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PRESS RELEASES

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TREASURY NEWS

department of the Treasury • Washington, D.C. • Telephone 566-2041

TEXT AS PREPARED

Remarks by
The Secretary of the Treasury
James A. Baker, ZZZ
at the 1988 Annual Meetings of the
African Development Bank and Fund
Abidjan, Cote D'Zvoire
June 1, 1988
Mr. Chairman, Distinguished Governors, President N'Diaye,
ladies and gentlemen:
It is a pleasure for me to address the participants in the
Twenty-Fourth Annual Meeting of the African Development Bank and
the Fifteenth Annual Meeting of the African Development Fund.
Since becoming a member in 1983,'the United States has strongly
supported the work of the Bank and it is a special privilege for
me to be the first U.S. Governor to attend an annual meeting.
This is a continent of dynamic peoples and unbridled promise, and
Z am particularly honored to meet with you here in the. host
country of the African Development Bank.
The generous hospitality that President Houphouet-Boigny and
the people of Cote D'Zvoire have extended to us is deeply
appreciated by my delegation.
Z would also like to congratulate President N'Diaye, who will
soon complete his third year as President of the premier
development finance institution of Africa. His dynamic
leadership and vision of a prosperous and vibrant Africa give us
confidence that Africa's future is bright.
We are all here today because of our strong interest and
determination to help the people of Africa build more prosperous
and more productive lives for themselves and their families.
This common goal is the theme of my remarks today and the theme
B-1438
of U.S. efforts in Africa and in the African Development Bank.

-2Problems Facing the Region in the 1980's
Mr. Chairman, the 1980rs witnessed the emergence of urgent
efforts by many African governments to return to a path of
economic growth. Their determination to resume growth has been
assisted by an intensive international effort based on a
recognition that the region's economies were clearly
deteriorating.
These pressures included a precipitous drop in the export
price of primary commodities, the resulting increased levels of
debt to GNP and export ratios, the legacy of unproductive
policies of the statist economic model, and crushing famine which
swept through large areas of the region.
Slow or negative economic growth, coupled with rapidly
growing populations, balance of payments and fiscal problems were
all signs of fundamental economic crisis. The adverse external
influences, weather and climatic patterns and unsustainable
economic policies all combined.to demonstrate the fragility of
African economies.
African governments had believed, by and large, that the
state was the mechanism through which economic development could
be achieved. Zn most countries, the role of the government
became pervasive. Industry and initiative were stifled.
Governments became the main source of employment for the
educated; they controlled agricultural production and marketing;
they controlled international trade; they entered into production
on their own; they protected inefficient industry, controlled
prices and mandated income levels through various price mechanisms; and they imposed taxes on producers and on exporters
while urban consumers and importers were subsidized.
Resources were no longer invested where they were most
productive. Savings declined, exports were discouraged and
imports encouraged. Economic growth and development stopped.
Response of African Governments and the International Community
Zn response to this deepening economic crisis, African
governments and the international community joined together to
begin putting in place policies and institutional arrangements
which could restore growth and development.
Zn tracing the emergence of this response, it is appropriate
that Z mention first that during this decade of the 1980's, the
African Development Bank was opened to non-regional membership.
The resources of the African Development Fund were also
strengthened. The World Bank and the IMF engaged African
governments in intensive dialogue on their economic policies.
This formed the basis of an international understanding that
economic
those
increased
countries
reform.
external
willing
assistance
to carry
would
outbefundamental
made available
programs
to support
of

-3An emergency Special Facility for Africa was organized under
the World Bank to provide additional financing for economic
reforms. As the linkages between the structural and
macroeconomic requirements of economic management became
more clearly defined, the World Bank and the IMF enhanced their
cooperation by instituting their joint program of Policy
Framework papers. Under this approach, African and other
low-income countries design comprehensive economic programs that
can attract external financing. These papers have become an
invaluable tool for coordinating external bilateral and
multilateral assistance.
As part of this process, the ZMF put in place its Structural
Adjustment Facility to support reforms, and subsequently expanded
that facility substantially with the financial support of many
ZMF member governments. Fifty percent of ZDA-8's. resources are
available to support African projects and policy reform efforts,
and a large part of that assistance will flow in conjunction with
ZMF Structural Adjustment Facility financing in the context of
the Policy Framework process. Adding further momentum, bilateral
aid agencies recently pledged over $6 billion in co-financing for
World Bank coordinated adjustment programs in the most severely
"debt-distressed" countries of the region.
For Africa, the problems of indebtedness often have been
pronounced and in some cases they remain very serious. Through
Paris Club reschedulings, the United States and other official
creditors are providing significant debt relief in support of
economic programs. The Paris Club has also begun to extend grace
and repayment terms for low-income, heavily-indebted countries in
a further effort to be responsive to Africa's economic problems.
Zn this context, while we recognize that the rescheduling of
interest payments provides temporary liquidity relief, the
build-up of rescheduled debt often presents a difficult problem
for the poorest countries. This is one of the most difficult
issues which the Paris Club has wrestled with, given the
different financial and legal requirements within which each of
the creditor governments must operate. Zn our case, for example,
United States laws, policy, and budgetary realities constrain us.
However, to help address this problem, I would like to
announce today the willingness of the United States to expand the
range of options within the Paris Club so that creditor
governments which are in a position to do so can — on a
case-by-case basis — provide concessional interest rate
reschedulings for the poorest countries. Other countries might
make a contribution toward relief by considering a broader range
of maturities for rescheduled debt than is currently the case.
Together,
believe
changes can produce substantial new
relief forwe
the
poorestthese
countries.

-4Z should emphasize that permitting such differentiation,
which is a departure from strict pari passu privileges,
represents a significant addition to the options available to the
Paris Club to address dire debt situations in the poorest
countries. Zt is consistent with our case-by-case approach to
addressing debt problems in developing countries and thus is not
a generalized approach. Zt is a special technique available to
assist only the poorest of the poor in a further effort to
support their return to stability and growth.
Commitment to Reform Process and Economic Progress
Zn my contacts with Africa's economic and political leaders,
Z am encouraged by the depth of their commitment to economic
reform not only for the present but for the long term, extending
into the 1990s and beyond.
Z know that pursuit of such reforms requires a large measure
of political courage. The commitment to reform is sustained by a
realization that failure to adapt an economy — failure to reform
— is to consign people to conditions of famine, debt,
stagnation, and political unrest. The truth is that the cost of
not adjusting far outweighs the cost of adjusting.
Although many serious problems remain for Africa, we are
beginning to see positive results from the combination of
financing and adjustment. Zt is clear that many African
governments are slowly but surely beginning the process of
reversing years of depressed economic growth, declining per
capita income, weak export sales, and difficulties in managing
their debt servicing. Zn countries with sustained economic
reform programs, growth more than doubled to some 4 percent a
year during 1986-87. Sadly, countries not pursuing economic
reforms saw their growth rates cut in half — to less than
1 percent per year. During 1984-86, per capita food production
rose 4.2 percent in countries pursuing economic reforms; for
those not pursuing reforms the growth rate was only 2.4 percent.
Needs for Future Development
Zn addressing Africa's needs, we are reaching broad agreement
that macro-economic and structural reforms provide a necessary
basis for more efficient use of resources. They establish a
climate within which more fundamental economic problems can be
addressed. However, for sustained growth and development, more
is needed on many fronts.
Zf agricultural production is to keep up with, let alone
exceed, population growth, new technologies must be found.
Scientists must be trained, research capabilities strengthened,
seed varieties developed, and land management techniques improved
dramatically. Health and basic education needs to be given a
higher degree of priority and support.

-5Domestic and regional financial systems must be nurtured,
strengthened and allowed to feed the African entrepreneurial
spirit. Markets for exchange of goods must be allowed to develop
and function free of excessive regulation and price controls.
Regulatory and economic environments must be made hospitable to
foreign investment which carries with it technological and
managerial skill. There is an urgent need for the private sector
to be allowed to function and grow.
And, as in every other region of the world, proper management
of Africa's natural resources requires increased attention. Much
of Africa is in an environmental crisis.
We must act on the fact that environmental conservation is
not only a social issue but an economic necessity. The concepts
of environmental conservation, economic growth and development
must be treated as an integrated whole if we are to fulfill our
vision for the future prosperity of Africa and the other regions
of the world.
'The Global Economic Environment
These multiple objectives represent an ambitious undertaking
for Africa and its leaders. Of course, we all recognize that the
health of the global economy plays a large role in determining
the future vitality and direction of African economic growth.
Mr. Chairman, Z believe it is important to note that in the
past year there have been a number of positive developments in
the industrial world that should help provide for a more
supportive global economic environment and continued market
growth for exports from the African countries. Real GNP in the
industrial countries grew 3 percent last year, the fifth year of
expansion; and another year of 3 percent growth is projected for
1988. External imbalances of the largest industrial countries
are being reduced and inflation remains low.
Zn the United States, we are working hard to resist
protectionist pressures and, in this regard, we consider that
progress in the Uruguay Round is an absolute necessity, if we
are to maintain an open global trading system that can benefit
developed and developing countries alike.
Zn reviewing industrial country efforts to assist Africa I
would like to mention that the United States continues to provide
significant levels of financial assistance for policy reform and
development programs in Africa despite our need to continue
reducing our own fiscal deficit.
We are providing almost $1 billion in bilateral economic
assistance and food aid to Sub-Saharan Africa in the current
fiscal year. In the multilateral area, we have pledged
$2.9-billion to IDA-8, $720 million to the fourth general capital
increase to the African Development Bank, and $315 million to the
fifth replenishment of the African Development Fund.

-6Role of the African Development Bank
Among the institutions and programs which »ddrt" ^J. M_
developmental and economic problems facing Africa, the African
Development Bank group plays a prominent role.
Since joining the Bank, the United States has *°rked to be •
constructive partner and to encourage the adoption of policies
and practices which we believe can improve the efficiency ana
effectiveness of the Bank Group.
On occasion, we have been highly critical of specific loans
and policies proposed by the Bank. Clearly, our criticism does
not reflect an absence of support for the Bank or its mission,
but rather our commitment to the Bank as a more effective channel
of assistance to encourage Africa's development efforts.
Zn this context, Z would like to review a number of issues
which we believe will be central to the Bank's ability to affect
the well-being of Africa.
Policy Based Lending
The first is policy-based lending. Sectoral and structural
adjustment loans must promote and support the adoption of sound
policies in borrowing countries. We believe this is an important
tool for the Bank in reinforcing its commitment to economic
reform in Africa.
We believe, however, since this is a relatively new activity
for the Bank, that it must proceed cautiously. The volume of
such lending cannot expand quickly, and the Bank must ensure that
its adjustment lending is coordinated with others, including
where appropriate, the World Bank Group, the ZMF and bilateral
agencies, international financial institutions must be partners
who can share their experience with each other. They must
not be competitors in the development process.
Loan Quality
The United States believes that further progress needs to be
made in improving the quality of overall lending. Zn our
opinion, the Board has been asked to fund too many projects that
will not contribute to economic growth.
We encourage management to work to ensure that projects are
priority investments and have the necessary conditions to ensure
their success. We ask that management put in place a stronger
system to ensure that loans that come to the Board are
developmentally and economically sound.

-7Private Sector
We believe the Bank must play a much stronger role in
development of the private sector within Africa. Unfortunately,
too often we find that projects are proposed for public sector
activities which have dismal records of performance.
Accordingly, we strongly welcome the establishment of the
President's Roundtable of African Businessmen to assist the Bank
in identifying ways in which it can play a much stronger role in
assisting the private sector.
Financial Management
The Bank has taken a number of steps to correct potential
financial problems, but we are concerned that it is not moving
quickly enough in this area. Management has presented proposals
to the Board which will alleviate interest and exchange rate
risks associated with Bank lending. We hope they can be
implemented quickly.
We also believe the rising levels of administrative expenses
and arrears can damage the Bank's financial standing. We
encourage members to support the Bank by providing their capital
subscriptions on time and we also encourage the Bank to institute
firm measures aimed at reducing the level of loan arrears and the
growth in administrative expenses.
Environment
>

The Bank has made progress in preserving Africa's environment
and we believe the Bank has a major role to play in this area.
We recognize that the Bank roust continue to operate within budget
constraints and therefore my own government is making available
an environmental specialist to the Bank. Over time, we hope the
Bank will be in a position to develop its own permanent cadre of
environmental experts.
Z also urge the Bank to proceed with the proposed joint
Bank-NGO outreach project which will provide positive support to
our environmental goals.
Conclusion
Together we have undertaken an ambitious set of challenges
for the African Development Bank, for African governments seeking
to achieve sustained economic growth and for the international
donor community at large. To date, the performance of each
offers the basis for optimism.
The Bank's challenge is to play an increasingly strong role
in helping African countries develop and reform their economies
in order to achieve economic growth. We believe
the coming years will be a crucial test — and we believe the
Bank ca'n fulfill its mandate with distinction.

-8Many African governments have accepted the challenge to
implement comprehensive reform programs, often with very
satisfying results. Some governments are just beginning the
process of economic adjustment and reform. And a number of
governments have yet to begin the process. To them — the
governments still at the door — we extend a special message of
encouragement, and we stress what Z am sure is our collective
willingness to work actively with you to support efforts toward
adjustment and sustainable growth.
And finally, my government, along with the international
donor community at large, has accepted the challenge to work with
Africa to help you achieve your economic goals. These goals are
ambitious — to end hunger, restore sustainable economic growth
and provide a positive standard of living for all Africans for
the coming decades and well into the future.
Z thank you for the honor of being able to join you here
today as part of this great African endeavor. Zn concluding, Z
want to assure you that you have the continuing warm regard and
Thankofyou.
support
my country as you wbrk to ensure the future success of
Africa and its proud people.

rREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone
FOR IMMEDIATE RELEASE June 1, 1988
RESULTS OF TREASURY'S AUCTION
OF 9-DAY CASH MANAGEMENT BILLS
Tenders for $4,005 million of 9-day Treasury bills to
be issued on June 7, 1988, and to mature June 16, 1988, were
accepted at the Federal Reserve Banks today. The details are
as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Rate
Low
High
Average

Investment Rate
(Equivalent Coupon*-Issue Yield)
7.03%
7.07%
7.03%

6.92%
6.9 6%
6.94%

Price
99.827
99.826
99.827

Tenders at the high discount rate were allotted

53%.

TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS
(In Thousands)

Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Franoisco
TOTALS

B-1439

Accepted

Received

Location
$

$

27,500,000
—
--mt « •

1,650,000
—
—
—
--

3,422,,100
-----

179,,500
-----

1,310,000

403,,000

$30,460,000

$4,004,,6.00

TREASURY NEWS
Department of the Treasury • Washington, DC. • Telephone 566-2041
June 2, 1988

FOR IMMEDIATE RELEASE
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION

Tenders for $8,776 million of 52-week bills to be issued
June 9, 1988,
and to mature
June 8, 1989,
were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BlDSt
Discount
Investment Rate
Rate
(Equivalent Coupon-Issue Yield)

Low
7.08%*
High
7.09%
Average 7.08%
* Excepting 1 tender of $1,375,000.
Tenders at the high discount rate

Location

92.841
92.831
92.841

7.59%
7.60%
7.59%
were allotted 11%.

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
Received

Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Ty££
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

3-1440

Price

$ 19,100
23,794,355
13,670
24,920
20,625
13,055
1,599,785
17,010
11,330
30,675
18,245
1,344,755
156.415
$27,063,940

$
19,100
7,979,955
13,670
24.920
16,735
13,055
198,940
13,120
11,330
30,675
8,795
289,555
156.415
$8,776,265

$23,323,125
513,915
«3,8*7:640
3,200,000

$5,035,450
513.915

26,900
$27,063,940

3,200,000
26.900
$8,776,265

TREASURY NEWS
opartment of the Treasury • Washington, D.c. • Telephone 566-2041
For Immediate Release:
June 3, 19&8

Contact:

Charley Powers
566-8773

TREASURY DEPARTMENT ASSESSES PENALTY AGAINST
SAN ANTONIO SAVINGS ASSOCIATION
The Department of the Treasury announced today that San Antonio
Savings Association (SASA) has agreed to a settlement that
requires it to pay a civil penalty of $60,000. The settlement is
based on its failure to report 12 currency transactions as
required by the Bank Secrecy Act.
Gerald L. Hilsher, Deputy Assistant Secretary (Law Enforcement),
and Helen Milburn Eversberg, United States Attorney for the
Western District of Texas, announced the penalty, which
represented a complete settlement of the civil liability of the
bank for the period between January 1, 19 82 and December 31,
1986.
This case originated through an investigation by the Internal
Revenue Service, Criminal Investigation Division and the United
States Attorney's office for the Western District of Texas. The
IRS said that there was no evidence of criminal activity by SASA
related to these violations. SASA cooperated fully during the
investigation and has made changes to ensure future compliance
with the Bank Secrecy Act.
The Bank Secrecy Act requires banks and other designated financial
institutions to keep certain records, to file Currency Transaction
Reports with Treasury on all cash transactions by or through the
financial institution in excess of $10,000, and, under some
circumstances, to file reports on the international transportation
of currency or other monetary instruments in bearer form or the
equivalent. The purpose of the reports and records required
under the Bank Secrecy Act is to assist the Government's efforts
in criminal, tax and regulatory investigations and proceedings.

B-1441

TREASURY NEWS

lopartmont of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
EMBARGOED FOR RELEASE UNTIL DELIVERY
EXPECTED AT 1:15 P.M. CDT

Remarks by
Secretary of the Treasury
James A. Baker, III
To the 1988 International Monetary Conference
Chicago, Illinois
Monday, June 6, 1988
Economic Policy Coordination and
International Monetary Reform
I am delighted to have this chance to speak once again
to this distinguished group of financial leaders. And I
particularly welcome the opportunity to hear some of your
thoughts on the eve of the Toronto Economic Summit. In order
that we can get in as much discussion as possible in the
question-and-answer session, I promise to make my remarks
reasonably brief.
The Development of Economic Policy Coordination
This year's Economic Summit begins in less than two weeks.
As I am sure you know, there are really two economic summits,
and both occur simultaneously.
The first Summit will take place in the meeting rooms where
the heads of state and their finance ministers confer. Another
may play out on the television screen, where reporters and
commentators speculate on all the possibilities for conflict
among the major actors.
I can't tell you what you can expect in this second,
hypothetical summit. But I can offer you some insight as to
what you can expect in the real Summit.
Much of the real Summit will focus on the economic
coordination process that was initiated in 1985 to give our
international economic system some sense of direction and
discipline.

B-1442

-2In 1986, I spoke briefly on the subject of coordination when
this conference was held in Boston. At that time, the process or
coordination was relatively new. In the intervening t w o v e a 5 s '
we have gained some experience with the process. I would H K e
to discuss with you what has taken place over the last few years
since the inception of the process; remark briefly on how tne
process is doing; and tell you why I believe the coordination
process (and not some more sweeping change) provides the best
way to achieve reform of the international monetary system.
Ever since cracks began to appear in the post-war monetary
system developed in the 1940s, there have been intensive efforts
to create a new international monetary order. These efforts
subsided for a while with the development of the flexible or
floating exchange rate system. But as weaknesses in the flexible
rate system permitted the growth of large, unsustainable
imbalances, interest in some sort of international monetary
reform began to grow once again.
Our response to these developments was to strengthen
international economic policy coordination among the industrial
countries. The need for coordination developed from two major
considerations. First, today's economies are far more
interdependent than they were just a decade ago, creating a
greater need for coordinating domestic economic policies.
Second, while the flexible rate system clearly needed more
discipline and structure, the system of fixed rates was clearly
too rigid to adequately reflect changes going on in the
international economy. Coordination represented a practical
compromise between the shortcomings of flexible rates and the
rigidity of fixed rates.
Building the Process
The 1985 Plaza Agreement represented the first major step in
the coordination effort. It involved an agreement by the G-5 on
the direction national economic policies and exchange rates
should take to facilitate growth and external adjustment. More
fundamentally, it represented a new commitment by the major
industrial countries to work together more intensely to achieve
global economic prosperity, and thereby enable each country to
better achieve its own domestic objectives.
The success of the Plaza Agreement created momentum that
led to further progress. At the Tokyo Summit, we developed a
framework for multilateral surveillance of our economies using
economic indicators. The IMF Managing Director was invited to
participate in these meetings, thus assuring that a truly global
perspective was taken. Further, a new group was formed, the G-7,
in order to bring to bear the political leadership of the Heads
of State or Government on the coordination effort. This
commitment at the highest political levels has been crucial to
progress to date, and it will be essential for maintaining
momentum in the period ahead.

-3At the Venice Summit last year, the coordination process was
strengthened further by the adoption of arrangements involving
the development of medium-term objectives and performance
indicators to assess policies and performance.
Thus the major industrial countries have now developed a
political mechanism to enhance their ability to coordinate
economic policies. And although the process is still very young,
there is already ample evidence that it is bearing fruit. Both
fiscal and monetary policies are being framed in an international
as well as a domestic context. As a consequence, the United
States has taken measures to reduce the budget deficit, increase
domestic savings and improve competitiveness. The major surplus
countries, Japan and Germany, have taken steps to improve
domestic demand and reduce reliance on export-led growth. There
have been coordinated interest rate actions. Cooperation in
exchange markets has been intensified based on specific
understandings.
As a result, the world economy is on a much more solid
footing. Growth continues, but is now more balanced and is
supportive of the adjustment process. Inflation remains low,
and external imbalances are being reduced. The U.S. trade
figures for March provide evidence that these imbalances are
now declining in nominal as well as real terms.
The coordination process was seriously tested last fall in
the wake of the October stock market crash. It would have been
easy for each of us to turn inward and focus on short-term
measures to address immediate domestic needs. Instead, the G-7
pulled together and intensified its efforts to find a compatible
and reinforcing set of policies to achieve common goals. These
efforts (which were conducted privately between Ministers and
Governors over a period of weeks) were reflected in the December
statement of the G-7, thereby demonstrating the resilience of the
coordination process in the face of adversity. Since that time,
strengthened underlying policy actions have been reflected in
enhanced stability of exchange markets.
Strengthening Coordination and Reforming the System
As this process of coordination among the major industrial
nations has been developing, questions continue to be raised
about the need for "more fundamental monetary reform." This
is natural. We certainly do not have a perfect monetary system,
nor total coordination of our policies. We cannot afford to rest
on our laurels. We need further strengthening and reform of the
system.
What form and direction should this take? It is tempting
to consider sweeping, revolutionary changes in the system —
particularly the exchange rate part of the system. But it is
far from clear that such changes are desirable or practical.

-4While it may be difficult to recognize reform when it
emerges gradually in a step-by-step fashion, I think that
further strengthening of our process of coordination is the
best means of achieving further reform of the monetary system.
What are the characteristics of this step-by-step or
incremental approach to monetary reform which make it the best
option available?
o First, it combines flexibility with greater commitment
and obligation. Countries have committed to this process
at the highest political level, and they have obligations
to develop medium-term economic objectives, along with
performance indicators to assess progress toward the
objectives. At the same time, it involves no ceding of
sovereignty.
o Second, it recognizes that reform of the system is not
simply a matter of exchange rates or reserve assets.
Exchange rates certainly are a key variable. Ultimately,
however, the test <of an international monetary system is
whether it can help foster an open and growing world
economy. This involves appropriate fiscal, monetary and
structural policies as well as exchange rates. The
indicator system we have developed covers this full range
the system can encourage corrective policy action
of policies.
o Third,
through the use of indicators and peer pressure without
relying on automatic trigger devices.
Fourth, the burden of adjustment is not biased toward or
away from domestic policies or exchange rates, as was the
case in the par value and early flexible rate regimes,
respectively. In 1985 and 1986, coordination stressed the
role of exchange rates. In 1987 and so far in 1988, the
emphasis has shifted to changes in underlying policies.
It is no mean feat that this shift was conducted without
a major breakdown in the system.
Fifth, the coordination and indicator process contains
symmetry by focusing on surplus as well as deficit
countries. Symmetry is a long sought after — and
necessary — element in international monetary
arrangements. Efforts to build it into the system through
various automatic techniques have failed in the past, and
would likely fail again. In contrast, the indicator
system now in place provides a structured but judgmental
framework for assessing the need for actions by deficit
and surplus countries alike.

-5o

Sixth, the final attribute that I would cite is
credibility. In today's era of global economic
integration and instant communications, credibility is
key. An attempt to make an abrupt or major change in
the structure of the system by imposing a detailed set of
formal constraints might well be viewed by the markets as
overly ambitious and unsustainable, and such an approach
might not give adequate regard to political realities or
the force of financial flows.
The global economy is too dynamic, and the forces of change
too strong, to be able to look ahead with great certainty and
envision a highly defined international monetary structure that
will fit the world economy of 1995 as well as that of 2005.
We must therefore move cautiously but steadily ahead, always
alert to further improvements in the process and the system. In
this connection, the major industrial countries agreed in April
to develop a commodity price indicator. This indicator will
supplement the existing national indicators in assessing and
reaching judgments about economic policies and performance. It
will be used as an analytical tool in examining global price
trends, not as an automatic trigger for policy action or an
anchor for currencies.
We will need to continue to consider other measures, such as
broadening the coordination process to cover structural reforms
in such areas as tax reform, financial market liberalization, and
deregulation of labor markets; and the use of "monitoring zones"
for key indicators such as growth and trade balances to help in
assessing an economy's performance.
Conclusion
So to conclude, I would submit that our process of
international economic policy coordination has reformed and
strengthened the international monetary system. We have created
a political mechanism that has brought discipline and structure
to international economic policy-making. And our approach has
worked — not perfectly of course. But I strongly suspect the
world economy is better off today than we would have been had we
not followed this course. And I think additional progress will
be achieved in the future.
Many of those who earlier had doubted this process have seen
its benefits. As a result, coordination now has broader support
and momentum that should carry it into the future, well beyond
the terms of current administrations in the G-7 countries. We
have come a long way in a few short years, and policy
coordination
should provide a sound framework for achieving
Thank you.
meaningful and effective reform during the years ahead.

TREASURY NEWS

Department
of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
CONTACT:

June 6, 1988

Office of Financing
202/376-4350

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,436 million of 13-week bills and for $6,411 million
of 26-week bills, both to be issued on
June 9, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing September 8, 1988
Discount Investment
Price
Rate
Rate 1/

26-week bills
maturing December 8, 1988
Discount Investment
Price
Rate
Rate 1/

6.42%
6.45%
6.44%

6.67%
6.72%
6.72%

6.62%
6.65%
6.64%

98.377
98.370
98.372

7.00%
7.05%
7.05%

96.628
96.603
96.603

Tenders at the high discount rate for the 13-week bills were allotted 31%
Tenders at the high discount rate for the 26-week bills were allotted 81%

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)
Received
Accepted
:
Received

Accepted

$
39,740
22,337,900
29,755
35,310
43,685
31,145
1,506,045
22,415
12,520
26,875
36,755
1,632,775
348,145

39,740
$
5 ,541,150
29,755
35,010
43,685
30,745
97,545
18,415
7,520
26,875
26,755
191,025
348,145

$
29,950
20,726,730
16,725
29,860
30,255
:
27,840
1,568,395
29,870
14,235
46,665
31,625
1,212,645
335,950

29,950
$
5 ,249,840
16,725
29,860
30,255
27,840
338,445
27,680
13,285
46,665
25,675
239,255
335,950

$26,103,065

$6 ,436,365

: $24,100,745

$6 .411,425

$22,564,885
961,950
$23,526,835

$2 ,898,185
961,950
$3 .860,135

: $19,654,880
:
857,165
: $20,512,045

$1 ,965.560
857,165
$2 ,822,725

2,508,030

2 ,508,030

:

2,150,000

2 ,150,000

68,200

68,200

:

1,438,700

1 ,438,700

$26,103,065

$6 ,436,365

: $24,100,745

$6 ,411,425

Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

1/ Equivalent coupon-issue yield.

B-1443

TREASURY NEWS

lepartment of the Treasury • Washington, D.c. • Telephone 566
FOR RELEASE AT 4:00 P.M.
CONTACT: Office of Financing
June 7, 1988
202/376-4350
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling approximately $12,800 million, to be issued June 16, 1988. This offering
will result in a paydown for the Treasury of about $4,625 million,
as the maturing bills total $ 17,413 million (including the 9-day
cash management bills issued June 7, 1988, in the amount of $4,005
million). Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington, D. C.
20239-1500, prior to 1:00 p.m., Eastern Daylight Saving time,
Monday, June 13, 1988. The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated March 17,
1988, and to mature September 15, 1988 (CUSIP No. 912794 QM 9),
currently outstanding in the amount of $6,884 million, the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,400 million, to be
dated June 16, 1988, and to mature December 15, 1988 (CUSIP No.
912794 QX 5).
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 June 16, 1988. 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 $1,759 million as agents for foreign and international monetary authorities, and $4,290 million for their own
account. These amounts represent the combined holdings of such
accounts for the three issues of maturing bills. Tenders for bills
B-1444
to be
maintained
on(for
the26-week
book-entry
records
of the
Department
of the
or
Treasury
Form
PD
should
5176-2
be
submitted
onseries).
Form
PD 5176-1
(for
13-week series)

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 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
10/87
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
the Public Debt.

TREASURY NEWS

lepartment of the Treasury • Washington, D.c. • Telephone 566-2041
For Release on Delivery
June 9, 1988

STATEMENT OF THE HONORABLE GERALD L. HILSHER
DEPUTY ASSISTANT SECRETARY (LAW ENFORCEMENT)
U.S. DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
UNITED STATES HOUSE OF REPRESENTATIVES
June 8, 1988

Mr. Chairman and Members of the Committee:
I am pleased to have the opportunity to testify before the
Committee today about the Committee's draft bill which would
revise the Bank Secrecy Act and the Right to Financial Privacy
Act. We understand that this bill will be put forward by the
Committee for inclusion in the House Omnibus Drug legislation.
While the Department of the Treasury is generally in agreement
with the Committee's bill, we have some comments that we hope you
will consider carefully. We also would like to discuss the
legislative proposals with respect to the Bank Secrecy Act and
related statutes that have been developed by Treasury under the
auspices of the National Drug Policy Board. These proposals will
be forwarded to Congress very shortly. Finally, I would like to
update the Committee on Treasury's activities in the area of
financial and Bank Secrecy Act enforcement since our testimony
last May.
Before I begin, I want to commend you, Mr. Chairman, and the
Committee for your continued interest in effective administration
and enforcement of the Bank Secrecy Act. Over the years, you and
the Committee have played a vital role in making the financial
community aware of its responsibilities for full compliance with
the Bank Secrecy Act and of the consequences of violating its
requirements. You also have been most responsive when Treasury
has sought to enact new legislation to enhance its authority for
ensuring compliance with the Bank Secrecy Act and to prevent
money laundering activities.
B-1445

-2The Committee's bill sets forth two new Bank Secrecy Act
provisions, 31 U.S.C. 5325 and 5326. First, I would like to
discuss proposed section 5325, which is aimed at one method or
money laundering, specifically "smurfing," through the cash
purchase of monetary instruments — cashiers' checks, bank
checks, travelers' checks and money orders. This provision was
drafted by Congressman Torres.
The intent of proposed Section 5325 is to require identification
from money launderers who are not account holders at the financial institutions where they purchase monetary instruments with
cash. Under the Bank Secrecy Act, the only identification
records currently required for individuals who do not engage in
currency transactions in excess of $10,000 are those that pertain
to new accounts. Thus, under the Act, a customer who does not
have an account relationship with a financial institution can
engage in currency transactions under the $10,000 reporting
threshold without being detected by the Government and, often, by
the financial institution.
Proposed section 5325 would require financial institutions to
obtain identification and maintain a record of cash purchases of
these monetary instruments by nonaccount holders. To comply with
this requirement, Treasury envisions that financial institutions
would need merely to maintain a chronological log of the cash
purchases of these instruments. This log would be reported to
Treasury upon request.
Treasury believes that the requirements of proposed Section 5 325
will be a useful deterrent to the practice of smurfing through
the purchase of monetary instruments and will not be overly
burdensome for financial institutions. In fact, Treasury has
recommended that a proposal similar to Congressman Torres'
proposal be included in the Administration's recommended legislative proposals being developed in the National Drug Policy
Board.
Treasury does, however, have some recommendations that we believe
would improve section 5325. First, we recommend that Treasury's
authority to require the financial institution to provide
Treasury with a report of the identification information it has
obtained be made explicit in the statute. Second, we urge the
Committee to delete any reference to a specific dollar amount at
which the identification information would be required from the
statute. Rather, we would prefer for the Secretary of the
Treasury to be given the authority to determine an appropriate
amount by regulation. In this way, Treasury will be able to
respond more easily to changing law enforcement needs.

-3Under the second proposed provision, section 5326, the Secretary
of the Treasury would be able to issue an order to target financial institutions in certain geographic locations for special
reporting of currency or monetary instrument transactions in an
amount less than $10,000 for a limited period of time. The
location would be selected based upon a determination by the
Secretary that there may exist a high level of drug money laundering activity in that area. A request from a Treasury law
enforcement "currency group" or joint financial investigative
task force would trigger such a determination.
Under this proposal, Treasury would be able to require all
financial institutions to file currency reports at an amount
lower than the normal $10,000 reporting threshold under the Bank
Secrecy Act. The purchasers of these instruments would have to
provide the identification required under the Bank Secrecy Act.
Treasury envisions that the form to be used for making these
reports would be the Currency Transaction Report ("CTR") which is
filed on Form 4789, and that no new form would be developed. The
report then would be separated from the usual CTRs and analyzed
by a team of Treasury investigators or analysts working in the
currency group or in a joint financial task force in the targeted
location.
Because time would be of the essence in maximizing the utility of
the information obtained pursuant to a targeting order, Treasury
is pleased to see that the bill exempts any order issued pursuant
to proposed section 5326 from the normal delayed effective date
provisions required for regulations under the Administrative
Procedure Act ("APA").
The implementation of a request to target a limited geographic
area does present some practical problems for Treasury as well as
the affected financial institutions. First, Treasury would have
the responsibility for quickly identifying all the financial
institutions to be targeted in the specific geographical area.
While it would not be difficult for Treasury to identify the
affected banks, it would be difficult for Treasury to identify
certain categories of nonbank financial institutions, e.g.
currency exchanges and check cashers. Second, Treasury would
have to transmit notice of the order by letter to all the affected institutions. Finally, the targeted institutions would have
to educate their tellers and other employees very quickly, as to
the new reporting requirements and any additional recordkeeping
procedures.
Despite the practical difficulties in implementing any order,
Treasury believes that the information obtained could be highly
useful to law enforcement officials. On-the-spot analysis of the
information may very well lead to the breakup of money laundering
organizations. For this reason, Treasury is anxious to develop
and refine the concept. Treasury recognizes, however, that a

-4significant drawback to any approach that is limited geographically will result in driving money launderers on to new locations
where law enforcement officials and financial institutions may
not be as sensitive to patterns of money laundering.
While we cannot judge with certainty the outcome of this kind of
targeting, Treasury hopes that next year, we will be able to come
back and report favorably to the Committee on its utility.
In addition to the amendments to the Bank Secrecy Act contained
in the Committee's bill, Treasury hopes that you will consider
including a number of technical corrections to the Money Laundering Control Act of 1986, Subtitle H of the Anti-Drug Abuse Act of
1986, Pub. L. 99-570, in the bill.
First, 31 U.S.C. 5312 needs to be amended to correct a numbering
error. As you know, that provision sets forth a list of the
types of financial institutions subject to the Bank Secrecy Act.
When the Postal Service was added to the list of financial
institutions in the Money Laundering Control Act of 1986, a
numbering error resulted. This error needs to be corrected.
Another technical correction relating to the Postal Service is
also necessary. When the Postal Service was added to the list of
institutions subject to the Bank Secrecy Act, no corresponding
change was made to 31 U.S.C. 5318(a). That section currently
authorizes the Secretary of the Treasury to delegate enforcement
responsibility for Bank Secrecy Act compliance only to "supervising agencies." Because the Postal Inspection Service, as part of
the Postal Service, cannot be considered a supervising agency
under current law, the Secretary may not delegate enforcement
authority for Bank Secrecy Act compliance by the Postal Service
to the Postal Inspection Service. Therefore, an amendment is
needed to add the Postal Inspection Service to the list of
agencies to which Treasury can delegate enforcement authority.
The bill also should be modified to correct an inadvertent
omission that arose in connection with the 1986 revision to the
civil penalty provision for violations by financial institutions
of the reporting requirements of the Bank Secrecy Act, 31 U.S.C.
5321(a). As you recall, in the 1986 Act, the amount of a civil
penalty that could be assessed against a financial institution
for reporting violations was raised to an amount keyed to the
underlying unreported funds. At the same time, however, the
daily penalty for violations by financial institutions of procedures promulgated by Treasury under 31 U.S.C. 5318 was inadvertently dropped. The bill should be modified to reinsert the
daily penalty of $10,000 for violations of procedures.

-5There is also a critical need for revision to the recordkeeping
provisions of the Bank Secrecy Act, 12 U.S.C. 1829(b) (applicable
to insured banks), and 12 U.S.C. 1951-1959 (applicable to nonbank
financial institutions). Violations of the recordkeeping provisions of the Bank Secrecy Act can be as deleterious to law
enforcement as violations of the reporting provisions.
Nevertheless, there is currently no civil penalty applicable to
insured banks which violate the recordkeeping provisions. There
should be a civil penalty for both willful violations of the
recordkeeping provisions up to a maximum of $10,000 and a maximum
$500 penalty for negligent violations of these provisions by
these institutions. Also, the penalty applicable to nonbank
financial institutions subject to the Bank Secrecy Act for
recordkeeping violations should be raised from a maximum of
$1,000 per violation to $10,000 per violation and a $500 negligent penalty added. The definition of nonbank financial institutions subject to the penalty also should be amended to cover all
types of nonbank financial institutions under the Bank Secrecy
Act. At this time, institutions such as casinos are not covered.
Although not within this Committee's jurisdiction, but certainly
of interest to the Committee, would be Treasury's recommendation
to revise the Internal Revenue Code to complement Treasury's Bank
Secrecy Act authority. This revision would provide all law
enforcement officials, and not only the IRS, with access to
reports filed under section 605 01 of the Internal Revenue Code.
Section 60501, which is similar to Section 5313 of the Bank
Secrecy Act, requires cash reporting of amounts in excess of
$10,000 received in "trades or businesses" other than those
covered by the Bank Secrecy Act. Clearly these reports are, in
many instances, of comparable utility to law enforcement, especially in drug cases, e.g., reports on the cash purchase of motor
vehicles or real estate. Unfortunately, however, the IRS disclosure restrictions in Internal Revenue Code section 610 3 currently
do not allow analysis of the information or law enforcement
access on a par with Bank Secrecy Act information.
Treasury strongly recommends that an amendment be made to section
60501 to exempt returns filed under that provision from the
disclosure restrictions of section 6103. This will enable law
enforcement to analyze section 60501 returns with Bank Secrecy
Act reports as part of Treasury's financial data base, and permit
Treasury to disseminate these reports to law enforcement agencies
to the same extent as Bank Secrecy Act reports. Enforcement
responsibility for section 60501 would remain with IRS. Section
60501 reports (like Bank Secrecy Act reports) would be exempt
from the Freedom of Information Act.

-6Finally, we recommend that an anti-structuring provision be added
to section 60501 that is comparable to the Bank Secrecy Act
anti-structuring provision applicable to customers who structure
transactions to evade the Bank Secrecy Act reporting requirements, 31 U.S.C. 5324, and that a willful violation of section
60501 be punished as a felony offense, and not just a misdemeanor.
This proposal has been suggested for inclusion in the National
Drug Policy Board legislative proposals.
I would like to turn now to the Committee's proposed amendments
to the Right to Financial Privacy Act ("RFPA"). While Treasury
shares the Committee's concerns with protecting the financial
privacy of individuals, Treasury believes that in today's climate,
we must, in some limited areas, reevaluate the appropriate
balance between the right to financial privacy and the legitimate
needs of Federal law enforcement. Treasury remains sensitive to
protecting the privacy rights of individuals within the context
of law enforcement.
Treasury, therefore, is very pleased that the bill does include a
revision to the RFPA that would allow information and records
relating to possible crimes against financial institutions or
against supervisory agencies by insiders to be provided by the
financial institution or supervisory agency to the Department of
Justice without notice to the insider. As you are well aware,
prior notice would enable the alleged wrongdoer to transfer
assets or otherwise impede the investigation. As Treasury has
testified before the Committee, we firmly agree with you on the
need for this measure.
While the draft bill similarly provides that possible violations
by insiders of the Bank Secrecy Act may be reported by a financial institution or supervisory agency to the Secretary of the
Treasury without notice, Treasury would like to point out that,
at least with respect to officers, directors and employees,
existing law already clearly authorizes such disclosures. This
is because, under section 1101(6)(H) of the RFPA, Treasury is a
supervisory agency for purposes of Bank Secrecy Act enforcement.
Section 1113(b) sets forth that "[njothing in this chapter [RFPA]
prohibits ... disclosure to any supervisory agency of financial
records or information in the exercise of supervisory, regulatory
or monetary functions with respect to a financial institution."
Under delegations from Treasury, bank supervisory agencies
routinely examine institutions and report to Treasury possible
Bank Secrecy Act violations by financial institution officers,
directors, and employees and provide supporting financial
records, where necessary, without notice. Financial institutions
also disclose information and records about their own past
noncompliance to Treasury without reference to the RFPA. We
strongly urge you to emphasize in the Committee report that this
is not a change to existing law.

-7Unfortunately, the law is not as clear, and an amendment to the
RFPA is very much needed, to permit financial institutions to
report possible violations of the Bank Secrecy Act by their
customers, i.e., in situations where the bank suspects that its
customer has violated 31 U.S.C. 5324, the anti-structuring
provision of the Bank Secrecy Act. If the bank is not implicated
in the possible anti-structuring violation, broad disclosure to
Treasury arguably may not be within the exercise of Treasury's
"supervisory functions ... with respect to a financial institution." Banks then only would be able to provide Treasury with
the limited suspicious transaction information allowed by section
1103(c) of the RFPA.
Generally, without access to the underlying customer account
records and other information about the customer, this limited
information would not be adequate to establish probable cause
that the anti-structuring provisions of the Act have been
violated. Without probable cause, Treasury cannot proceed to
seize funds that are on deposit with financial institutions.
Instead, Treasury would have to issue a summons to the
institution for the account records and other information and
provide notice of the summons to the customer. Notice to the
customer would be fatal to the investigation and seizure action,
because once the customer has knowledge of the summons, he can
withdraw the money on deposit or wire transfer it to a foreign
jurisdiction.
For these reasons, we would urge you to include a provision in
the RFPA that would allow a financial institution to report, in
good faith, all available information and to disclose records '
with respect to possible violations of the Bank Secrecy Act by
customers, without notice to the customer and without fear of
civil liability.
If an amendment to the RFPA is made which permits financial
institutions to disclose information without customer notice, it
is imperative that a corresponding amendment be made that protects a financial institution from civil liability to the customer
under State law if the disclosure is made in good faith. Without
this federal preemption, financial institutions will be faced
with the possibility of civil liability under State financial
privacy laws, and they will be deterred from cooperating with law
enforcement. As I will discuss later in this statement,
cooperation from the financial community in reporting suspicious
transactions is an increasingly important aspect in the attack
against the financial infrastructure that supports the drug
trade.
There is one technical amendment that is needed to the RFPA.
When Congress amended the suspicious transaction provision,
section 1103(c), in the 1986 Act, to specify what information a
financial institution could give relating to possible violations
of law or regulation, a good faith preemption clause was
included.

-8However, an ambiguity was created about whether financial institutions are protected from liability for good faith reports of
possible violations of law or regulation when the violations
involve corporations or corporate accounts. Although the legislative history makes it clear that Congress contemplated that
situations involving corporations would be covered, the RFPA
itself does not apply to corporate privacy. See Sen. Rep. No.
894, 99th Cong., 2d Sess. 15-16 (1986). A reference needs to be
made in section 1103(c) to expressly cover corporations. We have
provided the Committee staff with draft language to this effect.
The Bank Secrecy Act Requirements and Enforcement Organization
Before I proceed to update the Committee on Treasury's initiatives in the area of Bank Secrecy Act and financial enforcement,
I would like to explain briefly, by way of background, what the
Bank Secrecy Act is and Treasury's enforcement role in the area
of Bank Secrecy Act and related financial enforcement matters.
As you know, the Bank Secrecy Act was enacted in 1970 and gives
the Department of the Treasury broad authority to require the
maintenance of records and the filing of reports that have been
determined to have a high degree of usefulness in criminal,
tax, or regulatory investigations or proceedings. In passing
the Bank Secrecy Act, Congress hoped to lessen the impediment
to U.S. law enforcement authorities posed by stringent foreign
bank secrecy laws. Congress also hoped that the reporting
of the sources, volumes, and movements of domestic and international currency would betray a wide variety of criminal activity,
including drug trafficking and tax evasion. These hopes have *
been borne out.
The authority given to Treasury in the Bank Secrecy Act is
generally not self-executing, but must be implemented by regulations promulgated by the Secretary in his discretion. Since the
inception of the Bank Secrecy Act, Treasury, in exercising this
regulatory authority, has been acutely concerned with striking
the appropriate balance between the needs of the law enforcement
agencies and the costs of compliance to the financial community.
With this in mind, Treasury has imposed three major reporting
requirements under the Act. Briefly, these reports are:
(D The Currency Transaction Report (CTR) — This requires
that designated types of financial institutions report
all types of cash transactions by, through or to the
institutions in excess of $10,000. Financial institutions subject to this requirement include banks,
savings and loans, credit unions, securities brokers
and dealers, foreign currency brokers and several
categories of miscellaneous financial institutions such
as casinos, check cashers and currency exchanges.

-9(2)

The Currency or Monetary Instrument Report (CMIR) —
This requires that all persons report the import or
export of currency or monetary instruments in excess of
$10,000 into or out of the United States.

(3) The Foreign Bank Account Report (FBAR) — This requires
that all persons subject to the jurisdiction of the
United States make an annual report of their interests
in foreign bank accounts.
Finally, the Act and the regulations require financial institutions to maintain a variety of records (such as copies of signature cards, bank statements, and checks drawn for more than $100)
for a five-year period. Records required to be kept under the
Bank Secrecy Act, unlike the Bank Secrecy Act reports, generally
may be examined by law enforcement authorities only for the
purpose of assuring compliance with the Act's requirements; in
other cases, authorities must obtain subpoenas or comply with
other legal provisions. As I discussed above in connection with
the need for recordkeeping penalties, the recordkeeping provisions, less well known than the reporting provisions, are of
great value to law enforcement in the creation of a "paper
trail."
The Secretary of the Treasury has delegated to the Assistant
Secretary (Enforcement) overall responsibility for Bank Secrecy
Act enforcement. Within my office, the responsibility for
coordination of Bank Secrecy Act enforcement and policymaking
rests with the Office of Financial Enforcement. That office is
also responsible for imposition of civil penalties under the Bank
Secrecy Act, which I will discuss shortly.
Enforcement is accomplished through a complex series of delegations emanating from and supervised by my office which I will
briefly describe:
o The IRS Currency and Banking Reports Division is
responsible for the computerization of the CTRs and
FBARs. The IRS Examination Division is responsible for
compliance examination of miscellaneous financial
institutions for which examination authority has not
otherwise been delegated.
o The IRS Criminal Investigation Division ("IRS-CID") is
responsible for the investigation of all criminal cases
(except CMIR cases) under the Bank Secrecy Act for all
types of financial institutions.
o The United States Customs Service is responsible for
the computerization of the CMIRs and for civil and
criminal enforcement of the CMIR provisions. In
addition, Customs also maintains the combined data base

-10for all Bank Secrecy Act information. The Customs
Financial Intelligence Branch is responsible for the
analysis and dissemination of Bank Secrecy Act data for
a variety of law enforcement purposes.
o Examination of Bank Secrecy Act compliance is generally
delegated to the various regulatory agencies that have
responsibility for supervising financial institutions.
The Office of the Comptroller of the Currency is
responsible for the examination of national banks, the
Federal Reserve System for State member banks, the
Federal Home Loan Bank Board for insured savings and
loans, the National Credit Union Administration for
Federal and Federally insured credit unions, the
Federal Deposit Insurance Corporation for State banks
that are not members of the Federal Reserve, and the
Securities and Exchange Commission for federally
regulated brokers and dealers.
Enforcement of the Bank Secrecy Act
Treasury views the Bank Secrecy Act as a law enforcement "tool,"
and enforcement of its provisions as the "grinding wheel" that
sharpens the tool. Thus, in the past three years, Treasury has
been more vigorous than ever before in initiating investigations
and levying civil penalties against financial institutions for
civil violations of the Bank Secrecy Act. Since June, 1985,
Treasury has levied civil penalties totalling over $16 million
for Bank Secrecy Act violations in thirty-nine cases involving
financial institutions. In a number of these cases, the civil
penalty was assessed against bank holding companies that owned
more than one bank that had violations. Thus, these thirty-nine
penalties actually involved one hundred and seven banks that
Treasury concluded had violated the Act. Moreover, twenty-nine
of these penalties exceeded $100,000 — an indication that the
violations to which the penalties pertained were neither isolated
nor infrequent.
In addition, in the past five years, IRS-CID has steadily
increased the number of investigations and prosecutions for
criminal violations of the Bank Secrecy Act. The number of
indictments have increased from 29 in 1982 to 236 in 1987, and
convictions have also increased from 25 to 153 during that same
time period.
Another aspect of Bank Secrecy Act enforcement that is sometimes
overlooked, but is no less vital for an effective compliance
program, is the commitment of the United States Customs Service
to enforcement of the Bank Secrecy Act requirements for CMIRs.
During Fiscal Year 1987, Customs conducted a total of 2,138
seizures of currency and monetary instruments totalling
$192,382,985 for violations of CMIR requirements. Through April,
ments.
in
zures
Fiscal
totalling
Year 1988,
$56,323,737,
Customs has
for violations
conducted aof
total
the of
CMIR
641
requiresei-

-11The Financial Database
The CTRs, CTRCs, and the FBARs are filed with the Internal
Revenue Service and placed on a computer at the IRS Detroit Data
Center. The CMIR reports are filed with the U.S. Customs Service
and are processed in Newington, Virginia. These reports, when
combined, form what we call the Treasury Financial Database. The
Financial Database is accessible to Customs and IRS agents and
financial analysts for targeting suspicious currency
transactions, investigative case support, tax examination and
collection, and a host of other law enforcement uses.
Both Customs and the IRS have rule-based, artificial intelligence
("A-I") systems massaging the data contained in the financial
database, along with data received from the field. These A-I
systems are based on rules of suspicious indicators, for
instance, persons whose many CTRs list differing occupations,
social security numbers, and addresses, and whose transactions
involve multiple accounts or transactions at a variety of financial institutions. According to the expert rules used by the A-I
system, certain occupations are more suspicious than others, and
those that are more suspect are measured against the frequency
and amounts of financial transactions. CTRs filed by financial
institutions for amounts below the $10,000 report threshold, e.g.
a $9,900 CTR, are considered suspicious by the A-I computer,
because we have learned from experience that financial institutions often file such reports because they believe the currency
transactions to be suspicious.
The A-I computer applies these and other rules against the
database automatically and highlights certain "targets" for
further analysis by human financial intelligence analysts, and
ultimately for referral to the field for further investigation.
To date, over 270 targets representing reportable CTR activity
exceeding $201.9 million and reportable CMIR activity exceeding
$21.6 million have been generated by the A-I systems.
The Treasury Financial Database also can be used for law enforcement purposes unrelated to tracking suspicious financial transactions. Project Warrant is an operation being conducted through
the Customs Financial Intelligence Branch which seeks to match
information on fugitives against the database in the hope of
locating escapees, persons under indictment, or persons for whom
an arrest warrant has been issued. One notable success story for
Project Warrant was the arrest, in November of 198 7, of an
escaped convicted murderer who had been a fugitive since 1984.
The leads provided to the State police from the financial
activity identified in the Project Warrant report culminated in
the subject's arrest at the residence of one of his children.
The address was obtained from a CTR filed in 1984 when the
subject conducted a financial transaction.

-12We have been asked by many in the financial community and by
Congress, "Does anyone even look at the information that we send
to Detroit?" I hope you can see now that we do, and furthermore,
how very important it is that the identity of the customer of a
financial institution be verified and that the CTR be filled in
completely, including the occupation and address blanks.
Utility of Bank Secrecy Act
Now that I have described how the financial intelligence
divisions of IRS and Customs review and analyze this information,
I would like to describe how these reports have proved highly
useful for civil and criminal law enforcement purposes.
Particularly in recent years, these reports have provided law
enforcement authorities with investigative leads, information
that corroborates other sources of information about criminal
activities, and probative evidence in Federal criminal cases.
Perhaps the most prominent example of the reports' utility can be
found in United States v. Badalamenti (also known informally as
the "Pizza Connection" case). That case involved the smuggling
of substantial quantities of heroin into the United States by
members of Italian and U.S. organized criminal groups. In the
course of their investigation of heroin trafficking, Federal
authorities discovered a number of CTRs that reflected large cash
transactions by a Swiss national with stockbrokers in New York.
These reports eventually led to the discovery of an extensive
money-laundering operation that involved the transfer of tens of
millions of dollars through investment houses and banks in New
York City to financial institutions in Switzerland and Italy.
Ultimately, twenty individuals involved in the heroin network and
money laundering enterprise were convicted in Federal court on
various charges, including heroin trafficking, conspiracy,
racketeering and Bank Secrecy Act violations. All received
prison sentences ranging from fifteen to forty-five years. In
addition, the Swiss national was convicted and imprisoned by
Swiss authorities for violations of Swiss law relating to his
money laundering activities.
The Government also has made substantial use of the Bank Secrecy
Act to prosecute a number of leading money launderers in the
United States and abroad. In recent years, for example, the
Government has successfully prosecuted Isaac Kattan-Kassin, whose
money laundering organization handled gross proceeds estimated at
$200 million to $250 million per year; Ramon Milian-Rodriguez,
who transported approximately $146 million in cash from the
United States to Panama over a nine-month period; Eduardo Orozco,
whose money laundering organization laundered more than $150
million over a four-year period; and Barbara Mouzin, who masterminded and operated a large West Coast money laundering business
for cocaine traffickers.

-13In some instances, even a single CTR can provide significant
investigative leads for criminal investigators. In one case, the
Internal Revenue Service analyzed a single CTR and determined
that the individual listed on the CTR had not filed a tax return.
Subsequent investigation disclosed the existence of a massive
heroin distribution and money laundering organization, operating
primarily throughout southern California, which provided false
information to the financial institutions that filed CTRs on
their transactions. Eventually, the IRS arrested more than a
dozen persons associated with the organization, seized in excess
of $2 million in currency at various domestic banks, and charged
the organization with income tax evasion involving $27 million in
income over a three-year period.
Although many of the examples cited above involved large-scale
money laundering for drug traffickers, Bank Secrecy Act reports
are also highly useful in identifying or proving other types of
financial crimes, for instance, bank fraud and embezzlement. In
one recent case, for example, analysis of reports filed by a bank
provided a number of leads as to the disposition of tens of
millions of dollars that had been embezzled from the bank through
such devices as illegal loans. In another recent case, Federal
investigators discovered that a husband and wife had failed to
file a CMIR form for the $125,000 in cash that they took out of
the United States. Further investigation determined that the
wife had embezzled millions of dollars from the savings and loan
association in Texas at which she had been employed.
These examples amply demonstrate the substantial utility of Bank
Secrecy Act reports. In addition, unlike grand jury subpoenas or
court orders, the reports provide a constant stream of data on
large domestic and international movements of cash and ensures
that law enforcement agents obtain valuable information on
suspicious transactions in a timely fashion.
Suspicious Transaction Reporting
Treasury, and I know that this Committee, expects more from
financial institutions than mere compliance with the Bank Secrecy
Act. We expect vigilance on the part of financial institutions
to make timely reports of suspicious transactions. As you have
heard us say many times, Treasury needs legitimate financial
institutions to be partners with Federal law enforcement. Our
message on this score has had very gratifying results with many
banks and some securities brokers. Suspicious transaction
reports have experienced a great upsurge in the last year. In
addition, banks regulated by the Office of the Comptroller of the
Currency and the Federal Deposit Insurance Corporation have filed
almost 300 Criminal Referral Forms or Reports of Apparent Crime.

-14A case in point that you have read about recently was the recordbreaking drug seizure of 45 tons of marijuana and hashish on the
barge Intrepid in San Francisco Bay. The seizure was a direct
result of referrals of suspicious transactions to the Internal
Revenue Service by the Bank of America and other banks. These
reports prompted the Northwest Organized Crime Drug Enforcement
Task Force to commence an investigation that led to the seizure
of the barge.
This case commenced when, on August 7, 1987, an unidentified man
entered the North Napa Branch of the Bank of America and tried to
deposit $12,000 in cash into the account of a Napa Valley
mortgage institution. Bank officials explained that under the
Federal 1986 Money Laundering Control Act, financial institutions
are required to report any single deposit of $10,000 or more to
the IRS. The man then reduced the amount of the deposit to
$8,000, so that the report need not be filed. Later that day,
the same individual returned with a check for $4,000 from another
financial institution and deposited it into the Napa Valley
Mortgage account. These events led the bank officials to believe
that the individual may have been attempting to circumvent the
reporting law. They then called the IRS.
The rest, as they say, is history—a record seizure resulting
from this tip. In addition to the drug seizure, at least six
individuals have been arrested and over $1 million in cash, three
vessels and real property, have been seized. I would like to
take this opportunity to publicly thank the Bank of America and
all of the financial institutions that are supporting the
Treasury Department in its attack on the money that supports this
insidious crime.
This is a stellar example of what can happen when financial
institutions act in concert with law enforcement. Treasury
actively encourages and depends on this type of cooperation. In
order to facilitate this cooperation, within the next two weeks
Treasury will be introducing, in conjunction with the Internal
Revenue Service, a toll-free suspicious transaction number,
1-800-BSA-CTRS. Financial institutions will be able to call this
number to report possible Bank Secrecy Act violations or money
laundering violations, within the confines of the RFPA. A
similar toll-free number for Customs, 1-800-BE ALERT, for
reporting possible CMIR and other Customs law violations has been
operational for some time.
Update on Treasury's Administration and Enforcement of the Bank
Secrecy Act
Since last October, Treasury has reorganized the Office of
Financial Enforcement to increase its ability to act expeditiously
on civil penalty cases. The Office now has a new Director, Amy G.
Rudnick, as well as a permanent Deputy Director, an Assistant

-15for International Affairs, an Assistant for Bank Secrecy Act
Compliance on detail from the Office of the Comptroller of the
Currency, a Compliance Research Analyst, and a Legal Intern. In
addition, we have announced five additional permanent professional
staff positions (one Bank Secrecy Act Compliance Supervisor, two
Bank Secrecy Act Compliance Specialists and two Assistants for
Legislation, Regulations, and Interpretations) to carry out the
responsibilities of the Office. Treasury also has instituted a
program where personnel from the various agencies with Bank
Secrecy Act enforcement responsibility are working in the Office
of Financial Enforcement on forty-five to one-hundred-eighty-day
details. Currently, we have one detail from the Federal Reserve
and one detail from IRS/Examination Division. The Federal Home
Loan Bank System has committed a detail to begin on September 1,
1988. We believe that these details will be mutually beneficial
to Treasury and the regulatory agencies.
In addition, Treasury has been engaged in an extended project,
through the Bank Secrecy Act Working Group that Treasury heads,
to revise and expand the guidelines that the bank supervisory
agencies follow in referring possible violations of the Bank
Secrecy Act to Treasury. These revised guidelines, which have
been adopted by most of the bank supervisory agencies, address a
broader range of factors that the supervisory agencies should
consider in deciding whether to make referrals in particular
cases. They also seek to streamline the referral process to
minimize the time that it takes to forward a Bank Secrecy Act
referral from the district office of a supervisory agency to
Treasury.
Treasury also has taken a number of administrative actions to
make the Treasury Financial Database, in which computerized data
from the Bank Secrecy Act reports are stored, more readily
accessible to law enforcement and supervisory agencies. The
Office of Financial Enforcement has had "on-line" access to the
Financial Database for some time, and is now finalizing arrangements with IRS to provide the bank supervisory agencies and the
Securities and Exchange Commission with "on-line" access as well.
Treasury also has extensively revised the guidelines under which
the U.S. Customs Service and the Internal Revenue Service may
disseminate Bank Secrecy Act data to minimize procedural difficulties for other agencies and to make the data more readily
available to Federal, State and foreign agencies.
In addition, Treasury has concluded an agreement with the Office
of the Attorney General in California for transmission of magnetic
tapes of Currency Transaction Reports that have been filed by
California financial institutions. This agreement will allow the
State of California to carry out its responsibilities under its
own anti-money laundering law, without requiring California
financial institutions to file duplicate copies of CTRs with the
State.

-16Since last May, Treasury has had an unprecedented level of
activity in improvements to the Bank Secrecy Act regulations.
First, Treasury added the Postal Service to the list of institutions subject to the Bank Secrecy Act. We know of your special
interest in the subject, because in 1986 a former smurf testified before your Committee on how he purchased Postal Service
money orders to launder money. Law enforcement authorities in
several major cities also observed that money launderers were
purchasing Postal Service money orders with substantial amounts
of cash. As you know, this problem prompted Congress, at the
urging of this Committee, to add the Postal Service to the
definition of "financial institution" in the Anti-Drug Abuse Act
of 1986. Accordingly, Treasury amended the Bank Secrecy Act
regulations on January 13, 1988, to include the Postal Service in
the definition of the term "financial institutions."
We also have taken several other regulatory steps that would be
of interest to your Committee:
o On June 26, 1987, we added a new Subpart to our regulations
prescribing procedures for use of our administrative summons
authority given to us in the Anti-Drug Abuse Act of 1986.
o On September 22, 1987, we amended 31 C.F.R. 10 3.4 3 to
clarify our dissemination authority to governmental authorities of Bank Secrecy Act data and to provide for user fees
for disclosures to State and local governmental authorities.
The user fees would be used in the situations like the
California agreement that I referred to earlier.
o On September 22, 1987, we added a new Subpart to our
regulations establishing an administrative ruling system
which I will discuss later in my testimony.
o On March 29, 1988, we amended 31 C.F.R. 103.25, the international "targeting" regulation, to permit reporting on
retroactive transactions and to prohibit notification by the
reporting financial institution of the existence of the
reporting requirement to affected parties. These amendments
will enable us to look at currency flows from the recent
past, and will ensure that, when we do require reporting on
a prospective basis, that the data will not be altered as a
result of customers stopping their normal business patterns.
o We also have pending a Notice of Proposed Rulemaking, issued
on April 7, 1988, proposing two amendments to the
recordkeeping requirements for casinos. The comment period
ended May 9, and we are in the process of drafting a final
rule.

-17o

We also have several regulatory projects pending. Of
special interest to you might be a proposed definition of
structuring that will be published as a Notice of Proposed
Rulemaking in the next few weeks. In the near future, we
also will be issuing a proposed regulation improving the
CMIR provisions of the regulations. Finally, we soon will
be publishing comprehensive revisions of the regulations
applicable to casinos to address their unique compliance
problems and capabilities.
o Finally, on March 11, 1988, Treasury published an Advanced
Notice of Proposed Rulemaking to solicit the views of
financial institutions, law enforcement agencies, and others
on how financial institutions can best provide notice of the
anti-structuring provisions of the Bank Secrecy Act to
customers of financial institutions. We are in the process
of evaluating the comments that we have received on this
proposal.
Encouraging Compliance with the Bank Secrecy Act
Treasury has taken a number of steps to facilitate and assure
full compliance by all types of financial institutions. Treasury
also recognizes that many financial institutions have every
interest in complying with the Act's requirements, but have
legitimate questions about the requirements of the regulations
and concerns about the costs associated with compliance.
Treasury shares these concerns. To address these concerns, and
to make the process of complying with the Act's requirements more
efficient, Treasury has undertaken three significant projects.
First, Treasury, with the assistance of the IRS, has written a
comprehensive handbook on how to properly exempt certain types of
customer accounts and currency transactions from the CTR reporting requirements, as permitted by the regulations. Treasury and
the IRS have written this handbook in response to their observation that many banks are over-reporting on exemptible customers,
largely because of their concern that they may be penalized if
they mistakenly place ineligible customers on their exemption
lists. This practice has caused these banks to file many more
CTRs that the regulations require. The Exemption Handbook, which
is at the printers, should help to alleviate the banks' concerns
about the proper use of the exemption provisions of the regulations, and minimize confusion about their proper application. In
addition to the booklet, Treasury will be corresponding with the
50 largest banks that appear to be under-utilizing the exemption
process.
Second, Treasury is about to issue formal administrative rulings
on various provisions of the Bank Secrecy Act regulations. These
rulings are being issued pursuant to a revision in the Bank
Secrecy Act regulations, issued on September 22, 1987, that
explains the process for seeking administrative rulings from

-18Treasury. As Treasury responds to various requests for rulings,
or issues rulings on its own initiative, it will be able to
develop an expanding range of interpretations of the regulations
and provide the financial community with clearer guidance on the
meaning of the regulations.
Third, on December 31, 1987, Treasury published a notice in the
Federal Register that announced the establishment of a permanent
program that permits financial institutions to file CTRs on
magnetic tape with the IRS Data Center. An earlier pilot program
confirmed the expected benefits of magnetic tape filing of CTRS,
that is, an increase in the accuracy of data being reported (only
5% of CTRs filed by magnetic tape contained data inconsistencies
or format errors); a reduction in processing costs (net savings
to the government of $22 million over 10 years); and a reduction
in the processing time, measured from date of transaction to date
first available for agent review (from 45 days to 18 days, an
overall reduction of 27 days). With the encouragement of Treasury, IRS, and the financial community, the program is growing,
and we expect Chase Manhattan and Wells Fargo to begin filing by
magnetic tape very soon.
Financial Enforcement Strategy
I now would like to turn to some of the broader law enforcement
interests that influence Treasury's approach to Bank Secrecy Act
enforcement. Treasury views the Bank Secrecy Act not as a
discrete program that can be conducted without reference to the
enforcement activities of other Federal agencies, but rather as
an integral part of a coordinated approach to financial enforcement issues that Treasury, the Justice Department, and other
Federal law enforcement agencies are now pursuing.
One of the most significant means for developing this coordinated
approach is the Financial Enforcement Committee of the National
Drug Policy Board, which is chaired by Treasury. The Committee
has become increasingly active and visible as the overall coordinating body for government programs that attack the financial
operations of drug traffickers.
Two of the Committee's more substantial projects deserve special
mention. One is the development and coordination of an
interagency Financial Enforcement Training Program that will
include Federal, State, and local government training in financial investigation and prosecution techniques. This training
program is meant to implement the financial investigations
strategy that recognizes the importance of joint financial
investigative task forces as a means of attacking the serious
drug problem in this country. The strategy recognizes that, in
addition to targeting known trafficking organizations, a strategy
that follows the money flowing in and out of the trafficking
organizations can uncover previously unknown trafficking groups
and identify the upper echelons of the organization.

-19The other project is referred to by the Financial Enforcement
Committee as the Money Flow Model Project. This project is
designed to produce a computer simulation model of the money flow
mechanisms of drug trafficking and other illegal enterprises.
Such a model, in the Committee's view, is expected to provide the
Policy Board with new analytical tools to aid in the investigation of the money flow that supports illegal activities, to
assist in the analysis and development of financial policies to
limit illegal activities that are supported by illegally obtained
funds, to assist in the development of financial enforcement
methods, and to improve the quantification of the total volume of
illegal financial activity and its economic effects. The
long-range objective of the project is to develop a computer
simulation model that can be used by government agencies to plan
appropriate action against the assets of major criminals and
criminal organizations.
The Money Flow Model Project is being developed for the Financial
Enforcement Committee by the Los Alamos National Laboratory. The
initial phase of the project, the writing of the plan for the
model, has been funded by joint contributions from the IRS,
Customs, the FBI, and the DEA. The initial phase of the project
began in April, 198 8, and will run for ninety days.
In addition to these two projects, the Financial Enforcement
Committee is overseeing a substantial number of other projects,
including the cataloging of all financial enforcement training
now being conducted, a program for cross-training of intelligence
analysts involved in financial analysis, and a task force to
explore more effective uses of financial information. All of
these initiatives can be expected to yield substantial returns
for the Federal Government in investigating, prosecuting, and
seeking forfeiture of assets from leading drug traffickers and
the money laundering on which they rely.
International Initiatives on Financial Enforcement
While the United States has taken significant steps to deal with
the problem of money laundering, the Administration realizes that
it must obtain the commitment and cooperation of foreign
countries in order to effectively combat drug trafficking and
other types of organized criminal enterprises. It is for these
reasons that the Administration has raised the narcotics issue
with our Summit partners. Narcotics will be discussed in Toronto
because of the recognized urgent need for improved international
cooperation on programs to counter all aspects of the problem,
including its financing, production and trafficking.
The scope and complexity of these issues demand a cooperative
international reaction and response. The United States plans to
suggest that a special Summit country task force be convened that
will include key enforcement, foreign affairs and financial

-20experts who are involved in the battle against narcotics. We
will seek improved cooperation across a wide scale of activities
and we will also suggest greater efforts in the United Nations
and through bilateral treaties with both our Summit partners and
other countries. This will be an ongoing process, elements of
which are already in place.
In addition, Treasury has recently sent a series of letters to
the chief executive officers of U.S.-based financial institutions
with foreign branches. These letters set forth the risks associated with international money laundering, identify certain
patterns of activity that should be considered suspicious, and
encourage the foreign branches of these institutions to report
any suspicious transactions to overseas representatives of the
IRS and Customs in a manner that is consistent with foreign law.
This initiative, which Treasury had promised to pursue in the
foreign branches study, may well provide U.S. law enforcement
authorities with additional leads in money laundering and Bank
Secrecy Act cases, and should help to persuade leading U.S.
financial institutions that expanded cooperation with Federal law
enforcement authorities is in their interest and the interest of
their legitimate customers.
Conclusion
In conclusion, we are fighting a war with many fronts in the
battle against money laundering and the criminal enterprises it
sustains, but our goals are clear. Treasury shares the goal of
this Committee to close the doors of legitimate financial institutions to drug money launderers. We want financial institutions
to be partners with Treasury in achieving this goal. In turn, we
will act responsibly in balancing law enforcement needs with
costs to financial institutions in exercising our regulatory
authority. We also seek to maximize efficient and effective use
of Bank Secrecy Act data through vigorous enforcement.
Finally, we want to facilitate good compliance by financial
institutions through open communication with Treasury, education
and guidance. Again, I want to commend this Committee for your
continued interest in this most important mission.
I will be pleased to answer any questions that any member of the
Committee may have.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
PREPARED STATEMENT OF R. RICHARD NEWCOMB
DIRECTOR, OFFICE OF FOREIGN ASSETS CONTROL
DEPARTMENT OF THE TREASURY
before the
SUBCOMMITTEE ON TRADE
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
WASHINGTON, D.C.
June 9, 1988
The South African Sanctions Program and H.R. 1580
Thank you Mr. Chairman and Members of the Committee:
Good afternoon.

My name is Richard Newcomb.

Office of Foreign Assets Control at Treasury.

I direct the
It is a pleasure

to testify before the Committee on the South African Sanctions
Program currently in force and on H.R. 1580, the Comprehensive
Anti-Apartheid Amendments of 1988, as reported by the Committees
on Foreign Affairs and on Banking, Finance and Urban Affairs.
The Treasury Department strongly opposes this Bill.

Foreign Assets Control ("FAC") is the office within Treasury
responsible for implementing the import, financial, and new
investment prohibitions of the Comprehensive Anti-Apartheid Act
of 1986 (the "Act").

I would like to give you a brief overview

of our implementation of certain of the Act's provisions, and
then to comment on the impact Treasury believes H.R. 1580 would
have on U.S. trade, finance, and on the U.S. economy as a
whole.
B-1446

-2-

The Department of Treasury is responsible for implementing the
Act's import prohibitions on such things as South African gold
coins, agricultural products and food, iron and steel, sugar,
uranium ore, uranium oxide, coal, textiles, and products from
parastatal organizations (i.e., organizations owned or
controlled by the Government of South Africa), and the prohibitions against loans and new investment.

FAC coordinates and

oversees the activities of Treasury pursuant to the Act.

In

enforcing the Act's import prohibitions, FAC is supported by
the U.S. Customs Service.

FAC's experience in sanctions enforcement dates back to the
period prior to U.S. entry into World War II. Today, in
addition to the South African sanctions program, we have eight
other programs in place against North Korea (since 1950), Cuba
(since 1963), Vietnam (since 1964), Kampuchea (since 1975),
Nicaragua (since 1985), Libya (since 1986), Iran, first in 1979
and a second time in 1987, and now against Panama, pursuant to
sanctions imposed by President Reagan on April 8.

The Act prohibitions on the importation of krugerrands and on
lending to the South African Government closely followed those
in the pre-existing Executive Order sanctions adopted in the
autumn of 1985. The Act and its legislative history indicated
that the Senate Foreign Relations Committee staff was guided by
existing Treasury regulations and interpretations in drafting
the krugerrand and government loan prohibitions of the Act and

-3-

directed that we continue existing practice where not inconsistent with the Act's language.

Section 301 of the Act

expanded the krugerrand ban to include all South African gold
coins, in the event other gold coins are minted in the future.
With that note, thus, FAC and Customs Service enforcement of
the gold coin import prohibition was already in place on the
Act's effective date.

Similarly, the prohibition on new

lending to the South African Government and its controlled
entities had been fully implemented in 1985.

Enforcement of the current South African sanctions program as
mandated by the Act is among the highest priorities of FAC and
the Customs Service.

Customs currently has 15 on-going

investigations and has instituted several penalty actions
against importers who have attempted to circumvent the South
African import prohibitions.

We will continue to work with Customs in pursuing these cases
both civilly and criminally, as appropriate, to the full extent
of the law.

Upon passage of the Act, FAC, in cooperation with bank
supervisory agencies, contacted all banks known to hold
accounts of the South African Government and its controlled
entities, to inform the banks of the prohibition on accepting
or holding such accounts under section 308 of the Act.

FAC

implemented the exception permitting diplomatic and consular

-4-

accounts by issuing specific licenses to cover each such
account in the United States.

Section 310 of the Act, which contains the prohibitions against
loans and new investments, requires that "no national of the
United States may directly or through another person, make any
new investment in South Africa." (22 U.S.C. 5060).

"New

investment" is defined as "a commitment or contribution of
funds or other assets" and "a loan or other extension of
credit." (22 U.S.C. 5001).

Under these provisions, a disin-

vesting U.S. parent corporation may not extend credit to
corporations or individuals in South Africa (other than firms
owned exclusively by black South Africans) to facilitate their
purchase of its South African subsidiary nor contribute or lend
working capital to its South African subsidiary unless it is
necessary to enable it to operate in an economically sound
manner without expanding its operations.

In order to monitor compliance with the prohibitions against
loans and new investments, we have worked closely with all U.S.
companies operating in South Africa and have advised them in
writing of the Act's requirements.

The Act does not require or

encourage disinvestment from South Africa.

Nonetheless, state

and local procurement and investment laws and the Act have that
effect.

-5-

Of the approximately 250 U.S. companies with which we have
corresponded, approximately one-half have already disinvested
or are in the process of disinvesting.

The divestment

strategies of the vast majority of companies clearly have not
violated the Act; however, we are now examining a few
transactions which have involved deferred payment or other
extensions of credit in South Africa.

Although we consider it too early to determine the full impact
of the Act, it has been clear from our communication with these
companies that the Act's restrictions have forced those U.S.
companies still present in South Africa to operate under
serious financial constraint.

As a result, many have been

forced to disinvest, often under sales terms extremely unfavorable to the U.S. seller.

Moreover, U.S. companies do not

appear to be interested in making any new investments in South
Africa even where it is permitted; not one registration for a
new venture has been filed with our Office pursuant to the
Act's exception for investment in firms owned by black South
Africans.

We are also taking steps to insure that brokerage houses, stock
exchanges, and U.S. securities dealers are on written notice
about the Act's restrictions on investment in South African
securities. Generally, only trading in preenactment (preOctober 2, 1986) securities, including American Depository
Receipts evidencing preenactment issues, is permitted.

We have

-6-

also advised banks of the Act's prohibitions on loans and other
extensions of credit to the South African Government or its
controlled entities (effective November 11, 1985 under
sanctions which pre-dated the Act) or to any person or entity
in South Africa.

We are working with bank supervisory agencies

to ensure compliance in this area.

Let me now turn to the provisions of H.R. 1580, as reported by
the Committees on Foreign Affairs and Banking, Finance and
Urban Affairs. The Treasury Department is strongly opposed to
this Bill. Of particular concern to us are the provisions
requiring, first, the embargoing of most trade transactions
with South Africa; second, the forced divestiture of U.S.
interests in South Africa; third, termination of any
flexibility of U.S. banks in collecting on existing loans; and
fourth, the extraterritorial extension of the import, export
and investment prohibitions to foreign nationals outside the
United States.

First, H.R. 1580 requires a virtual trade ban on South Africa.
The loss of existing contracts to U.S. exporters and importers,
and the immediate need to replace supply sources and export
markets, might cause severe dislocations and bring higher
prices in key U.S. economic sectors.

Treasury is concerned about the McCollum amendment adopted by
the Committee on Banking and Finance.

This amendment to the

-7-

Bill's import sanctions would prohibit importation of
third-country products containing components of South African
origin.

Enforcement of this provision would be extremely

cumbersome, requiring the Customs Service to determine whether
South African content was included in virtually all imported
items.

Our trading partners, none of whom has adopted matching

South African trade sanctions, will in all likelihood view the
exclusion of their products under this provision as a
nullification of benefits under the GATT, and retaliate against
U.S. exports or seek compensation.

The exception to the H.R. 1580 import restriction for strategic
minerals also raises difficult questions.

In addition to

existing certification requirements to authorize such imports,
the Bill requires the President to certify that quantities of
strategic minerals essential to the national economy and
defense cannot be met in a timely manner by improved
manufacturing processes, conservation, recycling, and economic
substitution.

On what basis is the President to determine

whether essential economic and defense needs can be met on a
timely basis without South African strategic minerals through
improved manufacturing processes, conservation, recycling, and
economic substitution?

Is it intended that the President

curtail the availability of strategic minerals from South
Africa if U.S. business fails to adopt improved manufacturing
processes, conservation, recycling, and economic substitution
to end reliance on such minerals?

What effect will such

-8-

curtailment have on the industrial concentration in the United
States when firms financially unable to adopt expensive but
feasible new technology are forced out of the market?

South Africa does not have to rely on U.S. exports given the
foreign availability of the majority of goods traded by U.S.
exporters. Thus, we believe the major direct impact of this
sanction would fall on U.S. exporters, importers, and
consumers, and on black employment in South African export
industries. An indirect impact arises from the bill's proposed
coverage of exports and reexports to South Africa from thirdcountry producers that manufacture under U.S.-granted
technology licenses. This provision will make the United
States less attractive as a export trading partner, and is
likely to reduce U.S. exports of goods and technology to third
countries.

Second, the Bill requires U.S. nationals, within a period of
six months, to divest themselves of any "investment in South
Africa."

"Investment in South Africa" is defined to include

equity interests, capital contributions, loans made before
April 20, 1988, and an undefined concept called "control of a
South African entity" where no equity, loan, or capital
interest is involved.

It is unclear, but "control" may even

cover such things as contracts for management services or
trademark licenses essential to the success of a business. We
are dealing here with a definition of "investment" that bears

-9-

no relationship to the normal use of that term in the business
and financial communities.

The clear impact of the requirement for forced divestiture is
the immediate and irreversible loss of value of assets held by
U.S. investors and corporations.

Treasury has in the past and

will continue to oppose this proposal.

Forced disinvestment

runs counter to this Administration's policy that international
capital markets and foreign investment remain free of controls.
For U.S. investors holding South African securities, changing
the rules established in the 1986 Act guarantees that the
market value of their investments will plunge over the
six-month grace period.

Many American portfolio investors own

pre-enactment shares in South African entities. These could
involve investments of U.S. mutual funds.

I cannot quantify

the amount, but the value of these investments would also
suffer as a result of the legislation.

On the corporate side, disinvestment will lead to a loss of
job opportunities in South Africa, the possible demise of
enlightened, non-discriminatory labor policies followed by U.S.
companies as required by the Comprehensive Anti-Apartheid Act,
and windfall gains for South African companies.

American

companies will be lucky to receive any reasonable offers for
assets with a six-month deadline for divestiture.

Why would

South Africans or purchasers of any nationality pay fair value
for assets when they know their would-be sellers must divest at

-10-

any price within weeks to comply with U.S. law?

Further, South

African exchange controls will create additional losses as U.S.
companies convert their proceeds into U.S. dollars at the lower
"financial rand" exchange rate.

Such intended injury to the

U.S. parent companies arising from forced divestiture may
constitute a compensable taking of property under the Fifth
Amendment to the Constitution.

What will be the practical impact of this move for the South
African economy beyond a reduction in job opportunities?
Perhaps black workers will be able to finance the purchase of
their U.S.-controlled employers.

However, past experience

indicates that the more likely scenario is that businesses will
be acquired by white South African interests on terms very
advantageous to those investors. Unfortunately, the Bill's
call for negotiations with worker representatives cannot arm
the workers with sufficient economic power to finance purchases
of U.S. assets in South Africa.

Nor does the Bill continue

even the limited exception in the present Act which authorizes
investment in firms owned by black South Africans, so that
acquisition loans to workers' representatives would not be
possible.

H.R. 1580 is, therefore, likely to lead to further

concentration of economic power in white hands, and at firesale
prices.

The second aspect of the disinvestment provision in H.R. 1580 I
wish to address is the proposal to end U.S. lenders' ability to

-11-

reschedule loans made in South Africa prior to the 1986 Act.
The present Act and its legislative history permits such
rescheduling to avoid injury to U.S. lenders caught in the
South African Government's 1985 debt moratorium measures, which
limit the repatriation of hard currency loan proceeds, and
which permit the South African Government to substitute itself
for private sector borrowers on such loans.

The Bill would terminate this protection for U.S. lenders, and
require that loans made under agreements reached prior to
April 20, 1988, be repaid strictly in accordance with their
existing terms.

If not, the loans would be treated as

prohibited investments in South Africa, and subject to the
mandatory divestment provision.

As noted, South African law

permits the government to substitute itself as the borrower on
existing hard currency loans.

Such a substitution is treated

as a rescheduling under the present Act, in accordance with its
legislative history.

This gives the South African Government

the unilateral ability to trigger a divestiture requirement on
outstanding U.S. loans. The loans would have to be either
sold, probably at firesale prices, or otherwise divested.

Thus, U.S. banks, in effect, would be forced to provide debt
relief to South Africa and subsidies to those who purchase the
claims at the discounted price.

They would lose all leverage

in seeking repayment, without any corresponding damage to the
South African borrower.

-12-

The losses to the banking community could be substantial and
they would be concentrated in the nine money center banks.
Although the level of exposure has been declining in recent
years, it remains very substantial at $2.8B.

Of that total,

$2.2B is owed to the money center institutions or about 3.5% of
their capital. As this Committee knows, there is strong
regulatory and market pressure on these banks to increase
capital. The proposed Bill would undercut that effort.

Finally, the extraterritorial application of the proposed
disinvestment requirement will cause intense diplomatic
friction, and potential third-country retaliation against the
United States. This result would arise because the Bill
enunciates a disinvestment policy for assets owned, not only by
U.S. corporations, but by third-country entities that are owned
or controlled by U.S. nationals.

The breadth of this

extraterritorial assertion of U.S. jurisdiction has previously
been reserved for wartime conditions in sanctions programs
adopted pursuant to the Trading with the Enemy Act.

And even

in wartime, the United States has not required its own
nationals to divest themselves of foreign investments, but has
focussed on the U.S. holdings of enemy countries.

To summarize Treasury's opposition to H.R. 1580, it would do
more harm than good for U.S. interests whether viewed from an
economic or foreign policy perspective.

We believe the

disinvestment requirement's main economic impact in South

-13-

Africa will fall on employment opportunities for black South
Africans, while fostering greater concentration of economic
power in the hands of white South Africans.

The major effects

on U.S. financial institutions will be to reduce their bargaining power vis a vis South African borrowers on existing
loans, and force banks to incur substantial losses on their
claims.

The likely impact on the U.S. economy generally is a

degree of economic dislocation for investors and for
corporations with holdings in, or with service contracts,
licensing or management agreements, or long-term import or
export contracts with, South Africa.
respond to the Committee's questions.

I will be pleased to

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
Remarks by M. Peter McPherson
Deputy Secretary
of
The U.S. Treasury Department
before
The World Food Conference
Des Moines, Iowa
June 6, 1988
The Case for- Economic Policy Reform in Developing Countries
Thank you. It is a pleasure to be here today to offer you
the Treasury Department's perspective regarding the importance of
economic policy reform in fostering sustained economic growth in
the developing world. In my remarks this afternoon, I will
cover a number of financial and economic issues that are at the
heart of third world development, including the international
debt situation, needed structural reforms in developing countries,
reform of public sector finances, financial sector liberalization,
trade liberalization, and agricultural policy. Lastly, I will
note the importance of these measures in solving the poverty
conundrum.
The International Debt Strategy
As many of you are aware, Secretary Baker has taken a leading
role in tackling one of the most nettlesome issues, the international debt situation. I believe it useful to review the guiding
principles of the "Program for Sustained Growth," launched by
Secretary Baker in October 1985 at the IMF/World Bank meetings
in Seoul, Korea. These key tenets are also relevant to economic
development generally.
o First, the central importance of economic growth and
capital formation in easing the debt burden over time.
o Second, the need for market-oriented reforms in debtor
nations to achieve such growth.
o Third, new debt and equity financing, and the return
of capital flight, to help support such reforms.
o And fourth, a case-by-case approach to address the
individual needs of each country.

B-1447

- 2 -

I firmly believe that these basic principles should continue to
guide our approach in the period ahead. Developing nations need
financial resources to grow, and require sustained, market-oriented
reform of their economic structures. These adjustments will,
in turn, promise stronger growth, higher standards of living
and more productive and resilient economies with greater resources
for educational, health, social and cultural programs.
Substantial progress is being made by debtor nations in
putting into place policies to bring about the necessary financial
stability and the structural foundations for stronger growth and
external balance.
o According to World Bank data, 8 of the 15 major
debtor countries grew at 4 - 5 percent or better
last year, compared with only three countries
in 1985.
o Debt service ratios for the group have fallen
by one-fourth and interest service ratios by
one-third since 1982.
o Aggregate current account deficits'have been
sharply reduced and are in a more manageable
range.
o Export earnings have rebounded to near record
highs, while imports this year should be the
highest since 1982.
Despite concerns about the commercial bank component and
delays in some instances, external financial support for
these efforts by the major debtor nations has been provided
in amounts that compare well with those needed to sustain
the adjustment effort.
The support includes approximately $17 billion in new
commercial bank loan commitments, over $220 billion in commercial
bank reschedulings, $17 billion in Paris Club reschedulings,
almost $14 billion in new World Bank loans, and $5 billion
in temporary payments financing from the IMF since October
1985.
The international financial system is on a sounder footing,
as commercial banks have increased capital relative to their
loan portfolios, and enhanced reserves. Moreover, some
debtor nations that experienced arrears are working to normalize
relations with creditors. Indeed, there is now a deeper
understanding of the negative repercussions of both unilateral
moratoria and arrears that I believe is constructive.
While these are positive developments, we must all
recognize that problems remain. A full return to creditworthiness
by debtors is not a short-term process and will not be completed
overnight. Additional efforts are still needed to reduce

fiscal and external deficits, control inflation, encourage
new investment and savings, and unleash the creative potential
of the private sector within debtor nations to help catalyze
new loans, equity flows, and the return of flight capital.
These are essential to improving and sustaining growth.
Within this context, our strategy is an evolutionary
one. By emphasizing a diversity of options for commercial
banks and innovative financing techniques, the "menu"
approach to commercial bank support assists the return to
creditworthiness. The development of such "menus" is an
ongoing process. The options selected in individual cases
are the result of voluntary choices developed and mutually
agreed upon by the debtor governments and commercial creditors
themselves.
For several countries, additional borrowing will be
needed to support reforms, meet external obligations, and
provide a stimulus to production and growth. Such flows,
if used productively, can help to strengthen the debtors'
own resources, and they can be fully consistent with the
objective of restoring creditworthiness and reducing the real
debt burden over time. Trade credits, project loans, and
onlending for specific uses in the private sector all help
to target resource flows for stronger growth. New money bonds
which have some of the characteristics of a senior claim may
also be attractive to some banks as a way of providing
additional financing.
Debt conversion techniques have also been playing an
increasingly important role in the debt strategy. They can
shorten the debt, workout period for some countries, or reduce
current debt service burdens, or permit some banks to exit
from the concerted lending process, thus streamlining procedures
and accelerating the conclusion of new financing packages.
Such debt conversion transactions may hold benefits for all
parties and can supplement — but not supplant — the fundamental
reform and financial support elements of the current, strategy.
A number of such conversions have already been negotiated.
Some $7.5 billion in debt/equity swaps have been consummated
in 5 debtor countries in the past 3 years alone. Other
countries are developing debt/equity swap mechanisms. There
is a growing interest in debt/conservation and debt./charity
swaps, as well. Through these swaps, debt, instruments can be
retired in exchange for local currency for important conservation
or other social programs in the debtor country.
We are encouraging the World Bank to provide technical
advice for debt/equity and debt/conservation swap programs.
The U.S. has already taken steps in both the regulatory and
tax areas to facilitate such conversions. Debt/equity
conversions in particular have considerable untapped potential
and should be given more attention by both debtors and creditors.

- 4 -

The recent Mexican debt exchange offer, whereby some
$3.7 billion in bank claims were retired in exchange for $2.6
billion in new bonds with principal fully collateralized,
is yet another innovative technique, which can increase
flexibility for dealing with the current stock of debt. I
expect that other creative financial market instruments of a
similar nature will be developed in the period ahead.
To be successful, such efforts must be voluntary, privately
financed, and developed within the market to benefit commercial
banks and debtor nations alike. In contrast, we strongly
oppose any approaches which are generalized, global, financed
by creditor governments or mandatory in nature. This includes
the creation of an international debt facility under the
auspices of the IMF or World Bank aimed at providing a global
"quick-fix" of the debt problem via debt purchases or securitization of commercial bank loans. Such plans merely shift the-risk on private commercial bank debt to the international
financial institutions themselves and their member governments
-- which we certainly are not prepared to accept.
We would strongly discourage all from entertaining such
notions. They would not support the adoption of necessary
policy changes, but in fact would only delay needed adjustment
and financing. Moreover, they would undermine the restoration
of access to markets that some debtor nations are now achieving.
In sum, such proposals could distract attention from* the real
work at hand: establishing a sound foundation for sustained
growth.
In the effort to get developing countries back onto the
growth path, the World Bank is one of the cornerstones
of the debt strategy. The Bank is already committing 22-23
percent of its new lending towards "policy-based lending,"
i.e., lending that is conditional on the implementation of
structural economic reforms. By encouraging sound economic
policies in the debtor countries, policy-based lending also
catalyzes private flows of capital.
The IMF also has a continuing and central role to play
within the debt strategy. it must assist debtors in devising
growth-oriented reform programs, support those programs with
temporary balance of payments financing, and help catalyze
private fianancial flows.
The Agenda for Policy Reform
Economic growth is not only the key to solving debt problems,
it is also crucial to alleviating poverty. Growth means jobs
and income. A bad economic structure is not sustainable forever
and so the real choice is between prompt, orderly adjustment with
the benefits of growth and jobs, or delayed or stop-go adjustment
programs. Also, too often we forget that bad economic policies
fall hardest on the weakest or poorest people in a society. For
example, when politically powerful urban groups in developing

countries hold down prices farmers can receive, the impact often
is to impose a type of tax on very poor people so that a somewhat
better off urban population can have cheap food.
The action for reform lies first and foremost, of course,
with the developing countries themselves. Many of these
countries need to be more steadfast in their efforts to deal
with economic reforms.
I will turn now to some of the critical elements of the
development process.
Reform of Public Finance
The starting point for stabilization and orderly structural
adjustment is usually reform of public finance. Large fiscal
deficits, which ballooned in the late seventies and early
eighties, were often harbingers of serious economic and
financial problems in the major debtor countries: the ratio
of public debt to GDP exploded, domestic savers responded to
unsustainable fiscal deficits by sheltering their assets
abroad, and real exchange rates rose excessively. These
difficulties became especially acute in countries which had
leveraged earlier windfalls from the commodity boom into
excessive foreign borrowing to support dubious investment.
projects. When the boom ended, the resulting revenue contraction, combined with ongoing spending commitments, precipitated
fiscal and external debt crises.
The subsequent (and necessary) preoccupation of the major
debtor governments with stabilization has forced adoption of
fiscal austerity programs. Fiscal austerity had two elements:
spending cuts (fiscal policy) and improved revenue-raising
capabilities (tax policy). In some of the initial attempts
to cut back spending, however, fiscal austerity had the
unfortunate effect of reducing spending for programs that
help the truly poor. The challenge for structural adjustment.
in the areas of fiscal and tax policy has been to introduce
reforms which reduce deficits, encourage sustained growth,
minimize transitional costs, and establish a foundation for
relaunching efforts to alleviate poverty.
The reform of fiscal policy has been central to the structural
reform programs encouraged as part of the current debt strategy.
A few generalizations have emerged on the elements of sound
fiscal policy:
(1) Governments need to set spending priorities.
(2) Spending should be targeted to areas where government
participation may be necessary for a well-functioning
market, and economic growth, including primary education,
and transportation infrastructure.

- 6 -

(3) Governments should avoid interfering where markets
could be expected to operate effectively. Public
investment in direct production or marketing of
agricultural or industrial products is rarely justified.
(4) State-owned enterprises should be privatized where
feasible, and, where full privatization is not yet.
possible, their claims on government financial
resources should be reduced.
(5) Subsidy programs, particularly when they favor a
particular sector or privileged group, must be
reduced and eventually eliminated. Subsidy programs
designed to promote exports, affect investment and
production, or to control prices usually run counter
to achieving sound, sustainable growth.
Structural reform must usually encompass substantial
reform of the tax system. The effort to reduce large public
deficits tempts policy makers to rely on significant increases
in existing taxes. However, an increase in the rate of tax,
particularly when the tax base is narrow, introduces disincentives
and increases economic costs. Furthermore, developing country
governments often rely on tariffs or taxes on exports because
they generate revenue with limited administrative costs.
However, trade taxes distort investment, production, and
consumption decisions. Their impact is protectionist, often
insulating particular sectors of the economy from foreign
competition and creating an artificial privileged class
within the economy.
To provide the proper foundation for growth-oriented policies,
tax reform needs to focus on restructuring systems to increase
the efficiency of tax collection, reduce distortions, and
minimize the burden on the poor. In reforming tax systems,
a few basic precepts come to mind:
(1) The tax base should be as broad as possible, so that the
burden to raise additional revenue is spread equitably
throughout the economy, rather than borne by a few
sectors or groups.
(2) The structure of the tax system should avoid
determining patterns of production, trade, consumption,
saving, and investment.
(3) Developing countries should shift away from their
reliance on trade taxes, whether in the form of
export taxes or tariffs on foreign goods. Export
taxes reduce the competitiveness of exports,
discriminate against sectors with international
competitive advantages, and are counterproductive
to efforts to increase foreign exchange earnings.
Tariffs protect inefficient local producers, and
misallocate domestic resources.

(4)

More emphasis should be placed on realistic user fees,
so that those groups or individuals which receive
particular services from the public sector pay for
the cost of the services if possible.

(5) Tax systems should be simplified by reducing the
number of different rates and the number of exemptions.
Such reforms not only ease the collection burden
but reduce the risk of circumvention by the priveleged.
Structural reform usually requires reform of the two
major prongs of public finance, expenditures and taxation.
public finance can be a powerful tool for alleviating poverty.
Structural reform is a necessary foundation for sustainable
growth, the precondition for defeating poverty in both the
medium-term and the long run. At the same time, an inordinate
share of the transitional costs of adjustment may be borne by
the poor. For this reason, the -United States has been supportive
of the World Bank's policy-based social sector loans, an
innovative approach designed to ameliorate the social costs
of adjustment and/or improve the efficiency of existing social
programs to help the poor. Such lending can be effective as
a bridge during the difficult adjustment process, provided it
is well-targeted and used in an overall economic framework
which promotes an improved policy environment.
Financial Sector Liberalization
Financial markets — money, bond and equity markets, and
non-bank financial institutions — are with few exceptions
still relatively undeveloped in many developing countries.
A number of developing countries inadvertently disciminate
against the development of these markets owing to distortions
caused by interest rate controls and overvalued exchange
rates, onerous tax policies, subsidized loan schemes and the
practice of selling government bonds at below-market rates
to captive holders.
The debt strategy that I outlined earlier helped deal
with the need for domestic savings mobilization and on the
crucial role of equity in the financial system, which can
serve as a buffer against external shocks, such as lower
commodity prices and export earings, as countries become
less dependent upon external finance.
Measures to increase investment and develop domestic
capital markets must be an integral part of any policy package
that seeks to raise the rate of growth on a sustainable
basis. The reduction in public sector deficits, as I detailed
earlier, is likely to be an important component of the domestic
resource mobilization effort. Private saving is also important,
and can be promoted by allowing market forces to play a greater
role in determining interest rates. Positive real rates of
return on investment will also help to dampen consumption, and
may help attract flight capital, which is the cheapest and
most permanent form of investment.

- 8 -

With appropriate investment policies in place, much
more foreign direct investment will accrue to developing
countries. The benefits of foreign investment are manifold;
it expands the pool of available financial resources, brings
technical know-how, managerial and marketing expertise, and
has advantages over bank borrowing in that an outward flow of
earnings is unlikely to arise during stressful periods. I
understand the political questions that are sometimes posed by
foreign investment but the economic benefits are so great.
Trade Liberalization
The agenda for policy reform often must include the revamping
of restrictive trade regimes.
In the fifties and sixties, many believed that developing
countries could not open their markets to foreign competition
and at the same time achieve rapid development. It is time to
lay that myth to rest. We now know that trade liberalization
improves rather than damages the performance of developing
economies.
Trade barriers simply promote the development of uncompetitive industries that displace imports. These industries soak
up resources in a wasteful manner that developing countries
can ill afford. Often excessively capital intensive, these
industries absorb too much of the capital that is scarce in
developing countries and too little of what is abundant—labor.
Since protected industries face minimal competition, they are
frequently high-cost, low-quality producers which can only
export if subsidized.
The result is chronic balance of payments problems for
countries that adopt this inward-oriented development strategy,
and chronic reliance on trade restrictions. A vicious cycle is
created: protection leads to uncompetitiveness which leads to
payments problems which leads to more protection.
In contrast, outward-oriented countries have performed
markedly better. They have grown and developed substantially
faster, while avoiding chronic balance of payments problems.
They use resources more efficiently, as indicated by lower
incremental capital-output ratios, and they adjust better to
external shocks.
Importantly, this better performance does not just benefit
a few owners of capital in the modern industrial sector. It also
benefits workers and it benefits the agricultural sector.
In a study of 41 developing countries, the World Bank found,
for example, that manufacturing employment grew considerably
faster in outward-oriented countries as a group than in
inward-oriented countries. In addition, agricultural value
added, as well as manufacturing value added, increased more
rapidly in outward-oriented countries.

Income not only rises faster in countries with liberal
trade policies, it is distributed more equitably. Rapidly
growing exports in outward-oriented countries tend to be
relatively labor intensive. This labor intensity increases
the demand for labor and drives up wages over time. For
countries like Hong Kong and Singapore, the share of income
going to the poorest segments of the population increased in
the sixties and seventies as the benefits of liberalized
trade policies took effect.
Agriculture Policy Reform
The agricultural sectors in developing countries contribute
about 20 percent to GDP and over 60 percent of total employment
(WB data 1982-84). For the poorest countries, the agricultural
shares are much larger. This is often an issue of how well
people eat. Consequently, agricultural policies in these
countries not only dictate performance in the agricultural
sector, but they have major implications for their entire
economies. Several countries have made considerable progress
in raising agricultural productivity and food supplies.
Others, however, have adopted policies which are biased
against agriculture and frustrate the objectives of increased
food supplies and incomes for their people.
In many cases, the agricultural policies in developing
countries are the opposite of those in developed countries —
instead of supporting producer prices above world market levels
they tax producers directly or indirectly to the point that
prices received by farmers are below world levels. In other
instances, governments provide substantial export subsidies for
major export crops to generate foreign exchange earnings that
can pay for high levels of imports. Because of these policies
capital, land, and human resources are badly misallocated
causing a severe drag on economic growth.
The first step for agricultural reform in developing countries
is often to allow the farmer to receive market prices. This
will give them incentives to raise production of those commodities
in which they have a comparative advantage and to use available
resources more efficiently. Sometimes this means more exports
but usually the biggest impact is that the people in the country
eat better.
Farmers' production and marketing opportunities often are
much better over time if input subsidies to farmers and food
subsidies to consumers are reduced, especially if combined
with improved distribution systems. In addition, the government
would save substantial amounts in budget expenditures.
Several people have pointed out that developing countries
cannot be expected to undertake these steps to expose their
farmers to the instability in world markets, often caused by
industrial country policies that dump subsidized surpluses.

- 10 -

The United States agrees in principle and it has proposed
multilateral agreements to eliminate policies that distort
agricultural trade. Nevertheless, there are many policy reforms
that can be implemented unilaterally to raise the efficiency
of the agricultural and food sectors in poor countries. Then
the distortionary border measures can be phased out later as
part of the Uruguay Round commitments.
Removal of trade distorting measures by all countries
should enhance the economic performance of LDCs in several
ways. Reduced price instability in world markets should
positively benefit both importing and exporting developing
countries. The current system of highly insulated agricultural
systems tends to exacerbate world price swings for those
who depend on world markets for their income or their food.
New market opportunities would open up for efficient producers
as the less efficient redirected their resources to other
products where they have a comparative advantage. Clearly,
it is in the interest of developing countries to participate
actively in agricultural reform and trade liberalization that
will spur economic growth.
One estimate indicates that developing country liberalization for selected commodities could result in gains of nearly
$30 billion to themselves. World prices of most commodities
would rise along with world trade.
We recognize, however, that the collective advantages of
reform may not extend immediately to developing countries
individually, owing to their particular stage of development.
For this reason, the United States in the present Uruguay Round
of multilateral trade negotiations on agriculture acknowledges
that consideration should be given in the trade liberalization
process to the needs of countries whose adjustments to a freer
trade environment would be a severe hardship. Also, some LDCs
are not mature competitors in world agricultural trade and
will be unable to undertake fully policy adjustments as called
for by negotiated agreements among the leading world traders.
Nevertheless, the enhanced economic opportunities of trade
liberalization will be shared by all countries regardless of
their relative standing in the world economy, and all will need
to share in the reform effort.
The Effect of Adjustment on the Poorest
In summing up my remarks on the importance of structural
reform, I believe it worthwhile to take a few moments to
focus on the relationship between adjustment polcies and
poverty. The implications of adjustment — such as reduced
consumption, import reductions, and shrinking resources for
health, education and welfare — can vitally influence the
viability
Structural
of adjustment
adjustment
programs.
should incorporate positive steps
to safeguard the long-term interests of the poor. For example,

- 11 -

financial reform can increase the supply of loanable funds
available to the poor by raising foreign and domestic savings
rates, and reducing the role in rationing in allocating credit.
Programs could also support increased credit to agriculture.
Other measures include removing price controls; the poor
are often the hardest hit by high prices prevailing on black
markets, since they typically lack access to goods at official
prices. Depreciating the exchange rate can raise the real
value of earnings of the poor engaged in export production.
And shifting public expenditures that utilize the skills
of the poor by expanding labor-intensive programs will also
improve the position of the poorest.
Some countries may need to establish compensatory measures
to protect the poor who suffer immediate adverse effects from
policy measures aimed at restructuring production. Similarly,
emergency employment schemes and changing the composition of
social expenditures may be required.
Ideally, adjustment programs can act as a catalyst for
governments to find more efficient and better targeted
instruments to protect vulnerable groups.
Conclusion
A prime objective of the United States is to foster
sustainable growth and development in the third world. In
my view, major structural reform is the only viable approach
for the developing countries to break out of the cycle of
poverty that results from continued stagnation. In this
regard, I am happy to say, sound economic attitudes and efforts
are spreading across the developing world as countries increasingly recognize the importance of market-led growth. It is
all the more incumbent on us in the industrialized countries,
therefore, through our support of the multilateral development
banks, as well as through bilateral efforts, to ensure that
there are sufficient financial resources to support the
meaningful structural reforms being undertaken by developing
countries.
I look forward to discussing these issues with you today.
Thank you.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
EMBARGOED FOR RELEASE UNTIL DELIVERY
Expected at 2:00 p.m. EST
STATEMENT BY
DAVID MALPASS
DEPUTY ASSISTANT SECRETARY
FOR DEVELOPING NATIONS
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON INTERNATIONAL TRADE
OF THE
COMMITTEE ON FINANCE
UNITED STATES SENATE
JUNE 10, 1988
Introduction
Mr. Chairman, I welcome the opportunity to discuss economic
development in Central America. The bill before you, S. 2252,
raises some timely questions.
In my testimony today, I would like to briefly describe an
economic policy environment in which developing countries could
prosper, relate that environment to the Central American
democracies of Costa Rica, Guatemala, El Salvador, and Honduras,
and provide some specific comments on S. 2252.
Toward strong economies
The primary economic development lesson of the 1980s is the
importance of market-based economic systems. Some countries,
such as the strong economies of southeast Asia, are well along
in absorbing this approach, and are prospering. Others, such as
China and perhaps the Soviet Union, have recognized this lesson
and are testing its principles. In the developing world of Latin
America, and, increasingly, of Africa, leaders are choosing
market-based economic systems in order to successfully attract
flight capital, external financing flows and foreign investment.
The political foundations for such systems are democracy, a
respect for individual rights, and non-threatening neighbors.
With these foundations, and the personal and national courage to
undertake economic changes, we believe that the four democracies
of Central America would have good prospects for sustained economic
growth.
B-1448

-2-

While I do not bring a blueprint for running sound economies,
I believe that some politically difficult changes clearly need to
be taken by the countries of Central America. This effort should
obviously begin in Nicaragua, which is breaking all of the
principles of sound economics and whose people are suffering as a
result. But this hearing is on the democracies, so I would like
to discuss two principles applicable to them.
An open economy is the starting point for economic progress.
There are several key facets. First, the private sector must be
allowed access to capital, including foreign exchange. Second,
capital and goods must be allowed to flow easily into and out of
the economy. Investment capital, and therefore jobs and growth,
will shun an economy which places controls on it. Third, marketbased prices must be the clearing mechanism for goods, foreign
trade, the labor force and exchange rates. Fourth, an open
economy requires a. non-confiscatory tax system, one which leaves
much of the profit with those who earned it.
Sound government macroeconomic policies are equally
important. In addition to removing market restrictions which
close the economy, governments must leave more resources and
challenges to the non-government sector. Governments don't make
profits, so it is crucial that spending by the governments and
related parastatals be brought under control. Sound monetary
policy has eluded Central America in recent years. Printing
presses have been used to meet government payrolls, undermining
currencies that were once stable. The resulting inflation has
led to a severe misallocation of resources and of people's time
and energy.
While these principles are generally accepted, perhaps
even in the countries themselves, they are not being applied
assiduously. I would like to review each of the economies,
pointing to some of the key economic reforms which should be
undertaken.
Costa Rica. In the early 1980's, Costa Rica was adversely
affected by the rise in interest rates, deteriorating terms of
trade, and collapse of regional markets. Although Costa Rica
has introduced economic adjustment measures over the years,
these efforts have surged and waned throughout the decade and
have not had a lasting impact. Nonetheless, Costa Rica has made
some commendable progress on economic reform on several fronts,
leading to growth of over 4.5% in 1986 and 3% in 1987,
respectively. The government has reduced the real value of the
public sector wage bill and cut price supports for basic grains
from the State's Agricultural Agency. Costa Rica also continues
a flexible exchange rate policy with mini-devaluations of the
colon and is making great strides towards becoming a member of
the Generalized Agreement on Trade and Tariffs later this year.

-3-

The World Bank is working closely with the government of
Costa Rica to support efforts to reform the financial sector.
Costa Rica's National Development Corporation (CODESA) is working
with the assistance of U.S.A.I.D. on a. significant divestiture
program. Although two major CODESA subsidiaries have been sold
to the private sector in recent, years, Costa Rica must make
further progress on the nearly forty remaining CODESA enterprises.
Costa Rica's economy continues to be dependent on
agricultural products such as coffee and bananas. Given its
heavy debt, burden and its vulnerability to agricultural export
prices, Costa Rica needs to continue to develop and diversify
its non-traditional exports. Some progress has already been
made, but this must be supported by institutional reforms, such
as simplifying the administrative procedures to enhance exports
and to open the economy to foreign investment.
Internally, Costa Rica must concentrate on building confidence
in its troubled financial sector so as to attract private deposits
and support domestic investment. As a. temporary measure, the
Central Bank must tighten credit through ceilings on individual
deposits to release resources for lending to troubled private
commercial banks. Eventually, the government will have to place
greater reliance on monetary instruments for such short-term
adjustments. A deposit insurance scheme, recently announced
by the Central Bank, should be implemented as soon as possible.
Guatemala.. Vinicio Cerezo, the civilian president elected in
1986, inherited an economy characterized by uneven distribution
of land and income, unemployment and underemployment affecting
over 40% of the active population, stagnated foreign trade due to
an unmanageable multiple exchange rate system, and depressed savings
and investment. In his first year in office, Cerezo instituted
a major economic stabilization program which reversed several
years of economic decline. This set. the stage for 2.5% real GDP
growth in 1987 and possibly 3% in 1988.
The government is working on its diversification from
agricultural products — which account for 2/3 of its exports.
Monetary reforms, including positive real interest rates and
higher reserve requirements, have also been instituted. These
policies lowered inflation from 40% in early 1986 to 10% in
1987. The government also simplified the exchange rate regime
from more than thirty rates down to three.
However, several problems arose in 1987 which the government
must now address. The country's principal focus must be fiscal
discipline to allow room for increased private investment. The
government could start by eliminating the foreign exchange subsidy
to INDE, the power authority, either by unifying the three-tiered
exchange rate which provides the subsidy or by bringing utility
rates in line with the operating costs of the institution.

-4-

Honduras. During the 1984-86 period, the economy expanded at a
moderate pace with low7 inflation. However, the fiscal and balance
of payments situation continued to deteriorate. In 1987, Honduras
initiated an economic program designed to assure continued growth
and a strengthened balance of payments position, coupled with
structural reforms. Real GDP grew by 4% and an inflation rate
of 2.4% was the lowest in Latin America. But slippages in the
program have caused a serious financial crisis. In 1987, the
fiscal deficit came to more than 7% of GDP, the balance of payments
current account, deficit came to almost 8% of GDP, and external
arrears increased, including arrears to the IMF, the World Bank,
and the IDB -- Honduras' largest, creditors.
Honduras is now working closely with the IMF and World
Bank on a reform program. In February, the government, took
steps to curb the fiscal deficit by freezing government salaries
and positions, limiting all current, expenditures for goods and
services to the 1987 level, and reducing transfer payments to
parastatals and autonomous agencies. The first steps have already
been taken to make the economy more competitive by reducing
export, taxes and expanding the scope of the parallel market.
Honduras must adopt a more market-oriented foreign exchange
and trade system in order to diversify its export markets.
The central government, must strengthen its control over the
hiring and pricing policies of state enterprises, and quicken
the pace of divestment of these enterprises.
El Salvador. The economy has been burdened by a prolonged
guerrilla, war and the earthquake of October 1986.
The pace of economic recovery and reform has slipped. El
Salvador has maintained negative real interest rates, high
export taxes, an overvalued currency, extensive price controls,
and low tariff rates on public utilities. These policies
reinforced capital flight and discouraged exports. The 1988
Economic Plan will correct some of these distortions. Measures
have been designed to improve fiscal performance, stimulate the
growth of exports, and spur production. Price controls, import
controls and subsidies have been significantly reduced. The
freeze on public employment and wages has been continued. Some
utility rates have already been raised. A tight monetary and
credit policy will be used to keep the inflation rate below 20%.
Additional measures, however, are required. El Salvador
needs positive real interest rates and a more flexible and unified
foreign exchange system coupled with a reduction in export taxes.
Strengthened management, of state enterprises will also be imperative
in order to reduce pressure on central government finances.

-5-

S.2252 and the Role of Securitization
I would now like to provide some comments on S. 2252 in the
context of this economic overview. We profoundly share the
purpose of the bill, promoting economic development, in Central
America. The bill proposes three steps to assist in this:
securitization of debt, using U.S. government guaranteed bonds
issued by these countries in exchange for their obligations to
commercial banks; a. reduction in the interest rates on U.S.
government loans to those countries; and an increase in U.S.
sugar quotas for the region, so as to boost their export earnings.
The current international debt strategy is built on a caseby-case, market-oriented approach based on sound economic reforms
with external financial support. We cannot endorse either
sweeping debt forgiveness or broad based guarantee proposals,
and have been on the record many times with regard to this
fundamental policy. Schemes which shift risk from commercial
banks to the public sector run counter to the key tenets of the
debt strategy, in that they would afford debtor countries little
incentive to undertake needed reforms, and would likely choke off
commercial bank flows for years to come. I would also note at
this juncture that it. is both unrealistic and unreasonable to ask
the U.S. taxpayer to pick up the tab on an "exit" vehicle for
foreign banks.
With regard to securitization of outstanding commercial bank
claims, we are supportive of private, voluntary efforts to
repackage sovereign loans, which can afford debtor nations debt
relief and their commercial creditors better quality assets, as
in the case of the recent. Mexican debt-for-bond swap.
Such voluntary, market-driven securitization techniques
may be attractive to both debtors and commercial banks, if
appropriately designed. For example, the Mexican bond proposal,
with collateralization of principal, attracted a wide range of
bids from numerous banks. We expect to see more of these
proposals in the period ahead. And the surest demarcation of a
return to normal financial relations is access to international
capital markets. We are beginning to see progress on this
front — Venezuela and Colombia have, within the past year,
raised funds in the euromarkets, and Chile is planning to access
the markets in the next few years, once the country begins to
make principal repayments on its outstanding obligations.
As we interpret this legislation, all commercial banks,
both foreign and domestic, could voluntarily tender their sovereign
claims to the four countries at a discount, in exchange for a
new security that is backed by the full faith and credit of the
U.S. government. If the legislation were interpreted as mandatory
and U.S. commercial banks were required by law to tender their
claims, this would raise a host of additional concerns.

-6Again, as the legislation is drafted, the discount would
be set by the secondary markets. While we strongly endorse letting
the market value financial transactions — as in the case of
the two recent. Brazil debt/equity auctions and the Mexican debt/
bond offering — this secondary market is not a valid proxy for
the value of bank claims. The market is thin and supply outweighs
demand. Thus, the process of ascertaining the fair value of
these credits can be difficult, and highly judgemental.
By way of background, well developed secondary markets
have depth and breadth, and are usually supported by primary
markets. In the usual sense of the term, the existence of a
secondary market for any asset also implies that there is
some homogeneity of obligors, terms, and legal underpinnings
for the instruments traded. However, little of this infrastructure is found in the market for LDC debt. We believe
that prices currently being quoted reflect the fact that it is
still a very thin and imperfect, market. Indicative prices
published by Salomon Brothers, for example, have wide bid/offer
spreads. A million-dollar deal can move the market. Thus, this
secondary market, is more like a bazaar, with individual buyers
and sellers haggling over the terms of each transaction.
The proposal in S.2252 would politicize the debt work-out.
process in several ways. First, by offering a U.S. government
guarantee of the newly-issued bonds, secondary market prices
would rise in anticipation, increasing the contingent liability
of the U.S. government. The U.S. would inevitably become enmeshed
in the negotiation between the countries and their commercial
banks in an effort, to find a "fair" price for the transfer.
Second, the bill itself makes a political value judgment, offering
two countries the opportunity to transfer 100 percent of their
debt, and the two others only a 40 percent opportunity.
This is the type of dilemma the U.S. government, would be in if
this technique — the selective offer of the full faith and
credit, of the United States — were enacted. Furthermore, other
countries may merit U.S. government support as much as these
four, leading to a diplomatic nightmare and a lobbyist's
dream.
In examining this proposal, we should keep in mind that
U.S. government guarantees are not costless. The U.S already
has a large national debt, to finance, and, in this end, the
provision of guarantees is likely to add to it.
The bill also suggests an initiative aimed at reducing the
interest rates on claims owed to the Unites States government.
If Congress legislated such an initiative, it. would likewise
have to appropriate funds to make up the interest rate differential,
4 percent, in this case. Alternatively, the increased net outlay
in the 150 account would have to be offset, which would reduce
funds available for other debtor countries, including the poorest
countries of Sub-Saharan Africa and the multilateral lending
institutions. Reducing rates of interest on U.S. government
loans to a select group of developing countries would also

-7establish a precedent for similar treatment of other U.S. government
assets. Thus, the proposal would provide a relatively small
savings to Central America at. a large cost to the U.S. government.
I would like to conclude this section by returning to
what I believe is a. common objective between us — securing
strong economies in the region. I do not. believe that the
blanket debt, guarantee proposed in this bill will lead to
better economic systems in the region. Instead, it appears
that it would perpetuate dependency on the U.S. and broaden
it to a new area.
Sugar Import Quotas
U.S. quotas in general cause a tremendous loss of income
to developing nations and to U.S. consumers. With respect to
sugar quotas, the only permanent solution is the elimination of
the disparity between domestic and world prices, by opening
the U.S. market, to domestic and foreign producers on a more
competitive basis. We recognize that this goal would have to
be achieved over several years and that the reform should be
based on a. multilateral agreement among sugar trading nations.
The Administration currently supports pending legislation in
the Congress (S.1948) with certain modifications, including
authorization to lower the existing high price supports.
Conclusion
To conclude, I believe that the purpose of the bill is
meritorious. Economic development in Central America is
important, to all of us and should be pursued.
However, the proposals in the bill would have consequences
and costs far beyond Central America, and must, be evaluated in
that, context. I look forward to a discussion here today on
these issues.
Thank you, Mr. Chairman.

TREASURY NEWS

Department of the Treasury • Washington, D.c. • Telephone 566-2041
PREPARED STATEMENT OF R. RICHARD NEWCOMB
DIRECTOR, OFFICE OF FOREIGN ASSETS CONTROL
DEPARTMENT OF THE TREASURY
before the
SUBCOMMITTEE ON INTERNATIONAL ECONOMIC POLICY AND TRADE
COMMITTEE ON FOREIGN AFFAIRS
U.S. HOUSE OF REPRESENTATIVES
WASHINGTON, D.C.
June 8, 1988
U.S. Government Embargo Programs
Chairman Bonker and Members of the Subcommittee:
My name is R. Richard Newcomb and I am the Director of the
Office of Foreign Assets Control at the Department of the
Treasury.

I welcome the opportunity to appear before the

Subcommittee today to discuss U.S. Government embargo
programs administered by the Treasury Department and
subsidiary trade with Cuba and to comment on H.R. 4692.
This bill would provide an exemption from United States
trade embargoes imposed in peacetime for exports of
agricultural commodities produced in the United States.

The Office of Foreign Assets Control ("FAC") has primary
responsibility for administering trade and financial
sanctions imposed by the President against other countries
under authority of the International Emergency Economic
Powers Act ("IEEPA") Section 5(b) of the Trading with the
Enemy Act ("TWEA"), and the International Security and
Development Cooperation Act.
R-1449

The Office also has

- 2 -

responsibility for administering the sanctions program
against South Africa imposed by Congress under the
Comprehensive Anti-Apartheid Act of 1986.

I will first describe Treasury's principal economic
sanctions programs, including the embargo against Cuba. I
will then describe the policy under which FAC issues
licenses on a case-by-case basis for certain export and
import transactions with Cuba by foreign subsidiaries owned
or controlled by U.S. companies. I will then discuss the
data Treasury has gathered since 1982 concerning licensed
subsidiary trade with Cuba (tables providing this
information are attached to the copies of my written
statement provided to the Subcommittee). I should note that
this information on subsidiary trade with Cuba is provided
in response to a specific request, although the bill deals
with exports from the United States rather than with trade
by foreign subsidiaries. Finally, I will comment on issues
raised by the proposed legislation which are of concern to
the Treasury Department.

I should note that FAC lacks information concerning some of
the points listed in the Chairman's May 22, 1988 letter to
Secretary Baker. These areas, including the effectiveness
of achieving foreign policy objectives of previous embargoes
of American agricultural exports against certain nations;
the economic impact of agricultural expert restrictions on

- 3 -

American farmers and exporters; the effect of such embargoes
on foreign perceptions of the U.S. as a reliable supplier of
agricultural commodities and other goods; and an estimate of
the global market share lost for American agricultural
exports because of past and present embargoes, may be better
addressed by the Departments of State, Commerce, or
Agriculture.

I . THE PR IN CI. P A L T RE A SURY E M B A R G 0 P R 0 G R A M S

A - iP_es°_CiP_.tions__pf the _Prqgrams

1. Cuban As.se ^ sQQn tr; o_ 1 Re gu 1 a tions

The sanctions against Cuba include a freeze on Cuban assets
in the U.S. and prohibitions on exports and imports,
financial and transportation-related transactions, and
t

certain travel transactions. They apply to any person
subject to the jurisdiction of the U.S., including foreign
branch offices and subsidiaries of U.S. firms, although
exceptions are licensed on a case-by-case basis under
certain circumstances for trade with Cuba by foreign
subsidiaries of U.S. firms. The Cuban Assets Control
Regulations are published at 31 C.F.R. Part 515 and are
issued under the authority of Section 5(b) of the Trading
With the Enemy Act, 50 U.S.C. App. Section 5(b).

- 4 -

2•

E,or.g.A9.n_ Assets Control Regulations

The Foreign Assets Control Regulations impose sanctions
against Vietnam, Cambodia and North Korea, including an
assets freeze and export, import, financial and
transportation prohibitions. These sanctions apply to any
person subject to the jurisdiction of the U.S., including
foreign branch offices and subsidiaries of U.S. firms.
Unlike the Cuban Assets Control Regulations, no policy
exists to permit the specific licensing of trade by foreign
subsidiaries o*f U.S. firms with Vietnam, Cambodia, or North
Korea. The Foreign Assets Control Regulations are published
at 31 C.F.R. Part 500, and are issued under the authority of
Section 5(b) of the Trading With the Enemy Act, 50 U.S.C.
App. Section 5(b).

3 • N.iL?..'^€9.yjJlJLCSLI^J! Control Regulations

The sanctions against Nicaragua include export, import and
certain transportation prohibitions. They apply to exports
and imports between the United States and Nicaragua, but not
to trade in non-U.S.-origin goods between Nicaragua and
foreign branch offices or subsidiaries of U.S. firms, or
U.S. individuals located abroad. Thus U.S. nationals can
broker or facilitate trade in non-U.S.-origin goods between
the United States and Nicaragua. The sanctions against
Nicaragua do not include an assets freeze or a prohibition

- 5 -

on financial transactions in general, such as direct loans,
unlike the Cuban Assets Control Regulations or the Foreign
Assets Control Regulations. However, financial transactions
related to prohibited exports and imports (for example,
trade financing) are not allowed. The Nicaraguan Trade
Control Regulations are published at 31 C.F.R. Part 540 and
are issued under the authority of the International
Emergency Economic Powers Act, 50 U.S.C Sections 1701 1706.
4

• Libya_n_ _San_c t i.ons_Regu 1 a t.1 ons

The sanctions against Libya apply to any United States
person, which includes foreign branch offices but not
foreign subsidiaries of U.S. firms. The sanctions include
an assets freeze and export, import, financial,
transportation, and travel transaction prohibitions. The
Libyan Sanctions Regulations are published at 31 C.F.R. Part
550 and are issued under the authority of the International
Emergency Economic Powers Act, 50 U.S.C. Sections 1701 1706.

5 . Sou t h _A f ri.c a n_ Xr a n s .^ tions

The sanctions against South Africa include prohibitions on
certain imports (including South African agricultural
products) and certain exports (computer, military, and
nuclear-related items). They prohibit certain financial

- 6 -

transactions, such as new investments in South Africa and
loans to South Africa. The sanctions generally apply to any
United States person, which includes foreign branch offices,
but not foreign subsidiaries, of U.S. firms. The South
African Transactions Regulations are published at 31 C.F.R.
Part 545 and are issued under the authority of the
Comprehensive Anti-Apartheid Act of 1986, 22 U.S.C. 5001 5116.

6

• Iranian Transactions Regulations

These regulations prohibit importation into the United
States of goods and services of Iranian origin. Unlike the
Cuban Assets Control Regulations and the Foreign Assets
Control Regulations, they do not freeze Iranian assets in
the United States. They are published at 52 Fed. Reg. 44076
(Nov. 17, 1987) and are issued under the authority of
Section 505 of the Internationa] Security and Development
Cooperation Act of 1985, 22 U.S.C. Section 2349aa-9.

I should point out that formerly FAC administered a complete
embargo on trade and financial transactions, as well as an
assets freeze, with respect to Iran. This embargo, under
the Iranian Assets Control Regulations, 31 C.F.R. Part 535,
and the International Emergency Economic Powers Act, 50
U.S.C. Sections 1701 - 1706, was imposed in response to the
taking of U.S. hostages by Iran in 1979. The embargo was

- 7 -

largely lifted in January 1981, pursuant to the Algiers
Accords, which secured the release of the hostages.
However, the basic framework of the Regulations has been
kept in place in order to implement certain provisions of
the Algiers Accords as an adjunct to the effective
functioning of the Iran - U.S. Claims Tribunal at the Hague.

7

• Panamanian Transactions Regulations

These sanctions block all U.S.-located assets of the
Government of Panama and prohibit payments and financial
transactions, with certain exceptions, with the
Noriega/Solis regime emanating from the United States, or
from U.S. persons and subsidiaries located in Panama.
Exports from and to private parties are not prohibited. The
regulations are published at 53 Fed. Reg. 20566 (June 3,
1988) and are issued under the authority of the
International Emergency Economic Powers Act, 50 U.S.C.
Sections 1701 - 1706.

B . P_olic..y_ Objectives of the Programs

Treasury assets freezes and embargo regulations have a
number of policy objectives. They impose economic pressure
on specified foreign countries for purposes of implementing
United States foreign policy objectives such as, formerly,
pressuring Iran to release U.S. hostages or, currently,

- 8 -

influencing Cuba to end its adventurism in Central America.
A major goal of Treasury's regulations is to deny target
countries access to U.S. products. Treasury regulations
also prevent the countries subject to them from earning
foreign exchange from transactions with U.S. nationals or
U.S. capital markets, as such foreign exchange could be used
for purposes contrary to our national goals. In the case of
Cuba, the embargo is particularly significant because of the
proximity of the United States to Cuba. Such proximity
would, absent the embargo, make the United States an obvious
low-cost supplier of goods to Cuba and the natural market
for Cuban goods.

Another important objective of the controls, common to the
Foreign Assets Control and Cuban Assets Control Regulations,
is to maintain the U.S.-located assets of the target
countries in a blocked status as a bargaining chip for use
in negotiating an eventual normalization of relations and
claims settlement. The assets constitute important
collateral for settlement of U.S. private property claims
for expropriation, defaulted bank loans, unpaid U.S exports,
and other claims.

11 - SPECIFIC LICENSING OF SUBSIDIARY TRADE WITH CUBA

From the inception of the Cuban embargo in July 1963, until
October 1975, the Cuban Assets Control Regulations

- 9 -

effectively prohibited virtually all trade transactions by
foreign subsidiaries of U.S. firms with Cuba. However, in
the mid-1970's, a South American subsidiary of a U.S. firm
received a valuable order from Cuba for a shipment of
trucks. Its application for a license to make the shipment
was denied. This resulted in strong diplomatic protests,
adding to existing pressures on the United States Government
to modify provisions of the Cuban Assets Control Regulations
affecting foreign subsidiaries of U.S. firms. At the same
time, the Organization of the American States, which had
formerly supported the embargo against Cuba, softened its
stand with respect to trade with Cuba. In light of these
pressures, Treasury published a regulation (31 C.F.R.
section 515.559) setting forth terms and conditions under
which specific licenses would be granted for certain kinds
of foreign subsidiary trade with Cuba. The essential
requirements of the policy are as follows:

(I) The transactions must be by a U.S. subsidiary, that
is, a foreign-incorporated American-owned or controlled
firm operating in a third country. If the foreign
entity does not have a separate foreign legal
personality but is merely a branch, office, or agency,
trade transactions (and other transactions) involving
Cuba can not be licensed.

- 10 -

(ii) Both imports from and exports to Cuba may be
authorized.

Service contracts can also be authorized.

(iii) Goods exported must be non-strategic. "Strategic
goods" are defined as items designated with the letter
"A" on the Commerce Department's Control List,
signifying strategic or sensitive items, as well as
items subject to State Department munitions controls,
or to regulations relating to the export of nuclear
energy facilities or materials.

(iv) No transfer of U.S.-origin technical data (other
than maintenance, repair, and operations data) is
authorized.

(v) Any U.S.-origin parts or components must be
licensed by the Department of Commerce.

Commerce

generally license re-export if the U.S.-origin
components do not constitute more than 20% of the
of the finished product.

(vi) Generally speaking, no U-S dollar accounts or
dollar financing may be involved.

(vii) No person within the the U.S. may be involved;
the subsidiary must act on its own and conduct the
transaction completely offshore.

Involvement includes

- 11 -

assistance or participation by a U.S. parent firm, or
any officer or employee thereof, in the negotiation or
performance of a licensed transaction.

(viii) The subsidiary must be generally independent of
the U.S.-based parent firm in the conduct of
transactions of the type for which the license is being
sought in such matters as decision-making, risk-taking,
negotiation, financing, or performance.

(IX) The law or policy of the country in which the
subsidiary is incorporated must require or favor trade
with Cuba.

(x) Agricultural goods are subjected to the same
licensing criteria as other products. Most
applications for licenses of any type are granted.

III. VOLUME QF J_ I.C ENJ3^^

Between fiscal years 1982 and 1987, FAC received a total of
1,279 applications for licenses for subsidiaries to engage
in trade with Cuba. This constituted an average of 213
applications per year, with the number of denials of
licenses ranging from none in 1982 to two in 1984. Few
licenses are denied, in large part due to self-selection
prior to the filing of applications by persons not meeting

- 12 -

the above-mentioned criteria.

During that time period, FAC

compiled selected statistical information on the
applications. FAC is currently in the process of entering
the licensing records into its automated licensing tracking
database.

The attached statistical summaries provide an analysis of
licenses issued for fiscal years 1982 through 1987. Table I
of the summaries lists the types of goods and commodities
licensed for export to Cuba each year, broken down by
consumable and non-consumable categories. From 1982 through
1986 a higher percentage of licensed exports in terms of
dollar value were consumables, such as grain and wheat,
while in 1987 the value of non-consumables exported was
greater. The total value of licensed exports to Cuba each
year ranged from a low of $87 million in 1983 to a high of
$162 million in 1985. The average amount exported per yearwas $114 million.

As far as imports are concerned, Table I indicates that the
two primary categories of commodities licensed for
importation by foreign subsidiaries were sugar and naphtha.
Relatively small amounts of molasses and tobacco were also
licensed for importation during this period. The total
value of licensed imports from Cuba to countries where
foreign subsidiaries of U.S. firms are located ranged from a
low of $55 million in 1983 to a high of $161 million in

- 13 -

1982.

The average amount imported per year was $145

million.

The value of exports to Cuba exceeded that of imports from
Cuba in four of the six years for which statistics are
available. It should be noted that wide fluctuations have
occurred in the total value of licensed exports and imports,
which may be due to international shortages and surpluses of
certain agricultural crops such as sugar and wheat. For
example, 1986 experienced a 23 percent increase in total
exports and imports over 1985, while 1987 experienced a 31
percent decline in total exports and imports from 1986.

In descending order of value, foreign subsidiaries in the
United Kingdom, Switzerland, Canada, and Argentina have
experienced the greatest dollar value of licensed trade with
Cuba, as is indicated in Table II of the summaries. These
countries, however, are not necessarily the source or the
ultimate destination of the commodities, as the companies
operating in them may merely be acting as brokers for goods
originating from or destined to another location.

An attempt was made to compile data for fiscal years
1975-1980, but because of the manner in which the original
data were maintained during those years, reliable data are
not available.

- 14 -

IV.

COMMENTS

Existing law already provides certain restrictions on the
President's authority under the Export Administration Act of
1979, as amended, to impose embargoes for foreign policy or
short supply reasons on agricultural products. The Treasury
Department is opposed to any legislation that would tie the
hands of the President by further restricting his ability to
prohibit exports of agricultural products to embargoed
nations during peacetime.

The ban on trade with Cuba limits the flow of goods to Cuba
and helps isolate Cuba economically. Cuba, with Soviet
political, economic and military assistance, has provided
widespread support for armed violence and terrorism in this
hemisphere. Cuba also provides and maintains troops in
various countries in Africa and the Middle East, a factor
that impedes political solutions to regional problems and
furthers Soviet foreign policy interests. It is important
to U.S. national security to counter Cuban efforts to
advance Soviet strategic goals. The Cuban regulations,
including the ban on export trade, inflict a clear and
substantial cost on Cuba for its support for subversion and
deny Cuba products and services that it could use to engage
in activities inimical to U.S. national security interests.
Trade embargoes against other nations, including Libya,

- 15 -

Vietnam, Cambodia, and North Korea fulfill similar goals
with respect to those countries.

It should be noted that the licensing of subsidiary trade
with Cuba is an unusual policy for trade embargoes under
TWEA, brought about by specific foreign policy pressures.
Trade embargoes under IEEPA or the International Security
and Development Cooperation Act have not been applied to
foreign subsidiaries of U.S. firms, and thus have not
involved this issue. The fact that the United States
Government was persuaded to institute such a policy in this
instance should not play a role in determining whether the
President should be forever precluded from using a ban on
agricultural sales as a tool of foreign and economic policy.
There may be countries in the future as to which a cut-off
of agricultural exports would work serious economic harm.
Similarly, there may be countries as to which the United
States Government would feel it appropriate to ban
agricultural exports based on actions taken by that
government against United States interests. we believe that
to place this tool out of the President's reach, in advance
of unknown emergencies that may arise in the future, would
be inappropriate and ill-advised.

Thank you, Mr. Chairman, I'll be pleased to respond to any
questions.

U.S. FORIXOI SUBSIDIARY TRADI WIT! CUBA
FISCAL TZARS /«P2 - /987
TABU X

A.

A»»t,ieiTTQlM

FT 1412

n ii»

FY 1114

n ma

FY 1114

1.

Applications
approved

103

14*

243

24S

247

/78

2.

Application*
denied

0

1

2

1

0

2

3.

Applications
not acted upon

7

•

f

10

2

I

170

1*3

2S0

sst

24t

201

TOTAL APPLICATIONS

FYH87

n. ZXPQKTS TO c m TW MTU.IONS OP n.i. DOLIAM* AND AS A vtucnmez.

Of TOTAL IRAK
1. O n in, Vhest, $ 4 $
$
and other
it %
consumables
2. industrial $44 $ 33 $34
and othsr
17 %
non-conaunablas

SS
f 22
f lot
f St
)l I
30 %
3t %
l« %
$ S3 $ 4t 4 7d~
23 %
12 %

It %

* **
2X7*

14 %

-.
"' '•
--

™

C. TWPOUTI mow eomx m WTT^TOWS OT n.i. POUJUTC* }^ ^ * Ff»miTigr
OF TOTAL TlAQg

1. Raphth* $ S4 $ 2t $120 $ 35 $ 45 * 33
21 %
20 %
44 %
12 %
2. Sugar $105 $24 $31 $ tl $ 1$1 i 8\
42 %
IS %
14 %
32 %
3. Tobacco $ 0.7 $ 0.4 $ 0.2 $ 0.2 $ 0.3 fo.Z
0.2$
0.3%
0.07%
0 %
4. Molassas $1 $0 $0 $0 $0 f b
0.4%
0 %
0 %
0 %
S. Others $0 $ 0.7 $ 0 $0 $0 to
0 t
0.5%
0 %
0 %
Subtotal Imports $ 141 $ SS $ ISO $124 $ 254 < 114
$4 %
20 %
SO %
44 %

It %

14%

$2 %

23%

0 %
0%
0 %
70 %

0. TOTAL EXPORTS $ 253 $ 142 $ 27S $ 2$$ $ 3S4 $ 2H3
ft IMPORTS
PERCENT INCRZASZ 21 %
(44) %
04 %
S %
23 %
(DICXZASZ)
I. BXPORT/ZKPORT 30/ $2/ 42/ St/ 30/ 5^
RATIO
$4
30
SO
SOURCE: U.S. TREASURY DEPARTMENT
Offleo of Persian Assets Control

MAT it** nee
••lumbers aro roundad. Items say not add to totals
duo to rounding.

44

70

0

fo
D

%

o %
ifl %

(3i)Z

A)<]

i

TABLE IX

U . S . DOLLAR VALUES OP LICENSED U.S. SUBSIDIARY TRANSACTIONS WITH CUBA
(ZN MILLIONS OP DOLLARS 9 )
FY 1986

FIVE YEAR fifi
TOTAL

$22.35

$103.04 0*f1

PY 1984

PY 1985

$10.00

$12.00

$31.69

0.40

0

0

0

0

• 40

Austria

0.10

0

0

2.39

0

2.49

Belgium

0.10

0.10

0.11

• 36

• 64

Bermuda

53.00

47.00

05.00

0

0

165.00

0

Brazil

0

0

0.02

0

0

.02

0

Canada

45.00

29.40

40.20

33.35

63.38

Costa Rica

0

0

0.02

1.35

0

1.37

0

Denmark

0

0.50

0

0

0

.50

0

18.00

0.03

0.20

1.29

5.06

COUNTRY

FT 1982

FY 1983

Argentina

$22.00

Australia

France
Italy
Japan
Mexico

0
0.10

0

0

0

°
0

1.31 /.38

211.33 *.#

24.58 lOtf

0

.67

• 67

.48 6-6

0.10

0.09

0.08

• 11

0.70

0.73

9.50

4.98

0

15.91 i.50

Netherlands

0.10

0.20

0.83

0.60

.87

Panama

1.00

0.50

25.00

0

0

Spain

0.00

4.00

5.00

7.59

10.93

Sweden

0.20

0.10

0.26

5.73

• 09

6.38 0.2/

0

17.00

82.03

63.30

76.34

238.77 it.ft

United Kingdom 107.00

31.00

43.08

130.47

168.54

480.09 toW

0

0.10

0

0

n

.10 # *

0.50

0.60

1.00

1.02

.17

3.29 oft

$253.00

$142.00

$275.00

$288.72

$354.13

S1307.42W

Switzerland

Venezuela
West Germany
TOTALS

n • Negligible (less than $ 10,000)
* • Numbers ere rounded, therefore totals may not add
SOURCE; TREASURY DEPARTMENT
Office of Foreign Assets Control
MAY ***?-tfd&

2.60

0

26.50 t 0
22.59

%4

COUBTBY
Aresmtime
AsstrslU
Assists
Belgium
Bermuda

tasm 111
w u t s p u.s. D M J A B warn* toe HCSMSBD wecKr/exKstr TWUCACTICMS urn* am* tt U.S. SUBBIBIASJBJ
"
(In millions of dollare)
FY m i
FY Ittl
PY 1114
FY 1115
PY lttt
FV Wl
Cubes" Qmea
Cubs* cdben
' Cuban Cuban
Omen Oman
' Cubes Omen
lepocta Impacts
lapocts Bspocts
•sports B B P O C U
lapocts Reports
IsparU exports
l~f E*f\, ,
OON. evens.
a n . w-cos.
COM, B-COM.
a n . R-ODSJ.
a n . w-aw.
Cent N-t
"1
l.ei U.88
1
1
OPH
1
I.M 3.M
1
llTle~XH
1
1.11 U.41 W,$ *>.$ 14
0
0
0.4$
0 0 0
0
0
0
0
0
8
0
t
t
0 0
0
t t t . l t
0 0 0
0
0
0
0
0
2.29
0
0
0
0
0 0
0
0
0.10
0
0
0.10
0
0
0.U
0
0.12 0.24
0
0.44 0.2$ $
I.X AT*
Sl.tt 0
0

0
0

21.0$ 2t.$ 0
0

0

0

0

0

0

0.40 14.$ ll.tt

t.2t 21.0$ lt.tt

0.1$

Costa Bios

0

0

0

0

0

0

Dsmmsrk

0

0

0

$.51 t

t

$

Frames

$

17.0$

0

t.tl

0

Italy

$

0

Japes

0

0

0.10

t t t . l t

t

t

t.tt

0

0

0.0$

0

Bmmioo

0

0

0

0

0.70

t

0

0.71

0

0

0.S0

Retmerlasds

t

0

0.10

0.2$ 0

0

0

0.10 t.ll

0

0.2$ 0.3$

Pamams

1.0$ 0

0

0

0.5

0

0

Opaim

0

0

4.0$

0

0

4.4$

$

Swedes

t

0

0.3$

0

0

0.10

0

Bvltserlamd

t

t

0

0

17.0 0

0

Oaited Bimgdom 105.0$ $
Veoeinele
$
$

2.0$
$

Rest Osrmamy

$.5$

$

$

0
0

0

0

24.0$ 2.$
0
0
$

$

0

l.tt
O.lt
$.4$

0.02

0

1.0$ 2t.0$ 15.0$

0

0

0

Canada

0

0

0

0

0

0

0

Brasil

&•$$

0

45.00

0

0.02

$

0
0

0

0
0.3$

0

2S.tt

0
0

1.3$

0

0

0

0
1.2$

0

0

0
0

0

0

0

0

0

$.« §

0

atf

0

0

4.10 0

O

3.5"

0

0

0.07 O

0

0

0

0

0

O

0

0.24

0

2.44 3.27

0

0

""•*•
mmmera r o e U . Item amy sot e M to totala due to tatt*.
O H . • OmeuMfcle goaas
S-OQR. •fen-Omeueefalegoads
s
• BJtllglbls

fcxmflli

1

l.M

0,l1 I T
O

0

t

>

0.U O

0.02 10.01 O

l.tt

|

0

0

t

O

O

2.4$ 5.13

$1.1$ 17.0$ 1.21
t
O
O

0

0

0

ll.tt t.tt 4.0$
t
t
t

O

0.47 0

5.0$

25.01 2.4$

°

O

O

$

35.0$

0

0

0

$.$3

0

0

•

U.23 31.0$ It. 15 0>l W.S |l3

0
0

0

0

0

35.00 27.0$

t

0

0

0

15.4$ 11.4$
0

0

0

t.tl O

$5.0 11.14

0

1

0.17 0

fBBJduW hpasmeatf
Of Clo* of Borelgs Assets Control
MAY ItOB /T0B

0

O.OZ

35.0 JA?

145.M 0.4$ 2.57 7 M
0
0
0
0
0
0

O.lb f.B~
O

£5*&3
/¥.»"
O 0.1

TREASURY NEWS

lepartment
of the Treasury • Washington,
D.c. • Telephone 566-2041
CONTACT: Office of Financing
FOR IMMEDIATE RELEASE
202/376-4350

June 13, 1^8" 8

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,426 million of 13-veek bills and for $6,405 million
of 26-week bills, both to be issued on
June 16, 1988,
were sccepted todsy,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Aversge

13-veek bills
maturing September 15, 1988
Discount Investment
Rate
Rate 1/
Price

26-week bills
maturing December 15. 1988
Discount Investment
Rate
Rate 1/
Price

6.41%
6.44%
6.44%

6.63% a/
6.68%
6.67%

6.60%
6.64%
6.64%

98.380
98.372
98.372

6.96%
7.01%
7.00%

96.648
96.623
96.628

a/ Excepting 1 tender of $310,000.
Tenders at the high discount rate for the 13-week bills were allotted 43%
Tenders at the high discount rate for the 26-week bills were allotted 3%'.
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
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

Received

Accepted

Received
:

Accepted

$
36,955
22,540,535
27,380
49,525
66,880
30,640
1,689,125
21,595
11,715
26,155
30,910
1,079.060
344,720

$

$25,955,195

$6,426,010

• $24,093,250

$6,405,300

$22,134,225
1,058,625
$23,192,850

$2,605,040
1,058,625
$3,663,665

: $19,543,530
:
799,010
: $20,342,540

$1,855,580
799,010
$2,654,590

2,339,955

2,339.955

:

1,950,000

1,950,000

422,390

422,390

:

1,800,710

1,800,710

$25,955,195

$6,426,010

: $24,093,250

$6,405,300

36.955
5,521,410
27,380
49,240
66,880
30,640
123,350
21,595
8,865
26,155
20,910
147,910
344,720

•
:
:

•
l
:

j
.
.

$

30,225
21,172,950
15,370
28,775
25,805
25,120
1,379,785
16,385
16,845
33,915
26,040
1,014,220
307,815

$
30,225
5,714,900
14,370
28,775
25,805
25.120
47,485
16,385
11,995
33,915
16,040
132,470
307,815

An additional $33,210 thousand of 13-week bills and an additional $197,990
thousand of 26-week bills will be issued to foreign official Institutions for
new cash.
y

Equivalent coupon-issue yield.

B-1450

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
Expected at 9:30 a.m., EDT
TESTIMONY OF THE HONORABLE
GEORGE D. GOULD
UNDER SECRETARY FOR FINANCE
U.S. DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON AGRICULTURE
U.S. HOUSE OF REPRESENTATIVES
TUESDAY, JUNE 14, 1988
Good morning, Mr. Chairman and Members of the Committee. It
is a pleasure for me to testify on the progress made by the
President's Working Group on Financial Markets.
During the past two months, the principal members of the
Working Group and our respective staffs have analyzed and
discussed the extensive information and recommendations
emanating from last October's market decline. Far from being a
stalling device as some have criticized, the Working Group has
moved forward, after much deliberation, on a number of critical
issues to preserve the integrity, competitiveness, and efficiency
of our nation's financial markets.
Our focus has been on positive actions that can be taken now
— immediately — as contrasted with possible legislative
restructuring that is subject to protracted debate and possible
delay. Fortunately, the Working Group identified ways to act
affirmatively, without legislation.
Collectively, the Working Group's action proposals address
basic safety and soundness issues, should lessen the risk of
systemic problems, and as a result, work to the benefit of all
investors. The key issues — identified by the Brady Commission,
the General Accounting Office (GAO), the Securities and Exchange
Commission (SEC), the Commodity Futures Trading Commission
(CFTC), and others — on which the Working Group has agreed
unanimously and has taken constructive action include:
o an agreement on coordinated "circuit breakers"
across markets to allow for cooling-off periods
during times of extreme price declines;
o recommendations and conclusions on the
credit, clearing, and payments system to
ensure the necessary coordination of
information and operations within and between
markets and to avoid systems gridlock;
o agreement that current minimum margin requirements
provide an adequate level of prudential protection to
the financial system; and
B-1451

- 2

o

agreement on contingency planning, including
the continuation of the Working Group, to
ensure coordination and consultation in the
event of future, rapid market disturbances.
I also am pleased to report that the securities, futures,
and options industries already are making — and should continue
to make — significant efforts to enhance operational capacity,
to increase individual firm and clearinghouse capital, and to
improve the fairness and quality of order executions for all
investors, large and small.
THE NEED TO REDUCE SYSTEMIC PROBLEMS
The specific conclusions and recommendations are contained
in the Working Group's interim report to the President, which
has been sent to all members. It is essential, however, to
understand the premise from which these conclusions evolved.
The Working Group views its primary mission as taking
collective, safety and soundness actions which would
substantially lessen possible systemic dangers to the U.S.
financial system if we were again to encounter a severe stock
market decline. Consequently, the Working Group — acting on the
most significant suggestions of the Brady Report and others —
views coordinated circuit breakers, prudential margins across
markets, the proper functioning of credit, clearing, and payment
systems, and contingency planning as key ingredients to prevent
stock market declines from degenerating into self-feeding panics.
While markets will always react to changes in fundamental
economic information, it is important to assure all investors as
to the proper functioning of the financial system while such
information is being digested in terms of market pricing.
Indeed, reducing concerns over the viability of the mechanics and
infrastructure of the system could mitigate the extent of market
declines by reducing the risk premium inherent in those extreme
situations where market participants worry about receiving full
and timely payments. Hence, our emphasis on safety and soundness
issues first during these past 60 days.
Daily Volatility Is Not A Systemic Threat
The issue of daily volatility, although an expressed public
concern, is not in the category of systemic threat, in my
opinion. However disconcerting such volatility can be on a
short-term basis, it is important not to attempt cures that can
do more harm than good. Markets must be allowed to adjust to new
price levels without impediments to efficiency that in themselves

3

cause disruptive market action. Narrow price limits for circuit
breakers, causing frequent market shut downs, would be an example
of such self-defeating ••cures11.
Moreover, volatility is a subject which often has been
treated publicly with more emotion than analysis. It must be
noted that, with the exception of the period October 1987 through
January 1988, there is no evidence of any increase in daily
volatility. Volatility from 1983 through 1986, during which time
the futures market was growing rapidly, was moderate to low as
compared to similar prior periods. This is illustrated in
Exhibit A. I should note that since February 1988, daily price
volatility has returned to levels such as were seen in 1973,
1974, 1975, 1980, and 1982, and which are statistically
indistinguishable from the norm for 1971 through 1986. In any
case, we must be cautious in ascribing events of those few months
of extraordinary volatility to changes which have been in place
for some time or in extrapolating that those events will be the
new norm in the future.
Some observers believe the individual investor has left the
market because of a perception of increased volatility.
It is
equally possible that much of the retreat is in fact investors'
collective views that the bull market has paused or that more
attractive alternative investments are available. Individual
investors have "left the market" in the wake of other major
market declines (e.g., in the mid 1970s). Those individuals who
want to own equities but are concerned about competing with
large, sophisticated pools of capital can, if they wish, invest
through them (e.g., mutual funds and pension funds) rather than
trying to compete with them.
We must recognize that investor withdrawal during such bear
markets is a fact of life, reaffirmed recently in a New York
Times article which states in part:
Investor disillusionment with the stock market is not
a new phenomenon. Typically, investors withdraw each
time there is a bear market — contributing to the
bleak mood. After the almost 50 percent drop in the
value of stocks during the 1973-74 bear market, for
instance, many individuals fled the market and stayed
out until the bull market of the 1980's.
The number of individual shareholders who owned stocks
on the New York Stock Exchange fell to 25.2 million in
1975 from 30.8 million in 1970. The number of
shareholders of mutual funds dropped to 7.8 million in
1980 from 8.4 million in 1970, according to estimates
by the Investment Company Institute.

4

Numerous Factors Cause Markets to React More Quickly Today
There are numerous factors that have made markets react
more quickly today to changes in the fundamental determinants of
stock prices. First, the nature of stock ownership has changed
substantially over the past twenty years, led by private and
public pension funds. There have evolved very large individual
aggregations of capital of a size unknown in an earlier period.1/
This, in turn, has led to changes in the techniques of managing
such capital, often with an emphasis on the market as a whole
(e.g., the S&P 500) rather than individual stocks. In the case
of major broker/dealers, the need for trading liquidity by large
bodies of capital has also increased the need for hedging
techniques by corporate treasurers and money managers. Thus, the
stock index futures markets have evolved as the lowest cost, most
efficient response to these changed needs. "Trading the market"
and hedging are not in and of themselves either good or bad —
they are economic facts that are not going to go away.2/
It is not the futures products themselves that are called
into question; rather, it is the behavior of large institutional
investors and large traders (e.g., Fortune 500 companies, union
pension funds, mutual funds, etc.) that comes into play. I must
admit, too, that I have some difficulty in my own mind when it
comes to legislating behavior modifications of that magnitude.
Second, benefits of active futures markets are real: for
example, they apply directly to the Treasury securities market.
Treasury futures are used as hedging vehicles and as a costsaving means to adjust positions in the underlying securities.
These risk-reducing benefits of futures markets lead to a
reduction of the risk premium investors require on the underlying
Treasury securities and thus to lower interest costs for the
1/
At Government.
the end of 1987, U.S. private pension fund assets
Federal
totalled almost $1.5 trillion and U.S. public pension fund
assets were approximately another $500 billion. By
comparison, total pension fund assets were approximately
$820 billion at the end of 1980.
2/ 1987 statistics for the largest 200 pension funds show that
a growing percentage of their assets (11.8%) is in stock
index funds. A growing percentage of these pension funds
(36%) also uses stock index futures.

- 5

For an excellent discussion of the increasingly significant
role of derivative products — particularly futures on stock
indexes — in the securities markets, members of the subcommittee
really should review Chapter Three of the SEC's Staff Report "The
Effects of Derivative Products" (The October 1987 Market Break)
which I have attached as Exhibit B of my statement.
Third, with the index futures markets having exhibited
greater volume in the underlying stocks than the cash market
exchanges, it can be argued that the Chicago Mercantile Exchange
(CME) has become a leader — rather than a follower — in price
discovery of equity market value levels. Cash market prices are
now often following, rather than leading, the so-called
derivative market. The Brady Report and others have underscored
the close economic linkage between these markets. Thus, the
public debate over the role of index arbitrage is often
misdirected. Index arbitrage only takes place when there is a
difference of price level between the cash and futures markets,
and such arbitrage, as in its age old role, helps equate those
price levels.
Fourth, while it is true that index arbitrage can translate
buying or selling pressure from one market to another, if those
markets are truly economically linked and responding to the same
fundamentals, then such arbitrage serves the useful purpose of
quickly equalizing the price levels between the markets. It is
worth noting in this context that the proposal of the New York
Stock Exchange (NYSE) for trading baskets of stock on the NYSE
would itself produce "index arbitrage" between the value of the
basket and the underlying stocks — but this arbitrage would be
within the NYSE. What often is overlooked in discussions of
arbitrage is that if there were no linkage of the markets, then
more selling or buying could spill over into the cash markets
directly. If the futures market were to disappear from this
country, pressures on the stock market would only increase. The
Brady Report takes note of such selling when the linkage broke
down in October.
Much public criticism of index arbitrage is a classic case
of wanting "to shoot the messenger" that brings the bad news of
selling on the CME to the floor of the NYSE. If selling is
going to take place to a degree that pushes prices down sharply,
then cash markets will not be made immune by eliminating index
arbitrage. The emphasis, therefore, should be on increasing the
capacity of systems like the Designated Order Turnaround (DOT)
system of the NYSE so that the public has fair and equal access
to order transmission, rather than on restricting mechanical
linkages between economically-linked markets.

6

Put another way, if there were no index futures market,
then there would be no index arbitrage. But there is no evidence
that such a condition would give the cash markets immunity from
selling pressure generated by responses to fundamental events —
and no likelihood that having developed to meet a large and
important investment need there will not be a viable index
futures market, whether here or abroad.
Fifth, the volatility many people blame on index arbitrage
could also be evident from direct selling in the cash market.
In fact, pressures directly on cash markets are clear from
history. Earlier in the postwar periods before the index futures
markets came into existence in 1982, the Dow Jones Industrial
Average (DJIA) had a number of significant declines as outlined
in Exhibit C of my testimony. In fact, the 1973-74 bear market
was worse than the 1987 decline; while it took longer, the end
result was that price levels reacted to fundamental perceptions
and adjusted accordingly. While individual share ownership is an
important part of our financial system and should be encouraged,
we cannot expect to be able to legislate normal human behavior —
any more than we should be expected to protect the revenues of
brokerage firms by attacking symptoms rather than causes.
Sixth, the aggregation of capital is a factor in today's
global markets, just as the phenomenon of rapid information
dissemination also is important to recognize. The world now has
the technological systems — and therefore the ability
for
almost instantaneous response to any event. This provides
another type of aggregation in the form of concerted buying or
selling. While market liquidity has increased greatly in recent
years, clearly some greater volatility can be intrinsic to
concerted action. Eliminating information technology — either
by legislation or regulatory fiat — hardly seems like a
realistic reaction to concerns about volatility.
Finally, the Wall Street broker/dealer/specialist business
has become increasingly capital-intensive. Since 1975, when
fixed-rate commissions were ended, a notably larger percentage of
revenues are now a function of capital returns rather than
commission income. With capital risk thus less protected by a
cushion of commission income, there is a tendency for block
houses and specialists to become more risk averse in their bids
during uncertain times. This, too, can lead to greater
volatility.
Evolution in the Face of Change is Necessary
If I may be permitted a personal comment, I would like to
point out that when I started in Wall Street in 1951, a million

7 -

shares traded on the NYSE in one day was a big event. Wall
Street was like a private club, and a rather exclusionary club at
that. No one worked too hard, competition was limited,
individuals were as important as institutions, the U.S. economy
was dominant, and the NYSE was the market of the world. There is
more than a little nostalgia for those times that influences
today's debates about how markets should function.
I would suggest, however, that the Wall Street of an earlier
time also had its drawbacks and never could have accommodated the
demands of a growing U.S. economy without itself changing. Those
changes continue, particularly in an internationally competitive
world. It would be a mistake to focus only on the fall-outs of
those fundamental changes when attempting to determine whether
structural modifications are needed for the markets themselves.
Strong Agency and SRO Action Needed Against Frontrunnina and
Market Manipulation
Before I turn to our recommendations, I want to take a
minute to comment on an issue about which I feel strongly.
Virtually all of the reports voiced concerns about customer
protection, particularly in the areas of intermarket frontrunning
and market manipulation. For example, the Brady Report
recommended development of an extensive trading information
system for the stock markets to better diagnose developing
problems and uncover abuses. The CFTC staff urged establishment
of standards for identifying potential intermarket frontrunning
trading patterns and a mechanism — perhaps the Intermarket
Surveillance Group — for the timely and effective communication
of market surveillance data related to possible frontrunning
activity among all exchanges with common self-regulatory
interests. The SEC recommended strengthening current
prohibitions and working with the CFTC and self-regulatory
organizations (SROs) to ensure that adequate intermarket
information is available to pursue such matters.
The Administration fully agrees that vigorous action against
problems of intermarket frontrunning and market manipulation is
essential. Along with the benefits of new products,
technologies, and trading strategies have come increased
opportunities for abuse by market professionals and insiders.
These abuses have hidden economic costs in addition to their more
obvious effect on smaller individual and institutional investors
who come to believe that the rules are rigged against them. We
deplore this situation and expect the regulators and SROs, who
are in the best position to take affirmative action, to continue
to do so. They already have made significant progress:
o The CME has just circulated a proposed definition of

- 8 -

frontrunning to futures industry representatives;
o The NYSE recently notified its members that trading
futures based on knowledge of impending orders in the
stock market is a violation of exchange rules. The
NYSE plans to provide the futures exchanges with audit
trail information on stock trading that would enable
the Chicago futures markets to conduct ongoing
surveillance for frontrunning; and
o The American Stock Exchange (Amex) has recently
implemented systems to automatically monitor option
trading for frontrunning, mini-manipulation, and
pegging and capping. The Amex also is developing an
expert system which uses artificial intelligence
software to analyze potential insider trading market
manipulation cases.
It is in the best interest of all investors concerned that
the problems of frontrunning and market manipulation be resolved
quickly and effectively by the agencies and SROs. Such action is
crucial if we take seriously the charge that markets are rigged
to the disadvantage of the small investor.
RECOMMENDATIONS
Let me now briefly summarize the Working Group's
recommendations and conclusions. Our efforts have focused so far
on six subjects which are described in more detail in our report
to the President.
1. Continuing Coordination
The Working Group believes that its continuation is an
excellent way to coordinate what should be an on-going process
to address intermarket issues. The Brady Report and others have
recommended that some additional regulatory mechanism be
established to resolve these issues. Recognizing this concern
for coordination, we believe cooperative efforts under the
existing regulatory structure will continue to be effective, and
in large measure, fulfill the intent of several legislative
proposals. The very existence of this group has helped to keep
the pressure on the various SROs and market participants to
devise and implement necessary reforms on their own.
2. Circuit Breakers
In addressing coordinated trading halts and reopenings, socalled circuit breakers, the Working Group has focused on market
events that are so dramatic as to trigger ad hoc closings of

9 -

equity markets and to pose potential systemic risks to our
financial system. The Working Group has devised a cross-market
mechanism to avoid ad hoc and destabilizing market breaks,
recognizing that any disruption of trading is undesirable.
Our proposal is designed to substitute planned for
unplanned, ad hoc trading halts, without increasing the overall
frequency of such disruptions. Planned halts should allow time
for the dissemination of information and consideration of
decision to buy or sell in rare situations in which panic
conditions threaten.
3. Prudential Margin Requirements
The Working Group reached agreement on several key points
regarding prudential margins and concluded that:
o current minimum margin requirements provide an
adequate level of protection to the financial
system, although they do not cover all possible
price movements, and that margins sufficient to
cover all possible price movements would have
unacceptable costs for the liquidity and
efficiency of markets;
o there are additional protective cushions in place
from capital requirements and surveillance for
firms and clearinghouses; and
o given differences in price volatility of stocks
and indexes and grace periods for settling
margins, a consistent and harmonious margin
regime among markets would produce significantly
higher levels of margin for stocks than for
futures.
The positions of the Working Group members on the need for
margins in excess of the prudential level, and of the need for
federal oversight, are set forth in the report to the President.
4. Credit, Clearing, and Settlement
As former Senator Nicholas Brady, who chaired the
President's Task Force on Market Mechanisms, indicated recently,
extreme stress on our clearing and credit systems came close to
damaging our financial system last October. While a complicated
and technical area, our financial system's network of clearing,
credit, and settlement procedures truly is the nuts-and-bolts
that allow hundreds of millions of transactions to be conducted
and financed on a daily basis.

10 -

The Working Group has reviewed existing clearing, payments,
and settlement systems to identify and set priorities for
measures that they recommend be taken to reduce uncertainty,
increase coordination, to assure confidence in the integrity of
such systems, and to facilitate their smooth operation in
volatile markets.
The Working Group endorses the view that the proper
functioning of these systems is integral to the proper
functioning of the financial markets as a whole and is pleased to
report that significant progress has been made in this area. As
more fully set forth in the report to the President, the Working
Group is proposing an agenda of additional measures to be pursued
to achieve the goal of more perfectly coordinated systems.
5. Contingency Planning
The Working Group believes that the purpose of contingency
planning is to ensure that regulatory agencies and the SROs have
in place systems which will allow them to identify emerging
problems quickly and to react appropriately in the event of a
market crisis. In an important sense, the Working Group
recommendations for implementing circuit breakers, improving
information flows, clarifying credit arrangements, and
strengthening the clearing and settlement process can be viewed
as a key part of contingency planning. By improving the market
system's ability to withstand and react to shocks, these measures
will enhance the system's first line of defense.
Going beyond this, the Working Group has given high priority
to enhancing channels of communication among staffs of the
respective regulatory agencies and the Treasury. In addition,
staff of the three agencies are working jointly to improve
information sharing across the agencies, with particular emphasis
on a framework for coordinated monitoring of exposures and
developments at major market participants. Finally, regarding
international policy coordination, steps are being taken by the
various agencies to strengthen existing contacts with their
counterpart authorities in other major market centers to further
improve this aspect of market surveillance.
6. Capital Adeguacv and Systems Capacity Enhancement
Market participants, SROs, and regulatory agencies have
taken or are planning a number of significant actions to enhance
financial integrity and improve automated systems — two of the
issues the Working Group, the Brady Report, the GAO and others
have identified as critical to the financial integrity and smooth
functioning of the markets.
Our report to the President cites

-li-

the many constructive steps already taken in these areas. The
Working Group encourages these efforts and will continue to
monitor developments to ensure that needed improvements are made.
CONCLUSIONS
In summary, Mr. Chairman and Members of the Committee, the
Working Group has commenced action on a number of significant
steps that collectively will work to reduce systemic threats to
our financial markets. In so doing, we have pursued a sizeable
portion of the agenda defined in large measure by the
Presidential Task Force on Market Mechanisms,3/ the GAO, the
SEC, the CFTC and other market observers. Indeed, Senator Brady
concluded his recent public letter with a position that in fact
has been the operating basis of the Working Group:
We are not attempting to legislate against
decline or interfere with the smooth functioning
of the markets. The market will always seek its
level ground; we are only trying to assure that it
gets there safely.
The collective and coordinated actions recommended by the Working
Group — and corrective steps already taken by others — help to
assure that the market in fact does "get there safely" when it
moves for whatever reasons.
We cannot legislate against market declines, regulatory
dictates cannot eliminate volatility, and executive fiat is no
more effective. Price controls and capital controls have never
worked effectively in this country and no amount of government
control can sway markets if underlying economic fundamentals —
or investor perceptions of those same fundamentals — take the
market one direction or another.
Moreover, it is unrealistic and ultimately counterproductive
to attempt to roll back developments in financial markets brought
about by advancements in telecommunication and computer
technology and by changes in investment needs. We cannot go back
to the days of the abacus or mechanical adding machines. If we
did — by trying to legislate against particular products or
investor preferences or market strategies, for example — then we
would ultimately lose whatever competitive edge we now have to
3/
See,
for
example,
the summary
comparison of the
places
like
Toronto,
Tokyo,
or London.
recommendations in the Brady report and the actions taken by
the Working Group in Exhibit D.

12 -

Mr. Chairman, I would be remiss if I did not commend the
cooperative actions and constructive dialogue on the part of the
Working Group members. We have spent considerable time and
energy to arrive at our initial recommendations. The members of
the Working Group have demonstrated that it is possible to
address major, complex issues in a cooperative fashion — even
though we bring different perspectives and preferences to the
table — and in a reasonably short time frame. Disagreements on
some matters have not blocked significant agreements that are
apparent upon careful examination of the package we have
presented to the President.
The public also has been well served by the Working Group's
high caliber staff and their professional analyses, and I salute
them.
We have made progress on basic elements that are essential
to the safety and soundness agenda that we view as a priority.
More work will be done, and we welcome the continuing challenge.
* * * * * * * * * * * * * *

Exhibit A
Volatility Measures, 1971-1988
Standard Deviations of Daily Price Changes
(in Percentage Points)
NYSE Composite
S&P 500

Years

0.645
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988 (Jan--Apr)

0.640
0.500
0.997
1.373
0.967
0.694
0'.570
0.787
0.682
1.0 29
0.843
1.141
0.868
0.794
0.632
0.949
2.120
1.4 20

Inclusive Periods
1971--1974
1975--1978
1979-•1982
1983--1986

0.943
0.774
0.944
0.821

Jan-Sep 1987
Oct :L987-,Jan 1988
Feb :L988-;\pr 1988

0.984
3.538
1.073

Note:

0.494
1.007
1.354
0.949
0.676
0.539
0.775
0.682
1.017
0.825
1.073
0.781
0.738
0.589
0.874
1.972
1.27 5
0.939
0.755
0.916
0.756
0.905
3.290
0.960

These standard deviations were calculated by the S.E.C.
from daily data for the entire period indicated in the
left column. Approximately two thirds of all daily price
changes during a period will lie within one standard
deviation of the average price change for the period.
(About 95 percent of all changes will fall within two
standard deviations and 99.75 percent within three
standard deviations.)

CXU-L

Chapter Thrct

THE EFFECTS OF DERIVATIVE PRODUCTS
Derivative products, particularly futures oa stock indexes, ptoy am iacreasiagly
significant role ia the securities markets. For example, the trading volume of stock
index futures has growa spectacularly since their introductioa ia 1912. By the week
preceding the October market break, trading ia the Standard A Poor's 0 ± P " ) 500 index
futures contract ("SPZ") was avenging 106,400 contracts. 1/ This daily contract volume
(based oa the value of the SAP 500 iadea during the week preceding the market break)
was the equivalent of approximately $16 billioa worth of equity securities, sad
represeated more thaa two times the average daily dollar volume of tradiag oa the N e w
York Stock Exchange ("NYSE") during September 19$7.2/ Siautarty. opticas oa stock
iadexes were the fastest growing segment of the options market ia 1987 and, by October
19$7, oa average accounted for more thaa 4 3 % of total options contract volume. 2/
The growth of derivative products reflects, ia part, the treads toward greater
institutionalization of the markets sad of market basket tradiag, coupled with the
changing nature of investment strategies. Analysis of these treads sheds light oa the
growing impact of futures tradiag ia the securities markets.
A. Iastitatiounilxatlen
During the last tea years, institutional investors have held aa increasingly large
percentage of ail outstanding equities. Ia particular, the growth o£ Uaited States
pension funds sad mutual funds, sad the accompanying changes ia investment policy and
asset allocation, primarily are responsible for the increasing institutionalization of the
securities markets. 4/
At the ead of 1975, institutions held 35.3% of the S6I5.1 billioa total market value
of all NYSE-listed stocks. At that time, peasioa funds held a total of $252 billioa in
assets, SI 13 billioa of which were equity holdings. %J By the ead of 19$0, the market
V

Sfifi Divisions of Economic Analysis sad Tradiag sad Markets, Interim Report to
the Commodity Futures Trading Commission ("CMC") on Stock Iadea Futures and
Cash Market Activity During October 19$7, November 9, 19$7, Table 2.

2/ Sfift NYSE, Marketing Research Report (November 1917%
2/ Total volume for options contracts traded on ail exchanges for the period from
January to October 19$7 wms 276^570,000. The volume for iadea option contracts
traded for the same period oa all exchanges wms 119,5354)00 contracts. Index
option contracts generally are one-fifth the size of iadea futures contracts.
4/ §e& Chart 3-1 (overview of peasioa fuad growth sad management trends).
1/ See J. Light at A. Peroid, The Institutionalization of Wealth: Chaagsna Patterns
of Investment Decision Making, ia Wall Street m d Reemiariam 9$ (19S7, ed. S.
Hayes).

3-2
value of all NYSE-listed stocks had increased to $1.2 trillion, while the institutional
investors' share of that market value had remained coastaat, iacreasiag only . 1 % to
35.4%. At that time, however, the total value of peasioa fund assets had increased to
$4$5 billioa, $220 billioa of which were equity holdiaas, which accounted for 1 4 % of all
equities outstanding. £/ By 19$5, peasioa funds had more thaa doubled their 19S0 level
of equity investment, to almost $500 billioa worth of stocks, which accounted for 2 2 % of
all equities outstanding. 2J
The 1980s have seea not oaly a substantial growth ia the market value of
institutional holdings, but also a surge ia the perceatage of the total tradiag volume on
the N Y S E accounted for by institutional iavestors. \J Large block transactions, 2/ s
gauge of institutional participetioa ia the stock market, have increased sharply since
1977. A total of 54,275 large blocks, accounting for \2 billion shares ($34 billioa),
were traded ia 1977. lfl/ These traasactsons accounted for 22.4% of the reported volume
on the N Y S E for that year. By 19$3, these figures had more thaa doubled. Ia that
year, 363,415 block transactions occurred, accouating for 9 4 billion shares ($346.92
billioa), aad representing 45.6% of reported volume on the N Y S E . A record average of
2,631 daily block trades occurred ia 1986, up from an average of 2,139 daily block
trades ia 1985, representing 49.9% of reported volume oa the N Y S E . Moreover, the total
number of block transactions oa the N Y S E increased 23-5% ia 19$6 from the previous
year. This represented a 25.2% increase ia the number of shares accounted for by those
trades. 11/ A s further evidence of the rapid growth of these institutional transactions,
oa April 10, 1986, a aew record was set whea 48.1 million shares of Navistar
International were traded, which was the largest block transaction in history as of that
date. 12/ Prior to April 10,1986, the largest block transactions ia history had occurred
oa M a y 25,1983, whea 7.0 million shares of R a m a d a Inns were traded, aad oa November
30, 1983, whea 6.35 million shares of A T A T changed hands. 13/
B. Market Basket Tradiag
The types of institutional transactions that occur and the investment decisions
m a d e by moaey managers also have changed as a result of evolving investment and
tradiag strategies. Institutional moaey managers have made iacreasiag use of passive
a/

lit

2/ Id,
&/ §£& Chart 3-2.
2/ Large block transactions are transactions of 10,000 or more shares.
107 Sfit Chart 3-2.
11/ §£& Chart 3-2: 539,039 block transactions occurred ia 1985, accounting for 142
billioa shares ($501.26 billioa). Ia comparison, 665,587 block transactions occurred
ia 1986, accounting for 17.8 billioa shares ($685.3 billioa) traded.
12/ NYSE, Fact Book 12 (1987).

12/ Lt

3-3
asset management strategies. In 1980, money managers reported a total of $9 billioa in
indexed assets. W
This figure rose to $48.2 billioa at the ead of 1984. B y 1985, iadex
fund managers reported $81 billion in indexed assets, almost a 7 0 % increase over the
previous year's figure. As of M a y 31,1987, the value of indexed sssets for U S . peasion
funds grew to $187.96 billion, $124.07 billion of which tracked VS. equity indexes. 12/
As a resultof the proliferation of index funds and the growth ia iadexed assets,
along with investment tactics that require the simultaneous trades of large blocks of
stocks, institutional investors increasingly have used program trades. Index fund
managers began program tradiag ia the mid-1970s. 16/ Currently, aa estimated 2 5 % of
all institutional tradiag is accomplished by use of program trades. 12/ These trades
include straight execution of multi-stock orders, as well as iadex arbitrage aad
substitution strategies, among others. The increase ia this activity appears to have
accelerated ia 1987. For example, ia January 1987, aa average of 12.1 million shares
per day was executed through the List Order Processing ("LIST") capability of the
NYSE's Designated Order Turnarouad ("DOT) system but by August 1987, that number
had increased to an average of 16.6 million shares.
C The Effects of Futures
The increasing institutionalization of the markets and the growth of passive
investment strategies, such as indexing, U / have been accompanied by the increasing
use by institutional investors of derivative products such as iadex optioas aad financial
futures. By 1984, only two years after the introduction of cash settled stock iadex
optioas aad futures, a number of institutional investors were using or actively
coosideriag using derivative markets to eara incremental returns oa managed money,
allocate assets to adjust for market risk, aad manage various commercial and financial
risks. 12/ Forty of the top 200 peasioa funds were using stock iadex futures at that
time. Their use of derivative products, however, did not include dynamic hedging or
portfolio insurance to any large extent In 1984, only aa estimated $200 million in
14/

Christmaa, Indexed Assets up 7 0 % in 1985, Pensions A Investment Aae 6 (Dec 23,
1985).

12/ Berkowitz, Indexed Assets Top $187 Billion, Pension* A investment A«e % (July 13
1987).
1£/ Sej. fiX, Investment Dealera* Pieeat 25 (March 2, 1987%

12/ Light A Perold, sj&firj, note 5, at 110.
11/ Indexing involves holding stocks in proportion to a widely followed iadex like the
S A P 500.
12/ Board of Governors of the Federal Reserve System ("FRB"), Commodity Futures
Tradiag Commission aad the Securities aad Exchange Coaunisaioa ("SEC"), A Stndv
of the Effect! am the Economy of Tradime in Fatmr— «md Omiona (Dec 1984)

("Joiat Study") at IV-17.

3-4
pension fund assets were dynamically hedged. 20/ This changed rapidly over the next
three years u peasioa fuads expanded their use of dynamic hedging or portfolio
insurance strategies. Ia 1985, portfolio insurance was applied to aa estimated $6 billioa
of peasioa fund assets. 21/
By 1986, the amount of pension fund assets committed to portfolio insurance
strategies had increased to at least $8J billioa, forty times greater thaa the value of
peasioa fund assets that were dynamically hedged ia 1984.22/ By October 19, 1987,
stock valued at more thaa $60 billioa, mostly held by peasioa fuads, was reported to be
managed under portfolio insurance strategies. 22/
The Division of Market Regulation ("Divisioa") has attempted to verify the total
dollar value of portfolio assets that were subject to some type of portfolio insurance or
protective hedging program during the October 1987 market break. Divisioa staff spoke
with the major vendors of portfolio insurance programs, with broker-dealers aad banks
that manage large portfolios, aad with m a n y corporate-pension plan managers. Based on
these interviews, the staff has identified a minimum of approximately $55 billioa ia
portfolio assets that were committed to some type of portfolio insurance strategy. This
figure is a m i n i m u m estimate of portfolio assets subject to some type of portfolio
insurance or protection plan. 217 Moreover, staff interviews with market professionals
indicate that a wider raage of institutions actively use the futures markets. While these
institutions do not employ the precise tradiag strategies dictated by portfolio insurance,
they do employ the futures market to quickly adjust their relative equity holdiags ia a
manner that can have effects oa the market similar to portfolio insurance trading.
1. Benefits
As the staff has aoted ia prior analyses, the impact of index-related tradiag on
the markets should be viewed ia the context of the benefits provided by such trading.
Various studies conducted before the October 1987 market break concluded that futures
2P7

Ring, Funds Watch as Others Try Program Trades, Pensions A Investment Ase 1
(April 28, 1986).

21/ Ring, Dynamic Hedging Grows Despite Debate, Pensions and Investment Aae 3
(April 14, 1986).

22/ Lt
22/ Ring. Execs Ponder Compatibility of Strategies, Pensions A Investment Aae 15
(July 27, 1987).
24/ While this figure is smaller than estimates ranging from $60-$ 100 billion that have
appeared in the press, w e have attempted to the m a x i m u m extent possible aot to
double count portfolio assets. Various portfolio insurance programs are licensed
by vendors. As a result, obtaining an accurate estimate of the amount of
portfolio assets subject to some type of portfolio insurance strategy is difficult
because information obtained from licensees also m a y have been provided by
vendors.

3-5
and options on stock indexes offer significant benefits to today's capital markets. 22/
These studies found that the markets for these index products, especially the market for
S P Z futures, add substantial liquidity and pricing efficiency to equity markets generally.
Moreover, using these products, investors are able to control the risks in their
portfolios in accordance with their particular needs. As a result, the markets perform
their various economic roles more efficiently.
a. Liquidity Efficiencies
As described in Chapter One, an index option or future is a single instrument
that can be used as a surrogate for m a a y stocks. Substantial market making capital is
concentrated ia the more successful of these products, especially the S P Z future and the
S A P 100 index option. In addition, market makers and hedgers are afforded favorable
margin requirements, enabling them to effect transactions at lower cost. These factors
contribute to the futures market's liquidity, allowing investors to execute large
transactions with m u c h smaller market effects than is possible in the separate
stocks. 26/
b. Traasnctionnl aad Hedging Efficiencies
The availability of derivative index products has substantially enhanced
institutions' and other market professionals' hedging and market timing capabilities.
Index futures and options also significantly reduce transaction costs w h e n assets are
reallocated among such as stocks, bonds and cash equivalents ia a portfolio, or when
additional funds sre invested. 22/ Because commission rates, as well as execution costs,
are lower for futures than for stocks, institutions chaagiag the proportion of stocks in
a portfolio can do so at lower cost by initially using the futures rather than the stocks
themselves. For example, a debt portfolio can be converted rapidly to equity by
simultaneously selling bond futures and buying stock index futures. In doing so,
managers can increase their equity exposure without incurring the relatively higher
transaction costs of the stock and bond markets. Thus, futures not only allow for the
rapid reallocation of a portfolio, but create substantial savings in execution and
22/

Sfi&fiiaVJoint Study, sttfiZi. note 19, at IV-35; H. Stoll A R. Whaley, Expiration
Pav Effects of Index Options and Fntnrea H O M l (-Stoll Study").

26/ A 1985 study by the investment firm of Kidder, Peabody A Co. estimated the
difference ia costs as follows: the cost of executing a $20 million stock trade in
terms of the effect oa the price of the stock would be 0.27%; for a similar
futures trade, 0.04%. R. Wuasch, Stock Iadex Futures (Kidder Peabody A Co.,
April 23,1985). More recently, Morgan Stanley estimated the market impact cost
of a $120 million S A P 500 basket as 1.30 iadex points (or $520,000) in the stock
market versus .05 index points (or $20,000) in the SPZ. R. Johnson, Program
Tradiag Preseatatioa (Morgan Staaley, July 9, 1987).
22/ Of course, the cost of executing a program has chaaged over time According to
Fredric A. Nelson of Bankers Trust, a $50 million S A P 500 program would have
cost aa iavestor $290,000 to execute ia 1984, $165,000 to execute pre-October
1987, sad $345,000 to execute after October 1987. F. Nelson, Trading Strategies
and Execution Costs (Bankers Trust Compaay, December 3, 1987).

3-6
transaction costs. O f course whea aad if the stock transactions take place, commission
costs are incurred.
Moreover, as hedging vehicles, stock iadex products can offer investors
substantial benefits. Through the sale of futures contracts, peasioa, endowment and
other institutional investors can quickly, at relatively low cost, shift risk to those more
willing to accept it
2. Price Impacts of Futures
The existence of aa active futures market ia stock indexes has created, ia effect,
aa alternative or "synthetic" stock market for the growing number of institutional
investors w h o choose to trade passively by investing ia funds tied to specific indexes or
w h o are interested in buying and selling stocks in "baskets." The data set forth ia the
Market Chronology (Chapter T w o ) demonstrate the substantial impact this alternative
stock market can have oa the equity market, especially by iacreasiag iatra-day price
volatility.
Whea futures oa stock indexes were introduced, little attention was paid to the
possible "price discovery" aspect of this new product or to its ability to displace the
stock market as the preferred vehicle for tradiag baskets of stock. The primary
emphasis was oa the significant potential for hedging investment risk that was offered
by a cash-settled future Nevertheless, it is our view that, as a result of the increasing
use of the futures market by institutional investors, including investors employing
passive investment strategies aad dynamic hedging techniques, 28/ the character of the
market has chaaged to the point where the "price discovery" feature of the derivative
market is leading, rather thaa following, price trends ia the underlying equity markets.
Moreover, through index arbitrage, the prices "discovered" ia the futures pit are quickly
transmitted to the floor of the N Y S E where prices adjust to the general market
seatimeat expressed ia the futures arena.
There are several reasons for the increased impact of futures. First, low
transaction costs, low margin requirements, and normally high levels of liquidity, the
very benefits cited by futures proponents, have m a d e the futures market the "market of
choice" for m a n y active institutional traders. M a n y institutional traders w h o use futures
reported to the staff that they did so because futures were a "cheaper* alternative to
buying individual stocks. Some believed that they could increase or decrease market
exposure virtually instantaneously, with little market or liquidity costs. For this reason,
as noted above, the underlying market value of iadex futures traded daily generally
exceeds the dollar volume on the N Y S E . 22/ Accordingly, institution-led market
movements are usually observed first ia the futures markets.

28/

Dynamic hedging involves rebalancing a market portfolio to increase or decrease
the proportion of equity exposure dependiag oa market movements.

22/ The dollar value of SPZ 500 futures contracts traded daily has exceeded the dollar
value of daily transactions on the N Y S E since the last quarter of 1983. §£& N.
Katzenbach, A a Overview of Program Trading and Its Impact on Current Market
Practices, 10 (December 21, 1987).

3-7
Second, the capital available for index arbitrage has increased substantially. In
the early developmental stages of index arbitrage strategies, large broker-dealer firms
trading for their o w n proprietary accounts dominated the busiaess. These same firms
continue to be the major players in index arbitrage, but today m u c h of their business is
as agent for institutional customers. Moreover, the availability of aa efficient order
routing system for baskets of stock (the N Y S E LIST system) has decreased the time, and
therefore the execution risk, involved in executing program trades. Efficient order
routing also has increased the speed with which market movements in futures can be
transmitted to the stock market
Institutional investors also can make greater use of iadex arbitrage strategies
thaa firms caa trading for their o w n accounts. As noted below, the ability to initiate a
so-called "short" arbitrage (iSm buy futures, sell stocks "short") is limited by the
Commission's and exchanges' short sale rules, which require that the "short stock"
portion of the arbitrage be executed on "plus" ticks or "zero plus" ticks 20/ for each of
the stocks comprising an arbitrageur's basket M a n y institutional investors, particularly
those w h o manage passive or iadex funds, already o w n the stocks underlying the index
and, therefore, can initiate an arbitrage transaction involving stock selling without
considering the short sale rule, because their sales would be long" sales and not
subject to the "tick" test provisions of the short sale rule Moreover, because these
institutions already o w n the securities comprising the index, the return they must
receive on the arbitrage is less than would be required by other market participants.
Accordingly, they are willing to effect arbitrage transactions with a smaller spread
between the futures price end theoretical fair value
The result of all these trends has been to increase the speed aad frequency with
which index futures price movements are transmitted to the stock market There is, of
course nothing inherently wrong with index futures providing price discovery for the
stock markets. Indeed, such close coordination of two related markets generally
enhances pricing efficiency. The emergence of futures as a stock price leader, however,
has had a significant impact oa the stock market
First it increases the difficulty of enforcing marketmaking obligations imposed on
specialists. A s discussed ia detail ia Chapter Four, stock specialists are generally
expected to buy or sell securities to offset temporary imbalances ia supply aad demand
and to provide price continuity, depth, and liquidity, the general indicia of fair and
orderly markets. Interviews with specialists confirm, however, that if the future is
tradiag at a discount or premium to its theoretical value, specialists are unwilling to act
aggressively to offset imbalances because the discount or premium indicates that more
arbitrage selling or buying will eater the market 21/ Other market participants m a y be
equally reluctant to trade against pricing signals emanating from the futures market

212/

A "plus tick" is a trade at a price greater thaa the immediately preceding
transaction and a "zero-plus tick" is a trade at a price greater thaa the last
transaction at a different price (ej. a trade at 20 would be a plus tick if the
prior trade was 19 7/8, aad a zero-plus tick if the two prior trades were 19 7/8
aad 20).

21/ §££ Chapter Four, infra for a discussion of specialist obligations aad performance
standards.

3-8
Second, the relatively low margins and absence of short sale restrictions in the
futures market m a y encourage additional tradiag that might aot occur if the derivative
iadex products did not exist ia that large stock equivalent positions can be established
or liquidated more quickly. The price movements caused by this increased trading
velocity are then rapidly assimilated into the stock market through arbitrage because
arbitrage liquidations aad iadex substitutioa activity agaia can occur consistent with
short sale restrictions.
The staff believes that these two effects of futures price leadership (greater
difficulty ia maintaining orderly stock markets aad aa increase ia the velocity of
tradiag) have converged to contribute to increased iatra-day volatility ia the stock
market Indeed, recent studies have indicated that while, prior to 1987, iater-day stock
price volatility was aot out of line with prior periods, iatra-day volatility was
iacreasiag. Moreover, by early 1987, inter-day volatility appeared to be iacreasiag as
welL22/
This price impact does aot appear to occur because of speculative activity ia the
index futures market Neither our examinations of price volatility oa September 11 and
12,1986 aad January 23,1987 aor our analysis of futures tradiag during the October
market break indicates that speculative activity ia the futures market was predominant
Rather, as detailed ia Chapter T w o , institutions, not speculators, were the primary net
sellers of futures oa October 19, the day of the greatest market decline
22/

Sffi,fij.Cowan, Whether Swings Will Continue is Uncertain, N.Y.Timfia. January
2, 1988, at 31, coL 3 ("It used to be that oa a givea day the [DJIAJ moved up or
d o w n by more thaa 2(%] oaly about once a month. Since May, such swings
increased ia frequency to almoat once every three weeks, and by the fourth
quarter of 1987, they occurred almost every other day oa average"); N.
Katzeabach, supra note 29, at 21-23; F. Edwards, Finaaciai Futures and Cash
Market Volatility: Stock, Iadex aad Interest Rate Futures 18 (September 1987)
("Beginning in 1986, . . . volatility began to rise, and ia 1987 increased even
m o r e This pattern is evident for all measures of volatility, which show similar
movements [footnote omitted]." According to Professor Edwards, from 1985 to
1986, the standard deviation of the high-low estimator for the S A P 500 increased
from 0J534 to 0J832, while the mean of that indicator increased from 0.7809 to
1.1204. It should be noted, however, that Professor Edwards also stated: "It is
doubtful that the rise in stock market volatility is due to aaything associated
with futures trading.")
We would note that some of the studies which have sought to measure market
volatility before aad after the introduction of stock index futures have done their
comparisons using the Spring of 1982 as the relevant "event date" because that is
when such futures were first introduced. However, such an "event date" does not
accurately capture the full effects of futures trading. The dollar equivalent of
stock tradiag via futures did not exceed N Y S E trading volume until late 1983,
proprietary index arbitrage did not become significant until Spring/Summer of
1984, index substitution programs only came into play during 1985"-86, and dynamic
hedging became considerably greater in 1986-87. Thus, whether such pre-/poststudies can ever "prove" that the market has been more or less volatile since the
introduction of stock index futures, such studies should, at least, use a more
finely textured "event date."

Exhibit C

Percentage Declines in Postwar Bear Markets
by Month-end Peaks and Bottoms in the
Dov Jones Industrial Average
Closing DJIA

Dates

Duration

Percentage Drop

May
Oct.

1946
1946

212
169

5 months

20.3

Dec.
June

1961
1962

731
561

6 months

23.2

Dec. 1965
Sept. 1966

969
774

9 months

20.1

Apr.
June

1969
1970

950
683

14 months

28.1

Dec.
Dec.

1972
1974

1020
616

24 months

39.6

Dec.
Feb.

1976
1978

1004
742

14 months

26.1

March 1981
July 1982

1003
808

16 months

19.4

1987
1987

2662
1833

3 months

31.1

Aug.
Nov.

EXHIBIT D
SUMMARY COMPARISON OF BRADY RECOMMENDATIONS AND WGFM ACTIONS
Bradv Task Force
yenmrnnendations
Circuit
breakers:

Recommends circuit
breakers across
markets.

Clearing and
Settlement
Procedures:

Clearing systems
should be unified
to reduce financial
risk; Senator Brady
said flaws came
close to damaging
financial system in
his recent letter.

Intermarket
Regulation:

One super-regulator,
prefers FRB, but*
Senator Brady
recently stated that
action on reform on
other intermarket
issues was more
important than one
regulator at this
time.
Should be consistent
to control speculation and financial
leverage, though
not necessarily
equal for futures
and stocks; prefers
to be set by FRB.

Margins:

WGFM Actions
Action: Circuit
breakers across
markets; foilowed
five guidelines in
recent letter by
Senator Brady.
Action: Numerous
recommendations and
proposals to
increase coordination and facilitate
smooth operation of
market mechanisms;
goal is a more
perfectly coordinated system.
Action: Consultation and coordination by WGFM will
be on-going; important element of
contingency
planning.
Action: Existing
margins (which have
been increased
since October) are
prudential and harmonious across
markets to protect
against trader or
investor default;
prudential margins
appropriate for
carrying stock
should be significantly higher than
those for a stock
futures index contract; best left to
SROs to regulate;
additional cushions
exist in capital
requirements and
surveillance.

- 2 Should be consistent
to control speculation and financial
leverage, though
not necessarily
equal for futures
and stocks; prefers
to be set by FRB.

Monitor transactions
and conditions in
related markets
(e.g., customer
information behind
each large trade).

Action: Existing
margins (which have
been increased
since October) are
prudential and harmonious across
markets to protect
against trader or
investor default;
prudential margins
appropriate for
carrying stock
should be significantly higher than
those for a stock
futures index contract; best left to
SROs to regulate;
additional cushions
exist in capital
requirements and
Action:
Numerous
surveillance.
recommendations and
proposals for
improved intermarket information
flows; SROs are
exploring information for large
stock traders;
Administration
favors strong
action against
front running and
manipulation.

TREASURY NEWS
Department of the Treasury • Washington,CONTACT:
D.c. • Telephone
566-2041
Office of Financing
FOR IMMEDIATE RELEASE
June 14, 1988

202/376-4350
TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$ 12,800 million, to be issued June 23, 1988.
This offering
will result in a paydown for the Treasury of about $200
million, as
the maturing bills are outstanding in the amount of $13,000 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, June 20, 1988.
The two series offered are as follows:
91 -day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
March 24, 19 88,
and to mature September 22, 1988 (CUSIP No.
912794 QN 7 ) , currently outstanding in the amount of $6,418 million,
the additional and original bills to be freely interchangeable.
182-day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
December 24, 1987, and to mature December 22, 1988 (CUSIP No.
912794 QD 9 ), currently outstanding in the amount of $9,275 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 June 23, 1988.
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 $1,719 million as agents for foreign
and international monetary authorities, and $3,351 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 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series)
B-1452

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS
Department of the Treasury • Washington, o.c. • Telephone 566-2041
Text as Prepared
Embargoed Until Delivery
Expexcted at 9:30 A.M., E.O.S.T.
STATEMENT OF THE HONORABLE
JAMES A. BAKER, III
SECRETARY OF THE TREASURY
BEFORE THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
U.S. HOUSE OF REPRESENTATIVES
JUNE 15, 1988
Mr. Chairman and Members of the Committee:
I welcome this opportunity to discuss with you the Administration's legislative proposals for the Multilateral Development
Banks (MDBs)• I will begin by commenting on the Administration's legislative request for U.S. participation in the
Fifth Replenishment of the African Development Fund and then
turn to the general capital increase (GCI) for the World Bank
and the issue of developing country external debt.
African Development Fund (AFDF)
Last November the Administration concluded negotiations with
other donors on a $2.67 billion replenishment of the African
Development Fund and agreed to seek Congressional authorization
for U.S. participation. The proposed U.S. share is 11.3 percent
or $105 million annually for three years. In the course of
negotiating the replenishment, we succeeded .in having a number
of policy issues adopted on which Fund operations will focus.
These include:
o promoting market-based incentive systems and appropriate
pricing policies;
o meeting the primary needs of the poorest sections of the
population in low income countries;
o fostering employment creation and increased incomes, with
agriculture as the highest lending priority;
o eliciting or promoting the direct involvement of the
ultimate beneficiaries, including women, in the design
and implementation of projects and programs;
o contributing to the improvement of the environment; and

B-1453

- 2 o

developing country lending strategies, and coordinating
lending programs with other donors.

The aspect of fostering market-based incentive systems is
especially timely in view of the region's emerging commitment
to strong economic systems. As you may know, I recently
attended the annual meetings of the African Development Bank
and Fund in Abidjan. I wanted to be the first Secretary of
the Treasury to have done so. I had the opportunity to meet
with President Diouf of Senegal, President Houphouet-Boigny
of Cote D'lvoire and Finance Ministers of many African countries.
I am encouraged by the depth of their commitment to economic
reform — not only for the present but for the long terra. My
meetings in Abidjan reconfirmed this commitment.
The pursuit of such reforms requires a large measure of courage.
For the poorest countries, the personal and national concessional
financial support of the international community is a critical
factor in the ability to succeed. The AFDF is an important
source of such finance, and I urge you to support U.S. participation.
The World Bank General Capital Increase
The other important component of our legislative request is
authorization for U.S. participation in the General Capital
Increase (GCI) of the World Bank (IBRD).
After carefully reviewing the current and future demand for
World Bank lending, we agreed with Bank President Barber
Conable's assessment that a GCI was needed this year to insure
that the Bank can continue to provide the necessary support for
economic growth in the developing countries. The United States
has an 18.75 percent share of the GCI, which implies a budget
appropriation request of $70.1 million annually over a six
year period. The callable capital program limitation would be
$2.3 billion annually.
*

While the debt situation in developing countries is one factor
in our decision to support the GCI — and I will come back to
that — a healthy and vibrant World Bank will address broader
economic, social, and environmental issues. The main role of
the World Bank continues to be supporting economic development
through sound project lending. At least 75 percent of World
Bank lending is for projects to promote human and capital
infrastructure in areas such as energy development, development
finance corporations, agriculture and rural development, urban
development, and transportation.
Energy is clearly essential to development, and becomes
increasingly so as economies expand. But expansion of this
sector can be very expensive, often requiring large-scale

- 3 investment. In its last fiscal year (1987) the World Bank
made commitments of $3.5 billion for energy development
projects, including support for the generation and distribution of electric power to households, schools, hospitals,
and industry.
In contrast to direct support for large-scale projects,
the World Bank also supports small and medium-scale
productive enterprises through local development finance
companies (DFCs). Most DFCs lend to manufacturing enterprises, though some also specialize in particular sectors
or activities, such as tourism. In FY 1987 these financial intermediaries received IBRD commitments of $2.2
billion.
The reasons for World Bank lending to agriculture and rural
development are compelling. Approximately six out of every
ten people in developing countries depend on agriculture and
related pursuits for their livelihood. Bank projects help
developing countries expand irrigation systems, provide more
effective extension services, make credit available to small
farmers, adopt appropriate technology, increase storage, and
improve marketing and distribution facilities. The Bank
committed $1.9 billion of its resources to this sector last
year.
Urban development was the fourth largest recipient of IBRD
commitments in Bank fiscal year 1987, receiving $1.2 billion.
Urban areas now contain nearly one-third of the total population in developing countries. Urban projects usually contain
major components to upgrade slums and squatter development,
or to create sites for additional low-income housing.
The transportation sector received the fifth largest amount
of World Bank commitments last year, $1.1 billion. These
projects support the construction of thousands of miles of
main, secondary, feeder, and rural access roads; railway
reconstruction; and expansion of seaports, riverports, and
inland waterways.
\
Much of the Bank's lending program supports countries that are
strategically important to the United States. Table 1 below
compares last year's (FY87) World Bank commitments to U.S.
bilateral economic assistance (Development Assistance, ESF,
and PL-480J. As an example, Turkey received commitments of
$1.1 billion from the World Bank, compared to U.S. commitments
of $100 million.
Even more striking is the level of World Bank support to
countries who are very important to us but where there is
the virtual absence of U.S. bilateral assistance. As an
example, Argentina, Brazil and Mexico received $3.9 billion
from the World Bank in 1987 and virtually nothing from the
United States. In total, for all of the countries listed

- 4 in Table 1 below, World Bank commitments in 1987 amounted
to $7.7 billion compared to $1.1 billion in U.S. commitments .
Table 1
Fiscal Year* 1987 Loan Commitments
World Bank U.S. Bilateral
($millions)
Country

($mill
**4
**2

Mexico
Brazil
Argentina
Turkey
Pakistan
Philippines
Morocco
Tunisia
Thailand
Indonesia

$1,678
1,262
965
1,069
397
342
577
334
21
1,058

$100
325
340
87
84
21
128

Totals

$7,703

$1,091

——

* U.S. and World Bank fiscal years differ by three months.
** Country share of regional development programs.
The U.S. portion of the paid-in capital (which is actual budget
authority) that supported this $7.7 billion IBRD lending program
was approximately $60 million as compared to the $1.1 billion
dollar-for-dollar cost for the U.S. bilateral assistance.
These figures vividly illustrate how we cannot begin to duplicate
bilaterally the amount the World Bank can lend as a multilateral
institution. The cost would be prohibitive.
This funding has been put to good use:
o A $184 million loan will help Turkey improve
environmental conditions in Izmir by promoting
adequate water supply, sewerage, and sewage
treatment facilities, as well as appropriate
industrial waste-treatment policies and
practices.
o A $22.3 million education loan to Morocco will
improve the quality of vocational training and
reduce its costs through improvements to instructor training.
o A $70 million loan will help Pakistan improve
the efficiency of existing power stations, and
add about 200 mega-watts of additional generating capacity.

- 5 -

0

A $300 million loan will support Philippine
economic-recovery efforts, including programs of
tax reform, trade-policy rationalization, publicinvestment program restructuring, and rationalization of government financial institutions.
• In Brazil, an $84 million loan will benefit about
73,000 low-income farm families through construction of simple water-supply systems, construction
of two fish hatcheries, provision of extension
services, marketing support, funding for community
subprojects, and demarcation and protection of a
natural reserve.
An important aspect of our relationship with the Bank is the
procurement contracts U.S. businesses receive from the IBRD.
For FY 1987, the latest figures available, U.S. firms received
$1.6 billion in disbursements from the IBRD for foreign procurement. In an effort to increase this amount, personnel from
the Commerce Department, in conjunction with the U.S. Executive
Director's office at the World Bank and Treasury staff, are
working to increase the number of contracts on which U.S. firms
bid.
Another important dimension of World Bank operations is the
increasing effort to promote private sector development.
Development finance companies, which I described earlier,
channel considerable resources to the private sector. Bank
projects in other areas often have specific elements to
support the private sector. In Turkey, for example, Bank
projects support joint ventures with the private sector for
construction of power plants.
There is also support for the private sector through policybased lending. Consultants financed through World Bank
support are assisting governments in countries such as Kenya
and the Philippines to formulate model agreements and revise
legislation that affects petroleum in order* to attract investment by foreign oil companies. Burkina Faso is being helped
to revise mining sector tax and investment codes.
Policy Reform and International Debt
I will now turn to the essential role the World Bank plays in
addressing the international debt problems of the developing
countries. By encouraging growth-oriented structural reforms,
providing both policy based and project loans to support stronger
growth, and helping to catalyze private sector support for
these nations, the World Bank is a key part of the cooperative
international debt strategy. The strategy has broad international

- 6 -

support, recently reaffirmed at the spring IMF and World Bank
meetings. At its heart is a firm belief that economic growth
and capital formation are central to easing debt burdens over
time, and that both market-oriented reforms and external
financial support are essential to achieve those objectives.
The debt strategy provides a framework for addressing the
individual needs of each debtor country on a case-by-case
basis. However, it is dynamic in nature, supporting both
innovation and evolution over time to keep pace with changing
circumstances. Indeed, one of the great strengths of this
approach is its adaptability.
I recognize that some of the members of this committee have
questioned the extent of progress being made under this strategy,
and advocate instead U.S. support for debt reduction through
creation of a new international debt facility or other measures.
I would like to address these two issues directly, because they
are fundamental to where we go from here.
Progress
We must start from a recognition that the sheer magnitude of
the external debt of the 15 major debtor nations (some $450
billion) and the exposure of U.S. and foreign commercial banks
(approximately $290 billion) is such that "overnight" solutions
are neither feasible nor practical. No one has the resources
(or the political will) to purchase, guarantee, secure, or
wipe out debt of this magnitude in a short timeframe: not the
debtor nations, not the IMF, not the World Bank, and — given
current budgetary constraints in the U.S. and other industrial
countries — not our own taxpayers.
Moreover, total elimination of external debt isn't necessary.
The objective is to work down total debt burdens over time,
while improving the ability to service debt ^nd enabling a
return to creditworthiness. The question is how to best
accomplish those objectives. The strategy we have been
pursuing is a multi-faceted one, involving cooperative efforts
to improve productivity, growth, and exports in debtor nations;
to stretch out and reduce annual debt payments through reschedulings and other voluntary mechanisms; to provide interim financial
support where needed; and to buttress the debtors' efforts through
a supportive external environment.
While some countries such as Brazil or Peru have tried "shortcuts"
to avoid needed policy reforms and conserve resources through
unilateral debt moratoria, such policies have not worked —
indeed, they have been counterproductive and costly, as Brazilian
officials have publicly recognized.
Admittedly there is fatigue among both debtor countries and
commercial banks, but contrary to those who would argue that
wholesale debt relief is the only solution, I believe the

- 7 present strategy is producing results and moving us toward
resolution of this~difficult problem. Allow me to draw your
attention to the following facts:
o According to World Bank data, 8 of the 15 major debtor
countries grew at 4-5 percent or better last year,
compared with only three countries in 1985. We should
bear in mind that growth for the 15 countries was negative
by 3% in 1983.
o Debt service ratios for the group have fallen by
one-fourth and interest service ratios by one-third
in the past few years. This is largely due to the
substantial decline in interest rates since 1982.o Aggregate current account deficits have been sharply
reduced from a peak of $50 billion in 1982 to $15 billion
in 1986, and $8 billion in 1987.
o Export earnings rose by 13 percent to near record highs
last year, while imports this year should be the highest
since 1982.
o The adoption of debt/equity swap mechanisms in some
countries, as well as broader policy reforms, has
encouraged the return of flight capital, while also
helping to reduce debt and debt service burdens.
Perhaps the most important change during the past two years
has been in the attitudes towards macroeconomic and structural
policy reforms in the debtor nations. While some are doing better
than others, virtually all of the major debtors accept the need
to focus on market-led growth, restructuring their economies
and removing impediments to trade and capital flows. Let me
cite a few examples.
Mexico has liberalized its trade regime and continues its
privatization of state enterprises. Through a market-based
approach, the country has diversified its export base to the
point where, for the past two years, non-oil exports have
exceeded oil revenues. Foreign investment flows have also
sharply increased. Mexico has recently adopted a special
program to reduce inflation, although stronger efforts are
still needed to bring its fiscal deficit under control.
Chile's comprehensive reform program, including a strong
reliance on market mechanisms and a favorable business climate,
has increased economic efficiency, kept inflationary pressures
in check, attracted foreign direct investment and enabled
strong growth. In the past two years Chile has also swapped
$3.9 billion of its foreign debt into domestic equity and
other investment, equivalent to approximately 30 percent of
Chile's bank debt. If this could be accomplished in other
countries, we would be well on our way to resolving debt
problems.

- 8 Colombia has carried out a program of broad structural reforms
supported by the World Bank and an "enhanced surveillance"
arrangement with the IMF. Increased coffee revenues have been
effectively utilized to finance development while avoiding
inflationary pressures.
Uruguay has reversed the economic decline of the early 1980s
through an export-based economic strategy and a competitive
exchange rate. Its current account position is expected to
improve this year and the inflation rate should continue to
decline; growth prospects have also improved.
The Philippines has liberalized imports, is implementing a
comprehensive tax reform program, and is instituting major
agricultural reforms.
Finally, Bolivia has arguably produced the greatest measure of
internal reform. It has also implemented an imaginative plan
for accomplishing a substantial reduction in its stock of debt.
The World Bank has provided strong support for these reforms,
through both fast-disbursing, policy-based loans to support
structural reforms and project loans to enhance production
and development. Its loans have also helped to catalyze
additional private financial flows. Together, the IMF and
the World Bank have provided approximately $17 billion in
new loans for these countries since October 1985.
The commercial banks have also committed some $17 billion
in new finance during this period, while rescheduling some
$212 billion in outstanding debt, reducing spreads, and
providing longer grace periods and maturities. Official
creditors have also rescheduled some $18 billion in both
principal and interest payments.
We have also taken the lead in advancing ideas for strengthening the debt strategy in a number of areas. These include my
proposal last fall for the creation of a new ^MF External
Contingency Facility to help cushion the effect on IMF standby
programs of unforeseen external developments, such as weaker
commodity prices, natural disasters, or sustained higher
interest rates that might force a performing country off its
economic course. Our efforts to initiate these reforms resulted,
in part, from discussions with debtor nations, who felt that
longer programs with stronger structural reform content and
greater recognition of unforeseen contingencies are essential
to the long term resolution of the debt problem.
At the IMF Interim Committee on April 14, it was agreed in
principle to establish a combined Compensatory and Contingency
Financing Facility to address such external contingencies while
retaining the essential features of the existing Compensatory
Financing Facility and improving both its conditionality and
its operation. We expect the new facility to expand potential

- 9 access for the fifteen major debtors by more than 25 percent,
or, potentially, more than $12 billion, depending of course
upon external developments. The Interim Committee also agreed
to revitalize the IMF's Extended Fund Facility for use on a
case-by-case basis to enhance the focus on structural reform.
Here again there is potential for a significant increase in
resources for selected countries.
Creditor countries have also taken a number of significant
measures to assist low-income developing nations. For Africa,
the IMF's new Enhanced Structural Adjustment Facility will
provide concessional resources totalling SDR 6 billion to
low-income countries facing protracted balance of payments
problems that are engaged in economic and structural adjustment.
Donor governments have pledged $6.4 billion of financing to be
used in cooperation with the World Bank for low-income African
countries with severe debt problems that have undertaken adjustment programs. Likewise, the Continuing Resolution passed by
Congress in December gives the U.S. Agency for International
Development (AID) additional funds for development assistance
to Africa, and greater flexibility in allocating these funds.
In addition to these steps we recently indicated our willingness
to support a differentiated approach for the poorest countries
in future rescheduling of official debt in the Paris Club.
This would permit creditor countries which are in a position
to do so to provide concessional interest rates in debt reschedulings, in exchange for shorter repayments of their rescheduled
debts. Those countries not able to provide concessional rates,
such as the United States, would continue to reschedule the
poorest countries' debts on longer terms.
Finally, as you all know, we have encouraged the development
of a "menu" of alternative financing options to help meet the
diverse interests of both debtor nations and the banking community
in devising new financing packages. Financing innovations that
are developed for the mutual advantage of banks and debtors are
key to the resolution of the debt workout.
Such "menus" can provide a variety of options for new financing,
including traditional balance of payments loans, trade credits,
project loans, on-lending facilities, new money bonds, and
even limited, voluntary interest capitalization. They can also
include a range of new instruments, including debt/equity swaps,
debt/consex-vation swaps, and "exit" bonds. Debt conversion
instruments help to reduce both outstanding debt and debt
service burdens. Banks would choose among these options in
supporting debtor reform efforts, as in last-year's Argentine
new money package and the pending Brazilian package.
The recent Mexican debt/bond exchange provides an example of
an innovative, voluntary debt conversion technique worked out

- 10 between the debtor government and the commerical banks, with
the principal amount of the new Mexican bonds in this case
collateralized by the purchase of U.S. Treasury aero-coupon
bonds. We believe the results of that exchange demonstrate
that several commercial banks are interested in this kind of
market-driven technique, but that most banks will only entertain such exchanges at rates well above thin secondary market
values for such debt. We expect further market development
of these kinds of debt conversion options in the period ahead.
Clearly, more still needs to be done. Nevertheless, the
debtor countries are increasingly committed to reforms and
are making progress toward sustained economic growth. We
must continue to support these efforts, recognizing that a
careful balance between reforms and new financing is essential to assure that debt does not increase at a faster pace
than the debtor's ability to service it. While this is
undoubtedly a difficult task, I believe the debt strategy
now in place is the only viable approach to reach this goal.
Debt Facility Proposals
I recognize, of course, that a few critics urge another path —
the development of generalized debt forgiveness schemes,
particularly through a variety of international debt facility
proposals. The trade bill includes one option for such an
approach. Some have offered other options. While each proposal
varies in significant ways from the others, all have a number
of common characteristics:
oo They provide for the new facility to either purchase
commercial bank debt outright or swap new, discounted
securities issued by the facilities (e.g., consols,
preferred stock, or guaranteed bonds) for commercial
bank claims.
oo Some portion of the discount would be passed on to the
debtor nations, although the mechanisms for connecting
this with economic reforms are not clear.
oo Creditor governments, and perhaps the IMF or World Bank,
would back these transactions and assume the risk on
the debt transferred to the new facility.
There are a number of technical details that differ from
one proposal to the next. The trade legislation proposal would
involve the outright purchase of debt from the banks, a "cashing
out" for the banks, rather than an exchange for discounted
securities, as in most other proposals. This approach is
voluntary, but would involve an appreciable up-front cost,

- 11 depending upon the number of banks that want to sell their
debt, presumably at a sufficiently attractive price.
On the other hand, other proposals would impose penalties on
those banks that elect not to participate, through required
reserves, writedowns, subordination of loans, or lower-value
exit bonds. Such penalties to force participation and losses
on loan portfolios could make it very unlikely that banks would
provide any new credits to these countries for some time to come.
While treatment of interest on the new securities also varies,
all of the proposals shift, to varying degress, the risk on both
interest and principal to the international financial institutions
or creditor governments.
All of these proposals pose serious problems:
oo First and foremost, these proposals would substitute
new and generally very weak economic reform conditions
as the basis for debt forgiveness by the new debt
facility. This would contradict and confuse current
IMF and World Bank conditionality.
oo These proposals would also politicize the debt problem,
distracting creditors and debtors alike from the difficult
but fundamental adjustment task. For example, debtor
countries might purposefully attempt to capture a larger
discount on their debt through debt repudiation or unsound
economic policies. This could also exacerbate existing
problems with flight of capital. Thus these proposals
could well be counterproductive.
oo Furthermore, by consolidating debt in one international
body, pressure to immediately pass on the "discount" of
the debt swap or purchase would be intense, making it
difficult to reward debtors' adjustment efforts with debt
relief over time.
*

oo

Likewise, debtors would likely seek equal treatment on
any discount, forgiveness, terms, and conditionality.
For example, Mexico, which has always serviced its debt
on time, should not be put in the same category as Bolivia,
whose debt banks were willing to buy back at 11^ 6n the
dollar. This example illustrates the importance of
preserving the the case-by-case approach. Each country
has unique economic circumstances and each country is
at a different stage in the development process. Debt
conversion and other financing techniques must recognize
this fact.
oo Use of IMF or World Bank resources to back the facility
would also affect the lending base of the IMF and creditworthiness of the World Bank. There is some $290 billion
of commercial bank debt to the 15 major debtors alone.
The cost of repackaging this debt and guaranteeing new
securities would be substantial.

- 12 -

oo

It is inappropriate for governments unilaterally to force
private financial institutions to sustain losses*

Neither government bail-outs, outright debt cancellation, nor
debt repudiation offers permanent solutions; the only way to
assure stronger growth and to resolve debt problems is for
debtors to adjust structurally to strengthen growth and encourage
the return of voluntary lending.
That is the essence of the debt strategy we are pursuing. Debt
reduction techniques are voluntary options within this approach,
depending upon commercial bank negotiations with the debtor
nations. Through debt/equity swaps, some $7.5 billion in debt
has already been converted into equity holdings in the major
debtor countries since 1985. Debt/bond swaps and even debt
restructurings, where agreed upon by banks, are also possible
"menu" items — without involving substantial up-front costs
and contingent liabilities for creditor governments and their
taxpayers. In the final analysis, the banks and debtor governments themselves must develop the options they are prepared to
accept — we can't force them into a single mold, nor should
we try to do so.
Environmental Aspects of Lending Programs
The last issue of mutual interest I wish to address is the
role of MDBs in the environment. One of our most important
objectives in GCI negotiations has been to strengthen Bank
policies and programs on a broad range of environmental
issues. I have taken a personal interest in those issues.
They are crucial to the protection and preservation of our
natural resource base in all parts of the world. They are
critical if we are to achieve successful and sustainable
development and growth in developing countries over the
longer term.
The report on the General Capital Increase, npw adopted by
the Bank's Board of Directors, calls for:
oo Additional emphasis on the need for better management
of human and natural resources so that countries can
achieve fully sustainable development.
oo Integration of environmental work into country
development strategies, policies and programs.
oo Evaluation of the environmental costs of bank projects;
oo Mitigation or elimination of adverse effects of
bank projects.

- 13 -

oo

Support for national and regional programs to
improve environmental management.

Getting this language into the Report on the General Capital
Increase is an important step. It commits the institution's
shareholders from both developed and developing countries,
not just the President of the Bank, to an overall framework
for environmental work over the next several years. Our job
now is to see that this commitment is turned into a series of
strategy papers, policy decisions, and lending programs that
will have the impact that we seek.
During 1987, the World Bank carried out a major reorganization
of its management and staff. One of its primary aims was
strengthening the Bank's capacity to deal more effectively
with environmental issues. A Central Environmental Department
was created as well as environmental units in each of the
Bank's four regional offices. Thus far, 45 full time permanent
positions have been authorized for environmental purposes and
provisions made for the equivalent of 18 man-years of consultant services.
In the Inter-American Development Bank, two senior environmental experts have been added to the Bank's permanent staff,
an ecologist and an expert on rainforests. A three-day
seminar on environmental issues was held last December for
40 members of the Bank's project analysis staff. Two additional seminars for other members of the Bank staff took
place in May and a one-day briefing on environmental issues
for the Bank's representatives in borrowing countries was
held last week.
A start has also been made on promoting participation of
non-governmental organizations in the project preparation
cycle. The World Bank and the Inter-American Development Bank
have held meetings with non-governmental organizations here
in Washington to facilitate the exchange of information. The
African Development Bank is making preparations for a similar
meeting with African NGOs later this year in Abidjan. We
will be reporting to you later this month on other aspects of
NGO participation in multilateral development bank activities.
Within the U.S. Government we are working to improve the
ability of the early warning system to monitor MDB projects
with potential adverse effects. The Environmental Protection
Agency is taking a more active role in both the early warning
system and in our regular review of MDB projects. We are also
taking a tougher stand against unsatisfactory loan proposals
that reach the board, abstaining on environmental grounds on
a number of loans over the past year.

- 14 We are also beginning more systematic consultations on environmental issues with other member countries. These include
Development Committee discussions on environmental matters in
April and an OECD Meeting in May to help develop an environmental
checklist for decision-makers in multilateral and bilateral
agencies. We expect to build on this checklist in meetings
later this year and to develop more international support for
environmental issues in general.
In sum, I think we are making appreciable progress toward
our objectives. Obviously, we are not where we want to be,
and we will need to put continuing emphasis on all of these
issues. Our priority now should be to implement the provisions of legislation already in place. I look forward
to working with you in that process in the upcoming months.
Conclusion
I believe we have a number of shared objectives. First, we
must continue the work of the World Bank in supporting development and growth in developing countries. For the World Bank
to effectively pursue this role, it needs increased resources.
Second, the developing countries need to adopt market-oriented
reforms in order to achieve stronger growth. Third, we must
maintain a stable international financial system, while supporting increased flexibility and innovation in addressing debt
problems.
The current debt strategy is working to address these objectives.
I welcome the opportunity to discuss our perspective on these
issues with you today, and hope that we can work together to achieve
these common objectives.
Thank you, Mr. Chairman.

TREASURY NEWS
Department
of the Treasury
• Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE
PPTF^r
June 15, 1985

CONTACT:

—

Office of Financing
202/376-4350

TREASURY TO AUCTION 2-YEAR AND 4-YEAR NOTES
TOTALING $15,250 MILLION
The Treasury will auction $8,500 million of 2-year notes
and $6,750 million of 4-year notes to refund $16,294 million of
securities maturing June 30, 1988, and to paydown about $1,050
million. The $16,294 million of maturing securities are those
held by the public, including $2,202 million currently held by
Federal Reserve Banks as agents for foreign and international
monetary authorities.
The $15,250 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 prices of accepted competitive tenders.
In addition to the public holdings, Government accounts
and Federal Reserve Banks, for their own accounts, hold $1,826
million of the maturing securities that may be refunded by
issuing additional amounts of the new securities at the average .
prices of accepted competitive tenders.
Details about each of the new securities are given in the
attached highlights of the offerings and in the official offering
circulars.

oOo
Attachment

B-1454

HIGHLIGHTS OF TREASURY OFFERINGS TO THE PUBLIC
OF 2-YEAR AND 4-YEAR NOTES TO BE ISSUED JUNE 30, 1988
June 15, 1988
Amount Offered to the Public
Description of Security:
Term and type of security
Series and CUSIP designation

$8,500 million

2-year notes
Series AC-1990
(CUSIP No. 912827 WH 1)
Maturity date
June 30, 1990
Interest Rate
To be determined based on
the average of accepted bids
Investment yield
To be determined at auction
Premium or discount
To be determined after auction
Interest payment dates
December 31 and June 30
Minimum denomination available . $5,000
Terms of Sale:
Method of sale
Yield auction
Competitive tenders
Must be expressed as
an annual yield, with two
decimals, e.g., 7.10%
Noncompetitive tenders
Accepted in full at the average price up to $1,000,000
Accrued interest payable
by investor
None
Payment Terms:
Payment by non-institutional
investors
Full payment to be
submitted with tender
Payment through Treasury Tax
and Loan (TT&L) Note Accounts .. Acceptable for TT&L Note
Option Depositaries
Deposit guarantee by
designated institutions
Acceptable
Key Pates:
Receipt of tenders
Wednesday, June 22, 1988,
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a) funds immediately
b) readily-collectible
available to the Treasury
check ...
.. Thursday,
Tuesday, June
June 28,
30,1988
1988

$6,750 million
4-year notes
Series N-1992
(CUSIP No. 912827 WJ 7)
June 30, 1992
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
December 31 and June 30
$1,000
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
Thursday, June 23, 1988,
prior to 1:00 p.m., EDST

Thursday, June 30, 1988
Tuesday, June 28, 1988

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
Expected at 9:30 A.M., EDT
June 16, 1988

STATEMENT OF
DAVID R. MALPASS
DEPUTY ASSISTANT SECRETARY
FOR DEVELOPING NATIONS
U.S. DEPARTMENT OF TREASURY
BEFORE THE
SUBCOMMITTEE ON HAZARDOUS WASTES
AND TOXIC SUBSTANCES
COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS
UNITED STATES SENATE
THURSDAY, JUNE 16, 1988
Mr. Chairman:
I am pleased to participate in this review of
environmental reforms in the multilateral development
banks. We have had a clear and strong mandate from
Congress that we should act through these Banks to
promote environmentally sustainable economic growth
and improved management of natural resources in borrowing countries. Treasury strongly supports these
objectives. Let me begin by summarizing the principal
points of that Congressional mandate and then discuss
what we have done to implement it in managing U.S.
participation in the multilateral development banks.
The first Congressional mandate for environmental
action in the multilateral development banks, which
include the World Bank and three regional banks for
Asia, Africa, and Latin America, was included in the
Continuing Resolution Act for 1987, Public Law 99-591.
This legislation provided that the Secretary of the
Treasury should instruct the U.S. Executive Directors
in the Banks to promote a number of very specific and
detailed reforms. These reforms included:
B-1455

-2° addition of professionally-trained staff in the
Banks.
° development of plans for systematic and thorough
environmental review of projects.
° creation of line units to carry out such reviews.
° establishment of multidisciplinary planning
processes.
° development of plans for rehabilitation and
management of ecological resources.
° involvement of health and environmental ministers
and non-governmental organizations in the project
preparation cycle.
° increase in the proportion of environmentallybeneficial lending.
A report detailing progress in these areas was submitted to Congress in January, 1988. I will return in
a few minutes to the subjects in that report and provide
some details on the progress that is being made.
The second Congressional mandate on environmental
reforms was included in the Continuing Resolution for
FY 1988, Public Law 100-202. This legislation restated
many of the reform objectives outlined in the previous
year's Continuing Resolution and made them a part of the
permanent authorization legislation. It also provided
for a number of other initiatives including:
° an analysis of debt/conservation swaps.
° discussions with other donors regarding
personnel and financial support for
environmental programs in the regional
development banks.
° discussions with other executive directors in
the World Bank regarding establishment of a
grassroots collaboration program.
o

enhancement of the early-warning system for
identifying problematic loans.

o

report on a comprehensive strategy to address
natural resource problems.

-3° discussions with other executive directors
in the banks regarding integrated pest
management.
This legislation took effect in December, 1987.
We have already begun to implement some of these
initiatives but action still remains to be taken in
other cases.
It is clear even from this brief summary that a
great deal of legislation is already in place. I want
to assure you that we are making a conscientious effort
to implement it. In fact, I believe we should make
implementation our primary objective at this time and
not seek the passage of new law on this subject.
Within Treasury, we are working hard to improve
our oversight of environmental issues in the multilateral development banks. During 1987, we objected
to six loans, citing concerns about adverse environmental effects. These loans included agricultural
rehabilitation in the Sudan, electric power in Peru,
a paper mill in Nepal, an abattoir in Botswana, livestock development in Benin, and agroforestry and
livestock development in Mali. In February of this
year, we objected to a loan to Burkino Faso for a road
and water project because of serious environmental
issues. On another occasion, a loan proposal adversely
affecting tropical moist forests was withdrawn in the
face of our objection. I am confident, however, that
our influence on bank activities has been far broader
than these figures suggest and that other projects
have been modified before they reached the Board.
We are continuing close coordination with State
and AID and with environmental groups in an effort
to improve the early warning system for problematic
projects. We are intervening more frequently and more
effectively with MDB management to make our concerns
clearer at an early stage and to seek improvements in
project proposals. We have for example, visited the
site of a major dam project in India to examine
resettlement issues. We have also notified the World
Bank of concerns about a hydro-power study in Nepal at
the very earliest stage, the prefeasibility stage. We
are taking an active role in international meetings
on environmental issues, particularly those that affect
projects and programs funded by the multilateral
development banks.

-4We have had particularly strong support from a
number of non-governmental organizations in gathering
information and developing approaches to increase the
effectiveness of our efforts. These organizations
have assisted in the preparation of standards- for
evaluating projects that may adversely affect tropical
moist forests. They have also helped us put in place
standards for projects affecting open-range savannas
of Sub-Saharan Africa and are now working with us on
wetlands standards. The organizations have participated in the early warning system established by AID
to identify projects that may adversely affect the
environment. They have worked closely with us in
analyzing problems associated with specific loan proposals or with projects that are being implemented.
To sum up, we have been getting involved at an
earlier stage in the project cycle, trying to make
specific changes in proposals before they come to the
boards of the Banks. I might add that EPA is now
becoming integrally involved both in early warning
group meetings and in the final review of projects
just before they come to the board.
Let me turn now to implementation of some of these
legislative provisions, starting with those in Public
Law 99-591.
Staffing and Training
During 1987, the World Bank carried out a major
reorganization of its management and staff. One of
its primary aims was to strengthen the Bank's capacity
for addressing environmental issues. A central environmental department was established in the Policy,
Planning and Research complex. Twenty-three positions
have been authorized for the three divisions in the
department. In addition, environmental units have
been created in the technical departments of the Bank's
four regional offices. Twenty-two positions have been
authorized for these four units. The Bank has appointed
a new director for the Environmental Department and a
new advisor for scientific and environmental affairs.
Both of these individuals appear to be well-qualified
and capable, with extensive backgrounds in environmental
matters. In addition to 45 permanent staff positions,
the Bank has indicated that it expects to use the equivalent of 18 man-years in consultant services for
environmental issues during its current fiscal year.

-5The regional development banks need to hire more environmental specialists and to assign more staff to environmental issues. We have been encouraging them to do that.
The Inter-American Development Bank has recently hired two
senior environmentalists for positions at the Bank's
headquarters and a third expert has been assigned to the
Bank's field office in Brazil. The Asian Development
Bank has had five staff members working on environmental
issues; however, the chief of their environmental section
has recently been recruited for the World Bank's Asian
Environmental Unit and a well-qualified replacement is
needed to fill that position. The African Development
Bank has said that it will increase its environmental
staff from two to four and that a well-qualified African
candidate will be sought as Chief of the Unit. The unit
is currently headed by a Norweigan official seconded to
the Bank.
Significant progress has been made on training.
In the World Bank, an environmental training program
has been introduced for Bank staff. The program is
designed to raise awareness of environmental issues
in development, to convey new techniques, and to
introduce the latest developments in the field. The
integration of environmental and economic work and
the importance of policy intervention is to be
included in the curriculum of the Economic Development
Institute.
The Inter-American Development Bank has initiated
a series of seminars on environmental issues. The
first of these seminars took place over a three-day
period in December, 1987, with forty members of the
Bank's technical staff participating. Two other seminars were held in early May, one for projects analysis
staff and one for loan officers. Similar seminars for
other members of the staff are also planned. Just last
week a seminar on environmental issues was held for the
heads of the Bank's field offices in borrowing countries.
The African Bank has sponsored a one-day seminar on the
economic valuation of environmental impacts and a two-day
seminar on environmental planning in project development.
A third seminar focusing on grazing issues, which have
been problematic in some Bank projects, is to be scheduled
for later this year. In preparing for that seminar, we
are encouraging the Bank to emphasize conservation and
range management issues as well as productivity.

-6Management Line Units
Three of the Banks have established line units to
provide for a systematic and thorough review of projects affecting the environment and natural resources.
As I indicated earlier, the World Bank has set up four
regional units. The Asian Development Bank and the
African Development Bank have established smaller
units that need to be strengthened. The Inter-American
Development Bank decided to create an inter-departmental
Committee instead of a line unit. It reviews projects
in both the preparation and implementation phases an
d is advised by a senior environmental specialist. We
are encouraging the Bank to establish an environmental
unit in the project analysis area.
Involvement of Health and Environmental Ministers
and Participation of non-Governmental Organizations
The management of the banks report that they have
taken steps to emphasize the involvement of health and
environmental ministries. The Asian Development Bank
provides special briefing materials to its country programming teams on environmental and natural resource
development projects. The environmental unit at the
bank is also in contact with environmental agencies in
borrowing countries regarding specific projects in the
pipeline that may need assessment. The African Development Bank has issued instructions to staff for expanding
consultations with health and environmental ministers.
Participation of non-governmental organizations is
also being encouraged in all of the banks. In the World
Bank, the focal point for relations with non-governmental
organizations has been shifted from Public Affairs to
Policy, Planning and Research. This shift has facilitated the exchange of views and discussions on substantive
issues. A number of initiatives are also going forward on
the involvement of indigenous people and local community
groups. We expect to report to the Congress on some of
these initiatives over the next two weeks.
In May 1987, the Inter-American Development Bank
sponsored a conference on environmental issues in Latin
America and the Caribbean. There was extensive participation by regional and non-regional NGOs. There was also
very broad representation from public agencies throughout
the region, responsible for environmental protection and
natural resource conservation. A second conference is now
being planned to follow up on the results of the first
conference. The African Development Bank is also making
plans to hold a meeting for the African NGOs during the
second half of this year. Non-governmental organizations
from this country with our strong endorsement and support
are helping the Bank to prepare for this meeting.

-7The Asian Development Bank has completed a working
paper on cooperation with non-governmental organizations.
The paper was based on consultation with a number of those
organizations. A final report is expected shortly. All of
the banks are seeking to involve NGOs in borrowing countries
more actively in the project cycle and to see that local
community groups and other organizations are fully informed
of project planning at an early stage of the cycle. In
agriculture, this has involved wider contacts with farmers
organizations, water user associations and women's groups.
Multidisciplinary Planning in Land Uses and
Rehabilitation and Management of Ecological Resources
All of these banks have sought to incorporate new
technologies, including remote sensing techniques, into
efforts to encourage more effective land use planning.
The World Bank has begun preparation of comprehensive
environmental action plans in a number of selected
countries. It is also preparing terms of reference for
consultants to identify areas where multidisciplinary
support can help improve project preparation.
The multilateral development banks are providing funds
for national and international agricultural research programs and for science and technology programs that support
research into eco-system management. The World Bank is
working with Harvard University and the Institute for
International Environment and Development to assess alternative approaches to natural resource management. Task
forces have also been organized within the World Bank to
address desertification, deforestation, industrial accident
risk avoidance, protection of critical eco-systems and mitigation of natural disasters in urban areas.
New Initiatives
We have begun a number of new initiatives as a result of
the Continuing Resolution that was passed in December, 1987,
Public Law 100-202.
On April 13, 1988, we submitted to the Congress a
report that had been requested on debt for nature swaps.
An Internal Revenue Service ruling that encourages participation in such swaps was released last December. The
report recommends that the World Bank place additional
emphasis on working with countries to establish priorities
for conservation projects, possibly piggy-backing World Bank
projects onto debt for nature programs. It also looks to
the Bank to take a more active intermediary role in helping
to arrange debt for nature swaps and to consider starting a
pilot program in a country that has indicated that it is
willing to establish one.

-8We have been in contact with other developed countries regarding the possibility of providing environmental experts to work in the regional development
banks. Environmental experts from developed countries
have already been seconded to the African Development
Bank. Our executive directors in all three regional
banks have talked with management about how this
approach might be used to enhance effectiveness on
environmental issues.
We have held a series of meetings with representatives
of other donor countries regarding improvements in the
environmental performance of the multilateral development
banks. Environmental issues were an important point of
discussion at the Development Committee meeting at the World
Bank in April. In May, we participated in an OECD meeting
in Paris seeking agreement on common criteria for decisionmakers in evaluating environmental issues in the multilateral
development banks. I am pleased to say that EPA took part in
the OECD meeting and that agreement was reached on a checklist
for decisionmakers in both bilateral and multilateral agencies.
We are hopeful of making further progresss on this issue in
the months ahead.
We placed particular emphasis on environmental issues
at the annual meeting of the Inter-American Development
Bank in Venezuela in March, at the annual meeting of the
Asian Development Bank in Manila in April and at the annual
meeting of the African Development Bank in Abidjan earlier
this month.
All of these initiatives have been meant to
involve the governments of other countries more effectively
in our own efforts to improve environmental performance in
the banks. I would like to provide for the record copies of
the statements that we made at these meetings.
During the past year, we have worked closely with our
colleagues at AID in implementing the early warning system
for identifying problematic projects. We believe we can
continue to enhance this system and become more influential
in shaping the environmental aspects of individual loan
proposals in the banks. I am hopeful that EPA participation
will increase our effectiveness at this early stage of the
project cycle. We are also cooperating with Greenpeace and
other interested organizations in forming an informal working
group to examine integrated pest management issues.
At the end of this month we will report to Congress on
our discussions regarding establishment of a grassroots program to promote participation by indigenous people and local
community groups in MDB project formulation. Later this
Summer, we will collaborate with State and AID in analyzing
more comprehensive strategies that can address natural resource
problems through the multilateral development banks and in
our bilateral aid program.

Application of NEPA Standards
It has been suggested that an amendment might be
offered on the application of NEPA standards to multilateral development bank lending. As I understand the
suggestions that have been made, they would require
the preparation of environmental impact statements or
environmental assessments. In the absence of such
statements, it is my understanding that we would
have to oppose any MDB loan that might come up for
consideration.
I support strict environmental review of MDB projects.
However, I would strongly oppose enacting the application of
NEPA standards. We are most effective in the Banks when we
have latitude and can work to enlist the support of other
countries on specific issues. I believe the application of
NEPA standards would paralyze our ability to act cooperatively
and constructively with other member countries. It would
reduce our effectiveness in promoting environmental reform
in the banks and prevent us from making further progress
toward environmental objectives set forth in the legislation.
It could also set back some of the progress we have already
made and that I outlined earlier.
NEPA is, in large part, a process designed to fit into
the administrative and legal systems of the United States.
It does not take account of legal and administrative differences between the United States, other countries, and international organizations. It does not consider the legal
and administrative structures within which we operate in
these organizations. It does not reflect the reality under
which the United States has to conduct its relations with
other countries and organizations.
The difficulty of applying NEPA standards to international activities was first recognized when Executive_
Order 12114 was signed by President Carter in 1979. This
Executive Order specifically excluded from any form of NEPA
standards "U.S. Government votes and other actions in
international conferences and organizations." I believe
that exemption should be continued.
U.S. voting power varies widely in the multilateral
development banks. We have 18 percent in the World Bank,
34.5 percent in the IDB, 16.6 percent in the ADB; and 5.8
percent in the AFDB. I am particularly concerned about how
NEPA dictated U.S. votes would be perceived in the AFDB,
where our voting share is lowest.

-10Africa has the most pressing developmental problems i
the world. Hundreds of thousands of its people perished i
the famines of the the early 1980s. More than a million
people are now thought to be at risk again. Africa also h
very serious environmental problems: over-grazing, defore
tation, desertification and threats to wildlife and their
habitat.
Obviously, development and environment are linked ver
closely together. The focus of our efforts should be on
finding the innovative and creative approaches that are
needed to achieve substainable development objectives.
A stream of automatic abstentions on environmental grounds
would not help us in these efforts in the African Development Bank. Yet, the application of NEPA standards might
well require blanket opposition to AFDB projects if data
were not available or if a particular standard could not
be met at a certain time.
I am not arguing against objecting to MDB loans on
environmental grounds. As I said earlier, we have already
done so on a number of occasions. Those' actions were very
helpful in focusing attention on specific environmental
issues and in promoting positive changes. However, a
stream of automatic U.S. abstentions because of failure
to meet NEPA standards for environmental assessments
would send a different message to the AFDB and its member
countries and it would produce a different result. We
would, in effect, be opting out of the action, not only on
environmental issues but on other critical issues as well.
To sum up, Mr. Chairman, I am all in favor of strict
environmental review, aimed at sustainable growth and
development, for MDB projects in developing countries.
That is what we have been trying to accomplish under
existing legislation and I believe we have made substantial progress. The application of NEPA standards would
not advance that progress. In my view, it could very
likely set back the progress that has already been made.
There is extensive environmental legislation on the
books. We have supported that legislation and made a
strong effort to see that its provisions are implemented
in the multilateral development banks. I believe we need
to give that legislation a chance to work.
Our immediate objective is further progress on
environmental reforms in the multilateral development
banks. Beyond that, we look to strengthening the systems
for environmental review in borrowing countries. A
cooperative and constructive approach that gets support
from other countries is the most productive way for us
to proceed.

rREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566TEXT AS "PREPARED
FOR RELEASE UPON DELIVERY
EXPECTED AT 9:30 A.M. EDT
•'* Remarks by
Secretary of the Treasury
James A. Baker, III
To the U.S.I.A. International Council Briefing
Washington, D.C.
Thursday, June 16, 1988
Economic Policy Coordination and
International Monetary Reform
The Development of Economic Policy Coordination
This year's Economic Summit begins in three days. As I am
sure you know, there are really two economic summits, and both
occur simultaneously.
The first Summit will take place in the meeting rooms where
the heads of state and their finance ministers confer. Another
may play out on the television screen, where reporters and
commentators speculate on all the possibilities for conflict
among the major actors.
I can't tell you what you can expect in this second,
hypothetical summit. But I can offer you some insight as to what
you can expect in the real Summit.
Much of the real Summit will focus on efforts to coordinate
our economic policies in order to give our international economic
system a better sense of direction and discipline.
Since the coordination process was initiated in 1985, we have
gained some experience with it. I would like to discuss with you
what has taken place over the last few years; touch briefly on
how the process is doing; and tell you why I believe the
coordination process (and not some more sweeping change) provides
the best way to reform the international monetary system.
B-1456

-2Building the Process
The 1985 Plaza Agreement represented the first major step in
the coordination effort. It involved an agreement by the G-5 on
the direction national economic policies and exchange rates
should take to facilitate growth and external adjustment. More
fundamentally, it represented a commitment by the major
industrial countries to work together more intensely to achieve
global economic prosperity, and thereby enable each country to
better achieve its own domestic objectives.
The success of the Plaza Agreement created momentum that led
to further progress. At the Tokyo Summit, we developed a
framework for multilateral surveillance of our economies using
economic indicators.
At the Venice Summit last year, the coordination process was
strengthened further by the adoption of arrangements involving
the development of medium-term objectives and performance
indicators to assess policies and performance.
Thus the major industrial countries have now developed a
"political mechanism" to enhance their ability to coordinate
economic policies. And although the process is still very young,
there is already ample evidence that it is bearing fruit. Fiscal
and monetary policies are being framed in an international as
well as a domestic context. As a consequence, the United States
has taken measures to reduce the budget deficit, to resist
protectionism, and to improve competitiveness. The major surplus
countries, Japan and Germany, have> taken steps to improve
domestic demand and reduce reliance on export-led growth. There
have been coordinated interest rate actions. Cooperation in
exchange markets has been intensified based on specific
understandings.
As a result, the world economy is on a much more solid
footing. Growth continues, but is now more balanced and is
supportive of the adjustment process. Inflation remains low,
and external imbalances are being reduced. The U.S. trade
figures provide evidence that these imbalances are now declining
in nominal as well as real terms. The April deficit was the
lowest seasonally-adjusted monthly deficit since December 1984.
The coordination process was seriously tested last fall in
the wake of the October stock market crash. It would have been
easy for each of us to turn inward and focus on short-term
measures to address immediate domestic needs. Instead, the G-7
pulled together to find a compatible and reinforcing set of
policies to achieve common goals. These efforts demonstrate the
resilience of the coordination process in the face of adversity.
Since that time, strengthened underlying policy actions have been
reflected in enhanced stability of exchange markets.

-3Strengthening Coordination and Reforming the System
As this process of coordination among the major industrial
nations has been developing, questions continue to be raised
about the need for "more fundamental monetary reform." This
is natural. We certainly do not have a perfect monetary
system — nor total coordination of our policies. We cannot
afford to rest on our laurels. We need further strengthening
and reform of the system.
But what form and direction should this take? It is tempting
to consider sweeping, revolutionary changes in the system —
particularly the exchange rate part of the system. But it is far
from clear that such changes are desirable or practical.
While it may be difficult to recognize reform when it emerges
gradually in a step-by-step fashion, I think that further
strengthening of our process of coordination is the best means of
achieving further reform of the monetary system.
So you ask — what are the characteristics of this
step-by-step or incremental approach to monetary reform which
make it the best option available?
o First, it combines flexibility with greater commitment and
obligation. At the same time, it involves no ceding of
sovereignty.
o Second, it recognizes that reform of the system is not
simply a matter of exchange,rates or reserve assets, but
must also involve appropriate fiscal, monetary and
structural policies.
o Third, the system can encourage corrective policy action
through the use of indicators and peer pressure without
relying on automatic trigger devices.
o. Fourth, the burden of adjustment is not biased toward or
away from domestic policies or exchange rates, as was the
case in the par value and early flexible rate regimes,
respectively.
o Fifth, the coordination and indicator process contains
symmetry by focusing on surplus as well as deficit
countries.
o Sixth, evolutionary reform is more credible than attempts
to impose a detailed set of formal constraints through
broad structural changes which markets would consider
overly ambitious and unsustainable.

-4The global economy is too dynamic — and the forces of change
too strong — to be able to look ahead with great certainty and
envision a highly defined international monetary structure that
will fit the world economy of 1995, as well as that of 2005.
We must therefore move cautiously but steadily ahead, always
alert to further improvements in the process and the system. In
this connection, the major industrial countries agreed to adopt a
commodity price indicator, including gold, to assist in assessing
and reaching judgments about economic policies and performance.
It will be used as an analytical tool in examining global price
trends, not as an automatic trigger for policy action or an
anchor for currencies.
We will need to continue to consider other measures, such as
broadening the coordination process to cover structural reforms
in such areas as tax reform, financial market liberalization, and
deregulation of labor markets. We should also consider the use
of "monitoring zones" for key indicators such as growth and trade
balances to help in assessing an economy's performance.
Conclusion
So to conclude, I would submit that our process of
international economic policy coordination has reformed and
strengthened the international monetary system. We have created
a political mechanism that has brought discipline and structure
to international economic policy-making. And our approach has
worked — not perfectly of course. But I strongly suspect the
world economy is better off today,than we would have been had we
not followed this course. And I think additional progress will
be achieved in the future.
Many of those who earlier had doubted this process have seen
its benefits. As a result, coordination now has broader support
and momentum that should carry it into the future — well beyond
the terms of current administrations in the G-7 countries. We
have come a long way in a few short years, and policy
coordination should provide a sound framework for achieving
Thank you.
meaningful
and effective reform during the years ahead.

TREASURY NEWS
•partment of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT:

FOR IMMEDIATE RELEASE
June 20, 19 88

Office of Financin
202/376-4350

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,408 Billion of 13
of 26-week bills, both to be Issued on
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

ek bills and for $6,403 million
June 23, 1988,
were accepted today.

13-week bills
maturing September 22, 1988
Discount Investment
Rate
Rate 1/
Price
6.48%
6.52%
6.51%

6.68%
6.72%
6.71%

98.362
98.352
98.354

26
maturing
Discount
Rate

ek bills
December 22, 1988
Investment
Price
Rate 1/

6.79%
6.84%
6.83%

7.13%
7.18%
7.17%

96.567
96.542
96.547

Tenders at the high discount rate for the 13-week bills were allotted 57%.
Tenders at the high discount rate for the 26-week bills were allotted 62%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
Received
Received

Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treaaury
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

$

27.475
19,664,870
16,625
23,160
30,710
15,535
2,159,840
17,730
10,435
25,710
28,540
1,306,830
128,515

$

27,475
5,241,570
16,625
23,160
30,710
15,535
516,590
17,730
10,435
25,710
18,540
335,600
128,515

Accepted

'' $
25,850 $
25,850
• 18,127,695
5,442,695
!
18,170
17,490
!
23,125
23,125
'
80,765
71,265
:
23,905
23,905
:
1,587,920
188,420
!
18,090
18,090
;
12,265
12,265
•
44,225
44,225
26,395
16,395
:
.
1,334,650
280,650
238,645
238,645

$23,455,975

$6,408,195

: $21,561,700

$6,403,020

$20,954,705
601,395
$21,556,100

$3,906,925
601,395
$4,508,320

: $17,773,475
;
676,720
: $18,450,195

$2,614,795
676,720
$3,291,515

1,700,580

1,700,580

{

1,650,000

1,650,000

199,295

199,295

:

1,461,505

1,461,505

$23,455,975

$6,408,195

: $21,561,700

$6,403,020

An additional $38,905 thousand of 13-week bills and an additional $276,695
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
y

Equivalent coupon-issue yield.

B-l4^7

TREASURY NEWS
Dtpartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M
June 21, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$ 12,800 million, to be issued June 30, 1988.
This offering
will provide about $175
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $12,636 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, June 27, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
October 1, 1987,
and to mature September 29, 1988 (CUSIP No.
912794 QA 5 ) , currently outstanding in the amount of $15,917 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,400 million, to be dated
June 30, 1988,
and to mature December 29, 1988 (CUSIP No.
912794 QY 3).
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 June 30, 1988.
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 $1,975 million as agents for foreign
and international monetary authorities, and $3,207 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 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series)
B-1458

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 tende:
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
10/87
payment
by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
the Public Debt.

TREASURY NEWS
•partment of the Treasury • Washington, D.C. • Telephone 566-2041
TEXT AS PREPARED
EMBARGOED FOR RELEASE UPON DELIVERY
EXPECTED AT 1 P.M. EDT
Remarks by
Secretary of the Treasury
James A. Baker, III
before the Canadian Importers and
Exporters Associations
Toronto, Canada
Wednesday, June 22, 1988
CANADA-U.S. FREE TRADE AGREEMENT: THE INTERNATIONAL PERSPECTIVE
I am pleased to join this distinguished group of business
leaders in Canada. It is a special pleasure to see my good
friend and colleague Mike Wilson. Mike has just played a central
role in bringing the fourteenth Annual Economic Summit to a
successful conclusion. Under the leadership of Prime Minister
Mulroney, this Summit has demonstrated the effectiveness of
cooperative efforts by the leaders of the major industrial
countries. During this Summit, progress was achieved on a number
of fronts, including the strengthening of our open multilateral
trading system.
Today I would like to focus on another approach to
strengthening the trading system, an approach that can reinforce
and catalyze further multilateral progress. As you may have
guessed, my remarks today are on the Canada U.S. Free Trade
Agreement. Mike Wilson and I spent many hours working together
on this Agreement and he deserves a lot of the credit for
maintaining the momentum in the talks.
I know that all of you are here because you have both a
financial stake and keen intellectual interest in Canadian and
American trade policy. I mentioned that Mike Wilson deserves a
lot of the credit for this agreement. But I suppose in a much
more fundamental sense all of you share credit for the FTA. The
agreement simply is a recognition by two governments of the
underlying realities that have developed as a result of business
transactions by thousands of businesses on both sides of the
border.
B-14 59

-2Adventuresome international traders — like yourselves, or
Marco Polo, or de Champlain — have always been way ahead of
diplomats. And in fact, this agreement seeks to formally
recognize what you have already created. Our countries already
have a thriving trade, and it is time for the political system to
step aside and allow this trade to flourish freely.
Realizing that many of you know the subject of U.S.-Canadian
trade better than I, I'd like to focus on some international
aspects of the agreement. You see, I believe Canada and the
U.S. can take the lead in offering the world a model trade
agreement. This agreement can serve not only as a pattern for
future bilateral agreements, but also as a catalyst for action
on the multilateral front.
A Perspective from the Past
The postwar achievements of multilateralism create an
understandable caution about any bilateral trading agreement.
But it's useful to recall that the multilateral GATT system grew
out of a bilateral initiative to overcome destructive
"unilateralism."
For much of the 19th and early 20th centuries, the "tariff
question" was a major topic in international and domestic
politics around the world. In the United States, comprehensive
tariff bills were one of Congress' most important products.
This Congressional direction of trade policy culminated in the
infamous Smoot-Hawley bill, the Tariff Act of 1930, the last
general tariff law enacted by Congress. Smoot-Hawley amended
specific tariff schedules for over 20,000 items, establishing
the United States' highest general tariff rate structure.
But only four years later, Secretary of State Cordell Hull
persuaded Congress to enact a very different trade law, the
Reciprocal Trade Agreements Act of 1934. This law authorized
the President to negotiate and implement tariff reductions
through bilateral agreements. In doing so, Congress moved from a
rigid statutory tariff to a "bargaining tariff" that enabled the
Executive to negotiate a cooperative trading system.
Secretary Hull certainly did bargain. During the next eleven
years, the United States entered into 32 bilateral agreements
with 27 nations. (I might add that the first agreement concluded
under this act was with Canada.)
These bilateral achievements set a crucial precedent for the
multilateral negotiations that followed World War II. Indeed,
even the architects of GATT began with a bilateral model. They
expected that the new trading structure would be built upon a
U.S.-U.K. foundation, or later, a U.S.-European base.

-3The GATT system has enjoyed enormous success in lowering
tariffs and reducing direct barriers to trade. GATT also
has been relatively successful in defending these gains.
Nevertheless, new forms of protectionism have arisen —
subsidies, restrictive government procurement rules,
market-sharing schemes, voluntary export curbs, and
discriminatory product standards, among others. The specialized,
technical, and indirect nature of these barriers makes it harder
to package reciprocal national concessions.
In the Tokyo Round, GATT responded with a "minilateral"
solution: Some, but not all, GATT members agreed to special
rules governing countervailing and antidumping duties, subsidies,
government procurement, licensing, customs valuation, and product
standards. These codes have helped create international
standards — which are effective as long as they are enforceable.
The Present Challenge
The success of the multilateral trading system has raised
expectations — and led to more difficult challenges. There are
5 major challenges that I would note.
First, the changing patterns and volatility of capital flows
have had an enormous and sometimes destabilizing effect on trade.
Both short- and long-term capital now move relatively easily
around the globe to locations or securities offering more
attractive mixes of risk and return. These flows affect currency
values, which, in turn, influence the competitiveness of exports
and imports.
Second, technology and industrial processes can now be
transferred around the world with relative ease. As a result,
there are many highly competitive newly industrialized nations.
Unfortunately, some of the new titans of production have been
slow to expand consumption commensurately, thus helping to create
international imbalances.
Third, many of the successful exporting nations do not have
a special affinity for the postwar liberal trading regime. Their
"logic," labeled by some as the "New Mercantilism," is that
exports are good and imports are bad. This perspective poses
a serious threat to a trading system based on the presumption
that expanded trade — measured in terms of both imports and
exports — will increase world prosperity in a mutually
satisfactory and sustainable fashion.
Fourth, the "rules" of the trading system do not adequately
protect some sectors of growing importance — services,
investment, intellectual property, and high technology, among
others. These sectors are areas of comparative advantage for
some of the key sponsors and promoters of the multilateral
system.

-4Fifth, domestic political support for the liberal trading
system has been eroding in a number of nations. In the U.S.,
this political trend can be traced to stiffer foreign
competition, caused in part by the inevitable rise of productive
efficiency in reconstructed or developing nations.
There are some notable positive developments. The most
prominent is the initiation of the Uruguay Round. These
negotiations presage breakthroughs in the areas of services,
intellectual property, agriculture, and trade-related investment.
But many of these beneficial results, if they can be achieved,
are years from full fruition. Moreover, the ultimate success of
these negotiations depends on the creation of incentives for many
nations to conform. In the meantime, we need examples of
productive government activism that invigorate internationalists,
reawaken businesses and consumers to the gains of open trade, and
present possible models for arrangements with other nations.
Charting a Future Course
There is no assurance, however, that we will meet this
present challenge with a constructive vision of the future.
As you are all well aware, many in the U.S. Congress are
frustrated by the persistent trade imbalance and are trying to
legislate the problem away. One of their approaches is to return
to straightforward legislative protection for industries, for
example, through direct restrictions on imports. Other nations
are relying on similar barriers, frequently dressed up with local
political justifications.
A second counterproductive approach, perhaps more popular,
has been termed "process protectionism." This type of
legislation tries to conceal itself as nothing more than
seemingly modest adjustments in trade laws. But each tightening
twist of law chokes off trade a little more, with little or no
regard for GATT rules, international standards, or the likelihood
of triggering retaliatory trade wars.
The United States is not the only nation contending with
powerful internal factions advocating policies that will weaken
the open trading system.
Some nations with large trade surpluses are disinclined to
remove protection for politically powerful groups — despite the
obvious gains to their consumers and other businesses. Indeed,
an odd Calvinist ethic of the trading system seems to inspire the
belief in some of these nations (whether in Asia or Europe) that
continuing surpluses are a sign of national superiority and
a justification for inaction.

-5There is, however, an alternative approach to the future.
This approach is idealistic in aim, but realistic and often
incremental in method. It seeks to move nations toward a
more open trading system through a strategy of consistent,
complementary, and reinforcing actions on various international
fronts, bilateral and multilateral. As some of these actions
bear fruit, they should enhance domestic political support for
other actions.
This is the approach embodied in the Canada/U.S. Free Trade
Agreement. While the international trading system has been
subject to increasing stress and strain, the Canadian-U.S.
economic relationship has been growing and strengthening.
Indeed, after over a century of failed efforts, our governments
have a sterling opportunity to complete a North American Economic
Accord.
This would cap a historical journey from hostility (based on
two long-distant wars) to a high degree of economic
interdependence and common purpose — while maintaining national
identities.
Given similar challenges of adjustment in the face of
heightened international competition, businesses in both nations
will profit from secure access to a home-base market of about
270 million people. Most economists expect the benefits of this
open market to be greater for Canada because its opportunities
for larger scale production will grow much more. By way of
example, the 1965 Auto Pact produced a rationalization that led
to fewer models, much greater volume, and a sizable boost in
Canada's manufacturing trade, employment, and output. And the
increased income generated from more efficient production on both
sides of the border should prompt, additional economic activity.
If both nations accept the final agreement, this achievement
will grow in stature and importance over time. Its geopolitical
potential is significant. A successful economic arrangement
should enhance our ability to work together on other common
problems. In the 20th century, we have maintained the longest
peaceful border in the world and served with one another as
allies in a common defense. In the 21st century, we will also
need to work closely together to better address questions
concerning the environment, wildlife, ocean borders, the Arctic,
outer space, disease and medical science, terrorism,
communications frequencies, bank and securities regulation,
taxation, and immigration — to name a few topics.
In addition, the accord accommodates and enhances future
trade liberalization efforts in 6 ways.
First, the agreement respects GATT and is careful not to
undermine the successes of the multilateral approach. Canada and
the U.S. are lowering barriers between themselves, not raising
barriers to others. We are seeking a healthy, dynamic linkage
between bilateral and multilateral initiatives so as to prod and
reinforce the GATT.

-6Second, the Canada-U.S. agreement extends the reach of an
open, cooperative system by negotiating solutions in the areas of
services, investment, and technology — while respecting national
sovereignty. (These arrangements demonstrate what can be
achieved and offer conceptual approaches to which others may
turn.)
Third, we have lowered the cost of initiating international
liberalization in these new areas by breaking ground with only
one nation at a time. When more nations are involved, it is
often harder to arrange a satisfactory compromise.
Fourth, the rewards of this agreement offer an incentive
to other governments. If possible, we hope this follow-up
liberalization will occur in the Uruguay Round. If not, we might
be willing to explore a "market liberalization club" approach,
through minilateral arrangements or a series of bilateral
agreements. In this fashion, North America can build steady
momentum for more open and efficient markets.
Fifth, this agreement is also a lever to achieve more open
trade. Other nations are forced to recognize that we will devise
ways to expand trade — with or without them. If they choose
not to open their markets, they will not reap the benefits. By
employing this lever together, the U.S. and Canada may be able to
dislodge obstacles in special areas of common concern — such as
agriculture.
Sixth, this Canadian-U.S. accord could prove to be an
attractive counterweight to protectionism in both our countries.
It attracts those who want government to foster growth and
opportunity by breaking down obstacles to achievement and fair
competition, not by creating barriers to protect special
interests.
Conclusion
Ladies and gentlemen — as we know — the Canada-U.S. FTA
agreement is not yet law. In the weeks to come, there will be
ample opportunities for naysayers to criticize the agreement.
I hope they will be persuaded by logic and vision.
We need to enhance the resiliency of the trading system
by promoting liberalization on a number of fronts. While
we normally associate a liberal trading system with
multilateralism — bilateral or minilateral regimes may also
help move the world toward a more open system.
Indeed, different agreements may be complementary, each
fitting a special situation and together creating a liberalized
network of mutually reinforcing systems. If activity on one
frontier of trade negotiation slows, we may be able to maintain
momentum and achieve solutions worthy of imitation through other
agreements. If all nations are not ready to liberalize trade,
we will begin with those that are and build on that success.

-7The Free Trade Agreement provides economic opportunities for
both Americans and Canadians — and could be the catalyst for a
new trade policy strategy. The inquiries it already has elicited
for similar agreements are encouraging. This interest gives both
our countries an opportunity to set trade policy on a creative,
positive, and pragmatic international course — one that will
benefit everyone associated with it.
Thank you.

FJL^

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
June 22, 1988

CONTACT:

LARRY BATDORF

(202) 566-2041

PROTOCOL TO U.S.-FRANCE INCOME TAX TREATY SIGNED
The Treasury Department today announced that a Protocol to
amend the U.S.-France income tax treaty was signed in Paris on
June 16, 1988. The Protocol will be subject to ratification in
both countries and will enter into force upon exchange of
instruments of ratification.
The Protocol will amend the treaty in several respects to
conform the treaty rules to certain aspects of the Tax Reform Act
of 1986.
The present treaty provides for the imposition of a
branch profits tax by France at a rate of 10 percent.
The
Protocol will add rules for the imposition of the U.S. branch
tax, and will establish a reciprocal rate of tax on branch
profits of 5 percent.
The Protocol will amend the anti-treaty
shopping rules of the present treaty to conform them with the new
U.S. statutory rules by adding a "base erosion" test for
entitlement to treaty benefits.
The Protocol will make clear
that deferred income of a permanent establishment may be taxed by
the country where the permanent establishment is located, even if
the income is received after the permanent establishment has
ceased to exist.
Finally, the Protocol will specify that the
treaty applies to U.S. Federal income taxes imposed by the
Internal Revenue Code of 1986.
The Protocol will provide, at the initiative of the French
Government, that U.S. source investment income of U.S. citizens
resident in France will be exempt from French income tax.
Persons eligible for such benefits must demonstrate that they
have complied with their U.S. income tax obligations, and must
provide any certification of eligibility which may be required by
the French tax authorities.
The Protocol will make a number of technical changes in the
treaty to correct problems which have arisen in the application
of the treaty in the United States or France.
The provisions relating to the exemption of U.S. citizens
resident in France will have effect with respect to income
derived on or after January 1, 1988. The branch tax provisions
P

4 k £. A

-2will have effect with respect to profits realized in any taxable
year ending on or after the date of entry into force of the
Protocol.
Any changes in taxes withheld at source will have
effect for amounts payable on or after the first day of the
second month following entry into force. All other changes in
the treaty made by the Protocol will have effect for taxable
years beginning on or after the date of entry into force of the
Protocol.
Copies of the Protocol are available in the Treasury
Department Office of Public Affairs, room 2315 Main Treasury
Building.
o 0 o

PROTOCOL TO THE CONVENTION
BETWEEN THE FRENCH REPUBLIC AND THE UNITED
STATES OF AMERICA WITH RESPECT TO TAXES
ON INCOME AND PROPERTY OF JULY 28, 1967,
AS AMENDED BY THE PROTOCOLS OF OCTOBER 12, 1970,
NOVEMBER 24, 197B and JANUARY 17, J984

The Government of the French Republic and the
Government of the United states of America, desiring to
amend the Convention between the French Republic and the
United States of America with respect to taxes on income
and property of July 28, 1967, as amended by the Protocols
of October 12, 1970, November 24, 1978, and January 17,
1984, have agreed upon the following provisions:
ARTICLE I
Article 1, paragraph 1(a) is amended as follows:
The phrase •'the Federal income taxes imposed by the
Internal Revenue Code" i6 replaced by the phrase "the
Federal income taxes imposed by the Internal Revenue Code
of 1986M.
A W 1 CLE 21
In Article 3:
- at the end of subparagraph 1(a) "and" is deleted;
at the end of subparagraph 1(b) the period is replaced
with ",and", and a new subparagraph 1(c) is added which
reads as follows:
"(c) prance or any of its local authorities."
-_ at the end of subparagraph 2(a) "and" is deleted;
at the end of subparagraph 2(b) the period is replaced
with ",and", and a new subparagraph 2(c) is added which
reads as follows:
"(c) the United States or any of its political
subdivisions or local authorities."

- 2 ARTICLE III
In Article €:
- a new paragraph 3 iB added which reads as follows:
3* For the implementation of paragraphs 1 and 2, any
Income or gain attributable to a permanent establishment
during its existence is taxable in the contracting State
where such permanent establishment is situated even if the
payments are deferred until such permanent establishment
has ceased to exist.
- Paragraphs 3 through 5 become respectively
paragraphs 4 through 6.
- a new paragraph 7 is added which reads as follows:
7. When an insurance company of one of the Contracting
Stctes has a permanent establishment in the other
Contracting State, the reinsurance premiums received shall
be taken into account for the determination of taxable
profits only in the Contracting State of which the company
is a resident.
- Paragraph 6 becomes paragraph 8.
ARTICLE IV
Jn Article 9:
- paragraph 4 is replaced by a new paragraph which
reads as follows:
4. Dividends paid by a corporation of one of the
Contracting States shall be treated as Income from sources
within that Contracting State, and dividends paid by any
other corporation shall be treated as income from sources
outside that contracting State.
- a new paragraph 7 is added which reads as follows:
7. The term "dividends" as used in this Article means
iD.come from shares, "joulssance" shares or "jouissance"
rights, mining shares, founders shares or other rights,

- 3 not being debt claims, participating in profits, as well
as income treated as a distribution by the taxation laws
of the Contracting State of which the company making the
distribution is a resident.
ARTICLE V
In Article 10, at the end of paragraph 5, a sentence
is added which reads as follows:
"In that case such interest shall be deemed to be
paid by the permanent establishment or fixed base to the
beneficial owner at the latest wheri it is taken into
account as an expense of that permanent establishment or
fixed base."
ARTICLE VI
In Article 11:
- paragraph 2 is deleted and replaced as follows:
2, Except as provided in paragraph 3, royalties may also
be taxed in the Contracting State in which they arise, and
according to the laws of that State, but if the beneficial
owner of the royalties is a resident of the other
Contracting state, the tax imposed on such royalties shall
not exceed 5 percent of the gross amount paid.
- in paragraph 3 the phrase "and beneficially owned"
is inserted before the phrase "by a resident".
- paragraph 6 is deleted and replaced as follows:
6. a) Royalties shall be deemed to arise in a
Contracting State when the payer is that State
itself, a local authority, a statutory body or a
resident of that state.
b) Where, however, the person paying the royalties,
whether he is a resident of a Contracting state
or not, has in a Contracting State a permanent
establishment or a fixed base in connection with
- which the liability to pay the royalties was
Incurred, and such royalties are borne by such

- 4 permanent establishment or fixed base, then such
royalties shall be deemed to arise in the
Contracting State in which the permanent
establishment or fixed base is situated.
c) Notwithstanding subparagraphs a) and b),
royalties paid for the use of or the right to
use property in the United states shall be
deemed to arise therein.
- a new paragraph 8 is added which reads as
follows:
8. For purposes of this Article, royalties shall be
deemed to be paid to the beneficial owner at the latest
when they are taken into account as expenses. •
ARTICLE VII
in Article 12, a new paragraph 4 is added to read a6
follows:
"Paragraph (1) of this Article shall not apply in the
case of gains described in paragraph (3) of Article 6."
ARTICLE VIII
In Article 13:
- paragraph 1 is deleted and replaced as follows:
1, a) A French corporation shall be exempt from the
United States personal holding company tax in
any taxable year if all of its stock is owned by
one or more individual residents of France in
their individual capacities for that entire year.
b) A French corporation shall be exempt from the
United States accumulated earnings tax in any
taxable year if it is a corporation described in
"paragraph 1 a) of Article 24 A.
- paragraph 2(a) is deleted and replaced as follows:

5 2.

a)

A corporation which is a resident of a
Contracting State and which has a permanent
establishment in the other contracting State may
be subject in that other Contracting State to a
tax in addition to the tax allowable under the
other provisions of this Convention. Such tax,
however, may be imposed only on:
1) in the case of the United States, that
portion of the business profits of the
corporation attributable to the permanent
establishment which represents the
"dividend equivalent amount" of those
profits, In accordance with the provisions
of the internal Revenue Code; and
11) in the case of France, that portion of the
business profits of the corporation which
16 attributable to the permanent
establishment and which is included in the
base of the French withholding tax in
accordance with the provisions of French
internal law.
b) The taxes referred to in subparagraph (a) shall
apply to the portion of the business profits
attributable to a trade or business conducted in
one Contracting State through a partnership by a
corporation resident of the other Contracting
State which is a member of such partnership,
c) The taxes referred to in subparagraphs (a) and
(b) shall not be imposed at a rate exceeding the
rate specified in paragraph 2(b) of Article 9
(Dividends).
~ paragraph 2(b) becomes paragraph 3.
ARTICLE IX
in Article 23:
In paragraph(2)(a)(ii), replace ";and" at the end of
subparagraph(a) with "," and replace the period at the end
of subparagraph (b) with •,•.

- 6 - New subparagraphs (c), (d), and (e) are added to
paragraph (2)(a)(11) to read as follows:
(c) income consisting of dividends derived from
sources within the United States (as described
in paragraph (4) of Article 9), interest arising
in the United States (as described in paragraph
(5) of Article 10), or royalties derived from
sources within the United states (as described
in paragraph (6) of Article 11) which is
beneficially owned by a resident of France and
which is:
A) paid by the United States, any
political subdivision or any authority
thereof; or
B) paid by a United States legal entity
the principal class of shares of or
interests in which are substantially
and regularly traded on a recognised
stock exchange as defined in paragraph
3 of Article 24A* or
C) paid by a United States corporation
other than one 10 percent or more of
the outstanding shares of the voting
stock of which the resident of France
owned (either directly or indirectly)
at all times during the part of such
corporation's taxable year preceding
the date of payment of the income to
the owner of the income and during the
prior taxable year (if any) of such
corporation, provided that less than
50 percent of such stock is owned by
residents of Prance during the same
period; or
D) paid by a resident of the United
states not more than 25 percent of the
gross income of which for the prior
taxable year (if any) consisted
directly or indirectly of income
derived from sources outside the
United States,

- 7 d)

capital gains derived from the sale or
exchange of capital assets generating
Income as defined in subparagraph (c).
However such sale or exchange shall remain
taken into account for the determination of
the threshold of taxation applicable in
France to capital gains on movable
property, and
e) profits or gains derived from transactions
on a public United States options or
futures market.
The beginning of,subparagraph (b) of
paragraph 2 is amended to read as follows:
"b) As regards income or profits taxable in the
United States under articles 9, 11, 13 or
15 A..." (the rest is not modified)
A new subparagraph (e) is added at the
end of paragraph 2 which reads ae follows:
"e) The exemption provided by paragraph
(2)(a)(11) shall be granted:
1) only if the citizens of the
United states who are residents
of France demonstrate that they
have complied with their United
States income tax obligations, and
11) upon receipt by the competent
authority of France of such
certification as may be
prescribed by such authority or
upon request to such authority
for refund of tax withheld
together with the presentation of
any required certification."
ARTICLE X
In Article 24, the last sentence of paragraph 2 is
deleted and replaced as follows:

- 8 The provisions of this paragraph shall not be
construed to prevent the application by either Contracting
State of its tax on branch profits described in paragraph
2 of Article 13 (Branch Profits) of the convention.
ARTICLE XI
Article 24 A is replaced by the following article:
ARTICLE 24 A
Limitation on Benefits
1. A person (other than an individual) which is a
resident of a Contracting State and derives Income from
the other Contracting State shall not be entitled under
this convention to relief from taxation in that other
Contracting State, nor to relief from double taxation in
the first mentioned Contracting State, unless:
a) more that 50 percent of the beneficial interest
in such person (or, in the, case of a
corporation, more than 50 percent of the number
of shares of each class of the corporation's
shares) is owned, directly or indirectly, by any
combination of one or more of:
(i) individuals who are residents of the
United States;
(ii) citizens of the United States;
(ill) individuals who are residents of
France;
(iv) corporations in whose principal class
of shares there is substantial and
regular trading on a recognized stock
exchange as defined in paragraph 3; and
(v) the Contracting states, their local
authorities, or political subdivisions
of the United states; and

- 9b)

not more than 50 percent of the gross income of
such person is used, directly or Indirectly, to
meet liabilities (including liabilities for
interest or royalties) to persons who are not
residents of the Contracting States, one of the
Contracting states or its local authorities, or
political subdivisions of the United States or
citizens of the United states.
2. The provisions of paragraph 1 shall not apply if the
establishment, acquisition and maintenance of such person
and the conduct of its operations did not have as one of
its principal purposes the purpose of obtaining benefits
under the Convention.
>

3.
The provisions of paragraph 1 shall not apply if the
person deriving the income is a corporation which is a
resident of a Contracting State in whose principal class
of shares there is substantial and regular trading on a
recognized 6tock exchange. For purposes of the preceding
sentence, the term "recognized stock exchange* means:
a) the NASDAQ System owned by the National
Association of Securities Dealers, Inc. and any
stock exchange registered with the Securities
and Exchange Commission as'a national securities
exchange for purposes of the Securities Exchange
Act of 1934;
b) the French stock exchanges (Bourses de Valours);
and
c) any other stock exchange agreed upon by the
competent authorities of the Contracting States.
ARTICLE XII
A new Article 25 A "Provisions for Implementation" is
added which reads as follows:
The competent authorities of the Contracting States
may prescribe rules and procedures, jointly or separately,
to determine the mode of application of the provisions of
this Convention.

- 10 ARTICLE XI11
1.
Each party will notify the other upon the completion
of the necessary constitutional procedures which concern
it for entry into force of the present agreement which
will take effect on the day of receipt of the last
notification.
2. The provisions of this Protocol shall apply:
a) as regards taxes withheld at source, to amounts
payable on the first day of the second month
following the date of entry into force of this
Protocol;
b) as regards taxes referred to in paragraph 2 of
Article 13 of the Convention, as added by
Article VIII of this Protocol, to profits
realized in any taxable year ending on or after
the date of entry into force of this Protocol;
c) as regards the new subparagraphs c), d) and e)
of paragraph (2)(a)(ii) and the new subparagraph
(e) of paragraph 2 of Article 23 of the
Convention, as added by Article IX of this
Protocol, to income described therein derived on
or after January 1st 1988;
d) as regards all other modification*? of the
Convention made by this Protocol, for taxable
years beginning on or after the date of entry
into force of this Protocol.
ARTICLE XIV
This Protocol shall remain in force as long as the
Convention of July 28, 1967, as amended by the Protocols
of October 12, 1970, November 24, 1978 and January 17,
1984, remains in force.

- 11 -

IN WITNESS WHEREOF, the representatives of the
governments, duly authorized thereto, have signed this
Protocol.
Done at Paris this l*th day of June 1988, in
duplicate, in the English and French languages, both texts
being equally authoritative.

FOR THE GOVERNMENT OF
THE FRENCH REPUBLIC:

/s/ Pierre Beregovoy

FOR THE GOVERNMENT OF
THE UNITED STATES OF
AMERICA:
/s/ Joe M. Rodgers

EMBASSY OF THE
UNITED STATES OF AMERICA

NO. 181
Excellency:
I have the honor to refer to the Protocol,
signed today, to the Convention between the United
States of America and the French Republic with
respect to Taxes on Income and Property of
July 28, 1967, as amended by the Protocols of
October 12, 1970, November 24, 1978, and
January 17, 1984.
During the course of discussions leading to the
development of the Protocol, the United States and
French delegations agreed that nothing in paragraph 5
of Article 10 (Interest) of the Convention shall be
understood to prevent or limit the application by t
Contracting State of its internal law, or of its
Income tax treaty with a third State, with respect to
interest paid by a permanent establishment located in
the Contracting State to any resident of a third
State.

The provisions of internal law referred to in

His Excellency
Pierre Beregovoy
Ministre d'Etat, Ministrc de
l'Economie des Finances et du Budget

- 2 -

the preceding sentence are, in the case of the
United States, those provisions of the Internal
Revenue Code that impose a tax on interest
described in Section 884(f)(1)(A) of such Code
and, in the case of France, Article 119 bis and
125A of the Code General dee Impots.
If this is in accord with your understanding,
I would appreciate a confirmation from you to
this effect,
Accept, Excellency, the renewed assurances of
my highest consideration.

/s/ Joe M. Rodgers

tor it, June 16

1988

Dear Mr Ambassador,

I have the honor to acknowledge the receipt of your
note of today1a date which reads as follows :
"I have honor to refer to the Protocol* signed today,
to the Convention between the United States of America and the
French Republic with respect to Taxes on Income and Property of
July 28, 1967, as amended by the Protocols of October 12, 1970,
November 24, 1978, and January 17,' 1984.
During the course of discussions leading to the
development of the Protocol, the United States and French
delegations agreed that nothing in paragraph 5 of Article 10
(Interest) of the Convention shall be understood to prevent or
limit the application by a Contracting State of its internal law,
or of its income tax treaty with a third State, with respect to
interest paid by a permanent establishment located in the
Contracting State to any resident of a third State.
The provisions of internal law referred to in the
preceding sentence are, in the case of the United States, those
provisions of the Internal Revenue Code that impose a tax on
interest described in section 884 f (1) A of auch Code, and in
the case of France, articles 119 bis and 125 A of the Code
Central des Inpdts.

i Joe N. Hodgers
tbttssdor 9f the United
!*tes of America

- 2 -

If this is in accord with your understanding, I vouid
appreciate a confirmation from you te thi« effect*
Aceapt, ds. x M? Hifiiet^t, the renewed assurances of
my highest @eacidlaratic&."
1 have the honor to eonfirm to you that my Government
is in agreement with the atetemente in your Note.
Aeeept, Dear Mr Ambassador, the renewed assurance of
my highest consideration.

/s/

Pierre Beregovoy

TREASURY NEWS

Deportment of the Treasury • Washington, D.C. • Telephone 566FOR IMMEDIATE

CONTACT: Office of Financing
' '***
RESULTS OF AUCTION OF 2-YEAR NOTES
RRTPA.P

202/376-4350

The Department of the Treasury has accepted $8,539 million
of $29,177 million of tenders received from the public for the
2-year notes, Series AC-1990, auctioned today. The notes will be
issued June 30, 1988, and mature June 30, 1990.
The interest rate on the notes will be 8%. The range
of accepted competitive bids, and the corresponding prices at the
8%
rate are as follows:
Yield Price
Low
8.04%
99.927
High
8.06%
99.891
Average
8.05%
99.909
Tenders at the high yield were allotted 26%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location Received Accepted
Boston
62,915
$
New York
25,r685,395
Philadelphia
46,495
Cleveland
66,250
Richmond
302,485
Atlanta
55,500
Chicago
1,r571,595
St. Louis
93,840
Minneapolis
40,375
Kansas City
119,450
Dallas
19,530
San Francisco
,101,615
1,
Treasury
11,930
Totals
$29,r177,375

$
62,915
7,442,995
45,495
66,050
68,785
55,500
437,495
74,470
38,375
117,710
19,515
97,875
$8,539,110
11,930
The $8,539
million of accepted tenders includes $1,173
million of noncompetitive tenders and $7,366 million of competitive tenders from the public.

In addition to the $8,539 million of tenders accepted in
the auction process, $1,115
million of tenders was awarded at
the average price to Federal Reserve Banks as agents for foreign
and international monetary authorities. An additional $1,326
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-1461

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone
FOR IMMEDIATE RELEASE CONTACT: Office of Financing
June 23, 1988
202/376-4350
RESULTS OF AUCTION OF 4-YEAR NOTES
The Department of the Treasury has accepted $6,753 million
of $21,232 million of tenders received from the public for the
4-year notes, Series N-1992, auctioned today. The notes will be
issued June 30, 1988, and mature June 30, 1992.
The interest rate on the notes will be 8-1/4%. The range
of accepted competitive bids, and the corresponding prices at the
8-1/4% rate are as follows:
Yield
Price
Low 8.35% 99.666
High
8.37%
99.599
Average
8.36%
99.632
Tenders at the high yield were allotted 79%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
$
27,452
$
27,452
Boston
New York
18,780,599
6,272,773
Philadelphia
13,036
13,036
Cleveland
35,368
35,368
Richmond
127,724
22,678
Atlanta
25,305
25,305
Chicago
1,040,584
130,489
St. Louis
42,746
24,486
Minneapolis
18,146
18,146
Kansas City
44,112
44,102
Dallas
9,713
9,713
San Francisco
1,063,515
125,355
Treasury
4,123
4,123
Totals
$6,753,026
$21,232,423
The $6,75 3
million of accepted tenders includes $483
million of noncompetitive tenders and $6,270 million of competitive tenders from the public.
In addition to the $6,753 million of tenders accepted in
the auction process, $405 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $500 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-1462

TREASURY NEWS
Deportment of the Treasury • Washington, D.C. • Telephone 566-2041

FOR IMMEDIATE RELEASE

June 24, 1988

Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of May 1988.
As indicated in this table, U.S. reserve assets amounted to
$41,949 million at the end of May, down from $42,730 million in April

U..S„ Reserve Assets
(in millions of doll ars)

End
of
Month

Total
Reserve
Assets

Gold
Stock 1/

Special
Drawing
Rights 2/3/

Foreign
Currencies 4/

Reserve
Position
in IMF 2/

42,730
41,949

11,063
11,063

9,589
9,543

11,275
10,912

10,803
10,431

1988
Apr.
May

1/ Valued at $42.2222 per fine troy ounce.
2/ Beginning July 1974, the IMF adopted a technique for valuing the SDR
based on a weighted average of exchange rates for the currencies of
selected member countries.
The U.S. SDR holdings and reserve
position in the IMF also are valued on this basis beginning July
1974.
3/ Includes allocations of SDRs by the IMF plus transactions in SDRs.
4/ Valued at current market exchange rates.

B-1463

TREASURY NEWS
Deportment
of the Treasury • Washington,
D.C. • Telephone 566-2041
FOR RELEASE AT 12:00 NOON
CONTACT: Office of Financing
June 24, 1988

202/376-4350

TREASURY'S 52-WEEK BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for approximately $9,000
million of 364-day Treasury bills
to be dated
July 7, 1988,
and to mature July 6, 1989
(CUSIP No. 912794 SH 8 ) . This issue will result in a paydown for
the Treasury of about $800
million, as the maturing 52-week bill
is outstanding in the amount of $9,807
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, Thursday, June 30, 1988.
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.
The bills will be issued for cash and in exchange for
Treasury bills maturing July 7, 1988.
in addition to the
maturing 52-week bills, there are $13,170 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 currently hold $2,522 million as agents for foreign
and international monetary authorities, and $7,288 million for their
own account. These amounts represent the combined holdings of such
accounts for the three issues of maturing bills. 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 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 $115
million
of the original 52-week issue. Tenders for bills to be maintained
on the book-entry records of the Department of the Treasury should
be submitted on Form PD 5176-3.
B-1464

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS
Deportment
of the Treasury • Washington, D.C. • Telephone 566-2041
FOR I M M E D I A T E R E L E A S E
CONTACT:

June 2 7 , T§88

O f f i c e of F i n a n c i n g
202/376-4350
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

Tenders for $6,424 Billion of 13-week bills and for $6,413 Billion
of 26-veek bills, both to be issued on June 30, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-week bills
maturing September 29, 1988
Discount Investment
Rate
Rate 1/
Price

Low
6.56%a/
6.76%
High
6.60%
6.80%
Average
6.59%
6.80%
a/ Excepting 1 tender of $685,000.

26-week bills
maturing December 29, 1988
Discount Investment
Rate
Price
Rate 1/

98.342
98.332
98.334

6.72%
6.76%
6.75%

7.05%
7.10%
7.08%

96.603
96.582
96.588

Tenders at the high discount rate for the 13-week bills were allotted 36%.
Tenders at the high discount rate for the 26-week bills were allotted 87%.

Location
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

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Received

Accepted

$
30,355
20,421,135
19,035
57,940
28,710
26,690
2,062,715
19,995
8,020
33,430
18,710
1,259,095
316,040

$
30,355
5,165,015
19,035
57,940
28,710
26,690
341,715
19,355
8,020
33,430
18,710
359,455
316,040

: $
40,525
21,260,390
16,750
24,030
31,180
33,480
1,736,435
28,700
9,050
34,815
19,130
1,251,030
287,840
;

$
40,525
5,196,490
16,750
24,030
31,180
33,480
535,420
24,700
9,050
34,815
19,130
159,230
287,840

$24,301,870

$6,424,470

: $24,773,355

$6,412,640

$21,576,440
868,565
$22,445,005

$3,699,040
868,565
$4,567,605

• $20,808,185
746,425
•
j $21,554,610

$2,447,470
746,425
$3,193,895

1,707,410

1,707,410

:

1,500,000

1,500,000

149,455

149,455

:

1,718,745

1,718,745

$24,301,870

$6,424,470

: $24,773,355

$6,412,640

An additional $16,745 thousand of 13-week bills and an additional $327,055
thousand of 26-week bill6 will be Issued to foreign official institutions for
new cash.
1/ Equivalent coupon-is6ue yield.
B- 14 6 5

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
For Release Upon Delivery
Expected at 9:30 A.M.
June 28, 1988
STATEMENT OF
ADELBERT L. SPITZER
SPECIAL ASSISTANT TO THE ASSISTANT SECRETARY
(TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON SMALL BUSINESS
U.S. HOUSE OF REPRESENTATIVES
Mr. Chairman and Members of the Committee:
I am pleased to have this opportunity to present the Treasury
Department's views concerning the question of competition between
tax-exempt organizations and taxable businesses, particularly
small businesses.
As you know, the issue of "unfair competition" between
tax-exempt organizations and taxable businesses has been the
subject of considerable debate during the past several years and
is currently being considered by the Oversight Subcommittee of
the House Ways and Means Committee in its review of the unrelated
business income tax ("UBIT") that applies to tax-exempt
organizations. The Treasury Department has testified before the
Oversight Subcommittee twice on this subject during the past
year. On June 22, 1987, we testified with respect to general
issues raised by the UBIT and on May 9, 1988, we commented on a
list of "discussion options" prepared by the Subcommittee.
We believe this Committee's consideration of the issue of
competition between tax-exempt organizations and taxable
businesses is an important part of the current debate. Although
federal income tax exemption is, of course, a significant benefit
enjoyed by tax-exempt organizations, it is by no means the only
governmental subsidy provided to such organizations. An analysis
of the effect on competition of tax exemption is incomplete
unless it also considers both the other benefits granted by the
federal government (such as reduced postal rates and the ability
to issue tax-exempt bonds)-and those granted by state and local
governments (such as real estate tax exemption). In addition,
although changes to the federal income tax law undoubtedly would
affect
B-1466 the competitive balance between taxable and exempt firms,

-2there are a variety of other means of affecting this balance —
not all of which would involve legislation. This Committee is
well situated to undertake a broad review of this important
subject and to effectuate significant beneficial changes.
My testimony will focus primarily on the UBIT, the rationale
for income tax exemption, and the effect on competition of income
tax exemption and other governmental subsidies. I will begin by
describing the overall dimensions of the tax-exempt sector of our
economy. Second, I will describe the structure of the UBIT,
together with the historical developments that led to the
enactment of the tax in 1950. Third, I will outline the tax
policy considerations that are relevant to a review of the UBIT.
Fourth, I will summarize briefly Treasury's recommendations with
respect to the UBIT. Finally, I will offer several suggestions
as to how the interests and expertise of this Committee can best
be used to address the issue of competition between taxable and
tax-exempt firms.
I. Dimensions of the Tax-Exempt Sector
A. General Description of Tax-Exempt Organizations
It is important to note that there is a distinction between
nonprofit organizations and tax-exempt organizations. A
nonprofit organization is an organization that is prohibited,
generally by its organizational documents or state law, from
distributing profits or net earnings to individuals who exercise
control over it, such as its directors, officers or members. A
nonprofit organization is not prohibited from earning a profit
but, rather, is prohibited from distributing its profits to
individuals in their private capacity.
Although most nonprofit organizations are exempt from federal
income tax, the Internal Revenue Code (the "Code") does not- by
its terms grant tax-exempt status to all nonprofit organizations.
Instead, the Code exempts from tax a diverse group of
organizations, including religious, charitable, scientific and
educational organizations; social welfare organizations; labor
and agricultural organizations; business leagues; social clubs
and many others, (see Figure 1.) Certain of these organizations
— primarily religious, charitable, scientific and educational
organizations described in section 501(c)(3) of the Code — are
not only exempt from tax, but also are eligible to receive tax
deductible contributions.
The Code does not prohibit tax-exempt organizations (other
than private foundations) from engaging in business activities
for profit. If such business activities are substantially
related to the tax-exempt purpose of the organization, such as
the operation of a dining hall or a dormitoryby a college, any
profit from the business is exempt from tax. If a business is
unrelated to the exempt purpose of the organization, however,

-3such as the operation of a manufacturing facility by a
university, any profits from the unrelated business are subject
to income tax, generally to the same extent as the profits of a
taxable business. The fact that an organization is required to
pay tax on its unrelated business income does not, in general,
affect the organization's tax-exempt status. Nonetheless, if the
operation of unrelated businesses becomes the primary purpose of
a tax-exempt organization, and thus its exempt function becomes a
secondary purpose, the organization will cease to qualify for tax
exemption under the Code.
B. Size of Exempt Sector
Tax-exempt organizations make up a large, diverse and growing
sector of the U.S. economy. Currently, there are approximately
1.2 million exempt organizations, including 340,000 churches
exempt under section 501(c)(3); nearly 390,000 educational,
charitable, scientific, and religious organizations (other than
churches) also exempt under section 501(c)(3); 130,000 civic
leagues and social welfare organizations exempt under section
501(c)(4); and 355,000 mutual benefit organizations such as labor
unions, chambers of commerce, mutual insurance companies,
organizations of war veterans, and cemetery companies, also
exempt under section 501(c).
In the last 20 years, there has been substantial growth in
the nonprofit sector. During this period, the number of active
tax-exempt organizations included in the Internal Revenue Service
Master File ("IRS Master File")1/ more than doubled, from about
410,000 in 1968 to about 866,000" currently.
C. Economic Activity
A significant portion of U.S. economic activity occurs in the
exempt sector. The Bureau of Economic Analysis estimated that
current operating expenditures of nonprofit organizations totaled
$239 billion in 1985, or six percent of GNP. In 1984, employees
of nonprofit organizations (both paid and volunteer) accounted
for ten percent of total hours worked in the U.S. economy, and
paid employees of nonprofit organizations accounted for six
1/ The IRS
File worked
of Tax-Exempt
is a
percent
of Master
total hours
by paid Organizations
employees.
compilation of all organizations which have applied for and
received recognition of tax-exempt status from the Internal
Revenue Service. Since churches are not required to apply for
tax exemption, most do not do so, and very few are listed on the
IRS Master File. Of the 1.2 million estimated tax-exempt
organizations referred to in the text, 866,000 are active
tax-exempt organizations reported on the IRS Master File and
340,000 are churches that are not reported on the IRS Master
File.

-4Much of the economic activity of the nonprofit sector is made
up of public charities and social welfare organizations that
provide health, education or research services. In 1984, 47
percent of current operating expenditures of nonprofits were
accounted for by health service organizations, and 22 percent by
educational and research organizations. In turn, hospitals
accounted for the bulk of economic activity in the nonprofit
health service sector, and private elementary and secondary
schools and private colleges and universities accounted for the
bulk of economic activity in the nonprofit education and research
sector. In contrast, the broad range of mutual benefit
organizations exempt under provisions other than section
501(c)(3) and section 501(c)(4) accounted for only 10 percent of
current operating expenditures of all nonprofits in 1984.
D. Funding for the Nonprofit Sector
Nonprofit organizations finance their activities through a
number of sources: government grants, private donations, fees for
services, operation of businesses, and investments yielding
income such as interest, dividends, rents, or royalties. The
relative reliance on these different revenue sources differs
greatly among subsectors of the nonprofit community. For
example, while religious organizations rely mainly on private
contributions, health service organizations rely on fees and
charges for most of their funding, and social service
organizations rely most heavily on government grants. (See Table
1. )
The proportion of revenue derived from various sources also
varies with the size of nonprofit organizations. Data for 1983
indicate that with respect to "public charities" (section
501(c)(3) organizations that are not private foundations), the
greater the asset size of the organization, the lesser its
reliance on government grants or private contributions, and the
greater its reliance on fees and charges and other revenue
sources. (See Table 2.)
There is some evidence that nonprofits have increased their
reliance on income-producing or commercial activities in recent
years. IRS Master File data show that, in 1946, organizations
exempt under section 501(c)(3) obtained 59 percent of their
support from business receipts, interest, dividends, rents,
~T/
Survey data
organizations
such as the
Urban other
Institute,
royalties,
sales from
of assets
and miscellaneous
sources
than
Partners
Livable
Places,
the Rockefeller
Fund, and
governmentfor
grants,
private
contributions,
duesBrothers
and assessments?
the
Nationalfrom
Assembly
provide in
supporting
of in
a trend
71 percent
such sources
1975; and evidence
78 percent
1983.2/
toward increasing commercial activity by nonprofits.

-5For a number of reasons, however, the available IRS data do
not give a definitive picture of nonprofit funding trends.
First, requirements for filing Form 990, the information return
filed by tax-exempt organizations, have changed over time, and
the form has been subject to reporting and coding problems.
Specifically, because Form 990 is an information return that does
not result in tax liability, improper and erroneous information
is reported more frequently than on forms that require
computation of tax liability. Coding problems result from the
lack of detailed statistical tests to check for reporting
accuracy. Second, unrelated business income is reported on a
separate form (Form 990-T), income from for-profit subsidiaries
of nonprofit organizations is reported on the corporate income
tax return (Form 1120), and income from partnerships is reported
on the partnership return (Form 1065). Each of these forms would
need to be matched with the Form 990 of the tax-exempt entity in
order to obtain a comprehensive picture of the organization's
commercial activity.
E. The Unrelated Business Income Tax (UBIT)
As noted above, tax-exempt organizations are required to pay
income tax on their unrelated business income. In fiscal year
1985, approximately three percent of all tax-exempt organizations
on the IRS Master File of Exempt Organizations filed Form 990-T
in order to report unrelated business income. The amount of
unrelated business tax revenue has increased sharply during the
past several years, from about $30 million in fiscal year 1985 to
$53 million in fiscal year 1986 to $120 million in 1987.
Preliminary data suggest another sharp increase for 1988.
(During this same period, the number of Forms 990-T processed
increased each year by only approximately 15 percent.) This
rapid rise in the UBIT revenue has likely resulted from a
combination of increased compliance and increased unrelated
activity.
Data for 1984 indicate that most unrelated businesses have a
small amount of gross unrelated business income. Only 18 of the
roughly 25,000 nonprofits filing in 1984 reported unrelated
business income over $3 million, 56 reported unrelated business
income between $1 million and $3 million, and 1,412 reported
unrelated business income between $100,000 and $1 million. In
addition, fewer than one third of the 25,000 nonprofits
reporting unrelated business income had positive taxable income,
and were therefore subject to tax.
The amount of tax reported on Form 990-T, however, does not
present a complete picture of tax paid by exempt organizations on
unrelated businesses. As noted above, many exempt organizations
operate unrelated businesses in taxable subsidiaries that file
corporate income tax returns. Under current reporting
requirements, it is not possible to identify the returns of
taxable corporations owned by exempt organizations or to
correlate such returns with those of their parents. Thus, no
data are available with respect to the amount of tax paid by
subsidiaries of exempt organizations.

-6II. Current Law
A. Historical Development
Prior to 1950, the law was unclear as to the taxation of
unrelated business activities of tax-exempt organizations. Under
the "destination of income" rule described below, the majority of
courts had held that a tax-exempt organization did not lose its
tax exemption by virtue of the conduct of an unrelated business
so long as the profits from the business were dedicated to
charitable purposes. In fact, a "feeder" organization that
engaged exclusively in commercial, non-exempt activities was
treated as exempt from tax so long as all the profits from the
organization were distributed to an affiliated charitable
organization. The majority view was thus that the destination of
income, not its source, was the appropriate test for tax
exemption. Because of the liberality of the destination of
income rule, prior to 1950 a number of charitable organizations
carried on unrelated businesses — businesses that often competed
directly with taxable companies.
In 1950, Congress responded to the operation of unrelated
businesses by exempt organizations by enacting a tax on such
organizations' unrelated business income. The legislative
history of the Revenue Act of 1950 indicates that Congress was
primarily concerned with the issue of "unfair competition." Both
the House and Senate reports state:
The problem at which the tax on unrelated
business income is directed is primarily that
of unfair competition. The tax-free status of
[section 501(c)] organizations enables them
to use their profits tax-free to expand
operations, while their competitors can
expand only with the profits remaining after
taxes.
As part of the Revenue Act of 1950, Congress also enacted a Code
provision pertaining to "feeder organizations," which provides
that an organization carrying on a trade or business for profit
shall not be exempt under section 501 on the ground that all of
its profits are payable to another exempt organization.
In addition to directly operating a commercial enterprise,
some tax-exempt organizations engaged in transactions which
became popular during the late 1940s — the "sale and lease-back"
of a taxable business to an exempt organization. In such
transactions, a charitable organization would acquire a property
(such as real estate) from a business, often borrowing to finance
the entire acquisition, and would then lease the property back to
the seller under a long-term lease. The result of the
transaction was that the seller received capital for use in its

-7business, the seller's taxable income was substantially reduced
by the deductible rent, and the charity received the difference
between the rental payments and its loan amortization payments,
with little or no money down.
The House and Senate reports identified three principal
objections to sale and lease-back arrangements. First, the
tax-exempt organization was trading on its exemption because the
only contribution it made to the sale and lease-back was its tax
exemption. Second, the lease-back transactions, if unchecked,
would result in tax-exempt entities owning the bulk of the
commercial and industrial real estate in the country. Third, the
exempt organization that entered into the sale and lease-back and
either paid an above-market price for the property, or charged
below-market rent for the use of the property, had in effect sold
part of its tax exemption. In response to these objections,
Congress imposed the UBIT on income from the long-term rental of
debt-financed real property and personal property leased in
connection' with it.
Notwithstanding the changes made by the Revenue Act of 1950,
many tax-exempt organizations continued to engage in unrelated
commercial activities. Such activities were permissible under
the law because, first, a number of tax-exempt organizations such
as churches, social clubs, and fraternal beneficiary societies
were not subject to the tax on unrelated business income and,
second, because the tax on rental income from debt-financed real
property did not apply to leases of five years or less. The tax
on debt-financed real property was avoided by so-called Clay
Brown transactions — "bootstrap acquisitions" similar to trie
sale and lease-back transactions described earlier.3/
In response to the continued involvement of charitable
organizations in unrelated businesses, Congress in 1969 revisited
this area of the law and made several significant changes.
First, the rules regarding debt-financed property were expanded
to include all debt-financed property unrelated to the exempt
purpose of the organization, with no exception for short-term
leases. Second, the tax on unrelated business income was
expanded to apply to all exempt organizations, except certain
U.S. instrumentalities created and expressly granted
tax-exemption by a specific act of Congress. Third, the
investment income of social clubs and voluntary employees'
beneficiary associations was subjected to tax, based on the
rationale that an exemption for investment income constituted an
unwarranted subsidy of recreational or personal activities.
Fourth, any rent, interest or royalties paid by an 80-percent
controlled subsidiary to a tax-exempt parent was included in
unrelated business taxable income of the parent in an amount
J/ The transactions were named after the Supreme Court case that
7efused to recharacterize the transaction at issue and upheld the
taxpayer's claimed tax benefits. Clay Brown v. U.S., 380
U.S. 563 (1965).

-8reflecting the portion of the subsidiary's income that would be
unrelated business income if earned directly by the tax-exempt
parent organization. The controlled subsidiary rule was imposed
to discourage charitable organizations from "renting" part of
their physical plants to taxable subsidiaries, thereby reducing
or eliminating the taxable income of the subsidiaries. And
fifth, Congress clarified the definition of the term "trade or
business" to include activities carried on within a larger
aggregate of similar activities. Thus, the sale of advertising
in a magazine published by an exempt organization could be
treated as an unrelated business, even though publication of the
magazine was the organization's exempt function.
Each of the changes made by the Tax Reform Act of 1969 had
the effect of tightening the rules with respect to the unrelated
business activities of charitable organizations, helping to
ensure that such organizations paid tax on income from business
activities unrelated to the purpose for which they were granted
tax exemption.
During the early 1980s, a number of charitable organizations
again became involved in leasing transactions with taxable
entities, although with a different twist from the sale and
lease-back transactions described earlier. Due to the investment
tax credit and accelerated depreciation, certain types of
property were effectively subject to a negative rate of tax,
generating credits or losses that would offset income from the
other investments. Because tax-exempt organizations could not
benefit from these tax incentives directly, a number of exempt
organizations, including schools, city governments, federal
agencies, and foreign governments, sold part of their assets to
taxable businesses that could make use of the tax incentives and
would then lease the property back on a long-term basis. As' part
of the Tax Reform Act of 1984, Congress sought to discourage such
transactions by providing that property used by a tax-exempt
entity (including foreign and domestic governments) is not
eligible for tax incentives such as the investment tax credit and
accelerated depreciation.
Subsequent to the 1969 Act, exceptions were created to the
debt-financed property rule for certain real estate investments.
In 1980, with respect to pension trusts, in 1984 with respect to
educational institutions, and in 1986 with respect to real
property title holding companies, the general rule was modified
to exclude from the debt-financed property rules the acquisition
of real estate with debt so long as certain requirements were
met.
B. Structure of the Unrelated Business Income Tax
In general, the UBIT is imposed on the unrelated business
taxable income of organizations that are otherwise exempt from
tax under Code section 501(a). Tax-exempt trusts are taxed at
individual tax rates and all other exempt organizations are taxed
at corporate rates.

-9The term "unrelated trade or business" means any trade or
business that is regularly carried on and is not substantially
related, aside from the need of the organization for funds, to
the performance of the purpose for which the organization was
granted exempt status.
Specifically excluded from the term "unrelated trade or
business" is any trade or business (1) in which substantially all
the work is performed by volunteers; (2) which is carried on by a
section 501(c)(3) organization or a state or city college or
university primarily for the convenience of its members,
students, patients, officers, or employees (the "convenience
exception"); or (3) which is the selling of donated merchandise.
Certain trade show and similar activities are also specifically
excluded, as are services furnished by certain cooperative
hospital service organizations, the rental of telephone poles by
cooperative telephone or electric companies, the rental of
mailing lists to certain other exempt organizations, and the
distribution of low-cost articles incidental to soliciting
charitable contributions. Conducting bingo games is also
specifically excluded so long as bingo is legal under state law
and is not ordinarily conducted on a commercial basis.
The term "unrelated business taxable income" is defined as
the gross income derived from any unrelated trade or business
less deductions directly connected with the carrying on of such
trade or business, subject to certain modifications. Among the
most significant of the modifications are the following:
1. All dividends, interest, payments with respect to loans
of securities, and annuities are excluded.
2. Royalties (including overriding royalties), whether
measured by production or by gross or taxable income, are
excluded.
3. Rent from real property, and rents from personal property
leased with real property if the rents attributable to
the personal property are only an incidental amount of
the total rents received or accrued under the lease, are
excluded. If more than 50 percent of the rent under a
lease is attributable to personal property, then none of
the rent, whether attributable to the real property or
the personal property, qualifies for the exclusion. In
addition, rent does not qualify for the exclusion if the
determination of the amount of such rent depends in whole
or in part on the income or profits derived by any person
from the property leased (other than an amount based on a
fixed percentage of receipts or sales).
4. All gains or losses from the sale, exchange or other
disposition of property, other than the sale of property
of a kind properly includable in inventory and property
held primarily for sale to customers in the ordinary
course of a trade or business, are excluded. Thus, for

-10example, gain on commodity futures contracts ordinarily
would be excluded. Also excluded are all gains on the
lapse or termination of options to buy or sell securities
written by the organization in connection with its
investment activities.
5. Income from various research activities also is excluded.
All income from research performed for the United States,
a state, or a political subdivision of a state is
excluded. In the case of a college, university,
hospital, or organization operating primarily for the
purpose of carrying on fundamental research that makes
the results of its research freely available to the
public, all income derived from research is excluded,
regardless of for whom it is performed.
6. A "specific deduction" of $1,000 is allowed from
unrelated business taxable income for all tax-exempt
organizations, thus preventing the imposition of tax when
the profit from an unrelated business activity is very
small.
As noted earlier, the modifications for interest, royalties,
annuities and rents do not apply to an 80-percent controlled
subsidiary to the extent it is engaged in a trade or business
unrelated to the exempt purpose of the parent organization.
Special rules apply in computing the unrelated business
taxable income of social clubs, voluntary employees' beneficiary
associations, supplemental unemployment benefit trusts and group
legal services organizations. In general, all income of these
organizations other than "exempt function income" is deemed to be
unrelated. Exempt function income is income from dues, fees,
charges, or similar amounts paid by members of the organization
as consideration for providing such members (or their dependents
or guests) goods, facilities or services in furtherance of the
organization's exempt purpose, and income set aside for
charitable purposes or for certain defined benefits. In the case
of voluntary employees' beneficiary associations, supplemental
unemployment benefit trusts, and group legal services
organizations, there are in addition various limits on the extent
to which such set aside income is treated as exempt function
income. The primary effect of these rules is to tax the
investment income of the organizations subject to the rules.
The provisions of section 514, pertaining to "unrelated
debt-financed income," also represent a set of special rules in
that a charitable organization can have unrelated business
taxable income under this section regardless of whether it is
engaged in a trade or business. The section provides that to the
extent any property held for the production of income is
debt-financed, the income from the property is subject to tax.

-11There are a number of exclusions from the definition of
debt-financed property, including the following: (1) property the
use of which is substantially related to the exempt purpose of
the organization, (2) property used for research activities, the
income from which is specifically excluded from tax under section
512, and (3) property used in certain other trades or businesses,
the income from which is excluded under section 513, namely,
businesses run by volunteers, businesses run for the convenience
of members, students, etc., and businesses involving the sale of
donated property.
A final, and very significant, exception to the debt-financed
income rules is an exception, added in 1980 and subsequently
amended, for the acquisition of real estate by "qualified
organizations," namely, educational institutions, pension trusts,
and real property title holding companies exempt under section
501(c)(25). Section 514(c)(9) provides that the term
"acquisition- indebtedness" does not include debt incurred by a
qualified organization to purchase real property so long as
certain conditions are met. These conditions include: (1) the
purchase price is a fixed amount; (2) the amount of any
indebtedness, and the time for payment of such indebtedness, is
not contingent on revenue, income, or profits derived from the
real property; (3) the real property is not leased back to the
seller or a party related to the seller; (4) the real property,
if purchased by a pension trust, is neither purchased from, nor
leased to, certain disqualified persons; (5) neither the seller
nor a related party or certain disqualified persons (in the case
of a pension trust) provides financing in connection with the
real property; and (6) if the real property is held by a
partnership and one or more of the partners is not a qualified
organization, then allocations to the partners must be "qualified
allocations" (i.e., must not vary over time) or must follow a
special rule allowing certain variations from qualified
allocations. The elaborate requirements of section 514(c)(9)
were designed, in part, to prevent charitable organizations from
entering into the type of "bootstrap" acquisitions that were
common prior to the Tax Reform Act of 1969.
Ill. Tax Policy Considerations
A. Rationale for Tax Exemption of Nonprofit Organizations
The exemption of charitable, religious, and educational
organizations from tax has been a part of federal law since 1894
when the first federal act imposing a general tax on the .ncome
and profits of corporations was enacted. Many other tax
exemption provisions, including those for labor unions, trade
associations, and social clubs, were enacted over seventy years
ago. Despite, or perhaps because of, the long history of tax
exemptions in the federal income tax law, there is little
guidance in the legislative record as to the rationale for
exempting particular organizations from tax. At the time of the
early income tax statutes, however, most exempt organizations

-12were supported primarily by donations. Notions of taxable income
were not easily applicable to their activities, distinguishing
them from the for-profit businesses that Congress intended to
tax. Certain other organizations, such as labor unions or trade
associations, were (and continue to be) funded principally by
membership dues and could appropriately have been viewed as
mutual benefit organizations that function, in part, as conduits
for their members.
Over the years, the exempt sector has grown enormously in
both size and diversity. Moreover, many exempt organizations
have come gradually to derive much or all of their income from
sources other than donations. These changes have not only
increased the importance of tax exemption to the exempt sector,
but have also tended to blur the historical differences in
activities and funding between exempt and taxable organizations.
The broadest segment of the exempt sector, for example, including
in particular those organizations exempt under section 501(c)(3)
engaged in educational and health activities, draw substantial
revenues from sources that could, at least in concept, be subject
to income tax. Tax exemption for these organizations may, in
part, reflect historical circumstances, but is more importantly
based on the same tax policy principles that support an income
tax deduction for charitable contributions. Taxes are imposed to
fund the activities of government, and represent a removal of
resources from private hands to support the broad, public
purposes served by government. Although public charities are
privately operated and controlled, their exempt activities are
restricted to those deemed to serve the general public interest.
An organization that provides food and shelter for the poor, or
that encourages education, the arts or humanities, is serving the
same general purposes with which government itself is concerned.
Thus, resources dedicated to the activities of such organizations
may be viewed as similar to funds transferred to and used for the
general purposes of government. For this reason, income
transferred through a charitable contribution or earned directly
by a public charity may appropriately be exempted from tax.
Although the above rationale for exempting public charities
and their activities from taxation remains as strong today as
when the income tax was first enacted, limits on the scope of
such tax exemption are appropriate and necessary. This nation
has prospered through its reliance on a private, market-based
economy to supply necessary goods and services. The role of
government generally has been restricted to those socially
important activities not adequately supported by the private
sector. The role of the quasi-governmental, not-for-profit
sector should similarly be restricted to that of supplementing,
and not supplanting, the activities of for-profit businesses.
Thus, tax exemption for public charities should be restricted to
those areas where the quality or quantity of goods and services
that would be produced strictly through market forces is
inadequate, or the distribution of those goods or services
undesirable.

-13B. The Problem of Competition
As described above, Congress adopted the unrelated business
income tax primarily because of its concern with "unfair"
competition between tax-exempt organizations and taxable
businesses. Some competition between tax-exempt and taxable
activities is inevitable, however, and could not be eliminated
without repealing altogether the tax exemption for many nonprofit
organizations. A nonprofit hospital will compete with for-profit
hospitals for patients, and, in providing its patients with food,
drugs or medical devices, will compete with taxable businesses
offering the same products. Similarly, in maintaining student
dormitories and dining halls, an exempt university will compete
with local businesses offering housing and meals. Because the
hospital and university are not subject to tax, they may be able
to provide goods or services at a lower cost than their taxable
competitors or to expand more rapidly to attract additional
students or patients. Although this may leave the exempt
organization with a competitive advantage over its taxable
counterpart, this advantage is an intended consequence of the
societal decision to "encourage the exempt functions performed by
these organizations.
Competition between taxable and tax-exempt organizations
becomes of greater concern, however when the good or service
provided by the tax-exempt organization is further removed from
the organization's core purposes. We may not be concerned that a
state university's tax exemption extends to sales of textbooks
through the student bookstore, since the product is essential to
the school's educational function and may be irregularly or
incompletely supplied by private businesses. If the same student
bookstore, however, also sells clothes, appliances and other
consumer goods, the activity moves further from the university's
educational function, and involves products which in general' are
amply supplied by the private sector. Extending the university's
tax exemption to sales of these products may only displace
taxable businesses in an area where private markets are working
effectively.
There is little empirical evidence regarding either the
behavior of exempt organizations in competition with taxable
businesses or the response of taxable businesses to such
competition. Even though tax exemption allows a nonprofit
organization to earn a higher rate of return than a taxable
company within a particular activity, some have argued that this
does not necessarily create an adverse effect on the taxable
business. Because the nonprofit organization enjoys a similarly
higher rate of return on other uses of its capital, including
passive investments, the relative "opportunity cost" of entering
a particular business (which includes the revenue lost from
forgoing alternative investments) can be equivalent for taxable
and exempt organizations. As a result, taxable and exempt
businesses may be in the same relative position with respect to
the decision whether or not to enter a particular business.
Thus, following this analysis, if income tax exemption were .the

-14sole benefit granted to nonprofit organizations, nonprofit and
taxable organizations might well co-exist in the same business,
just as such organizations co-exist in the stock and bond
markets.
Nonetheless, when tax exemption is combined with other
governmental subsidies — such as the ability of some exempt
organizations to issue tax-exempt bonds, access to lower postal
rates, exemption from certain federal excise taxes, and exemption
from certain state and local taxes — an exempt organization's
cost of producing goods and services for sale is further reduced.
Hence, its profit is increased without a corresponding increase
in the return available from alternative passive investments.
Consequently, there exists an additional incentive to produce
such goods or services as opposed to making a passive investment.
In addition, as a result of their various cost-saving
benefits, it is possible that tax-exempt organizations would
reduce their prices in an attempt to drive out non-exempt
competitors. Engaging in this type of "predatory" pricing leads
firms to forego profits in the short run, in the hope that future
profits will be large enough to overcome the near-term losses.
There is little agreement, however, among economists about
whether such pricing is common or whether it is likely to be
successful. A further complicating factor with respect to the
pricing behavior of exempt organizations is.that they will often
be motivated primarily by the desire to maximize the output of
their exempt product, not by the desire to maximize profits.
This could result in prices of such exempt products that are
lower than the prices of the goods and services sold by taxable
competitors and that give rise to no taxable income. Although a
taxable competitor might well view this as predatory pricing, the
tax-exempt organization might in fact have no desire to
ultimately raise its prices to capture a monopoly profit. :he
desire to maximize exempt output would depend, of course, on
whether the organization views those items as part of its primary
exempt function, rather than as part of an ancillary, profitseeking function.
Thus, although the precise consequences are not perfectly
understood, the combination of tax exemption with other
governmental subsidies will in some cases create a competitive
advantage for tax-exempt organizations. Such advantage could be
sufficient in certain cases to discourage taxable firms from
entering an industry or could encourage existing taxable firms to
leave the industry. This result is of particular concern if
exempt organizations impinge on activities previously carried on
principally by taxable businesses. In such a situation, the
taxable businesses would not have anticipated competition from
tax-exempt organizations and would have made economic decisions
ignoring this possibility.

-15C. Economic Efficiency
In addition to limiting unfair competition, the unrelated
business income tax serves the goal of economic efficiency by
helping to ensure that the subsidy of tax exemption is used in
the manner that provides the greatest social benefit.
The effect of the UBIT on economic efficiency can best be
seen by considering the impact of a system that exempts from tax
all unrelated business income. Such a tax system would encourage
equally the pursuit of exempt and unrelated activities by
non-profit organizations. This would be an inefficient use of
the grant of tax exemption, in that a subsidy is not needed to
assure production of appropriate amounts of most commercial goods
and services.
Tax exemption for unrelated business income would also act as
an indirect subsidy to the primary exempt function of a nonprofit
organization because the organization would direct some or all of
its unrelated business income towards its exempt function.
Subsidizing the primary exempt function of nonprofit
organizations by means of a tax exemption for unrelated income,
however, would simply reward those organizations that are most
successful in pursuing commercial ventures. Such a system would
be unlikely to provide the greatest reward to the most deserving
organizations; i.e., those that provide the greatest social
benefit.
Our current tax system does not, of course, exempt all
nonprofit income from taxation. Nevertheless, the criterion of
economic efficiency can be applied to those particular areas in
which nonprofit commercial activities do, in fact, escape
taxation in order to help determine whether such activities
should remain exempt.
D. Accountability
As indicated above, the privilege of tax-exempt status
affords substantial benefits and, at least with respect to public
charities, may be justified because of the public, quasigovernmental purposes served by their activities. Because
nonprofit organizations are privately controlled, however, their
activities are not subject to the public review or scrutiny that
applies to the actions of government. It is thus necessary that
the tax system ensure that nonprofit organizations are operated
for the purposes that support their exemption.
At present, the responsibility for ensuring that nonprofit
organizations are accountable for the benefits of tax exemption
rests in large part on the enforcement activities of the Internal
Revenue Service. Through the return and audit process, the
Internal Revenue Service is in a position to review the
activities of nonprofit organizations and the purposes for which
their funds are spent.

-16In addition to focusing on an exempt organization's use of
funds, however, the tax system may improve accountability by
encouraging particular sources of funding. Thus, rules limiting
the scope of tax exemption may appropriately encourage an exempt
organization to concentrate on activities and investments that do
not distract from its exempt function. This chanelling function
may be served by the current law rules subjecting nonprofit
organizations to tax on their unrelated business activities.
Although the earnings from an unrelated business activity may go
equally to serve the organization's exempt purposes, the
unrelated activity may divert management resources or otherwise
cause the organization to lose sight of its exempt function. In
the same vein, the current law rules exempting passive investment
income, whether or not related to a nonprofit organization's
exempt function, effectively encourage investments that will not
directly engage the organization in purely commercial activity.
There are, of course, limits on the extent to which the tax
laws can be used to ensure accountability of tax-exempt
organizations. For example, the role of determining whether
contributed funds are used wisely and efficiently is not a
function of the tax law, but is performed to some degree by
donors who support exempt organizations. If an organization is
able to sustain itself to an increasing extent by commercial
activity, however, it becomes less dependent on the scrutiny of
such private donors. Hence the UBIT helps ensure that exempt
organizations remain, at least to some degree, accountable to
third-party donors. The ability of donors to perform this
oversight function would also be aided by fuller public
disclosure required by federal or state law.
IV. Analysis of Current Law
In our testimony before the Oversight Subcommittee on
June 22, 1987, we described a number of aspects of the UBIT as
warranting Congressional attention. Our recommendations, in
summary, were as follows:
1. With respect to business activities of exempt
organizations, the Treasury Department believes the
current standard of a substantial relationship to an
organization's exempt purpose has conceptual merit as the
basis for granting exemption from tax. We are concerned,
however, with administrative and interpretative problems
this standard has created. Although we do not propose
changes in the "substantially related" standard, we do
recommend more detailed reporting as a means of improving
enforcement and compliance and of providing a basis for
further review of the adequacy of the standard.
2. With respect to the existing exceptions from the
"substantially related" standard, we suggest that the
scope of the exemptions for businesses operated by
volunteers or for the convenience of students, patients

-17and others should be reexamined. We are concerned that
these provisions may extend to activities not meriting
exemption and, at least in their current form, cannot be
justified on grounds of administrative convenience.
Although similar conceptual questions might be raised
about the provision exempting sales of donated property,
in practice, we believe the exception operates
appropriately.
With respect to the computation of the tax on unrelated
business income, we suggest that the rules for allocation
of expenses be clarified to reflect the appropriate
relationship between an organization's exempt functions
and unrelated activities. In addition, we support
retention of the "fragmentation rule" and an increase in
the specific deduction from unrelated business income
from $1,000 to $5,000.
For purposes of characterizing otherwise tax-exempt
passive income from subsidiaries as taxable, we suggest
that the definition of a controlled subsidiary be
broadened to include subsidiaries in which an exempt
organization has more than a 50 percent interest in stock
value or voting power. In addition, for purposes of
determining whether the primary purpose of an
organization is the conduct of an exempt function, we
suggest that consideration be given to aggregating the
activities of an exempt organization and its subsidiaries
in appropriate cases.
With respect to passive investment income, we suggest
that such income should continue to be exempt in the.case
of public charities, but should be taxable to social
welfare organizations unless permanently set aside for
charitable purposes. The treatment of passive income of
labor unions and trade associations requires further
study. In addition, we suggest that the exclusion for
royalties should be narrowed to prevent avoidance of the
tax on unrelated business income in certain
circumstances.
With respect to the exclusions from tax for income
derived from certain research activities, we believe
additional attention should be given to the definition of
research and to requirements for public dissemination of
the results of research.
With respect to joint venture activities of exempt
organizations, we are concerned that current restrictions
on partnership allocations between taxable and tax-exempt
partners may nob be adequate to prevent abuse. In
addition, we have serious reservations whether current
law is adequate to deal with issues raised by
partnerships formed to conduct exempt activities of
tax-exempt organizations.

-18In our testimony before the Oversight Subcommittee on
May 9, 1988, we commented on a group of "discussion options"
released by the Subcommittee. We testified in support of a
number of these discussion options, some with certain
modifications. In general, the discussion options we supported
would:
1. Retain the "substantially related" standard.
2. Provide special rules that override the "substantially
related" standard in several particular areas, providing
instead a "bright line" test for taxability. These areas
include: retail stores, medical equipment sales, fitness
facilities, travel and tour services, some food sales,
veterinary services, hotels, routine testing, affinity
credit cards, advertising, and amusement parks.
3. Repeal the convenience exception.
4. Modify the taxation of royalties in order to distinguish
active from passive royalties.
5. Increase the specific deduction to $5,000.
6. Modify the definition of a "controlled subsidiary" and
the rules applicable to such subsidiaries.
7. Aggregate the activities of exempt organizations and
certain controlled subsidiaries for purposes of applying
the primary purpose test.
8. Revise the rules for allocating expenses between exempt
and taxable uses of property.
9. Expand reporting to the IRS and mandate certain studies.
In addition to supporting these relatively discrete changes
to the UBIT being considered by the Oversight Subcommittee, the
Treasury Department believes that Congress should undertake a
broad review of the rationale for tax exemption in order to
ensure that the substantial benefits of tax exemption are
appropriately limited. Such a review would enable Congress to
determine whether the current categories of exempt organizations,
and the basic rules regarding unrelated business taxable income,
are appropriate when applied to the tax-exempt sector of our
modern economy — a sector that is undeniably much changed since
the earliest rules regarding tax exemption were adopted by
Congress. This kind of comprehensive review would require the
collection of improved data regarding the scope of commercial
activities being conducted by exempt organizations and the effect
of those activities on taxable competitors. Hence Treasury
believes that a Congressional mandate to expand the reporting
requirements of exempt organizations, with appropriate exceptions
for small organizations, is particularly important.

-19V. Other Options for Addressing Issue of Unfair Competition.
The debate during recent years with respect to competition
between taxable businesses and tax-exempt organizations has
focused on the grant of federal income tax exemption and the
operation of the unrelated business income tax. Although these
are important issues and warrant careful consideration by
Congress, tax exemption is only one component of the overall
governmental effort to encourage and subsidize the activities of
certain non-profit organizations. Much work remains to be done
in analyzing these additional subsidies and helping to coordinate
the efforts of the federal government, together with state and
local governments, to provide incentives in the most economically
efficient and equitable manner. Such incentives should be
designed to encourage the increased production of undersupplied
goods and services by the tax-exempt sector while at the same
time not discouraging the taxable sector from providing these
same goods and services.
We believe the Committee on Small Business has an important
role in the analysis and resolution of the issues noted above.
In particular, we recommend that the Committee consider
undertaking the following three initiatives.
1. Coordination of federal, state and local actions.
The question of the appropriate scope of tax exemption and
other governmental subsidies has been sporadically reviewed at
the federal, state and local levels. Several localities, for
example, have recently challenged the real estate tax exemption
of non-profit hospitals. It would be helpful if a more
coordinated review were undertaken. In particular, it would be
useful to know where and how state criteria for exemption have
come to differ from federal criteria and why. As a first step,
an effort should be made to quantify, in a systematic manner, the
types and amounts of governmental subsidies provided to various
categories of tax-exempt organizations. For example, it would be
useful to know which organizations that are exempt from federal
income tax are also exempt from local real estate tax. A second
step would be to analyze whether those subsidies are being
allocated in an economically efficient manner — i.e. , whether
those organizations providing the greatest social benefit also
receive the largest subsidies.
2. Further analysis of "unfair competition".
As noted above, there is little conclusive evidence regarding
the competitive effects of tax exemption and other governmental
subsidies. This issue should be studied in greater detail,
utilizing improved data that the Internal Revenue Service intends
to collect as well as data collected by other governmental
agencies and private organizations. It would be helpful, for
example, to analyze particular industries in which the balance
between taxable and exempt firms has changed over time. More
generally, it would be useful for research to address basic

-20questions regarding the behavior of non-profit organizations to
determine, for example, whether they are likely to engage in
predatory pricing and whether they tend to produce higher or
lower quality output vis a vis taxable competitors. Because
current policy analysis is based largely on anecdotal evidence,
it is difficult to reach broad conclusions with respect to these
important issues.
In addition, it would be beneficial to undertake a broad
analysis of the interrelatedness of exempt organizations and
taxable businesses; in particular, whether exempt organization
activities may in some cases assist the growth of taxable
businesses. For the most part, representatives of particular
businesses (such as travel agencies or fitness clubs) have raised
concerns about exempt organizations that directly compete in
those businesses. Although such concerns are entirely
appropriate, these businesses may not have considered whether the
presence of exempt organizations may at times encourage other
kinds of taxable businesses. A number of exempt organizations
have asserted, for example, that their income-producing
activities often create substantial opportunities for taxable
businesses. Examples cited have included universities producing
new technology that is developed by the taxable sector or
organizations whose activities draw tourists to a particular area
and thus create opportunities for restaurants, hotels, etc. To
the extent that these increased opportunities represent new
economic activity, rather than simply replacement of such
activity elsewhere, they provide economic benefits to all.
3. Improved cooperation between taxable and exempt entities.
In many instances the problem of unfair competition could be
reduced by increased cooperation between taxable and exempt
competitors. Tax-exempt organizations generally do not have an
interest in developing and managing active businesses and thus
drawing attention away from their charitable, educational, etc.
pursuits. Concerns with funding for their exempt functions will
often mandate that an organization vigorously pursue every
revenue source, however, and exempt organizations should not be
expected to allow facilities or assets capable of producing
income to lie idle. Instead, taxable businesses should be
encouraged to work with exempt organizations in order to bring
these available facilities and other assets into the marketplace
in a manner that maximizes passive income for the exempt
organization and active business income for the taxable company.
We believe this Committee is well situated to encourage this form
of mutually beneficial cooperation.

-21The Committee on Small Business serves an invaluable function
in providing a forum for the concerns of small businesses. Such
concerns are of the utmost importance to those of us involved in
the formulation and administration of the unrelated business
income tax. We welcome your assistance in identifying problems
and formulating solutions in this important and difficult area.
This concludes my prepared remarks. I would be pleased to
respond to your questions.

* I q u i 0. |

"""rtiplioii, Genoa.I Ratuit of Kctl.ltii I. Il.apl., and Huab.i of T«i Ki-.p» Oaga
• y Int.iail ••«< iu« Code S.ctlon

Sect i on
of

Era.pI•

IRC

501Icllll'

Description

Corporations
of

5 0 1 | c | iIt

501|c!<Jl»

Act

General

Inetruaontalitlea

of

Activities

the

United

States

N>i.b*r

of
:

Orqanisations

red*>.ral

of

Or ga n i z a t i o n s

Deposit
Corp.

Unions!

Holding

organisation.

organisation

Religious, educational, charitable,
literary.

safety,

national

of

of

Insurance

•««»pt

•ports

Natura

federal

Title holding corporation for

public

I

under

(including

acientific,

I
CM
CN

Organisations

organised

Congress

Cr.dit

of

or

to

or

children

of

an

eleapt

for

description

Naugatuck
nullding

of

class

J l * .98 »

Aaerlcan Heert

or

organisation.

Association,
ford

S ,11 1

Masonic
Corp.

Inc.

foundation

aeateur

provantion
or

orqanicat ions.

Includ.a

foundations

noneseapt

and

property

certain

International

coapttitiona,

cruelty

to

Activities of nature laplied by

Tasting

fostering

titlo

inlaitt
private
charitabli

trusts

5 0 1 (c ! I 4 I

o r g e n i r. a t i o n s , a n d
associations

501(c!l5l

•roaotlon

Civil leagues, social welfare

Labor,

of

local

To

and

and

organisations

real

estate

welfare,

boards,

Lions

129.42)

Cluba

or

laprovo
to

conditiona

laprovo

of

producta

AfL-CIO

work
and

efficiency
Cha.ber

laprovoaent of business conditions of

50lltl|(il Busin*<><; leagues, chaabers of
caaaatcf,

coaaunlty

educational,

recreational.

employees

agricultural,

horticultural

of

charitable,

of

Nat ional

etc

Coaaerce

rootba1 I

League

50|lc!(7|

Social

and

recreational

;0l|c|lll rratoiml beneficiary aocieties
and

afi-. o r i a t i o n s

clubs

Pleasure,

recreation,

social

activities

to

accldant,

aenbera.

or

other

Ski

Club,

Inc.

Sf. . M f .

Knights of Coluabus 8 t. , I 5 S

Lodge providing for payment of life,
sickness,

Ocean

benefits

f • T«r -

I

(ontinu.ri

S«" » ion
of

IRC

5©i t o r n

[ra.pI•
_P_e_sr « 'pt i o n

Voluntary

of

Organisations

eaployeea' beneficiary

a a s o c i a t i o n s (Including federal
e a p l o y e e s * voluntary beneficiary
a s s o c i a t i o n s foraerly covered by
sect ion 501(c|(10|I
501 ( c M I0»

501Icl|I I|

501 I c I I U I

I
CM
I

50l|cHI)|*

Doaestic f r al
aaaoc i at i ons

T e a c h e r s ' retireaent
associat ions

General

N a t u r e 'of

Huran Fi r e flghers fund Aaaoc

10.48 1

Lodge devoting its net earnlnga to
charitable, fraternal, and other
apecifled purposea . No life, sickness,
or accident benefits to aeabers.

Knights Teaplar of
the US 11 Natick

16.95)

Coaaandery

fund
retireaent benefits.

Benevolent life insursnce
a s s o c i a t i o n s , autual ditch
or irrigation coapanies, autual
or cooperative telephone conpaniei
etc .

Activities of a nature slailar to those
iaplied by the deacrlptlona of class of
organlsstton beneficial to aeabera.

Co r p .

Ceaetery

•uriala

Wllliaason

State
autual

co.panlea

chartered
reserve

and

Incldential

actlvittea

credit

unions,

funda

Loana

to

building

for

S a l e . Rural

Water

Ceaetery

Assoc.

aeabers.
and

loan

(Eseaption
aasociations

for
and

Wllliaason County
Catholic Credit
Un Ion

Act of 1951, effecting all yeara after

19511 .
501 (cl<IS|

of

O r g a nitat •ons

Providing tor payaent of life, sickness
accident, or other benefita to aeabers.

aeabera.

5 0 1 (c I I 14 I

Numb.r

of

O r g a n 1 tit i o n s

Activities

Mutual insurance coapanlea or
assorlati ons

Providing inaurance to aeabera
substantially at coat ( H a l t e d to
organisations with gross incoae of
$150,000 or less! .

Sand-Clay Mutual
Bur I a I As soc.

7 . 704

Figure

I--Continued

Sect Ion
of IRC

501|c|(16|

description

Cooperative
finance

of Organisations

;

organ1 sationa to

crop operations

General nature of Activities

Pinancing crop operationa

501(c)(18|

Suppleaental
trust

Eaployee

uneaployaent benefit

funded pension trust

tna.pl* of
Organisations

Nuaber of
; Organisations

conjunction

18

with activities of a aarketing or
purchasing

501|c|(17)

in

:

Payaent

association

of auppleaental uneaployaent

coapenaatlon beneflta.

Dayton Malleable

Payaent of benefits under a pension
plan funded by eaployeea
June 35. 1 9 5 9 ) .

702

Iron Co.pany, Ohio
Malleable Div.

(created

5

before

501(c)(19|* Poat or organisation of wsr Activities iaplied by nature of Aaericsn Legion 24.815
veterans
organisation.
*3< 50l(c|(20| Trusts for prepaid group legal Poraa part of a qualified group legal 202
CM
services
aervice plan or p l a n s .
(Applicable to
I
taaable yeara beginning after December Jl,
197CI.
50l(c|(21| Black Lung Trusta Satiafiea claiaa for coapenaatlon under 21
Black Lung Acta.
(Oenerally, applicable
to tasable years beginning after
Deceaber 11. 19771.
501(cH22) Pension Trust Penalon plan withdrawal liability 0
trust created to provide funds to aeet
payaenta under aection 4121(11 >i (jl
of ERISA.
501(c)(2)) Veterans' Insurance aaaociations Provide inaurance and other benefits to 0

501(01241 Trusts Deacribed In ERISA aection 4049 0
501(0(25) Title holding coapaniea Those with 15 or fewer entities rre.pt 0
under IRC section 401 and 501(.)•)) and
gov*anaenta I units.

Posts

r igui e I - C o m inued

Sertlon
ot

Enemple

IWC

:

Description

of Organisations

:

General nature of Activities

*01,d' Religious and apostolic Regular bualneaa activltlea; coaaunal S4
associations
religious

:

of

Organisations

Number

of

: Organisations

coaaunity.

501(e)* Cooperative hospital service Enuaerated cooperative aervlcea for 79
organisations
hospttale.
501(f)-

Cooperative

service organisatlone

Colli

of operating educational
organlcatlona

educi

865,65)

•

Generally,
trusts

c o n t r i b u t i o n s under

under

Code

subsection

this Code subsection are tea deductible.

5 0 1 ( O ( J ) which aay

receive tas deductible

Other organisations not

aateriaked could

establish

contributions.

I MOTE: Cieaples are not shown for orfonlsatlona taa-eseapt under Code aubaectlona 50110(111, IICI. (101. (201, (211. 501(d).
ir>

501(e).

end

501(f) becauae there la very

little

activity.

I
MOTE:

Nuaber of o r g a n i s a t 1 o n a
of April 10. 1987.

la a count of the nuaber of active entitles on the IRS Eaeapt Organisation/Business Haater file as

Table I
Sources of Nonprofit

Type

of

I

Nonprof i t

Support

I

I

I
Total
|
Private
| Revenue* | Contributlona

Organisation

by Subsector,

|
1/ |

Qovernaent

1984

I

I

| Dues, rees l | Endowaent
|
Charges
| t Other

Health
$ billion
pe r cent

I
I

$125.7
100%

$17.4
11. •%

$44.5
15.4%

$60.•
49 .4%

$1.0
2.4%

$10.5
51 . 4%

$5.0
9 .9%

E d u c a t i o n l Research
$ blllion
pe r cent

$57.1
100%

$11.9
39.7%

$9.7
17.9%

R e l i g i o u s Organlsatlona
$ bi11 ion
percent

$29.9
109%

$24.9
99.1%

9%

9%

$4.9
11.9%

Social Service 1/
$ bi 1 H o n
pe r cent

$21.9
109%

$••1
19.1%

9.9
4.9%

2 .9
2.9%

$11
5.0%

Civic . Social
and Fraternal
$ bi1 I ion
pe r cent

$7.9
109%

$3.3
$11.4%

1.5
9.9%

0.9
2.9%

$9.4
5.7%

Arts and Culture
$ bi11 ion
pe r cent

$9.9
100%

$4.9
99.7%

9.9
1.9%

9.7
0.1%

$9.7
10.1%
June

Department of the Treeaury
Office of T n Analysts

Somra:

Dimensions of the

Independent

Sector. 1999. Teble 4.1

1/ including contributions froa churches.
2/

Including

legal

Note: Foundatlona
Note: Detail

aervlces.

are escluded.

may not add to totala due to

rounding.

19. 1947

Teble 2

Nonprofit

Charitable Organisation!

Private
naaot

I
I

Use

t

Duea a

:

I C

Other

Under $100,999

31.2

42.9

9.4

20.9

7.4

$!00.000--$499,999

19. 7

14.4

9.3

14 1

7. 4

$500.000--$999.999

22.9

49.9

3.9

26 7

7 . 1

$l,000,000--$9.999.999

17.9

11.3

3.9

55. 4

12 «

$l9,099.000--$49.999.999

11.9

4.5

1 .3

72.9

10. 4

« .5

5.9

9.7

7] 0

II •

$50,000,000 or More
D e p a r t a e n t of the Treaaury
O f f i c e of Ta> Analysis

June

19,

1997

TREASURY NEWS

apartment of the Treasury • Washington, D.C. • Telephone 566-2
FOR RELEASE AT 4:00 P.M. CONTACT: Office of Financing
June ^8, iy»8
202/376-4350
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$13,200 million, to be issued July 7, 1988.
This offering
will provide about $25
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,170 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, Tuesday, July 5, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,600
million, representing an additional amount of bills dated
April 7, 1988,
and to mature October 6, 1988
(CUSIP No.
912794 QP 2), currently outstanding in the amount of $7,086 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,600 million, to be dated
July 7, 1988,
and to mature January 5, 1989
(CUSIP No.
912794 QZ 0).
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 July 7, 1988.
In addition to the maturing
13-week and 26-week bills, there are $9,807 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 $1,993 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $ 2,108 million as
agents for foreign and international monetary authorities, and $7,288
million 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
R-14ft7
Department
(for 13-week
ofseries)
the Treasury
or Formshould
PD 5176-2
be submitted
(for 26-week
on Form
series).
PD 5176-1

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
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 566FOR IMMEDIATE RELEASE
CONTACT: Office of Financing
June 30, 1988
202/376-4350
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION
Tenders for $9,036 million of 52-week bills to be issued
July 7, 1988,
and to mature
July 6, 1989,
were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Rate

Investment Rate
(Equivalent Coupon--Issue Yield)

Low
7. 04% a/
High
7. 04%
Average 7. 04%
a/ Excepting 1 tende r of $20,000.
Tenders at the high discount rate

Pr•ice
92 .882
92 882
92 882

7.54%
7. 54%
7. 54%
were aillotted 76%.

TENDERS RECEIVED AND ACCEPTED
(In Thousands )
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS

Accepted

Received

Location
$

24,270
30 ,443, 110
11,700
18,345
22,685
16,685
240,420
1
20,945
10,230
24,660
10,415
1 230,245
159,440

$33 233,150

$

19,270
8,657,255
11,700
18,345
22,685
15,685
36,320
14,945
10,230
24,660
10,415
35,245
159,440
$9,036, 195

Type
Competitive
Noncompetitive
Subtotal, Pu blic
Federal Reserve
Foreign Official
Institutions
TOTALS

$29 ,713,655
504,495
$30 ,218,150
2 ,900,000
115,000
$33,233,150

$5,516,700
504,495
$6,021, 195
2,900,000
115,000
$9,036, 195

An additional$176,800 thousand of the bills will be issued
to foreign official institutions for new cash.

B- 1468

TREASURY NEWS

Department of the Treasury • Washington, D.C. • Telephone 566-2041
July 5 / 1988

MARTOCHE ASSUMES OFFICE OF THE
ASSISTANT TREASURY SECRETARY FOR ENFORCEMENT
Salvatore R. Martoche, Assistant Secretary of Labor (Office
of Labor Management Standards) has assumed the duties of the
Office of Assistant Secretary of the Treasury (Enforcement)
at the direction of the President.
In his new position, Mr. Martoche will take a leading role in
the nation's war against illegal drugs and money laundering. He
will coordinate Treasury-wide enforcement policy and supervise
the following Treasury Bureaus: the U.S. Customs Service; the
U.S. Secret Service; the Bureau of Alcohol, Tobacco and Firearms;
and the Federal Law Enforcement Training Center. He also will
oversee the Office of Foreign Assets Control.
Mr. Martoche was appointed Assistant Secretary of Labor in
1986. He served as United States Attorney for the Western
District of New York from 1982 to 1986. From 1969 to 1982 he was
in private law practice. His practice included administrative
proceedings and civil and criminal litigation.
Mr. Martoche is a 1962 graduate of Canisius College in
Buffalo, New York, and a 1967 graduate of the University of North
Dakota Law School. He is married to the former Mary Dee Benesh,
who is also an attorney. They have three children: Amy, 17,
Claire, 15, and Christopher, 13.

B-1469

TREASURY NEWS
Deportment of the Treasury • Washington, D.C. • Telephone 566-2041
Statement of
Stephen J. Entin
Deputy Assistant Secretary for Economic Policy
Department of the Treasury
before the
Subcommittee on Social Security and Family Policy
Committee on Finance
United States Senate
June 30, 1988
The Chairman and the Subcommittee are to be greatly commended for the close attention they are giving to the condition
of the Social Security System and its economic influence. This
is an important and complex subject which is too often ignored
except when a crisis is imminent. This hearing into the long run
outlook for the System is unusual in that it is being held at a
time of healthy trust fund balances and rising annual surpluses,
and is focusing on fundamental long term budget and growth
questions which are not, and probably cannot be, addressed in the
ordinary budget process.
In the last several years, the Trustees and the Social
Security Administration have, been working together to make more
information available in the annual reports, and to present it in
more useful form. Recent improvements to the Reports include
provision of two intermediate scenarios, II-A and II-B; clearer
presentation of the pattern of surpluses and deficits over 25
year subperiods, supplemented by the use of graphs; Appendix E,
which shows the combined condition of OASI, DI and HI in terms of
percents of taxable payroll; Appendix F, which shows the combined
system in terms of percents of GNP; and Appendix G, which shows
the long range estimates of Social Security Trust Fund operations
in dollars. The material in Appendix G has been published since
1983 as a separate Actuarial Note, and was moved into the
Trustees Report this year for the first time. It seems to have
attracted some interest.
We shall continue to work to improve the Reports, in the
hope of making them as useful as possible to the Congress, the
financial community and the public. Any comments on the content
and presentation of the Reports, or suggestions for additional
material for inclusion, would be greatly appreciated.
I should also like to recommend to the Subcommittee a pair
of just-released studies of the trust fund build-up and its
possible economic and budgetary consequences. These very timely
B-1470

2

studies were proposed, commissioned and supervised by the two
Public Trustees, Suzanne D. Jaffe and Mary Falvey Fuller, with
the assistance of the Department of Health and Human Services.
The studies were prepared by the Brookings Institution and by
Lewin-ICF, Inc.-^ I understand that the Subcommittee has
received copies. I shall draw heavily on their discussion and
conclusions in this presentation, and I have appended the final
chapters of each study to my statement. Chapters 2 and 5 of the
full Lewin-ICF study are particularly good at conceptualizing the
relevant issues and spelling out the key assumptions about fiscal
choices and the reactions of the public that must be made in
analyzing the problem.
Components of Social Security
Social Security comprises the major set of programs
affecting the elderly. There are four parts to Social Security,
each with its own trust fund. The payroll tax is used to finance
three of the four parts: Old-Age and Survivors Insurance (OASI),
Disability Insurance (DI), and Hospital Insurance (HI, or
Medicare Part A). The fourth part, Supplemental Medical
Insurance (SMI, Medicare Part B), covers physician's fees and
office visits, and is financed roughly three-quarters by general
revenues and one-quarter by premiums; it needs only a small trust
fund, as it has a direct claim on general revenues and the
premiums are adjusted annually. OASI and DI are managed by the
Social Security Administration (SSA), and are frequently referred
to jointly as OASDI. HI and SMI are managed by the Health Care
Finance Administration (HCFA). The three programs funded by the
payroll tax are often referred to jointly as OASDHI. The 1983
Social Security Amendments mandated that OASI, DI and HI (but not
SMI) be moved off-budget in 1993. The Gramm-Rudman-Hollings Act
accelerated the shift of OASI and DI off-budget to 1986.
Consequently, OASI and DI are currently reported off-budget, HI
and SMI are currently reported on-budget, and HI will be moved
off-budget in 1993.
Sudden awareness of the projected trust fund build-up has
led in recent weeks to considerable discussion among interested
parties. Some regard it as an unexpected solution to the budget
deficit problem. Others fear that that is exactly what the trust
fund surplus will be used for, financing other government
spending rather than preparing for the retirement of the baby
boom generation. Others fear that the trust funds will swallow
1/ "Final Report to Social Security Administration, U.S.
up the whole national debt, removing the entire supply of
Department of Health and Human Services on Contract No. 600-87Treasury bonds from the financial markets, complicating monetary
0072 to Brookings Institution", and "Study of the Potential
Economic and Fiscal Effects of Investment of the Assets of the
Social Security Old-Age and Survivors Insurance and Disability
Insurance Trust Funds."

3

policy and portfolio decisions. Some fear an even more massive
build-up which could require extensive trust fund investment in,
and control of, large portions of the U.S. private sector.
Before proceeding to discuss these concerns, it would be
helpful to put some of these figures in perspective.
The Magnitude of the Trust Fund Build-up
Table 1, derived from Table G-l in Appendix G of the OASDI
Trustees Report, shows income, outgo, near term trust fund
surpluses and subsequent deficits in both current and real 1988
dollars. It shows that the OASDI trust funds will peak at just
under $12 trillion shortly after 2030 under Alternative II-B
assumptions. This current dollar figure is not adjusted for
inflation. Alternative II-B assumes an average of 4 percent
inflation over the next 75 years. As shown in Graph 1 and Table
1, the OASDI trust fund peaks in real terms shortly after 2020 at
nearly $2.6 trillion in terms of real 1988 dollars. Alternative
II-B projects that nominal GNP in 2030 will be nearly $55
trillion. Real GNP in 2020 will be about $8.9 trillion in real
1988 dollars.
Looking only at the off-budget OASDI trust funds neglects
HI. HI is currently in surplus, but it will begin running
deficits in 1993 under Alternative II-B assumptions. Its trust
fund will be exhausted by 2005. The combined OASDHI trust fund
build-up is much smaller than that of OASDI. Graph 2 compares in
real terms the OASDI and combined OASDHI trust funds. In real
1988 dollars, the OASDI funds peak at $2.6 trillion in 2022,
while the combined OASDHI trust fund peaks at $1.7 trillion in
2016, six years earlier.
Another perspective can be gained by looking at the source
of the trust fund build-up. Table 1 shows that over half of the
annual surpluses of the OASDI system after 2005 are due to
interest from the general fund. Between 2015 and 2020, OASDI tax
income, excluding interest, falls below outlays, and more than
100 percent of the build-up of the trust fund from $9 trillion to
$12 trillion is due to the interest transfer from general
revenues. (See also Table 3.) Table 2 shows the same pattern
emerging earlier for the combined OASDHI system. The interest
element of these surpluses, and this interest-related build-up,
are an intra-government transfer. They do not contribute to a
surplus for the unified budget, and are not part of the net
impact of the OASDI system on the financing needs of the
government or on the credit markets.
The unified budget impacts of OASDI and OASDHI are shown in
Table 3 in current and real 1988 dollars, and in Table 4 in terms
of percent of taxable payroll and GNP. It is the unified budget
impact of OASDI, income excluding interest less outlays, which
measures the impact of OASDI on the credit markets. As OASDI's
outlays begin to exceed its tax revenues between 2015 and 2020,

4

OASDI will be increasing rather than reducing the Federal
Government's borrowing from the credit markets. HI begins to run
deficits on this basis in 1993. For the OASDHI system, the
annual deficits excluding interest begin between 2010 and 2015.
Thus, the trust fund build-up overstates the net
contribution of OASDI and OASDHI toward financing the unified
budget deficit. Tables 3 and 4 show that the OASDI surpluses
excluding interest never exceed $75 billion in real 1988 dollars
and 1.1 percent of GNP. The more distant OASDI deficits are
roughly 1.4 percent of GNP. The peak OASDHI surplus occurs in
the next few years at about 0.85 percent of GNP, and the outyear
combined deficits are slightly over 3 percent of GNP.
Macroeconomic Impact
The Brookings and the Lewin-ICF papers reach broadly similar
conclusions concerning the key elements of the macroeconomic
impact of a trust fund build-up. Some of these are straightforward; others are quite surprising. One of the most
interesting points is that the impact of the trust fund build-up
has little to do with Social Security, and is instead primarily
dependent on how other elements of the economy act or react.
One commonly hears that the trust fund build-up is designed
to pay for the retirement benefits of the large baby-boom generation. Of course, the trust funds themselves do not represent
real goods and services to. be consumed by future retirees. What
is meant by the statement is that the OASDI surplus is expected
to increase government saving, which in turn is expected to
increase national saving, investment, productivity and real
output. Under such conditions, future real benefits would be
paid out of the increased real output of the economy, without
lowering the real income of future workers. Whether this
scenario plays out as stated, however, depends on many factors,
which are analyzed in depth by Brookings and ICF.
Government Saving.
Both studies conclude that the effect of the OASDI Trust
Fund build-up on the economy depends heavily on the overall
fiscal behavior of the government. ICF states:
The accumulation of Treasury obligations by the OASDI
trust funds, in itself, will not provide real resources
to pay future benefits nor directly affect the
economy. If the current and projected OASDI surpluses
are used to finance other government spending, and
there is no increase in net government savings, the
surpluses will not contribute to the accumulation of
real resources that could be used to fund future social
security outlays.

5

Because of the demographic configuration, major
increases in both OASDI and Medicare expenditures will
be required in the 21st century. The burden of those
expenditures must be born by the working population at
that time. If those future workers are to be endowed
with increased resources to help them bear that burden,
current savings and capital accumulation must be
increased.
ICF and Brookings ran scenarios in which the OASDI surpluses
financed portions of other government spending for the next 25 to
30 years, followed by a period in which OASDI deficits were
financed by non-OASDI surpluses. This yielded results only
slightly better than the baseline Alternative II-B projections
for GNP, productivity and wages.
Both studies then ran other scenarios in which the non-OASDI
budget balance was stabilized so that movements in OASDI trust
fund surpluses and deficits were reflected dollar for dollar in
changes in government saving. (Brookings assumed that policy
changes would reduce the non-OASDI budget deficit to 1.5 percent
of GNP in the 1990s and stabilize it at that level. ICF assumed
the non-OASDI budget would be balanced.) In other words, both
scenarios assumed that the trust fund build-up would be allowed
to increase government saving through about 2030, after which the
trust fund drawdown would reduce government saving.
National Saving.
Net changes in government saving have the potential to
affect GNP. However, both studies point out that an increase in
government saving might not translate into increased capital
formation, due to reduced private saving. ICF suggests that a
complementary set of policies to promote saving and investment
would be required to ensure the desired outcome.
It is widely accepted that movements in government saving
are commonly offset to some greater or lesser degree by countermovements in private sector saving, thereby reducing the effect
on national saving. The studies give several reasons.
o Higher taxes may reduce disposable income and saving
directly.
o A reduced budget deficit, if it has adverse demand effects
on the economy, may reduce growth, income and saving.
o Higher capital formation, if it occurs, may reduce the
rate of return on capital, lower interest rates, and
reduce saving insofar as saving is interest sensitive.
o A lower rate of return on capital domestically might
result in some additional saving being diverted abroad,
reducing the domestic capital build-up.

6

o

Taxpayers may see the drop in the Government deficit as
relief from the prospect of higher future taxes. This
would increase perceived "permanent income" and lead to
greater private consumption (the Barro effect).
A recent study (The Impact of Government Deficits on
Personal and National Saving Rates) by Darby, Gillingham and
Greenlees of the Office of Economic Policy, U.S. Treasury,
supports this concern. The study also notes that the degree to
which a reduction in the Federal deficit is offset by lower
private saving is sensitive to the method of deficit reduction,
at least in the short term.
o The study found that after one year, a $1 increase in
taxes, holding government spending constant, leads to
roughly a $0.20 increase in national saving because the $1
increase in government saving (decrease in the government
deficit) is offset by an $0.80 decline in private
saving. In other words, national saving increases as a
result of a tax increase by only the 20-cents-on-thedollar consumer expenditure cut which it induces.
o In contrast, a $1 decrease in government spending, holding
taxes constant, would cause a much larger $0.80 increase
in national saving. Specifically, after one year, the
spending decrease increases government saving by $1 which
would be offset by only a $0.20 increase in consumption
and decline in private saving, thus increasing national
saving.by $0.80.
o Although these two fiscal actions have the same impact on
the budget deficit, a spending decrease has approximately
four times the short-run impact on national savings of a
tax increase.
Higher Investment and Capital Formation.
Assuming no adverse saving offset, the Brookings and LewinICF studies went on to demonstrate that if national capital
accumulation were increased by an amount equal to the OASDI Trust
Fund accumulation, the productivity, output, and income of the
economy would increase. According to ICF,
If additional capital investment matches the trust fund
accumulation during this period, GNP could be increased
by two to four percent, compared to what it would be
with no additional investment. The greater capital
stock and national output could help fund the greater
outlays that will be required after 2020 by (1)
permitting a greater level of consumption out of
current income, and (2) permitting an increase in
consumption at the cost of a reduction in capital

7

accumulation during the period when the trust fund is
being drawn down to finance outlays.
Longer Term Consequences.
Both studies make the surprising point that, under these
assumptions, OASDI Trust Fund accumulation and increased national
capital accumulation will not significantly help the long term
OASDI financing problem, if existing tax and benefit provisions
are not changed.
ICF states, "Increased capital accumulation would increase
national output and income and increase the level of real
resources that can be used to pay the increased OASDI outlays.
However, under existing OASDI tax and benefit provisions,
increased national income generated by domestic investment will
not improve the long term OASDI financial imbalances."
This non-intuitive result, emphasized both by Brookings and
ICF, comes from a peculiar feature of the tax and benefit
provisions of the OASDI System. Both tax revenues and benefit
levels earned by newly retired workers are linked to wages. (The
benefit formula is described in Appendix D of the OASDI
Report.) As higher saving and investment rates improve productivity, real wages will rise. Higher wages result in higher tax
receipts very quickly, improving the OASDI balance. However, the
higher wages result in higher benefit levels, in the same
' proportion, about 15 to 20 years later. Because benefits exceed
income under current assumptions, an equal percent increase in
wages, revenues and benefits ultimately would raise the OASDI
deficit. Furthermore, the assumed lower interest rates accompanying the higher capital stock will reduce OASDI interest
earnings and trust fund balances over the period relative to the
baseline, resulting in an even greater degree of dissaving toward
the end of the period, and a faster trust fund drawdown.
Both papers indicate that a faster trust fund drawdown, and
larger national dissaving, should they materialize mechanically
in this fashion, could ultimately depress the capital stock and
GNP below the baseline projections. Consequently, the
improvements in the economy would be temporary. This conclusion
is based on the admittedly unrealistic assumption built into the
presentations for expositional purposes that Congress would
permit the trust funds to become exhausted in this fashion, and
permit the unified budget to deteriorate. It also assumes that
the improvement in the rest of the budget due to faster growth
and lower interest outlays would automatically be spent.
o An illustration of the link between wages and benefits is
provided in Table 7. The wage-linked benefit formula
provides a nearly constant replacement rate (benefits as a
percent of preretirement income) over the next 75 years
for retired workers who earned the average wage. There
will be some adjustments to upper income replacement rates

8

due to the sharp increase in the maximum covered wage in
the 1977 Amendments, resulting in an increase in upper
income replacement rates through 2015. Thereafter, upper
income replacement rates will stabilize.
o Between 1988 and 2065, the real wage of the average wage
worker in the year prior to age 65 retirement will rise
175 percent in real terms, from $18,553 for the 1988
retiree to $50,934 for the 2065 retiree (all in real 1988
dollars). The benefit upon first retiring, assuming the
worker had always earned the average wage and worked full
time, will rise 169 percent (closely matching the 175
percent rise in real wages), from $7,534 for the 1988
retiree to $20,303 for the 2065 retiree (in real 1988
dollars). For a married worker with a spouse receiving
spousal benefits, these figures would be 50 percent
larger, or $11,301 in 1988 and $30,455 in 2065 (in real
1988 dollars).
o A single worker who has always earned the maximum covered
wage would have real wages in the year before age 65
retirement of $45,508 for the 1988 retiree and $120,233
for the 2065 retiree (all in 1988 dollars), up 164
percent, and benefits of $10,095 in 1988 versus $31,990 in
2065 (in 1988 dollars), a difference of 217 percent in
real terms. For a couple with spousal benefit, the
benefits in real 1988 dollars would be $15,143 in 1988 and
$47,985 in 2065.
o Faster real wage growth than assumed in Alternative II-B
would push real benefits up proportionally, and widen
projected long run deficits.
Uncertainty.
It should be emphasized that the Brookings and ICF projections of a weaker GNP 50 to 75 years from now are subject to
great uncertainty. They depend heavily on the assumption that an
accelerated trust fund drawdown will be permitted to reduce
national saving in the distant future below the baseline
projection. However, it is unlikely that the non-OASDI deficit
will be held strictly to the paths assumed in the two studies,
and it is certain that Congress will act to restore solvency to
the trust funds before they are exhausted. Thus, there are steps
that could be taken to preserve the stronger economy and prevent
the projected trust fund drawdown from depressing saving and per
capita GNP. The non-OASDI budget could be allowed to move into
greater surplus, boosted by the stronger assumed GNP and lower
interest rates, as the OASDI program begins to run deficits in
the outyears, or the OASDI balance could be improved through tax
changes, alteration of the benefit formula, or changes in
retirement age or other parameters of the program.

9

Investing the Trust Funds
Under current law, OASDI receipts in excess of amounts
needed for benefit payments are invested in U.S. Government
securities. For the most part, these are special, non-marketable
Treasury securities which are sold only to the trust funds, and
which by law pay interest at the average rate on marketable
Treasury securities outstanding with four years or more to
maturity. Unlike ordinary securities, these special securities
may always be redeemed at par. This provision shelters the trust
funds from the risk of price fluctuations in the event that
market interest rates change. The funds may also invest in
ordinary marketable Treasury securities, or other securities
guaranteed as to principle and interest by the United States.
During the period of trust fund build-up, the OASDI trust
funds have the potential to absorb most or all of the outstanding
and projected Treasury obligations held by the public. Other
things equal, this debt would then be reissued to the public as
the trust funds were drawn down during subsequent periods of
deficit.
If the non-OASDI portion of the budget were to run deficits
averaging 1.5 to 2.0 percent of GNP over the next 40 years
(roughly equal to the post World War II average of 1.7 percent),
the share of Treasury obligations in the hands of the public
would be greatly diminished, but the public's holdings would
probably not be eliminated entirely. If the non-OASDI budget
were balanced, or brought close to balance, then the trust fund
build-up could eliminate holdings of Treasury securities by the
public for some period of time.
A sharp reduction in Treasury debt held by the public could
result in some reduction in interest rates paid on Treasury
debt. However, there is a wide range of securities which are
reasonably close substitutes for one another, and it is unlikely
that a sharp skewing of interest rates would occur. The financial markets could cope with a markedly lower share of Treasury
securities in the total pool of financial instruments. Lewin-ICF
points out that the share of Treasuries in total credit market
paper has fluctuated widely over the last 40 years with little
impact on interest rates.
Nonetheless, ICF recommends that Treasury securities should
not be eliminated entirely, because of their useful characteristics of low risk, liquidity and diversity of maturities, traits
of particular importance to many fiduciary institutions. ICF
suggests that, if the need should arise, the trust funds might
obtain securities of other Federal agencies, or that additional
special assets could be created for the trust funds without
eliminating all marketable Treasury securities. Both Brookings
and ICF point to the rising volume of government guaranteed
mortgage instruments, such as GNMA securities, as possible
investment alternatives for the trust funds. These securities

10

will expand in volume as the economy grows, and could provide a
large pool of safe securities should the trust funds show signs
of absorbing an excessive share of Treasury obligations.
A substantial portion of Treasury securities is held by the
Federal Reserve. The Fed manages monetary policy by injecting or
withdrawing bank reserves by buying or selling these securities.
The Fed prefers to deal in a very liquid market where its
activities create the minimum disruption, and finds the Treasury
bill market ideal. Nonetheless, the Fed has the authority to
deal in a wide range of securities, and would not face
insurmountable obstacles in the event of a sharp reduction in the
supply of Treasury obligations.
Neither Brookings nor Lewin-ICF sees much economic impact
from alternative investment strategies for the trust funds.
Certainly, barring substantial improvement in the rest of the
budget, such a shift would be of limited economic impact. If the
trust funds were to lend to private sector borrowers instead of
the Treasury, more of the Treasury debt would have to be held by
the public. The trust funds would hold some of the non-Treasury
securities the public would otherwise hold. Total debt, saving
and capital formation would be unaffected. The public's portfolio would be somewhat less risky, the trust fund's portfolio
somewhat more risky.
Aggressive movement of the funds into equities and other
private securities would entail higher risk of loss or default
than Treasury obligations, a risk unsuitable to the social policy
goal of the programs. If ownership of equities or private sector
bonds were contemplated, significant problems would arise as to
potential federal control of corporations, the allocation of
investment resources, and the conduct of business. We recommend
against such involvement.
Conclusion
The OASDI trust fund build-up should be put into perspective
with respect to GNP, inflation and projected deficits in other
parts of the Social Security System and the rest of the budget,
and the projected outyear deficits of OASDI.
The economic impact of the trust fund surpluses will depend
on what happens to the rest of the budget. According to studies
by Brookings and Lewin-ICF, if the OASDI surpluses are used to
finance other government outlays, little additional capital
formation will occur. If the rest of the budget moves close to
balance, and if the trust fund surpluses and subsequent deficits
were translated into domestic saving and investment, they would
first raise and then lower GNP, wages, and real output. Output
could be 2 to 4 percent higher than otherwise in real terms prior
to the drawdown of the trust funds in the 2030s and 2040s.

11

This projection could be muted by a number of factors. The
changes in government saving could be largely offset by countermovements in private saving with little change in national
saving. Even if national saving did rise prior to 2030, domestic
capital formation would not be assured in the absence of improved
tax treatment; saving might move abroad rather than raise investment in the U.S. Beyond 2030, the beneficial effects of the
build-up eventually could be more than reversed by greater
dissaving, and the balance of OASDI would be worsened. The
earlier gains in real wages would raise real OASDI benefits via
the wage-linked benefit formula, leading to higher OASDI deficits
and a reduced government saving rate. This result is dependent
on the assumption of a fixed deficit path in the rest of the
budget, and could be altered by assuming rising surpluses in the
rest of the budget, or changes in the tax rate, benefit formula,
retirement age or other features of the OASDI system.
The trust fund build-up may reduce or eliminate publicly
held Treasury debt, depending on what one assumes regarding the
deficit of the rest of the budget. This debt would be reissued
in later years of OASDI deficit. Credit markets should be able
to cope with such shifts as they have in the past without major
changes in interest rates. Alternatively, other investment
options, such as federally backed mortgage instruments, would be
a secure investment option. There is ample time to explore this
issue, which may never arise in practice.

Graph 1

END OF YEAR OASDI TRUST FUND ASSETS
ALT IIB, 1988 TRUSTEES REPORT

1990

1995

2000

2005 2010 2015 2020 2025 2030 2035

2040 2045

Graph 2

REAL END OF YEAR TRUST FUND
ASSETS
ALT IIB, 1988 TRUSTEES REPORT

1988

1993

1998 2003 2008 2013 2018

2023 2028 2033 2038 2043 2048

Graph 3

OASDI and OASDHI Income and Outgo
Under Present Law, 1988 Alternative II-B
(Percent of Taxable Payroll)

Table 1
Estimated Operations of the OASI and DI Trust Funds
(billions of dollars)
Income
Excluding
Interest
•

Calendar
Year

Interest

Total
Income

Total
Outgo

Assets at
End of Year

Current Dollars
1988
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065

254.7
293.3
403.2
547.9
739.9
987.4
1 ,302.6
1 ,703.0
2 ,220.3
2 ,898.7
3 ,788.2
4 ,937.8
6 ,422.5
8 ,349.6
10 ,867.1
14 ,159.3
18 ,443.8

8.0
16.3
44.8
83.6
146.4
250.5
383.7
523.2
636.7
692.0
664.4
532.8
251.8
-282.2
-1,238.2
-2,836.9
-5,374.2

262.7
309.5
447.9
631.5
886.3
1 ,237.9
1 ,686.3
2 ,226.2
2 ,857.0
3 ,590.7
4 ,452.6
5 ,470.6
6 ,674.3
8 ,067.4
9 ,628.9
,322.4
13 ,069.6

n;

222.4
252.2
338.3
446.8
595.1
825.8
1 ,203.7
1,,775.4
2 ,549.4
3,,524.5
4,,703.2
6,,121.7
7,,966.8
10,,464.9
13,,797.0
18,,109.0
23,,662.1

109.1
211.9
645.5
1,409.4
2,632.5
4,460.6
6,763.0
9,124.3
10,996.2
11,837.5
11,240.0
8,840.4
3,799.4
-5,744.6
-22,752.8
-51,053.9
-95,828.2

222.4
231.3
254.5
276.2
302.4
344.9
413.2
500-9
591.2
671.8
736.8
788.3
843.2
910.4
986.5
1 ,064.2
1 ,143.0

109.1
193.5
485.6
871.3
1,337.6
1,863.0
2,321.6
2,574.4
2,550.1
2,256.3
1,760.9
1,138.4
402.1
-499.7
-1,626.8
-3,000.3
-4,628.8

Real (1988, Dollars
1988
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065

254.7
268.9
303.3
338.7
376.0
412.4
447.1
480.5
514.9
552.5
593.5
635.8
679.7
726.3
777.0
832.1
890.9

8.0
14.9
33.7
51.7
74.4
104.6
131.7
147.6
147.6
131.9
104.1
68.6
26.6
-24.5
-88.5
-166.7
-259.6

262.7
283.8
336.9
390.4
450.3
517.0
578.9
628.1
662.5
684.4
697.6
704.4
706.4
701.8
688.5
665.4
631.3

The top panel is from Table Gl -of the 1988 Annual Report of the Board of
Trustees of the Federal Old-Age and Survivors Insurance and Federal
Disability Insurance Trust Funds; the lower panel is derived from the upper
panel using the adjusted CPI in Table G2 of the Report.

Table 2
Estimated Operations of the OASDI and HI Trust Funds
(billions of dollars)

Calendar
Year

Income
Excluding
Interest

Interest

Total
Income

Total
Outgo

Assets at
end of year

Current Dollars
1988
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065

317.1
363.5
499.6
678.4
915.4
1221.3
1,609.4
2,101.3
2,736.4
2,569.5
4,663.0
6,077.6
7,904.4
10,274.5
13,369.6
17,417.6
22,686.6

15.7
26.0
53.2
84.6
131.5
204.2
283.4
330.8
283.2
56.2
-431.0
-1,282.5
-2,642.5
-4,751.0
-7,725.6
-12,497.9
-19,559.8

332.8
389.5
552.8
763.0
1046.9
1 ,425.5
1 ,892.8
2 ,432.1
3 ,019.5
3 ,625.6
4 ,232.1
4 ,795.1
5 ,261.9
5 ,523.4
5 ,644.0
4 ,919.7
3 ,126.8

276.7
317.9
441.5
600.9
817.5
1.,145.1
1.,662.4
2,,448.4
3,,540.6
4,,949.4
6,r675.9
8,r765.7
H i ,448.3
15,,036.1
19,,805.5
26,,022.2
34,,014.5

200.3
318.2
750.0
1,405.5
2,340.5
3,613.9
4,970.0
5,715.6
4,745.1
596.9
-8,103.9
-2,3149.3
-47,072.0
-84,118.1
-136,392.1
-220,101.4
-343,818.1

276.7
291.5
332.1
371.1
415.4
478.3
570.7
690.8
821.1
943.4
1,,045.9
1,,128.7
1,,211.7
1 ,308.0
1 ,416.1
1 ,529.3
1 ,643.0

200.3
291.8
564.1
868.9
1,189.3
1,509.3
1,706.1
1,612.6
1,100.4
113.8
-1,269-6
-2,980.9
-4,982.0
-7,317.5
-10,064.8
-13,274.8
-16,976.9

Real (1988) Dollars
1988
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065

317.1
333.3
375.8
419.4
465.1
510.1
552.5
592.9
634.6
680.4
730.5
782.6
836.6
893.8
955.4
1,023.6
1,095.8

15.7
23.8
40.0
52.3
66.8
85.3
97.3
93.3
65.7
10.7
-67.5
-165.1
-279.7
-413.3
-570.4
-754.0
-966.0

332.8
357.1
415.8
471.7
532.0
595.4
649.8
686.2
700.2
691.1
663.0
617.5
556.9
480.5
385.6
269.6
129.8

Treasury estimates derived from data underlying the 1988 Trustees Report.

Table 3
Unified Budget Impact of Projected OASDI and HI Surpluses and Deficits
(Excludes Interest) in Current and Constant Dollars (Alternative II-B)
(billions of dollars)
Current Dollars
YEAR OASDI HI • TOTAL OASDI HI TOTAL
1988
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065

32.30
41.00
64.90
101.10
144.80
161.60
98.90
-72.40
-329.10
-625.80
-915.00
-1183.90
-1544.30
-2115.30
-2929.90
-3949.70
-5218.30

8.10
4.50
-6.80
-23.60
-46.90
-85.40
-151.90
-274.70
-475.10
-754.10
-1097.80
-1504.10
-1999.60
-2646.30
-3506.00
-4654.80
-6109.60

40.40
45.50
58.10
77.50
97.90
76.20
-53.00
-347.10
-804.20
-1379.90
-2012.80
-2688.00
-3543.90
-4761.60
-6435.90
-8604.50
-11327.90

Real (1988, Dollars

32.30
37.59
48.82
62.50
73.58
67.49
33.95
-20.43
-76.32
-119.28
-143.35
-152.45
-163.44
-184.01
-209.49
-232.12
-252.06

8.10
4.13
-5.11
-14.59
-23.83
-35.67
-52.14
-77.50
-110.18
-143.74
171.99
-193.68
-211.63
-230.20
-250.68
-273.55
-295.11

40.40
41.72
43.71
47.91
49.75
31.82
-18.19
-97.93
-186.50
-263.02
-315.34
-346.13
-375.07
-414.21
-460.17
-505.67
-547.17

SOURCE: These figures have been derived from numbers presented in the 1988 Annual
Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds, Tables G2 and G3; for 2065, additional information
was provided by the Social Security Administration.

Table 4

i

Unified Budget Impact of Projected OASDI and HI Surpluses and Deficits
(Excludes Interest) as Percent of Taxable Payroll and Percent of GNP
(Alternative II-B)

Percent of Payroll
YEAR OASDI HI TOTAL OASDI HI TOTAL
1988
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065

1.56
1.79
2.07
2.37
2.53
2.53
1.02
-0.51
-1.89
-2.78
-3.12
-3.10
-3.11
-3.28
-3.50
-3.62
-3.68

0.38
0.19
-0.21
-0.52
-0.78
-1.06
-1.44
-2.00
-2.67
-3.26
-3.64
-3.83
-3.91
-3.99
-4.06
-4.14
-4.18

Percent of GNP

1.94
1.98
1.86
1.85
1.75
1.07
-0.42
-2.51
-4.56
-6.04
-6.76
-6.92
-7.02
-7.27
-7.56
-7.77
-7.85

0.68
0.76
0.88
1.01
1.07
0.89
0.41
-0.23
-0.80
-1.16
-1.28
-1.26
-1.26
-1.31
-1.38
-1.42
-1.43

0.17
0.08
-0.09
-0.23
-0.34
-0.47
-0.63
-0.87
-1.15
-1.39
-1.54
-1.61
-1.63
-1.64
-1.66
-1.67
-1.67

0.85
0.85
0.78
0.77
0.72
0.42
-0.22
-1.10
-1.95
-2.55
-2.83
-2.87
-2.88
-2.95
-3.04
-3.09
-3.10

SOURCE: OASDI and HI percentages were obtained from the 1988 Annual Report of the
Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability
Insurance Trust Funds, Tables 26 and E3; respectively. Additional information, for
2065, was provided by the Social Security Administration.

Table 5

CONTRIBUTION RATES FOR THE OASDI A N D HI P R O G R A M S
Contribution rates (percent)
Self-employed

Employees and employers, combined

Calendar years

HI

Total

OASDI

7.70
7.80
7.60
8.40
9.20

0.70
1.00
1.20
1.20
1.20

8.40
8.80
8.80
9.60
10.40

1973 9.70
1974-77
1978
1979-80
1981

9.90
10.10
10.16
10.70

2.00
1.80
2.00
2.10
2.60

1982-1983 10.80
1984'
1985'
1986-1987'
1988-89'
1990 and later

11.40
11.40
11.40
12.12
12.40

2.60
2.60
2.70
2.90
2.90
2.90

1966
1967
1968
1969-70
1971-72

,

OASDI

HI

Total

5.80
5.90
5.80
6.30
6.90

0.35
0.50
0.60
0.60
0.60

6.15
6.40
6.40
6.90
7.50

11.70
11.70
12.10
12.26
13.30

7.00
7.00
7.10
7.05
8.00

1.00
0.90
1.00
1.05
1.30

8.00
7.90
8.10
8.10
9.30

13.40
14.00
14.10
14.30
15.02
15.30

8.05
11.40
11.40
11.40
12.12
12.40

1.30
2.60
2.70
2.90
2.90
2.90

9.35
14.00
14.10
14.30
15.02
15.30

'See section enlilled "Nature of the Trust Funds", OASDI Trustees Report, lor description ol tax credits allowed against the combined OASDI and
HI taxes on net earnings from self employment in 1984 89.

TABLE 6-COMPARISON OF ESTIMATED TOTAL INCOME RATES AND COST RATES FOR
THE OASI, DI, AND HI PROGRAMS, BY ALTERNATIVE, CALENDAR YEARS 1988-2060
(As a percentage of taxable payroll')
ToltJ
Calandav yaar
Ailamaliva 1
1988
1969
1990
1991
1992
1993
1994
199S
1996
1997
2000
200s
2010
2015
2020
202S
2030
2035
2040
204 5
20 SO
205S
2060
AHarnalwa M A
1988
1989
1990
1991
1992
1993
IS94
19*5
1996
1997
2000
2O0J
2010
2015
2020
202S
2030
2035
2040
204S
20 SO
20S5
2060

(•!•
16 19
1520
15 46
IS SO
IS SO
IS SO
IS SO
IS SO
15 50
15 50
ISS4
ISS9
1563
IS 69
IS 76
1S6I
IS 84

is
as
IS 84
IS
IS
IS
IS

83
83
83
83

IS 18
IS 20
IS 48
15 50
IS SI
ISSI
ISSI
ISSI
ISSI
ISSI
ISS6
IS 62
IS68
IS 74
IS 83
IS 90
15 95
IS 88
IS 98
IS 89
16 00
16 02
16 02

ToUl

Cost !•••
OASI
•
8
8
9

58
46
39
27

SIS
801
6
6
6
8

HI*

01
106
104
101
99
96
97

87
7S
63
S3

96
97

6 17
7 76
7 90
6 7S
8 93
10 82
1127
1123
10 87
IOSS
10 42
10 37
10 29

101

961
9SS
9S7

97
98

ToltJ

2 50

13 13

206

2SI
2S9
263
266
266

1301
1300

2 19
2 46
2 61
2 72
2 65
2 97
306
3 15
3 24

2
2
2
2

70
72
74
74

89
78
65
53
44
34
25

132
133

3
3
3
3

31
40
44
48

1 32

3S2

1521

131

3 56

IS 16

108
10'
I0S
104
103
103
104
I0S
106
108

2SI
2S6
266

1321

6 73
6 44

1 12

666

1 44

• 72
11 16
12 45
13 32
13 6S
1360
1354
13 70
13 83
14 07

ISS
160
168
168
I6S
I6S
171

3
3
3
4

8
8
•
•
•
•
•

49
40
31
23
IS
06
99

1 30

126

1 74
1 73

172

2 7S
2 70

12
12
12
12
12
12
12

II 92
II 56
II 79
12 71
14 04
IS 16
IS 79
IS8S
IS 57
15 32
15 23

109
122
129
133
138
135
131

Balanca*

267
267
2 76
2 96

317

2 75
2 62
2 89

296
3 03
3 10
3 IS
31
S3
77
12

466
5
5
6
6
6
6
6
6

28
85
22
40
46
55
63
70

13
13
13
13
13
13
13
13
13

18
30
29
25
24
23
22
22
22

13 17
13 23
1390
15 38
17 44
19 44
20 85
21 51
2165
21 74
22 00
22 29
22 49

3
4
3
2

61
02
64
96

172
63
OS
00
27
51
60
62
67
1
2
2
2

98
03
18
22

226
2
2
2
2

27
26
26
29

228
2 39
2 30
1 78

36
'-162
-3 53

-4 80
-5 53
-5 66
-5 75
-6 00
-6 27
-6 46

Calendar yaai
Altarnabva II B
1968
1888
1890
1891
1892
1993
1994
1995
1996
1997
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
AHarnabva III
1868
1ft60
1880
1891
1992
1993
1994
1995
1996
1897
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060

.*.

•aw

Cotl rain

OASI

01

1 6 1ft
15 20
15 50
15 51
15 52
15 52
15 52
15 52
15 52
1552

• 65
• 65
• 74
• 73
• 66
• 62
• 54
• 47
• 40
• 33

108
108
107
107
106
106

15 57
15 65
15 71
15 78
15 67
15 64
16 00
16 03
16 03
16 04
16 05
16 06
16 07

HI*

Total

Balanca*

13 25
13 30
13 52
1360
13 62
1363,
13 64
13 65
1366
1366

194

1.10

2 52
2 56
2 71
2 60
2 68
2 95
3 03
311
3 18
3 23

• 14
• 81
• 16
10 26
1161
13 16
14 14
1454
1452
14 47
14 63
I4 86
15 02

1 16

3 42

IBS

131
149
160
166
176
174
171

368

6 16
654

1 71

6 73

176
180
160
176

681

13
13
14
16
18
20
22
22
22
23
23
23
23

15 19
16 21
15 53
1562
15 54
15 54
15 54
15 54
IS 64
1554

• 80
1002
10 IB
10 33
1069
1060
10 62
10 43
1037
10 32

113

256

1 16

2
2
2
3
3
3
3
3
3

1561
IS 70
IS 77
IS 65
IS 87
1607
1617
16 23
1627
1631
1636
16 41
16 46

1016
1000
10 35
1166

140
169
164
200
210

13 63
IS 66
1730
16 46
1118

1660
80 71

at
74
22 57

107
107

109

117
1 IB
1 24

125
127
1.26

131
134

2 25

126

2 2S

ISO
143
a s«
a
ct
8 46

3 96
4 34

480
5 57

6 69

696
7 04

67
85
99
16
28
43
57
71
65

4 31

S07
SB6
7
6
10
12
13
13
13
13
14
14

16
7B
60
17
14
53
71
86
01
17

'The taxable payroll for HI is somewhat larger than the taxable payroll for OASDI, because HI covers all
Federal civilian employees, including those hired before 1984, all Slate and local government employees
hired alter April 1, 1986, and railroad employees. This difference is relatively small and does not
significantly affect the comparisons
^Cosl rates for HI exclude amounts required for trust fund maintenance.
'The balance is I he total income rale minus the combined O A S D I and HI cost rate. Negative balances are deficits.

72
6B
63
20
37
50
04
78
96
06'
32
62
64

13 48
13 66
14 21
14 50
15 09
15 13
15 22
IS 28
15 40
ISSI

1666
1665
16 17
20 86
24 52
26 43
3173
33 66
34 66
3S 84
37 06

36 26
99 aa

1 BO

198
191
1
1
1
1

69
89
88
66

186
1 65

1 75

107
-42
-2
-4
-6
-6
-6
-7
-7
-7
-7

51
56
04
76
92
02
27
56
77

1 71
1 35
1 32

102
45
41
32
25
14
03
-26
-.65
-2 40

-4BB
-6 56
-12 36
-IS 67
-17 62
• 16 72

-1663
-20 78
-at M

-22 76

Table 7
Projected Initial Real Benefits for Single Retirees
Age 65 with Average and Maximum Covered Earnings (Alternative II-B)
Annual Benefits
Retirement Year
1988
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065

Current Dollars
Maximum
Average
7,534
8,621
10,558
13,762
17,907
23,291
30,297
39,415
51,277
66,704
86,769
112,866
146,811
190,964
248,410
323,127
420,320

10,095
11,690
14,691
19,891
26,827
35,931
47,635
62,214
80,942
105,292
136,776
177,910
231,374
300,899
391,411
509,142
662,284

Constant 1988 Dollars
Maximum
Average
7,534
7,905
7,941
8,508
9,099
9,727
10,400
11,121
11,891
12,714
13,594
14,534
15,538
16,612
17,761
18,989
20,303

10,095
10,719
11,050
12,297
13,632
15,006
16,352
17,553
18,771
20,069
21,428
22,909
24,488
26,175
27,986
29,921
31,990

ReDlacemei
Average

Maximum

42.2
44.0
41.4
41.4
41.4
41.4
41.4
41.4
41.5
41.5
41.5
41.5
41.5
41.5
41.5
41.5
41.5

23.0
25.1
24.4
25.3
26.2
27.1
27.6
27.7
27.7
27.7
27.7
27.7
27.7
27.7
27.7
27.7
27.7

Assumes retirement at age 65. Beneficiaries are assumed to have been full time workers
earning the average wage in covered employment, or the maximum covered wage throughout
their working lives. Married couples with a spousal benefit would receive 150 percent of
the amounts shown in the table. Data were provided by the Social Security Administration

S T U O Y Of THE POTENTIAL ECONOMIC A N D FI.SCAL
EFFECTS Of INVESTMENT OF THE ASSETS OF THE
SOCIAL SECURITY OLD-AGE A N D SURVIVORS INSURANCE
A N D DISABILITY INSURANCE TRUST FUNDS
FINAL REPORT
Submitted to:
U.S. Department of Health and Human Services
Social Security Administration
Joseph M. Anderson
Richard A. Kuzmack
Donald W . Moran
ICF Incorporated
1090 Vermont Avenue, N.W.
Washington, D.C. 20005

George R. Schink
Wharton Econometric Forecasting Associates
190 Monument Road
Bala Cynwyd, Pennsylvania 9004

Dale W. Jorgenson
and
William R.M. Perrandin
Harvard University
Cambridge, Massachusetts 02138

May 1988

caairm sn
COVCIJL7SI0BS

This chapter summarizes, several of the major conclusions of the study.
1. Tha Rffect of QASDT, TT"n ^"TTrf A—-,^1,«tlon on th* Kcotwwr and on the
Ability of the CMiEftT ^Tff*"^ «"? 7"™* Future B*Biy»f1«;ff t y ^ ~ u ^ rhe
Overall Fiscal fta»fr^?T »f fl^ rrfflrematnt.
The accumulation of Treasury obligations by the OASDI trust funds, in
itself, will not provide real resources to pay future benefits nor directly
affect the economy. If the current and projected OASDI surpluses are used
to finance other government spending, and there is no increase in net
government cavings, the surpluses will not contribute to the accumulation of
real resources that could be used to fund future social security outlays.
Because of the demographic configuration, major increases in both OASDI
and Medicare expenditures will be required in the 21st century. The burden
of those expenditures must be born by the working population at that time.
If those future workers are to be endowed with increased resources to help
them bear that burden, current savings and capital accumulation must be
increased.
Increasing real government savings will require significant changes in
non-OASDI taxes and expenditures. The changes required to balance nonOASDI federal accounts are illustrated by comparing Scenario 1 described in
Chapter 3 with Scenarios 4 or 7. In Scenario 4. for example. non-OASDI
taxes are increased by 1.4 percent of GNP, non-OASDI outlays are reduced by
1.4 percent of GNP, the Medicare HI payroll tax is increased to 3.9 percent
of payroll, and HI outlays are reduced by 20 percent. These major changes
are phased in over the period 1991-1995 in order to balance the federal
budget by 1997.

6-2

2.

g — If Feairrilflrflrjfff<MT frfirr^ ?1 nHflrimtlT TPJ frrlnnl
^TTTmiTrC f-^lTtffi M*1? Tncreagagrf. Prl^fre OpKill Agguilacioo Is Not

Increased government savings could be offset by increased private
consumption. If the accumulation of large OASDI trust funds, and the
corresponding government savings, is to help fund future OASDI outlays, a
complementary set of policies to promote -- or at least to avoid penalizing
-- private savings and investment is required. The large requirements for
retirement income and for health care that will be associated with the
significant increases in the elderly population that will occur in the next
century mandates the current importance of these issues.

3. Tf ^irtTtt"! Capita.] Af^rnil ation Is Increased by an Amount Equal to tne
the KconoaT Would Increase.
The size of the OASDI trust fund is projected to be greater than 25
percent of GNP during the period 2012-2026. If additional capital
investment matches the crust fund accumulation during this period. GNP could
be increased by two to four percent, compared to what it would be with no
additional investment. (Alternative macroeconomic model estimates are
presented in Table 4-1 and Table 4-11 in Chapter 4.) The greater capital
stock and national output could help fund the greater OASDI outlays chat
will be required after 2020 by (1) permitting a greater level of consumption
out of current income, and (2) permitting an increase in consumption at the
cost of a reduction in capital accumulation during the period when the cruse
fund is being drawn down to finance outlays.

6-3

aWiil^tM,™ a m Wit- S i g ^ ^ n ^ l y ffalp the Long Tent QASPT Vi^jt^ri^
FY?frlf IfftfcifftinfTfflT "TH1 ^ T T f R Provisiona Are Hot fTh«nff*<
Increased capital accumulation would increase national output and income
and increase the level of real resources that can be used to pay the
increased OASDI outlays. However, under existing OASDI tax and benefit
provisions, increased national income generated by domestic investment will
not improve the long term OASDI financial imbalances. Two factors are at
work. (1) Increased domestic investment will increase average wages.
Increased wages will increase tax revenues immediately but will increase
benefits equally, after a short lag. At first the projected OASDI surpluses
will be increased, but after about 2025 the projected deficits will be
increased. Ultimately, benefit payments will be increased more than tax
revenues. (2) The increased capital intensity of the economy will reduce
the rate of return to capital and will reduce the interest earned on che
trust fund balances. Interest rates could be reduced by five to six percent
during che period 2015-2025 when cne trust fund is greatest. Both che
increase in wages and che reduccion in inceresc races reflecc che increased
income and produccivicy of che economy, and hence an increase in economic
well-being. Nevertheless, under che currenc OASDI financing and benefic
calculation provisions, they hurt the long run financial balance of che
system.

5. ^P^lnn an Alternative to Treasury Securities for Investment of the
OASDT Tniitr P..^ i 3 Not a High Priority. Especially for the Next Two
Decades.
The possibility that the OASDI trust funds could acquire all marketable
Treasury securicies is of interest, but is not a current concern. First, ic
will not happen soon, if ac all. The earliesc chac oucscanding markecable

6-4
federal debt could be eliminated, under our most severe fiscal scenario, is
2008. Second, a significant reduction in the proportion of total financial
assets accounted for by Treasury securities is unlikely to affect
significantly che functioning of financial markets, interest races, or che
conduct of monetary policy. The share of financial assets accounted for by
Treasury securities has varied greatly over the past forty years with no
apparent effect on interest rates (as shown in Figures 5-1 and 5-2 of
ChapLer 5). Third, in the unlikely case that the federal government
maintains budget surpluses long enough to eliminate net government debt,
other assets could be created (or existing federal agency assets could be
increased) for the Treasury or the OASDI trust funds to hold, without
disrupting financial markets.

6. Because of the Useful Role They Plav in FlnflwflM M******?, Treasury
Securities Should Not Be Eliminated
Treasury securities have unique features, in terms of risk, liquidity,
diversity of maturities; chey are widely held; and chey play an important
role in world financial markets. Consequently, chey should noc be
eliminated. Other assets should be created for the Treasury or che OASDI
cruse funds co hold, rather than eliminating all marketable Treasury
securities. These assets could be designed to provide for che cruse funds
che desirable features that Treasury securities provide.

7. There Are No Alternatives to Current OASDI Trust F»TTW4 ^tw^r^^r Policy
r
frlt "—,.W PTT^lde a p.»awi-itif*i^ T»prn™»-gnt in Investment ?**»f?^"T*,
No alternative assets would provide an obvious improvement in che riskreturn characteristics of the OASDI trust funds, nor should that be che
focus of social securicy crust fund investment policy. The social securicv

6-5
system represents a major social commitment and a major element of social
policy, and it plays a major role in the economy. The focus of social
security investment policy should be (1) the overall long term productivity
of the economy, and (2) intergenerational and intragenerational equity. The
OASDI system may affect the long term productivity of the economy through
influencing the savings-consumption mix. This mix should be consistent with
accepted views of intergenerational equity.
An increased return on a portfolio of investments can be achieved only
by increasing the risk. A key issue is who bears the risk of the social
security system. Historically, beneficiaries have not corn the risk. The
risk that revenues will not match what is expected or required to pay
promised benefits has been born by all taxpayers, through the federal
budget. If the risk is born by all citizens, the best investment policy for
the social security system is to seek to maximize the aggregate rate of
return to capital and therefore the productivity of the economy. The focus
of OASDI cruse fund investment policy should be che long cerm produccivicy
of che economy. Ic may be chac assecs could be acquired oy che OASDI trust
fund which have a greater expected return, in exchange for bearing greater
risk. Such a policy would simply redistribute the composition of assecs and
risk in che economy. Ic would noc change che overall productivity of the
economy or the aggregate rate of return.

FINAL REPORT
TO
SOCIAL SECURITY ADMINISTRATION
U.S. DEPARTMENT OF HEALTH AND HUMAN SERVICES
ON
CONTRACT NO. 600-87-0072
TO
THE BROOKINGS INSTITUTION

Principal Investigators
Henry J. Aaron
Barry P. Boswarth
Gary T. Burtless

—69—

LESSONS TO BE LEA&G)

The mjor lessons of this study can be summarized briefly.

[1] Growth of total factor productivity in the nonfarm business
sector must be quite high by historical
grow at the rate

assumed

in the

gt-*nrfocds if real wages are to

IIB projections. From 1947 through

1973/ total factor productivity in the ncnfazm business sector grew 14
percent per decade. This
and 1985. Under our

rate

slumped

assumptions

to just 7 percent between 1975

about

the growth of productivity on

farms and in the government and institutional sectors and about sectoral
shifts, total factor productivity within nonfarm business must grow 13
to 16 percent per decade

to meet

the

IIB assumption about real wage

growth over the next 75 years.

[2] To replicate the detailed IIB projection of future trust fund
balances, we are forced to

accept the Social Security Administration's

exact projection of future interest rates on federal Treasury debt. The
interest rates projected by
entirely consistent with our

the Social Security AArdnistration are not
neoclassical

growth model.

The rise in

worker productivity over the projection period arises partly from capital deepening—that is, a

growing

level of

investment in capital per

worker. As capital per worker rises, and with it the ratio of capital
stock to nonfarm output, we would expect a decline in the rate of return
on capital and a corresponding drop

in

the rate of return on financial

— 70—
assets—such as Treasury debt.
1995, the year in which the

This decline should persist long after

IIB projection assumes the real return on

the trust fund will stabilize.

On the other hand, the IIB projections

are based on the assumption that the real rate of interest (adjusted for
inflation) will fall sharply from its current

level of 5 percent to a

constant 2 percent over the last 65 years of the projection period.

[3] The projections of future trust fund balances and solvency are
highly sensitive to the assumed rate of
return on the trust

fund is

interest. If the real rate of

just one percentage point higher than

assumed in the IIB projections, the reserve position in 2060 is changed
from a deficit equal to 9.7

percent of GNP

in that year to a surplus

equal to 4.3. percent of GNP.ffpcai.seprojections are so acutely sensitive to the

interest

rate, our simulation results depend on how we

assume the interest rate on the trust fund moves when the rate of return
on capital changes. We assume that a proportional change in the real,
after-corporate-tax rate of return on reproducible capital causes a
pi.u^uxt.iona1 change in the real interest rate on the trust fund balance.
(The real, after-corporate-tax rate of return is measured as a ten-year
moving average, so the interest rate on the trust fund r°«p™H« with a
lag to changes in the real return on capital.) In our > * « B H H B simulation we assume that the
fund is exactly correct.

IIB projection of interest rates on the trust

— 71—
[4] When a shift in policy changes the capital stock from the baseline projection, productivity and the real wage change iitrnediately. The
rise in wages will be proportionately
of the capital stock, but the
The rise in wages leads to

smaller than the rise in the size

effect on wages is nonetheless immediate.

an instantaneous and equal proportional rise

in social security payroll taxes.

[5] Because of the social security indexing formula, a rise in real
wages is followed in

15-20 years

benefits. Until this 15-20 year

by

a

proportionately egual rise in

interval has elapsed, payroll tax rev-

enues will have risen by proportionately more than benefit outlays, so
the balance of [Taxes - Benefit
interest rate earned on the
reserve at the end of this

Outlays] has probably improved.

trust

If the

fund were unchanged, the trust fund

period would therefore be increased, because

the social security surplus in each year

over the period is larger or

the deficit is smaller.

[6] Twenty years after an increase in real wages, benefits and tax
revenues will have risen by equal
the annual

net

balance of

proportionate amounts. The change in

social

security

(revenues minus outlays)

depends upon the baseline position of this net balance.
benefits in the baseline, a

If taxes exceed

proportionate increase in both improves the

balance. However, in periods when baseline benefits exceed taxes, a
prouuiLionate increase in both only worsens the annual balance.

— 72—
[7] Any federal fiscal policy that raises national saving and leads
to a deepening of the domestic
real rate of return on

capital

nonfarm

rates of return will tend

to

business

reduce

Treasury debt and, hence, on

the

reduces real interest on the

trust

year balance of fTaxes -

stock will tend to reduce the
A drop in real

the real interest rate on federal

trust

Benefit

investment.

fund reserve. A policy that

fund without affecting the year-to-

Outlays 1 must harm the long-term sol-

vency of the system.

[8] If a nonOASDI fiscal policy is adopted that permits swings in
the social security surplus to be
saving and domestic investment,
but ultimately

fully reflected as swings in national

domestic investment will initially rise

fall below the

level

Because the social security

surplus

year 2030, investment will

be

surplus disappears

in

is

raised

subsequent

it would

otherwise have been.

large and positive through the
through

years,

that year; because the

investment

will

be lowered

thereafter.

[9] The policy just mentioned will first raise the capital stock,
worker productivity, wages, and

social

they would otherwise have been.

But

security taxes above the level

by the end of the projection per-

iod, the capital stock, productivity, wages, and social security revenues will be lower than they would
the overall federal deficit as
stock must ultimately be

a

reduced

have been under a policy that fixed

constant

share of (SIP. (The capital

because over the entire 75-year pro-

— 73 —
jection period the trust

fund

implies that the solvency of
harmed by a fiscal policy

faces

the

that

a

small

deficit.)

This pattern

social security system itself will be
first raises but ultimately reduces the

rate of national saving and domestic investment.

[10] The effect of the social security surplus on financial markets
and the ecununy depends critically on the budget policy of the remainder
of the federal government.
is small enough, national

If

the deficit in the general fund account

saving

and

investment could rise well above

the levels projected in our baseline, with obvious effects on productivity, real wages, and social security benefits. However, these gains to
the real economy result in only

temporary gains to the social security

system itself. Ultimately, benefits
than tax revenues, leading

to

a

rise by a greater absolute amount

larger long-run deficit under current

assumptions about the real interest rate earned on the trust fund.

[11] International investment reduces growth of the domestic capital stock, output, wages,

and

social

security

tax revenues.

Because

some national saving is invested abroad rather than at home, the capital
stock and worker productivity fail to rise

as fast as they would if all

saving were invested domestically.

[12] Given the trust fund build-up indicated by the IIB projections, the burden of

social

security on

The near-term social security surplus will

the

economy will be reduced.

be smaller

than it would be

— 74—
if all saving is invested
return earned on the
domestic capital

at

trust

stock

home.

On

fund will

be

(in our model)

interest rate. Ultimately,

social

percentage of net and gross

national

the other hand, the rate of
higher, because the smaller

leads

to

a

higher domestic

security benefits absorb a smaller

the social security surplus abroad

income, because the investment of

does not raise domestic, productivity

and wages, and hence does not increase social security benefits.

[13] If one believes that the aggregate saving rate will vary with
changes in the

age-composition

of

the population, the private saving

rate should rise over the next three decades because of a decline in the
proportion of the

population

adults under age 35.

in

the

age bracket that Higsaves—young

Depending upon our assumption about the saving

rate among people over age 65, the aggregate saving rate over the entire
projection period will remain above the rate of the last decade. Hence,
the private saving rate should be higher than the rate we assume in our
baseline projection. A higher private
force the effects
saving rate.

of

This

short- or
conclusion

saving rate would tend to rein-

long-term
follows

percentage change in gross national product
fiscal policy will cause a bigger swing
turn to larger proportional effect

on

changes

from

the

in the government
fact

that a given

resulting from a change in
in private saving, leading in

investment, the capital stock or

foreign investment, and worker productivity or national incomeft*TT*aHon
foreign assets.

— 75—
[14]

If private saving rises with the real interest rate, the real

economic effects of any given change in fiscal policy or social security
investment policy will be smaller

than

they would be if private saving

did not respond to changes in the rate of interest.

[15] The assumption of a lower elasticity of substitution of capital for labor does not produce interesting (or convincing) results.

[16] Contrary to the fears of some analysts, we find that available
financial assets—Treasury debt, corporate bonds, residential mortgages,
state and local bonds—are close substitutes for one another.

The rela-

tive interest rates on these assets have fluctuated within narrow bounds
in spite of the wide variation

over

time in the market availability of

different types of assets. Hence, we
availability of Treasury debt

doubt that a sharp decline in the

will substantially affect the functioning

of financial markets.

[17] For several reasons it would be convenient to maintain a market in short-term and highly liquid

Treasury securities.

Such a market

would be precluded if all Treasury debt were held by the social security
trust fund.

Should

this

contingency

arise—and given current fiscal

policy, it seems highly unlikely it will—we suggest a policy of investing social security surpluses

in

federally

barked securities, such as

mortgage backed securities of

the Government National Mortgage Associa-

— 76 —

tion. This type of

investment

does

not require the OASDI Trustees to

become involved in issues of corporate management.

[18] The expected yield of the trust fund would rise under this
alternative policy, but the
well.

risk exposure of

The increase in risk would

expected gains.

The primary

the

fund would rise as

not be large; neither would be the

issues

surrounding

investaient in such

assets would be whether such a policy would increase the likelihood that
social security reserves would actually be allowed to accumulate and to
add to public saving.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
July 5, 1988

Contact:

Office of Financing
202/376-4350

TREASURY TO AUCTION $6,500 MILLION OF 7-YEAR NOTES
The Department of the Treasury will auction $6,500 million
of 7-year notes to refund $3,382 million of 7-year notes maturing
July 15, 1988, and to raise about $3,125 million new cash. The
public holds $3,382 million of the maturing 7-year notes, including
$305 million currently held by Federal Reserve Banks as agents for
foreign and international monetary authorities.
The $6,500 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 $87 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-1471

HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 7-YEAR NOTES
TO BE ISSUED JULY 15, 1988
July 5, 1988
Amount Offered:
To the public

$6,500 million

Description of Security:
Term and type of security
7-year notes
Series and CUSIP designation .... G-1995
(CUSIP No. 912827 WK 4)
Maturity date
July 15, 1995
Interest rate
To be determined based on
the average of accepted bids
Investment yield
To be determined at auction
Premium or discount
To be determined after auction
Interest payment dates
January 15 and July 15
Minimum denomination available .. $1,000
Terms of Sale:
Method of sale
Yield auction
Competitive tenders
Must be expressed as an
annual yield, with two
decimals, e.g., 7.10%
Noncompetitive tenders
Accepted in full at the average price up to $1,000,000
Accrued interest
payable by investor
None
Payment Terms:
Payment by noninstitutional investors
Full payment to be
submitted with tender
Payment through Treasury Tax
and Loan (TT&L) Note Accounts ... Acceptable for TT&L Note
Option Depositaries
Deposit guarantee by
designated institutions
Acceptable
Key Dates:
Receipt of tenders
Tuesday, July 12, 1988,
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a) funds Immediately
available to the Treasury .. Friday, July 15, 1988
b) readily-collectible check .. Wednesday, July 13, 1988

TREASURY NEWS

Department of the Treasury e Washington, D.C. e Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
July 5, 1988

Contact:

Office of Financing
202/376-4350
TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$13,200 million, to be issued July 14, 1988.
This offering
will result in a paydown for the Treasury of about $375
million, as
the maturing bills are outstanding in the amount of $13,578 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, July 11, 1983.
The two series offered are &s follows:
91-day bills (to maturity date) for approximately $6,6 00
million, representing an additional amount of bills dated
April 14, 1988,
and to mature October 13, 1988
(CUSIP No.
912794 QC 0), currently outstanding in the amount of $6,583 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,600 million, to be dated
July 14, 1988,
and to mature January 12, .1989
(CUSIP No.
912794 RA 4).
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 July 14, 1988.
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 $1,718 million as agents for foreign
and international monetary authorities, and $3,55 3 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 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series)
B-1472

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 s bank discount rate basis with
two decimals, e.g., 7.15%« Fr-iotions 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 end 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 one-half hour
prior to the closing time for receipt of tenders on the day of the
suction. 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 ss six-month bills. Dealers, who make primary markets in
Government securities and report daily to the Federal Xeeerve Btnk
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit s 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 tsnders 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 tendere for the difference
between the par payment submitted and the actual issue price as
determined in the euctlon.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible end recognized dealers
in Investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks end Branches. A deposit of
2 percent of the per 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
10/87
tenders.

TftatASURY'S 13* AND 26-WEEK BILL OFFERINGS, 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 rsssrvss
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 theae
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 acceptsd competitive bids for the respective Issues. The calculation of purchase prices for accepted bids will bs carried to
three decimal plaoes on the basis of pries psr hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to bs maintained
on the book-entry records of Federsl Kessrve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or othsr immediately-available funds or
in Treasury bills maturing on that data. Cash adjustments will bs
made for differences bstwssn ths psr vslue of the maturing bills
accepted in exchange and the lssus pries of the new bills. In
addition, Trsasury Tax and Loan Note Option Depositaries msy make
payment for allotments of bills for their own accounts and for
account of customers by ersdit to thslr Trsasury Tax and Loan Note
Accounts on ths settlement data.
In general, it a bill is purehassd st issue sftsr July 18,
1984, and hsld to maturity, ths amount of discount is rsportsbls
jk% ordinary incoms in ths Federal Income tax return of the owner
at the time of redemption. Accrual-basis taxpayers, banks, and
other peraona deslgnatsd in ssctlon 1281 of ths Internal Revenue
Code must include in Income the portion of the discount for the
period during the taxable year such holdsr held the bill. If the
bill is sold or otherwise disposed of before maturity, the portion
1
of the gain equal to the acerued discount will bs trsatsd ss ordinary Income. Any excess msy bs trsatsd as capital gain.
Department of the Treasury Circulars, Public Psbt Ssriss Nos. 26-76, 27*76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of thsse
Treasury
bills and govsm ths conditions of their lssus. Copies
6/37
of the circulars, guidelines, and tsndsr forms msy bs obtslnsd
from any FederslftsssrvsBank or Brsnch, or from ths Bursau of
ths Public Debt.

TREASURY NEWS
Department of the Treasury • Washington,
D.C. • Telephone
\0
July 3, 1988

FOR IMMEDIATE RELEASE
RESULTS OF TREASWT'S WEEKLY BILL AUCTIONS
,;

JUL

« n

U

J

Tenders for $ 6,639 Billion of 13-week kills end for $6,601 sillion
of 26-week bills, both to be Issued on July 7, 1988,
sere accepted today.
RANGE OF ACCEPTED
13-veek bille
COMPETITIVE BIDS: maturing October 6, 1988
Discount Investment
Rate
Rate 1/ Price
Low
High
Average

6.56X
6.57%
6.5755

6.76%
6.77%
6.77%

26-week blllf
maturing January 5. 1989
Discount Inveetsent
Price
Rate 1/
Rate

98.342 I
98.339 :
98.339 !

6.68%
6.71%
6.71%

7.01%
7.04%
7.04%

96.623
96.608
96.608

Tenders at the high discount rate for the 13-week bills were allotted 26%.
Tenders at the high discount rate for the 26-week bills vera allotted 95%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Location

Received

Accepted

Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury

$

40,470
33,677,350
26,405
43,205
44,090
45,660
1,946,090
36,585
7,240
39,735
26,595
1,250,620
371.380

$
40,470
5,853,905
26,405
40", 500
44,090
35,410
43,090
36,085
7,240
39,735
26,595
74,550
371,380

TOTALS

$37,555,425

Type
Competitive
Noncompetitive
Subtotal, Public

Received

Accepted

36,365
23 ,512,540
23,245
35,820
40,115
42,120
1 ,494,500
31,450
15,460
50,795
17,910
1 ,362,130
425.L60

$
36,365
5,755,805
22,245
33,820
40,115
42,120
59,450
31,450
15,460
50,793
17,910
68,150
425.160

$6,639,455

: $27,087,630

$6,600,845

$33,886,940
1,090.920
334,977,860

$2,970,970
l.090.920
$4,061,890

5 $22,269,320
J
1.108,940
t $23,378,260

$1,782,535
1.108.940
$2,891,475

Federal Reserve
Foreign Official
Institutions

2,387,635

2,387,633

I 2,000,000

2,000,000

189.930

I 1.709,370

1,709,370

TOTALS

$37,555,425

$6,639,455

: $27,087,630

$6,600,345

189.930

$
l

!
l

1
ll

An additional $96,970 thousand of 13-veek bills snd an additional $803,930
thousand of 26-week bills will be Issued to foreign official institutions for
new cash.
U

Equivalent coupon-Issue yield.

B-1473

2041

J_

\

AWS

FOR IMMEDIATE RELEASE
July 13, 1988

REVISED

FEDERAL FINANCING BANK ACTIVITY
Charles D. Haworth, Acting Secretary, Federal Financing
Bank (FFB), announced the following activity for the month of
December 1987.
FFB holdings of obligations issued, sold or guaranteed by
other Federal agencies totaled $152.4 billion on December 31,
1987, posting a decrease of $4,432.8 million from the level on
November 30, 1987. This net change was the result of an increase
in holdings of agency debt of $1,024.3 million, and decreases in
holdings of agency-guaranteed debt of $26.8 million and in agency
assets of $5,430.3 million. FFB made 126 disbursements during
December.
Attached to this release are tables presenting FFB December
loan activity and FFB holdings as of December 31, 1987.
# 0#

B-1474

FFB 566-2468

WASHINGTON, D.C. 20220

Press 566-2041

federal financing bank \

Page 2 of 6
FEDERAL FINANCING BANK
December 1987 ACTIVITY

BORROWER

DATE

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

AGENCY DEBT
^TIONAL CREDIT UNTON .ADMINISTRATION
Central Liauiditv Facility
•Note »456
Note »457

3/1/88
3/29/88

5.565%
6.065%

12/10/87
12/17/87
12/14/87
12/16/87
12/17/87
12/17/87
12/21/87
12/23/87
12/30/87
12/31/87
1/1/88
1/4/88
1/6/88
1/8/88

5.645%
5.715%
6.145%
6.145%
6.145%
6.165%
6.255%
6.255%
6.175%
6.245%
6.245%
6.155%
6.155%
6.015%

1,500,000,000.00

5/31/12

9.074%

93,676.60
60,034.84
6,724,153.63
951,560.42
1,230,059.51
652,134.70
182,891.13
176,769.93
24,643.54
12,149.20
731,142.00
104,061.73
568,294.73
797,941.24
962,881.79
156,485.94
62,356,100.37

9/12/96
5/5/94
9/1/13
3/12/14
3/12/14
5/31/96
9/8/95
9/12/96
5/31/96
9/5/91
3/12/14
4/10/96
8/25/14
3/12/14
3/12/14
9/1/13
8/25/14

8.105%
8.745%
9.218%
9.265%
9.305%
8.505%
8.995%
8.135%
8.505%
8.325%
9.335%
9.075%
9.195%
9.555%
9.255%
9.105%
9.061%

12/7
12/29

S 70,000,000.00
3,750,000.00

12/4
12/7
12/10
12/10
12/10
12/14
12/17
12/17
12/21
12/23
12/23
12/30
12/30
12/31

225,000,000.00
295,000,000.00
100,000,000.00
35,000,000.00
106,000,000.00
102,000,000.00
100,000,000.00
395,000,000.00
83,000,000.00
20,000,000.00
375,000,000.00
27,000,000.00
49,000,000.00
133,000,000.00

TENNESSEE VALLEY AUTHORITY
Advance *824
Advance 7825
Advance »826
Advance «827
Advance »828
Advance »829
Advance *830
Advance «831
Advance *832
Advance #833
Advance *834
Advance *835
Advance *836
Advance *837
U.S. POSTAL SERVICE
Note *14

12/1

GOVERNMENT - GUARANTEED LOANS
DEPARTMENT OF DEFENSE
Foreian Military' Sales
Philippines 11
Kenya 10
Greece 16
Turkey 18
Turkey 18
Morocco 13
Morocco 13
Turkey 18
Morocco 13
Columbia 7
Turkey 18
Peru 10
Greece 17
Turkey 18
Turkey 18
Greece 16
Greece 17

•rollover

12/1
12/2
12/2
12/2
12/2
12/2
12/2
12/3
12/4
12/4
12/8
12/8
12/8
12/14
12/17
12/29
12/29

INTEREST
RATE
(other than
semi-annual)

Page 3 of 6
FEDERAL FINANCING BANK
December 1987 ACTIVITY

BORROWER

AMOUNT
OF ADVANCE

DATE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual)

DEPARTMENT OF HOUSING & URBAN DEVELOPMENT
Community Development
•Harrisburg, PA
*St. Petersburg, FL
•St. Petersburg, FL
San Juan, PR
Toa Baja, PR
Florence, SC
Rochester, NY
Lincoln, NE
Montgomery Co. Dev. Corp.
Indianapolis, IN

12/1
12/7
12/7
12/10
12/10
12/14
12/15
12/15
12/17
12/29

S 1,474,951.00
2,365,000.00
1,474,951.00
301,471.83
79,450.90
49,990.00
90,000.00
5,000.00
210,717.00
893,517.00

12/1/93
12/1/95
12/1/95
10/1/88
5/2/88
7/1/88
8/31/88
10/3/88
5/16/88
3/1/88

8.745%
8.727%
8.727%
7.165%
6.635%
6.995%
7.185%
7.265%
6.705%
5.995%

8.936%
8.917%
8.917%
7.264%

arm
arm
ann
ann

7.020% ann
7.261% ann
7.364% ann

RURAL ELECTRIFICATION .ADMINISTRATION
*Corn Belt Power #55 12/2 125,000.00 12/31/15 9.209% 9.105% qtr.
•Corn Belt Power #138
12/2
162,000.00
12/4/89
Kamo Electric #209
12/3
4,941,000.00
12/4/89
Kamo Electric #209
12/3
1,136,000.00
12/4/89
•United Power #67A
12/4
1,300,000.00
1/2/90
•United Power #129A
12/4
3,000,000.00
1/2/90
Deseret General #315
12/4
2,303,000.00
1/3/17
•Colorado Ute Electric #152
12/9
1,045,000.00
12/31/15
•Upper Missouri Electric #172
12/9
345,000.00
12/31/15
•East River Electric #117
12/10
2,000,000.00
12/31/14
•Allegheny Electric #175A
12/10
3,366,000.00
1/2/90
•Allegheny Electric #175A
12/10
5,668,000.00
1/2/90
Old Dominion Electric #267
12/14
1,203,000.00
1/2/90
•Wabash Valley Power #104
12/14
5,302,000.00
12/31/15
•Wabash Valley Power #206
12/14
8,313,000.00
12/14/89
•Colorado Ute Electric #203
12/16
993,000.00
12/12/89
•Continental Telephone #254
12/16
2,400,000.00
1/2/18
•Continental Telephone #115
12/16
100,000.00
1/2/18
Sho-Me Power #324
12/16
500,000.00
1/2/90
•Colorado Ute Electric #96
12/21
3,720,000.00
12/31/15
•Wabash Valley Power #252
12/22
450,000.00
12/22/89
•Wabash Valley Power #252
12/23
350,000.00
12/26/89
•Wabash Valley Power #206
12/23
748,000.00
12/31/15
•Brazos Electric #108
12/28
40,000.00
12/31/18
•Brazos Electric #230
12/28
8,228,000.00
12/31/18
•W. Virginia Telephone #17
12/30
718,000.00
12/31/15
•Corn Belt Power #138
12/30
117,000.00
12/30/89
•Colorado Ute Electric #198A
12/30
8,565,000.00
1/2/90
•Colorado Ute Electric #152A
12/30
22,335,000.00
1/2/90
•Colorado Ute Electric #168A
12/30
418,323.00
1/2/90
•Colorado Ute Electric #198A
12/30
2,690,000.00
1/2/90

•maturity extension

*

7.895%
7.895%
7.915%
7.905%
7.907%
9.154%
9.315%
9.315%
9.266%
8.014%
8.014%
8.153%
9.500%
8.155%
8.045%
9.315%
9.315%
8.023%
7.945%
7.965%
8.045%
9.132%
8.999%
8.999%
9.028%
7.985%
7.975%
7.975%
7.975%
7.975%

7.819% qtr.
7.819% qtr.
7.838% qtr.
7.828% qtr.
7.830% qtr.
9.052% qtr.
9.209% qtr.
9.209% qtr.
9.161% qtr.
7.935% qtr.
7.935% qtr.
8.072% qtr.
9.390% qtr.
8.074% qtr.
7.966% qtr.
9.209% qtr.
9.209% qtr.
7.944% qtr.
7.868% qtr.
7.887% qtr.
7.966% qtr.
9.030% qtr.
8.900% qtr.
8.900% qtr.
8.928% qtr.
7.907% qtr.
7.897% qtr.
7.897% qtr.
7.897% qtr.
7.897% qtr.

Page 4 of

6

FEDERAL FINANCING BANK
December 1987 ACTIVITY

BORROWER

DATE

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual 1

PTTPM. FT.FCTRIFICATION ADMINISTRATION (Cont'd)
*01d Dominion Electric #267
•Wolverine Power #138A
•Wolverine Power #182A
•Wolverine Power #100A
•Wolverine Power #101A
•Wolverine Power #100A
•Wolverine Power #101A
•Wolverine Power #101A
•Wolverine Power #101A
•Wolverine Power #101A
•Wolverine Power #101A
•Wolverine Power #101A
•Wolverine Power #101A
•Wolverine Power #101A
•Wolverine Power #274
•Corn Belt Power #292
•Corn Belt Power #292
•Sunflower Electric #174
•Colorado Ute Electric #78A
•Colorado Ute Electric #297
•Colorado Ute Electric #276
•Colorado Ute Electric #78A
•Kamo Electric #266
•Tri State Electric #89A
•Tri State Electric #89A
•Tri State Electric #89A
•Tri State Electric #89A
•Cugach Electric #257
•Kansas Electric #216
•Kansas Electric #216
•Kansas Electric #216
#216
•Kansas Electric #216
#216
•Kansas Electric
•Kansas Electric
•Cajun Electric #263
•Cajun Electric #263
•Cajun Electric #263
•Kamo Electric #209
•Upper Missouri Electric #283
•New Hampshire Electric #270
•maturity extension

12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31
12/31

$ 43,816,484.90
21,772,000.00
14,946,000.00
1,489,711.12
1,247,000.00
1,031,044.48
1,880, 533.36
1,593,866.64
1,245, 088.88
461, 533.36
363, 111.17
47, 777.76
210, 222.24
200,666.64
656, 603.84
390, 743.81
474, 049.59
15,000,000.00
835, 714.32
8,350, 975.62
5,045, 378.78
3,514,333.28
7,484,235.29
23,176,640.00
4,943, 080.24
6,026,652.40
4,791, 360.00
12,645, 000.00
907, 000.00
1,140, 000.00
825 000.00
575, 000.00
1,065, 000.00
1,245, 000.00
45,224 242.43
61,060, 606.07
32,184 848.47
3,842, 000.00
1,624 257.44
2,706, 000.00

1/2/90
1/2/90
1/2/90
1/2/90
12/31/87
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
12/31/15
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
12/31/19
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
1/2/90
12/31/15
1/2/18

7.875%
7.880%
7.880%
7.874%
7.874%
7.874%
7.874%
7.874%
7.874%
7.874%
7.874%
7.874%
7.874%
7.874%
7.876%
7.869%
7.869%
8.971%
7.876%
7.876%
7.876%
7.866%
7.868%
7.875%
7.875%
7.875%
7.875%
8.996%
7.885%
7.885%
7.885%
7.885%
7.885%
7.885%
7.876%
7.876%
7.876%
7.885%
8.934%
8.984%

7.799% qtr.
7.804% qtr7.804% qtr.
7.798% qtr.
7.798% qtr.
7.798% qtr.
7.798% qtr.
7.798% qtr.
7.798% qtr7.798% qtr.
7.798% qtr.
7.798% qtr.
7.798% qtr.
7.798% qtr.
7.800% qtr.
7.793% qtr.
7.793% qtr8.873% qtr.
7.800% qtr.
7.800% qtr.
7.800% qtr.
7.790% qtr.
7.792% qtr.
7.799% qtr7.799% qtr.
7.799% qtr7.799% qtr.
8.897% qtr.
7.809% qtr.
7.809% qtr.
7.809% qtr.
7.809% qtr.
7.809% qtr.
7.809% qtr.
7.800% qtr7.800% qtr.
7.800% qtr.
7.809% qtr8.836% qtr.
8.885% qtr.

Page 5 of

6

FEDERAL FINANCING BANK
December 1987 ACTIVITY

BORROWER

DATE

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual)

SMALL BUSINESS ADMINISTRATION
State & Local Development Company Debentures
Forward Development Corp.
Alabama Community Dev. Corp.
Mid City Pioneer Corp.
Evergreen Comm. Dev. Assoc.
Tulare County Ec. Dev. Corp.
S. Eastern Ec. Dev. Corp.
Minneapolis Ec. Dev. Corp.
HEDCO Local Dev. Corp.
Metro. Growth & Dev. Corp.

12/9
12/9
12/9
12/9
12/9
12/9
12/9
12/9
12/9

$

141,000.00
286,000.00
349,000.00
416,000.00
500,000.00
146,000.00
149,000.00
359,000.00
500,000.00

12/1/02
12/1/02
12/1/07
12/1/07
12/1/07
12/1/12
12/1/12
12/1/12
12/1/12

9.111%
9.111%
9.201%
9.201%
9.201%
9.258%
9.258%
9.258%
9.258%

618,915,323.15

3/31/88

6.155%

1,000,000.00

9/14/99

9.076%

TENNESSEE VALLEY AUTHORITY
Seven States Energy Corporation
Note A-88-03

12/31

DEPARTMENT OF TRANSPORTATION
Section 511
Missouri-Kansas-Texas #7

12/7

8.975% qtr.

Page 6 of 6

NANCING BANK HOLDINGS
in millions)
Program
Agency Debt:
Export-Import Bank
NCUA-Central Liquidity Facility
Tennessee Valley Authority
U.S. Postal Service
U.S. Railway Association +
sub-total*
Agency Assets:
Farmers Home Administration
DHHS-Health Maintenance Org.
DHHS-Medical Facilities
Overseas Private Investment Corp.
Rural Electrification Admin.-CBO
Small Business Administration

December 31, 1987

sub-total*
grand total* $ 152,416.8
*figures may not total due to rounding
-hdoes not include capitalized interest

Net Change
12/1/87-12/31/87

FY '88 Net Change
10/1/87-12/31/87

$ 11,971.5
118.0
16,709.0
5,853.4
-0-

$ 12,463.5
122.8
16,688.0
4,353.4

$ -492.0
-4.8
21.0
1,500.0

S -492.0

-0-

-0-

-0-

34,651.9

33,627.6

1,024.3

1,337.6

59,674.0
84.0
102.2
0.7
4,071.2
18.5

64,934.0
84.0
102.2

-5,260.0

-5,335.0

0.7

-0-0-0-

-0-0-0-

4,241.2
19.0

-170.0
-0.3

-170.0
-1.1

69,380.9

-5,430.3

-5,506.1

18,358.2
4,970.0
325.1
30.6
2,034.9
394.6
33.2
27.2
949.4
1,788.3

-4.2

-810.0

sub-total* 63,950.5
Government-Guaranteed Lending:
DOD-Foreign Military Sales
DEd.-Student Loan Marketing Assn.
DHULVCommunity 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 Administration
SBA-Small Business Investment Cos.
SBA-State/Local Development Cos.
TVA-Seven States Energy Corp.
DOT-Section 511
DOT-fcMATA

November 30, 1987

18,354.0
4,940.0
323.4
30.4
2,034.9
391.6
33.2
26.7
949.4
1,788.3
-021,191.2
726.3
897.4
1,896.7
53.8
177.0
53,814.4

-021,214.8
732.3
899.0
1,883.9
52.8
177.0
53,841.2
==========
$ 156,849.7

6.6
323.0
1,500.0

-0-

-0-

-1.7
-0.2

-0.8
-0.2
-39.2
-4.0

-0-3.0

-0-

-0-

-0.4

-0.4
140.8

-0-0-0-23.5
-6.0
-1.6
12.8

-0-0-

1.0

-5.7
-14.3
-2.4
73.0
-1.6

-0-

-0-

-26.8
========
$-4,432.8

-664.8
=======
$-4,833.3

TREASURY NEWS _
Department of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT:

FOR IMMEDIATE RELEASE
July li, TSTS

Office of Financing
202/376-4350

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $ 6,608 million of 13-week bills and for $6,608 million
of 26-week bills, both to be issued on
July 14, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

26--week bills
maturing January 12, 1989
Discount Investment
Price
Rate 1/
Rate

13- week bills
maturing October 13, 1988
Discount Investment
Rate
Rate 1/
Price

Low
High
Average
a/ Excepting 1

6.69% i^
6.90%
98.309
6.73%
6.94%
98.299
6.72%
6.93%
98.301
tender of $17,000,000.

6.97%
7.00%
6.99%

7.33%
7.36%
7.35%

96.476
96.461
96.466

Tenders at the high discount rate for the 13-week bills were allotted 86%,
Tenders at the high discount rate for the 26-week bills were allotted 2%.

Location
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

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
:
Received

Accepted

$
36,010
21,852,110
26,170
43,970
43,790
49,090
1,164,86Q
29,075
6,600
48,345
36,040
1,510,360
397,815

36,010
$
4 ,988,110
26,170
43,970
43,790
49,020
525,860
26,935
6,600
48,345
36,040
379,520
397,815

40,625
$
21 874,955
23,185
34.025
40,555
33,425
830,820
34,740
21,505
69,495
27,395
:
1 514,520
479,915

$
40,625
5,556,495
21,185
34,025'
40,555
33,425
156,820
30,740
16,605
69.495
27,395
100,640
479,915

$25,244,235

$6 ,608,185

: $25 025,160

$6,607,920

$22,235,155
1,142,200
$23,377,355

$3 599.105
1 ,142,200
$4 ,741,305

: $20,448,265
:
1,174,845
: $21,623,110

$2,031,025
1,174,845
$3,205,870

1,800,130

1 800,130

:

1,800,000

1,800,000

66,750

66,750

:

1,602,050

1,602,050

$25,244,235

$6,608,185

$25,025,160

$6,607,920

An additional $20,650 thousand of 13-week bills and an additional $370,050
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
y

Equivalent coupon-issue yield.

B-1475

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
For Release Upon Delivery
Expected ac 9:30 a.a., £.S.?.
July 12, 1983

STATEMENT OF
DENNIS S. ROSS
DEPUTY ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
SENATE FINANCE SUBCOMMITTEE
ON
TAXATION AND DEBT MANAGEMENT
Mr. Chairman and Members of che Subcommittee:
It is a pleasure to be here to present the views of the
Treasury Dep artment regarding the miscellaneous bills that are
the subject of this hearing: S.243 4 (extension and modification
of research credit); H.R.1961 (por tability of pension benefits);
S.2073 and S .2291 (employee approv al of the establishment of
employee sto ck ownership plans); H .R.2792 (tax treatment of
Indian fishi ng rights); S.1239 (tr eatment of certain short-tern
obligations in the hands of certai n taxpayers); S.2611 (provision
of certain t ax return information to the Veterans
Administrati on); and S.1321 (exclu sion of certain seafood
of CREDIT
processors f rom the definition
RESEARCH
employee).
Let me turn first to S.2434, the Rese arch and Experimental
Credit and Extension Act of 1933, introdu ced by Senate Finance
Committee members John C. Danforth and Ma x Baucus. Because
research spending is essential to fosteri ng technological
innovation, which is a major source of gr owth in productivity,
the Administration is committed to encour aging continued growth
of private, domestic research activities. To this end, the
Administration strongly favors a permanen t R&E credit, and
supports the efforts of those, such as Se nator Danforth and
Senator Baucus, who are attempting to imp rove the effectiveness
of the credit.
B-1476

-2A. Background: Description of Current Law and S.2484
1. Current Law
The 1981 Economic Recovery Tax Act adopted a 25 percent
incremental RbZ tax credit "in order to encourage enlarged
researc* efforts by companies which already may be engaged in
some re=aarch activities." The R&E credit was originally
scheduled to expire on December 31, 1985, and it was intended
that Congress "have an opportunity to evaluate the operation and
efficacy of the credit" before any extension. The 1986 Tax
Reform Act (the "1986 Act") extended the credit to December 31,
1988, lowered the rate of credit to 20 percent, restricted the
definition of eligible expenditures, and included the credit in
the general business credit limitation.
Under section 41 of the current Code, a 20 percent tax credit
is allowed for a certain portion of a taxpayer's "qualified
research expenses." The portion of qualified research expenses
that is eligible for the credit is the excess of the current
year's qualified research expenses over the base amount. The
base amount is the average annual amount of qualified R&E
expenditures over the prior three years (or if the firm is not in
existence for three years, the average of the expenditures for
its years in existence). This base, however, is subject to the
limitation that it never be less than 50 percent of current
qualified expenditures.
The 1986 Act also established a separate 20 percent tax
credit ("the University Basic Research Credit") for corporate
funding of basic research through grants to universities and
other qualified organizations performing basic research. The
University Basic Research Credit applies to the excess of (1).100
percent of corporate cash expenditures (including grants or
contributions) paid for university basic research over (2) the
sum of (a) the greater of two fixed research floors plus (b) an
amount reflecting any decrease in nonresearch giving to
universities by the corporation as compared to such giving during
a fixed base period, adjusted for inflation.
In general, qualified expenditures consist of (1) "in-house"
expenditures for wages and supplies used in research; (2) 65
percent of amounts paid by the taxpayer for contract research
conducted on the taxpayer's behalf; and (3) certain time-sharing
costs for computers used in research. Restrictions adopted in
the 1986 Act further limit the credit to expenditures for
research that is technological in nature and that will be useful
in developing a new or improved business component. In addition,
certain research is specifically excluded from the credit,
including research performed outside the United States, research
relating to style, taste, cosmetic, or seasonal design factors,
research conducted after the beginning of commercial production,
research in the social sciences, arts, or humanities, and
research funded by a person other than the taxpayer.

-3The credit is available only for research expenditures paid
or incurred in carrying on a trade or business of the taxpayer.
With one exception, relating to certain research joint ventures,
the "trade or business test" for purposes of the credit is the
same as for purposes of the business deduction provisions of
section 162. As a result, new corporations and corporations
entering a new line of business cannot claim the credit for
qualifying R&E expenses because the expenses do not relate to an
ongoing trade or business.
The R&E credit is aggregated with certain other business
credits and subject to a limitation based on tax liability. The
sum of these credits may reduce the first $25,000 of regular tax
liability without limitation, but may offset only 75 percent of
any additional tax liability. Taxpayers may carry credits not
usable in the current year back three years and forward fifteen.
The Ways and Means Committee has tentatively agreed to extend
the present-law credit for two years. Thus, the credit would
apply to qualified research costs paid or incurred on or before
December 31, 1990. To offset some of the revenue cost of the
two-year extension, the Committee also agreed J.o reduce
deductions under section 174 by the amount of the taxpayer's
section 41 credit allowed for the taxable year.
2. Description of S.2484
S.2484 is designed to increase the R&E credit's incentive
effect and to increase the number of taxpayers that are eligible
for the credit. S.2484 would retain the incremental feature.of
the present credit and its 20 percent rate, but would make the
credit permanent and modify calculation of the base amount. The
new base would be a fixed historical base equal to the avera-ge of
the firm's qualified R&E expenditures for 1983-1987 and would be
indexed annually by the average increase in gross national
product (GNP). In addition, in 1989 the base would receive a
one-time upward adjustment of seven percent (in order to make the
base revenue-neutral with respect to earlier proposals with a
three-year base). Firms also would have the option of a separate
seven percent credit for expenditures over 75 percent of the base
amount. As with current law, all firms would be subject to a 50
percent base limitation.
Under the proposal, the "trade or business" test would be
made less stringent so that new firms and firms entering new
lines of business could claim the credit without regard to the
trade or business test if the taxpayer intended to use the
results of the research in the active conduct of a present or
future trade or business. The credit would not be available,
however, for research undertaken for investment rather than
business purposes. Thus, research intended solely to be licensed
to unrelated parties for use in their businesses would not be
eligible for the credit. In addition, the liberalized trade or

-4business rules would apply only to in-house research and not to
research contracted out to unrelated parties. S.2484 also
contains special rules for calculating the base for start-up
firms.
B.

Evaluation of the Danforth-Baucus Bill (S.2484)

1. Summary Evaluation
Prior Treasury testimony before this Subcommittee has
described certain weaknesses in the structure of the current R&E
credit. While continuing to believe that the R&E credit is an
important stimulant for economic growth and productivity, we have
also studied ways to restructure the credit so as to increase its
incentive effect. The Danforth-Baucus proposal is consistent
with our own views regarding the optimal credit structure, and we
believe it can have a significant effect in encouraging R&E.
Accordingly, the Treasury strongly supports the basic structure
and design of the credit proposed in S.2484.
The President has proposed a permanent R&E credit in his 1989
budget at a revenue cost equal to an extension of the current
credit. Although the Administration's first priority is to
prevent expiration of the credit, we would support an R&E credit
as modified in the Danforth-Baucus bill if the proposal were made
revenue-neutral to an extension of current law. As I will
discuss later, we believe the revenue cost of the Danforth-Baucus
bill can be reduced while maintaining the bill's important
structural improvements to the credit.
The R&E credit proposed in the Danforth-Baucus bill has
several advantages: (1) it greatly increases the incentive of the
R&E credit both in absolute terms and per dollar of credit; (2)
it increases the percentage of R&E-performing firms that are
eligible for the credit; (3) it eliminates the relationship
between the availability of the credit and the rate of inflation;
(4) it extends to new firms R&E incentives which had previously
been available only to established firms; and (5) it makes the
credit permanent. I will discuss each of these advantages in
turn.
2. Incentive Effects
The most important feature of the Danforth-Baucus credit is
the replacement of the current credit's moving-base with a
fixed-base structure. We believe the fixed-base structure
results in a five-fold increase in the credit's incentive effect
per dollar of revenue cost.
It is now widely acknowledged that an incremental credit -•" K^
a base equal to a moving average of previous expenditures ]
to an effective rate of credit which is only a fraction of tiv.
statutory rate. A credit's effective rate is the effective

-5reduction in price of the last or marginal expenditure undertaken
by any firm and is a measure of the credit's incentive effect.
Treasury analyses, as well as other studies, indicate that the
average effective rate of the current R&E credit is about two
percent. Thus, the credit on average provides the same incentive
as a two percent price reduction on R&E expenditures. This
relatively small effect is again primarily attributable to the
moving base, since additional R&E in one year increases the base
and effectively decreases the credit in subsequent years. Thus,
R&E generating a dollar credit in the first year will cause a
33.3 cent reduction in credit in each of the following three
years, so that the credit's only benefit to a firm is a deferral
rather than a reduction in taxes.
In some situations the moving base can actually turn the
effective rate of credit negative, so that the credit encourages
a firm to reduce R&E expenditures. This occurs both when a firm
is growing slowly and current R&E expenditures are below base and
when a firm is growing quickly and is subject to the 50 percent
base limitation. For firms below base, negative effective rates
of credit result because marginal increases in R&E yield no
credit but reduce credits in future years. For firms subject to
the base limitation, negative effective rates of credit result
because each 50 cents of credit earned in the current year is
followed by 33.3 cents less of credit in each of the following
three years.
The Danforth-Baucus bill would address both the low and
negative incentive problems by adopting a base equal to an
average of 1983 through 1987 expenditures, adjusted upward by
seven percent, and (to maintain relatively even revenue costs
over time) indexed to nominal GNP. The critical feature of this
so-called "fixed" base is that a firm's current spending will
have no effect on future credits. Thus, unlike the current
credit, a dollar of credit earned in the current year does not
reduce credits in the following year. Under the Danforth-Baucus
bill, firms eligible for a 20 percent credit on average receive
the incentive equivalent to nearly a 20 percent reduction in
price. Taxable high-growth firms facing the 50-percent base
limitation have an effective rate of credit equal to 10 percent.
Even
low-growth
firms on thefor
alternative
3. Growth
and Eligibility
the Credit seven percent credit
receive twice the incentive of that provided by current law.
The Danforth-Baucus bill would also significantly increase
the percentage of R&E-performing firms eligible for the credit.
This increase is achieved through the design of the primary and
alternative bases, which results in a larger number of firms with
R&E expenditures above base.
The limited availability of the current credit to firms
performing R&E is too often overlooked. High rates of.R&E growth

-6in the early 1980s (due both to real growth and to inflation)
minimized the problem because inflation kept many slow-growing
firms from falling below base. A slowdown in R&E growth in the
late 1980s, however, has made it increasingly apparent that an
increase in availability of the credit would improve its
effectiveness.
The goal of a tax credit for R&E is to encourage a firm to
invest in R&E at a level higher than it would absent the credit.
In economists' jargon, the credit is designed to increase
marginal expenditures. In the absence of a credit, all firms
determine their optimal amounts of R&E spending by weighing costs
against potential benefits. If it were known that each firm
would spend $X in the absence of a credit, the most efficient
credit would provide a tax reduction to all firms for
expenditures above their respective $X amounts. Although there
has been much debate about how the credit should be distributed
among firms with high, low or negative growth in R&E, the credit
is most effective if it encourages all firms, regardless of
whether their $X amount is declining or increasing, to increase
R&E investments.
Unfortunately, the $X amount for every firm cannot be
accurately determined and in designing a credit base some
judgment must be made about the behavior of firms with respect to
R&E expenditures. The three-year moving base of the current R&E
credit assumes that firms steadily increase R&E investment over
time, so that their $X amount is always in excess of prior years'
expenditures. Although this model may reflect the usual behavior
of larger firms, which tend to show steady growth in R&E, smaller
firms have more varied spending patterns. Small firms may have
only one or two research projects for which optimal expenditures
may increase or decrease greatly, depending on the particular
phase of the research cycle that is faced in the current year.
Both Treasury studies and a recent General Accounting Office
study indicate that the moving-base of the current credit result
in approximately one-third of all R&E-performing firms being
ineligible for the credit in any one year.
There are, of course, some trade-offs involved in designing a
credit base so as to improve the availability of the credit.
Lowering the credit base so as to increase the credit's
availability comes at the price of increasing the amount of
credit to all firms or lowering the rate of credit. At one
extreme, the base could be set at zero and all firms would be
eligible for the credit; but such a credit at a 20 percent rate
would be extremely expensive. Increases in the base save
revenue, but, of course, decrease availability. Although no
credit base can achieve optimal levels of availability at
acceptable revenue costs, the two-tiered credit of the
Danforth-Baucus bill significantly increases the credit's
availability without substantially expanding the credit's revenue
cost.

-74.

Inflation

Under S.2484 the credit base is indexed to GNP. As a result,
the amount of the credit allowable to any firm and the cost of
the credit to the government no longer depends on the rate of
inflation. In this way, the credit is provided only for real
increases in R&E spending. By contrast, under the current credit
structure, the availability of the credit, the amount of credit,
and the revenue loss from the credit are positively related to
the rate of inflation. This is undesirable as a matter both of
tax and economic policy.
From a tax policy standpoint, the incentive effects of the
credit are diminished since the amount of the credit available to
the taxpayer depends on the variable of inflation. There is
similarly uncertainty as to the credit's total cost to the
government.
The effect of inflation on the credit also has a perverse
macroeconomic effect. Since inflation is usually associated with
strong aggregate demand, the incremental credit has the opposite
effect of an automatic stabilizer: it encourages increased
business spending during economic expansions and decreased
spending during recessions.
As noted above, the Danforth-Baucus proposal provides a
credit insulated from the effects of inflation. Because the base
is indexed to nominal GNP growth (which includes inflationary as
well as real growth), firms are not unduly rewarded for growth in
qualified expenditures due to inflation nor are they penalized
for slowdowns in the rate of inflation. The revenue costs of the
Danforth-Baucus proposal are therefore much less dependent upon
the rate of inflation than the current credit. Furthermore,'
because the amount and availability of the credit is much more
certain, its incentive effect per dollar of revenue cost is
larger.
5• Entry into New Markets and Eligibility
for the Credit
S.2484 greatly expands the number of firms eligible for the
credit by allowing new firms and firms beginning a new line of
business to claim the credit for qualifying R&E expenses that
relate to the active conduct of a present or future trade or
business. Under current law, a new firm or a firm entering a new
line of business may not earn credits until qualified expenses
are incurred "in carrying on" a trade or business. Since it may
be several years between initial research expenditures and the
sale of products resulting from such expenditures, the tax system
puts start-up firms at a competitive disadvantage vis-a-vis
established firms who are already "carrying on" a trade or
business.

-8The Danforth-Baucus proposal would allow expenditures of new
firms and firms entering new lines of business to claim the
credit without regard to the trade or business test if the
taxpayer intends to use the results of the research in the active
conduct of a present or future trade or business. Thus, a firm
that intends merely to lease or license the results of research
would continue to be ineligible for the credit.
6.

Permanency of the Credit

S.2484 makes the credit permanent, which we strongly support.
The ability of the credit to induce additional R&E expenditures
depends directly on its availability at the time firms are
planning R&E projects and projecting costs. R&E activity, by its
nature, is long-term, and taxpayers should be able to plan their
research activity with certainty that the credit will be
available. Thus, if the credit is to have the intended incentive
effect, the R&E credit must be made permanent.
7.

The University Basic Research Tax Credit

We also support the provision in S.2484 that extends the
University Basic Research Credit along with a general R&E credit.
This provision was first available to taxpayers as a result of
the 1986 Act, and its structure should be reviewed for possible
modification once tax return data and other evidence is
available. At this time, however, it appears that the University
Basic Research Credit provides an important incentive to basic
R&E activities that are critical to this country's economic
future.
8.

Suggested Modifications to the Danforth-Baucus
:
ProposaT

As I stated earlier, we strongly support the structural
changes in the R&E credit proposed in the Danforth-Baucus bill.
Our full support for the legislation, however, would require that
its revenue cost be limited to that of the current R&E credit.
We believe that this revenue objective can be obtained without
sacrificing the bill's structural improvements to the R&E credit.
In our view, the best way to limit the revenue cost of the
Danforth-Baucus credit is to reduce a taxpayer's section 174
research deductions by the amount of credit taken. Such a
reduction of deductible expenses currently exists for the
rehabilitation tax credit and the targeted jobs credit.
Similarly, a reduction of depreciable basis equal to 50 percent
of the investment tax credit existed before it was repealed by
the Tax Reform Act of 1986.

-9Disallowing a deduction for R&E expenses to the extent of R&E
credits would treat all sources of Federal support for R&E
similarly for tax purposes. The Federal government supports
research indirectly through grants and tax credits. Although a
tax credit is economically equivalent to a grant (but
administered through the tax system), tax credits and grants have
different tax treatment. Research costs funded through grants
are not deductible while research costs offset by credits are
fully deductible. Disallowing the deduction of expenses
attributable to credits would rationalize the current budget
accounting for alternative funding sources for research by
measuring both direct subsidi-.s and tax expenditures for R&E in
pre-tax dollars.
For example, Firm A conducts $100 in qualifying research and
receives $20 from the government as a 20-percent matching grant.
Under current law, Firm A is entitled to deduct only the $80 R&E
expenses it actually incurred. By contrast, Firm B conducts $100
of research and receives $20 of tax credit rather than a $20
grant. Under current law, Firm B is entitled to deduct the
entire $100 of R&E expense even though the $20 tax credit to Firm
B is equivalent to $20 grant received by Firm A.
I should emphasize that our support for disallowance of R&E
expenses by the amount of the R&E credit is tied to adoption of
the balance of the Danforth-Baucus bill. Although this deduction
disallowance has a sound tax policy basis, as a practical matter
it is a reduction in the statutory rate of the credit.1/ As part
of the Danforth-Baucus proposal, this reduction is more than
offset by other improvements in the credit. We would not support
it, however, were it proposed as part of an extension of the
existing R&E credit.
To further improve the distribution of the credit while
maintaining revenue neutrality with respect to extension of the
current credit, the Treasury also recommends replacing the seven
percent upward adjustment of the fixed base with a two percent
adjustment. The revenue cost, incentive effect, and percentage
of firms eligible for credit under the Danforth-Baucus proposal
with Treasury's suggested revenue-preserving modifications are
shown in Table 1.
T7 The deduction disallowance effectively reduces the credit
by the tax rate, 34 percent, resulting in an effective credit
rate of approximately 13.2 percent.

TABLE 1

Summary of R&E Credit Stuctures with Permanent Extension

Proposal

Revenue Cost
Over Fiscal
Years 1989
Through 1993

Incentive:
Increase in
R&E Per Dollar
of Revenue Loss

Availability:
Percentage
of Firms
Earning Credit

(1) ways and
Means
Credit

$ 3,162 mil.

$ 0.20

<^67.5 %

(2) Extension
of Current
Law

$ 4,791 mil.

$ 0.20

67.5 %

(3) DanforthBaucus
R&E Credit

$ 6,459 mil.

$ 1.21

74.9 %

(4) Proposed
Treasury
R&E Credit

$ 4,865 mil.

$ 1.11

77.8 %

TABLE 2

Revenue Cost of R&E Credit Proposals Under Two-Year,
Three-Year, and Permanent Extensions

Revenue Cost
millions of dollars)
Proposal

1989

1990

265
265
265

538
538
538

1991
1992
(fiscal years)

1993

5-Year
Total

(1) Ways and
Means Proposal
(a) Two-year Extension
(b) Three-year Extension
(c) Permament Extension

361
675
675

139
438
789

93
191
896

1395
2107
3162

(a) Two-year Extension 401 815 547 211 140 2114
(b) Three-year Extension
401
815
1023
664
(c) Permament Extension
401
815
1023
1195

290
1357

3193
4791

385
1906

4196
6549

291
1418

3184
4865

(2) Extension of
Current Law

(3) DanforthBaucus Credit
(a) Two-year Extension 510 1059 713 276 182 2740
(b) Three-year Extension
510
1059
1357
886
(c) Permament Extension
510
1059
1357
1627
(4) Treasury
R&E Credit
(a) Two-year Extension 390 809 544 210 139 2092
(b) Three-year Extension
390
809
1028
667
(c) Permament Extension
390
809
1028
1220

-10-

PENSION PORTABILITY: H.R.1961
A.

Background

The issue of pension portability is a complex one, which
warrants serious and in-depth study by Congress, the Treasury
Department, the Department of Labor and other policymakers.
Prior to addressing H.R.1961, therefore, I would like to discuss
the issue in general terms, in order to identify the basic
sources of qualified plan benefit losses attributable to
employees changing employers, the difficulties associated with
increasing portability and the portability effects of some of the
recent, major legislative changes in the pension area.
1. Portability Under the Current Retirement Plan System
The issue of pension portability has often been viewed
narrowly as whether employees can "take" their full vested
benefits with them when they leave employers and invest them in
other plans or individual retirement accounts (IRAs). This view
of portability is often referred to as portability of assets or
cash va.ues. Other common view^ of pension portability have
included portability of benefits and portability of service.
Portability of benefits refers primarily to vesting and other
eligibility conditions (e.g., age and service conditions
applicable to early retirement subsidies) that may cause mobile
employees to lose pension benefits when they lose jobs. Finally,
portability of service refers generally to the recognition under
a defined benefit plan, for participation, vesting, and benefit
accrual purposes, of an employee's service for employers other
than the employer maintaining the plan. More recently,
commentators have begun to believe that while the concept of
portability includes these particular issues, it actually may be
a much broader concept that touches on many of the basic features
of our voluntary, employer-based private pension system.
Viewed more broadly, pension portability refers to the
differential between the total pension benefit that a short-term,
mobile employee receives for a working lifetime with many
employers and the total pension benefit that a long-term employee
receives for the same working lifetime with a single employer.
This benefit differential is often referred to as a portability
loss. Because many workers do not remain with a single employer
for their entire working lifetimes, or in many cases even for
their last 15 working years, portability actually reflects a
concern about whether sufficient numbers of this nation's workers
receive meaningful retirement benefits under the private pension
system. Also, portability reflects a concern about whether the
tax benefits associated with the private system are fairly
distributed among various groups of workers—for example, mobile

-11and long-term employees, young and old employees, highly
compensated and non-highly compensated employees, and women and
men.
Under current law, two employees may start out at equal jobs,
do an equal amount of work, and receive the same amount of cash
pay, but, under the voluntary, employer-based pension system,
they may receive very different levels of pension benefits for
the same amount of work. If women shift employment more often
than men, for instance, they will receive smaller total pensions
at retirement for the same number of years of work. The extent
of these portability losses will depend upon many factors,
including, for example, the future rate of inflation.
The issue of portability centers broadly on what is
considered a "fair" differential of lifetime pension benefits
between mobile and less-mobile workers. If one tries to
determine what is "fair" by examining the pension rules
established by Congress, it is difficult to come to a conclusion.
For example, under the typical defined contribution plan,
fairness generally is determined by providing employees with
contributions that are an equal proportion of current pay. Under
a typical defined benefit plan, however, "fairness" is often
based on the provision of an equal replacement rate on a 'service
and pay base approximating final salary or salary in the
employee's peak earning years.
While these defined contribution and defined benefit formulas
might sound similar in concept, in practical terras they can have
enormously different impacts on mobile employees relative to
long-term employees. Defined benefit formulas often result in
little or no real accrual of benefits to the mobile employee,
especially in their young and middle years. Moreover, these
formulas produce benefits that are much more subject to the
vagaries of such factors as inflation. For example, although the
typical defined benefit formulas may at low inflation rates
strike an appropriate balance between mobile and long-term
workers, at higher inflation rates these formulas may excessively
favor the long-term workers.
In evaluating portability issues and proposals, one should
recognize that pension benefit differentials between mobile and
long-term employees do not always reflect market failures or
imply that certain groups of employees are being treated unfairly
in the larger perspective. Such benefit differentials may to an
extent be the result of appropriate employer decisions to
maintain plans providing different amounts or forms of pension
benefits and of appropriate employee decisions to seek employment
offering different mixes of pension benefits, cash pay, and other
benefits.
For example, employers requiring specially skilled workers
may well prefer to link pension benefits to length of service,

-12such as through deferred vesting or deferred benefit accruals, in
order to retain such skilled workers. Other employers requiring
employees with more general skills, however, may have less
incentive to reward employees to stay for longer periods of time.
Similarly, for a variety of reasons (e.g., need for cash income
or other benefits), employees may appropriately select jobs
offering different levels of pension benefits. Also, to gain the
greater benefit security offered by properly funded and
PBGC-insured defined benefit plans relative to defined
contribution plans, employees may favor employment providing
defined benefit plan coverage over employment with an employer
that maintains only a defined contribution plan.
In this setting, it is important that employees have a better
understanding of their benefit entitlements and rights under
defined benefit plans and defined contribution plans. Informed
employees should be better able to make employment decisions and
bargain more effectively over the desired mix of cash
compensation and pension benefits.
The following discussion surveys the basic features of the
voluntary, employer-based private pension system that may
contribute to pension portability losses for mobile workers.
a. Gaps in Pension Coverage
Differentials of pension benefits between long-term
workers and mobile workers may first occur because not all
employers maintain qualified plans and those employers that do
maintain plans do not necessarily cover all of their employees.
Thus, many mobile employees are likely not be covered under
qualified plans for some portion of their working lifetimes.
Gaps in pension coverage generally are more common among
lower-paid workers in part because such workers may value
retirement benefits relative to cash compensation less than do
higher-paid workers. Nondiscrimination rules for qualified
plans, however, for broad social and tax equity reasons, require
employers to provide a portion of their lower-paid employees with
comparable pension benefits. Nevertheless, some disparity of
pension coverage is allowed to exist in favor of higher-paid
employees. For example, under current law, an employer that
provides pension benefits to 100 percent of its highly
compensated employees (generally, employees who have at least a
five percent ownership interest in the employer and employees who
earn over $50,000) need provide comparable pension benefits to
only 70 percent of the employer's non-highly compensated
employees.
Furthermore, it is common even for employers that
maintain broad-based qualified plans to exclude newly hired
employees from plan coverage until the employees have performed
at least one year of service for the employer. Thus, to the
extent mobile employees fail to stay with employers for at least
one year, they commonly do not earn any pension benefit. Thus,

-13their total working years commonly will exceed the total years of
pension coverage by at least the total number of jobs.
In the 1986 Act, the pension coverage rules were
modified to increase the extent to which an employer's low- and
middle-income employees must be provided comparable qualified
plan benefits. For example, under the pre-1986 Act rules, a
pension plan could qualify for tax-favored status if it covered a
reasonable classification of employees. While there is always
doubt whether a coverage classification is reasonable, in certain
circumstances a classification including 100 percent of an
employer's highly compensated employees and only 20 percent of
the non-highly compensated employees could qualify as reasonable.
Under the 1986 Act rules, not only must a pension plan cover at
least a reasonable classification of the employer's employees,
but also all of the non-highly compensated employees of the
employer must receive, on average, pension benefits that are at
least 70 percent of the average pension benefits received by the
employer's highly compensated employees.
While gaps in pension coverage have contributed to
mobile employees' portability losses, research to date has not
indicated the frequency with which such gaps lead to major
benefit differentials between mobile and long-term employees.
Also, the extent to which the coverage changes adopted in the
1986 Act will affect portability losses is as yet uncertain as
the new rules only go into effect in 1989.
b. Disparities in Benefit Levels
Even if a mobile employee is covered under an employer's
qualified plan, portability losses for mobile workers may occur
because employers do not all maintain qualified plans that
provide comparable levels of benefits. For example, one employer
may provide its employees with coverage under a defined
contribution plan that provides an annual contribution of five
percent of current compensation, while another employer maintains
a 10 percent defined contribution plan or a defined benefit plan
that provides a retirement benefit of 1.25 percent times years of
service times the employee's final pay. In the voluntary,
employer-based private pension system, there are numerous
differences in the benefit levels provided under the various
types of qualified plans. Indeed, one of the premises of our
voluntary pension system is that an employer should have the
flexibility to set an affordable and appropriate level of
benefits for its workforce.
In fact, while these disparities in benefit levels
contribute to differences in benefits among employees, it is not
clear that this factor per se would create a greater likelihood
that a mobile employee would incur a portability loss.

-14c.

Deferred Vesting

Even if a mobile employee earns a meaningful level of
pension benefits under a qualified plan, the plan may require
that the employee perform a minimum number of years of service
before vesting in his benefit. Beginning in 1989, the tax law
permits a plan to defer an employee's vesting in his earned
benefits until he has performed at least five years of service
(ten years in the case of a collectively bargained, multiemployer
plan). Obviously, mobile employees will more often fail to stay
with employers for the period necessary to vest in their pension
benefits and thus will more frequently suffer portability losses
due to deferred vesting.
In many cases, deferred vesting may also work to the
disadvantage of the lower-paid employees. To the extent that
low- and middle-income workers change jobs more frequently than
higher-paid employees, the lower-paid mobile workers are more
likely to lose accrued benefits due to inadequate vesting
service, just as they are more likely not to accrue benefits due
to gaps in pension coverage and lower levels of benefits.
In the 1986 Act, the pension vesting rules were modified
generally to reduce the number of years of service that a plan
could require an employee to complete before vesting. Before the
1986 Act, for example, a plan could defer vesting until an
employee had performed ten years of service. The 1986 Act
reduced the years of service that a plan could require for full
vesting from ten to five years (except that multiemployer plans
still may require ten year-s of service).
It is difficult at this time to assess fully the effect
of the 1986 Act vesting changes on portability since these
changes are not effective until 1989. However, it is clear that
fewer employees will incur portability losses under the 1986 Act
rules. While five-year vesti-ng will still contribute to some
employees' benefit losses, existing evidence does not indicate
that it is a major factor in causing significant portability
losses among mobile employees.
d. Deferral of Pension Benefit Accruals
Portability losses for mobile workers typically occur
under those pension plans that use contribution or benefit
formulas based, in whole or in part, on an employee's years of
service or final pay with the employer. Under such formulas, as
an employee accumulates additional years of service and
approaches retirement age, the employee earns pension benefits
representing increasing percentages of the employee's final pay
immediately preceding retirement. Thus, by producing a pattern
of deferred benefit accrual over an employee's working lifetime,
these formulas provide longer service employees and employees
closer to retirement with larger benefit accruals than short
service, more mobile, and younger employees.

-15For example, assume that a mobile employee earns 40
years of pension benefits with four employers (ten years with
each employer) under identical defined benefit plans that base
benefits on the employee's final pay with the employer. The
total pension benefit earned by this employee will be
significantly smaller than the total benefit earned by an
employee who earns all 40 years of benefits under an identical
defined benefit plan with a single employer. This is because
none of the plans base their benefits on the employee's years of
service with prior employers or on the employee's compensation
with subsequent employers. Indeed, very few of the defined
benefit plans in the private system (other than collectively
bargained, multiemployer plans) grant credit for service or pay
with other employers.
Service- and final-pay-based benefit formulas are most
common among defined benefit plans. Indeed, even defined benefit
plans with career average pay benefit formulas generally defer
benefit accruals because benefits under such plans are often
regularly improved or updated to reflect employees' pay as of the
update. However, some defined contribution plans, such as target
benefit plans and plans that allocate greater contributions to
employees with additional years of service, exhibit the same
pattern of deferred benefit accrual.
In addition to the deferred benefit accrual that
naturally occurs under service- and final-pay-based benefit
formulas, some defined benefit plans also permit long-service
employees who retire at an early retirement age (often, age 55)
to receive an additional generous pension benefit. Thus, for
example, a defined benefit plan may provide that an employee who
retires with at least 25 years of service at age 55 will receive
the same annual benefit that he had earned for commencement at
age 65. In effect, this early retirement benefit can be a very
valuable, deferred benefit for employees who retire at age 55
with at least 25 years of service.
The portability effect of deferred accruals, then, is
similar to the effect of deferred vesting. The value of the lost
benefits due to deferred benefit accruals, however, is generally
much greater than the value of the lost benefits attributable to
an employee's first few years of service. Thus, deferred
accruals may cause long-service and older employees to receive
significantly greater pension benefits than the more mobile,
younger employees. Also, the extent of the significant benefit
differential resulting from deferred accruals is dependent on the
level of inflation, and does not depend solely on real wage
growth. Finally, to the extent that lower-paid workers turn over
more rapidly than higher-paid employees, deferred accruals result
in the lower-paid employees accruing less than comparable pension
benefits than long-service employees over the same working
lifetime.

-16e.

Pre-Retirement Benefit Erosion

Some commentators argue that the issue of portability
involves not only differences in vested pension benefits earned
by mobile and long-term workers, but also differences in the
pension benefits ultimately received at retirement. That is,
portability problems can result not only from a mobile employee's
failure to accrue a benefit, but also from the failure to
preserve an accrued benefit as a retirement benefit.
Defined benefit plans generally may not make benefit
distributions available to an employee before the employee either
terminates employment with the employer or attains retirement age
under the plan. Mobile workers will have more opportunities to
receive pre-retirement benefit distributions than will long-term
employees. Research indicates that, particularly for younger
employees, high percentages of pre-retirement distributions are
used for nonretirement purposes, rather than rolled over to IRA
or other plans. Thus, mobile employees generally incur greater
reductions in their ultimate pension benefits through
pre-retirement benefit distributions. Note, however, that except
for foregone tax advantages, this factor does not imply that
mobile employees receive less compensation from employers, only
that they consume their pension benefits earlier.
The 1986 Act adopted various rules designed to reduce
the extent to which pension benefits are consumed before
retirement. The Act applied a 10 percent early distribution tax,
eliminated special ten-year averaging for pre-retirement lump-sum
distributions, and adopted a pro rata basis recovery rule for
qualified plans. These changes are likely to reduce the level
of pre-retirement benefit erosion by encouraging mobile employees
who do receive pre-retirement distributions to preserve their
benefits in IRAs and other plans for retirement.
2. General Problems with Portability Proposals
No matter how attractive the portability label may be,
proposals intended to promote portability must be carefully
evaluated in light of several important objectives: increasing
savings; promoting an efficient allocation of resources;
distributing fairly the significant tax benefits associated with
private pension plans; and providing meaningful private pension
benefits to low- and middle-income employees. As discussed
above, in evaluating portability proposals, one should remember
that pension benefit differentials between mobile and long-term
employees may be the result of appropriate employer decisions to
maintain plans providing different amounts or forms of pension
benefits and appropriate employee decisions to seek employment
offering different mixes of pension benefits, cash pay, and other
benefits.

-17Features of the voluntary, employer-based, tax-qualified
pension system that contribute to portability losses may also
provide important benefits more consistent with the objectives
set forth above. For example, it is difficult to expand coverage
or improve benefit levels without also either creating
disincentives for employers to maintain qualified plans by
increasing employer costs or threatening the voluntary nature of
the system (e.g., mandating employer-provided pensions). Also,
some employers and employees may have non-tax and non-pension
preferences that may justify some benefit differentials.
Finally, proposals to encourage the maintenance of additional
qualified plans that provide more meaningful levels of retirement
benefits within the context of the voluntary system are likely
either to have revenue costs or to affect adversely benefit
funding or discrimination.
a. Benefit Indexing
Those who criticize the portability effects of deferred
benefit accruals often suggest indexing an employee's benefit for
years between pre-retirement termination of employment and the
employee's retirement age. Such indexing could be based on price
or wage growth and is aimed at giving an employee credit for
future pay increases with subsequent employers. However,
indexing either would substantially increase the cost of
maintaining defined benefit plans or result in reductions in the
ultimate pension benefits for long-service employees and
employees who commence employment fewer than ten or fifteen years
before retirement.
b. Mandating Prior Service Credit
Another approach to addressing the portability losses of
deferred benefit accruals is to mandate that defined benefit
plans credit an employee's years of service with all prior
employers and then to permit such plans to offset employees'
pension benefits by the benefits provided by the prior employers.
This approach would impose significant costs on employers that
maintain defined benefit plans and thus would likely encourage
employers to stop providing defined benefit plan coverage. In
many ways, this approach would be impractical given the wide
differences among the types of plans and could significantly
deter employers from hiring older employees.
c. Deferred Accruals May Benefit Mobile Employees
To further complicate the analysis regarding the
portability effects of deferred benefit accruals is the view that
plans providing deferred accruals actually may be beneficial to
mobile employees. By working the last ten or fifteen working
years under a plan that defers employees' benefit accruals to the
years approaching retirement age, a mobile employee is able to
earn a significant portion of the pension benefits he would have

-18earned if he had stayed with a single employer. Under the
voluntary, employer-based private pension system in an economy
where mobility is common, many workers will earn no or very small
pension benefits for at least some of their years of employment.
Indeed, during certain periods of their lives, some employees
will opt for employment that maximizes their cash compensation in
lieu of pension benefits. The availability of plans that defer
benefit accruals to the years approaching retirement thus gives
many employees the opportunity to "catch up" on earning pension
benefits at the end of their working lifetimes.
Thus, one must balance the adverse portability effects
of deferred benefit accruals with other important economic, tax,
and retirement objectives. Given the ability of final pay
defined benefit plans to produce a meaningful retirement benefit
for an employee, including a low- or middle-income employee, over
his last ten or fifteen working years, there is no single factor
by which to determine when an appropriate balance has been
achieved.
d. Other Portability Proposals
Other proposals have been made to address pension
portability. For example, as discussed, minimum coverage and
vesting requirements for qualified plans may have some effect on
portability losses. Some proposals would facilitate or encourage
tax-free benefit rollovers and transfers among IRAs and
retirement plans (e.g., increases in the early distribution tax),
while others at least would permit employees who have made
after-tax employee contributions to plans to transfer such
contributions to IRAs and other retirement plans. Of course,
there are significant questions about the extent to which these
proposals meaningfully would improve pension portability. Also,
these and other proposals must be evaluated not only in light of
their purported portability effects, but also in light of the
important economic, tax, and retirement objectives outlined
above.
3. Description of H.R.1961—Pension Portability Act of 1988
H.R.1961, the Pension Portability Act of 1988, proposes to
make various changes to the qualified plan and IRA rules in an
attempt to promote the portability of pension benefits. In
general, H.R.1961 would provide that (i) in certain
circumstances, a plan would be required to make the direct
transfer of an employee's pension benefits to an IRA the primary
form of benefit distribution; (ii) the Secretary of the Treasury
could permit employees to roll over to IRAs their after-tax
employee contributions to qualified plans; (iii) IRA amounts
transferred from qualified plans would be subject to the spousal
protections applicable to defined contribution plans; (iv) IRA
trustees would be required to make IRA-to-IRA transfers within 10
days of receipt by the trustee of the IRS owner's transfer
request; and (v) employers that do not maintain pension plans

-19would be able to maintain an alternative salary reduction form of
simplified employee pension (SEP). These changes would not
become effective until 1992.
B. Discussion
In our view, the major feature of the bill likely to
facilitate portability is the rule permitting plan-to-IRA
transfers of after-tax employee contributions. Under current
law, because after-tax employee contributions may not be rolled
over or transferred from qualified plans to IRAs, in many cases
employees are not able to preserve these amounts in tax-favored
retirement vehicles.
Most of the other features appear to be intended to provide
employers with greater authority to move the qualified plan
benefits of employees who have terminated employment to IRAs
without employee consent. At best, these features would be
neutral with respect to portability issues. In fact, some of
these features would merely relieve employers of administrative
burdens at the risk of reducing some of the rights and benefits
that employees and their spouses would otherwise enjoy if their
benefits remained in the employer's plan.
The alternative salary reduction SEP generally is a SEP
design that many employers could adopt on their own under the
salary reduction SEP rules currently in effect. But H.R.1961
makes the salary reduction SEP available to employers of all
sizes—current law limits salary reduction SEPs to employers with
fewer than 25 employees—so long as the employers do not maintain
other qualified pension plans. However, it appears that H.R.1961
attempts to expand pension coverage through salary reduction
SEPs, in part, by applying nondiscrimination rules that are more
relaxed than the rules applicable to similar tax-favored
arrangements, such as cash or deferred arrangements under section
401(k). In our view, employers should not be able to avoid the
generally applicable nondiscrimination rules simply by providing
tax-favored pension benefits through a particular form of plan,
such as SEPs; tax-qualified retirement plans should be subject to
a consistent set of nondiscrimination rules.
We recognize that, despite recent legislative changes,
portability remains a very important issue that affects millions
of Americans and that the current pension system could be
improved to reduce portability losses. In this connection, we
believe that many of the legislative proposals under
consideration, including H.R.1961, make important contributions
to the continuing dialogue on portability. However, they must be
evaluated in light of the important economic, tax, and retirement
objectives previously discussed. Also, in recent years, the
private retirement system has been the subject of several
significant, positive legislative changes which many employers
and benefit advisors have yet to fully digest. Time is needed to
properly assess the portability effects of these recent changes
to the pension law, many of which only become effective in 1989.

-20EMPLOYEE APPROVAL OF THE ESTABLISHMENT OF EMPLOYEE STOCK
"
OWNERSHIP PLANS: 5.2078 and S.2291
A.

Background

An employee stock ownership plan ("ESOP") is a qualified
pension plan designed to invest primarily in employer securities.
An ESOP is a "defined contribution" type of qualified plan. In a
defined contribution plan, an employee's benefit is equal to the
value of the contributions and other amounts allocated to the
employee's account under the plan, adjusted for investments gains
and losses. Assets of a defined contribution plan are generally
invested by the plan trustee either in a diversified portfolio of
investments or according to participants' directions. Because
employees' benefits are directly dependent on the value of the
plan's assets, employees bear the risk of investment experience.
Under an ESOP, employees' benefits are directly dependent upon
the success and profitability of their employer because the
assets of an ESOP are primarily invested in employer securities.
Thus, the investment risk borne by ESOP participants is greater
than the risk borne by participants in other types of defined
contribution plans.
Significant tax preferences are available for ESOPs and
transactions involving ESOPs. All of the tax preferences
available for defined contribution plans are available for ESOPs.
This is so even though ESOPs are not solely retirement plans and
the tax preferences exist to encourage employers to provide
employees retirement income benefits. These tax preferences
permit a corporation maintaining an ESOP to receive a current
deduction for its ESOP contributions and provide that plan
participants are not taxed on their benefits until they are
distributed. Many additional tax preferences are available, some
of which simply increase the preferences available generally to
defined contribution plans and others which reflect the
nonretirement features of ESOPs. One often stated justification
for these additional preferences is that ESOPs provide employees
an equity ownership interest in their employers and, thus,
increase employee productivity and company profitability.
The increased tax preferences available for ESOPs are larger
permissible deductions for contributions and greater annual
allocations to accounts than are permitted for other defined
contribution plans. Generally, an employer may deduct the amount
of its contribution to a defined contribution plan up to 15% of
the compensation paid to plan participants. If an ESOP borrows
to purchase employer securities, the maximum deduction permitted
is increased to 25% of participants' compensation, to the extent
the compensation is used to repay principal on the loan.
Moreover, any contribution used to pay interest on the loan is
fully deductible. The maximum amount that may be allocated
annually to a participant's account in a defined contribution

-21plan is the lesser of $30,000 and 25% of the participant's
compensation. In the case of an ESOP satisfying certain
nondiscrimination requirements, the maximum dollar allocation is
increased to $60,000.
In addition, other special tax preferences are available for
ESOPs and transactions involving ESOPs. First, an employer may
deduct dividends paid on employer securities held by an ESOP.
Second, banks and certain other financial institutions may
exclude from income 50% of the interest received on an ESOP loan.
Third, persons who sell employer securities to an ESOP may defer
taxation on the gain from the sale if the proceeds of the sale
are reinvested in domestic companies and certain other
requirements are met. Fourth, an ESOP may assume the estate tax
liability of the deceased owner of the employer. Fifth, certain
estates may deduct up to 50% of the proceeds from certain sales
of employer securities to ESOPs. Sixth, early distributions from
ESOPs are exempted from the 10% excise tax on early distributions
from qualified plans. Finally, if a reversion from a defined
benefit plan is transferred to an ESOP, the reversion is not
subject to income tax and the 10% excise tax applicable to
reversions. This exception from taxation for reversions does not
apply to reversions transferred to ESOPs pursuant to plan
terminations occurring after December 31, 1988. Treasury
testified before the Subcommittee on Taxation and Debt Management
of the Committee on Finance on March 28, 1988 in opposition to
any extension of this expiring exi.nption from taxation for
transfers of reversions to ESOPs.
Senate bills S.2078 and S.2291 require a majority of the
employees of an employer establishing an ESOP to approve
establishment of the plan pursuant to an election conducted by
secret ballot. The employer is required to notify its employees
of all of the material facts concerning the plan, including (i)
the terms of the ESOP, (ii) whether assets from another plan will
be transferred to the ESOP and, if so, the terms of the other
plan and (iii) whether the ESOP would replace a plan of the
employer.
The bills also permit the Secretary of the Treasury to
provide that a participant's voting rights required under section
409(e) of the Internal Revenue Code are not satisfied unless the
participant's voting rights with respect to securities allocated
to the participant's account are substantially similar to the
voting rights of holders of the same or similar class of
securities.

-22B.

Discussion

The Treasury Department supports the underlying purpose of
S.2078 and S.2291, which is to provide ESOP participants with the
same stock ownership rights as other holders of similar classes
of stock. As I indicated earlier, current law provides
significant tax incentives for ESOPs. Although Treasury does not
believe this Committee should now reexamine the appropriateness
of these incentives, there are questions about whether the
existing ESOP rules provide employees with a degree of control
consistent with full ownership of their stock.
The bills' requirement of majority approval of employees for
the establishment of an ESOP does not directly provide ESOP
participants with more substantial stock ownership rights. It is
possible that the requirement may have the effect of inducing
employers to provide more substantial stock ownership rights so
that a majority of the employees will approve the plan. Although
we would be sympathetic with this result, it is not clear that
employees would exercise their voting rights to secure additional
stock ownership rights. Moreover, we are concerned about
interfering with the^historically voluntary decisions of
employers to establish compensation levels or employee benefit
plans.
A second more targeted effect of S.2078 and S.2291 is to
require ESOPs of closely held corporations to permit participants
to vote the shares allocated to their accounts on all matters for
which other shareholders of the same class of securities may
vote. The bills would have no effect on the voting rights of
participants in ESOPs which hold publicly traded employer
securities, because equal voting rights are already required in
such cases.
Under current tax law, employer securities contributed to an
ESOP must be either (i) common stock which is readily tradeable
on an established securities market or (ii) where there is no
class of stock which is so readily tradeable, common stock which
has combined voting power and dividend rights equal to or in
excess of the class of common stock having the greatest voting
power and the class of common stock having the greatest dividend
rights. Additionally, if the securities of the employer are
required to be registered with the Securities and Exchange
Commission, the ESOP must permit participants to. vote the
securities allocated to their accounts. If the securities are
not required to be registered, participants only have the right
to vote in corporate mergers, consolidations, recapitalizations,
liquidations and similar transactions.
It is apparent from Senator Armstrong's floor statement given
when S.2078 was introduced that the equal voting right provision
was intended to override an ESOP trustee's ability to vote shares
irrespective of the voting directions it receives from

-23participants. Since this is an issue of fiduciary responsibility
governed under Title I of the Employee Retirement Income Security
Act of 1974, it is under the jurisdiction of the Department of
Labor, which is the proper agency to consider its merits. We
understand that the Department of Labor intends to file a written
statement for the record on this issue.

-24INDIAN FISHING RIGHTS INCOME: H.R.2792
A.

Background

There is no provision in the Internal Revenue Code that
exempts a person from payment of Federal income tax on the
grounds that the person is an Indian. Thus, in their "ordinary
affairs," Indians are generally subject to Federal income tax to
the same extent as other persons. Any exemption from Federal
income tax must be derived from treaties or agreements with
Indian Tribes, from the Federal tax statutes, or from some other
Act of Congress.
Prior to 1871, when the Congress prohibited treaty making
with Indian tribes, several Indian tribes entered into treaties
with the United States Government and several territorial
governments reserving various fishing rights to the Indians.
Since then, additional Indian fishing rights have been
established by statute, executive order, or agreement later
approved by an Act of Congress. Fishing rights secured by
various treaties, Acts of Congress, and executive orders have
been held to include the right to fish for commercial purposes as
well as the right to fish for subsistence purposes. Washington
v. Washington State Commercial Passenger Fishing Vessel Ass'n,
443 U.S. 658, 676 (1979) . In three different cases, the courts
have held that income derived by an Indian from the exercise of
fishing rights reserved under a treaty was not exempt from
Federal income tax, on the grounds that there was no express
language in the treaty providing that income from such fishing
rights was to be tax-exempt. Peterson Estate v. Commissioner, 90
T.C. No. 18 (Feb. 11, 1988); Earl v. Commissioner, 78 T.C. 1014 ,
(198 2) ; Strom v. Commissioner, 6 T.C. 621 (1946), aff'd per
curiam 158 F.2d 520 (9th Cir. 1947).
H.R. 2792 would amend the-Internal Revenue Code to exempt
from tax income derived by a member of an Indian tribe from the
exercise of fishing rights of the tribe that are protected by
treaty. The exemption would also apply to income derived from
the exercise of protected fishing rights by certain Indian-owned
corporations and other business entities, referred to by the bill
as "qualified Indian entities". Income derived by an individual
member of a tribe from the exercise of protected fishing rights
would be exempt, whether such income is in the form of earnings
from self-employment, wages paid by another member of the tribe,
wages paid by a qualified Indian entity, or dividends or other
distributions from a qualified Indian entity. Income exempted
under the bill from Federal taxation would also be exempted from
State taxation.
The bill would exempt income derived from protected fishing
rights not only from income taxes, but also from employment
taxes, including social security (FICA), and unemployment

-25compensation (FUTA) taxes. The bill would amend the Social
Security Act to provide that exempt income is not taken into
account in determining social security benefits. The bill would
be effective for all taxable years, and thus would resolve all
current disputes between the Internal Revenue Service and
taxpayers involving prior years, and would apply to requests or
actions for refunds that are not time-barred. The bill would
also provide the sole basis for exempting fishing rights income
from tax; it would prevent treaties and other laws from being
construed to provide a tax exemption for such income.
B. Discussion
The Treasury Department recognizes that the issue of taxation
of income derived by Indians from exercise of fishing rights
protected by treaty is of great concern to Indian tribes
throughout the country, and particularly in the Northwest and
Great Lakes areas. As previous testimony from the Department of
the Interior has indicated, at the time these treaties were
signed, many tribes reserved the right to fish in perpetuity.
Statement of Ross 0- Swimmer, Assistant Secretary for Indian
Affairs, Department of the Interior, Hearings of the Select
Committee on Indian Affairs, .United States Senate, on S. 727, a
Bill "To Clarify Indian Treaties and Executive Orders with
Respect to Fishing Rights," March 27, 1987. The Indians who were
parties to the treaties understood that they would be able to
fish (and trade fish) on the same basis as before the treaties,
when they were neither required to pay taxes nor turn over any
portion of their catch to the Federal Government. H.R.2792 would
embody that understanding in law by providing a tax exemption for
fishing rights income even though no express exemption is
provided by treaty or other authority.
The Administration supports H.R.2792, while also believing
that it should not serve as a precedent for conferring tax-free
status on all income derived by Indians from resources covered by
treaties. Moreover, we understand that fishing serves a number
of unique and important functions in Indian cultural and
religious life, and thus may be distinguished from other types of
activities engaged in by Indians that would remain fully taxable
under H.R.2792.

-26TREATMENT OF CERTAIN SHORT-TERM OBLIGATIONS IN THE HANDS
OF CERTAIN TAXPAYERS: S.ttT5
A.

Background

Section 1281 requires certain taxpayers to accrue interest
income on short-term obligations (obligations with a fixed
maturity of not more than 1 year). Section 1281 applies to,
among others, accrual-basis taxpayers, dealers, banks and
regulated investment companies. With respect to taxpayers not
subject to section 1281, section 1282 requires the deferral of
interest expense on leveraged purchases of short-term discount
obligations. Both sections are effective for obligations
acquired after July 18, 1984.
Section 1803(a)(8)(A) of the 1986 Act added section
1281(a)(2) in order to clarify that the accrual rule of section
1281 applies to both acquisition discount and accrued, but
unpaid, coupon interest on short-term obligations. This
amendment to section 1281 under the 1986 Act is effective for
obligations acquired after September 25, 1985. Section 118(c)(1)
of the Technical Corrections Act of 1988 would make the amendment
effective for obligations acquired after December 31, 1985.
S.1239 would exempt banks not otherwise using an accrual
method of accounting from both sections 1281 and 1282 with
respect to loans made in the ordinary course of the banks' trade
or business. Accordingly, such banks would not be required to
accrue interest with respect to such loans and, also, would not
be required to defer interest expense incurred in producing such
deferred interest income. The provision would be effective for
obligations acquired after July 18, 1984.
Moreover, with respect to taxpayers to whom section 1281
still applied, S.1239 would change the effective date of the
provision which requires accrual of coupon interest on short-term
obligations under section 1281 to obligations acquired after
October 22, 1986.
B. Discussion
The Treasury Department opposes S.1239.
In general, the accrual method of accounting is preferable to
the cash method of accounting because the accrual method provides
a more accurate method of determining taxable income. Under the
accrual method of accounting, items of income are recognized as
they are economically incurred, as opposed to when they are paid.
Accordingly, it is generally appropriate to use the accrual
method except where the additional complexities created by the
use of such method outweigh the improvement in income measurement
that the method provides.

-27As part of the 1984 Act, Congress decided that in the case of
certain taxpayers, including banks, it was appropriate to require
accrual of acquisition discount on short-term obligations.
Banks, including small banks, were included under the requirement
because they are generally sophisticated taxpayers with respect
to both the financial systems which they maintain and the
financial instruments in which they regularly deal. Furthermore,
banks generally determine their income from short-term
obligations on an accrual basis for regulatory accounting
purposes. Thus, applying the provisions of section 1281 to banks
was not viewed as imposing unreasonable administrative burdens on
the affected taxpayers.
Moreover, in addition to the general superiority of accrual
tax accounting, there are other strong policy reasons for
continuing to apply section 1281 to small banks. An exception
for small banks would effectively permit small banks to use the
interest expense incurred in carrying such obligations to shelter
other unrelated income, leading to a distortion of income and a
mismatching of income and expense.
With respect to the provision in the 1986 Act clarifying that
taxpayers affected by section 1281 must accrue coupon interest,
the Treasury Department has no objection to the provision in the
Technical Corrections Bill which would change the effective date
of the clarification from September 25, 1985 to December 31,
1985. Such a change would have the effect of simplifying the
application of the provision for many taxpayers who report income
on a calendar-year basis. Changing the effective date to October
22, 1986, however, would provide an unwarranted benefit to the
affected banks and would unfairly reward the taxpayers who have
failed to comply with the law.

-28DISCLOSURE OF TAX INFORMATION TO THE VETERANS
ADMINISTRATION: S.2611
A.

Background

Under section 6103 of the Code, the IRS is required to
disclose tax return information upon request to a variety of
agencies or individuals, including federal and state tax
administrators, certain other government agencies, and certain
interested persons such as a taxpayer's spouse or attorney. The
IRS is not currently required to disclose tax return information
to the Veterans Administration. The bill would require the IRS
to disclose tax return information to assist the VA in its
administration of its benefit programs.
B. Discussion
The Office of Management and Budget has advised that the
Administration's position on this bill is under development.
Consequently, my testimony today represents solely the Treasury
Department's views on this issue.
Although the Treasury Department is sympathetic to the needs
of the VA for information, it opposes this bill on the ground
that it is the type of ad hoc modification to section 6103 which
tends to undermine the confidentiality of tax returns and has the
potential to damage the voluntary compliance system. In this
respect, S.2611 resembles other similar modifications, which have
been made or proposed.
Section 6103 was completely revised in 1976. The revision
was due in large part to concerns regarding the unwarranted
disclosure and inappropriate use of tax returns, in some cases
for political purposes. The general rule adopted at that time
and contained in section 6103 is that tax returns are
confidential and are not subject to disclosure except in
particular circumstances specified by statute. During the 1980's
there has been a steady expansion in the exceptions to the
general rule of confidentiality. The largest expansion came in
1984, when Congress required the IRS to commence disclosure of
return information to federal, state, or local agencies
administering certain benefit programs (AFDC, Medicare etc.).
Currently, 55 separate agencies participate in this program. In
1986-87, the IRS made 27.2 million disclosures to these agencies.
GAO has estimated that returns or return information of 80
million taxpayers now are subject to disclosure under section
6103. The bill under consideration would increase the number of
taxpayers whose returns are subject to disclosure by 1.5 million.
It is argued that permitting the VA access to tax returns
would increase federal receipts. It is possible that receipts

-29may, in fact, be increased, at least in the short term, but we
believe that focusing on increased receipts in this context is a
shortsighted approach.
Allowing the Veterans Adminstration access to taxpayer return
information will encourage other agencies to seek similar access.
Typically, as in the current case, a federal agency seeking
access to tax returns would be able to present data showing that
federal receipts would be enhanced. In each case, the argument
would also be made that it would not result in a significant
increase in the number of taxpayers subject to disclosure. Thus,
in any particular case an agency will be able to make the same
arguments that are made today. If we grant the VA access to tax
records, it will be difficult to deny access to other agencies in
the future. The eventual result will be that confidentiality of
tax returns will have become a hollow promise.
We believe that taxpayers have a right to expect that their
tax returns will remain confidential. Furthermore, it is
possible that permitting increased access to tax returns may
actually result in a reduction in voluntary compliance. Any
reduction in voluntary compliance would lose far more in federal
revenue that would be gained by permitting agency access to tax
records. (The IRS has estimated that a 1% drop in voluntary
compliance would cause federal revenues to drop by $3.8 billion.)
Admittedly, at this tine we do not know for certain that
weakening confidentiality will reduce compliance. The IRS has
begun a study of this issue, and we believe that any further
expansion of the exceptions to return confidentiality, even where
an increase in federal receipts can be predicated, should await
the outcome of the study. Furthermore, we believe that amendment
of section 6103 should not be handled on a piecemeal basis in
response to requests from specific agencies. Certainly any
federal agency would prefer to have the power to order the IRS to
disclose tax information, especially if other agencies are being
granted that power. Because of the important principles
involved, amendment of section 6103 should be handled on a
comprehensive basis; if there are good reasons to allow the
Veterans Administration access to return information, then it
should be handled as part of a general rule allowing federal
agencies access in certain cases.
In summary, we believe that Congress should not amend section
6103 to permit additional disclosure of tax return information
until the completion of the study on confidentiality and taxpayer
compliance. If, after the study is completed, amendment of
section 6103 appears in order, then section 6103 should be
revised by means of a thoughtful, comprehensive approach.

-30EXCLUSION FOR CERTAIN SEAFOOD PROCESSORS FROM THE
DEFINITION OF EMPLOYEE: S.1821

A.

Background

An employer is required to withhold from its employees' wages
Federal income tax and the employee's share of Federal Insurance
Contributions Act (FICA) tax and to pay Federal Unemployment Tax
Act (FUTA) tax and its portion of the FICA tax. These taxes only
apply with respect to employees. S.1821 excludes certain seafood
processors from the definition of "employee" and, thus, such
seafood processors would be treated as self-employed individuals.
B. Discussion
The Treasury Department opposes S.1821 because it treats
seafood processors who are in fact employees as self-employed
individuals for Federal tax purposes. This treatment is both
unfair and burdensome to seafood processors and detrimental to
the Federal tax system. If seafood processors are treated as
self-employed individuals, they would be required to pay taxes
under the Self-Employment Tax Act (SECA) in an amount
approximately equal to the sum of the employer's and employee's
portions of the FICA tax. The employers of the seafood
processors would pay no FICA or SECA taxes for these employees.
Seafood processors, who are not operating their own businesses and
who are unaccustomed to keeping business records would be
required to file additional tax forms and remit therewith Federal
income and SECA taxes. Such a system of collecting taxes is not
as effective as the withholding
system and, thus, S.1821 has the
CONCLUSION
effect of losing revenue.
This concludes my prepared remarks. I would be pleased to
address any questions which you might have.

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041

Release Upon Delivery
Expected at 9:00 a.m.
July 12, 1988
STATEMENT OF
C. EUGENE STEUERLE
DEPUTY ASSISTANT SECRETARY FOR TAX ANALYSIS
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
COMMITTEE ON WAYS AND MEANS
UNITED STATES HOUSE OF REPRESENTATIVES
Mr. Chairman and Members of the Subcommittee:
Thank you, Mr. Chairman, for the opportunity today to
discuss some of the Administration's current views on pension
portability. Let me begin by congratulating you on holding this
hearing. Pension portability is a subject that warrants serious
and in-depth examination by Congress and other policy-makers, and
I am sure that today's hearing will make a significant
contribution to that important dialogue.
WHAT IS PENSION PORTABILITY
The issue of pension portabi lity has of ten bee n viewed
narrowly as whether employees can "take" thei r full vested
benefits with them when they leave employers and inv est them in
other plans or individual retireme nt accounts (IRAs)
This view
of portability is often referred t o as portab ility o f assets or
cash values. Other common views o f pension portabil ity have
included portability of benefits a nd portabil ity of service.
Portability of benefits refers pri marily to v esting and other
eligibility conditions (e.g., age and service condit ions
applicable to early retirement sub sidies) tha t may cause mobile
employees to lose pension benefits when they lose jo bs. Finally,
portability of service refers gene rally to th e recognition under
a defined benefit plan, for partic ipation, ve sting, and benefit
accrual purposes, of an employee's service fo r employers other
than the employer maintaining the plan.
B-1477

- 2 -

More recently, commentators have begun to believe that
while the concept of portability includes these particular
issues, it actually may be a much broader concept that touches on
many of the basic features of our voluntary, employer-based
private pension system.
Viewed more broadly, pension portability refers to the
differential between the total pension benefit that a short-term,
mobile employee receives for a working lifetime with many
employers and the total pension benefit that a long-term employee
receives for the same working lifetime with a single employer.
This benefit differential is often referred to as a portability
loss. Because many workers do not remain with a single employer
for their entire working lifetimes, or in many cases even for
their last 15 working years, portability actually reflects a
concern about whether sufficient numbers of this nation's workers
receive meaningful retirement benefits under the private pension
system. Also, portability reflects a concern about whether the
tax benefits associated with the private system are fairly
distributed among various groups of workers—for example, mobile
and long-term employees, young and old employees, highly
compensated and non-highly compensated employees, and women and
men.
Under current law, two employees may start out at equal
jobs, do an equal amount of work, and receive the same amount of
cash pay. However, under the voluntary, employer-based pension
system, they may receive very different levels of pension
benefits for the same amount of work. If women shift employment
more often than men, for instance, they will receive smaller
total pensions at retirement for the same number of years of
work. The extent of these portability losses will depend upon
many factors, including, for example, the future rate of
inflation.
The issue of portability centers broadly on what is
considered a "fair" differential of lifetime pension benefits
between mobile and less-mobile workers. If one tries to
determine what is "fair" by examining the pension rules
established by Congress, it is difficult to come to a conclusion.
For example, under the typical defined contribution plan,
fairness generally is determined by providing employees with
contributions that are an equal proportion of current pay. Under
a typical defined benefit plan, however, "fairness" is often
based on the provision of an equal replacement rate on a service
and pay base approximating final salary or salary in the
employee's peak earning years.

- 3 -

While these defined contribution and defined benefit
formulas might sound similar in concept, in practical terms they
can have enormously different impacts on mobile employees
relative to long-term employees. Defined benefit formulas often
result in little or no real accrual of benefits to the mobile
employee, especially in their young and middle years. Moreover,
these formulas produce benefits that are much more subject to the
vagaries of such factors as inflation. For example, although the
typical defined benefit formulas may at low inflation rates
strike an appropriate balance between mobile and long-term
workers, at higher inflation rates these formulas may excessively
favor the long-term workers.
In evaluating portability issues and proposals, one should
recognize that pension benefit differentials between mobile and
long-term employees do not always reflect market failures or
imply that certain groups of employees are being treated unfairly
in the larger perspective. Such benefit differentials may to an
extent be the result of appropriate employer decisions to
maintain plans providing different amounts or forms of pension
benefits and of appropriate employee decisions to seek employment
offering different mixes of pension benefits, cash pay, and other
benefits.
For example, employers requiring specially skilled workers
may well prefer to link pension benefits to length of service,
such as through deferred vesting or deferred benefit accruals, in
order to retain such skilled workers. Other employers requiring
employees with more general skills, however, may have less
incentive to reward employees to stay for longer periods of time.
Similarly, for a variety of reasons (e.g., need for cash income
or other benefits), employees may appropriately select jobs
offering different levels of pension benefits. Also, to gain the
greater benefit security offered by properly funded and
PBGC-insured defined benefit plans relative to defined
contribution plans, employees may favor employment providing
defined benefit plan coverage over employment with an employer
that maintains only a defined contribution plan.
Consistent with this, it is important that employees have a
better understanding of their benefit entitlements and rights
under defined benefit plans and defined contribution plans.
Informed employees should be better able to make employment
decisions and bargain more effectively over the desired mix of
cash compensation and pension benefits.
The following discussion surveys the basic features of the
voluntary, employer-based private pension system that may
contribute to pension portability losses for mobile workers.

- 4 -

GAPS IN PENSION COVERAGE
Differentials of pension benefits between long-term workers
and mobile workers may first occur because not all employers
maintain qualified plans and those employers that do maintain
plans do not necessarily cover all of their employees. Thus,
many mobile employees are likely not be covered under qualified
plans for some portion of their working lifetimes.
Gaps in pension coverage generally are more common among
lower-paid workers in part because such workers may value
retirement benefits relative to cash compensation less than do
higher-paid workers. Nondiscrimination rules for qualified
plans, for broad social and tax equity reasons, nonetheless
require employers to provide a portion of their lower-paid
employees with comparable pension benefits. Still, some
disparity of pension coverage is allowed to exist in favor of
higher-paid employees. For example, under current law, an
employer that provides pension benefits to 100 percent of its
highly compensated employees (generally, employees who have at
least a 5 percent ownership interest in the employer and
employees who earn over $50,000) need provide comparable pension
benefits to only 70 percent of the employer's non-highly
compensated employees.
Furthermore, it is common even for employers that maintain
broad-based qualified plans to exclude newly hired employees from
plan coverage until the employees have performed at least one
year of service for the employer. Thus, to the extent mobile
employees fail to stay with employers for at least one year, they
commonly fail to earn any pension benefit. Thus, their total
working years commonly will exceed the total years of pension
coverage by at least the total number of jobs.
In the Tax Reform Act of 1986 (the 1986 Act), the pension
coverage rules were modified to increase the extent to which an
employer's low- and middle-income employees must be provided
comparable qualified plan benefits. For example, under the
pre-1986 Act rules, a pension plan could qualify for tax-favored
status if it covered a reasonable classification of employees.
While there is always doubt whether a coverage classification is
reasonable, in certain circumstances a classification including
100 percent of an employer's highly compensated employees and
only 20 percent of the non-highly compensated employees could
qualify as reasonable. Under the 1986 Act rules, not only must a
pension plan cover at least a reasonable classification of the
employer's employees, but also all of the non-highly compensated
employees of the employer must receive, on average, pension
benefits that are at least 70 percent of the average pension
benefits received by the employer's highly compensated employees.

- 5 -

While gaps in pension coverage have contributed to mobile
employees' portability losses, research to date has not indicated
the frequency with which such gaps lead to major benefit
differentials between mobile and long-term employees. Also, the
extent to which the coverage changes adopted in the 1986 Act will
affect portability losses is as yet uncertain as the new rules
only go into effect in 1989.
DISPARITIES IN BENEFIT LEVELS
Even if a mobile employee is covered under an employer's
qualified plan, portability losses for mobile workers may occur
because employers do not all maintain qualified plans that
provide comparable levels of benefits. For example, one employer
may provide its employees with coverage under a defined
contribution plan that provides an annual contribution of five
percent of current compensation, while another employer maintains
a 10 percent defined contribution plan or a defined benefit plan
that provides a retirement benefit of 1.25 percent times years of
service times the employee's final pay. In the voluntary,
employer-based private pension system, there are numerous
differences in the benefit levels provided under the various
types of qualified plans. Indeed, one of the premises of our
voluntary pension system is that an employer should have the
flexibility to set an affordable and appropriate level of
benefits for its workforce.
In fact, while these disparities in benefit levels
contribute to differences in benefits among employees, it is not
clear that this factor per se would create a greater likelihood
that a mobile employee would incur a portability loss.
DEFERRED VESTING
Even if a mobile employee earns a meaningful level of
pension benefits under a qualified plan, the plan may require
that the employee perform a minimum number of years of service
before vesting in his benefit. Beginning in 1989, the tax law
permits a plan to defer an employee's vesting in his earned
benefits until he has performed at least five years of service
(ten years in the case of a collectively bargained, multiemployer
plan). Obviously, mobile employees will more often fail to stay
with employers for the period necessary to vest in their pension
benefits and thus will more frequently suffer portability losses
due to deferred vesting.
In many cases, deferred vesting may also work to the
disadvantage of the lower-paid employees. To the extent that
low- and middle-income workers change jobs more frequently than
higher-paid employees, the lower-paid mobile workers are more
likely to lose accrued benefits due to inadequate vesting
service, just as they are more likely not to accrue benefits due
to gaps in pension coverage and lower levels of benefits.

- 6 -

In the 1986 Act, the pension vesting rules were modified
generally to reduce the number of years of service that a plan
could require an employee to complete before vesting. Before the
1986 Act, for example, a plan could defer vesting until an
employee had performed ten years of service. The 1986 Act
reduced the years of service that a plan could require for full
vesting from ten to five years (except that multiemployer plans
still may require ten years of service).
It is difficult at this time to assess fully the effect of
the 1986 Act vesting changes on portability since these changes
are not effective until 1989. However, it is clear that fewer
employees will incur portability losses under the 1986 Act rules.
While five-year vesting will still contribute to some employees'
benefit losses, existing evidence does not indicate that it is a
major factor in causing significant portability losses among
mobile employees.
DEFERRAL OF PENSION BENEFIT ACCRUALS
Portability losses for mobile workers typically occur under
those pension plans that use contribution or benefit formulas
based, in whole or in part, on an employee's years of service or
final pay with the employer. Under such formulas, as an employee
accumulates additional years of service and approaches retirement
age, the employee earns pension benefits representing increasing
percentages of the employee's final pay immediately preceding
retirement. Thus, by producing a pattern of deferred benefit
accrual over an employee's working lifetime, these formulas
provide longer service employees and employees closer to
retirement with larger benefit accruals than short service, more
mobile, and younger employees.
The attached Table 1 demonstrates how the value of an
employee's accrued pension benefit for a year varies by age and
inflation for continuing with an employer for one additional year
under a simple defined benefit plan. These results can be
contrasted with a typical defined contribution plan that provides
approximately the same level of accrued pension benefits for
employees of all ages earning the same amount of compensation.
At even zero percent inflation, a defined benefit plan provides
increasing levels of benefits as age increases. Note, in
particular, how the value of benefits varies enormously by
inflation. In effect, when there is an unindexed plan, the
combination of real wage growth and inflation erode enormously
the value of accrued benefits for an employee leaving employment
before normal retirement age.
This pattern of accrual has a significant effect on the
benefits ultimately received by a mobile employee. For example,
assume that a mobile employee earns 40 years of pension benefits

- 7 with four employers (ten years with each employer) under
identical defined benefit plans that base benefits on the
employee's final pay with the employer. The total pension
benefit earned by this employee will be significantly smaller
than the total benefit earned by an employee who earns all 40
years of benefits under an identical defined benefit plan with a
single employer. This is because none of the plans base their
benefits on the employee's years of service with prior employers
or on the employee's compensation with subsequent employers.
Indeed, very few of the defined benefit plans in the private
system (other than collectively bargained, multiemployer plans)
grant credit for service or pay with other employers.
Service- and final-pay-based benefit formulas are most
common among defined benefit plans. Indeed, even defined benefit
plans with career average pay benefit formulas generally defer
benefit accruals because benefits under such plans are often
regularly improved or updated to reflect employees' pay as of the
update. However, some defined contribution plans, such as target
benefit plans and plans that allocate greater contributions to
employees with additional years of service, exhibit some of the
same pattern of deferred benefit accrual.
In addition to the deferred benefit accrual that naturally
occurs under service- and final-pay-based benefit formulas, some
defined benefit plans also permit long-service employees who
retire at an early retirement age (often, age 55) to receive an
additional generous pension benefit. Thus, for example, a
defined benefit plan may provide that an employee who retires
with at least 25 years of service at age 55 will receive the same
annual benefit that he had earned for commencement at age 65. In
effect, this early retirement benefit can be a very valuable,
deferred benefit for employees who retire at age 55 with at least
25 years of service.
The portability effect of deferred accruals then is similar
to the effect of deferred vesting. The value of the lost
benefits due to deferred benefit accruals, however, is generally
much greater than the value of the lost benefits attributable to
an employee's first few years of service. Thus, deferred
accruals may cause long-service and older employees to receive
significantly greater pension benefits than the more mobile,
younger employees. Also, the extent of the significant benefit
differential resulting from deferred accruals is dependent on the
level of inflation, and does not depend solely on real wage
growth. Finally, to the extent that lower-paid workers turn over
more rapidly than higher-paid employees, deferred accruals result
in the lower-paid employees accruing less than comparable pension
benefits than long-service employees over the same working
lifetime.

- 8 -

PRE-RETIREMENT BENEFIT EROSION
Some commentators argue that the issue of portability
involves not only differences in vested pension benefits earned
by mobile and long-term workers, but also differences in the
pension benefits ultimately received at retirement. That is,
portability problems can result not only from a mobile employee's
failure to accrue a benefit, but also from the failure to
preserve an accrued benefit as a retirement benefit.
Defined benefit plans generally may not make benefit
distributions available to an employee before the employee
either terminates employment with the employer or attains
retirement age under the plan. Mobile workers will have more
opportunities to receive pre-retirement benefit distributions
than will long-term employees. Research indicates that,
particularly for younger employees, high percentages of
pre-retirement distributions are used for nonretirement purposes,
rather than rolled over to IRA or other plans. Thus, mobile
employees generally incur greater reductions in their ultimate
pension benefits through pre-retirement benefit distributions.
Note, however, that except for foregone tax advantages, this
factor does not imply that mobile employees receive less
compensation from employers, only that they consume their pension
benefits earlier.
The 1986 Act adopted various rules designed to reduce the
extent to which pension benefits are consumed before retirement.
The Act applied a 10 percent early distribution tax, eliminated
special ten-year averaging for pre-retirement lump-sum
distributions, and adopted a pro rata basis recovery rule for
qualified plans. These changes are likely to reduce the level
of pre-retirement benefit erosion by encouraging mobile employees
who do receive pre-retirement distributions to preserve their
benefits in IRAs and other plans for retirement.
DISCUSSION
No matter how attractive the portability label may be,
proposals intended to promote portability must be carefully
evaluated in light of several important "objectives: increasing
savings; promoting an efficient allocation of resources;
distributing fairly the significant tax benefits associated with
private pension plans; and providing meaningful private pension
benefits to low- and middle-income employees. As discussed
above, in evaluating portability proposals, one should remember
that pension benefit differentials between mobile and long-term
employees may be the result of appropriate employer decisions to
maintain plans providing different amounts or forms of pension
benefits and appropriate employee decisions to seek employment
offering different mixes of pension benefits, cash pay, and other
benefits.

- 9 -

Features of the voluntary, employer-based, tax-qualified
pension system that contribute to portability losses may also
provide important benefits more consistent with the objectives
set forth above. For example, it is difficult to expand coverage
or improve benefit levels without also either creating
disincentives for employers to maintain qualified plans by
increasing employer costs or threatening the voluntary nature of
the system (e.g., mandating employer-provided pensions). Also,
some employers and employees may have non-tax and non-pension
preferences that may justify some benefit differentials.
Finally, proposals to encourage the maintenance of additional
qualified plans that provide more meaningful levels of retirement
benefits within the context of the voluntary system are likely
either to have revenue costs or to affect adversely benefit
funding or discrimination.
Benefit indexing. Those who criticize the portability
effects of deferred benefit accruals often suggest indexing an
employee's benefit for years between pre-retirement termination
of employment and the employee's retirement age. Such indexing
could be based on price or wage growth and is aimed at giving an
employee credit for future pay increases with subsequent
employers. However, indexing either would substantially increase
the cost of maintaining defined benefit plans or result in
reductions in the ultimate pension benefits for long-service
employees and employees who commence employment fewer than ten or
fifteen years before retirement.
Mandating prior service credit. Another approach to
addressing the portability losses of deferred benefit accruals is
to mandate that defined benefit plans credit an employee's years
of service with all prior employers and then to permit such plans
to offset employees' pension benefits by the benefits provided by
the prior employers. This approach would impose significant
costs on employers that maintain defined benefit plans and thus
would likely encourage employers to stop providing defined
benefit plan coverage. In many ways, this approach would be
impractical given the wide differences among the types of plans
and could significantly deter employers from hiring older
employees.
Deferred accruals may benefit mobile employees. To further
complicate the analysis regarding the portability effects of
deferred benefit accruals is the view that plans providing
deferred accruals actually may be beneficial to mobile employees.
By working the last ten or fifteen working years under a plan
that defers employees' benefit accruals to the years approaching
retirement age, a mobile employee is able to earn a significant
portion of the pension benefits he would have earned if he had
stayed with a single employer. Under the voluntary,
employer-based private pension system in an economy where

- 10 mobility is common, many workers will earn no or very small
pension benefits for at least some of their years of employment.
Indeed, during certain periods of their lives, some employees
will opt for employment that maximizes their cash compensation in
lieu of pension benefits. The availability of plans that defer
benefit accruals to the years approaching retirement thus gives
many employees the opportunity to "catch up" on earning pension
benefits at the end of their working lifetimes.
Thus, one must balance the adverse portability effects of
the manner in which many plans provide deferred benefit accruals
with other important economic, tax, and retirement objectives.
Given the ability of final pay defined benefit plans to produce a
meaningful retirement benefit for an employee, including a lowor middle-income employee, over his last ten or fifteen working
years, there is no single factor by which to determine when an
appropriate balance has been achieved.
Other portability proposals. Other proposals have been
made to address pension portability. For example, as discussed,
minimum coverage and vesting requirements for qualified plans may
have some effect on portability losses. Some proposals would
facilitate or encourage tax-free benefit rollovers and transfers
among IRAs and retirement plans (e.g., increases in the early
distribution tax), while others at least would permit employees
who have made after-tax employee contributions to plans to
transfer such contributions to IRAs and other retirement plans.
Of course, there are significant questions about the extent to
which these proposals meaningfully would improve pension
portability. Also, these and other proposals must be evaluated
not only in light of their purported portability effects, but
also in light of the important economic, tax, and retirement
objectives outlined above.
CONCLUSION
Many believe that the current voluntary, employer-based
pension system is flawed from a portability perspective. We
recognize that, despite recent legislative changes, portability
remains a very important issue that affects millions of Americans
and that the current pension system could be improved to reduce
portability losses.
As we have suggested, the issue of pension portability is
at its core the issue of whether the existing system is "fair" as
between mobile and long-term employees. Even if Congress were to
come to an agreement about how fairness should be measured and to
conclude that some existing plans are unfair by that measure, the
preceding discussion indicates that it will be difficult to
identify the policy prescription that might succeed in achieving
greater fairness.

- 11 -

In this connection, many of the legislative proposals under
consideration make important contributions to the continuing
dialogue on portability. However, they must be evaluated in
light of the important economic, tax, and retirement objectives
previously discussed. For example, mandating greater levels of
coverage or benefits for mobile workers could also result in
fewer pension plans. Also, in recent years, the private
retirement system has been the subject of several significant,
positive legislative changes which many employers and benefit
advisors have yet to fully digest. Time is needed to properly
assess the portability effects of these recent changes to the
pension law, many of which only become effective in 1989.
Thank you again for giving me the opportunity to present
some of the Administration's views on pension portability. I
would be happy to answer any questions that you might have.

TABLE 1

THE EFFECT OF INFLATION AND PLAN TYPE ON THE CHANGE
in the
PRESENT VALUE OF PENSION BENEFITS
if the
W O R K E R REMAINS ON THE JOB AN ADDITIONAL YEAR

Age
of Employee

Years with
Employer

Defined
Contribution
Plan

0%

4%

Defined Benefit Plan
Inflation Rate

8%

25

1

$2559

$2559

$ 442

35

10

3119

3731

1238

414

45

20

3802

5294

3019

1586

55

30

4635

7362

6843

5442

65

40

5650

10082

14826

17556

Department of the Treasury
Office of Tax Analysis

$

84

July 11, 1988

Notes: Assumes employee works for employer continuously from age 25. Initial salary is $20,000.
rising to $44,160 in real terms at age 65. Pension benefits are based on high salary times 2 %
times years of service. Real economy is assumed to grow at 2 % annually. Defined contribution
plan assumes 12.795% of salary contributed.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 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
10/87
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY*S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
the Public Debt.

TREASURY NEWS

jepartment off the Treasury • Washington, D.C. • Telephone 566CONTACT: Office of Financing
FOR IMMEDIATE RELEASE
202/3 76-4350
July 12, 1988
RESULTS OF AUCTION OF 7-YEAR NOTES
The Department of the Treasury has accepted $6,505 million
of $17,934 million of tenders received from the public for the
7-year notes, Series G-1995, auctioned today. The notes will be
issued July 15, 1988, and mature July 15, 1995.
The interest rate on the notes will be 8-7/8%. The range
of accepted competitive bids, and the corresponding prices at the
8-7/8% interest rate are as follows:
Yield Price
Low
8.90%*
99.872
High
8.92%
99.769
Average
8.91%
99.821
•Excepting 2 tenders totaling $11,000.
Tenders at the high yield were allotted 80%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
9,916
$
9,916
Boston
$
New York
15,875,466
5 ,982,266
Philadelphia
7,550
7,550
Cleveland
11,655
11,655
Richmond
21,726
19,726
Atlanta
9,920
9,920
Chicago
-1,076,551
203,751
St. Louis
12,061
8,861
Minneapolis
8,284
8,184
Kansas City
13,551
13,551
Dallas
9,151
4,151
San Francisco
875,746
222,746
Treasury
2,331
2,331
Totals
$17,933,908
$6,,504,608
The $6,505
million of accepted tenders includes $331
million of noncompetitive tenders and $ 6,174
million of competitive tenders from the public.
In addition to the $6,505 million of tenders accepted in
the auction process, $200 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $87 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-1479

TREASURY NEWS

Department off the Treasury • Washington, D.C. • Telephone 566-2041
Release Upon Delivery
Expected at 9:30 a.m., E.D.T.
July 13, 1988

STATEMENT OF
0. DONALDSON CHAPOTON
ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON FINANCE
UNITED STATES SENATE
Mr. Chairman and Members of the Committee:
I am pleased to be here this morning on behalf of the
Administration to express our views on certain provisions
contained in H.R. 4333, the Technical Corrections Act of 1988, as
tentatively marked up by the House Ways and Means Committee. In
keeping with the purposes of this hearing, my testimony will
focus primarily on provisions in the Ways and Means bill that
have not previously been considered by this Committee and certain
other provisions of the bill which the Committee has determined
to cover in this hearing.
Before proceeding to the specific proposals in the Ways and
Means bill, I would like to describe for the Committee our view
of the constraints that should limit this Committee's
consideration of substantive provisions that go beyond technical
corrections to the Tax Reform Act of 1986 ("the 1986 Act") and
the Omnibus Budget Reconciliation Act of 1987 ("the 1987 Act").
First, it is imperative that Congress pass technical corrections
legislation this year. Such action is necessary to alleviate
taxpayer uncertainty and to ensure that the intent of Congress in
enacting the 1986 and 1987 tax legislation is carried out. The
addition of numerous substantive provisions to the technical
corrections bill jeopardizes the prospects for enacting such a
bill this year.
Second, we are still not very far down the road from the
1986 Act, which substantially overhauled the federal tax system.
As all interested parties have recognized, the system needs a
reasonable amount of time to assimilate these changes.
Consequently, no major changes in the tax laws are presently in
B-1480
order.

-2-

Finally, the President remains firmly opposed to any new
taxes, and will not support revenue-raising provisions adopted
merely to fund tax relief for some particular group or interest.
We hope this Committee will support the President in his
determination not to raise taxes on business or working
Americans.
The President's budget does propose the extension of
Medicare insurance coverage to state and local government
employees who began work before April 1, 1986. This is the only
major group of employees in the United States who are not
participating fully in Medicare. The proposal would eliminate
the drain on the Medicare trust fund caused by the fact that most
state and local employees are covered by Medicare even though
they are not subject to the payroll tax. It would also ensure
Medicare benefits to the 25 percent of state and local employees
who do not currently receive these benefits.
Although we have proposed extension of Medicare coverage
as an appropriate reform of the Medicare system, the proposal
also has a positive revenue effect. As I will discuss below,
we could recommend to the President certain of the revenue
measures marked up by the Ways and Means Committee, where those
measures have a sound policy basis and are not designed merely to
raise revenue. I should again emphasize, however, that the
President's tolerance for revenue measures is very limited, and
we will not recommend and do not expect him to support provisions
beyond those I will discuss here today.
Given that the legitimate revenue sources available to this
Committee will be very limited, it will be necessary for the
Committee to carefully limit possible revenue-losing provisions.
Our own priorities in this regard are generally reflected in the
budget. We believe it is essential that we continue to stimulate
research activities in this country. The encouragement of such
activities through an R&E credit and R&E allocation rules plays a
strategic role in our country's commitment to technological and
competitive leadership in the international community. The
budget also proposes a permanent extension of the one-year
deferral of the application of the 2-percent floor on
miscellaneous itemized deductions to mutual fund shareholders.
The President's budget also proposes remedying the so-called
"triple tax" problem faced by foreign corporations with both a
U.S. branch and U.S. shareholders, and we support recent efforts
to develop a domestic election procedure for solving that
problem.
Since the budget was prepared, we have become increasingly
aware of the burdens imposed by recent changes in the rules
relating to the collection of the excise tax on diesel fuel.
These burdens are especially pronounced in the case of farmers,

-3-

who are now experiencing what may be the worst drought since the
"Dust Bowl" days of the 1930's. We are pleased to see that the
Ways and Means Committee has essentially adopted the relief
provision that this Committee adopted in March of this year. We
strongly support this relief provision.
We also believe this Committee should give careful
consideration to extending the expiring relief provisions for
troubled thrifts. As recent months have made clear, the
financial problems facing the savings and loan industry and the
FSLIC have not diminished. Allowing the relief provisions for
troubled thrifts to expire would only complicate the task of
restoring the thrift industry to fiscal health.
REDUCE DIVIDENDS RECEIVED DEDUCTION
Background
Under present law, dividends received by domestic
corporations from other domestic corporations generally are
entitled to complete or partial relief from taxation. The extent
of the relief depends upon a number of circumstances, including
the relationship between the corporations paying and receiving
the dividend. Complete relief generally is allowed for dividends
between members of the same affiliated group. In the case of an
affiliated group that files a consolidated return, this is
accomplished by excluding intra-group dividends from the income
of the recipient. In the case of an affiliated (but
nonconsolidated) group, intra-group dividends generally are
eligible for a 100-percent dividends received deduction ("DRD").
In the case of nonaffiliated corporations, relief from tax on
dividend income is not complete. A recipient corporation with
so-called "direct" holdings (i.e., ownership of 20 percent or
more by vote and value of the stock of the distributing
corporation) is allowed an 80-percent DRD. A recipient
corporation with so-called "portfolio" holdings (i.e., ownership
of lesser amounts of the distributing corporation's stock) is
allowed a 70-percent DRD.
A number of special rules limit the benefit of the DRD in
certain situations in which allowance of the full DRD is viewed
as inappropriate. For example, the ability of recipient
corporations to utilize the DRD to avoid paying any tax is
limited by section 246(b) and the alternative minimum tax rules.
The ability of recipient corporations to gain an "arbitrage"
benefit by deducting interest or similar amounts used to finance
dividend-paying stock is limited by the debt-financed portfolio
stock rules of section 246A and the proration rules applicable to
insurance companies. The ability of recipient corporations to

-4-

manipulate the character of income to take advantage of the
differing treatment of dividend income and gain or loss from the
sale of stock is limited by the holding period rules of section
246(c) and the extraordinary dividend rules of section 1059.
Proposal
The Ways and Means bill would reduce the DRD available with
respect to portfolio holdings of stock from 70 percent to 55
percent for dividends received in 1989, 51.5 percent for
dividends received in 1990, and 50 percent for dividends received
in 1991 and subsequent calendar years.1/ No transition relief
would be provided for existing stock holdings.
Discussion
Decisions regarding the appropriate level of the DRD address
a central issue of corporate taxation — to what extent will
income earned indirectly by an individual through one or more
corporations be taxed differently than income earned directly by
the individual. Under our tax system, income earned through a
corporation is taxed at both the corporate level and the
individual level. As a matter of ideal tax policy, the
imposition of two levels of tax on income earned through
corporations may be questioned. Economists and academicians have
argued that the corporate and individual tax systems should be
integrated to produce only a single level of tax, and many of our
major trading partners provide some degree of integration of
their corporate and individual tax systems. In recognition of
the tax policy merits of providing relief from double taxation of
corporate income, the President's 1985 tax reform proposals to
the Congress proposed to allow corporations a partial dividends
paid deduction. This tax reform proposal was not enacted,
however, and we recognize that, for the foreseeable future,
income earned through corporations will continue to be subject to
two The
levels
ofand
tax.
1/
Ways
Means bill would also revise the threshold for
distinguishing between "direct" and "portfolio" holdings of
stock. It would provide that the 80-percent DRD is available
only with respect to dividends received by a corporation
owning more than 20 percent (rather than 20 percent or more)
of the distributing corporation. The principal effect of
this change would be to preclude any corporation that is a
member of an affiliated group from paying dividends
qualifying for the 80-percent DRD to any corporation that is
not a member of the affiliated group.

-o-

Although our tax system fails to provide relief from the
double taxation of income earned through corporations, the system
has since its inception provided relief from multiple taxation of
the same income within the corporate sector. The first federal
tax based on corporate income, the Payne-Aldrich Tariff Act of
1909, allowed corporations a 100-percent DRD on the ground that
"there is no reason in the world why a corporation that owns
stock in another company should pay a double tax on those
holdings...." 44 Cong. Rec. 4696 (1909) (remarks of Rep. Payne).
Although a DRD was not contained in the Revenue Act of 1913, a
100-percent DRD was reinstituted by the Revenue Act of 1917.
Since that time, the DRD has been retained with only minor
changes. The DRD was reduced from 100 percent to 90 percent by
the Revenue Act of 1935, and to 85 percent by the Revenue Act of
1936. These changes were intended to offset an anticipated
incentive for businesses to divide their income among several
corporations to avoid a newly-enacted surtax on income above a
certain level and to discourage the formation of holding
companies and other complicated corporate structures. Both of
these concerns have since been dealt with more directly and
effectively.2/ In connection with the limitation of the benefits
of multiple surtax exemptions for affiliated corporations, the
Revenue Act of 1964 increased the DRD for affiliated corporations
not utilizing multiple surtax exemptions from 85 percent to 100
percent. The DRD for dividends between nonaffiliated
corporations remained at 85 percent. The 1986 Act reduced the
DRD for nonaffiliated corporations to 80 percent to prevent the
1986 Act's reduction in corporate tax rates from producing a
significant reduction in the effective tax rate on intercorporate
dividends.
Thus, prior to the 1987 Act, dividends between nonaffiliated
corporations had been treated consistently for over fifty years,
2/
Holding
companies
regulated
by the
Public of
Utility
since
the Revenue
Act were
of 1935.
The House
version
the 1987 Act
Holding
Company
Act
of
1935
and
the
Investment
Company
Act of
would have reduced the DRD to 75 percent for all nonaffiliated
1940.
Multiple
surtax
exemptions
for
affiliated
corporations
corporations. The report accompanying the House bill stated that
were limited by the Revenue Act of 1964 and eliminated by the
Tax Reform Act of 1969. Finally, the ability of
nonaffiliated corporations to take advantage of multiple
surtax exemptions was limited by the Tax Reform Act of 1984,
which phased out the benefit of the graduated tax rates for
corporations with taxable incomes exceeding $1,000,000, and
by the 1986 Act, which reduced this threshold to $100,000.

-6-

the 80-percent DRD was "too generous for corporations that are
not eligible to be treated as the alter ego of the distributing
corporation because they do not have a sufficient ownership
interest in that corporation." H.R. Rep. No. 391, 100th Cong.,
2d Sess. 1094 (1987). This proposed reduction in the DRD for
dividends between nonaffiliated corporations would have
represented a significant change in the historical treatment of
intercorporate dividends. The 1987 Act, as enacted, however,
made an even more significant change in the treatment of
intercorporate dividends by introducing a distinction between
"direct" and "portfolio" holdings of stock for purposes of the
DRD.
The taxation under current law of dividends between
nonaffiliated corporations diverges to a minor degree from the
pure corporate-solution model of taxation inherent in allowance
of a DRD. The further reduction in the DRD proposed in the Ways
and Means bill would substantially increase that divergence. The
stated rationale of the new House proposal to further reduce the
DRD for portfolio holdings is the same as that given by the House
in connection with its 1987 proposal to reduce the DRD to 75
percent for all nonaffiliated corporations — the supposed undue
generosity of the current DRD for corporations that are not alter
egos. Description of Possible Committee Amendment Proposed By
Chairman Rostenkowski to H.R. 4333, prepared by the Staff of the
Joint Committee on Taxation, June 21, 1988 at 85. This second
reduction of the DRD in two years, and the "alter ego" theory
that is said to justify the reduction, augurs future erosion —
even the complete elimination — of the DRD for portfolio stock.
Although the "alter ego" theory has in the past justified a
higher DRD for dividends between affiliates than for dividends
between nonaffiliates, we believe that it does not justify
further substantially reducing the DRD for nonaffiliate dividends
and discarding the long-standing policy that the same stream of
corporate income should not be subject to tax at the corporate
level more than once. The combined effect of the 1987 Act
reduction and the proposed reduction in the DRD for portfolio
stock would be to increase the maximum effective tax rate on
intercorporate dividends from 6.8 percent (20 percent of the
dividend taxed at the maximum rate of 34 percent) to 17 percent
(50 percent of the dividend taxed at the maximum rate of 34
percent). This change would increase the aggregate corporate
level tax on this income from 38.49 percent to 45.22 percent.
Complete elimination of the DRD for portfolio stock would
increase the aggregate corporate level tax to 56.44 percent.
Although the erosion of the DRD for portfolio stock would
thus represent a substantial change in a basic tenet of our
system of corporate taxation, it appears that this proposal (and
the change made by the 1987 Act) were made without consideration
of its financial and economic impact. Indeed, revenue

-7-

considerations seem to be the only force driving this proposal.
We strongly believe that a change of this type in a basic
principle of corporate taxation should be made only after careful
consideration has been given to all its financial and economic
effects.
Any further erosion of the DRD for nonaffiliate dividends may
have a number of significant consequences. First, by further
encouraging corporations to rely on debt, it will likely alter
dramatically the existing balance between equity and debt
financing, a balance that arguably already favors debt to too
great a degree. This is particularly true, because this change,
coming on the heels of last year's legislation, could rationally
be taken to indicate that the deduction will soon be completely
eliminated.
Further reliance on debt capital may increase the
vulnerability of corporations, and the economy as a whole, both
to the risks of bankruptcy and to cyclical changes in the
economy. Moreover, corporations like banks and financial
institutions and utilities that have traditionally relied on
corporate shareholders as a source of capital will be affected
disproportionately by a reduction in the DRD.
One study shows that of the over $27 billion dollars of
preferred stock issued in the years in 1984-1987, approximately
21.7 percent was issued by utilities, 17.5 percent by banks, 14.9
percent by industrials, 7.6 percent by insurance companies and
the remaining 38.7 percent by other financial institutions
including thrifts. In the case of many of these heavy issuers of
preferred stock, the equity raised by preferred stock serves
crucial business and financial objectives. For example, banks
are required by both national and international regulatory bodies
to satisfy minimum capital requirements. See "Banks New Mini-mum
Capital Rules Add to International Banks' Worries," Wall Street
Journal, July 12, 1988, p. 17. One study has indicated that in
the three year period 1985-87, the U.S. banking industry raised
$3.5 billion of equity capital through preferred stock,
representing 42 percent of the total equity raised by the banking
industry. The manner in which banks currently meet regulatory
requirements may thus be significantly altered by the proposed
legislation.
Similarly, utilities, which generally have very high capital
requirements, historically have relied on preferred stock as an
important source of equity. One study has indicated that, in
1987, a group of 100 investor-owned utilities had $27.8 billion
of preferred stock outstanding.

-8-

The proposed reduction in the DRD would therefore likely
increase significantly the cost of equity capital of corporations
in these and other industries which have historically relied
heavily on preferred stock financing. As a consequence,
corporations in these industries will find it more difficult to
meet regulatory requirements, or to the extent not constrained by
regulatory requirements, will be induced to increase their debt
load and, potentially, the financial vulnerability of their
capital structures.
In addition, the proposed decrease in the DRD will likely
decrease substantially the market value of existing corporate
stock because it will reduce the after-tax return realized by
corporate investors. This effect will be especially large where,
as in the case of most preferred stock, a large proportion of the
stock is held by other corporations. The revenue generated by a
reduction in the DRD, then, will come largely from current
corporate holders of portfolio stock. In addition, the rate at
which any reduction in the DRD is phased in may affect the extent
of any decrease in the market value of stock. The rate of the
phase-in contained in the House proposal, however, appears to
have been dictated by revenue considerations and not by concerns
regarding the potential market impact of a reduction in the DRD,
a market impact that is likely to be a substantial one as is
indicated by the reaction of the market since the proposed
reduction was first announced in early June.
We recognize the concerns of some that, in certain
circumstances, the DRD may serve not merely to provide relief
from multiple levels of corporate taxation, but rather to provide
unwarranted tax benefits. It is certainly appropriate to study
and address these issues, and general reduction in the DRD with
respect to portfolio holdings may, indirectly, be responsive to
these policy issues. The proposed reduction in the DRD would,
however, affect all corporations that issue or hold portfolio
stock, whether or not allowance of the DRD had any effect other
than providing relief from multiple taxation. If Congress
ultimately determines that the existing restrictions on the use
of the DRD are not adequate, it should consider more targeted
measures to strengthen those restrictions.
In conclusion, we believe that the House proposal to reduce
the DRD for portfolio stock should not be adopted. Proposed
without careful consideration of the consequences, this measure
would reverse long-standing and fundamental principles of
corporate taxation solely as a revenue-raising measure. We
question whether a change of this magnitude can be justified as
part of technical corrections legislation and without the
foundation of a comprehensive study of its policy merits and
financial and economic impact.

-9-

REPEAL OF THE COMPLETED CONTRACT METHOD
Background
Pursuant to changes made by the 1986 Act, taxpayers producing
property under a long-term contract generally 3/ are required to
use either of two methods of accounting: the percentage of
completion method or the percentage of completion-capitalized
cost method. I.R.C. §460.
Under the percentage of completion method the taxpayer is
required to include in gross income in each year of the contract
a portion of the contract price based on the percentage of the
contract completed by the end of the taxable year. This
percentage is determined under the "cost-to-cost" method, and
generally is based on the ratio of all contract costs incurred
through the end of the year to total expected contract costs.4/
Under the percentage of completion method the taxpayer also
deducts contract costs in the taxable year in which they are
incurred.
Upon completion of the contract, a "look-back" rule requires
the taxpayer to redetermine contract income for each year of the
contract based on actual price and costs. The taxpayer is
entitled to receive, or required to pay, interest for each year
of the contract based on the difference between contract income
as originally reported and contract income as redetermined.
The percentage of completion-capitalized cost method is a
hybrid method under which the taxpayer is required to report a
portion of the contract price and costs using the percentage of
completion method. The remaining portion of contract price and
costs
may1986
be Act
reported
using does
the not
completed
method, if
3/ The
generally
apply contract
to any construction
contract of a taxpayer with average annual gross receipts not
exceeding $10 million, if the taxpayer estimates that the
contract will be completed within two years. See §460(e).
4/ The Internal Revenue Service has permitted taxpayers to use a
simplified method of determining the degree of contract
completion under which only certain costs are taken into
account. See Notice 87-61, 1987-2 C.B. 370, 373.

-10-

that is the taxpayer's "normal method of accounting". Under the
completed contract method no amount is includable in gross
income, and no contract costs are deductible, until the contract
is completed.
The 1936 Act required that 40 percent of contract income and
costs be accounted for under the percentage of completion method,
and limited the use of the completed contract method to the
remaining 60 percent. The 1987 Act raised the percentage of
contract income and costs required to be taken into account under
the percentage of completion method from 40 percent to 70
percent, and reduced the percentage allowed to be taken into
account under the completed contract method from 60 percent to 30
percent.
In addition to requiring that a portion of income and costs
from any long-term contract be taken into account under the
percentage of completion method, the 1986 Act also provided new
rules for allocating costs to long-term contracts. The general
effect of these rules is to require that more costs be allocated
to long-term contracts, and therefore to reduce the amount of
taxable income that can be deferred under what is left of the
completed contract method of accounting.
Under the 1986 Act, all costs, including indirect costs such
as administrative expenses, that directly benefit or are incurred
by reason of long-term contracts must be allocated to such
contracts. This rule effectively applies the cost allocation
rules provided by the Tax Equity and Fiscal Responsibility Act of
1982 for extended period long-term contracts to all long-term
contracts. In addition, the 1986 Act requires that all costs
identified as contract costs under a cost-plus contract or a
contract with the Federal Government be allocated to the
contract. Finally, the 1986 Act requires that interest costs be
allocated to long-term contracts, and therefore deferred to the
extent that the taxpayer uses the completed contract method.
Proposal
The Ways and Means bill would, by requiring use of the
percentage of completion method for all long-term contracts,
fully repeal the completed contract method. This provision
generally would apply to all long-term contracts entered into on
or after June 21, 1988. The provision would not apply to
contracts of small construction companies exempted by the 1986
Act, or to certain ship construction contracts exempted by the
1987 Act.

-11-

Discussion
The Administration opposes repeal of the completed contract
method. This proposal would again reopen a compromise reached in
1986 in the context of tax reform, and do so solely to raise
revenues, rather than for reasons of tax policy. This revenue
increase would come at the expense of certain industries that
already have experienced an increase in their relative tax
burdens as a result of the 1986 Act.
During the process that led to passage of the 1986 Act, the
relative merits of the completed contract and percentage of
completion methods of accounting for long-term contracts, as well
as the need for new cost allocation rules, were thoroughly
considered by both the Administration and the Congress. The
Administration did not propose repeal of the completed contract
method, but instead proposed to limit the potential for deferral
of income under the method through expanded cost allocation
rules.5/ The tax reform bill passed by the Senate in 1986 would
have retained the completed contract method, while providing such
expanded cost allocation rules. The tax reform bill passed by
the House, in contrast, would have repealed the completed
contract method and required use of the percentage of completion
method, except for certain construction contracts of small
taxpayers.6/ Recognizing that significant policy arguments can
be made for and against each method, the Congress arrived at a
compromise between the percentage of completion and completed
contract methods, which was embodied in the 1986 Act. In order
to raise revenues, the 1987 Act reopened this compromise and
further restricted use of the completed contract method. The
Administration did not support this action.
We believe that any change in current rules governing
accounting for long-term contracts should be based on tax policy
rather than revenue considerations. Such a change should take
place only after a thorough reexamination of this area, including
a reexamination not only of the relative merits of the completed
5/ The President's
Tax Proposals
to of
the completion
Congress for
Fairness,
contract
and cost-to-cost
percentage
methods,
but
Growth,
and
Simplicity
198-207
(May,
1985).
also of alternatives to these two methods.
6/ See H.R. Rep. No. 841, 99th Cong., 2d Sess. 11-310-11 (1986)

-12-

SPEED UP CORPORATE ESTIMATED TAXES
Background
Corporations are subject to a penalty with respect to
underpayments of estimated income tax liability. I.R.C. §6655.
In general, estimated tax payments must equal 90 percent of the
tax shown on the return for the taxable year to avoid imposition
of the penalty. Under a safe-harbor (not available to large
corporations), no penalty is imposed if the estimated tax
payments equal 100 percent of the tax shown on the corporation's
return for the preceding taxable year.
An additional safe-harbor, available to all corporations,
permits the amount of any quarterly estimated tax payment to be
based on an annualization of the corporation's year-to-date
income. This annualization safe-harbor is intended to allow
corporations to estimate their tax liability by reference to
events that have occurred prior to the due date of a required
payment.
Under current law, any reduction in a quarterly estimated tax
payment that results from using the annualization safe-harbor
must be partially made up in the next estimated tax payment for
the taxable year if the corporation does not continue to use the
annualization method in computing the subsequent payment. In
such cases, the corporation must increase the amount of the
subsequent payment by 90 percent of the shortfall resulting from
the prior use of the annualization method to avoid the penalty.
To illustrate the effect of this "recapture" rule, assume
that a corporation with a seasonal business has relatively little
income during the first part of its taxable year and
substantially higher income in the latter part of the year.
Assume further that under the general rule, which requires that
estimated tax payments equal 90 percent of the tax liability
shown on the return for the taxable year, each of the quarterly
estimated tax payments would have to be $88,000. Under the
annualization safe-harbor, however, the required payments for the
first and second quarter would be, say, only $27,000 each. If
the corporation did not continue to use the annualization method
in its third quarter, its required estimated tax payment of
$88,000 for the third quarter would be increased by $110,000 (90
percent of the excess of $176,000 over $54,000). Thus, an
underpayment penalty can be avoided if the corporation pays
estimated taxes of $198,000 ($88,000 + $110,000) for the third
quarter.

-13-

Proposal
The Ways and Means bill would require corporations to
increase quarterly estimated tax payments by 100 percent (rather
than 90 percent) of the reduction in a prior payment that results
from using the annualization safe-harbor.
Discussion
The recapture rule under current law, and under the proposal,
applies only if a corporation computes at least one quarterly
estimated tax payment using the annualization safe-harbor and
does not continue to use the same approach for the remainder of
the taxable year. If the taxable income of a corporation is
recognized uniformly throughout the taxable year, or if the level
of taxable income consistently declines throughout the taxable
year, none of the estimated tax payments due will be based on the
annualization method. In contrast, if the level of taxable
income recognition consistently increases throughout the taxable
year, all of the estimated tax payments due will be based on the
annualization safe-harbor. Thus, in these circumstances, no
recapture is required under current law or under the proposal.
If, however, taxable income recognition levels fluctuate
during the taxable year, the recapture rule may increase the
amount of an estimated tax payment. This is lixely to occur, for
example, when taxable income recognition levels start out
relatively low, peak during the middle of the year, and decline
towards the end of the year. In these circumstances, the first
and second quarterly estimated tax payments are likely to be
determined under the annualization safe-harbor, while the
payments for the third and fourth quarters would be determined
under the general rule (i.e., 90 percent of tax liability shown
on the return for the year).
Without a recapture rule, a corporation with fluctuating
taxable income would be required to pay less estimated tax than a
corporation that recognizes its income uniformly throughout the
year. This discrepancy is substantially reduced by the
90-percent recapture rule under current law and would be
eliminated entirely by the 100-percent recapture rule under the
proposal. We see no reason why a corporation that uses the
annualization method for only part of the year should not be
required to make up any shortfall completely when it ceases to
use that method.

-14-

REPEAL RULES PERMITTING LOSS TRANSFERS
BY ALASKA NATIVE CORPORATIONS
Background
Under present law, Alaska Native Corporations ("ANCs") are
exempt from several rules that limit the ability of loss
corporations to sell or otherwise transfer their losses to other
corporations. These exemptions began with the Tax Reform Act of
1984, which amended Code section 1504(a) to tighten the
definition of affiliated groups eligible to file consolidated
returns, but which also delayed the effective date of this change
until taxable years beginning after 1991 in the case of
affiliations with ANCs.
The 1986 Act further liberalized the requirements for
affiliation with an ANC (or with a wholly-owned subsidiary of an
ANC) for any taxable year beginning after 1984 and before 1992.
In particular, the 1986 Act made it clear that no provision of
the Code (e.g., sections 269 and 482) or principle of law (e.g.,
the assignment of income doctrine) may be applied to deny the
benefit or use of losses or credits of an ANC which is the common
parent of an affiliated group, or of a wholly-owned subsidiary of
such an ANC, to the group. Thus, as so liberalized, affiliation
with an ANC is to be determined solely according to the
provisions expressly contained in section 1504(a) of the Code as
it existed before the amendments made by the 1984 Act.
Proposal
The Ways and Means Committee proposal would terminate the
exemption of ANCs from the generally applicable current law rules
for losses and credits of an ANC (1) arising after April 26,
1988, or (2) arising on or before April 26, 1988 to the extent
such losses and credits are used to offset income assigned (or
attributable to property contributed) after that date. This
proposal is identical to H.R.- 4475 as introduced by Chairman
Rostenkowski on April 27, 1988.
Discussion
The exemption of ANCs from the general rules applicable to
loss corporations was intended to provide special relief to ANCs
with large net operating losses and numerous business credits
that they would not otherwise have been able to use. This relief
was designed to allow losses and credits of an ANC and its
wholly-owned subsidiaries to be used on a consolidated return
against the income and tax liability of profitable corporations
and to allow the ANC group to share in the resulting economic
benefits. It was hoped that the resulting infusion of capital
would help improve the financial condition of ANCs and that
resulting relationships with other corporations would permit ANCs
to acquire new business expertise.

-15-

As a tax policy matter, these special provisions have always
been controversial, and the tension between this provision and
sound tax policy has increased over the last several years.
Recent tax legislation has severely curtailed the ability of one
corporation to transfer its losses and credits to another. In
particular, transfers between corporations have been restricted
by (i) the amendments relating to the definition of an
"affiliated group" in section 1504 of the Code, (ii) the revised
limitations on net operating losses and certain built-in losses
following an ownership change in section 382, and (iii) the
limitation on the use of preacquisition losses to offset built-in
gains in section 384. In light of these changes, the
continuation of special rules that permit certain taxpayers to
sell losses and credits without regard to any provision of the
Code or principle of law that would otherwise restrict such a
transfer is unjustifiable.
Although it appears that there may have been some success in
achieving the goals underlying this relief provision, it also
appears that the losses and credits available to be transferred,
and that have been transferred, far exceed the estimates made at
the time these special relief provisions were adopted. Now that
it is clear that the associated revenue costs greatly exceed
Congress's expectations, it is appropriate to terminate this
relief.
The proposal would, in effect, prevent ANCs from engaging in
any transactions after April 26, 1988 that would have the effect
of transferring their losses or credits, whether such losses or
credits arose before or after such date, to another corporation
(except to the extent permitted by the generally applicable
rules). In addition, this proposal would affect certain
transactions entered into before such date if the losses or
credits "arise" after such date. It is unclear, however, whether
a loss arises for purposes of this proposal when it is realized
and recognized for tax purposes or when it is economically
incurred. For this reason, the time at which losses are deemed
to arise under the proposal should be clarified.
This proposal would also prevent ANCs from transferring
losses or credits arising on or before April 26, 1988 to the
extent such losses or credits are used to offset income assigned
(or attributable to property contributed) after that date. It
apparently would not prohibit transfers of such losses and
credits to the extent they are used to offset income which is
actually earned after that date as long as the income was
assigned (or the property to which it is attributable was
contributed) before April 26, 1988. This "grandfathering" of
transactions involving income actually earned after April 26,
1988 may result in further revenue losses. It may also be

-16-

perceived as unfairly benefiting those ANCs that had already
completed transactions transferring their losses and credits as
opposed to those that had not yet completed such transfers. For
these reasons, consideration should be given to expanding the
proposal to apply to all income earned after April 26, 1988.
NONDISCRIMINATION RULES FOR HEALTH
AND OTHER EMPLOYEE BENEFIT PLANS
Background
As part of the 1986 Act, with Administration support,
Congress adopted rules limiting the extent to which
employer-provided health, group-term life insurance, and certain
other employee benefit plans may discriminate in favor of an
employer's highly compensated employees. Satisfaction of these
new nondiscrimination rules, which are contained in section 89 of
the Code, is a precondition to the exclusion by the employer's
highly compensated employees of such tax-favored benefits from
income. The requirements of section 89 are not yet in effect;
they will be effective for taxable years beginning after the
earlier of (i) the date that is three months after Treasury
issues certain regulations, or (ii) December 31, 1988.
Section 89 requires not only that the health and other
benefits be available to employees on a nondiscriminatory basis,
but also that actual receipt of benefits be nondiscriminatory.
In general, an employer's health and other benefit plans are
nondiscriminatory if (i) at least 90 percent of the employer's
nonhighly compensated employees have benefits available that are
at least 50 percent as valuable as the benefits available to the
highly compensated employee with the most valuable benefit
available, and (ii) the per capita average value of the benefits
actually provided to the nonhighly compensated employees is at
least 75 percent of the analogous per capita average for the
highly compensated employees. Application of the section 89
rules requires that the benefit coverages provided by an employer
be valued and that data on the family status of employees and the
actual coverage received by employees and their families be
collected and analyzed.
Proposal
In response to many of the concerns raised by employers about
the difficulty of proving compliance with the section 89 rules,
the Ways and Means bill would make numerous changes to section
89.

-17-

Discussion
In our view, any changes to the section 89 rules should be
consistent with the nondiscrimination policy reflected in the
original rules and should address specific administrative
concerns raised by employers within the structure of the existing
rules; changes that would create new testing approaches or
otherwise add additional administrative complexity for employers
or the IRS should be avoided. In addition, any changes that
affect not only section 89, but also the nondiscrimination rules
applicable to qualified retirement plans (e.g., changes to the
highly compensated employee definition) must be carefully
scrutinized to assure that pension policy objectives are not
being frustrated. In certain circumstances, it may be
appropriate to provide that such changes apply only for purposes
of section 89.
We believe that the proposed changes generally satisfy these
guidelines, and we generally support them. In fact, we have been
considering many similar changes in developing administrative
guidance on the new rules.
Among the most significant of the proposed changes is the
transition valuation rule permitting employers to use any
reasonable method of health coverage valuation (including
employer cost) until the later of January 1, 1991 or 6 months
after the IRS issues valuation rules. The existing statute
directs employers to determine the value of health coverage in
accordance with guidelines and tables issued by the IRS.
However, developing generic value guidelines and tables has
proven to be a difficult task that we are not likely to complete
within the next 12 months. Thus, this change will enable
employers to prove compliance with the nondiscrimination rules by
using value or cost information that will in most cases be
accessable with little difficulty.
Another very significant change is the rule permitting
employers to prove compliance with the nondiscrimination rules by
testing the benefits available and provided on a single day of
the year, subject to appropriate anti-manipulation rules, instead
of tracking benefit availability and coverage for each day of the
year. By also permitting employers to prove compliance on the
basis of a statistically valid sample of employees and coverages,
rather than on the basis of data collected on all employees and
coverages, the proposed changes eliminate what may have been the
gravest administrative concern raised by employers—the
difficulty and cost of collecting and analyzing employee and
benefit data for each employee for each and every day of the
year.

-18-

Finally, we would like to mention one particular issue that
is not directly addressed in the Ways and Means bill, but that we
are aware is a matter of some concern to employers. The issue
relates to the extent to which employers will be able to apply
section 89 on a separate line of business or operating unit basis
(section 414(r)). Employers evidently are concerned that the
line of business regulations we are developing will not permit
sufficient disaggregation of an employer into separate units
based on geographical areas.
We are aware that special concerns relating to health
benefits argue strongly for permitting the disaggregation of an
employer into small, geographically based units for section 89
testing purposes (e.g., health plans and costs vary significantly
by geographical area and the health nondiscrimination rules apply
on a per capita, rather than a percentage of compensation,
basis). Consistent with these concerns, we intend to provide
early guidance under section 89 that will specifically address
the extent to which employers may separately apply the new rules
with respect to separate geographical sites. This guidance will
generally permit disaggregation beyond that permitted under
section 414(r). Also, an employer will be able to apply these
EXTENSION
FOR 89
ONE
YEAR OF THE LOW-INCOME
CREDIT
special
section
disaggregation
rules evenHOUSING
before TAX
section
414(r)
guidance
is
issued.
Background
The 1986 Act created a low-income housing tax credit which
may be claimed by owners of residential rental property used for
low-income housing. I.R.C. §42. The credit is intended to
encourage investment in rental housing for individuals near the
poverty level. The credit is set to expire on December 31, 1989.
New construction and qualified rehabilitation expenditures
for non-federally subsidized low-income housing units are
eligible for a tax credit of up to 70 percent of the initial
low-income housing investment. The owner of a qualified project
receives a portion of the credit each year over a 10-year period,
and the amount of each annual credit is grossed-up so that the
sum of the credits received equals 70 percent of the investment
on a present value basis. If tax-exempt bond financing or
certain other government subsidies are used to finance the
project, then a 30 percent credit rate applies. Purchases of
existing units that were last placed in service more than 10
years ago are also eligible for a 30 percent credit.

-19-

The credit is available only for units rented to households
near or below the poverty level. In general, a project owner can
choose one of two minimum qualifying criteria: (1) 40 percent of
units must be rented to households whose incomes do not exceed 60
percent of area median income, or (2) 20 percent of the units
must be rented to households whose incomes do not exceed 50
percent of area median income. In addition, the amount of rent
charged for the low-income units is subject to certain
limitations.
Designated state agencies authorize credits to qualifying
projects subject to an overall cap of $1.25 per capita of new
annual credit authority per year. In 1987, the total credit
authority was approximately $300 million. States generally may
not carry over unused credit authority. A limited exception is
provided for buildings placed in service in 1990, if expenditures
equal to 10 percent or more of total project costs are incurred
before January 1, 1989. Credit authority for such property may
be carried over from the 1989 credit allocation for the credit
agency.
A full or partial recapture of the credit is applicable with
respect to any project that (i) fails to provide the agreed upon
percentage of low-income housing units, (ii) exceeds qualifying
rent limits, or (iii) is transferred without the posting of a
suitable bond. For projects that fail to comply in the first 11
years, one-third of the credit is recaptured with interest. The
recapture fraction phases out between years 12 through 15.
The technical correction bills in both the Senate (S. 2238)
and the House (H.R. 4333) contain the same technical corrections
provisions relating to the low-income housing credit. These
changes are primarily technical in nature and are needed to make
the credit more effective and easier to use. Treasury generally
supports the entire package of technical corrections to the
credit proposed by both the House and the Senate. Passage of a
technical corrections bill is an important step to ensure proper
utilization of the credit.
Proposal
In addition to the numerous technical corrections provisions,
the Ways and Means Committee has agreed to extend the credit for
one year to December 31, 1990. The extension of the credit this
year is intended to help ensure the continued use of this housing
subsidy while Congress has an opportunity to gather more
information on its operation and relative efficiency before
deciding to continue, modify, or eliminate the credit. No
changes to the credit have been proposed by the Ways and Means
Committee to offset the revenue cost of a one-year extension of
the credit.

-20-

Discussion
The Administration is opposed to extending the low-income
housing credit for one year. The credit does not expire until
the end of 1989, and it is thus premature to enact a one-year
extension of the credit this year. Developers can continue to
plan low-income projects with the assurance that credits will be
available so long as the project is (i) placed in service before
the end of 1989, or (ii) placed in service in 1990 and 10 percent
or more of total project costs are incurred before January 1,
1989. Thus, we believe that development and construction of
low-income projects will continue this year without an extension
of the credit.
More importantly, we believe that it is critical that the
relative efficiency of the current credit and alternative housing
subsidies be fully analyzed before any decision is made to extend
the credit. Even a one-year extension of the credit is an
expensive proposition because credits are allowed in each of the
next ten years. Thus, a one-year extension means a significant
revenue cost each year for ten years. While the current revenue
cost of the low-income housing tax credit is estimated to be $60
million in calendar year 1987, the cost grows to around $800
million in fiscal year 1991 as a result of increased usage of the
credit and the continued payment of credits for 10 years on
earlier projects. We estimate that the cost of a one-year
extension of the credit would be $.8 billion over 5 years.
While the low-income housing credit is a clear improvement
over prior tax incentives for low-income housing, we have serious
concerns about the efficiency and equity of the credit that
require a further examination of the credit before it is
extended. First, would some subsidized units simply replace
units that would have been available in the absence of federal
assistance? If so, the credit may not result in a significant
long-run increase in housing supply. Second, the credit includes
no incentive for maintenance. If units receiving the credit rent
at below market levels, will landlords allow the projects to
deteriorate without losing tenants? In addition, without
additional subsidies, will project owners have any economic
incentive to continue to rent to low-income tenants after the
compliance period elapses? Finally, will households
substantially below the poverty level benefit from the credit?
Another source of inefficiency of the credit is that it may
not result in housing of a quality or location that is
appropriate for or desired by low-income renters. Thus, even if
the full value of the credit were passed along to low-income
tenants, the value to the renter would be less than the amount of
the subsidy.

-21-

The Administration has addressed many of these concerns by
reemphasizing its commitment to rental housing vouchers in the
1989 budget. Vouchers avoid many of the inefficiencies discussed
above. The budget proposes to provide 135,500 additional
vouchers to needy households. In light of the relative
efficiency of vouchers, we oppose making the low-income housing
credit the dominant mechanism for assisting low-income housing.
In this regard, we look forward to working with Congress to
determine the best method of providing housing assistance to poor
families.
ESTATE FREEZES
Background
The 1987 Act added section 2036(c) to the Code in an effort
to remove the tax advantages of various techniques designed to
"freeze" the value of an estate for federal estate tax purposes.
These techniques involve a transfer of the right to appreciation
in an asset with the owner retaining an income interest in the
asset or rights to control the asset. A typical "estate freeze"
consists of parents transferring common stock in the family
business to their children while retaining control of the
corporation, and a right to the corporation's income, through
ownership of preferred stock. The effect of section 2036(c),
where it applies, is to treat the owner as retaining the
transferred interest and to include that interest in the owner's
estate.
Section 2036(c) applies to any transfer occurring after
December 17, 1987, if the transferor holds a substantial interest
in an "enterprise" and in effect transfers property having a
disproportionately large share of the otential appreciation in
the enterprise while retaining a disproportionately large share
in the income of, or rights in, the enterprise. The Conference
Report describes an "enterprise" as including any business or
other property which may produce income or gain. A person holds
a "substantial interest" in an enterprise if he or she owns,
directly or indirectly, 10 percent or more of the voting power or
income stream, or both, in the enterprise. An individual is
treated as owning an interest in an enterprise which is directly
or indirectly owned by any member of an individual's family.
Section 2036(c) excludes from the decedent's gross estate an
interest that is transferred in a bona fide sale for full and
adequate consideration. However, this exception is not
applicable to a transfer between family members if the transfer
otherwise satisfies the criteria of section 2036(c). In
addition, section 2036(c)(4) provides that if a transferor
disposes of his retained interest within three years of his
death, the previously transferred interest will be included in
his estate for Federal estate tax purposes.

-22-

Under the current statute, a transferred interest is
includible in the transferor's estate (and valued as of the time
of the transferor's death) regardless of whether the transferee
transfers his interest in the enterprise (or whether
proportionality is restored) before the death of the transferor.
However, if the transferor disposes of his retained interest more
than three years before his death, or it is otherwise terminated
before that time, section 2036(c) does not apply.
The technical corrections bills in both the House (H.R.
4333) and the Senate (S. 2238) contain identical rules imposing a
gift tax when the original transferor transfers the retained
interest, or the original transferee transfers the transferred
property, to a person who is not a member of the original
transferor's family. Under this proposed technical correction,
the amount that would have been included in the transferor's
estate with respect to the transferred property if the transferor
had died at that -time would be treated as a current gift by the
transferor ("the deemed gift rule"). Section 2036(c) would then
no longer apply to that transferred property for estate tax
purposes. If the transferor or transferee transfers only a
portion of the retained or transferred interest, respectively, a
Proposal
proportionate amount of the interest would be treated as a deemed
gift under this rule.
In addition to the proposed technical corrections in H.R. 4333
and S. 2238, the Ways and Means Committee has tentatively adopted
additional technical corrections which further clarify and
broaden both the original statute and the first set of proposed
technical corrections. For example, the Ways and Means bill
provides that for purposes of the deemed gift rule described
above, terminations, lapses and other changes in any interest in
property of the transferor or transferee are treated as
transfers. The bill also confers upon the transferor a right of
contribution similar to that of section 2207A 7/ and provides the
Treasury Department with authority to describe circumstances in
which an individual and such individual's spouse will not be
treated as one person.8/
7/
Under section 2207A, a surviving spouse's estate is granted
a right to recover from the recipients of certain property
the estate taxes paid as a result of the inclusion of the
property in the spouse's estate.
8/ This rule is intended to prevent the inclusion of interests
in property under section 2036(c) in both spouses' estates
where there is a transfer of the retained interest between
spouses.

-23-

The Ways and Means bill includes safe harbors for certain
common business transactions that otherwise might be reached by
section 2036(c). For example, the bill provides that section
2036(c) will not apply solely because the transferor receives or
retains certain debt of the enterprise. Further, the statute
would not apply solely because the transferor enters into an
agreement for the sale or lease of goods or other property to be
used in the enterprise, or the providing of services, if the
agreement is an arms-length agreement for fair market value and
does not otherwise involve any change in interests in the
enterprise. Finally, the bill provides that section 2036(c) will
not apply merely because the owner has granted an option to sell
property at fair market value as of the time the option is
exercised.
Discussion
Section 2036(c) is designed to remedy the perceived unfair
estate tax advantage resulting from the creation and transfer of
fractional interests in an enterprise with different rights to
income, voting control and appreciation. The creation and
transfer of such interests may arguably result in the transfer of
wealth outside the transfer tax system in certain situations.
In general, the purpose of the proposed "deemed gift"
technical correction in the first set of technical corrections is
twofold. First, it is designed to impose the tax on the value of
the transferred interest at the time that the transferee disposes
of the transferred property or the transferor disposes of the
retained property (or when proportionality is restored). Second,
it is designed to prevent the complete avoidance of the
consequences of section 2036(c) by subsequent transfers more than
three years before death.
Both sets of technical corrections to section 2036(c) are
very broad in scope. While some of the technical corrections are
necessary to clarify the statute and provide safe harbors to
taxpayers who might otherwise be affected by section 2036(c), we
are concerned that they are considerably broader than the
perceived abuse would require.
We are also concerned whether further tightening of these
rules which has the effect of increasing taxes on estates is
warranted without further study. The Treasury Department is
interested in exploring whether additional safe harbors or
further guidance can or should be provided either by legislative
or administrative action. In this regard, we look forward to
working with this Committee to improve this provision and provide
needed guidance as soon as possible.

-24-

There is one other provision in the House bill — the
so-called "residual treaty override" — which is of such
far-reaching and fundamental significance to our tax policy and
tax law that I must ask for forebearance for a few moments in
order to comment on it here, even though I have testified on the
treaty override provision before.
RESIDUAL TREATY OVERRIDE
Background
In my statement before the Subcommittee on Taxation and Debt
Management last July 22 on the then-pending technical corrections
bill, I explained that the Administration strongly opposes the
provision in the technical corrections bill that purports to
"clarify" the relationship between income tax treaties and
provisions in the 1986 Act. This provision, section
112(aa)(2)(C) of the Technical Corrections Act of 1988 introduced
in the Senate and the House of Representatives on March 31, 1988,
remains in the bill tentatively approved by the House Ways and
Means Committee. I am not asking now, as I did before, that the
Committee eliminate this provision altogether. Instead, I would
strongly urge the Committee to consider modifying this provision
so that it addresses the concerns that Congress and the
Administration share regarding the relationship between treaties
and tax legislation, but does so in a manner that does not
needlessly and gratuitously undermine the standing and
credibility of the United States as a.treaty partner.
Description of Section 112(aa)(2)(C) of H.R. 4333.
Section 112(aa) of the technical corrections bill attempts
to provide definitive rules for the coordination of provisions in
the 1986 and 1987 tax legislation and pre-existing treaties. The
approach taken is to identify provisions in the recent tax
legislation that are thought .to conflict with one or more income
tax treaties and to specify those provisions that would not apply
to the extent inconsistent with pre-existing treaties and those
that would override U.S. treaty obligations. In addition,
section 112(aa)(2)(C) provides that, in any other cases of
conflict between the two recent tax Acts and treaties, the Acts'
provisions are to apply notwithstanding any treaty obligation of
the United States.

-25-

Discussion
During Congress's consideration of the 1986 Act, fhe
Administration made clear its opposition to the several treaty
overrides contained in that legislation. Our view then, and now,
is that treaty overrides are neither necessary nor appropriate.
Today, however, I do not want to restate old arguments, but
rather to focus solely on the residual override in section
112(aa)(2)(C).
In the 15 months since a residual override was first proposed
by congressional staff, we have regularly discussed with your
staffs the importance of treaties and the importance of ensuring
that treaties and tax legislation are interpreted in a manner
that is consistent with the intent behind both the legislation
and treaties. Significantly, there is agreement on many
important points:
— There is agreement that courts generally have done a good
job of reconciling statutes and treaties by applying canons of
construction developed in the process of two centuries of
judicial decisionmaking.
— There is agreement that courts do and should seek to avoid
finding a conflict between statutes and treaties whenever
possible, so that effect can be given to both.
— There is agreement that, in interpreting statutes and
treaties, courts do and should consider the intent of Congress
and the Administration in enacting the legislation and entering
into the treaty.
— There is agreement that taxpayers should not be permitted
to use treaties in ways not intended by the treaty partners to
prevent application of general tax provisions enacted by
Congress.
Regrettably, the residual override — as currently drafted —
would make it more difficult for courts to reconcile statutes and
treaties in a manner that gives effect to the purposes of both.
In the case of presently unidentified conflicts between statutes
and treaties, the residual override expresses a congressional
intent that the legislation be given effect over pre-existing
treaties in every case. Courts are simply instructed to make the
treaty yield to the later-enacted statute.
As I stated in my testimony last year, we believe that for
the non-judicial branches of government to insist that courts
blindly apply the later-in-time doctrine reflects a lack of
confidence in courts and a lack of regard for treaties. It also

-26-

denies both the United States and its treaty partners the benefit
of case-by-case consideration of how purported conflicts should
be resolved on their merits, in light of the respective purposes
and policies intended to be served by the treaties and the
relevant legislation.
Although the Administration strongly opposes the residual
override as it is currently drafted, we believe the attention
that has been given to the interaction of statutes and treaties
can lead to productive change. We recognize and share the
concerns expressed by congressional staffs that taxpayers not be
permitted to misinterpret or misapply treaties in a manner that
prevents appropriate application of the many important tax
changes included in the recent tax legislation. We agree with
congressional staffs that tiisuse of treaties, if permitted, can
undermine the respect for treaties that is essential to an
effective treaty network. At the same time, we sense broad
agreement in Congress that income tax treaties are an important
benefit for our multinational taxpayers and for the U.S. economy
and thus should be preserved and strengthened.
Accordingly, we are now in the process of discussing with
your staffs and the staff of the Joint Committee on Taxation an
alternative to the residual treaty override that would give
appropriate weight to treaties but would also ensure that
treaties are not misused to undermine congressional intent in
enacting tax legislation.
I urge you to reconsider the residual treaty override of
section 112(aa)(2)(C) and amend the provision appropriately. We
— Congress and the Administration — are presented with a
significant opportunity. Deleting the residual override as it is
currently drafted and substituting a suitable alternative will
reaffirm to treaty partners that the United States takes its
treaty commitments seriously and values its treaty network. It
will deter our treaty partners, many of whom are undergoing their
own tax reform following the United States' lead, from
unilaterally overriding our tax treaties to the detriment of
United States taxpayers and interests. It will remove a
significant impediment in our international relations that has
adversely affected our tax treaty program and has even spilled
over into international relationships on other issues. In
addition, appropriate amendment to this provision will strengthen
the Executive Branch's ability to carry out the responsibility
given it by Congress to implement in our tax treaties the many
important changes in tax law and policy established by the 1986
and 1987 Acts.

TREASURY NEWS
ipartment
off theRELEASE
Treasury • Washington,
D.c. • Telephone
FOR IMMEDIATE
CONTACT:
LARRY BATDORF566-2041
July 14, 1988

(202) 566-2041

RECIPROCAL TAX EXEMPTIONS OF SHIPPING AND AIRCRAFT INCOME
The Treasury Department today announced further agreements
with Finland, Greece and Taiwan for the reciprocal tax exemption
of income from international shipping and aviation.
The
exchanges of notes are in accordance with sections 872 and 883 of
the Internal Revenue Code.
In each case the exemption applies
for taxable years beginning on or after January 1, 1987. Earlier
such agreements with thirteen countries were announced in
Treasury News Releases B-1294 of February 24, 1988 and B-1411 of
May 17, 1988.
Copies of the notes with Finland and Greece are available
from the Office of Public Affairs, room 2315, Department of the
Treasury, Washington, D.C. 20220. The notes with Taiwan will be
released when they arrive in Washington andthave been processed
by the Department of State.
o 0 o

B-1481

NO. 60

The Embassy of the United States of America
presents its compliments to the Ministry of
Foreign Affairs of Finland and has the honor to
propose that the two governments conclude an
agreement to exempt from income tax, on a
reciprocal basis, income derived by. residents of
the other country frdm the international
operation of ships and aircraft.

The terms of

the agreement are as fjollows:
The Government of the United States of
America, in accordance with Sections 872(B) and
883(A) of the Internal Revenue Code, agrees to
exempt from tax gross income derived by an
enterprise of Finland from the international
operation of ships or aircraft.

For this

purpose, an "enterprise of Finland" means an
enterprise carried on by individuals who are
residents of Finland (other than United States
citizens) or by corporations organized in
Finland.

This exemption is granted on the basis

of equivalent exemptions granted by Finland to
enterprises of the United States.
In the case of a Finnish corporation, the
exemption shall apply only if the corporation
meets either of the following conditions:

(-2-)

(1)

More than 50 percent of the value of

the corporation's stock is owned, directly or
indirectly, by individuals who are residents of
Finland or of another country which grants a
reciprocal exemption to United States citizens
and corporations; or,
(2)

The corporation's stock is primarily

and regularly traded on an established
securities market in Finland, or is wholly owned
by a corporation whose stock is "so traded and
which is also organized in Finland.
For purposes of subparagraph (1), the
Government of Finland will be treated as an
individual resident of Finland.

For purposes of

applying the 50-percent test to a foreign
corporation, if the foreign corporation is a
United States controlled foreign corporation, as
defined in Section 957(A) of the Internal
Revenue Code, the United States shareholders of
the foreign corporation are treated as residents
of the foreign country in which the corporation
is organized.

For purposes of subparagraph (1),

stock of a corporation owned by another
corporation, partnership, trust or estate shall
be treated as owned proportionately by the
beneficial owners.

(-3-)

Gross income includes all income derived
from the international operation of ships or
aircraft, including income from the rental of
ships or aircraft on a full (time or voyage)
basis and income from the rental of containers
and related equipment which is incidental to the
international operation of ships or aircraft.
It also includes income from the rental on a
bareboat basis of ships and aircraft used for
international transport.

.-'

The Embassy of the United States of America
considers that this note, together with the
Ministry's reply note confirming that the
a

Government of Finland agrees to these terms,
constitutes an agreement between two
governments.

An enterprise of Finland which

derives income from the international operation
of ships or aircraft may choose to apply to such
income either the provisions of this agreement
or of the convention between the United States
of America and the Republic of Finland with
respect to taxes on income and property, signed
on March 6, 1970, or of any similar convention
subsequently entered into between the two
countries.

This agreement shall enter into

force on the date of the Ministry's reply note

(-4-)

and shall have effect with respect to taxable years
beginning on or after January 1, 1987.
Either government may terminate this agreement
by giving written notice of termination through
diplomatic channels.
The Embassy of the United States of America
avails itself of this opportunity to renew to the
Ministry of Foreign Affairs the assurances of its
highest consideration.

Embassy of the United States of America,

Helsinki, April 8, 1988

This is a true copy of the original Diplomatic Note
No. 60., attested by

Lawrence E. Butler William Kiehl
Economic Officer

A/DCM

OF FINLAND

The Ministry for Foreign Affairs present their compliments to
the Embassy of the United States of America and has the honor
to acknowledge receipt of the Embassy's note of 8 April 1988
containing a proposal for the terms of a reciprocal exemption
from income tax of income derived from the international
operation of ships and aircraft.
The Government of Finland agrees to exempt from tax gross
income derived from the international operation of ships or
aircraft by an enterprise of the United States. For this purpose,
the term "enterprise of the United States" means an enterprise
carried on by U.S. citizens (who are not residents of Finland) or
by corporations organized in the United States.
In the case of a U.S. corporation, the exemption shall apply only
if the corporation meets either of the following conditions:
(1) More than 50 percent of the value of the corporation's stock
is owned, directly or indirectly, by individuals w h o are citizens
of the United States or are residents of another country which
grants a reciprocal exemption

to Finnish

residents

and

corporations; or
(2) The corporation's stock is primarily and regularly traded on
an established securities market in the United States, or is
wholly owned by a corporation whose stock is so traded and
which is also organized in the United States.

To
the Embassy of the United States of America
Helsinki

Gross income includes all income derived from the international
operation of ships or aircraft, including income from the rental
of ships or aircraft on a full (time or voyage) basis and income
from the rental of containers and related equipment which is
incidental to the international operation of ships or aircraft. It
also includes income from the rental on a bareboat basis of
ships and aircraft used for international transport.
The Ministry for Foreign Affairs is pleased to confirm that the
Embassy's Note and this Reply Note constitute an agreement
between the two governments. A n enterprise of the United
States which derives income from the international operation of
ships or aircraft m a y choose to apply to such income either the
provisions of this agreement or of the Convention between the
United States of America and the Republic of Finland with
respect to taxes on income and property, signed on 6 March
1970, or of* any similar convention subsequently entered into
between the two countries. This agreement shall enter into
force on today's date and shall have effect with respect to
taxable years beginning on or after 1 January 1987.
Either Government may terminate this agreement by giving
written notice of termination through diplomatic channels.
The Ministry for Foreign Affairs take this opportunity to renew
to the Embassy of the United States of America the assurance
of their highest consideration.

Helsinki, 22 April 1988

/vfV.,A'**j'"...

V v. • ., . ; SJ
.

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•

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/

The Department of State proposes to the Embassy of
Greece that the Government of the United States of
America and the Government of Greece conclude an
agreement to exempt from income tax, on a reciprocal
basis, income derived by residents of the other
country from the international operation of ships and
aircraft.

The terms of the agreement are as follows:

The Government of the United States of America, in
accordance with sections 872(b) and 883(a) of the
Internal Revenue Code, agrees to exempt from tax gross
income derived from the international operation of
ships or aircraft by individuals who are residents of
Greece (other than U.S. citizens) and corporations
organized in Greece.

This exemption is granted on the

basis of equivalent exemptions granted by Greece to
citizens of the United States (who are not residents
of Greece) and to corporations organized in the United
States (which are not subject to tax by Greece on the
basis of residence).
In the case of a Greek corporation, the exemption
shall apply only if the corporation meets the
ownership or public trading requirements of U.S.
domestic law.

In the case of a corporation

.incorporated in a third country which grants an

- 2 corporations, section 883(c) of the Internal Revenue
Code will not apply if more than 50 percent of the
value of the stock of the corporation is owned by
individuals who are residents of Greece.
Gross income includes all income derived from the
international operation of ships or aircraft,
including income from the rental of ships or aircraft
on a full (time or voyage) basis and income from the
rental of containers and related equipment which is
incidental to the international operation of ships or
aircraft.

It also includes income from the rental on

a bareboat basis of ships and aircraft used for
international transport.
The Department of State considers that this note,
together with the Embassy's reply note confirming that
the Government of Greece agrees to these terms,
constitutes an agreement between the two Governments*
which shall enter into force on the date of the
Embassy's reply note and shall have effect with
respect to taxable years beginning on or after January
1, 1987.
A resident or corporation of Greece which derives
income from the international operation of ships or
aircraft may choose to apply to such income either the
provisions of the agreement or of the tax treaty
between the United States and Greece signed on
February 20, 1950.

- 3 Either Government may terminate this agreement by
giving written notice of termination through
diplomatic channels.

Washington,

June 10, 1988

EMBASSY OF GREECE
WASHINGTON. D. C

Ref. No. 1069.1/AS872

The Embassy of Greece presents its compliments to the Department of State and has the honor to acknowledge receipt of the
Department's note dated June 10, 19BB proposing the terms of a
reciprocal exemption From income tax of income derived from the
international operation of ships and aircraft.

The Government of Greece in accordance with its relevant legislation, agrees to exempt from income tax on a reciprocal basis
gross income derived from the international operation of ships or
aircraft by U.S. citizans Ctuho are not residents of Greece) end
corporations organizsd in the United States Cother then corporations which are subject to tax by Greece on the basis of residence*) .

In the case of a U.S. corporation, the exemption shall apply
only if ths corporation meets the ownership or public trading
requirements of Greece's domestic law.

Gross income includes all income derived from the international operation of ships or aircraft, including income from ths
rental of ships or aircraft on a full Ctime or voyage) basis and
income from the rental of containers and related equipment which
is incidental to the international operation of ships or aircraft. It also includes income from rental on a bareboat basis of
ships and aircraft used for international transport.

The Embassy is pleased to confirm that the Department of
State's note and this reply note constitute an agreement between
the two Governments, which shall enter into force on today's date
and shall have effect with respect to taxable years beginning on
or after January 1, 1987.

a resident or corporation of the United States which derives
income from the international operation of ships or aircrafts say
choose to apply to such income either the provisions of this
agreement or of the tax treaty between the United States end
Greece signed on February 80. 1950.

Either Government may terminate this agreement by giving
written notice of termination through diplomatic channels.

The Embassy of Greece avails itsslf of this opportunity to
renew to the Department of State the essurancas of its highest
consideration.

Washington, D.C.
June 10, 19BB

TREASURY NEWS
department of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT;
FOR IMMEDIATE RELEASE
July 1 8 , 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

OFFICE OF FINANCING

(202) 376-4350

Tenders for $6,671 million of 13-week bills and for $6,627 million
of 26-week bills, both to be issued on July 21, 1988,
were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing
October 20, 1988
Discount Investment
Price
Rate
Rate 1/
6.75%
6.77%
6.76%

6.96%
6.98%
6.97%

98.294
98.289
98.291

26-week bills
maturing January 19, 1989
Discount Investment
Rate
Rate 1/
Price
7.07%
7.09%
7.09%

7.43%
7.45%
7.45%

96.426
96.416
96.416

Tenders at the high discount rate for the 13-week bills were allotted 6%.
Tenders at the high discount rate for the 26-week bills were allotted 69%
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

Accepted

$

36.025
30,044,130
24,145
29,805
40,160
35,550
1,265,820
27,220
17,005
32,595
19,135
1,119,810
206,205

$
36,025
6,099,200
24.145
29,710
40,160
35,550
51,620
23,220
7,005
27,655
19,135
71,810
206,205

$
37,615
21,333,275
23,830
50,880
36,695
47,100
906,695
38,375
13,510
48,635
24,235
1,288,325
155,585

$ 37,115
6,017,110
21,830
40,415
36,695
44,750
56,695
30,915
8,510
44,255
24,235
108,825
155,585

$32,897,605

$6,671,440

$24,004,755

$6,626,935

Competitive
Noncompetitive
Subtotal, Public

$29,426,685
896,120
$30,322,805

$3,200,520
896,120
$4,096,640

$1,998,680
376, 500
$19

Federal Reserve
Foreign Official
Institutions

2.030,200

2,030,200

1,750,000
1,750 ,000

544,600

544,600

2,019,300
2 ,019 ,300

$32,897,605

$6,671,440

$24,004,755 $6,626,935

TOTALS

IZ£e

TOTALS
V

Equivalent coupon-issue yield

B-1482

858 955
$20 ,235 455

858,955
$2,857,635

TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
Text as Prepared
For Release Upon Delivery
Expected at 11:30 a.m. DST

Remarks by Thomas J. Berger
Deputy Assistant Secretary For International Monetary Affairs
U.S. Department of the Treasury
before ttie
Institute for International Research Conference
on
Penetrating Japanese Markets
Washington, D.C.
July 18, 1988
Structural Adjustment in the Land of the Rising Sun:
Japan's Next Great Challenge
Introduction
Good morning, ladies and gentlemen. It is a pleasure for me
to address this conference regarding current economic trends in
Japan and their impact on American companies doing business in the
Land of the Rising Sun. In talking about the "Japanese economy"
we must be careful to recognize that there are, in fact, two
Japanese economies. One is the international, free-market
oriented, manufacturing economy that is one of the most productive
in serving the world's demand for high-quality, technologically
sophisticated goods. The other is Japan's internal economy that
serves its domestic markets rather less well, presenting Japanese
consumers and investors with relatively high-cost goods and
services, even in the face of import competition; this economy is
held back by a vast network of regulations, tradition and
institutional barriers. It is in need of wide-ranging structural
reforms in order to achieve its full potential.
This morning I would like to briefly discuss with you
(1) Japan's two economies, (2) where changes are occurring
domestically, (3) what further reforms are needed and (4) what
the implications are for U.S. companies.

B-1483

- 2 -

Japan's External Economy
From reading the newspaper headlines, you might believe that
recent developments in Japan make it the ultimate success story.
In the first quarter of 1988, real GNP increased at an annual rate
of 11.3 percent — over three times the U.S. GNP growth rate for
the same period; consumer prices actually fell at an annual rate
of 0.8 percent and unemployment averaged only "2.7 percent.
Perhaps the most headline-grabbing bit of news was that Japan's
per capita GNP in 1987, at $19,200, surpassed the figure of
$18,200 for the United States.
The first quarter 1988 real GNP growth rate I just mentioned
was the highest quarterly figure for Japan in over ten years.
Indeed, if real GNP growth were to cease for the rest of the year,
Japan would still achieve a growth rate of at least 5 percent on
a year-average basis for 1988. This is certainly a strong
indication that Japan has weathered well the almost 100 percent
appreciation of the yen against the dollar since early 1985.
Adjustment of the external accounts in Japan has also been
progressing, even if somewhat more slowly. The 1987 current
account surplus rose slightly in dollar terms, but measured in
yen, it declined by about 14 percent from 1986 levels. Import
and export volume changes in 1987 were in the right direction
with imports increasing by 9.3 percent and exports registering
an upward movement of only 0.3 percent.
Both the Japanese inflation and unemployment rates are low
and expected to remain so, especially relative to the United
States. Consumer prices rose 0.1 percent in 1987 -- compared to a
3.7 percent increase in the United States -- and should rise no
more than 1.0 percent in 1988. Japan's fiscal policy should not
fan inflationary expectations anytime in the near future. The
central government budget deficit should drop to around 2 percent
of GNP in 1988. If you were to count the balance on social
security, as we do in the United States, the Japanese government
budget balance would be in surplus, albeit a small one, in 1988.
Japan's Internal Economy
Ironically, Japan's spectacular success in international
trade and commerce is not reflected fully in its domestic economy.
Although the unemployment rate is low, there is a widespread
redundancy of workers — so-called "underemployment". For
example, the inefficient retail and farming sectors are allowed to
survive in order to accommodate workers that elsewhere would be
either let go or retired early.
Although the inflation rate is almost zero, price levels are
quite high -- paying $50 for a melon and $70,000 per square foot
of land in Tokyo's business district are but two examples. In
fact, after taking into account such different relative price

-

5

-

levels, Japan's real per capita GNP as measured by the OECD on a
purchasing power parity basis becomes just $13,100, well below the
$18,200 figure for the U.S. I mentioned earlier.
Why is it that Japan's internal or "second" economy is less
of a success story than its external counterpart? An important
reason for this is that while old-fashioned, free-market
principles are respected and revered in Japan's international
manufacturing economy, there is much less of this orientation in
the Japanese domestic market. Instead, there exists a multitude
of government regulations and structural impediments that seem
designed to protect the status quo. These include inefficient
distribution systems, quantitative import restrictions,
administrative actions, cartel-like behavior and certification
requirements, among others. The end result is a higher price
structure, reduced economic activity and a lower level of imports.
A practical example of how these restrictions slow the
demand for imports is the difficulty U.S. and other foreign firms
have in introducing new products to the Japanese market. U.S.
firms typically use special premiums and other promotional devices
to introduce a new product or to spark new demand. However, in
Japan, the Japan Fair Trade Commission works together with groups
of domestic manufacturers to design market standards. Such
standards, including restrictions on the use of sales promotion
techniques, sometimes serve to inhibit foreign products from
gaining access to Japanese markets. Until recently, in one
industry the maximum promotional premium allowable was just
2-3 percent of the retail price -- not much of an incentive to
either the retailer or consumer they are directed at.
Turning to the farming sector, food prices in Japan are kept
well above international levels by using various laws that regulate price and distribution. Japan imports 86 percent of its
wheat. Yet, despite the substantial yen appreciation since 1985
that would normally be expected to lower the price of imports,
wheat prices have remained almost constant since 1984. Sugar and
milk prices are also kept artificially high and, as a result,
products made from these staples, such as bread and cookies, are
also expensive. On the other hand, poultry, eggs and other foods
that are marketed based on supply and demand are relatively
inexpensive .
Another example of how structural impediments in the domestic
economy blunt the demand for imports (despite substantial exchange
rate changes) is the institutional resistance to price reductions.
Recent Bank of Japan statistics show that while the prices of
imported goods entering Japanese markets have fallen 23 percent
since 1985, the prices of competing domestic products have dropped
by only half that amount. In the case of consumer products, the
prices of the competing domestic products have fallen by only a
thi rd as much. In most other economies such a divergence in
prices between imports and exports would bring forth a flood of
imports. Why hasn't this happened in Japan?

- 4 -

Part of the answer lies in the inability of certain
lower-priced foreign goods to actually reach final consumers at
those lower prices. In theory, international arbitrage — the
purchase of a good in the lower-price market and sale of the same
gocd in the higher-price market -- should remove major price
diiferences so that only transportation and other delivery costs
would be reflected. However, as a practical matter, arbitrage has
been prevented or slowed in a number of Japanese domestic markets.
The prices of certain foreign goods, once inside the Japanese
domestic economy, are raised by means of long-term supplier relationships which limit opportunities for new entrants, distribution
systems that sometimes prevent foreign goods from reaching the
consumer, government price controls and other factors. In such
circumstances, the competitive pressure in the tradeable goods
sector is diminished and consumers and investors have less
effective purchasing power.
The mechanism of Japan's marketing and distribution
systems, whether it be for food, durable goods, home appliances,
electronics, autos or leisure goods, overwhelmingly favor the
interests of the producer and not the consumer. Products
controlled by oligopolies, such as automobiles and electrical
appliances, have closed distribution channels. Legislation
protects other distribution networks through, for example, the
Alcoholic Beverage Approval Law, the Food Control Law and the
Large-Scale Retailing Law.
We often hear that the reason for the high cost of land in
Japan is the country's population density. Actually, Japan's
population density is below that of New Jersey where I grew up
and roughly the same as Massachusetts where I went to college.
And the Tokyo region is only slightly more densely populated than
New York City. In fact, various land-use regulations that interfere with the efficient functioning of the free market are more to
blame for the high prices. Examples include tax breaks for farm
land, rent-control laws that make redevelopment difficult and a
system that levies taxes on old houses and apartment buildings
based on their value in their current form rather than on their
much greater value as building sites.
It is because of the need for structural reform in Japan, and
in other industrial countries, that at the Toronto Economic Summit
last month the United States pushed for structural adjustment
objectives to be adopted as a regular part of the Group of Seven
(G-7) economic policy coordination process. The G-7 countries
recognized and stated in the Toronto Economic Declaration that:
"international cooperation involves more than coordination of
macroeconomic policies." Accordingly, the G-7 countries agreed
to "continue to pursue structural reforms by removing barriers,
unnecessary controls and regulations; increasing competition,
while mitigating adverse effects on social groups or regions;
removing all disincentives to work, save and invest, such as
through tax reform; and by improving education and training."

- 5 -

The specific priorities for each country were outlined in an
annex to the Summit Declaration.
How Japan Is Changing
Respected Japanese authorities -- such as the Maekawa
Committee, the central bank and noted private research groups -recognize the need for removing structural rigidities. Earlier this
year, the Bank of Japan stated: "It is of vital importance... to
continue to make every effort to open up Japan's markets further by
reforming the institutional framework and traditional practices...."
The Japanese government's new Five-Year Economic Plan, presented in
May, recommitted the government to push for structural adjustment
measures put forward in other fora.
Some changes recommended in the 1986 Maekawa Report have
already taken place. One aim was to stimulate domestic demand,
and, with the aid of the 1987 Economic Stimulus Package, domestic
demand has definitely been given a significant boost. What is
not yet clear is how much of that will translate into increased
domestic demand for imports, which is the ultimate goal. More
specifically, the Maekawa Report also called for tax reductions to
increase disposable income. Under the first stage of tax reform
legislated in the fall of 1987, the top marginal tax rate was cut
from 70 to 60 percent. In the second stage, due to be considered
by the Diet this month, another reduction in the top rate to 50
percent will be discussed. The introduction of an indirect tax
similar to Europe's VAT is planned to help finance these reductions in direct taxes. This will be coupled with the removal of
the current complicated maze of individual excise taxes.
Another recommendation from the Maekawa Report was the
removal of the preferential tax treatment for savings. The tax
exemption for interest on small-denomination savings was largely
abolished as part of the fall 1987 tax legislation, and went into
effect in April of this year. In response to the new tax on
interest, individual savers have been diverting a significant
portion of their funds to the equity market. To prevent the
growing disintermediation of funds from harming the banking
system, it is essential that the financial authorities quickly
liberalize interest rates on small deposits to make these
alternatives more attractive to investors.
Over recent years, the Japanese financial markets, also
highlighted in the Maekawa Report, have been experiencing the
winds of change. As you may be aware, the U.S. Treasury has been
engaged in a series of negotiations with the Japanese Ministry of
Finance, known as the "Yen/Dollar Talks," which have focused on
needed financial market changes. The most impressive progress has
been in the internationalization of the yen. This process has
been fostered through the development of a Euroyen market, which
has helped the yen to reflect more fully Japan's position as the
world's second largest economy. Starting with just $1 billion in
Euroyen bond issues in 1984, volume reached $23 billion at the end
of last year, making it one of the largest Euromarkets after the

- 6 -

dollar sector. Progress has also been made in improving the
access of foreign financial institutions to the Japanese market.
Foreign firms first joined the Tokyo Stock Exchange in 1986 and
now hold 22 out of a total of 114 seats. Foreign commercial banks
have been granted licenses to do trust banking and to indirectly
enter the securities business. In general, the degree of access
and transparency has improved considerably in the last few years,
although significant problems remain.
Meanwhile, as a result of greater consumer sophistication and
exchange rate movements that have produced a higher yen, cracks
are beginning to appear in Japan's traditional distribution
channels. The existing structure is certainly not collapsing, but
bargain hunters and some non-traditional retailers now pose a
perceptible, if limited, challenge to traditional networks of
distribution. A growing stream of relatively inexpensive manufactured imports from Asia — mainly textiles and food products,
but including increasing amounts of consumer electronics,
appliances and leisure goods — are reaching the Japanese market.
Discount stores are growing in popularity. Japanese entrepreneurs
have lately begun to exploit the price differences between similar
products available abroad and domestically in Japan through the
re-import of Japanese goods previously exported. For example, a
discounter in Japan recently re-imported cordless telephones and
sold them for the equivalent of $75 as opposed to the $646 price
on similar domestic models. Unfortunately, the volume of these
changes is not yet sufficient to have a profound effect on our
trade balance, nor is there necessarily a Japanese "consensus" to
encourage them.
Where Further Changes Are Needed
In Japan, an official report or study is often the first step
toward change. A case in point was the 1986 Maekawa Report which
was meant to be a blueprint for restructuring the Japanese
economy. Although some of the Maekawa Report's recommendations in
the macroeconomic area have been carried through -- including
stimulating domestic demand and partial tax reform — most of the
microeconomic recommendations have not been implemented. Needed
measures that have not been acted on include streamlining the
distribution system, further reducing working hours, strictly
enforcing the Anti-Monopoly Law, overhauling outdated building and
development codes, and further financial market liberalization.
Indeed, significant additional progress needs to be made
in the financial sector before it can be considered truly open,
market-driven and competitive. For example, the smalldenomination bank deposit that the average Japanese family might
hold currently returns only one-half of one percent because of
Ministry of Finance regulations. Access to the Japanese 10-year
government bond market, essentially 90 percent of all traded bonds
in Japan, is restricted through a tightly regulated syndicate
system in which all foreign firms together are allowed only 2.5
percent of newly-issued bonds. In comparison, under the auction

- 7 -

system in the United States, any one firm, foreign or domestic,
can take up to 35 percent of any one issue, and any three firms,
foreign or domestic, could conceivably take an entire issue.
Radical changes are also needed in the crucial areas of land
use patterns. Subsidies and taxes that keep land in urban areas
employed in farming should be eliminated.
Other structural rigidities that need to be addressed include
some obstacles that are relatively intangible such as the longterm supplier relationships I mentioned earlier that put foreign
producers at a disadvantage; cartel-like behavior by domestic
firms; tightly organized business associations; and the cultivated
perception of poor quality in foreign-produced goods.
There are other obstacles and rigidities that have not yet
fully emerged, but which the Japanese government will have to
contend with in the near future. These include the strains caused
by an aging population and the growing presence of women in a
traditionally male-dominated labor force.
Can Japan Change?
In evaluating the steps taken so far by Japan to remove
structural rigidities, the question is often asked whether Japan
will persevere. Can Japan continue to change and meet its next
greatest challenge?
One thing is clear. Meeting the challenge of successful
structural reform will take more than traveling abroad, buying
foreign goods and appearing at international meetings.
Although it is true that old habits are hard to shake off,
anyone who has traveled in Japan and spent time with these
remarkable people must be optimistic that change will come. Their
hard work, self-discipline, dedication and deep belief in the
worth of their country are an inspiration to us all. Let us hope
that these same qualities that have led to Japan's international
economic success will eventually force a more efficient and more
consumer-oriented domestic economic system.
If Japan is able to persevere and effect meaningful
structural reform, the implications are clear. For U.S. companies
doing business in Japan, it will mean a larger, more competitive
and more open market with an increased potential for profit. For
Japan, the removal of structural barriers will result in a more
robust domestic economy, higher productivity, lower prices and a
higher quality of everyday life. More generally, it will lead to
a faster reduction in existing trade imbalances between the U.S.
and Japan. This in turn will contribute to stable foreign
exchange
markets. These are certainly goals worth
Thankandyoufinancial
very much.
striving for.

TREASURY NEWS

Department
Treasury
e Washington,
D.C.Office
• Telephone
566-2041
FOR RELEASEof
ATthe
4 00
P.M.
CONTACT:
of Financing
July 19, 1988

202/376-4350
TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$13,200 million, to be issued July 28, 1988.
This offering
will provide about $250
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $12,960 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, July 25, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,600
million, representing an additional amount of bills dated
October 29, 1987
and to mature October 27, 1988
(CUSIP No.
912794 QB 3), currently outstanding in the amount of $15,709 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,600 million, to be dated
July 28, 1988,
and to mature January 26, 1989
(CUSIP No.
912794 RD 8).
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 July 28, 1988.
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 $1,436 million as agents for foreign
and international monetary authorities, and $3,240 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 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series)
B-1484

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS
Department of the Treasury e Washington, D.C. e Telephone 566-2041
FOR IMMEDIATE RELEASE
July 19, 1988

Contact; Bob Levine
566-2041

TREASURY STATEMENT ON BRAZILIAN BRIDGE LOAN

The U.S. Department of Treasury announced today that it has
agreed to participate in a multilateral bridge arrangement to
provide Brazil with approximately $500 million in short-term
financing.

The Bank for International Settlements (BIS) is also

participating in this bridge, supported by a number of central
banks.

United States participation in this multilateral effort

indicates our strong support for Brazil's economic reform efforts
and financing plan for 1988/89 in cooperation with the international financial community, including a stand-by arrangement
with the International Monetary Fund.

B-1485

TREASURY NEWS
Department of the Treasury e Washington, D.C. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
July 20, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY TO AUCTION $8,750 MILLION OF 2-YEAR NOTES
The Department of the Treasury will auction $8,750 million
of 2-year notes to refund $10,403 million of 2-year notes maturing
July 31, 1988, and to paydown about $1,650 million. The public
holds $10,403 million of the maturing 2-year notes, including
$1,064 million currently held by Federal Reserve Banks as agents
for foreign and international monetary authorities.
The $8,750 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 $1,478 million
of the maturing securities that may be refuncled 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-1487

HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 2-YEAR NOTES
TO BE ISSUED AUGUST 1, 1988
July 20, 1988
Amount Offered:
To the public

$8,750 million

Description of Security:
Term and type of security
2-year notes
Series and CUSIP designation .... AD-1990
(CUSIP No. 912827 WL 2)
Maturity date
July 31, 1990
Call date
No provision
Interest rate
To be determined based on
the average of accepted bids
Investment yield
To be determined at auction
Premium or discount
To be determined after auction
Interest payment dates
January 31 and July 31
Minimum denomination available .. $5,000
.Terms of Sale:
Method of sale
Yield auction
Competitive tenders
Must be expressed as an
annual yield, with two
decimals, e.g., 7.10%
Noncompetitive tenders
Accepted in full at the average price up to $1,000,000
Accrued interest
payable by investor
None
Payment Terms:
Payment by noninstitutional investors
Full payment to be
submitted with tender
Payment through Treasury Tax
and Loan (TT&L) Note Accounts ... Acceptable for TT&L Note
Option Depositaries
Deposit
guarantee by
Key Dates:
designated
Acceptable July 27, 1988,
Wednesday,
Receipt of institutions
tenders
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a) funds immediately
Monday, August 1, 1988
available to the Treasury
Thursday, July 28, 1988
b) readily-collectible check

TREASURY NEWS

Department of the Treasury e Washington, D.C. • Telephone 566-2041
10
FOR RELEASE AT 12:00 NOON
July 22, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY'S 52-WEEK BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for approximately $9,000
million of 364-day Treasury bills
to be dated August 4, 1988,
and to mature August 3, 1989
(CUSIP No. 912794 SJ 4 ) . This issue will result in a paydown for
the Treasury of about $575
million, as the maturing 52-week bill
is outstanding in the amount of $9,574
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, Thursday, July 28, 1988.
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.
The bills will be issued for cash and in exchange for
Treasury bills maturing August 4, 1988.
In addition to the
maturing 52-week bills, there are $13,160 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 currently hold $1,745 million as agents for foreign
and international monetary authorities, and $6,271 million for their
own account. These amounts represent the combined holdings of such
accounts for the three issues of maturing bills. 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 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 $150
million
of the original 52-week issue. Tenders for bills to be maintained
on the book-entry records of the Department of the Treasury should
be submitted on Form PD 5176-3.
B-1488

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 tende:
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
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, .AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS
Department of the Treasury e Washington, D.C. e Telephone 566-2041
FOR IMMEDIATE RELEASE

July 25, 1988

Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of June 1988.
As indicated in this table, U.S. reserve assets amounted to
$41,028 million at the end of June, down from $41,949 million in May

U.S. Reserve Assets
(in millions of dollars)

End
of
Month

Total
Reserve
Assets

Gold
Stock 1/

Special
Drawing

Rights

41,949
41,028

11,063
11,063

9,543
9,180

yy

Foreign
Currencies 4/

Reserve
Position
in IMF 2/

10,912
10,793

10,431
9,992

1988
May
June

1/ Valued at $42.2222 per fine troy ounce.
2/ Beginning July 1974, the IMF adopted a technique for valuing the SDR
based on a weighted average of exchange rates for the currencies of
selected member countries. The U.S. SDR holdings and reserve
position in the IMF also are valued on this basis beginning July
1974.
3/ Includes allocations of SDRs by the IMF plus transactions in SDRs.
4/ Valued at current market exchange rates.

B-1489

TREASURY NEWS
ipartment of the Treasury* Washington, D.C. e Telephone 566-2041
FOR IMMEDIATE RELEASE

July 25, i$88

CONTACT:

LARRY BATDORF

(202) 566-2041

UNITED STATES AND INDONESIA SIGN INCOME TAX TREATY
The Treasury Department announced today that the United
States and Indonesia have signed a treaty for the avoidance of
double taxation and the prevention of fiscal evasion with respect
to taxes on income, together with a related protocol and exchange
of notes. The proposed treaty, protocol and notes were signed in
Jakarta on July 11, 1988 by Secretary of State George Shultz and
Indonesian Minister of Foreign Affairs Ali Alatas.
They will
enter into force on the exchange of instruments of ratification.
The proposed treaty is the first such treaty signed by the
two countries. It is based on the model draft treaties published
by the United States, the Organization for Economic Cooperation
and Development, and the United Nations.
It also takes into
account recent tax law changes in both countries. In recognition
of Indonesia's status as a developing country, the proposed
treaty permits higher taxation at source than is permitted in
U.S. tax treaties with other industrial countries. For example,
the maximum rate of withholding tax at source on dividends,
interest and royalties is generally 15 percent, with an exemption
for interest paid to instrumentalities of the other government
and a 10 percent maximum rate on payments for the leasing of
certain equipment. It also provides lower thresholds (120 days)
for the taxation of certain business and employment income than
many U.S. income tax treaties.
The accompanying protocol and exchange of notes set forth
certain understandings with respect to specific provisions of the
treaty.
a*

The proposed treaty, together with the protocol and notes,
will be transmitted to the Senate for its advice and consent to
ratification.
They will enter into force on the exchange of
instruments of ratification.
The provisions with respect to
withholding taxes on dividends will take effect for amounts paid
or credited on or after the first day of the second month
following its entry into force. The provisions with respect to
other taxes take effect for taxable years beginning on or after
January 1 of the year of entry into force.
A copy of the proposed treaty and the accompanying exchange
of notes may be obtained from the Office of Public Affairs, U.S.
Treasury Department, room 2315, Washington, D.C. 20220.
oB-1490
0 o

TREASURY NEWS
Department of the Treasui*y • Washington, D.C. • Telephone
CONTACT: Office of Financing
FOR IMMEDIATE RELEASE
202/376-4350
July Jb, i y 0 0
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,611 million of 13-week bills and for $6,606 million
of 26-week bills, both to be issued on
July 28, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-•week bills
26- week bills
maturing October 27, 1988
maturing January 26 , 1989
Discount Investment
Discount Investment
Price
Price
Rate
Rate 1/
Rate
Rate 1/
7.07% b/
96.426
7.04%
98.274
7.43%
Low
6.83% £/
96.406
7.11%
98.256
7.48%
7.12%
6.90%
High
96.416
7.09%
98.261
7.45%
7.10%
6.88%
Average
a/ Excepting 2 tenders totaling $7, 225,000
b/ Excepting 1 tender of $500,000.
Tenders at the high discount rate for the 13- •week bills were allotted 13%.
Tenders at the high discount rate for the 26- •week bills were allotted 14%.

Location

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
Received
Received

Accepted

Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS

$ 28,670
$ 28,670
18,366,375
5,363,625
34,660
34.660
32,985
32,985
48,555
48,555
27,855
27,855
889,900
372,400
22,455
22,455
5,260
5,260
32,720
32,720
31,285
21,935
1,233,110
236.740
383,475
383,475
$21,137,305
$6,611,335

$ 34,660
17,766,895
20,140
40,465
50,440
24,050
815,190
23,795
10,320
36,310
30.990
1,268,375
487,620
$20,609,250

$
34,660
5,627,895
20.140
40,465
50,440
24,050
100,690
23.795
10,320
36,310
25,990
124,075
487,620
$6,606,450

Ty^e
Competitive
Noncompetitive
Subtotal, Public

$18,314,060
1,003,865
$19,317,925

$3,788,090
1,003,865
$4,791,955

$16,688,330
1,064,340
$17,752,670

$2,685,530
1,064,340
$3,749,870

Federal Reserve
Foreign Official
Institutions

1,690.160

1,690,160

1,550,000

1,550,000

129,220

129,220

1,306,580

1,306,580

TOTALS

$21,137,305

$6,611,335

$20,609,250

$6,606,450

An additional $57,080 thousand of 13-week bills and an additional $647,420
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
V

Equivalent coupon-issue yield

B- 1491

2041

TREASURY NEWS .
Department
of AT
the4:00
Treasury
e Washington,
D.C.
• Telephone
566-2041
FOR RELEASE
P.M.
CONTACT:
Office
of Financing
July 26, 1988

202/376-4350
TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$13,600 million, to be issued August 4, 1988.
This offering
will provide about $450
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,160 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, August 1, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,800
million, representing an additional amount of bills dated
May 5, 1988,
and to mature November 3, 1988
(CUSIP No.
912794 QS 6 ) , currently outstanding in the amount of $6,910 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,800 million, to be dated
August 4, 1988,
and to mature February 2, 1989
(CUSIP No.
912794 RE 6 ).
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 August 4, 1988.
In addition to the maturing
13-week and 26-week bills, there are $9,574
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 $ 1,455 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $1,605 million as
agents for foreign and international monetary authorities, and $6,271
million 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 5176-1
B-1492
(for 13-week series) or Form PD 5176-2 (for 26-week series).

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 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.
10/87

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
[•reasury of the amount and yield range of accepted bids. Com)etitive bidders will be advised of the acceptance or rejection of
:heir tenders. The Secretary of the Treasury expressly reserves
:he right to accept or reject any or all tenders, in whole or in
jart, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
Dr less without stated yield from any one bidder will be accepted
Ln 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
bhree 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
July 27, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF AUCTION OF 2-YEAR NOTES
The Department of the Treasury has accepted $ 8,782 million
of $ 23,516 million of tenders received from the public for the
2-year notes, Series AD-1990, auctioned today. The notes will be
issued August 1, 1988, and mature July 31, 1990.
The interest rate on the notes will be 8-3/8%. The range
of accepted competitive bids, and the corresponding prices at the
8-3/8% rate are as follows:
Yield
Price
Low
8.40%*
99.955
High
8.42%
99.919
Average
8.41%
99.937
*Excepting 3 tenders totaling $100,000.
Tenders at the high yield were allotted 67%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
$
75,345
$
75,345
New York
20,004,785
7,283,615
Philadelphia
55,045
54,055
Cleveland
83,440
83,440
Richmond
114,435
89,145
Atlanta
54,590
53,260
Chicago
1,582,515
537,115
St. Louis
86,375
82,550
Minneapolis
43,455
42,465
Kansas City
156,030
156,030
Dallas
29,410
24,410
San Francisco
1,214,955
284,555
Treasury
15,715
15,715
Totals
$23,516,095
$8,781,700
The $ 8,782 million of accepted tenders includes $ 1,366
million of noncompetitive tenders and $ 7,416 million of competitive tenders from the public.
In addition to the $ 8,782 million of tenders accepted in
the auction process, $605 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $1,478 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-1493

TREASURY NEWS
lepartment of the Treasury • Washington, D.C. • Telephone 566-2041
July 28, 1988
Robert B. Zoellick to Leave Treasury
Secretary James A. Baker, III announced today the resignation
of Robert B. Zoellick, Counselor to the Secretary and Executive
Secretary. Mr. Zoellick is leaving to become the Campaign
Issues Director of Vice President Bush's Campaign for President.
In that post, he will supervise all issues and policy development
for the campaign.
Robert Zoellick joined the Treasury Department in July, 1985,
as the Special Assistant to Deputy Secretary Richard G. Darman.
Shortly thereafter, he became Deputy Assistant Secretary for
Financial Institutions Policy, working for Under Secretary
George D. Gould and Assistant Secretary Charles 0. Sethness.
In August, 1986, Zoellick began working directly for Secretary
Baker as Executive Secretary and Special Advisor to the Secretary.
In January of 1988, "he was promoted to the Assistant Secretarylevel rank of Counselor to Secretary Baker, while retaining his
other responsibilities.
Secretary Baker noted that "Bob has been of great aid to me in
helping to develop and implement the Department's international
and domestic priorities since 1986. I appreciate in particular
his work on the U.S.-Canada Free Trade Agreement, the omnibus
trade bill, and the budget and reconciliation packages. Bob has
played a key role for me and for the Department during his three
years of service here. He is a first-rate public servant, and we
will miss him."
Under Secretary Gould added that Zoellick played an important
role in efforts to design and secure enactment of Treasury's
plan to recapitalize the FSLIC fund. "In the face of considerable
opposition, Bob's perservance proved a crucial contribution at a
critical time." Gould also noted that Zoellick's work with the
Farm Credit System helped save taxpayers billions of dollars
while ensuring the System's continued viability.
Immediately before coming to the Treasury Department, Zoellick
served as Vice President and Assistant to the Chairman and CEO
of Fannie Mae. He is a phi Beta Kappa graduate of Swarthmore
College, and earned a J.D. magna cum laude from Harvard Law
School and an M.P.P. from Harvard's Kennedy School of Government.
B-1494

TREASURY NEWS
Department
of the Treasunr • Washington,
D.C.Office
• Telephone
566-2041
of Financing
CONTACT:
FOR IMMEDIATE RELEASE
July 28, 1988

202/376-4350
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION

Tenders for $9,021 million of 52-week bills to be issued
August 4, 1988,
and to mature August 3, 1989,
were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Rate
7.39%
7.41%
7.40%

Investment Rate
(Equivalent Coupon-Issue Yield) Price
92.528
Low
7.94%
92.508
High
7.96%
92.518
Average 7.95%
Tenders at the high discount rate were allotted 76%.

Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Type

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
Received
$ 15,255
$
15,255
28,659,565
8,296,855
10,925
10,925
20,195
20,195
23,920
18,920
14,560
14,560
1,194,600
108,000
10,495
10,495
4,870
4,870
21,945
21,915
17,480
7,480
1,361,975
330,375
160,705
160,705
$31,516,490
$9,020,550

Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

$28,401,080
465,410
$28,866,490
2,500,000

$5,905,140
465,410
$6,370,550
2,500,000

150,000

150,000

$31,516,490

$9,020,550

An additional$245,000 thousand of the bills will be issued
to foreign official institutions for new cash.

B-1495

rREASURY NEWS
ipartment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
Contact: Charley Powers
Friday, July 29, 1988
566-8773
TREASURY DEPARTMENT ASSESSES FIRST CIVIL PENALTY
AGAINST A CURRENCY EXCHANGE HOUSE
Salvatore R. Martoche, Acting Assistant Secretary of Treasury for
Enforcement, today announced civil penalties totalling $3.01
million against Oscar's Money Exchange of Hildago, Texas, its
owner Oscar Ortiz Alvarez, and Antonio Franco, for violations of
the Bank Secrecy Act. This is the first time that Treasury has
imposed a civil penalty against a currency exchange house. It
reflects increased efforts by Treasury to detect and deter money
laundering being conducted through the use of currency dealers
and exchangers.
The Bank Secrecy Act requires that persons who transport currency
or currency equivalent monetary instruments in excess of $10,000
into or out of the United States to file a report with the United
States Customs Service. The purpose of requiring these reports
under the Bank Secrecy Act is to assist Government efforts in
criminal, tax and regulatory investigations and proceedings.
This case originated through an investigation by the North
Central and Gulf Coast Organized Crime Drug Enforcement Task
Forces (OCDETF). This OCDETF is comprised of special agents and
police officers from the U.S. Customs Service, Internal Revenue
Service, Federal Bureau of Investigation, Bureau of Alcohol,
Tobacco and Firearms, Drug Enforcement Administration, Texas
Department of Public Safety and the U.S. Marshals Service.
Antonio Franco is currently serving 35 years in a federal prison
for his participation in a massive drug smuggling and distribution ring. This organization laundered $5.56 million through
Oscar's Money Exchange. In June 1987, Federal agents seized
$2.55 million after executing a search warrant at Oscar's Money
Exchange. The remaining $3.01 million was transported to Mexico
by Alvarez and others without filing the necessary Customs forms.
Oscar Ortiz Alvarez was arrested in McAllen, Texas on July 25,
1988, on money laundering charges, filed in the U.S. District
Court for the Southern District of Texas.
Acting Assistant Secretary Martoche commends the OCDETF members
for their outstanding work in this case.
B-1496

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT:

Office of Financing
202/376-4350
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

FOR IMMEDIATE RELEASE
August 1, 1988

Tenders for $6,800 million of 13-week bills and for $6,816 million
of 26-week bills, both to be issued on
August 4, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing November 3, 1988
Discount Investment
Price
Rate
Rate 1/
6.86%
6.90%
6.89%

7.08%
7.12%
7.11%

26-week bills
maturing February 2, 1989
Discount Investment
Rate
Rate 1/
Price

98.266
98.256
98.258

7.14%
7.16%
7.15%

7.51%
7.53%
7.52%

96.390
96.380
96.385

Tenders at the high discount rate for the 13-week bills were allotted 14%.
Tenders at the high discount rate for the 26-week bills were allotted 35%.

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)
Received
Accepted
:
Received

Accepted

$
33,840
20,093,915
34,340
49,025
40,135
23,795
1,396,340
42,730
10,460
50,130
36,015
1,327,885
389,940

33,840
$
5 ,211,855
34,340
49,025
40,135
23,795
441,740
41,870
10,460
50,130
26,015
447,285
389,940

$
39,460
20,670,040
27,065
41,805
206,265
29,630
1,116,050
36,340
11,970
56,910
31,385
1,317,895
:
461,085

39.460
$
5 ,766,190
25,765
41,805
102,815
29,630
144,800
32,340
11,970
56,910
21,385
81,895
461,085

$23,528,550

$6 ,800,430

: $24,045,900

$6 ,316,050

$20,256,615
1,170,650
$21,427,265

$3 ,528,495
1 ,170,650
$4 .699,145

: $19,765,395
:
1,159,365
: $20,924,760

$2 ,535,545
1 ,159,365
$3 ,694,910

1,970,625

1 970,625

:

1,800,000

1 ,800,000

130,660

130,660

:

1,321,140

1 ,321,140

$23,528,550

$6,800,430

$24,045,900

$6,816,050

Izpe
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

An additional $59,940 thousand of 13-week bills and an additional $518,260
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
y

Equivalent coupon-Issue yield.

R-1497

TREASURY NEWS _

Department of the Treasury • Washington, D.C. • Telephone 566-2041

FOR RELEASE UPON DELIVERY
EXPECTED AT 10:00 A.M.
AUGUST 2, 1988
TESTIMONY OF THE HONORABLE
GEORGE D. GOULD
UNDER SECRETARY FOR FINANCE
U.S. DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
UNITED STATES SENATE
TUESDAY, AUGUST 2, 1988
Mr. Chairman, Senator G a m , and Members of the Committee, I
appreciate this opportunity to return again today to testify on
the condition of the Federal Savings and Loan Insurance
Corporation (FSLIC). Specifically, I will comment on why, from
the Administration's perspective, it is unnecessary to transfer
resources from the American taxpayer to FSLIC so FSLIC in turn
can close — or warehouse — insolvent savings institutions in
this country.
I. The Administration's Three-Prong Strategy
First, a bit of history is in order.
When I first testified in
March 4, 1986, I presented
strategy to revitalize the
strategy is as valid today
The challenge for Congress
through and ensure that it
To summarize briefly, our
still is — as follows:

front of this Committee on
the Administration's three-pronged
thrift industry and FSLIC. That
as it was when we first proposed it.
in the future will be to follow
is fully implemented.
three-pronged strategy was — and

o First, the thrift industry as a whole had to be
strengthened: capital had to be increased and the
growth of problem institutions had to be halted through
improved supervision;

B-1498

- 2 -

o

Second, FSLIC*s resources had to be augmented to permit
it to resolve a greater number of insolvent
institutions; and

o Third, the franchise value of ailing thrifts
particularly had to be enhanced to lower FSLIC*s
resolution costs: new entrants into the industry can
increase its overall capital base and long-term health.
For a more complete description of our triad approach, I
refer you to my March 4, 1986, testimony. It was our opinion,
however, that without the additional capital, the FSLIC would be
forced to continue deferring the resolutions of many insolvent
thrifts. With the appropriate financial and organizational
resources, the Federal Home Loan Bank Board (FHLBB) and the FSLIC
could set more ambitious targets and resolve more cases, more
quickly — and in a more cost effective manner. The attractive
interest rate environment then prevailing provided the ideal
window of opportunity to move ahead to resolve ailing thrift
institutions.
At that time, the Administration believed an immediate
recapitalization of the fund would reaffirm depositor confidence
in the health and stability of the thrift industry and the
viability of the deposit insurance funds. Furthermore, prompt
handling of the most debilitated thrifts would help healthy
thrifts by lowering their cost of deposits, which had been bid up
by feeble institutions calling for funds virtually at any price.
We still believe that these three inter-related segments of
our plan — if fully implemented and when finally in place —
will strengthen the savings industry and allow it to continue to
provide competitive housing finance into the next century.
Federal Home Loan Bank Board Chairman Dan Wall recently testified
before the Committee on the steps the Board is taking to
aggressively implement this strategy, and in the interest of
time, I will not repeat that description. New capital
regulations are in place, institutions without adequate capital
are supervised and regulated more closely, examination forces are
being upgraded, new entrants and acquirors are more actively
pursued, and problem cases are being resolved within the limits
of existing resources and market capacities — both financial
and, as importantly, managerial.
II. The Treasury/FHLBB FSLIC Recapitalization Plan
The Treasury Department, working in conjunction with former
Chairman Ed Gray and the Federal Home Loan Bank System, was
directly involved with developing the financing prong of the

- 3 -

strategy. In devising our plan to recapitalize FSLIC, two
simple requirements were upper-most in our minds.
First, the time-tested notion of self-help was vital. The
taxpayer was not to be called upon to bail-out an industry that
with some measure of sacrifice over time could substantially help
itself. After all, many thrift owners and managers have profited
greatly from their franchise and they presumptively were paying
too small an insurance premium in the past. In addition, by
structuring our recapitalization plan as a balance of the
financing burden of the recapitalization of the fund between the
Federal Home Loan Banks and the thrifts, a negative budgetary
effect was avoided.
Second, the recapitalization plan needed to make substantial
resources available up front to reduce the growth of insolvent
institutions as quickly as possible. To this end, we devised a
unique industry-based plan that would enable the FSLIC to devote
about $25 to $30 billion over 5 years to handling its sizeable
load of problem cases, while in all likelihood being able to
phase-out the special premium assessment over the same period.
Let me stress that our proposal, by providing a $15 billion
recapitalization which would have supplied up to $25 to $30
billion to FSLIC over 5 to 6 years, was adequate to cover even
the then most pessimistic estimates of the costs involved.
You will recall that I testified in support of our FSLIC
recapitalization plan on May 8, 1986. Based on our conversations at that time, Congress seemed to recognize the seriousness
of the problems confronting both FSLIC and the thrift industry.
I must confess that initially I had high hopes that Congress
would act expeditiously to approve an industry self-help plan —
that involved no appropriation from the U.S. taxpayer — so that
FSLIC could go about its business of closing down hopelessly
insolvent thrifts. But 1986 wore on, and we were faced with
numerous false starts in Congress and — to put it bluntly —
industry-induced delays, which the General Accounting Office
(GAO) testified cost FSLIC $6 million per day or over $2 billion
per year. We obviously were distressed by these delays since the
resolution costs for FSLIC were accumulating at a time when FSLIC
(assuming the proper resources) should have been aggressively
acting to resolve its caseload of problem institutions. The
situation was particularly disturbing since ours was the only
plan on the table.
Not only did active industry opposition slow the legislative
pace, but in the final days of the 99th Congress, controversial
and extraneous amendments began to materialize in both the House
and Senate — amendments which had absolutely nothing to do with

- 4 -

enhancing FSLIC's resources or protecting depositors. Only in
the final days of the session were attempts made to bounce a
loaded-down FSLIC recapitalization plan back and forth between
the two houses of Congress. Meanwhile, sick, insolvent thrifts
grew sicker.
In 1987, we were faced with three general problems left over
from the previous year:
o industry attempts to reduce the amount of their
contribution to revitalizing their insurance fund;
o the addition of more controversial, and extraneous
amendments that had nothing to do with helping FSLIC or
protecting depositors; and
o new, significant obstacles to FSLIC*s operation, both
in terms of its ability to properly supervise and, when
necessary, close problem institutions, and to attract
outside capital and potential acquirors for troubled
thrifts.
Throughout this period, Treasury Secretary Baker, others in
the Administration, and I repeatedly urged Congress to act to
bolster FSLIC's resources. In the end, only after the threat of
a Presidential veto did we get two-thirds of the financing we
originally proposed — and this only after the House of
Representatives voted overwhelmingly for only one-third, with the
Senate going as far as one-half the financing. Even then we
ended up with new restrictions on the Board*s ability to
supervise and resolve problem institutions (the so-called
"forbearance" provisions) and numerous disincentives to enhance
the acquisition of troubled thrifts.
III. Current Cries for a Taxpayer Bail Out
Less than a year later and after waiting more than fifteen
months for Congress to act, we now hear cries from some quarters
of the industry for a taxpayer bailout of massive, unprecedented
proportions. These bleatings are predicated on the dubious
assertion that the Government caused the thrifts' problems and,
therefore, it is time for the Government to ante up to solve the
problem. To my way of thinking, that is tantamount to a thrift
executive saying that the Government made me take out my charter
and then engage in housing finance for my livelihood — all under
the protection of FSLIC's shield on my front door. Let me offer
my observations on the two most frequently heard refrains in this
regard.

- 5 -

First, it is argued by some in the thrift industry that the
Government prematurely deregulated interest rates ceilings on
time and savings accounts in depository institutions (Regulation
Q) and this in turn caused the industry*s problems. It is true
that after years of simply extending Regulation Q, Congress
finally created the Depository Institutions Deregulation
Committee in 1980 to remove ceilings on savings accounts and
phase-out the differential that existed between commercial banks
and savings institutions. Obviously, there were those in the
industry who didn't like the move to market-determined rates —
and who would after years of protection by the Federal
Government.
However, beginning in the late 1970s and extending into
1980, double digit inflation and high interest rates were making
it next to impossible for thrifts to compete for deposits
because of the unprecedented disintermediation occurring in the
marketplace. Savers' funds were flowing into new products such
as money market mutual funds. Simply put, had the Government not
acted in a responsible manner to deregulate interest rates
ceilings imposed by Congress, thrifts would have been
disintermediated into the mist.
Second, others in the industry have said that either
inadequate or too liberal investment opportunities caused the
problems. I believe the increased asset powers authorized for
thrifts by the Garn-St Germain Depository Institutions Act of
1982 were neither inadequate nor too liberal. Among other
powers, the Act authorized thrifts to offer checking accounts to
their commercial customers, permitted commercial loans in an
amount equal to up to 10 percent of assets, and expanded consumer
lending authority from 20 percent of assets to 30 percent of
assets.
Was it the Garn-St Germain Act that caused Vernon Savings
and Loan Association in Texas to fail — with 94% nonperforming
loans? Did that Act cause the problems of the American Savings
and Loan Association in California? Did this limited
deregulation at the federal level cause the failure of numerous
state-chartered institutions? A review of the facts will show
that the answer to these questions is: no.
It is true that a number of states have granted their
state-chartered institutions broader asset powers than federal
thrifts enjoy and that this has contributed to pressure on
FSLIC. As I testified more than two years ago, we need to
reconcile States' authority to grant new thrift powers with
FSLIC's financial responsibility to pick up the pieces when
these state-chartered institutions fail. The Administration has
supported achieving a better balance by placing additional state-

- 6 -

approved activities in holding company subsidiaries — if the
Bank Board determines that this extra degree of protection for
FSLIC is required. State-chartered thrift institutions could
still engage in new business opportunities — properly supervised
— but with an important new distinction. Instead of operating
with the backing of a federal deposit insurance fund, those
managers who wanted to engage in new activities would have to do
so with their own capital at risk — up front in a separately
capitalized subsidiary — instead of with FSLIC-insured funds.
The most forceful defense the government has against these
industry allegations of premature deregulation is that 85 percent
of the FSLIC-insured institutions with 84 percent of the assets
are solvent under GAAP accounting today. This great majority of
the industry has been able to handle changes that the general
economy and competition from other providers of financial
services have been forcing on them over the past 10 years.
Now, in a surprising and abrupt change of view, a vocal part
of the industry is now saying that the problem is larger than the
$5 billion in FSLIC assistance it advocated just last year, and
that its problems have grown beyond its capacity to handle by
itself. Therefore, you undoubtedly can expect this portion of
the industry to continue to step up its calls for general
assistance from taxpayers.
The industry's spokesmen have not bothered, however, to tell
the taxpayers of this country how much of their — our — money
may be needed. A draft "Plan for Economic Revival," which was
advanced, floated, and then withdrawn this past spring by one
association gives an idea of the kind of assistance they feel is
necessary — the establishment of four new federal corporations
and a massive amount of resources transferred from taxpayers to
FSLIC. This is the same group that last year brought you a much
heralded, but soon forgotten "Pay-As-You-Go Plan" that never
quite managed to make it into legislative form. If we follow
this course, we'll be headed for a "We-Pay-As-They-Go Plan."
One of these proposed corporations was a new
Recapitalization Finance Corporation (RFC) based on the concept
of the RFC established in the 1930s. The new RFC would purchase
preferred stock and or subordinated debt, thus increasing the
capital of well managed but poorly capitalized institutions;
e.g., those that qualify for capital forbearance under the
Competitive Equality Banking Act (CEBA). Interest-bearing RFC
notes would be used to purchase the preferred stock which then
would be paid off by receiving institutions as they recovered.
The plan would have the RFC capitalized by periodic infusions of
capital from both the Federal Deposit Insurance Corporation
(FDIC) and FSLIC sufficient to buy zero-coupon Treasury

- 7 -

securities in an amount that would guarantee and eventually pay
off the principal of the notes. The Treasury would pay the
interest on the notes and the Federal Reserve would be expected
to accept the notes as collateral for borrowing.
We believe that establishing such an RFC would be an
unnecessary and extremely expensive way to give assistance,
especially if the only institutions that qualify for the
assistance are the same ones already given capital forbearance
under CEBA. Also, it seems unlikely that the FSLIC and the FDIC
could provide the necessary periodic capital infusions.
Furthermore, the FSLIC already has the authority to issue income
capital certificates, which serve the same purpose that the
proposed preferred stock and/or subordinated debt would serve:
that is, increasing capital in troubled institutions.
The Plan for Economic Revival also would have established
asset holding corporations (AHCs) — one for delinquent home
mortgage loans and one for non-mortgage loans. These AHCs would
purchase troubled assets from institutions and then hold them
and the underlying properties — off the market.
At the request of Congress, the FHLBB published a study last
February attempting to determine the feasibility of establishing
an AHC. The report concluded that in light of the estimated
organizational problems and huge costs of such an organization,
it would be preferable — and more cost effective — to assist
private institutions holding these troubled assets. The private
sector is usually able to manage such assets at a considerably
lower cost than a bureaucracy engaged in central planning.
Before anyone contemplates starting down the road of creating new
federal agencies, stop and ask yourself: does Washington do a
better job of managing properties and assessing local economic
conditions and markets?
I also am struck by the number of academics and consultants
who are quick to jump to a taxpayer remedy as the solution to
FSLIC's problems. I have seen figures that range from $64
billion upwards to $100 billion — two and three times what the
GAO estimates, for example. I'm not sure what their assumptions
are — or who their clients are for that matter — but I am
amazed at how quick some observers are to give up hope of
resolving the problem by existing means and to rush to use
someone else's money — yours and mine.
As I stated in my 1986 testimony to this Committee:
"Anyone's estimate of the cost of resolving
problem thrift cases entails considerable
uncertainty. The hesitation is partially

- 8 -

attributable to important variables — such
as interest rates and regional real estate
conditions — that may affect significantly
the health of many institutions over time."
It is my understanding that Federal Reserve Board Chairman
Alan Greenspan took a similar position during his recent
appearance here. Rather than focus on numbers in the future that
no one really knows, we should instead focus on numbers for
which we can account. We know, for example, that over the next
three years FSLIC will have about $19 billion to close insolvent
institutions — as much as it says it can handle efficiently —
and Chairman Wall has testified that $42 billion is available
over ten years for that same purpose.
Before we rush to a transfer of funds from taxpayers through
FSLIC to insolvent institutions, we really ought to exhaust all
other available resources. I should think that all Committee
Members would be on their guard against a general taxpayer
bailout for managers of failing and failed institutions,
particularly since any such bailout would be charged to the
Committee's annual budget allocation and force harder choices
among other programs under the Committee's jurisdiction that
already compete for limited resources from the Federal
Government.
IV. Actions Congress Can Take to Avoid Tapping Taxpayers
Resources
As I indicated at the beginning of my statement, the
challenge for Congress in the future will be to fully implement
the three-pronged strategy we proposed two and one half years
ago. Given FSLIC's considerable resources over the next several
years (together with those of the Federal Home Loan Bank
System), it is unnecessary to act hastily or to release the
industry from obligations established fairly less than a year
ago.
If Congress wants to take further steps to put the
Administration's inter-related triad in place, I can suggest the
following steps to help both FSLIC and the thrift industry before
you call on the American taxpayer. Let me list these for you
briefly:
o More Recapitalization Financing
The structure of the Administration's recapitalization plan
is now in place, it works as we indicated, and it is flexible in
the event that additional funds are needed. This structure could
be expanded, if necessary, using various sources (the industry or

- 9 -

the Federal Home Loan Banks, for example) both for the capital to
buy zero coupon Treasuries to guarantee the defeasance of the
principal and for the money to cover interest payments on the
bonds issued.
o Thrift Charter Enhancement
Thrift charter enhancement provides a vital means of
expanding the capital base of the industry. In general, we favor
efforts that will attract outside capital while maintaining the
safety and soundness of the industry.
On April 27 of this year, Assistant Secretary for Domestic
Finance Charles Sethness testified before this Committee on "The
Thrift Charter Enhancement Act of 1988" (S. 2073), introduced by
Senator Karnes. We are pleased that the Committee recently
reported a revised bill to meet a number of our concerns. We
still would urge you to take an extra step and repeal the counter
productive cross-marketing restrictions contained in the
Competitive Equality Banking Act.
o Facilitate Acguisitions
The resolution costs for FSLIC can be reduced, not only by
enhancing the franchise value, but also by facilitating
acquisitions. As I have testified previously, inter-industry
acquisitions are a touchy subject, but the acquisition logic is
straightforward and undeniable.
Insolvent institutions have imposed real costs on healthy
thrifts as well as FSLIC. Since the Administration — and
hopefully Congress — is not in the mood for a budget busting
bailout, all non-expenditure solutions should be explored. This
includes removal of the cumbersome bidding priorities for
emergency acquisitions of failing thrifts under Sec. 408(m)(3)(B)
of the National Housing Act.
o Use Private Capital to Back Additional State-Chartered
Authorities Instead of FSLIC-insured Funds.
As I indicated in 1986 and again this morning, Congress
should reconcile states' authority to structure new thrift
products and services with FSLIC's responsibilities, especially
now given its limited resources. Use of a separately capitalized
subsidiary of a holding company — with private capital as the
line of defense, rather than FSLIC — is our preferred approach.

- 10 -

o

Strengthened Enforcement Authority

The Administration generally supports the strengthened
enforcement provisions in the Proxmire Financial Modernization
Act (S. 1886) that is now pending before the House Banking
Committee. Many of these authorities were requested by former
Chairman Ed Gray four years ago and have been endorsed by
Chairman Wall. For example, the regulators would be empowered to
issue temporary cease and desist orders where an institution's
records were in disarray or not available. For whatever reasons,
Congress has delayed in giving the federal regulators the tools
they have long requested to carry out their supervisory
responsibilities.
o Extend Expiring Tax Provisions
Extension of the tax provisions that affect the FSLIC's
ability to arrange for assisted acquisitions of troubled thrift
institutions also should be considered by the Congress. These
provisions, which under current law will expire at the end of
1988, maximize the value of FSLIC assistance. One such
provision provides that assistance paid by the FSLIC in
connection with an assisted acquisition will not be considered
taxable income. The other provisions clarify that a FSLICsupervised merger or acquisition can quality as a tax-free
reorganization, such that the net operating and built-in tax
losses of troubled institutions can be utilized fully by a
subsequent acquiring institution. The extension of these
provisions would allow FSLIC to resolve a greater number of cases
and to resolve them more quickly than it could if the provisions
were allowed to expire.
VI. Conclusion
In closing, I urge this Committee in the strongest possible
terms to resist mounting pleas for an unnecessary, budget busting
bailout of FSLIC. The precious resources of our taxpayers should
not be tapped until the existing plan has had a chance to work
and all other reasonably available resources have been used. In
any case, no single change in existing mechanisms should be made
without re-evaluating the full array of institutional
arrangements.
Congress passed the recapitalization legislation less than
12 months ago. The FHLBB has a plan in place to close
approximately 100 institutions in Texas and 100 additional
institution in FSLIC's current caseload by the end of 1988. In

- 11 -

addition, they expect by the end of 1989 to have resolved all
259 institutions in FSLICs caseload as of December 1987. The
Bank Board believes that the financial resources available to
them will cover the costs of this ambitious plan.
In other words, important strides have been made in all
three areas of the Administration's 1986 plan, although there is
still more to do. Programs now in place should be given time to
work (and a better data base assembled) before taxpayer money is
thrown at the problem. All existing resources, including those
of the Federal Home Loan Bank System, should be utilized first
and all non-expenditure solutions should be implemented.
Obviously, more steps along the line I have suggested can and
should be taken.
If additional resources become necessary at a later date,
then the Bank Board, the Administration and the Congress will
have time — and the obligation — to carefully reconsider the
full range of inter-related policy issues with respect to our
regulatory and deposit insurance structure.
* * * * * * * * * * * * * * * *

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
August 2, 1988
Charles 0. Sethness to Leave Treasury
Charles 0. Sethness, Assistant Secretary for Domestic Finance since October 1985,
has resigned effective .September 2, 1988. Mr. Sethness will become the Director
of the Capital Markets Department of the International Finance Corporation (IFC).

In einnouncing Mr. .Sethness' pending departure, Secretary Baker noted that "C
has done an excellent job on a very wide range of extremely complicated issues.
We will miss his ability to master substantive issues, work effectively to
develop consensus in the Administration and be an effective advocate with
affected constituencies and the Congress, which have been invaluable to the
Department, the Administration and the country." Baker added that "Chuck's
leadership role in achieving a viable solution to the Farm Credit System crisis
saved billions of dollars of taxpayer money while protecting credit access for
farmers. He has made contributions of similar import to the recapitalization of
the FSLIC fund, the A±oinistration's loan asset sales and credit reform
initiatives, the protection of the integrity of the Federal Financing Bank, and
the progress we have sought to make in improving the competitiveness of our
financial services industry."
At Treasury, Mr. Sethness has been responsible for the management of the
government debt, the Federal Financing Bank, government credit program policy/
policy development for the financial services industry and the capital markets,
policy direction for the government securities markets, the fulfillment of the
government's responsibilities on the projects taken over from the U.S. .Synthetic
Fuels Corporation in 1986, and the Office of Revenue Sharing until its
termination in 1987.
Under Secretary George D. Gould, for whom Mr. Sethness worked directly, added
that "Chuck's energy, loyalty, support, integrity, professional ism and
effectiveness have been a superb example of public service at its best. He did a
remarkable job with Treasury's regulatory role under the Government Securities
Act of 1986; with the difficulties of REA and Foreign Military Sales borrowers'
prepayments of FFB loans; with our overall coordination and liaison role with the
financial institution regulators and our involvement with the Securities Investor
Protection Corporation, the Pension Benefit Guaranty Corporation, the Farm Credit
System Assistance Board; with a host of credit program and agency borrower
issues; and served with notable distinction and insight as the chief of staff of
the President's Working Group on Financial Markets. All of us who had the real
pleasure of knowing and working with him during the past three years will feel
his absence."
Before joining the Treasury Department Mr. Sethness spent four years as the
Associate Dean for External Relations at the Harvard Business School. Prior to
that he was a Managing Director of Morgan Stanley, Inc. He served as the U.S.
Executive Director on the board of the World Bank from 1973 to 1975.
Mr. Sethness graduated from Princeton University in 1963, and earned his MBA
with High Distinction in 1966 from Harvard Business School as a Baker Scholar.
B-1499

TREASURY NEWS

Department of the Treasury • Washington, D.C. • Telephone 566CONTACT: Office of Financing
FOR RELEASE AT 4:00 P.M.
August 2, 1988
TREASURY'S WEEKLY BILL OFFERING

202/376-4350

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$13,600 million, to be issued August 11, 1988.
This offering
will provide about $100
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,506 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, August 8, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,800
million, representing an additional amount of bills dated
May 12, 1988,
and to mature November 10, 1988 (CUSIP No.
912794 QT 4), currently outstanding in the amount of $6,423 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,800 million, to be dated
August 11, 1988,
and to mature February 9, 1989
(CUSIP No.
912794 RF 3 ) .
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 August 11, 1988.
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 $1,575 million as agents for foreign
and international monetary authorities, and $4,067 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 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series)
B-1500

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
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
August 3, 1988

Deputy Assistant Secretary Stephen J. Entin
to Leave Treasury

The Treasury Department today announced that Stephen J.
Entin, Deputy Assistant Secretary for Economic Policy, has
resigned his position, effective August 15. Mr. Entin is to
accept the post of resident scholar at the Institute for Research
on the Economics of Taxation. IRET is headed by Dr. Norman B.
Ture, former Under Secretary of the Treasury for Tax and Economic
Policy.
In announcing Mr. Entin's pending departure from government
service, Secretary Baker noted that "The Administration has
benefited for more than seven years from Steve's economic advice
and I have often relied on his counsel and expertise. He has
been a valuable asset to the Department and will be sorely
missed."
Mr. Entin joined the Treasury in 1981 with the incoming
Reagan Administration after serving for several years on the
staff of the Congressional Joint Economic Committee, where he
worked in the areas of tax policy, capital formation and labor
and savings incentives.
At Trea sury, Mr. Entin was instrumental in developing the tax
indexing pr ovision of the 1981 Economic Recovery Tax Act. He
assisted in the preparation of Administration macroeconomic
analysis, b udget forecasts and the annual Trustees Reports of the
Social Secu rity System. He was a member of numerous interagency
working gro ups covering a wide range of issues, including health
care, resea rch and development, competitiveness, the steel and
auto indust ries, space commercialization, the defense industrial
base, welfa re reform and the family.

B-1501

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR RELEASE WHEN AUTHORIZED AT PRESS CONFERENCE
CONTACT:

August 3, 1988
Office of Financing
202/376-4350
TREASURY AUGUST QUARTERLY FINANCING

The Treasury will raise about $14,250 million of new cash
and refund $14,756 million of securities maturing August 15, 1988,
by issuing $11,000 million of 3-year notes, $11,000 million of
10-year notes, and $7,000 million of 248-day cash management
bills. The $14,756 million of maturing securities are those held
by the public, including $2,501 million held, as of today, by
Federal Reserve Banks as agents for foreign and international
monetary authorities.
The three issues totaling $29,000 million are 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 prices of accepted competitive tenders.
In addition to the public holdings. Government accounts and
Federal Reserve Banks, for their own accounts, hold $1,955 million
of the maturing securities that may be refunded by issuing additional amounts of the new securities at the average prices of
accepted competitive tenders.
The 10-year note being offered today will be eligible for
the STRIPS program.
Details about each of the notes are given in the attached
highlights of the offering and in the official offering circulars.
Details about the cash management bills are given in a separate
announcement.
oOo
Attachment

B- 1 5 0 2

HIGHLIGHTS OF TREASURY OFFERINGS TO THE PUBLIC
AUGUST 1988 QUARTERLY FINANCING
August 3, 1988
Amount Offered to the Public
Description of Security:
Term and type of security
Series and CUSIP designation

$11,000 million

$11,000 million

10-year notes
Series C-1998
(CUSIP No. 912827 WN 8)
Listed in Attachment A
of offering circular
Issue date August 15, 1988
August 15, 1988
Maturity date
August 15, 1991
August 15, 1998
Interest rate.
To be determined based on
To be determined based on
the average of accepted bids
the average of accepted bids
Investment yield
To be determined at auction
To be determined at auction
Premium or discount
To be determined after auction To be determined after auction
Interest payment dates
February 15 and August 15
February 15 and August 15
Miniinum denomination available... $5,000
$1,000
Amount required for STRIPS
Not applicable
To be determined after auction
Terms of Sale:
Yield auction
Method of sale
Yield auction
Must be expressed as
Competitive tenders
Must be expressed as
an annual yield with two
an annual yield with two
decimals, e.g., 7.10%
decimals, e.g., 7.10%
Accepted
in full at the averNoncompetitive tenders
Accepted in full at the average
price
up to $1,000,000
age price up to $1,000,000
Accrued interest
None
payable by investor
None
Payment Terms:
Payment by non-institutional
Full payment to be
investors
Full payment to be
submitted with tender
submitted with tender
Payment through Treasury Tax
Acceptable for TT&L Note
Acceptable far TT&L Note
and Loan (TT&L) Note Accounts.,
Option Depositaries
Option Depositaries
Deposit guarantee by
Acceptable
Acceptable
designated institutions.
Key Dates:
Tuesday, August 9, 1988,
Wednesday, August 10, 1988,
Receipt of tenders
prior to 1:00 p.m., EDST
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a) funds irnnediately
Monday, August 15, 1988
Monday, August 15, 1988
available to the Treasury.
Thursday,
August
11,
1988
Thursday, August: 11, 1988
b) readily-cxDllectible check.
3-year notes
Series T-1991
(CUSIP No. 912827 WM 0)
CUSIP Nos. for STRIPS Components. Not applicable

$7,000 million
248-day cash
management hills
(see separate
announcement:
for details)

TREASURY NEWS

Department of the Treasury e Washington, D.C. e Telephone 566-2
FOR RELEASE WHEN AUTHORIZED AT PRESS CONFERENCE
August 3, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY OFFERS $7,000 MILLION
OF 248-DAY CASH MANAGEMENT BILLS
The Department of the Treasury, by this public notice,
invites tenders for approximately $7,000 million of 248-day
Treasury bills to be dated August 15, 1988, and to mature
April 20, 1989 (CUSIP No. 912794 RU 0 ) .
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,
Thursday, August 11, 1988. 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 of the Federal Reserve Banks and Branches. Tenders
will not be accepted for bills to be maintained on the book-entry
records of the Department of the Treasury (TREASURY DIRECT).
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.
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, 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.
R

_ i *ns

- 2A 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.
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 competitive 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 or Branch in cash or other immediately-available funds
on Monday, August 15, 1988. 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which the
bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
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 Bank or
Branch.

TREASURY NEWS
pepartment of the Treasury • Washington, D.C. • Telephone 566-204
For Release Upon Delivery
Expected at 10:30 A.M.
August 4, 1988

STATEMENT OF
WILLIAM M. PAUL
ACTING DEPUTY TAX LEGISLATIVE COUNSEL
DEPARTMENT OF THE TREASURY
BEFORE THE
SELECT COMMITTEE ON HUNGER
AND THE
WAYS AND MEANS SUBCOMMITTEE ON SELECT REVENUE MEASURES
U.S. HOUSE OF REPRESENTATIVES
Messrs. Chairmen and Members of the Committees:
am pleased to have this oppor tunity to present the
Treasu ry Departme nt's views concerni ng H.R. 81, which, if
enacte d, would al low taxpayers entit led to income tax refunds to
direct that all o r part of their refunds be contributed to a
trust fund for th e relief of domesti c and international hunger.
H.R. 8 1 would also establish a commi ssion to oversee the
distri bution of s uch contributed amo unts. With me today are two
assist ant commiss ioners of the Inter nal Revenue Service - John
Johnso n, Assistan t Commissioner (Pla nning, Finance and Research),
and Ro bert Brauer , Assistant Commissioner (Employee Plans and
Exempt Organizati ons) .
Background

\ /Sof

Before turning to the Treasury Department's views on H.R
81, I would like to provide the Committees with background
information regarding two existing programs that are, to a
greater or lesser degree, analogous to the funding mechanism
proposed in H.R. 81: the Presidential Election Campaign Fund
check-off, and California's program permitting voluntary
contributions on its state income tax returns.
Presidential Election Campaign Fund. S ince 1973,
individuals whose Federal income tax liabili ty is at least one
dollar have been able to designate one dolla r of their tax to the
Presidential Elec tion Campaign Fund. In Fis cal Year 1987, 22
percent of the to tal individual income tax r eturns, or 22.4
million returns, designated a total of $33.2 million to this
Fund. The main c osts of administering this provision consist of
labor costs to tr anscribe data at the IRS se rvice centers when
the returns are p rocessed. The Internal Rev enue Service
estimates that th e cost of administering thi s provision in Fiscal
Year 1984 was app roximately $400,000. We wo uld point out that
this program diff ers from the proposal in H. R. 81 in that
taxpayers simply check a box designating a d ollar of their tax to

-2go to the Campaign Fund, which in no way increases their tax or
reduces their refund. Under H.R. 81, taxpayers would have to
specify a dollar amount of their refund to be contributed to the
proposed trust fund.
California Check-off Program. Since 1982 California has
allowed taxpayers to make voluntary contributions to the
California Election Campaign Fund on their state income tax
returns. In 1983, the California legislature expanded this
program by adding four additional funds, and two more funds were
added in 1987. Thus, California's individual tax return forms
currently permit individuals to make voluntary contributions to
seven different funds: the Alzheimer's Disease/Related Disorders
Fund; the California Fund for Senior Citizens; the Rare and
Endangered Species Preservation Program; the State Children's
Trust Fund for the Prevention of Child Abuse; the United States
Olympic Committee Fund; the Vietnam Veterans Memorial Fund; and
the California Election Campaign Fund. The California
legislature is currently considering proposals to add yet two
more funds: the California Fire Foundation Fund and the State
Emergency Family Needs and Assistance Fund.l/
With respect to the 1987 tax year, the seven funds listed on
the California returns received roughly 700,000 contributions out
of 12,000,000 tax returns. Contributions totaled approximately
$3,400,000 at an estimated cost of 7 cents per contribution. The
implementation of the California program has required the
addition of ten lines to the California forms and requires
taxpayers to make approximately eight additional decisions and
Discussion
two additional calculations.
The Treasury Department agrees that domestic and
international hunger is a serious problem. Nevertheless, we have
consistently opposed proposals such as H.R. 81 that would use
federal tax returns and the federal tax collection system for
goals that are wholly unrelated to the raising of tax revenues.
It is our view that federal tax returns and the federal tax
collection system should not be used as a vehicle for voluntary
contributions to any charity or cause, however meritorious. In
this regard, the Committees should note that we have in the past
opposed proposals to add tax return "check-offs" for such
worthwhile causes as a U.S. Olympic Committee fund, a National
Organ Transplant fund, the National Endowment for the Arts, the
T7 According to information compiled by the Federation of Tax
Administrators, a total of 37 states have check-off programs
that allow taxpayers to designate a portion of their tax or
refund for at least one specified purpose.

-3-

National Endowment for the Humanities, and a fund for the
reduction of the public debt.2/ In addition, as part of The
President's Tax Proposals to the Congress for Fairness, GTowth &
Simplicity (1985), the President proposed the repeal of the
presidential election campaign check-off.
Our opposition to such proposals stems not from any
disagreement with the underlying purposes of the proposals, but
rather from our concerns regarding the confusion, complexity and
administrative burdens that such well-intentioned and seemingly
innocent proposals would create. These concerns are heightened
by the fact that, as the California experience illustrates, the
adoption of H.R. 81 would invite other charitable causes to seek
similar treatment. It would indeed be difficult to argue that
certain charitable goals, such as the fight against world hunger,
should have a check-off, but that others, such as the prevention
of child abuse, or aid for the handicapped, the elderly or the
homeless, should not._3/
Moreover, any check-off system would further complicate tax
returns and instructions. At least one and probably two
additional lines would have to be added to all affected forms.
This Administration is committed to reducing the paperwork burden
and complexity of the tax forms and has already made significant
progress in this area. Proposals such as this one are
inconsistent with these goals.
Several other problems are presented by the proposed
check-off system. First, the legislation under consideration
would, if enacted, place an administrative burden on the Internal
Revenue Service at a time when the Service is facing budgetary
2/ Since 1983, IRS publications have carried a message inviting
taxpayers to make voluntary contributions to reduce the
public debt when they file their tax returns. The
instructions for income tax returns have advised taxpayers
that they could make such contributions to the IRS in the
form of a separate check made out to the Bureau of the Public
Debt. In Fiscal Year 1987, there were 723 such contributions
totaling $159,000. For the five years since the Service has
been publicizing this program, there have been 10,382
contributions for a total of $1.5 million.
3/ The experience of other states also illustrates the
difficulty of resisting efforts to add additional check-offs
for other worthy causes. According to the Federation of Tax
Administrators, 31 new designated check-offs were added to
state tax returns during the past four years. Check-offs
were added for political campaigns (four states), protection
of wildlife (three states), child abuse and related causes
(ten states), Olympic funding (two states), funding for the
arts (one state) and other miscellaneous causes (eleven
states).

-4constraints. Were the Service required to reallocate resources
to implement this proposal, its traditional functions would
suffer. If the tax check-off system were extended to other
charities, which we believe would be a real possibility if H.R.
81 were enacted, the result would create further administrative
problems for the Service.
Second, we believe such a system would be confusing to
taxpayers. The fact that it would operate differently from the
current check-off for the presidential campaign fund, which is
made out of a taxpayer's tax liability and does not affect the
amount of any refund the taxpayer may receive, would itself cause
confusion. Further, voluntary contributions by taxpayers who
itemize would qualify as deductible contributions for the taxable
year in which they were made. Thus, a designation or check-off
in one year (e.g., on a 1989 return filed in 1990) would give
rise to a deduction on the next year's return (e.g., the 1990
return filed in 1991). Because the taxpayer might be making yet
another designation or check-off on the subsequent year's return,
there is significant potential for taxpayer confusion and error.
Third, if a taxpayer were to designate a portion of a refund
for contribution that turns out to exceed the refund to which the
taxpayer is actually entitled, either because the taxpayer's tax
liability is adjusted due to a mathematical error or substantive
change or because the refund is "intercepted" under the refund
offset program, the Service would presumably have to inquire
whether the taxpayer still wished to make the contribution. If
the transfer to the proposed trust fund were already made, a
request for reimbursement to the Treasury - either by the
taxpayer or the trust fund - might be necessary.
Another serious concern we have with the bill is that it
gives the Hunger Commission the authority to direct the Secretary
of the Treasury to revoke an organization's tax-exempt status if
the organization is found by the Commission to have committed
certain "prohibited acts." This concept of granting the
authority to revoke tax-exempt status to an agency other than the
IRS is unprecedented. In effect, it establishes an entirely new
system of administering the laws pertaining to tax-exempt status
for a certain class of tax-exempt organizations. Furthermore,
the Hunger Commission staff presumably will have no experience in
auditing exempt organizations, and we do not know the standards
that would be applied in determining if tax-exempt status should
be revoked. Granting this authority to the Hunger Commission
would open a Pandora's box of administrative and legal problems.
While we sympathize greatly with the underlying goals of
H.R. 81, we oppose the bill primarily because of the precedent it
would establish and because of the administrative problems its
enactment would create.
This concludes my prepared remarks. I would be pleased to
respond to your questions.

TREASURY NEWS
Department of the Treasury e Washington, D.C. • Telephone 566-2041

TEXT AS PREPARED
Embargoed for Release
Until Delivery
Expected at 12:30 p.m., EDT
Remarks by
M. Peter McPherson
Deputy Secretary of the Treasury
To the Institute for International Economics
Washington, DC
Thursday, August 4, 1988
The European Communityrs Internal Market Program:
An American Perspective
Good Afternoon:
I am pleased to have this opportunity to. speak to you today
about the European Community's ongoing efforts to create a single
integrated market. This is an ambitious effort to free the
movement of goods, services, capital, and people throughout the
12 member states of the EC by the end of 1992.
A unified internal market presents new opportunities for
Europeans and it presents new challenges for the rest of the
world. The United States has supported the goal of European
integration from its inception. We are concerned, however, by
statements from Brussels that suggest the EC may try to exclude
others as it liberalizes internal barriers. The creation of a
single market that reserves "Europe for Europeans" would be bad
for Europe, for the United States, and for the multilateral
economic system.
Today Z would like to comment, as an enthusiastic and
interested observer, on our hopes and concerns about the shape
of Europe that emerges after 1992.
I offer these remarks in a constructive spirit, with the hope
that we and the EC can have a mutually helpful process of candid,
open discussion about the implications of 1992 for countries that
are outside the Community. After a brief description of the
rationale of 1992, I will focus my remarks:
B-1505

- 3 The completion of the internal market will have implications
for the multilateral economic system. In my judgment, we are
poised at a critical juncture in the evolution of the
international economy. Economic interdependence has brought
great benefits to those nations which participate fully in the
global economy. But the pressures that often accompany the
expansion of trade among nations have also tested support within
many countries for the open, multilateral trading system.
Mercantilist attitudes have become more common. Adherence to the
pr7'nc«p!es and disciplines of the GATT has eroded. And areas of
critical importance to the U.S., such as financial and other
services, investment, and intellectual property, are not
adequately protected.
The Uruguay Round of multilateral trade negotiations is an
effort to deal with these strains on the international trading
system. How the EC approaches its effort at internal
liberalization will have an important influence on the success
of those negotiations and on the future direction of the global
economy. In essence, Europe faces two opposing choices.
The EC may liberalize barriers internally, yet try to
protect newly integrated markets from certain foreign
competition. If this path is taken the EC would
critically undermine the open, multilateral economic
system.
Alternatively, the EC can make integration within Europe
a genuinely free-market exercise and have an open policy
toward the rest of the world as it opens its markets
within. The industrial countries reaffirmed this goal
at the recent Toronto Economic Summit.
All countries have a stake in this process.
— We would all benefit from access to a dynamic,
integrated European market. .And we would suffer if
Europe closed its doors and turned in on itself.
Clearly, Europe would also suffer without the stimulus
of world competition.
A stronger, more unified Europe would strengthen the
economic underpinnings of the Atlantic Alliance. And a
protected, isolated Europe would weaken the industrial
base of the Community and undermine the economic
strength of Europe.
Yes, we see compelling promise in the program, but the
process of internal liberalization itself will generate pressures
for greater external protection. Some feel that the pressure of
greater competition within Europe should be mitigated by limiting
competition from the rest of the world. This is the sentiment
behind suggestions, such as that made by one prominent
industrialist, that a "protective curtain" be erected around the
internal market.

- 5 We find this reciprocity issue particularly troubling. I
would like to take a few moments here to explain why reciprocity
is unacceptable and why we expect the Community to grant national
treatment to branches and subsidiaries of U.S. institutions in
the EC.
The notion of reciprocity enjoys considerable simplistic
appeal, because it suggests fair and equitable treatment. The
Commission's proposal, however, could require countries to mirror
the laws and regulations of the EC in order to have equal access
to the internal market. The danger of this approach is that
legitimate differences in national regulatory regimes could be
used to justify discrimination against foreign firms. In the
financial area, differences in organizational structures, the
scope of permitted operations, regulatory and prudential
frameworks, market instruments, clearance and settlement
procedures, and methods of financing public debt will always
exist.
To illustrate from our side of the Atlantic:
We allow financial institutions in the United States —
foreign and domestic — to offer a greater range of
financial instruments than is permitted in some
EC countries. I ask you: Should we demand reciprocity
and deny banks of the EC access to U.S. financial
markets until their own countries adopt policies
- identical to our own?
Because of these differences, reciprocity that seeks to
achieve identical commercial privileges in countries with
different regulatory regimes will almost inevitably result in
discrimination. In short, reciprocity that seeks identical
treatment in different countries is a retreat back to
protectionism.
In fact, the variety of financial environments around the
world and the scale of our presence in each other's markets makes
it impossible to provide reciprocal treatment for foreign firms
without creating a huge regulatory bureaucracy and also severely
limiting the flexibility of the market and the range of
opportunities for foreign firms. I should point out that, at the
end of 1987, there were over 660 foreign bank operating entities
in the United States, representing 260 foreign bank families from
more than 60 countries, with total U.S. assets of over $594
billion. And 147 U.S. banks have a total of 873 branches in
70 foreign countries.

- 7 We welcome the opportunity to talk with the member states and
the Commission about the implications of 1992. We believe it is
important for the EC to be open, in a timely way, with others
about the external dimensions of the internal market program.
Greater information about the actual intentions of the EC would
help alleviate concerns generated by statements made in domestic
political contexts. Early consultations that respect the rights
and interests of others would surely be best for countries on
both sides of the Atlantic.
In concli^sicr., I vculd like to express once again genuine
admiration for the historic effort underway in Europe today. The
United States is enthusiastic about the potential contribution of
the completion of the internal market to a stronger, more dynamic
Europe.
The international economic system is at a critical and in
some ways vulnerable point in its evolution. This makes it
particularly important that the 1992 effort support, not
undermine, our shared objectives in moving toward a more
open international trading and financial system. Regional
efforts at liberalization can contribute to this goal, but
only if accomplished without raising barriers to others.
We have expressed our hopes and concerns about 1992, not to
challenge the program but to head off potential conflicts.
Countries outside Europe have a natural interest in the process.
And Europeans have a natural interest in preserving the support
of other countries for the multilateral economic system.
We share the excitement in Europe. And we look forward to
discussions
with Brussels and the member states.
Thank you.

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
August 4, 1988

Contact: Bob Levine
566-2041
TREASURY STATEMENT ON PROPOSED SHORT-TERM FINANCING FOR ARGENTINA
The U.S. Department of Treasury announced today that it is working
with the Government of Argentina to arrange short-term financing
of up to $500 million. These funds would become available when
Argentina meets the requirements for additional flows under the
World Bank's policy-based sector lending program. United States
willingness to participate in this effort reflects support for
Argentina's economic reform efforts and the determination of the
government of Argentina to address its international financial
relations in a constructive manner. These efforts will be fully
supported by the World Bank and we expect that they will be
supported as well by the international financial community,
including a new stand-by arrangement with the International
Monetary Fund. The United States believes that renewed Argentine
efforts should help stabilize its economy and promote sustained
growth. This bridge is being formulated with the B. I. ?.
representing other creditor governments.

B-1506

o
C\l
CD
CO

federal financing bank

m
CO

co

WASHINGTON, D.C. 20220

CD

August 8, 1988

FOR IMMEDIATE RELEASE

FEDERAL FINANCING BANK ACTIVITY
Charles D. Haworth, Acting Secretary, Federal Financing
Bank (FFB), announced the following activity for the month of
January 1988.
FFB holdings of obligations issued, sold or guaranteed by
other Federal agencies totaled $152.1 billion on January 31,
1988, posting a decrease of $318.2 million from the level on
December 31, 1987. This net change was the result of
decreases in holdings of agency debt of $258.6 million, in
holdings of agency-guaranteed debt of $59.3 million and in
holdings of agency assets of $0.3 million. FFB made 64
disbursements during January.
Attached to this release are tables presenting FFB
January loan activity and FFB holdings as of January 31, 1988.

# 0 #

B-1507

CO
CD
CM
CD
CD
in
CO
LL

Page 2 of
FEDERAL FINANCING BANK
January 1988 ACTIVITY
AMOUNT
OF ADVANCE

FINAL
MATURITY

1/7

S 16,400,000.00

4/7/88

6.155%

1/6
1/8
1/11
1/15
1/15
1/18
1/20
1/25
1/25
1/28
1/28
1/29
1/31

92,000.000.00
144,000,000.00
72,000,000.00
22,000,000.00
98,000,000.00
96,000,000.00
56,000,000.00
23,000,000.00
67,000,000.00
45,000,000.00
26,000,000.00
27,000,000.00
137,000,000.00

1/11/88
1/15/88
1/18/88
1/19/88
1/20/88
1/25/88
1/28/88
2/1/88
2/3/88
2/2/88
2/3/88
2/5/88
2/8/88

6.245%
6.085%
6.175%
6.195%
6.195%
6.185%
6.275%
6.115%
6.115%
6.045%
6.045%
5.985%
5.935%

1/4
1/8

660,,000.00

34 ,151,545.00

8/25/14
8/25/14
5/5/94
9/15/91
3/12/14
5/15/95
8/25/14
6/15/12
3/12/U
3/12/14
9/12/96

8.975%
8.988%
8.725%
8.315%
9.215%
8.310%
8.815%
8.915%
3.925%
8.785%

DATE

BORROWER

INTEREST
RATE
(semiannual)

iGENJT.DEBT
NATIONAL CREDIT UNION ADMINISTRATION
Central Liquidity Facility
Note s458
TENNESSEE VALLEY AUTHORITY
Advance
Advance
Advance
Advance
Advance
Advance
Vdvance
Advance
Advance
Advance
.Advance
Advance
.Advance

-838
#839
#840
*841
*842
#843
#844
#845
*846
#847
#848
#849
#850

GOVERNMENT - GUARANTEED LOANS
DEPARTMENT OF DEFENSE
Foreign Military Sales
Greece 17
Greece 17
Kenya 10
Colombia 7
Turkey 18
Niger 3
Greece 17
Greece 15
Turkey 18
Turkey 18
Phi H i pines 11

1/11
1/12
1/13
1/19
1/20
1/20
1/20
1/25
1/26

186,,135.02
37,,632.00
1,506,,736.91
155,,738.21
1,246,,100.37
1,495,,290.58
916,,656.71
609,,646.51
35,,101.94

INTEREST
RATE
(other th
semi-annu

Page 3

of 5

FEDERAL FINANCING BANK
January 1988 ACTIVITY

X tKRuWEE

AMOl "NT
OF ADVANCE

DATE

FI:-:\L
MATUK [TV

INTEREST
RATE
( -•iemi-

arj.ua 1:

INTEREST
RATE
(other than
semi-annual)

PEP.\RT>lENT_gF HOUSING & URBAN DEVELOPMENT
Cqmmunitv Development
•Baltimore, MD
Ponce, PR
San Juan, PR
Montgomery Co. Dev. Corp.
Florence, SC
Long Beach, CA
Ponce, PR
Rochester, NT

1/4
1/14
1/14
1/25
1/25
1/25
1/25
1/28

S

1,333,000.00
118,931.20
441,230.61
245,854.00
31,552.81
400,000.00
21,100.00
200,000.00

1/2/93
10/3/88
10/3/88
5/15/88
7/1/88
8/1/88
10/3/88
8/31/04

8,.455%

8,.634% ann
7,.079% ann
7 .079% ann

7.,005%
7,.005%
6,.295%
6,.555%
6,.635%
. 745%
6,
8..475%

6,.643% ami
5 .806% ann
8,.655% ann

9.024%
8.966%
7.885%
8.966%
8.966%
9.030%
9.224%
7.976%
7.985%
7.925%
9.163%
9.163%
7.909%
9.127%
7.628%
8.792%
8.729%
7.675%
7.682%
7.670%
8.783%
7.725%
8.607%

8.924%
8.868%
7.809%
8.868%
8.868%
8.930%
9.120%
7.898%
7.907%
7.848%
9.060%
9.060%
7.832%
9.025%
7.557%
8.697%
8.636%
7.603%
7.610%
7.598%
8.689%
7.652%
8.516%

RlrE^L-ELECTRIFICAT ION ADMINISTRATION
•Wabash Valiev Power *206 1/4 12,306,000.00 1/4/90 7.895% 7.319% qtr.
•Wabash Valiev Power =104
1/4
6,327,000.00
12/31/15
•Wahash Valley Power #206
1/6
29,911,000.00
1/3/17
•Northwest Elec Power Co #176
1/6
775,000.00
1/8/90
•Corn Belt Power #166
1/6
77,000.00
1/3/17
•Corn Beit Power #94
1/6
423,000.00
1/3/17
*San Miguel Electric Co. #110
1/7
6,218,000.00
12/31/15
Central Electric Power #248
1/11
5,000.00
1/3/23
•Allegheny Electric #175
1/12
1,708,000.00
4/2/90
•Allegheny Electric #255
1/12
5,893,000.00
4/2/90
•Wabash Valiev Power #206
1/13
11,896,000.00
1/16/90
•Wabash Valley Power #104
1/13
3,453,000.00
1/3/17
•Wabash Valiev Power #206
1/13
2,292,000.00
1/3/17
•Wolverine Power #183A
1/13
583,000.00
1/2/90
Brazos Electric Power #332
1/15
752,000.00
12/31/19
•Wolverine Power #183A
1/22
232,000.00
1/2/90
Tex-La Electric #329
1/22
10,997,000.00
1/3/22
Sunflower Electric #174
1/25
6,000,000.00
1/3/17
*Colorado-Ute-Electric »96A
1/25
1,145,000.00
4/20/90
Sho-Me Power #324
1/25
500,000.00
4/2/90
Blue Ridge Electric #307
1/25
987,000.00
4/2/90
Central Iowa Power #295
1/27
2,200,000.00
1/2/18
*Colorado-Ute-Electric *198A
1/27
1,810,000.00
4/2/90
•San Miguel Electric Co. «110
1/28
8,152,000.00
12/31/15

"maturity extension

qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.

Page 4 of 5
FEDERAL FINANCING BANK
January 1988 ACTIVITY

BORROWER

DATE

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

SMALL BUSINESS ADMINISTRATION
State & Local Development Company Debentures
Alabama Community Dev. Corp.
Comra. SB Dev. Corp.
Mid-Atlantic CDC
E. Central Michigan Dev. Corp.
Long Island Development Corp.
Massachusetts CDC

1/6
1/6
1/6
1/6
1/6
1/6

$ 114,000.00
121,000.00
245,000.00
126,000.00
184,000.00
260,000.00

11/1/03
11/1/03
11/1/03
11/1/08
11/1/08
11/1/08

8.877%
8.877%
8.877%
8.953%
8.953%
8.953%

663,569,912.25

4/29/88

6.055%

TENNESSEE VALLEY AUTHORITY
Seven States Energy Corporation
Note A-88-04

1/29

INTEREST
RATE
(other than
semi-annual)

Page S o£ S
FEDEFcAL

Program
Agency Debt:
Export-Import Bank
NCUA-Central Liquidity Facility
Tennessee Valley Authority
U.S. Postal Service
U.S. Railway Association +

January 31, 1988

sub-total*
Government-Guaranteed Lending:
DOD-Foreign Military Sales
DEd.-Student Loan Marketing Assn.
raUD-Oawnunity Dev. Block Grant
DHUD-New Communities
CHUD-Public Housing Notes +
General Services Administration +
DOI-Guam Power Authority
DOI-Virgin Islands
NASA-Space Communications Co. +
DON-Ship Lease Financing
Rural Electrification Administration
SBA-Small Business Investment Cos.
SBA-State/Local Development Cos.
TVA-Seven States Energy Corp.
DOT-Section 511
D0T-V#1ATA
sub-total* 53,755.1
grand total* $ 152,098.6
•figures may not total due to rounding
-frdoes not include capitalized interest

$ -o-

FY '88 Net Change
10A/87-1/31/88

0.4
-259.0
-0-0-

$ -492.0
7.0
64.0
1,500.0
-0-

-258.6

1,079.0

59,674.0
84.0
102.2
0.7
4,071.2
18.2

-0-0-0-0-0-0.3

-5,335.0
-0-0-0-170.0
-1.4

63,950.2

-0.3

-5,506.4

-31.5
-00.2
-1.3
-0-0-0-0-0-29.4
-3.9
-8.3
-1.4
16.3
-0-0-59.3

-841.5
-0-0.6
-1.5
-39.5
-3.8
-0-0.4
140.8
-29.4
-9.6
-22.6
-3.8
89.3
-1.6
-0-724.1

$ 11,971.5
118.4
16,450.0
5,853.4
-0-

sub-total* 34,393.3
Agency Assets:
Farmers Home Administration
CHHS-Health Maintenance Org.
DHHS-Medical Facilities
Overseas Private Investment Corp.
Rural Electrification Admin.-CBO
Small Business Achninistration

Net Change
l/l/88-l/3l7»8

18,322.4
4,940.0
323.7
29.1
2,034.9
391.6
33.2
26.7
949.4
1,758.9
21,187.4
718.0
896.0
1,913.0
53
.8
177.0

$-5,151.5

TREASURY NEWS
tepartment
of the
Treasury • Washington,
D.C. •Office
Telephone
566-2041
of Financing
FOR IMMEDIATE
RELEASE
ONTACT:
August

202/376-4350

8, 1988

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,814 million of 13-week bills and for $6,805 million
of 26-week bills, both to be issued on August 11, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing November 10, 1988
Discount Investment
Rate
Rate 1/
Price
6.92%
6.94%
6.94%

7.14%
7.16%
7.16%

26-week bills
maturing February 9, 1989
Discount Investment
Rate
Rate 1/
Price

98.251
98.246
98.246

7.26%
7.27%
7.26%

7.64%
7.65%
7.64%

96.330
96.325
96.330

Tenders at the high discount rate for the 13-week bills were allotted 94%.
Tenders at the high discount rate for the 26-week bills were allotted 03%.

Location
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

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
Received
Received

Accepted

$
44,190
21,064,540
26,020
34,525
50,535
27,890
1,324,610
36,060
14,120
36,330
34,670
1,758,180
395,005

$
44,190
5,412,740
26,020
34,525
50,535
27,890
374,310
33,000
9,120
36,330
24,670
345,210
395,005

$
41,795
20,343,935
26,095
32,760
47,320
37,435
1,245,135
32,290
19,775
53,200
35,525
1,261,415
472,315

$
41,795
5,912,765
24,155
32,760
47,320
37,435
47,985
26,835
14,925
53,200
25,525
68,215
472,315

$24,846,675

$6,813,545

: $23,648,995

$6,805,230

$21,604,855
1,086,890
$22,691,745

$3,571,725
1,086,890
$4,658,615

:

$19,133,910
1,134,600
$20,268,510

$2,290,145
1,134,600
$3,424,745

2,066,815

2,066,815

:

2,000,000

2,000,000

88,115

88,115

:

1,380,485

1,380,485

$24,846,675

$6,813,545

: $23,648,995

$6,805,230

An additional $28,585 thousand of 13-week bills and an additional $460,815
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
B-1508

TREASURY NEWS

Department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
August 9, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$13,600 million, to be issued August 18, 1988.
This offering
will not provide new cash for the Treasury, as the maturing bills
are outstanding in the amount of $13,590 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, August 15, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,800
million, representing an additional amount of bills dated
May 19, 1988,
and to mature November 17, 1988 (CUSIP No.
912794 QU 1), currently outstanding in the amount of $6,900 million,
the additional and original bills to be freely interchangeable.
182-day bills (to maturity date) for approximately $6,800
million, representing an additional amount of bills dated
February 18, 1988, and to mature February 16, 1989 (CUSIP No.
912794 RG 1), currently outstanding in the amount of $9,907 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 August 18, 1988.
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 $ 1,590 million as agents for foreign
and international monetary authorities, and $4,629 million for their
own account. Tenders for bills to be maintained on the book-entry
B-1509
records of the Department of the Treasury should be submitted on Form
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series)

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 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
10/87
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87any 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
FOR RELEASE UPON DELIVERY
Expected at 10:00 A.M.
August 9, 1988

STATEMENT OF
THE HONORABLE 0. DONALDSON CHAPOTON
ASSISTANT SECRETARY FOR TAX POLICY
DEPARTMENT OF THE TREASURY
BEFORE THE SENATE COMMITTEE ON FOREIGN RELATIONS
Mr. Chairman and Members of the Committee:
I am pleased to appear before you today in support of
protocols to our existing income tax treaties with France and
Belgium. We appreciate the willingness of the Committee to
consider the protocols. Prompt action by the Senate consenting
to the ratification of the protocols is important to our tax
treaty program and to the U.S. economy, which will benefit from
these agreements.
Because this is the Treasury Department's first opportunity
to appear before this Committee since tax reform, I want to
describe briefly the purpose of tax treaties and the special
significance of these two protocols, which are the first fruits
of our efforts to amend our tax treaties to reflect the important
tax law changes enacted by the Tax Reform Act of 1986.
The principal purpose of income tax treaties is to minimize
international double taxation and thereby promote the free flow
of capital, labor and technology unconstrained by tax
impediments. Tax treaties help create a "level playing field" by
minimizing the extent to which the decision to locate an
investment in the home country of the investor or a foreign
country depends upon tax considerations. By reducing barriers to
efficient investment, tax treaties help foster international
competitiveness and economic growth, to the benefit of all
countries.
Barriers to international investment in the form of double
taxation can occur, for example, when a corporation in one
country receives dividends from a corporation in another country.
Both countries may tax the income. A treaty may relieve the
double taxation, as our treaties typically do, by obligating the
source country where the income was earned to reduce its rate of
B-1510
tax
on the dividends and by requiring the country of the

- 2 recipient's residence to grant a credit against its tax for the
tax actually paid to the source country.
Tax treaties also aid international tax administration,
thereby reducing tax evasion and helping to ensure fairness for
taxpayers subject to more than one tax regime. Our treaties
typically provide for the exchange of tax information and
establish a mutual agreement procedure to address problems
affecting specific taxpayers or classes of taxpayers.
The importance and utility of tax treaties is evidenced, in
part, by the growing network of treaties that link various
countries. The United States now has 37 bilateral income tax
treaties in effect; many other countries, particularly in Europe,
have treaties with as many as 50 or 60 nations. The U.S. treaty
network is continuing to grow. In early July, we signed our
first agreement with Indonesia, which we plan to bring before
this Committee in the near future. We are in various stages of
negotiation with perhaps a half-dozen other countries with which
we do not presently have treaties, in addition to continuing our
efforts to amend or renegotiate existing treaties.
I am particularly pleased to be speaking in support of the
two protocols that are before the Committee today because they
are the first examples of our efforts to amend or renegotiate our
treaties to reflect the changes in U.S. tax law enacted by the
Tax Reform Act of 1986. As I will discuss in more detail later,
the French protocol includes several changes that conform it with
the 1986 Act; the Belgian protocol has less sweeping changes,
because we are in the process of renegotiating the entire treaty,
but the protocol does include an important provision to prevent
"treaty shopping" in the manner Congress indicated was
appropriate in the 1986 Act.
Significantly, we were able to reach agreement on these
protocols reflecting the 1986 Act with remarkable speed, as far
as tax law is concerned. Congress, as you are aware, is still
engaged in the process of enacting technical corrections to the
1986 Act; Treasury and the Internal Revenue Service are still
engaged in the process of providing taxpayers with the guidance
needed to comply with the Act. Yet we already have two protocols
with major trading partners that reflect tax law changes in the
Act ready for your consideration, and we have several more
protocols and new treaties that do so nearing the final stages of
completion. These include an important new treaty with Germany,
which we expect to conclude in the next few months.
We take some pride in this evidence of our ability to conform
tax treaties to changes in the U.S. tax laws. During
consideration of the 1986 Act and the pending technical
corrections bill, considerable attention has been focused on the
appropriate relationship between tax treaties and tax statutes.
The "inflexibility" of treaties has sometimes been cited as a
reason to justify Congress overriding treaties unilaterally, in

- 3 order to ensure that tax law changes will be applied to all
taxpayers. In candor, amending tax treaties through bilateral
renegotiation is not always an easy process. But there is
evidence that our treaty partners, many of which have followed
the United States' lead in pursuing comprehensive tax reform, are
often as interested as we are in expeditiously revising treaties
on a bilateral basis to accommodate important changes in domestic
tax law and policy as these affect the expanding economic
relations between us. Some of that evidence is before you today
— in the form of these two protocols — and we expect to make
continuing progress in demonstrating that treaties can be
promptly and successfully renegotiated to reflect important
changes in domestic tax law and policy.
Before turning to the details of the two protocols, I want to
note for the Committee that there is one tax policy concern that
will require the negotiation of further changes to our treaties
with Belgium and France, as well as with other countries, in the
near future. We are in the process of considering the
appropriate tax treatment under treaties of foreign shareholders
in U.S. regulated investment companies (RICs) and real estate
investment trusts (REITs), which are pass-through corporate
entities that do not pay tax if they distribute most of their
income annually to shareholders. Because of the special nature
of these entities, we believe that foreign shareholders in such
entities should not qualify for the low "direct investment"
dividend withholding rates available in many of our treaties to
principal (usually 10 percent or greater) shareholders; in
addition, it is possible that certain foreign shareholders of
REITs should not qualify for the reduced withholding rate on
portfolio dividends. We are continuing to examine this issue and
to discuss the matter with the staff of the Joint Committee on
Taxation.
We have already begun discussing this issue with several of
our treaty partners, including France, some of whom have
expressed analogous concerns regarding the eligibility of such
dividends for the treaty exemption applicable to direct
investment dividends. It is the Treasury Department's intention
to discuss these and other issues with France in the near future
with the objective of resolving such issues in a separate
protocol. We also intend to address this issue in our
renegotiation of the Belgian treaty.
In accordance with our usual procedure, I would like to
submit, for the record, the Treasury Department's technical
explanations of the protocols. I will now point out the most
important features of the protocols.
FRANCE
Our income tax treaty with France was signed in 1967 and
amended by protocols in 1970, 1978, and 1984. As mentioned
above, the protocol was prompted by the need to reflect in the

- 4 treaty certain key changes to the Internal Revenue Code
Code") made by the Tax Reform Act of 1986 ("the Act").

("the

One of the most significant provisions of the protocol
strengthens the so-called "anti-treaty shopping" rules of the
treaty. All of our recent tax treaties have a provision, a
limitation on benefits article, whose purpose is to prevent
residents of third countries from deriving benefits from the
treaty ("treaty shopping"). If, for example, a resident of
Portugal, with which we currently do not have an income tax
treaty, could invest in the United States through a French
corporation rather than directly and reduce the U.S. tax burden
on U.S. source income by claiming certain benefits under the
United States-France treaty, Portugal would have less of an
incentive to negotiate a treaty with the United States. Even
when the ultimate investor is resident in another treaty country,
the absence of a limitation on benefits article in the residence
country treaty creates a disincentive to renegotiate the third
country treaty and thus makes more difficult the objective of
ensuring that each of our treaties is responsive to important
changes in the law and policy of both countries.
The existing treaty with France generally provides that a
person (other than an individual) who is a resident of one of the
Contracting States is not entitled to treaty benefits unless more
than 50 percent of the beneficial interest in the person is owned
by residents of a Contracting State, the States themselves .or
local authorities thereof, U.S. citizens, or corporations in
whose principal class of shares there is substantial and regular
trading on a recognized stock exchange ("qualifying persons").
This "stock ownership" requirement alone may not be a
sufficient safeguard against treaty-shopping in all cases. A
French corporation could, for example, have all French individual
owners but largely eliminate its French tax by making deductible
interest payments to residents of third countries. Any reduction
in U.S. tax on the French corporation pursuant to the treaty
would indirectly inure to the benefit of the interest recipients.
Like some of our more recent treaties, the protocol
consequently provides that, in order to claim benefits, a person
must satisfy both stock ownership and "base erosion"
requirements. Under this latter requirement, not more than 50
percent of the gross income of the person may be used to meet
liabilities to persons who are not qualifying persons. It should
be noted that the addition of this "base erosion" requirement
makes the French limitation on benefits article consistent with
Congress' view of a proper limitation, as expressed in the
statutory limitation on benefits provision relating to the branch
profits tax, as added by the Act.
Similarly, several other provisions of the protocol amend the
treaty to make it more consistent with the Code as amended by the
Act. The Act added to the Code a "branch profits tax" on deemed

- 5 -

remittances from a U.S. branch of a foreign corporation to the
home office of the corporation. The tax is intended as a
counterpart to the withholding tax on dividends paid by a U.S.
subsidiary to its foreign parent corporation and functions to
equalize the tax treatment of these two forms of foreign
corporate investment in the United States. Although the present
treaty permits both the United States and France to impose branch
taxes within certain limitations, the treaty provision was
designed with the French branch tax, which has existed for many
years, in mind.
The protocol replaces this provision with one which permits
both countries to impose their branch taxes in accordance with
their internal law, subject to two limitations. First, only
earnings attributable to a permanent establishment are subject to
the tax, just as only the business profits earned by a resident
of one treaty partner which are attributable to a permanent
establishment maintained in the other treaty partner are taxable
by such other treaty partner. Second, the maximum rate for the
branch profits tax of both countries is fixed at 5 percent, the
same rate that applies to dividends paid by a subsidiary
organized in one of the treaty partners to its parent corporation
organized in the other. The protocol also clarifies that the
branch profits taxes (as well as other taxes added by the Act,
such as the alternative minimum tax) are creditable taxes under
the treaty.
In connection with the Act's narrowing of the Code exemption
for income earned by foreign governments, the legislative history
of the Act provided that for treaty purposes a foreign government
is to be treated as a resident of its country eligible for treaty
benefits unless it denies treaty benefits to the United States.
The protocol accordingly provides that the United States, France,
their local authorities, and the political subdivisions of the
United States qualify as residents of the respective countries.
Thus, if any of these governmental entities derive income from
the other Contracting State which is subject to tax by such
State, it is entitled to whatever benefits the treaty provides
with respect to such income.
In the French treaty, as in most of our tax treaties, only
business profits earned by a resident of one treaty partner which
are attributable to a permanent establishment in the other treaty
partner are taxable by such other treaty partner. The Act
amended the Code to provide that income attributable to a
business that a foreign person conducted in the United States
which is received after the business ceases to exist is taxable
by the United States. The protocol clarifies that this provision
may be applied consistently with the treaty, so long as the
income when earned was attributable to a permanent establishment
under the treaty's principles. The protocol allows France to tax
similarly income earned by a U.S. person that had a permanent
establishment in France to which the income is attributable.

- 6 There is one provision of the protocol which is not related
to the 1986 Act but which provides substantial benefits to U.S.
citizens resident in France. Under this change, France will
exempt certain U.S. source investment income of U.S. citizens
resident in France. These individuals now pay tax to France on
this income at a maximum rate of 54 percent. The Act cut the
maximum U.S. tax rate on individuals to 28 percent. U.S.
citizens, like U.S. corporations, can claim foreign taxes as
credits against U.S. tax, but only up to the U.S. rate on the
foreign source income subject to foreign tax (the "foreign tax
credit limitation"). U.S. citizens resident in France, by virtue
of a prior protocol provision permitting foreign source treatment
of certain of their U.S. source income, could claim their French
tax as a credit and thereby reduce their U.S. tax on their U.S.
source investment income, but one consequence of the Act's rate
reduction is that such individuals are now paying substantial
French tax in excess of (and thus not creditable against) their
U.S. tax.
Foreign taxes which are not creditable because of the
foreign tax credit limitation, known as "excess credits," have
become a much more serious problem for U.S. taxpayers as a result
of the Act's rate reduction, since the foreign tax credit
limitation declines as the U.S. rate declines. Without the
protocol U.S. citizens resident in France would not benefit at
all from the U.S. rate reduction (by contrast to U.S. citizens
resident in the United States) since, as before the Act, they
would continue to pay French tax at a 54 percent rate, a large
portion of which would result in excess credits.
The protocol accordingly exempts from French tax U.S. source
dividends, interest, and royalties earned by such individuals
which are paid by (a) the United States or a political
subdivision thereof, (b) a U.S. legal entity the principal class
of shares of or interests in which are substantially and
regularly traded on a recognized stock exchange, (c) a U.S.
corporation in which the individual has less than a 10 percent
interest, or (d) a U.S. resident which earns not more than 25
percent of its gross income from non-U.S. sources. Capital gains
from the sale of assets giving rise to this income also qualify
for the exemption. The exemption is available only if the
individual who realizes the income demonstrates to France that he
has complied with his U.S. tax obligations.
We believe this is an important illustration of how the
treaty process can respond to changes in U.S. law by providing
tax benefits to Americans without any cost to the U.S. Treasury.
Without this protocol Americans living in France would be
seriously disadvantaged as compared with Americans living in the
United States and U.S. firms would find it more difficult to
attract Americans to work for them in France, with concomitant
damage to the competitiveness of such firms abroad.

- 7 The remainder of the protocol principally consists of minor
changes to the dividends, interest, and royalties articles of the
treaty requested by France. All these changes are discussed in
the technical explanation.
BELGIUM
Our income tax treaty with Belgium, which was signed in 1970,
is currently under renegotiation, in part to have the treaty
reflect changes in the Code made by the Act. Both the United
States and Belgium are committed to the prompt completion of a
new treaty, and a round of negotiations will likely be held in
the next six months.
The Act's reduction of the maximum U.S. corporate tax rate
from 46 to 34 percent has had such a large impact on U.S.
corporations operating in Belgium through Belgian subsidiaries,
however, that both countries believe that one issue needs to be
resolved immediately. As discussed above, one effect of the U.S.
rate reduction is that U.S. taxpayers are now paying substantial
taxes to foreign governments which are in excess of their U.S.
tax liability. The combined Belgian tax rate on corporate
earnings and dividends out of those earnings paid to a foreign
parent corporation is more than 51 percent. With the U.S.
corporate rate now at 34 percent, U.S. corporations operating in
Belgium through Belgian subsidiaries are now generating large
amounts of excess credits on their dividend payments to the U.S.
parent corporation.
Under the existing treaty the withholding tax rate on
dividends paid by a Belgian subsidiary to its U.S. parent is 15
percent, the rate on all dividends which qualify for a rate
reduction under the treaty. To ameliorate the excess credit
problem, the protocol drops the rate to 5 percent in the case of
dividends paid by a resident of one of the treaty partners to a
corporate shareholder which is a resident of the other partner
and which owns at least 10 percent of the voting stock of the
payor company. The rate on all other dividends derived from
sources within one of the treaty partners and paid to a resident
of the other partner remains 15 percent. The treaty, as amended
by the protocol, has the same rates as the U.S. Treasury
Department Model Treaty.
The present treaty does not have a limitation on benefits
article. The protocol adds such an article to the treaty. It
serves to deny treaty benefits with respect to withholding taxes
on dividends, interest and royalties unless certain requirements,
similar to those in the French treaty, as amended by the
protocol, are met. The Belgian protocol generally provides that
the owner of the income must satisfy stock ownership and base
erosion requirements essentially identical to those in the French
protocol. These requirements, however, are deemed to be met if
one of two alternative requirements is satisfied. The first
alternative is satisfied if the income derived from one

- 8 Contracting State for which the treaty benefit is claimed is
derived in connection with, or is incidental to, the active
conduct of a business by the owner of such income in the other
Contracting State. The second alternative is satisfied if the
owner of the income is a corporation whose principal class of
shares is substantially and regularly traded on a recognized
stock exchange. These alternatives are consistent with recent
U.S. tax treaty policy and with the statutory limitation on
benefits provision applicable to the branch profits tax.
As mentioned above, the United States and Belgium are
continuing negotiations on a full new income tax treaty. We
recognize, however, that some people may be concerned that the
changes made by the protocol may decrease the incentive of both
the United States and Belgium to conclude a new treaty that fully
reflects the Act's changes to the Code. To allay this potential
concern, the protocol permits either partner to terminate the
protocol after it has been in force for five years. If this
option is exercised, the treaty will be effective as if the
protocol had never entered into force so that, for example, the
withholding rate on dividends paid by a Belgian subsidiary to its
U.S. parent would increase to 15 percent.
* * *

In conclusion, I want to state again my appreciation for the
willingness of the Committee to consider these two important
protocols. The Constitution directs us, the Executive Branch and
the Legislative Branch, to act together as partners in the
treaty-making process. In the context of tax treaties, this
partnership extends not only to the process of Senate advice and
consent to ratification, by which a signed treaty is brought into
force, but also to each and every phase of cooperative effort by
which the relevant features of our tax law and policy are brought
into force in a new protocol or treaty, from initial
consultations with the Joint Committee on Taxation and of the
Senate and House tax-writing committees and their staffs, through
negotiations with our treaty partners, to follow-up consultations
and finalization of the treaty documents. We take very seriously
this partnership and the obligations it imposes on us, as the two
protocols before you today — the most recent fruits of this
partnership — attest. We believe the partnership is in vigorous
health and operating in a manner most faithful to the spirit with
which it was created. I urge the Committee to take prompt action
in support of these two protocols.

TREASURY NEWS
department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
August 9!, 1988

CONTACT: Felice Pelosi
202/566-2843

SUSANNE H. HOWARD APPOINTED
DEPUTY TREASURER OF THE UNITED STATES
Treasury Secretary James A. Baker, III today
announced the appointment of Susanne Hinson Howard to be
Deputy Treasurer of the United States. She has been
serving as the Press Secretary to the Treasurer, Katherine
D. Ortega.
Mrs. Howard, who has an extensive background in
public relations and public affairs, came to the
Department of Treasury from the U.S. Small Business
Administration, where she served as the Conference
Coordinator for President Reagan's Women's Business
Ownership National Initiative Conferences. From 1981-1983
she served as Special Assistant to the Administrator of
the Economic Regulatory Administration, Department of
Energy.
Prior to joining the Reagan Administration, Mrs.
Howard was a consultant to the Electric Council of New
England, directing the design and management of a
collegiate energy education program. She organized energy
workshops in California, while serving on the board of the
Energy Advocacy Conference. She is also co-author of
"Getting Started," a primer on pro-energy citizen action.
Mrs. Howard, from El Centro, California, received her
Bachelor of Science degree from Brigham Young University.
She is married to Captain H. Wyman Howard, Jr., USN. They
have three children, Midshipman 2/c H. Wyman Howard, III,
Anne-Marie Evans Howard and Kent Hinson Howard.

B- 1511

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
August 5, 1988
MARGARET TUTWILER TO LEAVE TREASURY

Margaret DeB. Tutwiler, Assistant Secretary of the Treasury for
Public Affairs and Public Liaison, will leave the Treasury
Department on August 17, 1988 to join Vice President Bush's
Campaign for President as the Deputy to the Chairman.
In announcing Miss Tutwiler's upcoming departure, Secretary Baker
noted that "Margaret's tireless efforts in support of this
Administration, both at Treasury and the White House, are the
result of her relentless and consistent commitment to its
objectives. She has been a valued advisor for many years and I
am delighted that she has decided to dedicate her efforts toward
the Bush Campaign."
At Treasury, Miss Tutwiler serves as the principal spokesperson
for the Secretary. She oversees the Department's communications,
press activities, and scheduling on a daily basis and for all
major events. She is responsible for promoting understanding of
Treasury policy through her work with the press corps, business
and consumer groups.
. Before coming to Treasury in February 1985, Miss Tutwiler served
as a member of President Reagan's senior staff at the White
House, first as Special Assistant to the President and Executive
Assistant to the Chief of Staff (1980-1984) and later as Deputy
Assistant to the President for Political Affairs (1984-1985).
From 1978-1980, Miss Tutwiler was Director of Scheduling for
George Bush's Presidential and Vice Presidential campaigns.
Miss Tutwiler became Public Affairs Representative for the
National Association of Manufacturers in Alabama and Mississippi
after having worked for the Alabama Republican Party in 1974 and
having served in President Gerald Ford's re-election campaign
from 1975-1976.
In July 1985, Miss Tutwiler was a member of the official U.S.
delegation to the 1985 World Conference to Review and Appraise
the Achievement of the United Nations Decade for Women in
Nairobi, Kenya.
A native of Birmingham, Alabama, Miss Tutwiler graduated from the
University of Alabama. She resides in Washington, D.C.
B-1512

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
August 9, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF AUCTION OF 3-YEAR NOTES
The Department of the Treasury has accepted $11,097 million
of $32,819 million of tenders received from the public for the
3-year notes, Series T-1991, auctioned today. The notes will be
issued August 15, 1988, and mature August 15, 1991.
The interest rate on the notes will be 8-3/4%. The range
of accepted competitive bids, and the corresponding prices at the
8-3/4% rate are as follows:
Yield Price
Low
8.76%*
99.974
High
8.77%
99.948
Average
8.77%
99.948
•Excepting 2 tenders totaling $2,005,000.
Tenders at the high yield were allotted 95%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
53,990
$
53,980
$
New York
29 ,849,935
10,048,210
Philadelphia
35,010
33,960
Cleveland
95,650
82,350
Richmond
91,780
53,240
Atlanta
42,560
40,560
Chicago
1 ,352,685
185,685
St. Louis
89,180
74,855
Minneapolis
41,670
40,670
Kansas City
123,695
121,695
Dallas
30,820
24,820
San Francisco
1 ,004,185
329,035
Treasury
8,035
8,035
Totals
$32 ,819,195
$11,097,095
The $11,097 million of accepted tenders includes $1,186
million of noncompetitive tenders and $9,911 million of
competitive tenders from the public.
In addition to the $11,097 million of tenders accepted in
the auction process, $635 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $1,630 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-1513

TREASURY NEWS _
Depairtment of the Treasury • Washington, D.C. • Telephone 566-2041

For Release Upon Delivery
Expected at 9:30 A.M.
August 10, 1988

STATEMENT OF
DANA L. TRIER
TAX LEGISLATIVE COUNSEL
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON WAYS AND MEANS
UNITED STATES HOUSE OF REPRESENTATIVES
Mr. Chairman and Members of the Committee:
I am pleased to have this opportunity to present the views of
the Treasury Department regarding several bills designed to
revitalize the uranium industry of the United States, to provide
for the cleanup of various mining sites, and to modify the
enrichment program currently run by the Department of Energy. As
you know there have been three separate bills introduced in the
House to achieve the above purposes. Two of these bills,
H.R.4934 and H.R.4975 are nearly identical. I will begin my
H.R.4489
testimony with the third bill,
H.R.4489.
The Treasury Department opposes H.R.44 89. Title I of the
bill would impose a fee on the use of fore ign uranium by civilian
nuclear reactors. This provision would vi olate the pending Free
Trade Agreement between the United States and Canada, as well as
the General Agreement on Trade and Tariffs ("GATT"). Robert
Reinstein of the Office of the United Stat es Trade Representative
stated in testimony on June 28, 1988 befor e the Subcommittee*on
Energy and the Environment of the Committe e on Interior and
Insular Affairs that "the provisions of Ti tie I would be
inconsistent with the [Free Trade] Agreeme nt, as well as with
Article III of the GATT, and that the Pres ident's senior advisors
would recommend a veto of any bill contain ing this provision."
Thus, the Administration and the Treasury Department oppose
B-1514
H.R.4489.

-2-

H.R.4934 and H.R.4975
I would like to now turn to H.R.4934 and H.R.4975. These two
bills, which are for all practical purposes identical, would
enact the Uranium Revitalization, Tailings Reclamation and
Enrichment Act of 1988 (the "Act"). I will refer to these bills
collectively as the "Act."
The Administration supports this proposed legislation, with
certain modifications, as a reasonable compromise of the
competing interests involved. These modifications include
provision of the proposed government corporation with a private
sector-type board of directors, expanded authority to borrow from
the public for its project financings and independence and
flexibility to market its product effectively; subjection of the
corporation to NRC, EPA, and OSHA regulations; application of
apportionment to both the Uranium Revitalization Fund and the
proposed corporation; and elimination of legislative bypass
authority.
Moreover, the Treasury Department believes that, from a tax
policy perspective, the Act represents a far sounder approach to
implementing the significant compromises it embodies than that
taken by H.R.4489. However, we also believe it is appropriate
for Congress to consider clarifying several ancillary tax issues
raised by the proposed legislation.
Background
As the Committee is aware, among the purposes of the Act is
the resolution of two major disputes that have arisen among
miners and users of uranium and the United States government.
One of these disputes concerns the relative liability and
responsibility of uranium miners, the utility industry, and the
federal government for cleanup and reclamation of uranium mining
sites across the country. The other major dispute concerns the
liability of the utility industry for unrecovered costs of the
uranium enrichment program run by the federal government.
~ The Act would establish a Uranium Revitalization Trust Fund
(the "Fund" or "Uranium Fund") to achieve a number of goals,
including funding a program for the purchase of domestic uranium
and the mine tailings cleanup effort. The uranium and utility
industries would both make contributions to the Fund, as
discussed further below.
In addition the Act would also establish the United States
Enrichment Corporation, which would be a government-owned
corporation. The Corporation would take over the uranium
enrichment program from the Department of Energy, and would also
support the Uranium Fund. The Department of Energy would
transfer most of its existing uranium enrichment facilities to
the Corporation. The Corporation would issue capital stock to
the United States representing an equity investment equal to the
book value of the assets transferred to the Corporation. The

-3Corporation would pay dividends on its capital stock out of
earnings, unless there is an "overriding need" to retain those
funds for corporate purposes. The Corporation would have an
"initial debt" to the United States of $364 million dollars,
required to be repaid over twenty years. However, this debt will
be reduced by $300 million of the payments made by the
Corporation to the Uranium Fund over the next five years, so that
the initial debt will be reduced to $64 million. The United
States would be prohibited from selling the stock of the
Corporation without further legislation. Nonetheless, we
understand that the eventual privatization of the Corporation is
a goal of the legislation.
My testimony here today will focus on the tax policy
implications of the proposed legislation. The Administration
supports this proposed legislation with the modifications
described above. I will not, however, discuss the diverse
liability, energy, and environmental issues addressed by the Act,
which are being fully discussed in the testimony of the
Department of Energy. I will instead focus on four aspects of
the proposed legislation: the reliance on user fees; collection
of the taxes; the application of the Trust Fund Act; and certain
potential tax interpretation issues.
User Fees
From a tax policy perspective, the most attractive feature of
the Act is that the proposed Uranium Fund would be funded by what
might be appropriately termed "user fees," rather than taxes
levied on the general public- There are to be two major sources
of private contributions to the Fund: the mining industry and the
utility industry. Moreover, through the United States Enrichment
Corporation, the federal government will provide additional
support. In addition, states in which mining sites are located
are permitted to make voluntary contributions to the Fund,
although it is possible that few, if any, such voluntary
contributions will be made.
The largest component of the funding is to be $1 billion
contributed by the utility industry. Licensees for civilian
nuclear power reactors would contribute to the Fund by means of a
fee of $72 per kilogram of uranium contained in fuel assemblies
initially loaded into each civilian nuclear reactor during each
year, commencing January 1, 1988. The fee applies to the use of
either foreign or domestic uranium. The fee will continue to be
payable until the $1 billion figure is reached. It is
anticipated that it will take five or six years for the fees to
accumulate $1 billion. No specific cutoff date for the
contributions is provided, so that if the $1 billion figure is
not reached as quickly as anticipated, utilities will continue to
pay until it is reached. Because utilities using the nuclear
fuel are direct beneficiaries of the programs supported by the
Fund, it is appropriate that they should bear financial
responsibility under the Act in proportion to their use of
nuclear fuel.

-4-

Mining companies are required to contribute to the Fund only
if they elect to participate in the cleanup program under the Act
with respect to active mining sites listed in the Act. If they
do so elect, contributions are to be $2,000,000 per active site,
$1,000,000 of which is to be contributed by January 31, 1990, and
$1,000,000 of which is to be contributed by January 31, 1991.
Mining companies are also to contribute $.50 by January 31, 1992
and $.50 by January 31, 1993 per dry ton of tailings produced by
mining activities prior to the effective date of the Act. Total
contributions by the mining industry are estimated at
$300,000,000. It is also appropriate that producers of uranium
should assist in financing the Uranium Fund if they benefit
through participation in the cleanup program, and that the
contributions of participating producers are to be measured by
the number of their active sites and the amount of tailings at
each active site.
The United States Enrichment Corporation established by the
Act will also provide $450,000,000 in support to the uranium
Fund. This contribution is to be made through $90,000,000
payments each December 15 from 1989 through 1993. $60,000,000 of
each $90,000,000 installment is to be credited against the
"initial debt" of the Corporation to the United States Treasury.
Furthermore, since the United States will be the sole stockholder
of the Corporation, any payments made by the Corporation reduce
the value of the federal government's equity in the Corporation.
Collection By the Internal Revenue Service
Although the Administration supports this proposed
legislation, we also believe that it is appropriate to clarify
that the fees to be charged under the Act would most
appropriately be collected by the Department of Energy rather
than the Internal Revenue Service. The Act does not currently
specify which agency would be responsible for collection.
Certain types of user fees or excise taxes are collected by the
Service because collection would be impractical for an agency not
generally involved with tax collection. An example would be
excise taxes on trucks or tires; it would not make sense for the
Department of Transportation to collect such taxes. In this
case, however, the involvement of the Department of Energy in the
enrichment of uranium and the supply of nuclear fuel to civilian
reactors would indicate that the Department will be able to
effectively carry out collection of the fees due pursuant to the
Act. It may not be necessary to have a specific provision in the
Act concerning the role of the Service in collecting the fees,
but some type of indication of Congressional intent on this point
would be helpful.
Establishment Under the Trust Fund Code
The Fund would in some respects resemble other federal trust
funds that have been set up for various purposes, such as the
Hazardous Substance Superfund, the Leaking Underground Storage

-5Tank Trust Fund, and the Vaccine Injury Compensation Trust Fund.
Unlike these other funds, however, the Uranium Fund is not
established under the Trust Fund Code, a subtitle of the Internal
Revenue Code. Although the Fund may not have been intentionally
excluded from the Trust Fund Code, under the Act it would be
codified as part of the Atomic Energy Act, not the Internal
Revenue Code. Thus, the Fund would apparently be excluded from
the coverage of the Trust Fund Code. Since the Fund is to be
"established in the Treasury of the United States", we believe it
would be appropriate to consider establishing the Uranium Fund
under the Trust Fund Code.
In this regard, we note that some of the Act's provisions
would be inconsistent with provisions of the Trust Fund Code.
First, The Trust Fund Code requires that "the amounts
appropriated... to any Trust Fund shall be transferred at least
monthly from the general fund of the Treasury." Code section
9601(a). This rule would not be satisfied with respect to the
Uranium Fund as contemplated under the Act, which would require
payments to the Fund to be made annually by each of the parties
required to pay into the Fund. It would seem that if the
purposes of the Uranium Fund are better served by annual
payments, there is no overriding reason to impose monthly
payments. Thus, if the Fund were to be established under the
Trust Fund Code there would need to be a modification of the
rules of section 9601(a) for purposes of the Uranium Fund.
Second, the Act provides that moneys in the Fund would be
invested in a manner differing from the investment program
applicable to other funds under the Trust Fund Code. Code
section 9602 provides that it shall be the duty of the Secretary
of the Treasury to invest the portion of any trust fund that is
not, in the Secretary's judgment, necessary for current
withdrawals. The Act would grant the authority to determine the
amount of the Uranium Fund to be invested in any particular year
to the Secretary of Energy. It is not clear why this particular
fund should be handled differently from those funds pursuant to
the Trust Fund Code. If it is appropriate for the Secretary of
the Treasury to determine the amount to be invested under the
Vaccine Injury Compensation Fund, the Oil Spill Liability Trust
Fund, or the Black Lung Disability Trust Fund, then it would seem
that it would be appropriate that the Secretary of the Treasury
should manage the investments of the Uranium Fund to a like
degree.
The Act also provides additional specific rules concerning
the investment of moneys in the Uranium Fund which differ
slightly from the general trust fund rules. Section 9602
provides that investments under the Trust Fund Code may only be
made in interest bearing obligations of the United States. The
Act likewise provides that the investments of the Uranium Fund
can be made only in interest-bearing U.S. obligations, but
investments will be restricted to those that the Secretary had
determined to be of appropriate maturity for the needs of the
Fund. The Act also provides that the interest rate on the U.S.

-6obligations in which moneys of the Fund are invested "shall not
exceed the average rate applicable to existing borrowings." It
is not clear exactly what this restriction means. The phrase
"existing borrowings" is nowhere defined. It apparently could
refer to borrowings of the Fund, or to borrowings of the U.S.
government. It may be that the purpose of the restriction is to
restrict the profit the Fund earns at the expense of the U.S.
government. In any event, the restriction might well hamper
proper fiscal management of the Fund, and we therefore believe
that consideration should be given to deleting it.
In summary, we do not see compelling reasons for having
different investment rules for the Uranium Fund than for other
federal trust funds. Thus, it appears appropriate that if
enacted the Act should establish the Uranium Fund under the Trust
Fund Code.
Potential Tax Issues
We should also note that there are several collateral tax
issues potentially raised by the proposed legislation. First, we
note that the tax treatment of the fees paid is not entirely
clear. The Act provides that the fees paid by licensees of
civilian nuclear reactors are to be considered "as a component of
fuel cost for accounting and regulatory purposes." It is not
clear if this provision is also meant to require that the fees be
treated as part of fuel cost for federal tax purposes as well.
Although the language does not specify the tax treatment of the
fees, the broad language might be interpreted to require this
result. We would oppose such an interpretation. The purpose of
the fee is not to pay for the acquisition of fuel but to
compensate the U.S. government for unrecovered costs of prior
enrichment activities and to fund cleanup of the tailings
resulting from the mining of fuel used in prior years.
We believe it is appropriate for the tax treatment of the fee
to be determined through the normal process of determining the
federal tax treatment of any other payment; that is, through
regulations or by means of private or public rulings that address
the issue in a specific factual context. We believe that the
same logic applies to. the determination of the federal tax
treatment of contributors to the Fund by the mining industry.
Second, it appears that the Corporation would be subject to
federal income tax, although this is not explicitly stated in the
bill. Under the Internal Revenue Code, federal instrumentalities
formed by an act of Congress after 1984 are exempt from federal
income taxation only if the exemption is specifically provided
under the Internal Revenue Code. Therefore, the Corporation
would be subject to federal income tax, and it might be wise to
have the Act or legislative history clarify this point.
Finally, several state tax issues are raised by the Act.
Under the Act the Corporation would be exempt from state and
local taxes of any sort. The Act does provide, however, that the
Corporation is to make payments in lieu of taxes to state and
local authorities.

-7This provision raises a number of issues. The payments in
lieu of taxes are intended to approximate the amount that would
be payable by private industrial firms owning similar facilities
and engaged in similar activities, except that no payments are to
be made in lieu of taxes imposed on net income. Some
jurisdictions impose gross receipts type taxes. It is not clear
why the Corporation should make payments in lieu of a gross
receipts tax but not of an income tax. The Act would also
provide that in no event would the payment in lieu of taxes be
less than the amount payable as actual taxes calculated as if the
transfer of properties had not occurred. Despite this mandatory
minimum, the Act provides that the Corporation will have absolute
discretion to determine the amount of tax payable. It is
arguably inconsistent to have absolute discretion coupled with
the mandatory minimum.
Finally, I would like to note the possible ramifications of a
provision that includes certain contractors within the scope of
the state tax exemption. In providing the Corporation's
exemption, it is stated that "the activities of the Corporation
for this purpose shall include the activities of organizations
pursuant to cost-type contracts with the Corporation to manage,
operate, and maintain its facilities." The proposed legislation
goes on to provide that this exemption is not intended to exclude
income of the Corporation's contractors from state or local
income taxes. This provision appears to be aimed at cases which
have held that federal contractors may not rely on the federal
government's exclusion from state and local taxes. In United
States v. New Mexico, 455 U.S. 720 (1981), the Supreme Court held
that, despite the use of cost-type contracts, Atomic Energy
Commission contractors were liable for gross receipts and sales
taxes imposed by the state of New Mexico. The Court held that
constitutional immunity from state or local taxes exists only
where the contractors are "so closely connected to the government
that that the two cannot realistically be viewed as separate
entities, at least insofar as the activity being taxed is
concerned." Id. at 735. The Court found that the use of
cost-type contracts did not result in such an inseparable
relationship. Numerous other cases have considered the liability
of federal contractors for state and local taxes.
The extension of federal tax immunity to the Corporation's
contractors must be considered in light of this background. It
may be appropriate in certain cases for federal contractors to be
treated as instrumentalities of the federal government for
purposes of state and local taxes, and it may be that Congress
will determine that the Corporation's contractors should be so
•treated. However, it is important that the background and
possible collateral consequences of such a provision be
understood and considered before such a provision is enacted.

-8-

CONCLUSION
The Treasury Department supports the legislation proposed in
H.R.4934 and H.R.4975, with the modifications described
previously. Although a number of collateral issues are raised by
the bills, we believe that on balance the bills represent a
reasonable approach to the issues intended to be resolved by the
legislation.
This concludes my prepared remarks. I would be pleased to
respond to your questions.

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
August 10, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF AUCTION OF 10-YEAR NOTES
The Department of the Treasury has accepted $11,001 million
of $20,354 million of tenders received from the public for the
10-year notes, Series C-1998, auctioned today. The notes will be
issued August 15, 1988, and mature August 15, 1998.
The interest rate on the notes will be 9-1/4%. — The range
of accepted competitive bids, and the corresponding prices at the
9-1/4% interest rate are as follows:
Yield Price
Low
9.24%*
100.064
High
9.29%
99.743
Average
9.27%
99.871
•Excepting 1 tender of $50,000.
Tenders at the high yield were allotted 17%.
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
$
15,479
19,013,840
7,684
15,227
12,766
15,217
792,899
28,566
11,100
20,039
6,225
412,338
2,936
$20,354,316

Accepted
$
13,479
10,359,600
7,684
15,227
12,766
15,207
361,239
12,566
11,100
20,039
6,225
162,585
2,936
$11,000,653

The $11,001 million of accepted tenders includes $495
million of noncompetitive tenders and $10,506 million of competitive tenders from the public.
In addition to the $11,001 million of tenders accepted in the
auction process, $325 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.
1/ The minimum par amount required for STRIPS is $800,000.
Larger amounts must be in multiples of that amount.
B-1515

_L

\

*:ws
August 11, 1988

FOR IMMEDIATE RELEASE

FEDERAL FINANCING BANK ACTIVITY
Charles D. Haworth, Acting Secretary, Federal Financing
Bank (FFB), announced the following activity for the month of
February 1988.
FFB holdings of obligations issued, sold or guaranteed by
other Federal agencies totaled $150.2 billion on February 29,
1988, posting a decrease of $1.9 billion from the level on
January 31, 1988. This net change was the result of an increase
in holdings of agency debt of $91.7 million, and decreases in
holdings of agency-guaranteed debt of $2,011.7 million and in
agency assets of $0.9 million. FFB made 59 disbursements during
February.
Attached to this release are. tables presenting FFB
February loan activity and FFB holdings as of February 29, 1988.
# 0#

B-1516

FFB 566-2468

WASHINGTON, D.C. 20220

Press 566-2041

federal financing bank \

Page 2 of 4
FEDERAL FINANCING BANK
February 1988 ACTIVITY

BORROWER

AM3UNT
OF ADVANCE

DATE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

AGENCY DEBT
NATIONAL CREDIT UNION ADMINISTRATION
Central Liquidity Facility
+Note #459
Note #460

2/3
2/18

$

9,570,000.00
13,400,000.00

5/4/88
5/19/88

6.015%
6.045%

2/3
2/5
2/8
2/12
2/12
2/12
2/15
2/19
2/19
2/22
2/26
2/26
2/26
2/28
2/29

115,000,000.00
46,000,000.00
143,000,000.00
69,000,000.00
33,000,000.00
70,000,000.00
173,000,000.00
25,000,000.00
54,000,000.00
151,000,000.00
34,000,000.00
62,000,000.00
132,000,000.00
42,000,000.00
152,000,000.00

2/12/88
2/12/88
2/15/88
2/16/88
2/17/88
2/19/88
2/22/88
2/23/88
2/26/88
2/26/88
3/2/88
3/3/88
3/4/88
3/7/88
3/7/88

6.015%
5.955%
5.935%
5.935%
5.935%
5.935%
6.055%
5.995%
5.995%
5.985%
5.935%
5.935%
5.935%
5.885%
5.885%

2/1
2/1
2/1
2/1
2/1
2/1
2/3
2/4
2/4
2/10
2/16
2/16
2/16
2/16
2/17
2/22
2/22
2/25
2/26

69,617.70
18,950.00
231,671.96
2,000,000.00
738,508.68
6,020.50
2,804,512.02
297,284.86
148,105.27
649,533.81
1,404,710.00
1,000,000.00
73,132.76
479,460.13
108,633.44
9,452.01
1,246,100.41
1,138,636.29
536,290.00

4/10/96
5/31/96
9/12/96
6/15/12
3/12/14
12/8/95
3/14/12
3/14/12
4/10/96
3/12/14
2/15/90
3/20/89
5/15/95
3/12/14
9/12/96
9/12/96
8/25/14
6/15/12
7/15/88

8.215%
7.805%
7.535%
8.535%
8.545%
8.205%
8.435%
8.505%
8.195%
8.505%
7.029%
6.582%
8.085%
8.605%
7.495%
7.435%
8.455%
8.515%
6.068%

TENNESSEE VALLEY AUTHORITY
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance

#851
#852
#853
#854
#855
#856
#857
#858
#859
#860
#861
#862
#863
#864
#865

GOVERNMENT - GUARANTEED LOANS
DEPARTMENT OF DEFENSE
Foreign Military Sales
Peru 10
Morocco 13
Phillipines 11
Greece 15
Turkey 18
Morocco 11
Turkey 18
Turkey 18
Peru 10
Turkey 18
Gabon 6
Gabon 5
Niger 3
Turkey 18
Phillipines 11
Phillipines 11
Greece 17
Greece 15
Gabon 4
+rollover

INTEREST
RATE
(other than
semi-annual)

Page 3 of 4
FEDERAL FINANCING BANK
February 1988 ACTIVITY
BORROWER

AMOUNT
OF ADVANCE

DATE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual)

DEPARTMENT OF HOUSING & URBAN DEVELOPMENT
Community Development
*Toa Baja, PR
•Ponce, PR
•Rochester, NY

2/16
2/16
2/19

$

300,000.00
32,078.50
20,000.00

5/2/88
10/1/88
8/31/88

6.055%
6.555%
6.425%

6.598% ann,
6.436% ann,

7.396%
7.299%
7.365%
8.491%
7.245%
8.433%
8.433%
7.220%
7.220%
7.388%
7.395%
8.605%
7.347%
7.2%%
7.296%
7.297%
8.480%
7.285%

7.329%
7.234%
7.298%
8.403%
7.181%
8.346%
8.346%
7.156%
7.156%
7.321%
7.328%
8.514%
7.281%
7.231%
7.231%
7.232%
8.392%
7.220%

RURAL ELECTRIFICATION ADMINISTRATION
•Wabash Valley Power #206 2/1 134,000.00
•Allegheny Electric #175A
2/1
•Wolverine Power #182A
2/1
United Power #222
2/5
Brazos Electric #333
2/9
•Wabash Valley Power #206
2/10
•Wabash Valley Power #206
2/10
•Wabash Valley Power #104
2/10
•Wolverine Power #183A
2/10
•Wolverine Power #182A
2/10
•Colorado Ute Electric #198A
2/18
Oglethorpe Electric #320
2/18
•New Hampshire Electric #192
2/18
•Colorado Ute Electric #168A
2/22
•Colorado Ute Electric 168A
2/24
•Colorado Ute Electric #96A
2/24
•Colorado Ute Electric #203A
2/24
Tex-La Electric Coop #329
2/24
Cooperative Power Assoc. #156 2/29

1/3/17 8.489% 8.401% qtr.
7,042,000.00
4/2/90
459,000.00
1/2/90
950,000.00
5/2/90
3,000,000.00
1/3/22
821,000.00
2/12/90
1,981,000.00
1/3/17
4,062,000.00
1/3/17
1,101,000.00
1/2/90
858,000.00
1/2/90
540,000.00
4/2/90
5,184,000.00
4/2/90
970,000.00
12/31/18
873,000.00
4/2/90
1,290,057.00
4/2/90
745,000.00
4/2/90
1,505,000.00
4/2/90
1,637,290.67
1/3/22
2,396,000.00
3/1/90

SMALL BUSINESS ADMINISTRATION
State & Local Development Company Debentures
West Tennessee Invest Corp. 2/10 93,000.00

2/1/08

8.345%

5/31/88

5.945%

TENNESSEE VALLEY AUTHORITY
Seven States Energy Corporation
Note #A-88-05 2/29

•maturity extension

644,553,689.96

qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.

Page 4 of

4

FEDERAL FINANCING BANK HOLDINGS
(in millions)
Program
Agency Debt:
Export-Import Bank
NCUA-Central Liquidity Facility
Tennessee Valley Authority
U.S. Postal Service
U.S. Railway Association +
sub-total*
Agency Assets:
Farmers Home Administration
DHHS-Health Maintenance Org.
DHHS-Medical Facilities
Overseas Private Investment Corp.
Rural Electrification Admin.-CBO
Small Business Administration
sub-total*
Government-Guaranteed Lending:
DOD-Foreign Military Sales
DEd.-Student Loan Marketing Assn.
DHUD-Community 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 Administration
SBA-Small Business Investment Cos.
SBA-State/Local Development Cos.
TVA-Seven States Energy Corp.
DOT-Section 511
DOT-WMATA
sub-total*
grand total*
*figures may not total due to rounding
^r«>e

»-«-.»-

ir^r^liiHc* rpt<r> i t- PS 1 i "7.e*r\

i nteirest

Net Change
2/1/88-2/29/88

FY '88 Net Change
10/1/87-2/29/88

February 29, 1988

January 31, 1988

$ 11,971.5
113.1
16,547.0
5,853.4

$ 11,971.5

-0-

-0-

-0-0-

$ -492.0
1.7
161.0
1,500.0
-0-

34,485.0

34,393.3

91.7

1,170.7

59,674.0
84.0
102.2

59,674.0
84.0
102.2

-0-0-0-

118.4
16,450.0
5,853.4

$

-0-5.3
97.0

-0-

0.7

-0.7

4,071.2
17.9

4,071.2
18.2

-0.3

-5,335.0
-0-0-0.7
-170.0
-1.7

63,949.3

63,950.2

-0.9

-5,507.3

18,303.0
4,940.0
316.5
29.1
2,034.9
391.6
33.1
26.7
949.4
1,758.9

18,322.4
4,940.0
323.7
29.1
2,034.9
391.6
33.2
26.7
949.4
1,758.9

-19.4

-0-

-0-

-0-

19,192.9
716.4
893.1
1,927.0
53.5
177.0

21,187.4
718.0
896.0
1,913.0
53.8
177.0

-1,,994.4

-0-

-860.9
-0-7.7
-1.5
-39.5
-3.8
-0-0140.8
-29.4
-0-2,004.0
-24.2
-6.7
103.4
-1.8
-0-

51,743.4

53,755.1

-2 ,011.7

-2,735.3

$ 150,177.7

$ 152,098.6

$ -1 ,920.9

S -7,072.3

-0-7.1

-0-0-0-0-0-0-0-0-1.6
-2.9
14.0
-0.2

TREASURY NEWS
Department off the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT:

FOR IMMEDIATE RELEASE
August 11, 1988

Office of Financing
202/376-4350

RESULTS OF TREASURY'S AUCTION
OF 248-DAY CASH MANAGEMENT BILLS
Tenders for $7,021 million of 248-day Treasury bills to
be issued on August 15, 1988, and to mature April 20, 1989,
were accepted today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Rate

Investment Rate
(Equivalent Coupon-Issue Yield)

Price

Low
7.71%*
8.17%
94.689
High
7.74%
8.20%
94.668
Average
7.73%
8.19%
94.675
•Excepting 1 tender of $200,000.
Tenders at the high discount rate were allotted 63%.
TOTAL 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
$
200
23,319,040
1,800
13,310
250
170
1,236,315
5,055

Accepted
$
200
6,142,565
1,800
12,200
250
170
654,165
3,055

—

--

3,745
16,100
1,076,120
--

$25,672,105

3,005
6,100
197,620
—

$7,021,130

The $7,021 million of accepted tenders includes $13
million of noncompetitive tenders and $7,008 million of
competitive tenders from the public.

B-1517

TREASURY NEWS
Department
off the Treasury • Washington,
D.C. •Office
Telephone
566-2041
CONTACT:
of Financing
FOR IMMEDIATE RELEASE
August

202/376-4350

15, 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

Tenders for $6,807 million of 13-week bills and for $6,811 million
of 26-week bills, both to be issued on August 18, 1988,
were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing November 17, 1988
Discount Investment
Rate
Price
Rate 1/
7.02%
7.06%
7.05%

7.24%
7.29%
7.28%

26-week bills
maturing February 16, 1989
Discount Investment
Price
Rate
Rate 1/
7.48%
7.52%
7.51%

98.226
98.215
98.218

7.88%
7.93%
7.92%

96.218
96.198
96.203

Tenders at the high discount rate for the 13-week bills were allotted 82%.
Tenders at the high discount rate for the 26-week bills were allotted 22%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
:
Location
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

Ileceived

Accepted

$
36,140
21,632,865
24,295
51,910
39,625
36,275
1,145,450
30,605
7,010
35,985
35,860
1,125,725
380,910

$
36,140
5,907,150
24,295
51.605
39,625
36,275
65,950
26,605
7,010
35,985
25,860
169,355
380,910

38,985
$
20 ,040,620
23,155
44,200
44,060
33,210
1 ,010,300
37,985
10,575
57,380
31,950
1 ,199,150
433,005

$
38,985
5,839,320
23,155
44,200
44,060
31,675
152,500
34,205
10,575
57,380
21,950
79,550
433,005

$24,582,655

$6,806,765

: $23 004,575

$6,810,560

$20,893,265
1,105,985
$21,999,250

$3,117,375
1,105,985
$4,223,360

: $18 334,175
:
1 137,395
: $19 471,570

$2,140,160
1,137,395
$3,277,555

2,479,310

2,479,310

:

2,150,000

2,150.000

104,095

104,095

:

1,383,005

1,383,005

$24,582,655

$6,806,765

: $23 004,575

$6,810,560

An additional $41,105 thousand of 13-week bills and an additional $526,195
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
B-15 18

TREASURY NEWS .

apartment off the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
August 16, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$14,000 million, to be issued August 25, 1988.
This offering
will provide about $1,125 million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $12,884 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, August 22, 1988.
The two series offered are as follows:
9 2-day bills (to maturity date) for approximately $7,000
million, representing an additional amount of bills dated
November 27, 1987, and to mature November 25, 1988 (CUSIP No.
912794 QC 1), currently outstanding in the amount of $15,819 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,000 million, to be dated
August 25, 1988,
and to mature February 23, 1989 (CUSIP No.
912794 RJ 5 ) .
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 August 25, 1988.
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 $1,817 million as agents for foreign
and international monetary authorities, and $4,647 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 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series)
B-15 19

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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.
10/87

TREASURY NEWS

Department off the Treasury • Washington, D.C. e Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
August 17, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY TO AUCTION 2-YEAR AND 5-YEAR 2-MONTH NOTES
TOTALING $16,000 MILLION
The Treasury will raise about $5,425 million of new cash
by issuing $8,750 million of 2-year notes and $7,250 million
of 5-year 2-month notes. This offering will also refund $10,572
million of 2-year notes maturing August 31, 1988. The $10,572
million of maturing 2-year notes are those held by the public,
including $1,263 million currently held by Federal Reserve Banks
as agents for foreign and international monetary authorities.
The $16,000 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 $863 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 each of the new securities are given in the
attached highlights of the offerings and in the official offering
circulars.
oOo
Attachment

B-1521

HIGHLIGHTS OF TREASURY OFFERINGS TO THE PUBLIC
OF 2-YEAR AND 5-YEAR 2-MONTH NOTES
August 17, 1988
$7,250 million
Amount Offered to the Public
$8,750 million
Description of Security:
Term and type of security
2-year notes
Series and CUSIP designation ... Series AE-1990
(CUSIP No. 912827 WP 3)
Issue date
August 31, 1988
Maturity date
August 31, 1990
Interest rate
To be determined based on
the average of accepted bids
Investment yield
To be determined at auction
Premium or discount
To be determined after auction
Interest payment dates
February 28 and August 31
Minimum denomination available . $5,000
Terms of Sale:
Method of sale
Yield auction
Competitive tenders
Must be expressed as
an annual yield, with two
decimals, e.g., 7.10%
Noncompetitive tenders
Accepted in full at the average price up to $1,000,000
Accrued interest payable
by investor
None
Payment Terms:
Payment by non-institutional
investors
Full payment to be
Acceptable
for TT&L
Note
submitted with
tender
Option
Depositaries
Payment guarantee
through Treasury
Tax
Deposit
by
and
Loan
(TT&L)
Note
Accounts
Acceptable
designated institutions
Key Pates:
Tuesday, August 23, 1988,
Receipt of tenders
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a) funds immediately
Wednesday, August 31, 1988
available to the Treasury
Monday, August 29, 1988
b) readily-collectible check

5-year 2-month notes
Series M-1993
(CUSIP No. 912827 WQ 1)
September 1, 1988
November 15, 1993
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
May 15 and November 15 (first
payment on May 15, 1989)
$1,000
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, August 24, 1988,
prior to 1:00 p.m., EDST

Thursday, September 1, 1988
Tuesday, August 30, 1988

TREASURY NEWS

apartment off the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE August 18, 1988

M. Peter McPherson, Deputy Secretary of the Treasury since
August 6, 1987, is Acting Secretary of the Treasury effective
August 18, 1988.

Before joining the Treasury, Mr. McPherson served as
Administrator, Agency for International Development.

- 0 -

B-1522

TREASURY NEWS

Deportment off the Treasury • Washington, D.C. • Telephone 566-2041

FOR RELEASE AT 12:00 NOON
August 19, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY'S 52-WEEK BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for approximately $9,000
million of 364-day Treasury bills
to be dated September 1, 1988, and to mature August 31, 1989
(CUSIP No. 912794 SK 1), This issue will result in a paydown for
the Treasury of about $525
million, as the maturing 52-week bill
is outstanding in the amount of $9,524
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, Thursday, August 25, 1988.
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.
The bills will be issued for cash and in exchange for
Treasury bills maturing September 1, 1988.
In addition to the
maturing 52-week bills, there are $13,647 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 currently hold $2,128 million as agents for foreign
and international monetary authorities, and $7,379 million for their
own account. These amounts represent the combined holdings of such
accounts for the three issues of maturing bills. 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 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 $100
million
of the original 52-week issue. Tenders for bills to be maintained
on the book-entry records of the Department of the Treasury should
be submitted on Form PD 5176-3.
B-1523

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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.
10/87

TREASURY NEWS

Department off the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE

August 22, 1988

Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of July 1988.
As indicated in this table, U.S. reserve assets amounted to
$43,876 million at the end of July, up from $41,028 million in June.

U.S . Reserve Assets
(in mi llions of dollars)

End
of
Month

Total
Reserve
Assets

Gold
Stock 1/

Special
Drawing
Rights 2/3/

Foreign
Currencies 4/

41,028
43,876

11,063
11,063

9,180
8,984

10,793
14,056

Reserve
Position
in IMF 2/

1988
June
July

9,992
9,773

1/ Valued at $42.2222 per fine troy ounce.
2/ Beginning July 1974, the IMF adopted a technique for valuing the SDR
based on a weighted average of exchange rates for the currencies of
selected member countries.
The U.S. SDR holdings and reserve
position in the IMF also are valued on this basis beginning July
1974.
3/ Includes allocations of SDRs by the IMF plus transactions in SDRs.
4/ Valued at current market exchange rates.

B-1524

TREASURY NEWS _

Department off the Treasury • Washington, D.C. • Telephone 566-2041
_F,0R I

CONTACT:

EASE

Office of Financing
2Q2/376-4350

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,002 million of 13-week bills and for $7,009 million
of 26-week bills, both to be issued on August 25, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High .
Average

26-week bills
maturing February 23, 1989
Discount Investment
Rate
Rate 1/
Price

13-week bills
maturing November 25, 1988
Discount Investment
Rate
Rate 1/
Price
98.173
7.38%
7.15%
7.18%
7.42%
98.165
7.18%
7.42%
98.165

7.49%
7.52%
7.51%

7.89%
7.93%
7.92%

96.213
96.198
96.203

Tenders at the high discount rate for the 13-week bills were allotted
Tenders at the high discount rate for the 26-week bills were allotted

Location

TENDERS RECEIVED AND ACC:EPTED
(In Thousands)
Received
Accepted
:
Received
$

38,430
22,309,400
21,965
38,310
44,360
30,820
899,510
30,360
9,730
44,020
26,830
1,382,695
441,890

$

38,430
6,051,900
20,965
38,310
44,360
30,820
104,510
26,360
9,730
44,020
16,830
141,195
441,890

$

$24,651,'665

$7,001,545

. $25,318,320

$7,009,320

Type
. $21,103,405
Competitive
992,635
Noncompetitive
Subtotal, Public $22,096,040

$3,453,285
992,635
$4,445,920

$20,366,315
:
1,043,745
$21,410,060

2,446,585

2,446,585

32,057,315
1,043,745
$3,101,060
2,200,000

109,040

109,040

1,708,260

$24,651,665

$7,001,545

. $25,318,320

TOTALS

Federal Reserve
Foreign Official
Institutions
TOTALS

36,720
6,029,345
20,100
38,980
43,505
28,585
62,915
23,555
6,265
33,875
26,295
296,395
355,010

Accepted

$
36,720
21,798,715
20,100
38,980
43,505
28,585
1,017,665
27,555
6,265
33,875
36,295
1,208,395
355,010

Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury

:

2,200,000

81%,
25%.

1,708,260
$7,009,320

An additional $11,160 thousand of 13-week bills and an additional $349,540
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield
B-1525

TREASURY NEWS

Department off the Treasury e Washington, D.C. e Telephone 566-2041
CONTACT: Office-of-Financing
FOR IMMEDIATE RELEASE
August 23, 1988
RESULTS OF AUCTION OF 2-YEAR NOTES
The Department of the Treasury has accepted $8,779 million
of $35,272 million of tenders received from the public for the
2-year notes, Series AE-1990, auctioned today. The notes will be
issued August 31, 1988, and mature August 31, 1990.
The interest rate on the notes will be 8-5/8%. The range
of accepted competitive bids, and the corresponding prices at the
8-5/8% rate are as follows:
Yield
Price
Low
8.72%*
99.829
High
8.72%
99.829
Average
8.72%
99.829
*Excepting 2 tenders totaling $60,000.
Tenders at the high yield were allotted 74%.
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
$
56,995
31,352,165
32,375
91,555
102,640
61,600
1,429,750
102,510
39,150
137,410
35,460
1,733,785
96,525
$35,271,920

Accepted
$
56,995
7,895,245
32,375
71,555
63,600
40,600
172,750
81,970
39,150
132,410
29,160
66,785
96,525
$3,779,120

The $8,779
million of accepted tenders includes $1,224
million of noncompetitive tenders and $7,55 5 million of comperitive tenders from the public.
In addition to the $8,779 million of tenders accepted in
the auction process, $820
million of tenders was awarded at
the average price to Federal Reserve Banks as agents for foreign
and international monetary authorities. An additional $863
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-1526

TREASURY NEWS

2041
Department off the Treasury e Washington, D.C. e Telepho
C0NTACm.Office

of Financing
FOR RELEASE AT 4:00 P.M.
202/376-4350
August 23, 1988
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$14,000 million, to be issued September 1, 1988.
This offering
will provide about $ 350
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,647 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, August 29, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,000
million, representing an additional amount of bills dated
June 2, 1988,
and to mature December 1, 1988
(CUSIP No.
912794 QV9 ), currently outstanding in the amount of $7,268 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,000 million, to be dated
September 1, 19 88, and to mature March 2, 1989
(CUSIP No.
912794 RK2 ).
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 September 1, 1988. In addition to the maturing
13-week and 26-week bills, there are $ 9,524 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 $ 1,946 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $ 2,046 million as
agents for foreign and international monetary authorities, and $ 7,37 9
million 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 5176-1
(for 13-week series) or Form PD 5176-2 (for 26-week series).

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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.
10/87

TREASURY NEWS .

Department off the Treasury e Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
August 24, 19 3 3

CONTACT: Office of Financing
202/376-4350

RESULTS OF AUCTION OF 5-YEAR 2-MONTH NOTES
The Department of the Treasury has accepted $7,268 million
of $21,568 million of tenders received from the public for the
5-year 2-month notes, Series M-1993, auctioned today. The notes
will be issued September 1, 1988, and mature November 15, 1993.
The interest rate on the notes will be 9 %. The range
of accepted competitive bids, and the corresponding prices at the
9%
rate are as follows:
Yield
Price
99..800
Low
9 .03%
High
99..759
9 .04%
Average
9 .04%
99 .759
Tenders at the high yield were allotted 82%.
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
$
28,123
19,248,860
18,334
54,715
22,852
23,228
1,024,256
44,302
25,287
46,968
16,289
1,002,"53
1,889
S21,56~,956

Accepted
S
28,123
6,592,900
13,334
42,735
31,952
23,228
323,296
28,302
25,287
46,958
12,289
92,852
1,389
$7,268,146

The $7,268
million of accepted tenders includes $600
million of noncompetitive tenders and $6,668 million of competitive tenders from the public.
In addition to the $7,268 million of tenders accepted in
the auction process, $180 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities.
3-1528

TREASURY NEWS

lepartment off the Treasury e Washington, D.C. e Telephone 566-204'

FOR RELEASE AT 4:00 P.M.
CONTACT:Office of Financing
** n«on
202/376-4350
August 24, 19 88
TREASURY OFFERS $10,000 MILLION
OF 20-DAY CASH MANAGEMENT BILLS
The Department of the Treasury, by this public notice, invites
tenders for approximately $10,000 million of 20-day Treasury bills
to be issued September 2, 1988, representing an additional amount
of bills dated March 24, 1988, maturing September 22, 1988 (CUSIP
No. 912794 QN 7 ) .
Competitive tenders will be received at all Federal Reserve
Banks and Branches prior to 1:00 p.m., Eastern Daylight Saving time,
Tuesday, August 30, 1988. Each tender for the issue must be for
a minimum amount of $1,000,000. Tenders over $1,000,000 must be
in multiples of $1,000,000. 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.
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 $10,000 and in any higher $5,000
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-1529

- 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 or Branch in cash
or other immediately-available funds on Friday, September 2, 1988.
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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
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 Bank or
Branch.

TREASURY NEWS

Department off the Treasury e Washington, D.C. e Telephone 566-2041

FOR IMMEDIATE RELEASE
August 25, 1988

Contact: Charlie Powers
566-8773

ALL BANKS REQUIRED TO REPORT LARGE
CURRENCY TRANSACTIONS WITH CASINOS
The Treasury Department announced today that it is revoking all
existing exemptions granted to banks from reporting currency
transactions by casinos under the Bank Secrecy Act. The Bank
Secrecy Act generally requires banks and other financial
institutions to report all cash transactions in excess of
$10,000. Treasury's regulations under the Bank Secrecy Act allow
banks to exempt the transactions of certain businesses from
reporting and to request special exemptions for other types of
businesses from Treasury. Since April 8, 1987, the regulations
provide that banks may not request special exemptions for
transactions with any other nonbank financial institutions such
as casinos (with gross annual gaming revenues exceed $1,000,000).
Nevertheless, many exemptions granted by Treasury for casinos
predating the regulatory change remain in force and necessitate
this revocation action.
Casinos with gross annual gaming revenues of less then $1,000,000
are not considered nonbank financial institutions under the Bank
Secrecy Act regulations. However, Treasury is revoking existing
exemptions for these smaller casinos and has decided, as a matter
of policy, that no exemptions for those casinos will be granted
in the future by Treasury.
Banks must remove all casinos from exemption lists and begin
reporting all transactions with them in excess of $10,000 on IRS
Form 4789, the Currency Transaction Report, no later than
September 30, 1988. The September 30, 1988, effective date is
being provided to enable banks to implement this requirement more
easily.
000
B-1530

TREASURY NEWS

Department off the Treasury e Washington, D.C. • Telephone 566CONTACT: Office of Financing
FOR IMMEDIATE RELEASE
202/376-4350
August 25, 1988
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION
Tenders for $9,004 million of 52-week bills to be issued
September 1, 1988, and to mature
August 31, 1989, were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Investment Rate
Rate
(Equivalent Coupon-Issue Yield) Price
Low
92.194
7. 72%
8.32%
High
7. 73%
92.184
8.33%
Average 7. 72%
8.32%
92.194
Tenders at the high discount rate were allotted 6%.

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

Type
Competitive
Noncompe t i t ive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

$

18,200
28,899,975
12,540
16,050
24,045
13,635
1,469,030
20,200
9,970
27,270
21,525
1,689,885
154,665
$32,376,990

$
18,200
8,545,955
12.540
16,050
20,165
13,635
115,990
16,200
9,970
25,270
11,525
43,385
154,665
$9,003,550

$28,914,300
462,690
$29,376,990
2,900,000

$5,540,860
462,690
$6,003,550
2,900,000

100,000
$32,376,990

100,000
$9,003,550

An additional$180,000 thousand of the bills will be issued
to foreign official institutions for new cash.
B-1531

TREASURY NEWS _
Department off the Treasury • Washington, D.C. e Telephone 566-2041
Text as Prepared
For Release Upon Delivery
Expected at 11:00 a.m. DST

Opening Remarks by Thomas J. Berger
Deputy Assistant Secretary for International Monetary Affairs
U.S. Department of the Treasury
during the
American Institute in Taiwan Taiwan Coordination Council for North American Affairs
Financial Services Talks
Washington, D.C.
August 29, 1988
The talks we are embarking on today are indeed timely. The
winds of change are blowing in international financial markets
as never before. Interdependence between national economies
is increasing. Modern technology is making closer neighbors of
us all. It is a time of tremendous opportunity and also of
heightened risk. Those who can take advantage of the prevailing
winds will move ahead; their financial markets will be broadened,
deepened and made more prosperous. Efficiency will increase and
as a result the cost of providing services to consumers will be
reduced.
Financial deregulation is occurring around the globe and
pointing the way to an exciting future. The United Kingdom and
Canada with their "big" and "little" bangs have led the way.
There is a wave of financial liberalization and deregulation in
other European countries. Japan has shown steady progress in
creating more competitive and efficient capital markets.
In the United States, significant deregulation took place
several years ago, but the Congress is now rethinking the law and
the powers that separate our banking and securities business.
The Senate has passed a bill and the House is considering
legislation that would substantially revise the Glass-Steagall
Act. This Administration strongly supports Glass-Steagall reform
as the proper next step in modernizing the U.S. financial system.
B-1532

2
In this broad context, I offer praise to the CCNAA
delegation for those efforts being made in Taiwan towards greater
financial liberalization and internationalization. We are both
aware that over-regulation in any market results in
inefficiencies, market distortions, high-cost services and a weak
competitive situation. An obvious result is lower growth and a
weaker financial infrastructure than would otherwise be the case.
We are pleased that there is movement in Taiwan towards
liberalizing the foreign exchange, securities and banking laws.
The Taiwan authorities deserve praise and credit for these
initiatives. In my role as Chairman of the discussions on
banking and securities, I assure you that I give full credit to
your good intentions. But good intentions need to be translated
into concrete acts and accomplishments. The United States seeks
nothing less than full national treatment — equality of
competitive opportunity — for U.S. financial firms in Taiwan.
We realize this cannot be achieved overnight or in a single act.
What we do seek from you is an outline or model — call it a
timetable if you will — that will give an indication not only of
your intentions, but also of the stages by which you intend to
translate them into actual fact.
The progress we seek must benefit both of us. A steady
movement towards national treatment is in your own long-term
best interests as well as those of your financial partners.
When foreign firms enter your market to establish branches or
subsidiaries or to offer new instruments and services, they are
making a significant statement: they have decided to enter a
long-term inter-dependent and mutually beneficial relationship.
Taiwan has a highly intelligent and well-educated population.
Therefore, technology transfer and an increase in the skills of
the local population are certain to take place as well. U.S.
firms are second to none in their willingness to recognize and
reward local managers.
As we enter into these financial services discussions, each
side needs to approach the talks with perspective, flexibility,
and understanding. Accordingly, as we continue to work together,
I can think of no better words to keep in mind than those of
President Eisenhower to Speaker of the House Sam Rayburn some 33
years ago: "We shall have much to do together; I am sure we
shall Thank
get it
done,
that we shall do it in harmony and with
you
very and
much.
goodwill."

TREASURY NEWS

Department off the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,014 million of 13-week bills and for $7,038 million
of 26-week bills, both to be issued on September 1, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

26-•week bills
maturing March 2, 1989
Discount Investment
Rate 1/
Rate
Price

13--week bills
maturing December 1, 1988
Discount Investment
Rate
Rate 1/
Price
7.21%
7.28%
7.26%

7.45%
7.52%
7.50%

98.177
98.160
98.165

:
:

7.47%
7.50%
7.50%

7.87%
7.90%
7.90%

96.224
96.208
96.208

Tenders at the high discount rate for the 13-week bills were allotted 11%.
Tenders at the high discount rate for the 26-week bills were allotted 58%.

Location
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

TENDERS RECEIVED AND ACC:EPTED
(In Thousands)
Received
Received
Accepted
:

Accepted

$
39,110
$
39,110
6,015,830
22,259,995
26,595
27,015
38,230
38,230
37,380
42,380
30,435
30,435 .
237,010
1,676,410
33,710
29,710
6,345
6,345
39,480
39,480
29,750
19,750
79,735
1,543,735
438,680
438,680

$
37,070
20,162,200
24,300
41,940
40,530
35,225
1,180,880
27,445
15,535
57,455
34,950
1,306,080
348,355

$
37,070
5,452,700
24,300
41,210
40,530
35,225
402,880
24,555
10,535
57,455
29,950
509,130
348,355

$23,311,965

$7,013,895

: $26,205,275

$7,038,290

$19,741,130
1,030,030
$20,771,160

$3,443,060
1,030,030
$4,473,090

' $21,434,500
:
1,038,780
$22,473,280

$2,267,515
1,038,780
$3,306,295

2,379,400

2,379,400

:

2,100,000

2,100,000

161,405

161,405

:

1,631,995

1,631,995

$23,311,965

$7,013,895

: $26,205,275

$7,038,290

An additional $19,895 thousand of 13-week bills and an additional $276,805
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
B-1533

TREASURY NEWS
iportment
off the Treasury •Washington, D.C.
• Telephone 566-2041
FOR IMMEDIATE RELEASE
CONTACT: Felice Pelosi
August 29, 1988

202/566-2843

PETER H. DALY APPOINTED
DIRECTOR, BUREAU OF ENGRAVING & PRINTING

Acting Secretary M. Peter McPherson today announced the
appointment of Peter Hughes Daly to be the Director of the
Bureau of Engraving and Printing (BEP). He has been the Acting
Director since April, 1988.
Mr. Daly, who began his career in the Federal Government
in 1965 as a Management Intern, joined the BEP in 1968 as
Assistant Head, Labor Relations and Wages Branch, in the Office
of Industrial Relations. In 1974 he was promoted to Manager,
Human Resource Development Division, and in 1976 was selected
as Assistant to the Bureau Director. He was appointed Chief of
the Office of Planning and Policy Development in 1980 and in
1982 became Deputy Executive Director of the U.S. Savings Bonds
Division. In 1983 he returned to the BEP as Deputy Director
and in 1986 served in the dual capacities of the BEP Deputy
Director and Executive Director of the U.S. Savings Bonds
Division for a six month period.
Mr. Daly has been recognized by many awards and honors
during his tenure at Treasury. He holds a degree in Economics
from Villanova University and has done graduate work with
honors standing at Rutgers, George Washington, and American
Universities. He has published articles and studies in the
fields of economics and management.
He resides in Washington, D.C. and has two daughters, Jill
and Mary Megan.

B-1534

TREASURY NEWS 1&

Deportment off the Treasury • Washington, D.C. • Telephone 566-2
CONTACT: Office of Financing
202/376-4350
FOR RELEASE AT 4:00 P.M.
August 30, 1988
TREASURY*S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$14,000 million, to be issued September 8, 1988.
This offering
will provide about $300
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,699 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, Tuesday, September 6, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,000
million, representing an additional amount of bills dated
June 9, 1988,
and to mature December 8, 1988
(CUSIP No.
912794 QW 7), currently outstanding in the amount of $6,429 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,000 million, to be dated
September 8, 1988, and to mature March 9, 1989
(CUSIP No.
912794 RL 0).
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 September 8, 1988.
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 $1,599 million as agents for foreign
and international monetary authorities, and $4,664 million for their
own
account. Tenders for bills to be maintained on the book-entry
B-1535
records of the Department of the Treasury should be submitted on Form
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series).

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 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
10/87
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS

Department off the Treasury • Washington,
D.C.
• Telephone
CONTACT:
Office
of Financing566-2041
202/376-4350
FOR IMMEDIATE RELEASE
August 30, 1988
RESULTS OF TREASURY'S AUCTION
OF 20-DAY CASH MANAGEMENT BILLS
Tenders for $10,052 million of 20-day Treasury bills to
be issued on September 2, 1988, and to mature September 22,
1988, were accepted at the Federal Reserve Banks today. The
details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS
Discount
Rate
Low
High
Average

Investment Rate
(Equivalent Coupon--Issue Yield)

7.90%
7.94%
7.9 3%

8.05%
8.08%
8.08%

Price
99.561
99.559
99.559

Tenders at the high discount rate were a Hotted 37%.
TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS
(InL Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
TOTALS

B-1536

Accepted

Received
$

$

37,531,000
-----

1,535,000
4,000
----

9,753,190
-----

188,700
1,000
----

1,500,000

109,200

$40,570,000

$10,052,090

TREASURY NEWS

Department off the Treasury e Washington, D.C. e Telephone 566-2041
Text as Prepared

Statement by Thomas J. Berger
Deputy Assistant Secretary for International Monetary Affairs
U.S. Department of the Treasury
at the Conclusion of the
American Institute in Taiwan Taiwan Coordination Council for North American Affairs
Financial Services Talks
Washington, D.C.
August 31, 1988
Mr. See-Ming Chen, representing the Taiwan authorities, and
I have just concluded a meeting to discuss financial services in
the banking and securities sectors.
During the meeting, I noted the progress made by Taiwan over
the past few years. Important steps have been taken to
liberalize outward capital movements and deregulate interest
rates. With respect to the banking sector, Taiwan authorities
have raised the ceiling on commercial paper guarantees, allowed
foreign banks to buy and sell gold coins, permitted foreign banks
to set up a second branch, and have permitted foreign bank
branches to participate in the automated teller machine network.
In the securities sector, foreign firms are now able to
participate in new joint venture securities firms, and foreign
investors are able to invest in the domestic securities market by
way of mutual funds issued abroad.
These measures represent an important first step in the
development of Taiwan as a financial center. Building on this
progress, at our meeting over the past several days, Taiwan
agreed to raise the limit on loans to a single customer to NT$500
million, and facilitate the inward remittance of capital by
foreign institutions to execute guarantees and to boost branch
capital. The Taiwan authorities also agreed to permit U.S.
insurance companies greater flexibility in making investments in
New Taiwan Dollars through the ability to buy and sell Taiwan
public sector debt instruments.
I also took note of the Taiwan authorities' intention to
move substantially toward national treatment in the revision of
their banking law with respect to both savings and trust
B-1537

2
activities with a view to allowing U.S. firms to engage in and
receive national treatment in a substantial number of new
activities. In addition, the Taiwan authorities noted that they
are studying the potential design of a Taiwan Depository Receipt
which would foster domestic investment in foreign securities. In
this regard, we offered to supply technical assistance should the
Taiwan authorities request it.
The U.S. supports Taiwan's desire to become a major Asian
financial center within the next decade. Although I am
encouraged by the actions taken to date, it is important that
progress toward national treatment continue and that financial
market liberalization and development move forward without delay.
This would be encouraged by relaxing entry restrictions for
foreign banks (including additional branches), liberalizing
further foreign exchange controls, allowing movement toward
wholly-owned foreign securities branches and subsidiaries and
revising onerous capital requirements for foreign bank branches.
In this context, a timetable for future action is essential.

TREASURY NEWS
department off the Treasury • Washington, D.C. • Telephone 566-2041

Text as Prepared

"Iowa Exports to the World"
M. Peter Mcpherson
Deputy Secretary of the Treasury
Iowa International Trade Symposium
Des Moines, Iowa
September 1, 1988
Greeting
Excellencies, Governor, Senator, distinguished guests, I am
pleased to be here in Des Moines. I want to thank Senator
Grassley for inviting me here to be with you, and for asking me
to be a part of this year's Iowa International Trade Symposium.
Introduction
I'm delighted that this year's symposium has been such a
success. You have truly brought the world to Iowa. But it's
every bit as important to bring Iowa to the world. This evening
I want to talk about some of the things the United States
government does to help bring Iowa — and other American
exporters — to the world.
To start, I'd like to discuss how international economic
policy coordination creates the stable, certain business
atmosphere that fosters international trade and has improved the
prospects for American exporters.
Then I'd like to discuss our efforts to create a level
playing field for American exporters who want to bring their
products to the world.
We are trying to eliminate trade barriers that close
overseas markets to our exports.
We are trying to reform the world trade system. We want
strong new trade rules, based on free market principles.
We want the most efficient producer to be the most
competitive supplier.
B-1538

-2—

We also provide support for U.S. exporters, particularly
agricultural exporters who must compete against subsidies
as well as the weather.

Finally I'd like to talk a little about the opportunities
that Iowa has to bring itself and its products to the world.
Macroeconomic Policies
The process of coordinting international economic cooperation
is crucial to our competitiveness. The major industrial nations
have sought to improve global growth, thus expanding markets for
U.S. exports, both in developed and developing countries. We
have also been working to achieve exchange rate relationships
that more fully reflect competitive realities. actions on these
fronts are an antidote to protectionism which closes markets and
export opportunities.
The major countries have made significant progress in
achieving these objectives. The United states is reducing its
budget deficit and restoring competitiveness. Japan and Germany
have taken major steps to improve growth prospects. The
depreciation of the dollar has increased the competitiveness of
U.S. exports. Efforts to deal with international debt problems
through the debt strategy are helping debtor nations to adopt
market-oriented reforms and promote sustained growth. All of
these efforts are bearing fruit. U.S. exports have grown over
30 percent in the last year and real net exports now account for
well over one-half of U.S. growth.
There is little question that the decline in exchange rates
since 1985 has helped U.S. agricultural exports. In FY 1987,
exports were $28 billion, compared to $26 billion in FY 1986, and
for FY 1988, USDA is forecasting $34 billion.
Eliminating Trade Barriers
An immediate goal of the Administration effort to help
Americans export is to increase our access to foreign markets.
That often means aggressively pursuing the elimination of foreign
trade barriers.
No Administration has worked harder than this one against
subsidized competition and trade barriers abroad. And that work
has paid off. The President has rolled back barriers in Europe
and Japan, among other places.
Recently, we resolved a number of long-standing disputes with
the Japanese over processed foods. Japan agreed to reduce
barriers for eleven broad categories — from fruits, juices, and
dairy products, to peanuts, peas, beans, breakfast cereals, and
soup. Imports of these products had been severely restricted, in
some cases prohibited, for over 20 years. Under the three-year
settlement, Japan will eliminate many of its import quotas and
reduce a number of tariffs.

-3Earlier this year we reached a similar agreement with Japan
that reduced barriers to the sale of U.S. beef and citrus
products. Japan agreed to phase out beef import quotas. Tariffs
were initially increased but they will be phased down.
We have also fought hard against EC proposals aimed at
restricting imports of meat from animals treated with growth
hormones. We viewed these measures as a blatant maneuver to
impose trade barriers under the guise of health regulations.
In
December 1987, the President authorized retaliation against the
measures. As a result, the EC agreed to suspend the application
to imports of the proposed regulations until 1989. In the
meantime, EC member states have continued to permit imports of
our meats.
We have made it clear to the Community that we need a
permanent solution to the problem. We will retaliate again, if
necessary, to defend the interests of our meat exporters.
We have also insisted that the EC eliminate illegal subsidies
for oilseed processors. These subsidies have nullified the
advantages of the tariff rates for soybeans that we obtained in
earlier negotiations. We continue to press the EC on this issue.
We are actively pursuing this matter in the GATT.
We have also conveyed to the European Community our concerns
that their efforts to create a single European market by 1992 do
not create new barriers to U.S. agricultural exports.
Nor are we concentrating solely on Europe and Japan. We are
pressing the Koreans to remove an import ban on beef and wine;
they have already removed restrictions on cigarettes. We have
also concluded an agreement with India to relax restrictions on
almonds.
Our willingness to retaliate in cases where we face
discrimination in foreign markets has put other nations on
notice: We will defend the interests of U.S. exporters.
Negotiating New Trade Rules
The ultimate objective of our trade policy is to negotiate
new trade rules, based on free trade principles, that will
prohibit trade barriers and trade distorting subsidies. We have
taken some large steps in the direction of free trade. The Free
Trade Agreement with Canada is one. As I told Senator Grassley
during the negotiations with Canada, the agreement particularly
benefits iowans by providing access to Canadian gas and oil,
roughly equivalent as that of Canadians. We all remember the
seventies. Everyone benefits from this agreement -- consumers
who drive cars or who need heat; businessmen who use gas and oil;
or farmers with tractors or who use petroleum-based farm inputs
like fertilizer and pesticides. At the same time, it benefits
Canadians by encouraging new investment and employment there.

-4We also have an agreement with Mexico that establishes
principles for mutually beneficial trade and investment. These
agreements are a good start, but we must begin to address all of
these problems in a more comprehensive way.
The United States believes the time is right for a sweeping
reform of the world trade system. We believe the current Uruguay
Round of GATT trade negotiations gives us that opportunity.
Our main Uruguay Round objectives are to eliminate barriers
to agricultural trade and to establish rules in services,
investment, and intellectual property.
World Agricultural Trade
Agriculture is an area that requires particular attention.
As you know, world agricultural trade is plagued by trade
barriers and export subsidies that divert trade, smother market
signals, and burden government budgets. These distortions
eliminate the competitive advantage of the most efficient
farmers, make it more expensive to feed families, and empty
taxpayer wallets.
Agricultural trade is in such a state that American farmers,
the planet's most productive farmers, need billions of dollars in
government support every year to compete against foreign
subsidies.
Such subsidy programs can have strange results. For example:
In the European Community, surplus butter is being used
for animal feed.
In Japan, consumers pay nearly six times more for
domestic rice than the world market price.
In the Common Market, the export subsidy on feed wheat
is more than two times the world sales price of $73 per ton.
We can also find examples here at home.
If there is one bright spot in this dismal picture, it is
that the problem has become so bad that agricultural producing
nations are being forced to consider change. No country,
particularly not the United States, is willing to "unilaterally
disarm" and leave its farmers unprotected from subsidized
competition. The only way we can get rid of the problem is
through cooperation between ourselves and our trading partners.
What is the U.S government doing about this situation?
In the past, governments have been reluctant to develop more
disciplined agricultural trade policies. Now, however, we are
committed to going beyond the limitations of past negotiations in
order to truly reform the trading system for agriculture. That
reform will eventually provide the level playing field that will
work to the advantage of efficient farmers — like Iowa farmers.

-5Providing a Level Playing Field
Another goal of the Administration program is to provide a
level playing field for American producers. We will protect our
exporters, particularly our farmers, from subsidized competitors
until we can eliminate trade barriers. Our goal is to allow our
producers to compete with other efficient producers for the world
market, until that time, however, we are not willing to leave
our farmers exposed to unfair competition from foreign farmers
who can tap their government treasuries. Frankly, we have worked
hard to expand our export programs. That's the only way we can
protect our share of the world market from the encroachment of
other governments. We are prepared to continue such policies,
despite their expense, until we can get an international
agreement to stop the subsidy spiral.
The 1985 Food Security Act has helped U.S. farmers recapture
a larger share of world agricultural markets. One provision of
the Act, The Export Enhancement Program (EEP), provides
assistance to U.S. exporters competing against subsidized exports
from other nations. The EEP program has not only enabled us to
compete against subsidies, it has underscored our commitment to
even the terms of competition for our farmers. This in turn has
focused attention on the problems in world agricultural trade,
and focused attention on our proposals to reform the agriculture
trade system. By demonstrating our seriousness, the EEP program
has helped bring our trading partners to the negotiating table.
The Targeted Export Assistance Program (TEA) helps U.S.
agricultural exporters counter the effects of unfair trade
practices. It does that by providing cash or commodities to help
underwrite the development of promotions in targeted markets.
After one year of promotion under TEA, the average increase in
sales for 21 important products in target markets was over
48 percent.
I have strongly insisted here tonight that other countries
open their markets to us, but as we ask that of others, we must
continue to fight to keep our own country open to imports. Such
a policy benefits not just others but us.
Commitment to the Farm Community
These measures demonstrate our commitment to protect the
American farm community from today's distorted world trade
situation. More recently, the drought relief bill will provide
direct payments to farmers who have suffered catastrophic losses
and provide relief to hard-hit livestock producers as well. That
too demonstrates our commitment.
This bill provides a wide range of assistance to producers
affected by the drought but stays within necessary budget
limitations. The bill will provide an estimated $3.9 billion to
farmers in FY 1989.

-6The key provisions of the bill are:
o Feed assistance to livestock, dairy, and poultry
producers who normally grow their own feed and have a
loss in feed production on their farm.
o Payments to producers with production shortfalls of
greater than 35 percent for both program and non-program
crops. Lost tree seedlings, pasture, forage, and cover
crops may be reestablished with cost-share payments.
o No reduction in the dairy price support level on
January 1, 1989 and a 50-cent per cwt. increase for the
period April - June 1989.
o Emergency low interest loans to producers with losses in
eligible counties regardless of whether they had Federal
crop insurance.
o FHA guarantees for loans refinanced by farmers unable to
repay due to drought and guarantees for loans for rural
businesses weakened by the drought.
As President Reagan said, "This bill isn't as good as rain
but it'll tide you over until normal weather and your own skills
permit you to return to your accustomed role of being the most
productive farmers in the world."
Outlook
Even with all the problems we face — drought, subsidized
competition, and markets distorted by trade barriers — our
ability to sell in overseas markets continues to improve.
A week ago the trade numbers came out for the 2nd quarter.
In April, May, and June, American exports were the highest
they've been in our history. That, along with falling imports,
gave us our best international trade balance in 3 years, the
lowest deficit since the 2nd quarter of 1985. Rising
manufacturing exports and rising agricultural exports are two big
reasons for this strong showing, which covered trade with almost
every region of the world. Although our imports are still high,
we are now exporting more than we ever have before.
We expect the improvement in our trade balance to continue.
In particular, we are expecting another good year for U.S. farm
exports:
— For fiscal year '88, the volume of U.S. agricultural
exports is expected to climb to about 146 million tons —
up thirteen percent.
The value of agricultural exports is projected to rise to
about $34 billion — a 22 percent increase.

-7Our 1988 agriculture trade surplus should reach $12.5
billion, up by more than $5 billion from last year.
These increases come on top of our strong export recovery
in 1987, when sales volume and dollar values were up
significantly.
We have succeeded in gradually opening and reopening foreign
markets to U.S. exports, what's more, our efforts to change the
system are showing greater promise. U.S. manufacturers and
farmers now have a better chance to compete.
What Iowa Offers the World
How does Iowa best take advantage of that chance to compete?
Let me tell you what I see. I grew up on a farm in a part of
Michigan that is very much like rural Iowa. Our community
possessed the same strengths that I see here:
natural agricultural resources,
a superb educational system, and
the work ethic and the high productivity of the Iowa
people.
These basic strengths make Iowa very competitive. I know this
state well. I have been here many, many times over the years.
I have visited Iowa State and the University of Iowa. I have
talked to your farmers and businessmen.
The rich farmland here provides a solid underpinning for the
Iowa economy. The outstanding educational system — fine public
schools, great Universities, a network of community colleges -make it easy for Iowa to move into research and technology-based
enterprise and to build on an Iowa tradition of quality
production of a whole range' of products. Last but certainly not
least, the qualities of the Iowa people make Iowa an attractive
place for firms to do business and for people to live.
University research in Iowa is spawning new industry, just as
it has in North Carolina's Research Triangle. For example, Edge
Technologies is a high-tech firm in Ames that does metals
research. It grew out of the new industrial natural research
done at Iowa State. The University of Iowa's Laser Center
fosters applications of that flexible technology. Iowa's State's
Biotech Center combines both technological and agricultural
know-how.
The quality of Iowa's work force, its work ethic and high
productivity, the efforts of both Governor Branstad and the Iowa
Congressional delegation, are attracting business. Eastman Kodak
has a new facility in Cedar Rapids. NYPRO from Massachusetts has
set up a joint venture with a Japanese firm in Mt. Pleasant, and
General Foods has a new processed food plant in Mason.

-8This year's drought on top of the high interest rates of
eight years ago brought difficult times to Iowa. Basic
strengths, however, have brought the future to Iowa, a future
that Iowa can export to the world.
Thank you.

TREASURY NEWS _

Department off the Treasury e Washington, D.C. e Telephone 566-2041
For Immediate Release
September 6, 1988
Statement by
The Honorable David C. Mulford
Assistant Secretary for International Affairs
U.S. Department of the Treasury
with respect to the
Announcement by the Japanese Ministry of Finance
regarding
New Issuance Procedures for 10-Year
Japanese Government Bonds
The U.S. Treasury welcomes the announcement today by the
Japanese Ministry of Finance of a major change in its issuance
procedures for 10-year Japanese government bonds. Under the new
procedures 40 percent of the monthly issues of these bonds will be
sold by auction starting in April of 1989. In addition, the share
of U.S. financial institutions in the Underwriters Syndicate will
be increased effective next month.
We believe that these two steps, coupled with certain other
measures described in the Finance Ministry's announcement, should
significantly improve the competitive opportunities for U.S.
financial institutions in the Japanese government bond market when
fully implemented.
Although we are encouraged by these recent actions, it is
important that movement toward financial market liberalization in
Japan continue, building on the progress made over the past
several years.

B-1539

TREASURY NEWS _
Department off the Treasury e Washington, D.C. e Telephone 566-2041
FOR IMMEDIATE RELEASE
September 6, 1988

CONTACT:

Robert Levine
202/566-2041

Wetlands Standards Approved for
Multilateral Development Bank Loans
Acting Secretary M. Peter McPherson today announced approval of
standards for U.S. evaluation of multilateral development bank
loans that may adversely affect wetlands areas in developing
countries.
The standards were developed by Treasury with the cooperation of
an informal working group on international wetlands, chaired by
Malcolm Baldwin, former Acting Chairman of the Council on
Environmental Quality. The working group is composed of experts
from government and environmental organizations. It focuses on
the conservation of wetlands worldwide. The standards are the
third in a series of standards being prepared for the development
of projects that may affect various eco-systems in developing
countries. Other standards already developed by Treasury and the
working group are those for tropical moist forests and SubSaharan savannas.
In announcing approval of the wetlands standards, McPherson
emphasized the multilateral character of the development banks
and the importance of working cooperatively and constructively
with other member countries in order to bring about the reforms
that are being sought. He said, "The United States has been in
the forefront of an international effort to encourage greater
emphasis on environmental issues in the banks and in the
borrowing countries. How successful we are over the longer term
will depend on our ability to build support for our ideas among
other member countries."
Earlier this year, Treasury participated in a meeting of experts
under the auspices of the Organization for Economic Cooperation
and Development and sought to encourage wider use of standards
among both bilateral and multilateral donors. The next meeting
of the experts is expected to take place in Paris in December and
Treasury will seek acceptance of the wetlands standards at that
time.
B-1540

-2As McPherson noted, Treasury's work on the standards has been one
part of a more comprehensive effort to encourage a broad array of
environmental reforms in the multilateral development banks.
That effort has involved cooperation with a number of
environmental groups as well as work with the management of the
banks and with governments of other member countries.
Environmental reform was a key element of the agreement
negotiated last year to increase the capital of the World Bank.
Copies of these standards have been forwarded to U.S. Executive
Directors at the World Bank, the Inter-American Development Bank,
the Asian Development Bank and the African Development Bank.
They will also be used by Treasury and other agencies as part of
the U.S. Government's internal review of multilateral development
bank loans.

TREASURY NEWS _
CONTACT:
of Financing
Department off the Treasury • Washington,
D.C. •Office
Telephone
566-2041
202/376-4350
FOR IMMEDIATE RELEASE
September 6, 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,008 million of 13-week bills and for $7,016 million
of 26-week bills, both to be issued on September 8, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing Dec ember 8, 1988
Discount Investment
Rate
R.ate 1/
Price
7.22%a/
7.28%
7.26%

7.46%
7.52%
7.50%

:
:
:
:

98.175 :
98.160 :
98.165 :

26-week bills
maturing March 9, 1989
Discount Investment
Rate
Rate 1/
Pr ice
7.37%
7.40%
7.40%

7.76%
7.79%
7.79%

96.274
96.259
96.259

a/ Excepting 1 tender of $200,000.
Tenders at the high discount rate for the 13-week bills were allotted 11%
Tenders at the high discount rate for the 26-week bills were allotted 97%

Location
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

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Received
Accepted

Accepted

: $
36,430
: 20,408,245
:
13,120
:
32,140
:
34,260
:
29,710
:
860,945
:
33,325
:
16,675
:
35,670
27,085
:
.
1,294,490
:
451,020

$
36,430
5,939,345
12,120
32,140
34,260
29,710
206,195
29,325
16,525
35,670
21,935
171,480
451,020

$23,273,115

$7,016,155

: $18,589,130
:
993,375
: $19,582,505

$2,332,170
993,375
$3,325,545

$
32,630
20,445,650
18,455
38,950
39,380
31,480
986,685
31,970
12,785
28,100
37,260
1,310,575
368,140

$

$23,382,060

$7,007,830

:

$19,801,105
1,009,035
$20,810,140

$3,426,875
1,009,035
$4,435,910

2,364,130

2,364,130

:

2,300,000

2,300,000

207,790

207,790

:

1,390,610

1,390,610

$23,382,060

$7,007,830

: $23,273,115

$7,016,155

32,630
5,819,650
18,455
38,950
39,380
31,480
303,185
29,080
12,785
28,100
32,260
253,735
368,140

An additional $87,010 thousand of 13-week bills and an additional $562,490
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
B-15 41

TREASURY NEWS ^

Department off the Treasury e Washington o.c. e Telephone 566-2041
CONTACT: Office of Financing
202/376-4350
FOR RELEASE AT 4:00 P.M.
September 6, 1988
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$14,000 million, to be issued September 15, 198 8. This offering
will provide about $ 625
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,363 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, September 12, 1988.
The two series offered are as follows:
91 -day bills (to maturity date) for approximately $7,000
million, representing an additional amount of bills dated
June 16, 19 88,
and to mature December 15, 198 8 (CUSIP No.
912794 QX 5), currently outstanding in the amount of $6,625 million,
the additional and original bills to be freely interchangeable.
182 -day bills (to maturity date) for approximately $7,000
million, 'representing an additional amount of bills dated
March 17, 19 8 8
and to mature March 16, 1989
(CUSIP No.
912794 RM 8), currently outstanding in the amount of $9,200 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 September 15, 1988. 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 $ 1,987 million as agents for foreign
and international monetary authorities, and $ 4,445 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 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series).
B-1542

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 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 one-half hour
prior to the closing time for receipt of tenders 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 of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, 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.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. 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, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, 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.
10/87

TREASURY NEWS
Deportment off the Treasury • Washington, D.C. • Telephone
FOR IMMEDIATE RELEASE
September 7, 1988

CONTACT: Mark Beams
(202) 566-8275

TREASURY DEPARTMENT ANNOUNCES RULING WITH RESPECT TO
SECTION 1.863-3(b) OF THE INCOME TAX REGULATIONS
The Treasury Department today announced the issuance of
Rev. Rul. 88-73, which interprets section 1.863-3(b) of the
Income Tax Regulations to require the use of the independent
factory or production price ("IFP"), where such a price exists,
to determine the division between domestic and foreign sources
of income from sales outside the United States of inventory
(as defined in section 865(h)(1)) produced (in whole or in
part) within the United States. Rev. Rul. 88-73 was issued in
order to resolve uncertainty concerning whether the IFP method
set forth in Example (1) of section 1.863-3(b) is elective with
taxpayers, such that the so-called "50/50 method" set forth in
Example (2) of that section is available in circumstances where
an IFP can be shown to exist. The result reached in Rev. Rul.
88-73, which denies taxpayers use of the 50/50 method where an
IFP exists, reflects the language and purposes of the regulations, and is consistent with express language describing present
law in each of the Committee Reports relating to the Tax Reform
Act of 1986. See H. Rep. No. 426, 99th Cong. 1st Sess. 359
(1985); S. Rep. No. 313, 99th Cong. 2d Sess. 329 (1986); and
H. Rep. No. 841, 99th Cong. 2d Sess. 11-595 (1986).
The 1986 legislation preserved the existing rules for
allocating income from export sales of inventory between
foreign and domestic sources. Citing concerns over possible
adverse trade effects, Congress rejected proposals imposing
more restrictive allocation rules and directed instead that
Treasury study the relevant trade and tax policy issues.
H. Rep. No. 841, 99th Cong. 2d Sess. 11-596 (1986).
Although the Committee Reports to the 1986 Act indicate that
present law requires use of the IFP method where an IFP exists,
they also indicate that under present law the 50/50 method
"generally" will be available. H. Rep. No. 426, 99th Cong. 1st
Sess.
B-1543359 (1985). It follows that an interpretation of
the regulations under which the 50/50 method would cease to be
"generally" available would be inconsistent with the intent of
Congress in preserving existing law.

2041

-2-

Treasury does not intend to change the current regulations,
but is studying how the operative terms of those regulations,
including the term "independent factory or production price,"
should be interpreted, giving due regard to Congress' understanding that the division between domestic and foreign sources
of income from sales outside the United States of inventory
produced within the United States "generally" is made under
the 50/50 method. Treasury will issue appropriate guidance on
this issue in the near future and invites comments on the issue
from all interested persons. Comments should be sent to
Leonard B. Terr, International Tax Counsel, Room 3064, Department
of Treasury, Washington, D.C. 20220. Because of the need to
resolve this matter expeditiously, comments should be sent by
-oOoSeptember 19, 1988, or as soon as possible thereafter.

Part I
Section 863.--Allocation Methods for Income from Sources
Partly Within and Partly Without the United States

26 CFR 1.863-3:
price.

Use of an independent factory or production

Rev. Rul. 88-73

ISSUE
If a taxpayer that produces and sells inventory within the
United States and also sells the inventory outside the United
States makes certain sales which establish an independent factory
or production price for such inventory, must such price be used
for purposes of determining the division between domestic and
foreign sources of income from sales of the inventory outside the
United States, including sales to foreign subsidiaries of the
taxpayer?

FACTS
Corporation X, a domestic corporation, is engaged in the
production and sale of product A in the United States and the
sale of such product outside the United States, including sales

- 2 -

to its foreign subsidiaries.

Product A is inventory, within the

meaning of section 865(h)(1) of the Internal Revenue Code of
1986, in X's hands. Certain sales by X to unrelated distributors
establish an independent factory or production price, as
described in section 1.863-3(b) of the income tax regulations,
for sales of product A outside the United States.

LAW AND ANALYSIS

Under section 863(b) of the Code, income from the sale of
inventory (within the meaning of section 865(h)(1)) which is
produced (in whole or in part) in the United States and sold in a
different country is treated as derived from sources partly
within and partly without the United States. That section gives
the Secretary of the Treasury the authority to prescribe
processes or formulas of general apportionment to determine the
division of income between domestic and foreign sources in such
cases.
The processes or formulas of general apportionment to be
used under section 863(b) of the Code are prescribed through
three examples contained in section 1.863-3(b) of the
regulations. Example (1) of these regulations provides as
follows:

- 3 Where the manufacturer or producer regularly
sells part of his output to wholly independent
distributors or other selling concerns in such a
way as to establish fairly an independent factory
or production price — or shows to the satisfaction
of the district director (or, if applicable, the
Director of International Operations) that such an
independent factory or production price has been
otherwise established — unaffected by considerations
of tax liability and the selling or distributing
branch or department of the business is located
in a different country from that in which the factory
is located or the production carried on, the taxable
income attributable to sources within the United States
shall be computed by an accounting which treats the
products as sold by the factory or productive department of the business to the distributing or selling
department at the independent factory price so estabished. In all such cases the basis of the accounting
shall be fully explained in a statement attached to the
return for the taxable year. (Emphasis added.)
Example (1) requires a taxpayer to use an independent
factory or production price, if such a price exists, to determine
the division between domestic and foreign sources of income from
sales outside the United States of inventory produced (in whole
or in part) within the United States. The priority of Example
(1) over the other methods of apportionment described in section
1.863-3(b) of the regulations is confirmed by language contained
in the legislative history of the Tax Reform Act of 1986. In the
House Ways and Means Committee, Senate Finance Committee, and
Conference Committee Reports, the description of current law
provides that the division of income must be made on the basis of
an independent factory or production price if such a price
exists. H.R. Rep. No. 841 (Conf. Rep.), 99th Cong., 2d

- 4 -

Sess. 11-595 (1986), 1986-3 (Vol.4) C.B. 1, 595; S. Rep.
No. 313, 99th Cong., 2d Sess. 329 (1986), 1986-3 (Vol.3)
C.B. 1, 329; H.R. Rep. No. 426, 99th Cong., 1st Sess. 359 (1985),
1986-3 (Vol.2) C.B. 1, 359.

HOLDING

Corporation X must use the independent factory or production
price for purposes of determining the division between domestic
and foreign sources of income from sales of product A outside the
United States, including sales to its foreign subsidiaries.

TREASURY NEWS
Department off the Treasury e Washington, D.c. e Telephone 566-2041
FOR RELEASE ON DELIVERY
EXPECTED AT 10:00 A.M.
SEPTEMBER 8, 1988

TESTIMONY OF THE HONORABLE
GEORGE D. GOULD
UNDER SECRETARY FOR FINANCE
U.S. DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
UNITED STATES HOUSE OF REPRESENTATIVES
THURSDAY, SEPTEMBER 8, 1988
Mr. Chairman and Members of the Committee, I appreciate this
opportunity to testify before you today on your questions
regarding the Federal Savings and Loan Insurance Corporation
(FSLIC)• Given the misinformation I have heard and read recently
about FSLIC notes, these hearings should provide a useful,
educational forum to explain to the American people that the
Federal Government stands behind the obligations of the FSLIC and
the Federal Deposit Insurance Corporation (FDIC).
In my testimony this morning, I will first address your
specific questions and then discuss the related issue of the
cries for taxpayer assistance for the FSLIC.
Full Faith and Credit of FSLIC Notes
Your first question asks the Administration's position on
the need for the full faith and credit of the United States
behind the notes issued by the FSLIC. As you know, both the
FSLIC and the FDIC issue notes, in addition to using cash
resources, to satisfy their obligations to protect depositors at
insured thrifts and banks.
First, a brief refresher course in government budget
accounting is in order.
The Office of Management and Budget (0MB) scores these notes
as federal outlays when they are issued, just like payments of
other obligations are scored, such as those for certain housing
programs or export commitments.

B-1544

- 2 -

When either the FSLIC or the FDIC issues a note to meet its
obligations, the OMB's budget scoring rules state that four
simultaneous transactions occur, all equal to the principal
value of the note:
o the explicit recognition of a budgetary obligation;
o satisfaction (or payment) of that obligation (an
outlay);
o budget authority to borrow; and
o an increase in the federal debt.
Attached to my testimony are two appendices which are
helpful to further understand the budget treatment of these
notes. Appendix I, for example, is a May 20, 1988, OMB letter to
the Senate Budget Committee on this issue. Appendix II is from
the President's February budget for FY 1989 and indicates that
the FSLIC and FDIC notes — special instruments instead of cash
— are recorded as budget outlays (just as cash payments)
because, like cash, they satisfy the respective agency
obligations and carry the presumption of payment in cash when the
notes mature. These FSLIC and FDIC notes are classified by OMB
as budgetary obligations, spending (outlays) and debt.
I also want to point out to the Committee and others that
the Congressional Budget Office (CBO) concurs in OMB's scoring of
these notes. This conforms to the budget treatment that OMB has
been giving the Federal Housing Administration (FHA) debentures
that are used to pay default claims on FHA-insured mortgages.
Investors, accountants, and others — who take the time to
understand the budget treatment of these notes — will recognize
the severe consequences that would result if the insurance
agencies defaulted on their obligations. Therefore, they should
not need the extra comfort of a resolution stating that the full
faith and credit of the United States backs the notes.
FSLIC/s Use of the Notes
Your second question asks for the Administration's analysis
of the manner and purpose for which the notes are being utilized
by the FSLIC in assistance transactions.
The FSLIC has been using case resolution techniques that
depend on FSLIC notes and other obligations which are supported
in part by the Financing Corporation's (FICO) borrowing
authority, made available through the Competitive Equality
Banking Act of 1987 (CEBA)• The FSLIC has decided to use these

- 3

techniques instead of relying only on the FICO funding authority
because the resulting cost to the FSLIC may be roughly 300 basis
points less than the cost of using cash raised through the FICO
obligations.
Because the shorter-term, tax-exempt FSLIC notes
have a lower interest cost, more of the FSLIC's premium income
can be used to resolve problem institutions instead of using the
premium income to pay the interest on the FICO bonds.
Also, more resources are available up front to resolve cases
because of the current restrictions on FICO borrowings. To the
extent that the FSLIC's problems are related to cyclical real
estate, energy, and/or agricultural problems, the use of shortterm notes aids in determining the scope of such cyclicality
before incurring the costs of longer-term FICO borrowings. If
the problems turn out to be cyclical in nature for specific
institutions, the shorter-term assistance will be all that is
needed, and the industry will not have to pay the interest
expense on the FICO bonds for the thirty year period.
The Administration strongly supported the industry self-help
FICO borrowing plan, adopted by Congress over a year ago, which
provides assistance to the FSLIC in a budget neutral manner.
(The funds raised through the FICO authority offset the
assistance payments; this contrasts with the use of FSLIC notes
which are scored as budget outlays)• However, if the FICO
authority can be used to leverage the funds that are available to
FSLIC so more insolvent thrifts can be resolved more
expeditiously, then the Treasury has no objection to the use of
notes with one very important proviso; that is, that the FSLIC
continues to limit use of the notes to the resources available
for the ultimate redemption of the notes.
As you know, the 1987 CEBA (Sec. 505) removed the
President's authority to exercise oversight over the aggregate
level of budgetary obligations incurred by the deposit insurance
agencies. With this in mind, we fully appreciate the concerns
expressed by members of this Committee and others about the
actual and contingent liabilities which are accruing as a result
of FSLIC (and FDIC) operations. Both Congress and the Executive
Branch have a need to be kept well informed of potential future
liabilities of these agencies, with as much advance notification
as is realistically possible.
In the absence of formal Congressional or Executive Branch
approval of aggregate levels of FSLIC budgetary obligations,
Chairman Wall publicly — and correctly, in my opinion — has set
self-imposed limits on projected FSLIC obligations at a level
which the FSLIC believes can be completely covered by nontaxpayer funds (including the use of Financing Corporation
proceeds) over a 10-year period.

- 4

Policies Toward the Issuance of Full Faith and Credit
Your third question asks about the Administration's
policies concerning the full faith and credit commitments by
individual agencies of the Federal Government.
As I indicated earlier, FSLIC and FDIC notes are treated as
budgetary obligations, spending (outlays), and debt under
government accounting standards. To do otherwise would erode the
public's confidence in the obligations of the government agency
in question and, by extension, of all government obligations.
The end-result would be an increase in the overall cost of
government borrowing. Most agencies, however, are required to
stay within the spending and borrowing limits set by the Congress
through the appropriations process. The Office of Management and
Budget has oversight authority to ensure that agencies do stay
within their spending limits. Since OMB does not have oversight
over the budgetary obligations of the deposit insurance agencies,
your hearings today and in the future can serve a useful
oversight purpose.
Treatment of Notes in the Federal Budget
Your fourth question asks for an analysis of the treatment
of the notes in the federal budget and whether the full faith and
credit backing will change the budget treatment in any manner.
In light of some of the misstatements I have seen and read
recently, I have rechecked the proper accounting principles that
should apply. The Office of Management and Budget has assured me
— and CBO concurs — that the budget treatment of the FSLIC
notes, which I explained in my answer to your first question,
will not change in any manner if a full faith and credit
resolution is passed.
Issues of new notes would continue to be scored as outlays,
which in turn satisfy the FSLICs obligations and increase the
budget deficit.
Limits on FSLIC Notes
Another question asks whether there is a need to place
limits on the FSLIC's use of promissory notes and other financial
assistance agreements consistent with the FSLICs available cash
resource projections.
Unchecked spending authority, whether in government, private
industry, or a family, usually erodes financial discipline and
ultimately increases costs. For this reason, the Administration
did not support the provisions in the CEBA which exempted the

5 -

Federal depository institution insurance agencies from the
apportionment of funds provisions that apply to other government
agencies. Furthermore, the CEBA provisions, which removed the
Administration's oversight of the spending of these agencies, did
not assign the oversight responsibility to any other independent
party.
However, Chairman Wall and the other two members of the Bank
Board have repeatedly given public assurances that the FSLIC will
not issue notes in excess of the premium income, FICO borrowing
authority and other resources available to it. The FSLIC cash
flow projections through 1998 demonstrate that it has the
resources to repay the FSLIC notes that it expects to issue.
As long as the FSLIC abides by this self-imposed restriction
on the amount of notes outstanding, we would prefer that Congress
not set a statutory limit on the amount of notes that can be
issued. Any such limit could reduce the FSLICs flexibility to
resolve problems in a timely manner and erode public confidence
in Federal deposit insurance.
We would strongly urge Congress to continue to hold regular
oversight hearings to ensure that the FSLIC is adhering to its
self-imposed and financially responsible policy for the issuance
of notes. As contemplated in CEBA, it is entirely appropriate
that this Committee conduct such hearings to monitor the use of
the FSLICs available resources.
Limits on Insolvent Thrifts
Your last question asks for comments on the merits of any
provision that would require the Bank Board to limit any new
loans or investments on the part of insolvent thrift
institutions, the deposits of which are insured by the FSLIC, as
well as on limiting the asset growth rate of insolvent
institutions.
The Administration supports limiting the asset growth rate
of insolvent institutions so they do not take on high risk assets
that will raise the FSLICs ultimate resolution costs. However,
legislation or a sense of the Congress resolution should not be
necessary given the FHLBB's past and on-going actions.
Currently, the FHLBB's supervisory policy directive (SP-62)
limits not only the growth of thrifts that are insolvent, but
also the growth of thrifts that fail to meet the 3 percent
minimum net worth requirement. The directive states that, as a
general rule, institutions failin