small Transaction Rules to Dealers
We suggest that any special rules for small transactions
apply only to casual sales of property. Special rules for small
transactions can be justified only on the ground that the
generally applicable imputed interest and OID rules are too
complex when relatively unsophisticated parties are buying or
selling property. Dealers that regularly transact for the sale
or purchase of property are sufficiently sophisticated to be
aware of current market interest rates. Indeed, many dealers in
residential real property are New York Stock Exchange-listed
firms that engage in thousands of sales annually. These
taxpayers have little basis for claiming the new imputed interest
and OID rules are overly complex. Moreover, exempting dealers
from the small transaction rule would obviate many of the more
difficult aggregation issues referred to earlier.
5. No Special Rule for Sales of Certain Types of Property
A broadly-based special rule for small transactions would
provide a degree of certainty for parties to routine sale
transactions and can be justified on the grounds of simplicity.
This rule would apply sales of all types of property including,
sales of small businesses, residences and farms. Therefore, we
oppose providing additional exceptions to these rules for
transactions in these or other special types of property. Such
exemptions are unnecessary in light of the small transaction rule
and constitute a subsidy for transactions in such types of
property. Moreover, each additional exception adds complexity to
the Internal Revenue Code and to the regulations as rules must be
formulated defining the scope of each exception, identifying and
preventing abuses, and regarding the interrelationship of the
various exceptions.
If a general exception for small transactions of all types is
adopted, the existing special rules that provide lower rates for
transactions in certain types of property are no longer needed.
- 11 Thus, we would support the repeal of the existing special rules
for certain types of transactions, including the rules relating
to sales of principal residences, sales of farms and sales of
land between related parties.
Ill
SUGGESTED CHANGES TO THE BASIC RULE
Although we believe that the rules enacted in the 1984 Act
generally provide for the correct treatment of seller-financed
sales of property, we think that a number of improvements can be
made in the existing statutory structure. I turn now to these
matters.
1. Selecting the Appropriate Interest Rate Index
As I have already stated, if one party sells a piece of
property to another in a transaction that calls for one or more
deferred payments, and if the deferred payments do not include an
interest charge at a market rate of interest, the parties have
the opportunity to overstate the purchase price for the property.
The question then arises: What constitutes a "market rate of
interest"? The current statute answers this question by
reference to the rate at which the Federal Government borrows
money, taking into account (to a limited extent) the term of the
obligation.
We continue to believe that an interest rate index based on
the yields on United itates obligations is the most reliable and
appropriate indicator of market rates of interest, for the
following reasons:
• The Federal borrowing rate accurately reflects
trends in the market rate at which a given
borrower could obtain funds from an unrelated
lender.
0
A rate based on the yield of U.S. Government
obligations is not subject to manipulation.
0
8
U.S. Government rates are readily available;
no data need be gathered from third party
sources.
There is a large volume of U.S. obligations
with remaining maturities ranging from 30 days
to 30 years. This assures a statistically
valid data base from which to compute the
market interest rate index.
The imputed interest rules provide that the applicable
Federal rate is multiplied by a factor of 110 percent to compute
the appropriate test rate. This multiple reflects that even the
- 12 most creditworthy borrower will not be able to borrow at a rate
as low as the Federal Government pays on its obligations. We
support retention of the 110 percent factor applied to the
applicable Federal rates to determine the testing rate for
whether a transaction has adequate stated interest. The factor
is not punitive; in many arm's-length lending transactions the
market rate of interest would be 130 percent, 140 percent or more
of the applicable Federal, rate, due to the creditworthiness of
the borrower.
Attached to this testimony are four charts which show the
relationship between private and Federal Government interest
rates over the course of the last eight years. Chart 1 compares
the FHA mortgage rate to a Federal long-term composite rate.l/
This chart shows a close relationship between the two indices
during all periods, with the FHA rate consistently above the
Government rate.
Chart 2 shows the ratio of the FHA index to the long-term
Government index. In other words, this chart expresses the FHA
rate as a percentage of the long-term Government rate. At no
time during this period did this percentage ever drop below 110
percent and at times was over 130 percent. This relationship
indicates that a test rate based on 110 percent of a Federal
long-term borrowing rate is entirely appropriate.
Charts 3 and 4 provide the analogous comparisons between the
average prime lending rate and the average yield on new issues of
1-year Government securities. Again the correlation between the
two averages is extremely high. Chart 4 shows that the prime
rate was always at least 110 percent of the 1-year Government
rate.2/
1/
The FHA mortgage rate is the rate charged to home buyers for
FHA-insured mortgages. The Federal long-term composite rate
index is based on yields of Government bonds with constant
maturities of 10 years or more. The latter index is very
similar to the Federal long-term rate of current law and was
chosen in lieu of the Federal long-term rate because past
data for the latter index are not readily available. Both
indices are compiled from data published in Domestic
Financial Statistics, a publication of the Federal Reserve
Board.
2/ The data on the prime rate and the 1-year Government rate on
new issues are also taken from Domestic Financial Statistics.
Private borrowing rates are quite likely to exceed the prime
rate, especially on lending transactions of more than one
year (but not more than 3 years). Also, the 1-year
Government rate on new issues will not be identical to the
Federal short-term rate since the latter index takes into
account all maturities of 3 years or less on all outstanding
issues.
- 13 -
We are well aware that legislation has been introduced (with
the support of a number of the groups that will be testifying
before this Committee .later today) to lower the test rate to 80%
of the applicable Federal rate. We urge this Committee not to
adopt such change. Allowing taxpayers to state interest rates as
low as 80% of the AFR would allow very substantial overstatements
of true purchase price"in .sales of property calling for deferred
payments. This overstated purchase price benefits both the
seller (in the form of a conversion of ordinary interest income
into capital gain) and the buyer (by converting interest
deductions into depreciable basis that can be written off on an
accelerated basis).
At current interest rates, a shift to a test rate of 80
percent of the applicable Federal rate would allow a basis
overstatement in any sales transaction of more than 30 percent,
assuming a purchase money loan for the entire sales price with a
term of 30 years and level monthly payments over the term of the
loan. For example, a building having a value of $10 million
could be sold for over $13 million. In the case of loans calling
for a single payment of principal and interest at maturity, the
potential overstatement is far greater. For example, if the debt
instrument described above called for a single payment at
maturity, the same $10 million building"could be sold for a
purchase price of over $27 million.
For the tax law to permit distortions of this magnitude would
be a substantial step in the wrong direction. A system using a
test rate of 80 percent of the applicable Federal rate would
present the worst of two worlds; the complexities of a floating
test rate would be retained while one of the two major abuses
that led to enactment of the 1984 Act provisions (basis
overstatement) would remain unchecked.
2. No Blended Rate for Larger Transactions
We do not believe that the test rate for small transactions
should apply to any portion of the borrowed amount on a
transaction above the small-transaction threshold. Our primary
reason for opposing the "blended rate" approach of P.L. 98-612 is
that there is no reason to provide a test rate which is below a
market interest rate for transactions in excess of the threshold
amount. The sole justification for the 9 percent rate for small
transactions is that it is a fixed, well-known rate that parties
can use without reference to floating rates published
periodically. This justification disappears as soon as the fixed
rate is to be blended with a higher floating rate.
The blended rate also adds a significant amount of complexity
to the imputed interest rules. For example, if a small
transaction threshold based on purchase price is chosen, parties
- 14 •
needs 11 bl"hS£d blciiw tha? rate will depend on the purchase
neeas to pe cnargeu "«
nrice will depend in turn on the
•.£t«,,Xh 4-ho ncp of soohisticated mathematical techniques.
(sImi!SrproS!e«s-"!d arise with a threshold based on seller
financing.)
Finallv a blended rate for transactions in excess of $1
m i i n o n l s ^ o ? necessary to avoid a "cliff", that is, a dramatic
difference between the tax consequences of a sale of property
with a value just below the threshold amount and the consequences
of a sale of property worth just over the threshold amount. In
fact a specific dollar limit based on either the stated sales
price or the amount of seller financing essentially operates as a
gradual phase out of the lower rate.
To see why this is so, one must bear in mind that the right
to state a 9 percent interest rate when prevailing market rates
are higher allows parties to overstate the purchase price of the
property sold. For example, if the prevailing market interest
rate is 12 percent and the property is to be paid for in ten
equal annual installments, the purchase price of the property is
overstated by a factor of approximately 13.6 percent. Thus, a
sale of property for a $1 million note with interest a 9 percent
on these terms would indicate a true value of the property of
approximately $880,000. For property having a value of more than
$880,000 but less than $1 million, if the small transaction
threshold were $1 million of seller financing, the parties would
in each case state a purchase price of $1 million but would
charge an interest rate between 9 percent and a market rate to
achieve the correct economic result. Thus, the small transaction
rule is advantageous until the rate that must be charged equals
the rate applicable to large transactions.
The following table illustrates the correlation between the
value of property and the interest rate that would be charged if
the stated principal amount is $1 million.
Actual Value Stated Sales Price Interest Rate
9-0%
$ 880,418.26
$1,000,000
899,889.28
.1,000,000
9.5%
919,547.78
10.0%
1,000,000
939,390.94
10.5%
1,000,000
959,415.94
11.0%
1,000,000
979,619.91
1,000,000
11.5%
1,000,000.00
1,000,000
12.0%
- 15 We recognize that, notwithstanding the above analysis, a
perception remains that a cliff exists between the small
transaction and large transaction rules. If this Committee
wishes to address this perceived problem, we would recommend a
simple phase-out of the benefit of the 9 percent rate for
transactions with a sale price between $2 million and $3 million
(or seller financing between $1 million and $2 million) rather
than a blended rate for all large transactions. This would
simplify the system for larger transactions and would have the
added benefit of limiting the revenue loss from the 9 percent
subsidy rate.
3. Conforming the Imputed Interest Rate to the Testing Rate
Under current law, if the parties to a sales transaction do
not provide for interest at a rate at least equal to the safe
harbor test rate, interest will be imputed at a higher imputed
rate. For sales involving total financing $2 million, the test
rate is 9 percent and the imputed rate is 10 percent. To the
extent the total financing exceeds $2 million, the test rate is
110% of the AFR and the imputed rate is 120% of the AFR.
This feature of current law is a carryover from old section
483, under which interest of at least 9 percent had to be stated
to avoid interest being imputed at 10 percent. The original
reasons for having different test rates and imputed rates, as
well as the reasons for carrying this aspect of old section 483
forward in the 1984 Act, are not entirely clear.
Whatever these reasons, Treasury believes that the system
could be made simpler and fairer by setting both the test rate
and the imputed interest rate at 110% of the AFR for large
transactions and by setting both these rates at 9 percent for
small transactions. The system would be simpler because fewer
rates would have to be computed, published and assimilated by
taxpayers and their advisers. The system would be fairer because
parties would not be penalized for failing to provide the minimum
interest rate required; the tax law would simply recharacterize
the transaction as if this minimum interest rate had been
provided.
4. Frequency of Determination — Semiannual or Monthly?
The 1984 Act calls for semiannual redeterminations of the
applicable Federal rates. Soon after enactment of the 1984 Act,
however, it became apparent that if taxpayers are to be required
to state a market rate of interest, the system cannot work if the
test rate is substantially out of date.
The 1984 statute calls for rates that are, on the average, 9
months out of date. Moreover, transactions taking place at the
end of a semiannual period would be governed by a test rate based
- 16 on interest rates in effect as much as 15 months earlier. For
example, a transaction taking place on June 30, 1985 would be
governed by a test rate determined in part by reference to yields
on U.S. obligations during the month of April 1984.
As an interim measure, Treasury decided to address this "time
lag" problem by providing in temporary regulations an alternate
calculation of the applicable Federal rates, based on monthly
rather than semiannual recomputations. This substantially
reduces (but does not eliminate entirely) the time lag problem.
The monthly rates were provided as an alternative to the
statutory semiannual rates; the latter rates remain available in
the event they are lower.
In moving from a semiannual to a monthly redetermination of
the applicable Federal rates, we recognized that to some extent
we were making it more difficult to negotiate and plan sales
transactions. To ease this problem, we provided an additional
special rule, allowing taxpayers in a given month to use the
rates in effect for the preceding and the second preceding month
(in addition to the current month's rates). This rule assures
that, once a set of monthly rates is published, taxpayers can be
assured that the applicable Federal rates will be no higher than
those rates during a three-month period.
*,
We believe that the system of Federal rates computed on a
monthly basis contained in the recently released temporary
regulations strikes a reasonable balance between the need to
reduce the time lag problem and the need to provide some planning
stability to taxpayers-* We urge this Committee to adopt
the system of monthly'rates contained in the recent temporary
regulation in lieu of the statutory semiannual system. We see no
need to continue a dual system, especially since the statutory
rates can result in substantial overstatements of basis in times
of rising interest rates. More significantly, codifying the
monthly approach of the regulations as the exclusive means for
determining the applicable Federal rates would be far simpler
than the current dual system.
5. Limiting the Variation in the Applicable Federal Rate
It has been suggested that, whatever index is chosen.for
determining market interest rates, the index should not be
permitted to increase by more than a fixed number of percentage
or basis points from one period to the next. For example, it has
been suggested that the applicable Federal rates not be permitted
to increase by more than 10 basis points (0.1%) from one month to
the next. This proposal is sometimes referred to as placing a
"governor" on the applicable Federal rates.
As the charts attached to this testimony indicate, when
Federal borrowing rates increase or decrease significantly,
market interest rates in private lending transactions faithfully
- 17 reflect the increase or decrease. This applies to short-lived
peaks and valleys as well as long-term trends. To deny this
reality by placing a governor on the applicable Federal rates
would simply give taxpayers an opportunity to understate true
borrowing costs and overstate basis until the applicable Federal
rates had time to catch up with the change in the market rates.
Therefore, we believe .that placing a governor on the applicable
Federal rates is both unnecessary and unwise.
6. Alternate Methods of Proving Adequate Stated Interest
As noted above, the function of the applicable Federal rates
is to serve as an objective indicator of current market rates of
interest for short-term, mid-term and long-term lending
transactions. However, even with a shift from a semiannual to a
monthly redetermination of the applicable Federal rates, some
time lag remains in the system. In times of rapidly falling
interest rates, the market interest rate actually in effect at
the end of a given month may be significantly below the
applicable Federal rate for that month. This time lag is
inevitable in any system under which test rates are computed and
published on a periodic basis.
A related problem arises from the classification of all
lending transactions into short-term, toid-term and long-term for
purposes of determining the applicable Federal rate. If an
actual transaction has a relatively short maturity among
transactions within its class (for example, a 1-year loan, a
4_year loan or a 10-year loan), the use of an average yield for
all maturities falling within that class may unfairly prejudice
the relatively short maturities.
To take care of these and similar problems, we do not believe
it is appropriate to attempt to make specific statutory
refinements in the applicable Federal rates (such as weekly
adjustments in the rate or narrower classifications of
obligations by maturity). Such refinements would unduly
complicate the system with only a minimal gain in accuracy.
Instead, we think that taxpayers should be given certain
opportunities to demonstrate that their transaction contains
adequate stated interest other than by reference to the
applicable Federal rate.
First, we believe that taxpayers should be permitted to
compute and use indices based on the same principles as the
applicable Federal rate but with greater accuracy than the
published rates. For example, if a taxpayer selling property
with the payment of principal due in 10 years could show that 110
percent of the average yield on 10-year Treasury securities was
less than the interest rate provided in the sales transaction,
the transaction would be treated as having adequate stated
interest. Information of this type is readily available in
weekly and monthly publications of the Federal Reserve Board.
- 18 -
Second, if a taxpayer can demonstrate that third-party
financing could have been obtained by the buyer on the same terms
as provided in the seller financing, the debt will be considered
to have adequate stated interest. The taxpayer would have to
show that this financing was available to a broad segment of the
general public and that the buyer's creditworthiness would have
allowed it to qualify for this financing; a mere letter or
affidavit from a bank stating that it would have been willing to
provide the funds on the stated terms would not be sufficient if
no such loans were actually made on those terms.
Finally, sellers of fungible units of personal property on
the installment basis should be given the opportunity to
demonstrate that the financing contained adequate stated interest
by showing that substantial numbers of the same item of property
were sold for cash at the same price to other purchasers.
We believe that the regulatory authority in the current
statute is broad enough to allow us to address these situations.
However, we would welcome legislative confirmation of this
authority on these particular points.
IV
ASSUMPTIONS OF EXISTING'INDEBTEDNESS
1. Background
The last major issue that I would like to address today
concerns the treatment of assumptions of existing indebtedness on
property. The problem, simply stated, is that when property is
sold and, as part of the consideration for the sale, the buyer
assumes liability for an indebtedness with an interest rate that
is below a market rate at the time of the sale, the same
potential for overstatement of purchase price is present as in
the case where the indebtedness is seller financing.
The problem may be illustrated by the following example.
Suppose A, a commercial lender, lends $100 to B at 12%, which is
a market interest rate at the time of the loan. B uses the $100
to purchase depreciable property and secures the note with the
property. Some time later, when market interest rates have risen
to 15%, B sells the property to C. The fair market value of the
property, if unencumbered, remains at $100. However, because C
is able to assume B's favorable indebtedness to A, C is willing
to pay a total purchase price of $120, that is, C assumes B's
$100 debt to A and pays B $20 in cash.
The extra $20 that C is willing to pay B has nothing to do
with the value of the property sold; it simply reflects the fact
that B's obligation to A is less of a liability because of the
- 19 increase in interest rates. If the imputed interest rules do not
apply to this transaction, C will be able to write off the extra
$20 as depreciable basis. If the term of the debt is longer than
the ACRS life of the property, this gives a significant advantage
to C.
y ,
The seller B also .benefits from the overstated basis in the
following way. B originally owed $100 to A. When the property
securing the debt was sold, B gave up property worth $100 in
exchange for $20 in cash and C's assumption of B's debt. Thus,
B's $100 debt to A was discharged in effect at a net cost to B of
only $80. This $20 difference could be properly viewed as
ordinary income from cancellation of indebtedness. Instead,
unless the imputed interest rules apply to assumptions, C has
additional capital gain of $20.
2. Possible Approaches
Several possible approaches have been suggested for dealing
with these problems. These may be referred to as the novation
approach, the wraparound approach, and the anti-abuse approach.
a. Novation - The novation approach treats an assumption as
if the existing debt were repaid upon sale and a new debt issued
by the original lender to the buyer, Thus, in the above example,
the buyer C would have a depreciable basis of $100 and additional
interest deductions of $20 over the life of the loan and the
seller B would have ordinary income from the cancellation of
indebtedness of $20. To complete the picture, the original
lender A should be giv^n a bad debt deduction of $20 to match B's
income inclusion and Would have interest income of $20 over the
remaining life of the loan to match C's interest deductions.
b. Wraparound - The wraparound approach treats an assumption
as if the seller remained liable on the original debt and issued
new seller financing to the buyer. This approach has appeal
primarily where the seller in fact remains secondarily liable on
the assumed debt. In terms of the example, the treatment of the
buyer C would be the same but the seller B would have interest
income of $20 spread over the remaining life of the loan instead
of at the time of the sale. The original lender A would be
unaffected.
c. Anti-abuse - The anti-abuse approach focuses exclusively
on the buyer C and attempts to foreclose the conversion of
interest deductions into depreciation deductions in situations
where this conversion would present a significant tax advantage.
Under this approach, an assumed debt would be subject to the
imputed interest rules only if the property securing the debt
were depreciable in the hands of the buyer and only if the
remaining term of the debt were sufficiently long, when compared
to the ACRS life of the property, to indicate that the revenue
- 20 loss from the basis overstatement would be significant. The
seller and the original lender would be treated as under present
law.
3. Recommendation
Each of the three .possible approaches outlined above presents
certain advantages and disadvantages. The novation approach and
the wraparound approach both entail the matching of income and
deductions and hence would be quite effective in preventing
abuse. However, the novation approach is difficult to justify if
the consent of the original lender is not required for the
assumption.
The wraparound approach would seem to be correct
only where the seller remains secondarily liable on the assumed
debt and presents significant issues relating to the timing of
the seller's gain under the installment sale rules. Moreover,
adoption of either of these approaches arguably would require a
broad-based reexamination of fundamental principles relating to
cancellation of indebtedness income, market discount, and other
aspects of the taxation of financial contracts, an inquiry that
would not seem advisable at the present time.
We would suggest, therefore, that the Committee give its
primary attention to the formulation of an anti-abuse rule along
the lines described above. We would b*- happy to work with the
Committee in the design of such a rule. Of course, the rule
would apply only to assumptions of post-October 15, 1984
indebtedness. We see no reason to move this date forward since
the anti-abuse rule would apply to a more limited class of
taxpayers than those covered by P.L. 98-612.
* * *
This concludes my prepared remarks. I would be happy to
answer your questions.
Private and Government Interest Rates
Long—Term
d
v
o
u
0)
1985
Govt. Long
<• FIIA
Private and Government Interest Rates
FHA Over Government Long
o
1 # 1 -,,|,,|,|inii
1977
[ii
1979
i
II i i | i n II i
1981
in i m i n i i | m i
1983
iiii ii iM I in i
1985
Private and Government Interest Rates
Short-Term
•M
U
id
u
d
o
0)
0,
1977
Govt. 1 Yr.
Prime
Chart 4
Ratio
TREASURY NEWS
pepartment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
RESULTS OF AUCTION OF 2-YEAR NOTES
April 24, 1985
The Department of the Treasury has accepted $ 9,026 million of
$ 20,622 million of tenders received from the public for the 2-year
notes, Series U-1987, auctioned today. The notes will be issued
April 30, 1985, and mature April 30, 1987.
The interest rate on the notes will be 9-3/4%. The range of
accepted competitive bids, and the corresponding prices at the 9-3/4%
interest rate are as follows:
Yield Price
Low
9.80%
99.911
High
9.82%
99.876
Average
9.81%
99.893
Tenders at the high yield were allotted 86%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
Totals
Received
415,495
17,169,565
44,860
305,815
106,420
109,705
986,850
116,210
116,710
139,850
25,390
1,076,065
9,185
$20,622,120
$
Accepted
58,425
7,617,370
44,860
254,575
78,430
89,445
312,110
109,650
88,570
138,750
21,110
203,185
9,185
$9,025,665
$
The $9,026 million of accepted tenders includes $ 1,216 million
of noncompetitive tenders and $7,810 million of competitive tenders
from the public.
In addition to the $9,026 million of tenders accepted in the
auction process, $523 million of tenders was awarded at the average
price to Federal Reserve Banks as agents for foreign and international
monetary authorities. An additional $347 million of tenders was also
accepted at the average price from Government accounts and Federal
Reserve Banks for their own account in exchange for maturing securities.
B-108
Mr. Secretary, Distinguished Delegates, Guests and
Friends of long standing:
On behalf of the members of the Saudi delegation, I
would like to express my great pleasure to be here in
Washington, D.C. to attend this Ninth Session of the
Saudi Arabian - U.S. Joint Commission on Economic
Cooperation. I would like to extend a warm welcome to
Secretary James A. Baker III who is participating for
the first time in this forum. We look forward to working
with you, Mr. Secretary, in your capacity as Co-Chairman
of the Joint Commission.
I would also like to note that this ninth session
marks the fifth annual meeting of the Businessmen's
Dialogue — held within the framework of the Joint
Commission. We are delighted to have the participation
of the Saudi-U.S. Businessmen, and I wish to thank them for
enriching our discussions, and we look forward to their
reports and recommendations.
This meeting comes at a critical time in the history
of both the Joint Commission and Saudi Arabia. This
meeting is the first to be held after the second renewal
of the Joint Commission Agreement earlier this year. On
the one hand, the renewal of this agreement marked a
decade highlighted by fruitful cooperation — and a
strengthening of the ties of friendship between our two
..,./2
- 2 countries. On the other hand, this meeting, more than any
other, heralds a new decade of promise-filled years and
underlines our continued,and determined commitment to the
goals of the Joint Commission.
The first decade of the Joint Commission coincided
with the implementation of three ambitious five-year
economic plans in our country. These plans aimed at
transforming our country from a near-total dependence on
crude oil to a more diversified economy. These plans
focused on the development of basic infrastructure,
efficient financial and administrative institutions and
export-oriented industries — all of which lay the
foundation for a solid, production-based growth economy.
During this first ten-year period, about 30
different programs were implemented through the Joint
Commission. These programs have covered such essential
and diverse areas as technical training, agricultural
diversification, water resource development, the
development of national statistics, customs, consumer
protection, highway maintenance, financial and economic
information, solar energy and national parks. Most
recently, we have added projects in the areas of tax
assistance and training, emergency medical services,
space research of technology and meteorological systems
support. Currently, there are about 251 American personnel
engaged in various aspects of these programs.
..../3
- 3 Our investments in basic industries, infrastructure
organization and the like have just started to pay off.
Their real impact on .the growth of our economy has just
begun to unfold,and the future gains from such investments
should reflect Saudi progress in the years to come.
During fiscal year 1983/84 alone, despite a 31 percent
fall in the Kingdom's oil revenues, due to a continued
weakness in the oil market, the real non-oil gross domestic
product still grew by 5 percent. At the same time, the
private sector has been active, registering a real rate of
growth of almost 8 percent. There was also a 12 percent
rise in the growth rate of the agricultural sector
compared with 10 percent in the preceding year, while the
manufacturing sector has sustained a higher growth rate
of 16 percent. At the same time, inflation was successfully tamed to encourage real growth within an environment
of stable prices. In addition, the Saudi economy will
grow in the years to come less and less dependent on
government spending which was the driving force behind
our economy during the previous years.
As you can see then, this meeting takes place during
a historic transition in the Saudi Arabian economy. We
are emerging from a construction-based growth economy into
a more solid, production-oriented economy.
-1* -
The recent announcement of the Fourth Five-Year
Development Plan marks a new era of investment opportunity
and prosperity in the. Kingdom. This era will offer new
challenges and demands for the Joint Commission. Within
the framework of the Fourth Development Plan, the private
sector will be given the opportunity to undertake many of
the economic tasks previously undertaken by the Government.
Accordingly, this will provide a wide range of profitable
investment unavailable previously.
While many of the objectives.of the Fourth Plan are
continuations of the principles and policies of the Third
Plan and its predecessors, there are several themes which
differentiate it from previous plans. In particular, the
Kingdom of Saudi Arabia is especially concerned with the
efficiency of operations and with economic diversification.
To achieve this we are placing a definite emphasis on
promoting private sector involvement in economic development.
To this end, joint ventures will constitute a major
vehicle within the private sector for investment and
industrial diversification. As our diversification moves
forward, accelerated inputs of technology will be needed
not only in manufacturing and engineering, but also in
marketing expertise.
..../5
- 5 In order to assume this role and to make use of the
best possible management arid technology, we continue to
actively seek joint ventures with U.S. companies who are
interested in our market'and who wish to participate in
the challenges and rewards of our spectacular growth.
In particular, we look to the Joint Commission to
play a greater role in the transfer of this technology
and expertise. This will primarily take place through
the direct involvement between Saudi Government agencies
and their counterpart agencies in US Government, which
would also stimulate joint projects ,and ventures.
I sincerely hope that American business will continue
its strong participation in our private sector growth
and that American business will continue to be the most
important source of foreign joint venture partners in
Saudi Arabia.
We are happy to see the importance the U.S. Government attaches to the need for trade liberalization, for
we also believe that this will contribute to the improvement
of world trade and economic conditions. We strongly feel
that an environment should be created where products of
various countries will have reasonable access to relevant
markets.
..../6
- 6It'was with great interest, in this general spirit,
that the Government of Saudi Arabia saw that the OECD
Secretariat and the Organisation as a whole is interested
in the matter of petrochemicals and that they see the
importance of a balanced development of trade in these
products in the years to come.
I want to express, in the name of the Government of
Saudi Arabia, our sincere interest in this field and I
hope that some form of consultation with my country and
other countries of the GCC can be developed in time.
In closing, I want to re-emphasize my conviction
that the Joint Commission is playing an important role in
Saudi Arabian development. The course that we have set
for the future offers even greater opportunities for Joint
Commission involvement as we move into the years ahead.
Your thoughtful and enthusiastic discussion of the
items on our agenda and your ideas and recommendations
at this Ninth Annual Meeting thus will help improve the
quality and productivity of our Joint Commission and set
the direction of its activities in the years to come.
Thank you.
•
» »
*
*
TREASURY NEWS
department of the Treasury • Washington, D.c. • Telephone 566-2041
For Release Upon Delivery
Expected at 10:00 a.m., E.D.T.
April 25, 1985
STATEMENT OF
MIKEL M. ROLLYSON
TAX LEGISLATIVE COUNSEL
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON FINANCE OF THE
UNITED STATES SENATE
Mr. Chairman and Members of the Committee:
I am pleased to be here today to discuss the provisions of
S. 972, which contains the Administration's proposal for funding
the reauthorization of the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980 ("CERCLA"). CERCLA
established and provides funding for the Hazardous Response Trust
Fund, the "Superfund," which is recognized as the Federal
Government's primary program for addressing dangerous
environmental and health conditions created by the release of
hazardous substances into the environment.
I want to emphasize this Administration's continuing
commitment to protecting the public and the environment from the
release or improper disposal of hazardous chemical substances.
As the President stated in his recent State of the Union Address,
reauthorization of Superfund is a top Administration priority.
The Environmental Protection Agency ("EPA") has submitted a
statement that describes the level of funding required for the
Superfund and how those funds should be expended. It is our
belief that the provisions of S. 972 provide an adequate, stable,
and equitable financial base for the Superfund.
B-109
- 2 BACKGROUND
CERCLA provides the Federal Government with the authority to
clean up hazardous substances released into the environment, to
pay for restoration of natural resources caused by such
substances, and to recover the costs of such cleanup and
restoration from the parties responsible for releasing the
hazardous substances. The response program is administered by
the EPA and is financed by the $1.6 billion Superfund.
CERCLA authorizes appropriations to the Superfund equal to
$44 million per year for fiscal years 1981 to 1985. The
Superfund is principally funded, however, by excise taxes on
crude oil, petroleum products, and certain specified chemicals.
Section 4611 of the Internal Revenue Code imposes an excise tax
of .79 cent a barrel on domestic crude oil received at a United
States refinery or exported, on imported crude oil and petroleum
products entered into the United States for consumption, use, or
warehousing. Section 4661 of the Code imposes an excise tax on
42 listed chemicals sold or used by the manufacturer, producer,
or importer of the listed chemicals. These taxed chemicals are
either themselves hazardous or are the basic chemical components
of nearly all other major inorganic and organic hazardous
substances and hazardous wastes. The tax is assessed at rates
ranging from 22 cents per ton to $4.87 per ton depending upon the
chemical. The tax rates for crude oil, imported petroleum
products, and the listed chemicals reflect a Congressional
decision to allocate 65 percent of the Superfund tax burden to
petrochemicals, 20 percent to inorganic chemicals, and 15 percent
to crude oil and imported petroleum products. This allocation
was based on estimates of hazardous waste generated by these
broad industry segments at the time of enactment of CERCLA. The
rate of tax on any chemical, however, is limited to two percent
of its wholesale price as of 1980, and in many cases is much
less.
CERCLA imposes upon those who generate, transport, or dispose
of wastes, the liability for damages caused by a release or
threatened release of hazardous substances. Hazardous substances
are defined to include those hazardous substances specified under
various other environmental statutes as well as substances that
EPA determines present substantial danger to the public health or
welfare or the environment. Responsible parties may be held
strictly, jointly, and severally liable for all response costs
associated with removal and cleanup of hazardous substances
releases and damages for injury to, destruction of, or loss of
natural resources, including the reasonable costs of assessing
such injury, destruction, or loss.
Liability limits are fixed by statute. Generally, liability
is limited to response costs plus $50 million. The liability
limitations do not apply, however, if the release or threatened
- 3release is the result of willful misconduct or willful negligence
or if the responsible person does not provide assistance and
cooperation when requested by a public official. In addition,
punitive damages up to three times the response costs incurred
may be imposed if the responsible person fails without cause to
provide remedial and removal action when ordered by the
President.
CERCLA also established the Post-Closure Liability Trust
Fund. This fund is obligated to pay all costs arising out of
liability imposed by any law with respect to a hazardous waste
disposal facility after its closure, provided the facility had
received a permit under Subtitle C of the Solid Waste Disposal
Act and complied with other regulatory requirements designed to
protect against future releases of hazardous substances. Thus,
if these prerequisites are satisfied, future liabilities arising
from the closed facility are shifted from the responsible parties
to the Federal Government. The Post-Closure Liability Trust Fund
is funded with revenues collected under section 4681 of the Code,
which imposes a tax on hazardous waste received at a qualified
hazardous waste disposal facility. The tax is assessed at a flat
rate of $2.13 per dry weight ton, and is imposed upon and
collected from the owner or operator of the facility.
The authority to collect the taxes enacted by CERCLA,
including the tax supporting the Post-Closure Liability Trust
DESCRIPTION
OF THE
PROVISIONS
OF S. 972
Fund, terminates
on September
30,
1985.
S. 972 would fund a five-year, $5.3 billion Superfund by
maintaining the existing level of excise taxes on crude oil,
imported petroleum products, and currently listed feedstock
chemicals ("feedstock taxes") and by imposing a tax on the
management of hazardous waste ("waste management tax"). No
chemicals would be added to or deleted from the list of taxed
feedstock chemicals, and no change would be made to the present
rate structure. The bill would not authorize appropriations from
general revenues for the Superfund.
The parameters of the waste management tax component set
forth in the Administration proposal were based principally upon
a 1981 EPA survey of hazardous waste volumes and management
practices. Since the introduction of the proposal, industry
representatives have assisted us in revising and updating our
data base. Based upon this new information, we are recommending
that certain provisions of the waste management tax be modified.
The following is a description of the revised Administration
proposal.
- 4 The Administration proposal would impose an excise tax on the
management of hazardous waste at a waste management unit subject
to permit requirements under the Resource Conservation and
Recovery Act ("RCRA"), effective October 1, 1985. The tax would
be imposed on a wet weight basis on the receipt at a permitted
waste management unit of any waste identified or listed under
section 3001 of the Solid Waste Disposal Act as of the date of
enactment. Wastes subsequently identified or listed as hazardous
would not be subject to the tax, absent Congressional action.
The tax also would be imposed on the ocean disposal of hazardous
waste and on the transport of hazardous waste from the United
States on or after October 1, 1985. The owner or operator of the
permitted waste management unit or the exporter of the hazardous
waste would be liable for the tax.
The tax would be assessed on the receipt of hazardous waste
at a waste management unit subject to permit requirements under
Subtitle C of the Solid Waste Disposal Act. The tax rates
imposed would vary depending upon how the waste is managed.
Hazardous waste received at waste water facilities would be taxed
at a rate of 25 cents/ton over the reauthorization period;
hazardous waste received at injection well facilities would be
taxed at a rate of $5.00/ton over the reauthorization period;
hazardous waste received at landfills, surface impoundments
(other than impoundments contained in waste water or deep well
injection facilities), waste piles, or land treatment units would
be taxed at an initial rate of $35/ton, increasing to $40/ton
over the five year reauthorization period; and hazardous waste
received at all other permitted units would be taxed at an
initial rate of $6.00/ton, increasing to $7.80/ton over the
reauthorization period. The bill contains a formula for
adjusting the scheduled rates beginning October 1, 1987 if
amounts credited or appropriated to the Superfund for preceding
fiscal years fall below projected revenues for the period. The
authority to collect taxes would terminate when the sum of the
amounts credited or appropriated to the Superfund during the
reauthorization period total $5.3 billion. To ensu're against
subjecting the same volume of waste to multiple taxes, a credit
would be provided for taxes paid with respect to hazardous wastes
that are transferred from one permitted waste management unit to
another.
The tax would not be imposed with respect to hazardous wastes
that are not managed in permitted waste management units, to
certain wastes generated prior to the date of enactment that are
received at permitted waste management units from CERCLA required
removal or remedial actions or from RCRA corrective actions; or
to wastes generated by Federal facilities.
L:
ty Trust Fund would
- 5 -
be terminated as of that date. Liability for certain damages
from the release or threatened release of hazardous waste from
waste sites after their closure would therefore remain with the
responsible parties for such facilities. Taxes already collected
from owners and operators of qualified hazardous waste disposal
facilities under Code section 4681 would be transferred to the
Superfund.
In summary, under the Administration proposal the Superfund
would be funded by revenues generated by the existing excise
taxes on crude oil, imported petroleum products, and feedstock
chemicals, and by an excise tax on the management of hazardous
waste.
DISCUSSION
Maintenance of the Current Feedstock Taxes
The Administration proposal would extend through
September 30, 1990 the current excise taxes on crude oil,
imported petroleum products, and 42 listed chemicals sold or used
by the manufacturer, producer, or importer of chemicals. The
feedstock taxes enacted by CERCLA reflect the policy decision
that Federal Government action taken to clean up and contain
spills or threatened or actual releases of hazardous substances,
and the payment of damage claims when responsible parties are not
known should be funded by the producers and users of hazardous
substances rather than by the general public. The feedstock
taxes have been criticized on the grounds that the tax collected
from any individual firm is not based upon that firm's actual
experience with hazardous substances and provides at best a form
of rough justice. While these criticisms are not without merit,
the taxes were imposed in recognition of the fact that there are
present and future environmental costs associated with the use of
hazardous substances. Prior to the enactment of CERCLA, however,
these costs were not reflected in the price of the products made
from such substances. By taxing the basic building materials
used to make hazardous products and waste, these costs are borne
by those persons utilizing hazardous materials.
Moreover, the taxed chemicals or derivative products of those
chemicals appear in the response sites now being investigated by
EPA. A nexus thus exists between the manufacture or use of the
taxed chemicals and Superfund expenditures. It has been
suggested that the list of chemicals subject to tax should be
expanded to include other chemicals that have appeared in EPA
response sites. We do not favor that approach. New sources of
funds to support the Superfund should come, if possible, from
taxes on the very substances that pose a threat to human health
and the environment. We believe the waste management tax
authorized in the Administration proposal would be more efficient
than the feedstock taxes in taxing directly those persons that
create hazardous wastes.
- 6 -
Finally, the feedstock taxes provide a stable source of
revenue for the Superfund. Currently, revenues from these taxes
total approximately $300 million per year. The Internal Revenue
Service has not encountered substantial difficulties in
administering the feedstock taxes.
Waste Management Tax
The Administration proposal would impose a tax on the receipt
of hazardous waste at a unit subject to RCRA permit requirements
that treats, stores, or disposes of the waste. We estimate that
this tax would raise approximately $600 million per year.
The waste management tax would be paid by the industries that
generate the hazardous waste believed to be responsible for many
of the existing Superfund sites. Because a closer nexus exists
between the generation of hazardous waste and Superfund spending
than between the use or production of feedstock chemicals and
Superfund spending, this tax more appropriately allocates the
environmental costs associated with the use or production of
hazardous substances. Data we have received from various
industries indicates that the waste management tax would be borne
to a large extent by the same taxpayers who currently pay the
feedstock taxes. The tax would expand somewhat the number of
taxpayers who are funding the Superfund, however, as it would be
imposed on a number of taxpayers that are not subject to the
feedstock taxes.
Other legislative proposals for the reauthorization Superfund
would tax the general public by appropriating funds from general
revenues or tax corporations whose practices may have no
connection to the problems that Superfund addresses. These
broad based taxes have the support of those industries that are
subject to the feedstock taxes and those that are expected to pay
the waste management tax. We understand the interest these
industries have in urging Congress to enact a broad based tax.
We, however, support the Congressional decision made at the time
of the enactment of CERCLA to fund Superfund expenditures by
imposing the environmental costs of using hazardous substances on
the industry segment that uses or produces such substances. The
Administration proposal, therefore, relies upon the waste
management tax as the principal funding source for Superfund
while maintaining the existing feedstock taxes.
8 6 ma a e
£ 9 ^nt tax, by taxing the treatment, storage,
anH £?* J?* ?
and disposal of hazardous waste, is consistent with the EPA
walte* 2 « y v S n 9 n m ; h
^ ^ i o n of the treatment of hazardous
S
6 re ulatl
h^^Ao
I
^
2
° * °f disposal and storage of
hazardous waste, under the Solid Waste Disposal Act, reflects the
the9manaaement of^1^10" that theCS are risks associated with
managedIZT L\1he\Z0wesr J ^ r ^ t e s ^ r ' ^
?
P
S° P ° 8 e d W * Ste
, unc luwest tax rates are imposed upon waste water
- 7 treatment and deep well injection. Each of those waste
management techniques involve the use of large volumes of water;
the lower rates reflect the dilute concentrations of hazardous
waste commonly associated with those such management techniques.
Higher rates are imposed upon the management of concentrated
wastes. The highest rate is imposed on the treatment, storage,
or disposal of concentrated hazardous waste in or on the land,
i.e., in landfills, waste piles, land treatment units, and
surface impoundments (other than those contained within waste
water or deep well injection facilities).
The tax would be based upon the wet weight tonnage of a
hazardous waste received at an interim status or permitted waste
management unit and collected from the owner or operator of the
waste management unit. Measuring the tax by reference to wet
weight tonnage, as opposed to dry weight tonnage, has several
advantages. From an environmental standpoint, the wet weight
approach is more consistent with the EPA regulatory program and
the Congressional decision to encourage taxpayers to reduce the
volumes of hazardous waste. A dry weight approach also would
ignore the fact that many wastes are extremely toxic at low
concentrations. Finally, the wet weight approach will be
significantly easier to administer.
At present, there are approximately 5,000 facilities with
permitted units. Due to the relatively small number of potential
taxpayers, we believe this tax could be administered without
difficulty. The Internal Revenue Service has estimated that the
cost of implementing the tax would not exceed $100,000.
Superfund expenditures during the reauthorization period
would be committed based upon amounts projected to be credited or
appropriated to the Superfund during each fiscal year. To assure
that funds are available as needed, the bill permits EPA to
borrow from other Federal sources if revenues fall below
projected levels and sets forth a detailed formula based upon
actual receipts for adjusting the waste management tax rates
beginning in October of 1987 to make up any such shortfall.
In summary, the Administration proposal would provide
principal funding for a five-year, $5.3 billion Superfund by
imposing a tax on a wet weight basis on the management of
hazardous wastes in interim status or permitted units.
Additional funding would be obtained from the maintenance of the
existing level of excise taxes on crude oil, imported petroleum
products, and currently listed feedstock chemicals.
• * *
This concludes my prepared remarks on the provisions of
S. 972. I would be happy to respond to your questions.
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1985-04-25
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TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 25, 1985
CONTACT: Brien Benson
(202) 566-2041
CUBA EMBARGO VIOLATION GUILTY PLEA
UNITED STATES v. PETER D. YATRAKIS
PETER D. YATRAKIS pleaded guilty today in the United
States District Court for the Southern District of New York
to violating the Trading With the Enemy Act in connection
with his commercial dealings with Cuba from 1931 to 1983.
Mr. Yatrakis leased vessels to Cuban firms for the transport
of Cuban cargoes.
No date was set for the sentencing of Yatrakis, who
could receive a maximum sentence of 10 years in prison and a
$50,000 fine. Pending sentencing, Yatrakis is released on
bail.
Rudolph W. Giuliani, United States Attorney for the
Southern District of New York and John M. Walker, Jr.,
Assistant Secretary of the Treasury for Enforcement and
Operations, jointly announced this plea. Secretary Walker
stated that this case represented part of his department's
policy to strictly enforce United States embargo regulations
against Cuba and the other embargoed countries (North Korea,
Vietnam, and Kampuchea).
Civil litigation concerning the sinking of the vessel
RAGNAR, owned by Yatrakis, while en route with Cuban cement
bound for Libya helped precipitate this investigation.
According to Steven M. Kaplan, the Assistant United
States Attorney in charge of this case, Yatrakis was the
ownpr of a number of firms operating out of lower Mannattan
and engaged in the international maritime freight shipping
business. During a period running from April of 1981
through February 1983, Yatrakis time chartered (leased for a
period of time) a number of ships owned or operated by those
B-110
-2firms to companies controlled by the Cuban government for
the express purpose of transporting Cuban cargo—usually
construction material—from Cuba. These goods were shipped
by Yatrakis' vessels to a number of destinations including
Libya and Grenada. Since July 8, 1963 to the present time,
the United States embargo on trade with Cuba has barred
persons subject to U.S. jurisdiction from transporting goods
to or from Cuba or engaging in any other unauthorized
dealings in Cuban property.
Both Mr. Giuliani and Secretary Walker commended the
work of the United States Customs Service and the Office of
Foreign Assets Control on this case. They further noted
that this investigation is continuing, and that additional
indictments are expected.
Yatrakis, 44 years old, resides in Brooklyn, New York.
@FedFRASER