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TREASURY DE?A:VfivlENT

TREAS.
HJ
10
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v. 287

U.S. DEPT. OF THE TREASURY

PRESS RELEASES

J ON

TREASURY NEWS

Department of the Treasury • Washington, D.c. • Telephone 566-2041
September 16, 1988
Edith E. Holiday Joins Treasury

Secretary of the Treasury Nicholas F. Brady today announced that
Edith E. Holiday has joined the Department of the Treasury.
Ms. Holiday will oversee matters pertaining to public affairs and
public liaison and will act as counselor to the Secretary.
Prior to joining the Department, Ms. Holiday was Chief Counsel
and National Financial and Operations Director for the
Bush-Quayle '88 Presidential Campaign. Previously she served as
Director of Operations for George Bush for President and Special
Counsel for the Fund for America's Future.
In 1984 and 1985, Ms. Holiday was Executive Director for the
Commission on Executive, Legislative and Judicial Salaries. She
practiced law with the firm of Dow Lohnes & Albertson in 1983 and
1984 and with the firm of Reed Smith Shaw & McClay from 1977 to
1983. Ms. Holiday also served as Legislative Director for then
U.S. Senator Nicholas F. Brady.
Ms. Holiday received her B.S. and her J.D. degrees from the
University of Florida, Gainesville. A native of Georgia, Ms.
Holiday is married to Terrence B. Adamson.

NB-J.

TREASURY NEWS

Department of the Treasury • Washington, D.c. • Telephone 566-2041
September 19, 1988

Appointment of Bruce R. Bartlett
As Deputy Assistant Secretary for Policy Analysis
Bruce R. Bartlett has been appointed Deputy Assistant
Secretary of the U.S. Treasury for Policy Analysis, in the office
of Economic Policy, effective September 18, 1988.
Until his appointment, Mr. Bartlett was Senior Policy Analyst
in the Office of Policy Development at the White House, where he
specialized in economic analysis.
Before joining the Reagan Administration, Mr. Bartlett was a
senior fellow at the Heritage Foundation from 1985 to 1987. He
previously had been Vice President of Polyconomics, an economic
consulting firm, and Executive Director of the Joint Economic
Committee of the U. S. Congress. He also served on the staffs
of Senator Roger Jepsen, Congressman Jack Kemp, and Congressman
Ron Paul.
Mr. Bartlett is the author of The Supply-Side Solution (1983)
and Reaganomics: Supply-Side Economics in Action (1981). He has
been a contributor to the Wall Street Journal, the New York
Times, the Washington Post") and many other business and news
publications.
Born in Ann Arbor, Michigan, in 1951 and educated at Rutgers
University (B.A., 1973) and Georgetown University (M.A., 1976),
Mr. Bartlett currently resides in Alexandria, Virginia.

NB-2

TREASURY NEWS
ipartment of the Treasury • Washington, D.C. • Telephone
CONTACT: Office of Financing
202/376-4350
FOR IMMEDIATE RELEASE
September 19, 19~88
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,047 million of 13-week bills and for $7,007 million
of 26-week bills, both to be issued on September 22, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing December 22, 1988
Discount Investment
Rate
Ra te 1/
Price
7.16%a/
7.18%
7.17%

7. 39%
7. 41%
7. 40%

98.190
98.185
98.188

:
:
:
:

26-week bills
maturing March 23, 1989
Discount Investment
Rate
Rate 1/
Pr ice

:
:
:

7.31%
7.34%
7.34%

7.70%
7.73%
7.73%

96. 304
96. 289
96.289

a/ Excepting 1 tender of $10 ,000.
Tenders at the high discount. rate for the 121-week bills were allotted 25%
Tenders at the high discount. rate for the 26>-week bills were allotted 95%

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

30,310
21,467,390
14,200
19,130
26,035
:
19,105
1,010,520
24,195
6,460
25,165
:
:
22,165
1,320,930
:
107,080

$
30,310
6,322,640
12,200
19,130
26,035
19,065
149,270
21,145
6,460
25,165
12,165
256,680
107,080

$24,092,685

$7,007,345

: $19,559,365
:
529,020
: $20,088,385

$2,474,025
529,020
$3,003,045

$
32,610
26,311,575
16,575
29,710
47,785
16,265
1,331,170
24,665
4,650
24,150
32,885
1,275,010
155,030

$
32,610
6,314,025
16,575
29,710
27,785
16,265
155,420
20,655
4,650
24,150
24,135
225,510
155,030

$29,302,080

$7,046,520

$26,675,845
679,855
$27,355,700

$4,420,285
679,855
$5,100,140

1,678,180

1,650,000

268,200

2,354,300

$29,302,080

$7,046,520

: $24,092,685

$7,007,345

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

1/ Equivalent coupon-issue yield.
NB-3

TREASURY NEWS

epartment of the Treasury • Washington, o.c. • Telephone 566-2041
TEXT AS PREPARED
REVISED
Expected at 1:15 P.M., EDT
Remarks by M. Peter McPherson
Deputy Secretary
of
The U.S. Treasury Department
before
New York Financial Writers' Association
New York, New York
September 19, 1988
Third World Development in the Information Acre
Good afternoon. Thanks for inviting me to speak to you.
You all rely on high technology to assemble information from
all over the world — to analyze, synthesize, and dispatch it to
a wide audience. For this reason, I think my chosen topic for
today — Third World Development in the Information Age —
will
be of particular interest to you.
My message today is straight forward. The new information
age makes it imperative that LDCs open themselves up to advancing
technology for their own self interest. This means liberalizing
investment regimes, protecting intellectual property rights, and
not restricting trade in services. LDCs have essentially two
options as they face the current round of GATT negotiations:
they can either join in the efforts to liberalize the world
economy and to ensure equal access to markets, or they can shut
themselves off from the benefits of this new age. If LDCs fail
to make needed policy changes, the information age will pass them
by and leave them even further behind economically. There is a
separate speech on why such LDC policy changes are important for
the U.S., but today I will focus on how important the changes
are to the LDCs.
LDCs need help to take advantage of the new information age,
and more assistance should come from the World Bank.
Better
public policies alone will not solve the problem. LDCs need help
to train their people, build institutions and infrastructure, and
prepare themselves for continuing technological advancement.
This is especially true for LDCs that are not NICs. The World
Bank has made some efforts in this area but should be more active
in encouraging and assisting LDCs along this path.
NB-4

2
The latest technological revolution — commonly called the
information age — must be distinguished from the earlier
agricultural and industrial technologies.
First, agricultural implements and industrial machines both
substitute mechanical power for muscle power. ^ Information
technology leverages brain power. Leveraging brain power isn|t
new. The abacus has been with us for 26 centuries. What is
different is the quantum, almost infinite leap in leveraging
afforded by information technology.
Second, the speed at which this technology is spreading and
developing can be thought of in terms of months and days compared
to the thousands of years that the agricultural and industrial
revolutions required, respectively, to take seed and grow.
Indeed, within a matter of decades government and commerce in
the industrialized world have become
dependent on the rapidly changing computer and the new forms of
telecommunications — satellite transmissions and optic-fiber
cables — that link computers.
The uses of information technology are ubiquitous and well
known to you, so at this point in my presentation I will simply
list some of them: the control of inventories, costs, finance,
or marketing; transportation planning; computer controlled
electric service grids; industrial robots; computer controlled
machine tools; and research. In fact, it is hard to imagine end
uses that cannot benefit from information technology — many of
which depend primarily on developing a computer capacity.
In brief, information technology is revolutionizing and is
critical for LDCs.
To further set the stage for my argument, I want to reflect
for a moment on the key, reasons for economic growth and
development —
not just in the third world today, but
historically.
Development is a process particular to each country, and
each must establish its own needs, methods, and pace. However,
a country's strategy and policies must also be sensitive to the
external environment.
Indeed, I think most would agree that
development has been and continues to be driven by the combined
force of good economic policies and the advance of technology.
This relationship is reflected both in history and in recent
trends. Policies can constrain or promote economic development.
For instance, there is growing recognition of the economic
development value of policies that allow the productive property
of society to be owned by private parties and used for private

3
gain. Look at the impact of the changes in China in recent
years. Also, the Soviet Union is now in the throes of altering
past policies to produce greater productivity — for example, by
leasing land to individual farmers for up to 50 years.
To further make the point, changes in trade policy in Turkey
since the late 1970*s have had a tremendous impact on economic
growth. From highly protectionist and inward-oriented policies
in the late 1970's, Turkey has reversed course and begun a major
trade liberalization. As a result, export growth, which averaged
5.5 percent between 1965 and 1980, has registered almost 20
percent per year since 1980.
Recent changes in the U.S. tax code have also revealed an
important link between policy and economic development. The
dramatic reduction in marginal tax rates begun in 1981 has
boosted the incentive to productive activity and deserves an
important share of the credit for the vast increase in new jobs
created by the U.S. economy — 17.8 million since November
1982.
Certainly government policies have helped and burdened
economic progress, and, as I will discuss later, many LDCs must
come to terms with the fact that their current policies hinder
development in today's information age.
History also shows the importance of technology in driving
economic development.
The invention of the plow ushered in
productive agriculture and altered the human lifestyle in a way
that fostered further invention. James Watt in the 1770's made
a number of innovations to improve the efficiency of steam
powered engines and produced a practical power plant that
contributed immeasurably to the Industrial Revolution.
The
perfection of the internal combustion gas engine about a century
later made possible cars, trucks, and the airplane, all of
which have radically transformed human lifestyles.
And a
critical stimulus to economic growth since WWII has been the
computer — which has joined with related technical breakthroughs
to generate the new technological age now driving economic
progress at a fast pace.
It is instructive at this point to look at the record of
developing countries in incorporating technology in their pursuit
of economic development.
First, it must be noted that the circumstances of
international competition and economic advancement have changed
for LDCs as technology has advanced.

4
Advanced technology has brought on a gradual decline in some
of LDCs' traditional comparative advantages. Peter Drucker has
pointed out that LDC comparative advantages in low labor costs
and raw material exports have begun to erode.
For example,
because of increased flexibility and an extended life-cycle of
manufacturing processes in more developed countries, low labor
costs no longer ensure that LDCs will produce textiles more
cheaply and effectively than highly automated mills in the
Carolinas.
Similarly, technological advancements have often
displaced traditional raw materials.
For instance, the
prevalence and quality of fiberoptic products have diminished
the importance of copper as an input for production.
Advanced information technology has also altered the very
nature of international market economic activity. Competition
to provide inputs, services, and final products has been
heightened by the minimization of distance and the ease of
establishing and changing relations between providers and
utilizers. Manufacturers will quickly switch their source of
parts and services to the cheapest provider of an input to
production.
Countries must as a result maintain their
comparative advantage and competitive prices or they lose. In
some ways all countries, certainly all LDCs, are competing
against all other countries. Open economies will tend to get
the technology and win; closed economies will usually stagnate.
And while competition has intensified, developing countries are
also increasingly expected by developed countries — as reflected
in the new U.S. trade bill — to carry their own weight by
operating on an even plane in the world economy.
Even though circumstances have been changing to make
information technology central to operation in the international
market, many LDCs do not have a good record of incorporating this
modern technology into their economies.
Indeed, the process of adopting appropriate policies and
allowing technology to lead the way to development has been
inhibited by bad policies in many of the developing countries.
I would like to review the background to this situation.
When low rates of technology transfer in the modern sectors
of many less developed countries became apparent, commentators
quickly concluded that technology designed for conditions in
developed countries — relatively cheap capital and expensive,
skilled labor — often was not appropriate for the LDCs. Their
solution to the alleged incompatibility of advanced technology
with LDC conditions was to transfer or develop "appropriate
technology" — e.g., improved plows or ovens that would be
directly applicable to the a developing country.

5
The concept itself is sensible. However, we now know that
appropriate technology for developing countries need not exclude
advanced technology, even if designed principally with the
developed world in mind. Many new technologies are flexible
enough to be adjusted to the needs and capabilities of a
developing country, if accompanied by proper training.
Information technology is "appropriate" for mechanization
of the financial sector of most any country; it can also be
invaluable in agricultural research, health services, and other
traditional development activities. Furthermore, employment of
these technologies can help control the high costs of
development: microelectronics can, for instance, help countries
make more efficient and limited use of electric power, thus
limiting capital costs.
And by allowing separation of the
provider from the utilizer of inputs, information technology
opens up new potential for developing countries to expand nontraditional exports, e.g. data processing in the Caribbean for
a U.S. client.
Information technology is also crucial to countries that
would like to prepare themselves to be more receptive to higher
levels of technology. Computers are useful tools of education
and training.
Through what is called computer-assisted
instruction, or interactive instruction, a student sitting at a
computer terminal can work through a series of "frames" that
teach and test understanding. Limited application of computer
technology can also improve the electric power and telephone
systems in LDCs, making them better able to support more
extensive use of information technology in business and industry.
And there are other applications through which computers and
other information technology can help speed up the development
process. As advancements continue to be made — e.g. making
desktop computers more affordable and other information
technology more accessible — information age technology should
become more appropriate in the development process. The returns
on investments in technology transfers will grow as such
technology is incorporated more broadly and effectively.
How can LDCs better take advantage of these benefits of the
information age and keep from being left behind in the world
economy?
Because of the unique nature of information technology and
the significance of its incorporation in economic development,
LDCs must plan carefully their strategies and policies for
becoming part of the information age.
The establishment of appropriate and stable macroeconomic
policies that encourage private enterprise and a healthy economy

6
is a preliminary and critical step. There are also a series of
important policy changes which many developing countries must
make.
Investment must be encouraged. In a speech on
interdependence, top Canadian government official and GATT
negotiator Sylvia Ostry pointed out that
the trend to increasing international integration that is
inherent in the information revolution is likely, at least
for a time, to enhance the role of the multinational
enterprise as a carrier of leading-edge technology. Access
to this new generic technology and the flows of capital by
which it will in considerable part be transferred will
become a prime determinant of growth and development around
the world.1
Thus LDCs must come to realize the importance for their
advancement of allowing foreign investment to enter their
markets.
Many LDCs have policies that impede such foreign-owned
establishments. They often require foreign firms to enter into
uneconomical partnership with LDC governments or private
enterprises and impose other costly conditions on the entry of
a multilateral corporation into their market.
Because the
operation of multinational firms in developing countries is a
primary mechanism for the transfer of information technology,
such restrictive policies are counterproductive for LDCs.
Although LDCs can certainly purchase, for example, off-theshelf personal computers as their trade regime allows, direct
investment often facilitates transfer of capital, management
expertise, and an ongoing stream of technological know-how that
is otherwise very difficult to secure.
Foreign investors must also keep their end of the bargain
by being good "citizens" in developing countries. Such investors
should provide lasting and useful training to nationals; they
should take advantage of local contributions and strengths and
not isolate their operations. By carrying their business and
technology to developing countries, foreign investors are also
creating new demand for their goods and services. They should
accordingly maintain a balanced long-term perspective on their
involvement in these countries.
Another pivotal policy area is protection of intellectual
property rights. Such policies are an important determinant of
a multinational firm's willingness to enter an LDC and to carry
advanced technology there. The widespread, unauthorized copying
of software and the cloning of hardware undercut the markets and

7
profits of those that bear development costs and marketing
expenses.
Software publishers — whether in developed or
developing countries — may be particularly wary of circulating
their product in an area where it might be copied and distributed
without means of legal recourse. I am told often of corporate
decisions to go to one country as opposed to another because of
concerns with intellectual property protection.
Also, for
example, Brazil has already burdened its whole industrial base
by sharply cutting back critical informative technology from
outside the country.
Policies for the protection of intellectual property
rights should not afford multinationals undue advantages, such
as a mechanism for establishing a monopoly they might have lost
in the developed world because of the expiration of a patent.
At the same time, stronger agreements might encourage not only
the distribution of equipment and software by multinational
firms in LDCs, but also the development of systems and programs
targeted more precisely to their needs.
In addition, policies governing trade in services help
determine the ability and inclination of firms to engage in
technology transfer.
Many LDCs have significant non-tariff
barriers that impede the sale of international border services.
They impose restrictions on the import of, for example, computer
data and information and other value-added services.
Such
restrictions inhibit the incorporation of established technology
into a developing country's economy, despite market demand for
such technology. They can also work against LDCs that establish
export potential in services.
In designing a strategy for the information age, developing
countries must also address the relative weakness of their
physical and human resource bases. Well-trained workers and
efficient institutional infrastructures are vital to securing and
utilizing the mechanisms of advanced technology. Those countries
that want to join the current acceleration of technology must
concentrate on improving their capacity for education and
training. The indigenous private sector — which benefits from
private development of highly profitable sectors such as
telecommunications — can be expected to provide some training,
and for this reason domestic private enterprise should be
encouraged. The potential of multinationals to contribute to
training and education is also extremely high.
Yet these countries need more than just more skilled
labor. The proper institutional structure to train and carry
out other functions is key. The importance and difficulty of
building such institutions must not be minimized.

8
In sum, appropriate policies and enthusiastic initiatives
to attract technology and encourage its development are crucial
to LDCs who want to continue to advance in the world economy.
Information technology can help these countries become more
competitive producers of goods and services. It can also help
them to update their traditional modes of production and perhaps
conserve some of the comparative advantages afforded them by
their own national characteristics.
It is my thesis that those countries that prepare themselves
for the advance of information technology will prosper, while
those that choose not to do so will stagnate. As the leading
development institution, the World Bank has a crucial role to
play in helping these countries adapt to the information age.
What has the Bank been doing in this area? The recent
advent of microcomputers and improvements in memory technology
and portability have contributed to increased Bank involvement
in transfer of information technology.
Bank spending on
information technology has grown at roughly 30 percent annually
in the past six years, compared to 15 percent in the previous
five years.
o The Bank gives support to projects involving a variety
of levels of technology, ranging from a few
microcomputers for a health and nutrition project to
large mainframe computers for a petroleum exploration
project.
o The Bank has also made use of information technology
to assist member countries in automating statistical
and economic data bases and developing reliable
management systems.
o The IFC has recently established, on an interim and
experimental basis, a Technology Service Program which
will serve as a technology broker, matching demand in
the private sectors of developing countries with
appropriate suppliers.
Yet with one exception, the Bank has only supported
information technology as a small component of other projects.
And the cost of information technology as a percentage of total
project cost is usually very small, five percent or less. There
is some indication, then, that the World Bank's lending program
is still oriented to an industrial age mindset and requires
adjustment to an information age focus.

9
The Bank has a critical role to play in helping developing
countries to gain access to and become more receptive to
information technology. It must make a significant additional
effort to support transfer of information technology in all
aspects of its work.
Sector loans, which are traditionally conditioned to the
adoption of proper policies, are an important tool here. Just
as the Bank has sought to promote improved trade policies and
more open trade regimes in developing nations, it could more
broadly utilize sector loans to encourage policies which better
protect intellectual property rights, liberalize trade in
services, and open up investment regimes.
Also, additional
project loans could be supported to improve telecommunications
and other support systems for information technology. Massive
amounts of training are, of course, critical.
Technical
assistance could be enhanced with the target of making transfer
of information technology a component of most World Bank activity
in developing countries.
The Bank should consider how it might best focus its efforts
on encouraging integration of information technology in the
development process.
The information age is still accelerating. Many developing
countries are at a crossroads where they must decide whether to
participate by opening up their economies and attaining a higher
standard of living for their people, or, alternatively, to
stagnate and fall further behind. Self interest should compel
the LDCs to work in GATT to open up their economies by
liberalizing investment regimes, providing better protection for
intellectual property rights, and reducing restrictions on trade
in services.
Because of the enormous importance of the information age
for the economies of LDCs, we have an obligation through the
World Bank to train people and help build institutions and
infrastructure. And of course the Bank, through its sectoral
loan program, should help bring about the changes critical to
LDCs1 joining in the industrial age.
Ladies and Gentlemen, I thank you for your attention, and
I will be delighted to take questions.
1. Ostry, Sylvia, "Interdependence:
Vulnerability and
Opportunity," 1987 Per Jacobsson Lecture.

TREASURY NEWS

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

September 19, 1988

Charles H. Dallara
Senior Advisor for Policy to the Secretary of the Treasury
Secretary of the Treasury Nicholas F. Brady today
announced that Charles H. Dallara will serve as Senior Advisor
for Policy to the Secretary of the Treasury. Mr. Dallara
continues to serve as the U.S. Executive Director to the
International Monetary Fund (IMF).
As Senior Advisor for Policy to the Secretary,
Mr, Dallara will support the Secretary and Deputy Secretary in
the monitoring and development of policies covering the full
range of the Department's activities. He will also be
responsible for the oversight of the Executive Secretary and
the related functions.
Mr. Dallara has served in his current positions at the
IMF and the Treasury since 1984. Prior to that, he held a
variety of other positions at the Treasury, and served as the
U.S. Alternate Executive Director at the IMF.
Mr. Dallara received his Ph.D., M.A., and M.A.L.D. from
the Fletcher School of Law & Diplomacy, Tufts University, and
a B.A. in economics from the University of South Carolina. He
also served as an officer in the U.S. Navy from 1970-1974.

NB-5

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

TEXT AS PREPARED
EMBARGOED FOR RELEASE UPON DELIVERY
EXPECTED AT 10:30 A.M. EDT
Remarks by
Secretary of the Treasury
Nicholas F. Brady
at the Acceptance Ceremony for the
Lockheed P-3 Aircraft by the Customs Service
Hangar #6, Federal Aviation Administration
Washington National Airport
Tuesday, September 20, 1988
Thank you, Commissioner von Raab, and good morning, ladies
and gentlemen. I took office just last Friday and this is my
first formal event as Secretary of the Treasury. Nothing could
suit me more, as it underlines the importance with which we in
the Treasury view the War on Drugs. Ensuring a drug-free America
is a high priority for all of us.
I am joining the efforts of a group of men and women I
greatly respect. We are all grateful for the leadership of the
President, our First Lady, Nancy Reagan, and Vice President
George Bush.
Attorney General Dick Thornburgh and I have worked together
in the past. I am looking forward to working with him again.
Since he became Attorney-General, Dick has again shown us his
gift for leadership by galvanizing our coordinated efforts.
The members of Congress here today (Senator Pete Domenici,
Senator Dennis DeConcini, Senator Phil Gramm and Congressman
Glenn English) show by their presence that same strength of
purpose.
And when it comes to people like Willy von Raab and
Commandant Paul Yost and the men and women of the
Customs Service and the Coast Guard, we all express our
appreciation and admiration for their level of commitment and
dedication. But we do know that the American people understand
both the importance and the frustrations in the fight against
drugs.
NB-6

-2The Administration's continuity of drug enforcement efforts
IS paying off. However, the pace of our progress will never be
fast enough until illegal drugs are no longer available on
American streets and all agree much work needs to be done.
The Treasury Department has done its part in the crackdown on
drugs on at least three separate fronts. We are working hard to
reduce the flow of drugs across our borders and having the P-3 as
part of the Customs Service fleet marks a red-letter day in that
effort. It gives Customs a new dimension for its interdiction
efforts. Furthermore, this plane is a tangible result of what
can happen when the Administration and Congress work together
toward a worthwhile goal.
Second, we're working to close the doors on the places that
the money-laundering drug kingpins hide their profits derived
from poisoning our young people.
Third, Treasury agents have fanned out across the
United States to seek out and prosecute the criminals who make
a career of running the illegal drug network.
Drug abuse is a problem that doesn't respect national
boundaries. But it can become a minor chapter in our history if
we continue to stand together.
We must close down the sources, cut off the shipments,
vigorously enforce the laws, wipe out the demand, and firmly but
compassionately treat the addicted. This Blue Eagle Aircraft
symbolizes our commitment to use every resource at our command
to make sure that this happens.
Thank you.

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT: Office of Financing
FOR RELEASE AT 4:00 P.M.
202/376-4350
Se
Ptember 20, 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 29, 1988. This offering
will provide about $900
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,097 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 26, 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 30, 1988,
and to mature December 29, 1988 (CUSIP No.
912794 QY 3 ) , currently outstanding in the amount of $6,766 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $ 7,000 million, to be dated
September 29, 1988, and to mature
March 30, 1989
(CUSIP No.
912794 RQ 9 ) .
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for Treasury
bills maturing September 29, 1988. In addition to the maturing
13-week and 26-week bills, there are $9,281
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 $1,964 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $2,064 million as
agents for foreign and international monetary authorities, and $5,660
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).
NTB-7

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

September 21, 1988

Contact:

Art Siddon
566-5252

Secretary of the Treasury Brady Requests Treasury FSLIC study

Secretary of the Treasury Secretary Nicholas F. Brady today
directed the Treasury Department to review the position of the
Federal Savings and Loan Insurance Corporation (FSLIC) in light
of the variety of methodologies being used to arrive at
potentially higher case resolution cost estimates.
The Treasury study will be headed by Under Secretary for
Finance George D. Gould, who oversees Treasury's monitoring of
the thrift industry. Mr. Gould will report his findings and
recommendations directly to Secretary Brady.
Background
Under Secretary Gould recently testified before both the
Senate and House Banking Committees on additional steps Congress
should take before considering any taxpayer bailout of FSLIC.
Those steps include:
o authorizing the remaining $5 billion in nontaxpayer
recapitalization resources the Administration requested
in 1986;
o utilizing the flexibility of the current FSLIC
recapitalization plan to provide additional resources,
if necessary, for both principal and interest payments
on FSLIC's Financing Corporation bonds;
o enhancing the charter for a savings and loan
association to attract more private capital to the
industry;

NB-8

2
o

protecting insured depositors by using separately
capitalized affiliates of a holding company to engage
in state-chartered activities not permitted for federal
s&Ls, if FSLIC determines such action is necessary;
o strengthening enforcement and supervisory authority;
and
o extending expiring tax provisions on a temporary basis.
One of Mr. Gould's first assignments at Treasury was to
devise the Administration's plan to recapitalize FSLIC with $15
billion of nontaxpayer funds in March 1986. This plan, together
with FSLIC's normal resources, would have produced $25-30 billion
to begin resolving insolvent savings and loan associations two
and a half years ago. Congress approved a restricted $10 billion
recapitalization in August 1987.

FREASURYNEWS _
ipartment of the Treasury • Washington, D.C. • Telephone 566-2041

September 21, 1988
NICHOLAS F. BRADY
SECRETARY OF THE TREASURY

Nicholas F. Brady became the 68th Secretary of the Treasury
on September 15, 1988.
Secretary Brady served in the United States Senate from
April 20, 1982 through December 27, 1982. During that time he
was a member of the Armed Services Committee and the Banking,
Housing and Urban Affairs Committee.
In 1984 President Reagan appointed Secretary Brady Chairman
of the President's Commission on Executive, Legislative and
Judicial Salaries. He has also served on the President's
Commission on Strategic Forces (1983), the National Bipartisan
Commission on Central America (1983), the Commission on Security
and Economic Assistance (1983), and the Blue Ribbon Commission on
Defense Management (1985). Most recently, Secretary Brady
chaired the Presidential Task Force on Market Mechanisms (1987).
Secretary Brady's career in the banking industry spans
34 years. He joined Dillon, Read & Co. Inc. in New York
in 1954, rising to Chairman of the Board. He has been a
Director of the NCR Corporation, the MITRE Corporation, and
the H. J. Heinz Company, among others.
He has also served as a trustee of Rockefeller University and
a member of the Board of The Economic Club of New York. He is a
member of the Council on Foreign Relations, Inc. He is a former
trustee of the Boys' Club of Newark.
Mr. Brady was born April 11, 1930 in New York City. He was
educated at Yale University (B.A., 1952) and Harvard University
(M.B.A., 1954). He and his wife, Katherine, have four children.

MB-9

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

CONTACT:

Office of Financing
202/376-4350

TREASURY TO AUCTION 2-YEAR AND 4-YEAR NOTES
TOTALING $15,750 MILLION
The Treasury will auction $8,750 million of 2-year notes
and $7,000 million of 4-year notes to refund $17,473 million
of securities maturing September 30, 1988, and to paydown about
$1,725 million. The $17,473 million of maturing securities are
those held by the public, including $2,210 million currently held
by Federal Reserve Banks as agents for foreign and international
monetary authorities.
The $15,750 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 prices of accepted competitive tenders.
In addition to the public holdings, Government accounts
and Federal Reserve Banks, for their own accounts, hold $1,646
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

NB-10

HIGHLIGHTS OF TREASURY OFFERINGS TO THE PUBLIC
OF 2-YEAR AND 4-YEAR NOTES TO BE ISSUED SEPTEMBER 30, 1988
September 21, 1988
Amount Offered to the Public ... $8,750 million
Description_of Security:
Term and type of security
2-year notes
Series and CUSIP designation ... Series AF-1990
(CUSIP No. 912827 WR 9)
Maturity date
September 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
March 31 and September 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
Fuli 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, September 27, 1988,
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a)
funds
»>) a
rv
< -a,itl(a
ll
bimmediately
llye- c o
to
l l ( tho
K M i l )Treasury
l c <-liec:k ...
... W
Friday,
e d n e s d a ySeptember
, S e p I e m l x3 •
0 r, 'Ail,
19881 9 H B

$7,000 million
4-year notes
Series P-1992
(CUSIP No. 912827 WS 7)
September 30, 1992
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
March 31 and September 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
Wednesday, September 28, 1988,
prior to 1:00 p.m., EDST

Friday, September 30, 1988
Wednesday, S e p t e m b e r 211, 1 9 8 0

TREASURY NEWS

lepartment of the Treasury • Washington, D.C. • Telephone 506-2041
FOR IMMEDIATE RELEASE
September 22, 1988
Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of August 1988.
As indicated in this table, U.S. reserve assets amounted to
$47,778 million at the end of August, up from $43,876 million in July.

U.S. Reserve Assets
(in millions of dollars)

End
of
Month

Total
Reserve
Assets

43,876
47,778

Stock V

Special
Drawing
Rights 2/3/

Foreign
Currencies 4/

Reserve
Position
in IMF 2/

11,063
11,061

8,984
9,058

14,056
18,017

9,773
9,642

Gold

1988
July
Aug.

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.

NB-ll

TREASURY NEWS

Bpartment of the Treasury • Washington, p.c. • Telephone 566-2041
TEXT AS PREPARED
FOR RELEASE UPON DELIVERY
EXPECTED AT 10:45 A.M. EDT
Testimony of the Honorable
M. Peter Mcpherson
Deputy Secretary of the Treasury
before the
Legislation and National Security Subcommittee
of the
House Committee on Government Operations
September 22, 1988
Good morning, Mr. Chairman, and Members of the Committee.
I appreciate the opportunity to comment on the proposed Financial
Management Improvement Act.
While this Administration has made significant progress in
improving Federal financial management in the areas of cash
management, credit management/debt collection, accounting,
financial reporting and internal controls, there is still much
to do. Thus, we support the Comptroller General's legislation in
order to continue the progress and improvement made over the last
several years.
In my testimony today, I would like to share Treasury's
specific positions with respect to the four key elements of the
legislation. While I recognize the Chief Financial Officer issue
is raised first in the draft legislation, I would like to address
Financial
I.
that
issue last.Statements
Treasury supports the second key element of the proposed
legislation—development of integrated financial statements.
Financial statements measure the results of agency and
governmentwide asset and liability management and also provide
"early warnings" of emerging concerns before they become major
problems.
We share your belief, Mr. Chairman, that the financial
statements must accurately portray the Government's financial
position and be understandable to users. Further, the statements
must present financial results objectively, on a consistent
basis, and take into account the unique character of the Federal
Government.

NB-12

-2While there are still some accounting issues that need to
be resolved, none are insurmountable or need cause delay.
II. Audit Requirements
Second, the legislation would require annual audits of the
financial statements. While Treasury recognizes the need for
audits and supports the concept, Treasury opposes annual auditing
because it is not practical at this time. In the Department
alone, there are over 21 accounting systems and approximately
100 other miscellaneous fund accounts. Performing annual audits
on all these systems and accounts would drain most audit
resources away from contract and program audits, which are
high-priority activities helping to ensure the integrity of
Treasury's operations. Treasury recommends a cyclical audit
schedule established by the CFO in coordination with the
Inspectors General in order to best allocate scarce audit
resources.
Ill. Agency Controllers
Third, Treasury supports the proposed provision that would
legislatively establish agency controllers. While agencies
currently have designated financial officers, the legislation
will place a more appropriate level of importance on the
function.
IV. Chief Financial Officer
And now I return to the CFO issue. The Administration
strongly supports the concept of a Chief Financial Officer (or
CFO) for the Federal Government. In July 1987, Jim Miller
established a CFO administratively to provide the leadership and
organization to rectify the widely recognized deficiencies in
Federal financial management. A statutory CFO would further
strengthen the efforts underway by mandating a governmentwide
financial structure that could provide the needed organization,
direction, and guidance.
The organizational location of the CFO, however, is an issue
still open to debate. There are pros and cons to locating the
CFO in OMB, and pros and cons to locating the CFO in Treasury, as
proposed by this legislation.
The arguments for keeping the CFO at OMB are:
o OMB is in the Executive Office of the President, and
has a leadership role;
o OMB oversees the budget process and approves funding
for financial management systems; and
o During this Administration, OMB has provided strong
leadership which, in partnership with Treasury, has
led to significant progress in improving Federal
financial management.

-3(As an aside, I would like to note that the strong
leadership from OMB in this area can largely be
attributed to Joe Wright and his eight year
personal commitment to improving management in the
Federal Government. It is rare for a senior
government official to dedicate himself to a
long-term view of "good government," and even rarer
for someone to make as great a difference as Joe
has. )
The arguments against are:
o Of the 33 functions of a CFO, OMB currently
provides policy direction and shares
responsibility—with Treasury—for ten other
functions. In contrast, Treasury is involved in
31 of the 33 functions.
o OMB institutionally focuses most of its efforts on
the budget process, and, more specifically, on
program funding decisions; by necessity, other
matters traditionally receive less attention and
priority at OMB.
o OMB currently does not have the staff or the
in-depth technical expertise to implement the full
range of CFO functions.
The arguments for placing the CFO in Treasury are:
o Treasury is already performing most CFO-type
responsibilities. Of 33 typical CFO functions,
Treasury performs 18 independently, and is a key
player in 13 others.
o The CFO function is a logical extension of
Treasury's responsibilities. Treasury is already
the Federal Government's cash manager, debt manager,
central operating accountant, the central source for
governmentwide financial reports, manager of central
financial systems, and the financial operational
link for all government agencies.
o Treasury also collects most of the Government's
revenue and disburses most of its payments.
o Moreover, Treasury already has an organization and
staff in place that could quickly be adapted to
support a statutory CFO.

-4For example, the Financial Management Service within
the Treasury has:
212 professional accountants,
209
computer professionals,
76
financial specialists, and
- 2,000
operations personnel.
o Finally, a Treasury-located CFO could draw upon the
wealth of financial and economic expertise that
already exists within the Treasury.
The primary argument against a Treasury-located CFO is that:
o . The Treasury Department is not in the Executive
Office of the President and does not control the
agency budgets. The budget process has been an
important tool in bringing about changes in the
process.
Overall, I want to stress that I strongly support a
statutory CFO, regardless of its ultimate location.
I would like to add two technical points here relating to
the CFO provision. If the legislation ultimately placed the CFO
in Treasury, we would urge that the CFO functions be assigned to
the Secretary of the Treasury, thus preserving the Secretary's
management prerogatives, although we would not object to
establishing an additional Under Secretary position. In
addition, Treasury believes that a standard Presidential
appointment of an Under Secretary would be more appropriate than
the proposed eight-year term, because it limits necessary
Secretarial and Presidential management prerogatives.
In conclusion, Mr. Chairman, Treasury supports the proposed
legislation and recommends the specific modifications I
addressed. The time is right for moving forward because it is
the logical next step in our joint and continued efforts to
improve Federal financial management.
Mr. Chairman, I thank you for the opportunity to appear
before the Subcommittee and I am available to answer any
questions.

rREASURY NEWS
partment of the Treasury • Washington, D.C. • Telephone 566-2041
September 22, 1988

Contact:

Art Siddon
566-5252

ADMINISTRATION OPPOSES ENERGY AND COMMERCE COMMITTEE AMENDMENTS
Under Secretary of the Treasury for Finance George D. Gould
today expressed the Administration's strong opposition to the
controversial amendments reported by the House Energy and
Commerce Committee. The amendments were to the Depository
Institution Act of 1988 already reported by the House Banking
Committee on a 31-20 vote on July 28, 1988.
"For years, we have encouraged Congress to step forward and
make the hard decisions to modernize outdated statutes in ways
that promote greater competition, benefit consumers, and equalize
regulatory burdens of financial services providers. The Energy
and Commerce action today, on top of earlier action by the House
Banking Committee, demonstrates that the House of Representatives
is not prepared to move forward into the modern financial world.
Their collective action is two steps backwards, retreating into a
protectionist, anti-competitive regime left over from the 1930s,*1
Gould said.
"If Congress wants to do something in the public interest
before it adjourns and accommodate innovation in the future, it
should simply pass those provisions in the Senate bill repealing
the Glass-Steagall Act and building new firewalls to ensure the
safety and soundness of our financial system," Mr. Gould
declared.
"In light of today's rapidly evolving financial world, it is
critical for the United States to act in a positive fashion,
particularly because of the increasing global competition that we
face from our major trading partners in the delivery of financial
services."
The Administration supports much of the Financial
Modernization Act, which passed the Senate by a 94-2 vote on
March 30, 1988. It repeals parts of the Glass-Steagall Act and
re-writes the Bank Holding Company Act in ways that would bring
new capital and new competition to investment banking. Bank
holding companies could establish separately capitalized
NB-13

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350

FOR IMMEDIATE RELEASE
September 22, 1988
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION
Tenders for $9,029 million of 52-week bills to be issued
September 29, 1988, and to mature September 28, 1989, were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Investment Rate
Rate
(Equivalent Coupon-Issue Yield) Price
92.447
Low - 7.47% 8.03%
92.437
High
7.48%
8.04%
92.437
Average 7.48%
8.04%
Tenders at the high discount rate were allotted 82%.

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)
i
Accepted
Received
13,415
$
13,415
$
25,,058,465
8,202,130
9,710
9,710
12,505
12,505
76,730
24,930
12,875
12,875
1,,196,905
115,105
14,965
12,975
10,965
23,565
7,975
20,235
23,565
1.,507,045
10,235
152,850
432,545
$28,,112,240
152,850
$9,028,805

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

$25,,388,750
423,490
$25 ,812,240
2 ,200,000

$6,305,315
423,490
$6,728,805
2,200,000

100,000
$28 ,112,240

100,000
$9,028,805

An additional$372,300 thousand of the bills will be issued
to foreign official institutions for new cash.

NB-14

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350
FOR IMMEDIATE RELEASE
September 26, 198s
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $ 7,019 million of 13-week bills and for $7,004 million
of 26-week bills, both to be issued on September 29, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing December 29, 1988
Discount Investment
Price
Rate
Rate 1/
7.19% £/
7.25%
7.23%

7.42%
7.49%
7.47%

98.183
98.167
98.172

26-week bills
maturing March 30, 1989
Discount Investment
Rate
Rate 1/
Price
7.41%
7.49%
7.48%

7.80%
7.89%
7.88%

96.254
96.213
96.218

a/ Excepting 2 tenders totaling $2,650,000.
Tenders at the high discount rate for the 13- •week bills were allotted 145
Tenders at the high discount rate for the 26- •week bills were allotted 445

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

$
27,940
' 19.743,650
18,275
53,610
36,430
30,495
903,795
22,520
5,435
24,370
31,055
1,137.895
333,075

$
27,940
5,738,650
18,275
53,610
36.430
30.495
135,295
22,520
5,435
24,370
31,055
562,035
333,075

$
26,375
20,249,925
20,840
30,200
40,885
26,725
731,805
37,665
10,290
51,620
32,240
1,082,470
512,460

$
26,375
5,864,925
20,840
30,200
40.885
26,725
71,205
33,665
10,290
51,620
24.440
290.470
512,460

$22,368,545

$7,019,185

$22,853,500

$7,004,100

$19,451,380
890,955
$20,342,335

$4,102,020
890,955
$4,992,975

$18,583,690
1,050,310
$19,634,000

$2,734,290
1,050,310
$3,784,600

1,828,510

1,650,000

197,700

1,569,500

$22,368,545

$7,019,185

• $22,853,500

$7,004,100

1/ Equivalent coupon-issue yield.

TREASURY NEWS _
lepartment of the Treasury • Washington, D.c. • Telephone 566-2041

For Release Upon Delivery
Expected at 10:00 a.m. EST
September 27, 1988
STATEMENT OF
THOMAS S. NEUBIG
DIRECTOR AND CHIEF ECONOMIST
OFFICE OF TAX ANALYSIS
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON SELECT REVENUE MEASURES
COMMITTEE ON WAYS AND MEANS
Mr. Chairman and Members
of the
U.S. HOUSE
OF Subcommittee:
REPRESENTATIVES
I am pleased to have this opportunity to d
iscuss the results
of the Treasury Department's Interim Report to the Congress on
Life Insurance Company Taxation. The Deficit Reduction Act of
1984 (the "1984 Act") substantially altered th e tax treatment of
life insurance companies and their products. During the
consideration of the life insurance company pr ovisions, the
Congress expressed concern about two issues: (1) the amount of
taxes paid by companies in the life insurance industry; and (2)
the relative tax burden of mutual (policyholde r-owned) and stock
(shareholder-owned) life insurance companies. The interim report
ned in the 1984 Act
responds
to the congressional
contai
My testimony
today will firdirective
st discuss
the f
rules
governing
those
issues. the
that
the
Treasury
Department
conduct
a
study
o
taxation of life insurance comp anies before and after the 1984
Act. Second, I will discuss th e results of the Treasury
Department's interim report on the amount of taxes paid by life
insurance companies since the 1 984 Act and the relative tax
burdens of the mutual and stock segments of the life insurance
industry. The analysis of the revenue effect of the 1984 Act is
based upon data reported to the Treasury Department in a special
survey of life insurance compan ies. These data are an important
improvement over information pr eviously available from financial
statements and IRS statistics.

NB-16

-2Although the interim report contains information that may
assist the Congress in its review of these issues, I would like
to emphasize at the outset that the Treasury Department is not
here today either to evaluate the success of the 1984 Act in
properly taxing life insurance companies or to suggest the
appropriate tax burden of the life insurance industry or the
mutual or stock segments. We intend to continue our analysis of
life insurance company tax rules and possible changes, and to
present the final report on life insurance company taxation to
the Congress early next year.
I. Summary of Prior and Current Law Taxation of Life Insurance
Companies
Since 1921, life insurance companies have been subject to tax
under three different sets of rules. Between 1921 and 1958, life
insurance companies were taxed only on "free" investment income.
Free investment income was the amount of investment income that
was not needed to fund obligations to policyholders. This amount
was calculated under formulas that changed over the years.
Income and losses from underwriting operations (e.g., premium
income and benefits paid to policyholders) were ignored as were
gains and losses from the sale of investment assets.
Between 1958 and 1984, life insurance companies were taxed
under a complex "three-phase" system enacted by the Life
Insurance Company Tax Act of 1959 (the "1959 Act"). The three
phases referred to the three different tax bases that could be
applicable to a life insurance company. The first tax base was
the company's free ("taxable") investment income. The second tax
base was the company's gain from operations. The gain from
operations tax base included premium income and investment income
not needed to fund obligations to policyholders. In calculating
gain from operations, deductions were allowed for additions to
reserves for future obligations. The amount of the reserve
deductions was generally equal to the amount of the additions to
the reserves required by state regulators. In addition, limited
deductions were allowed for policyholder dividends and certain
"special deductions."
Under the 1959 Act, a life insurance company was taxed on the
lesser of its taxable investment income or its gain from
operations. In calculating its gain from operations, however,
the amount of deductions for policyholder dividends and special
deductions was limited to $250,000, plus the amount by which the
gain from operations (before these deductions) exceeded taxable
investment income. Thus, these deductions could not reduce a
company's taxable income to more than $250,000 below its taxable
investment income. If a company's gain from operations exceeded
its taxable investment income, the company was taxed on
50 percent of such excess. The untaxed gain from operations
(along with the special deductions) was added to a deferred tax
account and, subject to certain limitations, was taxed only when
distributed to shareholders. When triggered, this deferred tax
account was the third tax base under the 1959 Act.

-3The existence of multiple tax bases under the 1959 Act
produced differing tax treatment of different types of income.
For example, a company that had reached the limit on the
deduction of policyholder dividends and special deductions would
be taxed on the receipt of additional investment income, but not
on the receipt of additional underwriting income. Life insurance
companies were able to manipulate the character of their income
by entering into so-called "modified coinsurance" transactions.
In a modified coinsurance transaction, the ceding company
retained ownership of the assets and the reserve liabilities
connected with the risks reinsured. Former section 820 of the
Code, however, permitted the parties to treat the transaction as
if the assets and reserves had been transferred to the reinsurer.
As part of a modified coinsurance transaction, the reinsurer
would pay "experience refunds" to the ceding company. The
experience refunds reflected investment income earned by the
ceding company (which under section 820 was deemed to be earned
by the reinsurer) but were characterized as underwriting income
to the ceding company. Thus, a modified coinsurance transaction
had the effect of converting taxable investment income of the
ceding company into more favorably taxed (or untaxed)
underwriting income.
The special treatment of modified coinsurance transactions
under former section 820 of the Code was repealed by the 1982
Act. At the same time, however, the limitation on the
deductibility of policyholder dividends was revised for a
temporary two-year period. In general, under the revised
limitation, a partial deduction (85 percent for stock companies
and 77.5 percent for mutual companies) was allowed for all
policyholder dividends. Several other favorable tax provisions
were enacted for a temporary two-year period.
The rules for taxing life insurance companies were
substantially revised in 1984 in response to concerns that the
1959 Act rules were unduly complex, did not work well in a high
interest rate environment, and taxed life insurance companies
differently from other corporations. Under the 1984 Act, life
insurance companies are taxed on a single income tax base corresponding generally to the tax base applicable to other
corporations. Many of the special deductions and accounting
rules that had applied under the 1959 Act were repealed. Even
with these changes, however, the tax base of life insurance
companies differs from that of other corporations in three
significant respects.
First, 1984 Act allowed life insurance companies a "special
life insurance company deduction" and a "small life insurance
company deduction." The "special" deduction, which was repealed
by the Tax Reform Act of 1986, was equal to 20 percent of the
company's taxable income from insurance businesses, and had the
effect of reducing the maximum marginal rate of tax on this
income from 46 percent to 36.8 percent. The "small company"

-4deduction, which applies to companies with assets of less than
$500 million, is equal to 60 percent of the first $3 million o£
the company's taxable income from insurance businesses, and is
phased out at income levels of between $3 million and $15
million.
Second, as under the 1959 Act, life insurance companies are
allowed to deduct additions to life insurance reserves and
similar items. In calculating the maximum amount of the
reserves, the 1984 Act required that the reserves be calculated
using Federally prescribed rules. In general, the Federally prescribed reserve rules specify a tax reserve method and require
use of the highest interest rate and most recent mortality or
morbidity table permitted to be used by insurance regulators in a
majority of states. For taxable years beginning after 1987, the
interest rate that must be used in calculating reserves is the
greater of the prevailing state rate or a five-year average of
the Federal mid-term rate.
Third, to address the perceived tax advantage of the mutual
form of organization, the 1984 Act imposed a limitation on the
deduction by mutual life insurance companies of policyholder
dividends. Under section 809 of the Code, the deduction of
policyholder dividends by a mutual company is reduced by the
company's "differential earnings amount." The differential
earnings amount is equal to the product of the mutual company's
average equity base and the "differential earnings rate." The
differential earnings rate, in turn, is equal to the excess of
the "imputed earnings rate" (90.55 percent of a three-year
average of the earnings rates of the 50 largest stock life
insurance company groups) over the average earnings rate of all
mutual life insurance companies for the second calendar year
preceding the taxable year. The differential earnings amount for
a taxable year is "recomputed" in the subsequent taxable year.
The recomputed amount reflects the average mutual earnings rate
for the calendar year in which the taxable year begins (rather
than the second preceding calendar year). The difference between
the differential earnings amount and the recomputed differential
earnings amount (the so-called "true-up") is included in income,
or deducted, in the subsequent year.
For example, the differential earnings amount of mutual
companies for 1985 was calculated using the 1983 average mutual
earnings rate of 10.166 percent. The recomputed differential
amount for 1985 was calculated using the 1985 average mutual
earnings rate of 13.135 percent. The difference between the
differential earnings amount for 1985 and the recomputed
differential earnings amount for 1985 (i.e., 2.969 percent of
each company's 1985 average equity base) was allowed as a
deduction in calculating the taxable income of each mutual life
insurance company in 1986.
Prior to 1981, life insurance companies were not permitted to
join in the filing of consolidated income tax returns with

-5affiliated corporations that were not life insurance companies.
Thus, income and losses of life insurance companies and
affiliated non-life companies could not be used to offset one
another. The filing of consolidated returns by life and non-life
companies has been permitted since 1981, subject to two
restrictions. First, consolidated returns may be filed by a life
company and a non-life company only if they have been affiliated
for the preceding five years. Second, the amount of non-life
losses that can be offset against the income of life companies is
limited to the lesser of 35 percent of the non-life losses or 35
percent of the life company income. The latter restriction does
not limit the use of life insurance losses to offset income of
non-life affiliates.
II. Analysis of the Revenue Effects of Recent Legislation
Changing the Taxation of Life Insurance Companies
Revenue estimates generally depend on four factors: (1) the
level of economic activity, including both the macro-economic
national forecast as well as the market share of the particular
economic activity affected; (2) the taxpayers' economic
situation, including types of products sold, portfolio choice,
and form of organizations; (3) how the specific changes in the
tax law affect particular taxpayers' economic situations
independent of behavior changes; and (4) how taxpayers react to
the tax law changes. If these factors are misspecified or
forecasted incorrectly, estimated receipts will differ from
actual collections. "Offsetting" errors will often reduce the
discrepancy (e.g., an overestimated tax rate may be accompanied
by an underestimated tax base), but the chances of this occurring
for estimates that affect a specific industry or particular
companies are much less likely. As a result of the many
different factors involved, it is difficult to estimate
accurately the revenue effects of proposed tax legislation.
Estimates of the four revenue estimating factors described
above for the life insurance industry were generally based on
historical data from tax returns and regulatory data. With
respect to the 1982 and 1984 life insurance company tax changes,
the data were particularly difficult to interpret for three
reasons: (1) the occurrence of significant changes in the
insurance industry and its products; (2) the different
definitions of the life insurance industry in the available data
sources; and (3) the effect of consolidation on life insurance
industry tax statistics. The Appendix appearing at the end of
this testimony contains a discussion of the data that were
available at the time the estimates of the 1984 Act were made.
For the life insurance industry during the 1980's, it has
been particularly difficult to estimate revenue changes, because
of the changing nature of the industry's products and practices,
the limitations of the available information, and the significant
tax law changes. The use of modified coinsurance from 1979 to
1981 unexpectedly decreased insurance industry taxes. The

-6explosion of new life insurance products in the early 1980's, the
availability of consolidation with non-life insurance companies
starting in 1981, and the temporary tax law changes combined witn
the general economic downturn in 1982-83 made predicting the
amount of industry revenues before the 1984 Act changes
difficult. Finally, the complete overhaul of the life insurance
industry's tax rules in 1984 made estimating the effects on the
industry and the consequent tax collections extremely uncertain.
Estimated Revenue Effects at the Time of the 1984 Act
The complete overhaul of the life insurance industry's tax
rules in 1984 made it extremely difficult to estimate the revenue
effects of specific tax provision changes. Thus, the principal
focus of the legislative debate was on the expected receipts from
the industry after the tax law changes, rather than the revenue
change from the legislation. Nevertheless, estimates by the
Treasury and the Joint Committee on Taxation (JCT) of the level
of receipts from the industry after the 1984 Act were quite
similar. The level of receipts from the life insurance industry
after the 1984 Act changes was expected to grow from $3.0 billion
in calendar 1984 to between $3.8 and $3.9 billion in 1988, as
shown in Table 1. These estimates took into account the effects
of consolidation for the life insurance subgroups.
Estimates of the revenues from the mutual and stock segments
of the life insurance industry were made for 1984, as shown in
Table 2. For calendar year 1984, the total life insurance
industry was expected to pay $3.0 billion, with approximately
55 percent paid by the mutual segment ($1.6 billion with
rounding) and 45 percent paid by the stock segment ($1.4
billion).
Total Life Insurance Industry Taxes Paid in 1984 and 1985
To obtain information on taxes paid by life insurance
companies in 1984 and 1985, the Treasury Department conducted a
special survey of life insurance companies. The Treasury
Department's survey was sent to the largest (measured by assets)
50 mutual life insurance companies, the largest 198 stock life
insurance companies, and a random sample of smaller mutual and
stock companies.
Table 3 presents the estimates of taxes paid by the life
insurance industry1 from the Treasury survey in terms comparable
to those used in the original estimates of receipts from the 1984
Act shown in Table 2. The life insurance industry paid $2.4
1
billion
in paid
taxesare
in as
calendar
year
compared
to $3.0
Taxes
reported
on 1984,
Federal
tax returns
butbillion
may
differ from actual collections of the Federal government in cases
of consolidated returns with non-life losses.

- 7Table 1
Treasury and Joint Committee Estimates of Life Insurance
Industry Receipts Before and After the 1984 Act Changes
($ billions)

1984

1985

3.0
-0.5
2.5*

4.0
-0.9
3.1

Fiscal Year
1987
1986

1988

Treasury Estimates
Baseline Before 1984 Act
1984 Act Changes
Baseline After 1984 Act

4.3
-1.0
3.3

4.6
-1.1
3.5

5.0
-1.2
3.8

Joint Committee on Taxation Estimates
Baseline Before 1984 Act
1984 Act Changes
Baseline After 1984 Act
Department of the Treasury
Office of Tax Analysis

3.1
-0.1
3.0

3.5
-0.3
3.1

3.7
0.4
3.4

4.1
4.4
-0.5
-0.5
3.6
3.9
September 1988

SOURCE:

Treasury, Office of Tax Analysis and the Joint
Committee on Taxation, calculations as of June 1984 at
the end of the Conference Committee.
Details may not add due to rounding.
* Difference in FY 1984 estimate from JCT due to Treasury's lower
estimate of 1983 CY receipts with the full effect of end of the
CY 1982 and 1983 safety net rules shown in the change between
FY 1984 and 1985. The Treasury's 1984 calendar year receipts
estimate was $3.0 billion.

- 8Table 2
Estimate of Calendar Year 1984 Life Insurance Industry Tax
Liabilities After the 1984 Act Changes
by Mutual and Stock Segments Made at The Time of the Legislation
($ billions)

Mutual Life
Companies

Stock Life
Companies

Total

10.7

6.0

16.7

Less: Allowable Policyholder Dividends 2/

5.6

1.7

7.3

Gain From Operations After Policyholder Dividends

5.1

4.3

9.4

Less: Net Operating Loss Deductions
Less: Small Business Deduction
Less: Special Life Insurance Deduction

*
*
1.0

0.4
0.2
0.7

0.4
0.2

Net Income Less Deficits

4.1

3.0

7.1

Taxable Income
Tax Before Credits
Less: Tax Credits
Tax After Credits

4.2
1.9
0.3
1.6

3.1
1.4
0.1
1.4

7.3
3.3
0.4
3.0

Gain From Operations 1/

Department of the Treasury
Office of Tax Analysis

SOURCE:

September 1988

Office of Tax Analysis August 1984 calculations.

1/ After adjustment for change in reserve deductions.
2/ Estimate of mutual segment's allowable policyholder dividends assumed a $37.4 billion
equity base and a 16.5 percent applicable imputed earnings rate.
*Less than $50 million.
Detail may not add due to rounding.

Table 3
Life Insurance Industry 1/ Tax Liabilities for
Mutual and Stock Segments for 1984 and 1985
($ billions)

Mutual Life
Companies 2/

1984
Stock L i
Companies

|
| Total

Gain From Operations 3/

11.3

10.2

21.5

13.9

11.3

25.2

Less: Allowable Policyholder Dividends

8.0

4.2

12.2

8.7

4.9

13.6

Gain From Operations After Policyholder
Dividends

3.2

6.0

9.3

5.2

6.4

11.6

Less: Net Operating Loss Deductions
Less: Small Business Deduction
Less: Special Life Insurance Deduction

0.4
0.1
0.6

1.7
0.2
0.9

2.0
0.2
1.5

0.8
0.1
0.8

1.0
0.2
1.2

1.8
0.3
2.0

Taxable Income 4/
Tax Before Credits 4/
Less: Tax Credits
Tax After Credits 4/

2.3
1.0

3.4
1.4
•

1.0

1.4

3.4
1.4
0.1
1.3

4.0
1.6

5.7
2.4
0.1
2.4

7.4
3.0
0.1
2.9

Department of the Treasury
Office of Tax Analysis
SOURCE:

1.6

September 1988

Preliminary results from 1987 Treasury Department Survey of Mutual and Stock Life Insurance Companies.

NOTE: All figures weighted to estimate industry totals. Figures exclude specially surveyed Canadian-owned
companies.
* Not available
1/ Includes companies that file separate, life/life consolidated, or life/nonlife consolidated returns.
2/ Includes stock life insurance company subsidiaries of mutual life companies.
3/ For comparability with Table 3.3, before policyholder dividend deductions and net operating loss deductions
and after income offset by nonlife losses.
4/ Taxable income includes mutual segment "true-up" in 1985 of approximately $0.95 billion for an additional $0.35
billion tax liability in 1985 reflecting the mutual segment's 1984 actual experience. Taxable income of the mutual
segment in 1986, not shown on this table, includes a negative "true-up" of approximately $0.95 billion for a
reduction of $0.35 billion tax liability in 1986 reflecting the mutual segment's 1985 actual experience.

-10estimated at the time of the 1984 legislation.
The life
insurance industry paid $2.9 billion in calendar year 1985,
compared to $3.2 billion estimated at the time of 1984
legislation.
The taxes paid by the life insurance industry shown in Table
3 are determined on a life subgroup basis, allowing for losses
from consolidated non-life companies to offset partially the life
subgroup's taxable income and for some reallocation of tax
credits between the subgroups. The use of the life subgroup
after consolidation basis permits comparison with the revenue
estimates made at the time of the 1984 Act. In evaluating the
tax rules of life insurance companies, however, it may be
appropriate to examine the tax law effects of the life subgroup
before consolidation with non-life companies. Estimates of tax
liabilities of the life subgroup before consolidation are
contained in the Appendix to this testimony.
The shortfall in expected revenues from the life insurance
industry in 1984 is largely attributable to an underestimate of
$1.6 billion of allowable net operating loss deductions. The
shortfall in expected revenues in 1985 is also largely
attributable to an underestimate of allowable net operating loss
deductions.
The large net operating loss deductions claimed in 1984 and
1985 were an unexpected result of the 1982 Act's temporary relief
provisions, the availability of consolidation, and the economic
downturn in 1983. The temporary relief provisions removed the
limitation on deductions of policyholder dividends contained in
the 1959 Act, permitting the accumulation of large net operating
losses in 1982 and 1983. According to IRS data, life insurance
companies generated $5.5 billion in net operating losses in 1982
and 1983. Before 1980, the largest annual deficit for the
industry had been less than $250 million.3 Almost $4 billion of
these net operating losses were carried forward as deductions in
1984 and 1985. Because of normal lags in reporting of tax
statistics, this effect of the 1982 Act was not apparent at the
time the revenue estimates were made for the 1984 Act.
Gain from operations before policyholder dividends was about
$4.8 billion higher in 1984 than projected, but policyholder
Tax liability
generated
from lifeAlthough
insurancethese
activity
may
dividends
were $4.9
billion higher.
differences
affect
tax payments
future
years. they
For did
instance,
offset each
other forin the
industry,
not for the
the "true-up"
stock
for section 809, and the carryover of unused net operating losses
and tax credits from 1984 activity affect 1985 tax payments.
Department of the Treasury, Interim Report to the Congress on
Life Insurance Company Taxation, p. 41.

-11and mutual segments separately, as discussed below. These
offsetting differences are largely due to the 1984 Act's change
in the definition of policyholder dividends to include any
distribution to a policyholder that is the economic equivalent of
a dividend. Under the 1984 Act, policyholder dividends
specifically include excess interest (i.e., amounts in the nature
of interest that are paid or credited to policyholders and are
determined at a rate in excess of the rate used under the
contract for purposes of computing the company's reserve
deduction), premium adjustments, and experience-rated refunds.
Because of these changes, gain from operations after policyholder
dividends is the most comparable measure of what was projected at
the time of the 1984 Act.
Segment Balance Receipts in 1984
The revenue estimates of the 1984 Act projected that the
mutual segment of the life insurance industry would pay
approximately $1.6 billion in tax and the stock segment would pay
approximately $1.4 billion in tax in 1984. Actual collections
from the industry in 1984 were $1.0 billion for the mutual segment (or $1.35 billion including the "true-up" for 1984 paid in
1985) and $1.4 billion for the stock segment.
The stock segment paid approximately the same amount of tax
after credits in 1984 as estimated at the time of the
legislation. The stock segment's taxable gain from operations
after policyholder dividends was $1.7 billion higher than
estimated. The stock segment's higher taxable income (net of the
special life insurance deduction) was offset almost exactly by
the underestimate of its net operating loss deductions.
The mutual segment paid less tax in 1984 than originally
estimated at the time of the legislation due to an overestimate
of the mutual segment's gain from operations after policyholder
dividends. Unlike the stock segment, whose gain from operations
before policyholder dividends increased by more than the increase
in its policyholder dividends, the mutual segment's gain from
operations before policyholder dividends was higher by only $0.6
billion while its allowable policyholder dividend deductions were
higher than estimated by $2.4 billion.
Approximately one-quarter of the $1.5 billion overestimate of
the gain from operations (after policyholder dividends and the
special life insurance deduction) was due to an overestimate of
the mutual segment's average equity for purposes of the section
809 policyholder dividend deduction limitation. The 1984
estimates assumed that the mutual segment's average equity base
would be $37.4 billion. The actual mutual equity base as
reported by the IRS for 1984 was $32.1 billion. The overestimate
of the mutual equity base resulted in allowance of approximately
$0.4 billion additional policyholder dividend deductions, or
approximately $150 million less tax liability, assuming a 36.8
percent marginal tax rate in 1984.

-12The overestimate of the mutual segment's equity was the
result of two factors. First, the estimated equity was based on
regulatory data, which differ in scope and measurement from the
tax definitions used in section 809. Second, possible
tax-minimizing behavior on the part of the mutual segment in
reducing their equity as measured for section 809 purposes may
have been underestimated.
The mutual segment had an additional tax liability in 1985
due to their lower than expected earnings rate in 1984. The
mutual segment had an average earnings rate (i.e., gain from
operations after policyholder dividends) of 5.746 percent in
1984. Thus, the recomputed differential earnings rate for 1984
was 10.754, as compared with the statutory 7.8 percent
"transition" differential earnings rate for 1984. Consequently,
the mutual segment paid a "true-up" rate of 2.954 percent of
their 1984 average equity on their 1985 tax returns. The
additional taxable income in 1985 from the 1984 "true-up" was
approximately $950 million, or an additional $350 million in tax
liability, assuming a 36.8 percent marginal tax rate.
Segment Balance Receipts in 1985
The original estimates of the 1984 Act implied approximately
$3.2 billion in receipts, $1.7 billion paid by the mutual segment
and approximately $1.4 billion paid by the stock segment of the
life insurance industry in calendar year 1985. Actual receipts
from the two industry segments estimated from the Treasury survey
shown on Table 3 indicate the mutual segment paid $1.3 billion
($0.6 billion excluding the estimated $350 million 1984 "true-up"
reflected in 1985 returns and the negative $350 million 1985
"true-up" reflected in 1986 returns), and the stock segment paid
$1.6 billion.
The stock segment's tax payments in 1985 were higher than in
1984 due to an increase of approximately 10 percent in gain from
operations and a $0.7 billion decline in net operating loss
deductions. Both the stock and mutual segments realized large
amounts of capital gains in 1985 which increased their gains from
operations, and their earnings rates for section 809 purposes.
The mutual segment's tax payments in 1985 were lower than
estimated due to a smaller gain from operations after policyholder dividends and a larger net operating loss deduction. The
mutual segment's gain from operations after policyholder
dividends in 1985 was about the same as that projected for it in
1984, and thus none of the expected growth in gain from
operations occurred. In addition, the mutual segment's net
operating loss deduction increased to $0.8 billion in 1985, when
no significant amount of net operating loss deductions by mutual
companies was anticipated in 1985. These two differences account
for most of the shortfall in expected revenues in 1985.

-13The mutual segment's gain from operations after policyholder
dividends in 1985 of $5.2 billion included approximately $950
million attributable to the "true-up" from 1984 resulting from
the higher recomputed differential earnings rate. Thus,
approximately $350 million of additional tax liability that was
attributable to 1984 activity was paid by mutual companies in
1985. In addition, the mutual companies' 1985 differential earnings rate was calculated as 6.157 percent, but the 1985
recomputed differential earnings rate was only 3.188 percent.
Thus, a negative "true-up" rate of -2.969 percent arising from
1985 activity resulted in approximately $950 million less taxable
income in 1986. The negative 1985 "true-up" reduced mutual
companies' tax liability in 1986 by approximately $350 million.
If both the 1984 "true-up" and the 1985 negative "true-up" are
excluded from the 1985 figures, the mutual segment's tax
liability for 1985 would be $0.6 billion.
After excluding the 1984 "true-up", the mutual segment's gain
from operations after policyholder dividends was $4.3 billion in
1985. Like 1984, the mutual segment's gain from operations after
policyholder dividends and the special life insurance deduction
was overestimated by approximately $850 million. A combination
of explanations are possible:
o The activity of the mutual segment was overestimated,
possibly resulting from an overestimate of total life
insurance activity, the mutual segment's market share of
the industry, or the mutual segment's rate of profitability
on its life insurance business.
o The equity base of mutual companies in 1985 was
overestimated as it was in 1984. The overestimation of the
mutual equity base accounts for approximately one-quarter
of the difference.
o Taxable gains from operations may have been overestimated
by underestimating the companies' tax-minimizing behavior.
o The original estimates underestimated the earnings rates of
the stock segment during the 1981-83 period which enter
into the calculation of the imputed earnings rate under
section 809. The statutory rate of 16.5 percent was
thought to be higher than the average earnings rate of the
50 largest stock company groups during the 1981-83 base
period. In fact, the average stock earnings rate during
the base period was 18.221 percent, which resulted in the
1985 imputed earnings rate (16.323 percent) being lower
than the 1985 current stock earnings rate (18.026 percent).
III. Conclusion
The recent changes to life insurance company taxation have
resulted in less additional revenue than had been predicted. In
particular, the tax payments of the life insurance industry and
the relative shares paid by the different industry segments in
1984 and 1985 did not meet Congressional expectations.

-14Differences between estimated receipts and taxes paid largely
reflect the difficulty in predicting accurately life insurance
company taxes. Actual income tax collections depend on a number
of factors which are difficult to predict accurately, including
general macroeconomic conditions and relative market shares of
and within the life insurance industry. Moreover, the
significant changes in the practices of life insurance companies,
their products, and tax rules during the last decade and the
inadequacies of available data upon which to base estimates have
magnified prediction problems. Thus, the "shortfall" in actual
collections does not necessarily imply that the 1984 Act changes
have not been effective in taxing life insurance companies more
like other corporations.
The Treasury Department believes that it is more appropriate
for tax legislation to attempt to measure accurately the economic
income of companies than to attempt to collect a particular
amount of revenue from an industry or from the different segments
of an industry. We intend to continue to evaluate the tax rules
affecting life insurance companies and to report to the Congress
early next year.
This concludes my prepared remarks. I would be happy to
answer any questions.

-15APPENDIX
Comparison of Tax Liabilities From Different Data Sources
Several measures of tax liabilities of the life insurance
industry were available at the time the 1984 estimates were
made. The most readily available industry data are from
financial statements. However, these data are based upon a
definition of the group of companies that comprise the life
insurance industry that is different from the tax definition of
the life insurance industry. Financial statement information and
tax statistics also use different concepts to measure income and
taxes. On the other hand, the tax statistics published by the
IRS include only partial information regarding the effects of
consolidation. As a result of these defects in the available
data, the Treasury Department conducted a special survey of life
insurance companies to evaluate the taxation of life insurance
companies. The Treasury survey was designed to assess accurately
the taxes paid by the life insurance industry both before and
after consolidation with non-life companies using the tax code's
definition of the industry, taxable income, and tax liability.
Table 4 compares preliminary estimates of tax liabilities of
the life insurance industry reported on the Treasury's survey
with statistics from other sources.
The table shows seven
different measures of tax liabilities of the life insurance
industry in 1984 and 1985. The first three measures in Table 4
are liabilities on life insurance company tax returns as reported
in the Treasury survey. These measures use tax return statistics
and the tax definition of life insurance companies. The first
two survey measures are tax after credits. The only difference
between the first two survey measures is the degree of
consolidation with non-life companies. The third survey measure
is tax before credits. The third survey measure differs from the
first two, because it does not include the effects of
consolidation or take into account tax credits.
In general,
"all consolidated companies" includes the effects of income and
allowable losses of all companies filing consolidated returns
with a life insurance company, and "life insurance subgroup
4
(after
includes the
of allowable
Thenon-life
Treasury losses)"
survey requested
the effects
latest available
tax losses
return
of
non-life
companies
filing
consolidated
returns
with
a
information including amended returns as of August 1987. life
Later
company. returns
The "life
insurance
subgroup will
(before
non-life
losses)"
amended
and audit
adjustments
result
in further
does
not in
include
the effects of allowable losses of non-life
changes
tax liability.
5affiliated companies.
Tax after credits was not calculated for the life subgroup
(before non-life losses) because the survey collected tax credits
used on a consolidated basis.

-16The fourth measure in Table 4 is the tax after credits of the
life insurance industry as reported by the IRS Statistics of
Income (SOI) program. This measure is from tax returns, but
includes taxes from a different sample of companies. The SOI
classifies consolidated returns by industry based on the industry
group from which the largest percentage of total receipts is
derived. As a result, a significant amount of taxes of life
insurance companies included in the Treasury survey measure is
not included in the SOI reported total. The SOI data also report
bottom-line taxes from consolidated returns. For both 1984 and
1985, the SOI measure of taxes is less than the two tax return
measures of taxes from the Treasury survey.
The fifth, sixth, and seventh measures in Table 4 report
annual financial statement taxes. The fifth measure in Table 4
presents the financial statement measure of taxes paid by the
life insurance industry in the Treasury survey. This measure is
based upon a sample of life insurance companies consistent with
the tax law, but taxes reported on financial statement are higher
than taxes reported on tax returns by the same companies due to
differences in financial and tax accounting. The final two
measures are reports of financial statements taxes from A.M.
Best's Aggregates and Averages and from the American Council of
Life Insurance's Life Insurance Fact Book. These latter two
measures are based on samples of life insurance companies'
regulatory statements.
Taxes reported on financial statements are generally higher
than tax return measures for several reasons. Tax liabilities
are measured differently for tax and financial reporting
purposes. Financial statement amounts are estimates of tax
liabilities that are made several months before a company files a
tax return. The taxes reported on financial statements may
include amounts never reported on tax returns, such as assessed
tax deficiencies relating to audits of prior year tax returns.
Where financial and tax accounting differ on the timing of income
recognition, the financial statement taxes may include amounts
that are not actually paid to the Treasury until later years due
to tax deferral. In addition, the regulatory statements do not
allow consolidation with non-life companies, although life
insurance companies have been allowed to file consolidated tax
returns with non-life companies since 1981.

1985
| Mutual Life | Stock Life
| Companies | Companies

Total

Tax Return Measures
Treasury Survey
All Consolidated Companies

891

1,467

2,357

1,211

1,542

2,754

Life Subgroup (after non-life
losses)

974

1,426

2,400

1,282

1,601

2,883

1,083

1,759

2,842

1,482

2,119

3,601

704

558

1,262

914

1,341

2,256

1,212

1,643

2,855

2,080

2,270

4,359

Financial Statements from
A.M. Best

1,231

1,525

2,756

2,084

2,049

4,133

Financial Statements from
ACLI

N/A

2,785

N/A

4,134

Life Subgroup (before non-life
losses) 1/
SOI Tax Statistics
Financial Statement Measures
Financial Statements from

Treasury Survey

Department of the Treasury
Office of Tax Analysis
SOURCE:

September 1988

Preliminary results from 1987 Treasury Department Survey of Mutual and Stock Life Insurance
Companies, Internal Revenue Service Corporation Source Book of Statistics of Income, A.M. Best
Aggregates and Averages Life-Health 1986, and American Council of Life Insurance Life Insurance
Fact Book.

NOTE: All figures weighted to estimate industry totals. Figures exclude specially surveyed
Canadian-owned companies.
N/A = Not Available.
1/

Amounts shown are tax before credits.

TREASURY NEWS ^

epartment of the Treasury • Washington, D.C. • Telephone
CONTACT: Office of Financing
202/376-4350
FOR RELEASE AT 4:00 P.M.
September 27, 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 October 6, 1988.
This offering
will provide about $ 150
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,841 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, October 3, 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
July 7, 1988,
and to mature January 5, 1989
(CUSIP No.
912794 QZO ), currently outstanding in the amount of $7,432 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,000 million, to be dated
October 6, 1988,
and to mature April 6, 1989
(CUSIP No.
912794 RR7 ).
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 October 6, 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 $ 1,715 million as agents for foreign
and international monetary authorities, and $4,610 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
NB-17 (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 NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
September 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 $32,282 million of tenders received from the public for the
2-year notes, Series AF-1990, auctioned today. The notes will be
issued September 30, 1988, and mature September 30, 1990.
The interest rate on the notes will be 8-1/2%. The range
of accepted competitive bids, and the corresponding prices at the
8-1/2% rate are as follows:
Yield
Price
Low
8.52%*
99.964
High
8.53%
99.946
Average
8.53%
99.946
*Excepting 2 tenders totaling $100,000.
Tenders at the high yield were allotted 75%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location Received Accepted
Boston
$
54,720
$
54,710
New York
28,638,300
7,689,010
Philadelphia
39,230
37,230
Cleveland
83,510
72,110
Richmond
184,790
63,940
Atlanta
54,075
53,825
Chicago
1,362,350
192,830
St. Louis
98,445
77,445
Minneapolis
41,325
40,325
Kansas City
118,425
116,425
Dallas
38,275
28,260
San Francisco
1,496,435
283,935
Treasury
72,290
72,290
Totals
$32,282,170
$8,782,335
The $8,782
million of accepted tenders includes $1,227
million of noncompetitive tenders and $7,555 million of competitive tenders from the public.
In addition to the $8,782 million of tenders accepted in
the auction process, $740
million of tenders was awarded at
the average price to Federal Reserve Banks as agents for foreign
and international monetary authorities. An additional $1,146
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.
NB-18

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

FOR IMMEDIATE RELEASE
SEPTEMBER 28,1988

CONTACT:

DAVID S. LIEBSCHUTZ
(202) 376-4302

SAVINGS BONDS NOW PROCESSED LIKE CHECKS
There is good news for the more than 40,000 financial
institutions that redeem U.S. Savings Bonds: It's going to get
easier. Beginning October 1, 1988, agents will be able to take
advantage of a new processing system known as "EZ CLEAR." This
system allows paying agents to process savings bonds in much the
same way they process checks.
According to Richard L. Gregg, Commissioner of Treasury's Bureau
of the Public Debt, "For nearly 50 years agents have been
required to process bonds as 'exception' items. This has been a
costly, time-consuming and largely manual process. Our new
system is completely different. EZ CLEAR utilizes the modern
high-speed technology of the check world to simplify and
accelerate the processing of savings bonds."
The Bureau and the Federal Reserve Banks have been testing the
new system since November 1986. Based on the improved efficiency
of the new system and the extremely favorable reaction of the
paying agents, the Bureau decided to make EZ CLEAR available to
all agents. Currently, the 520 participating institutions in EZ
CLEAR are processing over 58,000 paid bonds per day (about 14.5
million per year). All authorized paying agents redeem nearly 60
million bonds each year.
Under EZ CLEAR, redeemed bonds can be submitted to correspondents
or Federal Reserve Banks either in mixed or separately sorted
cash letters in a similar fashion to the way that checks are
submitted. In addition, paying agents will be reimbursed by
Treasury more promptly because they will receive redemption fees
monthly rather than quarterly. Although the terms and conditions
are not affected, customers may notice that the bonds themselves
have been redesigned to look and function more like checks.
Financial institutions should contact Federal Reserve Check
Processing Offices for detailed information and specific
instructions on how to participate in EZ CLEAR.
NB-19

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
TEXT AS PREPARED
Embargoed for Release
Upon Delivery, Expected
at 4:00 p.m. (Berlin Time)

Remarks by
Secretary of the Treasury
Nicholas F. Brady
at the Joint Annual Meetings of the
International Monetary Fund and World Bank
Berlin
September 27, 1988
Chairman Feldt, Chairman Dennis, Managing Director Camdessus,
President Conable, fellow Governors and distinguished guests:
It is a great pleasure to join you for the forty-third joint
Annual Meetings of the International Monetary Fund and the World
Bank. This is the first such meeting held in Germany. It is
especially appropriate that it takes place in Berlin. This city
is a symbol of individual liberty and economic freedom for
millions of people. As President Kennedy said 25 years ago:
"Ail free men, wherever they may live, are citizens of Berlin."
Future historians will record that we have come together at a
time when these fundamental principles of individual liberty and
freedom have received a new impetus. Economic prosperity and
progress flourish only where the rights of the individual are
respected and protected, and private initiative is encouraged.
But, with the privilege of freedom comes responsibility. As
individuals pursue their personal goals, they must consider the
broader interest of their neighbors. And so it is with nations.
In pursuing our national objectives, we must recognize our shared
responsibilities to improve the world in which we live.
Two fundamental principles should guide us as we consider how
to meet this challenge. First, the only lasting prosperity for
any of us is sustained prosperity for all of us. Second, the
achievement of global prosperity in a world of limited resources
requires their prudent use. These principles should guide us as
we make the difficult choices to extend benefits to future
generations.
And as we undertake this task, four mutually reinforcing
pillars continue to support our efforts — the economic policy
coordination process, the cooperative debt strategy, the IMF and
the World Bank. Let me address each of these in turn.
NB-20

-2-

Buildina Economic Prosperity
Global economic prosperity begins with sound policies and
strong performance in the industrial world. Over the past three
years, the major industrial countries have built a new pillar —
economic policy coordination — to buttress global expansion and
development.
This has helped to reinvigorate our economies. Economic
growth in the major industrial countries will approach 4 percent
this year, providing a solid footing for all countries.
Importantly, this higher growth has been achieved without a
resurgence of inflation. A reduction in our external imbalances
is also occurring. Consequently, prospects are excellent for
sustained growth with low inflation and exchange rate stability.
The policy coordination process represents a pragmatic
approach to strengthening the international monetary system. It
involves a discipline that encourages each of us to take actions
whose benefits transcend national boundaries. The United States,
for example, has implemented measures to reduce its budget
deficit. We do not intend to stop here. Other countries are
also pursuing monetary and fiscal policies that foster growth
without igniting inflation. Most of us need to reduce trade
imbalances further, and all of us need to promote open markets.
In addition, structural barriers to growth must be substantially
reduced if we are to unleash the vitality of our economies.
Spreading Prosperity to Developing Nations
Policy coordination has provided an improved framework for
achieving prosperity in the industrial nations. But this is not
enough. Our prosperity must be shared. We should not rest until
the benefits of hard work and sound policies are broadly realized
throughout the world. There is a necessity, indeed an urgency,
to raise living standards throughout the developing nations.
Some developing countries have already made great progress.
The newly industrialized economies of Asia have made tremendous
strides through the energy and initiative of their people. They
have also benefited from the open trading system. Now they
should take greater responsibility for sustaining this system by
opening their economies and exchange rates to market forces.
For the heavily indebted nations, the course has been more
difficult. However, the international debt strategy has provided
a working basis for addressing the debt problem. This strategy
has become our second pillar for building global prosperity. It
is dynamic and has adapted to changing global circumstances. Its
principles remain valid. Growth stands at the center — the
product of sound economic policies. International financial

-3-

institutions and commercial banks support these efforts. The
strategy is credible because it recognizes the necessity for
economic reform, the scarcity of global financial resources, and
the political realities of economic development.
Many debtor countries have adopted tough economic measures.
They have tackled fiscal imbalances, liberalized trade,
introduced realistic exchange rates, and generally allowed a
greater role for market forces. These actions required great
political courage. Their reward has been a resumption of growth
that with continued effort can be sustained.
Despite this progress, we cannot ignore the serious problems
we still face — both in financial flows and policies. On the
finance side, there have been shortfalls. The response has been
the menu approach which offers an innovative range of
opportunities for new finance, cooperative arrangements with
international financial institutions, and techniques which
contribute to growth and also have the benefit of debt reduction.
I have in mind especially market-based techniques which are
voluntary and do not depend upon resources from international
financial institutions, or which may otherwise shift private risk
to the public sector. We should not forget that if the stock of
private debt is to be reduced, we must embrace only techniques
that private markets find acceptable and which simultaneously
maintain the willingness of private lenders to continue financing
future development.
Debtor countries need to renew efforts to enhance domestic
savings, to attract home the capital of their own people, and to
open their economies to the productive potential of foreign
investment. Inflation must be defeated and economies freed from
controls. There is no realistic substitute for these policies if
debtor countries are to muster resources for growth in a world
that is short of capital.
Also, we need to harness private ingenuity in all our
countries. We all welcome additional official resources, but we
must recognize their limitations and ensure that we preserve the
essential principles on which our debt strategy is based.
Otherwise, the prospects for true reform, sustainable growth and
a return of debtors to world capital markets will be dimmed —
and we will miss the opportunities we now see before us.
Consequently, the United States regards with skepticism
proposals that may appear to conform to the basic principles of
the debt strategy, but which in practice will produce only an
illusion of progress. Indeed, such proposals will make the debt
problem intractable — by weakening the international
institutions on which we depend, by undermining the difficult but
lasting reforms the debtor nations are making, and by building
political opposition among taxpayers in creditor countries. We
must see proposals for what they are, not for what they purport
to be.

-4-

If we embark on a course that involves the transfer of risk
from the private to the public sector, a true and lasting
solution to the restoration of sustained growth among debtor
nations will have escaped. And then, when official resources
have been exhausted, as they will be; when our international
institutions have been made static and vulnerable, and they will
be; when private lenders have long since withdrawn from the
financing of development, we will still face exactly the same
problems we see today. But our firepower will be gone, there
will be divisions among us, and we will be reduced to words, not
actions.
Role of the IMF
The IMF is the monetary pillar for cooperative international
efforts to promote a stable international environment. It is one
of the key means by which all of us blend our energies and
resources to build global prosperity. In recent years, the Fund
has modified its policies and facilities to meet the changing
needs of its members.
The Fund, however, should remain faithful to its basic
principles. Let us remember that the IMF began as a revolving
pool of resources to which all members contribute and from which
all members in need may draw. A revolving fund must revolve,
with payments made in a timely fashion. The existence of deeply
embedded arrears strike at the core of this fundamental IMF
principle.
We welcome the IMF's three part strategy to overcome the
arrears problem. It includes preventive measures to stop a
further buildup of arrears, a collaborative approach to deal with
existing arrears, and remedial actions to safeguard the IMF's
financial position. The United States stands ready to
participate in this strategy if all the essential elements are in
place.
We have been a strong supporter of the IMF, and we will
remain so. However, at a time of competing demands and budget
constraints, the case for additional quota resources must be
compelling. There should be a clear vision of the IMF in the
1990's, and a demonstrated need for more funds — not simply a
presumption that more is better.
Finally, the arrears problem
poses a hurdle to any increase in IMF resources. If our
countries are expected to use scarce financial resources wisely,
our international institutions must do no less.
Role of the World Bank
The World Bank is the fourth pillar on which our global
prosperity rests. It is the key multilateral institution for
transforming resources into better lives. Through its lending,
the Bank is promoting structural reforms which are essential for
sustained growth.

-5-

With the recently ratified General Capital Increase <GCI>,
the Bank will now have the resources to address the needs of
developing countries. The United States strongly supports the
GCI. I am happy to report a major step forward for our
participation with the approval last week of GCI legislation by
key congressional committees.
With the provision of new resources, the Bank must take into
account the potential impact of its operations on the poor, on
the environment and on the private sector. Properly designed
projects for infrastructure and for agricultural technologies can
help bring the benefits of growth to the poorer segments of the
population.
Environmental concerns continue to be a high priority for the
United States. We strongly support President Conable's decision
to establish a central Environmental Department and regional
environmental units. This should reinforce the Bank's efforts in
this area.
The Bank should strengthen its efforts to promote greater
reliance on the private sector. It is important to support the
growing recognition by developing countries that approaches to
development which suppress market forces do not work.
Conclusion
Let me close by expressing my admiration for what you have
accomplished over these past years. Through policy coordination,
the debt strategy, and our international institutions, prosperity
is being advanced throughout the world.
The IMF and World Bank have exercised leadership and
imagination during a difficult period. They have earned our
appreciation and deserve our continued strong support. As we
seek solutions to the challenges which confront us, I look
forward to working with my new colleague Michel Camdessus, my old
friend Barber Conable, and each of you.
Together there is no limit to what we can accomplish in building
a better world for our children and grandchildren.
Thank you.

TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
September 28, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF AUCTION OF 4-YEAR NOTES
The Department of the Treasury has accepted $7,025 million
of $22,552 million of tenders received from the public for the
4-year notes, Series P-1992, auctioned today. The notes will be
issued September 30, 1988, and mature September 30, 1992.
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 8.74% * 100.033
High
8.77%
99.934
Average
8.76%
99.967
•Excepting 2 tenders totaling $1,510,000.
Tenders at the high yield were allotted 26%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Accepted
Location
Received
$
27,964
Boston
$
27,964
New York
5,964,871
19,637,528
Philadelphia
20,079
20,079
Cleveland
40,017
40,017
Richmond
28,155
55,735
Atlanta
23,952
24,692
381,156
Chicago
1,196,636
St. Louis
28,523
26,303
Minneapolis
29,731
30,731
Kansas City
47,795
47,715
Dallas
17,918
14,438
San Francisco
402,063
1,405,663
Treasury
18,821
18,821
Totals
$22,552,102
$7,025,265

The $7,025 million of accepted tenders includes $666
million of noncompetitive tenders and $6,359 million of competitive tenders from the public.
In addition.to the $7,025 million of tenders accepted in
the auction process, $420 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.

NB-21

TREASURY NEWS
epartment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
SEPTEMBER 30, 1988

CONTACT:

DAVID S. LIEBSCHUTZ
(202) 376-4302
or
L. RICHARD KEYSER
(202) 755-1591

TREASURY AND HUD CALL
FHA INSURANCE FUND DEBENTURES
The Departments of Treasury and Housing and Urban Development
announced today the call of all Federal Housing Administration
(FHA) General Insurance Fund debentures (MM series), outstanding
as of September 30, 1988, with interest rates of 9 percent or
higher. The date of the call for the redemption of the over $18
million in debentures will be January 1, 1989, with the semiannual interest due January 1 paid with the debenture principal.
Record owners of the debentures as of September 30, 1988, will be
notified by mail of the call and given instructions for
submission. Those owners who cannot locate the debentures should
contact the Claims Section of the Bureau of the Public Debt (3 00
13th St SW, Room 429; Washington, DC 20239-0001) for assistance.
No transfers or denominational exchanges in debentures covered by
the call will be made on or after October 1, 1988, nor will any
special redemption purchases be processed.
The Federal Reserve Bank of Philadelphia has been designated to
process the redemptions and to pay final interest on the called
debentures. To insure timely payment of principal and interest
on the debentures, they should be delivered by December 1, 1988
to:
The Federal Reserve Bank of Philadelphia
Securities Division
P.O. Box 90
Philadelphia, PA 19105-0090

NB-2 2

TREASURY NEWS
CONTACT:
Office of Financing
department of the Treasury • Washington, D.C.
• Telephone
566-2041
202/ 376-4350
FOR IMMEDIATE RELEASE
October 3, 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,031 million of 13-week bills and for $7,010 million
of 26-week bills, both to be issued on October 6, 1988,
were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing January 5, 1989
Discount Investment
Rate
Rate 1/
Price
7.22%
7.23%
7.23%

7.46%
7.47%
7.47%

98.175
98.172
98.172

26-week bills
maturing April 6, 1989
Discount Investment
Rate
Rate 1/
Price
7.43%
7.47%
7.46%

7.83%
7.87%
7.86%

96.244
96.224
96.229

Tenders at the high discount rate for the 13-week bills were allotted 85%.
Tenders at the high discount rate for the 26-week bills were allotted 58%.

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Received
Accepted

Accepted

$
32,875
23,899,945
31,270
38,170
43,185
35,635
1,449,410
35,510
5,555
48,055
34,330
1,832,580
394,995

$
31,195
6,024.425
31,270
37,845
43,185
35,635
45,410
31,260
5,555
47,995
24,330
277,580
394,995

$
29,280
21,700,255
18,475
29.725
40,935
30,845
1,303,460
29,530
6,540
47,965
33,865
1,701,020
551,460

$
29,280
5,652,755
18,475
29,725
40,935
30,845
141,460
25,530
6,540
47,965
26,765
408,020
551,460

$27,881,515

$7,030,680

$25,523,355

$7,009,755

$24,172,835
1,113,655
$25,286,490

$3,322,000
1,113,655
$4,435,655

$20,713,385
1,097,060
$21,810,445

$2,199,785
1,097,060
$3,296,845

2,510,135

2,100,000

84,890

1,612,910

$27,881,515

$7,030,680

$25,523,355

$7,009,755

An additional $51,910 thousand of 13-week bills and an additional $773,890
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.

NB-2 3

TREASURY NEWS
CONTACT-.Office
of Financing
Department of the Treasury • Washington,
D.C. • Telephone
566-2041
FOR RELEASE AT 4:00 P.M.
October 4, 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
$14,000 million, to be issued October 13, 1988.
This offering
will provide about $775
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,232 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, October 11, 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
July 14, 1988,
and to mature January 12, 1989
(CUSIP No.
912794 RA 4), currently outstanding in the amount of $7,006 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
April 14, 1988,
and to mature April 13, 1989
(CUSIP No.
912794 RS 5), currently outstanding in the amount of $9,062 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 October 13, 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 $1,831 million as agents for foreign
and international monetary authorities, and $3,648 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)
NB-24

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 $1,000,000Banking 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 NEWS
leportment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
October 5, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY TO AUCTION $6,750 MILLION OF 7-YEAR NOTES
The Department of the Treasury will auction $6,750 million
of 7-year notes to refund $3,198 million of 7-year notes maturing
October 15, 1988, and to raise about $3,550 million new cash. The
public holds $3,198 million of the maturing 7-year notes, including
$330 million currently held by Federal Reserve Banks as agents for
foreign and international monetary authorities.
The $6,750 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 $276 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

NB-25

HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 7-YEAR NOTES
TO BE ISSUED OCTOBER 17, 1988
October 5, 1988
Amount Offered:
To the public ..."

$6,750 million

Description of Security:
Term and type of security
7-year notes
Series and CUSIP designation .... H-1995
(CUSIP No. 912827 WT 5)
Maturity date
October 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
April 15 and October 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
Key Dates:
Option Depositaries
Wednesday, October 12, 1988,
Receipt
of
tenders
Deposit guarantee by
prior to 1:00 p.m., EDST
designated
Acceptable
Settlement institutions
(final payment
due from institutions):
a) funds immediately
Monday, October 17, 1988
available to the Treasury
Thursday, October 13, 1988
b) readily-collectible check

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

OCT 03 1988
Dear Senator
This is to reiterate you of the opposition of the Department of
the Treasury to a proposal we understand that Senator Kerry will
likely offer as an amendment to the drug bill. The proposal
would require foreign banks and other financial institutions to
keep records of large U.S. currency transactions and to provide
the records to U.S. authorities in drug cases. If a bank failed
to do so, it would be virtually precluded from access to the
United States banking system.
We believe this proposal is unenforceable, detrimental to U.S.
economic interests, and most importantly, counterproductive to
ongoing international cooperation in the area of drug trafficking
and money laundering. Our allies regard this unprecedented
extraterritorial imposition of a bank regulatory requirement as
an affront to their sovereignty. Diplomatic protests have been
filed with the Department of State on behalf over a dozen
European countries.
We are particularly distressed that enactment of this proposal
could jeopardize the anticipated December ratification of the
U.N. (Vienna) Convention Against Narcotics Trafficking. This
convention will oblige signatory countries to enact money
laundering legislation and to provide judicial assistance in drug
money laundering cases. In the long run, these measures will be
more effective than currency reporting in the fight against
international drug trafficking.
We trust that you will agree that this is not a good or effective
approach to the problem of international money laundering. I
appreciate your consideration of this matter.
Sincerely,

Salvatore R. ttartoche
Assistant Secretary
(Enforcement)
The Honorable
United States Senate
Washington, D.C. 20510

TREASURY NEWS

apartment of the Treasury • Washington, D.C. • Telephone 566-2041
October 7, 1988
David W. Mullins, Jr. Joins Treasury

Secretary of the Treasury Nicholas F. Brady today announced
that David W. Mullins, Jr. joined the Department of the
Treasury. Dr. Mullins will oversee matters pertaining to
domestic finance policy.
Prior to joining the Department, Dr. Mullins was a Professor
of Business Administration at the Harvard University
Graduate School of Business Administration. He received a
B.S. in administrative sciences from Yale University and an
S.M. in finance from the Sloan School of Management at the
Massachusetts Institute of Technology. After earning a
Ph.D. in finance and economics at M.I.T., he joined the
faculty of the Harvard Business School where he taught
finance in the MBA, executive and doctoral programs.
Professor Mullins was faculty chairman of Harvard's
Corporate Financial Management program, an executive program
for senior financial officers of major corporations. In
addition, he has served as course head for the first year
MBA finance course. He taught the Capital Markets course in
the MBA program.
Professor Mullins has been a consultant to a wide variety of
firms and governmental agencies and has taught in numerous
executive training programs in the U.S. and abroad. He
recently served as Associate Director of the Presidential
Task Force on Market Mechanisms.
In teaching, research, and consulting, Professor Mullins
specialized in capital markets and corporate finance.

NB-26

TREASURY NEWS
apartment of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT: office of Financing
202/376-4350

FOR IMMEDIATE RELEASE
October 11, 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

Tenders for $7,006 million of 13-week bills and for $7,025 million
of 26-week bills, both to be issued on October 13, 1988, were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-•week bills
maturing January 12
Discount Investment
Rate
Rate 1/
7.28%
7.34%
7.32%

7.52%
7.58%
7.56%

1989
Price
98.160
98.145
98.150

26-•week bills
maturing April 13, 1989
Discount Investment
Rate
Rate 1/
Price
7.45%
7.46%
7.46%

7.85%
7.86%
7.86%

96.234
96.229
96.229

Tenders at the high discount rate for the 13-week bills were allotted 84%.
Tenders at the high discount rate for the 26-week bills were allotted 37%.

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Received

Accepted

$
42,365
20,252,030
23,395
49,000
45,355
41,855
910,015
33,805
7,630
49,170
37,630
1,591,735
424,270

$
42,365
5,262,030
23,395
49,000
45,355
41,855
351,015
33,645
7,630
49,140
37,630
638,575
424,270

$
34,230
26,431,200
15,635
27.875
45,250
28,550
985,705
35,360
7,910
44,915
34,430
1,309,585
487,990

$
34,230
6,155,405
13,635
27,875
45,250
28,175
40,705
30,955
7,910
44,880
24.430
83,335
487,990

$23,508,255

$7,005,905

$29,488,635

$7,024,775

$20,309,975
1,222,830
$21,532,805

$3,807,625
1,222,830
$5,030,455

$24,927,930
1,061,225
$25,989,155

$2,464,070
1,061,225
$3,525,295

1,847,530

1,800,000

127,920

1,699,480

$23,508,255

$7,005,905

$29,488,635

$7,024,775

An additional $28,980 thousand of 13-week bills and an additional $380,820
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
NB-2 7

TREASURY NEWS
•partment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR RELEASE AT 4:00
October 11, 1988

P.M.

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 October 20, 1988.
This offering
will provide about $ 875
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,125 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, October 17, 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
January 21, 19 88,
and to mature January 19, 1989
(CUSIP No.
912794 RB2 ), currently outstanding in the amount of $16,092 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
August 15, 1988,
and to mature April 20, 1989
(CUSIP No.
912794 RU0 ) , currently outstanding in the amount of $7,021 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 October 20, 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 $ 1,284 million as agents for foreign
and international monetary authorities, and $ 3,773 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 s e r i e s ) .

N73-2 8

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 NEWS
epartment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
October 12, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF AUCTION OF 7-YEAR NOTES
The Department of the Treasury has accepted $6,754 million of
$16,138 million of tenders received from the public for the 7-year
notes, Series H-1995, auctioned today. The notes will be issued
October 17, 1988, and mature October 15, 1995.
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%interest rate are as follows:
Price
Yield
Low
99.510
8.72%
High
99.356
8.75%
Average
99.459
8.73%
Tenders at the high yield were allotted 61%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Received
Accepted
Location
$
8,806
$
8,806
Boston
14,051,634
6,083,604
New York
Philadelphia
4,952
4,952
Cleveland
10,711
10,711
Richmond
16,580
16,530
8,367
8,357
Atlanta
1,127,456
348,206
Chicago
St. Louis
23,263
7,263
Minneapolis
3,384
3,384
Kansas City
9,667
9,667
Dallas
7,322
6,322
San Francisco
863,865
244,365
Treasury
1,675
1,675
Totals
$16,137,682
$6,753,842
The $6,754
million of accepted tenders includes $306
million of noncompetitive tenders and $6,448
million of competitive tenders from the public.
In addition to the $6,754 million of tenders accepted in
the auction process, $150 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $276 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.
NB-29

TREASURY N E W S ^
iepartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
Expected at 9:00 A.M.
October 13, 1988
Testimony of Marcus W. Page
Deputy Fiscal Assistant Secretary of the Treasury Department
before the
Commerce, Consumer, and Monetary Affairs Subcommittee
of the
Committee on Government Operations
Mr. Chairman and members of the Committee, I appreciate the
opportunity to provide you with an update on the accomplishments
of the Financial Management Service and Treasury's ongoing
activities to improve financial information in Executive Branch
agencies.
With me this morning is Commissioner Douglas of the
Financial Management Service who will cover the significant
progress that FMS has made in improving financial management
across government, particularly in cash management, debt collection, and the central financial systems. These recent successes
have produced substantial dollar savings over the last four
years. During that time we have successfully replaced 90% of our
central financial systems. We now have wide recognition in the
private sector as a leader in innovative cash management practices, as a major force in electronic funds transfer with our
Vendor Express program, and as a pace setter in the application
of security technology to electronic payments.
The Financial Management Service has an exceptionally strong
career staff that has set strategic objectives, laid out tactical
plans, and successfully completed project after project, system
after system, and the results in the central financial operations
of government have been substantial. Drawing from this experience, we have underway now a program to help other executive
agencies upgrade their financial systems and products. Treasury
is uniquely qualified to carry out a government-wide upgrade of
financial management because we touch in one way or another all
of the payments, all of the collections, all interagency financial transactions, all banking relationships, most of the
financial reporting, and most of the investment management
programs. Treasury has taken on this assignment and will produce
the same successful results that we have in our central financial
activities. And, we will do it in cooperation with the program
NB-30
-agencies,
respecting their individual and often unique managerial
needs.

At this point, Commissioner Douglas will describe the major
elements of the Financial Management Service's improvement
program. Upon his completion, I will deal specifically with the
four questions in your letter to Secretary Brady.
Mr. Chairman,
1.
Your first question asks how FMS is carrying out the
policies of OMB Circular A-127.
o Two years ago, FMS established a Financial Systems
Program staff to work directly with the 23 departments
and major agencies initially targeted for financial
system improvement.
o Joint OMB/Treasury management hearings were held to
negotiate and set specific systems priorities and goals
for each agency.
o Each agency has submitted a financial systems improvement plan detailing methods to reach their goals.
o The three central agencies: Treasury, OMB, and GAO have
worked cooperatively to establish three important
financial systems standards: the Standard General
Ledger, the financial systems core requirements document, and the revised Treasury reporting requirements
that tie directly to the Standard General Ledger.
o The FMS Program staff is monitoring closely agency
performance against the financial systems plans. "Each
agency is evaluated on:
Establishing standard coding structures and
operating procedures
Having the capability
of producing departmentwide reports
Establishing a single primary accounting system
Implementing the Standard General Ledger
Providing interface between subsidiary systems and
the primary system; and
Reaching compliance with Section 4 of the Federal
Manager's Financial Integrity Act.
'
o Periodically, Treasury and OMB hold management hearings
with the agencies to review agency progress.

3
o

We believe this approach is effective, given the
resources available.
For example, thirteen agencies
have implemented the Standard General Ledger, six are
implementing this fiscal year, three more in 1990, and
one in 1991. Twenty agencies have met FMFIA, Section
4, internal control requirements, with one scheduled
each of the next three years.
Twelve agencies have
primary accounting systems in place, three more in this
fiscal year, and the remainder in 1990, 1991, and 1992.
2. Your second question asks how implementation of A-127 and
other FMS initiatives will accomplish four specific needs.
(a) The first — financial reporting overlaps and inconsistency is well on the way to resolution.
Direct
integration of Treasury's reporting requirements with
the Standard General Ledger account structure is a
major step toward consistent and effective reporting.
Perhaps even more important, Treasury has installed a
fully electronic reporting system that requires
agencies to telecommunicate their financial data in
standard formats. This system uses front end edits to
assure consistency of reporting.
It also has solved
most of our problems with late reporting as over a
thousand reporting activities across the nation can
telecommunicate their financial data and receive
Treasury reconcilation reports without the delays
common to paper reporting.
(b) Improving agency financial systems through A-127 will
contribute to management efficiency in the Executive
Branch. As many of our departments and agencies have
had dozens of incompatible systems serving their
bureaus and field locations, it has been difficult for
management to obtain consistent financial information
at department level.
This often resulted in labor
intensive exercises to meet unexpected
reporting
deadlines.
But beyond responding to budget and other
information crises, is it not reasonable to expect a
manager to better manage program mission objectives if
the knowledge of budget status, cost of operations
availability of assets and collectability of receivables is close at hand. The objective of our systems'
improvement program is to gather financial data
quickly and to make it available with micro-computer
based analytical tools so that managers can assemble
the facts needed to make effective decisions.
(c) Implementation of A-127 and the FMS financial analysis
program has augmented Executive Branch accountability.
Initially, the focus has been on Federal receivables
and debt collection, but will soon be expanded to
improve control of other assets, such as, equipment and

4
inventories.
That is the importance of the Standard
General Ledger. It helps focus management attention on
assets and liabilities, rather than total concentration
on the budgetary accounts.
(d) The final item listed is Congress's need for meaningful
financial information on Executive Branch operations.
Certainly, improved financial systems across the
Executive Branch will help.
It is also fair to say
that agencies currently provide good financial data, on
the cash basis and the obligation basis.
However,
other financial information could be improved to better
meet Congressional needs.
3. Your third question asks how FMS is using the Standard
General Ledger as an information standardization measure.
We have made it a requirement. We have tied all Treasury
reporting to that structure.
We are analyzing agency
reporting on an account-by-account basis to determine
compliance with the structure.
Our electronic reporting
requires standard record formats.
We are making good
progress on standard financial information.
4. Finally, your letter asks what the best state government
systems can do for accountability that is not done well in
Federal systems and will the planned A-127 improvements meet
those capabilities. Most Federal financial systems provide
reliable information for cash management and budget
execution purposes.
Federal systems fall short in two
areas.
First, most Federal systems do not focus attention
on managing our assets and liabilities.
Second, many
Federal systems do not provide complete information on the
cost of programs and projects.
Our A-127 implementation
will improve asset/liability management. In some respects,
Federal systems may well exceed state government capabilities. A-127 implementation will also provide cost information for all business-type accounts, reimbursable operations
and other accounts where managers need such information.
Mr. Chairman, I thank you for the opportunity to appear
before the Subcommittee. Commissioner Douglas and I are available to answer any questions.
o 0 o

TREASURY NEWS
lepartment of the Treasury • Washington, D.c. • Telephone 566-2041

FOR RELEASE AT 12:00 NOON
October 14, 1988

CONTACT:

Office of *<
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 October 27, 1988,
and to mature October 26, 1989
(CUSIP No. 912794 SM 7). This issue will result in a paydown for
the Treasury of about $275
million, as the maturing 52-week bill
is outstanding in the amount of $9,284
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, October 20, 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 October 27, 1988.
In addition to the
maturing 52-week bills, there are $13,116 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 $ 1,929 million as agents for foreign
and international monetary authorities, and $5,853 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 $ 15
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
NB-31
be
submitted on Form PD 5176-3.

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 S10,000. Tenders over $10,000 musr
be in mui-ipies of 55,300. Competitive tenders must also sr.cw
the vield 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 S200 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
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE Contact: Bob Levine
October 17, 1988

566-2041

The U.S. Treasury Department and Federal Reserve welcome the
economic measures recently announced by the Government of
Mexico.

The U.S. financial authorities believe that these

measures build upon the progress already achieved in the
sustained adjustment effort undergone by the Mexican economy.
Mexico's adjustment record, particularly the process of fiscal
consolidation and the structural transformation of its external
sector, has established the basic conditions for the renewal of
sustained economic growth.

In the context of normal consultations between countries with
close economic relations, U.S. and Mexican authorities have
agreed that Mexico's strengthened economic policies merit .
support.

Accordingly, the U.S. Treasury and Federal Reserve are

prepared to develop a short-term bridge loan of up to
$3.5 billion, depending on the development of loan programs by
Mexico with the World Bank and the International Monetary Fund.

NB-32

TREASURY NEWS
•partment of the Treasury • Washington, D.c. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350

lo&Sgg-W, W

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,077 million of 13-week bill* and for $7,006 million
of 26-week bills, both to be issued on October 20, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low

13-week bills
maturing January 19, 1989
Discount Investment
Rate
Rate 1/
Price
7.33Z
7.362
7.36Z

High
Average

7.57Z
7.60Z
7.60Z

26-week bills
: maturing April 20, 1989
Discount Investment
Rate
Rate 1/
Price
7.90Z
96.208
7.50Z
98.147
7.97Z
96.178
7.56Z
98.140
7.96Z
96.183
7.55Z
98.140

Tenders at the high discount rate for the 13-week bills were allotted 44Z.
Tenders at the high discount rate for the 26-week bills were allotted 79Z.
*
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

$
29,910
26,055,610
24,095
37,435
38,730
34,170
-r, 212,020
28,435
12,185
41,035
26,940
1,372,130
252,780

$
29,910
6,415,470
24,095
26,285
38,730
-34,170
41,350
• 24,435
7,185
41,035
16,940
124,130
252,780

25,800
21,144,975
17,560
21,490
29,610
28,720
998,775
22,680
9,700
39,745
29,075
1,272,100
446,605

$
25,800
5,787,475
17,560
21,490
29,610
28,720
267,775
20,470
4,700
39,745
24,075
292,000
446,605

$29,165,475

$7,076,515

: $24,086,835

$7,006,025

$26,137,335
925,765
$27,063,100

$4,048,375
925,765
$4,974,140

$20,312,655
923,355
$21,236,010

$3,231,845
923,355
$4,155,200

1,972,500

1,800,000

129,875

1,050,825

1,800,000
.
1,050,825

$29,165,475

$7,076,515

$24,086,835

$7,006,025

An additional $44,125 thousand of 13-week bills and an additional $372,675
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.

TREASURY NEWS

lepartment of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
Embargoed for Release
Upon Delivery
October 17, 1988

For delivery at the Swiss National Bank,
Zurich, Switzerland, October 17, 1988, and
for the session on Harmonization of
Economic Policies, Volatility of Interest
and Exchange Rates, and World Economic
Disequilibrium at the Lugano
International Banking Symposium
October 18, 1988, 9:00 a.m. - noon,
Lugano, Switzerland

Choosing Types of Volatility in a World of Change
Michael R. Darby
Assistant Secretary for Economic Policy
U.S. Department of the Treasury
The topic for this morning's session and the comparatively
meager time available to address it reminds me of the high school
history teacher who set only one question for a half-hour
examination: "Explain the Second World War — use both sides of
the paper if necessary."
Faced this morning with a similarly impossible challenge, I
hope to address some of the fundamental issues by pulling my
academic hat out of the closet and concentrating on two topics.
The first is some work which I, my coauthors, and others have
done comparing the volatility of economic variables under the
Bretton Woods and floating rate systems. The other is how the
Federal Reserve System has dealt with volatility of real exchange
rates across regions of the United States. I hope that my
observations are of more than purely historical interest and may
be informative in thinking about the possible evolution of the
European Monetary-System. Some of you may have a positive role
in that evolution while others of us must assess whether 1992
represents a milestone in an ongoing process or a fundamental
Those of us who a re not members of the Community are
change in our relationship with the Community.
understandably concern ed that tearing down barriers to the free
flow of goods, service s, and capital among the members of the
Community must not bee ome the occasion for erecting barriers
between the Community and nonmember trading partners. We have
certainly been hearten ed by Community leaders who have provided
assurances of strong s upport for the view that greater openness
within the Community i s not to be bought through exclusion of
others. Nonetheless, I believe that continued vigilance is
required because trade and capital barriers — and variations in
NB-34

them — have been a traditional tool for limiting volatility in
exchange rates or monetary policy. If those barriers are removed
at the national level, there may still be temptation to impose
them for those traditional reasons at the Community level.
Volatility under and after Bretton Woods
Across regions or countries there must be a mechanism or
strategy for adjusting to continuous changes in the equilibrium
level of the real exchange rate — the relative purchasing power
of a given amount of money. Monetary or exchange-rate systems
embody choices as to which variables will do the adjusting or, in
the terms of this session's title, exhibit volatility.
These changes in equilibrium real exchange rates are not
unlike those observed in prices on the stock exchanges and other
asset markets: The confluence of many minor factors moves the
equilibrium real exchange rate up or down a little bit each week
— each day or hour really — and, on occasion, a change in a
major fundamental factor can cause a large movement up or down in
the equilibrium real exchange rate. Even if no major fundamental
change occurs over a long period of time, the cumulation of small
day-to-day movements makes the real exchange rate at the end hard
to predict at the beginning of the period. Thus, the realities
of a changing world mean that a truly stable system is one which
allows for compensating movements — the question is which
variables should adjust to underlying change.
The monetary, financial, and trade system by which regions
or nations are linked can ultimately deal with these movements in
the real exchange rate in only four ways: by movements in the
nominal exchange rate, by movements in relative money supplies
and price levels, by forestalling major changes in tax and other
policies which would result in major changes in the equilibrium
real exchange rate, or by making offsetting changes in other
fundamental policies.
A unified monetary system, to which we shall return,
emphasizes adjustment of relative money supplies and price levels
in response to variations in equilibrium real exchange rates. My
coauthor James Lothian and I recently examined the empirical
evidence on how this underlying volatility was handled under the
Bretton Woods system of pegged exchange rates and the ensuing
system of floating exchange rates. Some of our results were
quite predictable while others were not.
As expected, international parity conditions dominated the
longer run trends in monetary policies of the nonreserve
countries under the Bretton Woods system. Much greater monetary
independence was evidenced under floating rates, although there
was evidence that the previous nonreserve countries continued to
engage in only partially sterilized intervention. It is hardly
surprising that nominal exchange rates would be more responsive

and monetary policies less responsive under floating than pegged
exchange rates.
A more paradoxical result is that there is nonetheless
substantial evidence that real variables and especially interest
rates moved more closely together under floating than pegged
rates. We believe this reflects the attenuation of the use of
controls on trade and capital flows which followed the breakdown
of the Bretton Woods system. These controls made the different
national economies more closed and thus less subject to
variability in equilibrium real exchange rates. Variations in
the control regimes were a popular tool, often the first resort,
used to offset variability in equilibrium real exchange rates.
Alterations in monetary policy or, in extremis, nominal exchange
rates came later. Controls, particularly capital controls, seem
to have little attraction to countries that do not attempt to
maintain pegged exchange rates and were abandoned by them.
Let me expand on this point for a moment by drawing on
results in our NBER monograph with Anna Schwartz and others on
The International Transmission of Inflation. Under the Bretton
Woods system, the Federal Reserve acted as the reserve central
bank, quite properly determining monetary policy based on
domestic conditions without regard to reserve flows, the balance
of payments, or other external conditions. Inconsistencies arose
because the other countries maintaining pegged exchange rates
with the dollar were unwilling to allow their monetary conditions
to adjust passively to changes in the equilibrium real exchange
rate or in Federal Reserve policy.
Speculators, perhaps
inevitably, seemed to spot fundamental disequilibrium long before
a convincing case could be made for adjusting the exchange
rate. Exchange rate adjustments were the last resort of a
humiliated government or the first act of their successors.
Instead, policy fundamentals affecting the equilibrium real
exchange rate — notably controls on the flows of capital and
goods — became vital tools to offset other forces changing the
real exchange rate or changes in Federal Reserve policy which
were undesirable in terms of the domestic goals of the particular
nonreserve country. Only over time would the cumulative burden
on trade and freedom of more and more controls — required to
pursue simultaneously conflicting exchange-rate and monetary
goals — become so heavy that it became obvious to everyone that
revaluation of the nominal exchange rate and relaxation of
controls was a necessity. Thereafter, the cumulative process
would begin again pending another crisis.
But here I overstate my case. Variable controls did not
eliminate entirely the pressure for nonreserve countries to
adjust to changes in the equilibrium real exchange rate or
reserve-country monetary policy. Exchange rates were pegged for
substantial periods, and monetary policy in nonreserve countries
did reflect a weighting of those pressures and the domestic
goals. Nonetheless, it was very difficult for separate,
independent central banks to long accept the dictates of one of

their number and of the randomly walking equilibrium real
exchange rate.
International trade has risen sharply as a percentage of GNP
since the breakdown of the Bretton Woods system. A number cf
observers had expected the opposite since more variable nominal
exchange rates doubtless do impose a burden international
trade. Nonetheless, the facts seem to tell us that this method
of accommodating underlying change is less burdensome than a
strategy which implicitly embodies trade and capital barriers.
Unified Monetary Systems
As we look forward to 1992, it might be interesting to
consider briefly the system in the United States by which twelve
regional central banks have managed to coexist peacefully without
either controls or floating exchange rates among their respective
currencies. A unified monetary system like the Federal Reserve
System chooses to deal with real exchange rate movements in very
particular and automatic ways: First, there can be no changes in
nominal exchange rates so long as the system survives.
Ultimately, one authority determines the overall quantity of
money or price level in the system with relative money supplies
adjusting as required by movements in equilibrium real exchange
rates.
In the early days of the Federal Reserve System, the New
York Federal Reserve Bank was the independent authority with the
other Federal Reserve Banks adjusting their money supplies as
required to maintain parity with New York. In the 1930s, power
shifted to Washington and particularly the Federal Open Market
Committee which now determines national monetary conditions with
the relative money supplies of the twelve Federal Reserve Banks
adjusting to maintain parity among their respective dollars.
There are great attractions to a system of free and open
trade in goods, services, and capital and of sure, fixed exchange
rates. In the United States, for example, most people don't even
notice the seal on each piece of currency indicating which of the
twelve Federal Reserve Banks is its issuer. Against these
attractions must be weighed those occasions in which a region
suffers, say, from a worldwide collapse in the prices obtained by
a major industry. This would be painful enough in itself, but
the resulting collapse in desired investment depreciates the
equilibrium real exchange rate of the suffering region with the
other regions. Since it is impossible for one of the Reserve
Banks to devalue its currency against the other Reserve Banks,
this real depreciation is automatically effected by a deflation
in the region. In this case, monetary policy necessarily
exacerbates a bad situation in the one region unless a major
inflation is elected for the rest of the system.

Reducing Volatility in Real Equilibrium Exchange Rates
Each strategy for dealing with commercial and financial
relations across nations or regions clearly involves costs as
well as benefits. For the United States, the unified monetary
system is obviously the right choice, but I still suspect that
there have been state governors who would have availed themselves
of an option to float or devalue or impose capital controls if it
had been available to them.
Coordination of fiscal policies across nations or regions
can reduce the costs associated with any of the three basic
strategies. It does so by reducing the underlying volatility in
equilibrium real exchange rates. Suppose, for example, that two
countries undertake similar fiscal policy initiatives, but begin
them three years apart. The real exchange rate might sharply
appreciate when the first country moves and then move back to its
original level when the second country moves. The implied
dislocations involved in moving between tradeable and
nontradeable production would be avoided if the countries
coordinated the timing of their moves.
Efforts to coordinate fiscal policy, like most worthwhile
projects, are not easy. First, we must have a clear
understanding of how fiscal policy moves equilibrium real
exchange rates. It does so by changing the desired gap between
investment and national saving. On the one hand, anything that
makes a region or country a better place to invest appreciates
its equilibrium real exchange rate. We certainly saw that
process in America as we moved first to lower our tax rates on
capital relative to other countries while freeing our markets.
We saw it operate in reverse after Tax Reform was proposed with
the effect of raising capital taxation, which previously had been
cut further than planned due to unexpectedly rapid
disinflation. As other nations moved toward lower taxes and
freer markets, our equilibrium share of world investment fell
back toward more normal levels, reinforcing the depreciation of
the real exchange rate between 1985 and 1987.
On the other hand, anything that reduces national saving
tends to appreciate the equilibrium real exchange rate.
Proponents of the twin-deficits approach argue that the size of
the government deficit — that is, government dissaving — is
crucial here. However, I believe it is the level and type of
expenditures and taxes which affect national saving. The change
in the level of the budget deficit is a potentially misleading
gauge of the magnitude or even direction of the effects of fiscal
policy on national saving and the exchange rate. Reductions in
the budget deficit are a high priority of the government, but
they must come through expenditure reductions not tax
increases. Our econometric estimates at Treasury support in
large part the Ricardian view that offsetting movements in
private saving very largely neutralize the effects on national
saving of variations in taxes on the budget deficit. A simple

example will illustrate the point. In 1987, American GNP grew by
some $250 billion with falling unemployment. Based on normal
relations, that should have accounted for a $20 to $30 billion
increase in private saving. As measured in the national income
accounts, the general government deficit fell by $40 billion and
is now lower relative to GNP than two thirds of our G-7
partners. If you were to follow the twin-towers approach, a $20
to $30 billion increase in private saving and a $40 billion
decrease in government dissaving should have resulted in a $60 to
$70 billion increase in national saving. But national saving
actually went up by only $33 billion, trivially more than would
have been predicted from the normal relationship between
consumption on the one hand and GNP growth and unemployment on
the other. In other words, private saving was reduced nearly
dollar for dollar as government revenues and government saving
increased.
This does not mean that reducing the government deficit is
not a high priority. But it is crucial that it be done the right
way — by holding down expenditures. Our estimates indicate that
over the short and medium run, each dollar of reduction in
government expenditures on real goods and services increases
national saving by 80 cents compared to only 20 cents for a
dollar of tax increase. This increases not only our national
saving but world saving.
Regardless of whether or not the effect of capital taxation
on investment demand, as I argue, is rather more important than
the magnitude of the budget deficit in moving the equilibrium
real exchange rate, an interesting question remains: The
reduction in tax rates around the world spawned by emulation of
our successful policy leaves us all better off. Since we never
could have achieved consensus in 1981, isn't it better that
America went ahead alone even at the cost of the 1981-84 dollar
appreciation which was subsequently reversed?
The American federal system puts the dominant role in fiscal
policy in the hands of the central government, but leaves an
important degree of freedom to experiment in the hands of the
state and local governments. These experiments are not always
successful and do move equilibrium real exchange rates among the
states, but the range of variability in those rates remains
easily tolerable within the framework of an automatically
adjusting unified monetary system. Certainly, no pattern of
regional dissents is obvious in the minutes of the Federal Open
Market Committee.
This perspective suggests that a degree of fiscal
harmonization which appears as a 1992 goal may well so complement
the removal of trade and capital barriers that the variability of
equilibrium real exchange rates among the community is little
increased if not actually reduced. Friends like us, who are not
members of the Community, certain believe that the opening of
individual national markets within the Community over the next

four years should provide the occasion for increased, not reduced
trade between us.
*••

Ladies and gentlemen, I thank you for your attention and
hope that you found these remarks informative, or at the very
least provocative. Thank you.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone
Text as Prepared
For Release Upon Delivery
Expected at 1:00 p.m. DST
Remarks by Thomas J. Berger
Deputy Assistant Secretary for International Monetary Affairs
U.S. Department of the Treasury
before the
Institute of International Bankers, Inc.
New York, New York
October 17, 1988
Berlin Diary:
An Assessment of the 1988 IMF/World Bank Annual Meetings
Introduction
It is a great pleasure to join you once again in New York.
As many of you know, I have strong ties to Manhattan. I was born
here and I lived and worked here for many years earlier in my
career. As a sign in Times Square used to read: "If the United
States is a melting pot, New York makes it bubble." Or, as my
favorite Gotham cafe crooner, Bobby Short, put it: "New York is a
bad habit one never wants to lose." Thank you for inviting me
once again to speak with you in the city that is the navel of the
financial universe.
Since I last met with you in 1987, the Institute has
undergone a name change which reflects the financial revolution
that has occurred in the 1980s. All bankers are now international
bankers and your bottom line is influenced as much by events
abroad as by developments in your own country.
A few weeks ago the international financial community met in
Berlin for the 1988 annual meetings of the IMF and the World Bank.
Today I would like to share with you my assessment of what
happened in Berlin. The issues discussed there — economic
growth, trade imbalances, exchange rates and international debt —
are critical to the success of your efforts. It is not
surprising, therefore, that the number of bankers far exceeded the
government officials at the meetings.
In contrast to recent years, the 1988 annual meetings
produced few surprises and no fundamental changes in approach. In
part, this reflected the political reality of a transition to a
new U.S. Administration. It also reflected, however, the fact
that 1988 was a pretty good year for the world economy and a
general reluctance to change horses when the horse you are riding
NB-35
appears to be winning the race.

2041

-2-

Economic Policy Coordination and the World Economy
The major industrial countries are turning in a solid
economic performance this year. Growth is approaching 4 percent — the best since 1984 and better than had been expected
earlier in the year. Furthermore, the pattern of growth among
industrial nations is supportive of balance of payments adjustment
objectives. Thus, while growth in domestic demand in the United
States is slowing, the growth of this component of GNP in the
other Summit countries is strengthening, and will, in fact, be
twice as fast as in the United States this year. This, coupled
with the effects of earlier exchange rate changes, is facilitating
a sizeable reduction in our trade and current account deficits.
The trade deficit for the first eight months of 1988 was running
at an annual rate some $30 billion below the defict recorded in
1987.
A major element of this improved economic picture is an
acceleration of investment to nearly 7 percent in the industrial
countries. This will add to capacity, and permit greater output
and employment without higher prices. Indeed, stronger growth is
being achieved with continued moderate inflation. While we must
remain vigilant, and recent monetary measures demonstrate that we
will, there is no evidence that generalized price pressures are
emerging. The fall in interest rates from the peaks achieved
following the Fed's latest discount rate hike suggests that
inflationary expectations are easing, in part due to lower oil
prices.
The framework of economic policy coordination among the seven
major industrial countries has been essential to the progress that
has been achieved over the last three years. A principal
objective of the G-7 meeting in Berlin was to demonstrate that the
coordination process is working, that the participants are
committed to strengthening it further, and that cooperation in
exchange markets is continuing. The solid performance turned in
this year provides convincing evidence that coordination is
producing the desired results and reinforces confidence that the
basic policy directions that have been agreed are correct and
should be continued.
There is no complacency among the G-7, however. Countries
with large external and budget deficits need to strengthen their
fiscal positions. In the United States, we have already made
significant strides in reducing the Federal budget deficit, but we
share the concerns of our trading partners and consider further
progress a high priority. Similarly, surplus countries must
maintain strong domestic demand growth.
The coordination process represents a pragmatic approach to
strengthening the international monetary system. It involves a
discipline that encourages each participant to take actions whose
benefits transcend national boundaries. Despite the
accomplishments of the past few years, coordination is still in
its infancy and there is room for strengthening the discipline of
liberalization.
the
reforms
system.
into At
the Berlin,
process,
a start
focusing
was initially
made in integrating
on financialstructural
market

-3-

In the area of financial market reform, an issue of
particular concern to this group involves the European Community's
(EC) plan to achieve an integrated market by 1992. The United
States has long supported European integration and believes that
this process could have major benefits for the world economy.
However, you may be aware that officials of the EC Commission
have proposed using "reciprocity" as a standard for granting third
countries access to newly liberalized sectors in Europe in those
areas not covered by the GATT. Specifically, the proposed banking
and investment services directives state that the reciprocal
treatment afforded an EC financial institution in a third-country
market may determine whether firms from that third country will be
permitted access to an integrated European market for financial
services.
If applied on a narrow or mirror-image basis, this standard
of reciprocity could discriminate against non-European firms
seeking entry to the EC and against third-country firms already
operating in Europe. It would undermine the principle of
"national treatment" and the decades-long effort by the OECD to
liberalize capital movements.
Frankly, we find this reciprocity concept very troubling.
The danger of this approach is that legitimate differences, for
example, in national regulatory regimes, are not recognized and
could be used to justify discrimination against non-European
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.
As representatives of the international banking community,
you have a special interest in seeing to it that EC 1992, which is
meant to liberalize different sectors of the European market, not
end up having precisely the opposite effect. It would indeed be
unfortunate if the application of reciprocity in the EC financial
sector resulted in a response from the U.S. Government that
damaged the present national treatment standard upon which your
operations in the world's largest financial market now rest.
The G-7 is also working to improve the functioning of the
international monetary system by further strengthening the current
coordination process. As the process of coordination 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 need further strengthening and reform of the
system, but what form and direction should this take? These are
precisely the issues that are being examined by the G-7. The
development of the economic coordination process is evolutionary.
Improvements have been and will continue to be made in a
step-by-step manner that may not appear dramatic, but will
nevertheless produce the improved international monetary system we
all seek.

-4-

International Debt
The debt of developing countries was another key focus of
attention at the meetings. There was broad recognition that the
current market-based, case-by-case strategy for achieving recovery
and growth in these countries is the correct one. The key
policymaking bodies of the IMF and the World Bank — the Interim
Committee and the Development Committee — reiterated their
support for this approach, which has evolved significantly since
its initiation in October 1985. They reinforced the importance of
economic reforms by debtor countries and identified increased
foreign direct investment as an additional source of financing
which would not add to the level of debt.
As Secretary Brady indicated in his address to the meetings,
this strategy has produced progress in improving the situation of
the major debtors, and the prospects for these countries are
brighter. Current account deficits have been reduced, and growth
has been strengthened. Most debtors are adopting market-oriented
reforms to foster growth. Those governments that have sustained
such reform efforts — Chile, Colombia, and Turkey, for example —
have achieved the strongest economic performance and are either
approaching or have achieved a return to voluntary access to
financial markets. For the 15 major debtors as a whole, economic
growth has improved substantially since the 1982-83 period. Trade
is expanding, and critical interest/export ratios have declined by
nearly one-third.
The progress is encouraging, yet it was agreed that further
efforts need to be made to reform debtor economies and to pursue
adjustment and growth. Concern was expressed about the adequacy
of commercial bank financing, and the need to ensure sufficient
financial support for the process of adjustment was underscored.
Consequently, participants agreed that the "menu" approach
should be broadened further through voluntary, market-based
techniques to increase financial flows or to reduce the stock of
debt without transferring risk from private lenders to official
creditors. This will require innovation and creativity on the
part of debtors and commercial banks alike.
A number of proposals have been advanced to facilitate the
securitization of part of commercial bank debt or to encourage new
financing. Most, however, appear to require either additional
financing from the multilateral institutions or other measures to
shift risk from the private to the public secor to make them
viable.
As Secretary Brady pointed out, the United States regards
with skepticism proposals that may appear to conform to the basic
principles of the debt strategy but which in practice will produce
only an illusion of progress, at considerable public expense.
True market-based, voluntarily agreed alternatives — such as
those contained in the "menu" of options for the recent successful
Brazilian financing package — support both new financing and debt
reduction while avoiding these pitfalls.

-5-

A special attempt to address the needs of the poorest
countries was outlined in Toronto this summer and was most
recently endorsed in Berlin. This approach would provide more
generous debt relief for the very poorest countries through
official reschedulings in the Paris Club. Under this initiative,
official creditors could choose among several options when
negotiating rescheduling agreements in the Paris Club:
concessional interest rates with shorter maturities; longer
repayment periods at commercial rates; partial write-offs of debt
service obligations; or a combination of these options. This new
Paris Club approach is limited to the very poorest countries, as
it is in these nations where the burden of official debt is
relatively high. We expect that two or three sub-Saharan African
countries will benefit from use of these broader options this
fall.
Role of the IMF and World Bank
The Berlin meetings provided an opportunity for the Interim
and Development Committees to provide guidance on major policy
issues. The IMF and World Bank are the central institutions for
cooperative international efforts to promote a sound world
economy. The ability of the IMF and World Bank to fulfill their
responsibilities is of major importance to you as international
lenders.
These two institutions are responsible for promoting sound
policies in borrowing countries. This, of course, is central to
preserving the creditworthiness on which your lending rests. The
resources provided by the Fund and Bank are often critical to
assembling the financial packages to deal with LDC debt problems.
And, they serve as indispensable coordinators and catalyzers that
bring together the disparate interests and objectives of the
myriad financial institutions that today are involved in
international lending.
The progress that has been achieved in dealing with LDC debt
problems and preserving a stable international financial system is
due in no small part to the efforts of the IMF and World Bank. It
is in everyone's interests — the banks, the LDC borrowers, and
the creditor governments — that they be preserved as financially
strong and effective institutions.
It is for this reason that the Interim Committee devoted a
substantial portion of its agenda to the large and growing problem
of arrears on IMF obligations. In a few short years, arrears have
grown from a negligible amount to over $2 1/2 billion, more than
double IMF reserves. Had the IMF been a private institution, the
regulators would have stepped in long ago.

-6-

Unless addressed promptly, the arrears problem will erode the
monetary character of the institution, undermine its central role
in the system and weaken its financial integrity, perhaps
irreparably. The Interim Committee received a report from the IMF
Executive Board describing a three-part approach for addressing
arrears. It includes preventive measures to avoid a further
buildup of overdue obligations, an intensified collaborative
approach to help members restore normal financial relations with
the IMF, and remedial actions to protect the Fund's financial
position in the event the member does not cooperate. The United
States believes that this approach offers the opportunity, perhaps
the last, to make a real breakthrough and is urging the Executive
Board and members to move ahead expeditiously to implement it.
The United States is prepared to cooperate constructively in this
effort and will do its part.
The Interim Committee also discussed the issue of a possible
increase in IMF quotas as part of the current Ninth General Review
of IMF quotas. The review is scheduled to be concluded next April
and no decisions were therefore expected at this meeting. A wide
divergence of view exists, however, on the principal issues of the
size and distribution of a quota increase. At a time of scarce
financial resources and budget constraints, the case for an
increase in IMF resources must be compelling. There must be a
demonstrated need that additional resources are required, a case
that does not now exist given the IMF's $45 billion in loanable
resources. There must be an agreed vision of the IMF's role in
the 1990s, so that our taxpayers will know how the resources will
be used. And, the arrears problem must be dealt with so that
those taxpayers, and their legislative representatives, will not
think that good money is being thrown after bad.
The discussion of World Bank issues in the Development
Committee focused on how the resources provided by the recently
agreed General Capital Increase (GCI) are to be used. In
particular, considerable attention and support was given to the
World Bank's renewed efforts in the area of poverty reduction and
in protecting the poor in adjustment programs. In this
connection, agreement was reached on the timetable and agenda for
the negotiations on the Ninth Replenishment of IDA. Finally, the
Committee stressed that protecting the environment and conserving
natural resources should be critical elements in World Bank
lending.
Conclusion
Let me close by observing that the annual meetings of the IMF
and World Bank have traditionally been a time for stocktaking and
course setting. This year was no exception and, to summarize, the
report card issued at the Berlin meetings had the following
features. The world economy is on a much more solid footing than
it was when the decade began. Growth continues, but it is now
more balanced and, as a result, external imbalances are being
reduced. Inflation remains low and investment is accelerating.
The international debt strategy remains valid and progress
continues to be made.

-7-

These are indeed positive developments and ones which this
group should welcome for a very simple reason — it will allow
your firms to do a greater volume of profitable business.
Thank you very much.

TREASURY NEWS

apartment of the Treasury • Washington, D.c. • Telephone 566-2
CONTACT: Office of Financing
FOR RELEASE AT 4:00 P.M.
202/376-4350
October 18, 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 October 27, 1988.
This offering
will provide about $ 875
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,116 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, October 24, 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
July 28, 1988,
and to mature January 26, 1989
(CUSIP No.
912794 RD8 ), currently outstanding in the amount of $7,283 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,000 million, to be dated
October 27, 1988,
and to mature April 27, 1989
(CUSIP No.
912794 RV8 ).
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 October 27, 1988.
m addition to the maturing
13-week and 26-week bills, there are $ 9,284 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 $1,834 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $1,849 million as
agents for foreign and international monetary authorities, and $ 5,921
million for their own account. These amounts represent the combined
holdings of such accounts for the three issues of maturing bills.
NB-36
Tenders for bills to be maintained on the book-entry records of the
Department
of series)
the Treasury
should
be submitted
on Form
PD 5176-1
(for 13-week
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 NEWS
lepartment of the Treasury • Washington, D.c. • Telephone 566-2041

FOR IMMEDIATE RELEASE
OCTOBER 19, 1988

CONTACT:

LARRY BATDORF
566-2041

U.S.-GERMAN INCOME TAX TREATY NEGOTIATIONS
NEARING CONCLUSION

U.S.-German income tax treaty negotiations were held from
October 10 to October 14. There is now substantial agreement on
all important points in the new treaty and the few open questions
should be resolved at a concluding session in December 1988. The
parties plan to initial the treaty at this meeting.
Treaty ratification is expected in 1989.
-oOo-

NB-37

TREASURY NEWS
deportment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
October 19, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY TO AUCTION $9,000 MILLION OF 2-YEAR NOTES
The Department of the Treasury will auction $9,000 million
of 2-year notes to refund $10,904 million of 2-year notes maturing
October 31, 1988, and to paydown about $1,900 million. The public
holds $10,904 million of the maturing 2-year notes, including
$1,232 million currently held by Federal Reserve Banks as agents
for foreign and international monetary authorities.
The $9,000 million is being offered to the public, and any
amounts tendered by Federal Reserve Banks as agents for foreign and
international monetary authorities will be added to that amount.
Tenders for such accounts will be accepted at the average price of
accepted competitive tenders.
In addition to the public holdings, Government accounts and
Federal Reserve Banks, for their own accounts, hold $639 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

NB-38

HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 2-YEAR NOTES
TO BE ISSUED OCTOBER 31, 1988
October 19, 1988
Amount Offered:
To the public

$9,000 million

Description of Security:
Term and type of security
2-year notes
Series and CUSIP designation .... AG-1990
(CUSIP No. 912827 WU 2)
Maturity date
October 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
April 30 and October 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
Key Dates:
Deposit
Wednesday, October 26, 1988,
Receipt guarantee
of tendersby
designated institutions
Acceptable
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a) funds immediately
Monday, October 31, 1988
available to the Treasury
Thursday, October 27, 1988
b) readily-collectible check

TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE

October 19, 1988

Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of September 1988.
As indicated in this table, U.S. reserve assets amounted to
$47,788 million at the end of September, up from $47,778 million in
August.

U.S. Reserve Assets
(in millions of dollars)

End
of
Month

Total
Reserve
Assets

47,778
47,788

Stock y

Special
Drawing
Rights 2/3/

Foreign
Currencies 4/

Reserve
Position
in IMF 2/

11,061
11,062

9,058
9,074

18,017
18,015

9,642
9,637

Gold

1988
Aug.
Sep.

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.

NB-39

OVERVIEW AND BACKGROUND

Wt ?/^

Chapter 1
OVERVIEW
A. Introduction
Section 482 of the Internal Revenue Code1 authorizes the
Secretary of the Treasury to allocate income, deductions, and
other tax items among related taxpayers to prevent evasion of
taxes or to reflect their incomes clearly. The Tax Reform Act of
1986 [hereinafter 1986 Act] amended section 482 for the first
time in many years by providing that the income from a transfer
or license of intangible property must be commensurate with the
income attributable to the intangible. The Conference Committee
report stated:
The conferees are also aware that many important and
difficult issues under section 482 are left unresolved by
this legislation. The conferees believe that a
comprehensive study of intercompany pricing rules by the
Internal Revenue Service should be conducted and that
careful consideration should be given to whether the
existing regulations could be modified in any respect.2
In response to this recommendation, the Internal Revenue Service
and the Treasury Department have reexamined the theory and
administration of section 482, with particular attention paid to
transfers of intangible property. This study presents the
findings and recommendations of the Service and Treasury.
The study is divided into four parts. Part I recounts the
history of section 482 and the evolution of issues leading to the
1986 amendments. Part I also contains recommendations and
suggestions for further consideration to assure both thoughtful
analysis by taxpayers in setting transfer prices and disclosure
of information to permit adequate development of transfer pricing
issues on examination.
The problems that have been encountered in relation to
transfers of intangible property are both legal and
administrative. The 1986 Act clarifies the legal standard for
1
Unless
otherwise
stated, by
allstating
references
sections
and
determining
arm's
length pricing
that to
transfer
prices
regulations are to the Internal Revenue Code of 1986 and the
regulations promulgated thereunder.
2
H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. 11-638
(1986) [hereinafter 1986 Conf. Rep.].

- 2 for intangible property must be "commensurate with income." Part
II discusses Congress' 1986 change to section 482 and explains
that this standard requires periodic, and generally prospective,
adjustments to transfer prices to reflect significant changes in
the income attributable to intangible property. In any event,
transfer prices must be determined on the basis of true
comparables if they in fact exist. Part II concludes that the
commensurate with income standard is fully consistent with the
arm's length principle.
The primary administrative difficulty relating to transfers
of intangible property is the failure of the regulations to
specify a so-called fourth method of income allocation for
situations in which comparable transactions do not exist. This
problem has been particularly acute with respect to high profit
intangibles. Part III of the study explores the economic theory
underlying section 482 and proposes a methodology for allocating
income, and thereby determining transfer prices in such cases,
which draws upon various methods that have been used on an ad hoc
basis by the Service, taxpayers, and the courts. The methodology
would utilize functional analysis and allocate income by using
comparable transactions when they exist, arm's length rates of
return when comparables do not exist, and a profit split approach
when neither comparables nor arm's length rates of return can be
used to allocate all intangible income.
Part IV examines cost sharing arrangements and relevant
implications arising from the 1986 legislation.
The specific chapters in each part and the appendices to the
study are described below.
B. Part I: Background
Chapter 2 reviews the history of particular transfer
pricing legislation and regulations before 1986, including
regulations promulgated in 1968, which are still in effect today.
Chapter 3 discusses administrative problems. This chapter
is supplemented by a survey of selected International Examiners
and Group Managers, summarized in Appendices A and B, which
sought information about how the section 482 regulations work in
practice. Significant problems include access to pricing
information and difficulties in applying pricing methods to
transfers of intangible assets. The chapter includes
recommendations regarding the maintenance of transfer pricing
information in the taxpayer's books and records, which would be
required to be provided to the IRS immediately upon request in an
examination, summary reporting of the taxpayer's transfer pricing
methodology on Forms 5471 and 5472, and the assertion of
appropriate penalties for failure to disclose information or for
substantial understatements of income.

- 3 The regulations place strong emphasis on finding comparable
unrelated party transactions as a guide for evaluating related
party transactions. Chapter 4 discusses the search for
comparables in the decided cases, and concludes that comparables
are often either absent or misused when transfers of intangible
property are at issue.
The regulations provide that, when comparables are
unavailable, some other appropriate method of allocating income
among related parties may be used. Chapter 5 examines the
decided cases to see what other methods have been used, including
profit splits, rates of return, income to expense ratios, and
customs valuations.
C. Part II: Section 482 After the 1986 Tax Reform Act
Chapter 6 focuses on the "commensurate with income"
standard incorporated into section 482 by the 1986 Act. After
describing the legislative history, the chapter discusses
limitations some have suggested on the scope of the standard, and
explains its application to normal profit potential intangibles
as well as to high profit potential intangibles.
Chapter 7 addresses an issue of major concern to the foreign
trading partners of the United States: compatibility with
international transfer pricing standards. The chapter concludes
that the arm's length standard is the accepted international norm
for making transfer pricing adjustments. The study reaffirms
that Congress intended the commensurate with income standard to
be consistent with the arm's length standard, and that it will be
so interpreted and applied by the Internal Revenue Service and
the Treasury Department.
Chapter 8 discusses the need under the commensurate with
income standard to make periodic adjustments to intangible income
allocations. Recommendations address the issues of the frequency
of review, retroactivity, lump sum payments, and set-offs.
Taxpayers and practitioners have long advocated safe harbors
as a solution to many of the problems arising under section 482.
Chapter 9 discusses safe harbors in theory and analyzes some of
the safe harbors that have been proposed. While the Service and
Treasury do not categorically reject the possibility that some
useful safe harbors might be developed, none of those currently
proposed appears satisfactory.
D. Part III: Methods for Valuing Transfers of Intangibles
The current regulations adopt a market-based approach,
distributing income among related parties the way a free market
would distribute it among unrelated parties. Some critics have

- 4 suggested that a unitary business approach, eliminating the
fiction of arm's length dealing and accounting for economies of
related party dealing through a formulary method, might be more
theoretically sound. Chapter 10 examines these arguments and
concludes that the market-based arm's length standard remains the
better theoretical allocation method.
Chapter 11 discusses the formulation of a methodology for
applying the arm's length standard to transfers of intangible
property. Beginning with a discussion of the use of exact and
inexact comparables, the chapter proposes as an additional method
an arm's length return method that, with appropriate adjustments,
could be used in a large percentage of cases. For cases
involving intangibles in which comparables and the arm's length
return method cannot account for all income to be allocated, a
profit split addition to the arm's length return method is
described.
E. Part IV: Cost Sharing Arrangements
Chapter 12 presents a description of cost sharing
arrangements and describes the history of their tax treatment,
comparing the detailed section 482 cost sharing regulations that
were proposed in 1966 with the terse version actually promulgated
in 1968. The chapter reviews foreign experience with cost
sharing, a 1984 Congressional recommendation that the cost
sharing rules be expanded, and the special rules governing cost
sharing arrangements between possessions corporations and their
domestic affiliates.
The legislative history regarding the change to section 482
in the 1986 Act states that Congress intended to permit bona fide
cost sharing arrangements, but expected the economic results of
such arrangements to be consistent with the commensurate with
income standard. Chapter 13 identifies and discusses various
issues related to the use of cost sharing arrangements after the
1986 Act.
F. Appendices
Appendices A and B to the study summarize the results of a
survey of Service personnel about the administration of section
482. Appendix C analyzes the transfer pricing law and practices
of selected jurisdictions. Appendix D describes the publicly
available information about third party licensing practices.
Appendix E contains 14 examples that illustrate how the
principles explained in the study are applied in different
factual contexts.

- 5 G.

Future Agenda

This study reflects input from taxpayer groups,
practitioners, and other concerned members of the public, as well
as the combined experience and careful thought of those in the
government charged with enforcing section 482. Nevertheless, it
is only a beginning; it sets forth conclusions and
recommendations in some areas, and describes the need for further
study in others.
In the study, input is requested on specific issues from
taxpayers and practitioners. More generally, however, readers
are urged to provide any comments that would be useful in
formulating a fair and workable system of administering a statute
that has challenged taxpayers and the government alike. It is
anticipated that comments will be taken into account in drafting
proposed regulations and in examining additional issues not
discussed in this study -- including such areas as the services
portion of the section 482 regulations, the impact of currency
fluctuations on transfer pricing, a more detailed review of
functional analysis, and the proper methodology for valuing
assets under the various "fourth method" approaches described in
Chapter 11.
Comments should be forwarded in triplicate to the Office of
Associate Chief Counsel (International), Branch 1, 950 L'Enfant
Plaza South, S.W., Room 3319, Washington, D.C. 20024. Comments
are requested to be filed by February 15, 1989.

- 6 Chapter 2
TRANSFER PRICING LAW AND REGULATIONS BEFORE 1986
A. Early History
The Commissioner was generally authorized to allocate income
and deductions among affiliated corporations in 1917.3 He could
require related corporations to file consolidated returns
"whenever necessary to more equitably determine the invested
capital or taxable income...." The earliest direct predecessor
of section 482 dates to 1921, when legislation went beyond
authority to require consolidated accounts and authorized the
Commissioner to prepare consolidated returns for commonly
controlled trades or businesses to compute their "correct" tax
liability.4 This legislation was passed partly because
possessions corporations, ineligible to file consolidated returns
with their domestic affiliates, offered opportunities for tax
avoidance.5 As early as 1921, Congress perceived the potential
for abuse among related taxpayers engaged in multinational
transactions.
When the predecessor to current section 482 was incorporated
into the 1928 Revenue Act (as section 45), the provision was
removed from the expiring consolidated return provisions and
significantly expanded.6 The Commissioner's authority to make
an adjustment under section 45 was expressly predicated upon his
duty to prevent tax avoidance and to ensure the clear reflection
of the income of the related parties (to determine their "true
tax liability," in the words of the legislative history).7
B. Regulations and the Courts -- through the early 1960s
For many years, the small number of United States companies
with multinational affiliates meant that section 482 had little
impact in the international context. Prior to the early 1960s,
3
Regulation
Articles
77-78,
War Revenue
Act using
of 1917,
the primary
focus of41,
the
Service's
enforcement
efforts
ch. 63, 40 Stat. 300 (1917).
4

Rev. Act of 1921, ch. 136, §240(d), 42 Stat. 260 (1921).

S. Rep. No. 275, 67th Cong., 1st Sess. 20 (1921).

Rev. Act of 1928, ch. 852, §45, 45 Stat. 806 (1928).

H.R. Rep. No. 2, 70th Cong., 1st Sess. 16-17 (1928).

- 7 section 482 was domestic. Regulations issued in 19358 (under
section 45) remained in effect substantially unchanged until
1968.
The regulations set forth the arm's length standard as the
fundamental principle underlying section 482: "The standard to
be applied in every case is that of an uncontrolled taxpayer
dealing at arm's length with another uncontrolled taxpayer."9
They did not, however, mandate the use of any particular
allocation method.
The case law interpreting section 482 and its predecessors
took a broad approach. The concepts of "evasion of taxes"10 and
"clear reflection of income"11 were developed into far-reaching
weapons to attack a variety of tax abuses. The predecessors of
section 482 were used to prevent recognition of a tax loss on
securities following a tax-free transfer from the corporation
that had incurred, but could not use, the loss,12 and to prevent
the mismatching of the expenses incurred by one corporation in
growing crops from the income artificially realized by another
corporation from harvesting and selling those crops.13
The courts applied a number of different standards for
determining when transactions were conducted at arm's length.

8
9

Treas. Reg. 86, §45-l(b) (1935).

Id.

Asiatic Petroleum Co. v. Comm'r, 79 F.2d 234, 236 (2d
Cir.), cert, denied, 296 U.S. 645 (1935) (concept of evasion for
this purpose includes civil tax avoidance).
11
Central Cuba Sugar Co. v. Comm'r, 198 F.2d 214, 215 (2d
Cir.), cert, denied, 344 U.S. 874 (1952) (application of clear
reflection standard does not require proof of tax avoidance
motive).
12
National Securities Corp. v. Comm'r, 137 F.2d 600 (3d
Cir.), cert, denied, 320 U.S. 794 (1943).
13

Central Cuba Sugar, supra n. 11; Rooney v. U.S., 305
F.2d 681 (9th Cir. 1962).

- 8 Transactions were scrutinized to determine if related parties
received full, fair value,14 a fair and reasonable price,15 or a
fair price including a reasonable profit.16
Before 1964, it was generally understood that section 482
could not be used by the Service to place taxpayers, in effect,
on a consolidated return basis.17 In 1964, the Tax Court used'
section 482 to combine the incomes of two separate corporations
that operated a downtown clothing store and its suburban branch
store.18 This case raised concerns among taxpayers over the use
of section 482 in substance to ignore separate corporate
entities.
C. Developments in the 1960s
By the early 1960s, the business and regulatory climate in
which U.S. and foreign multinationals operated changed
substantially. In 1961, the Treasury Department urged that
significant changes be made in the taxation of U.S. enterprises
with foreign affiliates. In particular, Treasury contended that
section 482 was not effectively protecting U.S. taxing
jurisdiction.x9
14
Friedlander Corp. v. Comm'r, 25 T.C. 70, 77 (1955).
15

Polack's Frutal Works v. Comm'r, 21 T.C. 953, 975 (1954).

Grenada Industries v. Comm'r, 17 T.C. 231 (1951), aff'd,
202 F.2d 873 (5th Cir.), cert, denied, 346 U.S. 819 (1953).

Seminole Flavor Co. v. Comm'r, 4 T.C. 1215 (1945); cf.
Moline Properties v. Comm'r, 319 U.S. 436 (1943). In extreme
cases of income shifting, other legal theories such as assignment
of income, substance over form, disregard of corporate entity, or
treatment of corporate entity as an agent have been used by
courts to attribute income to the appropriate person or corporate
entity. These theories are beyond the scope of this paper, and
they are generally not used by courts when section 482 is also
applicable. See, e.g., Hospital Corporation of America v.
Comm'r, 81 T.C. 520 (1983) (foreign affiliate not treated as a
sham; section 482 applied for use of U.S. parent's intangibles).
18
Hamburgers York Road, Inc. v. Comm'r, 41 T.C. 821
(1964); Aiken Drive-in Theatre Corp. v. U.S., 281 F.2d 7 (4th
Cir. 1960) (the shifting of an abandonment loss from one
corporation to another created an inaccurate picture of income,
justifying use of section 482).
19
Hearings on the President's 1961 Tax Recommendations
Before the Committee on Ways and Means, 87th Cong., 1st Sess.,
vol. 4, at 3549 (1961) (statement of M. Caplin, Commissioner of

- 9 In 1962, Congress considered how to stop U.S. companies
from shifting U.S. income to their foreign subsidiaries.20 While
the Ways and Means Committee observed that under existing law the
Service could prevent this practice by allocating income under
section 482, it proposed further legislation to minimize "the
difficulties in determining a fair price," particularly in
instances "where there are thousands of different transactions
engaged in between a domestic company and its foreign
subsidiary."21
The Ways and Means Committee proposal as adopted by the
House would have added to section 482 a new subsection dealing
with sales of tangible property between U.S. corporations and
their foreign corporate affiliates.22 Unless the taxpayer could
demonstrate its use of an arm's length price under the comparable
uncontrolled price method, taxable income was to be apportioned
between related parties under a formula based on their relative
economic activities. In addition, no income was to be allocated
to a "foreign organization whose assets, personnel, and office
and other facilities which are not attributable to the United
States are grossly inadequate for its activities outside the
United States."23
The Senate version of the 1962 Revenue Bill, which prevailed
in conference, omitted the House provision. Instead, the Finance
Committee concluded that section 482 already provided ample
regulatory authority to prevent improper multinational
allocations.24 The Conference Committee endorsed this approach,
stating:
The conferees on the part of both the House and the
Senate believe that the objectives of section 6 of the
bill
as passed"Problems
by the House
can
be accomplished
Internal Revenue,
in the
Administration
of by
the Revenue
amendment
of
the
regulations
under
present
section
482.
Laws relating to the Taxation of Foreign Income").
20

H.R. Rep. No. 1447, 87th Cong., 2d Sess. 28 (1962).

Id.

H.R. 10650, 82d Cong., 2d Sess., §6 (1962).

Id.; see H.R. Rep. No. 1447, 87th Cong., 2d Sess.
537-38 (1962).

See, e.g., Hearings on H.R. 10650 Before the Senate
Committee on Finance, 87th Cong., 2d Sess., pt. 7, at 2913, 30113012 (1962) (statements by P. Seghers and D- N. Adams).

- 10 Section 482 already contains broad authority to the
Secretary of the Treasury or his delegate to allocate
income and deductions. It is believed that the
Treasury should explore the possibility of developing
and promulgating regulations under this authority which
would provide additional guidelines and formulas for
the allocation of income and deductions in cases
involving foreign income.25
D. The Current Regulations
Treasury responded by promulgating regulations, issued in
final form in 1968, that (with only a few changes) govern
transfer pricing practices today.26 Those regulations reaffirmed
the arm's length standard as the principal basis for transfer
pricing adjustments but attempted, for the first time, to
establish rules for specific kinds of intercompany transactions.
The final regulations applied to the performance of services, the
licensing or sale of intangible property, and the sale of
tangible property.27
1. Services. In determining an arm's length charge for
services, section 1.482-2(b)(3) of the regulations provides:
For the purpose of this paragraph an arm's length charge for
services rendered shall be the amount which was charged or
would have been charged for the same or similar services in
independent transactions with or between unrelated parties
under similar circumstances considering all relevant facts.
The regulations do not provide any specific guidance for
determining what the charge in independent transactions would
have been in the absence of comparable transactions with
independent parties.
25
26

H.R. Rep. No. 2508, 87th Cong., 2d Sess. 18-19 (1962).

Proposed regulations were issued in 1965, were withdrawn
and reproposed in 1966, and were issued in final form in 1968.
Proposed Treas. Reg. §§1.482-l(d) and 2, 30 Fed. Reg. 4256
(1965); Proposed Treas. Reg. §§1.482-l(d) and 2, 31 Fed. Reg.
10394 (1966); and T.D. 6952, 1968-1 C.B. 218.
27
In addition to the tangible and intangible property and
the services regulations, there are safe harbors and other rules
for interest rates on related party loans, Treas. Reg. §1-4822(a), and rules similar to the services rules for related party
leasing transactions, Treas. Reg. §1.482-2(c). These rules are
generally not discussed in this paper.

- 11 2. Intangible Property. As to the licensing or sale of
intangible property, section 1.482-2(d)(2)(ii) of the regulations
provides:
In determining the amount of an arm's length consideration,
the standard to be applied is the amount that would have
been paid by an unrelated party for the same intangible
property under the same circumstances. Where there have
been transfers by the transferor to unrelated parties
involving the same or similar intangible property under the
same or similar circumstances the amount of the
consideration for such transfers shall generally be the best
indication of an arm's length consideration.
The intangible property portion of the regulations contemplate a
failure to find appropriate comparables. Where they are
unavailable, the regulations list 12 factors to be taken into
account, including prevailing rates in the industry, offers of
competitors, the uniqueness of the property and its legal
protection, prospective profits to be generated by the
intangible, and required investments necessary to utilize the
intangible.28 The regulation offers little or no guidance,
however, in determining how much relative importance particular
factors are to be given.
3. Tangible Property. Finally, the section 482 regulations
set out detailed rules for determining the transfer prices of
tangible personal property. Section 1.482-2(e)(2)(4) of the
regulations describes three specific methods for determining an
appropriate arm's length price: the comparable uncontrolled
price method, the resale price method, and the cost plus method.
All three rely on comparable transactions to determine an arm's
length price, either directly or by reference to appropriate
markups in comparable unrelated transactions. The regulations
mandate that the three enumerated methods be used in the order
set forth. They also authorize other unspecified methods, which
have come to be known generically as "fourth methods":
Where none of the three methods of pricing ... can
reasonably be applied under the facts and circumstances as
they exist in a particular case, some appropriate method of
pricing other than those described in subdivision (ii) of
this subparagraph, or variations on such methods, can be
used. [Emphasis supplied.]29
Treas.
Reg. §1.482-2(d)(2)(iii).
The specific
transaction-oriented
models described above for
29 transfer pricing determinations were adopted in lieu of
making
Treas. Reg. §1.482-2(e)(1)(iii ).

- 12 "mechanical safe havens" based on profit margins, percentage
mark-ups or mark-downs, and the like, which had been suggested by
various taxpayers commenting on proposed regulations issued in
1965 and 1966. Such safe harbors were rejected for two reasons.
First, because of the extraordinary range of returns earned at
arm's length, even within a single industry or company, no
principled and equitable basis for such safe harbors could be
devised. Second, any effective safe harbor income allocation
would inevitably serve as a "floor," applying only to those
taxpayers not able to document a more advantageous fact
pattern.30 As discussed in Chapter 9, infra, the concerns
raised by safe harbors still have not been satisfactorily
dispelled.
E. Conclusion
In general, the section 482 regulations relating to
services, intangible property, and tangible property rely
heavily on finding comparable transfer prices or comparable
transactions. The regulations provide little guidance for
determining transfer prices in the absence of comparables.

Surrey, Treasury's Need to Curb Tax Avoidance in
Foreign Business through the Use of Section 482, 28 J. Tax'n 75
(1968).

- 13 Chapter 3
RECENT SERVICE EXPERIENCE IN ADMINISTERING SECTION 482
In order to determine what difficulties International
Examiners are encountering in administering the regulations, a
questionnaire was prepared through the joint efforts of Treasury,
Chief Counsel, and International Examination personnel. The
questionnaire was sent to selected International Examiners (IEs)
and IE Group Managers. In addition, selected IRS economists,
IEs, Group Managers, and IRS trial attorneys were interviewed.
The results of the analysis of the questionnaires have been
compiled and are set forth in Appendix A. Included in Appendix B
is a completed questionnaire reflecting the aggregate data
supplied by the respondents.31 In general, the survey and
interviews revealed no surprises. The two primary problems in
administering section 482 have been the difficulty of obtaining
pricing information from the taxpayers during an examination and
the difficulty of valuing intangibles — including the valuation
of intangible property in connection with sales of tangible
property. This chapter discusses these problems, makes several
related suggestions regarding disclosure of information and
penalties, and suggests that the early use of counsel and
economic experts would alleviate these problems.
A. Service's Access to Pricing Information
A significant threshold problem in the examination of
section 482 cases has been IRS access to relevant information to
make pricing determinations. In some cases, relevant information
3x

IEs and Group Managers were requested to complete one
questionnaire for each of the three cases they considered to be
their most important section 482 cases. In some instances
respondents had not had experience with three important section
482 cases, so that fewer responses were made to some questions.
In others, some respondents answered based on their general
experience, rather than the particular case for which the
questionnaire was completed. In many instances the
categorization of particular issues entails a great deal of
judgment. For example, a case such as Hospital Corporation of
America, supra n. 17, could be viewed as a services case, an
allocation of income case, a profit split case, or an
intangibles case. For these reasons we have used the results of
the questionnaire throughout this paper primarily for purposes of
illustration. However, the results, where used, represent and
correspond with the experiences of persons interviewed and
others in the Service responsible for administering section 482.

- 14 is not furnished by the taxpayer to the examining agent.32 In
other cases, long delays are experienced by agents in receiving
information, in most cases without explanation for the delays.
In many cases, delays in responding to IE requests for
information exceed one year.33 Because of the emphasis upon
timely closing of large cases in the recent past, section 482
cases have been closed without receiving necessary information or
without the opportunity for agents to follow up on information
that has been provided.34
The experience of the agents has been that the vast majority
of taxpayers, when asked, are unable to provide an explanation
of how their intercompany pricing was established.35 This may
account in large part for the denial of access to information and
delays encountered by IEs.
In recent years the Service has placed an emphasis on
examination of transactions with subsidiaries located in tax
haven jurisdictions.36 Because of the financial and commercial
secrecy laws that exist in tax haven jurisdictions, IRS access to
third party data has been significantly hampered. Problems with
access to information because of foreign secrecy laws have been
to some extent alleviated by the enactment of section 98237 and
32
by a broad
interpretation
of the
administrative
summons
Many
of the requests
forIRS
information
that are
not power
honored concern transactions with third parties that would
provide comparables for analyzing a potential section 482
adjustment. Appendix B, infra, at Question 18C.
33
Appendix B, infra, at Question 19.
34

Appendix B, infra, at Question 13, and Appendix A,
infra, at 4-5.

35
36

Appendix B, infra, at Question 14.

General Accounting Office, Report to the Chairman,
Committee on Ways and Means, IRS Audit Coverage: Selection
Procedures Same for Foreign and other U.S. Corporations 26-29
(1986) [hereinafter GAO, IRS Audit Coverage].
37
Under section 982, a taxpayer which, without reasonable
cause, fails to produce, within 90 days, foreign based documents
sought by the agent during the course of the examination through
the use of a formal document request may be precluded from
introducing the documents sought in a subsequent court
proceeding. A special court proceeding is established at which
the taxpayer may show reasonable cause for failing to produce the
requested documents or otherwise move to quash the formal
document request.

- 15 by the courts.38 However, as will be subsequently discussed,
agents have failed to use the section 982 and administrative
summons procedures aggressively.
Because of the dramatic increase in recent years in direct
foreign investment in the United States,39 the examination of
transactions between foreign parents and their U.S. affiliates
will become an increasingly more important part of the
international examination program. A survey of rates of return
on these companies based on IRS statistics of income ("SOI")
data reveals a substantially lower than average profit in this
country reported by these companies, which may involve transfer
pricing policies.40
In practice, examinations of United States subsidiaries of
foreign parents have developed into some of the Service's most
difficult examinations. A primary reason for the difficulty is
that agents are unable to obtain timely access to necessary
data, which is typically in the hands of the parent company. In
many cases, foreign parent companies refuse to produce this
information upon request. An additional difficulty encountered
by agents is that foreign parent corporations may not be subject
to information reporting requirements similar to U.S.
requirements.4 x
Both the administrative summons procedures42 and the formal
document request procedures43 are tools that are available to IEs
to compel production of information necessary to determine
38
whether
aVetco
section
v. United
482 adjustment
States, is
644appropriate.
F.2d 1324 (9th
Unfortunately,
Cir. 1981),
cert, denied, 454 U.S. 1098 (1982) (summons for books and records
of Swiss controlled foreign corporation enforced notwithstanding
potential violations of the Swiss Penal Code).
39
Foreign direct investment in the United States increased
from about $34.6 billion in 1977 to about $100.50 billion in
1984. GAO, IRS Audit Coverage, supra n. 36, at 10.
4
° Hobb, Foreign Investment and Activity in the United
States through Corporations, 1983, SOI Bulletin 53-68 (Summer
1987); see BNA Daily Tax Report, April 1, 1987, at G2.
41
Wheeler, SEC Requires Less Disclosure from Foreign
Corporations. Tax Notes, October 12, 1987, at 195-197.
42

Section 7602; United States v. Toyota Motor Corp., 561
F. Supp. 348 (CD. Cal. 1983); United States v. Toyota Motor
Corp., 569 F. Supp. 1158 (CD. Cal. 1983).
Section 982.

- 16 for a variety of reasons, IEs seldom serve administrative
summonses or section 982 requests.44 The most common reason
given for failing to use these procedures is the time delay
necessary to follow them, which conflicts with the need to close
the examination. Another reason given in many cases was the
necessity of maintaining a good working relationship with the
taxpayer, which IEs feared would be harmed if these procedures
were used.
Although section 6001 contains a general requirement that a
taxpayer maintain adequate books and records, the section 482
regulations are generally silent with regard to records and their
accessibility to either support or to determine arm's length
prices.45 Thus, the current regulations do not advise taxpayers
specifically of the type of information that is necessary in
order to determine compliance with section 482. Specific
information on transactions between parent and subsidiary
corporations is required on forms 5471 and 5472, which have been
widely used by agents in planning and conducting section 482
examinations.
Service experience has been that many taxpayers do not rely
upon any form of comparable transactions or other contemporaneous
information either in planning or in defending intercompany
transactions.46 Although the legislative history to the 1986 Act
expresses concern that industry average royalty rates are used by
taxpayers to justify royalties for high profit intangibles,47 the
more serious problem has been that the taxpayer, not having
structured the transaction with any comparable in mind, seeks to
defend its position by finding whatever transaction or method
gets closest to the transfer price initially chosen, whether that
be an44industry
of return
or of
some
other
type IEs
of
In theaverage
survey rate
conducted
as part
this
study,
comparable.
reported using summonses and section 982 requests in
approximately 5% and 4%, respectively, of the cases reported in
the survey. Appendix B, infra, at Questions 21, 22.
45
An exception in Treas. Reg. §1.482-2(b)(7) requires
adequate records to verify costs or deductions used in connection
with a charge for services to an affiliate.
46
Appendix B, infra, at Question 57.
47

H.R. Rep. No. 426, 99th Cong., 1st Sess. 424 (1985)
[hereinafter 1985 House Rep.]. The survey revealed that in
approximately 41% of the cases in which taxpayers relied upon
comparables, industry averages were used. Appendix A, infra.

- 17 Problems related to information and aggressive return
positions would be alleviated if the regulations specifically set
out a taxpayer's responsibility to document the methodology used
in establishing intercompany transfer prices prior to filing the
tax return and to require that such documentation be provided
within a reasonable time after request. The documentation should
include references to any comparable transactions, rates of
return, profit splits, or other information or analyses used by
the taxpayer in arriving at transfer prices. In general, a
taxpayer making relatively minor investments would not be
required to obtain information regarding comparable transactions
outside of its own knowledge of its business affairs and those of
its competitors, but to use information and analyses that
generally would have been produced by the taxpayer in the course
of developing its business plan. However, a taxpayer engaging in
a major transaction or one involved in a complex profit split
analysis involving significant high profit intangibles48 would be
expected to gather and analyze the types of information
illustrated by the examples in Appendix E which, once again, is
information likely to be produced by the taxpayer in developing
its business plan. In the absence of comparables, taxpayers
should be required at a minimum to apply a rate of return
analysis or profit split methodology that may be prescribed in
regulations under which the taxpayer would identify assets and
functions performed by it and its affiliates and identify the
rate of return or profit split that the taxpayer believes should
be assigned or allocated to each activity or function.
Furthermore, Forms 5471 and 5472 should be revised to
include summary information describing how intercompany prices
were determined and an attestation that the documentation
required to be maintained under the section 482 regulations, as
described above, was available at the time of preparation of the
return and will be made available at the start of an IRS
examination. Requiring information to be made available at the
beginning of an audit would alleviate problems of receiving
either too little or too much information near the expiration of
the statute of limitations.
The Service and Treasury believe that taxpayer compliance in
the transfer pricing area with respect both to disclosure of
information and to conformity with the arm's length standard
would be enhanced by the proper assertion of appropriate
penalties. While the penalty imposed by section 6661 for
Seeunderstatement
discussion infra
Chapter
substantial
of tax
can 11.
apply, to date the Service
has only infrequently imposed penalties in connection with making

- 18 section 482 adjustments.49 The Internal Revenue Service is
currently engaged in a comprehensive study of the role of civil
tax penalties,50 as are many other interested parties. It,
therefore, seems timely to focus now on the effectiveness of
existing penalties in encouraging compliant taxpayer behavior and
penalizing unjustified positions in the transfer pricing area.
Consideration should be given to when the section 6661 penalty
should be raised and whether it is adequate to deter instances
where taxpayers do not make intercompany pricing decisions upon a
reasonable basis, or whether a new penalty should be proposed.
The Service and Treasury are interested in recommendations
in this area, including such specific comments as to the type and
amount of penalties, and whether there should be certain
transaction oriented thresholds that ought to apply before any
penalty could be asserted. For example, a transaction specific
penalty (similar to the overvaluation penalty of section 6659)
may be an appropriate means of deterring substantial deviations
from the commensurate with income standard. Specific
consideration should be given to whether the applicable penalty
provisions should be amended to apply if there is a substantial
deviation from the appropriate commensurate with income payment
regardless of whether there is disclosure on the tax return of
the manner in which taxpayers computed transfer prices.
Disclosure of the taxpayer's method of computing a transfer price
can not adequately inform the Service as to whether such a
transfer price substantially deviates from the appropriate
section 482 transfer price absent a thorough audit.
Consequently, such disclosure should not prevent the imposition
of a penalty for substantial deviation from the correct section
482 transfer price.51 Since it is possible to use the provisions
of section 367(d) to deter abusive situations (see discussion of
49
section
367(d)
Under Rev.
infra Proc.
Chapter
88-37,
6), it
1988-30
may also
I.R.B.
be 31,
appropriate
a taxpayer
to
clarify
that
reports
how taxpayers
intercompany
may transactions,
avoid imposition
on of
Schedules
penalties
G and
in the
M of
context
Form 5471,
of may
section
avoid
367
the
adjustments.
substantial understatement penalty. See
Rev. Proc. 85-26, 1985-1 C B . 580 (amended returns or statements
made following commencement of a CEP examination may avoid
assertion of the substantial understatement penalty).
50
Commissioner's Penalty Study, A Philosophy of Civil Tax
Penalties (discussion draft June 8, 1988).
51
See discussion of the commensurate with income standard
and periodic adjustments infra Chapters 6 and 8.

- 19 B.

Intangibles

A significant portion of section 482 adjustments proposed in
recent years have involved an adjustment for pricing with respect
to the licensing or other transfer of intangibles.52 Because of
the absence of comparables in many cases, intangible transfers
generally are the most problematic of adjustments due to the
inherent difficulty of valuing intangibles under the existing
regulations. As previously noted in Chapter 2, the intangible
property portion of the regulations contemplate a failure to find
appropriate comparables and list 12 factors to be taken into
account in valuing intangibles in the absence of comparables. No
guidance is given, however, in determining the relative
importance of particular factors.
In a significant number of cases, IEs relied upon sections
of the regulations other than the intangibles portion to make a
transfer pricing adjustment.53 Intangibles are often transferred
by incorporation into tangible property that is sold or rented.
In these types of cases, the taxpayers have not been required to
isolate the value of the intangible.54 Incorporating a return on
an intangible in a transfer price for tangible property does not
alleviate, however, the difficulty of valuing the intangible.
A common example is the transfer of tangible property with a
trademark, trade name, or recognizable logo attached. It is
clear from the regulations that a trademark, trade name, or logo
is an intangible.55 The regulations governing the sales of
tangible property specify that, in applying the comparable
uncontrolled price, resale price, and cost plus methods,
adjustments must be made for sales with or without trademarks,
provided there is a reasonably ascertainable effect on the
56
price.
In some cases adjustments for trademarks are relatively
52
In
theThe
survey
conducted
for the
study,
an more
adjustment
was
easy to make.
analysis,
however,
becomes
much
complex
made
underare
Treas.
Reg. §1.482-2(d)
in about
50%without
of the reported
if there
no similar
products sold
(with or
cases. Appendix B, infra, at Question 68.
53
In approximately 40% of the cases reported in the
survey, IEs cited the inability to value an intangible as the
reason why they failed to follow the intangibles section of the
regulations. Appendix B, infra, at Question 72.
54
Rev. Rul. 75-254, 1975-1 CB. 243.
55
56

Treas. Reg. §1.482-2(d)(3).

See, e.g., Treas. Reg. §§1.482-2(e)(2)(ii) and example
(2), 1.482-2(e)(3)(ii) example (2), and 1.482-2(e)(4) ( iii) (c).

- 20 trademarks) on which to base a comparison. Setting a transfer
price for a product in such a case involves the same difficult
exercise as setting a royalty rate for a licensed intangible.
One of the recent pharmaceutical cases presents an example of
this latter situation since it involved the sale of unique
pharmaceutical products.5 7
Intangibles may also be transferred in the form of services.
In some circumstances, taxpayers have attempted to shift large
amounts of income to tax haven subsidiaries by "loaning" a few
key employees to a tax haven affiliate. By loaning employees,
the parent company may simultaneously provide services and
transfer valuable intangible know-how. In transactions which are
structured as an intangibles transfer, it is difficult to value
services rendered in connection with the transfer of intangible
property, which may be necessary for purposes of determining the
source of the income.58
A particularly difficult aspect of valuing intangibles has
been determining what part of an intangible profit is due to
manufacturing intangibles and what part is due to marketing
57

Eli Lilly & Co. v. Comm'r, 84 T.C. 996 (1985), rev'd in
part, aff'd in part and remanded, Nos. 86-2911 and 86-3116 (7th
Cir. August 31, 1988) [Lilly]. See the discussion of Lilly,
infra, Chapters 4 and 5.
58
In certain circumstances, no separate allocation is
required for services performed in connection with the transfer
of intangible property. Treas. Reg. §1.482-2(b)(8). Services
are rendered in connection with the transfer of intangible
property if they are merely ancillary or subsidiary to the
transfer of the intangible property. The regulations give as an
example of ancillary services start-up help given to a related
entity in order for it to integrate a trade secret manufacturing
process into its operations. The regulations then state that,
should the transferor continue to render services after the
process has been integrated into the manufacturing process, a
separate allocation for services would be required under the
regulations. The experience of the IEs is that the current
regulations fail to give them specific guidance on how to
determine when services rendered in connection with the transfer
of an intangible require a separate allocation.
Appendix D discusses results of a preliminary survey of data
available at the SEC. This data has the potential to determine
when unrelated parties would extract a specific charge for
services rendered in connection with the transfer of an intangible.

- 21 intangibles.59 This problem has particular significance in
section 936, since the possessions corporation is generally
entitled to a return only on manufacturing intangibles when it
elects the cost sharing method under section 936(h).
Problems with intangibles underlie the amendment made to
section 482 by the 1986 Act, as discussed in Part II. The
intangibles section of the section 482 regulations should be
modified to provide a specific analysis to be used when
comparable uncontrolled transactions do not exist. The method
should provide for appropriate allocations of income when
multiple intangibles (such as marketing and manufacturing
intangibles) are present in the same set of transactions. Part
III is devoted to the subject of an appropriate methodology for
allocating intangible income.
C. Application of Pricing Methods for Transfers of Tangible
Property
When considering an adjustment with respect to the transfer
price for tangible property, the regulations require both the
taxpayer and the Service to follow a priority of pricing methods:
first, the comparable uncontrolled price method must be
attempted, then resale price method, then cost plus method, and,
if none of them are applicable, some other method or combination
of the prior methods.60 Five prior studies using data available
from both the Service and multinational corporations have
examined the frequency with which each of these methods has been
used. The results of these surveys are set forth below:

In Lilly, supra n. 57, the Tax Court ultimately
determined the parent company's marketing return based upon using
its "best judgment." Lilly, 84 T-C at 1167; See also G. D.
Searle and Co. v. Comm'r [Searle], 88 T.C. 252, 376 (1987).
60
Treas. Reg. §§1.482-2(e)(l)(ii) and (iii).

- 22 Report

1973 Treas. Report 61
Conference Bd Report 6 2
Burns Report 6 3
GAO 64
1984 IRS Survey65
1987 IRS Survey
(overall)
1987 IRS Survey66
(tangible property)

Percentage of Cases in which Various
§ 482 Pricing Methods Were Used
CUP

Resale

Cost Plus

Other

20
28
24
15
41
32

11
13
14
14
7
8

27
23
30
26
7
24

40
36
32
47
45
36

Treasury Department News Release, Summary Study of
International Cases Involving Section 482 of the Internal Revenue
Code (Jan. 8, 1973), reprinted in 1973 Standard Federal Tax
Report (CCH) par. 6419.
62
Tax Allocations and International Business: Corporate
Experience with Section 482 of the Internal Revenue Code,
Conference Board Report No. 555 (1972).
6 3
Burns, How IRS Applies the Intercompany Pricing Rules of
Section 482: A Corporate Survey, 54 J. Tax'n 308 (1980).
64

General Accounting Office, Report by the Comptroller
General to the Chairman, House Committee on Ways and Means, IRS
Could Better Protect U.S. Tax Interests in Determining the Income
of Multinational Corporations (1981) [hereinafter GAO, IRS Could
Better Protect U.S. Tax Interests].
65
IRS Publication No. 1243, IRS Examination Data Reveal an
Effective Administration of Section 482 Regulations (1984).
66

As stated earlier, the percentages from the 1987 survey
do not represent a scientifically valid random sample. They are
based upon responses to a questionnaire sent to selected groups
of International Examiners who responded with respect to a small
number of cases selected by them. Compared to the 1984 survey
undertaken by the Assistant Commissioner (Examination), however,
they suggest one significant trend: a substantial increase in the
use of the cost plus method with a corresponding decrease in
cases classified as either "comparable uncontrolled price" or
"other." Such a trend would probably be due to an emphasis
during the last several years on examining cases that involved
manufacturing activities in tax haven jurisdictions. See GAO,
IRS Audit Coverage, supra n. 36, at 26-29.

- 23 Recent Service experience has been that the starting point
for analyzing any pricing issue begins with the search for a
comparable uncontrolled transaction. For a significant number of
cases, these transactions can be found, although frequently not
without a great deal of ingenuity and persistence by the
examining agent or other Service personnel.67 If comparable
uncontrolled prices do not exist, IEs or Service economists will
seek to locate comparable transactions based on functions
performed and risks borne by the entity at issue* This type of
an issue lends itself to resale price or cost plus, depending
upon the circumstances. If neither comparable uncontrolled
prices nor comparable uncontrolled transactions can be found, a
variety of fourth methods may be used.
One justification given for the current priority of methods
in the regulations is that both the taxpayer and the Service are
thus directed to a common frame of analysis to avoid the problem
of the Service using one method while the taxpayer uses another
method. However, as currently structured, the regulations
literally require that both the taxpayer and the agent attempt to
apply the methods in priority order. Because the resale price
method generally applies only to distributors of goods, while the
cost plus method applies generally to manufacturers, there does
not seem to be any reason in theory why the agent or taxpayer
should attempt to apply the resale price method before applying
the cost plus method.68 In practice, taxpayers and agents rely
upon comparable uncontrolled prices or transactions, when they
exist. When they do not exist, agents or taxpayers use whatever
method they believe best reflects the economic realities of the
transaction at issue. While there are valid theoretical reasons
for retaining the priority of the comparable uncontrolled price
method,69 there do not seem to be any valid reasons for
preferring
resale price over cost plus or another method, or for
67
Appendix
B, infra,
at Questions
preferring resale price
or cost
plus over 62-64.
some other economically
68
sound
method. supra
Rather,
the method
should
the
In Lilly,
n. 57,
the IRSused
notice
of generally
deficiencybewas
one
for
which
the
best
data
is
available
and
for
which
the
fewest
based upon the cost plus method while the taxpayer initially
number
of to
adjustments
attempted
rely upon are
therequired.
resale price method. The Tax Court
rejected application of the cost plus method and, also, the
taxpayer's analysis under both the resale price and "fourth"
methods. It ultimately adopted a profit split method for the
first two years at issue and a CUP method for the final year.
See discussion of Lilly infra Chapters 4 and 5.
See discussion of this issue infra Chapter 11.

- 24 One technique that is missing from the section 482
regulations that in practice is used extensively by the
international examiners is functional analysis. This analysis
focuses on the economic functions performed by the affiliated
parties to a transaction and the economic risks borne by each of
the parties.70 This technique is used by IEs and Service
economists not as a method standing alone but rather as a means
of verifying that prices or transactions are truly comparable to
the situation under examination or as a basis for a fourth
method.
As discussed in section B, intangibles are often transferred
by incorporation into tangible property that is sold, and setting
a transfer price for a product in such a case involves the same
difficult exercise as setting a royalty rate for a licensed
intangible. The difficulty of valuing intangibles is, therefore,
as much a problem in the context of sales of property as in the
case of licenses or other transfers of intangibles.
D. Use of Specialists and Counsel
The use of counsel and economic specialists at the
examination level would ameliorate some of the problems,
discussed above, of obtaining information and dealing with
difficult intangible pricing cases. Legal assistance during
examination is needed to assist in obtaining relevant information
and in determining whether an appropriate legal basis exists for
a proposed adjustment. Economists are needed in many cases to
perform a functional analysis and to help evaluate the proper
returns to be accorded to the related parties. Other experts
may be required to analyze practices within the taxpayer's
industry. The goal of the attorney, the economist, and other
specialists should be to assist the IE in obtaining all relevant
facts and to determine whether an adjustment may be sustained on
appropriate legal and economic theories if the matter ever
results in litigation.
For section 482 cases developed 10 years ago, it would have
been normal for the IE to develop the case without the assistance
of an economist or without the assistance of a Chief Counsel
attorney. Authority and expertise in international tax matters
were then split between the National Office Examination function
and the Director, Foreign Operations District. Legal expertise
in international tax matters was diffused among at least four
70
national
office
I.R.M. §4233(523.2).
divisions and was
The limited
Manual states
in field
that
offices.
almost all
cases can be analyzed using a functional analysis.

- 25 In May 1986 the Office of the Assistant Commissioner
(International) was created to provide an emphasis upon, and a
focal point for, development of international issues at the
examination stage. The Office of Associate Chief Counsel
(International) was created in March 1986 to provide a similar
focal point for legal issues. In addition, a network of
International Special Trial Attorneys and senior District Counsel
attorneys has been created to litigate significant international
tax cases, including section 482 cases. More importantly, these
field attorneys and their National Office counterparts have been
encouraged to assist the field in developing these cases, and
IEs are encouraged to use their assistance.71
Within the last several years, the Service has substantially
increased the number of economists available to assist IEs and
has decentralized those activities from the national office to
three key District offices: Baltimore, New York, and Chicago.
Use of economists in major section 482 examinations that do not
involve safe harbors is now required.72
One criticism that has been made concerning the more
extensive use of counsel and experts at the examination stage is
that the time necessary to complete an examination (already
lengthy) will be further extended. Service experience has been,
however, that increased use of specialists has not unduly delayed
disposition of the examination in the vast majority of the
cases.73 Furthermore, the early use of specialists in some cases
will prevent erroneous adjustments from ever being made, thus
saving both taxpayers and the government substantial sums of time
and money.
E. Conclusions & Recommendations
Access to pricing information
1. The failure of the taxpayer to document the methodology
used to establish transfer prices under the section
482 regulations and delays or failure by taxpayers in
supplying information to IEs are significant problems
that hamper the IRS in its administration of section
482.
2. The section 482 regulations are deficient in not
requiring taxpayers to document intercompany pricing
policies
and to supply information upon examination.
I.R.M.
§4233(524).
I.R.M. §42(12)3.
73

Appendix B, infra, at Question 32.

- 26 The section 482 regulations should be amended to
require taxpayers to document the methodology used to
establish transfer prices prior to filing the tax
return and to provide such documentation during
examination within a reasonable time after request.
The documentation should include references to any
comparable prices or transactions, rates of return,
profit splits or other information or analysis used by
the taxpayer in arriving at the transfer price.
Forms 5471 and 5472 should be revised to include: (a)
summary information describing how intercompany prices
were determined; and (b) an attestation that the
documentation described in paragraph 2, supra, was
available at the time of preparation of the return and
will be made available at the start of an IRS
examination.
IEs experiencing difficulties in obtaining transfer
pricing information have failed to deal with noncompliant taxpayers through the issuance of section
982 requests and administrative summonses. The Service
should more aggressively pursue noncompliant taxpayers
that delay, without justification, in producing
relevant pricing information by using the section 982
and administrative summons procedures.
The assertion of appropriate penalties is a necessary
but often ignored element of transfer pricing
compliance. In conjunction with the Service's broadbased review of penalties, the Government should
determine whether existing penalties are sufficient to:
(a) compel taxpayers to provide thorough and accurate
information as set forth in paragraphs 2 and 3 supra;
and (b) deter taxpayers from setting overly aggressive
and unjustified transfer prices that are inconsistent
with the commensurate with income standard. If it is
felt that existing penalties are inadequate,
legislative solutions should be pursued. The Service
and Treasury encourage comments in this area, including
Establishing
appropriate
prices for
the type of penalty,
suchtransfer
as a transaction
based
intangibles
has
been
a
significant
problem
because of
penalty, that might be proposed.
the inherent difficulty of valuing intangibles -es
particularly when intangibles are transferred
simultaneously with the transfer of tangible property
or the provision of services.

- 27 7.

The intangibles section of the section 482 regulations
should be modified to provide a specific method of
analysis to be used when comparable uncontrolled
transactions do not exist. This method should provide
for appropriate allocation when multiple intangibles
(such as marketing and manufacturing intangibles) are
present in the same set of transactions. Part III is
devoted to the subject of an appropriate methodology
for allocating intangible income.
Application of pricing method for transfers of tangible property
8. The current priority for the comparable uncontrolled
price method should be retained, since such prices
generally provide the best evidence of what unrelated
parties would do in an arm's length transaction. There
does not appear to be any reason to retain the current
priority of the resale price method over the cost plus
method, or for preferring resale price or cost plus
over some other economically sound method. Rather, the
method used should generally be the one for which the
best data is available and for which the fewest number
of adjustments are required.
9. Since intangibles are often incorporated into tangible
property that is sold, the difficulty of valuing
intangibles is as much of a problem in many transfers
of tangible property as in the context of licenses or
other transfers of intangible property.
Use of specialists and counsel
10- The use of counsel and economic specialists at the
examination level would ameliorate the problems of
obtaining information and dealing with the difficult
intangible pricing cases. Chief Counsel attorneys
familiar with transfer pricing issues should be
involved in significant cases at an early stage to
make sure that relevant information necessary for the
examination is being obtained and that a technical
basis for a potential adjustment exists. An economist
needs to be involved at an early stage to perform a
functional analysis and to evaluate the proper returns
to be accorded to the related parties. The goal of the
attorney, the economist, and other specialists should
be to assist the IE in obtaining all relevant facts and
to determine whether an adjustment may be sustained on
appropriate legal and economic theories if the matter
ever results in litigation.

- 28 Chapter 4
THE SEARCH FOR COMPARABLES
A. Introduction
As explained in Chapter 2, the section 482 regulations rely
heavily on finding comparable goods, services, and intangibles to
determine whether an arm's length price has been used. Where
such comparables exist — where arm's length transactions bearing
a reasonable economic resemblance to those being examined have
occurred in the free market — application of the regulations is
relatively straightforward. Where no comparables can be found,
or where similar items are only distantly comparable, the
regulations leave the Service, the taxpayers, and the courts with
little guidance.
This chapter examines several recent cases decided under
section 482 to assess the use of comparables by the parties and
the courts, whether in the context of either sales of tangible
property, the provision of services, or licenses or other
transfers of intangible property. These cases show that
comparables are often difficult to locate, and may be misused or
misinterpreted even if they are found. In most of the cases
discussed in this chapter, no comparables were available. The
courts' resolution of the issues in the absence of comparables is
discussed in Chapter 5.
B. Specific comparables
In recent years, transfer pricing cases involving highly
profitable products -- which usually are associated with unique
intangibles — have severely tested the comparables approach of
the present section 482 regulations. This problem is illustrated
by the Lilly77 case. In Lilly, the U.S. parent corporation,
Lilly U.S., transferred highly profitable manufacturing
intangibles, including patents and know-how (primarily relating
to the drugs Darvon and Darvon-N), to its newly-formed U.S.
subsidiary in Puerto Rico, Lilly P.R., in a tax-free exchange
for Lilly P.R. stock under section 351. The Service took the
position that the income associated with those intangibles should
be allocated to Lilly U.S., notwithstanding their tax-free
transfer to Lilly P.R.
In preparation for trial, the government's experts surveyed
the most successful U.S. pharmaceutical products. They
discovered that the patents to such products were rarely
Supra
n. 57.to a related party. The government argued
transferred,
except
that unrelated parties would not have transferred the Darvon

- 29 intangibles and that, accordingly, there were no comparable
marketplace transactions. While the Tax Court did not fully
subscribe to the government's theory of the case, it
nevertheless was not able to find appropriate comparables for the
patented products in question for the first 2 years at issue,
1971 and 1972.78 The court proceeded to make its own
allocations, basing its adjustments on the proposition that a
distortion of income was created by the transfer of intangibles
from Lilly U.S. to Lilly P.R. in exchange for Lilly P.R. stock.
In the Tax Court's view, the distortion arose because it felt
that Lilly would have demanded a stream of income from the
transferred Darvon intangibles in order to fund a proportionate
part of its ongoing general research and development efforts.
The Tax Court also used a profit split approach to increase the
return of Lilly U.S. on marketing expenditures and intangibles.79
On appeal, the Seventh Circuit rejected the Tax Court's
allocation to support research and development, but affirmed its
profit split methodology.
In Searle,80 the petitioner transferred the patents (or
licenses) on its most successful pharmaceutical products to its
U.S. subsidiary, SCO, operating in Puerto Rico. These
intangibles represented products accounting for approximately 80
percent of the petitioner's profits and sales. As in Lilly, the
government argued that a section 482 allocation from SCO to the
petitioner was appropriate.
The petitioner, relying on section 1.482-2(d)(2)(ii) of the
regulations, argued that, since it had originally acquired two of
the transferred intangibles by licensing agreements carrying
royalties of ten percent and eight percent of net sales, an
unrelated party would not have paid more than a royalty in this
range for the intangible property transferred to SCO. The court,
however, found that the original licenses were not comparable;
the products were licensed from European pharmaceutical firms
prior78to their
approval
by Court
the FDA,
thus
coulda not
have been
For 1973,
the Tax
was and
able
to use
comparable
marketed
in
the
United
States
at
the
time
of
the
license.
uncontrolled price approach because the Darvon patent had The
expired. However, numerous adjustments were made to reach a
transfer price.
79
See discussion of the Tax Court's profit split analysis
infra Chapter 5.
Supra n. 59.

- 30 court concluded that the intangibles to SCO were significantly
more valuable than the "mere licensing agreements" upon which the
taxpayer relied.81
Ultimately, the court found, despite the voluminous record,
that "there is little hard evidence from which we can determine
what consideration petitioner would have demanded had the
transactions under scrutiny here taken place between unrelated
parties dealing at arm's length."82
Problems with finding or applying comparables for valuable
intangibles have not been limited to pharmaceutical companies.
In Hospital Corporation of America,83 a U.S. hospital management
company, HCA, entered into negotiations to recruit professional
and non-professional staff to manage a state-of-the-art hospital
in Saudi Arabia. It formed a Cayman Islands corporation, LTD,
ostensibly to negotiate and perform the management contract. HCA
performed services for LTD and made available at little cost all
of its know-how, experience, management systems knowledge, and
other intangibles. The parties offered no evidence of comparable
transactions, and the court identified none. Nevertheless, the
court allocated 25% of the income to LTD as compensation for its
management service.
The Tax Court was also unable to find appropriate
comparables in Ciba-Geigy Corp. v. Comm'r.,84 where the Service
sought to reduce royalties paid by a U.S. subsidiary to its
foreign parent for the rights to manufacture and sell a
herbicide. Unlike the approach taken by the courts in Lilly for
1973, where multiple adjustments were made to a third party
transaction in order to determine a comparable price, the court
in Ciba-Geigy rejected as comparables licenses of the same
product to unrelated parties because of differences in geographic
markets, years of the license, and differences in required
purchases of raw materials.85 Instead the court relied upon
testimony from an unrelated party about what his company would
have been willing to pay in the form of a royalty for the same
rights.
81
Id. at 375.
The comparability
of third party resale price margins was
at issue
in
E.I.
DuPont
de Nemours & Co. v. United States
82
Id. at 376.
83

Supra n. 17.

85 T.C 172 (1985).

8 5

Id. at 225-26.

- 31 [DuPont].86 In that case, the U.S. parent company incorporated
DuPont International S.A., DISA, in Switzerland to serve as a
super distributor of DuPont products in Europe. Internal DuPont
memos indicated that DuPont planned to sell its goods to DISA at
prices below fair market value, so that on resale most of the
profits would be reported in a foreign country having much lower
tax rates than the United States.87 Although for many products
DISA performed no special services for either DuPont or its
customers, DuPont structured its pricing to DISA anticipating
that the latter would capture 75 percent of the total profits
involved, although DISA actually realized less than this
percentage. The Service reallocated much of this profit back to
the parent.
The government introduced expert testimony at trial to the
effect that, after the allocations, DISA's ratio of gross income
to total operating costs was greater than that achieved by 32
specific firms that were functionally similar to DISA.
Additionally, it was shown that, after the allocations, DISA's
return on capital was greater than that of 96 percent of 1133
companies surveyed.88
The taxpayer, on the other hand, relied solely upon the
resale price method. It contended that similar companies selling
similar products experienced average markups of between 19.5 and
38 percent, comparing favorably with DISA's 26 percent gross
profit margin. In rejecting the taxpayer's position the court
made the following comments:
Taxpayer tells us that a group of 21 distributors,
whose general functions were similar to DISA's,
provides the proper base of comparison. Beyond the
most general showing that this group, like DISA,
distributed manufactured goods, there is nothing in the
record showing the degree of similarity called for by
the regulation. No data exist to establish similarity
of products (with associated marketing costs),
86
comparability
of functions,
or parallel geographic (and
608 F.2d 445
(Ct. CI. 1979).
economic) market conditions. Rather, the record
87
Thesuggests
facts in
DuPont are
similar to the
abuse has
relating
significant
differences.
Defendant
to the use of foreign base sales companies to defer the taxation
of income in the United States that Congress sought to end
through the Subpart F provisions enacted in the Revenue Act of
1962. H.R. Rep. No. 1447, 87th Cong., 2d Sess. 28 (1962).
88
See discussion infra Chapter 5 regarding the income to
costs ratio and return on capital methods used in DuPont.

- 32 introduced evidence that the six companies plaintiff
identifies most closely with DISA all had average
selling costs much higher than DISA. Because we agree
with the trial judge and defendant's expert that, in
general,, what a business spends to provide services is
a reasonable indication of the magnitude of those
services, and because plaintiff has not rebutted that
normal presumption in this case, we cannot view these
six companies as having made resales similar to DISA's.
They may have made gross profits comparable to DISA's
but their selling costs, reflecting the greater scale
of their services or efforts, were much higher in each
instance. Moreover, the record shows that these
companies dealt with quite different products
(electronic and photographic equipment) and functioned
in different markets (primarily the United States).89
Another case that raised questions of comparability is
United States Steel v. Comm'r.90 There, the Service contended
that Navios, the petitioner's wholly owned shipping company, was
charging the petitioner more than an arm's length rate for
shipping ore from Venezuela to United States ports. The
government relied on evidence that, had U.S. Steel contracted
with other shippers for the same tonnage per year, it would have
paid considerably lower rates. The petitioner countered that,
because Navios charged unrelated steel producers the same rate as
the petitioner, a perfect comparable was available from which to
determine an arm's length price. The government contended that
the unrelated third party transactions were not comparable
because they were few in number, they were not based on a
continuing long-term relationship, and the volume shipped was
much smaller than the ten million tons annually shipped by Navios
for U.S. Steel.
The Tax Court did not decide the case on the basis of
comparables. Instead, the court focused on constructed freight
charges and on the profit that the tax haven subsidiary was
projected by the taxpayer to earn on the activities it undertook.
On appeal, the Second Circuit held that, if appropriate
comparables
were available to support the petitioner's prices, no
89
Supra n. 86.
section 482 allocation would be sustained despite evidence
90 to show that the activities resulted in a shifting of tax
tending
617 F.2d 942 (2d Cir. 1980), rev'g T.C. Memo. 1977-140.
liability
among controlled taxpayers.91 The appellate court
91
617 F.2d at 951.

- 33 accepted the third party transactions as comparables and reversed
the Tax Court on this issue, notwithstanding the substantial
economic differences from the related party transactions.
C. Industry Statistics as Comparables
The Service and taxpayers have relied on industry statistics
in several cases to justify or defend against section 482
allocations. Industry statistics have generally been offered as
evidence of comparable uncontrolled prices or for markup
percentages under the resale price or cost plus methods. The
courts, however, have been reluctant to accept such statistics in
the absence of a specific showing of comparability.
In the DuPont case, discussed supra, the taxpayer relied on
gross profit margins of drug and chemical wholesalers contained
in the Internal Revenue Service's Source Book of Statistics of
Income for 1960 to support a gross profit margin of 26 percent.
The gross profit margins of these companies averaged 21 percent
and ranged from 9 to 33 percent. The court noted that in
applying the resale price method it was necessary to find
substantially comparable uncontrolled resellers. Because there
was no indication from the Source Book that the necessary degree
of comparability was present, the court rejected the taxpayer's
industry statistics.
'The government relied upon the Source Book of Statistics of
Income in PPG Industries Inc. v. Comm'r,92 to allocate a
substantial portion of the income of a Swiss corporation to its
U.S. parent. Rejecting this approach, the court found the Source
Book evidence wanting because it could not be determined whether
comparable transactions were involved.
In Ross Glove Co. v. Comm'r,93 the Service allocated income
from a foreign glove manufacturer to its U-S. parent. The
government relied upon expert testimony that the glove
manufacturing industry was not a high profit industry, and that
a typical glove manufacturer rarely had a year in which gross
profits equalled three percent of sales. The court rejected this
testimony because it did not relate to the rate of return earned
by Philippine glove manufacturers, such as the taxpayer's
subsidiary, whose profits generally were higher than those of
92
93

55 T.C 928 (1970).
60 T.C. 569 (1973).

- 34 U-S. manufacturers.
Industry statistics were also rejected as
unreliable in Edwards v. Comm'r94 and in Nissho Iwai American
Corp. v. Comm'r.95
D. The Regulations in the Absence of Comparables
The only detailed transfer pricing methods in the
regulations rely in one way or another on comparables. The cases
discussed in this chapter, in which comparables were generally
unavailable, suggest that the regulations fail to resolve the
most significant and potentially abusive fact patterns. This
failure was noted both in the Court of Claims opinion and the
trial judge's opinion in DuPont. Trial Judge Willi, after
finding for the government, suggested that the current regulatory
structure was wholly inadequate:
At least where the sale of tangible property is
involved, the Commissioner's regulations seem to accommodate
nothing short of a "pricing method" to determine the
question of an arm's length price. Treas. Reg. §1.4822(3)(e)(l)(iii). Moreover, as plaintiff has correctly
noted, the regulation approach seems to rule out net profit
as a relevant consideration in the determination of an arm's
length price, this despite Congress' encouragement to the
contrary, as expressed in H. R. Rep. No. 2508, 87th Cong.,
2d Sess. 18-19 (1962) (Conference Report).
As evidenced by the magnitude of the record compiled in
this case, the resolution by trial of a reallocation
controversy under section 482 can be a very burdensome,
time-consuming and obviously expensive process -- especially
if the stakes are high. A more manageable and expeditious
means of resolution should be found.96
In difficult cases for which comparable products and
transactions do not exist, the parties and the courts have been
forced to devise ad hoc methods of their own -- so-called "fourth
methods" -- to determine appropriate allocations of income. The
next chapter describes the methods that the courts have used to
resolve these issues.
94
67 T.C. 224 (1976).
95
96

T.C. Memo. 1985-578.

78-1 USTC para. 9374, at 83,910 (Ct. CI. Trial Div.
1978).

- 35 E. Conclusion
The failure of the regulations to provide guidance in the
absence of comparable products and transactions has created
problems in cases involving sales of tangible property, the
provision of services, and licenses or other transfers of
intangible property. Taxpayers and the courts have been
forced to devise ad hoc "fourth methods" to resolve such
cases.

- 36 Chapter 5
FOURTH METHOD ANALYSIS UNDER SECTION 482
A. Introduction
Although the "other method" provision of section 1.4822(e)(l)(iii) (commonly known as the "fourth method") by its terms
applies only to tangible property transfer pricing cases, the
term "fourth method" has been used to describe any case resolved
by using a method not specifically described in the regulations,
typically when comparable uncontrolled transactions were
unavailable. This chapter discusses the use of the "fourth
method" approach in the decided cases, including cases involving
the sale of tangible property, the licensing or other transfer of
intangible property, and the provision of services.
B. Profit Splits
The most frequent alternative method used by the courts in
the absence of comparables is the profit split approach. Under
this approach, the court determines the total profits allocable
to the transactions at issue and simply divides them between the
related parties in some ratio deemed appropriate by the court.
The validity of the method, of course, rests on the accurate
determination of total profits and the reasonableness of the
factors used to set the profit split ratio.
An illustration of the profit split method is found in
Lilly.97 After rejecting the resale price and cost plus pricing
methods advocated by the parties because of the absence of
comparables, the Tax Court attempted to find an appropriate
fourth method under section 1.482-2(e)(1)(iii) of the
regulations. The court cited a number of studies and surveys
indicating that fourth methods were used by the Service
approximately one-third of the time, and determined that a profit
split approach was permissible.98
In adopting the profit split approach, the Tax Court relied
heavily on PPG Industries Inc.99 The court there, in considering
the allocation of income between PPG and its foreign subsidiary,
applied a profit split analysis (which produced a 55-45 profit
split9 7in favor of PPG) to buttress the court's primary analysis
n. 57.uncontrolled
See discussion
ofmethod.
Lilly supra Chapter 4.
using theSupra
comparable
price
98
84 T.C. at 1148-49. The results of these surveys and
studies are referenced in Chapter 3, supra.
99

Supra n. 92.

- 37 The Tax Court in Lilly also found support in Lufkin Foundry
& Machine Co. v. Comm'r,100^ in which it had used a profit split
method. On appeal, the Fifth Circuit rejected the Tax Court's
profit split approach because the court had not attempted to
apply the three specific pricing methods in the regulations and
because, by itself, a profit split approach was not sufficient
evidence of what parties would have done at arm's length.
However, the court in Lilly distinguished the Fifth Circuit's
reversal of the Tax Court's holding on the following grounds:
The three preferred pricing methods detailed in the
regulations are clearly inapplicable due to a lack of
comparable or similar uncontrolled transactions.
Petitioner's evidence amply demonstrates that some
fourth method not only is more appropriate, but is
inescapable,101
After providing for location savings,102 manufacturing
profit, marketing profit, and a charge for ongoing general
research and development performed by the parent, the Tax Court
in Lilly arrived at undivided profits of $25,489,000 for 1971
and $19,277,000 for 1972.103 It considered these amounts to be
the profits from intangibles, consisting of manufacturing
intangibles belonging to Lilly P.R. and marketing intangibles
belonging to Lilly U.S. The court rejected the taxpayer's
argument that its marketing intangibles were of little value and
assigned 45 percent of the intangible income to Lilly U.S. as a
marketing profit and 55 percent of the intangible income to
Lilly P.R. as a manufacturing profit. The court did not explain
how it arrived at the 45-55 split, other than stating that it
used its best judgment and that it bore heavily against the
100

T.C. Memo. 1971-101, rev'd, 468 F.2d 805 (5th Cir.

1972).
101
102

84 T.C at 1150-51.

"Location savings" were specifically authorized for
certain Puerto Rican affiliates by Rev. Proc. 63-10, 1963-1 C B .
490, 494. Location savings do not otherwise automatically accrue
to an affiliate, but under the arm's length standard of section
482 are distributed as the marketplace would divide them.
84 T.C. at 1168, n. 102.

- 38 taxpayer because it failed to prove the arm's length prices for
Lilly P.R.'s products.104 On appeal, the Seventh Circuit
affirmed the Tax Court's profit split.105
The Searle106 case was tried by the Tax Court shortly after
Lilly. The primary facts that distinguished Searle from Lilly
were that Searle transferred nearly all of its highly profitable
manufacturing intangibles to its Puerto Rican subsidiary and that
Searle did not purchase the products produced in Puerto Rico, but
instead marketed them in the United States as an agent for its
subsidiary. While the court could not technically apply a fourth
method under the regulations governing sales of tangible property
(since there were no intercompany sales), the court nevertheless
imposed a profit split similar in result to the profit split
imposed in Lilly.
In Searle, the Tax Court did not specifically determine the
revenue that each of the parties should earn from manufacturing
and marketing or which party should bear the expenses of
research and development and administration. While suggesting
that additional royalties were due Searle for the intangibles
provided to SCO, the court stated that "whether our allocation
herein is considered an additional payment for services or for
intangibles that were not transferred or as a royalty payment for
intangibles themselves, the result is the same."107
A profit split approach is also contained in section 936(h)
of the Code, added by the Tax Equity and Fiscal Responsibility
Act of 1982, effective for years beginning after December 31,
1982. In general, section 936(h) authorizes a profit split
election under which the combined taxable income of the
possessions affiliate and the U.S. affiliate, with respect to
products produced in whole or in part in the possession, will be
allocated 50 percent to the possessions affiliate and 50 percent
to the U.S. affiliate. If a profit split election is made,
section 482 is not available for any further allocation.
The section 936(h) 50-50 profit split does not, however,
provide any logical support for 50-50 profit splits in cases not
falling within the narrow scope of the section. Thus, even
1 0 4the Tax Court and Congress have moved in the direction of
though
84 T.C. at 1167.
50-50 profit splits in some limited cases, it would appear that
105
See discussion
supra
Chapter
4. absence of appropriate
profit
splits
should only
be used
in the
106
107

Supra n. 59. See discussion of Searle supra Chapter 4.
88 T.C. at 376.

- 39 comparables, and then only after a careful analysis of what
functions each party has performed, what property they have
employed, and what risks they have undertaken. When one
affiliate's role in the transactions has been extremely limited,
a 50-50 profit split may not be at all appropriate.
Such a lopsided division of relevant factors occurred in
Hospital Corporation of America.108 The court's opinion recites
in great detail the numerous services HCA provided for LTD in
negotiating the management contract and in staffing and operating
the hospital, as well as the numerous intangibles that HCA
provided, such as its substantial experience, know-how, and
management systems. Under these circumstances it would be
extremely difficult to estimate accurately the arm's length value
for the large volume of services and intangibles made available.
It was certainly easier for the court to look at the relative
value of the functions that each party performed, so that a
profit split ratio could be developed. The court in HCA did just
that, adopting a 75-25 (75 for HCA and 25 for LTD) split of the
profits previously reported by LTD. 109 Unfortunately, there is
no discernible rationale contained in the opinion for such a
split.
Hospital Corporation of America, like Searle, was not a
transfer pricing case and therefore was not a fourth method case
under the tangibles pricing regulation. However, both of these
cases illustrate that, when highly profitable, unique intangibles
are at issue, traditional methods of valuation will often fail
because comparables are unavailable. In these circumstances a
profit split approach appears reasonable as long as it is based
on a careful functional analysis to determine each party's
economic contribution to the combined profit.
C. Rate of Return; Income to Expense Ratios
Although profit splits are being used more frequently, the
courts have used other methods as well to justify transfer
pricing adjustments. Two of these methods are illustrated by
the DuPont110 case.
In defending the Service's section 482 allocations, the
government used two different methods. The first method was
computing ±he ratio of gross income to total operating costs
1 0 8as the "Berry ratio" because it was first used by the
(known
Supra n. 17. See discussion supra Chapter 4.
Government's expert witness, Dr. Charles Berry). DISA's Berry
109
81 T.C. at 601.
no

Supra n. 86.

See discussion supra Chapter 4.

- 40 ratio before the allocation was 281.5 percent of operating
expenses for 1959 and 397.1 percent for 1960. After the section
482 allocation, DISA's Berry ratio was 108.6 for 1959 and 179.3
for 1960. A survey of six management firms, five advertising
firms, and 21 distributors (firms which were generally
functionally similar to DISA) revealed average Berry ratios
ranging from 108.3 to 129.3. Thus, DISA's combined Berry ratio
for 1959 and 1960 before the allocation was about three times
higher than the average for the other firms. As noted by the
court, in over a hundred years of those companies' experience,
none of them had ever achieved the ratios claimed by DISA. Even
after the allocation, its Berry ratio was somewhat higher than
that of the comparable firms.111
The second approach, developed by Dr. Irving Plotkin, was to
compare DISA's rate of return on capital to that of 1133
companies that did not necessarily have functional similarities
to DISA, but instead reflected a comprehensive selection from
industry as a whole. Prior to the allocation, DISA had a rate of
return of 450 percent in 1959 and 147.2 percent in 1960 — rates
higher than those of all 1133 other companies. Even after the
allocation, DISA's rate of return exceeded that of 96 percent of
the 1133 companies surveyed.112 Based on this evidence the court
sustained the Service's allocations.
While the Berry ratio and the rate of return analysis found
in DuPont are interesting, it should be kept in mind that the
court may have looked favorably on this evidence partly because
it indicated that even after the allocation DISA earned greater
profits than almost any other corporation, whether comparable or
not. These methods were not used directly to make a section 482
adjustment, but rather to support the reasonableness of the
Service's allocation.
Evidence relating to rates of return was also presented in
Lilly.113 No general research and development costs for new
drugs were being charged by the parent to the subsidiary. The
Tax Court determined that a substantial adjustment should be made
111
Id. of
at 456.
to the
income
the Puerto Rican subsidiary to reflect a
proportional payment by the subsidiary of the general research
112
and Id.
development expense of the parent.114 The difference between
113
84 T.C. at 1157, 1161.
114

The court relied upon testimony by the Service's
accounting expert, Dr. James Wheeler, to show that, if the
taxpayer had transferred the rest of its successful products to

- 41 the rates of return to the two entities was not, however, due
solely to the understating of the subsidiary's research and
development expense (as determined by the court), but was also
attributable to the presence of valuable intangibles that were
not properly reflected in the transfer price. A rate of return
analysis was used to identify what appeared to be excessive rates
of return on assets, so that further inquiry could be made to
determine if the returns were in fact excessive and, if so, why.
The rate of return analysis and other information contained
in the report by Dr. Wheeler was as follows:115
1971 1972 1973
Return on Average Employed Assets:116
Parent (consolidated return)
19.9%
Puerto Rican Subsidiary
138.4%
117
Adjusted Taxable Income to Net Sales:
Parent (consolidated return)
16.9%
Puerto Rican Subsidiary
69.6%
Operating Expenses to Sales:
Parent (consolidated return)
41.5%
Puerto Rican Subsidiary
9.8%

23.8% 30.4%
142.6% 100.7%
20.4% 24.7%
68.9% 58.8%
39.8% 38.9%
11.6% 16.2%

Puerto Rico under terms similar to its transfer of Darvon, its
return would have been insufficient to enable it to continue
funding its R&D program, which the court characterized as the
"life-blood" of a successful pharmaceutical company. 84 T.C. at
1160-1161. As noted previously in Chapter 4, supra, the Tax
Court was reversed on this issue.
115 34 T#c# at 1086-88, 1092-93. See Wheeler, An Academic
Look at Transfer Pricing in a Global Economy, Tax Notes, July 4,
1988, at 91.
116
These assets must also have been recorded on Lilly's
financial books of account; thus some intangible assets are not
included. In a recent article, it was noted that Eli Lilly had a
five year average return on shareholders equity of 23 percent (on
an after-tax basis). Who's Where in Profitability, Forbes,
January 11, 1988, at 216. Compare this consolidated return on
assets with the return in excess of 100 percent earned by the
Puerto Rican subsidiary during the years 1971-1973.
117
The adjusted taxable income for the subsidiary does not
reflect the exclusion provided by section 931 of the Internal
Revenue Code of 1954 and excludes interest income.

- 42 Computations based on the record in Searle118 and reflected
in the companies' income tax returns (also part of the record)
show a similar disproportion. By way of indirect comparison, in
1968 (the year before intangibles were transferred to Puerto
Rico), Searle reported taxable income of approximately
$46,700,000 on sales of approximately $81,800,000. In the years
before the Tax Court, Searle's sales declined to approximately
$38,200,000 in 1974 and $46,700,000 in 1975, resulting in losses
of $9,800,000 in 1974 and $23,100,000 in 1975. During these
years the Year
Puerto Rican subsidiary
income of:
Net saleshad net sales
Net and
income
1974
1975

$114,784,000
138,044,000

$74,560,000
72,240,000

The rates of return on assets based on the company's tax
return position were as follows:119
1974

1975

Return on Average Employed assets:
(31.2%)
(42.3%)
Parent (consolidated return)
109.2%
119.0%
Puerto Rico Subsidiary
Cost of Goods Sold to Sales:
54.0%
56.2%
Parent (consolidated return)
13.3%
13.6%
Puerto Rico Subsidiary
98.7%
106.5%
Operating Expenses to Sales:
35.4%
35.6%
Parent (consolidated return)
Puerto Rico Subsidiary
It is important to note that the data regarding rate of
return and other evidence presented by the government in Lilly
and Searle did not necessarily provide the court or the parties
with a definitive, quantitative transfer price or charge for
intangibles. Rather, like Dr. Plotkin's testimony in DuPont, it
was used to support the reasonableness of a resulting allocation
or determination.120 As discussed in Chapter 11, the Service and
Treasury believe that, in cases where no comparables exist, a
more refined rate of return analysis can be used to establish a
transfer
1 1 8 price and not merely to verify the reasonableness of an
Supra n. 59.
allocation.
119
Wheeler, supra n. 115, at 91.
120

The Seventh Circuit in Lilly, supra n. 57, discounted
this type of evidence because it called into question Lilly
P.R.'s ownership of the intangibles at issue.

- 43 D.

Customs Values

An additional approach to transfer pricing that has
occasionally been used in litigation is that of adopting the
values set by the United States Customs Service. For example, in
Ross Glove Co., 121 the Tax Court accepted the taxpayer's use of
the markup used by Customs in valuing gloves imported from the
Philippines for purposes of applying the cost plus method.
However, in Brittingham v. Commissioner,122 the Tax Court made it
clear that it would not bind taxpayers to their own declared
Customs' valuations where it could be shown that those values
were erroneous,123
E. Conclusions and Recommendations
1. Over the years the courts, and in particular the Tax
Court, have used various fourth methods for determining
appropriate arm's length prices for section 482
allocations. A profit split is appropriate in some
cases to establish a transfer price on an arm's length
basis because unrelated parties are concerned about the
respective shares of potential profits when entering
into a business arrangement.124 The problem with the
profit split approach taken by the courts, however, is
not that the courts have focused on the wrong elements
of the transaction, but that they generally have
failed to adopt a consistent and predictable
methodology.
2. The rate of return on assets and costs to income ratio
methods used in DuPont provide some reasonable basis
for allocating income and determining transfer prices
in the absence of comparables. However, these methods
have not yet been sufficiently developed by the courts
to fill the gap in analysis left by the section 482
121
regulations
transactions
Supra n. 93.when
Seecomparable
discussionuncontrolled
supra Chapter
4.
cannot be located. A profit split or other method
122
66 T.C. 373 (1976), aff'd, 598 F.2d 1375 (5th Cir.
1979).
123

Largely in response to the Brittingham case, Congress
enacted section 1059A in 1986. This section generally forces an
importer to use a value for income tax purposes no greater than
the value declared for customs purposes.
124
See J. Baranson, Technology and the Multinationals at
64 (1978).

- 44 should be developed to determine transfer prices in the
absence of comparables, which is the subject of Part
III of this study.

- 45 II.

SECTION 482 AFTER THE 1986 TAX REFORM ACT

Part I of the study described the history of section 482,
its administration by the Service, and its interpretation by the
courts. The lack of specific guidance in the tangible property,
intangible property, and services provisions of the section 482
regulations to resolve cases for which appropriate comparables do
not exist — notably cases involving high profit intangibles —
has caused significant problems for taxpayers, the Service, and
courts alike.
The amendment made by the 1986 Act to section 482 is
Congress' response to the problem described in Part I of
determining transfer pricing for high profit intangibles.
Specifically, section 482 was amended to provide that income from
a transfer or license of intangible property shall be
commensurate with the income attributable to the intangible.
This Part II discusses the scope of the commensurate with income
standard and the requirement for periodic adjustments. The
compatibility of these changes with the international norm for
transfer pricing -- the arm's length principle -- is also
discussed. Finally, this part explores the role of safe harbors
for avoiding adjustments under section 482.
Chapter 6
THE COMMENSURATE WITH INCOME STANDARD
A. Legislative History
The 1986 Act amended section 482 to require that payments to
a related party with respect to a licensed or transferred
intangible be "commensurate with the income"124 attributable to
(e) Treatment of Certain Royalty Payments.—
(1) In General.— Section 482 (relating to
allocation of income and deductions among taxpayers) is
amended by adding at the end thereof the following new
sentence: "In the case of any transfer (or license) of
intangible property (within the meaning of section
936(h)(3)(B)), the income with respect to such transfer
or license shall be commensurate with the income
attributable to the intangible."
(2) Technical Amendment.— Subparagraph (A) of
section 367(d)(2) (relating to transfers of intangibles
treated as transfer pursuant to sale for contingent
payments) is amended by adding at the end thereof the
following new sentence: "The amounts taken into
account under clause (ii) shall be commensurate with

- 46 the intangible. The provision applies to both manufacturing and
marketing intangibles.125 The legislative history clearly
indicates Congressional concern that the arm's length standard as
interpreted in case law has failed to allocate to U.S. related
parties appropriate amounts of income derived from
intangibles.126 The amendment is a clarification of prior law.
Accordingly, it should not be assumed that the Service will cease
taking positions that it may have taken under prior law.
The primary difficulty addressed by the legislation was the
selective transfer of high profit intangibles to tax havens.
Because these intangibles are so often unique and are typically
not licensed to unrelated parties, it is difficult, if not
impossible, to find comparables from which an arm's length
the income attributable to the intangible."
Sec. 1231(e)(1), Tax Reform Act of 1986, 100 Stat. 2085 (1986).
125

For this purpose, intangibles are broadly defined by
reference to section 936(h)(3)(B) under which intangible property
includes any:
(i) patent, invention, formula, process, design,
pattern, or know-how;
(ii) copyright, literary, musical, or artistic
composition;
(iii) trademark, trade name, or brand name;
(iv) franchise, license, or contract;
(v) method, program, system, procedure, campaign,
survey, study, forecast, estimate, customer list, or
technical data; or
(vi) any similar item,
which has substantial value independent of the services of any
individual. See also Treas. Reg. §1.482-2(d)(3)(ii) and Rev.
Rul. 64-56, 1964-1 C B . 113, regarding the treatment of know-how
as property in a section 351 transfer.
126
1985 House Rep., supra n. 47, at 420-427; 1986 Conf.
Rep., supra n. 2, at 11-637-638. Several commentators have
suggested that the phrase "commensurate with income" derives from
Nestle Co., Inc. v. Comm'r, T.C. Memo. 1963-14, where the Tax
Court sanctioned a taxpayer's post-agreement increase in
royalties paid by an affiliate for a very profitable intangible
license. The opinion states that "[s]o long as the amount of the
royalty paid was commensurate with the value of the benefits
received and was reasonable, we would not be inclined to, nor do
we think we would be justified to, conclude that the increased
royalty was something other than what it purported to be."
(Emphasis supplied). There is, however, nothing in the
legislative record to indicate that this is the case or to
indicate Congressional approval or disapproval of the result in Nestle

- 47 transfer price can be derived. When justifying the compensation
paid for such intangibles, however, taxpayers often used
comparisons with industry averages, looked solely at the
purportedly limited facts known at the time of the transfer, or
did not consider the potential profitability of the transferred
intangible (as demonstrated by post-agreement results).
Taxpayers relied on intangibles used in vastly different product
and geographic markets, compared short-term and long-term
contracts, and drew analogies to transfers where the parties
performed entirely different functions in deriving income from
the intangible.
Congress determined that the existing regime, which depends
heavily upon the use of comparables and provides little clear
guidance in the absence of comparables, was not in all cases
achieving the statutory goal of reflecting the true taxable
income of related parties. Congress therefore decided that a
refocused approach was necessary in the absence of true
comparables. The amount of income derived from a transferred
intangible should be the starting point of a section 482
analysis and should be given primary weight.127 Further, it is
important to analyze the functions performed, and the economic
costs and risks assumed by each party to the transaction, so that
the allocation of income from the use of the intangible will be
made in accordance with the relative economic contributions and
risk taking of the parties.128 The application of the functional
analysis approach to the actual profit experience from the
exploitation of the intangible allocates to the parties profits
that are commensurate with intangible income. Looking at the
income related to the intangible and splitting it according to
relative economic contributions is consistent with what
unrelated parties do. The general goal of the commensurate with
income standard is, therefore, to ensure that each party earns
the income or return from the intangible that an unrelated party
would earn in an arm's length transfer of the intangible.
In determining the income that forms the basis for
application of the commensurate with income standard, what time
frame should be used as a point of reference: the time of the
transfer alone, or an annual or other periodic basis? The
legislative history reflects Congressional concern that, by
127
confining
an analysis
of ansupra
appropriate
1985
House Rep.,
n. 47, transfer
at 426. price to the
time 128
a transfer was made, taxpayers could transfer a high profit
Conf. Rep.,
2, at
potential1986
intangible
at ansupra
early n.
stage
and11-637.
attempt to justify use
of an inappropriate royalty rate by claiming that they did not

- 48 know that the product would become successful.129 Accordingly,
for these reasons, Congress determined that the actual profit
experience should be used in determining the appropriate
compensation for the intangible and that periodic adjustments
should be made to the compensation to reflect substantial changes
in intangible income as well as changes in the economic
activities performed and economic costs and risks borne by the
related parties in exploiting the intangibles.130 As discussed
further below, this is consistent with what unrelated parties
would do.
The legislative history indicates that the commensurate with
income standard does not prescribe a specific, formulary approach
for determining an intangible transfer price. For example, it
does not automatically require that the transferor of the
intangible receive all income attributable to the exploitation of
the intangible. It does not prescribe (nor depend for its
application upon) a specific legal form for transfers of
intangible property. Thus, it applies to licenses of intangible
property, sales of tangible property which incorporate valuable
intangibles, and to transfers of intangibles through the
provision of services. Nor does it mandate any specific
treatment of the transferor or transferee. In particular, the
provision does not mandate a "contract manufacturer" return for
the licensee in all cases.131
B. Scope of Application
The scope of the commensurate with income standard is not
discussed in the legislative history. Two proposals have been
made for limiting the scope of the standard, one based on
potential double taxation and one limiting the application of the
provision to the types of cases that prompted the legislative
change.
1. Double Taxation and Related Issues. Double taxation can
occur when two countries have different rules of allocation; have
the same rules but interpret or apply them differently in actual
operation; have the same rules and interpret and apply them in
the same way, but do not allow correlative adjustments; or
129

1985 House Rep., supra n. 47, at 424.

130

Id. at 425-426.

131

Id. at 426.

- 49 permit correlative adjustments in theory but do not remove
procedural barriers (e.g., statutes of limitation on refund
claims).132
Taxpayers and others have argued that the commensurate with
income standard will necessarily increase the incidence of double
taxation, and that therefore Congressional intent should not be
fully implemented. As described more fully in the next chapter,
the correct application of the commensurate with income standard
is premised soundly on arm's length principles. The Service and
Treasury therefore do not believe that the commensurate with
income principle will increase the incidence of double taxation.
Indeed, in fairly common cases where the commensurate with
income standard will be applied — outbound transfers of
intangibles from U.S. parents to foreign subsidiaries — the
issue of double taxation does not arise. In these situations,
the foreign tax credit provisions of U.S. domestic law (including
the foreign sourcing and characterization of royalties relating
to intangibles used overseas) will normally prevent the double
taxation of earnings.133 Furthermore, the outbound transfer
patterns that were the subject of Congressional concern involve
transfers to manufacturing affiliates located in tax havens,
where there is no potential for double taxation. The question of
whether the appropriate amount of income is attributed to foreign
operations in these cases is, therefore, whether the correct
amount of income is eligible for deferral from U.S. tax and
whether it is properly characterized for foreign withholding tax
purposes, rather than the issue of double taxation.
2. Legislative Impetus. The commensurate with income
standard was clearly intended to overcome problems encountered in
applying the section 482 regulations to transfers of high profit
International such
Fiscal
Cahiers
de Droit
potential intangibles,
as Association,
those at issue
in Lilly
and
Fiscal
International
(Studies
on
International
Fiscal
Law),
Searle. Because of its origin as a response to the problem Vol
of
LVI, at 1-6 (1971).
133
So long as the foreign affiliate ultimately pays out
its residual earnings as a dividend and exhausts its remedies for
obtaining an adjustment in the foreign jurisdiction, the total
amount of foreign source income on the U.S. return in the
relevant limitation category (and, therefore, the amount of
limitation under section 904) will be the same no matter what the
amount of royalty, and the taxes paid by the foreign affiliate
will be deemed paid by the U.S. parent. The operation of the
foreign tax credit will thus prevent any double taxation on those
earnings irrespective of the amount of the royalty payment for
U.S. tax purposes.

- 50 high profit intangibles, it has been suggested that the
commensurate with income standard should be limited to transfers
of high profit intangibles to affiliates in low tax
jurisdictions.134 The statute, however, applies to all related
party transfers of intangibles, both inbound and outbound,135
without quantitative or qualitative restrictions.
Furthermore, the economic theory of arm's length dealing
underlying the methods set forth in this study apply to all
transfers of intangibles, regardless of the type of intangible or
residence of the licensee. Consequently, the commensurate with
income standard should apply to transfers of all related party
intangibles, not just the high profit potential intangibles. The
analysis set forth in Chapter 11 provides a framework for
implementing the commensurate with income standard that can be
applied to all intangible transfers, rather than merely to high
profit potential intangibles.
C. Application of Commensurate with Income Standard
to Normal Profit and High Profit Intangibles
1. Normal Profit Intangibles. In related party transfers
of normal profit intangibles, there are likely to be comparable
third party licenses. Such licenses can produce evidence of
arm's length dealings. The arm's length bargaining of the
unrelated parties over the terms of the arrangement reflects each
party's judgment about what its share of the combined income (or
appropriate expense reimbursement) ought to be. Hence, each has
made a judgment that the remuneration it expects to receive is
commensurate with the income attributable to its exploitation of
the intangible.
Application of the commensurate with income standard to
normal profit intangibles will ordinarily produce results
consistent with those obtained under pre-1986 law in those cases
where economically appropriate comparables were used. For
example, the licensing agreement for the formula to a particular
brand of perfume is likely to have many "inexact"
comparables.136
If appropriate comparables exist, they can be
134
examined
to
determine
an arm's
or commensurate
with
Wright & Clowery,
The length,
Super-Royalty:
A Suggested
income, return.
Thus,
inNotes,
many cases
income
Regulatory
Approach,
Tax
July the
27, appropriate
1987, at 429-436.
135
136

1986 Conf. Rep., supra n. 2, at 11-637.

See discussion of the concepts of inexact and exact
comparables infra Chapter 11.

- 51 allocation under both the existing regulations and the
commensurate with income standard will be the same, provided that
internal and external standards of comparability are met.137
2. High Profit Potential Intangibles. As described in
Chapter 4, the difficulty in applying section 482 to high profit
potential intangibles138 is that unrelated party licenses of
comparable intangibles almost never exist. Consequently, if the
appropriate related party transfer price for a high profit
potential intangible is expressed in terms of a royalty, the
result may not bear any resemblance to a third party license for
a normal intangible. That is, owing to the intangible's
enormous profitability, an allocation under the commensurate with
income standard, if made solely through a royalty rate
adjustment, might be so large compared to normal product royalty
rates that it does not look like an arm's length royalty.
Therefore, one might argue that an extraordinarily high rate
could never be an arm's length royalty merely because third
party royalties are never that high.
From an economic perspective, however, an unprecedented or
"super-royalty" rate may be required to appropriately reflect a
relatively minor economic contribution by the transferee and
achieve a proper allocation of income.139 As discussed in
Chapter 11, the commensurate with income standard, in requiring a
"super-royalty" rate in order to achieve a proper allocation of
1 3 7in such a case, does not mandate a rate in excess of arm's
income
See discussion of the concepts of internal and
length
rates.
Nor doesinfra
it permit
taxpayers
to set a "superexternal comparability
Chapter
11.
138
The term high profit potential intangibles refers to
those products which generate profits far beyond the normal
returns found in the industry. No specific definition or formula
for determining whether an item is a high profit potential
product is suggested herein. Nonetheless, hypothetical products
such as an AIDS vaccine, a cure for the common cold, or a cheap
substitute for gasoline would all fit into this concept because
of the enormous consumer demand for such a product, the market
protection provided by a patent, and the corresponding potential
for enormous profitability. Similarly, a patented product that
just happens to work better than others, or produces the same
result with fewer side effects, may also qualify.
139
The German tax authorities have faced a similar
situation, and the imputation of very high royalty rates has led
to the charge that the imputed royalties are not arm's length.
See Jacob, The New "Super-Royalty" Provisions of Internal
Revenue Code 1986: A German Perspective, 27 European Taxation
320 (1987).

- 52 royalty" rate in excess of arm's length rates. For example,
enactment of the commensurate with income standard would not
justify royalty increases in excess of arm's length rates by
U.S. affiliates of foreign parent corporations (or vice versa).
Rather than creating a new class of royalty arrangements,
the enactment of the commensurate with income standard reflects
the recognition that, for certain classes of intangibles
(notably high profit potential intangibles for which comparables
do not exist), the use of inappropriate comparables had failed to
produce results consistent with the arm's length standard.
Enactment of the commensurate with income standard was thus a
directive to promulgate rules that would give primary weight to
the income attributable to a transferred intangible in
determining the proper division of that income among related
parties. In the rare instance in which there is a true
comparable for a high profit intangible, the royalty rate must be
set on the basis of the comparable because that remains the best
measure of how third parties would allocate intangible income.
D. Special Arrangements
1. Lump sum sales or royalties. Some commentators have
suggested that the commensurate with income standard should not
prohibit the use of non-contingent, lump sum royalty or sale
payments. While the Service and Treasury agree that parties are
free to structure their transactions as either a sale or license,
the economic consequences of a lump sum payment arrangement
generally must resemble those under a periodic payment approach
in order to satisfy the commensurate with income standard, unless
the taxpayer can demonstrate, by clear and convincing evidence,
that such treatment is inappropriate on the basis of arm's length
arrangements, i.e., an exact or inexact comparable
transaction.1415 By its terms, the amendment to section 482
applies to any transfer of an intangible, which includes an
outright transfer by sale or license for a non-contingent, lump
sum amount.141 Furthermore, exempting such arrangements from the
commensurate with income standard would elevate form over
substance and encourage non-arm's length lump sum arrangements
designed
Thus, periodic adjustments
1 4 0 to circumvent the new rules.
See
infra
Chapter
11.
may be required under the commensurate with income standard even
141
in the
of lump
salen.
or47,
royalty
arrangements.142
1985case
House
Rep.,sum
supra
at 425.
142

See discussion of the mechanism for making adjustments
to lump sum payments infra Chapter 8.

- 53 2. Interaction with Section 367(d). Section 367(d),
enacted as part of the 1984 Tax Reform Act, provides that when
intangible property is transferred by a U.S. person to a foreign
corporation in a transaction described in section 351 or 361, the
transferor shall be treated as receiving annual payments, over
the useful life of the property, contingent on productivity or
use of the property, regardless of whether such payments are
actually made. These payments are treated as U.S. source income.
A subsequent disposition to an unrelated party of either the
intangible property or the stock in the transferee triggers
immediate gain recognition. The 1986 Act made the commensurate
with income standard applicable in computing payments
attributable to the transferor under section 367(d). The
periodic adjustment of lump sum royalty or sale payments would
merely achieve parity with section 367(d) transfers.143 Section
367(d) may also suggest that certain exceptions from the
periodic payment approach may be appropriate — e.g., transfers
to corporations in which an unrelated corporation has a
substantial enough interest that an objective valuation of the
transferred intangible can be considered to be arm's length.144
Sales and licenses of intangibles are generally not subject
to section 367(d), since they are not transactions described in
section 351 or 361. The temporary regulations state that, when
an actual license or sale has occurred, an adjustment to the
consideration received by the transferor shall be made solely
under section 482, without reference to section 367(d). 145
However, if the purported sale or license to the related person
is for no consideration146 or if the terms of the purported sale
or license differ so greatly from the substance of an arm's
length transfer that the transfer should be considered a sham,147
the transfer will be treated as falling within section 367(d).
143
Staff
Joint Comm. with
on Taxation,
General Explanation
In essence,
the of
commensurate
income standard
treats
of
the Revenue
Provisions
the DeficitasReduction
Act of 1984,
related
party transfers
ofof
intangibles
if an intangible
had
98th Cong.,
2d Sess.
[hereinafter
General
been
transferred
for 432-433
a license(1984)
payment
that reflects
the
Explanation of the DRA of 1984].
144
The Service and Treasury invite comments as to whether
this possible exception should be under a different standard than
the concept of control under section 482.
145
Treas. Reg. §1.367(d)-lT(g)(4)(i).
146

Id.

147

Treas. Reg. §1.367(d)-lT(g)(4)(ii).

- 54 intangible's value throughout its useful life, a result similar
to section 367(d). Because the section 367(d) source of income
rule can apply to certain transactions cast in the form of a sale
or license, the temporary regulations could be amended to specify
which sales or licenses are subject to both the commensurate with
income standard and the U.S. source income characterization of
section 367(d). Moreover, a license payment that is less than
some specific percentage of the appropriate arm's length amount
could be considered so devoid of economic substance that the
arm's length charge should be subject to section 367(d). Thus,
those related party transfers which deviate substantially from
the proper commensurate with income payment would be subject to
367(d), even if cast in the form of a sale or license.
3. Cost sharing agreements. The legislative history
envisions the use of bona fide research and development cost
sharing arrangements as an appropriate method of attributing the
ownership of intangibles ab initio to the user of the intangible,
thus avoiding section 482 transfer pricing issues related to the
licensing or other transfer of intangibles.148 Use of cost
sharing arrangements had previously been encouraged in
connection with the enactment in 1984 of section 367(d). 149 Cost
sharing arrangements are discussed in detail in Chapters 12 and
13, infra.
E. Conclusions
1. Congress enacted the commensurate with income standard
because application of existing rules had not focused
appropriate attention upon the income generated by the
transfer of an intangible in situations in which
comparables do not exist.
2. Application of the commensurate with income standard
requires the determination of the income from a
transferred intangible, and a functional analysis of
the economic activities performed and the economic
costs and risks borne by the related parties in
exploiting the intangible, so that the intangible
income can be allocated on the basis of the relative
economic contributions of the related parties. The
commensurate with income standard does not mandate a
148
"contract
return
the licensee in all
1986
Conf.manufacturer"
Rep., supra n.
2, at for
11-638.
or even most cases.
149
General Explanation of the DRA of 1984, supra n. 143,
at 433.

- 55 3.

The commensurate with income standard requires that
intangible income be redetermined and reallocated
periodically to reflect substantial changes in
intangible income, or changes in the economic
activities performed and economic costs and risks
borne by the related parties.
The application of the functional analysis approach to
the actual profit experience from the exploitation of
intangibles is consistent with what unrelated parties
would do and is, therefore, consistent with the arm's
length principle.
Because the commensurate with income standard is
consistent with arm's length principles, it should not
increase the incidence of double taxation.
The commensurate with income standard applies to all
types of intangible property transfers between related
parties, not just high profit potential intangibles,
including both inbound and outbound transfers of
intangibles. In the cases of normal profit intangibles
in which comparables normally exist, the new standard,
like prior law, will ordinarily base the analysis on
comparable transactions, with refinements in the
definition of appropriate comparables. In any event,
intangible income must be allocated on the basis of
comparable transactions if comparables exist.
Lump sum sale and royalty payments for intangibles
generally will be subject to the commensurate with
income standard.

- 56 Chapter 7
COMPATIBILITY WITH INTERNATIONAL TRANSFER PRICING STANDARDS
A. Introduction
Shortly after passage of the 1986 Act, various U.S.
taxpayers and representatives of foreign governments expressed
concern that the enactment of the commensurate with income
standard was inconsistent with the "arm's length" standard as
embodied in tax treaties and adopted by many countries for
transfer pricing matters. As a result, they argued, the
application of the commensurate with income standard would lead
to double taxation for which no remedy would exist under
treaties, because of application of transfer pricing standards by
the United States that would be inconsistent with those applied
by various other foreign governments,150
To allay fears that Congress intended the commensurate with
income standard to be implemented in a manner inconsistent with
international transfer pricing norms and U.S. treaty obligations,
Treasury officials publicly stated that Congress intended no
departure from the arm's length standard, and that the Treasury
Department would so interpret the new law.151 Treasury and the
Service continue to adhere to that view, and believe that what is
proposed in this study is consistent with'that view.
B. The Arm's Length Standard as an International Norm
The problem of double taxation arising from different
transfer pricing methods has been addressed through
intergovernmental negotiation and agreement, principally in
bilateral tax treaties that specifically provide for certain
adjustments by the treaty partners to the tax liability of any
entity when its dealings with related entities differ from those
that would have occurred between unrelated parties. For example,
150
See discussion
supra Chapter
6 regarding
relief
an OECD model
income tax convention
permits
adjustments
tofrom
the
double taxation pursuant to the foreign tax credit provisions and
sourcing rules of United States internal law.
151
Letter from J. Roger Mentz, Assistant Secretary (Tax
Policy) of the Department of Treasury to Representative Philip M.
Crane (May 26, 1987); Remarks of Stephen E. Shay, International
Tax Counsel of the Department of Treasury before the
International Fiscal Association (February 12, 1987). Appendix C
to this study summarizes the legal and administrative approaches
similar to those described throughout this study taken by some of
our major treaty partners in dealing with transfer pricing
issues.

- 57 profits of an enterprise where, in dealing with related
enterprises, "conditions are made or imposed between the two
enterprises in their commercial or financial relations which
differ from those which would be made between independent
enterprises
" 1 5 2 If the adjustment is consistent with that
standard, the OECD Model Convention calls for the other
contracting state to make an adjustment to the profits of the
enterprise in its jurisdiction to take into account the first
state's adjustments.153 If differences of opinion arise between
the two states as to the proper application of this standard, the
OECD Model Convention calls for the competent authorities of the
respective jurisdictions to consult with one another.154 The
other major model used by countries in negotiating their tax
treaties, the United Nations Model Double Taxation Convention
Between Developed and Developing Countries, contains an Article 9
entitled "Associated Enterprises" that is not materially
different.155
In 1981, the Treasury Department released a model income tax
treaty that it uses as a starting point for negotiating income
tax treaties with other countries.156 Although this model has
been revised in a number of particulars to account for the many
changes in U.S. tax law since the time of its release, the
provisions governing associated enterprises have not changed.
152
Organization
of Economic
Cooperation
andOECD
Development,
The basic provision
is virtually
identical
to the
Model
157
Committee
on
Fiscal
Affairs,
Model
Double
Taxation
Convention
on
Convention,
Income and on Capital, Art. 9(1) ("Associated Enterprises")
(1977) [hereinafter OECD Model Convention].
153
Id. at Art. 9(2).
154
155

Id.

United Nations Model Double Taxation Convention Between
Developed and Developing Countries, U.N. Doc. ST/ESA/102, at 27
(1980) [hereinafter U.N. Model Convention].
156
U.S. Treasury Dept., Proposed Model Convention Between
the United States of America and .... for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income and Capital (1981).
157
The United States model adds a third paragraph to the
OECD Model Convention Article 9 that reserves to each state the
right to make adjustments under its internal law. The purpose of
this paragraph is only to make explicit that the use of the word
"profits" in the OECD model does not constrain either
jurisdiction to make adjustments, consistent with the arm's

- 58 The arm's length standard is embodied in all U.S. tax
treaties; it is in each major model treaty, including the U.S.
Model Convention; it is incorporated into most tax treaties to
which the United States is not a party; it has been explicitly
adopted by international organizations that have addressed
themselves to transfer pricing issues;158 and virtually every
major industrial nation takes the arm's length standard as its
frame of reference in transfer pricing cases.159 This
overwhelming evidence indicates that there in fact is an
international norm for making transfer pricing adjustments and
that the norm is the arm's length standard.160
It is equally clear as a policy matter that, in the interest
of avoiding extreme positions by other jurisdictions and
minimizing the incidence of disputes over primary taxing
jurisdiction in international transactions, the United States
should continue to adhere to the arm's length standard.
length standard of paragraph 1, with respect to deductions,
credits, or other allowances between related persons. This
provision reads as follows:
3. The provisions of paragraph 1 shall not limit any
provisions of the law of either Contracting State which
permit the distribution, apportionment or allocation of
income, deductions, credits, or allowances between persons,
whether or not residents of a Contracting State, owned or
controlled directly or indirectly by the same interests when
necessary in order to prevent evasions of taxes or clearly
to reflect the income of any of such persons. Id.
158
U.N. Model Convention, supra n. 155, at 106; see
generally Organization for Economic Cooperation and Development,
Report of the Committee on Fiscal Affairs, Transfer Pricing and
Multinational Enterprises (1979) [hereinafter OECD, Transfer
Pricing and Multinational Enterprises].
159
See, e.g., Cross-Border Transactions Between Related
Companies: A Summary of Tax Rules (W. R. Lawlor, ed. 1985)
(discussion of transfer pricing practices of twenty-five
different countries, most of which take the arm's length
standard as their basic rule of transfer pricing).
160
A recent article has suggested that the arm's length
standard for transfer pricing should not limit the transfer
pricing practices of governments. Langbein, The Unitary Method

- 59 C. Reference to Profitability under the Arm's Length Standard
Because the arm's length standard is the international norm,
a serious potential for disputes over primary taxing jurisdiction
would exist if the United States were to implement the
commensurate with income standard in a manner that violates arm's
length principles. Does a system which, only in the absence of
appropriate comparable transactions, places primary emphasis upon
the income (or profits) related parties earn from exploiting an
intangible violate the arm's length standard, as understood in
the international context?
Probably the most commonly referenced expression of the
arm's length standard as understood by the nations that have
adopted it is a report issued in 1979 by the OECD.161 This
report adopts the general principle of arm's length pricing for
all transactions between related parties. Concerning transfers
of intangible property, the report states:
The general principle to be taken as the basis for the
evaluation for tax purposes of transfer prices between
associated enterprises under contracts for licensing patents
or know-how is that the prices should be those which would
be paid between independent enterprises acting at arm's
length.162
It is useful to refer to those methods that the report
considers inconsistent with its arm's length concept to aid in
defining such concept. These the report refers to as "global"
methods for transfer pricing. They would include, for example,
"allocating profits in some cases in proportion to the respective
costs of the associated enterprises, sometimes in proportion to
their respective turnovers or to their respective labour forces,
or by some formula taking account of several such criteria."163
The report also notes that the effect of its arm's length
The report criticizes these methods as necessarily arbitrary.164
approach, as distinguished from those it criticizes, is:
[T]o recognise the actual transactions as the starting
point for the tax assessment and not, in other than
161

OECD, Transfer Pricing and Multinational Enterprises,
supra n. 158.
162

Id. at 51.

163

Id. at 14.
164

Id. at 14-15.

- 60 exceptional cases, to disregard them or substitute other
transactions for them. The aim in short is, for tax
purposes, to adjust the price for the actual transaction to
an arm's length price.165
Nowhere, however, does the report suggest that the profits
of the related enterprises are irrelevant to this determination.
Indeed, there are several instances where the report specifically
authorizes an inquiry into profits or profitability. For
example, the report notes:
[Its criticism of global methods] is not to say, however,
that in seeking to arrive at the arm's length price in a
range of transactions, some regard to the total profits of
the relevant [multinational enterprise] may not be helpful,
as a check on the assessment of the arm's length price or in
specific bilateral situations where other methods give rise
to serious difficulties and the two countries concerned are
able to adopt a common approach and the necessary
information can be made available.166
In arriving at an arm's length price, the report specifically
authorizes an analysis of economic functions performed by each
related party in determining "when a profit is likely to arise
and roughly what sort of profit it is likely to be." 167
Other references to profits occur in the report. For
example, in the section of the report relating to the sale of
tangible goods entitled "Methods of Ascertaining an Arm's Length
Price," methods are outlined that permit reference to comparable
profits or returns on capital invested as a means of determining
the appropriate transfer price. These methods are viewed by the
report as a supplement to the traditional approach of looking to
comparable transactions, but they are clearly suggested as
appropriate tools for arriving at a proper transfer price.168
With regard to valuing transfers of intangible property, the
report notes that, "[o]ne of the common approaches employed in
practice is to make a pragmatic appraisal of the trend of an
enterprise's profits over a long period in comparison with those
165
Id. at 19.
of other unrelated
parties engaged in the same or similar
166

Id. at 15.

167

Id. at 17.

168

Id. at 42-43.

- 61 activities and operating in the same area."169 The report
questions whether this approach is practical, because it would be
difficult to isolate respective profits due to different
accounting methods, and difficult to know-how to apportion the
overall profit between the two parties. No suggestion is made,
however, that such a method could never be used in the absence of
comparable transactions because it conflicts in principle with
the arm's length standard.170
D. Periodic Adjustments under the Arm's Length Standard
The next chapter describes an important element of the
commensurate with income standard — periodic adjustments must be
made in appropriate cases to reflect actual profit experience
under the license. As noted in that chapter, there are sound
arm's length reasons to require such adjustments — principally
the rarity of long-term, fixed licenses negotiated at arm's
length, particularly with respect to high profit potential
intangibles, and the fact that actual profit experience under a
license indicates in most cases anticipated profits that would
have been considered by unrelated parties. Moreover, that
chapter permits taxpayers to avoid adjustments over time if they
can demonstrate on the basis of arm's length evidence that no
such adjustments would have been made by unrelated parties. The
Service and Treasury therefore believe that such periodic
adjustments as will be made under the new standard will be
consistent with the arm's length standard as embodied in U.S.
double taxation treaties.
E. Resolution of Bilateral Issues
The Service and Treasury recognize that implementation of
the commensurate with income standard in all its particulars,
including periodic adjustments, treatment of lump-sum
payments171 and access to information to perform the necessary
169
Id. at
54.
analysis, may
lead
to differences with the competent authorities
170

The objection raised in the report regarding the type
of analysis advocated in this report is not that it violates the
arm's length standard, but that it may call for more information
than can be practically obtained and analyzed by the tax
authorities. See id. at 15. As noted in Appendix D, the degree
of detail and analysis that will be called for under the new
methodology will depend in each case on the magnitude of the
potential for income shifting. Further, in cases of transfers of
routine intangibles, available comparable licenses will generally
obviate the
need
almost all
of this
information.
See
the for
discussion
infra
Chapter
8.

- 62 of our treaty partners and perhaps more general issues of treaty
policy and interpretation. Recognizing this, the United States
competent authority and the Treasury Department should be
receptive to the concerns of foreign governments, and endeavor to
seek bilateral solutions insofar as those concerns can be
accommodated in a manner consistent with Congressional intent in
enacting the commensurate with income standard.
F. Conclusions
1. The arm's length standard requires that each entity
calculate its profits separately and that related party
transactions be priced as if unrelated parties had
entered into them. Reference to the profits (including
the trend of those profits over time) of related
parties to determine a royalty in a licensing
transaction is intended to reflect what unrelated
parties would do and, therefore, is consistent with the
arm's length standard.
2. The arm's length standard as accepted by the
international community does not preclude reference to
profits of related parties to allocate income, but in
fact encompasses such an approach as a supplement to
the traditional approach of looking to comparable
transactions. It is, therefore, reasonable to conclude
that such an approach is consistent with international
norms as applied to situations in which comparables do
not exist.
3. The approach taken by Congress in enacting the
commensurate with income standard and the approaches
suggested in Chapters 8 and 11, infra, for implementing
that standard, including the provision for periodic
adjustments, are consistent with internationally
recognized arm's length principles. Applied in a
manner consistent with arm's length principles, the
commensurate with income standard is not likely to
increase international disputes over the right of
primary taxing jurisdiction.
4. The United States competent authority and the Treasury
Department should endeavor whenever possible to seek
bilateral solutions to problems that may arise with our
treaty partners in the interpretation and
administration of the commensurate with income
standard.

- 63 Chapter 8
PERIODIC ADJUSTMENTS
A. Introduction
As discussed in Chapter 6, an intangible transfer price that
is commensurate with the income attributable to the intangible
must reflect the "actual profit experience realized as a
consequence of the transfer."172 The "commensurate with income"
language requires that changes be made to the transfer payments
to reflect substantial changes in the income stream attributable
to the intangible as well as substantial changes in the economic
activities performed, assets employed, and economic costs and
risks borne by related entities.
The Congressional directive to the Service to make
adjustments to intangible returns that reflect the actual profit
experience is in part a legislative rejection of R.T. French v.
Comm'r.173 That case endorsed the view that a long-term, fixed
rate royalty agreement could not be adjusted under section 482
based on subsequent events that were not known to the parties at
the original contract date. Thus, underlying the directive is
perhaps a view that contractual arrangements between unrelated
parties — particularly those involving high profit intangibles - are not entered into on a long term basis without some
mechanism for adjusting the arrangement if the profitability of
the intangible is significantly higher or lower than
anticipated. A very preliminary review of unrelated party
licensing agreements obtained from the files of the Securities
and Exchange Commission, discussed in Appendix D, and other input
received to date, seems to support this view. Indeed, as a
matter of long term business strategy, unrelated parties may
172
1985
House Rep.,
supra n. 47,
atabsent
425. explicit
renegotiate
contractual
arrangements
even
renegotiation
provisions
to
reflect
revised
expectations
173
60 T.C. 836 (1973).
174
regarding an intangible's profitability.
174
Since related parties always have the ability to
renegotiate contractual arrangements, explicit contractual
provisions permitting renegotiation of related party arrangements
would have little meaning and, therefore, should not be a
prerequisite for making adjustments. Furthermore, related party
contracts that contain these provisions will not necessarily lead
to results that conform to the experience of unrelated parties
operating under similar circumstances. If the contract proves
more profitable than expected, the parties can refuse to
renegotiate or adjust it, despite explicit provisions in the

- 64 Aside from the empirical evidence of what unrelated parties
seem to do, actual profit experience is generally the best
indication available, absent comparables, of anticipated profit
experience that arm's length parties would have taken into
account at the outset of the arrangement. It is, therefore,
perfectly consistent with the arm's length standard to treat
related party license agreements generally as renegotiable
arrangements and to require periodic adjustments to the transfer
price to reflect substantial changes in the income stream
attributable to the intangible.175
Intangible transfer prices will in any event be determined
on the basis of comparables if they exist. If a particular
taxpayer demonstrates that it has comparable long-term, nonrenegotiable contractual arrangements with third parties, the
arm's length standard will preclude periodic adjustments of the
related person intangible transfer price. In that event, a
comparable would exist by definition, which would determine the
consideration for the related person transfer, both initially and
over time. Comparables are always the best measure of arm's
length prices. In the case of a high profit intangible, however,
a third party transaction generally must be an exact comparable
in order for the transaction to constitute a valid comparable.176
It may also be possible in certain other cases to exclude
subsequent profit experience from consideration under the arm's
length standard. To do so, the taxpayer would need to
demonstrate each of the following to avoid an adjustment based on
contract
which
permit
or require them to do so. Thus, requiring
subsequent
profit
experience:
that related party contracts mimic the terms of unrelated party
contracts will not alone ensure that the results experienced by
the related parties under those contracts will approximate arm's
length dealing.
1985 House Rep., supra n. 47 at 425-426.
Without the ability to make changes for adjustments over time,
related party agreements will be observed when they suit the tax
needs of the parties and amended or changed when they work to
their detriment. Compare R.T. French Co. v. Comm'r, 60 T.C 836
(1973), with Nestle Co., Inc. v. Comm'r, T.C. Memo. 1963-14.
175
Periodic adjustments will also obviate the need for the
often fruitless inquiry into the state of mind of the taxpayer
and its affiliate at the outset.
176
See the discussion infra Chapter 11, regarding the
role of comparables in determining whether an adjustment over
time is necessary.

- 65 1. That events had occurred subsequent to the license
agreement that caused the unanticipated profitability;
2. That the license contained no provision pursuant to
which unrelated parties would have adjusted the license; and
3. That unrelated parties would not have included a
provision to permit adjustment for the change that caused the
unanticipated profitability.
For example, assume that there are twelve heart drugs that
perform similar therapeutic functions, none of which has a
dominant market share. Several of these drugs are licensed to
unrelated parties under long term arrangements which do not
provide a mechanism for adjusting the royalty payments because of
subsequent changes. The taxpayer's drug, which is licensed to a
related party, uses an active ingredient which is different from
the other products with which it competes. The competitors'
drugs, however, lose all of their market share during the course
of the license agreement because their products are found to
cause serious side effects, and the licensed product's profits
increase dramatically. In this case, if the taxpayer could prove
the three factors above, the taxpayer could avoid an adjustment
based on the increase in profitability.
As noted earlier, Congress was particularly concerned about
taxpayers attempting to justify low-royalty transfers at an early
stage based on the purported inability to predict subsequent
product success.177 Because of this concern, it would be
appropriate to impose a high standard of proof, such as a clear
and convincing evidence standard, on taxpayers in order to
demonstrate that subsequent profitability could not have been
anticipated. In no event should this test be available to
taxpayers if inexact comparable licenses with no provision for
periodic adjustments cannot be found in the marketplace.
A substantial change in intangible income will not
necessarily result in an adjustment. As discussed in Chapter 6
and described in Chapter 11, determining the intangible income is
merely the first step in the analysis of allocating intangible
income. The second step involves allocating income on the basis
of the activities performed and economic costs and risks borne by
the parties. If intangible income increases solely due to the
efforts of the transferee, then the increase in intangible income
will be allocated exclusively to the transferee, and no
adjustment 1985
willHouse
be made
to supra
the income
of at
the
transferor.
Rep.,
n. 47,
424.

- 66 B.

Periodic Review

Annual adjustments may not be required to reach the
appropriate amount of income under the commensurate with income
standard. Adjustments are not required for minor variations in
intangible income, only for substantial changes in intangible
income.178 Several issues are raised by this requirement. How
often should the taxpayer review its transfer pricing structure
to determine whether income is being properly reported and to
avoid potential penalties? How often may the Service make
adjustments in the course of examination? Should the regulations
define substantiality? Should the adjustments be applied
retroactively or prospectively? Should periodic adjustments be
made in the case of a sale of intangibles and other situations
involving lump sum payments? Should set-offs be permitted?
The frequency with which a taxpayer should review its
related party intangible transfer agreements and how often the
Service should be able to make adjustments are not questions
that can be governed by inflexible rules. When the transferee
experiences a substantial change in its profits from the
intangible resulting from some particular event (whether
anticipated or not), a review by the taxpayer is clearly
warranted; further, an adjustment by the Service is warranted
unless the taxpayer can demonstrate, by clear and convincing
evidence, that the conditions discussed above for avoiding an
adjustment based on subsequent profit experience are met. Even
absent a clear-cut event, it is possible that gradual changes
over time may create a substantial deviation from the parties'
expectations at the time they entered into the contract.
In general, taxpayers should review transfer pricing
arrangements relating to intangibles (especially high profit
intangibles) as often as necessary to assure that their transfer
prices are consistent with substantial changes in intangible
income that may have occurred since the inception of the current
transfer pricing arrangements. For industries that undergo rapid
technological change or for products that have a relatively short
life, this standard may dictate annual review. In short, the
taxpayer should review its pricing structure relating to
intangibles
as often and thoroughly as necessary to assure that
178
Id.
at 426.
income is reported
on its U.S. tax return in a manner that is
179
consistent
with
the
commensurate
with
standard. or
Taxpayers
As discussed supra
in Chapter
3, income
the regulations
that fail
to dobe
soamended
risk the
of thedisclosure
substantial
statute
should
toimposition
ensure adequate
of
179
understatement
or
other
appropriate
penalty.
transfer pricing methodology and penalize unjustified

- 67 On the other hand, the Service should be permitted to make a
transfer pricing adjustment without necessarily having to
demonstrate that its proposed adjustment is justified by
identifiable changes in intangible income compared with a prior
taxable year. In other words, if the adjustment can be supported
on the basis of exact or inexact comparables, or on the basis of
the rate of return analysis or such other methodology as is
adopted by the Service for use in cases in which exact or inexact
comparables do not exist,180 then the Service should not have to
demonstrate that the adjustment specifically relates to
identifiable changes in intangible income occurring since the
last taxable year examined. An approach whereby the Service
would be estopped from making an adjustment, absent clearly
identifiable changes in intangible income, because of the
Service's prior acceptance of some commensurate with income
amount in a prior year would present problems of proof that are
not necessarily relevant to the appropriateness of the
adjustment. At most, consideration should be given only to
requiring that the proposed adjustment to income be substantial
in relation to the income reported by the taxpayer from the
transaction -- and then only for audits subsequent to the first
in-depth audit of transfer prices conducted for taxable years
after 1986.
It may be advisable to publish in the Internal Revenue
Manual a list of factors that, if one or more changes
substantially, would indicate that there may be a substantial
change in intangible income that may warrant an examination of
the taxpayer's intangible transfer pricing. These factors might
include: (a) the size and number of markets penetrated; (b) the
product's market share; (c) the product's sales volume; (d) the
product's sales revenue; (e) the number of uses for the
technology; (f) improvements to the technology; (g) marketing
expense; (h) production costs; (i) the services provided by each
party in connection with the use of the intangible; and (j) the
product's profit margin or the process' cost savings.181
Any periodic adjustments that are made under the
substantial
of taxgenerally
resulting should
from nonconformity
commensurate understatements
with income standard
be made
to
the
arm's
length
standard.
prospectively -- i.e., for the taxable year under audit and
180
subsequent
taxable
years
See infra
Chapter
11.(provided that there is no further
substantial change in the intangible income and other relevant
181
See also the factors set forth in Treas. Reg. §1.4822(d)(2)(iii).

- 68 facts). Unless unrelated parties would have set a different
royalty rate on the date of the transfer based upon expectations
of future high profitability or other facts known on the date of
transfer, the arm's length standard would require only that the
transfer price be commensurate with actual income — i.e., that
the transfer price be changed only as the intangible income
changes.
C. Lump Sum Payments
As discussed in Chapter 6, the commensurate with income
standard applies to transfers of intangibles by sale or license
for noncontingent, lump sum amounts. Thus, periodic adjustments
may be required under the commensurate with income standard in
the case of lump sum sale or royalty arrangements as well as
periodic royalty arrangements. In the case of a lump sum sale,
how should the Service make a section 482 allocation if it is not
apparent until many years after the sale that the lump sum
payment was insufficient under the commensurate with income
standard?
One possibility would be to recharacterize the sale as a
license, thereby giving the Service the ability to require
additional royalty payments sufficient to satisfy the
commensurate with income standard. It is clear, however, that
parties dealing at arm's length occasionally sell intangibles.
Thus, failure to recognize sale arrangements for related party
transactions could be viewed as a deviation from the arm's length
standard.
Alternatively, the Service could recognize the transfer as a
sale but make a section 482 allocation to increase the initial
lump sum payment. Unless taxpayers using lump sum sale
arrangements were required by regulation or statute to keep the
statute of limitations open for the payment year, the statute of
limitations could bar adjustments to a lump sum payment in closed
taxable years, contrary to Congressional intent. Moreover, other
problems would exist in adjusting the lump sum even if the
statute of limitations were open. For example, any mid-stream
adjustment to the initial lump sum made before the statute of
limitations expires on the year of sale would necessarily be
based on a projection of future profits over the remaining life
of the intangible that could be too high or too low.
Furthermore, any mechanism, whether elective or mandatory, that
would keep the statute of limitations for the year of transfer
open for extended periods would disrupt the examination process
by unduly delaying the closing of audits.
A lump sum sale arrangement should instead be treated as an
open transaction to assure that the sale over time satisfies
commensurate with income standard. This approach is the only
approach which recognizes the transaction as a sale, allows for

- 69 adjustments of the sale price under the commensurate with income
standard, and minimizes the statute of limitation and other
problems inherent in making adjustments to income in the year of
the sale. Under this approach, a lump sum sale payment made in
the year of the transfer would result in gain taxable in the year
of transfer but would then be treated as a prepayment of the
commensurate with income amounts. No section 482 allocation
would be required until the aggregate commensurate with income
amounts exceed the prepayments.
Under this method, the lump sum is treated as invested on
the date of the lump sum payment in a hypothetical certificate of
deposit ("CD.") maturing on the last day of taxpayer's current
tax year bearing interest at the appropriate federal funds rate
based on the anticipated life of the intangible (for U.S.
developed intangibles) or the appropriate rate in the development
country. At the end of year one the balance of the C D investment would be computed. From this amount, the amount of
the commensurate with income amount would be subtracted. The
remaining balance would then be treated as invested in a C D .
maturing at the end of year two- At the end of each tax year a
computation similar to that done at the end of year one would be
made. When the C D . balance is exhausted, the taxpayer would be
required thereafter to include the entire commensurate with
income amount in income each year.
Consider, for example, an intangible that is transferred for
Col. 1
Col. 2
Col. 3
$1,000 and that would demand a commensurate with income amount
in each ofLump
ten years
as shown:
sum $1000
payment increased
by time value
return (assume
10%) at end
of year
(Col.. 3 plus
returns on
Col. 3 amount)
Year

1
2
3
4
5
6
7
8
9
10

1100
1100
1100
990
850
715
237

Commensurate
with Income
Amount
(assumed)
$

100
100
200
200
200
500
500
500
200
200

Remaining lump
sum payment at
beginning of
year (prior
year Col. 1
less prior year
Col. 2)
$

1000
1000
900
790
650
215
-0-0-0-0-

- 70 The $1,000 lump sum payment would be converted as shown in column
1 into a stream of income which is offset by the commensurate
with income amount in column 2 until the stream of income is
exhausted in year 7. Thereafter, the commensurate with income
amount would be fully included in the transferor's income.182
Because section 482 may be applied only by the Service, no
refunds could be allowed if an excessive lump sum was paid.
However, to prevent abuse of outbound lump sum payments in
inbound licensing arrangements, the Service would be al3.owed to
adjust excessive lump sum payments that clearly exceed the
commensurate with income standard.
D. Set-Offs in Royalty Arrangements
It is possible that the initial royalty rate set by the
parties could be too large in some years and too small in other
years when analyzed under the commensurate with income standard.
Under existing regulations, section 482 adjustments traditionally
have been made on a year-by-year basis. Only intra-year set-offs
of proposed adjustments against excessive income derived on
related party transactions are authorized under section 1.482182

It has been suggested that the commensurate with income
standard will result in all gains from the sale of intangibles
being treated as royalties under the Internal Revenue Code and
under our tax treaties, because of the provision in the Code and
those treaties covering gains contingent on productivity, use or
disposition of the relevant intangible. There is no intention by
the Service or Treasury to eliminate the possibility of sale
treatment for transfers of intangibles in appropriate cases,
either for treaty purposes or for U.S. withholding tax purposes.
Further, the Service and Treasury believe that the mere fact that
subsequent profits may be taken into account in appropriate cases
by U-S. tax authorities in determining transfer prices on audits,
or that a lump sum is treated as a deposit on the appropriate
section 482 transfer price in order to assure that a commensurate
with income adjustment can be made notwithstanding the statue of
limitations, does not have this effect. The terms of the
transaction itself (i.e., whether it provides for contingent
consideration based, e.g., on sales volume or units sold) will
determine treatment under the royalty article. Further, even if
the commensurate with income standard were incorporated by
reference into the relevant sales document, there is no necessary
relationship between productivity, use or disposition and a
proper commensurate with income payment. For example, sales
might increase dramatically in a given year, but the method
called for may result in no increase in payments, or the taxpayer
may have an arm's length basis for making no adjustment.

- 71 1(d)(3) of the regulations.183 Thus, the Service could make
adjustments in some years without making an allowance for
excessive royalties paid in other years. Assume, for example,
that a license generates a fixed royalty amount on an intangible
that produces fluctuating income due to business cycles or
changes in demand. Over time, the royalty may be an appropriate
one on average, but in some years it may be too low and in others
too high.
Because of the problems inherent in an open transaction
approach, the current rule prohibiting multi-year set-offs should
be retained. The potentially harsh effect of this rule will be
mitigated by the fact that periodic adjustments generally should
be made only in cases of substantial changes in circumstances and
by the ability of taxpayers to adjust their own arrangements
prospectively, reducing or increasing the royalty, to account for
changed circumstances. It will also create an incentive for
taxpayers to examine their arrangements periodically to see
whether an adjustment favorable to them would be appropriate.
E. Conclusions
1. Periodic adjustments are necessary in order to reflect
substantial changes in the income stream produced by a
transferred intangible, taking into account the
activities performed, assets employed, and economic
costs and risks borne by the related parties.
2. Requiring periodic adjustments is consistent with the
arm's length principle, since unrelated parties
generally provide some mechanism to adjust for change
in the profitability of transferred intangibles and
since actual profit experience generally is the best
indication available of the anticipated profit
experience that unrelated parties would have taken
into account at the outset of the arrangement.
3. Taxpayers should review transfer pricing arrangements
relating to transferred intangibles as often and as
thoroughly as necessary to assure that income is
reported over time in a manner consistent with the
commensurate with income standard.
4. Periodic adjustments made under the commensurate with
income standard generally should be prospective unless
a different royalty rate would have been set on the
date of transfer based upon expectations of the parties
183
But
see Treas.
Reg. §1.482-2(d)(1)(ii)(d),
Ex. 3, which
and the
facts known
as of the date of transfer.
appears to allow an inter-year set-off.

- 72 A lump sum sale of an intangible should be
characterized as an open transaction whereby the lump
sum sale payment results in gain at the time of
transfer, but is then treated as a prepayment of the
commensurate with income amounts. No section 482
allocation would be required until the aggregate
commensurate with income amounts exceed the prepayment.
Multi-year set-offs of proposed adjustments against
excessive related party income derived in other taxable
years will not be permitted.

- 73 Chapter 9
THE NEED FOR CERTAINTY: ARE SAFE HARBORS THE SOLUTION?
A. Introduction
One of the most consistent criticisms of the section 482
regulations is that they do not provide taxpayers with enough
certainty to establish intercompany prices that will satisfy the
Service without overpaying taxes. Based on the government's
experience in litigation, the current section 482 regulations
also fail to provide the Service and the courts with
sufficiently precise rules to make appropriate section 482
adjustments, especially when third party comparables are not
available.184 One of the most common suggestions for solving
these problems is to amend the section 482 regulations to adopt
safe harbors, or simple, mechanical, bright-line tests that may
be used in lieu of the fact-specific arm's length inquiry under
section 482. 185
B. General Problems with Safe Harbors
While numerous safe harbors have been proposed, they
generally have taken two forms: (1) absolute safe harbors that
grant the taxpayer total freedom from a section 482 adjustment
once the criteria for the safe harbor are satisfied, and (2)
conditional safe harbors that produce a rebuttable presumption or
a shift in the burden of proof in the taxpayer's favor, but that
may be overcome by the Service through evidence showing that a
section 482 adjustment is necessary.
Although various types of safe harbors are available, they
all have one common element that makes them both attractive to
the taxpayer and potentially troublesome to the government: they
generally would serve only to reduce tax liability. Taxpayers
for which a safe harbor would produce a lower tax liability than
the appropriate normative rule would use it. Those for which a
safe harbor would produce a higher tax liability than the
appropriate normative rule generally would not seek the
protection of the safe harbor but would apply the normative rule.
Reducing
administrative costs, or the need for certainty, may
184
IRS Could Better
U.S. Tax
Interests, supra
encourage GAO,
some taxpayers
to use Protect
a safe harbor
in marginal
n.
64, at 63;
ABA
on Affiliated
and Related
situations
even
ifComm.
application
of the normal
rule Corporations,
would result in
Administrative Recommendation No. 8 (1986) [hereinafter ABA
Admin. Rec.]; Langbein, supra n. 160, at 655.
185
See GAO, IRS Could Better Protect U.S. Tax Interests,
supra n. 64, at 48-50.

- 74 a tax savings. In general, however, the only benefit a safe
harbor offers from the Service's perspective is a saving of
administrative costs.
Ideally, safe harbor standards should be easy and
inexpensive vehicles for selecting cases that warrant closer
scrutiny. The perfect safe harbor would result in the
elimination of all insignificant cases and the selection of
cases for detailed analysis by taxpayers and further examination
by the Service that would more likely produce sustainable,
significant adjustments if analyzed incorrectly by the taxpayer.
The question is whether there are any safe harbors that are
capable of approaching these goals.
A look at the Service's experience with section 482 safe
harbors is instructive. The best example is the safe harbor for
interest rates found in section 1.482-2(a)(2)(iii). From the
Service's point of view, results under this safe harbor have
been mixed at best. The safe harbor was originally set between 4
and 6 percent. This was probably sufficient in 1968, but it
soon became inappropriately low. However, the government was
very slow to change the safe harbor range as interest rates
rose.186 The safe harbor for interest now tracks the Federal
rates required to be determined for purposes of the original
issue discount rule under section 1274(d), which reflect market
rates and are adjusted monthly., While this is probably a
satisfactory solution, many taxpayers were able to gain a
substantial windfall while the government made successive
attempts to choose an appropriate safe harbor rate.
Another example of a safe harbor is found in section 1.4822(c)(2)(ii) of the regulations, which provides a safe harbor
computation of an arm's length rental for the use of tangible
property. Experience has demonstrated that this safe harbor was
overly generous to taxpayers (i.e., requiring too little rent).
It was repealed by regulations finalized this year.187. No
substitute safe harbor has been provided to date.188
186
The government's
The following
experience
changes
in have
the section
been made482
to area
the safe
has been
harbor
that safe
interest
harbors
rate:
have generally
6-8 percenttreated
effective
amounts
January
as arm's
1, 1976;
length
1113 percent effective July 1, 1981; 100-130 percent of the
applicable Federal rate effective May 9, 1986. Final regulations
were published on June 13, 1988. T.D. 8204, 1988-24 I.R.B. 11.
187
188

T.D. 8204, 1988-24 I.R.B. 11.
See Treas. Reg. §1.482-2(c)(2)(ii).

- 75 that were usually different from market rates. This result is
even more likely to occur in the transfer pricing area because of
the inherent difficulty of constructing valuation safe harbors
for the types of intangible and tangible property that have
created transfer pricing problems under section 482.
Furthermore, because of the complexity of the regulatory process
and the difficulty in obtaining reliable data, adjustments or
corrections to safe harbor standards would be slow. In any
event, the fundamental deficiencies of safe harbors are not
resolved by continually reviewing and revising the rates, or by
intentionally setting the safe harbor on the conservative side
for protection of the revenue. If safe harbors are set at nonmarket rates, they will be used only by taxpayers that will
benefit by making or receiving payments at those rates.
C. Specific Proposals
The following lists some of the safe harbors that have been
proposed and includes a short explanation of some of the reasons
why they have not been endorsed by the Service and Treasury.
1. Pricing Based on Industry Norms. This approach is
contrary to the legislative history of the section 482 changes in
the 1986 Act.189 Industry norms generally do not reflect arm's
length prices for highly profitable intangibles. Accordingly,
any safe harbors based on industry norms or statistics would
permit transfer prices that would be far different from the arm's
length standard in the most significant cases.
2. Profit Split — Minimum U.S. Profit. This approach
would guarantee that the United States would capture a certain
minimum of the profit in transfer pricing cases, perhaps 50
percent. The commensurate with income standard is designed to
divide the income involved between related parties to "reasonably
reflect the relative economic activity undertaken by each."190 A
safe harbor that splits profits a certain way in all cases would
be inconsistent with the case-by-case factual determination that
is necessary to measure the economic contribution made by each of
the related parties. Furthermore, a fixed U.S. profit
requirement would be objectionable to other countries when
intangibles were developed outside the United States.

189
190

1985 House Rep., supra n. 47, at 424-25.
Id.

- 76 3. Profit Split Based on Taxpayer's Proportionate Share of
Combined Costs (ABA Proposal).191
The problem with this safe harbor is that it presumes that
different types of expenses contribute equally to the combined
profit. For example, expenses incurred for highly skilled
technical services might contribute proportionately more to the
combined profit than those incurred for unskilled services.
Furthermore, it might be very difficult to determine what
indirect expenses (including, for example, research and
development expenses) are attributable to particular products,
and taxpayers might be able to manipulate the profit split by
shifting expenses from one product to another or one entity to
another (such as by "loaning" employees).
4. Profit Split Based on Share of Combined Costs and
Assets (ABA Proposal).192 The second ABA safe harbor is a
modification of the first one. Instead of relying entirely on
relative expenses, it relies 50 percent on expenses, and 50
percent on the fair market value of the assets used in the
production of the property involved in the sale. However, at a
minimum not less than 25 percent of the combined taxable income
would be allocated to the buyer. If one of the parties employed
its assets in a very inefficient manner, it would nevertheless be
rewarded in the same manner as if it were highly efficient.
Additionally, assets could be arbitrarily shifted from one entity
to another; difficult questions of property valuation could
arise; and property could be purchased just to tip the balance of
profits. Because of those problems, a party could receive a
substantial amount of the combined taxable income, yet be doing
very little to earn the income.
5. Insubstantial Tax Benefit Test. This safe harbor would
be available if the rate of tax in the foreign jurisdiction was
at least 90 percent of the U.S. rate. The theory behind this
safe harbor is that taxpayers will use arm's length pricing if
no overall tax savings result from doing otherwise. While this
approach
1 9 1 may have some pragmatic appeal, there are still several
ABA, it.
Admin.
supraunder
n. 184,
at 14.
ABA
problems with
An Rec,
adjustment
section
482The
does
not
proposals
applicable
onlytaxes.
to the Even
transfer
of taxpayer
tangible is
depend on are
an intent
to avoid
if the
property.
proposals
apply
only toif
intangible
property.
overpaying Other
its worldwide
tax
liability,
U.S. income
is being
Because many of the safe harbors would have the same advantages
and disadvantages regardless of the type of property involved,
this discussion does not address the different types of property
separately.
192
Id. at 14-15.

- 77 understated, an adjustment should be made. Furthermore, as a
policy matter the United States will not cede its taxing
jurisdiction to a foreign country other than by treaty.
Accordingly, if a taxpayer intentionally or inadvertently shifts
income to a high tax jurisdiction it should be subject to a
section 482 adjustment without the benefit of a safe harbor. As
a practical matter, however, the Service proposes relatively few
adjustments between a U.S.-based parent company and its
affiliates located in another jurisdiction whose effective tax
rate is nearly the same or higher. Different problems are
presented by foreign-based parents and their U.S. affiliates.
6- Profit Distribution Test. This safe harbor would be
satisfied if at least 25 percent of the pre-royalty net profit
of an affiliate was distributed to the parent. This test is
directly contrary to the commensurate with income concept. If an
affiliate is responsible for only 10 percent of the economic
activity in question it should not be able to keep up to 75
percent of the profit involved.
7. Prior Settlement Test. Under this proposal, when the
Service had accepted a specific pricing method in a prior
examination, the burden would be on the Service to show that the
pricing method is unreasonable for the current year. This safe
harbor is unacceptable because there could be any number of
reasons why the Service had accepted a particular pricing method.
To force the Service to demonstrate that the previously agreed
upon method has become unreasonable could help perpetuate an
error or make it more difficult to adjust to changing
circumstances.
D. Burden-Shifting Safe Harbors
Some of the safe harbor proposals would operate by shifting
the burden of proof to the Service. It has been proposed, for
example, that a taxpayer's full disclosure of the method by which
it determines its transfer prices would shift the burden of proof
to the government. (See Chapter 3, supra, for a description of
IEs' experiences in seeking information.) Section 6001 requires
all taxpayers to maintain adequate books and records to
substantiate positions taken on the tax return, including section
482 issues. Thus, a taxpayer could obtain a shift in the burden
of proof merely by complying with the law.
The Service and Treasury do not believe that "burdenshifting" safe harbors are a viable approach. The critical
issues presented in the section 482 area are almost always
factual in nature, and taxpayers are almost always uniquely
familiar with -- and in exclusive possession of -- the relevant
facts. To place the burden of proof on the government in this
situation would be unworkable.

- 78 E.

Conclusions and Recommendations

1. Historical experience with safe harbors indicates that
they generally result in unwarranted windfalls for
taxpayers, without significant benefits for the
government.
2. In the highly factual section 482 context, no one safe
harbor or combination of safe harbors has yet been
proposed that would be useful but not potentially
abusive.
3. While the possibility that useful safe harbors could
be developed is not categorically rejected, additional
section 482 safe harbors are not recommended at the
present time.

- 79 III.

METHODS FOR VALUING TRANSFERS OF INTANGIBLES

A significant reason for the enactment of the commensurate
with income standard was the failure to properly take into
account the income earned by related parties in exploiting
intangibles. As detailed in earlier chapters, inappropriate
comparables or ad hoc profit split approaches have been used to
analyze cases involving related party transfers of unique
intangibles.
This part of the study seeks to define the appropriate use
of comparable transactions. It also proposes an alternative
method of analysis that does not directly rely upon comparable
transactions. Fourteen detailed examples applying the methods
described in this part are set forth in Appendix E. These
methods are generally consistent with various methods of income
allocation used by the Service, taxpayers, and the courts under
pre-1986 Act law and, if adopted, would appropriately be
applicable to cases arising prior to the 1986 Act.
Chapter 10
ECONOMIC THEORIES CONCERNING THE IMPLEMENTATION OF SECTION 482
A. Introduction
The current section 482 regulations use a market-based
approach to income allocation. The goal of this approach is to
distribute income in the same way that the market would
distribute the income; that is, related parties should earn the
same returns that unrelated parties would earn under similar
circumstances. This approach is implemented through separate
accounting in which an individual transfer price is determined
for each transaction.193
The argument for the market-based method to allocate income
was articulated by Stanley Surrey, former Assistant Secretary
(Tax Policy), who discussed the way that unrelated parties are
taxed:
Tax administrators do not question transactions that
are governed by the marketplace. If Company A sells
goods to unrelated Company B at a certain price or
furnishes services at a particular price, the income of
both companies is determined by using that price. One
193
A variation of this approach retains the goal of a
market-based allocation but claims that in some situations the
target is best reached by an estimate, or that average prices can
be used for certain transactions. The estimate can be provided
by some type of formulary apportionment.

- 80 company may be large and the other small; one may be a
monopoly; one may be financially strong and the other
in a weak condition. But these and other factors which
may affect the price at which the transaction occurs
are not the concern of the tax administrator.194
Having established the tax system's acceptance of the
marketplace, he concludes:
Presumably, most transactions are governed by the
general framework of the marketplace and hence it is
appropriate to seek to put intra-group transactions
under that general framework. Thus, use of the
standard of arm's length, both to test the actual
allocation of income and expense resulting under
controlled intra-group arrangements and to adjust that
allocation if it does not meet such standard, appears
in theory to be a proper course.195
Recent criticism has questioned whether the market-based
arm's length approach is flawed as a matter of general principle.
An alternative approach might be based on the concept of an
integrated business. Loosely defined, an integrated business
consists of firms under common control and engaged in similar
activities. Proponents of the alternative approach assert that
one cannot assume that related parties conduct market-based
transactions within the entity.
They claim that, because an
entity will not act as if its parts are unrelated, it does not
make sense to try to account for individual transactions in the
way that unrelated parties subject to market forces would account
for similar transactions. Under this theory, the allocation of
income can only be accomplished by applying some formula chosen
by the government.
This chapter explores the tension between these alternative
approaches, and suggests a way to apply the arm's length
principle to an integrated business. It concludes that the
market-based arm's length approach remains the best theoretical
allocation method.
B. The Arm's Length Approach in an Integrated Business: Theory
The goal of a market-based approach is to ensure that the
return to an economic activity is allocated to the party
194
Surrey,
Reflections
on the
Allocation
ofmarket-based
Income and
performing
the economic
activity.
Critics
of the
Expenses Among National Tax Jurisdictions, 10 Law and Policy in
International Business 409, 414 (1978).
195
Id. at 414.

- 81 approach argue that an arm's length price will not achieve this
goal. Relevant practical issues are how close one can get to the
right price and whether getting that price is costly relative to
settling for an estimate.
One commentator has suggested that the difficulties
encountered in administering the current regulations stem not
from practical considerations, but rather from fundamental
problems inherent in applying a market-based approach to
transactions of integrated businesses.196 Specifically, it has
been argued that the flaw in an arm's length approach is that it
does not allow a return to the form of organization. That is,
because an integrated enterprise is presumably more efficient,
it will be able to execute an integrated economic activity at a
lower cost than a series of independent firms whose joint efforts
are necessary to execute the same series of transactions. This
omission creates a "continuum price problem," a situation in
which the sum of the returns for separate services rendered by
independent parties is less than the actual return of the
combined group. This argument grows out of the literature on the
reasons for the existence of multinationals.197
That multinationals may exist because of integrated or
"firm-specific" economies does not require a rejection of the
arm's length principle. Transfer prices are supposed to reflect
the contribution of the activity and assets utilized in each
location to economic income. Therefore, each party should earn
at least as much as it could have earned as an unrelated party
under alternative arrangements.
Furthermore, an analysis of "alternative arrangements" need
not be restricted to analyzing conventional arm's length
transactions. Consider a U.S. firm that owns the worldwide
rights to a unique patented drug that it wishes to sell into a
new market (and assume that the drug or patent is valuable in its
own right and that marketing activity, for example, is not an
196
important
factor). supra
The firm
license
Langbein,
n. could
160, at
627. the use of the patent
to unrelated parties to produce the drug in the new market.
197
Caves explains
that could
many multinationals
exist
because
Alternatively,
the firm
enter into a joint
venture
by
of a failure in the market for intangibles. R. Caves,
Multinational Enterprise and Economic Analysis (1982). In
essence, intra-firm transactions can be more profitable than
inter-firm transactions because of the expense of negotiating
complete contracts or the inability of a firm to capture the full
value of a piece of knowledge through contracts with unrelated
parties without fully explaining the knowledge and thus
eliminating its value.

- 82 affiliating with a company that has the ability to produce the
drug. If the pharmaceutical firm entered into a joint venture it
would probably be able to negotiate a very large share of the
profits given the value of the patent, because any number of
local firms could provide the labor and capital necessary to mix
and package the drug.
There are, therefore, two types of arm's length transactions
to consider — one in which the parties remain independent and
another in which the two parties make an arm's length agreement
to affiliate by merger, joint venture, acquisition, or simply
through the hiring of local labor and capital within a
subsidiary. Restricting attention to transactions between
parties that remain unrelated can fail to accomplish the
objective of allocating to each party its contribution to income,
if such transactions do not accurately reflect the actual
relations between the related parties.
Another way of describing the arm's length agreements that
have to be considered is to say that they are the arrangements
that would be made between unrelated parties if they could choose
to have the costs of related parties -- i.e., to use the related
party technology. In general, tax rules should distort business
decisions as little as possible because rules that minimize such
distortions will lead to the greatest possible production
efficiency. Transfer pricing rules will allow the most efficient
production technology to come to the fore if, holding the cost
functions constant, they result in the same tax burdens whether
or not the parties are related. In other words, if unrelated
parties somehow had access to the technology available to related
parties, their operations should not result in more or less total
taxes than would be paid by a multinational using this
technology. The difficulty, of course, is the practical
application of this interpretation of the arm's length standard.
C. The Arm's Length Approach in an Integrated Business:
Practice
The arm's length approach can be more correctly applied to
an integrated business by using certain tools of microeconomic
theory. The continuum price problem arises when a vertically or
horizontally integrated production technology that is available
to multinational corporations results in lower costs than a nonvertically or horizontally integrated technology, which unrelated
parties would have to use. How can an examination of unrelated
party transactions lead to a satisfactory resolution of the
transfer pricing problem?
As a first step, consider an industry in which there is no
difference in costs between related party and unrelated party
dealings; there is only one production technology, and it is
available to the parties in both types of arrangements. There

- 83 is thus no continuum price problem, and the arm's length
standard, as traditionally interpreted, can be applied. It is
likely that both unrelated party and related party transactions
will actually occur in the marketplace, and it should be possible
to observe prices from the former and use them to determine the
incomes of each party in the latter.
This procedure satisfies the objective described in section
B above of using information about unrelated parties operating at
arm's length to determine the allocation of income in the related
party setting. The related parties that sell intermediate goods
will be given the same gross revenues as the corresponding
unrelated parties; related parties that purchase them will have
the same cost of goods sold as corresponding unrelated parties.
Further, it has already been assumed that the two sets of parties
operate in the same market and have the same cost structure;
therefore, the external prices and internal costs will be equal.
Thus, the related parties will have the same net taxable incomes
as the corresponding unrelated parties. They should therefore
have the same total tax burden as the unrelated parties with
which they are competing.
Now return to the situation in which a vertically or
horizontally-integrated technology, available only to
multinational companies, is dominant. If multinational
corporations are able to produce at lower cost, then in the long
run it should be difficult for the smaller companies to continue
in existence. Therefore, arm's length prices may be unavailable.
An appropriate transfer pricing result will be achieved if each
related party were assigned the income that the corresponding
unrelated party would earn, if the latter were using the
efficient cost structure.
Microeconomic theory leads to an unambiguous and natural
statement of what the income of unrelated parties should be in
these circumstances. As long as the industry under analysis is
competitive and the factors of production are homogeneous and
mobile between sectors, it is assumed that "economic," "excess,"
or "above-normal" profits will be zero in the long run.198 That
is, each firm will earn just enough to be able to pay for the
land, labor, capital, and other factors of production that it
9 8 produce its outputs.
uses 1to
For a narrative explanation of the zero profit
The
zero economic
profitand
concept
does not
state that
taxable
condition,
see R. Lipsey
P. Steiner,
Economics
229-231
(6th
income
should
be
zero.
If
owners
of
the
firm
have
supplied
it
ed. 1981). For a mathematical presentation of the implications
of this condition, see J. Henderson and R. Quandt, Microeconomic
Theory 107-110 (3d ed. 1980).

- 84 with capital or other inputs, the firm should earn enough to be
able to reward the shareholders for these factors; otherwise, the
shareholders would be wise to find a better investment. Rather,
the zero profit concept implies that in a competitive industry
there should be an equality between the gross revenues of a firm
and the summation of the market returns that are or could be
earned by all of the factors of production that the firm employs.
If gross revenues were higher than this amount, then the firm
would be earning "above-normal" profits; the existence of
"above-normal" profits would attract other firms to enter the
industry until these "above-normal" profits disappeared through
competition. If gross revenues were lower than this amount, a
firm would not be able to earn enough to reward all of the
factors it employs and, in the long run, would have to shrink or
disappear.
This equality between revenue and the sum of returns to each
factor of production may be used to determine the proper
allocation of income among the related parties within the
multinational. Specifically, subject to the discussion in
section D infra regarding monopoly situations and intangibles,
one should measure the factors of production used by each
related party and compute the returns that each one would earn on
its best alternative use in the marketplace. The sum of these
amounts yields the total input returns that each related party
would have to earn if it were an unrelated enterprise. The sum
also equals the amount that the multinational enterprise would
have to pay an unrelated party to get it to produce the same
outputs (employing the same inputs and using the same technology)
as the related party does. Attributing this gross income to each
related party will result in its tax base being equal to the
hypothetical unrelated party alternative; therefore, the tax
burden will be equal. Thus, there will be no tax incentive or
disincentive to related party transactions.
The theory discussed above implies that a competitive firm's
gross revenue, which equals price times quantity of output, will
be equal to the returns that the factors it employs could earn in
the marketplace. The traditional arm's length approach looks at
the gross revenue side of this equation; the alternative
procedure outlined above looks at the input side. It starts by
identifying the factors of production employed by the firm,
determining the returns that these factors would earn in the
marketplace, and computing the sum. In short, the traditional
approach looks for the prices that the firm's outputs would
command in the marketplace, whereas the alternative approach
seeks to determine the returns that the firm's factors would earn
in the marketplace. Both approaches are equally consistent with
the basic goal of the arm's length principle, which is to use
determine
information
the
about
allocation
unrelated
of parties
income in
operating
a relatedatparty
arm'ssetting.
length to

- 85 D.

Further Practical Problems

There are two further practical difficulties in applying the
arm's length approach to integrated business economies:
application of the approach to monopoly situations and valuation
of intangibles. This section briefly describes these
difficulties and suggests possible approaches to solving them.
1. Monopoly Situations. In a market that cannot be entered
by more than one or a few firms, the existence of "above-normal"
profits cannot be ruled out, because potential competitors will
not be able to compete them away. The equality discussed above
between gross revenue and the returns that factors could earn in
the marketplace, and the results derived from it, cannot then be
assumed to hold.
However, it may still be possible to apply the basic idea.
For example, consider a situation in which a corporation has been
granted worldwide patent rights to a unique product. The company
still can choose between exploiting this patent through related
party or unrelated party dealings, and it would be worthwhile for
this decision to be made free of distortions that could be caused
by transfer pricing rules. To get an unrelated corporation to
provide a good or service, the company would have to pay the
unrelated corporation the sum of the returns that would be earned
by the factors it would employ. Therefore, it would still be
proper to use the alternative procedure to determine the income
of the related corporation.199
2. Valuation of Intangibles. The starting point for the
alternative application of the arm's length approach is to
measure the factors of production employed by the related
199
In more
complicated
situations,
affiliated
parties, and
to determine
the returns
thatboth
they the
would
earn in the
corporation and any potential unrelated party participant may
each possess monopoly rights that allow them to earn above-normal
profits. In deciding whether to use such an unrelated party, a
corporation would have to consider what would happen if it
attempted to bargain with it. There are analyses, relating to
economic game theory, that attempt to predict what the range of
outcomes would be in such a bilateral monopoly situation. If the
outcome, specifically the income of the potential unrelated
party, can be predicted, then it would be proper to use it to
determine the income of the corporation's affiliate. This is so,
to repeat, because this procedure would allow the corporation's
choice between using an affiliate versus an unrelated party to be
made free of tax distortions. To implement this procedure,
however, one would need to analyze the theoretical models of
bargaining situations in detail, and this analysis is beyond the
scope of the present discussion.

- 86 marketplace. This procedure can be implemented in a straightforward fashion only if the factors can be identified and
measured.
However, there is at least one factor of production,
intangible assets, for which it is often difficult to assign a
precise value. These assets are often unique and it is
frequently difficult to decide what returns they would earn if
separately employed in the marketplace.
One should not conclude that the presence of any intangible
asset will make the alternative procedure impossible to'
implement. It may be that only one of the related parties
employs intangible assets to any significant degree. In this
situation it suffices to measure the factors of production
employed by the party with measurable assets and to allocate the
residual income to the related party employing significant
intangible assets. If both parties employ intangible assets,
valuation becomes more difficult and, in some cases, judgmental,
but not impossible.
E. Conclusions
1. The arm's length standard remains the theoretically
preferable approach to income allocation.
Microeconomic theory can be utilized to apply the arm's
length standard to an integrated operation.
2. In certain situations, production technologies may be
such that unrelated parties operating at arm's length
can be expected to coexist with vertically or
horizontally integrated multinational corporations. In
these cases, arm's length prices should exist and their
application to related party transactions should lead
to appropriate results. This is the traditional
approach embodied in the section 482 regulations.
3. In other situations, vertically or horizontally
integrated technologies available only in related party
dealings may dominate. Third party prices will be
difficult to find in these cases; moreover, the use of
the rare third party prices that occur may be
inappropriate. However, since information may exist as
to the arm's length returns attributable to the factors
of production employed by one or both of the related
parties, this information can be used to modify the
traditional approach and take account of the integrated
businesses.

- 87 Chapter 11
ARM'S LENGTH METHODS FOR EVALUATING
TRANSACTIONS INVOLVING INTANGIBLE PROPERTY
A. Introduction
This chapter discusses the methodology for implementing the
arm's length principle for transactions involving intangible
property. The goal of this chapter is to propose a theoretical
framework for analyzing the situations that have caused the
greatest amount of difficulty in the transfer pricing area in
order to generate further consideration of the difficult issues
involved.
B. Role of Comparable Transactions
"Exact comparables," which are those involving the transfer
of the same intangible property, supply the best evidence of what
unrelated parties would do in a related party transaction. The
weight to be given to evidence of "inexact" comparables, which
generally are those involving different but economically similar
intangible property, is not so clear. Nor is the resort to
inexact comparables automatically justified by the arm's length
principle. This section first outlines the standards for exact
comparables. It then discusses the appropriate role for inexact
ones.
1. Exact Comparables: Two Examples
Exact comparables are most likely to occur in connection
with the transfer of common products that embody intangibles that
are widely available to producers, such as the once unique
technology now employed in pocket calculators, digital watches,
or microwave ovens. Comparability in such cases of widely
available technology is usually easy to demonstrate.
The existence of an exact comparable for unique intangible
property, however, is not inconceivable. Consider a
multinational company that acquires an unrelated company whose
only assets are a small amount of cash, equipment, and the rights
to a valuable new invention. If, immediately after this
acquisition, the multinational sells those rights to a
subsidiary, there really can be no question as to the proper
transfer price: it is the acquisition price minus the cash and
value of the equipment. In fact, because this comparable is
available, any other arrangement could be held suspect. Assume
further that the subsidiary and the parent have no other
transactions in the initial and following years. The
subsidiary's income should include the return to the intangible
in all future years, assuming that the subsidiary paid the arm's
length consideration at the time of the initial transfer.

- 88 As a second example, consider a U.S. corporation that
decides to exploit one of its intangibles. It sets up a Mexican
subsidiary to serve the Latin American market, while it licenses
the Asian rights to an unrelated Korean company. Assume further
that the Asian and Latin American markets, and the parent's
dealing between the Korean company and the Mexican subsidiary,
are comparable in all important aspects. The Korean licensing
arrangement should determine the Latin American subsidiary's
allocation of income from the transfer of the intangible.
2. Standards For Exact Comparables
The assumptions made in these examples raise the crucial
question: How is one to know if a potential comparable is indeed
exact? The first requirement is that the comparable transaction
involve the same intangible property transferred under
substantially similar circumstances. Thus, an exact comparable
should involve the same patent, product design, process,
trademark, or other intangible transferred to the related party.
However, licenses of intangibles are usually exclusive.
Therefore, it is extremely unlikely that the same intangible
would be licensed to two different parties for the same use and
geographic market. The standards for exact comparables should
not require these aspects to be identical.
Instead, two types of additional standards should be met.
First, the comparable transaction and the related party
arrangement must take place in substantially similar economic
environments; these standards may be called "external" ones.
Second, the transactions must contain substantially similar
contractual features; they must satisfy "internal" standards of
comparability.
No amount of general discussion of these standards is
likely to turn them into objective tests. As in all matters
concerning transfer pricing, facts and circumstances must
determine the outcome of specific cases. The following
observations, however, may suggest some useful guidelines.
a. "External" Standards
In examining external standards, the essential question is
whether unrelated parties would regard the economic environment
of the transaction under examination as similar to that of the
proposed comparable transaction. In other words, would unrelated
parties earn substantially similar profits from a substantially
similar transaction? For example, the size and level of economic

- 89 development of the markets should be substantially similar.200
If one market is much larger, or if the product is already
accepted in one market and not the other, one can presume that
unrelated parties would not arrive at the same arrangements to
license an intangible into these two markets. As another
example, one market may contain many competitors, but in the
other a licensee can expect to have a monopoly for a number of
years. Again, it is reasonable to conclude that unrelated
parties would come to different terms in negotiating licenses for
these markets.
Another set of external standards concerns transactions
between the licensor and licensee that are collateral to the
transfer of the intangible in question. If the parties to one
transaction have substantial dealings in the intangible with
third parties (such as a cross-licensing arrangement) but the
parties to the other set of transactions do not, external
standards of comparability are not satisfied. There are clearly
reasons why unrelated parties will reach different outcomes if
they expect to have further dealings than if they do not. For
example, an isolated exchange should not be taken as exactly
comparable to a continuing transactional relationship. The
comparable used in the U.S. Steel decision201 has been
criticized on this basis.
Finally, the level of economic risks being assumed and the
functions performed by each party must be similar. Clearly, it
would be inappropriate to compare a related party transaction
where the affiliate engages solely in manufacturing a product
with a transaction in which the unrelated party not only
manufactures but also must market the product.
b. "Internal" Standards
To meet this set of standards, the contractual aspects of
the transactions being compared must be substantially similar in
all important aspects. The most obvious ones include the amount
and form of compensation for the transferred intangible. The
most common compensation form is a royalty determined as a
percentage of sales or quantity produced, but, as Appendix D
discusses, other forms are sometimes used. If the comparable
transaction contains accelerator or decelerator clauses under
which the royalty increases or decreases as sales increase, for
example, such clauses should appear in the related party
Rev.Other
Rul. 87-71,
1987-2
C B . 148.
transaction.
elements
of a transaction
can have a
significant effect on the income realized by unrelated parties to
discussion
supra Chapter
a license See
or similar
agreement.
These 4.
elements must be

- 90 substantially similar in order for the unrelated party
transaction to be an exact comparable. For example, if the
unrelated party agreement provides for the licensee to receive a
specified level of technical assistance and training, the related
party transaction should contain similar rights. Similarly, if
one agreement calls for the licensee to perform significant
marketing or product development, while in the other the licensor
performs the marketing, the agreements lack internal
comparabi1ity.
3. Exact Comparables and Periodic Adjustments
A comparable that is exact at the outset of a transaction
may lose its exactness over time. There should therefore be two
requirements of continued use of the exact comparable over time.
First, the arrangements must be consistent in their provision for
options and other types of contingency clauses so that they
provide for substantially the same types and amounts of
adjustments for changing circumstances. Second, the comparables
will not remain exact over time unless related parties perform
these adjustments as unrelated parties do, under circumstances
that are comparable.
Is the concept of an exact comparable so rigid that the
results of related party and unrelated party agreements must be
the same? Consider a U.S. company that licenses an intangible to
two unrelated parties, one in Asia and one in Latin America. It
is reasonable to predict that the arrangements will be similar if
the economic environments are similar. However, it will probably
not be the case that the U.S. company will realize the same
income from the two transactions in every year. Business cycles,
for example, vary across locations over time. The Asian licensee
may have a very profitable experience when times are "lean" in
Latin America, or vice versa.
The standards for exact comparables should not require yearby-year equality between the results of the unrelated party
arrangement and of the related party one if it is reasonable to
conclude that the long-term results will be comparable. Related
parties should not be required to exercise rights they might
have, if unrelated parties do not in fact exercise them.
4. The Role of Inexact Comparables
This section describes the appropriate role for unrelated
party transactions that cannot satisfy one or more of the
standards for exact comparables. Because of the unpredictable
outcomes that inexact comparables have caused in the past, one
might argue that they simply should not be used. However, the
data presented in Appendix A suggests that some continued use of
inexact comparables would be appropriate. The International
Examiners reported that they made some use of comparables in

- 91 making transfer pricing adjustments 75 percent of the time. 202
Although the reported use of comparables for transfers of
intangibles in general was lower, it was higher (76.5 percent)
for marketing intangibles.203 The IEs did not report making
final determinations based solely on these comparables in all
these cases, but that they made some use of them. Clearly, in
practice, inexact comparable transactions provide significant
information, even with respect to transfers of intangible
property.
The problem, therefore, is not that inexact comparables are
useless or misleading. Rather, either they have been given too
much emphasis in many cases or inappropriate comparables have
been used. The proper conclusion is that it is appropriate to
make use of them, but that it is inappropriate to determine
transfer prices solely on the basis of inexact comparables. This
conclusion is fully consistent with the arm's length principle.
The arm's length approach requires that exact comparables, when
they are available, should determine transfer pricing allocations
of income. However, it does not follow that the same is true of
inexact comparables. That is, inexact comparables should be
resorted to only when exact comparables are unavailable.
Further, they should not be given priority over the alternative
method outlined in section C of this chapter in all cases.
5. Selection of Appropriate Inexact Comparables
Once it is determined that an exact comparable does not
exist, how should inexact comparables be selected? The most
obvious point is that the external and internal standards
discussed previously should parallel those in the transaction at
issue as closely as possible. For example, if the unrelated
parties in the potential comparable operate in a very different
economic environment — if the market is much smaller or the
related parties carry on a much broader set of transactions —
then the comparable should not be used to justify the related
party arrangement. Similarly, if the intangible in the unrelated
party transaction is at a very different stage of development or
concerns a dissimilar product or service, then its use as a
comparable is inappropriate.
In more traditional terms, an unrelated party arrangement
should be used as an inexact comparable if the differences
between it and the related party transaction can be reflected by
Appendix
a reasonable
numberA,ofinfra.
adjustments that have definite and
ascertainable
effects on the terms of the arrangement. The
203
Id.
current regulations for section 482, although silent on this

- 92 issue in connection with transfers of intangible property,
discuss it quite carefully in connection with transfers of
tangible property. They mention that adjusting a sale for
differences in transportation costs or minor physical
modifications would probably be appropriate, but that an
adjustment for the presence or absence of a trademark would
not.204
This approach should be extended to transfers of intangible
property. For example, unrelated party arrangements frequently
require the licensor to provide a specified amount of training or
expert assistance to the licensee for a brief period.205 It may
be possible to adjust a comparable that includes such a provision
by comparing it with an arrangement that does not, or that
provides for less assistance.
At the other extreme, consider an attempt to compare an
unrelated party license with a related party license when the
unrelated party licensee performs different functions than the
related party licensee. For example, the former may be
responsible for substantial marketing, while the latter may net.
It seems clear that the effect of this difference would not be
definite and ascertainable. Therefore, an adjustment for it
would be too speculative to be appropriate.
Similarly, intangibles differ in their fundamental
profitability. Attempting to compare a low-profit intangible to
a high-profit one by adjusting for this difference would clearly
be too speculative to be appropriate. Comparable transactions
involving intangibles that are likely to be of typical or average
profitability are therefore appropriate inexact comparables only
if the related party intangible under analysis is typical or
average.
The current regulations contain a list of twelve factors
which are essentially internal and external standards that might
be examined in order to determine whether an unrelated party
license is an appropriate inexact comparable. As many observers
have pointed out, however, it is difficult to derive useful
guidance from this list, because it does not discuss the
relative weights to be placed on the factors in a given
situation. For example, prospective profits to be realized from
204
the intangible
appears
late in the list,
Treas.
Reg. §1.482-2(e)(2
)(ii).but after the 1986 Tax
Reform
Act
this
factor
must
be
given
special consideration. In
205
See
infra
Appendix
D
for
further
discussionindustry
of
contrast, the first listed item cites prevailing
rates,
unrelated party licenses.

- 93 which should not be relied upon unless the intangible being
transferred is demonstrably average, based on observable
indicators of profitability.
Another approach that provides a framework for use of
inexact comparables is "functional analysis." Although not
explicitly mentioned in the regulations, this procedure is
outlined in the IRS Manual206 and has been found to be a useful
place to start in transfer pricing situations. In essence, the
goal of functional analysis is to identify the economic
activities actually undertaken or to be undertaken by the parties
in both the related party situation and unrelated party
situation. The most appropriate comparables may be chosen by
identifying the ones in which the unrelated parties carry on the
same major economic activities as the related parties. Section C
of this chapter examines functional analysis in the context of
the arm's length rate of return method. Functional analysis is
an equally valid approach for analyzing comparables on the basis
of the similarity between the economic activities performed.207
6. Use of Inexact Comparables And Periodic Adjustments
It is inappropriate to use inexact comparables to justify a
related party transaction merely by analyzing similarities at the
time of the initial transfer. For example, there may be valid
inexact comparables that justify the establishment of a related
party agreement with a fifteen percent royalty rate. These
comparables may further justify fixing this rate for two years.
Even if no adjustment were required during the first two years,
in year three the taxpayer may not continue to rely upon the
prior inexact comparables unless, after re-examination, use of
these comparables remains appropriate.
Suppose a significant change occurs during the term of a
license agreement. For example, suppose a taxpayer licenses a
product design to a related party. At the time of the transfer,
the taxpayer makes a good faith estimate that the product will be
a routine one, and will attain 10-25 percent of its market.
Based on this fact, the taxpayer gathers information on
comparable transactions (none of which can meet the standards
2 0 6exact comparable).
for an
The information indicates that a
I.R.M. §600 et seq.
royalty rate of 10 percent of sales is appropriate. The
207
As Appendix
D stresses,
it is insufficient
merely
to
comparables
contain
varying duration
and contingency
clauses.
In
replicate a royalty rate in order to achieve a comparable
license. For example, the technological services provided by the
licensor may have a large impact on the profitability of the
license from the licensor's perspective.

- 94 year three, the product design becomes uniquely popular and
garners 95 percent of the market. Given this set of facts, the
inexact comparables previously used may no longer be used in year
three and succeeding years to justify the 10% related party
royalty rate.208
Although unlikely, the taxpayer may find inexact comparables
involving products with a 95 percent market share that
demonstrate that the 10 percent royalty rate is still
appropriate. More realistically, suppose that there are
comparables that show that products in the taxpayer's industry
with a 95 percent market share typically command a much higher
royalty, or, as may be more likely, that there are no comparables
for such a situation. In such case, the taxpayer must use the
arm's length return method outlined in section C below either to
justify the royalty rate previously set or to adjust the related
party arrangement to bring it into compliance with the results of
this new analysis.
C. An Arm's Length Return Method
The previous chapter discusses why a method that looks to
arm's length returns, as distinct from arm's length prices, is
appropriate. This section discusses how such a method should
operate. Although some of the terminology in this section may be
new, most of the techniques discussed in it are not. One of the
main arguments for the development of an arm's length return
method, in fact, is that taxpayers, the Service, and especially
the courts have found it necessary to use ad hoc and incompletely
developed versions of such a method in the past and will
undoubtedly continue to do so in the future. Therefore, the goal
of this discussion is to lay a foundation for this approach so
that it may be used to achieve more consistent and satisfactory
results.
1. Basic Arm's Length Return Method
a. General Description
Consider a U.S. company, Widgetco, that holds worldwide
patent rights to the widget, a high-tech light gathering device
that is expected to be a vital component in certain satellites
and scientific instruments. Widgetco intends to exploit this
patent in the following way. A foreign affiliate will
manufacture the widgets, under license from Widgetco. Besides
208
utilizing
the license,
Widgetco
andwhere
the affiliate
willcan
engage in
There
may be other
cases
the taxpayer
demonstrate an arm's length basis for continuing to use inexact
comparables. See discussion infra Chapter 8 regarding periodic
adjustments.

- 95 the following transactions. Widgetco will sell various types of
microchips, seals and filters to the affiliate, which will also
buy some of these products from unrelated suppliers. The
affiliate will use these components to manufacture the widgets
and sell them to Widgetco, which will market and distribute them.
Widgetco maintains a research staff that developed the widget and
will continue to try to improve it.
It would be very difficult to depend purely on comparable
transactions, as traditionally defined, to establish the proper
allocation of income in this sort of "round trip" transferpricing situation. There are three separate types of comparables
that would have to be found. The first is a set of prices for
the components the parent will sell to the affiliate. The second
is the royalty that the affiliate should pay to the parent under
the production license. The third is the transfer price for the
finished widgets. Although it may be possible to find exact
comparables for one of these types of transactions, such as the
purchase price of some of the components, it will in general be
impossible to find comparables for all three. Further, finding
an answer to only one aspect of the problem provides little help
in deciding the proper allocation of income between the related
parties.
Another approach would be to try to find one or more
comparable transactions in which a company contracts with an
unrelated party to manufacture a product similar to the widget.
It is likely that these transactions will not be good inexact .
comparables. In general, the form, risks, and extent of
relationships in the related party case will at least appear to
be quite different from those in a contract manufacturer
transaction. Among other things, the foreign affiliate carries
raw material, work-in-process, and finished goods inventories
and should receive a normal market return on its activities that
reflects its investment in such assets and the moderate risk that
manufacturers using routine manufacturing processes bear with
respect to their investment in manufacturing facilities and
inventories. Using the terminology of the previous section, a
contract manufacturer transaction is likely to fail both the
external and internal standards for inexact comparables, because
both the types of transactions between the parties and the terms
of their agreements will differ. While comparables of this type
should not be discarded from all consideration (because this type
of comparable may provide useful information), it would be
improper to base a resolution of the transfer pricing issue
solely on such information.
An arm's length return approach would start from a different
perspective. It would seek to identify the assets and other
factors of production that will be used by the related parties
in the relevant line of business and would try to assign market
returns to them.

- 96 The first step in this process is to perform a functional
analysis — i.e., to break down each line of business into its
component activities or functions. It should then be possible
to identify which of the functions utilize only factors of
production that can be measured and assigned market returns and
those which do not. In most cases, identifying functions with
measurable factors will lead to distinguishing between those
functions that make significant use of preexisting intangible
assets and those that do not. In Widgetco's case, Widgetco owns
several types of assets that are difficult to measure, including
the widget patent and other manufacturing intangibles, the
ongoing enterprise value of the research staff, and the marketing
intangibles. On the other hand, the foreign affiliate utilizes
measurable factors of production, assuming that the manufacturing
process is a routine one. Specifically, the affiliate employs
labor, plant, equipment, working capital, and what might be
called "routine" manufacturing intangibles—i.e., know-how
related to efficiency in routine manufacturing processes that
most manufacturers develop through experience. Since it is
easier to evaluate the factors of production to be used by the
foreign affiliate, the market rate of return analysis will focus
on the affiliate. As the theoretical analysis in the previous
chapter demonstrates, focusing on the return of the affiliate in
this manner is a valid extension of the arm's length principle.
Next, income should be assigned to each of the functions
with measurable factors — here the functions performed by the
affiliate. The reason for identifying measurable factors (and,
therefore, focusing on the affiliate) is that the functions that
employ measurable factors will probably be carried on by a wide
range of unrelated parties for which information will probably
be available regarding market returns earned by them. A market
return consistent with the returns of unrelated parties can be
assigned to each of the affiliate's functions since they all
employ measurable factors. Once returns are identified for all
of the affiliate's functions, the residual income from the line
of business is then allocated to Widgetco.
Assume, as stated, that the only function to be performed by
Widgetco's foreign affiliate is manufacturing and that this
function does not involve the significant use of intangible
property developed by the affiliate or purchased by it from
unrelated parties. Under the rate of return method, the assets
of the foreign affiliate would be divided into liquid working
capital and all other assets (i.e., the production assets). The
actual return on the liquid working capital will be identified
and allocated to the foreign affiliate. Rates of return on
production assets used in similar manufacturing activities of

- 97 similar risk must be identified or estimated.209 Income will
then be allocated to the affiliate for its manufacturing activity
in an amount equal to the identified or estimated rate of return
as applied to its production assets. This rate of return would
include, by definition, a return on routine manufacturing
intangibles that manufacturers commonly possess as well as a
return for assuming normal business risks that manufacturers bear
with respect to their investment in manufacturing facilities and
inventories.210 The residual amount of income from the line of
business is allocated to Widgetco.
The same allocation would be made to the foreign affiliate
if it sold its output to a second affiliate and not back to
Widgetco. In neither case would the foreign affiliate receive a
return for marketing its product.
b. Use of Arm's Length Information
There are two ways that arm's length information can be used
to allocate income to the activities of the Widgetco
manufacturing affiliate. The first method has been previously
described — to identify the unrelated parties' rates of return
on assets utilized in a particular function, taking into account
only the non-liquid assets relevant to the function in the line
of business being examined. If satisfactory measures of the
unrelated parties' assets are available, it should be possible to
calculate an appropriate rate of return for each function and
apply it to the related party's assets utilized in that
function.
The second way to use the arm's length information is to
measure it against a yardstick other than rates of return on
assets. A common alternative is the ratio of income to operating
costs. For example, in the DuPont case,211 an expert witness,
Dr. Charles Berry, computed the ratio of gross income before
reduction by operating costs and interest to operating costs for
DISA, DuPont's Swiss affiliate, and for a number of unrelated.
parties performing similar functions. This analysis is useful to
measure returns on service activities and in other situations
where assets are difficult to measure consistently or, more
generally,
where there is reason to believe that the
209
Because
manufacturing
a broad
category,
theeasier
function
relationship between
income and is
costs
is more
stable or
to
or
activity
would
be
defined
more
precisely.
An
example
might
be
measure than the relationship between income and assets. As is
"medium instrumentation fabrication, assembly, and testing."
210
See discussion of risk infra section E.
See discussion supra Chapter 4.

- 98 true with assets, it is important to consider the types of costs
and their relationships to income earned, not just the totals.
For example, some analysts have used the ratio of gross income to
"above the line" costs. This approach is suspect if the
unrelated parties incur proportionately larger amounts of "below
the line" costs, such as advertising, than the related affiliate
incurs.
The use of both types of unrelated party information is
consistent with the fundamental goal of the basic arm's length
return method, which is to use information about unrelated
parties to determine the returns that would have been earned had
the related parties' activities been undertaken at arm's length.
Therefore, both approaches are potentially applicable depending
upon the availability of either type of information and the
appropriateness of using either type of information in the
particular circumstances.
c. Applicability of Basic Arm's Length Return Method
The basic arm's length return method should have wide, but
not universal, applicability in situations where exact or inexact
comparable transactions are not available. It will not be
sufficient alone, however, when both of the related parties own
preexisting and significant intangible assets that are vital to
the success of the project — for example, if Widgetco's foreign
affiliate actively markets the products it manufactures in a
manner that utilizes significant self-developed marketing
intangibles. In such cases, it will be difficult to find a set
of unrelated parties that possess the same type and amount of
intangible assets as the affiliate and are thus able to perform
the same activities. It will be difficult, therefore, to obtain
the arm's length information needed to assign a return to either
affiliate's activities.
This discussion is not meant to imply, however, that the
basic arm's length return method is to be avoided whenever an.
affiliate possesses any amount of intangible assets. It is
unlikely, for example, that any manufacturing operation is so
simple that it does not involve the use of some intangibles. An
affiliate engaged only in manufacturing may employ a skilled
labor force, and the efforts expended in recruiting and training
it may create at least some amount of going concern type of
intangible. Further, the affiliate's experience in producing the
parent's designs may lead to the development of some amount of
know-how. These facts alone, however, should not prevent the
application of the basic method. The reason is that unrelated
parties performing similar activities will, in general, possess
these types of "routine" intangibles. Therefore, by measuring
the return on assets that unrelated parties earn for performing
similar activities and bearing similar risks, the basic method
will automatically capture the returns earned by these "routine"

- 99 intangibles and will properly attribute them to the affiliate.
It is only when the affiliate owns some type of intangible that
is of major importance to the enterprise, and which few unrelated
parties possess, that the basic method is insufficient standing
alone to resolve the issue.
The basic arm's length return method will probably be
appropriate for most manufacturing affiliates. It should be
possible to observe the rates of return on assets or ratios of
income to costs that are earned by unrelated parties performing
similar manufacturing activities involving similar risks and
amounts of routine intangibles. It is possible to think of
exceptions, however. Consider a corporation that has assembled a
large and valuable team of engineers and skilled craftsmen within
a European subsidiary in order to develop or perfect a complex
manufacturing process. If no or few unrelated parties would be
capable of performing this development activity, the basic arm's
length return method will not be sufficient standing alone to
resolve the case.
Similarly, the basic method will be applicable to many
distribution and marketing affiliates. An affiliate that sets up
and maintains a distribution network undoubtedly possesses a
going concern intangible; an affiliate that markets products to
industrial customers by participating in trade shows and
maintaining a staff of salespersons undoubtedly possesses some
amount of know-how. However, it seems likely that these sorts of
activities are undertaken by unrelated parties that possess
similar amounts of going concern value and know-how. Therefore,
it should be possible to determine the arm's length returns on
assets for these activities, which will include the appropriate
returns to these "routine" intangibles. In other situations,
however, the basic method alone will not suffice.
2. Profit Split Addition to the Basic Arm's Length Return
Method
Although the basic arm's length return method should be
widely applicable, there are situations in which its use alone
will clearly be inadequate. A large multinational corporation
may have foreign subsidiaries that have research, marketing,
planning, manufacturing, and other divisions that are as large
and active as those of all but the biggest U.S. companies.
Therefore, these affiliates may perform complex functions, take
significant risks and own significant intangible assets equal to
those of the typical parent corporation. If so, the basic arm's
length return method would be impossible to apply because exact
or inexact comparables, or rates of returns, for these complex
functions are generally unavailable.
Consider Teachem, a U.S. company that is a world leader in
designing and producing educational toys. It serves its major

- 100 overseas market, Western Europe, through a French sales
affiliate, Enseignerem. Teachem is planning to license a new set
of designs to Enseignerem, who will modify them in minor ways,
such as translating the instructions and markings, and who will
hire local contract manufacturers to produce them. Enseignerem
will utilize its own trademark and be responsible for all
aspects of marketing and distribution in Europe. It will decide
which of the toys to include in its line, set its own advertising
budget, and design campaigns to promote the new line and its
Enseignerem trademark. It also maintains a sales force and
distribution network. Teachem maintains a research and testing
staff to develop new products. The affiliate does not.
Assume further that Teachem has a business policy of not
licensing its designs to unrelated parties. Exact comparables
will therefore be absent, and inexact comparables may be
difficult to find. How would an arm's length return approach be
applied to determine the appropriate royalty rate to be paid by
Enseignerem for the use of Teachem's designs? The first step is
to identify the functions performed by the parent and the
subsidiary in the line of business in which the licensed designs
are used (the sale of new toy designs in the European market).
The parent should be allocated the returns on the basic product
designs, while the subsidiary is entitled to the returns to be
earned by its trademarks, marketing efforts, and distribution
network, plus any intangibles related to the modifications.
The next step is to identify the functions that employ
measurable factors -- i.e., activities that do not involve the
use of significant intangible assets. These activities should be
analyzed using the basic arm's length return method.
Enseignerem's distribution and manufacturing activities may be
examples. It should be possible to find unrelated parties that
perform these types of activities and incur similar business
risks. Thus, it should be possible to determine an arm's length
rates of return on assets (or income-to-costs ratio) for each
activity and apply the arm's length rate or ratio to the
appropriate related party factors. The resulting income shouid
then be allocated to the party performing the activity. In this
case, income attributable to distribution and manufacturing
activities would be allocated to Enseignerem. If the parent
corporation performs or is to perform routine activities
involving the line of business, they too should be analyzed using
the basic method.
These two steps will leave a quantity of income not yet
allocated and a set of activities involving significant
intangible assets not yet accounted for. The goal of the first
two steps is to isolate the income that is attributable to the
significant intangible assets owned by the corporate group as a

- 101 whole and used in the line of business in question -- primarily
the designs owned by Teachem and the marketing intangibles
(including the trademark) owned by Enseignerem.
The goal of the remaining step is to identify the
intangible income attributable to the relevant line of business
and then split that income according to the relative value that
the marketplace would put on each party's significant intangible
assets had they been employed by unrelated parties operating at
arm's length. The intangible income is equal to the combined net
income from the line of business less the income allocated under
the prior steps to functions with measurable factors -- i.e., the
residual combined net income determined after applying the basic
rate of return method to activities with measurable factors of
the parties. In splitting this residual amount between the
related parties, it is not necessary to place a specific value on
each party's intangible assets, only a relative value. Of
course, it is easier to state this principle than to describe in
detail how it is to be applied in practice. In many cases, there
will be little or no unrelated party information that will be
useful in determining how the split would be determined in an
arm's length setting. Furthermore, the costs of developing
intangibles, even if known, may bear no relationship to value,
especially in the case of legally protected intangibles, and
generally should not be used to assign relative values to the
parties' intangible assets. Splitting the intangible income in
such cases will largely be a matter of judgment. There are two
possible sources of arm's length information, however.
First, it may be possible to find unrelated parties that
engage in similar activities and that use similar intangibles.
The unrelated party transactions must be economically similar, of
course, including the level of economic risks assumed. It would
be inappropriate to use a profit split derived from a situation
in which the unrelated parties' intangibles were much less (or
more) profitable than those owned by the related parties.
Further, it would be inappropriate to compare the split derived
from a transaction in.which an unrelated party conducted only
wholesale level marketing, for example, with a related party
situation in which an affiliate markets products to consumers.
These requirements resemble the standards discussed above for
inexact comparables. The analysis of unrelated party profit
splits should explain the relationship between the observed
profit splits and the overall profitability of the significant
intangibles involved with a reasonable degree of accuracy. It
is also necessary to analyze the functions that the unrelated
licensors and licensees perform and the risks that they bear.
Comments in this area should focus on how such an analysis can be
implemented.
Second,
length evidence
in some of
circumstances,
the value of its
a taxpayer
own or its
mayaffiliate's
have arm's

- 102 intangibles. For example, a taxpayer may have recently purchased
its affiliate and may have some basis for determining the value
of the intangible assets using the purchase price.
3. Arm's Length Return Method and Periodic Adjustments
Issues involving periodic adjustments are easier to analyze
for the arm's length return method than for the methods involving
comparable transactions. Because the basic arm's length return
method looks to the factors of production used by the parties,
the income allocation should adjust as the factors change. Thus,
as an affiliate's plant, equipment, and other measurable factors
change from the projections in the initial analysis, the income
allocated to them should change. Similarly, the profit split
percentage is intended to reflect the relative values of
significant intangible assets owned by the parties. When the
value of intangibles belonging to one of the parties has changed,
the percentage should be changed. For example, a dramatic
increase in sales may be due to either a recent product
improvement or an extensive marketing campaign, in which case
proportionately more profit should be assigned to the developing
or marketing affiliate, respectively.
These conclusions are not intended to imply, however, that
there must be year-by-year equality between the related parties'
incomes and the results of an ideal application of the method.
The prior discussion of long-run versus year-by-year results is
again relevant. For,example, consider an independent firm that
uses only plant and equipment. Although it should earn the
market rate of return in the long run, it will, in general,
experience lower returns or even losses in "lean" times and
higher returns at the other end of the business cycle. Periodic
adjustments will be required for significant changes in income.
Therefore, changes (either negative or positive) that are less
than significant may tend to even out in a long-term
equilibrium. The absence of a requirement for an adjustment over
time when insubstantial changes in income occur is a corollary of
the rule that de minimis adjustments will not be made. Chapter 8
discusses this issue, including reasons why explicit inter-year
set-offs would not be practicable, in more detail.
D. Priority And Coordination Among Methods
The previous sections of this chapter discussed two broad
approaches for analyzing transfers of intangible property: an
approach based on comparable transactions and one based on arm's
length returns to factors employed. Which is to be used in a
given situation? The answer is clear in one case. If an exact
comparable is present, it and only it should be used to determine
the allocation of income from the transfer. It follows from the

- 103 definition of exactness that there can be no better evidence of
what unrelated parties operating at arm's length would have
done.
Finding an exact comparable, however, can be extremely
difficult. In the majority of cases, particularly contested
ones, the allocation of income will come from either the inexact
comparable method or the arm's length return method. The facts
and circumstances of each case should determine which method -or methods — should be used.
There are four basic types of cases. In the first, the
intangible for which a section 482 transfer price is being
determined is comparable, to those used by unrelated taxpayers
and each of the related parties is expected to employ significant
and complex intangibles. The inexact comparables method should
be chosen.
In the second case, the section 482 intangible is unique,
and the affiliate utilizing the intangible will engage in
functions that use only measurable factors of production and
routine amounts of intangibles. The basic arm's length return
method should be used.
In the third case, the section 482 intangible has many
competitors and the affiliate using the intangible will engage in
simpler kinds of functions. Both of the methods are potentially
applicable. Under the theory on which they are based, they
should yield similar results. This situation should, in
practice, be the easiest for the taxpayer to analyze and should
engender the least amount of controversy.
In the final case, the section 482 intangible is unique and
both of the related parties own one or more significant
intangibles that will be used in exploiting it. This is the
hardest case. The profit-split version of the arm's length
return method must be used.
E. Risk-Bearing in Related Party Situations
Economic environments are full of uncertainty, and this fact
must be recognized in all methods of income allocation. In
general, in a related party transaction, the market reward for
taking risks must be allocated to the party truly at risk.
Companies take risks in all dealings in the marketplace, and
are rewarded for doing so. Some of this risk disappears in
related party transactions. The legislative history of the Tax
Reform Act of 1986 noted:
In addition, a parent corporation that transfers
potentially valuable property to its subsidiary is not faced

- 104 with the same risks as if it were dealing with an unrelated
party. Its equity interest assures it of the ability
ultimately to obtain the benefit of future anticipated or
unanticipated profits, without regard to the price it
sets. 212
How should risk be accounted for in related party
transactions? The riskiness of true economic activities gives
rise to greater returns in the marketplace; therefore, if one
part of an enterprise is inherently more risky than another, more
income should be allocated to it. This allocation should be
based on the risks arising out of the true economic activities
undertaken by the parts of the enterprise, not on mechanisms that
merely shift risks within the group.
This conclusion has implications for the proper application
of both the comparables approach and the arm's length return
approach. First, in searching for appropriate comparables, one
should look for situations in which an unrelated party contracted
to perform an economic activity that is about equal in riskiness
to the activity done by the affiliate; it would be inappropriate
to rely on comparables in which the unrelated party undertook a
significant risk of some kind not undertaken by the related
party. Likewise, in applying the arm's length rate of return
method, unrelated party rates of return should be used only if
they reflect similar levels of risk. But merely stating that
unrelated party transactions must bear the same level of risk as
the related party begs the question of what risks the related
party should be allowed to assume. It's necessary to decide
first what risks may be appropriately assumed by the related
parties, depending on the functions that each performs. Only
then is it possible to identify what unrelated party arrangements
are comparable so that comparable rates of return (or inexact
comparable transactions) can be determined.
Returning to the Widgetco example, the affiliate, as the
manufacturer, is at risk both with respect to its investment in
2
plant2 1and
equipment
with
respect
to inventories.
1985 House and
Rep.,
supra
n. 47,
at 424 (1985).The
A risk
line of
with
respect
to
plant
and
equipment
will
be
significant
only
court cases not directly relevant to section 482 has reached if
a
the facilities
cannot In
beCarnation
used for other
purposes without
similar
conclusion.
and succeeding
cases, members
of an affiliated group of corporations were denied deductions for
"insurance premium" payments to another member of the group that
insured predominantly risks of the group. The courts decided
that no true insurance was present, because there was no true
risk shifting between the parent and its affiliates. Carnation
Co. v. Comm'r, 71 T.C. 400 (1979), aff'd, 640 F.2d 410 (9th Cir.
1980), cert, denied, 454 U.S. 965 (1981).

- 105 incurring significant additional costs. If there is risk that
the product will not be successful because there is uncertainty
that the product will perform as anticipated or have the usages
anticipated, then that risk should be borne by Widgetco as owner
of the manufacturing intangible (the patent) and should not be
reflected in the affiliate's rate of return. The affiliate's
return should reflect only the moderate level of risk borne by
manufacturers of products that are reasonably expected to achieve
market acceptance. Likewise, if there is uncertainty that the
product will be marketed successfully, then that marketing risk
also should not be borne by the affiliate but should probably be
shared in some fashion by the owner of the manufacturing
intangible and the marketer, depending upon the extent to which
anticipated profits from the enterprise are attributable to the
manufacturing intangibles or the marketing activities.
On the other hand, assume that the risk does not relate to
undue uncertainty regarding the anticipated performance or usage
of the product or the market acceptability of the product.
Assume, instead, that it is highly uncertain whether the product
can be produced cheaply enough to make the enterprise viable, or
that it is uncertain whether the manufacturing process will
produce the product with the same quality as prototypes produced
in the laboratory. These risks are risks inherent in the
manufacturing function and should probably be shared in some
fashion between the owner of the manufacturing intangible and the
manufacturing affiliate. If the manufacturing affiliate is
itself developing an efficient production process that attempts
to achieve low production costs or to assure consistency in
quality of output, then the affiliate should be allocated a
return that reflects a substantial portion of that risk being
borne by the manufacturing affiliate. (In such case, the
manufacturing affiliate would bring to bear significant
manufacturing process intangibles which would necessitate the
application of the profit split addition to the basic arm's
length return method.) If, instead, the owner of the intangible
has also developed the production process without significant.
contribution by the manufacturing affiliate, then a separate
manufacturing intangible related to the production process has
been created, and the owner of such intangible is entitled to an
arm's length return. The manufacturing affiliate's return should
not bear more than the moderate level of risk borne by
manufacturers of products that are reasonably expected to achieve
market acceptance.
F. Coordination with Other Aspects of Transfer Pricing
The purpose of this chapter is to provide a framework for
the development of new methods for allocating income from
intangible property. Therefore, methods for allocation of income

- 106 in situations involving provision of services213 or transfers of
tangible property214 may appear at first glance to be outside the
scope of the present discussion. However, the rules for
intangible property must be coordinated with the rules for other
types of transactions between related parties for obvious
reasons. Transfers of tangible property and provision of
services frequently accompany a transfer of intangible property;
all three are often bundled into a single economic transaction.
Further, if the rules relating to one type of transaction become
more or less favorable to taxpayers, then they will easily be
able to find ways to structure their transactions to take
advantage of the disparities.
It may be helpful to establish a priority for single
economic transactions that involve more than one type of
transfer. For example, licensing agreements often contain
clauses that require the licensor to provide training or other
services to the licensee. Further, transfers of tangible
property often involve intangibles, since the goods transferred
often depend for their value on embodied trademarks or patents.
In these cases, the basic allocation of income issue should be
settled under the rules to be developed for intangible property.
G. Conclusions and Recommendations
1. An approach incorporating two alternative methods for
determining transfer prices for intangibles would
achieve more appropriate allocations of income and
greater consistency in result.
2. The first method uses exact or inexact comparables
when they exist.
a. An exact comparable is the same intangible
licensed to an unrelated parties, when the
circumstances surrounding it and the related party
transfer are similar. The price derived from this
method has priority over all others.
b. An inexact comparable is an intangible very
similar to the intangible transferred to a
related party, but not identical. Differences
must be definite and ascertainable. If the other
intangible, the contractual arrangements, or the
economic circumstances are too different, it may
not be used as a comparable.
213
Treas. Reg. §1.482-2(b).
214

Treas. Reg. §1.482-2(e).

- 107 3.

The second method uses an arm's length return analysis
instead of looking for a comparable transaction and
adopting that transfer price as the section 482
transfer price for the related party transfer.
a. The basic arm's length return approach applies
when one party to the transaction performs
economic functions using measurable assets or
other factors, but not using significant
intangibles of its own. The first step is to
break down the relevant line of business into its
component activities or functions and measure the
factors (generally assets) utilized by the party
performing the simpler set of functions. Income
attributable to those functions is determined by
identifying rates of return to assets or other
factors of unrelated entities performing similar
economic activities and assuming similar economic
risks, and applying a comparable rate of return to
the assets or other factors of the related party.
Any residual income is thereby effectively
assigned to the other party. The royalty rate or
other transfer price for intangibles utilized by
the related party must be set to achieve the
allocation of residual income to the other party.
b- When both parties perform complex.economic
functions, bear significant economic risks, and
use significant self-developed intangibles, a
profit split analysis must be added to the basic
rate of return method. Under the profit split
analysis, the combined net income from the line of
business must first be determined. The profit
split analysis assigns the residual net income,
determined after applying the basic rate of return
method to the measurable assets of the parties,
between the parties based upon the relative values
of the parties' unique intangibles.
4. While the standards for exact or inexact comparables
do not require year-by-year equality between results of
the unrelated party arrangements and related party
arrangements, unrelated party arrangements can lose
their comparability over time as the facts and
circumstances relevant to the standards for
comparability change. In such case an adjustment to
allocations of income may be necessary. Under the
arm's length return method, income allocations reflect
the functions performed by the parties and -- i.e.,
they reflect the measurable factors of production and
the valueinof
significant
intangibles
employed
by the
parties
performing
those
functions.
Therefore,

- 108 income allocated to the related parties under the arm's
length return method will change as the functions
performed or the factors of production or value of
intangibles employed by the parties change.
Other than in the case of exact comparables, there
should be no priority among these methods. However,
each is designed to be utilized under a specific set of
facts, so the underlying fact pattern should determine
the method or methods to be used.
Risk should be accounted for under all methods
described in this chapter, since the market rewards
risk takers. However, the risk premium should be
attributed to the affiliate undertaking the economic
function in which the risk inheres.

- 109 IV.

COST SHARING ARRANGEMENTS

Preceding parts of this study have analyzed the proper
prices to be applied, or amount of income to be allocated, when
an intangible is transferred between related parties. Cost
sharing arrangements are an alternative method by which related
parties can develop and exploit intangibles. The history of such
arrangements, their acceptance for tax purposes, and an outline
of rules that should be followed for post-1986 cost sharing
arrangements are discussed in this part.
Chapter 12
HISTORY OF COST SHARING
A. Introduction
In general, a cost sharing arrangement is an agreement
between two or more persons to share the costs and risks of
research and development as they are incurred in exchange for a
specified interest in any property that is developed. Because
each participant "owns" specified rights to any intangibles
developed under the arrangement, no royalties are paid by the
participants for exploiting their rights to such intangibles.
The Conference Report accompanying the 1986 Act indicates that
Congress did not intend to preclude the use of bona fide research
and development cost sharing arrangements. However, Congress
expected the results produced under a bona fide cost sharing
arrangement to be consistent with results under the commensurate
with income standard.215
Cost sharing arrangements have long existed at arm's
length between unrelated parties. Typically, unrelated parties
pool their resources and expertise in a joint effort to develop a
specified product in exchange for a share of potential profits.
The Service has little experience with ordinary unrelated party
cost sharing arrangements because they are at arm's length and
normally do not have unusual tax consequences.216
In view of the limited information currently available on
both related and unrelated cost sharing agreements, the Service
and Treasury would appreciate receiving information from
taxpayers regarding their contractual arrangements and experience
with 2cost
sharing.
15
1986 Conf. Rep., supra n. 2, at II-6.
216

See generally Rev. Rul. 56-543, 1956-2 CB. 327,
revoked by Rev. Rul. 77-1, 1977-1 C B . 161; see also Gen. Couns.
Mem. 36,531 (December 29, 1975).

- 110 B. 1966 Proposed Section 482 Regulations
Proposed Treas. Reg. §1.482-2(d)(4), published on August 2,
1966, provided extensive rules for cost sharing arrangements.217
The proposed regulations permitted any affiliate (other than one
in the trade or business of producing intangible property) to
participate in the cost sharing arrangement, provided that the
intangible property was intended for use in connection with the
active conduct of the affiliate's business. The regulations
specifically authorized cost sharing arrangements for single
projects, but did not disqualify multiple projects or continuing
arrangements. The sharing of costs and risks was required to be
proportional to the anticipated benefits to be received by each
member from the arrangement. Cost sharing was required to be
based on sales, profits or other variable criteria.
The 1966 proposed regulations did not explicitly address the
"buy-in" question -- that is, the compensation to be paid to the
developer or owner of intangibles that are made available at the
time the arrangement commences. They did, however, require that
an arm's length amount be paid to the affiliate that provides
intangibles that substantially contribute to the arrangement.
Any required section 482 allocation for services provided by
other affiliates was also to be included as a cost of the
arrangement.
The proposed cost sharing regulations were ultimately
abandoned in favor of the simpler general requirements presently
contained in section 1.482-2(d)(4).
C. Current Regulations
The current rules in section 1.482-2(d)(4) state that a cost
sharing agreement must be in writing and provide for the sharing
of costs and risks of developing intangible property in return
for a specified interest in the property that may be produced. A
bona fide cost sharing arrangement must reflect an effort in good
faith by the participants to bear their respective shares of all
costs and risks on an arm's length basis. The terms and
conditions
must
beReg.
comparable
to those that would have been
217
31
Fed.
10394 (1966).
adopted by unrelated parties in similar circumstances.218
218
Whether a particular cost sharing agreement meets the
requirements of section 482 is generally a factual question not
appropriate for a private letter ruling. There have been private
letter rulings regarding issues that are peripheral to the
central question of whether a cost sharing agreement is bona
fide. However, none of these rulings concerned the
characteristics necessary for an agreement to be considered bona

- Ill D.

Foreign experience with cost sharing agreements

The 1979 OECD report on Transfer Pricing and Multinational
Enterprises219 stated that, although international cost sharing
agreements for research and development costs were not common,
some had recently been entered into by large multinational
enterprises. The OECD report indicated that, with the exception
of the United States, none of its members had laws or regulations
pertaining specifically to cost sharing arrangements. A major
concern expressed by the OECD report was that the participants to
the arrangement be in a position to benefit from any intangibles
developed under the arrangement before the cost sharing payments
would be allowed as deductible expenses. The OECD report stated
that the United States did not require a profit mark-up for
research and development activities performed. The OECD report
reflected a consensus, however, that a profit mark-up would be
appropriate when research was performed at the specific request
of a member of the cost sharing group. There was also a
consensus that withholding taxes should not apply to cost sharing
payments when paid.
A few countries have specifically addressed cost sharing
arrangements since publication of the OECD report. Germany has
developed guidelines220 for the use of cost sharing agreements in
cases in which expenses for research and development can only be
valued in the aggregate. Division of the costs must be based on
the extent that each party actually benefits or expects to
benefit from the arrangement. When determining costs incurred,
no profit element is recognized for tax purposes. Appropriate
costs
to bethe
shared
may regulations.
include a contribution
general
fide under
current
See Priv.to
Ltr.
Ruls.and
administrative
costs.
8111103,
8002001,
8002014, and 7704079940A.
219

OECD, Transfer Pricing and Multinational Enterprises,
supra n. 158, at 55-62.
220

The guidelines for cost sharing agreements are found
in paragraph 7 of the German Transfer Pricing Guidelines.
English and French translations of these guidelines are contained
in Raedler-Jacob, German Transfer Pricing/Prix de Transfert en
Allemagne (Kluwer Law and Taxation Publishers, Devender,
Netherlands, and Metzner, Frankfurt, Germany 1984). The
guidelines are also available in International Bureau of Fiscal
Documentation, Tax Treatment of Transfer Pricing (Amsterdam,
Netherlands 1987).

- 112 E.

Deficit Reduction Act of 1984

Section 367(d), enacted in 1984, provides that a transfer
of intangibles to foreign corporations in an exchange described
in section 351 or 361 is to be treated as a sale, with the
transferor being treated as receiving amounts that reasonably
reflect the amounts that would have been received under an
agreement providing for annual payments contingent on
productivity, use, or disposition of the property. Such payments
are treated as reductions of the foreign entity's earnings and
profits and as U.S. source income to the U.S. recipient. The
"Blue Book" discussion of section 367(d) indicates that it is to
have no application to bona fide cost sharing arrangements.221
The Blue Book further recognized that it may be appropriate for
the Treasury Department to elaborate on the current cost sharing
rules to address problems with cost sharing arrangements.222
F. Cost Sharing under Section 936(h)
After 1982, the intangible income of a domestic corporation
qualifying for the possessions tax credit must be included in the
income of its U.S. shareholders, unless the possessions
corporation either elects the cost sharing method or elects the
50% of combined taxable income method, both of which are
contained in section 936(h). Under the section 936(h) cost
sharing election, the possessions corporation must pay its share
of the affiliated group's total research and development costs
based on the ratio of sales by the affiliated group of products
produced in the possession to total sales by the affiliated group
of all products. The cost sharing payment must be computed with
respect to "product areas" rather than single projects. "Product
areas" are defined, in general, by reference to the three-digit
Standard Industrial Classification codes (SIC codes) promulgated
by the Commerce Department. Cost sharing payments made by the
possessions corporation are not treated as income to the
recipient but reduce otherwise allowable expenses.
A possessions corporation making the cost sharing election
is treated as owning the manufacturing intangibles utilized in
its business, and the income from such intangibles then becomes
eligible for the possessions tax credit. Pricing of products
between a possessions corporation electing the cost sharing
method
2 2 1and its domestic U.S. affiliates must still meet the
General Explanation of the DRA of 1984, supra n. 143,
requirements of section 482, taking into account that the
at 433.
possessions corporation is treated as owning the manufacturing
222
Id.
intangibles.

- 113 Pursuant to an amendment made by the 1986 Act, a possession
corporation making the cost sharing election must pay the greater
of 110% of the pre-1986 statutory cost sharing amount or the
royalty required to be paid to the developer of the intangibles
under the commensurate with income standard.223 Given the
special circumstances in which the section 936(h) cost sharing
provisions apply and the 1986 Act changes, section 936(h) cost
sharing arrangements do not provide much guidance with regard to
the appropriate requirements for other cost sharing
arrangements.

223

Section 936(h)(5)(C)(i)(I), as amended by
§1231(a)(l)(A), Pub. L. No. 99-514, 100 Stat. 2085 (1986).

- 114 Chapter 13
COST SHARING AFTER THE TAX REFORM ACT OF 1986
A. Introduction
The Conference Report to the 1986 Act states that, while
Congress intends to permit cost sharing agreements,224 it expects
cost sharing arrangements to produce results consistent with the
purposes of the commensurate with income standard in section 482
— i.e., that "the income allocated among the parties reasonably
reflect the actual economic activity undertaken by each." The
Committee Report also emphasized three potential problems that
should be addressed in any revision of section 1.482-2(d)(4).
The first problem is selective inclusion in the arrangement
of high profit intangibles. The Report states:
Under a bona fide cost sharing arrangement, the cost sharer
would be expected to bear its portion of all research and
development costs, on successful as well as unsuccessful
products within an appropriate product area, and the cost of
research and development at all relevant development stages
would be included.225
The second issue concerns the basis on which contributions
are to be measured. The Report states:
In order for cost-sharing arrangements to produce results
consistent with changes made by the Act to royalty
arrangements, it is envisioned that the allocation of R&D
cost-sharing arrangements generally be proportionate to
profit as determined before research and development.226
The third specific Congressional concern relates to the
"buy-in" issue. The Report states:
In addition, to the extent, if any, that one party is
actually contributing funds toward research and development
at a significantly earlier point in time, or is otherwise

224

1986 Conf. Rep., supra n. 2, at 11-638.

225

Id.

226

Iu.

- 115 effectively putting its funds at risk to a greater extent
than the other, it would be expected that an appropriate
return would be required to such party to effectively
reflect its investment.227
This chapter examines these and other issues that have
arisen with regard to the requirements for a bona fide cost
sharing arrangement after the Tax Reform Act of 1986. It should
be made clear at the outset that, if an arrangement is not bona
fide, any payments made under the cost sharing agreement will be
considered as offsets to the arm's length price that should have
been paid for the intangibles. While section 1.482-2(d)(4)
limits adjustments by the Service in the context of cost sharing
arrangements to an adjustment of contributions paid, this
regulation presupposes that the arrangement is bona fide. If the
arrangement is not bona fide, normal arm's length standards would
apply, including the commensurate with income standard.
B- Products Covered
In section 936(h), product area research is defined
generally by reference to the three-digit Standard Industrial
Classification (SIC) codes, meaning that the section 936(h) cost
sharing arrangement covers research and development costs over a
very broad product area.228 As described above, the legislative
history to the 1986 Act contemplates that a section 482 cost
sharing arrangement should cover all research and development
costs within an "appropriate product area." The approach in
section 936 and in the 1986 Act legislative history contrasts to
the proposed 1966 regulations. Cost sharing arrangements
described in the 1966 proposed regulations could cover a single
project, although multi-project or product area cost sharing
agreements were not prohibited.
As discussed in section C below, broad product area cost
sharing arrangements raise the issue of whether the potential
benefits are proportionate to the participants' cost sharing
payments. This issue is of particular concern in cost sharing
arrangements of foreign-owned multinational groups if U.S.
227
Id.
persons are
participants, since cost sharing payments made by
U.S. participants are deductible for U.S. tax purposes.229
228
Section 936(h)(5)(C)(i)(I).
229

Another potential abuse may arise in the context of a
domestic affiliate that is a co-developer of the intangible, or
otherwise participates in a de facto cost sharing arrangement.
In such cases, the foreign entity may try to avoid the
characterization of a cost sharing arrangement in order to

- 116 On the other hand, single product arrangements present the
potential that cost sharing may be employed solely for high
profit potential intangibles, such that foreign affiliates of
U.S. multinational groups acquire the rights to such intangibles
without bearing the cost of research related to low profit
potential intangibles and unsuccessful research. The incentive
to include selectively only high profit potential intangibles in
a cost sharing arrangement is most acute when tax haven entities
are the primary or predominate participants in the
arrangement.2 3 °
Three-digit SIC code product areas would seem to be the
appropriate scope of most cost sharing arrangements. Both the
Service or the taxpayer should be permitted to demonstrate,
however, that a narrower or broader agreement is more
appropriate. Taxpayers choosing a narrower agreement would need
to show that the agreement is not merely an attempt to shift
profits from successful research areas while leaving expenses of
unsuccessful or less successful areas to be absorbed by the U.S.
or higher tax affiliates. For example, some members of a
multinational food and beverage group might be interested in
research and development to develop a multi-purpose artificial
sweetener, yet their respective food and beverage product lines
might be sufficiently diverse (or might be products for which
research and development is not necessary) that a single product
agreement would be appropriate. Taxpayers choosing a broader
agreement would need .to show that the agreement is not being used
to charge U.S. affiliates or other participants for research and
development without reasonable prospect of benefit. From the
Service's perspective, a product area that is broader or narrower
than three-digit SIC codes may be necessary to avoid these
distortions.
C. Cost Shares and Benefits
Underlying all of the problems discussed in the legislative
history of the 1986 Act in relation to cost sharing arrangements
is the fundamental principle that the costs borne by each of the
participants should be proportionate to the reasonably
anticipated benefits to be received over time by each participant
extract
royaltiesintangibles
from the domestic
from exploiting
developedaffiliate,
under theparticularly
cost sharing where
the
withholdingThis
tax cost
on the
royalties is
reduced has
by aseveral
tax treaty
arrangement.
share/benefit
principle
and
the royalty
income
is not taxed
or lightly
taxed
the
facets,
including
the appropriate
product
area to
be by
covered
foreign jurisdiction.
See Lilly, supra n. 57, at 1150.

- 117 (discussed in section B above), definition of costs to be covered
(discussed in section D below), and the measurement of
anticipated benefits and several other issues discussed below.
1. Assignment of exclusive geographic rights. In general,
the computation of cost shares should reflect a good faith effort
to measure reasonably anticipated benefits to be derived from the
arrangement. While it is difficult under the best of
circumstances to predict what benefits each of the participants
will derive, it is virtually impossible to do so unless the
participants are assigned specific exclusive geographic rights to
intangibles developed under the arrangement. Specific assignment
of rights could take the form of assigning the rights to
manufacturing intangibles relating to products to be sold in the
United States to a U.S. affiliate, rights related to European
markets to an Irish affiliate, rights related to Middle Eastern
and Pacific rim markets to a Singapore affiliate, etc. In such
case, the U.S. affiliate would derive the income attributable to
the manufacturing intangibles developed under the arrangement
with respect to any sales in U.S. markets regardless of whether
ultimately the U.S. affiliate is manufacturing the products sold
in U.S. markets. (As discussed below, however, the participants
must be those expected to exploit the intangibles by performing
the manufacturing function themselves.)
Alternatively, exclusive worldwide rights to different types
of intangibles developed under the arrangement could be assigned
to particular participants. This latter type of arrangement
would warrant special scrutiny to assure that the cost shares
reflect reasonably anticipated benefits.231 Moreover, if
research activities are not common to the various types of
intangibles produced under the arrangement, then the research
related to each type of intangible should be charged to the
specific affiliate that will receive the rights to that type of
intangible. This is particularly true of arrangements where one
of the parties produces components. The Service and Treasury
would welcome comments on this topic. In short, such research
activities are not the proper subject of a cost sharing
arrangement.
For various reasons, including consistency with longstanding
section 367(a) policy, U.S. geographic rights should never be
permitted to be assigned under a cost sharing arrangement to a
foreign
(1)next
the participants
are part
of a
2 3 1 person if either:
As discussed in the
paragraph, rights
to exploit
U.S.
owned
multinational
group;
(2)
a
significant
portion
an intangible in the U-S. must belong to a U.S. affiliate.of the
research is performed in the United States; or (3) any U.S.
person participates in the arrangement. Accordingly, U.S. rights
could be acquired by a foreign person only in the case of a

- 118 foreign-owned multinational group that conducts the research
overseas and does not include any U.S. affiliates as a
participant in the arrangement.
2. Overly broad agreements. The principle that cost shares
be proportionate over time to the reasonably anticipated benefits
may affect the issue of whether cost sharing arrangements are
overly broad in terms of the products covered or the affiliates
participating in the agreement. For instance, a manufacturing
conglomerate makes widgets and gadgets. An overall cost sharing
agreement for research and development may be inappropriate if a
particular affiliate does not make both widgets and gadgets. If
a disproportionate amount of research and development relates to
widgets but affiliate A manufactures only gadgets, affiliate A
would be subsidizing the research for the widget manufacturers.
Although every participant in a cost sharing agreement should not
be required to benefit from every intangible that may be
produced, cost shares should be proportionate to the reasonably
anticipated benefits. It may be necessary, therefore, either to
have separate cost sharing agreements for widget and gadget
research, to adjust affiliate A's cost share to reflect the costs
related to gadget research, or to exclude affiliate A from the
cost sharing arrangement.2 3 2
3. Direct exploitation of intangibles by participants. The
cost share/benefit principle may otherwise affect who may
participate in a cost sharing arrangement. In general, the
benefit to be derived under a cost sharing arrangement is the
right to use a developed intangible in the manufacture of a
product. Therefore, the participant must be in a position to
232

The exclusion of affiliate A from the cost sharing
arrangement raises the question of which of the other
participants should pay for research related to intangibles that
may be used by affiliate A. For various reasons, not all
affiliates that anticipate using the intangibles developed under
the cost sharing agreement may actually participate in the
arrangement. For example, there may be reason to exclude a
particular affiliate that manufactures only certain types of
products and therefore will use only certain types of intangibles
developed under the arrangement. Alternatively, the arrangement
may not be recognized under foreign law for tax purposes, such
that a deduction for cost sharing payments would be denied. In
such cases, some affiliate must fund research for intangible
rights to be used in manufacturing by the nonparticipants. While
there is no clear answer, it seems appropriate that the affiliate
that performs the research should fund and receive the residual rights.

- 119 exploit the intangible in the manufacture of products.233 It is
not necessary that all participants be capable of manufacture at
the time costs are being incurred, so long as it is reasonably
anticipated that the participants will be capable of manufacture
once the intangibles are developed and will use intangibles
developed under the arrangement in the manufacture of
products.2 3 4
4. Measurement of anticipated benefits. In order to
determine whether cost shares are proportionate to reasonably
anticipated benefits, it is necessary to measure the anticipated
benefits. Obviously there has to be some prediction, rough
though it may be, of the kinds of intangibles likely to be
produced and the relative proportion of units that will be
produced and sold under the rights of each participant. In many
cases, estimated units of production may be an appropriate
measure of benefit assuming that there is a uniform unit of
production that can be used as a measuring device. If there is
no uniform unit of production, then sales value may be an
233
Asmeasure,
a roughly
the 1966
appropriate
if analogous
measured requirement,
at the same level
of production
regulations required that participants use the intangibles
developed under the cost sharing arrangement in the active
conduct of their trade or business. Prop- Treas. Reg. §1.4822(d)(4)(ii)(b), 31 Fed. Reg. 10,394 (1966). The 1966 regulations
would also have excluded as participants companies in the trade
or business of performing research for others. This latter
exclusion seems unnecessary so long as the affiliate that
performs the research and development funds an appropriate
portion of the research and development costs and is capable of
using the intangible rights that it acquires under the agreement
in the manufacture of products.
234
Expectations will not always prove true, and in some
situations the participant that acquires certain rights to
intangibles developed under the cost sharing agreement will not
ultimately directly exploit those rights. For example, assume
that a Dutch affiliate acquires the European rights to
intangibles developed under the arrangement with the anticipation
of manufacturing products for European markets in Ireland. It
later appears that it will be necessary for various reasons to
have a locally incorporated entity manufacture in Germany
products to be sold in the German market. Unless the German
rights to the intangible are transferred in a contribution to
capital or other tax free transaction, the German rights would
have to be licensed or sold to the German affiliate. In either
case the intangible would be subject to section 482 and,
generally, the subpart F provisions would treat the resulting
royalty or sales income as foreign personal holding company
income includible in subpart F income.

- 120 or distribution for all participants. As stated in section A
above, however, the Conference Report anticipated that cost
shares be proportionate to profit as determined before research
and development. Given the legislative history, therefore,
neither units of production nor sales would be an appropriate
measure if it were apparent (or became apparent during the course
of the agreement) that profitability differed substantially with
respect to various participants' rights. This would be true, for
example, in situations in which geographic markets differ
significantly in terms of production costs, market barriers, or
other factors that bear significantly on profitability. In such
cases, estimated gross profit or net profit may have to be used,
or some adjustments may have to be made to cost shares determined
on the basis of units of production or sales.
It is not realistic, however, to expect taxpayers in most
instances to be able to estimate gross or net profit margins from
estimated sales. Even estimates of units produced or sales
value probably would be imprecise. It may be that a cost sharing
agreement should not be recognized if units of production or
sales are not appropriate measures and gross or net margins are
extremely difficult to estimate. In such cases, the
relationship between cost shares and anticipated benefits may
simply be too tenuous.
5. Periodic adjustments. The language in the legislative
history that the results of cost sharing arrangements be
consistent with changes made by the 1986 Act to royalty
arrangements has one other obvious implication. The cost shares
should be adjusted periodically, on a prospective basis, to
reflect changes in the estimates of relative benefits, including
a change in the measurement standard if that becomes appropriate.
In any event there is always a risk that the cost sharing
agreement could subsequently be rejected as a bona fide
arrangement if the estimates of benefits derived under the
arrangement proved to be so substantially disproportionate to the
cost shares that the estimates of benefits cannot be considered
to have been made in good faith. Periodic adjustments to the'
cost sharing arrangement would reduce that risk.
D. Costs To Be Shared
In general, the costs to be shared should include all direct
and indirect costs of the research and development undertaken as
part of the arrangement. Direct costs would include expenses for
salaries, research materials, and facilities. However, there
should be a limitation on the annual inclusion of costs for
depreciable assets that is consistent with U.S. tax accounting
principles. Otherwise, deductions for outbound payments may be
overstated. Indirect costs should include a portion of overall
corporate management expense and overall interest expense that is
allocated and apportioned to research and development activities

- 121 in a manner consistent with U.S. expense allocation principles.
The costs to be reimbursed should be net of any charges for
research undertaken on specific request or for any government
subsidies granted.235
E. Buy-in requirements
As previously stated, the legislative history to the 1986
Act states that a party to a cost sharing arrangement that has
contributed funds or incurred risks for development of
intangibles at an earlier stage must be appropriately compensated
by the other participants -- hence the requirement for a buy-in
payment. One of the primary reasons for adopting cost sharing
provisions is to avoid the necessity of valuing intangibles.
Yet, if there are intangibles that are not fully developed that
relate to the research to be conducted under the cost sharing
arrangement, it is necessary to value them in order to determine
an appropriate buy-in payment.
There are three basic types of intangibles subject to the
buy-in requirement. A participant may own preexisting
intangibles at various stages of development that will become
subject to the arrangement. A company may also conduct basic
research not associated with any product. Finally, there may be
a going concern value associated with a participant's research
facilities and capabilities that will be utilized.
Fully developed intangibles command a royalty to the extent
used by other participants and are generally not appropriately
incorporated into a cost sharing arrangement. Thus, royalties
for preexisting developed intangibles may not be included in the
buy-in payment, but instead are subject to the general rules of
the commensurate with income standard. Because a subsequent
substantial deviation in the income stream from the intangible
might require an adjustment, it is important to identify
separately the income stream and royalties related to preexisting
developed
intangibles. In many situations, research is
235
It isrespect
generally
expected that
there will in
not
be ato
performed with
to preexisting
intangibles
order
profit
element
in
cost
sharing
agreements.
A
profit
should
improve the preexisting intangibles (improved software, for be
required, however, for research performed at the specific request
of a group member or a for a person outside the arrangement
group. OECD, Transfer Pricing and Multinational Enterprises,
supra n. 158, at p. 119. In either case, the amount received
should reduce the costs to be shared. One item that should not
be included in the costs to be shared among the participants is
the buy-in cost of transferring intangibles from the party by
whom they were developed to the other participants. This general
subject is discussed in section E below.

- 122 example) or to develop the next generation of intangibles. The
requirement for an adjustment to the royalty paid for the
intangible would not apply if the intangible is enhanced in value
solely as a result of research undertaken after inception of the
cost sharing arrangement.
The buy-in payment should reflect the full fair market value
of all intangibles utilized in the arrangement and not merely
costs incurred to date. To permit a buy-in based on cost would
be inconsistent with the provisions of section 367(d) which
effectively precluded the tax-free transfer of intangibles and,
by implication, the transfer of intangibles at cost.236 The buyin payment could take the form of lump sum or periodic payments
spread over the average life expectancy of contributed
intangibles — perhaps on a declining basis since intangibles
generally have greater value in the earlier stages of their life
cycle. Obviously, periodic payments should reflect the time
value benefit of not making a lump sum payment at the inception
of the agreement.
A "buy-out" occurs when a participant withdraws from a cost
sharing arrangement. Having funded a portion of research and
development prior to withdrawal, that person owns a share of
whatever the agreement has borne to date and must be compensated
by the other participants for the value of what the arrangement
has produced to date and not merely reimbursed for costs incurred
to date.
A "secondary buy-in" is required when new members are
admitted after a cost sharing agreement is in place. If a new
member is acquiring a portion of the geographic rights of one of
the original participants, any buy-in amount should be paid to
the affiliate whose geographic rights are being reduced. Once
again, in order for the buy-in to be arm's length, any new member
must compensate the original participants in a manner similar to
the original buy-in computation, but based upon current values
and not merely costs incurred to date.
F. Marketing Intangibles
The 1986 amendment to section 482 provides that the term
"intangible property" shall have the same meaning as in section
936(h)(3)(B).
The sectionhistory
936 definition
of intangible
236
The legislative
of the 1984
Act statesproperty
that
includes
marketing
intangibles.
This
does
not
mean,
however,
the provisions of section 367(d) can be avoided by selling
intangibles subject to the application of section 482 to the
sale. S. Rep. No. 169, 98th Cong., 2nd Sess., vol. 1 at 368
(1984). The legislative history did not contemplate that a
transfer at cost would avoid the application of section 367(d).

- 123 that marketing intangibles are necessarily the proper subject of
cost sharing rules developed with manufacturing intangibles in
mind.
In general, marketing costs yield a present benefit (even if
also a future benefit) and, therefore, are currently deductible
expenses for which a charge must be made under the services
provisions of the section 482 regulations if the benefit
therefrom accrues to a related person.237 (Research expenses
related to manufacturing intangibles generally do not yield
present benefits but, nevertheless, are currently deductible
pursuant to the special provisions of section 174.) In the
context of marketing expenses, the services regulations under
section 482 presently serve the same function as would rules
governing cost sharing arrangements in identifying the potential
beneficiaries of a marketing expense and requiring an appropriate
charge (albeit with a profit element in certain cases). There
seems to be no need for an additional regime to deal with the tax
treatment of cost sharing arrangements related to marketing
expenses. Comment is requested, however, concerning any
situations which are believed not to be covered by the section
482 services regulations or any perceived problems which arise
under those regulations as they affect marketing expenses.
G. Character of Cost Sharing Payments
Under section 936(h), the amount of any required cost
sharing payment is not treated as income of the recipient, but
instead reduces the amount of deductions otherwise allowable.238
More generally, when expenditures are made with the expectation
of reimbursement, they are treated as loans, and therefore the
reimbursement does not constitute gross income to the
recipient.239 Accordingly, cost sharing payments are not income
to the recipient but, instead, reduce costs which are otherwise
deductible in computing taxable income and earnings and profits.
Since cost sharing payments are not gross income to the
recipient, no U.S. withholding tax would be imposed on outbound
cost sharing payments made by a U.S. person to a foreign person.
Characterizing cost sharing payments in this manner also
reduces the amount of research and development expenses of the
2 3 7performing the research that are subject to allocation
entity
Treas. Reg. §1.482-2(b)(2).
under
the
rules of section 1.861-8 and increases the amount
238
Section
936(h)(5)(C)(i)(IV)(a);
Treas.
Reg.the
§1.936subject
to allocation
by the participants
making
cost
6(a)(5).
239

Boccardo v. U.S., 12 CI. Ct. 184 (1987).

- 124 sharing payments.240 Furthermore, since the payments received by
the entity performing the research will not constitute income,
payments received by a U.S. entity from foreign affiliates are
not foreign source income to the U.S. entity.
For purposes of calculating the credit allowable under
section 41 for research expenditures, members of a commonly
controlled group of corporations may disregard intercompany
reimbursements for research expenditures.241 This rule treats a
U.S. company that actually performs U.S. situs research as
incurring 100 percent of the research expenses for purposes of
calculating the research credit, even if the U.S. company is
reimbursed for a portion of those expenses pursuant to a section
482 cost sharing arrangement.
One group of taxpayers has suggested that the regulations
should allow a cost sharer to denominate its rights under a cost
sharing arrangement as a geographically exclusive, no-royalty,
perpetual license if a license is required to obtain local
country tax benefits or if the parent would be in a better
position to protect against infringement than the subsidiary. If
under U.S. law, the participant is clearly the beneficial owner
of intangibles developed under the cost sharing arrangement, then
labeling its interest as a "license" will not change the
characterization for U.S. tax purposes, even if legal title to
the rights are held by its parent serving as nominee owner of
such rights. Therefore, whatever label is applied to the
arrangement for foreign law purposes generally would not affect
240
its U.S.
tax
treatment
unless
substantive
Section
1.861-8
setsthe
out label
rules affects
for allocating
and legal
rights
relating
to
the
intangible.
apportioning deductions between U.S. and foreign source gross
income. A special allocation rule gives companies the right to
allocate fewer U.S. research and development expenses to foreign
source income, even though the income generated by the expenses
is foreign source. Treas. Reg. §1.861-8(e) (3 ) (B) (ii). Under the
1986 Act, 50 percent of all amounts allowable as a deduction for
qualified domestic research and experimental expenditures is
apportioned to income from sources within the United States, with
only the remaining 50 percent apportioned on the basis of gross
sales or gross income of companies benefitting from the research
and development. This special provision applies only to expenses
incurred in tax years after August 1, 1986, and on or before
August 1, 1987. §1216, P.L. 99-514, 100 Stat. 2085 (1986).
Provisions similar in concept are currently under consideration
in Congress.
241
Treas. Reg. §l-44F-6(e); Priv. Ltr. Rul. 8643006
(July 23,1986).

- 125 H. Possessions Corporations
The cost sharing payment made by a possessions corporation
pursuant to the special cost sharing election under section
936(h)(5)(I) must be determined under those rules and not under a
contractual cost sharing arrangement that would otherwise govern
the charges incurred by the participants. Indeed, the statute
and regulations explicitly provide that the section 936(h) cost
sharing payment shall not be reduced by a contractual cost
sharing payment.242 Under section 936(h), the cost sharing
payment by the possessions corporation must equal the greater of
the amount required under the new commensurate with income
standard or 110% of the pre-1986 Act statutory cost sharing
amount. Under the commensurate with income standard, the cost
sharing amount must at least equal the fair market royalty which
would have to be paid to the developer if the manufacturing
intangibles had been licensed (even in cases in which the
intangible had previously been transferred in a section 351
exchange).
The amount paid under section 936(h) entitles the
possessions corporation to be treated as the owner of
manufacturing intangibles previously developed by its U.S.
affiliates. The fact that a possessions corporation has entered
into a cost sharing arrangement for the development of future
intangibles and is paying a lesser amount under that arrangement
does not affect the amount required under the section 936(h) cost
sharing election. Indeed, since the section 936(h) cost sharing
payment is compensation for intangibles previously developed and
the section 482 cost sharing payment made pursuant to the
contractual cost sharing agreement is for the cost of developing
new intangibles, both amounts appropriately must be paid
initially -- one by statutory election and the second pursuant to
the contractual arrangement. It might be argued that, once
intangibles are developed under the section 482 cost sharing
arrangement, the possessions corporation's section 936 cost
sharing payment should be reduced so that the possessions
corporation does not pay a second time for that intangible. The
statute, however, precludes that result.
I. Administrative requirements
Taxpayers seeking to enter into cost sharing arrangements
should be required to make a formal election and to document the
242
specifics
of
the agreement
contemporaneously.
Any §1.936-6(a)(3).
U.S.
Section
936(h)(5)(c)(i)(I);
Treas. Reg.
participant should be required to include a copy of the agreement
with its first return filed subsequent to the agreement's
effective date. Taxpayers making the election would agree to

- 126 produce, in English and in the United States, the records of
foreign participants necessary to verify the computation and
appropriateness of the respective cost shares within 60 days of a
request by the Service. These records would include
identification of the SIC code or other basis used to determine
products covered by the agreement, and summary information
concerning sales, gross margins, and net income derived with
respect to such products. The House Report accompanying the 1986
Act suggests that the Service should require similar records to
be kept and produced under the authority of section 6001 for
section 936(h) cost sharing agreements.243
J. Transitional Issues for Existing Cost Sharing Agreements
It is unlikely that there will be preexisting cost sharing
agreements that will meet all of the standards described above.
If such agreements are not recognized, the Service and taxpayers
will encounter significant problems in determining ownership of
preexisting intangibles and the treatment of the payments that
have been made pursuant to the preexisting agreements. Some
type of grandfather treatment would therefore appear to be
appropriate. One possibility would be to permit any cost sharing
agreement that conforms to the requirements of the existing
regulations, and that has been in existence for more than 5 years
prior to 1987, to be recognized fully if conformed within a
certain period after the promulgation of the new rules with
respect to matters other than the buy-ins that occurred prior to
June 6, 1984 (the effective date of section 367(d)). If the
cost sharing agreement has been in effect for less than 5 years
and the agreement does not conform substantially to the new
rules, then the old agreement would not be recognized. If a new
agreement that conforms to the new rules is adopted, then all
payments pursuant to the old agreement would be taken into
account as an adjustment to any required buy-in payments
relating to the new agreement.244
K. Conclusions and Recommendations
1. Congress intended to permit cost sharing arrangements
if they produce results consistent with the
243
1985
House Rep.,
n.standard
47, at 418-419.
commensurate
withsupra
income
in section 482.
244

This approach is generally consistent with the cost
sharing regulations published in 1968, which permitted preexisting cost sharing agreements to be modified within 90 days of
publication of the section 482 regulations. Treas. Reg. §1.4822(d)(4).

- 127 2.

Three-digit SIC code product areas seem to be the
appropriate scope for most cost sharing arrangements.
Both the Service and the taxpayer should be permitted
to demonstrate, however, that a narrower or broader
agreement is more appropriate.
The fundamental principle underlying the concerns
identified in the legislative history of the 1986 Act
with respect to cost sharing is that costs borne by
each of the participants must be proportionate to the
reasonably anticipated benefits to be received over
time by the participants from exploiting intangibles
developed under a cost sharing arrangement. This
principle has several implications.
In order for taxpayers to make a good faith effort
to predict anticipated benefits, it is essential
that the participants be assigned specific and
exclusive geographic rights to intangibles
developed under the arrangement. U.S. geographic
rights generally should not be permitted to be
assigned to a foreign person.
Cost sharing arrangements may be overly broad in
terms of products covered or affiliates
participating in the agreement if some
participants would utilize only a narrow range of
intangibles developed under the agreement.
Since the benefit to be derived under a cost
sharing arrangement is the right to use developed
intangibles in the manufacture of a product,
participants must generally be capable of
manufacturing and using developed intangibles in
the manufacture of products.
In estimating anticipated benefits, units of
production or sales value generally would be ah
acceptable unit of measure unless profitability
would reasonably be expected to differ
significantly with respect to various
participants' rights. In the latter instance,
some adjustments must be made, or some other
standard of measurement utilized, to reflect more
accurately the reasonably anticipated benefits to
be derived by the participants.
Cost shares should be adjusted periodically, on a
prospective basis, to reflect changes in the
estimates of relative benefits, including a change
in the measurement standard if that becomes
necessary.

- 128 4.

The costs to be shared should include all direct and
indirect costs determined in a manner consistent with
U.S. tax accounting and expense allocation principles.
A party that contributes funds or incurs risks for
development of intangibles at an earlier stage must be
appropriately compensated by the other participants in
the form of a buy-in for the value of preexisting
intangibles (including basic research and the going
concern value of research capability).
Fully developed intangibles command a royalty and
should not be incorporated into a cost sharing
agreement, with the result that the buy-in may not
reflect compensation for fully developed
intangibles.
A secondary buy-in is required whenever a
participant withdraws from a cost sharing
arrangement or a new participant enters the
arrangement.
Expenses relating to marketing intangibles are
presently governed by the services provisions of the
section 482 regulations. There seems to be no need for
marketing expenses to be subject to a cost sharing
regime developed for manufacturing intangibles.
Cost sharing payments are not income to the recipient
but, instead, reduce costs that are otherwise
deductible for purposes of computing taxable income and
earnings and profits. Consequently, outbound cost
sharing payments are not subject to U.S. withholding
tax, and inbound payments are not foreign source
income.
Since a section 936(h) cost sharing payment is
compensation for intangibles previously developed and a
section 482 cost sharing payment is for the cost of
developing new intangibles, both amounts appropriately
must be paid initially if a possessions corporation
making the section 936(h) cost sharing election enters
into a section 482 cost sharing arrangement. Under the
statute, the section 936(h) payment may in no event be
reduced to reflect amounts paid under a section 482
cost sharing agreement.
Taxpayers should be required to make a formal election
if they enter into a cost sharing arrangement, to file

- 129 a copy of the agreement with their return, and produce
records necessary to verify the computation and
appropriateness of the respective cost shares.
Cost sharing agreements in existence for more than five
years prior to 1987 should be grandfathered if they
conform in certain respects with new rules to be
promulgated. Other agreements will not be bona fide
unless and until they substantially conform to the new
rules.

APPENDIX A
ANALYSIS OF QUESTIONNAIRE RESPONSES
A.

IRS Access To Pricing Information

Significant section 482 issues were identified by IEs over
70% of the time and by the domestic agent about 10% of the
time.
Significant section 482 issues were initially identified
using the following sources:
Source Percentage of Responses
Form 5471
Form 5472
Financial Data
Prior Exam
Industry Experience
Customs Data

50.36%
23.74%
13.67%
7.19%
2.88%
2.16%

Time alloted to develop the 482 issue was determined by:
Percentage of Responses
Case Manager 51.32%
Domestic Group Mgr
7.78%
I.E. Manager
35.53%
Branch Chief
5.26%
About 66% of the IEs reported that the decision on time
allotment was made after receiving adequate opportunity
analyze the section 482 issue.
Almost 90% percent of respondents stated the time
alloted to examine the section 482 issue was flexible.
Factors affecting time allotment were:
Percentage of Responses
Potential yield 32.84%
Assurance of yield
4.48%
Both of the above
28.35%
Neither of the above
34.33%
Annual Reports to shareholders were used to identify or
develop section 482 issues in 34% of the cases.

- 2 The portions of the Annual Report specifically considered for
identification or development of section 482 issues were:
Percentage of Responses
Income Tax Notes 19%
Segment Information Note
for Product Line
Segment Information for
Geographic Area
Other

31%
36%
14%

65% of respondents thought that information on Forms 5471 and
5472 was helpful in planning exams.
In 29% of the reported cases, section 482 issues were
identified and not pursued. In 20% of the reported cases,
section 482 issues were identified and not changed.
The taxpayer had no readily available basis to support its
section 482 transaction in almost 75% of the cases.
In over 50% of the reported cases, taxpayers failed to make
timely and complete responses to questions asked in
developing section 482 issues.
More than 66% of the responses indicate that there was no
reasonable explanation for any delay in responding to
questions aimed at developing section 482 issues.
Reasons given for delays in responding to IDRs:
Tax department staffing.
Records located overseas.
Foreign parent refused to produce records.
* * Extremely detailed requests for information from the
foreign subsidiaries.
Lack of cooperation existed between the parent and
subsidiary.
Unreasonable delays in responding to requests for information
concerned:
** Control of affiliates -- 34.4% of responses.
Existence of comparable transactions with third
parties -- 48.5% of responses.

- 3 * * Terms of comparable transactions with third parties
- 48.5% of responses.
The average length of delay to responses was 12.2 months.
The portion of the delay deemed as reasonable by the
responding IEs averaged 2.2 months.
Using a summons to obtain information was considered as
follows:
Percentage of Responses
Considered 41%
Discussed with taxpayer
Employed

34%
5%

IE descriptions of circumstances in which issuance of a
summons was considered:
* * Formal summons discussed - not used because case manager
felt that the action would close the door to future
cooperation in domestic audits.
*" It was felt that the issuance of a summons for records
would only delay the overall development and completion
of the case.
* * Summons considered due to delay in response to agent and
economist. Not issued as taxpayer eventually did
respond, although the responses were generally
inadequate.
'" Used as a threat to speed-up IDR response time.
Generally not useful.
*" Taxpayer complained that our request was overly broad.
After discussion with Branch Chief, including the use of
section 982 and summons, Taxpayer offered an alternative
to books and records, under which most of the
information requested was eventually received.
Section 982 procedures arose to the following extent:
Percentage of Responses
Considered 26.6%
Discussed
Employed

17.6%
4.0%

- 4 IE descriptions of the circumstances in which section 982 was
considered:
*" The section 982 procedures were mentioned in opening
conference.
"* Taxpayer's practice was to furnish as little information
as possible with approximately a 90-day turn around
time. When subsequent IDRs needed to be issued, the
same practice was followed.
* * Taxpayer is well aware of our open year policy and
planned closing dates. IE was of the opinion that
taxpayer feels if they use delaying tactics the case
will become "old" and will be closed out undeveloped.
Taxpayer's delaying tactics prevented the issuance of
follow up IDRs. Taxpayer refused to furnish its
parent's cost data for the products that were at issue.
Taxpayer was late in providing data after initial
adjustments were prepared. Taxpayer's attorney's tactic
was to continue indefinite discussion of the issue,
including appeals to the National Office.
* * Taxpayer's responses to IDRs took from 6 months to a
year. The audit was stretched out to the point that the
planned audit closing date became a problem.
* * Section 482 issues were raised on the previous audit.
The prior examiner received virtually no information
from the taxpayer. Detailed information was submitted
by the taxpayer in the Appeals protest. This
information was used by the IE and the economist in
subsequent years.
* * Taxpayer clearly not responsive to IDRs that could hurt
him. In three cycles, the key IDRs were not answered.
* * District allows taxpayers excessive amount of time to
respond to IDRs. A two year audit cycle takes five
years to complete.
According to responding IEs, the following adversely
affected the development of section 482 issues:

- 5 Number of Responses
Yes No
a) 3.0, 5 open years policies 21 44
b) Planned audit closing dates
28
39
c) Taxpayer tactics
31
30
Competent Authority considerations affected the resolutions
of 10% of the reported cases.
Only 3% of respondents claimed that competent authority
considerations affected their decision to pursue any section
482 issue.
Appeals settled 28% of the section 482 issues in the reported
cases.
69% of respondents disagreed with the terms of the Appeals
settlement.
Counsel was involved in 26% of cases settled by Appeals.
76% of respondents did not receive a copy of the Appeals
settlement.
The section 482 issues were resolved at the examination level
43.4% of the time in the reported cases.
The IE was appropriately consulted in 90% of the reported
cases resolved by Examination.
The section of the 482 regulations providing the basis for
Examination's resolution was:
Percentage of responses
Comparable uncontrolled price 32%
Resale price method
8%
Cost plus method
24%
Other
36%
The IE agreed with the resolution by Examination 85.7% of the
time.

- 6 Application of Pricing Methods
IEs stated that the taxpayer used comparables as follows
with regard to section 482 transactions:
Percentage of responses
Planning transactions 9%
Defending transactions
33%
Did not rely on comparables
58%
71% of IEs who responded stated that the comparables used
were not made available to them at or near the beginning of
the examination.
Description of comparable(s) relied on by taxpayer in
planning or defending its section 482 transaction:
* * In performance of services, taxpayer tried to
establish comparables based on charges to third
parties.
* * The taxpayer presented pricing data with an unrelated
distributor of similar property in a different country.
*" Sales invoices to third parties.
"" Contracts between unrelated third parties.
* * Taxpayer claimed it was charging the same royalties
to all of its foreign subsidiaries.
* * Taxpayer secured quote from third party in small
quantity transaction.
* * Weighted average of Canadian CFC's third party sales.
Method required by Revenue Canada.
** Sales to 50% owned subsidiaries.
.. Industry norms.
Only.19% of those responding accepted the taxpayer's
comparables.
Examples of explanations why taxpayer's comparables were
not accepted:

- 7 * * The taxpayer was looking only at the services and not
looking at the overall transaction, i.e. providing
services, the transfer of technology and other
intangibles.
** The comparables did not reflect true arm's length
pricing because they ignored the fact that the
parent performed substantial marketing, distribution,
and trademarking functions, or the circumstances were
otherwise different.
The taxpayer's method generated approximately 185%
of the combined profit to the low tax entity and a loss
to the U.S. parent.
The taxpayer's comparables included very small volumes.
The taxpayer relied on comparables based on "industry norms"
in 41% of the cases reported.
Description of industry average "comparables" submitted by
the taxpayer to support its assertions:
Robert Morris Associates — Annual Statistics by SIC
Code of Gross Profit Margins for Wholesale Automotive
Equipment Dealers.
Taxpayer relied on published AFRA demurrage rates.
Taxpayer used the average resale mark-ups for the
industry.
Comparables were used as a basis for adjustment in about 75%
of the cases reported.
Representative sources for finding comparables relied upon
by IEs:
*" The IRS Economist used industry (construction)
comparables. The services that the offshore company
performed were that of a construction manager. The
economist determined that, based on comparables, the
offshore company should receive a comparable profit.
The remaining profit was allocated back to the taxpayer
for services and intangibles.
* * Economist used industry statistics from docketed cases
and SEC reports of unrelated taxpayers.
*" Taxpayer was requested and did provide comparable
transactions of its manufacturer parent with its
unrelated distributors.

- 8 *" Information from third parties with respect to
comparable transactions (a similar product under similar
circumstances in a similar market).
License agreement with related and unrelated parties.
Analysis of industry, consulting with ISP, contacting
other IEs examining similar companies.
Third party agreements for similar services or
intangibles with same taxpayer in same circumstances.
*" Obtained Form 10K information from several U.S. entities
and used to establish the arm's length price on a cost
plus basis.
Third party sales of taxpayer and compiled statistics
from "Robert Morris & Associates - Annual Statement
Studies."
The following are descriptions of significant problems
encountered by IEs in developing a comparable:
The information sought from third parties was old - 5
to 6 years. In one instance the third party relocated
and finding records was difficult. Records were not
organized when obtained.
Difficulty in acquiring information from third parties
and obtaining permission to use data from the third
party.
Adjusting for differences in geographic markets.
There are no comparables at this level of distribution.
All manufacturing/sales companies in this industry are
related.
The products manufactured and sold by the Puerto Rican
affiliates were the high volume, profitable
products. The functions performed by the subsidiaries
did not correspond to any third party situation.
Consequently, the comparables identified were useless.
Methods used in proposing tangible property adjustments by
percentage of response:
Comparable Uncontrolled Price 31%
Resale Price Method
Cost Plus Method
Other Method

18%
37%
14%

- 9 '

A majority of IEs who responded claim that the priority
of methods was useful in development or analysis of the
tangible price issue.
Market penetration was not considered as a factor when
determining section 482 adjustment in about 75% of the cases
reported.
The taxpayer's documentation considered the priority of
pricing methods in 50% of the cases reported where
documentation existed.
Excerpts of descriptions of "other methods" used by the
taxpayer to justify its pricing policies.
Taxpayer claimed intercompany price was arm's length
because it was negotiated between the lower tier sub
and its foreign parent.
Taxpayer contended all income attributable to
intangibles belonged to the Puerto Rican
affiliate.
Prior appellate settlements.
Taxpayer attempted to identify other charges made by
the parent to its subsidiaries that were equivalent to
the royalty adjustment that was proposed.
Taxpayer explained its method as being required by
Revenue Canada.
"Old fashioned business know-how".
In over 75% of the cases reported, the taxpayer
relied on a profit split to determine its transfer price.
Descriptions of taxpayer's methods of computing profit
split:
Market penetration accounted for any difference in
price.
Resale price.
* * Taxpayer computes revenues of products made in Puerto
Rico then reduced them by: cost of sales P.R., an R&D
cost sharing amount based on section 936(h), selling
and administrative expenses based on a fractional

- 10 calculation and other income or expenses using section
936(h) - this gave CTI of which they considered the
P.R. entity to possess half.
"" Taxpayer used prior Appeals settlement profit split.
* * Taxpayer allowed its domestic subsidiaries a profit of
6% on the cost incurred by such subsidiaries.
*' Taxpayer used profit earned by the parent on other
transactions with related parties. Taxpayer's
contention is that the subsidiary's high profit is
irrelevant as long as the parent made an adequate
profit on the transaction.
* * Taxpayer claimed that the marketing company should
recover all of its marketing costs (11% of sales)
plus derive a profit (4% of sales).

- 11 C.

Services

The IEs proposed an adjustment for services in 32.8%
of the reported cases.
In 43% of the reported cases, difficulty in applying the
services regulations was the primary reason for not making an
adjustment.
Difficulties reported by IEs in applying the service
regulations included:
Determining for whose benefit services were provided.
Undue burden on the IE to: (1) isolate costs, (2)
determine whether the service was an integral part of
the business,•and, (3) develop comparables to determine
proper adjustment.
Determining what services were rendered, by whom, the
amount of time spent rendering the service, and the
cost of the service.
The service regulations do not allow a profit in the
allocation.
Examples of difficulties in deciding whether to propose an
adjustment for services rendered or intangibles transferred
included:
Taxpayer only wanted to charge for services at the same
rate they generally charged third parties. IE used a
functional analysis to show that know-how was also
transferred to related parties but not to third parties.
Taxpayer does purchasing for a subsidiary and picks up a
5% profit. IE had no idea if the profit mark-up was
appropriate.
Taxpayer allocated a portion of cost based on time spent
by officers. Because of the 25 percent rule, the IE was
prevented from making an adjustment.

- 12 Intangibles
50% of the cases reported involved a significant transfer of
intangibles.
Adjustments were made under Treas. Reg. §1.482-2(d) in
about 50% of the reported cases.
Factors reported by IEs as affecting the decision to
proceed under services or sales of tangible property
regulations rather than under the intangibles section:
a) Inability to separately identify
the intangible
39.2%
b)
Inability to document the transfer
17.4%
c)
Inability to value the intangible
43-4%
IE recommend changes in the regulations that would have made
an adjustment for intangibles more feasible:
Spell out that T/P's reputation is an intangible.
* * Clarify that a CFC should not get a marketing
profit if they don't do marketing.
In reported cases involving the transfer of intangibles to a
related party, the taxpayer acknowledged the transfer at the
outset of the examination 48.6% of the time.
Documentation produced by taxpayers with respect to the
transfers of intangibles:
* * Unrelated professional appraisal
"* Corporate minutes and legal documents
* * Licensing agreements
a. With related entities
b. With unrelated entities
*" Section 351 transfer documents
* * Section 367 ruling
Marketing intangibles were involved in 25% of the intangible
cases.

- 13 Data relied upon or method of intangible valuation:
* * Advertising and marketing expenses
"* Trade name and trademark defense costs
"" Distribution costs
*" Market dominance - 3rd party brokerage statements
- market studies - royalties textbooks - profit and loss
comparisons - patent infringement cases prevailing rates in the industry.
* * Compared rates charged by taxpayer to unrelated
parties.
*" Used functional analysis to show that CFCs were
not active in crude oil trading. Only administrative
and communication services were performed. Economist
determined an arm's length service fee due the CFC for
services performed, then used the residual method to
value the income to be allocated to the domestic
subsidiary.
Taxpayers used a cost sharing agreement with a related party
in 17 1/2% of the cases reported.
Description of cost sharing agreements:
*' Parent billed Puerto Rican subsidiary for their
share of R&D.
* * R&D costs shared based on percentage of sales.
Direct costs charged to entity deriving benefit.
"• Reimbursed for R&D, marketing, and administration.
** Share in R&D and reimbursed marketing costs.

- 14 E.

Use of Specialists and Counsel

The following specialists were involved with reported cases:
Percentage of responses
Engineer 18%
Economist
59%
Appraiser
2%
IE descriptions of issues considered by specialist and how
the specialist was brought into the case:
Economist performed a functional analysis of
activities of CFCs and identified comparables.
The economist was requested after the
taxpayer prepared a section 482 study to
refute the proposed adjustment. In order to
be successful in Appeals or court, an
economist was considered essential.
An economist was requested to assist in
developing the third party comparables found
by the IE and to assist in assessing
taxpayer's arguments.
An economist was involved in the prior year
and, accordingly, was requested for the
current cycle. An engineer was needed to
assess the electrical engineering function of
the related companies.
An economist was requested for a valuation of risk
capital.
An engineer was used to compare the CFC shop to
unrelated shops. An economist found comparable
mark-ups.
An economist was used on an informal basis as
to procedure and appropriate percentage of
profit.
An economist was used on the royalty expense
issue and to evaluate a trademark transfer;
engineer was used to evaluate a fee structure.

- 15 The economist was requested to review our
position with respect to imputation of royalty
and technical service income. Looking beyond
this, the economist suggested that a potential
pricing issue existed. The economist was
assigned late in the examination and was not
granted the time needed to develop the pricing
issues.
The economist added support in the development
of the transfer of intangibles issue. The
economist was brought into the case after we
recognized and began developing the issue.
An economist was requested by IE - used to establish
arm's length pricing of foreign autos.
An appraiser was brought in by the IE and the Case
Manager to evaluate the sale of U.S. entity's
stock at book value and to establish control elements.
The economist performed a functional analysis on Puerto
Rican operations. It was difficult to attack taxpayer's
pricing as long as we accepted the function of the
Puerto Rican subsidiary as a full-fledged manufacturer.
IE received informal advice on a stewardship issue.
According to the IEs, specialists were brought in at
appropriate times in 91% of the reported cases.
Specialists raised additional issues in 9% of the reported
cases.
79% of respondents thought that specialists'
reports were particularly useful in proposing issues.
Brief descriptions of specialists' reports which were
helpful:
The economist report was very useful since it
discussed, in depth, the functional analysis and
comparables used in determining the arm's length
rates for intangibles and services.
Economist report supported the IE's conclusion that
market penetration was not prevalent in the years under
examination, which was the thrust of the taxpayer's
argument.
Economist report gave a basis for reasonable profit
factor in pricing computation.

- 16 The economist's report was useful in establishing the
service fee for CFC and the function of taxpayer's
worldwide trading activity.
The report made a good case for treating the subsidiary
as a contract manufacturer. Prior to that, taxpayer
was maintaining its position that the resale method
applied.
The economist developed a method of joining data secured
by means of a private survey with data from a public
source. The economist revealed to the agent a number of
other sources that are available for statistical
analysis and comparisons.
Specialist's reports were used:
Percentage of Responses
To support an adjustment 87.5%
Not used

10.0%

Responses indicate that specialists did not cause an undue
delay in 90% of the cases.
14% of respondents stated that restrictions were placed on
their use of a specialist.
The taxpayer employed a specialist in 27% of the reported
cases.
The taxpayer's use of a specialist was as follows:
Percentage of Responses
Planning section 482 25%
transaction
Involved in audit 80%
IRS Counsel was involved in 39% of the reported cases.
14% of respondents claimed that had counsel been involved,
their cases would have been better developed.
Counsel was involved' at a timely stage of case development
in 76% of reported cases.
Persons who determined that counsel should become involved
were:

- 17 Percentage of Responses
Case Manager 22%
Domestic Group Manager
3%
IE Manager
38%
IE
32%
Industry Specialist
5%
The types of legal assistance rendered:
Percentage of Responses
Activity
District Counsel technical
assistance

61%

National Office technical
advice

11%

Summons review 20%
Section 982 proceedings
review

The assistance rendered by counsel was considered useful in
development of section 482 issues in 68% of responses.

.APPENDIX. B
SECTION 482 QUESTIONNAIRE—INTERNATIONAL EXAMINES

CASE NAME

Years
PLEASE ATTACH A COPY OF YOUR EXAMINATION REPORT
ON THIS CASE TO YOUR RESPONSE
TO THIS QUESTIONNAIRE.

Please check the appropriate column(s). Check:
(A) if the listed section 482 issue was present in this case;
(B) if the taxpayer agreed to the proposed adjustment; and
(C) if the taxpayer did not agree to the proposed adjustment.
Please enter the dollar amount of the proposed adjustment in
column (D).
(A)

(B)

(C)

(D)

$
5.9 billion
Transfer pricing [36] [17]
[2d
Income allocation
(other than transfer pricing)
1.1 billion
$
[13
D23
[2]
Expense allocation
agreements).
CL9]
$ 105 million
(not including cost sharing &2]
&9]
s
[0]
• [0]
Cost sharing agreements
$ 460 million
[5]
rial
[1]
$
34 million
[3]
[8]
175
million
Intangibles
[16]
s
CLO]
[10]
—
$
Services
•
tlO]
[i]
[03
$
27 million
Interest
D-7]
$
58 million
[i]
[1]
Rental expense
[ 1]
[2]
[2]
Gain
[2] any routine
in allocation
this questionnaire
Do not further identify or discuss
Miscellaneous
and administrative [5]
or overhead expenses
of related
parties.)
adjustments
to the
general
(Please briefly identify.

[ ]

Please check here if this case involved section 936.

[ ]

Please check here if you have answered question 100 on this
questionnaire•

SECTION 4S2 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

;

lm Who initially identified the significant 482 issues in this
case? (Please check the appropriate box or boxes and
briefly identify the issues raised by each.)
- Domestic agent [ 9] ^
Case manager
[ 0]
Domestic group manager
[ 0]
Yourself
£7]
I.E. group manager
[1]
Economist
[3]
Other
Q.0]
If other, please identify.

•

Please list each of the significant 482 issues in this case
in the spaces provided below. (Use an additional sheet to
identify other significant 482 issues, if any.) Please also
indicate how each of these issues was initially identified
(whether by you or by someone else) by filling in the number
corresponding to the method used to identify the issue in
the space below.
(1) Form 5471
(2) Form 5472
(3) Financial data
(4) Prior exam
(5) Experience with the industry
(6) • Customs data
(7) Other (please briefly explain in the appropriate
space)
(8) Do not know hew issue was identified by another
person
Issue How identified?
A.
(1) 70
B.

(2) 33

(3) 19

(4) 10

(5)

(6)

(7)

SECTION 482 QUESTIONNAIRE -- INTERNATIONAL EXAMINERS
3. Who principally determined the amount of time alloted to
developing" the 482 issues in this case?
A. Case manager [393
B. Domestic group manager
C. I.E. manager
D. Branch chief
E. Exam chief
4-

[-6]
\Zl\
[ 4]
[ 0]

Was the decision on time allotment made after you had an
adequate opportunity to analyze the 482 issues?

Yes [41] No [23
5.

Was the time allotment flexible?

Yes [51] No [6]
6. Was the amount of time alloted to the development of the 482
issues in this case affected either by the potential yield
or the likelihood that there would be a yield? (Check one.)
A. Potential yield affected allotment [23
B. Assurance of yield affected allotment
[ 3]
C. Both affected the allotment-,
[19]
D. Neither affected the allotment
[23]
7. Did you use one or more annual reports to shareholders to
identify* or develop a 482 issue?
Yes [24] Please continue.
No
[46] Skip to question 10.
8. Which of the following portions of the annual report, if
any, were specifically considered? (Check if considered.)
A. The income tax note to the financial statement [8]
B. The segmental information note for
product line data
''
C. The segmental information note for
geographic area data
D. Other
(please identify)
__
3 identified

[13
[l3
[ 6]

SECTION 482 QUESTIONNAIRE -- INTERNATIONAL EXAMINERS

9. Who initiated the use of annual reports in your
consideration of the 482 issues in this case?
A. Yourself
B. Domestic group manager
C. Case manager
D. I.E. group manager
E. Domestic agent
F. Other
(please identify)

E>2]
[0]
[0]
[0]
[2]
[3]

10.

Was the information required to be reported on Forms 5471 or
5472 (or predecessor forms) helpful or inadequate in
planning the exam?
Generally helpful [36]
Generally inadequate
Q.9]
11.

Please briefly describe any specific information required to
be reported on these forms that you found helpful in
planning your examination in this case.

12.

Please briefly describe any specific respects in which the
information now required to be reported on Forms 5471 and
5472 was (or would have been) inadequate in this case. What
specific additional information reporting requirements would
have been useful in the planning and conduct of your
examination in this case? (For example, would your case
development have been improved if taxpayers were
affirmatively required to disclose the transfer pricing
method relied upon by the taxpayer?)
36

SECTION 432 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

13. Were there_any identified 482 issues that were not pursued
or that were no-changed?
A. Not pursued? Yes 0-9] No [47]
B. No-changed?
Yes D-0] No

[40]

If you answered yes to either question, please briefly
identify the issue(s) and explain.
23

14. Did the taxpayer have readily available the basis and
support for its section 482 transactions?
Yes [13 No [51]
15. Did the taxpayer generally make timely and complete
responses to the questions in your IDRs that were asked to
develop the 482 issues in this case?
Yes pi] Please skip to question 20.
No • [40] Continue.
16. Were there reasonable explanations for any delays by the
taxpayer in responding to the questions you asked in IDRs
that were aimed at developing the 482 issues in this case?
Yes [13] Please continue.
No
[27] Skip to question 18.
17. . Please briefly describe any reasonable bases" for the delays
16 •

SECTION 4S2 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

18. Please indicate whether the taxpayer unreasonably delayed
responding" to any questions in your IDRs that dealt with the
following:
Yes
No
A. Control of affiliates
[23]
CLI]
B. The existence of its comparable
[16]
CL9]
transactions with third parties
C. The terms of its comparable
[17]
&6]
transactions with third parties
19. In the spaces below/ please estimate the length of any delay
and the portion of the delay, if any, that was reasonable.
Total time delayed 12.2 mos .
Reasonable portion of delay

2.2 mos

20. Did IRS management become involved in attempting to secure
information from the taxpayer? If so, indicate each
management level involved and whether the information sought
was obtained as a result of that involvement.
Was the recuested
information obtained?
Level
No
Yes
•

A.
B.
C
D.
E.

No involvement
Group Chief
Branch Chief
Exam Chief
District Director

[26]

L35J
Lis]
[43
[3]

C22]

[19]

ai]
[2]
[1]

[9]
&0]
do]

21. Was the use of summonses considered, discussed with the
taxpayer, and/or employed?
Yes No
Considered?
Discussed?
Employed?

P8]
El]
[3]

[41]
[4(3
[54]

If you answered yes -to any of the above, please briefly
describe the circumstances and the results obtained. •
24
(space continues)

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

22. Was the use of section 982 considered, discussed with the
" taxpayer, and/or employed?

Considered?
Discussed?
Employed?

Yes

[1-7]

[47]

[9]

»2]

B9J

If you answered yes to any of the above, please briefly
describe the circumstances and the results obtained.
13

23. Did you work with an economist, engineer, appraiser or other
specialist on the case?
Yes
A.
B.
C
D.

Engineer?
Economist?
Aooraiser?
Other?

CIO]
[40]

[1]
[9]

——

[461
[281
[49]
[40]

(If other, please
briefly describe.)

If you have answered yes to any of the above, please
continue.
If you answered no to all of the above, please skip to
question 34.
?4.

Please briefly describe the issue(s) considered by any
specialises) and how the specialises) was (were) brought
into the case.
43
(space continues)

SECTION 432 QUESTIONNAIRE -- INTERNATIONAL EXAMINERS

25. Was (were) the specialises) involved in the case at an
appropriate time?
[40] Yes, all specialists were brought into the case at
appropriate times.
[ 4] No,- not all specialists were brought into the case
at appropriate times.
If no, please briefly explain.

26. Did the specialises) raise new 482 issues?
Yes [ 4] Please continue.
No
[40] Skip to question 28.
27.

Please briefly identify the 4S2 issues initially raised by
the soecialist(s) in the case.
9

28.

Were any. of the specialists' reports useful to 'you?

Yes [331 Please continue. •*'
No - [ SO Skip to question 30.
29. Please briefly identify which report(s) was (were) useful,
and why.
34
_
:
(space continues)

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

30. Please briefly indicate which report(s) was (were) not
useful, and why.
12

31. How were specialists' reports used in connection with your
proposed adjustment? (If more than one specialists' report
was prepared in this case, please fill in the appropriate
number of reports in the spaces provided.)
A. Report recommended against the adjustment [ 1]
B. Used to support adjustment
[35]
C Not used to support adjustment
"»
[4]
32.

Did the involvement of any specialist unduly delay the case?

Yes [4] No g0]
33. Did anyone place a restriction on your use of a specialist?
Yes [6] No [380
If yes, who? (Please identify.)

34.

Did the taxpayer employ a specialist?

Yes [13 Please continue.
No
[4$ Skip to question 36.
35. Was the taxpayer's specialist utilized in planning the
transaction, in refuting a proposed adjustment, or both?

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

Yes No
Involved in planning? [4] [12]
- Involved in audit?
D.6]

[ 43

36. Did Counsel become involved in the case?
Yes [273 Please skip to question 38.
No
[423 Continue.
37. Would the case have been better developed if Counsel had
become involved?
Better developed [ 6]
No difference

p73

Please skip to question 43.
38. Was Counsel involved at a timely stage?
Yes [22J Please skip to question 40.
No
[73 Continue.
39. Would the case have been better developed if Counsel had
become involved at an earlier time?
Better developed [63 No difference [ 43
40. Who determined that Counsel should become involved?
•

A. Case manager
B. Domestic group manager
C. I.E. manager
D. . Exam Chief
. E. Yourself
F. .Industry Specialist

. [ 83
[ ]]
[143
[ Q3
0.23
[23

41. Please check the appropriate box- to indicate the type of
assistance rendered by Counsel in this case.
Oral Written
A. District Counsel technical assistance D-8] [93
B. National Office technical advice
[o3
C. Summons review
[43
D. Section 982 proceeding review
[13

[53
[53
[23

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

42. Was the assistance rendered by Counsel useful in your
development of the 482 issues in this case?
Yes [19 No [9]
43. Did any of the following adversely affect your development
of 482 issues in this case?
Yes No
A. 3.0, 5 open years policies [2]] [44]
B. Planned audit closing dates
[23
P9]
C. Taxpayer tactics
[31]
PO]
D. Other
[71
[27]
If you checked yes for C or D., please briefly explain.

44. Were any of the 482 issues resolved in Examination?
Yes [3Q. Please continue.
No
[391. Skip to question 50.
45. Did Examination's resolution involve only the 482 issues in
the case.alone or was it part of a broader resolution?
482 issues resolution only [23]
Part of over-all resolution

[ 73

46. Were you appropriately consulted regarding the resolution of
the 482 issue(s) in the case that were resolved in
Examination?
Yes' [273 No [3]
47. Which provisions of the 482 regulations provided the basis
for Examination's resolution of 482 transfer pricing issues
in this case?
A. Comparable uncontrolled price [83
B.
Resale price method
[23
(question continues)

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

C. Cost plus [6]
D.
Any "other" reasonable method

[9]

48; Did you agree with the resolution?
Yes [24] No [ 4]
If no, please briefly explain.

49.

Did Competent Authority considerations affect Examination's
resolution of any section 482 issue in this case?

Yes [3] No [283
If yes, please briefly describe the transaction that gave
rise to this concern.

50-

Did Competent Authority considerations affect your decision
to pursue or not pursue any section 482 issue in this case?
Yes

[ 23

[67]

If yes, please briefly explain.t

51.

Did Appeals settle any section 482 issue in this case?
Yes
No

[173 Please continue.
[44] Skip to question 54.

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

52. Did you agree with the terms of Appeals* settlement of the
482 issue(s) in this case?
Yes [53 No [Ll3
If no, please briefly explain.

53. Was Counsel involved in the Appeals settlement?
Yes [ 3 No [143
54. Did you receive a copy of Appeals' final report on this
case?
Yes [93 No £9]
55. In this case, were there difficulties establishing "control"
for purposes of section 482?
Yes [53 No [643 •
56. Was control established by means other than direct or
indirect ownership of a majority of the stock of a
controlled corporation?
Yes [ 71 No pi]
If yes, please briefly explain how control was established.

57.

Did the taxpayer rely on comparables either in planning or
defending its 482 transactions?

[ 7] Relied on comparables in planning transactions.
[24] Relied on comparables in defending transactions.
[42] Did not rely on comparables in either planning or

SECTION 452 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

defending transactions. Please skip to question 62.
58. Were those comparables made available to you at or near the
beginning of the examination?
Yes [ 9] No [23
59. Please briefly describe the comparable(s) relied upon by the
taxpayer in planning or defending its 482 transactions.
27

60. Did you accept the taxpayer's comparables?
Yes [5] No [22]
If no, please briefly explain why.

61. Did the taxpayer rely upon comparables based on "industry
" norms" in planning or defending its transfer pricing?
Yes [11] No 116]
If yes, please briefly describe the data provided by the
taxpayer to support its assertions.

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

62. Did you seek to use a comparable as a basis for making any
482 adjustments in this case?
Yes [43 Please continue.
No
[253 If either you or the taxpayer sought to rely
- or relied on comparables, skip to question
67. Otherwise, skip to question 68.
63. Did you actually use a comparable as the basis for making
the 482 adjustments in the case?
Yes [343 No [l2
64. How did you identify the comparable you used or sought to
use?
40

65. Were you able to properly develop information regarding the
comparable you used or sought to use?'
Yes P23 No D.13
66. Please briefly describe any significant problems you
encountered in attempting to develop the comparable you used
or sought to use.
23

67.

What kind of adjustments, if any, were needed for both the
taxpayer and Service comparables to achieve arm's length?
(Please check all that apply.)
(question continues)

SECTION 482 QUESTIONNAIRE -- INTERNATIONAL EXAMINERS

Government comparable Taxpayer comparable
[ 9] warranties and rebates [ 3
Cl23
level of market
[ 83
geographic market
[ 9]
volume of transactions
[ 6]
length of agreement
[12
product differences
[9]
terms of sale
[4]
currency translation
[12]
other
If other, please explain briefly.
12

[ 73
[ 4]
[ 8]
[ 4]
[ 5]
[5]
[13
[ 63

68.

In your opinion, did this case involve any significant
transfer or permissive use of any of the following: a
patent, invention, formula, process, trade secret, design,
brand name, pattern, know-how, marketing expertise, or showhow?
Yes [34] Please continue.
No
[3X Skip to question 79.
69. Please briefly describe the patent, etc.
35

70. Did you specifically make an adjustment in this case for
intangibles under Treas Reg. 1.482-2(d)?
Yes [19] Please skip to question 73.
No * [2CQ Continue.
71. In making an adjustment for (1) related party services, or
(2) the transfer pricing of tangible property, did you take
the transfer or use of intangibles into account?
(question continues)

SECTION 482 QUESTIONNAIRE —
Yes
No
72.

[ID
[l3

INTERNATIONAL EXAMINERS

Please continue.
Skip to question 73.

What factors dictated the decision to proceed under the
services or sales of tangible property regulations rather
than make an adjustment under the intangibles regulations?
A. Inability to separately identify the transferred
intangibles
[ 93
B. Inability to document the transfer or use
[43
C. Inability to value the intangibles
[L03
D. Other
[ 1]
If other, please explain.

. 73

A.
B.
C.
D.
E.
F.
G.
H.
Z.
J.
K.

Which of the following factors were most important to you
and to the taxpayer in determining the arm's length pricing
for the most significant transferred intangible in this
case? Please select up to five factors that were most
important to you and to the taxpayer • and number them in
decreasing order of importance (i.e., five is most
important, one is least) in the appropriate spaces.
Government
Taxpayer
Weight
Responses
weight Responses
4.,7
3.6
Prevailing rates in the same
14
6
industry for similar property
3..0
4.0
Offers of competing transferors 41.,7
Bids of competing transferees
2..3
Limitations on geographic
2.0
3..8
T70
area covered
4
Nonexclusivity of grant
3
2,
.7
10
3.4
Uniqueness of the transferred
property
17
2,
.3
1'.9
Likelihood of continuing
1,i
1.4
uniqueness
.. 10
3.5
3.1
Patent or other legal protections 9
Services rendered in connection
with the transfer of property
14
3,5
10
3.5
Prospective profits to be realized
by the transferee from the
3.2
2.4
10
property
19
(question continues)
Costs to be saved by the transferee
as the result of the transfer
12
of the property

Determining Arm's Length Pricing of Transferred Intangibles

1
2
3
4
5
Weighted Averages of Responses (5 is Most Important)

BEE »/«

Factors Considered Most Important by Taxpayers in Determining
•Arm's Length Pricing of Transferred Intangibles

1
2
3
4
5
Tyg&ShVed Averages of Responses (5 is Most Impcr-ant)

BEE M / M

The key to the factors on the previous pages are:
A. Prevailing rates in the same industry for similar property
B. Offers of competing transferors
C. Bids of competing transferees
D. Limitations on geographic area covered
E. Nonexclusivity of grant
F. Uniqueness of the transferred property
G. Likelihood of continuing uniqueness
H. Patent or other legal protections
I. Services rendered in connection with the transfer of property
J. Prospective profits to be realized by the transferee from
the property
K. Costs to be saved by the transferee as a result of the
transfer of the property
L. Capital investment and start-up expenses of the transferee
M. Availability of substitutes for the transferred property
N. Prices paid by third parties where the property is resold or
sublicensed to them
0. Transferor's costs of development
P. Other facts or circumstances

SECTION 452 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

L. Capital investment and start-up
expenses of the transferee
__8
M. Availability of substitutes for the
5
transferred property
N.
Prices paid by third parties where
5
the property is resold or
12
sublicensed to them
,4
0. Transferor's costs of development
P. Other facts or circumstances
(please explain)

74-

2.1
3.0

2.4
2.6
2,0

3
8
4

3.3
2.4
3.0

Did the taxpayer acknowledge at the outset the existence of
a transfer of intangibles to a related party in this case?

Yes [18] Please continue.
No
[113 Skip to question 76.
75-

What documentation for the intangible transfer did the
taxpayer produce? Please briefly describe.
14

76.

What changes, if any/ in the intangibles regulations would
have made an adjustment for intangibles more feasible in
this case?

77.

if there were marketing intangibles involved in the case,
did you attempt to value such marketing intangibles separate
and apart from the manufacturing or other intangibles
involved in the case?
(question continues)

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

Yes [ 9] Please continue.
No
[273 Skip to question 79.
78. Please briefly describe the method utilized to value the
marketing intangibles in this case and the type of data you
relied upon.
14

. 79. Did the 482 issues in this case involve the pricing of
tangible property?
Yes [40] Please continue.
No
[28J Skip to question 82. '»
30. Which method did you use in proposing your adjustment?
A. Comparable uncontrolled price?
Yes D-53 Please continue.
No
(263 Skip to part G. of this question.
Please check the appropriate box if you relied on:
(1) transactions between the same taxpayer (or a
related taxpayer) and third parties; or
(2) transactions between two parties both of which
were not related to your taxpayer.
[ 4] Relied only on related party transactions.
Please skip to part G. of this question.
[13] Relied on one or more unrelated party
transactions. Continue.
B. Please briefly describe the unrelated party
transaction(s) you relied upon to develop your
comparable(s )."
(space for answer on next page)

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

Were you able to disclose to the taxpayer the terms of
the comparables(s) you documented through unrelated
party transactions?
No. [53 Please continue.
Yes. [ 6] Skip to part G. of this question.
D. Please briefly describe the reasons (promises cf
confidentiality, etc.) that you were unable to discuss
the terms of the comparable with the taxpayer.

If it became necessary, would you have been able to
disclose the terms of the comparable(s) you documented
through unrelated party transactions as evidence in
court?
No. [23 Please continue.
Yes. [53 Skip to part G. of this question.
F. ' Please briefly describe any impediments to your
introduction of the terms of the comparable (s) in court
that were different than those described in part D. of
this question. (If no difference, please write
"Same.")

(space continues)

SECTION 482 QUESTIONNAIRE -- INTERNATIONAL EXAMINERS

Resale price method?

Yes

[ 93 No

[23]

H. Cost-plus method? Yes [183 No &33
I. "Other" method? Yes [73 No DL73
If other, please describe briefly the "other method"
used by you.

81. Was the priority of methods required under Treas. Reg. sec.
1.482-2(e) useful or detrimental in your development or
analysis of the.tangible transfer price issue?
Useful [L93 Detrimental [173
If detrimental, please briefly explain.

82.

in considering any proposed adjustments under section 482,
did you consider whether the taxpayer's interest in
"penetrating" a new market needed to be taken .into account?

Yes [173 No &73
83. In its responses to your proposed adjustments, did the
taxpayer argue that your proposed pricing, adjustments needed
to be modified to take into account its market penetration
goals?
(question continues)

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

Yes [ 5] Please continue.
No
052] Skip to question 87.
84. For how many years had the taxpayer sold in that market?
9 responses 17.88 years (average)
>

85. Did you accept the taxpayer's contentions?
Yes [ 2] Skip to question 87.
No
[ 6] Please continue.
86- If you rejected all or part the taxpayer's contentions with
respect to market penetration, please briefly explain.

87. Did the taxpayer provide you with contemporaneous
documentation regarding the methods it used to set its
transfer prices?
Yes" D.6] Please continue.
No
[483 Skip to question 89.
88. Did the taxpayer's documentation expressly consider the
priority of pricing methods set out in Treas. Reg. sec.
1.482-2(e)?
Yes [103 No D.03
89. Please describe briefly any "other method" used by the
taxpayer jto justify its pricing'policies.

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

90. Did the taxpayer contend in Examination that its "other
reasonable method" of transfer pricing resulted in an
appropriate profit split, or did it rely on a profit split
to determine its transfer prices?
Yes [14] Please continue.
No
[493 Skip to question 92.
91. Please briefly describe the taxpayer's means of computing
the profit split it utilized or defended as appropriate.
11

92. Did this taxpayer utilize a cost sharing agreement with a
related party?
Yes [12 Please continue.
No
[583 Skip to question 95.
93. Please briefly describe the cost sharing agreement.
11 •

94. Please briefly describe any adjustments you proposed to make
to the expense allocations required by this agreement.

95.

In this case, did you have difficulty deciding whether to
propose making a 482 adjustment based on —

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

(1)-services performed by one related party on behalf
of another;
or —
(2) transfers of intangibles between the related
parties?
(Example: Did you have to decide between proposing an
adjustment based on (1) a parent corporation's "training"
its new subsidiary's employees, or (2) the parent's transfer
of "know-how" to the new subsidiary?)
Yes [19] Please continue.
No
[43] Skip to question 97.
96. Please briefly describe the issue.
18

97.

In this case, did you consider proposing an adjustment based
on the provision of services by one related party to
another?
Yes £23 Please continue.
No
$53 Skip to question 100. •
98. If your proposed adjustments did not include an adjustment
with respect to related party services, was your decision
based on difficulties in applying the services regulations
under section 482?
Yes P-33 Please continue.
No
[173 Skip to question 100.
99. Please briefly describe any specific difficulties you had
applying the services regulations.
8

SECTION 482 QUESTIONNAIRE —

INTERNATIONAL EXAMINERS

100. If we have overlooked asking about any significant 482
issues that you believe could be better addressed in
regulations, please take the time to identify the issue, the
regulation, and any thoughts you have about how that
regulation might better address the issue. Please do not
confine yourself to the issues raised in this case. Please
attach additional sheets if necessary.

APPENDIX C
TRANSFER PRICING LAW AND PRACTICES OF SELECTED
U.S. TREATY PARTNERS
CANADA
The statutory basis for transfer pricing allocations is
section 69(2) of the Income Tax Act1 that provides as follows
Where a taxpayer has paid or agreed to pay to a nonresident person with whom he was not dealing at arm's
length as to price, rental, royalty or other payment
for or for the use or reproduction of any property or
as consideration for the carriage of goods or passengers, or other services, an amount greater than the
amount (in this subsection referred to as the "reasonable amount") which would have been reasonable in the
circumstances if the non-resident and the taxpayer had
been dealing at arm's length, the reasonable amount
shall, for the purpose of computing the taxpayer's income under this Part, be deemed to have been the amount
that was paid or payable therefor.
Section 69(3) of the Income Tax Act provides as follows:
Where a non-resident person has neither paid nor agreed
to pay to a taxpayer with whom he was not dealing at
arm's length as to price, rental, royalty or other payment for or for the use or reproduction of any property, or as consideration for the carriage of goods or
passengers or for other services, the amount that would
have been reasonable in the circumstances if the nonresident person and taxpayer had been dealing at arm's
length, that amount shall, for the purposes of computing the taxpayer's income under this Part, be deemed to
have69(2)
been received
or receivable
by the taxpayer
Sections
and (3) apply
to all taxpayers
including
therefor.
individuals, unincorporated businesses, trusts, and corporations
However, section 69(2) applies only when the Canadian taxpayer
has paid more than a reasonable amount and does not apply when
the Canadian taxpayer has paid less than a reasonable amount.
Similarly, section 69(3) applies only when the Canadian taxpayer
has received less than a reasonable amount and does not apply
when the Canadian taxpayer has received more than a reasonable
amount.
Income Tax Act, S.C 1970-71-72

- 2 Interpretation of this statute by the Canadian government
has been provided in an Information Circular issued by the
Department of National Revenue in 1987.2 In this Circular,
Revenue Canada interprets the phrase "reasonable in the
circumstances" to mean the price that would have prevailed if the
parties to the transaction had been dealing at arm's length. In
applying this arm's length standard, Revenue Canada has endorsed
the methods enumerated in the 1979 OECD report on Transfer
Pricing and Multinational Enterprises. Although the methods are
not prioritized as to the order that they must be used, Revenue
Canada has expressed a preference for the comparable uncontrolled
price method and the following sequence of tests:
1. Sales by the taxpayer to unrelated parties;
2.
Comparable transactions between unrelated third
parties;
3.
Resale price method;
4.
Cost plus method; and
5.
Any other method in support of the other methods or
where the other methods are inappropriate.3
These methods apply to the sale of goods as well as to the
acquisition or disposition of intangible property. With respect
to royalty rates on the disposition of intangibles, Revenue
Canada's Information Circular states that, in determining an
arm's length rate, the focus will be on:
a) prevailing rates in the industry;
b) terms of the license, including geographic
limitations and exclusivity of rights;
c) singularity of the invention and the period for
which it is likely to remain unique;
d) technical assistance, trade-marks, and "know-how"
provided along with access to the patent;
e) profits anticipated by the licensee; and,
f) benefits to the licensor arising from sharing
information on the experience of the licensee.4
In addition, when only use of the intangible is transferred, it
must 2be Department
determined whether
the transferee's
payment Circular
is "in fact
of National
Revenue Information
No.
87-2, International Transfer Pricing and Other International
Transactions (Feb. 27, 1987).
3
Id. at paras. 13-19.
4

Id. at para. 46.

- 3 for the use of the intangible for the year -- as opposed to a
payment for its outright acquisition or other capital outlay."5
FRANCE
The statutory basis for transfer pricing allocations is
Article 57 of the French General Tax Code which is as follows:
In assessing income tax due by enterprises which are
subordinated to or controlled by enterprises
established outside France, the income to which is
indirectly transferred to the latter, either by
increasing or decreasing purchase or sale prices, or by
any other means, shall be restored to the trading
results shown in the account. The same procedure is
followed with respect to undertakings which are
controlled by an enterprise or a group of enterprises
also controlling enterprises located outside France.
Should specific data not be available for making the
adjustments provided for the preceding paragraph, the
taxable profits are determined by comparison with those of
similar undertakings run normally.6
The tax administration has endorsed the 1979 OECD Report on
Transfer Pricing and Multilateral Enterprises, although the OECD
guidelines are not binding on the French authorities.7 In
enforcing Article 57, the authorities generally compare profit
margins of similar entities to identify any abnormalities.8
A similar approach is apparently taken with respect to the
payment of royalties by a French taxpayer in that a deduction
will be allowed for the payment only to the extent that the net
income of the payee or subsidiary is at least equal to that
realized by a French enterprise engaged in a similar activity.5
6

Id. at para. 42.

Code General des Impots, art. 57.

See Instruction Administrative (May 4, 1973), published
in Bulletin Official de la Direction Generale des Impots 4A-2-73

BNA, No- 364-9253, France: Transfer Pricing Within
Multinational Enterprises and Article 56 of the French General
Tax Code 11 (1980).

- 4 Furthermore, under the French exchange control law, all royalty
agreements with and payments to nonresidents must be reported,
prior to payment, to the National Institute of Industrial
Property.9
The experience of the Office of Assistant Commissioner
(International) is that French companies filing consolidated
returns that include foreign subsidiaries must agree to allow
French tax authorities on-site inspection of the subsidiaries'
books and records; that, as indicated above, profit experience is
a very important factor in examinations; and that no guidelines
have been developed for evaluation of royalty cases involving
transfer of intangibles. When intangibles are transferred to a
tax haven, payments received on account of the transfer are
deemed to be unreasonable, and the burden is on the taxpayer to
establish that the payments are reasonable.
Although cost sharing arrangements are permitted,10 the
French authorities do not have specific rules applicable to such
arrangements.
GERMANY
The statutory basis for intercompany pricing adjustments
includes Article 8(3) of the Corporation Tax Law, which states
that hidden distributions of income do not reduce taxable
income.11 Section 31 of the Corporation Tax Regulations
interprets "hidden distributions" to include a benefit granted by
a company to a related person, outside the normal statutory
profit distributions, which an orderly and conscientious manager
would not have granted to an unrelated party under comparable
circumstances.'x2
Similarly, Article 1(1) of the Foreign Tax Affairs Law
states that where the income of a taxpayer resulting from his
business relationship with a related person is reduced because
the taxpayer, within his business relationship extending to a
foreign country, has agreed on terms and conditions which
deviate from those unrelated third parties would have agreed upon
under the same or similar circumstances, then his income shall,
notwithstanding
other provisions, be determined as if the income
9
Id.
at
11.
had been earned under terms and conditions agreed upon between
10

Id. at 11.

Koerperschaftsteuergesetz art. 8(3).

Koerperschaftsteuerrichtlinien §31.

- 5 unrelated third parties.13 Article 1(1) applies to all related
or affiliated taxpayers, including individuals, partnerships, and
corporations.
Paragraph 2.1.1 of the Transfer Pricing Guidelines of 198314
(hereinafter referred to as Guidelines) requires that business
dealings between related parties be evaluated on the principle of
arm's length dealings between independent parties acting in a
situation of free competition.
Paragraphs 2.2.2 through 2.2.4 of the Guidelines list the
following as the standard methods for evaluating transfer prices:
comparable uncontrolled price method, resale price method, and
cost plus method. In contrast to section 1.482-2(e)(1)(ii),
which requires that these methods be used in the order prescribed
if the circumstances of the case permit, paragraph 2.4.1 of the
Guidelines states that, "[t]here is no single correct sequence of
standard methods for the examination of transfer prices which
applies to all groups of cases." Also, paragraph 2.4.2 of the
Guidelines, similar to the "fourth method" provision of section
1.482-2(e)(l)(iii), allows use of a combination of the three
standard methods or of other methods.
In cases involving transfers of intangibles to offshore
manufacturing affiliates, paragraph 5.1.1 of the Guidelines
recognizes that a determination must be made whether the
transferor has received an adequate consideration for the
transfer of the intangible. Paragraph 5.2.2 of the Guidelines
states that an arm's length price for transfer of an intangible
is to be determined under "an appropriate method." Paragraph
5.2.3 of the Guidelines indicates that the preferable method is
the comparable uncontrolled price method but, if the facts of a
case will not support application of this method:
then the starting point for the examination is the
consideration that a sound business manager of the
licensee enterprise would only pay a royalty up to an
amount which leaves the enterprise with an acceptable
commercial profit from the licensed product. [Emphasis
added.]
According to paragraph 5.2.4 of the Guidelines, the cost plus
method may be used "in exceptional cases." One such exceptional
case 13
is described in paragraph 3.1.3 (Example 3) of the Transfer
Koerperschaftsteuergesetz
art. 1(1).
Pricing Guidelines
of 1983, as follows:
14

See Intl. Bureau of Fiscal Documentation, The Tax
Treatment of Transfer Pricing (1987) (English translation).

- 6 An enterprise transfers particular manufacturing
functions to a foreign subsidiary corporation.
Production and marketing by the foreign corporation are
closely tied in with the business of the domestic
enterprise.
The articles produced are purchased by the parent
corporation under a long-term arrangement. The
subsidiary corporation with its limited range of
production could not in the long run survive as an
independent corporation. Between unrelated parties the
production would have been carried out on a subcontract basis.... The transfer price can accordingly
be determined using the cost plus method.
This approach is essentially the same as that of the IRS in the
Lilly case, discussed supra, Chapters 4 and 5.
One commentator, Mr. Friedhelm Jacob, Counselor for Tax
Affairs at the West German Embassy in Washington, D.C, has noted
that, in contrast to the 1986 Tax Reform Act amendments to
section 482, which require adjustments over time for substantial
changes in circumstances, the German approach has been that the
determination of fair market consideration for an intangible is
made at the time of the transfer.15
Paragraph 2.4.3 of the Guidelines recognizes that related
entities may enter into bona fide cost sharing arrangements and
that such arrangements can affect transfer prices. Under
paragraph 7.1.1 of the Guidelines, cost sharing arrangements are
to be taken into consideration in making transfer price income
allocations between the entities involved in the arrangement.
However, full costs, direct and indirect, must be calculated and
included under a recognized accounting method. If the cost
sharing arrangement is to be recognized, the services must be
distinguishable and the aggregate of the costs must be separable
as to the services. No profit is permitted in such an
arrangement. Furthermore, a taxpayer seeking a deduction for -a
cost sharing payment must have "a specific right, definite both
in nature and scope, to benefit from the activities of the
central organization."
The experience of the Office of the Assistant Commissioner
(International) has been that, if the comparable uncontrolled
price method cannot be utilized, the German tax authority
15
New "Super-Royalty"
Internal
generallyJacob,
allowsThe
a price
or royalty that Provisions
leaves theof
enterprise
Revenue
1986: commercial
A German Perspective,
27 European
Taxation
with an code
acceptable
profit from the
sale or license,
320 (1987).

- 7 although there are no published industrial safe harbor profit
norms. With respect to the transfer of intangibles, the tax
authority does not consider that the intangible property itself
was used when a person acquires the goods or merchandise produced
with the intangible.
JAPAN
Article 66-5 of Japan's Special Taxation Measures Law is
effective for taxable years beginning on or after April 1,
1986.16 This law applies only to corporations (and certain other
legal entities recognized under Japanese law), but does not apply
to individuals, unincorporated joint ventures, and similar
entities. Furthermore, Art. 66-5 applies only to transactions
between a foreign corporation and a corporation that is subject
to Japanese tax and only when the two entities are related by at
least a 50 percent direct or indirect ownership.
Article 66-5 is as follows:
(1) In the event that, during a business year
commencing on or after April 1, 1986, a corporation
("Corporation A") has conducted sale or purchase of
assets, provision of services or other transactions
with a foreign affiliated corporation ("Corporation B")
which has a relationship with Corporation A in which
one of the corporations in question, directly or
indirectly, owns a number of shares comprising 50
percent or more of the total number of issued shares of
the other one or has any other special relationship
with Corporation A ("Special Relationship") and, in
connection with such above mentioned transaction
("Transaction"), if the amount of consideration of
which payment was received by Corporation A from
Corporation B was less than an arm's length price, or
if the amount of consideration which Corporation A paid
to Corporation B was greater than an arm's length
price, then, for purposes of corporate income taxation
of Corporation A for the said business year, the
Transaction will be deemed to have been carried out at
an arm's length price.
Paragraph
(2) of Article 66-5 lists the methods by which the
16
Japan
Special
Taxation
Measures although
Law, art.
(March
arm's length price
is to
be determined,
in66-5
contrast
to31,
1986),
outline of which the
is methods
containedare
innot
Appendix
I, to the
sectionan
1.482-2(e)(l)(ii)
prioritized
as to
Speech of Toshiro Kiribuchi, Deputy Commissioner (International
Affairs), National Tax Administration, at the International Tax
Institute Seminar, New York, N.Y. (June 2, 1986).

- 8 the order in which they must be employed. In the case of sale or
purchase of inventory assets, the permissible methods are
comparable uncontrolled price, resale price, cost plus, and, if
none of the first three methods may be applied, a method
"similar to" the first three methods or "other methods prescribed
by cabinet order." In the case of other transactions (i.e.,
that do not involve the sale or purchase of inventory assets),
the arm's length price is determined by "a method which is
equivalent to" the comparable uncontrolled price method, the
resale price method, the cost plus method, and, if none of the
first three methods may be applied, a method "equivalent to" or a
method which is "similar to" one of the first three methods.17
The comparable uncontrolled price method is described
generally as the price that would have been paid between a buyer
and a seller.who are unrelated, where the sale or purchase of
inventory is the same type of inventory as the inventory involved
in the subject transaction, and the circumstances, including
commercial level and transaction volume, are similar. It is
permissible to use this method where the transactions are not
precisely comparable, but it is possible to adjust for
differences.18
The resale price method is described as the price computed
by deducting a normal amount of profit (meaning an amount
computed by multiplying the resale price by a normal profit
percentage) from the amount of consideration when a buyer of
inventory assets involved in the subject transaction resells
inventory assets to a person with which it has no special
relationship.1 9
The cost plus method is described as the price computed by
adding a normal amount of profit (meaning an amount computed by
multiplying the amount of costs by a normal profit percentage),
to the amount of the costs of the seller to acquire, by purchase,
manufacture, or other acts, the inventory assets involved in the
subject transaction.20
The guidance given by the Japanese legislation for
Special
Measures
art.transfer
66-5, §2(i)
determinating
an Taxation
arm's length
priceLaw,
for the
of anand (ii).
intangible asset is that methods similar to comparable
Special Taxation Measures Law, art. 66-5, §2(i)(a).
Special Taxation Measures Law, art. 66-5, §2(i)(b).
20

Special Taxation Measures Law, art. 66-5, S2(i)(c).

- 9 uncontrolled price, resale, and cost plus methods can be used,
and that, if none of these methods is applicable, a fourth method
may be used.
A unique aspect of Japan's transfer pricing law is a preconfirmation system whereby a Japanese parent or subsidiary may
request pre-approval of a sale or purchase price from a foreign
related entity from the tax administration. The purpose for this
procedure is to reduce the number of transfer pricing cases and
to eliminate uncertainties in international transactions. No
such procedure is available under U.S. law, and the IRS would not
grant such a ruling because of the. factual nature of the issue.
The Japanese experience to date is that taxpayers are taking a
"wait and see" attitude towards the pre-confirmation procedure.21
UNITED KINGDOM
The statutory basis under U.K. law for adjustments to
transfer prices is section 770 of the Income and Corporation
Taxes Acts of 1988 [ICTA]. This section provides that where any
property is sold and:
(a) the buyer is a body of persons over whom the
seller has control, or the seller is a body
of persons over whom the buyer has control,
or both the buyer and the seller are bodies
of persons over whom the same person or
persons has or have control; and
(b) the property is sold at a price ("the actual
price") which is either —
(i) less than the price which it
might have been expected to fetch
if the parties to the transaction
had been independent persons
dealing at arm's length ("the arm's
length price"), or
(ii) greater than the arm's
length price,
then, in computing for tax purposes the income, profits
or losses of the seller where the actual price was less
than the arm's length price, and of the buyer where the

Go, Kawada, Director, Office of International
Operations, National Tax Administration, Remarks at the
International Tax Institute Seminar, New York, N.Y. (June 27, 1988)

- 10 actual price was greater than the arm's length price,
the like consequences shall ensue as would have ensued
if the property had been sold for the arm's length
price.22
This section applies to rentals, grants and transfers of rights,
interests or licenses, loan interest, patent royalties,
management fees, payments for services, and payments for goods.
Guidance with respect to application of section 770 of the
ICTA is provided in Notes published by Inland Revenue.23
An Inland Revenue Note defines "arm's length price" as the
price which might have been expected if
the parties to the transaction had been independent
persons dealing at arm's length, i.e. dealing with each
other in a normal commercial manner unaffected by any
special relationship between them.24
The Note dealing with methods of arriving at arm's length
prices is as follows:
In ascertaining an arm's length price the Inland
Revenue will often look for evidence of prices in
similar transactions between parties who are in fact
operating at arm's length. They may however find it
more useful in some circumstances to start with the resale price of the goods or services etc. and arrive at
the relevant arm's length purchase price by deducting
an appropriate mark-up. They may find it more convenient on the other hand to start with the cost of the
goods or services and arrive at the arm's length price
by adding an appropriate mark-up- But they will in
practice use any method which seems likely to produce a
satisfactory result. They will be guided in their
search for an arm's length price by the considerations
set out in the OECD Report on Multinationals and
Transfer
Pricing.
Report
examines the
22
Income
Tax Acts (This
of 1988,
§770.
considerations which need to be taken into account in
23
Thomas, Richard, Deputy to Assistant of Taxes, Board of
Inland Revenue, Remarks at the International Tax Institute
Seminar, New York, N.Y. (June 27, 1988).
24
The Transfer Pricing Of Multinational Enterprises, Notes
by the UK Inland Revenue (Jan. 26, 1981), at 1, reprinted in
Int'l Bureau of Fiscal Documentation, Tax Treatment of Transfer
Pricing (1987).

- 11 arriving at arm's length prices in general and also in
particular in the context of sales of goods, the
provision of intra-group services, the transfer of
technology and rights to use trade marks within a group
and the provision of intra-group loans).25

Id. at 3.

APPENDIX D
AN EMPIRICAL ANALYSIS OF THE MARKETPLACE FOR INTANGIBLES
A. Introduction
One question that has been raised during the preparation of
the paper is whether the requirement for periodic adjustments in
certain situations is consistent with the manner in which
unrelated parties structure arrangements involving transfers of
intangibles. Additionally, the Congressional concern about
related party use of inappropriate comparables raises questions
about which characteristics of unrelated party arrangements
should be included in related party arrangements. This appendix
draws upon academic work that examines actual licensing
experience by unrelated parties in an effort to address this
issue.1 Although each of the papers examined had a different
goal, the underlying data collected through surveys or
interviews with licensees and licensors provides relevant
information about what unrelated parties do.
In addition to synthesizing other authors' work on
technology transfers, the Service and Treasury have collected a
sample of license agreements drawn from the records of the
Securities and Exchange Commission ("SEC"). The SEC requires
that companies disclose license agreements that are "material" to
the operation of the company.2 The disclosures to the SEC
provide a potential data base of over five hundred agreements.
Only sixty of these agreements have been analyzed for this
report. The choice of agreements in the sample was largely
dictated by the ease of discovery and the availability of
documents within the SEC's files. The sample consists of forty
agreements for the manufacturing industry, most of which are
clustered in the Standard Industrial Classifications (SIC) for
pharmaceutical preparations, toilet preparations, electronic
computing equipment, semiconductors, surgical and medical
equipment, and ophthalmic goods. The other twenty agreements are
1
for the
services
industry,
within
the include
SICs for
computer
Authors who
rely onmostly
statistics
that
related
programming,
computer
software,
and
research
and
development
party transactions are quick to point out that the numbers are
laboratories.
biased
due to potentially tax motivated manipulations. See,
e.g., Katz and Shapiro, How to License Intangible Property, 101
Quarterly Journal of Economics 567-589 (1986).
2
"Material" is an accounting concept that describes items
about which a prudent investor ought reasonably to be informed.
For an explanation of a "material contract," see Item 10 of the
Instructions to the Exhibit Table for Form 10-K, 17 C.F.R. § 229.601.

- 2 In this study, the SEC documents have been used primarily
for further illustration of the points raised by other authors.
Further examination of the SEC agreements will be conducted
after publication of this study, with a view toward relating them
to financial accounting and tax data of the firms involved, and
publishing the results. An analysis of available data might give
a more complete picture of the incomes realized by the two
parties to the transaction and suggest criteria for determining a
profit split in comparable cases.
B. Goal of Licensing Agreements
Parties contemplating entering into a license agreement are
ultimately concerned with the income they can expect to receive
from the arrangement. The existence of proprietary knowledge
suggests that production and sale of the product will result in
profits that are greater than those necessary to provide a normal
rate of return to the inputs provided by both parties. The
actual division of these profits will depend on each party's
forecast of the total profits, and on the relative bargaining
strength of the two parties.
Some authors have formally diagrammed and discussed the
negotiating range of unrelated parties.3 The basic premise is
that the parties are concerned with the split of the net income
from the product. Baranson reports that Bendix officials
"indicated that, if a broad cross-section of American industry
were polled, one would find that the average goal is a return to
the licensor equal to, about one-third of the profit of a wellrun, well-established licensee with a broad market."4 Caves et
al. find that the licensor will capture an average of forty per
cent of the expected profits that remain after the deduction of a
normal return on capital. According to their sample, the range
of the split leaves one-third to one-half of the profits to the
licensor.5 Contractor's overview of the literature suggests
that licensors "should settle for a 25 to 50 percent share of
the licensee's incremental profit."6
These3 averages
canF.not
necessarily
be used to Technology
replicate an
See, e.g.,
Contractor,
International
individual at
arm's
length
because they do not, for example,
Licensing,
Chapter
3 deal
(1981).
4

J. Baranson, Technology and the Multinational 64 (1978).

Caves, Crookell, and Killinger, The Imperfect Market for
Technology Licenses, 45 Oxford Bull, of Economics and Statistics
249, 258 (1983).
6

Contractor, supra n. 3, at 125.

- 3 control for the specific economic activities undertaken by the
parties. They do show that unrelated parties enter negotiations
for a license agreement with expectations about the total profits
that they think will be earned from the exploitation of the
intangible, and about the share of the profit that they can
expect to receive.
C. Payment Terms for a License
Although the goal is to capture a portion of the profits,
the provisions in license agreements rarely specify that a
percentage of the profits will be paid as compensation for the
right to exploit the intangible. This may be because the
licensor fears that the accounting for profits can be
manipulated too easily by a licensee, who may be able to choose
what costs are included. Instead, a royalty that is a percentage
of the net selling price is typically chosen.7 Fifty-eight
percent of the agreements in the SEC sample used a royalty based
on the net selling price.8 This means of achieving the split of
profits from the intangible leads to a more easily verifiable
number for the licensor.
Of the SEC agreements that have royalties based on the net
selling price, 40 percent have a constant royalty rate. Because
costs vary over time, a flat royalty rate will lead to a
different profit split on a year-by-year basis. Therefore, an
examination of the returns over the lifetime of the agreement is
necessary to determine the true division of the profits.
Some agreements apparently attempt to even out the returns
earned by varying the royalty rate. A number of different
structures are possible. Some agreements have a royalty rate
that declines over time; others are structured so that the rate
rises and then falls. Thirty per cent of the SEC agreements
that have royalties based on the net selling price vary the
royalty rate over the years of the agreement.
The remaining 30 percent of agreements with royalties based
on the net selling price vary the royalty rate based on total
7
The net selling price is typically the price charged by
the licensee to unrelated parties on an f.o.b. factory basis
after deduction for state and local sales taxes and, sometimes,
after deduction for quantity discounts.
8
Recall that the sample size is small and was not chosen
randomly. All percentages provided are purely illustrative and
should not be accorded the weight one would give to a larger,
randomly selected sample.

- 4 sales of the product. This structure may be most clearly tied to
the returns that the licensor requires. It may also provide
incentives to the licensee; this aspect will be discussed below.
Not all compensation packages are based on a percentage of
the net selling price. Eighteen percent of the agreements in
the SEC sample require a royalty per unit. Once again, the
royalty per unit may be constant or it may change as more units
are sold. In the SEC sample, 60 percent of the royalties per
unit were constant, and 40 percent declined per unit as the
number of units increased. The licensor may prefer to base the
royalty on units sold instead of on net selling price if the
licensee is contemplating discounts or if the intangible may be
sold as part of a larger package, such as when software is
distributed free of charge to the buyer of a computer. In the
SEC sample, 80 percent of the royalty per unit agreements
occurred in licenses for computer software. Computer software
would seem to be the type of product for which "free" samples may
be provided or which may be part of a package deal. Indeed, 67
percent of the sample agreements in the SIC code for "Computer
Programming and Software" contain royalties per unit.9
Some agreements combine advance or lump sum fees with a
royalty based on sales or units. Different factors might explain
these payments in different settings. If the licensee's country
of incorporation limits the allowable royalty rate, an initial
lump-sum fee might be used to ensure that the licensor earns the
required return.10 Alternatively, the goal of a front-end fee
may be to lower the licensor's risk by ensuring a minimum return.
In the SEC sample, 16 percent of the agreements with per unit or
net selling price royalties also have initial lump sum fees.
Another means of lowering the licensor's risk is for the
licensee to prepay a nonrefundable amount of money against which
future royalty obligations are credited. In addition, a minimum
payment may be due each year. If the total royalties paid are
less than this amount, the licensee must pay the difference to
the licensor.
Forty-seven percent of the agreements with per.
9
This
product
specific
use ofcontain
a certain
unit or net selling price
royalties
thistype
typeofofroyalty
base
is the type of information that one would hope to find in
arrangement.
more situations after a thorough examination of the SEC data.
10
If the licensee's country of incorporation intends to
limit the compensation flowing out of the country, attempts to
provide a lump sum payment may only serve to shift the analysis.
In addition to limiting the royalty rate, the country may also
challenge the lump sum payment.

- 5 Finally, a lump sum fee may provide the sole compensation
for the use of an intangible for a certain number of years.
Twenty percent of the SEC agreements used a one time, lump sum
payment or annual lump sum payments. Such an arrangement fixes
the return that the licensor will receive. This payment scheme
leaves the licensee to absorb all the variance in the amount
earned. Just as in the minimum payment scheme, if the product is
much less popular than expected, the licensee will absorb the
loss. However, unlike the minimum payment scheme, if the product
is much more popular than expected, the licensee will reap all of
the unexpected rewards. This type of arrangement could provide a
strong incentive to the licensee to concentrate resources on
selling the product.
Forcing the licensee to absorb the risk may not be the only
reason that lump sum fees are chosen. The licensor may have
patented a new technique or instrument that the licensee wishes
to use to attempt to create another product. In this case there
is no readily apparent unit to be produced, nor is anything being
sold initially. Therefore, a lump sum fee may be the only
practical means of compensating the licensor for the use of the
patent. Lump sum fees may also be used to settle disputes over
patent infringement claims.
D. Provisions Which May Affect Returns
Other clauses in the agreement, which do not explicitly
affect payment, may affect the returns earned by the licensor and
the licensee. For example, the licensor may require the licensee
to perform a certain amount of marketing. This clause can be
very specific, and may require that a certain amount be spent or
that a certain percentage of the licensee's marketing
11
expenditures
devoted states
to thethat:
licensor's product.11
One be
agreement
Alternatively, the marketing or advertising clause may be open[I]n each License Year during the term of this
Agreement, Licensee shall expend a sum equal to 2%
of the Net Sales of Licensed Products...for trade
and consumer advertising of Licensed Products
under the Licensed Trademarks. All such
advertising shall be in accordance with the
provisions of this Agreement. Licensee shall
furnish Licensor with copies of each such
advertisement and with proof of such advertising
expenditure.
The agreement goes on to define advertising and to require that
"such advertising shall have been submitted to Licensor and
received its prior written approval."

- 6 ended, requiring that the licensee use its "best efforts."12
Although such a clause does not readily translate into a dollar
figure, it potentially gives the licensor the ability to
terminate the agreement or to file suit if unsatisfied with the
results.
One might expect to find these clauses in licenses for
products in which advertising plays a pivotal role in determining
the success of the product. Indeed, in the SEC sample, these
marketing or advertising clauses seem to be particularly
prevalent in the SIC code for toilet preparations. Seventythree percent of the agreements in the SEC sample that contain
advertising clauses are for licenses with respect to clothing
articles or toilet preparations. Once again, certain features of
agreements seem to be product specific. This suggests that a
comprehensive analysis of the marketplace for intangibles should
ideally focus on individual product groups.
In addition to lowering the licensor's risk, these marketing
clauses imply that the licensee is engaging in a significant
economic activity beyond the manufacture and distribution of the
good that embodies the intangible. One would expect that the
performance of this additional activity would affect the returns
that each party anticipated.
A major factor affecting the licensor's return from
licensing the intangible is the amount of technical support
required as a condition of the license. The total expense of
transferring a technology to a licensee will depend on the
technology and on the licensee's level of expertise. Transfer
costs include the physical transfer costs of plans,
specifications, and designs, as well as the cost of training the
licensee to make use of them. Since the licensor has typically
already created the product being licensed, the cost of
transferring the technology may be the biggest resource cost to
the licensor. Indeed, Contractor finds that the most important
factor in determining the licensor's return on an agreement is
the amount of technical services provided.13 By carefully
limiting the amount of service automatically provided, the
licensor
can minimize uncertainty of return from the transfer.
12
One such clause reads: "[Licensee] shall use its best
efforts to document, package, market, distribute, advertise and
promote the Use of the Software. All advertising and
promotion...shall be undertaken at [the licensee's] expense...."
Contractor, supra n. 3, at 123, n. 6.

- 7 Additional technical support is sometimes provided on a time
and expense basis.14 The split between "free" technical support
and additional support for which the license is charged varies
depending on the circumstances. Additional detail would be
necessary to test hypotheses concerning how expectations about
technical support affect technical assistance provisions and how
these provisions affect the whole licensing package. The SEC
data reveal a variety of solutions to the technical assistance
question. Some set a specific time period for "free" technical
support.15 Others require that technical assistance be
reimbursed at cost,16 at a fixed rate,17 or at the lowest rate
18
charged
14 by the licensor to third parties.
Baranson, supra n. 4, at 65, n. 4. As is true of the
15

A license for the design, use, and sale of laser
accessories with a per unit royalty provides:

Upon [licensee's] request, [licensor] shall give or
shall cause to be given to [licensee] such technical
assistance and shall give or shall cause to be given to
[licensee's] employees such training for 6 months after
the date hereof as [licensee] may reasonably require
in connection with the transfer of technology provided
in the preceding paragraph....
16
A license to manufacture and sell clothing using the
licensor's trademark with a royalty based on net sales notes:
Licensor agrees to furnish technical aid to the
licensee (including information concerning advertising,
packaging and customer lists) if requested in writing,
provided that the licensee pays all of the expenses for
such aid....
17
A 1985 license agreement to modify and sell software
where the license makes regular, fixed royalty payments says:.
[Licensor] agrees to provide technical assistance
concerning the Software to licensee, upon request by
Licensee, in the development of the Modified Software;
provided, however, that in addition to all other sums
payable under this Agreement, Licensee agrees to pay
[licensor] the sum of $100.00 per hour for all labor
provided by [licensor], plus reimbursement for all
expenses incurred by [licensor] in providing such
18
assistance
to Licensee.
Atechnical
license for
the use of
a new type of laser where the
licensee provides fixed annual royalty payments requires:

- 8 marketing clauses in a licensing agreement, a licensor may need
to balance the desire to push all of the technical costs onto the
licensee with the need to ensure that the licensed intangible is
used productively.
E". Preparing for Surprises
An arm's length license agreement is shaped by each party's
expectations about costs, sales, and the overall profit potential
from the use of the intangible. The parties' expectations may
differ, and they may differ markedly from the actual profit
experience with the product. Therefore, even if both parties are
pleased with the royalty rate to be paid, the level of technical
services to be provided, and any marketing clauses or clauses on
market restrictions, it is possible that future events will leave
one or both of the parties dissatisfied with the arrangement.
There are two types of surprises from which the parties may
desire protection. One surprise occurs if further development of
the intangible significantly improves the product's
profitability. The other occurs if several years of actual
profit experience lead to a change in expectations about future
profitability.
The first surprise is of particular concern to the licensor.
In order to insure against this risk, many license agreements
contain "grant back" or "technology flowback" clauses. These
clauses specify that the licensor receives, free of charge, any
enhancements to the technology that are developed by the
licensee. These clauses serve to discourage the licensee from
doing its own R&D and potentially competing with the licensor.
They further protect the licensor from losing out on
serendipitous discoveries by the licensee. Caves et al. found
grant back clauses in 43 percent of the 257 agreements they
studied. However, the clauses appeared 76 percent of the time
19
in agreements
involving
"dominant
product" such
licensors.
[Licensor]
shall
make available
technical
assistance as [licensee] may reasonably request for
understanding or exploiting the Proprietary Technology
at [licensor's] standard rates, and under terms that
are no less favorable than those extended to any of its
other customers.
19
Caves, supra n. J5, at 261, n. 5. A dominant product is
one that accounts for more than 60% of a firm's sales. This
classification relates only to the level of the firm's
diversification. It does not make any distinction with regard to
the overall profitability of the product. Id. at 252.

- 9 The second type of surprise, changes in the parties'
expectations about future profitability, can create problems from
which both licensors and licensees may want relief. Termination
clauses provide one kind of protection in these circumstances.
In one agreement, a license for the use of a trade name, the
licensee was required to meet certain sales targets. This type
of arrangement allows the licensor to exit from the deal or
renegotiate if the volume is insufficient to realize the expected
returns from the intangible.
In other cases, termination clauses allowed the parties to
end the contract, without cause, after giving notice. This
safety valve may not lead to actual termination but instead may
offer an opportunity for renegotiation if one of the parties
thinks that its returns are inadequate. The structure of
termination clauses varies. Clauses may allow immediate
termination, or they may require several years' notice.
Manufacturers' distributors can typically be dropped by the
manufacturer to whom they are under contract on 30 days'
notice.20 At the other end of the spectrum, some terminations
without cause are tied to the length of a patent. However, not
all agreements involving patent life specify such a long period
before renegotiation is considered. Thirty-four percent of the
SEC agreements provide for termination without cause for the
licensee, while 21 percent allow the licensor to terminate
without cause after a given period of time.
Some agreements have no termination clause except for cause.
There are several situations in which a license might be likely
to lack a termination clause. If the licensee was required to
make a substantial initial investment in order to make use of the
intangible, one can hypothesize that the licensee would not enter
into the agreement if the licensor could easily pull out of the
deal. Another type of agreement without a termination clause
might be one involving the license of products, such as computer
software, that have a very short lifespan. In this case the
relevant life is so short that termination is not a useful
option; both parties must choose correctly the first time.
Related to this group are agreements that are scheduled to end
after a specific, and relatively short, length of time. These
agreements will automatically be renegotiated if the parties wish
to extend the license.
Fifty-five
percent of the SEC sample agreements allow no
20
Galante,
Divorce
Curbs of
Sought
Manufacturer's
termination except Quickie
for cause.
However,
thisBy
subset,
22
Distributors.
Wall
Street
Journal,
July
13,
1987,
at
25.
percent are agreements that have a specified length of less than

- 10 three years, and another six percent are agreements of five or
six years in duration. These agreements seem to fall into the
category of licenses with relatively short lengths.
Twenty-eight percent of the SEC sample agreements without a
termination clause (16 percent of the total sample) were
agreements with a duration of ten years or more. More
information on these licenses would need to be gathered in order
to test the hypothesis that extended licenses tend to exist when
the licensee is required to make a substantial initial
investment.2 x
Of the remaining agreements with no termination clause, 22
percent were for agreements with lump sum payments and 22 percent
were for agreements of indeterminate length. The latter group
typically specified that the agreement lasted until the patent
expired; these patent expiration dates were not readily
available.22
The existence of termination clauses shows that companies
are concerned about their ability to predict the total profits
from the exploitation of an intangible. Regardless of the
existence of termination clauses, agreements do get renegotiated.
The frequency of renegotiation would give information about the
"surprises" that occurred and the companies' ability to predict
the outcome of a license agreement. Although it is not possible
to make general statements about the overall frequency of
renegotiations or terminations based on the sample of agreements
we examined, some examples of renegotiations were found. A
license to manufacture and sell clothing under a trademark was
renegotiated in the second year of a six year term. The amended
agreement provided the licensor with a royalty rate, based on net
selling price, one percentage point higher than the original
rate. However, the new agreement also lowered the percentage of
the net selling price to be spent by the licensee on advertising
by one-half a percentage point.
Other agreements provide clear evidence that the parties '
contemplated
the possibility that renegotiation might be
21
In
addition,
representative
information
on allprovides
necessary. One agreement,
with no termination
clause,
licenses,
regardless
of term,
that
require
licensee
make
a
for
renegotiation
of the
royalty
rate
after the
three
years.toAt
that
substantial investment would be necessary in order to test the
hypothesis that a large initial investment by the licensee leads
to a license of long duration.
22
These agreements could be of short duration; several of
the other license agreements in the sample were for patents with
only two or three years left before expiration.

- 11 time, "[B]oth the royalty rate and the scope of the Patented
Portions will be renegotiated...[to] aggregate to not less than
1.5 percent and not more than 2.5 percent of the Royalty Portion
selling price of such Licensed Products." Another agreement
provides for renegotiation after certain events occur, instead of
after a certain time period. This is a 15 year agreement which
the licensee can terminate on six months' notice. It says:
"Licensor or Licensee are unable at the Effective Date of this
Agreement to value on a proportionate basis the future worth to
Licensee of the rights presently owned by Licensor in the
Technological Field...." The agreement goes on to provide for
current royalty payments and for additional payments, depending
on the outcome of certain events.
This discussion of terminations and renegotiations shows
that there is no single way of dealing with uncertainty.
Ultimately, much more detailed analysis would have to be
undertaken to determine what circumstances lead unrelated parties
to renegotiate or terminate contracts.
F. Conclusions and Recommendations
The agreements filed with the SEC and those analyzed in the
academic work provide a body of information concerning arm's
length transactions involving intangible property. This body of
information points out key factors that should be considered when
determining the proper allocation of income in related party
situations. The SEC data and other sources will be further
analyzed in greater detail following publication of this paper.
For example, patterns might be disclosed between royalty rates
and specific levels of technical assistance, or marketing
expenditures, either in general or by specific industry groups.
Moreover, a study of the prevalence of, and circumstances that
trigger, termination or renegotiation clauses (as well as the
results following exercise of the clause) might be helpful in
determining when unrelated parties exercise these rights.

APPENDIX E
EXAMPLES OF METHODS FOR VALUING TRANSFERS OF INTANGIBLES
Preamble to Examples
The examples that follow illustrate the principles and
methods described in Chapter 11. They are intended to set forth
what the Service and Treasury believe is an ideal application of
these principles and methods to specific factual situations.
They are intended to serve as guidance for taxpayers in planning
their pricing transactions as well as for both taxpayers and the
Service on audit. In large part, the types of information set
forth are based upon information used by IEs and economists on
audit and used by taxpayers or outside economists for planning
purposes.
In general, it is expected that the amount of information
about comparable transactions, rates of returns, and costs for a
taxpayer's industry and claimed comparable transactions will be
the greatest following a full examination of the taxpayer's
return. But, as Chapter 3 makes clear, taxpayers have a burden
to document contemporaneously, and to justify, their transfer
pricing policies and their return positions. The Service and
Treasury recognize the practicalities involved in locating and
analyzing the type of information set forth in certain of these
examples when transactions are planned or returns filed. In
general, the taxpayer making a relatively minor investment would
not be expected to have gathered and analyzed data outside of its
own knowledge of its .business affairs and those of its
competitors. As Chapter 3 indicates, however, a taxpayer
engaging in a transaction involving high profit intangibles
should arguably be expected to gather and analyze the type of
information set forth in certain of the examples, to the extent
that it is available, contemporaneously with the transaction.
Example 1: Exact Comparable
Hydrangea, Inc. is a U.S. developer, producer, and marketer
of business software for personal computers. It has developed a
new line of specialized accounting software that it expects to
sell mainly in foreign markets.
Hydrangea expects that this product will have a life cycle
similar to most other products in its line. Thus, it expects
that this software will have a peak productive life of three to
five years. If it is moderately successful, there will be a
small, declining market after that, as obsolescence sets in. If

- 2 the product is very successful, Hydrangea may decide to develop
an enhanced, substantially modified version after the peak
period, which it would treat as a new product.
Hydrangea has decided to serve the market in country F for
this software by licensing it to an unrelated country F
corporation, Fleur, with which it has had satisfactory dealings
in the past. Specifically, Hydrangea and Fleur have negotiated a
licensing agreement with the following terms. Fleur receives an
exclusive license to market Hydrangea's product in country F and
agrees to pay Hydrangea 20 percent of the net selling price for
each copy it sells. Fleur agrees not to market competing
products while the license is in effect. Fleur will market the
product under its brand name and will perform the necessary work
to modify the product to integrate it into its own line of
accounting software. Hydrangea agrees to provide Fleur, for
free, with any corrected, revised, and enhanced versions of the
software that it releases publicly during the first four years.
(Fleur and Hydrangea understand that, after that period, the
latter is permitted to develop an enhanced, substantially
modified product and to call for new negotiations with Fleur,
find another licensee, or market the new product itself.) The
agreement grants Fleur a perpetual license to the current
product. During the first four years, neither party can
terminate without cause; after that period, Fleur can terminate
with six months' notice.
Hydrangea will serve the market in country B through its
wholly owned local subsidiary, Royal Hydrangea. The markets in
countries F and B are substantially similar in size,
sophistication, and ability to use business software intended for
personal computers. Royal Hydrangea performs the same functions
as Fleur relating to marketing and distribution of accounting
software. Thus, it will modify the product as necessary for
local requirements; it has been and will continue to be
responsible for marketing its products and developing its
trademark; and, it maintains a distribution network, including a
sales staff. For these reasons, Hydrangea concludes the external
standards for using the Fleur agreement as an exact comparable
are satisfied.
Hydrangea satisfies the internal standards by including all
important features of the Fleur agreement in its agreement with
Royal Hydrangea. Thus, the royalty is set at 20 percent of net
selling price. The provisions concerning corrections and
revisions are also, therefore, included, as are the provisions
concerning duration and termination.
Each year, Hydrangea reexamines its related party
arrangement to determine if the exact comparable approach is
still valid. Specifically, it determines whether the two markets
are still similar, and whether Fleur and Royal Hydrangea still

- 3 perform similar functions. If these aspects of the external
standards have substantially changed, or if Fleur terminates its
agreement, Hydrangea must reestablish the appropriateness of its
related party transaction, which may require adjusting the
royalty rate.
Example 2: Unavailability of Comparables
A U.S. company has developed a unique good that it believes
will capture 80 percent of the relevant market. The U.S.
company plans to produce the good in the United States and to
license the rights to production and sale for the rest of the
world to its foreign subsidiary. The U.S. company can find no
examples of situations in which an unrelated party licensed the
rights to production for a product that captured such a large
share of the market. Therefore, the company should use the
arm's length return method in order to set the appropriate
royalty rate with its foreign subsidiary.
Example 3: Inexact Comparable
Shampoo Inc., a well known hair-care products corporation in
the United States, plans to set up a subsidiary in country Z in
order to introduce its line of products in country Z. The
subsidiary will manufacture, distribute, and market the products
using the Shampoo trademark. When planning the appropriate
transfer price for the license, Shampoo officials started with
the knowledge that one of their competitors, Condition Corp.,
licensed a line of hair-care products to an unrelated party in
country Z, Lotions, Inc.
The Condition license covers the formulas for all of
Condition's hair-care products as well as the Condition
trademark. The license gives Lotions the right to manufacture,
distribute, and market the licensed products. Terms include an
exclusive license in country Z for a term of four years paying a
royalty of four percent of the net selling price. The licensor
agrees to provide the licensee with product formulations,
scientific data, manufacturing know-how, marketing, public
relations, and related assistance. The licensee must adhere to
strict quality control standards in manufacturing, distribution,
and marketing. The licensor has the right to inspect operations
of the licensee to verify such quality. The licensee is
prohibited from manufacturing, importing, or marketing competing
products in country Z.
From the terms of the agreement it is clear that Lotions
performs the same functions that Shampoo's subsidiary in country
Z will perform. It is also, clear that Condition provides the
same type of services and quality control for Lotion's
operations that Shampoo will provide for its subsidiary in
country Z. It is anticipated that Shampoo's subsidiary will have

- 4 a volume of sales similar to Lotion's once its operations are
fully developed. Finally, Shampoo knows that the gross margin,
(net sales - cost of sales)/net sales, on sales of Shampoo's
products in the United States is similar to the gross margin
achieved by Condition in the United States, which indicates that
their manufacturing processes and sales activities have
comparable efficiencies. Therefore, it is appropriate for
Shampoo to set a royalty rate of four percent of the net selling
price for a four year term.
Example 4: Likely Use of Inexact Comparables
Computers Inc., a U-S. software company that specializes in
games, plans to acquire the rights to manufacture, market, and
distribute a new computer game, Gizmo, created by its European
subsidiary. Gizmo will be an addition to Computers' existing
line of games. Computers Inc. projects that the total number of
Gizmo copies distributed will be close to the industry average.
Numerous third party licenses for computer software are
available. Computers examines these licenses for appropriate
inexact comparables and should be able to determine the
appropriate royalty amount and other terms for its agreement with
its affiliate from the third party agreements.
Example 5: Basic Arm's Length Return Method: U.S. Importer and
Distributor
TravelFun is a large publicly traded foreign corporation
with a U.S. subsidiary, TravelUS. TravelFun produces a unique
recreational product using sophisticated and highly sought-after
production technology. TravelUS imports the assembled product
and distributes it under the Travel name. TravelUS has the
exclusive right to develop the Travel name in the United States.
Because of the importance of the intangibles, TravelUS must apply
the rules governing the transfer of intangible property.
TravelFun does not license the Travel name to unrelated
parties, nor does it allow unrelated parties to distribute the
product. Therefore, no exact comparables are available. Similar
products exist that could potentially serve as inexact
comparables; however, none of them are sold to unrelated
distributors. Therefore, when TravelFun sets up its policy for
transfer prices of units sold into the United States for 1989 it
uses the rate of return method. In order to apply the method
properly, the following information is necessary: 1) a general
description of the functions that TravelUS performs, 2) financial
information on companies performing similar functions, and 3)
analyses of appropriate rates of return.
1) Functions of TravelUS. TravelUS imports the product from
TravelFun and distributes it to retailers. TravelUS is

- 5 responsible for developing the marketing strategy in the United
States.
2) Companies performing similar functions. Initially,
TravelFun seeks data about publicly traded independent operators
of wholesale distribution businesses. A search of the
appropriate SIC categories yields a number of companies that
differ in the following ways: 1) some are importers, while
others acquire their products in the United States; 2) some are
distributors of final products, while others distribute parts;
and, 3) some apply intensive marketing, while others do not.
Examination of these firms' published financial information
indicates that the sample should be narrowed to 16 firms in
order to reflect more clearly the functions performed by
TravelUS. TravelUS is an importer that distributes final
products and performs an important marketing function. Each firm
in the final sample has some combination of these characteristics.
Balance sheet and income data are then collected for the sample
of 16 companies.
3) Analysis of appropriate rates of return. The company
evaluates the available information in order to determine the
appropriate ratios on which to base its comparisons. Comparable
asset data are not available for all firms in the sample.
Therefore, an attempt must be made to determine a rate of return
for TravelUS based on available cost data for the sample of
firms. A number of ratios can be considered as a means of
determining an appropriate return on costs. Possibilities
include the ratio of gross profit to operating expenses (the
Berry ratio), the ratio of operating income to the cost of sales
and operating expenses, and the ratio of net pre-tax income to
total expenses. The choice of the appropriate ratio will depend
on the composition of the sample and the stability of the ratios
over time.
For the sample of 16 companies, all of the ratios lead to
similar results. TravelUS retains the information that supports
this claim, but upon examination presents only the analysis using
Operating
the Berry ratio. As
defined Expenses
above, the Berry Ratio is the ratio
of gross
profit
to operating
Net
sales
are total
revenueexpense:
from sales less cash discounts to
Net
Sales
Cost
of
Sales
customers for payment within a specified time. Cost of sales is
also referred to as cost of goods sold, including freight
charges. Operating expenses include selling expenses such as
sales salaries and commissions, advertising and marketing

- 6 expenses, depreciation expenses, supplies, office salaries, and
payroll taxes. The major expense not included in either cost of
goods sold or operating expenses is interest expense.
For the 16 firms in the sample the average Berry Ratio is
1.40 with a standard deviation of .15. (The minimum ratio was
1.17 and the maximum was 1.61.) TravelUS uses the average ratio,
1.40, in order to determine the payment that should be made to
the parent. Additional information that will be necessary
includes net sales, operating expenses, and cost of sales that
are not included in the payment to the parent for the product.
TravelUS projects sales of 20,000 units, net sales revenue
for 1989 of $100 million, and operating expenses of $30 million.
Cost of Sales are projected to be $2 million plus transfer
payments to TravelFun. Plugging this information into the
equation for the Berry ratio yields:
$100 mil. - [$2 mil + 20,000 x ]
1.40
=
$30 mil
Therefore, x, the transfer price paid for each unit, is $2800TravelUS will pay TravelFun $2800 per unit of import and
projects that it will pay TravelFun a total of $56 million in
1989.
Example 6: Basic Arm's Length Return Method: Foreign
Subsidiary Serving Local Market
Counter Inc., a U.S. corporation that specializes in overthe-counter drugs, plans to set up a subsidiary in country X.
The subsidiary will manufacture, distribute, and market Counter's
products in country Z. The manufacturing process is not
particularly complex. The subsidiary will set up its own
distribution network, which will be of average size for the
industry. Further, it will perform its own marketing; however,
because the subsidiary will, in general, sell "generic" products
that will sell under its customers' brand names and trademarks,
its marketing activities will involve contacting drug stores and
other selling concerns, and not the development of a unique,
consumer-level marketing intangible.
Counter's search for unrelated party licenses for comparable
products proves fruitless. The search does yield a number of
licenses in which the functions performed by each party are
similar. The products are not similar enough to over-the-counter
drugs to be classified as inexact comparables; however, the
level of manufacturing, the type of distribution network, and the
type of marketing performed in each case are similar. Therefore,
Counter searches for information about the returns earned by
each of these companies. Analysis of the income statements and

- 7 balance sheets of the firms in the sample yields an average rate
of return earned. This average can be used by Counter to
determine the royalty rate to be paid by its subsidiary in
country Z.
Example 7: Basic Arm's Length Return Method: Foreign Subsidiary
Producing for U.S. Market
A U.S. corporation has developed and patented the formula
for a new heart drug that has fewer potential side effects than
any drug in existence. The U.S. corporation plans to manufacture
the drug in a foreign subsidiary to be located in country Y,
which has very low labor costs. The completed product will be
returned to the parent for sale in the United States. In
addition, some of the manufactured drug will be shipped from the
manufacturing subsidiary to a marketing subsidiary in country X
for sale in Europe. The parent wishes to fashion the transaction
so that a royalty will be paid by the subsidiary to the parent
for the right to manufacture and sell the drug. The parent and
the subsidiary in X will then pay the manufacturing subsidiary
for the finished product.
The following information is known or projected:
1. The drug will sell for $2.00 per pill.
2. The volume of sales in the United States in 1989 will be
approximately 900 million pills.
3. The volume of sales in Europe in 1989 will be approximately
600 million pills.
4. Marketing and distribution costs in the United States are
estimated to be $14.4 million.
5. Marketing and distribution costs incurred by the country X
subsidiary are estimated to be $9.6 million.
6. The manufacturing subsidiary's costs will be as follows:
$110 million
Cost of Chemicals
$ 75 million
Operating Expenses
To be determined
License Payments
$ 5 million
All Other Expenses
The manufacturing subsidiary will have the following assets
Cash
Factory

$ 12 million
$360 million

- 8 8.

The manufacturing subsidiary will have the following income:

Interest Income $ 1 million
Revenue from Sale of Drug

To be determined

There are no transfers by unrelated parties that would
provide an inexact comparable for either the license the parent
grants to the manufacturing subsidiary or for the pill that is
sold to the parent and to the marketing subsidiary. There are
other companies that perform similar marketing and manufacturing
functions. The difficult piece to measure is the value of the
patent which is held by the parent. Therefore, the parent turns
to the arm's length return method as the appropriate method. The
parent will find proper rates of return for the manufacturing and
marketing segments of production and allocate to itself the
residual profits.
A sample of manufacturers in locations with low labor costs
shows that manufacturers earn an average rate of return on their
manufacturing assets of 12 percent. The subsidiary's total
manufacturing assets, the factory, cost $360 million. Prices
should be structured so that the manufacturing subsidiary earns
profits of $44.2 million ($43.2 million return on the factory
asset plus the known $1 million return on cash).
If all of the drug were resold to the parent, the split
between the cost of the final pill and the license payment would
be unimportant as long as the correct amount of income remained
allocated to the subsidiary. However, in this case the final
product is also being sold to the subsidiary in country X, so
the correct split is important.
Information on marketers and distributors of drugs shows
that they earn approximately cost plus 25 percent, both in the
United States and in country X. Based on the costs outlined
above, the parent should earn net income of $3.6 million on its
distribution and marketing activities, and the Country X
subsidiary should earn net income of $2.4 million. Revenue from
the sale of the heart drug will be approximately $1800 million in
the United States and $1200 million in Europe. Therefore, the
manufacturing subsidiary should charge $1.93 per pill.
Total revenue received by the manufacturing subsidiary will
be $2971 million ($2970 million from sales and $1 million from
interest income.) The royalty to be paid to the parent will be a
percentage of the net sale price of $1.98. The correct royalty
rate, r, can be determined by the following equation, which shows
the manufacturing subsidiaries revenues and costs:

- 9 Net Income = Total Revenue - Cost of Chemicals
($44.2 mil.)
($2971 mil.)
($110 mil.)
- Operating Expenses - Other Expenses
($75 mil.)
($5 mil.)
- Royalties Paid
[(1500 mil.)($1.98)r]
Solving for r shows that r equals .921.
Therefore, the appropriate royalty rate is 92.1 percent of the
net selling price of $1.98.
Example 8: Likely Use of Basic Arm's Length Return Method
A U.S. company manufactures electronic equipment for sale in
the United States. The U.S. company designs the equipment and
licenses the designs to its foreign subsidiary. The subsidiary
assembles the circuit boards and other components for the
products and sells them to the parent. For transfer pricing
purposes, the parent searches for the rate of return earned by
independent computer assembly operations in order to determine
the amount of income that should be attributed to its foreign
subsidiary.
Example 9: Likely Use of Either Inexact Comparables or Basic
Arm's Length Return Method
A U.S. company manufactures and markets a line of
sportswear. The company plans to introduce the same line of
clothing to Europe through its European subsidiary. The
subsidiary will manufacture, market, and distribute the casual
wear using the parent's trademark. The clothing is marketed
toward middle income consumers and is projected to sell at prices
and earn a market share similar to several other brands which are
marketed to this group. The parent has two options when setting
its transfer pricing policy. If unrelated party licenses of •
trademarks for clothing can be located, then these inexact
comparables can be used to establish appropriate terms for the
license agreement. If information is available on the returns
earned by unrelated parties that perform functions similar to the
European subsidiary, then the rate of return method can be
employed.
Example 10: Profit Split Method using Split Observed in Arm's
Length Transaction
ABC is a U.S. corporation that produces advanced machine
tools. It maintains a large artificial intelligence research
lab, which has made significant advances in computer vision.
Recently, this work has begun to yield marketable products.

- 10 Specifically, ABC has developed a "sighted" numerically
controlled machine tool (NCMT) that can be programmed to
recognize the pieces on which it should perform its fabrication
tasks. ABC expects this new device to be a significant advance
over competing NCMTs because the pieces will not have to be
precisely aligned before the fabrication operations can be
performed; therefore, the "sighted NCMT" should be much easier to
operate and integrate into an assembly line. The key element in
this advance is the software that allows the NCMT to determine
the precise position and orientation of a piece placed on its
operating deck. ABC has obtained worldwide patent protection for
this software. As is true of most of ABC's products, the device
must be substantially modified for each customer's specific
application, and ABC maintains a large and expert engineering
staff to accomplish this.
ABC projects that devices based on the new technology will
eventually become an important source of revenues and profits for
the company. During the first three to five years, ABC expects
to have no significant competitors, and plans to market the
devices to the high price, high mark-up, low volume, most
technologically advanced segment of the NCMT market. After that
period, as the technology becomes more common, ABC expects that
sighted NCMTs will, in general, replace other types of NCMTs and
that its lead will enable it to capture a significant share,
perhaps 50 percent or more, of the overall NCMT market.
ABC-Europe is a wholly owned subsidiary of ABC incorporated
in country X. All of ABC's products currently sold in Europe are
produced and marketed by this company. ABC-Europe maintains its
own research and engineering staffs and manufactures all of the
devices it sells. A majority of the products in its line
involve technology licensed from ABC, but a significant fraction
depend on technology developed through its own research efforts.
ABC-Europe performs all of the marketing for Europe, and its
engineering staff performs the necessary development work of the
devices for each customer.
ABC plans to transfer the European rights to exploit the
software arid associated technology for sighted NCMTs to ABCEurope. ABC has no plans to license the technology to an
unrelated party; therefore, no exact comparable is available.
ABC has conducted a search for inexact comparables; although the
search does turn up unrelated party transactions involving
licenses of machine tool devices and patents, ABC has concluded
that none of them can meet the standards for the inexact
comparable method. Specifically, none of the potential
comparables are for devices which involve profit margins as high
as the sighted NCMTs will have in the short run, nor market
shares as large as ABC anticipates having in the long run.

- 11 ABC next considers the basic arm's length return method. It
concludes that ABC-Europe's activities in exploiting the sighted
NCMT technology can be split into four functions: (a) conducting
research to search for uses in the European market, (b) marketing
the devices, including participating in trade shows, conducting
demonstrations, and providing technical assistance (mass-market
retail-level advertising is not necessary in this industry), (c)
designing the specific devices to meet the requirements of each
customer's application, and (d) manufacturing and distributing
the devices.
ABC concludes that some but not all of these functions can
be analyzed under the basic arm's length return method. Once
each customer's design has been set, manufacture of the devices
will not be much more complicated than current NCMTs, and ABC is
familiar with firms that manufacture current-generation NCMTs
according to others' designs. Therefore, ABC concludes that
function (d) can be analyzed in this way; specifically, it
concludes that a rate of return to operating assets of 16 percent
is the average for firms that perform this function. Marketing
is not a major activity in this industry, because the customers
are extremely knowledgeable. ABC deals with firms that perform
marketing functions for it; based on its knowledge of these
firms, ABC concludes that a 20 percent ratio of income to costs
is a reasonable way to value the contribution of function (b).
Functions (a) and (c), however, cannot be analyzed in this
way. ABC-Europe's staff of scientists and engineers, while
smaller than ABC's, is still one of the largest and most expert
in Europe. ABC knows of no independent firm in the machine tool
industry, in the United States or Europe, that would be able to
conduct research, development, or design work as satisfactorily
as or on a scale comparable to ABC-Europe. Therefore, ABC
concludes that it would be inappropriate to value the
contributions that ABC-Europe's performance of these functions
will make toward selling sighted NCMTs in Europe by multiplying
the assets employed by a rate of return, or multiplying the costs
incurred by an income-to-costs ratio. In short, a profit-split
approach is necessary.
Although ABC's search for comparables did not turn up
appropriate licenses in the machine tool industry, other
transactions between unrelated parties were found. For example,
ABC obtained information about the following transaction: a
group of professors, in partnership with their university,
established a consortium to patent and exploit a process through
which a new product can be produced by a genetic engineering
technique. The consortium bargained at arm's length with several
large chemical companies, and negotiated a licensing agreement
with one of them. The licensee manufactures the product, tailors
it to meet the specific needs of various groups of farmers, and
markets it. The product has no significant competitors and has

- 11 ABC next considers the basic arm's length return method. It
concludes that ABC-Europe's activities in exploiting the sighted
NCMT technology can be split into four functions: (a) conducting
research to search for uses in the European market, (b) marketing
the devices, including participating in trade shows, conducting
demonstrations, and providing technical assistance (mass-market
retail-level advertising is not necessary in this industry), (c)
designing the specific devices to meet the requirements of each
customer's application, and (d) manufacturing and distributing
the devices.
ABC concludes that some but not all of these functions can
be analyzed under the basic arm's length return method. Once
each customer's design has been set, manufacture of the devices
will not be much more complicated than current NCMTs, and ABC is
familiar with firms that manufacture current-generation NCMTs
according to others' designs. Therefore, ABC concludes that
function (d) can be analyzed in this way; specifically, it
concludes that a rate of return to operating assets of 16 percent
is the average for firms that perform this function. Marketing
is not a major activity in this industry, because the customers
are extremely knowledgeable. ABC deals with firms that perform
marketing functions for it; based on its knowledge of these
firms, ABC concludes that a 20 percent ratio of income to costs
is a reasonable way to value the contribution of function (b).
Functions (a) and (c), however, cannot be analyzed in this
way. ABC-Europe's staff of scientists and engineers, while
smaller than ABC's, is still one of the largest and most expert
in Europe. ABC knows of no independent firm in the machine tool
industry, in the United States or Europe, that would be able to
conduct research, development, or design work as satisfactorily
as or on a scale comparable to ABC-Europe. Therefore, ABC
concludes that it would be inappropriate to value the
contributions that ABC-Europe's performance of these functions
will make toward selling sighted NCMTs in Europe by multiplying
the assets employed by a rate of return, or multiplying the costs
incurred by an income-to-costs ratio. In short, a profit-split
approach is necessary.
Although ABC's search for comparables did not turn up
appropriate licenses in the machine tool industry, other
transactions between unrelated parties were found. For example,
ABC obtained information about the following transaction: a
group of professors, in partnership with their university,
established a consortium to patent and exploit a process through
which a new product can be produced by a genetic engineering
technique. The consortium bargained at arm's length with several
large chemical companies, and negotiated a licensing agreement
with one of them. The- licensee manufactures the product, tailors
markets
it to meet
it.the
The
specific
product needs
has no
ofsignificant
various groups
competitors
of farmers,
and has
and

- 12 achieved widespread use in certain important agricultural
applications. The licensee pays the university consortium a
royalty of $7 per pound.
ABC next gathers information about the chemical company and
the industry in which it operates. It is able to determine that
the chemical company maintains a large staff of scientists and
engineers which performs functions concerning the new product
that are comparable to the research and development activities
that ABC-Europe will perform. The chemical company undertakes
significantly more marketing activities than will ABC-Europe, and
the manufacturing process for the product is not comparable.
Further, ABC is able to determine the following information: (a)
the product sells for $27 per pound; (b) production costs are
ten dollars per pound; (c) independent firms that produce
chemicals using similar production techniques earn profits equal
to 20 percent of costs; (d) marketing and distribution expenses
are three dollars per pound, and (e) independent firms that
perform similar marketing and distribution activities earn 33
percent of expenses.
This information allows ABC to determine the profit split
between the basic technology contributed by the university
consortium, on the one hand, and the research, development, and
application activities and know-how contributed by the chemical
company, on the other. Specifically, the latter's profit per
pound, net of royalty and expenses, is seven dollars ($7 = $27 $7 - $10 - $3). Of this amount, two dollars should be attributed
to the manufacturing activity and one dollar to the marketing and
distribution ($2 = $10 x 0.20, and $1 - $3 x 0.33). This leaves
four dollars per unit as the return to the chemical company's
know-how and skills as to R&D and application of technology to
its customers' needs. The university's income is the seven
dollars royalty. Therefore, the profit split is 64 percent (64
percent = 7 / ( 7 + 4 ) ) for the licensor's basic technology and 36
percent (36 percent = 4 / ( 7 + 4 ) ) for the intangibles employed
by the licensee. (Note that the licensor and licensee each earn
50 percent of the total profits, since they each earn seven
dollars per pound; however, 50 percent vs. 50 percent is not the
relevant profit split for this situation, because it does not
distinguish between the profits for the manufacturing and
marketing functions.)
Finally, ABC is able to determine the proper arrangement
for its license to ABC-Europe. There are many ways ABC could
structure the arrangement. One would simply be to specify that
ABC-Europe (a) determine gross profits from sales of sighted
NCMTs (with gross profits defined as sales receipts minus
manufacturing and marketing costs), (b) subtract 16 percent of
the value of assets used in manufacturing the devices, (c)

- 13 subtract 20 percent of the marketing costs, (d) subtract 36
percent of the remainder, and, finally, (e) remit the remaining
amount to ABC as a royalty.
Alternatively, ABC could use additional information about
ABC-Europe's future activities to set a more traditional
licensing arrangement. ABC's projections for sales of sighted
NCMTs in Europe during the first three years of operations
include the following figures. The devices will sell, on
average, for $100,000 each. Cost of production will be $56,000
and will require $50,000 of production assets per device.
Marketing costs will be $5,000 per device. These projections
imply that gross profits, defined as sales receipts minus
manufacturing and marketing costs, equal $39,000 per machine. Of
this amount, ABC-Europe should be allocated $8,000 for the
manufacturing function and $1,000 for marketing ($8,000 = $50,000
x 0.16 and $1,000 = $5,000 x 0.20). Remaining profits are thus
$30,000 per device. This amount should be split 64 percent to
ABC and 36 percent to ABC-Europe; thus, ABC should be allocated
$19,200 per device and ABC-Europe the remaining $10,800. A more
traditional licensing arrangement, therefore, would require that
ABC-Europe pay ABC a royalty equal to 19.2 percent of sales
(19.2 percent = $19,200 / $100,000).
If ABC chooses the former type of arrangement, periodic
adjustments to it are less likely to be necessary, because the
allocation of income between ABC and its affiliate will
automatically adjust to a large extent. ABC should reconsider
periodically, however, whether the manufacturing rate of return
to assets, the marketing income to cost ratio, and the profit
split percentages are still appropriate. If ABC chooses the
latter type of licensing arrangement, many more periodic
adjustments to it will likely be necessary. Specifically, in
addition to considering the preceding factors, ABC must determine
if actual experiences depart from the projections enough to imply
significant changes in the appropriate allocation of income. If
so, ABC will have to recalculate the sales based royalty rate by
substituting the relevant actual figures for the projections in
the preceding paragraph.
Example 11: Profit Split Method Using Information about
Relative Values of Preexisting Intangibles
Teachem is a U.S. corporation that designs, produces, and
markets educational toys in the U.S. It maintains a staff of
educational psychologists and engineers to develop and design the
toys, which are perceived, as uniquely high quality and sell at a
premium. Enseignerem is a wholly owned affiliate of Teachem and
is incorporated in country F. It is one of the largest toy
companies in Europe. It was, and still is, the largest toy
company in country F when it was acquired by Teachem a number of
years ago. Enseignerem incurs large advertising and other

- 14 marketing costs to develop its trademark and reputation as a
producer of high quality educational toys. It is responsible for
its own marketing strategies, which are different in important
respects from Teachem's marketing efforts in the United States.
For example, Enseignerem maintains a large sales force that calls
on schools and other institutions, and institutional sales
account for a much larger proportion of its revenues.
Teachem has recently developed a new line of electronic toys
and intends to license the European rights to the designs to
Enseignerem. Teachem does not plan to license them to any
unrelated parties; therefore, an exact comparable is not
available. Further, Teachem expects that Enseignerem will be
able to capture its usual high market share, especially in the
institutional market, and will be able to sell the toys for its
usual significant premiums over its competitors. For these
reasons, Teachem decides that suitable inexact comparables will
probably not be available.
Teachem next considers the basic arm's length return method.
Enseignerem will perform three functions with respect to the new
line of toys. It will be responsible for manufacturing them;
specifically, it will negotiate contracts and supervise
independent contract manufacturers who will actually produce the
toys. Second, it will distribute them. Third, Enseignerem will
be responsible for all aspects of marketing them.
The first two functions can be analyzed under the basic
arm's length return method. Teachem projects that the new toys
will sell for $100 each in Europe. Payments to the contract
manufacturers will be approximately $40 per toy. Enseignerem has
found that distribution costs, including transportation and costs
of holding inventories, are usually one-half of production costs,
and expects that the new line will be typical in this regard.
Therefore, Teachem projects that distribution costs will be $20
per toy. Finally, Enseignerem expects to incur costs of four
dollars per toy relating to the supervision of the contract
manufacturers. These costs include the salaries of engineers'who
will be assigned to visit and test the contractors, and premiums
for liability insurance.
In some of its product lines, Enseignerem employs contract
manufacturers who are willing to distribute, as well as produce,
the items. By comparing these contracts with those calling for
manufacturing only, Teachem concludes that the independent firms
that perform distribution earn a return for it equal to 25
percent of the distribution costs. Teachem therefore allocates
five dollars per toy to Enseignerem for the distribution function
($5 « $20 x 0.25). Teachem also decides that a 25 percent
income-to-costs ratio -is appropriate for the first function,

- 15 responsibility for manufacturing. Thus, Teachem allocates one
dollar per toy to the affiliate as the return for performing it
($1 = $4 x 0.25).
Teachem decides that the affiliate's final function,
marketing, cannot be analyzed by the basic method. Enseignerem
is not planning to incur any significant costs attributable
solely to the new toys. In general, it focuses its advertising
on promoting the Enseignerem reputation rather than displaying a
single item, and does not plan to issue a separate catalog or set
up a separate sales force for the new line. Therefore, Teachem
decides that it is not possible to identify or measure the costs
or assets that Enseignerem will devote to the new product line.
However, it would clearly be wrong to conclude that Enseignerem
deserves no return for the marketing function, because its
preexisting reputation, sales force, and knowledge of its market
are crucial to the success of the new product line in Europe.
Therefore, a profit split is necessary.
To summarize the analysis to this point, the toys are
projected to earn a gross profit of $36 each ($36 = $100 - $40 $20 - $4). Of this amount, six dollars should be allocated to
Enseignerem for the functions analyzed with the basic method.
Thus, $30 per toy is left as the combined return to Teachem's
product designs and Enseignerem's trademark, sales force, and
other marketing intangibles. The next step is to split these
profits in a way that reflects the relative economic values of
these sets of intangibles.
Teachem concludes that the new line of toys is similar to
other lines that the corporate group has introduced in the past
few years in terms of the importance of the underlying design
relative to marketing intangibles. Specifically, the designs
involved a typical amount of research and development effort and
the toys will be marketed in ways similar to, and with similar
intensity as, other products. Teachem analyzes its own
performance record and educational toy industry information on
the relative importance of design and marketing intangibles
therein. Based on a good faith analysis of this data, Teachem
concludes that it is reasonable to assign a relative value of the
design intangibles equal to one-half the value of marketing
intangibles. Accordingly, it allocates ten dollars of the $30 to
be split to itself and the remaining $20 to Enseignerem.
Teachem can structure the arrangement in any form that
achieves the appropriate allocation of income, ten dollars per
toy to the parent and $20 to Enseignerem. Specifically, it could
establish an agreement in which Enseignerem pays Teachem a
royalty for the European rights to the product designs at a rate
of ten percent of sales. In future years, Teachem must reexamine

- 16 its arrangement and, if any key element in the analysis described
above changes significantly, must adjust the royalty rate
accordingly.
Example 12: Likely Use Of Profit Split Method
The research staff of a European company that manufactures
and markets food products has just created a chemical compound
that will alter the way that the human digestive system reacts to
sugar. The company believes that by adding the compound to its
products, the products will pass through the human digestive
system without being absorbed. The compound is unique because it
leaves the taste of the product unchanged. No information is
known about the possible side effects of this compound. The
company wants to use this discovery to offer a whole line of diet
products. The European company has a U.S. subsidiary that
presently manufactures and markets existing products in the
United States. The U.S. subsidiary also has a research staff.
Because the prime market for this new product is the weightconscious United States, the parent licenses the compound to the
U.S. subsidiary for development and for the extensive and
expensive testing that will be necessary in order to obtain
approval from the Food and Drug Administration. Because the
product is unique and because the subsidiary performs such
complex functions, the profit split arm's length return method is
probably most appropriate.
Example 13: Periodic Adjustments to Reflect Changes in Functions
A U.S. corporation produces and markets widgets in the
United States and it has a subsidiary in country X that produces
and markets widgets in Europe. The U.S. parent is in the early
stages of developing a new super-widget. In 1988 it is clear
that this could be a major breakthrough in widget technology;
however, the manufacturing process is still cumbersome. It is
unclear whether the process can be developed to the point that
it would be possible to mass-produce the super-widget. The U.S.
parent believes that the team of employees at its subsidiary in
country X is best suited for the time-consuming and expensive job
of developing the process to produce the super-widget.
In determining an appropriate transfer price for the license
of the technology, the parent can find no inexact comparable for
the super-widget. Similarly, the basic arm's length return
method is not feasible because neither party is performing
standardized functions. Therefore, the U.S. parent attempts a
profit split analysis.
Based on the best information available in 1988, the U.S.
corporation predicts that the development process should be
completed by 1994. An increasing number of super-widgets will be
produced between 1988 and 1994; however, only in 1994 will true

- 17 assembly-line style production be feasible. Based on an analysis
of the relative costs incurred by the parent and by the
subsidiary, and on an analysis of the relative returns earned by
unrelated parties when risky products are jointly developed, a
50-50 profit split on the returns of the design of the superwidget is adopted by the parent.
By the end of 1989, as the parent is filing its 1989 tax
returns and is rechecking its transfer price policy for 1990,
super-widgets are being successfully mass-produced at close to
the volume predicted for 1994. Instead of requiring the extended
development process predicted two years earlier, establishing
production was more similar to the effort necessary when
adjusting production lines for improved versions of products.
Accordingly, the parent adjusts its transfer price policy to a
basic arm's length return analysis for its subsidiary in country
X. Specifically, the parent determines the average rate of
return earned by independent companies that manufacture a product
similar in complexity to super-widgets. Because the parent is
particularly cautious and feels it would be difficult to sustain
its profit split for 1989, it also modifies the 1989 policy to a
rate of return analysis. While at the outset of this transaction
it appeared that the subsidiary in country X would be required to
use significant intangibles of its own to establish the
production process, the actual experience of the parties was that
no unique intangibles were contributed by the subsidiary. The
decrease of five years in the time expected to develop production
to the 1994 level constitutes a significant change that requires
an adjustment.
Example 14: Periodic Adjustments to Reflect Changes in
Indicators of Profitability
A U.S. pharmaceutical company has patented the formula for a
new anti-arthritic drug with fewer side effects that those in
existence. The U.S. parent's subsidiary in country Y will
manufacture the drug and market it worldwide. There are numerous
third party licenses for the existing anti-arthritic drugs. The
parent decides that these products are comparable because it
feels that its product will be a close competitor to them, and
will sell for a similar price and capture a similar market share.
Specifically, it believes that its drug will capture
approximately 15 percent of the market, as do several of the
existing products. The parent uses the eight percent royalty on
net selling price that is found in those licenses and adopts
other significant features of such licenses as well. For
example, the length of the agreement is for the length of the
patent.
The U.S. parent reviews its license with the subsidiary at
the start
of year
two and
finds the
thatmarket
its drug
hasseems
only to
an be
eight
percent
market
share.
However,
share

- 18 continuing to grow. Indeed, at the beginning of year three its
market share is 16 percent and at the beginning of year four its
market share is 21 percent. In each of these years the U.S.
parent decides that the inexact comparable is still appropriate.
By the end of year four the popularity of this drug has
skyrocketed and it captures 50 percent of the market. Since
this share of the market is far beyond that captured by any of
the third party licenses, it can no longer be assumed that the
level of overall profitability for the product licensed to the
related party is similar to that for the products licensed to
unrelated parties. Specifically, to the extent that market share
is an indication of the mark-up that can be charged on a product,
the related party product, which captures 50 percent of the
market, is probably much more profitable than products that
capture only 15 percent of the market. Therefore, the present
inexact comparables are no longer valid. A search for other
inexact comparables fails to produce a license involving a
similar market share. Therefore, the parent turns to a basic
arm's length return analysis to determine what its subsidiary
should earn.

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

Office of Financing
202/376-4350

FOR IMMEDIATE RELEASE
October 20, 1988
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION

Tenders for $9,018 million of 52-week bills to be issued
October 27, 1988,
and to mature October 26, 1989, were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Investment Rate
Rate
(Equivalent Coupon-Issue Yield) Price
Low
7.54%
8.11%
92.376
High
7.57%
8.15%
92.346
Average 7.57%
8.15%
92.346
Tenders at the high discount rate were allotted 81%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
Received

$
14,655
24,154,200
11,990
18,840
49,545
17,190
1,082,325
19,020
10,745
19,740
22,485
1,932,930
153,520
$27,507,185

$ 14,655
7,747,650
10,990
18,840
49,535
17,000
345,645
16,830
9,795
19,740
12,485
600,930
153,520
$9,017,615

$24,750,150
442,035
$25,192,185
2,300,000

$6,260,580
442,035
$6,702,615
2,300,000

15,000
$27,507,185

15,000
$9,017,615

An additional$537,700 thousand of the bills will be issued
to foreign official institutions for new cash.
NB-40

TREASURY NEWS _
ptpartment of the Treasury • Washington, D.c. • Telephone 566-2041
October 21, 1988
Edith E. Holiday
Assistant Secretary of the Treasury
(Public Affairs and Public Liaison) and
Counselor to the Secretary

Edith (Ede) E. Holiday was confirmed by the United States
Senate as Assistant Secretary of the Treasury for Public
Affairs and Public Liaison on October 19, 1988 and was sworn
into office by Secretary Nicholas F. Brady on October 20,
1988. President Reagan had nominated Ms. Holiday for this
position earlier this month. Ms. Holiday will also continue
to serve as Counselor to the Secretary, a role she assumed
after joining the Department of the Treasury in September
1988.
Prior to joining the Department, Ms. Holiday was Chief
Counsel and National Financial and Operations Director for
the Bush/Quayle 88 Presidential Campaign. Previously she
served as Director of Operations for George Bush for
President and Special Counsel for the Fund for America's
Future.
In 1984 and 1985, Ms. Holiday was Executive Director for the
President's Commission on Executive, Legislative and
Judicial Salaries. She practiced law with the firm of Dow
Lohnes & Albertson in 1983 and 1984 and with the firm of
Reed Smith Shaw & McClay from 1977 to 1983. Ms. Holiday
also served as Legislative Director for then U.S. Senator
Nicholas F. Brady.
Ms. Holiday was graduated from the University of Florida
(B.S., 1974; J.D., 1977). Born in Middletown, Ohio, she
resides in Atlanta, Georgia and is married to Terrence B.
Adamson. She is the daughter of Mr. and Mrs. Harry Holiday,
Jr., formerly of Middletown, Ohio, currently of Delray
Beach, Florida and Highlands, North Carolina.

NB-41

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
EMBARGOED FOR RELEASE
AT 4:00 P.M. EDT
OCTOBER 24, 1988

October 24, 1988
CONTACT:

Bob Levine
566-2041

Treasury Department Report to the Congress on
International Economic and Exchange Rate Policy
The Treasury Department issued today a report to the Congress
on exchange rates and international economic policy pursuant to
the 1988 Omnibus Trade and Competitiveness Act.
The report provides the Congress with an assessment of the
impact of exchange rate changes and international economic
policies on the U.S. and world economies. The report analyzes the
underlying causes of exchange market trends and the effects on the
U.S. economy and external position. It also describes
multilateral efforts to improve the coordination of economic
policies among the major industrial countries and considers the
exchange rate policies of certain countries with large external
surpluses.
The report concludes that the world economy is on a solid
footing which provides the foundation for continued growth with
low inflation and a more stable international monetary system. An
improved level and pattern of growth among the major industrial
countries and the effects of past exchange rate changes are
producing more appropriate and sustainable trade balances among
the major industrial countries. In particular, a substantial
reduction in the U.S. trade deficit is occurring (amounting to
about $30 billion in 1988) and further improvements are expected.
The significant strengthening of the U.S. competitive position and
more rapidly growing foreign markets is resulting in sharply
higher U.S. net exports which is serving as an important stimulus
for continued growth of the economy.
In its consideration of exchange rate policies, the report
concludes that Korea and Taiwan have been pursuing exchange rate
policies which prevent effective balance of payments adjustment
and provide an unfair competitive advantage. As provided in the
trade legislation, the United States is initiating negotiations
with both countries on an expedited basis to ensure that the
exchange rates for their currencies are adjusted regularly and
promptly.
NB-42

/U. <V/
EMBARGOED FOR RELEASE
AT 4:00 P.M. EDT
OCTOBER 24, 1988

DEPARTMENT OF THE TREASURY

Report to the Congress
on
International Economic and Exchange Rate Policy

October 15, 1988

EMBARGOED FOR RELEASE
AT 4:00 P.M. EDT
OCTOBER 24, 1988

DEPARTMENT OF THE TREASURY

Report to the Congress
on
International Economic and Exchange Rate Policy

October 15, 1988

TABLE OF CONTENTS

Page
Part I

Introduction

Part II

Economic Policy Coordination

Part III

World Economic Performance and Outlook

Part IV

Exchange Market Developments

Part V

United States Economic and
Balance of Payments Situation

Part VI

Conclusions

APPENDIX

Tables and Charts

PART I:

INTRODUCTION

The Omnibus Trade and Competitiveness Act of 1988 (P.L.
100-418) contains comprehensive reporting requirements designed to
provide the Congress with information to assess the impact of
exchange rates and international economic policies on the domestic
economy. The impetus for this report reflected widespread
dissatisfaction with the large swings in exchange rates and the
emergence of substantial external imbalances. It also reflected a
desire on the part of the Congress to increase the accountability
of the Executive Branch for the impact of international economic
and exchange rate policies on the economy.
The report is to include, inter alia, an analysis of currency
market developments, an evaluation of the economic factors
underlying exchange market conditions, a description of currency
intervention or other official actions to affect exchange rates,
and an assessment of the effects of exchange rate changes on the
U.S. economy and external position. The report is to describe
also the results of negotiations to improve the coordination of
economic policies among the major industrial countries and to deal
with countries that are manipulating exchange rates within the
meaning of the legislation to obtain an unfair competitive
advantage. Finally, the report is to describe key issues in
recent IMF consultations on U.S. economic policies and provide
recommendations for changes in U.S. policies to attain a more
appropriate and sustainable external position.
This is the initial report submitted to the Congress pursuant
to these provisions. Part II provides a description of the
economic policy coordination process developed by the major
industrial countries to address concerns with the operation of the
international monetary system. Part III examines global economic
performance in recent years as the basis for understanding
developments in the foreign exchange markets and the measures
necessary to achieve improved global growth, reduced external
imbalances and greater currency stability. Part IV analyzes
recent exchange market developments, including the dollar's
movement in terms of the currencies of major U.S. trading
partners, and U.S. foreign exchange market intervention. Part V
reviews U.S. economic and balance of payments developments,
including the net investment position and international capital
flows of the United States, and provides an assessment of the
impact of exchange rate changes on U.S. competitiveness, the
external sector and the economy in general. Part VI highlights
key domestic and international economic policy issues for the
United States.

-2-

PART II:

DEVELOPMENT OF THE ECONOMIC POLICY COORDINATION PROCESS

Overview
Major structural changes in the world economy have
intensified the need for more consistent and compatible policies
and performance among the major industrial countries. In
particular, the globalization of financial markets has reduced
substantially the independence that domestic policy-makers had
anticipated they would enjoy under flexible exchange rates as wide
currency swings involved unacceptable economic and social costs.
The liberalization of international trade and investment and the
development of global integrated production facilities have
increased substantially the importance of the external sector for
all countries. Also, the greater balance in economic size among
the major countries requires that effective external adjustment be
a shared responsibility of a number of countries. No single
nation, whether it be in surplus or deficit, can be expected to
undertake a disproportionate share of the adjustment role.
Against this background, the major industrial countries have
developed a process for coordinating economic policies for the
purpose of achieving sustained global growth with low inflation,
reduced external imbalances, and greater stability of exchange
rates. This process, which reflects a major U.S. initiative, has
been developed gradually over the last few years.
From Plaza to Berlin
The 1985 Plaza Agreement represented the first major step in
the coordination process. At the Plaza Hotel meeting in New York,
the G-5 (United States, Japan, Germany, France, and United
Kingdom) agreed on the direction national economic policies and
exchange rates should take to facilitate growth and external
adjustment. More fundamentally, the Plaza Agreement represented a
new commitment by the major industrial countries to work together
more intensively to encourage global economic prosperity, and
thereby to enable each country to better achieve its own domestic
objectives.
The Plaza Agreement fostered an orderly exchange rate
realignment and new policy undertakings consistent with balance of
payments adjustment requirements, including a gradual and
substantial depreciation of the dollar to improve U.S.
competitiveness and measures to achieve better balance in global
growth. The success of the Plaza Agreement provided momentum for
further efforts to coordinate economic policies.
At the 1986 Tokyo Summit, a framework for multilateral
surveillance of the economies of the major industrial countries,
using economic indicators, was developed. The Tokyo Summit also
formed the G-7 (G-5 countries plus Canada and Italy) in order to
bring to bear the political leadership of the Heads of State or
Government to the coordination process.

-3-

At the 1987 Venice Summit, the G-7 refined the economic
policy coordination process. In particular, they agreed to:
o Use short-term performance indicators to review and assess
current economic trends;
o Develop medium-term objectives and projections for each
country and for the group as a whole that are mutually
consistent both individually and collectively; and
o Consider the consistency oc short-term performance with
the medium-term objectives and to determine whether there
are significant deviations from an intended course that
require remedial actions.
The February 1987 Louvre Accord and the G-7 Statement of
December 22, 1987, represented important milestones in
implementing the strengthened coordination process. At the
Louvre, the G-7 agreed on new undertakings to improve the
prospects for global growth and adopted specific understandings
and cooperative arrangements to reflect their view that their
currencies were then within ranges broadly consistent with
economic fundamentals and policy intentions.
The December 22, 1987 G-7 Statement demonstrated the
resilience of the coordination process in the face of the October
stock market crash. In the period following the crash, the major
industrial countries coordinated reductions in interest rates and
fiscal measures to improve growth, including the two-year package
of measures to reduce the U.S. budget deficit provided in the
agreement between the President and the Congress. The G-7
reaffirmed the policy directions that they were pursuing and
agreed to new arrangements for exchange market cooperation.
The 1988 Toronto Summit furthered the progress made in
strengthening economic policy coordination, including the addition
of a commodity-price indicator. This indicator — consisting of a
basket of a wide range of commodities including, inter alia, gold
and oil — supplements existing national indicators in assessing
and reaching judgments about economic policies and performance.
It is to be used as an additional analytical tool in examining
global price trends, not as an automatic trigger for policy action
or an anchor for currencies.
Furthermore, it was decided to broaden the coordination
process to include structural policies as a complement to
macroeconomic measures. This reflected a growing recognition that
the removal of structural impediments to growth and adjustment
would improve the effectiveness of fiscal, monetary and exchange
rate policies.

-4-

The coordination process is now firmly in place and
functioning. At the 1988 IMF/World Bank Annual Meetings in
Berlin, the G-7 met to review the recent performance and prospects
for their economies based on the short-term performance indicators
and medium-term objectives and projections developed under the
economic policy coordination process. They noted that the
policies and commitments that their countries have undertaken are
producing the desired results in terms of sustaining growth and
reducing external imbalances. Furthermore, they agreed that
though little inflationary pressure was evident, continued
vigilance is necessary and recent monetary policy measures have
demonstrated the will to contain price pressures. Finally, they
reiterated their commitment to pursue policies that will maintain
exchange rate stability and to continue to cooperate closely on
exchange markets.
Where We Stand
The successful implementation of the economic policy
coordination process has allowed the major countries to put into
place a comprehensive approach to improve consistency and
compatibility of their economic policies and achieve a more
sustainable pattern of current account balances and exchange
rates. A regular dialogue now occurs at the political level on
key economic issues by the major industrial countries. Greater
discipline and rigor is achieved through efforts to establish
mutually consistent medium-term objectives and projections for
each country and the group as a whole. Indicators are used to
assess whether current performance is compatible with the agreed
objectives and projections and to determine whether there is a
need to consider possible remedial actions.
The improvement in global economic performance and prospects
— discussed at length in the following section — is in large
measure attributable to the successes in strengthening
coordination. In particular:
o Surplus and deficit countries are implementing policies to
sustain growth and reduce external imbalances.
In the United States, domestic demand is now growing
more slowly than output, thus releasing resources for
the external sector. The budget deficit is also
declining and, as a share of GNP, has been reduced from
a peak of 6.3 percent in Fiscal Year 1983 to slightly
over 3 percent at present.
Japan and Germany have adopted important policy
measures to promote strengthened domestic demand and
reduced reliance on export-led growth. Japan, for
example, adopted a major domestic stimulus package in
1987. Germany, for its part, has initiated an important
round of tax reforms and advanced to 1988 a significant
portion of the tax cuts planned for 1990.

-5-

The G-7 monetary authorities are cooperating closely and
have undertaken coordinated actions to assure that sound
growth and low inflation will continue.
o A substantial and sustained adjustment of external
imbalances is occurring which is producing a more
appropriate pattern of trade and current account
positions.
o The major countries have intensified their cooperation on
exchange markets, based on specific understandings and
shared commitments.
o Protectionist pressures have been firmly resisted.
Next Steps
The coordination process is continuing to evolve and more
remains to be done to improve its functioning. The G-7 are
committed to making the process work and to strengthen it further.
They believe that the gradual step-by-step evolution of the
economic policy coordination process represents the most realistic
and practical path towards improving the functioning of the
international monetary system.
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 towards 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 trade and payments arrangements
that will produce an open and growing world economy. This
involves appropriate fiscal, monetary and structural
policies as well as exchange rates. The indicator system
that has been developed covers this full range of
policies.
o Third, the system can encourage corrective policy actions
through the use of indicators and peer pressure.
o Fourth, the burden of adjustment is not biased toward or
away from domestic policies or exchange rates, as was the
case in the fixed and early flexible exchange rate
regimes, respectively.

-6-

Fifth, the coordination and indicator process provides
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.
o Finally, the process is credible. In today's era of
global economic integration and instant communications,
credibility is critical. 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. In
addition, such an approach might not give adequate regard
to political realities or to the force and speed with
which financial flows now move.

-7-

PART III:

WORLD ECONOMIC PERFORMANCE AND OUTLOOK

Industrial Country Economic Developments and Prospects
o Overview
Any assessment of the performance of currency markets must
start with an analysis of macroeconomic developments in the major
countries. The industrial countries have turned in an
impressively steady economic performance over the past 18 months,
and recent developments give good reason to expect the current
expansion to continue at least into 1990. Average real GNP growth
of the seven largest economies (G-7) strengthened appreciably in
1987 and, contrary to the expectations of many observers in the
wake of last October's stock market crash, will be even stronger
this year.
Moreover, a welcome shift is underway in the pattern of
growth among the major economies, providing essential support for
ongoing efforts to reduce large current account imbalances. In
surplus countries, domestic demand growth is exceeding GNP growth,
while in the United States, domestic demand growth is below GNP
growth. These efforts are bearing fruit: the U.S. trade and
current account deficits are on a clear downward trend in both
real and nominal terms; the Japanese and German external surpluses
have also peaked and, like the U.S. deficit, are dropping as a
share of GNP.
While average inflation rates have risen somewhat over the
past year, they have done so from exceptionally low levels. The
available evidence suggests that inflation will remain modest and
contained. Overall, the industrial economies appear to be on a
path of balanced, sustainable growth characterized by moderate
inflation, expanding trade flows and reduced external imbalances.
o Economic Expansion Continues
The economic expansion that got underway in the industrial
countries in 1983 has continued, and indeed strengthened, since
early 1987. Aggregate real GNP growth accelerated during the
second half of 1987. Measured on a fourth quarter over fourth
quarter basis, average real growth in the G-7 countries exceeded
4.5 percent in 1987. This remarkably strong year-end 1987 outturn
both raised the overall G-7 growth rate for the year (to 3.4
percent vs. 2.7 percent in 1986) and imparted considerable growth
momentum going into 1988.
This solid performance stands in striking contrast to the
prevailing expectations of a sharp economic downturn in the wake
of the October 1987 events. Fears cf strongly negative wealth
effects producing a serious contraction in consumer spending have
not been confirmed by events in 1988, nor has there been any
significant retrenchment of investment spending and intentions.

-8-

In fact, during the first half of 1988 aggregate private
consumption in the G-7 countries has remained on a steady,
moderate growth path, providing essential support for overall GNP
growth as well as world trade. Business fixed investment in the
seven largest economies has shown impressive strength and is on
course this year to register its best growth rate since 1984.
Overall growth in the industrial economies has not only been
more robust than widely anticipated, but substantially better
balanced as well. Several points are worth highlighting in this
regard.
Most importantly, the G-7's improved aggregate economic
performance has been broadly shared, resulting in a much more
evenly distributed and, therefore, more sustainable international
growth pattern. The composition of growth in the key surplus and
deficit economies has shifted significantly, providing decisive
support for the international adjustment process.
In the United States, domestic demand growth has slowed,
helping to reduce the rate of import absorption and to make
productive capacity available to meet the substantially higher
demand for U.S. exports. In fact, the U.S. economy was strongly
export-driven in 1987, with the sharp, price-adjusted improvement
in U.S. net exports pushing average GNP growth from 2.8 percent in
1986 to 3.4 percent in 1987 even though domestic demand growth
dropped from 3.7 percent to 3.0 percent over the same period.
The counterpart to this more balanced growth picture in the
United States is generally more balanced growth in the industrial
countries with large external surpluses. This is especially so
for Japan. Aided by stimulative fiscal and monetary policies and
terms of trade gains, Japanese domestic demand growth has
accelerated rapidly, outstripping overall real GNP growth since
1986 and replacing net exports as the driving force of growth.
Last year, for example, Japanese domestic demand grew 5.1 percent,
while real GNP growth was 4.2 percent. Key contributors to this
stronger home-grown growth have been equipment investment and
construction, along with private consumption.
Germany presents a qualitatively similar picture, though
quantitatively its performance is less striking. As with Japan,
domestic demand growth has been the source of overall economic
growth since 1986, while the external side has been exerting a net
contractionary impact; i.e., net exports have been declining )me
in
real terms. In 1987, domestic demand rose nearly 3.0 percent in
real terms though the external drag held growth to only 1.8
percent. Tax reductions and terms of trade gains have contributed
to the relatively stronger domestic demand, providing a welcoi
boost to private consumption growth and import absorption.

-9-

An important contributor to the generally better aggregate
industrial country growth has been a pronounced pick-up recorded
in business investment. Recent developments here are quite at
variance with earlier speculation that the October 1987 market
break would severely undermine business confidence and willingness
to invest.
Since the second quarter of last year, business equipment
investment in the United States has grown by over 16 percent.
Solid, though not as vigorous, equipment investment growth has
also been underway in both Germany and Japan, with both countries
experiencing strong advances in the first two quarters of 1988.
For the United States, this stronger investment trend promises,
inter alia, expanded capacity to meet export demand without
encountering production bottlenecks, while for the surplus
countries it directly boosts domestic demand and enhances their
prospects for durable, internally generated growth.
o Near-Term Growth Prospects
The growth momentum provided by last year's buoyant second
half, coupled with favorable recent developments, virtually
guarantees that overall real growth in the industrial countries
will increase further in 1988. Many forecasters expect average
G-7 growth of nearly 4.0 percent; this would be the best result
since 1984, which was by far the strongest growth of the current
expansion.
As importantly, the qualitative improvement in the industrial
country growth picture — its distribution across the key
countries and its composition within them — should persist.
Specifically, domestic demand growth this year will again be
relatively stronger than GNP growth in the key surplus countries.
The most recent forecasts from the IMF indicate that in Japan,
real domestic demand growth is expected to accelerate to about 7.5
percent versus real GNP growth of 5.5 to 6.0 percent; in Germany,
domestic demand growth is forecast to remain at about 3.0 percent
for 1988 while real GNP also expands in the 3.0 percent range. In
contrast, GNP growth in the United States this year will again be
led by exports and investment, rising 3.5 percent compared with
domestic demand growth of 2.6 percent.
Among the G-7, Japan will again register the highest GNP
growth rate for the year, due entirely to surging domestic demand.
Indeed, propelled mainly by much higher investment and consumer
spending growth, Japanese domestic demand this year should post by
far its highest growth rate of the entire decade. As a result,
import growth will strengthen further, and will substantially
exceed export growth for the third consecutive year. This welcome
outturn reflects the impact of past price and exchange rate
developments coupled with deliberate policy steps.

-10-

GNP growth in the four major European economies (Germany,
France, U.K., and Italy) is also expected to increase this year,
producing an aggregate average rate of about 3.0 percent for the
group. The pace of domestic demand will again outstrip GNP,
though the gap between the two will likely narrow from 1987.
Within the group, domestic demand growth is expected to be
particularly buoyant in the U.K. and Italy. German domestic
demand growth will remain the prime motor of overall growth in
1988. Canadian domestic demand growth will remain strong in 1988.
o Inflation: Still Moderate and Contained
Well into their sixth consecutive year of expansion, the G-7
countries have an average consumer price inflation rate that is
substantially below its level when the upswing began in 1983.
Indeed, last year's rate of 2.9 percent was less than half of what
it was during the trough of the recession in 1982. This is in
sharp contrast to earlier expansions, which were characterized by
rising rather than falling inflation. Indeed, aggregate inflation
rates have been, in the last two or three years, the lowest rates
in 20 years. This is surely one of the salient economic
achievements of the decade.
The exceptionally low inflation rates recorded in 1986 have
given way over the past 18 months to somewhat higher, but still
moderate rates. This in large part reflects the impact of a
variety of special developments. In particular, oil and other
commodity prices were generally firmer in 1987 after substantial
declines in 1986. Thus, the domestic pass-through effects of
lower commodity prices tended to diminish during the year.
In addition, past appreciation of many national currencies
against the dollar tended to further reduce the domestic cost of
imports, which heavily dampened inflation in those countries. In
Japan and Germany, for example, inflation averaged 0.4 and zero
percent, respectively, in 1986 and 1987. U.S. inflation was
somewhat higher over the same period (averaging about 2.8
percent), mainly reflecting the import price pass-through of past
exchange rate changes.
Thus far in 1988, inflation in the major industrial countries
is running at an average rate of around 3 percent, or just
slightly above last year's annual average. A number of key trends
suggest persuasively that this moderate rate is likely to persist.
The concerns of a significant inflation acceleration that have
emerged periodically over the past year seem largely overdrawn and
unsupported by actual developments. In particular, various price
dampening factors (such as wage and monetary restraint and soft
oil prices) appear to be providing an effective offset to
potentially price boosting developments such as high capacity
utilization in some sectors and past non-oil commodity price
increases.

-11-

The major industrial countries must remain vigilant against
inflation and be prepared to take prompt appropriate action if the
situation deteriorates. But current developments provide a good
measure of confidence that inflation is likely to be modest.
o Trade and Current Account Developments
Steady economic growth in the industrial countries has helped
world trade volume expand at an average annual rate of about 5
percent since the recovery got underway in 1983. Latest available
estimates indicate that trade volume growth strengthened to nearly
6.0 percent in 1987, both reflecting and underpinning the
international adjustment process. In addition, trade growth
accelerated further during the latter part of 1987, leading most
forecasters to anticipate yet another increase in overall growth
in 1988.
The industrial countries remained the major contributors to
overall world trade growth, though trade by the non-oil developing
countries expanded substantially. Aggregate industrial country
import volume growth actually slowed from about 9.0 percent in
1986 to about 7.0 percent in 1987. However, this largely
reflected shifts in the distribution of trade flows, shifts which
themselves reflect the major international adjustment process that
is presently underway.
In particular, import volume growth in the United States
decelerated sharply in 1987 (from about 15 percent in 1986 to
about 5 percent) while export volume growth surged from less than
3 percent in 1985 to nearly 12 percent last year. Continued
moderate economic growth this year and past exchange rate changes
are helping to prolong this trend; during the first half of 1988,
exports grew at more than double the rate of import growth.
Developments elsewhere reflect the other side of the
pronounced adjustment in the United States. For example, Japanese
import volume growth has averaged nearly 10 percent annually over
the past two years after averaging only about 1 percent during the
previous six. Japanese export growth, on the other hand, was
actually negative over the 1986-87 period after a series of large
annual increases in previous years. The most recent data (for the
second quarter of 1988) show a fairly sharp contraction in real
exports of goods and services while imports rose nearly 5 percent
relative to the first quarter.
coi
German

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percent in 1984-85. On the import side, however, recent increases
have been more limited — from 4.7 percent growth in 1984-85 to
just under 6.0 percent in 1986-87. Nevertheless, import volume
growth has exceeded export volume growth since 1986. During the
first quarter of this year, import volume accelerated strongly
while export volume remained essentially unchanged.

-12-

These welcome shifts in trade flows have obviously been
integral to the progress that has been made thus far in reducing
the major industrial countries' large accumulated trade and
current account imbalances. And this progress has been
considerable.
This can perhaps be seen most clearly by focusing on national
external imbalances expressed as a proportion of a country's GNP,
which allows direct comparison and eliminates valuation problems
created by exchange rate changes. The U.S. trade deficit has been
cut from 3.4 percent of GNP in 1986 to a projected 2.6 percent
this year; the U.S. current account deficit by this measure is
projected to decline from 3.3 to 2.8 percent of GNP. Over the
same period, Japan's trade surplus is expected to decline from 4.7
percent of GNP to 3.2 percent, and its current account surplus
from 4.4 to 2.8 percent. Germany's current account surplus is
estimated to narrow from 4.4 percent to 3.8 percent of GNP, though
its trade surplus remains virtually unchanged in relation to GNP.
In terms of dollar values (as opposed to volume terms) the
adjustment appears to be less substantial. This is due
importantly to the impact of the large price and exchange rate
shifts which tend to obscure the real underlying adjustment that
has been occurring in both deficit and surplus countries. Sharp
dollar depreciation between early 1985 and the end of 1987 tended
to decrease the value of foreign country imports (which would
widen a nominal surplus) while increasing the value of U.S.
imports (which tends to boost our own deficit in nominal dollar
terms).
This problem notwithstanding, however, progress is being made
in nominal terras as well. As described more fully in Part V, the
U.S. trade and current account deficits are projected to decline
this year by $30 billion and $20 billion, respectively, with
further improvements occurring next year. Japan's current account
surplus should fall by around $5 billion this year and
considerably more in 1989 as the effects of past exchange rate
changes and strong domestic demand filter through. In nominal
terms, Germany's current account surplus is widely forecast to be
reduced next year.
Economic Situation of the Developing Nations
o Non-OPEC Developing Countries
While it is difficult to generalize about the diverse group
of non-OPEC developing countries, there has been broad improvement
in the major macroeconomic indicators for the group as a whole
since 1982-83 when the international debt crisis emerged.

-13-

Growth performance for the group of non-oil developing
countries has improved from the sharp deceleration experienced in
the 1981-83 period. For the aggregate of 137 non-OPEC developing
countries, growth in 1987 was on the order of 3-1/2 to 4 percent,
down somewhat from the roughly 4-1/2 percent rate experienced in
1986, but still well above the 2 percent average rate of
population increase. The 1986-87 growth performance compares
favorably with the weak growth performance by the group in the
1982-83 period, when growth was on the order of only 1 to 2
percent a year.
The aggregate current account deficit for the group of nonoil developing countries has also strengthened compared to the
high, and ultimately unsustainable, levels experienced in the
early 1980s. In 1987, the aggregate current account deficit
excluding official transfers for the non-OPEC developing countries
is estimated to have improved to a level of roughly $20 billion,
down from a 1986 current account deficit of just over $30 billion.
The 1987 improvement is attributable to export volumes and
receipts growing more rapidly than import payments. The current
account deficits in 1986-87 represent a major improvement over the
deficits of more than $80 billion per year recorded in the early
1980s.
Much of the improvement in 1987 was accounted for by the
larger surpluses of Mexico, Korea, Brazil and Taiwan. The
deficits of the poorer officially-financed developing countries
increased in 1987 in line with increased official financing flows.
Inflation in 1987 remained steady for most non-OPEC LDCs.
While average inflation for the entire group increased in 1987,
this is largely attributable to the poor three-digit inflation
performances of Argentina, Brazil, Mexico, Peru and Syria.
Outside these countries, inflation was generally low (under 10
percent), steady or improving.
The estimated aggregate debt service ratio for the 24 major
non-OPEC developing countries in 1987 implies some easing in the
debt servicing burden on these countries relative to 1985-86.
This improvement is attributable to higher export earnings, lower
interest rates and debt reschedulings for Mexico (1985-86) and
Argentina (1987). For a smaller group of heavily indebted
countries (such as Argentina, Brazil, Chile, Colombia, Ivory
Coast, Mexico, Morocco, Peru and the Philippines), the improvement
in the debt service ratio was more modest.
The 1988 outlook for the aggregate of 137 non-OPEC LDCs is
for continued positive real growth, an improving pattern of
current account deficits, some improvement in the debt situation,
and generally controlled inflation outside of a few major
countries.

-14-

Fifteen Heavily Indebted Countries

The fifteen heavily indebted developing countries have also
made progress since 1982-83 in several key economic and financial
areas. GDP growth in 1987 was about 2-1/2 percent, a significant
improvement over the average 1-1/2 percent per annum decline
experienced in 1982-83. Average GDP growth in 1985-86 was even
higher, in the 3-1/2 to 4 percent range, as many of these debtors
implemented stabilization programs which also reduced inflation
rates considerably. The aggregate current account deficit
improved substantially to about $9 billion in 1987 from the
unsustainably high $50 billion levels in 1981 and 1982. The
aggregate debt service ratio improved to under 40 percent in 1987,
down from the 45 percent average for 1982-83, as a result of lower
interest payments and recent debt relief operations.
The outlook for 1988 is for somewhat lower GDP growth for the
group as a whole. However, this result is attributable to a
decline in Brazilian growth from the 1987 level. Excluding
Brazil, the aggregate growth of the other countries is expected to
continue improving. The aggregate current account balance for the
group as a whole is expected to remain steady as both export and
imports grow in 1988. The debt service ratio is projected to rise
somewhat as some of the large debtors settle debt service arrears
which arose in 1987.
0
Sub-Saharan Africa
For the group of Sub-Saharan African countries (excluding
South Africa and Nigeria), GDP growth, while still relatively
weak, is considerably improved in comparison with the early 1980s.
In 1987, GDP growth for the group was about 2-1/2 percent,
significantly higher than the average 1/2 percent growth
experienced during 1982-83 and only slightly below the average 3
percent per annum growth during the 1970s. The group's aggregate
current account deficit (excluding official transfers) improved
significantly between 1981 and 1985 before increasing in 1986 and
1987, as official grants and loans rose sharply. The debt service
ratio for the group was above 25 percent during the mid-1980s, but
is expected to fall below that level in 1987.
The outlook for 1988 is for accelerated GDP growth to about
3-1/2 percent. Higher exports and increased official assistance
flows are expected to allow continued import growth and some
deterioration in the current account deficit.
o OPEC
For the OPEC countries, the aggregate current account
balance, excluding official transfers, improved in 1987 to a $5
billion deficit, down sharply from a 1986 deficit in excess of $20
billion. Weak oil prices and.the consequent sharp reduction in
oil revenues in 1986-87 forced most OPEC countries to cut import

-15-

levels, and created financial problems for several of the debtor
OPEC countries outside the Persian Gulf. The current account
deficit is expected to increase in 1988 as oil prices remain weak
and imports rise.
Asian Newly Industrialized Economies (NIEs)
o Overview
In recent years, the four Asian NIEs (Korea, Taiwan, Hong
Kong, and Singapore) have emerged as a significant force in the
international trading system. Since 1970, their share of world
exports has more than tripled to 7.4 percent. Moreover, most of
these economies have accumulated external surpluses that are
contributing significantly to global imbalances. In 1987, the
current account surpluses of the NIEs amounted to $29.7 billion,
accounting for 14.9 percent of the total global surplus. Taiwan
and Korea especially enjoy large current account surpluses — two
to four times those of Japan and Germany as a proportion of GNP.
The United States is a major market for a wide variety of NIE
exports and a significant share of the U.S. trade deficit reflects
transactions with the NIEs. The U.S. trade deficit with the Asian
NIEs increased tenfold from 1980 to 1987 to $34.8 billion,
representing nearly a quarter of the total U.S. trade deficit.
However, in the first 7 months of 1988, the deficit with the four
declined somewhat, reflecting in part a significant decline in our
deficit with Hong Kong.
The factors that are responsible for the growth of the Asian
NIEs' external surpluses vary among the NIEs and generalizations
are difficult. However, the hard work and initiative of their
people and the ardent export orientation of these economies are
certainly important elements. Production for export has also been
pursued at the expense of domestic consumption and improved living
standards within some of these economies. The expansion of the
world trading system, and of the U.S. economy especially, has also
been an important factor benefiting all of the NIEs.
Undervalued exchange rates have also been a major factor in
the increase in the external surplus of the NIEs. In the cases of
Taiwan and Korea, the undervaluation is the direct result of
currency intervention by the central bank, capital controls, and
administrative mechanisms aimed at preventing the exchange rate
from reflecting market forces and achieving competitive gain.
Among the four, where currency appreciation has occurred, it has
tended to lag far behind that of other major U.S. trading partners
such as Japan and Germany. Thus, some of their exchange rate
policies have directly influenced, and frequently frustrated,
multilateral efforts to reduce global imbalances.

-16-

Action by some of these economies to permit their currencies
to move in line with market forces and the underlying strength of
their economies is required to sustain the recent decline in the
U.S. trade deficit and contribute to further global adjustment.
Other policy changes, including structural reforms to give greater
emphasis to domestic demand as a source of growth and, in the case
of Korea and Taiwan, measures to liberalize their trade and
capital flows restrictions, are also necessary.
Since mid-1986, we have conducted discussions with the four
— most intensively with Korea and Taiwan — about these issues.
o Taiwan
The strength of Taiwan's economy, its small foreign debt, and
its large external surpluses and international reserves point to
the need for a stronger currency. However, Taiwan continues to
prevent the necessary appreciation of its currency through
intervention in the currency market, use of an undervalued basket
of currencies to determine the exchange rate's value, and capital
controls. High tariffs and other import controls continue to add
to the problem, despite recent significant trade liberalization.
The New Taiwan (NT) dollar has been under a managed floating
system with its daily value determined against the U.S. dollar
based on interbank transaction rates. Taiwan authorities have
also stated recently that the central bank is utilizing a basket
of currencies as a guide to the management of the exchange rate.
However, the weights of the component currencies are unknown and
the basket was established using an undervalued base. In the
past, the Central Bank of Taiwan has intervened heavily to prevent
NT dollar appreciation. In addition, Taiwan maintains capital
controls, particularly on inflows of foreign exchange, which
facilitate its ability to prevent currency appreciation.
Taiwan has registered the greatest movement among the NIEs in
terms of currency appreciation — 25 percent since the start of
the period of U.S. dollar appreciation in July 1980 and 40 percent
since the Plaza Agreement in September 1985. However, the NT
dollar's appreciation still lags significantly behind that of the
yen and the German mark, which have strengthened by 92 percent and
60 percent, respectively, since Plaza. Despite periods of
stability in 1987, the authorities moved the rate substantially.
In 1988, the rate has not appreciated and in fact has actually
depreciated by over 1 percent this year.
Taiwan's external position has been the most distorted of the
four NIEs. In 1987, its global current account surplus was $18.1
billion or 18.5 percent of GNP, compared to 3.6 percent of GNP for
Japan and 4 percent of GNP for Germany. In addition, its foreign
exchange reserves climbed by 66 percent from 1986 to 1987 to $76.7
billion (28 months of imports). The overall trade surplus reached

-17-

$20.7 billion in 1987 and the bilateral surplus with the United
States totalled $17.4 billion (18 percent of GNP). Due primarily
to the appreciation of the NT dollar from late 1986 through 1987
and gold imports from the United States, Taiwan's bilateral trade
surplus with the United States has fallen by 39 percent so far in
1988, but it is not a sustainable reduction. Gold purchases are a
temporary phenomenon and cannot contribute to structural
adjustment of bilateral imbalances. Indeed, purchases have now
virtually ceased. Thus, excluding central bank gold purchases in
the early part of the year, the decline in Taiwan's surplus with
the United States is less than 16 percent. Now that both NT
dollar appreciation and gold imports from the United States have
stopped, the improvement in the imbalance has also stalled and as
of April 1988, larger Taiwanese surpluses have begun to reemerge.
Taiwan's economy continues to be one of the world's best
performers, which also suggests that the currency would be
strengthening if market forces were given freer rein. In 1988,
real GNP growth is likely to be 8.5 percent on top of 11 percent
last year, while inflation remains very low.
Taiwan has made significant success in liberalizing its trade
regime. However, it has not been sufficient to lead to a
significant reduction in its external surpluses. Tariffs have
been lowered substantially in successive rounds of tariff
reductions, representing an important step forward. However,
tariffs remain prohibitively high on many products, especially
agricultural products. Also, market access for U.S. insurance
companies and financial institutions and protection of
intellectual property rights have improved.
Under Section 3004 of the legislation, the Secretary of the
Treasury must "consider whether countries manipulate the rate of
exchange between their currency and the U.S. dollar for purposes
of preventing effective balance of payments adjustments or gaining
unfair competitive advantage in international trade." Within the
meaning of the legislation, Taiwan is considered to be
manipulating its exchange rate. Taiwan's underlying economic
fundamentals strongly suggest that further appreciation would
occur if capital and exchange restrictions were dismantled and
market forces were given freer rein. Taiwan has a strong economy
with a large global current account surplus, a large bilateral
surplus with the United States, its foreign exchange reserves have
risen sharply and yet its currency is depreciating. Pursuant to
provisions of Section 3004, the United States intends to initiate
bilateral negotiations with Taiwan on an expedited basis for the
purpose of ensuring that Taiwan regularly and promptly adjusts the
rate of exchange between the NT dollar and the U.S. dollar to
permit effective balance of payments adjustment and to eliminate
the unfair trade advantage.

-18-

Korea

Korea's strong economic fundamentals — 3 consecutive years
of double digit real growth, large and growing external surpluses,
substantial prepayment of external debt, and reserve accumulation
also point to an undervalued exchange rate. The Korean
authorities have used administrative arrangements and strict
capital controls to perpetuate the undervaluation of their
currency. As with Taiwan, numerous tariff and non-tariff barriers
continue to restrict Korean imports and prevent a sizable shift in
its external surpluses, despite recent progress on trade
liberalization.
The value of the Korean won is established administratively
by the Korean authorities based on an undisclosed basket of
currencies of Korea's trading partners and on "policy variables,"
chiefly the balance of payments target. Tight restrictions on
capital inflows coupled with severe monetary restraint and close
control of the Korean financial sector, enhance the authorities'
ability to control the exchange rate and limit exchange rate
appreciation. Although the Korean won has appreciated 12 percent
so far this year, appreciation since the Plaza Agreement in
September 1985 amounts to only 26 percent, which is very modest
compared with 40 percent for the NT dollar and 92 percent for the
yen. The disparity in the period since 1980 is even greater.
Accordingly, despite recent wage increases, the competitiveness of
Korea's exports remains quite strong.
The strength of Korea's recent economic performance reflects
in part the degree to which the undervaluation of its currency has
strengthened its competitive advantage. Led by exports, which
account for about 40 percent of GNP, real GNP expanded by about 25
percent in 1986 and 1987 combined. The current account, which had
recorded steadily declining deficits since 1980, registered a
surplus of $4.7 billion in 1986, which more than doubled in 1987
to nearly $10 billion, greatly exceeding the authorities'
expectations in both years. The 1987 current account surplus was
equal to 8.3 percent of GNP, compared to 3.6 percent for Japan and
4 percent for Germany.
Korea took advantage of its 1986/1987 current account
surpluses to prepay substantial portions of its external debt,
reducing the total from $46.7 billion at end-1985 (54 percent of
GNP) to $35.6 billion at end-1987 (30 percent of GNP). Thus, the
burden of Korea's once heavy external debt burden has been
substantially reduced.
The outlook for 1988 is equally robust. Korea should
experience 10 percent real GNP growth, rising employment and
inflationary pressures, a current account surplus exceeding $11
billion, and a further reduction of external debt. Moreover,
international reserves, which were relatively flat in 1987, have
increased by over $7 billion so far this year. Thus, Korea's goal
of becoming a net international creditor, like Japan, is within
reach by end-1989, nearly 2 years ahead of target.

-19-

Under Section 3004 of the legislation, the Secretary of the
Treasury must "consider whether countries manipulate the rate of
exchange between their currency and the U.S. dollar for purposes
of preventing effective balance of payments adjustments or gaining
unfair competitive advantage in international trade." Within the
meaning of the legislation, Korea is considered to be
manipulating its exchange rate. Given Korea's strong underlying
economic fundamentals, further exchange rate appreciation within a
framework of liberalized trade, exchange, and capital controls, is
clearly required. As such, the United States also intends to
initiate bilateral negotiations with Korea on its exchange rate
policy to allow for balance of payments adjustment and to
eliminate the unfair trade advantage.
o Hong Kong
Hong Kong's economy and policy framework are different from
those of Korea and Taiwan in important ways. First, it is
essentially a free port: tariffs are few and non-tariff barriers
are virtually non-existent. Second, it has no capital and
exchange controls. Third, its current account surplus in 1987 was
smaller, $1.3 billion or 3 percent of GNP; and its global trade
account was at near balance.
However, despite the smaller current account surplus and
global trade balance, Hong Kong has sustained large bilateral
surpluses with the United States. Hong Kong's trade surplus with
the United States in 1987 was $5.9 billion (13.8 percent of GNP).
Our imbalance with Hong Kong is falling, having dropped by 28
percent in the first 8 months of 1988, compared to the same period
last year.
Last year, the economy exhibited some signs of over-heating,
registering real GDP growth of 13.6 percent, with inflation of 5.5
percent, and growing labor shortages. This situation has
continued in 1988, as growth and inflation are expected to be 8
percent and 7 percent, respectively.
The Hong Kong (HK) dollar is the NIE currency most closely
linked with the U.S. dollar. The HK dollar was fixed at the rate
of HK$7.8 to US$1 in 1983 to preserve confidence in the HK dollar
during negotiations on the transfer of sovereignty to China in
1997. Given the continued uncertainty caused by the upcoming
political transition, Hong Kong authorities do not want to de-link
the currency from the U.S. dollar. Even so, a case could be made
that an appreciation of the currency could help to reduce the
inflationary pressures in the economy. The HK dollar has
depreciated by 37 percent against the U.S. dollar since July 1980
and, given the fixed link in effect since October 1983, has
remained unchanged since the Plaza Agreement in September 1985.

-20-

Singapore

Like Hong Kong, Singapore can also be distinguished from
Taiwan and Korea in important respects. It has one of the most
open trading regimes in the world and does not maintain controls
on capital transactions. Also, Singapore's current account
surplus is relatively modest — $500 million in 1987 or 2.6
percent of GNP, while the overall trade account was in deficit by
$3.9 billion.
Singapore's trade balance with the United States was in
deficit until 1984, but grew to a surplus of $2.1 billion last
year. Although this is the lowest of our bilateral deficits with
the NIEs in absolute terms, it is large relative to the size of
Singapore's economy (10 percent of GDP) and has continued to
expand this year (up 12 percent).
Singapore's economy is performing strongly, registering a
broadly based 8.8 percent increase in real GDP in 1987.
Reserves have been increasing, contributing to a rise in the
money supply. This reflects in part capital inflows associated
with Singapore's role as a- regional banking center, but may also
suggest some intervention to resist market forces for
appreciation. However, this has not translated into
proportionately higher domestic prices due to the offsetting
effect of modest exchange rate appreciation on import prices.
The Singapore dollar is based on a secret basket of
currencies. Its value is influenced by the Monetary Authority of
Singapore (MAS) via intervention in the exchange market,
ostensibly with a view toward controlling inflation. However, the
basket appears to be largely dominated by the U.S. dollar, thus
leading to roughly parallel movements in the two currencies. The
Singapore dollar has appreciated against the U.S. dollar by 5
percent since July 1980 and by 9 percent since Plaza.
Thus, while Singapore's exchange rate policy has undoubtedly
contributed to its success, it is not clear that it has been a
major problem impeding adjustment of global imbalances. Still,
Singapore's growing imbalance with the United States and increase
in reserves point to the need for a close monitoring of its
external policy, including its exchange rate policy.

-21-

PART IV:

EXCHANGE MARKET DEVELOPMENTS

Overview
This section reviews currency market developments since the
February 22, 1987 Louvre Accord and examines experience with
cooperation on exchange rates among the monetary authorities of
the Group of Seven (G-7) industrial countries. During this
period, a framework for cooperation on exchange rates was
developed which complemented the broader economic policy
coordination efforts to promote growth and external adjustment.
Greater stability in currency markets emerged during this
period, although there have been episodes of substantial exchange
rate pressures and rate movements. The improvement in market
conditions reflects several factors, including the attainment of
more balanced global growth and external adjustment discussed in
Part III, closer cooperation on monetary policies and exchange
market operations, and enhanced market confidence in the economic
policy coordination process.
Trends in exchange rates since Louvre can be divided into
three distinct subperiods. The period following the Accord
witnessed greater currency stability as market confidence in and
the results of the coordination effort increased. The period
following the sharp drop in the world's equities markets in
mid-October 1987 resulted in a renewed decline of the dollar due
to a sharp deterioration in expectations about economic growth and
external adjustment as well as a substantial change in interest
rates which resulted in a narrowing of interest rate differentials
favoring dollar placements. Finally, the G-7's December 22, 1987
statement, reaffirming the commitment to effective coordination of
economic policies and cooperation on exchange rates, initiated a
period of renewed currency stability which is continuing.
From Louvre to the Stock Market Crash
In the Louvre Accord of February 22, 1987, the major
industrial countries agreed on new undertakings to improve the
prospects for global growth and adopted specific measures and
cooperative arrangements to reflect their view that their
currencies were then within ranges broadly consistent with
economic fundamentals and policy intentions. The prospect of more
balanced global growth and greater exchange rate stability eased
the market's sense of downside risk in holding dollars and
contributed to a gradual increase in demand for dollars.
Consequently, exchange rate movements in this period on balance
were limited, with the dollar depreciating by about 4 percent
against other major currencies.

-22-

The change in market expectations emerged only gradually over
the period and was at times shaken by ongoing developments.
Initially, expectations were for further dollar depreciation,
based on the belief that adjustment of world trade imbalances
would be slow, that interest differentials favoring dollar
placements were insufficient, and that the G-7 authorities were
not committed enough to exchange rate stability to make major
economic policy adjustments. Also, there was widespread concern
whether foreign investors would continue at then prevailing
interest and exchange rate levels to buy U.S. assets and fears
that U.S. political pressures would lead to protectionist trade
legislation that could hamper global growth and adjustment.
Pursuant to the new currency understandings, the G-7 intervened
actively in the exchange markets, of which dollar purchases by the
U.S. authorities totalled about $4.8 billion.
Subsequently, policy measures and statements by G-7
authorities demonstrated a strong commitment to exchange rate
stability which enhanced market confidence. In particular, the
Venice Summit in mid-June reaffirmed the Louvre Agreement
regarding exchange rates and announced a plan for enhanced
multilateral surveillance. Also contributing to dollar demand
were market expectations that the U.S. economy would shift
increasingly toward export-led growth and better economic
performance in the United States than overseas, particularly in
Europe. Tensions in the Persian Gulf added an element of "safe
haven" demand for dollars. Consequently, the dollar rose through
mid-summer.
In mid-August 1987, a renewed wave of dollar selling
developed following the disappointing news that June trade data
showed a deficit larger than in any previous month in 1987, thus
heightening concern about progress in reducing global trade
imbalances. By late in the month, the dollar had declined through
levels not seen since late spring 1987. The dollar's decline, and
increased U.S. employment and capacity utilization, also created
expectations of a possible rise in inflation and further downward
pressure on the dollar. U.S. interest rates moved sharply upward
and, on September 4, the Federal Reserve increased its discount
rate "to deal effectively and in a timely way with potential
inflationary pressures". Subsequently, demand for dollars
increased and pressures in the currency market diminished.
The market remained sensitive, however, to possible monetary
and interest rate developments. For some time, central bank
officials in both Japan and Germany had repeatedly expressed their
desire to counter possible inflationary pressures. Subsequent
interest rate increases overseas led the market to conclude that
-- given the G-7 commitment to exchange rate stability — U.S.
interest rates must also move up. This expectation received
further support by the release in October of U.S. trade statistics
for August showing another large deficit. After the trade
release, U.S. stock and bond markets deteriorated as expectations

-23-

of higher interest rates grew and fears emerged that coordination
was breaking down.
From October 19 to December 21, 1987
The period following the sharp drop in world equity markets
on October 19, 1988, witnessed a decline of the dollar of about 7
percent against other major industrial countries. The decline
reflected a deterioration in market expectations regarding
prospects for growth and balance of payments adjustment in the
world economy and changes in interest differentials which
adversely affected investment in dollar assets.
In particular, there were widespread expectations that the
United States would be more adversely affected by the stock market
decline than other major industrial countries. Stock ownership in
the United States was larger and more widespread than in other
countries, leading to the belief that the wealth effects of the
decline would have a more pervasive impact on consumption and
investment. Moreover, reduced domestic growth was expected to
contribute to a larger federal budget deficit as tax revenues fell
and expenditures increased. The increased budget deficit was seen
as exacerbating the savings and investment imbalance in the
economy and creating increased demand for foreign capital that
could be attracted only with a lower dollar. The release of
monthly trade data pointing to continued large deficits tended to
support these expectations.
The G-7 response to the stock market crash demonstrated
forcefully the resilience and flexibility of the coordination
process. In the United States, negotiations on additional
measures to reduce the budget deficit were initiated, resulting
in an historic two-year budget agreement between the President and
the Congress. A coordinated round of interest rate reductions
were implemented which resulted in a sharp drop in interest rates
and in a narrowing of interest differentials favoring dollar
assets. Germany introduced new measures to improve domestic
growth and investment. The major stimulus package introduced
earlier by Japan also began to have its effects on domestic
growth. Finally, concerted intervention in exchange markets,
including purchases of $2.4 billion by U.S. authorities, helped to
maintain orderly exchange markets.
Developments Following the December 22, 1987 Statement of the G-7
The December 22, 1987, G-7 Statement initiated a period of
renewed exchange rate stability. The statement, which brought
together the range of measures that had been implemented in
response to the crash, particularly the U.S. budget deficit
reduction agreement, provided increased market confidence in the
coordination process, especially the willingness of participants
to implement necessary policy, actions. Moreover, confidence was

-24-

bolstered as evidence mounted that the long awaited adjustment of
external imbalances was occuring. Consequently, the dollar
recovered from the temporary lows reached following the stock
market decline and has been more stable subsequently.
The improvement in market confidence did not occur overnight.
In the period following the statement the dollar depreciated
sharply before stabilizing at the turn of the year. In response,
coordinated intervention efforts increased, with the United States
purchasing $3 billion in cooperation with other G-7 countries. By
early spring, however, fears of a recession on the heels of the
stock market decline had been replaced by growing confidence that
moderate economic growth would continue. Moreover, during the
spring, interest rate differentials favoring dollar placements
widened, and market expectations of higher U.S. interest rates
prompted increased demand for dollars. Successive favorable U.S.
trade reports were seen as confirming that the trade deficit was
narrowing and that the decline of the dollar was finally reducing
import demand. Also, the market questioned investment prospects
in Germany, and capital outflows from Germany ran at a record pace
following discussion about the imposition of a 10 percent
withholding tax. Consequently, demand for dollar assets
increased, and the dollar began to appreciate.
On the eve of the Toronto Summit, the market doubted that the
G-7 would resist significant dollar appreciation and consequently
regarded the Summit's subsequent endorsement of G-7 exchange rate
cooperation as a readiness to tolerate a higher dollar. These
expectations were reinforced by a view that the Federal Reserve
System would tend toward a more restrictive monetary posture. In
early August, the Board of Governors raised the discount rate, and
the dollar was temporarily bid up to a 20-month high of over
DM 1.92. Later, the dollar neared ¥ 137 after a statement by
Japanese officials appeared to sanction some yen depreciation.
Subsequently, however, some monetary policy adjustments
overseas and an easing of U.S interest rates from the highs
reached following the discount rate rise eased upward pressure on
the dollar. By mid-October, the dollar had dropped back to levels
prevailing around the time of the Toronto Summit.
G-7 Cooperation on Currency Markets
With the Plaza Agreement of September 22, 1985, the G-7
industrial nations embarked on a process of intensified
cooperation on currency markets that has continued to the present.
This cooperation was enhanced through the Louvre Accord and
subsequent understandings, and it has been adjusted as necessary
to reflect market and economic conditions. This close and
continuing cooperation, including the active participation of the
United States, has served to make the markets more aware of and
sensitive to official intentions. This has served to enhance the

-25-

effectiveness of the intervention beyond the actual amounts
involved. Thus, from the Louvre Accord of February 22, 1987
through July 1988, the United States, in cooperation with G-7 and
other foreign monetary authorities, have made net purchases of
some $7.1 billion. This amount includes net purchases of over
$8.5 billion in 1987 and net sales of about $1.4 billion during
1988 through July. The reduced scale of operations in 1988
reflected an improvement in exchange rate stability relative to
1987.
The evidence of this period suggests that official
intervention in the currency market has played a useful
complementary role in supporting G-7 economic policy coordination
efforts. First, the intervention has generally been supportive of
and consistent with broader economic policy coordination efforts.
Second, the market has had confidence, despite occasional doubts,
that the G-7 monetary authorities are prepared to make policy
adjustments as necessary to further coordination efforts. As a
consequence, the market has tempered somewhat its reactions to
isolated economic statistics that appear to lie outside estimates
of underlying trends in fundamentals. Third, G-7 operations in
the foreign exchange market have been conducted on a concerted and
cooperative basis with agreed objectives and responsibilities.
Key to the growing effectiveness of G-7 cooperation on exchange
rates is precisely that it has reflected close consultations and
specific understandings on objectives and responsibilities.
In these circumstances, intervention can have a positive
effect on foreign exchange market expectations and important
spillover effects in domestic securities and money markets. There
have been questions whether foreign exchange market intervention
can be considered effective if it has no monetary impact (i.e.,
whether it is "sterilized" or not), but such questions have proven
difficult to answer definitively in practice. Recent experience
suggests that, in the context of cooperation on exchange markets
and broader economic policy coordination, intervention can be more
helpful than previously thought.

-26-

PART V: U.S. ECONOMIC AND BALANCE OF PAYMENTS SITUATION
Emergence of the Deficit
Starting in 1982, the U.S. economy embarked on the longest
peacetime expansion in post-WWII history, now entering its
seventh year and creating over 18 million jobs. At the same
time, however, the U.S. began to move into increasing external
deficits. These deficits reflected four fundamental factors.
First, the U.S. expansion was earlier, and more robust,
than occurred in the other major industrial countries. Between
the low point of the U.S. recession in the fourth quarter of
1982 and the fourth quarter of 1984, the U.S. GNP grew in real
terms at an average of 5.8 percent per year, compared with a
3.4 percent average for the other industrial countries.
This "growth gap" was a reversal of historic trends —
during the 1960s, U.S. growth averaged 4.0 percent vs. 6.2
percent for the other industrial countries; during the 1970s,
the U.S. grew 2.8 percent on average, vs. 3.8 percent for the
other industrial countries. The contrast in performance in the
eighties was especially marked compared with Europe, where
employment growth was negative and industrial production
stagnant.
Second, serious LDC debt problems emerged in 1982, with
Mexico's declaration of its inability to service its foreign
debt. The debt situation forced retrenchment in several major
U.S. overseas markets, which had previously been among the
fastest-growing outlets for U.S. exports. U.S. exports to
Latin America nearly doubled in value terms between 1978-81;
they declined by 40 percent (balance of payments basis) between
1981-83, and still were nearly 20 percent ($8 billion) below
their 1981 level in 1987.
A third major fundamental development which influenced the
U.S. trade and current account was the emergence of the Asian
NIEs as major producers of a broad range of low-priced
manufactures, exported aggressively to the U.S. market.
Finally, exchange markets responded to these fundamental
factors in ways which reinforced their effect on the U.S. trade
balance. Traditional analysis would suggest that the dollar
should have begun to depreciate as the current account went
into deficit during 1983-84. However, the reverse occurred
with the dollar strengthening sharply as capital flowed into
dollar assets on an unprecedented scale. This reflected
several factors.

-27-

Foreign investors were attracted by the robust domestic
expansion, both absolutely and relative to others;

o Tax measures to improve after-tax rates of return and
remove withholding also improved the U.S. investment
climate; and
o There was some "safe haven" element related to LDC debt
problems.
These factors all attracted capital to the United States,
putting upward pressure on the dollar in the process. Looked
at another way, the favorable investment climate increased U.S.
investment demand relative to U.S. savings. Meanwhile,
investment abroad seemed less attractive, given modest growth
performance, despite relatively high national savings rates.
The dollar continued to strengthen through early 1985,
peaking over 40 percent, on a trade-weighted basis in nominal
terms against other major currencies, above its 1980 level.
The effects of exchange rate changes on trade flows operate
with quite long lags — most studies suggest 2-3 years for the
full impact to be felt. Thus, U.S. trade and current account
deficits — and counterpart surpluses elsewhere — continued to
increase after 1985, peaking in 1987 at $160 billion (trade)
and $154 billion (current account) respectively.
During the past few years, however, the factors which
continued to favor investment in the United States tended to be
overtaken by progress in improving the relative investment
climate abroad:
o Other countries acted to lower marginal tax rates, and
made important strides in the areas of deregulation and
privatization.
o The disparity in growth performance shifted, closing
the "growth gap". The U.S. expansion slowed to a more
sustainable pace while foreign growth — aided recently
by stimulative policies — has accelerated.
o In addition, with growth resuming in many LDCs as their
financing problems have eased in comparison with the
early 1980s, U.S. exports to Latin America are
expanding again (albeit modestly apart from Mexico).
o At the same time, by late last year, the dollar had
reversed the 1981-85 run-up on average, against the
other major currencies. Some major NIE currencies also
have appreciated.

-28-

Recent Developments and Outlook for the Trade Balance
Reflecting these developments, the U.S. trade and current
account deficits peaked in 1987, and are now on an improving
trend. The improvement showed up first in real or volume
terms. On this basis, the trade deficit peaked in late 1986,
and has declined in six of the last seven quarters. The
balance in value terms leveled-off towards the end of 1987, but
clear signs of improvement on this basis did not appear until
the first quarter of this year. The delayed reaction probably
reflected a combination of factors:
o Slow pass-through of the exchange rate change to import
prices as foreign suppliers accepted a squeeze on
profit margins to avoid raising prices, thus protecting
their U.S. competitive position and market share.
o U.S. exports must grow substantially faster than
imports just to hold the trade deficit constant, let
alone allow the trade balance to improve. In 1987,
imports were over 1-1/2 times as large as exports ($410
billion vs. $250 billion); if exports and imports were
to grow at similar rates, the trade balance would
continue to deteriorate.
o Many models indicate that U.S. imports are somewhat'
more responsive to U.S. income growth than are our
exports to foreign income growth. Thus, U.S. growth
which equals or exceeds foreign growth hurts our trade
deficit. Relative growth rates in the U.S. and the
other industrial countries have been less favorable for
our trade balance in the 1980s than was the case in the
1960s and 1970s.
The improvement on the trade account which has emerged in
1988 appears to be broadly-based in both product and geographic
terms, involving substantial increases in exports and slower
import growth. The improvement has been most marked against
the other major industrial countries where the dollar has
experienced the greatest depreciation. These are also the
countries with large external surpluses, the clear counterpart
of the U.S. deficit.
In the first half of this year, the trade deficit on a
balance-of-payments basis was running at a seasonally adjusted
annual rate of $130 billion, down $30 billion from both the
first half of 1987 and 1987 as a whole. The second quarter
trade deficit on a seasonally adjusted balance-of-payments
basis was $29.9 billion, down $5.2 billion from the first
quarter, which in turn was $6.0 billion below fourth quarter
1987. This second quarter figure, at an annual rate of $120
billion, was the lowest quarterly deficit figure since the

-29-

second quarter of 1985. The second quarter deficit also
declined substantially ($17 billion annual rate) in real terms,
continuing the trend which emerged in the third quarter of
1986.
Strong export growth has been the major contributor to the
reduction in the trade deficit during the first half of 1988,
with exports up 33 percent in value terms over the first half
of 1987, while imports rose only 12 percent. Second quarter
exports were up 6 percent ($4.4 billion) from the first
quarter, compared with a 1 percent ($0.9 billion) decline in
imports.
Exports grew across-the-board in terms of geographic area,
but strongest growth was vis-a-vis Western Europe, the Asian
NIEs, Canada, Japan, and Mexico. Export growth was also
broadly-based across product categories, with values up 30
percent or more for 5 of 6 principal end-use commodity
categories, covering 90 percent of total exports. By contrast,
import strength was concentrated in two end-use categories that
appear to reflect strong U.S. industrial production and
investment spending rather than foreign competitiveness.
Capital goods imports were up 24 percent and industrial
supplies and materials up 19 percent from a year earlier, while
imports in all other categories rose only 4-1/2 percent in
value.
July-August trade data reinforce the picture of sustained
improvement in U.S. trade performance.
o The average monthly deficit (Customs basis census data,
seasonally adjusted) was $9.3 billion, compared with a
$9.6 billion monthly average for the second quarter,
$10.9 billion deficit for first quarter, and $12.8
billion for fourth quarter 1987. For the first eight
months of 1988, the trade deficit was running at a
o seasonally adjusted annual rate $31 billion below the
same period in 1987.
Exports have continued strong, with increases over
year-earlier levels in the 30 percent range, roughly
three times the rate of growth of imports.
A major factor in this improvement in trade performance
continues to be exchange rate change, although strong
foreign growth this year is also exerting a positive
influence. On a regional basis, over 80 percent of the
total improvement in the trade deficit for the first
eight months of 1988 compared with 1987 has been
accounted for by improvement against the major
industrial countries and the Asian NIEs.

-30-

Reflecting these effects on U.S. competitiveness,
export growth has been broadly based by product
categories. Import strength was concentrated in the
two categories of capital goods and industrial supplies
and materials. Auto imports, a major contributor to
the earlier surge in the trade deficit, are virtually
flat in the first eight months of this year compared
with the same period in 1987.
Current Account
The current account includes both merchandise trade and
trade in services. The services component of the U.S. current
account has deteriorated less rapidly than the trade balance,
in large part reflecting the strength of net investment income,
especially income from U.S. direct investment abroad. While
the U.S. trade deficit was worsening from $36 billion in 1982
to $160 billion in 1987, net direct investment income was
rising from $18 to $42 billion.
Reflecting strong direct investment income, which acted to
offset deterioration in portfolio income and other invisible
payments, the overall surplus on invisibles transactions
worsened only gradually, from $28 billion in 1982 to $6 billion
in 1987. (However, 1987 was buoyed by an extraordinary fourth
quarter bulge of $9 billion in capital gains on U.S. direct
investment abroad, most of which resulted from a rise in the
dollar value of investments in countries whose currencies
appreciated against the dollar.)
In the first half of 1988, the current account deficit was
$70.3 billion, down $5.2 billion from an unusually low second
half of 1987, and $8.2 billion below the first half of last
year.
o Trade balance improvement more than accounts for the
reduced current account deficit so far in 1988.
o In the second quarter, the services portion of the
current account was in deficit (by about $500 million),
for the first time since at least 1960.
The current account deficit should continue to improve in
the remainder of 1988, and continue in 1989. The expected
improvement, however, will be more gradual than the trade
deficit due to the continued erosion of our services balance.
The major factor in this erosion is a growing deficit on net
investment earnings, as the U.S. net asset position continues
to deteriorate.

-31-

Capital Flows
Analysis of international capital flows has become
extremely complex with increased liberalization and
internationalization of capital markets. The size of gross
capital flows dwarfs trade and current account transactions, as
illustrated by the fact that one week's volume of foreign
exchange transactions ($200 billion per day) roughly equals the
yearly total of current account transactions. These
developments mean that highly fungible capital can respond very
rapidly, through a variety of channels, to perceived changes in
the economic fundamentals.
The major recent event influencing the pattern of capital
flows appears to have been the October 1987 stock market crash.
Reflecting this development, capital movements in the fourth
quarter of 1987 showed major swings in two categories —
foreign purchases of U.S. non-Treasu"ry securities (which
shifted to net sales) and official purchases of U.S. assets,
which rose sharply in response to dollar weakness as net
foreign private inflows dried up. Securities purchases
remained low in the first quarter of 1988, with an apparent
continuation of major recorded official inflows.
However, these further official inflows almost certainly
reflect a delayed impact of fourth quarter events, as central
banks moved 1987 intervention proceeds from initial Euro-market
placements to direct official accounts with the Federal
Reserve. These movements could also explain the substantial
shift in private banking flows, from inflows to outflows,
between the fourth quarter of 1987 and the first quarter of
this year. By the second quarter of this year, the effects of
October had substantially been worked out and private capital
inflows resumed.
U.S. Investment Position
Developments in the U.S. net international asset position
are simply a mirror-image of the large trade and current
account deficits we have been running in recent years.
Published data on the U.S. net international investment
position show us as net debtors internationally by $368 billion
at the end of 1987. There is some question as to how much
weight to place on the precise published figures of our
investment position itself. The latest Commerce Department
presentation of the U.S. international investment position
notes several possible sources of understatement of both assets
and liabilities, and includes this caveat: ".... the net
investment position is only a rough illustration, rather than a
precise measure, and should be treated with caution."

-32-

But while the precise level of U.S. foreign net
indebtedness is uncertain, the trend is clear: the United
States borrows abroad each year an amount equal to the U.S.
current account deficit. (By the same token, Japan is a net
supplier of capital to the world by an amount equal to its
current account surplus.)
Concerns have been raised by some that the need to finance
ongoing U.S. current account deficits, involving increasing
levels of U.S. indebtedness to foreigners, has put the U.S. in
a position in which foreign lenders could exact increasingly
advantageous terms. For example, .. is argued that if
foreigners become increasingly unwilling to provide capital to
the United States, substantial interest and exchange rate
adjustments would be needed to induce foreigners to resume
their lending.
Such concerns are exaggerated or unwarranted in the
current circumstances. The receipts of income on U.S. assets
abroad still are running roughly equal to U.S. payments on
liabilities to foreigners. The United States does not face a
significant net debt service burden, either absolutely or as a
share of GNP — the U.S. net external debt at about 8 percent
of GNP is modest by international standards. Also, the United
States remains an extremely attractive place for investment.
As discussed previously, pursuant to the G-7 coordination
process, the major countries are promoting sustained growth
with low inflation, reducing external imbalances, and fostering
greater stability of exchange rates. In this context, U.S.
economic performance is strong. The composition of output has
shifted from consumption to investment and net exports, while
substantial progress has been made in reducing the budget and
trade deficits. The United States is the largest economy in
the world and continues to maintain one of the most open
investment climates. The U.S. financial markets remain the
largest, deepest and most resilient in the world.
Assessment of Progress and Prospects
The trade legislation requires the Treasury to assess the
effects of exchange rates on the domestic economy and U.S.
competitiveness. As indicated, exchange rate changes have been
a major factor, though not the only one, in the turnaround in
the U.S. trade deficit which began in late 1986.
Exchange
rate change operates directly via changes in U.S. cost/price
competitiveness. The so-called "real" exchange rate (exchange
rate adjusted for changes in relative inflation) is a
frequently-used measure of changes in competitiveness.
The real exchange rate, measured against 13 currencies
covering roughly 67 percent of U.S trade, has declined over 20
percent from its peak in early 1985, and has been on average
this year over three percent below its end-1980 level.

-33-

(Against the major industrial countries with the largest
surpluses, Japan and Germany, the dollar has depreciated by
about 47 percent and 37 percent in nominal terms, respectively,
since the Plaza.) Data on unit labor costs in manufacturing,
another frequently cited indicator of competitiveness, also
show substantial U.S. gains during the period of dollar
depreciation since early 1985. Of course, strong U.S.
productivity growth in manufacturing, coupled with wage
restraint, have also been important factors in strong U.S.
competitiveness.
The effects of exchange rate related improvements in U.S.
competitiveness on the trade and current account have been
described above. These improvements have had direct favorable
effects on the performance of the the domestic economy.
The improvement in trade volumes beginning in late 1986
has been a major factor sustaining the U.S. expansion into its
seventh year. Trade deficit improvement contributed nearly
one-quarter of real GNP growth between the third quarter 1986,
when trade deficit improvement in real terms began to emerge,
and the second quarter of 1988. The share of growth
contributed by the external sector has been rising — during
the first half of this year, improvement in real net exports
accounted for over one-half of the 3.2 percent annual rate of
GNP growth.
Inflation has been cut by roughly two-thirds since the
Administration took office — from the 12 to 13 percent range
at the turn of the decade to the roughly 4 to 4-1/2 percent
maintained since 1982 (as measured by the consumer price index
and after allowance for shifts in widely fluctuating energy
prices). Currently, major price indicators show only scant
evidence of any acceleration. The consumer price index has
increased by an annual rate of 4.6 percent so far this year, or
close to the 4.4 percent increase during all of 1987 and about
in line with the Administration forecast of last summer. The
drought contributed modestly to higher prices this year, but
overall is expected to have only a minor impact on price
levels.
Employment growth has remained robust (over 3 million
additional jobs in 1987) despite the shift from domestic
demand-led growth to the current situation with net exports
making a major contribution. In particular, manufacturing
employment has shown renewed vitality, after declines in 1985
and 1986.
The favorable trend in the trade balance should be
sustained over the remainder of the year and in 1989, despite
the dollar appreciation earlier in the year. Recent exchange
rate developments should be interpreted in light of the October
1987 stock market break. After being relatively stable during

-34-

much of 1987, the dollar depreciated sharply in the aftermath
of the October stock market crash as markets overestimated the
negative effects of the crash. This overreaction was
temporary. The dollar today, while above the low levels
reached temporarily at end-1987, is still 4 percent (on a real
trade-weighted basis) below the pre-October crash levels.
Furthermore, the average value of the dollar so far this year
is down over 6 percent from last year's average. Contrary to
popular belief, the U.S. has not lost competitiveness.
In addition, experience post-1985 indicates a weakening of
the linkage between exchange rate change and import prices,
which historical experience of the 1970s and early 1980s might
have led us to expect. Thus, the transitory lows of late 1987
and early 1988 were too brief to have a significant effect on
prices of traded goods. For both these reasons, it seems
unlikely that movements in the dollar so far this year will
significantly alter the outlook for sustained trade and current
account improvement.
On a more fundamental issue, many trade forecasting models
predict that progress will not be sustained — that favorable
exchange rate effects will run out after 2 to 3 years, after
which time the trade balance will again begin to deteriorate.
However, this analysis takes little or no account of several
very important developments which should contribute to
sustained improvement in the trade deficit over the
longer-term, without further exchange rate change.
o Strengthened U.S. competitiveness is much broader-based
than simple exchange rate calculations, or even unit
labor cost comparisons, show. Intense competitive
pressures during the period of dollar strength forced
U.S. producers and workers to make fundamental changes
in the way they operate, increasing efficiency and
cutting costs while improving quality. A convincing
indicator of this longer-term change is the recent
strength of capital spending, showing the willingness
of U.S. firms to commit — at current exchange rate
levels — substantial financial resources to increase
capacity in response to strong export demand, on top of
the very strong export growth already experienced to
date.
o A second factor in adjustment of the deficit which has
longer-run implications is the strong inflows of direct
investment, noted previously in this report. These
inflows are strongly motivated by a desire on the part
of foreign producers to remain competitive in the U.S.
market, and defend (or increase) existing U.S. market
shares. The new investments create U.S. based
production of products previously exported to the
United States. This import-replacing aspect of foreign

-35-

direct investment in the United States is most clearly
present in the automobile sector, but is an inherent
element of the process in other industries as well.
o Finally, assumptions of "no policy change" are a
standard feature of model-based projections of trade
flows. The essence of the G-7 coordination process,
described previously in this report, is that policies
are under regular review, with an eye to possible
changes in light of developments in the underlying
fundamentals. The G-7 countries are agreed that a
further reduction in external imbalances is desirable
in both surplus and deficit countries. They are
committed to implementing the policies necessary to
build on the progress that has been achieved.
The "sustainability" of the U.S. external position is a
concept that is often raised but little understood. There is
no accepted methodology for quantifying a "sustainable" current
account as it depends on the willingness of the market to
provide sufficient financing at a particular level and pattern
of exchange rates. This, in turn, reflects judgments by the
market regarding the economic policies and prospects for the
United States and other major countries. Such judgments are
based on assessments of a broad range of factors including
monetary, fiscal and tax policies as well as considerations
regarding safety and soundness of particular investments and
political stability.
While there may be a wide divergence of views regarding
such issues, most observers would agree that a continued
reduction in external imbalances is necessary and desirable.
The adjustment of external imbalances will result in a
corresponding reduction in the capital flows needed to finance
the remaining imbalances. This adjustment will continue to be
accomplished in an orderly fashion so long as the markets
believe that the major countries are pursuing sound policies
that will result in a reduction of the imbalances in the
context of adequate growth with low inflation. The major
industrial countries are committed to implementing the policies
necessary to build on the considerable progress that has been
achieved.

-36-

PART VI:

CONCLUSION

In an increasingly integrated world, the achievement of a
more stable, open and growing global economy requires sound and
consistent policies, particularly among the major industrial
economies. The G-7 is making significant progress in achieving
this objective through the economic policy coordination process.
o The United States is now entering the seventh consecutive
year of growth, the longest peacetime expansion in its
post-war history. Recent growth has been characterized by
a shift in the composition of demand, with domestic demand
slowing to below the rate of growth in output. This shift
has released resources to facilitate a reduction in the
external deficit. The United States must persevere in its
efforts to reduce its budget and trade deficits and avoid
protectionism. Indeed, in recent consultations with the
United States, the International Monetary Fund welcomed
the reductions achieved in the U.S. fiscal deficit. It
recommended that: fiscal adjustment, emphasizing
expenditure restraint, continue to play a major role in
increasing national savings to allow the external balance
to improve further; the Federal Reserve demonstrate
continued vigilance to keep inflation firmly in check; the
firm stance against protectionism be maintained; and the
United States continue to play its constructive role in
international efforts to coordinate policies and to
resolve the debt problems of the developing countries.
o In Japan, domestic demand growth has outstripped GNP since
1986, aided by stimulative fiscal and monetary policies
and terms of trade gains. Growth this year will be the
highest among the G-7. Meanwhile, Japan is experiencing
very little inflation and its trade and current account
surpluses, albeit large, are declining in both real and
nominal terms. To continue this progress, Japan must
sustain strong domestic demand growth and restructure its
economy to reduce the reliance on export-led growth.
o In Germany, domestic demand growth has also been the
source of overall growth since 1986 — though not as
strongly as in Japan — with tax reductions boosting
private consumption and import absorption. Germany has
also experienced little inflation in recent years, and its
current account surplus is being reduced moderately.
Germany must continue its efforts to promote domestic
demand and to free up labor and capital markets to allow
employment to grow and generate growth in its productive
capacity.
While the major countries bear a special responsibility in
these efforts to reduce external imbalances in the context of
sustained growth, others have a clear and complementary role to
play.

-37-

The global current account surpluses of the four Asian
NIEs have expanded rapidly, reaching $30 billion in 1987.
Their bilateral trade surplus with the United States has
also been large and growing, amounting to $35 billion last
year. Undervalued exchange rates, particularly in Taiwan
and Korea, have been a major factor in this expansion. In
the cases of Taiwan and Korea, this undervaluation is a
direct result of central bank currency intervention,
capital controls, and administrative guidance designed to
prevent their exchange rates from reflecting market forces
and to achieve a competitive advantage. These policies,
coupled with a lack of structural reforms to strengthen
domestic demand and numerous trade restrictions, have
frustrated multilateral efforts to reduce global
imbalances.
Since mid-1986, the United States has conducted
discussions with the four, particularly Taiwan and
Korea, about these issues.
Under Section 3004 of the Omnibus Trade and
Competitiveness Act, the Secretary of the Treasury must
"consider whether countries manipulate the rate of
exchange between their currency and the U.S. dollar for
purposes of preventing effective balance of payments
adjustments or gaining unfair competitive advantage in
international trade." Within the meaning of the
legislation, Taiwan and Korea are considered to be
manipulating their exchange rates.
Pursuant to the provisions of Section 3004, the United
States intends to initiate bilateral negotiations with
Taiwan and Korea on an expedited basis for the purpose
of ensuring that these two countries regularly and
promptly adjust the rate of exchange between their
currencies and the U.S. dollar to permit effective
balance of payments adjustment and to eliminate the
unfair trade advantage.
o The developing countries must continue to implement
structural reforms to promote sustained growth, reduce
current account deficits and achieve a return to voluntary
access to capital markets. Their efforts, along with those
of the international financial community, are showing
results. Sustaining this progress will require continuing
efforts by debtors and creditors.
The global economy finds itself today on strong and solid
footing.
This strength will facilitate sustained efforts to assure
continued progress in promoting balanced growth with low inflation,
reducing external imbalances and fostering greater stability of
exchange rates.

-38-

Yet, the process of economic policy coordination is still in
its beginning stages. Far more remains to be done. In particular,
the major countries will need to pursue the broad range of
macroeconomic and structural policies that will reduce external
imbalances in the context of sustained growth. Exchange rates have
an appropriate role to play in these efforts, but they represent
only one of the many and often more important economic factors that
affect growth prospects and competitive positions. It is this wider
range of fundamentals that the coordination process is seeking to
address in order to promote lasting stability. All countries have
important responsibilities in these efforts.

-39-

APPENDIX
TABLES AND CHARTS

Table
1.

Economic Performance of
Key Industrial Countries

2. Economic Performance of
Developing Countries
3. U.S. Trade with Asian NIES and
Currency Changes
4. ' Measurements of Dollar Movements
Versus G-7 Currencies
5. Balance of Payments: Trade and Current
Account, 1986-88Q2
6. Balance of Payments: Capital Flows,
1986-88Q2
Charts
1.

U.S. Dollar vs. Yen and DM

2. Real Trade-Weighted Dollar

- 40 Table 1

Economic Performance of
Key Industrial Countries
GNP Growth 1/
1987
US
Japan
Germany
France
U.K.
Italy
Canada

3.4
4.2
1.8
2.2
4.4
3.1
4.0

(5.0)
(5.5)
(2.4)
(2.8)
(4.5)
(2.8)
(6.1)

G-7 2/

3.4 (4.6)

Domestic Demand Growth

1988
3.5
5.8
2.9
2.9
4.0
3.0
4.2

(2.8)
(4.5)
(2.2)
(2.4)
(3.8)
(2.9)
(3.0)

4.1 (3.2)

Inflation 3/

1987
3.0
5.1
3.1
3.3
4.1
4.7
4.7

(4.4)
(6.8)
(3.3)
(3.4)
(4.9)
(4.8)
(8.5)

3.7 (4.9)

1988
2.6
7.4
3.2
3.0
6.1
3.8
5.3

(1.7)
(5.7)
(1.8)
(3.0)
(5.0)
(3.8)
(3.4)

4.2 (3.2)

Current Account 4/
1987

1988

1987

1988

US
Japan
Germany
France
U.K.
Italy
Canada

3.7
0.1
0.2
3.3
4.1
4.6
4.4

4.1
1.1
1.2
2.5
4.6
4.9
3.9

-3.4
+ 3.6
+ 4.0
-0.5
-0.4
-0.1
-1.9

-2.8
+ 2.8
+ 3.8
-0.3
-2.4
-0.3
-1.8

G-7 2/

2.9

3.2

-0.3

1/ Real GNP/GDP (or domestic demand) growth rates, annual averag
figures in parentheses are fourth quarter over fourth quarter
growth rates; 1988 figures are IMF projections except for U.S
(which are Mid-session Budget Review projections).
2/ Weighted by GNP.
3/ Consumer prices; 1988 figures are IMF estimates.
4/ Calculated as percent of GNP; negative indicates deficit.
figures are IMF projections, except for U.S. (Treasury
projection).

-41Table 2

Economic Performance of
Developing Countries

Real GDP Growth (%) 4/
1982-83 1986 1987
(annual changes in percent)
Non-OPEC 1/
Sub-Saharan Africa 2/
15 Major Debtors 3/

1.3
0.6
-1.6

4.5
3.6
3.8

3.7
2.3
2.4

Consumer Price Inflation 4/
1982-83 1986 1987
(annual changes in percent)
Non-OPEC 1/
Sub-Saharan Africa 2/
15 Major Debtors 3/

55
24
74

54
24
77

80
26
116

Current Account Balance
(excluding Official Transfers)

1982-83

1986

1987

(Billions Of U.S. Dollars)
Non-OPEC 1/
Sub-Saharan Africa 2/
15 Major Debtors 3/

-68
-10
-34

-33
-9
-16

-22
-11
-9

1/ 137 developing countries. Excludes European countries,
South Africa, and the Peoples' Republic of China.
2/ Excludes South Africa and Nigeria.
3/ Argentina,Bolivia,Brazil,Chile,Columnla,Ecuador,Ivory
Coast,Mexico,Morocco,Nigeria,Peru,Philippines,Uruguay,
Yugoslavia,Venezuela.
4/ Weighted averages. Weights are U.S. dollar values
of 1982 GDP.

-42Table 3

U.S. TRADE WITH ASIAN NIES AND CURRENCY CHANGES

U.S. Trade Deficit with Asian NIEs [1]
(U.S. $ Billions)
1980[2] 1986[2] 1987[2] %Chanqe[3
Hong Kong
Korea
Singapore
Taiwan
TOTAL NIEs

-2.1
0.2
1.1
-2.8

-5.8
-7.0
-1.3
-14.7

-5.9
-9.4
-2.1
-17.4

181%
n.a.
n.a.
521%

-3.6

-28.8

-34.8

867%

Total U.S.

•25.5 -144.3 -159.2
159.2

524%

% Total
U.S.

[1]
[2]
[3]

14%

20%

22%

Totals may not equal sum of components due to rounding
U.S. balance of payments adjusted data.
From 1980 to 1987.

Cumulative Change against US$* as of October 14, 1988
from:
7/22/80 9/20/85 end-87
Rate on 10/14
HK$
Won
Singapore$
NT$
¥
DM

-37.13%
-17.18%
4.61%
24.57%
74.24%
-3.75%

0.01% -0.69%
25.93% 11.54%
8.92% -1.32%
40.21% -1.21%
91.54% -2.23%
59.95% -11.51%

HK$ 7.81
W 710.3
S$ 2.02
NT$ 28.90
¥ 126.42
DM 1.80

This table is calculated in terms of the movement of the
foreign currency aqainst the U.S. dollar, as this is the
way the Asian NIEs measure their foreign currency movements
Thus, foreign currency appreciation is represented by a (+)
and depreciation by a (-).

-43-

Table 4

Measurements of Dollar Movements
Versus G-7 Currencies Since Key Dates
Percent dollar appreciation (+) or depreciation

(-)

as of October 14, 1988

Value of the
dollar in
terms of:
Japanese yen
German mark
Sterling
French franc
Canadian dollar
Italian lira

Source:

Floating
Begins
3/20/73
to date
-51.6
-35.5
+ 41.2
+ 37.5
+ 21.0
+139.9

Dollar
Peak
2/26/85
to date

Plaza
Agreement
9/22/85
to date

Louvre
Accord
2/22/87
to date

-51.1
-47.6
-40.3
-41.4
-14.0
-37.5

-47.2
-36.9
-22.5
-29.4
-12.5
-30.1

-16.9
-0.5
-12.4
+ 2.0
-9.4
+ 4.1

London midday rates.

Decembe
Stateme
12/22/8
to date
+0.8
+ 11.7
+ 4.8
+ 12.7
-7.6
+ 13.1

-44Table 5
United States
BALANCE Of PAYMENTS TRADE and CURRENT ACCOUNT DETAIL: 1986 - 8802
(in S billion)

Taars
1986
1987

1?€7
01

(

Exports
Agricultural
NonAgricultural

224.0
27.4
196.6

249.6
29.5
220.1

56.8

59.9

64.9

68.0

6.5

7.1

8.3

7.6

50.3

52.7

56.6

60.4

Imports
Patrol I Prods
NonPatrolaua

•368.5
•34.4
•334.1

•409.9
•42.9
-367.0

•96.7
•8.8
-87.9

•99.4
-10.1
•89.3

•104.6
•12.8
-91.8

•109.2
•11.3
-97.9

-110

•144.5

•160.3

•39.9

•39.6

•39.7

•41.2

•35

Nat Irwaat—nt tncoaa
Oiract In'nast—nt
(of i*ich Capital
Gains/Losss* on U.S.
Invasoasnts Abroad)

23.1
33.0

20.4
41.8

5.1
9.4

1.7
6.9

1.1
6.7

12.5
18.8

1
7

9.6

15.6

4.7

0.9

1.0

9.0

Portfolio Invaat—nt

•9.9

•21.4

•4.3

•5.2

•5.6

•6.3

•6

•2.1
•4.4
-8.1
•1.3
11.6

-0.6
•2.4
•9.1
•1.2
12.0

0.1

-0.1
-2.4
•0.2

•0.2
•2.2
•0.3

-0.4
-0.9
•2.2
•0.3

•0.5
•1.3
•2.3
•0.3

2.8

3.0

3.4

0
•1
•1
•0
3

Unilat Transfars
Rasrits 4 Pans ions
Govarnaant Grants

•15.3
-3.6
-11.7

-13.4
•3.4
•10.0

-3.0
•0.9
•2.1

•3.1
•0.9
•2.2

•3.0
•0.9
-2.1

-4.4
•0.8
•3.5

-3
•0
•2

NET INVISIBLES

5.7

6.3

2.2

•1.3

•2.3

138.8

•154.0

•37.6

•40.9

•42.0

TRADE BALANCE

Nat Othar Ssrvicas
Military
Trawl 4 Faros
Othar Transport
Faas, Royals 4 Misc

CURRENT•ACCOUNT BALANCE

Sourca: SURVEY Of CUMCMT BUSINESS, Sapt 1988

7.7
-33.5

75
9
66

•10
•100

-1
•36

-45Table 6
United States
BALANCE OF PAYMENTS CAPITAL FLOWS: 1986 • 8802
(inflows (•) outflows (•); in S billion)

Y987

1988

YEARS
1986
1987

U.S. Rasarva Assats
(Incr(-) Oacr(-O)
Othar US-Govt Assets

0.3

9.1

2.0

3.4

0.0

3.7

1.5

0.0

•2.0

1.2

•0.1

0.3

1.1

•1.0

•0.8

Foreign Official Assats:
Industrial
OPEC
Othar

35.5
29.4
•9.3
15.5

45.0
49.2
•10.0
5.7

14.0
16.6
•2.8
0.2

10.3
17.5
•2.7
•4.5

0.6
•0.9
•1.7
3.3

20.0
16.1
•2.8
6.7

24.7
20.8
-1.4
5.2

5.8
6.7
•1.8
0.9

19.8
•60.0
79.8

47.2
•40.5
87.8

15.8
21.9
•6.1

•4.5
•22.4
18.0

29.6
•16.5
46.2

6.3
•23.5
29.8

•0.1
17.1
•17.2

14.8
-14.0
28.8

Securities, nat
Foreign Securities
U.S.Trees Securities
Other U.S. Securities i

65.6
•4.3
3.8
66.0

27.1
•4.5
•7.6
39.2

14.5
•1.6
•2.8
19.0

11.7
•0.1
•2.4
14.2

7.7
•1.0
•2.8
11.5

•6.8
•1.8
0.5
•5.6

3.6
•4.5
6.9
1.2

14.8
1.6
4.5
8.7

U.S. Direct Invest. Abroad
Reinvested Earnings
Equity 4 Inter-Co Debt i

•22.9
•19.7
•3.2

•41.4
•35.7
•5.8

•11.6
•8.9
•2.7

•6.2
-6.7
0.5

•5.9
•5.6
•0.3

•17.8
•14.4
•3.3

•6.0
•4.4
•1.7

•1.6
•4.9
3.3

For. Oirect Invest, in U.S.
Reinvested Esrnings
Equity 4 Inter-Co Oebt

34.1
-2.3
36.4

42.0
2.5
39.4

8.0
1.6
6.3

7.2
0.7
6.5

15.0
2.1
12.9

11.7
•1.9
13.7

7.3
3.3
4.0

13.4
0.9
12.4

Other U.S.-Corp., net
Claims
Liabilities

•7.1
•4.2
•2.9.

5.3
3.1
2.2

1.2
-0.5
1.7

4.2
2.6
1.6

•0.3
-0.2
•0.1

0.2
1.2
-1.0

1.7
-0.3
2.0

0.0
0.0
0.0

NET CAPITAL FLOWS

123.3

135.5

43.7

26.1

47.1

18.6

31.6

46.5

Statisticsl Discrepancy

15.6

18.5

•10.7

15.7

0.3

13.2

0.5

•12.3

138.8

154.0

33.0

41.8

47.3

31.8

32.2

34.2

Banks, nat:
Claims
Liabilities

TOTAL •

Source: Sept 1988 SUflVIY Of CURRENT BUSINESS
* Adjusted to treat Intsr*Caapany borrowing by U.S. corporations from NetherI
financing subsidiaries as US-Securities, rather than Oirect-Investment, tr
* Equsls seasonelIy-vned justed Current Account Balance, with reversed sign.

Antilles
tions.

CilciJTt

US Dollar vs. Yen (solid) and DM (dotted)
Monthly Averages*

Y
e
n

1885
Plaza

1887

1888
Tokyo

Louvre

Venice

1888
Dec. 22, 1987

Downward Movement Shows Dollar Depreciation
*Last observation: 10/14

Chart 2

Real Trade-Weighted Dollar*
(December 1880 - 100)

Downward Movement Shows Dollar Depreciation
w Against basket accounting for 2/5 U.S. trade.

TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350
FOR IMMEDIATE RELEASE
October 24, 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,005 million of 13-week bills and for $7,017 million
of 26-week bills, both to be issued on October 27, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

26-week bills
maturing April 27, 1989
Discount Investment
Price
Rate
Rate 1/
96.208
7.90%
7.50%
96.183
7.96%
7.55%
96.188
7.95%
7.54%

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

Low
7.41%a/
7.66%
High
7.46%
7.71%
Average
7.45%
7.70%
a/ Excepting 1 tender of $860,000.

98.127
98.114
98.117

Tenders at the high discount rate for the 13-week bills were allotted 66%.
Tenders at the high discount rate for the 26-week bills were allotted 8%.

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Received

Accepted

$
33,375
22,061,810
22,610
33,510
39,825
25,820
991,515
25,245
12,950
38,955
33,245
1,425,200
452,370

$
33,375
5,764,810
22,610
33,510
39,825
25,820
468,315
21,325
8,350
37,955
23,645
84,600
452,370

$7,004,710

: $25,196,430

$7,016,510

$21,190,320
1,076,950
$22,267,270

$3,730,920
1,076,950
$4,807,870

: $20,906,480
:
1,031,730
: $21,938,210

$2,726,560
1,031,730
$3,758,290

1,921,860

1,700,000

274,980

1,558,220

$24,464,110

$7,004,710

: $25,196,430

$7,016,510

$
33,210
21,296,920
27,845
37,880
41,905
29,865
1,070,360
30,155
9,890
40,630
30,815
1,401,060
413,575

$
33,210
5,400,220
27,845
37,880
41,905
29,865
436,360
28,155
9,890
40,630
24,115
481,060
413,575

$24,464,110

An additional $33,920 thousand of 13-week bills and an additional $253,580
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
V

Equivalent coupon-issue yield.
NB-4"*

TREASURY NEWS
ptportment of the Treasury • Washington, D.c. • Telephone 566-2041
October 24, 1988

Charles H. Dallara
Assistant Secretary of the Treasury for Policy Development
and Senior Advisor for Policy
Charles H. Dallara was confirmed by the United States Senate
as Assistant Secretary of the Treasury for Policy Development
on October 19, 1988, and was sworn into office by Secretary
Nicholas F. Brady on October 20, 1988. President Reagan had
nominated Dr. Dallara for this position earlier this month.
As Assistant Secretary for Policy Development, Dr. Dallara
will continue to serve as Senior Advisor for Policy to the
Secretary of the Treasury, a role he assumed in September.
He will support the Secretary in the monitoring and development of policies covering the full range of the Department's
activities. He will also be responsible for the oversight of
the Executive Secretary and the functions of the Executive
Secretariat.
Since 1984, Dr. Dallara has also been serving as United States
Executive Director of the International Monetary Fund (IMF).
He had served as Senior Deputy Assistant Secretary of the
Treasury for International Economic Policy from 1985 to 1988,
and prior to this had held a variety of other positions at the
Treasury, and served as the U.S. Alternate Executive Director
at the IMF.
Dr. Dallara received his Ph.D., M.A., and M.A.L.D. from the
Fletcher School of Law & Diplomacy, Tufts university, and
a B.A. in economics from the University of South Carolina.
He also served as an officer in the U.S. Navy from 1970-1974.
Dr. Dallara was born on August 25, 1948 in Spartanburg, South
Carolina to Harry P. and Margaret Dallara. He is married, has
two children, and resides in Falls Church, Virginia.

NB-44

TREASURY NEWS
apartment
of the
Treasury • Washington, D.c. • Telephone
566-2041
FOR IMMEDIATE
RELEASE
October 24,1988
Washington— The Department of the Treasury today announced
that it has directed the Internal Revenue Service to delay
until May 1, 1989 the issuance of determination letters for
terminating defined benefit plans with assets in excess of
liabilities if all or a portion of the excess assets are to be
recovered by the employer. This temporary delay applies to
determination letter applications for such terminating plans that
are filed with the Internal Revenue Service on or after October
24, 1988. The temporary delay does not apply to the issuance of
a determination letter upon the termination of any defined
benefit plan if the application for the letter was filed with the
Service prior to October 24, 1988, or if the parties affected by
the plan termination were provided, prior to October 24, 1988,
with 60-day notices of intent to terminate the plan, as required
by section 4041(a)(2) of the Employee Retirement Income Security
Act of 1974.
Applications for determination letters received by the
Service on or after October 24, 1988 will continue to be
processed in the ordinary course, with taxpayers afforded the
opportunity to discuss the terms of the letter as it is
processed. Determination letters with respec- to such
applications will be issued beginning May 1, 1989. Since the
processing of applications under existing procedures requires
several months, the May 1, 1989 issuance date will result in only
minimal delay in the issuance of letters.
While the Treasury Department believes the current policies
regarding plan terminations are sound and does not anticipate any
changes in this area, the delay in the issuance of letters until
May 1, 1989 will provide an opportunity for additional review of
the guidelines applicable to determination letters for
terminating plans.
NB-45

TREASURY NEWS
Oipartment of the Treasury • Washington, D.C. • Telephone 566-204'

Oct. 24, 1988
NOTICE TO THE PRESS

At 2:15 pm today the Treasury Department's report to Congress
on international economic and exchange rate policy will be made
available to accredited media only in room 4121 of the main
Treasury building. A briefing by a senior Treasury official will
follow at 3 pm.
The report and briefing will be embargoed for release at 4:00
pm. Come in through the 15th street entrance. Contact: Bob Levine
566-2041.

TREASURY NEWS

Department of the Treasury • Washington, D.c. • Telephone 566-2
CONTACT: Office of Financing
FOR RELEASE AT 4:00 P.M.
202/376-4350
October 25, 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
$14,400 million, to be issued November 3, 1988.
This offering
will provide about $600
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,801 million.
Tenders will be received at Federal Reserve Banks and Branches and at
the Bureau of the Public Debt, Washington, D. C. 20239, prior to 1:00
p.m., Eastern Standard time, Monday, October 31, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
August 4, 1988,
and to mature February 2, 1989
(CUSIP No.
912794 RE 6), currently outstanding in the amount of $7,367 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,200 million, to be dated
November 3, 1988,
and to mature May 4, 1989
(CUSIP No.
912794 RW 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 November 3, 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 $1,88 2 million as agents for foreign
and international monetary authorities, and $3,776 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).

NB-46

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 NEWS
apartment
of theRELEASE
Treasury • Washington,
• Telephone
566-2041
FOR IMMEDIATE
CONTACT:D.c.
Office
of Financing
October 26, 1988

202/376-4350

RESULTS OF AUCTION OF 2-YEAR NOTES
The Department of the Treasury has accepted $9,014 million
of $25,136 million of tenders received from the public for the
2-year notes, Series AG-1990, auctioned today. The notes will be
issued October 31, 1988, and mature October 31, 1990.
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
99,.891
8..31%
Low
High
8..34%
99,.837
Average
8..33%
99,.855
Tenders at the high yield were allotted 88%.
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

58,130
21 ,066,055
38,740
68,755
91,455
41,200
1 ,372,515
93,755
41,750
119,165
23,135
2 ,034,140
87,245
$25 ,136,040

Accepted
$
58,130
7,946,255
38,740
68,755
90,840
38,200
213,515
85,745
40,725
119,165
23,135
203,140
87,245
$9,013,590

The $9,014
million of accepted tenders includes $1,14 6
million of noncompetitive tenders and $7,868 million of competitive tenders from the public.
In addition to the $9,014 million of tenders accepted in
the auction process, $980 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $639 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.
NB-47

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
October 28, 1988

Contact:

Art Siddon
(202) 566-5252
Barbara Clay (202) 395-3080

FOR IMMEDIATE RELEASE
October 28, 1988

JOINT STATEMENT OF
NICHOLAS F. BRADY, SECRETARY OF THE TREASURY
AND
JOSEPH R. WRIGHT
ACTING DIRECTOR OF THE OFFICE OF MANAGEMENT AND BUDGET
ON
BUDGET RESULTS FOR FISCAL YEAR 1988

SUMMARY
The Treasury Department is today releasing the September Monthly
Treasury Statement of Receipts and Outlays of the United States
Government, which shows the actual budget totals (including
social security) for the fiscal year that ended on September 30,
1988. The statement shows:
— total receipts of $909.0 billion;
— total outlays of $1,064.1 billion; and
— a total deficit of $155.1 billion.

NB-48

Table 1.—TOTAL RECEIPTS, OUTLAYS, AND DEFICITS
(in billions of dollars)
Receipts Outlays Deficit (-)
1987 Actual 854-1 1,003.8 -149.7
1988 Estimates and Actual:
February a/
July b/
Actual

909.2
913.4
909.0

1,055.9
1,065.8
1,064.1

-146.7
-152.3
-155.1

a/ February 1988 from the 1989 Budget.
b/ July 1988 from the Mid-Session Review of the 1989 Budget
DEFICIT
The deficit for 1988 was $155.1 billion, $2.8 billion higher than
the July estimate.
Although the 1988 deficit was $5.4 billion
higher than the 1987 deficit, the underlying trend in the
deficit,
excluding temporary factors, remains downward, as
indicated in Table 2.
Table 2.—FEDERAL DEFICIT 1983-1988
(in billions of dollars)
Actual
1983 -207.8
1984
1985
1986
1987
1988

-185.3
-212.3
-221.2
-149.7
-155.1

After declining by a record $71.5 billion in 1987, the deficit
increased by $5.4 billion in 1988.
However, this can be
attributed to a number of special factors that reduced the
deficit in 1987 below its trend level.
The phase-in of the Tax Reform Act of 1986 added $21.5 billion to
receipts in 1987 but reduced tax collections by $4.5 billion in
1988. Timing changes, such as the one day shift in military pay,
and one-time savings, such as the sale of Conrail, held down net
outlays by $10.5 billion in 1987. Were it not for these special
factors, the deficit would have declined by $31.1 billion between
1987 and 1988.
-2-

RECEIPTS
Receipts were estimated in the February budget at $909.2 billion,
and were revised upward to $913.4 billion in the July Mid-Session
Review.
Actual
receipts
for 1988 were $909.0 billion,
$4.5 billion
lower than the July estimate.
Most of the
$4.5 billion difference is attributable to lower than anticipated
collections of individual income taxes.
Receipts Changes by Source
Individual Income Taxes and Employment Taxes and
Contributions
were
below
the
July
estimate by
$4.0 billion and $0.7 billion respectively. Lower than
estimated withholding was in large part responsible for
the shortfall in these receipts.
— Corporation Income Taxes were $94.2 billion,
$0.8 billion higher than the $93.4 billion estimated in
July, largely because estimated payments of 1988 tax
liability were higher than expected.
Excise Taxes were $35.5 billion, $0.9 billion more than
the July estimate.
Customs Duties were $16.2 billion, $0.9 billion lower
than the July estimate, and substantially offsetting the
higher excise taxes.
— Miscellaneous Receipts were $19.9 billion, $0.6 billion
less than the July estimate.
Lower than estimated
deposits of earnings by the Federal Reserve System
account for $0.2 billion of the shortfall.

-3-

OUTLAYS
Total
outlays
in
the February budget were estimated at
$1,055.9 billion.
This estimate was increased by $9.9 billion,
to $1,065.8 billion in the Mid-Session Review, reflecting the net
impact of technical reestimates, policy changes, and a revised
economic forecast.
Actual 1988 outlays were $1,064.1 billion,
$1.7 billion below the July estimate.
The $1.7 billion decrease from the July estimate reflects the net
impact of numerous increases and decreases. Outlays were higher
than anticipated for the Department of Defense - Military
($4.7 billion above the July estimate) and the Federal Home Loan
Bank Board ($3.0 billion above the July estimate). These and
other increases were more than offset by lower than anticipated
outlays for the Agriculture Department ($2.9 billion below the
July estimate), Military and other funds appropriated to the
President ($2.2 billion below the July estimate), the Federal
Deposit
Insurance Corporation ($1.3 billion below the July
estimate), and other agencies.
Outlay Changes by Agency and Program
The major outlay changes since the July Mid-Session Review are
described
below.
Table 3, which follows this discussion,
displays the estimates for February and July and the actual
levels by agency and major program.
Funds Appropriated to the President.—Outlays of Funds
Appropriated to the President were $7.3 billion, $2.2 billion
lower than the $9.4 billion estimated in July.
Foreign Military Sales Credit.—Collections exceeded
outlays for the Foreign Military Sales Credit program by
$0.1 billion. In July it was estimated that net outlays
would be $1.5 billion.
Net outlays were $1.5 billion
lower than estimated in July, due to greater than
expected loan refinancings and slower than expected loan
disbursements.
Military Sales Programs.—Outlays for military sales
programs were $0.1 billion, $0.8 billion lower than the
$0.9 billion estimated in July, due mainly to higher
sales activity and resulting higher offsetting receipts
than expected in July.
Department of Agriculture.—Outlays of the Department of
Agriculture were $44.0 billion, $2.9 billion lower than the
$46.9 billion estimated in July.
— Commodity Credit Corporation and Foreign
Assistance.—Outlays were $13.3 billion, $1.0 billion
lower than the July estimate of $14.3 billion, because
-4-

the impact of the 1988 drought was greater than assumed
in July.
Commodity prices were higher than expected,
thus reducing final deficiency payments and net lending
activity.
— Federal Crop Insurance Corporation.—Outlays were
$0.4 billion, $1.0 billion below the July estimate of
$1.4 billion, largely due to a slower chan expected
settlement of claims resulting from the 1988 drought.
— All Other Agriculture.—Outlays of all other Agriculture
Department programs were $30.3 billion, $0.9 billion
lower than the July estimate of $31.2 billion. Outlays
of the Rural Electrification Administration were lower
by $0.2 billion due primarily to lower advances of
guaranteed Federal Financing Bank loans and higher
prepayments of Rural Telephone Bank loans. Other outlay
changes are a result of numerous differences across the
department.
Department of Defense-Military.—Outlays of the Department of
Defense-Military were $281.9 billion, $4.7 billion higher than
the
$277.3 billion estimated in July.
This was due to
unanticipated funding requirements from the decline in the value
of the U.S. dollar, the absorption of military and civilian pay
raises, and increased medical costs.
In addition, there was
faster than planned execution of prior year programs.
Department of Education.—Outlays of the Department of Education
were $18.2 billion, $0.7 billion lower than the July estimate of
$19.0 billion due to a write-off of unexpended balances and to
slower than anticipated spending in education grant programs.
Department of Energy.—Outlays of the Department of Energy were
$11.2 billion, or $0.3 billion higher than the $10.9 billion
estimated in July, due mainly to faster than planned execution in
atomic energy defense programs.
Department of Health and Human Services — except Social
Security.—Outlays were $159.0 billion, $1.6 billion below the
$160.6 billion estimated in July.
— Medicare outlays were $87.7 billion, $0.6 billion below
the July estimate.
The Omnibus Budget Reconciliation
Act of 1987 (OBRA 87) mandated that the payment of
Medicare claims would be no faster than ten days
starting on July 1, 1988. HHS underestimated the impact
of this change in the timing of payments, which resulted
in outlays lower than planned.
Medicaid.—Medicaid outlays were $30.5 billion,
$0.3 billion lower than the $30.8 billion estimated in
July, due to the underestimate of the savings from the
ten day delay mandated by OBRA 87. Since Medicaid is
-5-

the payor of last resort, delays by the first payor,
Medicare, caused delays in Medicaid as well, resulting
in lower actual outlays.
— Public Health Service.—Outlays by the Public Health
Service were $11.4 billion, $0.3 billion higher than the
$11.1 billion estimated in July, due to faster than
estimated spending.
Department of Housing and Urban Development.—Outlays by the
Department of Housing and Urban Development were $19.0 billion,
$0.5 billion lower than estimated in July, due to slower than
anticipated
outlays
in
subsidized
housing
programs for
very-low-income families.
Department of Transportation.—Outlays of the Department of
Transportation were $26.4 billion, $0.3 billion higher than the
July estimate of $26.1 billion.
Federal Highway Administration.—Outlays were
$14.0 billion,
$0.6 billion
higher
than the July
estimate, due to greater State cash drawdowns than
anticipated.
— Other.—Outlays were $0.3 billion lower than the
$12.7 billion estimated in July, due to lower spending
by the Coast Guard and the Maritime Administration's
Federal Ship Financing Fund.
Department of the Treasury.—Outlays were $202.5 billion,
$0.2 billion higher than the July estimate of $202.3 billion.
Interest on the Public Debt.—Interest on the public
debt was $214.1 billion, $0.5 billion higher than the
$213.7 billion estimated in July, due to higher interest
rates.
Other.—Other outlays were $0.4 billion lower than
estimated in July due to a number of factors, including
lower claims, judgments, and relief payments, lower
Federal Financing Bank interest payments to the Office
of
Personnel
Management,
and delays in expected
obligations in operating accounts.
Office of Personnel Management.—Outlays of the Office of
Personnel Management were $29.2 billion, $0.4 billion higher than
the
July estimate of $28.8 billion primarily because more
retiring employees elected to receive lump-sum payments than had
been estimated.
Veterans Administration —Outlays were $29.2 billion,
$0.5 billion higher than the $28.8 billion estimated in July,
primarily because supplemental funds were made available to pay
certain veterans compensation payments earlier than expected.

-6-

Federal
Deposit
Insurance
Corporation.—Outlays
were
$2.1 billion, $1.8 billion lower than the July estimate of
$4.0 billion because of a delay in the settlement of two large
assistance cases.
Federal Home Loan Bank Board.—Outlays were $8.1 billion,
$3.0 billion above the July estimate of $5.1 billion, because the
costs
of
assisting
troubled
savings
institutions
were
substantially greater than anticipated.

-7-

Table 3.--1987 and 1988 BUDGET RECEIPTS BY SOURCE AND OUTLAYS BY AGENCY
(fiscal years; in millions of dollars)
1988
Estimate
1987
Actual
February

July

Actual

Receipts by Source
Individual income taxes
Corporation income taxes
Social insurance taxes and contributions:
Employment taxes and contributions
On-budget
Off-budget
Unemployment insurance
Other retirement contributions
Subtotal, Social insurance taxes and contributions.
Excise taxes
Estate and gift taxes
Customs duties
Miscellaneous receipts
Total, Receipts
On-budget
Off-budget

392,557
83,926

393,395
105,567

405,188
93,361

401,181
94,195

273,028 303,069 305,787 305,093
(59,626) (63,170) (63,601) (63,602)
(213,402) (239,899) (242,186) (241,491)
25,575
23,727
24,531
24,584
4,715
4,717
4,713
4,658
303,318 331,513 335,031 334,335
32,457 35,342 34,669 35,540
7,493
7,567
7,567
7,594
15,085
16,399
17,086
16,198
19,307
19,380
20,510
19,909
854,143
909,163
913,411
908,953
(640,741) (669,264) (671,225) (667,462)
(213,402) (239,899) (242,186) (241,491)

Outlays by Major Agency
2,989
109

Legislative branch and the Judiciary
Executive Office of the President...
-8-

3,302
124

3,351
124

3,189
121

Table 3.—1987 and 1988 BUDGET RECEIPTS BY SOURCE AND OUTLAYS BY AGENCY
(fiscal years; in millions of dollars)
1988
Estimate
1987
Actual
Funds Appropriated to the President:
International Security Assistance:
3,758
Foreign Military Sales Credit
,
3,466
Economic Support Fund
,
-404
Other
,
2,673
International development assistance
-575
International monetary programs
,
1,386
Military sales programs
102
Other
,
Subtotal, Funds Appropriated to the President 10,406 5,233 9,429 7,252
Agriculture:
Commodity Credit Corporation and foreign assistance
Federal Crop Insurance Corporation
Rural Electrification Administration
Farmers Home Administration
Food and Nutrition Service
Other
Subtotal, Agriculture ,
Commerce
Defense-Military:
Military personnel
Operation and maintenance
Procurement
Research, development, test, and evaluation

,
,
,
,
,

,
,
,

-9-

February

July

Actual

-2,264
3,362
995
2,932

1,464
3,362
740
2,934

-75
3, 184
1, 164
2,980
-136
106
29

186
23

869
60

23,424
-296
-238
3,748
18,435
4,520

18,862
491
-1,187
6,810
20,000
5,738

14,319
1,425
-1,589
7,341
19,850
5,561

13,284
411
-1,825
7,277
19,581
5,276

49,593

50,715

46,907

44,003

2,156

2,485

2,489

2,279

72,020
76,178
80,744
33,596

75,453
80,433
79,166
33,127

76,337
84,480
77,166
34,792

Table 3.—1987 and 1988 BUDGET RECEIPTS BY SOURCE AND OUTLAYS BY AGENCY
(fiscal years; in millions of dollars)
1988
Estimate
1987
Actual

February

July

Actual
9, 165

9,096

277,275

281,940

20,659
16,800
10,688

22,284
18,796
10,506

22,284
18,970
10,853

22,047
18,246
11,161

81,640
27,435
9,886
29,933

87,657
30,664
11,088
31,024

88,237
30,829
11,092
30,416

87,676
30,462
11,408
29,445

148, 893

160,432

160,573

158,991

214,695

214,052

214,178

9, 852
-555
-675
2, 991
3, 851
15,464

10,954
281
193
2,980
4,145

10,914
1,387
289
2,980
3,888

11,108
1,134
208
3,044
3,461

18,553

19,457

18,956

Interior

5,054

5,407

5,382

5,152

Justice.

4,333

5, 151

5,159

5,426

Other

11, 399

Subtotal, Defense-Military 273, 938
Defense-Civil
Education
Energy
Health and Human Services -- except Social Security:
Medicare
Medicaid
Public Health Service
Other
Subtotal, Health and Human Services — except
Social Security
Health and Human Services -- Social Security 202,422
Housing and Urban Development:
Housing payments
Federal Housing Administration fund
Government National Mortgage Association
Community development grants
Other
Subtotal, Housing and Urban Development

-10-

Table 3.—1987 and 1988 BUDGET RECEIPTS BY SOURCE AND OUTLAYS BY AGENCY
(fiscal years; in millions of dollars)
1988
Estimate
1987
Actual
Labor:
Training and employment services
Advances to the unemployment trust fund and other funds...
Unemployment trust fund
Other
Intrabudgetary transactions
Subtotal, Labor
State
Transportation:
Federal Highway Administration
Urban Mass Transportation Administration
Federal Aviation Administration
Other
Subtotal, Transportation
Treasury:
Exchange Stabilization Fund
Interest on the public debt
Offsetting receipts
Other
Subtotal, Treasury
Environmental Protection Agency
General Services Administration
National Aeronautics and Space Administration
Office of Personnel Management
-11-

February

July

Actual

3,545
168
20,527
1,999
-2,786

3,717
30
17,500
1,733
-971

3,717
114
18,700
2,002
-2,517

3,701
95
18,598
2,005
-2,528

23,453

22,009

22,016

21,870

2,788

3,321

3,421

12,738
3,299
4,895
4,499

13,400
3,535
5, 311
4,077

13,375
3, 122
5,265
4,341

14,002
3,266
5, 192
3, 944

25,431

26,323

26,102

26,404

-1, 410
195, 390
-23,693
10, 058

-176
210,058
-24,030
13,045

-1,490
213,654
-23,812
13,988

-1,498
214,145
-23,771
13,596

180,345

198,898

202,340

202,472

4,903
74
7,591
26,966

4,853
-135
9,112
28,493

4,859
-22
9, 112
28,838

4, 872
-285
9,092
29, 191

Table 3.--1987 and 1988 BUDGET RECEIPTS BY SOURCE AND OUTLAYS BY AGENCY
(fiscal years; in millions of dollars)
1988
Estimate
1987
Actual
February

-72
26,952

Small Business Administration
Veterans Administration
Other independent agencies:
District of Columbia
Export-Import Bank
Federal Deposit Insurance Corporation
Federal Emergency Management Agency
Federal Home Loan Bank Board
Postal Service
Railroad Retirement Board
Tennessee Valley Authority
Other (net)
Subtotal, other independent agencies

•
•
•
•

Undistributed offsetting receipts:
Other interest
Employer share, employee retirement (on-budget)
Employer share, employee retirement (off-budget)
Interest received by on-budget trust funds
Interest received by off-budget trust funds
Rents and royalties on the Outer Continental Shelf lands
Sale of major assets
Subtotal, undistributed offsetting receipts

-12-

267
-2,300
-1,438
544
4,755
1,593
4,196
1,091
5,557

280
27,623
523
-985
2,268
644
2,189
2,223
4,116
992
5, 918

July

128
28,754

Actual

-54
29,244

523
-985
3,982
703
5,087
2, 083
4,139
1,198
5,955

520
-894
2,146
551
8,078
2,229
4,147
1,089
5,495

14,266

17,886

22,685

23,361

-903
•27,259
-3,300
•29,752
-5,290
-4,021
-1,875

•28,670
-4,298
•34,321
-7,271
-3,155

28,683
-4,302
•34, 643
-7,294
-3,757

-1
28,957
-4,071
34,481
-7,416
-3,548

-72,400

-77,715

-78,679

-78,473

For Fiscal Year 1988
Through September 30, 1988,
and Other Periods

Final1 Monthly Treasury Statement
of Receipts and Outlays of
the United States Government
Department of the Treasury
Financial Management Service

Summary
Page 2

Receipts page 6

Deficit
Financing
page 20

Outlays page 7

II
Receipts/
Outlays
by Month
Page 26

Federal
Trust Funds/
Securities page 28

'"1This publication contains the final budget results for fiscal year 1988.

Receipts
by Source/
Outlays by
Function page 29

Explanatory
Notespage 30

Introduction
The Monthly Treasury Statement of Receipts and Outlays of the United States
Government (MTS) is prepared by the Department of the Treasury, Financial Management Service, and after approval by the Fiscal Assistant Secretary of the Treasury,
is normally released on the 15th workday of the month following the reporting month.
The publication is based on data provided by Federal entities, disbursing officers,
and Federal Reserve banks.

of receipts are treated as deductions from gross receipts; revolving and management fund receipts, reimbursements and refunds of monies previously expended
are treated as deductions from gross outlays; and interest on the public debt (public
issues) is recognized on the accrual basis. Major information sources include accounting data reported by Federal entities, disbursing officers, and Federal Reserve
banks.

Audience
The MTS is published to meet the needs of: Those responsible for or interested
in the cash position of the Treasury; Those w h o are responsible for or interested
in the Government's budget results; and individuals and businesses whose opera-*
tions depend upon or are related to the Government's financial operations.
Disclosure Statement
This statement summarizes the financial activities of the Federal Government
and off-budget Federal entities conducted in accordance with the Budget of the U.S.
Government, i.e., receipts and outlays of funds, the surplus or deficit, and the means
of financing the deficit or disposing of the surplus. Information is presented on a
modified cash basis: receipts are accounted for on the basis of collections; outlays

Triad of Publications
The MTS is part of a triad of Treasury financial reports. The Daily Treasury Statement is published each working day of the Federal Government. It provides data
on the cash and debt operations of the Treasury based upon reporting of the
Treasury account balances by Federal Reserve banks. The MTS is a report of
Government receipts and outlays, based on agency reporting. The U.S. Government Annual Report is the official publication of the detailed receipts and outlays
of the Government. It is published annually in accordance with legislative mandates
given to the Secretary of the Treasury.
Data Sources and Information
The Explanatory Notes section of this publication provides information concerning the flow of data into the MTS and sources of information relevant to the MTS.

Table 1. Summary of Receipts, Outlays, and the Deficit/Surplus of the U.S.Government, Fiscal Years 1987 and 1988,
by Month (in millions)
Period

F Y 1987
October
November
December
January
February
March
April
May
June
July
August
September
Year-to-Date

F Y 1988
October
November
December....
January
February
March
April
May
June
July
August
September
Year-to-date

Receipts

Outlays

Deficit/Surplus (-)

$59,012
52,967
78,035
81,771
55,463
56,515
122,897
47,691
82,945
64,223
60,213
92,410

$84,302
80,054
90,404
83,928
83,842
84,446
84,155
83,328
83,568
86,562
82,009
77,206

854,143

'1,003,804

62,354
56,987
85,525
81,791
60,355
65,730
09,323
59,711
99,205
60,690
69,479
97,803

93,164
84,009
109,889
65,895
84,382
95,013
95,554
82,295
90,071
83,634
92,561
87,588

30,810
27,022
24,363
-15,896
24,027
29,283
-13,769
22,583
-9,134
22,944
23,082
-10,214

$908,953

'$1,064,055

•$155,102

$25,290
27,087
12,369
2,157
28,379
27,931
-38,742
35,637
623
22,339
21,796
-15,204
1

149,661

1
The outlays by month for FY 1987 have been increased by a net of $737 million to reflect reclassification of the Thrift Savings Fund receipts of $743 million and Federal Retirement Thrift Investment Board (FRTIB) administrative expenses of $6 million to a non-budgetary status. The Federal Retirement Thrift Investment Board outlays by month for FY 1988 have been adjusted by a net of
$1,084 million. Data for fiscal years 1987 and 1988 previously reported by Treasury for Federal Savings and Loan Insurance Corporation and FRTIB have been reclassified in consultation with the
Office of Management and Budget resulting in revised totals as shown above. Historical tables in the Budget will be changed to agree with Treasury totals with the exception of a difference of $7 milli
for the Small Business Administration and the administrative expenses for the FRTIB. O M B will continue to reflect the administrative expenses for the FRTIB in budgetary totals.
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

Table 2. Summary of Budget and Off-Budget Results and Financing of the U.S. Government, September 1988 and
Other Periods (in millions)

Classification

Total on-budget and off-budget results:
Total receipts

Actual
Previous
Fiscal Year
to Date
(1987)

Budget
Estimates
Next Fiscal
Year (1989) 1

$913,411

$854,143

$974,045

242,186

640,741
213,402

711,958
262,087

1,003,804

1,096,740

809,972
193,832

885,877
210,863

-149,661

-122,695

-169,231
+ 19,570

-173,919
+ 51,224

149,661

122,695

151,717
-5,052
2,996

117,780

Actual
Fiscal Year
to Date

Budget
Estimates
Full Fiscal
Year 1

$97,803

$908,953

22,217

241,491

Current
Month

On-budget receipts 75,586 667,462 671,225
Off-budget receipts
Total outlays 87,588 1,064,055 1,065,759
On-budget outlays 70,071 861,364 863,303
Off-budget outlays

17,518

202,691

202,456

Total surplus (+) or deficit (-) +10,214 -155,102 -152,348
On-budget surplus (+) or deficit (-) +5,515 -193,901 -192,078
Off-budget surplus (+) or deficit (-)
+4,699

+38,800

+39,730

Total on-budget and off-budget financing -10,214 155,102 152,348
Means of financing:
By Borrowing from the public
By Reduction of operating cash, increase (-)
By Other means
1

14,665
-31,444
6,564

166,171
-7,963
-3,106

132,708
16,436
3,204

Based on the Mid-Session Review of the FY 1989 Budget released by the Office of Management and Budget on July 28, 1988.
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

Figure 1. Monthly Receipts, Outlays, a n d B u d g e t Deficit/Surplus of the U . S . G o v e r n m e n t , Fiscal Y e a r s 1 9 8 7 a n d 1 9 8 8

in billions of dollars

150
Outlays

Deficit( - )/Surplus

Oct.
FY
87

Dec. Feb. Apr. June Aug. Oct. Dec. Feb. Apr. June Aug. Sept.
FY
88

4,915

Figure 2. Monthly Receipts of the U.S. Government, by Source, Fiscal Years 1987 and 1988
In billions of dollars

140

Oct. Dec. Feb. Apr. June Aug. Oct. Dec. Feb. Apr. June Aug. Sept.
FY
FY
87
88

Figure 3. Monthly Outlays of the U.S. Government, by Function, Fiscal Years 1987 and 1988
In billions of dollars

120
100

Oct. Dec. Feb. Apr. June Aug. Oct. Dec. Feb. Apr. June Aug. Sept.
FY
FY
87
88

Table 3. S u m m a r y of Receipts and Outlays of the U.S. Government, September 1988 and Other Periods (in millions)
Actual
Comparable
Prior Period

Budget
Estimates
Full Fiscal Year 1

Actual
This Month

Actual
This Fiscal
Year to Date

$41,784
20,668

$401,181
94,195

$392,557
83,926

$405,188
93,361

22,217
5,774

1,367
1,454

241,491
63,602
24,584
4,658
35,540
7,594
16,198
19,909

213.402
59,626
25,575
4,715
32,457
7,493
15,085
19,307

242,186
63,601
24,531
4,713
34,669
7,567
17,086
20,510

97,803

908,953

854,143

913,411

(On-budget)

75,586

667,462

640,741

671,225

(Off-budget)

22,217

241,491

213,402

242,186

161
93
8

1,852
1,337

1,812
1,178

1,942
1,409

121

109

124

-1,547
2,764

7,252
44,003
2,279
281,940
22,047
18,246
11,161

10,406
49,593
2,156
273,938
20,659
16,800
10,688

9,429
46,907
2,489
277,275
22,284
18,970
10,853

158,991
214,178
18,956
5,152
5,426
21,870
3,421
26,404

148,893
202,422
15,464
5,054
4,333
23,453
2,788
25,431

160,573
214,052
19,457
5,382
5,159
22,016
3,321
26,102

214,145
-11,673
4,872
-285
9,092
29,191

195,390
-15,045
4,903

213,654
-11,314
4,859

Classification

Budget Receipts
Individual income taxes
Corporation income taxes
Social insurance taxes and contributions:
Employment taxes and contributions (off-budget).
Employment taxes and contributions (on-budget)
Unemployment Insurance
Other retirement contributions
Excise taxes
Estate and gift taxes
Customs duties
Miscellaneous receipts
Total Receipts

285
418
3,158

678

Budget Outlays
Legislative Branch
The Judiciary
Executive Office of the President
Funds Appropriated to the President
Department of Agriculture
Department of C o m m e r c e
Department of Defense—Military
Department of Defense—Civil
Department of Education
Department of Energy
Department of Health and H u m a n Services,
except Social Security
Department of Health and H u m a n Services, Social Security
Department of Housing and Urban Development
Department of the Interior
Department of Justice
Department of Labor
Department of State
Department of Transportation
Department of the Treasury:
Interest on the Public Debt
,,
Other
Environmental Protection Agency
General Services Administration
National Aeronautics and Space Administration
Office of Personnel Management
Small Business Administration
Veterans Administration
Other independent agencies
Allowances, undistributed
Total Outlays
Undistributed
offsetting receipts:
Interest
(On-budget)
Other
(Off-budget)
Surplus ( + ) or deficit (-)

211
21,036
1,913
1,611

813
14,298
17,973
1,584

725
427
1,462

356
2,511
15,250
- 2,206

459
255
530
2,222

-22

7,591
26,966

9,112
28,838

-26

-54

-72

128

3,091
6,924

29,244
23,361

26,952
14,266

28,754
22,685

-418
-4,892

-41,898
- 36,576

-35,945
- 36,455

-41,937
-36,742

1,003,804

1,065,759

809,972

863,303

193,832

202,456

-149,661

-152,348

87,588

1,064,055
861,364

70,071

202,691

17,518
+ 10,214

-155,102

(On-budget)

+ 5,515

-193,901

-169,231

-192,078

(Off-budget)

+ 4,699

+ 38,800

+ 19,570

+ 39,730

'Based on the Mid-Session Review of the F Y 1989 Budget released by the Office of Management and Budget on July 26, 1988.
^ h e outlays by month for FY 1987 have been increased by a net of $737 million to reflect reclassification of the Thrift Savings Fund receipts of $743 million and Federal Retirement Thrift Investment Board (FRTIB) administrative expenses of $6 million to a non-budgetary status. The FRTIB outlays by month for F Y 1988 have been adjusted by a net of $1,084 million.
... No Transactions.
Source: Financial Management Service, Department of the Treasury.

Table 4. Receipts of the U.S. G o v e r n m e n t , S e p t e m b e r 1988 a n d Other Periods (in millions)
Current Fiscal Year to Date

This Month
Classification

Individual Income taxes:
Withheld
Presidential Election Campaign Fund
Other

Gross
Receipts

Refunds
(Deduct)

Receipts

Gross
Receipts

Refunds
(Deduct)

Receipts

$341,435
33
132,199

$27,2091
1
16,793

Prior Fiscal Year to Date
Gross
Receipts

Refunds
(Deduct)

Receipts

$322,463
33
142,957

44,003

$2,219

$41,784

473,668

465,453

$72,896

$392,557

21,380

712

20,668

109,683

15,487

94,195

102,859

18,933

83,926

18,557
1,714
4

207,880
12,929
40

512

207,368
12,929
40

179,409
10,181
5,325

374

179,035
10,181
5,325

(**)

Total—FOASI trust fund
Federal disability insurance trust fund:
Federal Insurance Contributions Act taxes .
Self-Employment Contributions Act taxes ..
Receipts from Railroad Retirement Account
Deposits by States
Other

20,275

220,849

512

220,337

194,916

1,778
164

19,949
1,245

19,901
1,245

17,251
990

29 17,222

649

649
•__

Total—FDI trust fund
Federal hospital insurance trust fund:
Federal Insurance Contributions Act taxes
Self-Employment Contributions Act taxes .
Receipts from Railroad Retirement Board .
Deposits by States

1,942

21,203

21,154

18,889

29 18,861

4,939
448

56,200
3,517
332
-42

147

56,052
3,517
332
-42

50,969
2,816
330
1,989

113 50,857
2,816
330
1,989

5,387

60,007

147

59,859

56,105

113
5,992

55,992

Total—Individual income taxes
Corporation Income taxes
Social Insurance taxes and contributions:
Employment taxes and contributions:
Federal old-age and survivors ins. trust fund:
Federal Insurance Contributions Act taxes .
Self-Employment Contributions Act taxes ..
Deposits by States
Other

Total—FHI trust fund
Railroad retirement accounts:
Rail industry pension fund
Railroad social security equivalent benefit
Total—Employment taxes and contributions
Unemployment insurance:
State taxes deposited in Treasury
Federal Unemployment Tax Act taxes
Railroad Unemployment taxes
Railroad debt repayment

(**)

<")

374 194,541

990

207
179

2,315
1,460

2,283
1,460

2,310
1,342

18
2,292

2,292
1,342

27,999

27,991

305,833

740

305,093

273,562

533
3,028

273,028

208
87

208
77
(*•)
(**)

18,310
6,178
195
158

18,310
5,920
195
158

19,134
6,232
204
157

19,134
152

285

24,841

24,584

25,727

152

404
2

4,501
33
3

4,562
48
3

407

4,537

4,613

122

102

28,694

335,333

998

334,335

304,004

685

303,318

(")
(")
295

404
2
< " )

Total—Federal employees retirement contributions.
Other retirement contributions:
Civil service retirement and disability fund

Total—Excise taxes

(")

(**)

•_

216
179

Total—Unemployment insurance

Total—Social Insurance taxes and contributions

(")

<")

5,387

Federal employees retirement contributions:
Civil service retirement and disability fund ...
Foreign service retirement and disability fund.
Other

Excise taxes:
Miscellaneous excise taxes1
Airport and airway trust fund
Highway trust fund
Black lung disability trust fund

$72,487 $401,181

28,712

•

258

6,080
204
157
25,575

1,536
368
1,275
45

(")

1,470
368
1,275
45

18,246
3,195
14,406
594

603
6
292

17,643
3,189
14,114
594

16,553
3,066
13,159
572

760
6
127

15,793
3,060
13,032
572

3,224

3,158

36,441

901

35,540

33,350

893

32,457

689

678

7,784

190

7,594

7,668

175

7,493

Customs duties

1,409

1,367

16,690

492

16,198

15,574

489

15,085

Miscellaneous receipts:
Deposits of earnings by Federal Reserve banks
All other

1,276
168

Estate and gift taxes

1,276
178

17,163
2,748

1,444

-9
-9

1,454

Total—Receipts

100,861

3,058

Total—On-budget

78,644

3,058

Total—Off-budget

22,217

Total—Miscellaneous receipts

1ncludes amounts received for windfall profits tax pursuant to P.L. 96-223.
.. .No Transactions
(**)Less than $500,000.
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

17,163
2,746

16,817
2,510

19,911

2
2

19,909

97,803

999,510

90,557

75,586

757,459

22,217

242,051

16,817
2,490

19,327

20
20

19,307

908,953

948,234

94,091

854,143

89,996

667,462

734,429

93,688

640,741

560

241,491

213*805

403

213,402

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)

Classification

Legislative Branch:
Senate
:
House of Representatives
Joint items
Congressional Budget Office
Architect of the Capitol
Library of Congress
Government Printing Office:
Revolving fund (net)
General fund appropriations
General Accounting Office
United States Tax Court
Other Legislative Branch agencies
Proprietary receipts from the public
Intrabudgetary transactions

Total—Legislative Branch

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

$28

(**)

47
9
2
9
15
13
8
30
2
1
-1

(")

162

....'.

$28
47
9
2
8
15

$336
568
92
17
126
283

13
8
30
2
1

-25
103
326
24
19

161

(**)
-3

-1

$1
1

1,866 14

$335
567
92
17
119
283
-25
103
326
24
19
-5
-3
1,852

$314
495
83
16

$1
1

118
370

$313
494
83
16
109
370
4

91
301
22
19
5
-6
1,827 15

91
301
22
19
-5
-6
1,812

The Judiciary:
Supreme Court of the United States
Courts of appeals, district courts, and other
judicial services
Other

86
5

1,258
62

1,100
61

Total—The Judiciary

1,337

1,178

Executive Office of the President:
Compensation of the President and the
White House Office
Office of Management and Budget
Other

2
3
3

Total—Executive Office of the President

121

Funds Appropriated to the President:
International Security Assistance:
Guarantee reserve fund
Foreign military sales credit
Economic support fund
Military assistance
Peacekeeping operations
Other
Proprietary receipts from the public
Total—International Security Assistance

565
180
325
64
5
6

1,145

41
55

1,182
4,324
3,184
607
36
49

-47

462
2,770
325
64
5
6
47

3,005

-1,860

9,383

103
2,950

523
4,399

26
41
55

121

109

37
47

....

25
'37
47

109

714
4,468
3,466
356
46
51

831
709

188

659
-75
3,184
607
36
49
-188

739

-117
3,758
3,466
356
46
51
-739

5,110

4,273

9,100

2,279

6,820

620
138
476
263

546
221
276
263

International Development Assistance:
Multilateral assistance:
Contributions to International Financial Institutions:
International Development Association
Inter-American Development Bank
Other
International Organizations and Programs

620
138
476
263

Total—Multilateral assistance

1,498

1,306

1.306

103

1,474

1,391

505

355

223

297

Agency for International Development:
Functional Development Assistance Program
Operating Expenses, Agency for
International Development
Payment to Foreign Service Retirement and
Disability Fund1
Other
Proprietary receipts from the public
Total—Agency for International Development .
Trade and Development Program
Peace Corps
Overseas Private Investment Corporation
Other
Total—International Development Assistance ... .
Table continued on next page.

5
54

40
-54

266

43
798

-798

182

123

2,245

841

1,404

2,088

20
146
54
38

20
146
165
15

-110

(**)

1
11
-7
4

151

4,000

1,021

1
11
8
4
226

31
763

-763

794

1,294

18
125
56
35

142
19

18
125
-86
16

2,980

3,628

954

2,673

266

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Classification

Funds Appropriated to the President:—Continued
International Monetary Programs
Military Sales Programs:
Foreign military sales trust fund
Other
Proprietary receipts from the public
Other
Total—Funds Appropriated to the President
Department of Agriculture:
Departmental Administration
Agricultural Research Service
Cooperative State Research Service
Extension Service
Foreign Agricultural Service
Foreign Assistance Programs
Agricultural Stabilization and Conservation Service:
Conservation Program
Other
Federal Crop Insurance Corporation
Commodity Credit Corporation:
Price support and related programs
National Wool Act Program
Rural Electrification Administration
Farmers Home Administration:
Public enterprise funds:
- Agricultural credit insurance fund
Rural housing insurance fund
Rural development insurance fund
Other
Rural water and waste disposal grants
Salaries and expenses
Other
Total—Farmers Home Administration

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

-$16

683
49

$16
543

4
2,091

3
46
29
23
5
268

3,638

....

89
85
119
548 1,233
2
-128
775

264
573
287
1
11
32
5
1,172

578

175
242
-39
(**)

377

-$16

-$136

683
33

9,057

271

-543

$257
8,964

-$136

$575

9,057
13
-8,964
29

9,910
247

7,252

22,412

1,547

22,604

3
46
29
23
5
268

93
540
302
318
84
1,060

88
527
281
319
78
1,083

23
581

170

494
23
411

158
55
602

685 23,614 11,394
128
5
197
3,856
5,681

12,219
5
-1,825

89 494
85
117

89
332
325
1
11
32
5

5,643
6,243
2,927

795

15,411

1
136
397
64

15,352

3,025
2,632
2,477

(")

8,134

12,005

10,406

102

88
527
281
319
78
1,083
158
898

8,721
30,910
152
3,244
3,006

55
-296
22,189
152
-238

136
397
64

......

7,277

15,034

11,286

3,748

362
227
43
324

(")

35
17
5
21

450
203
49
340

55
3
-22
31

55
22
31

382
131
391

Total—Food and Nutrition Service

1,423

Forest Service:
National Forest system
Construction
Forest research
Forest Service permanent appropriations
Cooperative work
Other

Total—Department of Agriculture

9,910
-21
-8,504
102

2,564
798
-210
-2
157
384
56

35
17
5
21

Other
Proprietary receipts from the public
Intrabudgetary transactions

$267
8,504

6,099
5,991
2,348
-2
157
384
56

2,618
3,611
450

Soil Conservation Service:
Conservation operations
Water resource management and improvement
Other
Animal and Plant Health Inspection Service
Agricultural Marketing Service:
Funds for strengthening markets, income, and supply.
Other
Food Safety and Inspection Service
Food and Nutrition Service:
Food stamp program
Nutrition assistance for Puerto Rico
Child nutrition programs
Women, infants and children programs
Other

Total—Forest Service

-$575

3,536
5,193
2,557
('*)

362
227
43
324

391
93
373

391
90
373

13,144
1
4,286
1,852
297

12,405
2
4,045
1,702
281

1,423

19,581

18,435

-348
28
12
235
533
25

348
28
12
235
533
25

964
243
136
450
707
188

1,231
228
120
424
72
156

484

2,688

2,231

23
-152

289

252
-1,462

288

1,081

(")

(**)

147
161
34

3
152

37
1,462

33
1,281

(*')

(")
5,108

2,344

Table continued on next page.

2,764

70,882

26,879

44,003

75,059

255
-1,281

25,466

49,593

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Classification

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

Department of Commerce:
General Administration
Bureau of the Census
Economic and Statistical Analysis
Promotion of Industry and Commerce
Science and technology:
National Oceanic and Atmospheric Administration .
Patent and Trademark Office
National Institute of Standards and Technology ...
National Telecommunications and Information
Administration

$55
21
8
18

93
10
8

$51
21
8
18
92
10
8

$334
333
76
213

6
-5
-1

27
-5

211

2,461

2,568
2,348
1,795

Total—Military personnel..

6,710

Operation and Maintenance:
Department of the Army
Department of the Navy
Department of the Air Force.
Defense agencies

-1
221

Total—Department of Commerce.
Department of Defense—Military:
Military personnel:
Department of the Army
Department of the Navy
Department of the Air Force

Total—Operation and Maintenance
Procurement:
Department of the Army
Department of the Navy
Department of the Air Force
Defense agencies
Total—Procurement.
Research, Development, Test, and Evaluation:
Department of the Army
Department of the Navy
Department of the Air Force
Defense agencies
Total—Research, Development, Test, and Evaluation

1,472

27
-53
-5

182

113

1,329

(")

113

1,307

-45
-6

145

2,156

-6
2,301

29,196
25,795
21,346

27,273
24,008
20,739

6,710

76,337

72,020

2,136
2,281
2,016
750

24,762
28,358
23,752
7,608

22,259
24,893
20,587
8,438

7,183

84,480

76,178

798
1,705
2,397
198

15,578
28,800
30,845
1,943

15,839
29,201
33,815
1,889

5,097

77,166

80,744

326
574
1,034
608

4,624
8,828
14,302
7,038

4,721
9,176
13,347
6,352

2,541

34,792

33,596

124
157
138
59

1,712
1,756
1,616
789

1,979
1,569
1,778
527

479

5,874

5,853

273

3,082

2,908

20 2

-58

-60

213
478
654
-342
371

213
478
654
-342
44
-829
-26

477
1,526
453
1,067
357

477
1,517
453
1,067
28
-813
-28

281,940

275,092

Total—Military construction.

Total—Department of Defense—Military

119

$377
217
63
243

2,279

Military Construction:
Department of the Army
Department of the Navy
Department of the Air Force.
Defense agencies

Family housing
Revolving and Management Funds:
Public Enterprise Funds
Intragovernmental Funds:
Department of the Army
Department of the Navy
Department of the Air Force ...
Defense agencies
Other
Proprietary receipts from the public
Intrabudgetary transactions

....

34 34 34

$78

34
1,484

Other
Proprietary receipts from the public
Intrabudgetary transactions

$454
217
63
243

1,224 1,096 22 1,074
95
86

114

115

$216
333
76
213

1,236 12
95
119

Total—Science and Technology

$118

3
-90
-251
42
-242
31

(**)
-90
-251
42
-242
31
392

-318
21,459

423

Table continued on next page.

(**)
-392
-318

-26

21,036

283,098

327
829

1,158

330
813

-28
1,154

273,938

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Classification

Department of Defense—Civil
Corps of Engineers:
General investigations
Construction, general
Operation and maintenance, general
Flood control, Mississippi River and coastal emergencies
Other
Proprietary receipts from the public
Total—Corps of Engineers
Military retirement fund:
Payments to military retirement fund
Military retirement fund
Retired pay
Intrabudgetary transactions
Education benefits fund
Other
Proprietary receipts from the public
Total—Department of Defense—Civil
Department of Education:
Office of Elementary and Secondary Education:
Compensatory education for the disadvantaged
Impact aid
Special programs
Chicago litigation
Indian education
Total—Office of Elementary and Secondary Education
Office of Bilingual Education and Minority Languages
Affairs
Office of Special Education and Rehabilitative Services:
Education for the handicapped
Rehabilitation services and handicapped research
Payments to institutions for the handicapped
Office of Vocational and Adult Education
Office of Postsecondary Education:
College housing loans
Student financial assistance
Guaranteed student loans
Higher education
Howard University
Higher education facilities loans
Other
Total—Office of Postsecondary Education
Office of Educational Research and Improvement
Departmental Management
Proprietary receipts from the public
Total—Department of Education
Department of Energy:
Atomic energy defense activities
Energy programs:
General science and research activities
Energy supply, R and D activities
Uranium supply and enrichment activities
Fossil energy research and development
Naval petroleum and oil shale reserves
Energy conservation
Strategic petroleum reserve
Federal energy regulatory commission
Alternative Fuels Production
Nuclear waste disposal fund
Other
Total—Energy Programs
Power Marketing Administration
Departmental Administration
Proprietary receipts from the public
Intrabudgetary transactions
Total—Department of Energy
Table continued on next page.

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

Gross Applicable
Outlays Receipts Outlays

$15
93
166
46
5
327

$132
1,058
1,358

951

1,345

298
388

319
74

$21

$15
93
166
46
5
-21

$82

319
74
-82

306

3,234

2,732

1,614

(")
-11
4

(**)

-73
70

1
21

1,913

22,242

281
55
1

<")

(")

-5

332

5,197

160

135
125
7
144

1,466
1,537

1,934

$187

-187

187

3,047

2,814

10,285
19,009
2
-10,285

10,524
18,078
3
-10,524
-195

10,285
19,009
2
-10,285

-11
4
-1

(**)

$125

1
7

-73
70
-7

194

$125

10,524
18,078
3
-10,524
-195

1
6

48
-6

22,047

20,748

20,659

4,028

3,210

708
443

704
889

(**)

<")
18

5,197

4,843

160

141

1,466
1,537

1,339
1,405

122

1,276

1,231

5,220
2,779

-373
5,220
2,779

4,780
2,548

-558
4,780
2,548

412
169
-70
27

419
218
-85

412
169
-70
27

855

8,607

444

8,163

7,979

144
296
81

144
296
-81

190
285

-19
21
-3

1,611

18,770

524

18,246

17,537

882

7,913

7,451

69
163
62
30
14
31
30
7

(**)

29
21
457

1
530
200
102
23

<")

(")

859
4-19

21
1,618

225
30

39
744

1
1,596

-3
530
200
102
23

782

444

657

7,322

190
285
-80

737

16,800

7,451

763

697

2,025
1,137

1,912
1,053

326
187
340
562
99
1
405
310

316
149
271
782
95
1
446
263

316
149
271

29
21

326
187
340
562
99
1
405
310

457

6,154

5,984

186
30

1,380

192
387

1,345

1,188

387

-744
1

-188

3,298

813

15,647

4,486

782-

95
1
446
263,

1,088

258
377

3,291

-3,291
-91

4,379

10,688

377

-3,298
-188

-91

11,161

15,068

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Classification

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

Gross Applicable Outlays
Outlays Receipts

Department of Hearth and Human Services, Except Social
Security:
Public Health Service:
$45
Food and Drug Administration
Health Resources and Services Administration:
Public enterprise funds:
Medical facilities guaranteed and loan fund
1
Other
107
Health resources and services
94
Indian Health Service
52
Centers for Disease Control
119
National Institutes of Health:
97
Cancer Research
39
Heart, Lung, and Blood Research
„..
42
Diabetes, Digestive and Kidney Diseases
43
Neurological and Communicative Disorders and Stroke
51
Allergy and Infectious Diseases
27
General Medical Sciences
74
Child Health and Human Development
10
Other research institutes
57
Research resources
559
Other
86
Total—National Institutes of Health
Alcohol, Drug Abuse, and Mental Health Administration 26
Office of Assistant Secretary for Health
969
Total—Public Health Service
Health Care Financing Administration:
2,854
Grants to States for Medicaid
1,046
Payments to health care trust funds
17
Other
Federal hospital insurance trust fund:
4,516
Benefit payments
92
Administrative expenses and construction
4,607
Total—FHI trust fund
Federal supplementary medical ins. trust fund:
Benefit payments
Administrative expenses and construction

(**)

( *•)

3,066
73

$45

$466

$463

1
107
94
52

28
1,535
951
614

19
1,535
951
614

119
97
39
42
43
51
27
74
10
57

559

1,404 1,404
959
518
506
542
586
363
....
909
332
215
6,334 6,334

86
26

1,237 1,237
256
12

959
518
506
542
586
363
909
332
215

$424

-6
15
1,489
866
466
1,246
822
472
424
392
467
314
661
286
137
5,222

-6
6

256

1,200
211

11,408

9,888

$422

10
1,489
866
466
1,246
822
472
424
392
467
314
661
286
137
5,222
1,200
211

9,886

-18

27,435
21,298
99

969

11,420

2,854
1,046
17

30,462
26,463
53

27,435
21,298
81

4,516
92

52,022
707

49,967
836

4,607

52,730

50,803

3,066
73

33,682
1,265

29,937
900

3,140

34,947

30,837

11,664

144,654

130,454

Social Security Administration:
Payments to social security trust funds
Special benefits for disabled coal miners
Supplemental security income program

293
75
1,805

5,768
919
12,345

5,615
955
10,909

Total—Social Security Administration

2,173

19,032

17,480

Family Support Administration:
Program Administration
Family Support Payments to States
Low Income Home Energy Assistance
Refugee and Entrant Assistance
Community Services
Interim assistance to states for legalization
Other
Total—Family Support Administration

12
794
32
33
34
9
4
918

12
794
32
33
34
9
4

78
10,764
1,585
321
408
10
90
13,256

56
10,540
1,829
387
361
137

918

78
10,764
1,585
321
408
10
90
13,256

13,311

Human Development Services:
Social services
Human development services
Payments to states for foster care and adoption assistance

172
233
73

2,666
2,216
1,004

2,688
1,959
802

478

5,886

5,448

-54

-54
-803

117

117
-8,819

149

....
6,553

149
-6,553

155,431

6,537

148,893

Total—FSMI trust fund
Total—Health Care Financing Administration

Total—Human Development Services
Departmental management
' Proprietary receipts from the public
Intrabudgetary transactions:
Payments for health insurance for the aged:
Federal supplementary medical insurance trust fund
Payments for tax and other credits:
Federal hospital insurance trust fund
Total—Department of Health and Human Services,
Except Social Security

.. ..
....
....

$803

.. .

8,819

-978

-978 -25,418 -25,418 -20,299 -20,299

-68

-68 -1,125 -1,125 -999 -999

15,101

804

Table continued on next page.

14,298

167,822

8,831

158,991

30,837

-18

. ..
. . .

130,472

2,688
1,959
802
5,448

Table 5. Outlays of the U.S. G o v e r n m e n t , S e p t e m b e r 1 9 8 8 a n d Other Periods (in millions)—Continued

Classification

Department of Health and Human Services,
Social Security:
Federal old-age and survivors insurance trust fund:
Benefit payments
Administrative expenses and construction
Payment to railroad retirement account
Interest on normalized tax transfers
Total—FOASI trust fund
Federal disability insurance trust fund:
Benefit payments
Administrative expenses and construction
Payment to railroad retirement account
Interest on normalized tax transfers

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

$16,326
120

$16,326 $192,541
120
1,730
2,790
836

$192,541 $182,055
1,730
1,542
2,790
2,557
836
625

$182,055
1,542
2,557
625

16,446

16,446 197,897

197,897 186,780

186,780

1,788
32

1,788 21,416
32
803
61
80

21,416 20,436
803
738
61
57
80
60

20,436
738
57
60

Total—FDI trust fund

1,820

Proprietary receipts from the public
Intrabudgetary transactions 5

-293

Total—Department of Health and Human Services,
Social Security
Department of Housing and Urban Development:
Housing Programs:
Public enterprise funds:
Federal Housing Administration fund
Housing for the elderly or handicapped fund
Other
Rent supplement payments
Homeownership assistance
Rental housing assistance
Rental housing development grants
Low-rent public housing
Public housing grants
College housing grants
Lower income housing assistance
Supportive housing demonstration program
Other

1,820

(")
17,973

(")

636
24

$587
45

-2
4
13
82
3
57
37
1
766

(")

22,360

(**)

202,456

202,422

5,734
929
86
48
182
638
66
773

6,289
525
64

-555
404
22
48
182
638
66
773

214,178

1,134
322
-34
47
177
628
66
776
261
20
9,133

17,973

214,178

49
-21
-8
4
13
82
3
57
37
1
766

7,319
825
29
47
177
628
66
776
261
20
9,133

(**)

$6,184
503
63
....

-33
-5,614

-5,614

-6,079

21,290

$33

(**)
-6,079

-293

(")

21,290

(**)

<")

20
8,125

-44

6
1,628

638

6
991

19,304

6,750

12,554

16,556

6,878

9,678

Public and Indian Housing:
Payments for operation of low-income housing projects
Low-rent housing—loans and other expenses

194
90

194
77

1,489
1,272

1,489
1,173

1,388
1,474

118

1,388
1,356

Total—Public and Indian Housing

284

271

2,760

2,662

2,862

118

2,744

8
49

9
54

-1
-5

118
627
491

309
719

-191
-92
491

138
211
-25

601
398

-463
-187
-25

Total—Housing Programs

Government National Mortgage Association:
Management and liquidating functions fund
Guarantees of mortgage-backed securities
Participation sales fund
Total—Government National Mortgage Association ...
Community Planning and Development:
Public enterprise fund
Community Development Grants
Urban development action grants
Rental rehabilitation grants
Other
Total—Community Planning and Development
Management and administration
Other
Total—Department of Housing and Urban Development

(")

(**)

57 62

-5

6 13
275
15
18
8
323

11
7
2,310

726

Table continued on next page.

1,236 1,028

-7
275
15
18
8

99 312
3,044
216
114
53

310

3,525

11
7

297
22

1,584

27,145

312

8,189

208

-675

323 998

-213
3,044
216
114
53

74 162
2,992
354
99
27

3,213

3,547

297
22

308
25

18,956

23,621

(**)

162

-88
2,991
354
99
27
3,384
308
25

8,157

15,464

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Classification

Department of the Interior:
Land and minerals management:
Bureau of Land Management:
Management of lands and resources
Payments in lieu of taxes
,
Other
Minerals Management Service
Office of Surface Mining Reclamation and Enforcement .
Total—Land and minerals management

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

$66
104
10
52
26

$538

$450

103
171
561
349

105
165
541
325

258

1,723

1,586

713
151
185
451
157

$84

629
151
185
451
136

718
133
197
400
153

105

1,552

1,601

Water and science:
Bureau of Reclamation:
Construction program
Operation and maintenance
Other
Geological Survey
Bureau of Mines
Total—Water and science

89
15
190
27
12

$26

62
15
190
27
10

332

304

1,657

Fish and wildlife and parks:
United States Fish and Wildlife Service
National Park Service

64
100

700

1,023

590
988

Total—Fish and wildlife and parks

164

1,723

1,577

101
8

963
89
368
94

963
89
368
66

930
88
311
71

930
88
311
60

1,485

1,401

1,390

344
86

460
75

Bureau of Indian Affairs:
Operation of Indian programs
Construction
Indian tribal funds
Other
Total—Bureau of Indian Affairs
Territorial and International Affairs
Departmental offices
Proprietary receipts from the public:
Receipts from oil and gas leases, national petroleum
reserve in Alaska
Other
Intrabudgetary transactions
Total—Department of the Interior
Department of Justice:
Legal activities
Federal Bureau of Investigation
Drug Enforcement Administration
Immigration and Naturalization Service
Federal Prison System
Office of Justice Programs
Other
Total—Department of Justice
Department of Labor:
Employment and Training Administration:
Training and employment services
Community service employment for older Americans
Federal unemployment benefits and allowances
State unemployment insurance and employment service
operation
Advances to the unemployment trust fund and other
funds
Other
Table continued on next page.

101
8
-26
5

1,514

(")

344
86

3_26

(")
156
-9

(**)
-156

-9

-12

725

7,036

105
109
37
90
58
33
-6
427

5,469

310
29
11

-10
13
5

910
105
109
37
90
62
33
-6
431

185

(")
3

635
133
197
400
133

103

1,498

$83

460
75

-1

1,750

-1,750

1,498

-1,498

-12

-34

5,152

6,668

1,204
1,384

977

1,216

506
963
984
341
87

506
963
941
341
87

412
689
764
237
78

412
689
724
237
78

5,426

4,373

3,701

3,545

324
131

370
108

-10

13
5

95
64

168
63

1,884

(")
43

-34
1,613

(**)
40

5,054

4,333

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Classification

Department of Labor:—Continued
Employment and Training Administration:—Continued
Unemployment trust fund:
Federal-State unemployment insurance:
State unemployment benefits
State administrative expenses
Federal administrative expenses
Veterans employment and training
Repayment of advances from the general fund
Railroad unemployment benefits
Other

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

$886
231
-17
10
2,271
6
7

$13,542
2,399
103
133
2,271
113
37

$15,370
2,333
68
133
2,433
164
24

Total—Unemployment trust fund 3,393 3,393 18,598 18,598

20,527 ....

20,527

Total—Employment and Training Administration 3,751 3,751 22,940 22,940

24,820

Labor-Management Services 4 4 65
Pension Benefit Guaranty Corporation
Employment Standards Administration:
Salaries and expenses
Special benefits
Black lung disability trust fund
Special workers compensation expenses
Occupational safety and health administration
Mine safety and health administration
Bureau of Labor Statistics
Departmental management
Proprietary receipts from the public
Intrabudgetary transactions

$129

14
107
55
6
22
12
7
10
156
-2,299

-71
14
107
55
6
22
12
7
10
-156
-2,299

445
195
216
639
75
226
164
169
147

159
-2,528
882

Total—Department of Labor 1,747 285 1,462 22,752
Department of State:
Administration of Foreign Affairs:
Salaries and expenses
Acquisition and maintenance of buildings abroad
Payment to Foreign Service retirement and disability
fund
Foreign Service retirement and disability fund
Other

$723

65
-278

195
216
639
75
226
164
169
147
-159
-2,528

176

$588

....

315
-2,786
24,356

903

57
-72
176
210
643
72
215
147
154
133
-315
-2,786
23,453

237
37

1,737
335

1,497
263

144
27
-2

230
287
20

301
240
33

2,334

360
341
60
52

360
341
60
52
-12
-348

International Organizations and Conferences 20 20 547 547
Migration and Refugee Assistance
24
International Narcotics Control
6
Other
6
Proprietary receipts from the public
-144
Intrabudgetary transactions

Department of Transportation:
Federal Highway Administration:
Highway trust fund:
Federal-aid highways
Other
Other programs

210
643
72
215
147
154
133

21,870

Total—Administration of Foreign Affairs 443 443 2,608 2,608

Total—Department of State

516

356

(**)

1,503
2
10

24
6
6
(**)
-144

378
87
69
-266

356

3,423

1,503
2
10

13,829
84
89

1,515 14,002

Total—Federal Highway Administration 1,515

378
87
69
-2
-266

12
-348

2,788

50
97

12,614
28
97

12,760

12,738

3,421

2,800

13,829

12,614

84
89
14,002

208

National Highway Traffic Safety Administration 17 17 206 206
Table continued on next page.

208

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued
This Month
Classification

Department of Transportation:—Continued
Federal Railroad Administration:
Grants to National Railroad Passenger Corporation.
Other

Gross Applicable
Outlays Receipts

Current Fiscal Year to Date
Outlays

Gross Applicable
Outlays Receipts

Outlays

Prior Fiscal Year to Date
Gross
Outlays

Applicable
Receipts

Outlays

$30

$29

$591
28

$42

$591
-14

$597
204

-$5

$597
209

619

577

802

-5

806

122
62
47

1,937
696
634

1,822
668
810

171
2

2,281
43

2,215
78

117
98
19
73

825
1,043
170
830

917
892
170
622

Total—Airport and airway trust fund

306
306

306

,868
2,868

2,868

2,602
602

2,602

Total—Federal Aviation Administration

•78
478

(**)

478

,192
5,192

5,192

4,895
895

Coast Guard:
Operating expenses
Acquisition, construction, and improvements
Retired pay
Other

144
65
29
7

(")

144
65
29
7

1,798
414
360
155

1,798
414
360
150

1,707
389
350
140

Total—Coast Guard

245 (**)

244

2,726 5

2,721

2,586 5

2,581

-10
230
117
136
-19

795 263
227
98
123

531
227
98
110
-55

-16

-8

26,404

25,785

-1,270

-1,353

231
361
56

272

272
919

(**)

Total—Federal Railroad Administration
Urban Mass Transportation Administration:
Formula grants
Discretionary grants
,
Other
Federal Aviation Administration:
Operations
Other
Airport and airway trust fund:
Grants-in-aid for airports
Facilities and equipment
Research, engineering and development
Operations

Maritime Administration:
Public enterprise funds
Operating-differential subsidies
Other
Other
Proprietary receipts from the public
Intrabudgetary transactions

Total—Department of Transportation
Department of the Treasury:
Departmental Offices
Financial Management Service:
Salaries and expenses
Claims, Judgements, and Relief Acts
Energy Security Reserve
Other

122
62
47
171
2

16
23
4
12

(")

(**)
2,570

-8
23
4
10
-4

417
230
117
148

(**)

-16

2,511

26,908

-10

- 1,270

20
43
11

20
43
11
4

Total—Financial Management Service
Federal Financing Bank
Bureau of Alcohol, Tobacco and Firearms:
Salaries and expenses
Internal Revenue collections for Puerto Rico ... .
United States Customs Service
Bureau of Engraving and Printing
United States Mint
Bureau of the Public Debt

(")

2,184

2,417

16
12
78
-6
-26
15

Table continued on next page.

....

(")

(**)

427
12
19

504

250

1,409

80
33

1,772

919

-233

16,490

-213

13,976

16
12
78
-6
-26
15

213
210

179
225

1,347

1,029

-30
79
202

-41
71
195

16,703

1.822
668
810

(")

(**)

13
55

2,215
78

4,895

1,707
389
350
135

-8
354

14,454

25,431

-478
179
225
1,029
-41
71
195

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Classification

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

Department of the Treasury:—Continued
Internal Revenue Service:
Salaries and expenses
Processing tax returns
Examinations and appeals
Investigation, collection and taxpayer service
Payment where earned income credit exceeds liability for tax
Refunding internal revenue collections, interest
Other

$1
142
121
117
19
133
1

Total—Internal Revenue Service

533

33
16

United States Secret Service ..
Comptroller of the Currency...
Interest on the public debt:
Public issues (accrual basis)
Special issues (cash basis)
Total—Interest on the public debt

14,615
636
15,250

Other
Proprietary receipts from the public ...
Receipts from off-budget Federal entities
Intrabudgetary transactions

-2,399

Total—Department of the Treasury

15,780

Environmental Protection Agency:
Salaries and expenses
Research and development
Abatement, control, and compliance ...
Construction grants
Hazardous substance superfund
Other
Proprietary receipts from the public ...
Intrabudgetary transactions
Total—Environmental Protection Agency
General Services Administration:
Real property activities
Personal property activities
Information Resources Management Service .
Federal property resources activities
General activities
Proprietary receipts from the public
Other
Total—General Services Administration
National Aeronautics and Space Administration:
Research and development
Space flight, control, and data communications.
Construction of facilities
Research and program management
Other
Total—National Aeronautics and Space
Administration
Office of Personnel Management:
Government payment for annuitants, employees
health benefits
!
Payment to civil service retirement and disability fund
Civil service retirement and disability fund
Employees health benefits fund
Employees life insurance fund
Retired employees health benefits fund
Other
Intrabudgetary transactions:
Civil service retirement and disability fund:
General fund contributions
Other
Total—Off Ice of Personnel Management.

.. .

315

58
17
53
249
87
3

(**)

$87
1,684
1,791
1,422
2,698
1,681
8

532
33

$80
1,344
1,576
1,162
1,410
1,941
4

....

$87
1,684
1,791
1,422
2,698
1,681
1

9,370

9,363

7,517

7,513

382
217

209

382
8

312
184

207

312
-23

14,615
636

168,926
45,219

157,170
38,220

15,250

214,145

195,390

3
315

33
-3,254
-916
-19,601

99
-685
-20,083

202,472

197,935

763
204
598
2,514
830
148
-59
-125

674
206
576
2,920
540
657

4,872

4,924
-84
133
-56
39
125

101
-3

332
102
-103
6
141
-101
3

285

157

2,916
4,362
166
1,648

2,436
3,518
149
1,409

$1
142
121
117
19
133

2,735

(**)
9

3,254

-2,399

-916
-19,601

13,045

222,644

58
17
53
249
87
3
-9

763
204
598
2,514
830
148

459

4,932

273
-48
33
1
11

332
102
103
6
141

12
2

273
-48
33
1
11
-12
-2

255

187

233
147
17
132

2,916
4,362
166
1,648

233
147
17
132

(")
59

-125

467

268

20,172

2,925

17,590

1
21

-650

$80
1,344
1,576
1,162
1,410
1,941

(**)

99
-2,925
-685
-20,083
180,345
674
206
576
2,920
540
656
-21
-650

4,903

78
6

-84
133
-56
39
125
-78
-6

-79

2,436
3,597
149
1,409

(**)
530

530

9,092

7,512

195
15,572
2,353
737
99
2
3
-26

195
15,572
2,353
-276
-22
1
-26

2,113
15,572
28,140
8,751
1,053
13
72

2,113
15,572
28,140
-359
-743
1
72

1,592
15,803
25,798
7,269
987
13
104

-15,572
-3

-15,572
-33

-15,803
-33

2,222

40,110

29,191

35,730

1,012
121
1

-15,572
-3
3,357

1,135

Table continued on next page.

9,110
1,796
12

10,918

-79

7,065
1,689
10

7,591

1,592
15,803
25,798
204
-702
2"
104

-15,803
-33
8,764

26,966

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Classification
Gross Applicable
Outlays
Outlays Receipts
Small Business Administration:
Public enterprise funds:
Business loan and investment fund
Disaster loan fund
Other
Other

Total—Small Business Administration
Veterans Administration:
Public enterprise funds:
Loan guaranty revolving fund
Direct loan revolving fund
Other
Compensation and pensions
Readjustment benefits
Medical care
Medical and prosthetic research
General operating expenses
Construction projects
Post-Vietnam era veterans education account
Insurance funds:
National service life
United States government life
Veterans special life
Other
Proprietary receipts from the public:
National service life
United States government life
Other
Intrabudgetary transactions
Total—Veterans Administration
Independent agencies:
Action
Board for International Broadcasting
Corporation for Public Broadcasting
District of Columbia:
Federal payment
Proprietary receipts from the public
Equal Employment Opportunity Commission
Export-Import Bank of the United States
Federal Communications Commission
Federal Deposit Insurance Corporation
Federal Emergency Management Agency:
Public Enterprise Funds
Disaster Relief
Salaries and expenses
Emergency management and planning assistance.
Emergency food distribution and shelter program .
Federal H o m e Loan Bank Board:
Public enterprise funds:
Federal H o m e Loan Bank Board revolving fund .
Federal Savings and Loan Insurance Corp. fund
Federal Trade Commission
Intragovernmental agencies:
Appalachian Regional Commission
Washington Metropolitan Area Transit Authority...
Other
Interstate Commerce Commission
Legal Services Corporation
National Archives and Records Administration
National Credit Union Administration:
Credit union share insurance fund
Central liquidity facility
Other

Gross Applicable
Outlays Receipts

-$10
-362

29
303

1,616

-54

2,067

2,139

-72

1,649
95
491

1,160
-80
4
15,328
725
10,045
197
781
641
303

2,342
17
468
14,426
812
9,500
195
720
535
284

1,959
50
498

382
-33
-29
14,426
812
9,500
195
720
535
284

1,096
37
-76
120

1,034
40
76
70

$959

293
45
303

641
16

124

-26

1,562

213
1
38
1,792
40
825
18
25
52
17
84
3
7
15

-83
3
37

295
-2
1
1,792
40
825
18
25
52
17

2,809
15
495
15,328
725
10,045
197
781
641
303

1,096
37
84
120

-$38
-348

18
282

1,034
40
-78
70

3
3
15

-33

422

(**)

(")

-38
-6

433
-184

-433
-184

-88

3,091

32,493

3,249

29,244

30,431

153

159

194
214

156
200

550
-30

560

176

158

3,050

-894

2,709

(•*)

14
31

160

550

11
376
8

146
17

2,101

1,668

17
10
13
18
2

6
72

(")

-442

(**)

375

-375
-88

3,479

26,952

293

560
-293

5,009

-2,300

12,603

2,146

9,031

10,468

-1,438

-22
10
13
18
2

177
187
145
299
120

376

-199

198
219
120
297
114

405

-207

2,156

187
145
299
120

158

219
120
297
114

-12

3,001

15,635

7,558

8,077

7,188

2,421

4,767

150
49

148
49

150
52

3
43
306
102

3
42
309
96

328
39
3

3
49
4

Table continued on next page.

(**)

101

(**)

442

-422

14,748

3
49
4
6
8

176

154

11
230
-9
433

(**)

6
-5
5

Outlays

730
14

$921

-30
2
20

Applicable
Receipts

$1,395

-$19

3,073

Gross
Outlays

368
32
282

$83
40
1

3,123

Outlays

$1,385

$64
10
4
20

-6

Prior Fiscal Year to Date

Current Fiscal Year to Date

This Month

(")
-13
5

3
43
306
102

(**)

351
86

344
308
1

(")

-222

-2

148
52

3
42
309
96
321
236
2

7
-198

Table 5. Outlays of the U.S. G o v e r n m e n t , S e p t e m b e r 1 9 8 8 a n d Other Periods (in millions)—Continued

Classification

Independent agencies:—Continued
National Foundation on the Arts and the Humanities:
National Endowment for the Arts
National Endowment for the Humanities
Institute of Museum Services
National Labor Relations Board
National Science Foundation
Nuclear Regulatory Commission
Panama Canal Commission
Postal Service:
Public Enterprise Funds
Payment to the Postal Service Fund
Railroad Retirement Board:
Federal windfall subsidy
Federal payments to the railroad retirement accounts ...
Payment to railroad unemployment insurance trust fund
Milwaukee railroad restructuring, administration
Railroad retirement accounts:
Social Security Equivalent Benefit Account
Benefits payments and claims
Advances to the railroad retirement account from the
FOASI trust fund
Advances to the railroad retirement account from the
FDI trust fund
Disbursements for the payment of FOASI benefits...
Disbursements for the payment of FDI benefits
Administrative expenses
Interest on refunds of taxes
Other
Intrabudgetary Transactions:
Railroad retirement account:
Payments from other funds to railroad retirement
trust funds
Interest on advances to railroad accounts
Federal payments to the railroad social security
equivalent benefit account
Federal payments to the rail industry pension fund ..

This Month

Current Fiscal Year to Date

Prior Fiscal Year to Date

Gross Applicable
Outlays
Outlays Receipts

$21
13

(**)

9
162
3
-149
-9

9
162
-149
-9

3,969 $1,751

2,218

$167
134
21
132
1,665
232
151
33,349
517

$113
31,636

$167
134
21
132
1,665
232
38
1,712
517

$155
135
20
127
1,562
393
456

$441

30,783 29,840
650

$155
135
20
127
1,562
393
15
943
650

28
2

349
248
-1

373

(**)

(")

325
206

3,854
2,484

3,834
2,284

-68

-802

-757

-3
68
3
6
7

<")

<">

-42
805
41
62
31
2

-44
756
42
58
29
1

-5

-2,851
-15

-2,614
-8

-13

162
-13

224
-242

224 162
-242

373
91

....

Total—Railroad Retirement Board

569

4,147

4,147 4,196

4,196

Securities and Exchange Commission
Smithsonian Institution
Tennessee Valley Authority
United States Information Agency
Other independent agencies

9
23
487
74
71

346

9
23
140
74
50

126
260
6,015
843
682

4,926

126 108
260
1,089
843
585

11,003

4,079

6,924

84,516

61,156

Total—Independent agencies
Undistributed offsetting receipts:
Other Interest
Employer share, employee retirement:
Legislative Branch:
United States Tax Court:
Tax court judges survivors annuity fund
The Judiciary:
Judicial survivors annuity fund
Department of Defense—Civil:
Military retirement fund
Department of Health and Human Services:
Federal old-age and survivors insurance trust fund
(OFF-BUDGET)
Federal disability insurance trust fund
(OFF-BUDGET)
Federal hospital insurance trust fund
Department of State:
Foreign Service retirement and disability fund
Office of Personnel Management:
Civil Service retirement and disability fund
Subtotal

(")

(**)
97

23,361

-327

5,637
1
46

108
242
1,091
830
690

69,449

55,184

14,266

903

-903

-1

(")
(**)

-1,602

242
6,728
831
736

(**)

-1

18,382 -18,288

-18,288

-1,602

-18,382

327

-3,716

3,011

-3,011

-31

-159

-355
-1,804

-289
-1,700

-4

-62

-58

-2,578

-8,708

-7,212

-4,701

-33,028

-30,559

Table continued on next page.

Table 5. Outlays of the U.S. Government, September 1988 and Other Periods (in millions)—Continued

Gross Applicable
Outlays Receipts
Undistributed offsetting receipts:—Continued
Interest received by trust funds:
The Judiciary:
Judicial survivors annuity fund
Department of Defense—Civil:
Education benefits fund
Military retirement fund
Soldiers' and Airmen's H o m e permanent fund
Corps of Engineers
Department of Health and H u m a n Services:
Federal old-age and survivors insurance trust fund
(OFF-BUDGET)
Federal disability insurance trust fund
(OFF-BUDGET)
Federal hospital insurance trust fund
Federal supplementary medical insurance trust fund .
Department of Labor:
Unemployment trust fund
Department of State:
Foreign Service retirement and disability fund
Department of Transportation:
Airport and airway trust fund
Highway trust fund
Environmental Protection Agency:
Other
Post-closure liability trust fund
Office of Personnel Management fund:
Civil Service retirement and disability fund
Veterans Administration:
United States government life insurance fund
National service life insurance fund
Independent agencies:
Railroad Retirement Board:
Railroad retirement account
Other
Subtotal
Unrealized Discount on trust fund investments
Rents and Royalties on the Outer Continental Shelf lands
Sale of major assets

Prior Fiscal Year to Date

Current Fiscal Year to Date

This Month
Classification

Gross Applicable Outlays
Outlays Receipts

Outlays

Gross Applicable
Outlays Receipts

Outlays

-$10

(**)

$12
-4
-28

-46
4,450
-17
-61

-46
-4,450
-17
-61

-31
3,219
-18
-6

-31
-3.219
-18
-6

-99

-6,758

-4,495

1
-36
-39

-657
-5,169
-828

-795
-3,994
-1,019

-22

-2.341

-1,909

(•*)

(**)

-358

-313

-5
-35

-893
-1,193

-880
-1,278

8
-1

-2

-31

(**)

-3

(**)

-17,348

-15,537

15,537

(**)

-1

-16
-982

-18
-947

-21
-55

-573
-126

-454
-74

454
-74

-356

-41,822

-34,999

-61
-190

-74
$3,548

-74
-3,548

-44

$190

-74,924

3,549

- 78,473

- 65,601

-61

$4,021
1,875

-44
-4,021
-1,875

6,799

- 72,400

Total—Undistributed offsetting receipts

-5,119

190

-5,309

Total outlays

105,195

17,606

87,588

1,233,998 169,943 •1,064,055 1,159,424 155,620 •1,003,804

Total On-Budget

87,677

17,606

70,071

1,031,307 169,943

Total Off-Budget

17,518

(**)

17,518

202,691

(**)

861,364

965,558 155,587

809,972

202,691

193,865

193,832

+ 10,214 I

•-155,102

•-149,661

Total On-Budget

+ 5,515;

-193,901

-169,231

Total Off-Budget

+ 4,6991

+ 38,800

+ 19,570

Total Surplus ( + ) or Deficit

MEMORANDUM
Receipts offset against outlays (In millions)
Current

Proprietary receipts $34,630 $35,469
Receipts from off-budget Federal entities
Intrabudgetary transactions

Fiscal Year
to Date

Comparable Period
Prior Fiscal Year

916
159,508

685
145,727

Total receipts offset against outlays 195,053 181,881

'A $35 million payment to the foreign service retirement and disability fund was erroneously reported as operating expenses, Agency for International De
2
The Fiscal Year 1988 Appropriation Act for the Commodity Credit Corporation provided that $126,108,000.00 of the Corporation's appropriation would be used to cover expenses applicable to
"special activities (wool program)" This advance appropriation was not credited to the wool program as a non-expenditure transfer but was recorded as a receipt netted against outlays.
includes adjustments between appropriations.
includes prior month adjustments.
includes FICA and SECA tax credits, non-contributary military service credits, special benefits for the aged, and creditforunnegotiated OASI benefit checks.
•The outlays by month for FY 1987 have been increased by a net of $737 million to reflect reclassification of the Thrift Savings Fund receipts of $734 million and Federal Retirement Thrift Invest
ment Board (FRTIB) administrative expenses of $6 million to a non-budgetary status/The FRTIB outlays by month for FY 1988 have been adjusted by a net of $1,084 million.
No transactions.
("(Less than $500,000.
Note: Details may not add to totals due to rounding.
Source Financial Management Service, Department of the Treasury

Table 6. Means of Financing the Deficit or Disposition of Surplus by the U.S. Government, September 1988 and Other Periods
(in millions)

Assets and Liabilities
Directly Related to
Budget and Off-budget Activity

Net Transactions
(-) denotes net reduction of either
liability or asset accounts
Fiscal Year to Date

Account Balances
Current Fiscal Year

Beginning of

This Month

Liability accounts
Borrowing from the public:
Public debt securities, issued under general financing authorities:
Obligations of the United States, issued by:
United States Treasury
Federal Financing Bank
Total public debt securities.
Agency securities, issued under special financing authorities
(See Schedule B. For other agency borrowing, see Schedule C)
Total federal securities
Deduct:
Federal securities held as investments of government accounts
(See Schedule D)
Total borrowing from the public

Close of
This month

This Year

Prior Year

$26,538
1
-155

$252,061
-155

$224,973

$2,335,277
15,000

$2,560,800
15,000

$2,587,338
1
14,845

26,384

251,906

224,973

2,350,277

2,575,800

2,602,183

2,106

7,469

269

4,929

10,291

12,398

28,490

259,375

225,242

2,355,206

2,586,091

2,614,581

13,824

93,204

73,525

457,444

536,824

550,649

14,665

166,171

151,717

1,897,761

2,049,267

2,063,932

-1,174

This Year

This Month

-4,201

247

-9,702

-12,729

-13,902

13,492

161,970

151,964

1,888,060

2,036,538

2,050,030

6,499

2,354

2,232

324

-683
2,489

-609
-3,265

-1,830
-2,421

31,712
6,270
9,114
13,633

27,567
6,311
9,188
7,879

34,067
6,322
8,505
10,368

Total liability accounts .

21,808

160,504

150,269

1,948,788

2,087,484

2,109,292

Asset accounts (deduct)
Cash and monetary assets:
U.S. Treasury operating cash:3
Federal Reserve account
Tax and loan note accounts .

8,633
22,811

3,904
4,059

1,606
3,446

9,120
27,316

4,390
8,564

13,024
31,375

31,444

7,963

5,052

36,436

12,954

44,398

-5

784

9,078
-5,018

9,058
-5,018

9,074
-5,018

-5

784

4,060

4,040

4,056

-1,854

1,186
- 2,366

19,699
3,230
-12,855

19,699
3,383
-14,756

19,699
3,423
-14,709

4
739

-2
588

-66
257

-28
1,020

-62
996

-918

-594

10,265

9,318

9,347

-35
561

-354
906

-405
-1,908

642
9,408

323
9,754

288
10,314

32,014

7,592

2,928

60,811

36,390

68,403

419

-1,079

-1,653

5,714

4,216

4,635

32,432

6,513

1,275

66,525

40,606

73,038

-10,624

+ 153,991

+ 148,993

+ 1,882,263

+ 2,046,878

+ 2,036,254

Transactions not applied to current year's surplus or deficit
(See Schedule A for details)

410

1,111

668

701

1,111

Total budget and off-budget federal entities
[Financing of deficit ( + ) or disposition of surplus (-)]

-10,214

+ 155,102

+ 149,661

+ 2,047,579

+ 2,037,365

Premium & discount on public debt securities
Total borrowing from the public less premium & discount ..
Accrued interest payable to the public
Allocations of special drawing rights
Deposit funds 2
Miscellaneous liability accounts (includes checks outstanding etc.).

Balance
Special drawing rights:
Total holdings
S D R certificates issued to Federal Reserve Banks
Balance
Reserve position on the U.S. quota in the IMF:
U.S. subscription to International Monetary Fund:
Direct quota payments
Maintenance of value adjustments
Letter of credit issued to IMF
Dollar deposits with the IMF
Receivable/payable (-) for interim maintenance of value adjustments

40
47
-35
-24

Balance
Loans to International Monetary Fund
Other cash and monetary assets
Total cash and monetary assets.
Miscellaneous asset accounts
Total asset accounts
Excess of liabilities ( + ) or assets (-) .

193

+ 1,882,263

includes a redemption of $155 million for Federal Financing Bank obligations not reported in the September 1988 Daily Treasury Statement or the Monthly Statement of the Public Debt of the
U S These publications will be adjusted in October 1988.
^ h e outlays by month for FY 1987 have been increased by a net of $737 million to reflect reclassification of the Thrift Savings Fund receipts of $734 million and Federal Retirement Thrift Investment Board (FRTIB) administrative expenses of $6 million to a non-budgetary status. The FRTIB outlays by month for FY 1988 have been adjusted by a net of $1,084 million.
3
Major sources of information used to determine Treasury's operating cash include the Daily Balance Wires from Federal Reserve Banks, reporting from the Bureau of Public Debt, electronic
transfers through the Treasury Financial Communications System and reconciling wires from Internal Revenue Service Centers. Operating cash is presented on a modified cash basis, deposits are
reflected,
as received;
and
withdrawals
are to
reflected
as processed.
Note: Details
may not
add
to totals due
rounding.
... No transactions.
Source:
Financial Management Service, Department of the Treasury.

Table 6. Schedule A—Analysis of Change in Excess of Liabilities of the U.S. Government, September 1988 and
Other Periods (in millions)
Fiscal Year to Date
Classification

Excess of liabilities beginning of period:
Based on composition of unified budget in preceding period
Adjustments during current fiscal year for changes in
composition of unified budget:
Classification of FDIC securities as budgetary transactions
Classification of FSLIC securities as budgetary transactions
Reclassification of Federal Retirement Thrift Investment
Board to a non-budgetary status
Excess of liabilities beginning of period (current basis)

This Month

$2,046,878

This Year

Prior Year

$1,880,606

$1,732,827

442
920
737
2,046,878

1,882,263

1,733,270

Budget surplus (-) or deficit:
Based on composition of unified budget in prior fiscal year
Changes in composition of unified budget

-10,214

155,102

149,661

Total surplus (-) or deficit (Table 2)

-10,214

155,102

149,661

Total—on-budget (Table 2)

-5,515

193,901

169,231 I

Total—off-budget (Table 2)

-4,699

-38,800

-19,570 \

-37
-330
-37
-6

-470
-539
-37
-63

-458 \

-410

-1,111

2,036,254

Transactions not applied to current year's surplus or deficit:
Proceeds from sales of loan assets with recourse
Profit on sale of gold
Net gain (-)/loss for IMF loan valuation adjustment
Total—transactions not applied to current year's
surplus or deficit
Excess of liabilities close of period

-173 \
-37 | |

-668 ;
1,882,263 iii

Table 6. Schedule B—Securities issued by Federal Agencies Under Special Financing Authorities, September 1988 and
Other Periods (in millions)
Net Transactions
(-) denotes net reduction of
liability accounts

Account Balances
Current Fiscal Year

Fiscal Year to Date

Beginning of

This Month
This Year
Agency securities, Issued under special financing authorities:
Obligations of the United States, issued by:
Export-Import Bank of the United States
Federal Deposit Insurance Corporation
Federal H o m e Loan Bank Board:
Federal Savings and Loan Insurance Corporation
Obligations guaranteed by the United States, issued by:
Department of Defense:
Family housing mortgages
Department of Housing and Urban Development:
Federal Housing Administration
Department of the Interior:
Bureau of Land Management
Department of Transportation:
Coast Guard:
Family housing mortgages
Obligations not guaranteed by the United States, issued by:
Department of Defense:
Homeowners assistance mortgages
Department of Housing and Urban Development:
Government National Mortgage Association
Independent agencies:
Postal Service
Tennessee Valley Authority
Total agency securities
• ...No transactions.
('•)Less than $500,000.
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

Prior Year

This Year

This Month

(**)

Close of
This m o n t h

(**)

-$108

$682

-242

2,214

8,814

920

-5

-22

-59

178

115

120

-2

(**)

(**)
5

-4

2,106

$200
920

$990

$882

7,520

9,733

-1,965

-200

1,965

-245

250
1,380

269

4,929

10,291

12,398

7,469

Table 6. Schedule C (Memorandum)—Federal Agency Borrowing Financed Through the Issue of Public Debt Securities,
September 1988 and Other Periods (in millions)
Account Balances
Current Fiscal Year

Transactions
Classification

Fiscal Year to Date

Beginning of

This Month
This Year
Borrowing from the Treasury:
Housing and Other Credit Guarantee Program, AID
Commodity Credit Corporation
Federal Emergency Management Agency:
National Insurance Development Fund
Federal Financing Bank
Federal Housing Administration:
General insurance
Special risk insurance
General Services Administration:
Pennsylvania Avenue Development Corporation
Rural Communication Development Fund
Rural Electrification Administration
Rural Telephone Bank
Secretary of Agriculture, Farmers Home Administration:
Rural housing insurance fund
Agricultural credit insurance fund
Rural development insurance fund
Federal Crop Insurance Corp
Secretary of Education:
College housing loans
Secretary of Energy:
Bonneville Power Administration
Secretary of Housing and Urban Development:
Housing for the elderly or handicapped
Low-Rent Public housing
Secretary of the Interior:
Bureau of Mines, helium fund
Railroad retirement account
Railroad retirement social security equivalent fund ........
Secretary of Transportation:
Aircraft purchase loan guarantee program
Federal ship revolving fund
Railroad revitalization and improvement
Regional rail reorganization
Smithsonian Institution:
John F. Kennedy Center parking facilities
Tennessee Valley Authority
Veterans Administration:
Veterans direct loan program
Ocean Freight
Total agency borrowing from the Treasury
financed through Issues of public debt securities.

Prior Year

This Year

This Month

Close of
This month

$3
441

$25
-9,210

$20
-3,831

$20
20,969

$42
11,318

$45
11,759

-3,505

16
-9,652

21
-812

97
140,952

113
134,805

113
131,300

460

125

1,596
1,935

2,026
1,937

2,056
1,937

3
-2

340
330
335

-185

196

-1,995

25
7,865
759

295
81
680

1,740
2,690
1,035

5,981
10,756
2,896
113

5,936
10,507
3,241
113

6,276
10,837
3,576
113

-944

-538

2,049

1,105

-52

385

1,844

1,977

1,792

5,901

6,226
800

6,226
850

252
2,128
2,144

252
2,128
2,059

252
2,128
2,255

325
850

111
9

6
-36

25
7,865
759

95
6
-36

550
810

141
-11
-955
-12
32

420

515

128

20
150

515
6
92
20
150
1,730

1,730
22

1,730

-22
-16,961

1,407

210,803

195,837

193,842

Table 6. Schedule C (Memorandum)—Federal Agency Borrowing Financed! Through the Issue of Public Debt Securities,
September 1988 and Other Periods (in millions)—Continued
Account Balances
Current Fiscal Year

Transactions
Classification

Fiscal Year to Date

Beginning of

This Month
This Year

Prior Year

This Year

Close of
This m o n t h

This Month

Borrowing from the Federal Financing Bank:
Funds Appropriated to the President:
$16,088
$19,164
$19,038
-$2,950
$367
-$3,076
Foreign military sales
1
1
1
Overseas Private Investment Corporation
Department of Agriculture:
23,345
23,296
25,438
49
-2,094
-248
Rural Electrification Administration
Farmers H o m e Administration:
27.625
27.625
-385
28,010
-385
Agriculture Credit Insurance Fund
4,900
5.868
-968
170
8,048
-3,148
25.971
Rural Development Insurance Fund
25,971
-150
28,951
-2,980
1.759
1,759
40
1,788
-29
Rural housing Insurance Fund
Department of the Navy
4,910
4,940
4,940
-30
-30
-30
Department of Education:
50
50
50
Student Loan Marketing Association
Department of Energy
182
192
182
-11
-25
Department of Health and H u m a n Services, Except Social Security:
Medical Facilities Guarantee and Loan Fund
2,037
2,037
-37
-37
2,074
318
322
-4
-37
22
355
Department of Housing and Urban Development:
Low Rent Housing Loans and Other Expenses
59
-1
-2
-2
60
59
Community Development Grants
Department of Interior:
46
-5
55
48
-2
-9
Territorial and International Affairs
Department of Transportation:
-7
387
387
395
-8
Grants to National Railroad Passenger Corporation
90
809
899
899
-80
General Services Administration:
Federal Buildings Fund
-142
-149
1,662
1,521
-42
1,563
National Aeronautics and Space Administration:
Space Flight, Control and Data Communications
-269
-1,506
-1,805
12,463
11,226
10,958
Small Business Administration:
7
7
111
118
118
Business Loan and Investment Fund
1,238
1,499
4,353
5,592
5,592
Independent Agencies:
180
1,084
1,293
18,210
19,114
19,293
177
177
177
Export-Import Bank of the United States
National Credit Union Administration
-4,037
150,271
-11,025
475
157,258
146,234
Postal Service
Tennessee Valley Authority
.Washington
.. No transactions.
Metropolitan Transit Authority
Note:
This table
has the
beenFederal
expandedFinancing
to include lending
Total
borrowing
from
Bank by the Federal Financing Bank accomplished by the purchase of agency financial assets, by the acquisition of agency debt securities,

and by direct loans on behalf of an agency. The Federal Financing Bank borrows from Treasury and issues its own securities and in turn may loan these funds to agencies in lieu of agencies borrowing
directly through Treasury or issuing their own securities.
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

Table 6. Schedule D—Investments of Federal Government Accounts in Federal Securities, September 1988 and
Other Periods (in millions)
Securities Held as Investments
Current Fiscal Year

Net Purchases or Sales (-)
Classification

Fiscal Year to Date

Beginning of

This Month
This Year
Federal funds:
Department of Agriculture
Department of Commerce
Department of Energy
Department of Health and Human Services
Department of Housing and Urban Development:
Federal Housing Administration:
Federal Housing Administration fund:
Public debt securities
Agency securities
Government National Mortgage Association:
Management and liquidating functions fund:
Public debt securities
Agency securities
Guarantees of mortgage-backed securities:
Public debt securities
Agency securities
Participation sales fund:
Public debt securities
Agency securities
Other
Department of the Interior:
Public Debt Securities
Agency Securities

(**)
-8

(**)

$4
4
256
-12

-277
-134

Prior Year

This Year

This Month

Close of
This month

$2
4
84
5

$6
15
1,506
12

$8
20
1,771

$9
19
1,763

957

6,482
134

6,205

(**)

-463

-50
-6

-346
-2

71
72

484
65

22
65

4
1

103
-5

221
8

1,522
17

1,622
11

1,625
12

-79

2,164
12

-2,164
-12
193

178

193

21
2

-220
2

-2,757

1,249

1,008

1,029
2

Department of Labor

284

479

693

763

Department of Transportation

Department of the Treasury
Veterans Administration:
Veterans reopened insurance fund

(**)

160

176

189

-101

-1,512

2,464

2,945

1,534

1,433

-4

627

639

635

-504

-355

319

443

591

207

196

349

403

-797

-3,891
-12
785
177
6

826
55
4,588
1,561
1,242

2,436

1,640

6,432
1,793
1,575

3,949
1,802
1,653

Independent agencies:
Export-Import Bank of the United States
Federal Emergency Management Agency:
National insurance development fund
Federal Savings and Loan Insurance Corporation:
Public debt securities
Agency securities
Postal Service
National Credit Union Administration
Other

-2,484
9
78

813
-55
-640
241
410

Total public debt securities
Total agency securities

-4,096
3

-2,678
-210

-1,750
-6

26,098
290

27,515
76

23,420
80

Total Federal funds

-4,092

-2,888

-1,756

26,388

27,591

23,499

2
1

3
3

Trust funds:
Legislative Branch:
United States Tax Court
Library of Congress

(**)

-1

The Judiciary:
Judicial survivors annuity fund

119

128

-6

-1

-506
-121

10,673
128

9,768
284

30,637
769

41,816
1,017

41,310
897

4,508

38,781

21,408

58,356

92,629

97,137

184

153

-1,143

7,193

7,161

7,345

1,026

15,704
-405
160
2

12,489
-50
-3,258
-35

50,374
405
6,166
5

65,052

66,078

Department of Agriculture

-13

Department of Defense—Military
Department of Defense—Civil:
Military Retirement Fund
Other
Department of Health and Human Services:
Federal old-age and survivors insurance trust fund:
Public debt securities
Agency securities
Federal disability insurance trust fund
Federal hospital insurance trust fund:
Public debt securities
Agency securities
Federal supplementary medical insurance trust fund.
Other

(**)

-1,601

(**)

Table continued on next page.

7,928
6

128

6,326
6

Table 6. Schedule D—Investments of Federal Government Accounts in Federal Securities, September 1988 and Other Periods
(in millions)—Continued
Securities Held as Investments
Current Fiscal Year

Net Purchases or Sales (-)
Classification

Beginning of

Fiscal Year to Date
This Month
This Year

Prior Year

This Year

This Month

Close of
This m o n t h

Trust funds:—Continued
Department of the Interior:
Public debt securities
Agency securities
Department of Labor
Unemployment trust fund
Other
Department of State:
Foreign service retirement and disability fund
Other

$30
122

-$31
122

$53

$212

$151

$181
122

-1,497
-3

8,280
-1

6.677
-2

27.917
33

37.695
36

36,197
32

125

450

534

3,474

3,799

3,924

(")

(**)

Department of Transportation:
Airport and airway trust fund
Highway trust fund
Other

109
-510
-11

1,194
757
66

1,341
1,192
36

9,937
12.691
363

11,022
13,958
440

11.132
13,448
429

Department of the Treasury
Environmental Protection Agency

25
109

70
731

29
443

134
737

179
1,359

204
1,468

16,250

18,299
-175
356
767
-1

22,704

178,797

195,048

-210
677
-2

176,748
175
1,208
8,078
2

1,296
8,824
2

1.564
8,845
1

Office of Personnel Management:
Civil service retirement and disability fund:
Public debt securities
Agency securities
Employees health benefits fund
Employees life insurance fund
Retired employees health benefits fund
Veterans Administration:
Government life insurance fund
National service life insurance:
Public debt securities
Agency securities
,
Veterans special life insurance fund
General Post Fund National H o m e s
Independent agencies:
Federal Deposit Insurance Corporation
Federal Emergency Management Agency
Harry S. Truman Memorial Scholarship Trust Fund.
Japan-United States Friendship Commission
Railroad Retirement Board
Other

268
21
-1
-3

-21

-23

222

204

201

-48

450
-135
76
1

357

9,990
135
1,093
21

10,489

10,440

1.171
22

1.168
22

-1,475
-1
2
1
1,095
16

1,184

17,040
1
45
17
6,688
47

16,154
1
46
18
7,735
63

15,565

-3
-589
-1

(**)
(**)
48

78
1

(**)
(**)
(**)

46
18
7.783
63

Total public debt securities
Total agency securities

17,795
122

96,686
-593

690
42
75,331
-50

430,342
715

509,233

527,028
122

Total trust funds

17,917

96,093

75,281

431,057

509,233

527,150

Grand total

13,824

93,204

73,525

457,444

536,824

550,649

(**)

... No transactions.
C*)Less than $500,000.
Note: Investments are in public debt securities unless otherwise noted.
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

Table 7. Receipts and Outlays of the U.S. Government by Month, Fiscal Year 1988 (in millions)

Classification

Oct.

Nov.

Dec.

Jan.

Feb.

March

April

May

June

July

Aug.

Sept.

Fiscal
Year
To
Date

Comparable
Period
Prior
F.Y.

Receipts
Individual income taxes
Corporation income taxes
Social insurance taxes and
contributions:
Employment taxes and
contributions
Unemployment insurance
Other retirement contributions
Excise taxes
Estate and gift taxes
Customs duties
Miscellaneous receipts
Total—budget receipts this year ..

$32,429 $25,039 $36,537 $43,987 $25,651 $20,637 $53,334 $17,958 $46,092 $25,791 $31,942 $41,784 $401,181 $392,557
1,667 17,748 3,630
1,855
975 12,706 12,026
1,613 18,347 1,499
1,461 20,668 94,195 83,926

20,791 20,725 22,735 26,920 25,739 25,141 34,464 24,948 27,200 24,964 23,477 27,991 305,093 273,028
2,667
170
956
883
2,399
179
2,477 8,073
352
1,598
4,545
285
24,584 25,575
364
457
431
360
362
356
417
375
415
354
351
418
4,658
4,715
2,551
2,848 3,832 2,371
2,199
2,885 2,767 3,055 3,136
3,250 3,490 3,158
35,540 32,457
608
617
540
531
566
622
749
751
644
627
661
678
7,594
7,493
1,367
1,217
1,340
1,253
1,301
1,444
1,204
1,282
1,430
1,343
1,650
1,367
16,198
15,085
2,141
1,392
1,807
1,893
1,164 1,760
1,886
1,657
1,590
1,265
1,902
1,454
19,909
19,307
62,354 56,987 85,525 81,791 60,355 65,730 109,323 59,711 99,205 60,690 69,479 97,803 908,953

(On-budget)

45,992 40,630 67,645 60,645 40,610 44,958 81,993 39,764 77,643 40,980 51,015 75,586 667,462

(Off-budget)

16,362 16,357 17,880 21,146 19,745 20,772 27,330 19,947 21,562 19,710 18,464 22,217 241,491

Total—budget receipts prior year 59,012 52,967 78,035 81,771 55,463 56,515 122,897 47,691 82,945 64,223 60,213 92,410

854,143

(On-budget)

43,865 38,158 60,694 62,981 37,919 38,469 99,083 30,205 64,222 47,880 43,510 73,755

640,741

(Off-budget)

15,147 14,809 17,341 18,791 17,544 18,047 23,814 17,486 18,723 16,342 16,702 18,656

213,402

Outlays
Legislative Branch
The Judiciary
Executive Office of the President ...
Funds Appropriated to the President:
International security assistance ..
International development assistance
Other
Department of Agriculture:
Foreign assistance, special export
programs and Commodity Credit
Corporation
Other
Department of Commerce
Department of Defense:
Military:
Department of the Army
Department of the Navy
Department of the Air Force
Defense agencies
Total Military
Civil
Department of Education
Department of Energy
Department of Health and Human
Services, except Social Security:
Public Health Service
Health Care Financing
Administration:
Grants to States for Medicaid ..
Federal hospital ins. trust fund .
Federal supp. med. ins. trust
fund
Other
Social Security Administration ....
Family Support Administration....
Human Development Service
Other
Department of Health and Human
Services, Social Security:
Federal old-age and survivors ins.
trust fund
Federal disability ins. trust
fund
Other

157
83
8

124
85
15

182
90
8

143
85
11

174
86
9

141
222
8

195
90
13

142
151
10

130
92
9

155
92
3

871
464
-82

584
121
-523

647
91
-416

255
371
425

501
184
2

704
93
-144

459
386
517

600
134
-25

524
172
136

683
493
-49

5,115
2,530
153

3,283
1,911
179

1,543
2,263
243

2,495
1,933
194

426
216
139

995
3,363
206

900
3,549
181

304
3,338
192

-509
3,061
213

-475
2,775
165

-250
2,470
202

7,423
8,506
8,060
1,285

5,356
7,183
7.015
1,106

7,990
9,283
9,172
1,913

5,084
6,673
6,194
1,254

6,487
7,307
7,783
1,490

6,814
8,592
8,627
1,723

7,336
9,161
8,525
1,080

5,471
6,728
6,628
1,446

6,908
8,301
8,096
1,284

6,433
8,426
7,433
1,564

6,144
7,918
8,197
1,505

149
168
18

161
93
8

1,852
1,337
121

1,812
1,178
109

304 -1,860
319
151
-2
161

4,273
2,980
-1

6,820
2,673
913

-545
3,309
211

13,284
30,719
2,279

23,424
26,169
2,156

5,870
6,483
7,331
1,353

77,315
94,560
93,060
17,004

73,808
90,813
91,144
18,172

25,274 20,660 28,358 19,205 23.067 25.756 26,102 20,273 24,589 23,856 23,764 21,036 281,940 273,938
1,829
1,386
952

1,814
2,060
939

1,797
1,420
941

1.813
1,612
1,126

1,806
1,946
815

1,818
1,545
993

1,823
1,308
836

1,853
1,304
1,018

1,837
1,424
1,037

1,867
1,012
712

1,877
1,618
978

1,913
1,611
813

22,047
18,246
11,161

20,659
16,800
10,688

970

909

914

876

930

864

981

1,045

1,091

867

992

969

11,408

9,886

2,444
4,119

2,619
3,926

2,020
4,479

2,398
3,863

2,476
4,472

2,673
5,245

2,606
4,432

2,475
4,130

2,830
4,906

2,328
3,712

2,740
4,837

2,854
4,607

30,462
52,730

27,435
50,803

3,022 2,613
2,856
1,778
4,244
1,775
2,640
186
2,023
817
950
1,263
434
430
413
-2,324 -2,339 -5,447

15,507 15,447 31,907
1,895
-824

1,731
-36

3,423
-60

2,914
2,550 2,774 3,168
2,867 3,045 2.647 3,350 3,140
34,947 30,837
2,394 2,359 3.037 2,416
292
2,431
2,358 2,369
1,063
26,516 21,397
3,941
1,120
1,209
1,149
363
1,295
1,866
19,032
17,480
1,068
2,173
1,466
1,175
1,311
1,157
1,179
943
1,037
1,042
13,311
918
13,256
617
605
449
506
535
391
327
5,448
702
478
5,886
-395 -3,189 -3,133 -3,857 -3,117 -3,259 -3,103 -3,179 -1,903 -35,245 -27,703

368
284
-986

16,258 16,654 16,434 16,411
1,864
-191

Table continued on next page.

1,863
1,920
-122 -2,026

1,856
-137

19,634 16,407 16,422 16,446
1,948
1,879
-249 -1,097

1,876
-58

1,820
-293

197,897 186,780
22,360
-6,079

21,290
-5,648

Table 7. Receipts and Outlays of the U.S. Government by Month, Fiscal Year 1988 (in millions)—Continued

Classification

Oct.

Nov.

Jan.

Dec.

Feb.

March

April

May

June

July

Aug.

Sept.

Fiscal
Year
To
Date

Comparable
Period
Prior
F.Y.

Outlays—Continued
Department of Housing and Urban
Development
Department of the Interior
Department of Justice
Department of Labor:
Unemployment trust fund
Other
Department of State
Department of Transportation:
Highway trust fund
Other
Department of the Treasury:
Interest on the public debt
Other
Environmental Protection Agency ..
General Services Administration ...
National Aeronautics and Space
Administration
Office of Personnel Management .
Small Business Administration ..
Veterans Administration:
Compensation and pensions
National service life
Government service life
Other
Independent agencies:
Postal Service
Tennessee Valley Authority ....
Other independent agencies ...
Undistributed offsetting receipts:
Employer share, employee
retirement
Interest received by trust funds .
Rents and royalties on Outer
Continental Shelf lands
Other
Totals this year:
Total outlays
(On-budget)
(Off-budget)

$1,962 $1,421 $1,900 $1,361 $1,396 $1,605 $1,698 $1,327 $1,683
592
406
439
408
336
502
348
356
335
397
340
529
407
554
431
407
445
513

1,012 1,122 1,450 1,488 1,780 1,843 1,427 1,328 1,287 1,158
574
-95
447
761
582
698
395
429
591
28
302
280
479
389
321
159
242
230
221
222

1,310 3,393 18,598 20,527
2,926
794 -1,931
3,272
2,788
222
3,421
356

1,276 1,149 1,246 837
741
1,203 1,257 1,232
945
800
1,024
1.043
1,039
954
1,037 1,016
1,049 1,191
1,154 1,061

1,722 1,505 13,913 12,642
12,789
12,491
916
1,006

14,115 16,623 30,355 14,674 15,043 14,436 14,856 17,407 31,595 14.534 15,25615,250 214,145 195,390
-711 -1,271
-2,318
-355 -2,206 -11,673 -15,045
141
-152
-726 -1,524 -1,243
-773
-536
4,903
394
4,872
393
403
478
376
459
415
389
392
360
391
423
74
-530
-285
-544
293
261
144
255
297
92
-434
167
-430
143
777
805
936
772
622
804
863
843
606
816
2,645
2,400 2,193 2,324 2,554 2,392 2,510 2,773 2,326 2,492
241
-34
-7
-20
-45
-2
-45
-45
-29

(Off-budget)

717
530
9,092 7,591
2,359 2,222 29,191
26,966
-54
-72
-42
-26

2,352 44
2,342 44
52
62
45
51
3
3
3
3
1,232
802
1,374
1,102

1,243 1,232 1,259 1,792 15,328 14,426
1,192 1,334 2,422 73
592
55
60
55
51
675
47
79
66
52
40
4
3
3
3
37
2
4
3
3
828
1,060
944
1,246
13,204 11,894
917
1,138 1,257
1,304

149
355
-85
439
97
138
104
-289
2,292
908
343
1,848

11
-405 8
-233 347
57
167
140
145
1,010
182 2,793 1,411

-2,567 -2,528 -2,506 -2,628 -2,367 -2,570
-405
-145
-228 -2,109 -16,647
-75
-440

-234

-3

8
5

-468
-2

-195
-1

193
27

-610
139
608

35
58
4,053

2,218 2,229
1,593
1,089
140
1,091
4,566 20,042
11,582

-2,654 -2,687 -2,554 -2,584 -2,682 -4,701 -33,028 -30,559
-187 -2,873 -18,252
-69
-476
-356 -41,822 -34,999
-208
-3

584 -657
4
-28

93,164 84,009 109,889 65,895 84,382 95,013 95,554 82,295 90,071

121 -359 -190
-3,548 -4,021
7]
-1
-61
-76 -2,821

83,634 92,561 87,588 1,064,055

76,979 67,239 77,993 66,682 66,629 76,994 79,629 64,688 72,888 66,818 74,756 70,071 861,364
16,185 16,770 31,896

-30,810 -27,022
Total—surplus ( + ) or deficit (-).
(On-budget)

$1,339 $1,681 $1,584 $18,956 $15,464
5.054
5,152
367
339
725
4,333
5,426
519
455
427

-30,986
+ 176

26,609

-787 17,753 18,020 15,925 17,607 17,184 16,816 17,805 17,518 202,691

24,363 + 15,896 -24,027 -29,283 + 13,769 -22,583 + 9,134 -22,944 -23,082 + 10,214 1-155,102
10,347 -6,037 -26,019

32,036 + 2,364

24,924 + 4,756 -25,838 -23,741 + 5,515

414 14,016 + 21,933 + 1,992 + 2,752 + 11,405 + 2,340 + 4,379 + 2,894

193,901

+ 659 + 4,699 + 38,800

Totals—outlays prior year

84,302

80,054

90,404

83,928

83,842

84,446

84,155

83,328

83,568

86,562

(On-budget)

68,815

63,721

75,915

68,162

67,152

67,791

69,130

66,282

66,423

70,87? 65,140 60,563

809,972

(Off-budget)

15,486

16,334

14,489

15,766

16,690

16,655

15,025

17,046

17,145

15,685

193,832

Total—surplus (+) or deficit (-)
-25,290
prior year
(On-budget) .
(Off-budget).

-27,087 -12,369

24,950 •25,563
-340

15,221

82,009

77,206

16,868 16,643

-2,157 -28,379 -27,931 + 38,742 -35,637

-623 •22,339 -21,796 +15,204

-5,181 -29,233 -29,322 + 29,953 -36,077

-2,201 -22,996 -21,630 + 13,191

1,524 + 2,853 + 3,024

+ 854 +1,391

+ 8,790

+ 440 +1,578

+ 65?

-166

+ 2,013

'1,003,804

'-149,661
-169,231
+ 19,570

The outlays by month for FY 1987 have been increased by a net of $737 million to reflect reclassification of the Thrift Savings Fund receipts of $734 million and Federal Retirement Thrift Investment Board (FRTIB) administrative expenses of $6 million to a non-budgetary status. The Federal Retirement Thrift Investment Board outlays by month for FY 1988 have been adjusted by a net of
$1,084 million. Data for fiscal years 1987 and 1988 previously reported by Treasury for Federal Savings and Loan Insurance Corporation and FRTIB have been reclassified in consultation with the
Office of Management and Budget resulting in revised totals as shown above. Historical tables in the Budget will be changed to agree with Treasury totals with the exception of a difference of $7 million
for the Small Business Administration and the administrative expenses for the FRTIB. O M B will continue to reflect the administrative expenses for the FRTIB in budgetary totals.
....No transactions.
(")Less than $500,000.
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

Table 8. Trust Fund Impact on Budget Results and Investment Holdings (in millions) as of September 30, 1988
Current Month

Securities held as Investments
Current Fiscal Year

Fiscal Year to Date

Beginning of
Receipts

Trust receipts, outlays, and investments held:
Airport
Black lung disability
FDIC
Federal disability insurance
Federal employees life and health
Federal employees retirement
Federal hospital insurance
Federal old-age and survivors insurance ...
Federal supplementary medical insurance ..
Highways
Military advances
Railroad retirement
Military retirement
Unemployment
Veterans life insurance
All other trust
Total trust fund receipts and outlays and
investments held from Table 6-D
Interfund transactions
Trust fund receipts and outlays on the basis
of tables 4 & 5

Outlays

$373

$306

55
433

1,996

1,820
-297
2,381
4,607
16,446
3,140
1,505
683
544
1,614
3,393

18,757
5,654
20,969
1,813
1,310

542
412
1,590

326
34
424
54,258

Excess

Receipts

$67

(**)

413,440

89
968

-544

37,688

16,570

510,861

Total federal fund receipts and outlays

69,604

75,959

Interfund transactions

- 2,296

-2,296

Federal fund receipts & outlays on the basis
of table 4 & 5

67,308

73,663

Offsetting proprietary receipts

-1,534

Net budget receipts & outlays

97,803

87,588

$11,132

17,040
7,193
9,287
180,516
50,779
58,356
6,166
12,691

16,154
7,161
10,121
182,725
65,052
92,629
7,928
13,958

15,565
7,345
10,409
199,100
66,078
97,137
6,326
13,448

-592

6,688
30,637
27,917
11,440
2,409

7,735
41,816
37,695
11,864
3,373

7,783
41,310
36,197
11,810
3,509

97,420

431,057

509,233

527,150

-2,146

47,063
67,999
239,386
35,002
15,307
8,964
4,507
33,117
26,984
1,423
3,863

15,460

$11,022

16,376
1,047
4,523
-1,327
-195
-141
-132

-55

$9,937

$1,214

639
2,146
22,360
-1,101
28,431
52,730
197,897
34,947
13,913
9,057
6,435
19,009
18,598
1,058
4,455

-3,067

This Month

$2,868

22,521

Close of
This Month

This Year

640

176
297

-25

Excess

$4,081

-433

161
1.101
18,632
15,270
41,490

55
1,394
-93
-1,928
14,108
8,386

365

-137,338 -137,338

-22,228 -22,228

32,030

Outlays

16,570

373,522

276,102

-6,356

557,642

810,164 - 252,522

-6,356

10,214

97,420

-2,717

554,925

807,447 -252,522

-19,494

908,953 1,064,055 -155,102

....No transactions.
(**)Less than $500,000.
Note: Interfund receipts and outlays are transactions between Federal funds and trust funds such as Federal payments and contributions, and interest and profits on investments in Federal securities.
They have no net effect on overall budget receipts and outlays since the receipt side of such transactions is offset against budget outlays. In this table, interfund receipts are shown as an adjustmen
to arrive at total receipts and outlays of trust funds respectively.
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

Table 9. Summary of Receipts by Source, and Outlays by Function of the U.S. Government, September 1988
and Other Periods (in millions)
Fiscal Year
To Date

Comparable Period
Prior Fiscal Year

$41,784
20,668

$401,181
94,195

$392,557
83.926

27,991
285
418
3,158
678
1,367
1,454

305,093
24,584
4,658
35.540
7,594
16,198
19,909

273,028
25,575
4.715
32,457
7,493
15,085
19.307

97,803

908,953

854,143

21,941
-691
702
116
1,625
-414
6,076
2,568
743
2,588
3,823
6,949
11,226
18,266
3,085
710
796
12,371
-4,892

290,349
10,469
10,876
2,342
14,538
17,210
19,064
27,196
5,577
30,856
44,482
78,798
130,174
219,030
29,248
9,205
9,506
151,711
-36,576

281,999
11,649
9,216
4,115
13,363
26,606
6,156
26,221
5,051
29,724
39,968
75,120
123,255
207,353
26,782
7,548
7,564
138,570
-36,455

87,588

1,064,055

1,003,804

Classification
RECEIPTS
Individual income taxes
Corporation income taxes
Social insurance taxes and contributions:
Employment taxes and contributions
Unemployment insurance
Other retirement contributions
Excise taxes
Estate and gift taxes
Customs
Miscellaneous
Total
NET OUTLAYS
National defense
International affairs
General science, space, and technology
Energy
Natural resources and environment
Agriculture
Commerce and housing credit
Transportation
Community and regional development
Education, training, employment and social services
Health
Medicare
Income security
Social security
Veterans benefits and services
Administration of justice
General government
Interest
Undistributed offsetting receipts
Total
Note: Details may not add to totals due to rounding.
Source: Financial Management Service, Department of the Treasury.

Explanatory Notes
1. Flow of Data Into Monthly Treasury Statement
The Monthly Treasury Statement (MTS) is assembled from data in the
central accounting system. The major sources of data include monthly
accounting reports by Federal entities and disbursing officers, and daily
reports from the Federal Reserve banks. These reports detail accounting transactions affecting receipts and outlays of the Federal Government
and off-budget Federal entities, and their related effect on the assets and
liabilities of the U.S. Government. Information is presented in the MTS
on a modified cash basis.

tragovernmental outlays do not require issuance of checks. An example
would be charges m a d e against appropriations representing a part of
employees' salaries which are withheld for individual income taxes, and
for savings bond allotments. Outlays are stated net of offsetting collections and refunds representing reimbursements as authorized by law,
refunds of money previously expended, and receipts of revolving and
management funds. Interest on the public debt (public issues) is recognized on the accrual basis. Outlays of off-budget Federal entities are excluded from budget outlay totals.

2. Notes on Receipts
Receipts included in the report are classified into the following major
categories: (1) budget receipts and (2) offsetting collections (also called
applicable receipts). Budget receipts are collections from the public that
result from the exercise of the Government's sovereign or governmental
powers, exluding receipts offset against outlays. These collections, also
called governmental receipts, consist mainly of tax receipts (including
social insurance taxes), receipts from court fines, certain licenses, and
deposits of earnings by the Federal Reserve System. Refunds of receipts
are treated as deductions from gross receipts.
Offsetting collections are from other Government accounts or the public
that are of a business-type or market-oriented nature. They are classified
into two major categories: (1) offsetting collections credited to appropriations or fund accounts, and (2) offsetting receipts (i.e., amounts deposited
in receipt accounts). Collections credited to appropriation or fund accounts
normally can be used without appropriation action by Congress. These
occur in two instances: (1) when authorized by law, amounts collected
for materials or services are treated as reimbursements to appropriations
and (2) in the three types of revolving funds (public enterprise, intragovernmental, and trust); collections are netted against spending, and outlays
are reported as the net amount.
Offsetting receipts in receipt accounts cannot be used without being
appropriated. They are subdivided into two categories: (1) proprietary
receipts—these collections are from the public and they are offset against
outlays by agency and by function, and (2) intragovernmental funds—
these are payments into receipt accounts from Governmental appropriation or fund accounts. Theyfinanceoperations within and between Government agencies and are credited with collections from other Government
accounts. The transactions m a y be intrabudgetary when the payment and
receipt both occur within the budget or from receipts from off-budget
Federal entities in those cases where payment is m a d e by a Federal entity whose budget authority and outlays are excluded from the budget
totals.
Intrabudgetary transactions are subdivided into three categories:
(1) interfund transactions, where the payments are from one fund group
(either Federal funds or trust funds) to a receipt account in the other fund
group; (2) Federal intrafund transactions, where the payments and receipts
both occur within the Federal fund group; and (3) trust intrafund transactions, where the payments and receipts both occur within the trust fund
group.
Offsetting receipts are generally deducted from budget authority and
outlays by function, by subfunction, or by agency. There are four types
of receipts, however, that are deducted from budget totals as undistributed
offsetting receipts. They are: (1) agencies' payments (including payments
by off-budget Federal entities) as employers into employees retirement
funds, (2) interest received by trust funds, (3) rents and royalties on the
Outer Continental Shelf lands, and (4) other interest (i.e., interest collected
on Outer Continental Shelf money in deposit funds when such money
is transferred into the budget).
3. Notes on Outlays
Outlays are generally accounted for on the basis of checks issued by
Government disbursing officers, and cash payments made. Certain in-

4. Processing
The data on payments and collections are reported by account symbol into the central accounting system. In turn, the data are extracted from
this system for use in the preparation of the MTS.
There are two major checks which are conducted to assure the consistency of the data reported:
1. Verification of payment data. The monthly payment activity reported
by Federal entities on their Statements of Transactions is compared to
the payment activity of Federal entities as reported by disbursing officers.
2. Verification of collection data. Reported collections appearing on
Statements of Transactions are compared to deposits as reported by
Federal Reserve banks.
5. Other Sources of Information About Federal Government
Financial Activities
• A Glossary of Terms Used in the Federal Budget Process, March 1981
(Available from the U.S. General Accounting Office, Gaithersburg,
Md. 20760). This glossary provides a basic reference document of standardized definitions of terms used by the Federal Government in the
budgetmaking process.
• Daily Treasury Statement (Available from GPO, Washington,
D.C. 20402, on a subscription basis only). The Daily Treasury Statement
is published each working day of the Federal Government and provides
data on the cash and debt operations of the Treasury.
• Monthly Statement of the Public Debt of the United States (Available
from G P O , Washington, D.C. 20402 on a subscription basis only). This
publication provides detailed information concerning the public debt.
• Treasury Bulletin (Available from GPO, Washington, D.C. 20402,
by subscription or single copy). Quarterly. Contains a mix of narrative,
tables, and charts on Treasury issues, Federal financial operations, international statistics, and special reports.
• Annual Budget Publications (Available from GPO, Washington,
D.C. 20402). There are five annual publications which provide information concerning the budget:
-The Budget of the United States Government, FY 19_
-Appendix, The Budget of the United States Government, FY 19_
-The United States Budget in Brief, FY 19_
-Special Analyses
-Historical Tables
• United States Government Annual Report and Appendix (Available,
from Financial Management Service, U.S. Department of the Treasury>Washington, D.C. 20226). This annual report presents budgetary results
at the summary level. The appendix presents the individual receipt and
appropriation accounts at the detail level.

Scheduled Release
The release date for the October 1988 Statement
will be 2:00 p.m. EST November 22, 1988.

For sale by the Superintendent of Documents, U.S. Government Printing
Office, Washington, D.C. 20402 (202) 783-3238. The subscription price is
$22.00 per year (domestic), $27.50 per year (foreign).
N o single copies are sold.

TREASURY NEWS _
CONTACT:
of Financing
Department of the Treasury • Washington,
D.C. • Office
Telephone
566-2041
202/376-4350
IOR_^MMEDI;ATE RELEASE

October 31

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,201 million of 13-.week bills and for $7,220 million
of 26-week bills, both to be issued on November 3, 1988, were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-•week bills
maturing February 2
Discount Investment
Rate
Rate 1/
7.33%
7.38%
7.37%

7.57%
7.62%
7.61%

1989
Price
98.147
98.135
98.137

26-•week bills
May 4, 1989
maturing
Discount Investment
Rate
Rate 1/
Price
7.45%
7.49%
7.48%

7.85%
7.89%
7.88%

96.234
96.213
96.218

Tenders at the high discount rate for the 13-week bills were allotted 9%.
Tenders at the high discount rate for the 26-week bills were allotted 6%.

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
leceived
Accepted
Received

Accepted

32,555
$
24 ,255,800
27,540
51,405
46,680
29,740
1,228,820
34,540
12,555
46,250
37,160
1,519,050
425,460

$ .32,555
5,784,050
27,540
51,405
46,680
29,740
140,370
34,540
12,555
46,250
27,610
542,300
425,460

$
27,835
22,965,220
26,475
30,465
36,865
29,415
1,436,320
20,080
8,910
47,275
36,000
1,469,990
466,305

27,835
$
5 ,855,455
26.475
30,465
36,865
29,405
429,620
20,080
8,910
42,480
26,300
220,290
466,305

$27 747,555

$7,201,055

$26,601,155

$7 220,485

$24 416,795
1 180,255
$25 597,050

$3,870,295
1,180,255
$5,050,550

$22,089,395
1,014,840
$23,104,235

$2 ,708,725
1 ,014,840
$3 ,723,565

1 925,925

1,925,925

1,850,000

1 ,850,000

224,580

1,646,920

$27 747,555

$7,201,055

$26,601,155

$7 220,485

An additional $47,720 thousand of 13-week bills and an additional $328,580
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
NB-49

TREASURY NEWS

Department of the Treasury • Washington, D.c. • Telephone 566CONTACT: Office of Financing
202/376-4350
FOR RELEASE AT 4:00 P.M.
November 1, 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
$14,400 million, to be issued November 10, 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 $ 13,283 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m., Eastern Standard time, Monday, November 7, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
August 11, 1988
and to mature February 9, 1989
(CUSIP No.
912794 RF 3), currently outstanding in the amount of $ 7,308 million,
the additional and original bills to be freely interchangeable.
182-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
May 12, 1988
and to mature May 11, 1989
(CUSIP No.
912794 RX 4 ) , currently outstanding in the amount of $8,786 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 November 10, 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 $ 1,649 million as agents for foreign
and international monetary authorities, and $ 4,420 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).
NJ-50

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
November 2, 1988
CHARLES H. POWERS TO LEAVE TREASURY

Charles H. Powers, Deputy Assistant Secretary of the
Treasury for Public Affairs, will leave the Treasury
Department on November 13, 1988 to join the Tobacco
Institute as Senior Vice President for Public Affairs.
In announcing Mr. Powers' upcoming departure, Secretary of
the Treasury Nicholas F. Brady noted "Charley has been a
tremendous asset to the Department. His institutional
knowledge and experience have been invaluable and we wish
him well in his future endeavors."
Mr. Powers has served as Deputy Assistant Secretary for
Public Affairs since March 1986. He rejoined the Treasury
Department in 1985 after an association with Ogilvy & Mather
Washington. He had previously served with the Treasury
Department including the Internal Revenue Service from 1975
to 1978 and from 1980-1985. Mr. Powers was Press Secretary
to U.S. Senator Richard S. Schweiker of Pennsylvania from
1978-1980.
His active duty U.S. Air Force service included assignment
in Southeast Asia in 1969. He also served as a lieutenant
colonel in the U.S. Air Force Reserve. Mr. Powers has
worked in television news at WTVJ-TV, Miami, Florida and
WMAL-TV, Washington, D.C.
Mr. Powers received his AB degree from the University of
Miami (1965) and MA degree from New York University (1967).
He resides in Alexandria, Virginia with his wife and two
sons.
NB-51

TREASURY NEWS

Department of the Treasury • Washington, D.c. • Telephone 566-2
FOR RELEASE WHEN AUTHORIZED AT PRESS CONFERENCE
November 2, 1988
CONTACT: Office of Financing
202/376-4350
TREASURY NOVEMBER QUARTERLY FINANCING
The Treasury will raise about $13,250 million of new cash
and refund $16,756 million of securities maturing November 15,
1988, by issuing $9,500 million of 3-year notes, $9,500 million
of 10-year notes, and $11,000 million of. 37-day cash management
bills. The $16,756 million of maturing securities are those held
by the public, including $1,507 million held, as of today, by
Federal Reserve Banks as agents for foreign and international
monetary authorities.
The three issues totaling $30,000 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 $1,896 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.
If Treasury has sufficient bond authority, a $9,000 million
bond will be sold later in November or early in December to mature
November 15, 2018. In the absence of such authority, Treasury
would sell an additional cash management bill for settlement early
in December.
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

NB-52

8
cs

§5
o>
as H
H

§5
as
as H
H
IT) H

»o.

D 8I

133*3
i-1

W 'O 'J? £

TREASURY NEWS 1&
ptportment of the Treasury e Washington, D.C. e Telephone 566-2041
FOR RELEASE WHEN AUTHORIZED AT PRESS CONFERENCE
November 2, 1988
CONTACT: Office of Financing
202/376-4350
TREASURY OFFERS $11,000 MILLION
OF 37-DAY CASH MANAGEMENT BILLS
The Department of the Treasury, by this public notice, invites
tenders for approximately $11,000 million of 37-day Treasury bills
to be issued November 15, 1988, representing an additional amount
of bills dated December 24, 1987, maturing December 22, 1988 (CUSIP
No. 912794 QD 9 ) .
Competitive tenders will be received at all Federal Reserve
Banks and Branches prior to 1:00 p.m., Eastern Standard time,
Thursday, November 10, 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,

NB-53

- 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 Tuesday, November 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
Department of the Treasury • Washington, D.c. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350
FOR IMMEDIATE RELEASE
November 7, 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,202 million of 13-week, bills and for 9 7,225 million
of 26-week bills, both Co be issued on November 10, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-week bills
maturing February 9, 1989
Discount Investment
Price
Rate .
Rate 1/

Low
,.
7.50%a/
7.75%
98.104
High
7.55%
7.80%
98.092
Average
7.54%
7.79%
98.094
a/ Excepting 2 tenders totaling $2,870,000.

26-week bills
maturing May 11, 1989
Discount Investment
Rate
Rate 1/
Price
7.68%
7.72%
7.71%

8.10%
8.15%
8.13%

96.117
96.097
96.102

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 57%.

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Received

Accepted

$
39,370
21,157,515
28,815
35,910
56,350
35,890
1,290,885
51,840
6,600
36,445
35,615
1,318,900
423,860

$
39,370
5,908,465
28,815
35,910
56,350
35,890
347,885
34,690
6,600 "
36,445
25,615
222,470
423,860

$
36,690
21,170,905
18,730
34,330
34,450
34,420
1,099,865
23,660
8,835
39,950
30,920
1,183,835
440,460

$
36,690
6,189,825
18,730
34,330
34,430
34,420
142,615
23,660
8„835
39,950
23,770
197,585
440,460

$24,517,995

$7,202,365

$24,157,050

$7,225,300

$20,550,155
1,152,220
$21,702,375

$3,234,525
1,152,220
$4,386,745

$19,918,475
984,880
$20,903,355

$2,986,725
984,880
$3,971,605

2,370,415

2,050,000

•

445,205

1,203,695

$24,517,995

$7,202,365

$24,157,050

$7,225,300

• An additional $96,995 thousand of 13-week bills and an additional $287,505
thousand of 26-week bills will be issued to foreign official Institutions for
new cash.
V

Equivalent coupon-issue yield.

NB-54

TREASURY NEWS

apartment of the Treasury • Washington, D.c. • Telephone 566CONTACT: Office of Financing
FOR RELEASE AT 4:00 P.M.
November 8, 1988

2Q2/376-435Q

TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$14,400 million, to be issued November 17, 1988. This offering
will provide about $ 650
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,758 million.
Tenders will be received at Federal Reserve Banks and Branches and at
the Bureau of the Public Debt, Washington, D. C. 20239, prior to 1:00
p.m., Eastern Standard time, Monday, November 14, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,200
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 $17,279 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,200 million, to be dated
November 17, 1988, and to mature
May 18, 1989
(CUSIP No.
912794 RZ 9 ) .
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for Treasury
bills maturing November 17, 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 $1,899 million as agents for foreign
and international monetary authorities, and $4,515 million for their
own
NB-55account. 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 NEWS _
Department of the Treasury e Washington,CONTACT:
D.c. • Telephone
566-2041
Office of Fin
FOR IMMEDIATE RELEASE
November 8, 1988

202/376-4350

RESULTS OF AUCTION OF 3-YEAR NOTES
The Department of the Treasury has accepted $9,513 million
of $28,326 million of tenders received from the public for the
3-year notes, Series U-1991, auctioned today. The notes will be
issued November 15, 1988, and mature November 15, 1991.
The interest rate on the notes will be 8-1/2%. The range
of accepted competitive bids, and the corresponding prices at the
8-1/2% rate are as follows:
Yield Price
Low 8.58%* 99.792
High
8.60%
99.740
Average
8.59%
99.766
•Excepting 1 tender of $5,000.
Tenders at the high yield were allotted 3%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
$
50,015
$
50,015
New York
24,366,065
7,948,575
Philadelphia
279,965
279,965
Cleveland
69,150
69,150
Richmond
140,995
78,200
Atlanta
42,820
40,335
Chicago
1,745,285
506,035
St. Louis
79,600
59,600
Minneapolis
56,015
55,515
Kansas City
110,930
110,900
Dallas
19,980
14,980
San Francisco
1,358,350
292,855
Treasury
7,005
7,005
Totals
$28,326,175
$9,513,130
The $9,513
million of accepted tenders includes $1,049
million of noncompetitive tenders and $8,464 million of
competitive tenders from the public.
In addition to the $9,513 million of tenders accepted in
the auction process, $340 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $1,596 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.
NB-56

TREASURY NEWS

apartment of the Treasury • Washington, D.c. • Telephone 566FOR IMMEDIATE RELEASE CONTACT: Office of Financing
November 9, 1988

202/376-4350

RESULTS OF AUCTION OF 10-YEAR NOTES
The Department of the Treasury has accepted $9,593 million of
$28,912 million of tenders received from the public for the
10-year notes, Series D-1998, auctioned today. The notes will be
issued November 15, 1988, and mature November 15, 1998.
The interest rate on the notes will be 8-7/8%. A/ The range
of accepted competitive bids, and the corresponding prices at the
8-7/8% interest rate are as follows:
Yield
Price
Low
8..93%
99..641
High
8..94%
99,.576
Average
8..94%
99..576
Tenders at the high yield were allotted 4 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

Received
$
16,897
26,408,819
4,847
7,752
41,216
10,379
1,383,604
25,769
5,463
15,242
11,134
978,206
2,670
$28,911,998

Accepted
$
16,897
8,798,254
4,847
7,752
16,386
10,379
480,574
12,762
5,463
15,237
9,564
212,006
2,670
$9,592,791

The $9,593 million of accepted tenders includes $457
million of noncompetitive tenders and $9,136 million of competitive tenders from the public.
In addition to the $9,593 million of tenders accepted in the
auction process, $300 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 $ 1,600,000.
Larger amounts must be in multiples of that amount.

TREASURY NEWS
Pipartment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR RELEASE AT 12:00 NOON
November 10, 19 88

CONTACT: O f f ^ ® 7 ° f 4 ^ £ a n C :

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 November 25, 1988, and to mature November 24, 198 9
(CUSIP No. 912794 SN 5 ). This issue will result in a paydown for
the Treasury of about $ 375
million, as the maturing 52-week bill
is outstanding in the amount of $9,373
million. Tenders will be
received at Federal Reserve Banks and Branches and at the Bureau
of the Public Debt, Washington, D. C. 20239, prior to 1:00 p.m.,
Eastern Standard time, Thursday, November 17, 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 November 25, 1988.
In addition to the
maturing 52-week bills, there are $13,481 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 $2,222 million as agents for foreign
and international monetary authorities, and $7,686 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 $ 279
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.
NB-58

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
FOR IMMEDIATE RELEASE
November 10, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF TREASURY'S AUCTION
OF 37-DAY CASH MANAGEMENT BILLS
Tenders for $11,025 million of 37-day Treasury bills to
be issued on November 15, 1988, and to mature December 22, 1988,
were accepted at the Federal Reserve Banks today. The details
are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS
Discount Investment Rate
Rate
(Equivalent Coupon-Issue Yield)

Price

Low 8.06%=*/ 8.24% 99.172
High
8.08%
8.26%
99.170
Average
8.07%
8.25%
99.171
a/ Excepting 2 tenders totaling $2,000,000.
Tenders at the high discount rate were allotted 58%.
TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS
(In Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
TOTALS

NBL-55

Received

Accepted
$

—

44,288,000
1,000

10 ,211,280
1,000

—
---

95,000
--

1,992,000
—

534,000
--

3,000
1,000
20,000
2,260,000

1,580
277,240

$48,660,000

$11,,025,100

---

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
November 14, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY TO AUCTION $9,000 MILLION
OF 30-YEAR BONDS
The Department of the Treasury will auction $9,000 million
of 30-year bonds to raise new cash. Additional amounts of the
bonds may be issued to Federal Reserve Banks as agents for foreign
and international monetary authorities-at the average price of
accepted competitive tenders.
The 30-year bond being offered today will be eligible for
the STRIPS program.
Details about the new security are given in the attached
highlights of the offering and in the official offering circular.
oOo
Attachment

NB-60

HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 30-YEAR BONDS
November 14, 1988
Amount Offered:
To the Public

$9,000 million

Description of Security:
Term and type of security
.-. 30-year bonds
Loan Title and CUSIP designation .. Bonds of 2018
(CUSIP No. 912810 EB 0)
CUSIP Nos. for STRIPS Components .. Listed in Attachment A
of offering circular
Issue date
November 22, 1988 (to be
dated November 15, 1988)
Maturity date
November 15, 2018
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
May 15 and November 15
Minimum denomination available
$1,000
Amount required for STRIPS
To be determined after auction
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
To be determined after auction
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
c. Acceptable
Key Dates:
Receipt of tenders
Thursday, November 17, 1988,
prior to 12:00 noon, EST
Settlement (final payment
due from institutions):
a) funds immediately
available to the Treasury
Tuesday, November 22, 1988
b) readily-collectible check
Friday, November 18, 1988

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
November 14, 1988

Emily Landis Walker
Appointed Deputy Assistant Secretary
(Policy Review and Analysis)

Secretary of the Treasury Nicholas F. Brady today announced
the appointment of Emily Landis Walker to serve as Deputy
Assistant Secretary of the Treasury for Policy Review and
Analysis in the Office of Policy Development, effective
Monday, November 7, 1988. Mrs. Walker will be responsible
for providing the Assistant Secretary for Policy Development
with analysis and briefings on the full range of the
Department's policies.
Since 1984, Mrs. Walker served as Assistant to the U.S.
Executive Director of the International Monetary Fund (IMF)
while he was serving concurrently as Senior Deputy Assistant
Secretary of the Treasury for International Economic Policy.
Prior to that she worked in the Exchange and Trade Relations
Department of the IMF.
Mrs. Walker received her M.A. in 1981 from Johns Hopkins
School of Advanced International Studies, attending the
Bologna Center in Italy, and a B.A. in International Affairs
and French from the University of North Carolina at Chapel
Hill in 1978. She also attended the vanderbilt-in-France
program.
Mrs. Walker was born on July 2, 1956 in Clarendon Hills,
Illinois to George H. and Jane M. Landis. She resides in
Alexandria, Virginia with her husband, William J. Walker and
daughter, Sarah Jane.

NB-61

TREASURY NEWS
of Financing
Department of the Treasury • Washington,CONTACT:
D.c. • Office
Telephone
566-2041
202/376-4350
FOR IMMEDIATE REL1
November 1 4 , 1
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $ 7,203 million of 13-week bills and for $7,204 million
of 26-week bills, both to be issued on November 17, 1988, were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-week bills
maturing February 16, 1989
Discount Investment
Rate
Rate 1/
Price

Low
High
Average
a/ Excepting 1
b/ Excepting 3
Tenders at the
Tenders at the

7.74%a/
8.00%
98.044 :
7.84%b/
8.28%
96.036
7.84%
8.11%
98.018 :
7.88%
8.32%
96.016
7.82%
8.09%
98.023 :
7.87%
8.31%
96.021
tender of $23,965,000.
tenders totaling $5,205,000.
high discount rate for the 13-week bills were allotted 73%.
high discount rate for the 26-week bills were allotted 16%.
TENDERS RECEIVED AND AC(:EPTED
(In Thousands)
Received
Received
Accepted

26-week bills
maturing
May 18, 1989
Discount Investment
Rate
Rate 1/
Price

Accepted

34,505
19,384,375
17,320
54,690
40,675
38,900
1.065,750
24,890
3,225
38,915
32,365
1,374,080
408,715

$
34,505
5,942,125
17,320
54,690
40,675
38,900
375,250
24,890
3,225
38,915
31,015
192,330
408,715

$
27,910
20,524,200
16,340
34,655
45,995
34,880
838,235
16,590
8,050
42,985
26,560
1,250,280
417,410

$
27,910
6,167,200
16,340
34,655
45,995
34,880
115,435
16,590
8,050
42,985
26,560
250,280
417,410

$22,518,405

$7,202,555

• $23,284,090

$7,204,290

$18,934,990
1,105,195
$20,040,185

$3,619,140
1,105,195
$4,724,335

'• $18,406,625 $2,326,825
:
947,575
947,575
. $19,354,200
$3,274,400

2,364,610

2,150,000

113,610

1,779,890

$22,518,405

$7,202,555

: $23,284,090

$7,204,290

An additional $42,190 thousand of 13-week bills and an additional $572,310
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
NB-62

TREASURY NEWS

Department of the Treasury • Washington, D.c. • Telephone 566-2
CONTACT: Office of Financing
202/376-4350
FOR RELEASE AT 4:00 P.M.
November 15, 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
$14,400 million, to be issued November 25, 1988. This offering
will provide about $ 925
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $ 13,481 million.
Tenders will be received at Federal Reserve Banks and Branches and at
the Bureau of the Public Debt, Washington, D. C. 20239, prior to 1:00
p.m., Eastern Standard time, Monday, November 21, 1988.
The two series offered are as follows:
90-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
August 25, 1988,
and to mature February 23, 1989 (CUSIP No.
912794 RJ 5 ) , currently outstanding in the amount of $7,397 million,
the additional and original bills to be freely interchangeable.
181-day bills for approximately $7,200 million, to be dated
November 25, 19 88,
and to mature May 25, 1989
(CUSIP No.
912794 SA 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 November 25, 1988.
In addition to the maturing
13-week and 26-week bills, there are $9,373
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 $ 1,917 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $2,197 million as
agents for foreign and international monetary authorities, and $7,686
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).
NB-63

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 NEWS .
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
November 16, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY TO AUCTION 2-YEAR AND 5-YEAR 2-MONTH NOTES
TOTALING $16,500 MILLION
The Treasury will raise about $5,350 million of new cash
by issuing $9,000 million of 2-year notes and $7,500 million
of 5-year 2-month notes. This offering will also refund $11,140
million of 2-year notes maturing November 30, 1988. The $11,140
million of maturing 2-year notes are those held by the public,
including $1,267 million currently held by Federal Reserve Banks
as agents for foreign and international monetary authorities.
The $16,500 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 $495 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

NB-64

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TREASURY NEWS
ppartment of the Treasury • Washington, D.c. • Telephone 566-2041
CORRECTED COPY
FOR IMMEDIATE RELEASE
November 17, 1988

CONTACT: Office of Financing
202/376-4350

RESULTS OF AUCTION OF 30-YEAR BONDS
The Department of the Treasury has accepted $ 9,02 6 million
of $21,580 million of tenders received from the public for the
30-year Bonds auctioned today. The bonds will be issued
November 22, 1988, and mature November 15, 2018.
The interest rate on the bonds will be 9 %. 1/ The range
of accepted competitive bids, and the corresponding prices at the
9%
interest rate are as follows:
Yield
Price 2/
9.09% a/
Low
99 .072
High
9.11%
98 .869
Average
9.10%
98 .970
a/ Except.ing 2 tenders total:Lng $49,000 .
Tenders at the high yield were allotted 37%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Accepted
Received
Location
Boston
$
2,294
2,294
$
New York
20,047,235
8,593,805
Philadelphia
585
585
Cleveland
2,543
2,543
Richmond
1,469
839
Atlanta
3,462
3,462
Chicago
926,025
323,925
St. Louis
4,471
4,471
Minneapolis
2,989
2,789
Kansas City
' 3,967
3,967
Dallas
3,552
2,922
San Francisco
581,127
84,117
Treasury
429
429
Totals
$21,580,148
$9, 026,148
The $9,026 million of accepted tenders includes $413
million of noncompetitive tenders and $8,613 million of competitive tenders from the public.
1/ The minimum par amount required for STRIPS is $200,000
~~ Larger amounts must be in multiples of that amount.
2/ In addition to the auction price, accrued interest of $1.74033
~ per $1,000 for November 15, 1988, to November 22, 1988, must
be paid.

NB-6 5

TREASURY NEWS
ppartment of the Treasury • Washington, D.c. • Telephone 566-2041
CONTACT: Office of Financing
FOR IMMEDIATE RELEASE
202/376-4350
November 17, .198 8
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION
Tenders for $ 9,052 million of 52-week bills to be issued
November 25, 1988, and to mature November 24, 1989, were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:

Low
High
Average -

Discount
Rate
7.91%
7.93%
7.92%

Investment Rate
(Equivalent Coupon-Issue Yield) Price
92.002
8.54%
91.982
8.56%
91.992
8.55%

Tenders at the high discount rate were allotted 37%.

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
$
20,955
$
20,955
8,215,730
25,896,300
11,255
11,255
18,670
18,670
19,200
19,200
13,140
13,140
68,205
1,233,135
15,950
30,100
7,735
7,735
28,895
28,895
9,600
17,750
502,435
1,580,935
120,270
120,270
$9,052,040
$28,998,340

Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

$25,276,625
442,415
$25,719,040
3,000,000

$5,,330,,325
442,,415
$5,,772,,740

279,300
$28,998,340

279,,300
$9,052,040

3,r000,,000

An additional $51,700 thousand of the bills will be issued
to foreign official institutions for new cash.

NB-66

TREASURY NEWS .
Department of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350
FOR IMMEDIATE RELEASE
November 21, 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,218 million of 13-week bills and for 37,204 million
of 26-week, bills, both to be issued on November 25, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average
a/ Excepting
b/ Excepting
Tenders
Tenders

13-week bills
maturing February 23, 1989
Discount Investment
Price
Race
Rate 1/

7.95%a/
8.22%
98.013
7.97%
8.24%
98.008
7.97%
8.24%
98.008
1 tender of $90,000.
3 tenders totaling $4,560,000
at the high discount race for the 13-week bills were allotted 98%.
ac the high discount race for che 26-week bills were allocted 57%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
Received
Received

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

26-week bills
maturing May 25, 1989
Discount Investment
Rate 1/
Price
Rate
95.988
7.98%b/
8.43%
95.983
7.99%
8.44%
95.983
7.99%
8.44%

Accepted
$

29,810
6,253,705
21,085
44,370
44,645
31,425
98,195
21,945
11,015
48,565
21,230
210,640
367,065

44,110
26,364,160
526,380
43,115
81,215
43,620
1,321,805
73,990
9,325
42,025
43,860
2,060,250
389,700

$
44,110
5,867,720
526,380
43,100
51,215
43,620
56,805
33,490
9,325
42,025
33,860
76,250
389,700

$31,043,555

$7,217,600

$25,357,915

$7,203,695

$27,104,110
1,255,935
$28,360,045

$3,278,155
1,255,935
$4,534,090

$20,478,760
969,980
: $21,448,740

$2,324,540
969,980
$3,294,520

2,435,585

2,250,000

247,925

1,659,175

$31,043,555

$7,217,600

: $25,357,915

$7,203,695

29,810
22,074,855
21,085
45,370
69,645
31,425
1,009,045
47,665
11,015
48,565
31,230
1,571,140
367,065

An additional $74,775 thousand of 13-week bills and an additional $410,325
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
y

Equivalent coupon-issue yield.
NB-67

Removal Notice
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Citation Information
Document Type: Transcript

Number of Pages Removed: 4

Author(s):
Title:

NBC Today Interview with Nicholas Brady

Date:

1988-11-18

Journal:

Volume:
Page(s):
URL:

Federal Reserve Bank of St. Louis

https://fraser.stlouisfed.org

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
November 23, 1908

CONTACT:

Office of Financing
202/376-4350

RESULTS OF AUCTION' OF 5-YEAR 2-MONTH NOTES
The Department of the Treasury haa accepted $7,504 million
of $21,793 million of tenders received from the public for the
5-year 2-month notes, Series H-1994, auctioned today. The notes
will be issued December 1, 1988, and mature February 15, 1994.
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% rate are as follows:
Yield
Price
8.95%
99.616
Low
8.98%
99.493
High
8.97%
99.534
Average
Tenders at the high yield were allotted 3%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Received
Accepted
Location
Boston
33,859
$ 33,859
$
19,,307,995
New York
6,933,425
13,007
Philadelphia
13,007
28,876
Cleveland
28,876
40,118
Richmond
40,118
14,264
Atlanta
1,,110,187
14,264
41,976
Chicago
241,025
22,632
St. Louis
26,066
48,811
Minneapolis
22,122
5,714
Kansas City
43,961
1,,123,423
Dallas
2,081
5,714
$21,792,943
San Francisco
99,773
Treasury
2,081
The $7,504
million of accepted tenders includes
$551
Totals
$7,504,291
million of noncompetitive tenders and $6,953 million of competitive tenders from the public.
In addition to the $7,504 million of tenders accepted in
the auction process, $260 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities.

NB-68

TREASURY NEWS
Deportment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
November 22, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF AUCTION OF 2-YEAR NOTES
The Department of the Treasury has accepted $9,027 million
of $27,081 million of tenders received from the public for the
2-year notes, Series AH-1990, auctioned today. The notes will be
issued November 30, 1988, and mature November 30, 1990.
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% rate are as follows:
Yield Price
Low
8.86%*
100.027
High
8.89%
99.973
Average
8.88%
99.991
•Excepting 2 tenders totaling $20,000.
Tenders at the high yield were allotted 85%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
$
61,350
$
61,350
New York
22,810,330
6,930,400
Philadelphia
417,455
387,455
Cleveland
67,795
67,795
Richmond
117,090
111,190
Atlanta
46,315
45,165
Chicago
1,782,020
711,870
St. Louis
102,155
88,255
Minneapolis
46,700
45,450
Kansas City
144,960
144,960
Dallas
36,535
26,535
San Francisco
1,346,090
304,840
Treasury
102,020
102,020
Totals
$27,080,815
$y ,uz/ ,^ss
The $9,027
million of accepted tenders includes $1,275
million of noncompetitive tenders and $7,752 million of competitive tenders from the public.
In addition to the $9,027 million of tenders accepted in
the auction process, $970 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $495 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.

NB-69

TREASURY NEWS
Deportment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
November 22, 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
$14,400 million, to be issued December 1, 1988.
This offering
will provide about $ 75
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $14,315 million.
Tenders will be received at Federal Reserve Banks and Branches and at
the Bureau of the Public Debt, Washington, D. C. 20239, prior to 1:00
p.m., Eastern Standard time, Monday, November 28, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
September 1, 1988, and to mature
March 2, 1989
(CUSIP No.
912794 RK 2), currently outstanding in the amount of $7,349 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,200 million, to be dated
December 1, 1988,
and to mature
June 1, 1989
(CUSIP No.
912794 SB 1 ) .
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 December 1, 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 discbunt 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 $2,341 million as agents for foreign
and international monetary authorities, and $4,442 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)
NB-70

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
FOR IMMEDIATE RELEASE
November 22, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY AMENDS 2-YEAR AND 5-YEAR 2-MONTH NOTES ANNOUNCEMENT
In an announcement made on November 16, the Treasury offered
two new note issues, including the 5-year 2-month note of Series
H-1994, to be dated and issued December 1, 1988. The new 5-year
2-month notes will have the same maturity and interest payment
dates as the outstanding 9% 15-year 1-month bonds of 1994, issued
January 11, 1979.
If, under Treasury's usual operating procedures, the auction
of 5-year 2-month notes results in the same interest rate as the
outstanding 9% bonds of February 15, 1994, the new notes will be
issued with either an 8-7/8% or a 9-1/8% coupon. The 9-1/8%
coupon will apply if the auction results in an average accepted
yield in a range of 9.05% through 9.22%.
A H other particulars of the November 16 announcement remain
unchanged.
oOo
Attachment

NB-71

2041

TREASURY NEWS
Deportment of the Treasury • Washington, D.C. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350
FOR IMMEDIATE RELEASE
November 28, 1988
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,210 million of 13-week bills and for $7,227 million
of 26-week bills, both to be issued on December 1, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing March 2, 1989
Discount Investment
Price
Rate
Rate 1/
8.03%
8.06%
8.05%

8.31%
8.34%
8.33%

97.970
97.963
97.965

26-week bills
maturing June 1, 1989
Discount Investment
Price
Rate
Rate 1/
8.12%
8.13%
8.13%

8.58%
8.60%
8.60%

95.895
95.890
95.890

Tenders at the high discount rate for the 13-week bills were allotted 59%.
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

$7 ,209,560

$ 31,080
23,352,325
17,635
32,925
43,210
26,430
926,205
30,060
9,255
45,390
25,080
1,606,225
375,545
$26,521,365

$ 31,080
6,419,875
15,635
32,790
42,830
26,430
49,305
23,680
9,255
44,365
19,130
136,725
375,545
$7,226,645

$24,471,960
1,124,635
$25,596,595

$3 ,248,475
1,124,635
$4,373,110

$21,718,465
879,050
$22,597,515

$2,423,745
879,050
$3,302,795

2,306,600

2,150,000

$
43,055
24,681,655
22,300
47,500
47,590
37,340
1,165,380
55,170
9,205
54,335
38,130
1,856,815
374,570

41,870
$
6 ,086,830
22,300
46,775
45,590
37,340
107,330
41,070
9,205
43,335
31,080
322,265
374,570

$28,433,045

J2£e
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

529,850

$28,433,045

$7,209,560

1,773,850

$26,521,365

$7,226,645

An additional $59,750 thousand of 13-week bills and an additional $215,950
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
NB-73

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

TOR IMMEDIATE RELEASE
November 29, 1988

CONTACT:Robert Levine
(202)566-2041

Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of October 1988.
As indicated in this table, U.S. reserve assets amounted to
$50,204 million at the end of October, up from $47,788 million in
September.

U.S. Reserve Assets
(in millions of dollars)

End
of
Month

Total
Reserve
Assets

47,788
50,204

Stock y

Special
Drawing
Rights 2/3/

Foreign
Currencies 4/

Reserve
Position
in IMF 2/

11,062
11,062

9,074
9,464

18,015
19,603

9,637
10,075

Gold

1988
Sep
Oct.

1/ Valued at $42.2222 per fine troy ounce.
2/ Beginning July 19 74, 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.

NB-73

TREASURY NEWS
Upartment of the Treasury e Washington, D.c. • Telephone 566-2041
November 29, 1988
GEORGE D. GOULD
UNDER SECRETARY OF THE TREASURY FOR FINANCE
LEAVES TREASURY
Secretary of the Treasury Nicholas F. Brady announced that
George D. Gould, Under Secretary of the Treasury for Finance, has
resigned his post at the Treasury Department, effective November
25, 1988.
In announcing his departure, Secretary Brady praised his
"dedicated service to President Reagan and the Treasury
Department" and noted that Mr. Gould "has truly distinguished
himself as one of this Administration's key financial market
experts."
Citing Gould's tireless efforts on behalf of the nation's
banking and thrift industries and his leadership role in
Administration efforts to analyze U.S. financial markets in the
wake of the 1987 Stock Market crash, Secretary Brady noted that
"George Gould has been one of the moving forces in the Treasury,
and I can assure you that he will be missed. He has our sincere
best wishes for the future."
Mr. Gould was confirmed as Under Secretary of the Treasury
for Finance on November 14, 1985. He has been the Department's
chief policymaker in the areas of Banking, Debt Management, and
Financial Market Analysis. He served as Chairman of President
Reagan's Working Group on Financial Markets, whose interim report
was issued in May, 1988.
Before assuming his duties as Under Secretary, Mr. Gould was
Chairman and Chief Executive Officer of Madison Resources, Inc.
He was also a General Partner in the investment banking firm of
Wertheim and Company. He had previously been associated with
Donaldson, Lufkin, and Jenrette Securities Corporation, rising to
the position of Chairman of that firm.
A 1951 graduate of Yale University, with a Master of Business
Administration degree from Harvard University (1955), Mr. Gould
has been an advocate for open financial markets and wider choices
for American consumers throughout his career in public service.
He has also been active in civic affairs in New York State
and in New York City, where he and his wife reside.

NB-74

TREASURY NEWS
department of the Treasury • Washington, D.c. e Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
November 29, 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
$ 14,400 million, to be issued December 8, 1988.
This offering
will provide about $ 850
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $13,545 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m., Eastern Standard time, Monday, December 5, 198 8.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
September 8, 1988, and to mature March 9, 1989
(CUSIP No.
912794 RL 0 ) , currently outstanding in the amount of $7,604 million,
the additional and original bills to be freely interchangeable.
182-day bills (to maturity date) for approximately $7,2 00
million, representing an additional amount of bills dated
June 9, 1988,
and to mature June 8, 1989
(CUSIP No.
912794 SC 9 ) , currently outstanding in the amount of $ 8,801 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 December 8, 19 88.
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 $ 1,236 million as agents for foreign
and international monetary authorities, and $4,588 million for their
own
account. Tenders for bills to be maintained on the book-entry
NB-75
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
tenders.
10/87

TREASURY NEWS
department of the Treasury e Washington, D.c.
e Telephone
566-2041
CONTACT:
Office of Financing
202/376-4350
FOR IMMEDIATE RELEASE
December 5, 1988

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

Tenders for $ 7,203 million of 13-week bills and for $7,207 million
of 26-week bills, both to be issued on December 8, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-week bills
maturing March 9, 1989
Discount Investment
Rate
Rate 1/
Price

Low
High
Average
a/ Excepting 1
b/ Excepting 2
Tenders at the
Tenders at the

26-week bills
maturing
June 8, 1989
Discount Investment
Rate
Price
Rate 1/

8.02% a/
8.30%
97.973 :
8.23% b/
8.71%
95.839
8.04%
8.32%
97.968 :
8.26%
8.74%
95.824
8.04%
8.32%
97.968 :
8.25%
8.73%
95.829
tender of $200,000.
tenders totaling $100,000.
high discount rate for the 13-week bills were allotted 97%
high discount rate for the 26-week bills were allotted 15%
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Received
$
49,305
24,921,820
44,165
52,960
88,170
43,755
1,076,530
70,035
11,990
40,750
42,115
2,302,300
393,565

$
49,305
5,893,620
44,165
52,930
53,170
43,755
221,565
30,035
11,990
40,750
36,965
330,800
393,565

$29,137,460

Accepted

$
35,670
22,344,230
23,415
50,220
49,480
39,210
1,217,935
57,180
12,345
56,445
31,770
1,808,245
395,910

$
35,670
6,181,480
23,415
50,220
44,080
39,210
140,185
29,480
12,345
56,445
21,670
176,745
395,910

$7,202,615

: $26,122,055

$7,206,855

$25,260,240
1,269,800
$26,530,040

$3,325,395
1,269,800
$4,595,195

: $21,825,465
:
1,082,880
: $22,908,345

$2,910,265
1,082,880
$3,993,145

2,414,330

2,200,000

193,090

1,013,710

$29,137,460

$7,202,615

: $26,122,055

$7,206,855

:
:
:
:
:
:

.
:

An additional $134,110 thousand of 13-week bills and an additional $ 656,290
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
NB-7G

TREASURY NEWS
Deportment of the Treasury e Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
December 6, 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
$14,400 million, to be issued December 15, 19 88.
This offering
will provide about $ 750
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $ 13,661 million.
Tenders will be received at Federal Reserve Banks and Branches and at
the Bureau of the Public Debt, Washington, D. C. 20239, prior to 1:00
p.m., Eastern Standard time, Monday, December 12, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $ 7,200
million, representing an additional amount of bills dated
March 17, 1988,
and to mature March 16, 1989
(CUSIP No.
912794 RM 8), currently outstanding in the amount of $ 16,817million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $ 7,2 00 million, to be dated
December 15, 19 88, and to mature
June 15, 1989
(CUSIP No.
912794 SE 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 December 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 $ 1,467 million as agents for foreign
and international monetary authorities, and $ 4,572 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).
NB-77

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 NEWS
Department of the Treasury • Washington, D.c. e Telephone 566-2041

FOR RELEASE AT 12:00 NOON
December 9, 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 December 22, 1988, and to mature December 21,
1989 (CUSIP No. 912794 SP 0 ) . This issue will result in a paydown
for the Treasury of about $275 million, as the maturing 52-week bill
is outstanding in the amount of $9,275 million. Tenders will be
received at Federal Reserve Banks and Branches and at the Bureau
of the Public Debt, Washington, D. C. 20239, prior to 1:00 p.m.,
Eastern Standard time, Thursday, December 15, 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 December 22, 1988. In addition to the
maturing 52-week bills, there are $13,756 million of maturing
13-week and 26-week bills and $11,025 million of maturing 37-day
cash management bills. The disposition of these two latter amounts
will be announced next week. Federal Reserve Banks currently hold
$3,114 million as agents for foreign and international monetary
authorities, and $6,005 million for their own account. These
amounts represent the combined holdings of such accounts for the
four 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 $358 million of the original
52-week issue. Tenders for bills to be maintained on the book-entry
records
NB-78 of the Department of the Treasury should be submitted on
Form PD 5176-3.

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
apartment of the Treasury e Washington, D.c. • Telephone 566-2041

FOR IMMEDIATE RELEASE
Dec. 12, 1988

Contact: Bob Levine
(202) 566-2041

William E. Barreda Named DAS For Trade and Investment
The Department of the Treasury announced today the appointment
of William E. Barreda as Deputy Assistant Secretary for Trade and
Investment.
Mr. Barreda assumed this position on Nov. 6, 1988. From 1980
until that date he was Director of the Office of International
Trade in the Department of the Treasury. He is also the chief
U.S. negotiator for investment matters in the Uruguay Round of
international trade negotiations.
In his 23 years of government service Barreda has also held
positions in the Commerce and State Departments and the Office of
the U.S. Special Trade Representative.
Mr. Barreda holds A.B. and M.A. degrees in economics from the
University of California at Berkeley. He was born in Corpus
Christi, Texas in 1941.

NB-79

TREASURY NEWS
Department of the Treasury • Washington, D.c • Telephone 566-2041
Text as Prepared
For Release Upon Delivery
Expected at 3:30 p.m. EST
Remarks by Thomas J. Berger
Deputy Assistant Secretary for International Monetary Affairs
U.S. Department of the Treasury
before the
U.S.-U.S.S.R. Emerging Leaders Summit
December 8, 1988
The U.S. Economy and the Budget Outlook:

What's Next?

Introduction
Good afternoon. It is a pleasure to address this important
and diverse group of Soviet financial leaders. I visited Moscow
and Leningrad for the first time early this year and was treated
with great hospitality. I hope your stay in the United States
during this conference will be equally enjoyable.
B.N. Chakravarty, in his book, India Speaks to America,
described Americans as follows:
"The Americans are a funny lot; they drink
whiskey to keep them warm; then they put some
ice in it to make it cool; they put some sugar
in it to make it sweet, and then they put a
slice of lemon in it to make it sour. Then
they say "here's to you" and drink it
themselves!"
Sir Winston Churchill vividly portrayed his image of the Soviet
Union when he wrote:
"It is a riddle wrapped in a mystery inside an
enigma."
Like all generalizations these quotations contain a certain element
of truth, but they also give a somewhat exaggerated and misleading
view of America and the Soviet Union. I hope in our discussions
today we can cast aside some of the common misconceptions we have
about each other and develop a better mutual understanding of our
two nations. Toward this end, today I would like to discuss with
you briefly (1) the U.S. economy, (2) our near-term economic
forecast and (3) the U.S. budget outlook.
NB-80

- 2 But before I get into the details, I'd like to take just a few
moments to place America's current economic situation in its policy
context. The impressive economic achievements we have produced in
recent years didn't simply happen by chance. Our achievements are
the fruit of a policy program that broke with the past in important
respects, charting a new course for the U.S. economy and, by
implication, for the global economy as well.
The basic elements of this new course are not themselves new
or technically complicated. Our goal has simply been to enhance
the strength and vitality of the free market, and to provide a
supportive climate for private initiative and individual
enterprise, free from intrusive and excessive qovernment
intervention. Our motto has been that the best thing government
can do is to get out of the way. And that's precisely what we've
tried to do. Our program has:
Eliminated suffocating rules and regulations in a wide
array of important areas;
— Reduced the scope of Federal activity and by returning key
responsibilities to the state and local levels where they
rightly belong;
Brought about a fundamental reform of the tax system that
has improved the efficiency and equity of a cumbersome tax
code and has encouraged innovation and risk taking; and
Created a climate of price stability that allows long-term
planning.
I recognize that some might be tempted to dismiss this kind of
talk as the hyperbole of a Reagan Administration official. To them
I would simply say two things:
First, these views are not confined to the United States,
but rather have an increasingly global appeal. They are
being embraced throughout the world, by rich nations and
poor, by peoples of every race and by governments of every
political stripe; and
— Second, these views have gained strength because, whether
one agrees with the theory or not, the results have been
undeniable.
The U.S. Economy
To illustrate, let's take a closer look at our own experience
here in the United States. The U.S. economic expansion completed
its 72nd month in November. This has been the longest peacetime
record by a wide margin. During the current vigorous upswing, real
GNP has risen at a 4.2 percent annual rate, impressive by any
standard.

- 3 And growth has» remained solid this year, rising during the
first three quarters at a 3.0 percent real annual rate, off from a
5.0 percent increase during 1987. Even so, real growth this year
has been substantially stronger than had been estimated by most
forecasters, including the Reagan Administration.
One of the reasons for this is that the stock market crash in
October 1987 has had a relatively minor impact on the U.S. economy
in 1988. There are many explanations for why the crash had such a
limited impact, but clearly the flexibility and resiliency of the
American economy, -produced by the policies I mentioned earlier, had
something to do with it.
As an illustration, during 1987 and into 1988 the volume of
U.S. exports rose sharply, contributing to gains in industrial
production and increases in business capital spending.
Exports of goods and services increased 18-1/2 percent in
real terms during 1987 and were up at a strong 15 percent
annual rate during the first three quarters of 1988. By
contrast, the growth in imports has been substantially
slower — 10-1/2 percent during 1987 and a 4-3/4 percent
annual rate so far this year.
There has been a major reduction in the U.S. trade deficit
this year, although the deficit remains large. The
merchandise trade deficit (on a balance of payments basis)
totalled $160 billion in 1987, but fell to $125 billion at
an annual rate this year for the first three quarters.
The surge in U.S. exports also contributed to more
optimistic spending actions on the part of U.S.
businesses. So far this year, business capital spending
has risen at a 9 percent annual rate.
Other measures of industrial sector development have also
shown improvement over the past year or so. Industrial production
rose by 5-1/2 percent over the twelve months of 1987, compared to
just over 1 percent during all of 1986. During the first ten
months of this year, industrial output has continued to increase at
a solid 4-3/4 percent annual rate.
•
Throughout the expansion, U.S. labor markets have shown
striking dynamism and strength. Indeed, it is not an exaggeration
to describe the U.S. economy of the 1980s as a "job creating
machine." Since November 1982, 18.8 million new jobs have been
created. Employment in manufacturing rose by over 460,000 durinq
1987, after two consecutive yearly declines. More than 370,000
additional factory jobs have been added during the first eleven
months of 1988. The percentage of working-age Americans employed
has reached new highs and in November was at a level of 62.9
percent. The total unemployment rate was 5.3 percent in November
and, along with an October reading of 5.2 percent, was the lowest
since 1974.

- 4 •

Here again, these results aren't the product of luck. They
reflect a vibrant, flexible labor market coupled with a sound
economic environment.
Inflation Prospects
Slashing inflation from the double-digit rates of the 1970s
has been one of the key policy achievements of the decade, and we
are determined to keep rates low. There is currently little
evidence of any market acceleration in inflation. Consumer prices
advanced by 4.4 percent during 1987 and rose at a similar 4.6
percent annual rate during the first ten months of 1988. Despite
pifess reports to the contrary, the drought has had relatively
little impact on inflation — this is because food accounts for
only 16 percent of the consumer price index.
Several factors suggest that inflation should remain well
behaved.
— Rates of increase in compensation remain in a moderate
range of 4 to 5 percent, despite the impressive employment
gains.
Particular progress in containing costs has been made in
the manufacturing sector, due in no small measure to solid
productivity gains. Declines in factory unit labor costs
in recent years have placed these costs at slightly below
their level at the end of 1981.
Why the Expansion is Likely to Continue
So far the economy has not experienced the stresses and
imbalances which in the past have been associated with a hard
landing. Thus, there is little on the horizon at this point that
suggests an end to the current expansion.
Utilization of industrial capacity is still well below
rates reached in prior economic expansions, and robust
investment today ensures greater capacity in the future.
Inventories have been held in good balance with no
backlogs.
With the exception of a few sectors, such as multi-family
housing and commercial structures, there have been no
excesses in the capital investment sector.
Consumer balance sheets appear to be in reasonably good
shape.
Inflation, as noted above, remains under control.

- 5 Near-Term Economic Forecast
These considerations give us great confidence about the
future. The Reagan Administration's year-end economic forecast
projects that real GNP will grow by 3.5 percent (on a fourth
quarter over fourth quarter basis) next year, of which about 0.7
percent will reflect higher farm output following the drought.
Growth this year is estimated at 2.6 percent — or 3.3 percent
(again on a fourth quarter over fourth quarter basis) if the effect
of the drought were excluded.
The Reagan Administration figure for 1989 is higher than the
2.2 percent contained in the November Blue Chip consensus forecast
of some 50 private economists. However, it should be noted that
the consensus figure for 1988 was also quite low late last year and
has been revised up consistently to 2.7 percent — virtually the
same as the current Administration estimate. This year, it is not
clear that the private forecasters have adequately accounted for
the phasing out of the drought impact in 1989.
All in all, we believe the U.S. economy is on a solid footing.
We have seen a desirable shift in the composition of growth toward
net exports and investment. The consumer has rebuilt savings
somewhat and the savings rate has risen almost a full percentage
point to 4.1 percent in the first three quarters of 1988 from 3.2
percent during all of last year. There are no readily apparent
threats to continued growth such as accelerating inflation or
inventory imbalances.
The Budget Outlook
President-elect Bush is committed to the same principle of
deficit reduction through outlay restraint that characterized the
Reagan Administration. This approach has already achieved some
important results.
As a share of GNP the Federal budget deficit has dropped
from a high of 6.3 percent in 1983 to 3.2 percent in the
1988 fiscal year just ended.
In FY-1987 the deficit narrowed by a record $71 billion to
$150 billion (3.4 percent of GNP) from $221 billion in
FY-1986 — the largest single-year decline on record.
The achievements of 1987 were to some extent due to
special factors, including one-time asset sales and a jump
in revenues as taxpayers chose to take capital gains under
the old tax law. Nevertheless, the drop in the 1987
deficit reflected the first decline in real outlays in
fourteen years.
— The FY-1988 budget deficit edged up slightly to S155
billion (3.2 percent of GNP), but this should not be
viewed as implying that our deficit reduction efforts have

- 6 stalled out. Adjusting for the special factors affecting
FY-1987 that I mentioned above, the deficit declined by
some $30 billion in both FY-1987 and FY-1988.
I would also note that many observers fail to consider
that our state and local governments run substantial
budget surpluses. When the combined deficit of all levels
of government is considered, the U.S. deficit as a percent
of GNP compares favorably with other major economies.
The Reagan Administration is in the process of preparing its
budget for FY-1990 which will be submitted to Congress on January
9, 1989. The Gramm-Rudman-Hollings Act mandates reduction of the
deficit to $100 billion in FY-1990 (with leeway of $10 billion) and
a balanced budget in FY-1993.
The incoming Bush Administration will have the option of
laying out a new budget of its own, providing an overall blueprint
of any changes in direction it may wish to take, or moving to work
directly with the Congress in hammering out an agreement which
adheres to the Gramm-Rudman-Hollings path. It is not known which
direction the new Administration will take. In any event,
President-elect Bush has made it clear that deficit reduction will
be a first priority and, as I noted earlier, has also stipulated
that the effort must be directed toward the outlay side.
In conclusion, let me thank you for your attention and invite
you to ask any questions you may have.

TREASURY NEWS
apartment of the Treasury • Washington, CONTACT:
D.c. • Telephone
566-2041
Office of Financing
202/376-4350

FOR IMMEDIATE RELEASE
December 12, 1988

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

Tenders for $ 7,202 million of 13-week bills and for $ 7,201 million
of 26-week bills, both to be issued on December 15, 1988, were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-week bills
maturing March 16, 1989
Discount Investment
Rate
Rate 1/
Price

Low 7.95% a/ 8.23% 97.990
High
7.99%
8.27%
Average
7.98%
8.26%
a/ Excepting 1 tender of $4,000,000.

26-week bills
maturing
June 15, 1989
Discount Investment
Price
Rate
Rate 1/
8.19%
8.22%
8.21%

97.980
97.983

8.66%
8.70%
8.69%

95.860
95.844
95.849

Tenders at the high discount rate for the 13-week bills were allotted 79%,
Tenders at the high discount rate for the 26-week bills were allotted 59%,

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

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
:
Received
$
36,455
25,109,815
31,985
45,155
61,820
45,205
1,253,650
65,995
7,585
41,175
37,725
1,725,140
408,190

$
36,455
5,825,650
31,985
45,155
49,720
45,205
329,500
40,995
7,585
41,175
27,725
312,480
408,190

$28,869,895

$7,201,820

: $26,460,010 $7 ,201,290

Type
Competitive
$25,061,170
Noncompetitive
1,225,835
Subtotal, Public $26,287,005

$3,393,095
1,225,835
$4,618,930

2,372,155

210,735

$28,869,895

$7,201,820

TOTALS

Federal Reserve
Foreign Official
Institutions
TOTALS

: $
38,665
: 22,878,355
34,665
30,540
40,415
37,730
1,187,200
50,875
10,660
:
43,140
:
27,090
:
1,712,070
:
368,605

Accepted
$

38,665

5 ,988,555
34,665
30,540
40,415
37,730
354,700
28,055
10,660
43,140
17,090
208,470
368,605

$22,158,770
994,875
$23,153,645

$2 ,900,050

2,200,000

2 ,200,000

1,106,365

:
;

994,875

$3 ,894,925

1,106,365
: $26,460,010 $7 ,201,290

An additional$101,865 thousand of 13-week bills and an additional $567,035
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupotl-issue yield.
NB-81

TREASURY NEWS

Department of the Treasury • Washington,
D.c.Office
• Telephone
566-2041
CONTACT:
of Financing
202/376-4350
FOR RELEASE AT 4:00 P.M.
December 13, 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
$14,400 million, to be issued December 22, 1988. This offering will
result in a paydown for the Treasury of about $L0,375 million, as the
maturing bills are outstanding in the amount of $ 24,781 million
(including the 37-day cash management bills issued November 15, 1988,
in the amount of $11,025 million). Tenders will be received at
Federal Reserve Banks and Branches and at the Bureau of the Public
Debt, Washington, D. C. 20239, prior to 1:00 p.m., Eastern Standard
time, Monday, December 19, 1988. The two series offered are as
follows:
91-day bills (to maturity date) for approximately $ 7,200
million, representing an additional amount of bills dated
September 22, 1988, and to mature March 23, 1989 (CUSIP No. 912794
RP 1), currently outstanding in the amount of $ 7,026 million, the
additional and original bills to be freely interchangeable.
182-day bills for approximately $ 7,200 million, to be dated
December 22, 1988, and to mature June 22, 1989 (CUSIP No. 912794
SF 2) .
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 December 22, 1988. In addition to the maturing
13-week, 26-week, and 37-day bills, there are $ 9,275 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 $ 2,443 million of the original 13-week
and 26-week issues. Federal Reserve Banks currently hold $ 2,801
million as agents for foreign and international monetary authorities,
and $ 6,255 million for their own account. These amounts represent
the combined holdings of such accounts for the four issues of
NB-82
maturing bills. Tenders for bills to be maintained on the book-entry
records
of (for
the Department
of the
submitted
on Form
PD
5176-1
13-week series)
orTreasury
Form PD should
5176-2 be
(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 mast 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

lepartment of the Treasury • Washington, D.C. • Telephone 566-2041
TEXT AS PREPARED
FOR IMMEDIATE RELEASE
Remarks of the Honorable M. Peter McPherson
Deputy Secretary of the Treasury
Before the
Center for Strategic and International Studies
Washington, D.C.
December 14, 1988
I want to talk today about one of the greatest challenges
facing the world: the development of Africa. This is an issue
I was personally involved with for many years as Administrator
of AID. It is an issue we at Treasury are concerned about
because of our involvement in African countries' financial
problems and our strong commitment to the efforts of the
multilateral development banks and the International Monetary
Fund in helping African countries to lay down the foundation
for sustainable growth and development.
In the 1980• s, Africa drew more focused and dedicated
attention from the United States than ever before. U.S.
bilateral aid to the continent has increased significantly, so
that total aid flows for this decade will tower over those
provided in the 1970's. The U.S. has played an important role
in addressing the crisis needs of Africa, including leading the
international relief effort for the 1984-1985 famine. U.S.
diplomatic activities in the region reflected an increased
willingness to devote resources and effort to Africa. The
Presidents End Hunger Initiative for Africa in 1987 focused
the U.S. effort on reform, resources, and growth. This overall
commitment exists both in the U.S. and the international
community as a whole.
Because of these efforts, we monitor closely the economic
developments in Sub-Saharan Africa. The message I have for you
today is that progress is being made in this suffering continent
through the combined efforts of Africans and the international
community.
Many countries in Africa are starting down the development
path with only the most fragile of human resources and
institutional structures to support them. Much remains to be
accomplished in their struggles to overcome economic adversity
NB-83
and to develop steadily with the help of stable growth.
Nevertheless, we can today see progress.

2
Progress in the growing realization among African
countries that they must be responsible for their own
future;
Progress in the growing commitment and stepped-up
actions of African governments to implement difficult
but much needed economic reforms;
Progress in the actions of the international community
to help Africa through an unprecedented cooperative
effort — by committing more net resources and by
providing a greater proportion of those resources on
a fast disbursing basis.
Progress in the actual performance — for example, in
terms of GDP growth and agricultural production — of
Sub-Saharan African economies undertaking serious
reform efforts.
African Efforts
A traveller who visited Africa in the early 1980*s would
be struck upon returning today by the fundamental change in
attitude toward the importance of rational economic policies.
Ineffective economic policy choices played a large role, along
with external fluctuations, in the decline of Sub-Saharan
Africa's already fragile economy in recent decades. Today, in
contrast, there is a growing consensus in many countries that
the key to the resumption of growth is more efficient use of
resources through sound macroeconomic and sectoral policies.
Such policies are also being recognized as tools for helping to
control the impact of external events, such as rising interest
rates or fluctuating commodity prices.
Many African countries have therefore altered their approach
to their economic problems, and many have committed themselves
to policy reform efforts aimed at economic recovery and growth.
For example, a number of countries have increased incentives for
farmers, by allowing producers to be paid prices that more
closely reflect market conditions. Many countries have taken
steps to reduce their fiscal deficits, restructure their public
sectors, achieve more realistic exchange rates, open up to
increased trade, and strengthen their economic management
generally.
Reforms are not implemented uniformly and policy changes
do not reap the same results in all countries. However, about
half the countries in Sub-Saharan Africa have already committed
to reforms. Furthermore, those entering serious adjustment
programs are generally achieving improved growth and making
progress in dealing with economic and financial problems.

3
Data published in the 1988 World Development Report make
the case clear. Average growth in countries studied in SubSaharan Africa from 1980-1985 was about 1%.
Using economic
performance indicators for 14 countries undertaking strong
adjustment programs, World Bank data show significant results.
Those countries with strong adjustment programs improved their
growth rates in 1986-87 to an average of 4%. This compares to
virtually no increase in the average growth rate among seven
countries identified in the study as having a weak adjustment
program or no adjustment at all.
I note that this comparison excludes countries recently
affected by strong positive or negative external shocks — such
as Nigeria, which suffered from the sharp drop in oil prices in
1985. However, in addition to improving growth, economies with
strong reform programs have also slowed inflation and reduced
their fiscal deficits. According to World Bank data, in