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L)IJggp

~PA&;-,~,-:~

LIBpggy

&pa~~in&

Tl'Iasury ~ Na~lnyioy

4& &h4

p. c. ~ Telephone 566-2041

UNTIL GIVEN
EXPECTED AT 10:00 A. M.
EMBARGOED

FEBRUARY

6, 1991

TESTIMONY OF NICHOLAS
BRADY
BEFORE THE
SENATE BUDGET COMMITTEE
FEBRUARY 6, 1991

Mr. Chairman and Members of the Committee, I am pleased
meet with you to discuss President Bush's FY 1992 budget and

other issues. My comments will concentrate on selected features
of the budget. Chairman Boskin will follow with his comments and
review the economic forecast.

We meet today at a difficult
time. We are at war in the
Gulf, the economy is in recession, and problems inherited from
the past continue to occupy our attention.
We cannot shirk our

responsibility

make government

positive

and

effective force

in dealing with the current problems that we are expected to
address, while at the same time investing for America's future.
Although

economic and budget

realities constrain

our

actions, I believe that this budget achieves the goals of meeting
our ongoing responsibilities,
addressing problems inherited from
the past, and building a base for future economic growth and
competitiveness.

The need to restrain government spending and abide by the
terms of the budget agreement is an over-arching concern.
Over
the next five years, the Federal government will borrow in the
credit markets a half trillion dollars less than it would have
borrowed in the absence of the budget agreement.
Although a
near-term
deficits
obscure
our efforts,
sharp rise in the
may
there is widespread consensus that this budget agreement is an
effective effort to deal with the deficit.

Furthermore,

important

budget

process reforms were adopted

to ensure that the deficit reduction targets are met. These
process reforms are an integral part of the agreement and it js
essential that both the letter and spirit of these reforms are
adhered

to.

President Bush's budget, which increases spending less than
inflation, represents a strong commitment to reducing future
Deficits have a corrosive effect on economic
budget deficits.
activity. They crowd private borrowers out of financial markets,
and they represent a large diversion of our national savings away
in new plant and equipment, research and
from investment

and other uses which would directly enhance
productivity and competitiveness and create economic growthshort, deficits make
more difficult to manage our
macroeconomic affairs and ultimately they reduce our economy's

development,

growth

potential.

Our 1992 budget priorities have been
udget deficits on a downward path. Our

set to keep future
plans for dealing with

current problems, as well as the need to 1mprove econom1c growth
challenges of the
and prepare our economy for the international
the overall
Given
uture, have been shaped by this necessity.
of
re-ordering
budgetary constraint, this necessarily requires a

priorities.

demands
Although the pressure to deal with contemporaneous
must
that
we
believes
Administration
Bush
the
always great,
number
made
a
have
also look to the future. Toward this end, we
of proposals for addressing the economy's long-term growth

potential.

Since productivity is the critical element in the long-term
well-being of the American economy and the key to our
international competitiveness, it must be a central focus of
attention. Although many factors affect productivity, three of
the most important are education, investment, and technology.
And, as I will discuss later, this budget addresses all three of
these elements.
cannot begin until we get past the
there are several uncertainties that
affect our budgetary situation. The most important are the depth
and duration of the recession and the length of the war in the
Gulf.
Of course, the long-run
short-run.
In the near-term

is the unpredictable

course of the S&L
with this
deal
to
aggressively
The RTC has
cleanup.
problem and progress has already been made. Quick action by
Congress on funding, combined with lower interest rates and an
early end to the recession, will help us continue to move ahead
on this problem.
anticipates a recovery from the recession
The Administration
and
a brisker upturn in the latter part of
mid-year
beginning by
the year, which should bring the unemployment rate down and put
us back on a growth track.
President Bush's budget, sets an important markez
believe must be adhered to--namely, to hold spending growth bel~~
In other words, the real level of
the rate of inflation.
The reason is simple: spending gzowth
spending must decline.
Unless we can hold the level of
deficit.
the
fueled
what has
we cannot hope to make the
rate,
inflation
the
spending below
A

further uncertainty

moved

kind of progress

on reducing

people expect of us.

the deficit which the American

fulfill

to the economy and
our responsibility
in OBRA, it is essential that we
deficit down by controlling spending. It will not be
have already done a good deal of the hard first steps
economic recovery can do much of the rest.
To

the promises

made

make

good

get the
easy. We
and

the context of spending restraint and deficit
this budget shows there is still room for action and
initiative. We have just put forward a comprehensive plan for
Such a reform is
fundamental
reform of the banking system.
necessary to build capital in the banking industry, protect
taxpayers and depositors, and remove archaic restrictions on
banking activities.
Our goal is to provide the American people
with the best quality financial services available, and to
provide our banks with the tools to meet the challenge of
international competition.
I have appended a summary of our
reform proposal to my testimony.
Within

reduction,

has proposed extension of the
targeted jobs tax credit, to help deal with the problem of
and extension
unemployment
among the economically disadvantaged,
of the low-income housing credit, to encourage private
construction of low-income housing. We are also asking for
extension of the solar and geothermal energy credits to encourage
investment in renewable energy technologies'

In addition,

Together,

the President

these proposals

address

some

of the issues facing

of financial institutions, unemployment,
us today--problems
and
However, as I mentioned earlier, we also
housing
energy.
to deal with the long term. Toward this
have a responsibility
end, President Bush has put forward in this budget initiatives
improve our Nation's educational system by providing
opportunities for individual choice, and to improve and expand

In addition, we are asking
system.
our Nation's transportation
Congress to support the following initiatives designed to induce
long-term economic growth and competitiveness:

Increasing national saving is
the capital our economy will need
to modernize and expand its productive capacity. We
believe that providing individuals with a new savings
vehicle will help stimulate such saving.
Family Savings Accounts.

critical to

providing

permanent research and experimentation
(R&E) credit.
Research and experimentation
are essential to
We believe that the R&E tax
innovation and growth.

credit is
research

an effective method of promoting private
and development.
But
needs to be enacted

permanently

are to derive

its

maximum

benefit.

Zones. The problems of the inner city
We believe that enterprise
a new approach.
method of targeting private
effective
zones can be an
resources to areas that are experiencing economic

Enterprise
demand

distress.

for first-time home
buyers. Owning a home is part of the American dream.
But many younger people increasingly find it beyond
their reach. We believe that permitting penalty-free
withdrawals from individual retirement accounts for
first-time buyers will not only bring home ownership
within the means of more people, but also provide a
greater incentive for young people to open and
contribute to IRAs.
5. A capital gains tax differential. We believe that
entrepreneurial
activity is the engine that drives the
economy in the long run, creating new inventions,
This is
products, and services that sustain growth.
in the capital gains tax is important.
why a reduction
We are hopeful
that Chairman Greenspan, working with
Congress, can illuminate and help resolve the
disagreements on this issue.
We believe that these incentives
will help achieve our
economy's long-term growth potential and provide the tools to
meet the competitive challenges of the future.
In closing, I would like to turn briefly to the
international sphere. It is increasingly clear that we live in
an integrated world economy and that the economic health of other
nations is essential to our own. The budget reflects this.
Funding is provided for President Bush's Enterprise for the
Americas Initiative, to help improve trade and investment for our
neighbors in the Western Hemisphere.
We are also lending
a
helping hand for economic reform in Eastern Europe, through
direct aid and technical assistance. And we continue to support
the critical role of the international financial institutions,

including

Permit withdrawals

the

IMF and

Mr. Chairman,

from IRAs

the World Bank.

would

now

be happy

to take your questions.

UBLI
of the Treasury

Department

FOR IMMEDIATE

February

DEBT NEW
~

Bureau of the Public Debt ~ Q'ashington,
";"1
l lQPARY F~

RELEASE

6, 1991

CONTACT:

[Eall. ''~

DC 20239

i&4,.'

Office of Financing

202-376-4350

RESULTS OF TREASURY'S AUCTION

OF 10-YEAR NOTES

Tenders for $11, 014 mill/pa of 10-yea+ notes, Series A-2001,
be issued on February 15, 1991 and mature on February 15, 2001
were accepted today (CUSIP: 912827ZX3).

interest rate

The

on the notes
and corresponding

will be 7 3/4%. The range
prices are as follows:
Yield
Price
Low
7. 84%
99. 384
High
7. 85%
99. 316
Average
7. 85%
99-316
Tenders at the high yield were allotted 67%.

of accepted bids

TENDERS RECEIVED AND ACCEPTED

Location

Received
16, 965
27, 488, 427
5, 818
10, 912
25, 860
10, 133

Boston
New

York

Philadelphia

Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

897, 267
15, 514
7, 103
17, 289
4, 163
434, 548

759
$28, 936, 758
2

(in thousands)

16, 932
10, 783, 584
5, 818
10, 897
23, 530
9, 118
67, 812

11, 514

5, 938
17, 189
4, 163

54, 748
2

759

$11, 014, 002

The $11, 014 million of accepted tenders includes
million of noncompetitive tenders and $10, 634 million
competitive tenders from the public.

$380

In addition,
$85 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign
and
international monetary authorities.
An additional
$200
million
of tenders was also accepted at the average price
Federal
Reserve Banks for their own account in exchange forfrom
maturing

securities.

The minimum

Larger amounts
NB-1120

par amount required for STRIPS is
be in multiples of that amount

must

$8QQ ppp

Department

ot the Treasury

Bureau of the Public Debt
F.S
. J l ~

il.

a=r"T.

~ Kl

ashinyon. DC 20239

lac

FOR RELEASE AT 3:OO PM
February 6, 1991

Contact: Peter Hollenbach
(202) 376-4302

PUBLIC DEBT ANNOUNCES ACTIVITY FOR
SECURITIES IN THE STRIPS PROGRAM FOR JANUARY 1991

Treasury's Bureau of the Public Debt announced activity figures for the month of January 1991, of
securities within the Separate Trading of Registered Interest and Principal of Securities program,

(STRIPS).
Dollar Amounts

$473, 539,610

Principal Outstanding
(Eligible Securities)

Held in Unstripped

Form

$357, 379,340

Held in Stripped Form

Reconstituted

Thousands

$116,160,270

in January

$4, 270, 160

The accompanying table gives a breakdown of STRIPS activity by individual loan description.
The balances in this table are subject to audit and subsequent revision. These monthly figures are
included in Table VI of the Monthl Statement of the Public Debt, entitled "Holdings of Treasury
Securities in Stripped Form. " These can also be obtained through a recorded message on
(202) 447-9873.

oOo

PA-43

TABLE Vl

—HOLDINGS

OF TREASURY SECURITIES IN STRIPPED FORD JANU
(In thousands)
Pnncipal Amount Outstanding

Loan Descnpbon

11-1/4% Note B-1995

10-1/2% Note C-1995

Note

8-1/24%%d

6, 491,461

442. 400

5/1 5/95

7, 127, 086

5, 915,886

1,211,200

8/15/95

7, 955,901

7, 283.901

672.000

-0-0-

7, 318,550

6, 339,750

978.800

25, 200

2/15/96

8, 575. 199

8, 343, 199

232.000

. 5/15/96

20, 085, 643

19,871,243

214, 400

20, 258, 810

19,967,610

291.200

5/15/97

9, 921,237

9, 848.037

73,200

. . . 8/15/97

9,382, 836

9, 330,836

32, 000

9, 808.329

9,792, 329

16,000

9, 158, 188

2.880

1/1 5/95

C-1996

Note A-1997

. . . 11/15/96
.

8-5/8% Note B-1997 . . .

8-7/8% Note C-1997 . . .

. .. . 11/15/97

8-1/8% Note A-1998

. .

9% Note B-1998 . . . .

5/1 5/98

9.159.068
9, 165.387

9, 135,387

30,000

9-1/4% Note C-1998 .

. . . 8/15/98

11,342, 646

11,213,846

128, 800

9.902.875

9, 896,475

6, 400

8-7/8% Note D-1998

. . 2/15/98

. . 11/15/98

. . . 2/15/99

9, 719,623

9, 716,423

3,200

. . 5/15/99

10,047, 103

9, 178,303

868, 800

8% Note C-1999

8/1 5/99

10, 163.644

10,081,644

82, 000

7. 7/8% Note 0-1999 .

10, 773, 960

10.765, 960

8, 000

8-1l2% Note A-2000

2/1 5/00

10,673,033

10, 673,033

—

. . 5/1 5/00

10, 496, 230

10,461,030

35.200

8/1 5/00

11,080, 626

8-7/8% Note A-1999

9-1/8% Note B-1999 . . .

S.TIS'%%d Note B-2000

. .

8-3/4% Note C-2000

1/1

5/99

1-3/4% Bond 2009-14

t-t/4% Bond 2015. . .

. .

-0-0-0-

11,519.682
3, 666, 606

4.635,200

5/1 5/05

4, 260, 758

1,530, 808

2, 729, 950

-0-0-

. BI15/05

9, 269, 713

8, 344, 1 13

925, 600

25, 600

2/15/06

4, 755, 916

-0-

. . 11/15/14
. . 2I1 5/15

t0-5/8% Bond 2015. . .

-0-0-0-0-

8.301,806

9-3/8% Bond 2006
1

-0-0-

11,519,682

12% Bond 2005 . .
tO3/4% Bond 2005

—

1,080.626

-0-0-0-

. . 11/15/04

11/15/00 . .
.

41,440

-0-

8-1/2% Note D-2000

11-5/8% Bond 2004

$24, 000

2/15/95

0-1995

7-1/4% Note 0-1996

$1,067.200

8-7/8% Note A-1996 . .
7-3/Bsib Note

This Morlth

$5.591,354

Reconstitute
Portion Held In
Stripped Form

6, 933,861

11/15/94 .

11-1/4% Note A-1995

Portion Held in
Unstnpped Form

Total

$6.658.554

11-5/8% Note C-1994

9.1/2%

Date

Matunty

6, 005.584

1, 537, 584

4, 468, 000

138,400

12, 667, 799

2.276, 599

10,391,200

378, 160
478, 400

7, 149,916

2, 102, 878

5, 047, 040

9-7/8% Bond 2015. . . .

11/15/15 . .

6, 899,859

2.269.459

4, 630,400

150.400

9-1/4% Bond 2016. . . . . .

2/15/1 6

7, 266, 854

6, 493,254

773, 600

415,200

7-1/4% Bond 2016

5/1 5/1

18,823, 551

16,825, 951

1,997, 600

198,000

7-i/2% Bond 2016. .

11/15/16

18,864. 448

601,280

. . 8/15/15

4.539, 1 68

4, 325, 280

8-3/4% Bond 2017

. . . 5/15/17

18, 194, 169

5, 726, 649

12, 467, 520

167,880

8-7/8% Bond 2017

. . 8/15/17

14, 016, 858

9, 282.458

4, 734, 400

337, 800
104, 000

9-1/8% Bond 2018.

8-1/24%%d

2, 868.639

5, 840, 000

1,413,670

7, 619.200

66, 400

. 2/15/19

19.250, 798

3,909,998

15,340, 800

390,400

. BI15/19

20, 213,832

11,044, 552

9, 169,280

102.400

2/1 5/20

10.228, 868

3.728. 468

6, 500, 400

249, 800

. 5/15/20

10, 158.883

3, 739,523

6, 419,360

158,000

. . 8/15/20

21, 418, 606

19,668, 846

1, 749, 760

218,000

473.539.610

357.379,340

116,160,270

4, 270, 160

5/15/18
1

Bond 2020

8-3/4% Bond 2020. . .

8-3/4% Bond 2020. . . .

Total

'Etfectrve May 1, 1987. secunties held

8, 708, 639

9.032.870

9% Bond 2018
8-7/Bo%%d BOnd 2019 . .
8-1/8% Bond 2019.

1/1

5/18

stnpped lorm were ekgible lor reconstitution

Note: Qn the 4th workday ol each month a recording ol Table Vl will be available atter
The balances in this table are sublect to audit and subsequent adlustments.

lo their unstnpped

form.

3:00 pm. The telephone

number

is (202) 447-9873.

epartment

of the Treasury

Washington,
~

O. C. ~ T'elephone

%66-204

„~

TESTIMONY

OF NICHOLAS
BRADY
BEFORE THE
HOUSE BUDGET COMMITTEE
FEBRUARY 7, 1991

Mr. Chairman and Members of the Committee,
I am pleased to
~eet «ith you to discuss President Bush's FY 1992 budget and
other issues. My comments will concentrate on selected features
of the budget.

at a difficult time. We are at war in the
Gulf, the economy is in recession, and problems inherited from
the past continue to occupy our attention.
We cannot shirk our
responsibility to make government a positive and effective force
in dealing with the current problems that we are expected to
address, while at the same time investing for America ' s future.
We

meet today

Although economic and budget realities constrain our
actions, I believe that this budget achieves the goals of meeting
our ongoing responsibilities,
addressing problems inherited from
the past, and building a base for future economic growth and

competitiveness.

to restrain

government spending and abide by the
terms of the budget agreement is an over-arching concern.
Over
the next five years, the Federal government will borrow in the
credit markets a half trillion dollars less than
would have
borrowed in the absence of the budget agreement.
Although a
The need

rise in the near-term deficits may obscure our efforts,
there is widespread consensus that this budget agreement is an
sharp

effective effort to deal
Furtheraore,

with the

important

budget

deficit.

process reforms were adopted

to ensure that the deficit reduction targets are met. These
process reforas are an integral part of the agreement and it is
essential that both tha letter and spirit of these reforms are
adhered

to.

President Bush's budget, which increases spending less than
represents a strong commitment to reducing future
budget deficits.
Deficits have a corrosive effect on economic
activity. They crowd private borrowers out of financial markets,
and they represent a large diversion of' our national savings away
from investment
in new plant and equipment, research and

inflation,

NS-1121

eve' op?.;e;. , and o.her uses which would directly enhance
pro -t-''~ -y and co™petitiveness and create economic grow-- . .
defici s make it more diffcult to manage our
a=roeco, ", "-.„i= affa'=s and ultimately they reduce our econ=;.
-.

-o

''s

e--'a'

Our l992 budget priorities have been set to keep future
budget deficits on a downward path.
Our plans for dealing with
cu". =ent problems, as well as the need to improve economic growth
and prepare our economy for the international
challenges of the
future, have been shaped by this necessity.
Given the overall
budgetary constraint, this necessarily requires a re-ordering of

priorities.

demands
Although the pressure to deal with contemporaneous
believes that we must
always great, the Bush Administration
also look to the future. Toward this end, we have made a number
of proposals for addressing the economy's long-term growth

potential.

Since productivity is the critical element in the long-term
well-being of the American economy and the key to our
international competitiveness,
it must be a central focus of
attention.
affect productivity, three of
factors
Although many
the most important are education, investment, and technology.
And, as I will discuss later, this budget addresses all three of
these elements.
cannot begin until we get past the
there are several uncertainties that
affect our budgetary situation. The most important are the dep h
and duration of the recession and the length of the war in the
Gulf.
Of course, the long-run
short-run.
In the near-term

cleanup.

further uncertainty

is the unpredictable

course of the

S&L

The RTC has moved aggressively to deal with this
problem and progress has already been made.
Quick action by
Congress on funding, combined with lower interest rates and an
early end to the recession, will help us continue to move ahead
on this problem.

The Administration
anticipates a recovery
by mid-year and a brisker upturn in
the year, which should bring the unemployment
us back on a growth track.

beginning

recession
the latter part of
from the

rate

down

and put

President Bush's budget sets an important marker which we
believe must be adhered to--namely, to hold spending growth below
the rate of inflation.
In other words, the real level
spending must decline.
The reason is simple:
spending growth is
wha" has fueled the deficit.
Unless we can hold the level of
spending below the inflation rate, we cannot hope to make the

'-e-lcd". .

war

expe=t o
o-. .

".
.e

5efic':

==". ses

..a=e

—..

=esponsiti

—.

al rea" ~' ~one a good
economy. c rec ove ' c an do

ha ~e

™

ea'
Mch

-y =o =he econom. an~
is essen- al tha= e -eeasi.
J
=he
he

.irst
"est.

;ard

s-eps

he contex
of spen= ng restraint and def'-i=
budge- sho. s here is still room for ac= on a. , d
have jus- pu
ard a comprehensive plan =or
"he
reform of
Such a reform is
banking system.

Wi=hin

ction, this
ni=iative. 4e

red

fundamental

.".-

to build capital in the banking industry, protect
and depositors,
on
and remove archaic restrictions
activities.
Our
the
American
banking
goal is to provide
people
with the best quality financial services available, and to
provide our banks with the tools to meet the challenge of
international competition.
I have appended a summary of our
reform proposal to my testimony.
necessary
taxpayers

the President has proposed extension of the
jobs tax credit, to help deal with the problem of
unemployment
and extension
disadvantaged,
among the economically
of the low-income housing credit, to encourage private
construction of low-income housing.
We are also asking
for
extension of the solar and geothermal energy credits to encourage
investment in renewable energy technologies.
In addition,

targeted

Together,

these proposals

address

some

of the issues facing

us today--problems
of financial institutions, unemployment,
housing and energyHowever, as I mentioned earlier, we also
have a responsibility
to deal with the long term. Toward this
end, President Bush has put forward in this budget initiatives to
improve our Nation's educational system by providing
opportunities for individual choice, and to improve and expand
our Nation's transportation
system.
In addition, we are asking
Congress to support the following initiatives designed to induce
long-term economic growth and competitiveness:

Accounts.
Increasing national saving is
providing the capital our economy will need
to modernize and expand its productive capacity. We
believe that providing individuals with a new savings
vehicle will help stimulate such saving.
Family Savings

critical to

permanent research and experimentation
(R&E) credit.
Research and experimentation
are essential to
innovation and growth.
We believe that the R6E tax
credit is an effective method of promoting private
research and development.
But it needs to be enacted
permanently
if we are to derive its maximum benefit.

Enterprise Zones. The problems of the inner city and
that
rural America demand a new approach.
We believe
enterprise zones can be an effective method pf
argeting private resources to areas that are
experiencing economic distress.

Pe~' t

from IRAs for first-time home
withdrawals
a
home
is part of the American dream.
buyers.
Owning
find it beyond
But many younger people increasingly

their reach. We believe that permitting penalty-free
retirement accounts for
withdrawals
from individual
first-time buyers will not only bring home ownership
within the means of more people, but also provide a
greater incentive for young people to open and
contribute to IRAs.
We believe that
A capital
gains tax differential.
entrepreneurial
activity is the engine that drives the
economy in the long run, creating new inventions,
This is
products, and services that sustain growth.
in the capital gains tax is important.
why a reduction
We are hopeful
that Chairman Greenspan, working with
can illuminate and
Congress and the Administration,
help resolve the disagreements on this issue.
believe that these incentives

will help achieve our
the tools to

economy's long-term growth potential and provide
meet the competitive challenges of the future.

In closing, I would like to turn briefly to the
international sphere. It is increasingly clear that we live in
an integrated world economy and that the economic health of other
nations is essential to our own. The budget reflects this.
Funding is provided for President Bush's Enterprise for the
Americas Initiative, to help improve trade and investment for our
neighbors in the Western Hemisphere.
We are also lending
a
helping hand for economic reform in Eastern Europe, through
direct aid and technical assistance. And we continue to support
the critical role of the international financial institutions,
including the IMF and the World Bank.
Mr. Chairman,

would

now

be happy

to take your questions.

of the Treasury

Oenartment

Washington,

!7.C.

Telephone 564-204~

MODERNIZING THE FINANCIAL SYST M:
TIVE BANKS
FOR SAF ER MORE COMP

RECOMMZNDAT IONS

RVARY

It is
and

time

our financial

system

strong,

essential to

a strong,

NB-1ll2

ode

businesses

and

banking
growing

system

economy

the

hurting

make banks

that date back to the 1930s.
Banks must be
to protect depositors
taxpayers.

way

financial

when the economy slows,
costing )obs.

are
of the 30 largest hanks in the world is
American, compared to nine Of 30, including the top
three, )ust 20 years ago.
Our hanks
Only one

The

Benefits of
A

industry

Reform

safe

modern,

vill

benefit workers

internationally

and

rotect

ositors

businesses,

and

Protect de ositors

and

and
and

competitive banking
a ers, serve consumers,
stren then our nation.

a e

Depositor confidence and taxpayer

result from:
A

well-ca ita 'zed banking

safe, competitive,

system;

'mitations

failures;

bank
and a

protection will

er e osu e to losses

strong, wel -ca 'ta 'zed 'nsurance

from

fund.

Serve consumers:
An

efficient, integrated

mean:

healthy

system with strong,

banking

first

markets
good.

us' e s

will ensure:
the

an e

also will enjoy the convenience

Consumers
'

services system will

will have access to a wider
at the least possihle cost.

Consumers

~serv'ces

ene

financial

competitive

banks

because loans are not called at
sign of economic downturn.

that lack access to securities
in bad times as well as

world-class

financial services system provides a
for a world-class economy:
International economic leadership in the 21st
century will require an '
1
QREtitim f

foundation

*'V

The

Princi les Governin

Reform

savers
reserve de osit insurance for sma
F rst, we will
w~ile rotectin
ta a ers b reducin the ove extended de osit
insurance s stem. Deposit insurance, originally intended to
protect small depositors who could not protect themselves, has
been expanded so that large, sophisticated investors receive
unneeded protection.
This reform will restore market discipline
over risky activities that have increased the possibility of
taxpayer exposure to losses in the banking system.
we w' l make banks stron er and sa er b
then'n
stren
the role o ca ita -- not by raising capital
standards, but with a plan to attract capital to the banking
industry.
This will include rewarding well-capitalized banks
with new activities that will attract still further capital, and
taking prompt corrective action to address under-capitalized
banks.

Second,

Third,

financial markets have put banks at a competitive disadvantage
at home and abroad -- that has weakened the system and hurt the
economy.
Changes will allow banks to engage in a broader range
of financial services and to operate nationwide.
Fourth,

regulatory

responsibilities

Currently, overlapping
lead to confusion and uneven results.

RE COMMENDAT IONB

PART ONE:

DEPOBIT INBURANCE

AND

BANKINQ

REPORT

deposit insurance recommendations go
The Administration's
well beyond the narrow issue of deposit insurance and encompass
the entire range of safety, soundness and competitiveness issues
facing the banking system. They form a balanced, integrated
No single
package that must be considered as a whole.
recommendation
will be effective by itself, and indeed, could be
counterproductive
if adopted in isolation.

I. t

en then the Role

tal

single most powerful tool to make banks safer is
Capital standards need not be raised, but the role of
This will discourage excessive
can
capital
be strengthened.
risk-taking, reduce the possibility of bank failure, and provide
a cushion to absorb losses ahead of the insurance fund and,
ultimately, the taxpayer.
Well-capitalized banks are better able to keep lending,
rather than shrinking loans to build capital ratios, during
economic declines.
And they are better able to meet competitive
challenges and to take advantage of new opportunities.
The

capital.

u ance

'v' '
(each described
d
~re
further in other sections of the report) will provide incentives
for banks to build and maintain strong capital bases and make
e
bank franchises more attractive.
In addition,
will be added to credit risk as a criterion for risk-based
capital standards.
i~am and

Deposit insurance, originally intended to protect small
depositors who could not protect themselves, has been expanded so
that large, sophisticated investors receive unneeded protection.
This has increased the exposure of taxpayers to possible losses
and decreased market discipline on risky banks.
By returning deposit insurance to its original purpose, we

possibility that taxpayer funds will be needed t"
cover depositor losses, while simultaneously
reintroducing market
discipline that will help curb excessive risk.
S ec' 'c Recommendations:
can rendu"e the

deposits:

Insured

"Pass-throu

reducing

h" covera e of

protection
investors.

government

institutional

ed 'nsu ed de

be el'm'nated,
for large, sophisticated
man

os'ts w'l

be e 'ming

ending

practice that has given banks access to large pools of belowmarket-rate funds that are deposited without concern on the part
of the depositor about the safety of the investment.

000
overa e w'
be 'm't d
after a two-year phase-in period, plus another
$100, 000 per institution for a retirement account. This change
will reduce taxpayer exposure to losses from coverage for
wealthier individuals with multiple accounts, including
individual, )oint and revocable trusts, in a single failed
e

d'v'dua
'

institution.

The FDIC

will be required
v

to undertake
w

an 18-month
w

~~
0

This would more effectively limit
taxpayer exposure to losses resulting from coverage of multiple
accounts, but should not be implemented until it can be shown
that the benefits would outweigh the potentially large
e

administrative
Uninsured

costs.

deposits:

The government must preserve its ability to protect
banking system and the economy in genuine systemic risk

the

circumstances.
But protection of uninsured deposits as a matter
of course both expands taxpayer exposure and encourages excessive
risk-taking by banks. To
the FDIC will be permitted to cover uninsured deposits only if
that would be the least costly approach. To protect the system
in rare instances of systemic risk, the Treasury and Federal
Reserve could step in and order that uninsured deposits be
covered. This policy would be implemented after three years to
allow for an appropriate transition.
Non-deposit

creditors:

While protecting

exception,
1aulLtUI

uninsured

deposits should be the rare

III.

Risk-Based

osit Insurance

Flat-rate premiums subsidize high-risk, poorly run
institutions at the expense of well-run institutions and the
There is a perverse incentive to take risks because
taxpayer.
there is no cost to offset the upside potential.
S

ecific Recommendat'ons:
First, in the short-term,

'tal

evels
will reward institutions that build capital to act as a buffer
ahead of the insurance fund.
In the longer term, a demonstration
'vate
project may lead to rem'ums set b
IV-

emiums

base

roved Bu ervisio

Even with deposit insurance limits, the insurance fund and
the taxpayer remain exposed to possible bank losses. Effective
bank supervision can help.
Capital standards need not be
increased. But because veil-capitalized institutions are the
safest, regulation should be reoriented tovards a system of
capital-based supervision that provides rewards and penalties

that encourage banks to hold adequate capital.
The rewards of capital-based supervision vould be much
greater regulatory freedom for well-capitalized banks to expand
and engage in new financial activities.
The sanctions of
capital-based supervision vould involve "prompt corrective
action" to address problems as capital levels decline, well in
advance of insolvency.
'
S ec'
e omm

vould establish five zones for
their capital levels. Those with capital in
excess of minimum requirements vill he eligible to engage in a
broad range of nev financial services. Those vith less than
minimum capital vould he subject to increasingly
stringent
corrective action —including dividend cuts or even forced sale
of the hank —aimed at preventing failure.
banks based on

State-chartered hanks vith federal deposit insurance may be
authorized by charter to engage in risky activities that are
precluded for national banks. It is important to protect federal
taxpayers from such excessive risks vhile maintaining state
regulatory responsibilities under the dual banking system.

ecif'c Reco~endat'ons:
qualifications
by state banks

Federal deposit insurance

activ'ties

direct 'nvestment
not

VI.

ermitted

or national

at onv'de Bankin
Nationvide

efficient

banking

banks.

would p~o ~b't
'm't act'vities
and
.

and Braachin
and branching

competitive

lead to safer, more
decreasing taxpayer

would

hanks,
exposure to losses. The U. S. is the only major industrialized
country without a truly national banking system.
After 1992,
members of the European Community vill permit international
banking throughout the EC. Not only do we put our banks at an
international competitive disadvantage, but ve also forego
and more

safety, efficiency and consumer benefits.
Already, 33 states permit nationvide banking and another 13
permit regional banking.
Only four prohibit all interstate
banking.
So the trend is clearly toward interstate banking.
Yet
there is almost no authority for interstate branching.
Given the
cost savings and efficiency arguments for interstate branching,
the advantages to consumers and taxpayers of interstate branching

significant

are clear.

for

bank holding

three-year delay.
w
for national banks in any state in vhich the
bank's holding company could acquire a bank. Thus, after the
three-year delay, full nationvide branching vill be permitted.
companies

folloving

VII '
Banks are no longer the protected and steadily profitable
businesses they once vere. Technological advances and
innovations hy competing financial services providers have ended
their monopoly on transaction accounts and certain types of
business credit. They no longer enjoy protected access to lovcost funds from interest rate controls. And old lava that once
protected them from competition have become barriers that impede

hanks from responding to changing market conditions.
The result
has been declining profitability and increasing bank failures.
The losers are not just banks, but also depositors, taxpayers and
the overall strength of the economy.

Out-of-date lavs must be adapted to permit well-capitalized
banks to reclaim the competitive opportunities
they have lost to
Banks vith expertise in other financial
changing markets.

services should be allowed to provide them for consumers, and
other financial services companies with natural synergies with
This will provide
banking should be allowed to invest in banks.
new sources of capital for the banking system and help promote
safe, strong, well-capitalized banks.
The proposed changes will be accompanied by safeguards to
prevent exposure of the federal deposit insurance fund to these

activities.
ecific Recommendations:

new

In order to strengthen the banking system, new rules will
ermit inane'al af 'liates o we 1-ca 'ta 'zed banks. A new
financial services holding company structure will permit a single
company to own affiliates engaging in banking, securities, mutual
funds and insurance.
The new rules will allow commerc'al fi s
to own inancial serv'ces o din com an'es.
To protect the deposit insurance fund and the taxpayer, ~onl
-ca 'tal'zed banks will be permitted to engage in new
ave access to de osit
financial activities. On the bank w'
d
new financial activities will be in
e a

wel

b',

VIII.

edit

nion Re o

a study of adequacy of capital in the
union industry and insurance fund and of the regulatory
structure governing the credit union industry.
The law required

credit
S

ec' 'c

To ensure

insurance

ecomme

fund,

accountability

adequate

the

capitalization"of

Ptdd

the credit union

for credit union regulation,

PELT

REOUIkTORY

RESTRUCTURINO

The current regulatory structure is complicated, overlapping
confusing.
Individual institutions often are supervised by
several regulators, and bank holding companies rarely have the
same regulator as their subsidiary banks.
and

redesigned

structure

should

reduce duplication

and

consistency, accountability and efficiency.
also separate the insurer from the regulator.
ecific Reco~endat' ns:
improve

and

company

MLJIJRI
national
a k'
0

subsidiary

bank.

state-charte
e'
d

eserve w' l su ervise a
ew
ede a
co ' an'es.
anks
su e
a 'o a
e a

ede al
o d'

casu

its

banks,

en
s 5

jurisdiction

tak

ove

P "Y
over the entire organization

ed banks
under

will go

It2RUIB1

date

ussed o

PART TEREE

es ons'b'

0 S

should

Federal Reserve,
Federal Deposit
Supervision) will be
responsible for a bank

The present four-regulator
model (the
Office of the Comptroller of the Currency,
Insurance Corporation and Office of Thrift
simplified to two, with the same regulator

holding

RECAP TALI 3AT ION

ance

Ot TEE

BANK

IMBURANCE

tUND

The Bank Insurance Fund (BIF) has experienced losses in each
of the last three years due to increasing numbers of bank
failures. FDIC projects additional losses over the next two
years that, under the most pessimistic assumptions, could exhaust
the fund's net worth. The FDIC must exercise the authority given
to it in the FDIC Assessment Rate Act of 1990 to recapitalize the
BIF fund in the near term. Because the FDIC has the authority

industry participation is essential, a plan to
the fund ought to be worked out with the industry
the FDIC within the following parameters:
and because

recapitalize

.SB
Department

of ihe treasury
JE 'i. ~i-

'lj

Washinaion, D.C.

telephone SIN-204'

'«'"-~;p'f

Statement of the Honorable
Robert R. Glauher
Under Secretary of the Treasury for Finance
Before the

Senate Committee

Agriculture,
Pehruary

Chairman

Leahy,

Nutrition,

and

Porestry

7, 1991

Senator Lugar,

members

of the Committee:

I appreciate having this opportunity to present the
Administration's
views on S. 207, the "Futures Trading Practices
"
Act of 1991.
to congratulate the Committee on its thorough work in
II to update the Commodity Exchange Act. We are
generally supportive of Titles I and II and will be glad to
submit technical comments on these two titles at a future date
Rather than elaborating on Titles I and II, I would like to
focus my remarks this morning on the crucial issue embodied in'
Title III —fragmented regulation of the "one market" of stocks,
stock options, and stock index futures. We continue to believe
that this issue is so closely related to the CFTC's
reauthorization that Congress should consider them only as a
legislative package.
Last summer the Administration proposed legislation that we
believe is critical to the well-being of the nation's capital
Entitled "The Capital Markets Competition, Stability
markets.
and Fairness Act of 1990, " the centerpiece of the bill was a
provision designed to unify regulation of stock and stock
derivative markets under the Securities and Exchange Commission.
the bill was based substantially on
As you know, Mr. Chairman,
developed by the 1987 Presidential Task Force on
recommendations

want
and

Titles I

Market Mechanisms,

chaired by Secretary Brady.

With the help of your able leadership,
Mr. Chairman, key
Committee
and
members
of the Senate Banking
members of this
Committee developed a compromise proposal late in the last
Congress that you now have reproposed as Title
of the Futures
Trading Practices Act. The compromise deleted our proposal for

III

unified regulation

elements

important
the considerable
compromise.

NB-1122

of equity-related markets but preserved other
of our bill in modified form. We appreciate
efforts that you and others made to reach t. his

Mr. Chairman, I understand that the major futures exchanges
oppose even this compromise, as they have other constructive
legislation on these issues. While the Administration does not
goes, we believe
oppose the compromise in concept as far as
that
is
needed to reduce
falls short of the comprehensive reform
the likelihood and consequences of major market disruptions like
those we experienced in October 1987 and October 1989. We will
be very disappointed if the compromise is all that emerges from
Congress on this issue.

continue to believe that our 1990 proposal is the most
appropriate means of resolving the issue crucial to the stability
Accordingly,
of the capital markets -- regulatory fragmentation.
the Administration intends to resubmit its proposal, now entitled
"The Capital Markets Competition, Stability, and Fairness Act of
1991," for introduction in the current Congress. We strongly
urge the Committee to substitute our proposal for the compromise
in Title III.
We

Let me explain why we believe the need for unified
regulation of the markets for stocks and stock derivative
I described many of the
products continues to be so compelling.
reasons when I appeared before this Committee last spring.
We have experienced
repeated, violent drops in the stock
We have
market in the absence of any significant news events.
done little to respond, and as a result, we are taking a chance
with the very essence of the system, the clearance and settlement
process. Perhaps most important, we have damaged the confidence
of individual investors. We continue to believe that any market
system that disillusions and disenfranchises
the individual

investor will lose
greatest strength.
Let

its political

standing,

and in

the end

its

specific.

Friday, June 22, 1990, in the last few minutes of
trading, the stock market plunged 64 points on no significant
news.
Sell programs kicked in shortly after 3 p. m. , and in the
last half hour of trading accounted for more than half of S&P 500
trading volume.
On

Friday, October 13, 1989, the Dow Jones Industrial
Average fell 191 points.
Almost 90 percent of the drop occurred
in the last 90 minutes of trading, supposedly triggered by news
of a failed takeover attempt for a single company. The following
Monday, October 16, the market lost 63 points in the first 40
minutes of trading, then sharply rebounded to close 88 points up
A week later,
on the dayon October 24, 1989, the S&P 500 index
dropped 2. 7 percent (roughly 90 Dow points) and the price of the
S&P index futures contract dropped 3. 2 percent in slightly over
one hour of trading.
On

And in October of 1987 the Dow Jones Industrial
Average lost
almost a third of its value -- $1.0 trillion -- in just four
days. This included the one-day drop of 508 points, or 22. 5
percent, the largest recorded amount since Dow Jones started
computing index numbers in 1885. Moreover, the very real
prospect of clearinghouse failures in the wake of this crash led
to a crisis of confidence that brought the system to the brink of
breakdown.
While we all remember these consequences,
few can
remember what caused them.

Indeed, in each of these episodes, minor, even untraceable,
events appear to have triggered precipitous, violent market
declines. Each episode occurred in the last four years, when
stock index futures have been actively trading in large volumes.
And each episode constituted
a ma'or
tion, a period
a et 's
when the markets for stocks and stock index futures disconnect
with prices spiraling

down.

These major market disruptions create clear and obvious
risks to the system. But they also alienate individual
investors, who feel the whole system is stacked against them.
Those who are in the best position to judge the mood of the

individual investor -- the stock exchanges and the large retail
brokerage houses -- report a growing disillusionment
with the

stock market

by such

investors.

Reported data seem to confirm this trend.
From 1965 to 1990
individual ownership of equity securities outstanding declined
from 84% to 56%. In 1952, individuals
accounted for 70 percent
of the volume of public trading, while institutional investors
represented only 30 percent. Today, the reverse is true. From
1970 to 1990 the proportion of equities in small investors'
portfolios declined from 50% to 28%. Although it is true that
individuals have rechannelled many of these investments into
mutual funds, the switch to institutional
investment has not
fully offset the attrition in direct holdings.
In 1989, for
example, individuals sold $18 billion more on the New York Stock
Exchange than they bought, but of these net sales only $11
billion were reinvested in mutual funds.

costs associated with the withdrawal of
individual investors from the equity market.
One consequence
is
that smaller capitalization companies, which generally are not
investors because of perceived risk, may
favored by institutional
be forced to pay higher capital costs to compensate for thinner
Moreover, individual
trading by individuals.
investors are
passing up opportunities to create wealth for themselves by
holding diversified portfolios of individual securities, which in
the past has been a very successful method of investment.
Finally, the presence of small investors in the market can be a
stabilizing influence that offsets some of the volatility caused
by the often herd-like trading of institutions.
There are several

This disillusionment
by small investors is disturbing.
Individuals bring to the market a diversity of views, which are a
source of stability -- indeed, individuals were net buyers during
the October 1989 downdraft and appeared to stop the market from
political support for
More importantly,
plunging even further.
our free market system rests on the foundation of broad-based
As I said before, when markets operate to
individual ownership.
disenfranchise the individual investor, they lose that political
standing and in the end their greatest strength.

Let me emphasize that when I use the term "major market
disruption, " I am not talking about increased volatility, an
issue so popular with economists. Critics charge that there is
no compelling evidence of increased stock market volatility or
average price swings.
They may be right, but the focus on
volatility is a red herring. Our concern is not average price
During
changes, but the episodes of violent market freefalls.
these major market disruptions, pricing relationships between
stocks and futures break down; markets in particular stocks
experience difficulties in staying open; serious supply-demand
imbalances develop; and very large market moves occur in the
absence of underlying fundamental information.
These sudden declines unrelated to changes in underlying
In the
fundamental
information are a new market phenomenon.
past, large market moves were relatively infrequent and
associated with news events that clearly affected fundamental

values.

in the 42 years between 1940 and 1982 (the year
the Dow Jones Industrial
Average declined by more than 6 percent on only three occasions:
when the Germans took the Netherlands
in May of 1940 (6. 8
percent); when they encircled the Allied forces at Dunkirk just
days later in the same month (6. 8 percent); and when President
Eisenhower suffered a heart attack in September of 1955 (6. 5
For example,

stock index futures began trading)

percent).

By contrast, with the growth of stock index futures trading,
such massive one-day selloffs have occurred four times in less
than the last four years:

October 19, 1987
October 26, 1987
January
8, 1988
October 13, 1989

-- 22. 6
-- 8. 0
-- 6. 9
-- 6. 9

percent
percent
percent
percent

of these days corresponded with any major news events
like the ones before 1982. But they all shared the
characteristic of enormous selling pressure from the stock index
futures markets flowing over to the stock market.

Not one

point is this. Stocks and stock index futures are "one
"
Movements in the price
market,
linked together by electronics.
of stock index futures are translated almost immediately to stock
prices through index arbitrage, and vice versa. This is what we
concluded in the President's 1987 Task Force on Market
Mechanisms, and essentially no one -- not academics, not people
on Wall Street, not politicians -- has disputed that conclusion.
The Task Force also concluded that the interaction of trading in
stock and stock index futures in the "one market" is a major
cause of market disruptions.
Yet the Nation's disjointed
regulatory system has not kept pace with this reality, preventing
us from putting the "one market" tools in place to deal with
these market disruptions.
The single most important step Congress can take to reduce
both the likelihood of major market disruptions and the severity
of their consequences is to unify regulation for the "one
market. " A single regulator would be able to coordinate the key
intermarket mechanisms that disconnect to create or exacerbate
While the problem of major market
major market disruptions.
disruptions would not be magically cured overnight, unified
regulation could at least begin to develop and apply the
regulatory tools to control what is too often out of control
the interaction between stock index futures and stocks.
Moreover, we strongly believe that if we fail to come to
grips with regulatory fragmentation, the government will have
done precious little in the face of clear evidence that we face a
As I have said before, minor events are likely to
problem.
continue to cause major market disruptions -- and major events
could cause even worse results.
Simply stated, we are accepting
too much systemic risk for too little benefit.
believes that Congress should act by
The Administration
addressing the regulatory structure for stocks and stock index
futures. The legislation we intend to resubmit contains three
First, the bill transfers the authority to
key provisions.
regulate stock index futures from the Commodity Futures Trading
Commission (CFTC) to the Securities and Exchange Commission
(SEC), but in a manner specifically designed to create the least
Second, it provides federal
disruption to market participants.
oversight authority over the ability of futures markets to set
margins on stock index futures -- not to prevent volatility, but
to safeguard the financial system. Third, the bill modifies the
"exclusivity clause" of the Commodity Exchange Act to end costly
legal disputes over what constitutes a
and anticompetitive
"futures contract. "
Before I describe the bill in more detail, let me briefly
explain the specific problems that we believe require this
legislative remedy.
My

Uncoordinated

Intermarket

Mechanisms

these is the failure to coordinate key
intermarket mechanisms, which would not happen if the »one
These mechanisms include
market" were regulated as one market.
unharmonized
margins, disjointed clearance and settlement
systems, evasion of short selling restrictions, and uncoordinated
circuit breakers.
As you know, while there is federal
Mar ins.
Unharmonized
oversight of margins on stock, there is virtually none over
The futures exchanges and their
margins on stock index futures.
The result
clearinghouses set these futures margins themselves.
stock
and
stocks
on
levels
is a tremendous disparity in margin
where
market
one
index futures, even though they are part of
margin levels on one instrument can have a direct impact on the
trading and price of the other.
The

first of

result has been that futures margins, which have no
levels.
federal oversight, have often dipped to dangerously low -the
Indeed, Chairman Greenspan of the Federal Reserve Board
guardian against excessive risk to the financial system -- has
expressed his strong concerns about the low level of stock index
futures margins prior to the mini-crash in 1989Again, those who try to dismiss our proposal by claiming
that margins are unrelated to volatility are simply missing the
point. We have never said that average volatility has increased.
and how to slow them down
Our concern is major market disruptions
-not volatility.
when the tidal wave starts to form
The Federal Reserve Board agrees with the need for federal
oversight of margins on stock index futures to limit systemic
risk. Indeed, no credible argument has been advanced against
federal oversight -- we must have it where the actions of private
market participants in a narrow segment of the market create
risks for the financial system as a whole. It is a dangerous
practice that's not in the public interest. We ought to address
this unjustified anomaly.
The

elaborate on the link between margins and systemic
risk. The fact is that futures traders can control large amounts
of stock with little of their own money
Relatively small
amounts of capital can concentrate enormous selling pressure on
the stock market. For example, just prior to the October 13,
1989 break, a professional trader in the futures market with
$50, 000 in cash could control roughly $2, 000, 000 in stock, which
is nearly 10 times more than the $200, 000 that a professional
trader in the stock market can control with the same amount of
cash.
Let

that, while stock index
futures margins were increased temporarily in the wake of the
October 1987 break, they were soon again lowered, so that margins
were lower in October of 1989 than they were in October of 1987.
Futures margins were 3. 6 percent at the opening on Monday,
October 19, 1987. The futures markets raised them to above 12
percent the following week, but then allowed them to drift back
down so that at the opening on October 13, 1989 -- the day the
market dropped 190 points -- they were only 2. 2 percent.
Today margins on the S&P 500 futures contract are only about
5. 8 percent, which means that a market decline of just 5 percent
(about 135 Dow Jones points) faces a futures trader with a
choice: he either has to virtually double his original margin
simply to hold an existing position or sell out, which could put
more pressure on a falling market.
A consequence
of low futures margins is that during market
downdrafts, when the system is most in need of liquidity, futures
exchanges are forced to restrict liquidity through increased
because margins have been set so low. This
margin requirements
is precisely the opposite of what should occur: during
emergencies it is critical to pump liquidity into the system.
Indeed, Chairman Greenspan has testified that during the October
1989 mini-crash he was "shaken" at the prospect of increasing
margins at a time when liquidity was critical.
Let me mention one related point. Our 1987 Task Force
Report showed conclusively that a mere handful of firms created
enormous selling pressure in Chicago that swept back to New York
markets.
For example, on October 19, 1987, three firms in the
futures market accounted for the equivalent of $2. 8 billion in
stock sales' In the futures market the top 10 sellers accounted
for sales equivalent to $5 billion, roughly 50 percent of the
non-market maker total volume.
Low futures margins contribute
to this ability of a small
number of traders to concentrate enormous buying and selling
Many

pressure

observers

were astounded

the stock market.

Sett

tems.

The most

of major market disruptions is the risk
they pose to the entire financial system, especially through the
clearance and settlement process. For example, after the October
1987 break, the clearance and settlement system fell over six
disturbing

consequence

hours behind its normal payment times, with over $1. 5 billion
houses. Had these funds been missinq for any
owed to investment
longer
time, it could have unleashed a chain
significantly
reaction of events spreading losses through the payments system.

presidential Task Force concluded that the prospect of
clearinghouse failures reduced the willingness of lenders to
finance market participants, leading to "a crisis of confidence
the specter of a full-scale financial system
[that] raised
"
breakdown.
To reduce the possibility of financial gridlock, we
need to have a single regulator for the "one market" who can
facilitate coordination of intermarket clearance and settlement
Little effective coordination has occurred in the over
systems.
three years since the 1987 market break. While the recentlyenacted Market Reform Act of 1990 will help address these
systems, a single regulator would obviously help accelerate the
coordination process.
For over 50 years
vas'o of Short Sell'n Restrictions.
the securities laws have restricted bear raiders like the 1920s'
Jessie Livermore from selling short in declining markets. The
purpose of these restrictions is to prevent "gunning" the market,
investor
which drives down the market and leaves the individual
futures
helpless. However, a concerted selling effort in the
market can completely undermine the short selling restriction-and in fact, because of low futures margins, can accelerate the
stock market downdraft.
Again, it is critical to harmonize these
intermarket rules to prevent traders from using one market to
The

evade

restrictions

in another market.

Circuit Breakers. Some progress has been made
to coordinate circuit breakers in stock and stock index futures
markets, and discussions are continuing within the President's
Nevertheless, more can and
Working Group on Financial Markets.
should be done. Fundamental disagreements continue to exist
between markets and their regulators over the appropriate kinds
of circuit breakers.
In short, fragmented regulation has impeded progress on the
We
coordination of these fundamental intermarket mechanisms.
believe one regulator with appropriate authority could accelerate
progress substantially towards the harmonized regulation we need
One
to address the problem of major market disruptions.
regulator is what every other country with important trading in
these instruments has -- the United Kingdom, Japan, and France.
ne fective Intermarket Enforcement
Another problem created by regulatory fragmentation
involves
Uncoordinated

intermarket

enforcement.

different regulators, it is sometimes hard to
prevent manipulation and fraud in transactions between the stock
In particular, it is extremely difficult to
and futures markets.
detect intermarket "frontrunning, " where a trader trades ahead of
his client in one market knowing that the client's trade will
In fact, at
drive a linked market in a particular direction.
With two

this time there is not even a universally accepted definition of
illegal frontrunning in the cross-market context. The current
fragmented regulatory system is an open invitation for
intermarket

manipulation.

Barriers to Innovation
Apart from major market disruptions and intermarket
enforcement, regulatory fragmentation also is creating a serious
This was not always true -- in the
impediment to innovation.
past, fragmented regulation sometimes promoted innovation.
Competition between Chicago and New York markets spurred new
product development, while the practices of different regulators
and creativity.
often promoted diversity, experimentation,
But regulatory competition can also cause jurisdictional
This is precisely what
that can strangle innovation.
happened to Index Participation Certificates, which litigation,
prompted by the "exclusivity clause" of the Commodity Exchange
Act, has prevented from trading in the United States.

squabbles

With the globalization of financial markets, other countries
We can
have provided us all the regulatory competition we need.
no longer afford
at home and drive

To remedy

"The Capital

conflicts that stifle innovation
important
away from U. S. markets.
'n'st ation's Pro osa

jurisdictional

business

the Administration will resubmit
Competition, Stability, and Fairness Act of

these problems

Markets

1991." The bill contains three key provisions.
First, it
transfers the authority to regulate stock index futures from the
CFTC to the SEC. In order to minimize disruptions
to market
participants, the SEC will operate under the basic framework of
the Commodity Exchange Act, augmented with key enforcement and
antifraud provisions from the securities laws. In addition, the
SEC would have to consider the sufficiency of any existing CFTC
rules as well as the views of the CFTC before adopting its own
rules regarding stock index futures. Moreover, in designating
contract markets for stock index futures, the SEC would have to
consider the fair and efficient operation of the stock index
futures market and the maintenance of fair and orderly markets in
underlying securities.
Taken as a whole, these provisions will unify SEC regulation
of the "one market" of stocks, stock options, and stock index
futures in the least disruptive manner.
This will enhance
coordination of key intermarket issues such as margins, circuit
breakers, enforcement, and clearance and settlement.

10
Second, to enhance the safety and soundness of the financial
system, the bill gives the SEC oversight authority over the
futures exchanges' ability to set margins on stock index futures.
The exchanges would still have the flexibility to initiate margin
changes, and the statute would not require minimum margins
levels, which would be left to regulatory discretion. This is
similar to the SEC's current margin authority over stock options.

that, for the first time since stock
index futures began trading in 1982, the federal government would
have prudential oversight authority over margins on all stock and
stock derivative products. This is crucial to the protection of
the integrity of the nation's financial system.
Third, the bill modifies the "exclusivity clause" of the
legal
Commodity Exchange Act to end costly and anticompetitive
"
Hybrid
disputes over what constitutes a "futures contract.
equity securities like Index Participation Certificates could
trade in both the futures markets (under the framework of the
Commodity Exchange Act) and the securities markets (under the
securities laws). Institutional swaps would similarly be
excepted from exclusive CFTC jurisdiction under limited
circumstances.
The bill would also allow the CFTC to exempt
other financial instruments under certain conditions.
The

result

would be

Mr. Chairman, you and others have questioned whether the
bill would create regulatory gaps, for example by allowing cashsettled U. S. Treasury bond futures to be traded in casinos. Let
problems raised could be
me just say that we believe hypothetical
cured by SEC enforcement action under existing securities laws.
We certainly
did not intend to create regulatory gaps, and none
to
was given the opportunity
were identified by the CFTC when
If any inadvertent gaps are
comment on our draft proposal.
discovered, we would be happy to consider any suggestions for

clarifying the appropriate language.
the bill does not take effect
To facilitate transition,
until 90 days after enactment, leaving time for the SEC, CFTC,
Persons, contract
and stock index futures markets to adjust.
markets and futures associations registered under the Commodity
Exchange Act would be deemed to be registered with the SEC on the
effective date, and rules and interpretations of the Commodity
Exchange Act would continue in effect. To take advantage of
economies of scale, the SEC could enter into cooperative
agreements with the CFTC to administer reparations proceedings
under the Commodity

Exchange Act.

Finally, the bill requires the SEC to report to Congress
within 18 months on any additional modifications that are
necessary for the efficient regulation of the "one market" of
stocks, stock options, and stock index futures.

11
Conclusion

proposal will
In sum, we believe the Administration's
accomplish the two major purposes we have in mind. The first is
to reduce both the likelihood of major market disruptions and the
The second is to create a market
severity of their consequences.
environment that rekindles the interest of the individual

investor.

proposal is not the
the Administration's
proverbial "camel's nose under the tent. " The way markets are
makes no further shifts in regulatory
now functioning
jurisdiction necessary -- not Treasury bond futures to the SEC,
not a full merger of the SEC and CFTC. Secretary Brady has
stated that he will oppose more sweeping changes to CFTC
bill passes in its present
authority if the Administration's
Furthermore,

form.

a less effective regulatory body
No. The CFTC would be able to concentrate
its expertise on the more traditional agricultural and financial
futures products that have long been the core of its
jurisdiction.
Indeed, our proposal would have minimal effect on

Would

the

CFTC

bill passes?

be rendered

less than 10
jurisdiction.
jurisdiction over stock index

the CFTC because stock index futures
percent of the futures volume under
In fact, we believe
futures to the SEC makes

moving

represent

CFTC

it m~o e likely the CFTC will survive as
Further episodes of severe market
agency.
disruptions could build pressure to merge the CFTC and SEC, as
proposed in the Glickman-Eckart bill in the last Congress.
an independent

Concerns that our bill would strangle stock index futures
We expect the changes we propose would
also are unfounded.
increase investor confidence in the stock index futures markets
and would attract the interest of investors who currently do not
use these instruments.
What

impact would our proposal

have on the individual

agricultural community in general? None whatsoever.
Stock index futures simply have no relation to agricultural
products or agricultural futures.
and the

farmer

Finally, opponents of the bill have tried to characterize
these issues as nothing more than a turf fight between government
agencies or congressional committees, or a regional battle
Turf is not the issue. Nor is it a
between financial centers.
geographical battle between Chicago and New York. In fact, some
of the largest traders on the futures exchanges are New York
The Treasury Department comes to this issue
investment houses.
parochial
perspective.
Our sole objective is
particular
no
with

policy -- how best to reduce the likelihood of
violent market disruptions and position our markets for continued
leadership in the face of mounting competition around the world.
sound public

emphasize that the problems I have
described do not come from the CFTC or SEC. These regulators are
doing a good job under impossible circumstances
trying to
administer a system of regulation that simply is not in concert
is unfair to
with the "one market" reality that exists today.
expect them to regulate markets effectively without the proper
tools to do so. Our concern, as I have explained, is the few but
critical intermarket issues that are slipping through the
regulatory cracks. Unless properly coordinated through a
coherent regulatory structure, these few issues pose a serious

Moreover,

let

—

risk to the financial system.

For the reasons I have outlined, the Administration believes
the need to adopt our legislative proposal is urgent.
We
strongly urge the Committee to substitute our proposal for the
compromise version contained in Title III.
Mr. Chairman, that concludes my. testimony.
I would be
pleased to answer any questions the Committee may have.

t-IBR:;y

a1 the 7raesutY

department

«Estz„'i g

FOR

IMMEDIATE

Fecruarv

N. 8. ~

Waahthmteh,

RELEASE

1'eleahane

u)O

Contact: Robert Levine

1991

202/566-2001

UNI:ED STATES
VE~

PAKiSTAN TQ DISCUSS
TAX TREATY

AND

INCOME

. he . reasu

ry Department announced today that representatives
United States and Pakistan will meet in Washington,
of a
he ~ee k of Macch 11, 1991, to resume discussions
ng
".e

The income tax treaty
tax "reaty.
Prior
195I.
discussions, most
in
:u c cent' y in f orce was signed
o e en 'y in 19 82, wece not suc"essful
in ceaching agreement on a

pos

s;ble

new

ilatecal

income

ceaty.

new

. he

t at ons wl 1 l take into account the model income tax
treat es pub lished by he Qrgani=at on 'or Economic Cooperation
and Deve 1opm ent, the United Vat ons, and the U. S. Treasury
reaties recently concluded by the two
Depzc ment, as dwell as ax
coun:. ies
th other countr es, and cecent changes in their

. espec
. e.
r

. esi
may

"3X
coya
betw
non-

ncome

:ax laws.

income
ax t reat es provide cules 'oc the taxation of income
. ed n one o the "ountries (the 'source" country) by
'ents o f the othec. They establish when the source country
:ax iac '- ous =lasses of income and specify maximum rates of
interest and
souc ce on certain items, such as dividends,
cooperation
1 t' es.
They also provide foc administrative
of the two countries and guarantee
een he ax authorities
llsccim inato cy taxat on. Treaty benefits are limited to

.
~

nego

'. e
.

cesl "en:s

3II.2141

the two

:ountries.

. sons ~ishing o offer comments oc suggestions on the
o Phil p D. Morrison,
~t. ions ace in-iced :o write
. n:e"nat cnal Tax "ounsel, Treasuc'y Department, Washington,

ne"-"

'0''0.

o 0

D. C

Department

of the Treasun

FOR IMMEDIATE

February

Bureau of the Public Debt

RELEASE

RESULTS OF TREASURY'S AUCTION

Tenders

Washington,

CONTACT:

7, 1991

on February

DC 20239

Office of Financing

202-376-4350

OF 30-YEAR BONDS

for $11, 012 million of 30-year bonds to be issued
15, 1991 and mature on February 15, 2021 were

accepted today (CUSIP: 912810EH7).
The

interest rate

of accepted bids

on the bonds
and corresponding

will be 7 7/8%. The range
prices are as follows:

Price
Low
7. 97%
98. 922
7. 98%
High
98. 810
Average
7. 98%
98. 810
Tenders at the high yield were allotted 87%.
TENDERS RECEIVED AND ACCEPTED (in thousands)
Yield

Location
Boston
New

Received
2, 631
21, 782, 055
1, 636
2, 179
25, 162

York

Philadelphia
Cleveland
Richmond

Atlanta

2, 631

10, 818, 769

1, 636

2, 179
20, 022
3, 416
80, 065

3, 446

Chicago
St. Louis
Minneapolis
Kansas City

782, 945

TOTALS

$22, 958, 960

8, 045
7, 458
9, 182
2, 360
331, 411

Dallas
San Francisco
Treasury

8, 045
5, 678
9, 182
2, 360
57, 586

$11, 012, 019

The $11, 012 million of accepted tenders includes $223
million of noncompetitive tenders and $10, 789 million of
competitive tenders from the public.

In addition,

$100 million of tenders was also accepted
from Federal Reserve Banks for their own

at the average price
account in exchange

for maturing

securities.

The minimum par amount required
Larger amounts must be in multiples

NB-1124

for STRIPS is $]
of that amount.

6pp ppp

LI DEBT EW
Department

of the Treasury

FOR IMMEDIATE

Bureau of Ui884gig De}j)

RELEASE

11, 1991

February

+5~ington,

Office of Financing

ggNTACQ

i,
of

RESULTS OF TREASURY'S AUCTION
)~PT t.

DC 20239

R
i~L4..

202-376-4350

OF 13-WEEK

BILLS

~ URY

Tenders for $9, 722 million
13-week bills to be issued
on February 14, 1991 and mature on May 16, 1991 were
accepted today (CUSIP: 912794WJ9).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate
6. 014

Price
98. 524
High
6. 03%
98. 519
Average
6. 03%
98. 519
Tenders at the high discount rate were allotted 35:.
The investment
rate is the equivalent coupon-issue yield.
Low

5. 84%
5. 86%
5. 86'o

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia

Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

Received
51, 925
416,
095
48,
20, 860
61, 700
107, 215
37, 750
2, 341, 860
59, 875

9, 025

37, 615
27, 830
1, 495, 340

(in thousands)

51, 925

8, 085, 230
19, 145
61, 660
57, 215
35, 750
151, 665
19, 875
9, 025
37, 615
27, 830
197, 440

967 505

967 505
$9, 721, 880

$49, 387, 510
1 980 730
$51, 368, 240

$5, 474, 795

2, 177, 210

89 145

89 145
$9, 721, 880

$53, 634, 595

980 730

$7, 455, 525

additional $67, 955 thousand of bills will be
issued to foreign official institutions for new
An

NB-1125

LI DEBT
Department

of the Treasury

FOR IMMEDIATE

~fi

Bureau of the Public De

RELEASE

'E8

11, 1991

February

E
~

341fgggT)

on, DC 20239

/@ice of

Financing

202-376-4 350

RESULTS OF TREASURY ' S i~'ggep= OF 2+qPEEK BILLS

Tenders for $9, 668 million of 26-week bills to be issued
on February 14, 1991 and mature on August 15, 1991 were
accepted today (CUSIP: 912794XC3).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Low

Discount
Rate
5. 834

5. 85+a
5. 85'o

Investment
Rate
6 094

Price
97. 053
97. 043
97. 043

6. 11%
Average
6. 11'o
Tenders at the high discount rate were allotted 61'. .
The investment rate is the equivalent coupon-issue yield.
High

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia
Cleveland
Richmond

Atlanta

Received
37 , 015
742
22,
, 795
19 , 170
45 , 870
53 , 120
38 , 660

(in thousands)
ed
37 , 015
8, 127 , 865

19 , 170

45 , 870
53 , 120
34 , 865
302 , 015
24 , 540
9 , 845
49 , 820
20 , 080
250 , 330
693 340

Chicago
St. Louis
Minneapolis
Kansas City

1, 730 , 715

TOTALS

$26, 166, 500

$9, 667, 875

$21, 632, 380

$5. 133, 755

Dallas
San Francisco
Treasury
Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

43 , 490
9 , 845

49 , 820
20 , 080
682 , 580
693 340

1 412 865
$23, 045, 245

1 412 865

$6, 546, 620

2, 400, 000

721 255
$26, 166, 500

721 255
$9, 667, 875

additional $598, 745 thousand of bills will be
issued to foreign official institutions for new cash.
An

NB-1126

aR"

apartment

of the 7reaeory

wlpphqtan~
~:~T. Cl i,':,

FOR IMMEDIATE

February

RELEASE

7elephoae see-ao. l1

ji. 'iS~py

CONTACT

11, 1991

pp.

BOB LEVINE

(202) 566-2041

TREASURY RELEASES FIFTH REPORT ON THE
INTERNATIONAL
BOYCOTT PROVISIONS OF THE INTERNAL REVENUE

The Treasury Department
report on the international
Operation and Effect of the

the Internal

Revenue Code".

announced

the release

its

CODE

f ifth

boycott provisions, titled "The
International Boycott Provisions

The international
boycott provisions, added to the Code by
the Tax Reform Act of 1976, deny certain tax benefits to persons
who participate
in or cooperate with an international
boycott.
The tax benefits affected include the foreign tax credit, the
deferral of tax on the earnings of controlled foreign. corporations
Sales Corporations as
and interest charge Domestic International
well as the exemptions from tax of certain income of Foreign Sales

Corporations.

The Fifth Report broadly covers the tax accounting
periods
1983, 1984, 1985 and 1986. The report, which included statistical
tables and a description of operations, shows that the number of
persons agreeing to participate in boycott operations declined to
44 from 234.
For 1986, the tax benefits lost by persons participating in boycott activities was $2, 850, 000.

Copies are available at the Treasury Press
D. CD 20220, Phone (202) 566-2041.
Washington,
oOo

NB-1127

Office,

Room

2315,

.partment

of the Treasury

FOR IMMEDIATE

Washlniton,

D.C. ~ Telephone $66-204$

CONTACT:

RELEASE

BARBARA CLAY

202-566-5252

REMARKS BY
DAVID C ~ MULFORD
HONORABLE
THE
UNDER

SECRETARY OF THE TRF~URY FOR INTERNATIONAL AFFAIRS
AT THE
ANNUAL BANQUET OF THE
VIRGINIA JOURNAL OF INTERNATIONAL LAW
AT THE UNIVERSITY OF VIRGINIA, CHARLOTTESVILLE
FEBRUARY 8, 1991

Thank you for your kind
honored to have been invited

introduction.

to speak to

you

pleased and

this evening.

was with considerable
to speak to this
invitation
trepidation that I accepted your
I understand that yours is the oldest
distinguished gathering.
I
law journal in the United States.
student-run international
won
more
than
the
having
is
best,
that
it
among
also understand
its fair share of awards for excellence. The thought of speaking
to such a distinguished gathering of law professors and students,
reminds me of what Thomas Jefferson once said about Chief Justice

However,

must admit

that

John Marshall:
"When

conversing

with Marshall

great is his sophistry,

never admit anything.
never give him an

. . . So
affirmative answer, or you will be forced to grant his
it was ' daylight
conclusion.
Why, if he were to ask me whether
can't
don't
I'd
know.
'Sir,
I
I
tell.
or not,
reply,
Several weeks ago I discussed with our host the issue of
He suggested
say here tonight.
what I might appropriately
several frightening legal subjects, including an analysis of some
recent developments in the international economic area in terms
of certain contract law concepts.
This caused me to reflect in a new light about how I do my
-especially the relationships among legally binding and
job
enforceable agreements, agreed rules, pragmatic understandings,
and shameless

you must

adhocery.

For better or for worse, I am not a lawyer -- though many
years ago I did a term at Oxford on the Law of Torts. As I
believe most non-practicing lawyers would say, I found the
However, the only case I clearly
general training valuable.
-which might have application to my appearance here
remember
NB-1128

tonight -- is Rylands vs. Fletcher -- where, like the water in
the reservoir, I might escape from international finance to
international law and do mischief, through no particular fault of
my

own!

that parties entering into a
contract may make essentially whatever enforcement arrangements
they mutually agree upon. Some contractual provisions are
clearly intended by the parties to be legally enforceable; that
is if one party violates such a provision the other party can go
into court and obtain a remedy such as damages or some specified
performance.
In short, the parties decide that matters covered
by such provisions will be settled and absorbed in the context of
a formal institutional
framework.
On the other hand, parties entering
into a contract may also
make commitments
which, for one reason or another, are not
legally enforceable. They might do this for a number of reasons.
For example, demanding a strict, airtight clause during
negotiations might appear excessively legalistic (a term
we often use in talking with our lawyers at the Treasury
Department) and thus offend the other party at a time when it may
be important to remain in the other party's good graces. Or it
time consuming and expensive to draft
may be just too difficult,
and negotiate a legally enforceable clause.
Contract law recognizes

However, just because a commitment is not legally
enforceable does not mean that there are no sanctions for
ensuring that it is adhered to. A party might adhere to a
commitment that is not legally enforceable because it does not
want to have a bad business reputation or because it wants to be
able to continue to do business with the other party in the
future or because, as is often the case between nations, it must
be able to continue business with the other party.
Indeed, in
the fast-moving and fluid world of international economic and

political affairs,
formal

sanctions.

International

such arrangements

Moneta

Arran

may

be more

effective than

ements

The international
monetary arrangements
established at the
of World War II -- the Bretton Woods agreement -- have been
characterized as a rule based system similar in many respects to
a contract among the participants.
The basic elements of this
contract were contained in the Articles of Agreement of the
International Monetary Fund (IMF).
First, countries committed to maintain or fix the price of
their currencies -- the exchange rate -- in a narrow range,
and these prices could not be changed except in the case of
fundamental
economic problems and with the prior approval of

end

the IMF. In practice, these prices were maintained by
governments buying and selling their currencies with dollars
whenever market forces tended to push the price outside the
In the case of the United States,
agreed limit.
agreed

to convert official dollar holdings into gold at a fixed
price to maintain the value of the dollar.
Second, each country had an obligation to pursue the
disciplined policies necessary to ensure that large
imbalances in supply and demand for its currency did not
emerge, thus giving rise to pressures to change the exchange
rate.
failure to perform satisfactorily could result in the
implementation
of specific penalties, including the denial
of financing

or the imposition

of trade sanctions.

Bretton Woods system was extremely effective in
promoting global economic growth and an open, expanding
international trading system. However, the system contained the
seeds of its own demise and ultimately proved incapable of
withstanding
the fundamental changes in the world economy which
The

possible.
~F' ~s , it relied on a continuing
supply of dollars to
finance international trade and investment.
However, as
foreign dollar holdings rose dramatically, there was a loss
of confidence in the ability or willingness of the United
States to convert dollars into gold at the agreed fixed
price.
Second, there were no orderly means of adjusting the price
of currencies as economic conditions changed.
In
particular, the ability of the U. S. to change the exchange
rate for the dollar was constrained by the central role of
the dollar in the system.
the sanctions under the system to encourage changes
+i~,
in economic policy were biased in favor of surplus countries
and largely ineffective in promoting adjustment
among major
countries.
The demise of the Bretton Woods system in the early 1970s
produced a sharp reaction in international
monetary arrangements
which were reflected in the second amendment of the IMF Articles
of Agreement.
The new rules maintained the obligation of
countries to pursue economic policies that would foster stable
currencies but eschewed the requirement that countries buy and
sell their currencies to maintain its price at agreed levels; the
value of currencies was allowed to float in response to market
forces. Moreover, the growth of private international capital
had made

the 1970s reduced substantially the role of
official financing as a constraint on the policies of those major
industrial countries with the greatest influence on the
functioning of the system. Many, therefore, have criticized the
international monetary system of the 1970s and early 1980s as a
"non-system. "

markets

during

dissatisfaction had emerged
In particular, wide fluctuations
with the floating rate system.
in the price of currencies, especially the sharp increase in the
price of the dollar in the early 1980s, as well as divergent
economic conditions, resulted in large trade imbalances among the
For example, the dollar rose around
major industrial countries.
100 percent against many major European currencies and the U. S.
trade position moved from near balance to a deficit of $160
billion, some 3-1/2 percent of GNP. The large U. S. trade deficit
that emerged led to the strongest protectionist pressures since
the 1930s and threatened to undermine the open trading system
By

the mid-l980s, widespread

of the post-war economic prosperity.
Since the mid-1980s, the major industrial countries have put
in place new international monetary arrangements which seek to
navigate between the rigidities of the rule-based fixed exchange
rate system and the absence of effective constraints under the
floating exchange rate system. The economic policy coordination
process established by the G-7 countries in recent years has many
of the characteristics of an informal contract which relies on a
mutuality of interests, peer pressure, and informal sanctions
rather than legally enforceable sanctions to achieve effective

which had been a cornerstone

performance.

countries participating in the G-7 economic policy
coordination process -- the United States, Japan, Germany, United
Kingdom, France, Canada, Italy -- have continued to affirm their
The seven

commitment to pursue sound, mutually compatible policies designed
to achieve sustainable economic growth with low inflation,
reduced trade imbalances, and stable international
currency
-this
markets.
To
end, they meet regularly
usually with a
representative of the IMF -- to review their economic policies
These reviews are based on key economic
and performance.
indicators and understandings regarding general objectives for
each country which are mutually compatible.
When economic
policies and performance diverge significantly from the agreed
path, countries are expected to take remedial measures.
There are also informal understandings
on exchange rates
markets and
to
maintain
stable
currency
which are designed
rates'
in response to changes in
orderly adjustment of exchange
For this purpose, the United
economic conditions.
fundamental
States and the other countries cooperate in foreign currency

markets

through

concerted purchases

and

sales of currency as

necessary

and

appropriate.

However,

they have avoided

any

to maintain the value of currencies at
legally
specific levels or within formal zones. This approach in
currency markets reflects the lessons of the past and recognizes
In
the great size and strength of global financial markets.
addition, there is recognition that changes in currency values
can play an appropriate role in correcting trade imbalances.
nature under
There are, however, sanctions of a non-legal
'
the economic policy coordination process.
t nd o emost,
the G-7 countries recognize that the coordination process is
mutually beneficial.
Each accepts that it has much to gain from
an open, growing world economy and stable international
monetary
system.
Moreover, the ability of each country to achieve
national economic objectives is influenced considerably by the
actions of others in an integrated world economy. This mutuality
of interest serves as a strong incentive to seek consensus and
compromise in order to avoid creating undesirable
instability.
In this connection, the public statements released by the group
G-7 communiques -- are subject to intense scrutiny and
and the media.
judgment both by private financial institutions
This has forced the G-7 to present a common front to the
international community at large.
gee~, the participants accept that the effectiveness of
their joint efforts depends crucially on maintaining the
credibility of the process in the eyes of the market. Many
attribute the stock market crash of October 1987 in part to the
perception that G-7 cooperation had collapsed. Moreover,
experience over the last few years has demonstrated that the
effectiveness of exchange market operations is enhanced through
concerted actions. Such actions at key moments in recent years
have helped produce the relatively more stable currency markets
that we have enjoyed since 1987. In this regard, it is perhaps
worth noting that currency marks s in past mon .. ':; ,
~en
binding

commitment

remarkably
war.

stable despite the uncertainties

peer pressure
~i~,
countries take into

generated

effective

by the Gulf

means of assuring
account international
repercussions of
domestic policies. This peer pressure takes many forms and at
varying levels. The Finance Ministers and Central Bank Governors
meet regularly in informal, restricted session for full and frank
discussion of key issues. Unlike many other international
meetings, these sessions do not include prepared statements, nor
are official records of the meeting kept. The unique character
of these meetings enhances understanding of each others' views
The Heads of State also
and permits some real horse trading.
providing both a political seal of approval and
meet annually,
credibility to the process that is essential for its

that

has been an

result is strong pressure to reach
that can be implemented.
understandings
The record of success under economic policy coordination has
In terms of economic performance, the
already been considerable.
major countries have achieved the longest expansion in the post
and trade
war period, inflation has declined significantly,
The foreign currency markets
imbalances reduced substantially.
have become more stable and more orderly adjustment of currency
values is taking place in response to changes in underlying

effectiveness.

realistic

The end

economic conditions.

Equally important, we have a process in place that permits
the system to evolve gradually in response to changing
circumstances without the necessity of large, disruptive
upheavals that in the past have proven so costly. This is
especially necessary at the present time, when the world economy
is undergoing dramatic change as a result of the unification of
Western Europe, the political and economic transition in Eastern
Europe, the economic decline of the Soviet Union, and the
continuing restructuring in the developing countries.

there are now in place fewer sanctions which are
enforceable
to make the system work than there were
legally
forty-five years ago when the Bretton Woods system began
That is not to say, however, that the replacement of
operating.
enforceable
measures by measures which are not legally
legally
enforceable has resulted in a crippling of the system. On the
contrary, under economic policy coordination there are strong
pressures and incentives to achieve the underlying policies
necessary for lasting stability.
Probably

International

Debt

The 1980s also saw a major change in the traditional
contractual relations between sovereign borrowers and their
lenders, as countries' inability to meet their scheduled payments
It became clear that the provisions in the old
proved chronic.
contracts could not be enforced to the benefit of either side:
the borrower could not pay, and the banks knew that they would
not gain by enforcing all possible protections in the contracts.
to address this circumstance was required, and
A new framework
the international community has responded to this challenge by
adopting a flexible strategy based on mutual needs.
The original loan contracts were straight forward.
A bank
committed to provide dollars to a country at a rate of interest.
The country was obligated to make interest and principal payments
on the loan over a certain period. Further, the negative pledge
and sharing clauses in the contracts assured that no bank could
benefit at the expense of another. Sanctions were also

established

assets.

whereby

non-payment

could result

in the seizure

As you know, commercial banks and developing
countries
contracted debt of this nature at a rapid rate during the 1970s.
These contracts were established in specific circumstances.
Banks were flush with resources due to heavy petrodollar deposits
and eager to lend.
They could offer loans at negative real
interest rates to countries which were enjoying a boom in
commodity prices and export earnings yet were also faced with the
Both sides entered into
prospect of maintaining oil imports.
their loan contracts assuming that these circumstances would
continue.
In these transactions, top international lawyers did
their usual thorough job on behalf of their respective clients.

In the early 1980s, however, the situation changed
dramatically.
Interest rates took a surprise jump upward while
And the
export earnings in developing countries fell sharply.
economic policies pursued by many countries during the period of
Countries could
easy money proved increasingly unsustainable.
not meet their payments, and banks were faced with a situation in
which
there were insufficient assets in the aggregate for all
banks to be paid and sharing clauses precluded payment to less
than all the banks.
The absence

procedure

international

left debtors, creditors,

equivalent

to our

and governments

bankruptcy
without a

framework for dealing with these new realities.
Banks adjusted
the
and
rescheduling
of
payments
extending new
by accepting
loans. Countries were obligated to undertake broad adjustment
and economic reform programs to address problems which had
contributed to their payments difficulties.

This process was guided by the need to avoid a breakdown in
the international payments system and the imperative of
preserving the sanctity of loan contracts in a changing context.
To accomplish this, countries and banks had to build on a
relationship beyond that formally contained in loan contracts.
Creditor governments stepped in to support this new reality in
order to protect their own interests, and the international
financial institutions such as the IMF and World Bank facilitated
this process by helping set the parameters for financing packages
and economic reforms.

required continued evolution of the
preserving the international payments
solvency was the predominant concern
Gradually, however, the international
focused on means to help countries resume

Ongoing debt problems
framework.
At the outset,
system and commercial bank
of creditor governments.
community

growth.

increasingly

difficult to

assemble rescheduling
needs -- particularly
and new money packages that met
for those countries whose debt did not pose a major systemic risk
to the banks. The large syndicates of commercial banks, which
were originally seen as spreading and reducing the risks of
sovereign lending, soon began to unravel as the disparate
exposure and interests of individual banks came to the fore.
While providing additional loans remained attractive to those
banks seeking to preserve business relationships with and
maintain a stake in debtor countries, other banks sought
aggressively to reduce their exposure and accept losses.
became increasingly

countries'

their
reserves against potential
time, debtor countries committed to economic reform continued to
This confluence of events
face serious economic difficulties.
shifted the emphasis of the international debt strategy to a
broader range of options -- and, in particular, focused on the
reduction of debt and debt service as important mechanisms for
banks to fulfill their obligations.
Banks were withdrawing

from new lending and increasing
losses on old loans. At the same

This latest stage of the evolution of the debt strategy-as the Brady Plan -- recognizes the realities of changing
bank interests and ongoing debtor needs,
Allowing banks to
choose among disparate options puts banks in a better position
to act, and facilitating actual reduction in the stock of debt
and servicing requirements
serves as a greater incentive for
countries to pursue reforms. Instead of creating sanctions to
enforce these new, flexible agreements, creditor governments
through the international
financial institutions -- have helped
debtor countries collateralize the debt and debt service
reduction instruments.
These "enhancements" have enticed
commercial banks to participate by providing short-term coverage
of interest payments and ensuring principal payment in the long
term.
known

The system for addressing payment difficulties of developing
countries that has evolved is an informal one. Much of the
success in gaining banks' commitments to the new forms of
financing results from their ability to find market solutions,
outside of previous legal restrictions, to their dilemmas.
Peer
pressure both within the banking community and from creditor
governments has also played an important role. The sanctions
that existed in original loan contracts have been superseded by a
new system of obligations
The legal agreements
and incentives.
that continue to be forged as part of this process form only the
basic framework for resolving problems that arise.

perspective, however, is that
Early efforts helped preserve
working.
the solvency of the international financial system. And now the

critical point
this informal system is
The

from

Brady Plan's new emphasis on debt and debt service reduction
produced real results for debtor countries.

has

Seven countries have reached agreements with their
commercial banks on packages that include debt/debt service
These countries account for almost half of the
reduction.
total commercial bank debt of the major debtor countries.
The Mexican agreement reduced annual interest payments by
$1. 5 billion, cut bank debt by the equivalent of $15
billion, and removed the burden of $42 billion in principal
The Costa Rican agreement reduced that country' s
payment.
commercial bank debt by 624 and cut annual debt service
payments by 74%.

Chile, Venezuela, Morocco, and Uruguay have also reached
agreements that will result in significant reductions in
debt burdens, and several other countries are continuing
discussions with their banks.
These types of agreements adapt but do not abrogate the
They are producing
commitments and obligations of old loans.
investor
restore
results for debtor economies by helping
confidence and stimulate new investment flows.
onc us'on
Many

lawyers.

of
Some

you

in becoming international
this evening
taken
have
my remarks

are interested

you may
on nonlegal commitments

reliance
prescription for your future
want to allay your fears.

unem

and

about

sanctions to be a
ent. Before concluding,

I do not share the conclusion reached in a recent study by
Institute
for International Economics that economic
the
performance deteriorates the more lawyers there are in a country!
economic
There will always be a place in the international
involved in
Lawyers are continually
system for binding rules.
drafting and helping me negotiate such rules whether they concern
the Articles of Agreement of the International Monetary Fund or
the multilateral development banks or an agreement
reduction with a Latin American government.

on debt

in helping determine the
Lawyers are also invaluable
costs and risks involved in accepting nonlegal commitments rather
than legal commitments and making sure that a policymaker has not
accepted a non-legal commitment when a legal commitment was

intended.

former member of your faculty and former
distinguished
of the World Court, Hardy Cross Dillard, once said,
r. ember
As a

-10-

.there

virtue which law alone
possesses. I refer to its capacity to produce a sense
of order and, in the long run, a tolerable degree of
. . . In the decentralized international
predictability
system, law, better than any other method, helps to
provide this modicum of order not only by settling
fusses but by providing the institutional framework
for absorbing them.
I too recognize this virtue. Nevertheless, my experience in
international finance increasingly convinces me that in the real
economic and political affairs, lawyers
world of international
will need to have a keener awareness and broader understanding of
the role played by informal, non-legal arrangements in the
economic relations.
conduct of international
remains

one

Thank you very much.

partment of the Treasu~' 4- Vfashlrioton, D.c. ~ Telephone 566-2041

FOR IMMEDIATE

February

CONTACT:

RELEASE

12, 1991

TR1&SURY ANNOUNCES
AND

Barbara Clay
(202) 566-5252

CENSUS OF BLOCKED IRAQI ASSETS

U. S. CLAIMS AGAINST IRAQ

of blocked Iraqi property and U. S. nationals wishing to
assert claims against the Government of Iraq will be required to
report to the Treasury Department's Office 1'of Foreign Assets
&date'
t
j d
p bl' t d
q 1
yesterday.
Reports on claims against the Government of Iraq must be submitted
by March 1, 1991. The submission of a claims report will not
constitute the formal filing of a claim for compensation against
the Government of Iraq.
Reports by holders of blocked Iraqi property must be submitted by
March 1, 1991, or within 15 days of the acquisition of the
property, whichever is later. This information is needed by the
U. S. Government to monitor compliance with the asset freeze
imposed by President Bush following Iraq's invasion of Kuwait on
August 2, 1990.
Copies of the necessary report forms were published in yesterday' s

Holders

~dm,

bb'dby'g

fthm

twelve regional Federal Reserve Banks located throughout the
country or by calling the Office of Foreign Assets Control at
(202) 535-4026. Photocopies of the report forms may be used.
oOo

NB-1129

~ 5l4Fttlltlat

Of f flO Tl%0$UFf ~ Washington,

O.C. ~ Telephone SSS-2441
February

12, 1991

ROGER BOLTON

ASSISTANT SECRETARY

(PUBLIC AFFAIRS/PUBLIC

LIAISON)

TO LEAVE TREASURY

Roger Bolton, Assistant Secretary for Public Affairs and Public
Liaison, today announced his resignation, effective March 15, in

order to accept a position

in the private

sector.

Mr. Bolton has served in his present position since 1989. Prior
to that, he was Special Assistant to President Reagan for Public
Liaison and Assistant U. S. Trade Representative for Public
Affairs and Private Sector Liaison. He was Director of
Speechwriting for Reagan-Bush '84 and before that worked for nine

years

NB-1130

Capitol Hill.

'R.

LI
Department

of the Treasury

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

ll'ashinyon,

CONTACT:

12, 1991

February

RESULTS OF TREASURY'S AUCTION

DC 20239

+~q4P

Office of Financing

202-376-4350

OF 52-WEEK

BILLS

Tenders for $11, 811 million of 52-week bills to be issued
on February 14, 1991 and mature on February 13, 1992 were
accepted today (CUSIP: 912794XZ2).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

5. 83%
5. 85%
5. 85%

Investment
Rate

Price

6. 19%
94. 105
High
6. 21%
94. 085
Average
6. 21%
94. 085
Tenders at the high discount rate were allotted 49%.
The investment
rate is the equivalent coupon-issue yield.
Low

(in thousands)

TENDERS RECEIVED AND ACCEPTED

Received

Boston
New

York

Philadelphia
Cleveland

Chicago
St. Louis
Minneapolis
Kansas City

2, 032, 345

31, 265
14, 635

TOTALS

Type

Competitive
Noncompetitive

Public

Federal Reserve
Foreign Official

Institutions

additional

issued to foreign
NB-1131

l3, 635

47, 535
23, 235
745, 295

Dallas
San Francisco
Treasury

TOTALS

39, 225
10, 523, 695
23, 250
41, 805
41, 410
34, 975
287, 545
21, 225

41, 410
35, 995

Richmond

Atlanta

Subtotal,

39, 225
30, 156, 475
23, 250
41, 805

47, 535
23, 235
254, 035

459 775
$33, 692, 245

$11, 811, 320

$29, 450, 700
1 171 445
$30, 622, 145

$7, 569, 775
1 171 445
$8, 741, 220

2, 900, 000

170 100

170 100
$11, 811, 320

459 750

$33, 692, 245
$716, 900 thousand

of bills will be
for new cash.

official institutions

jA+(p~

~PottlNIllt of ttlo TtOOUlf
4:00 P. M.

FOR RELEASE AT

February

Noslllhgtoll,
CONTACT:

12, 1991

O.C. ~ Telephone SI5-2041
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 $19.200 million, to be issued February 21, 1991.
This offering will result in a paydown for the Treasury of about
$175 million, as the maturing bills are outstanding in the
amount of $19, 382 million.
Tenders will be received at Federal
Reserve Banks and Branches and at the Bureau of the Public Debt,
Washington, D. C. 20239-1500 Tuesday, February 19, 1991,
prior to 12:00 noon for noncompetitive tenders and prior to
Standard
1:00 p. m. , Eastern
time, for competitive tenders.
The two series offered are as follows:
91-day bills (to maturity date) for approximately
$9, 600 million, representing an additional amount of bills
dated November 23. 1990. and to mature May 23, 1991
(CUSIP No. 912794 WK 6), currently outstanding
in the amount
of $10.484 million, the additional and original bills to be
freely interchangeable.
182-day bills for approximately $9, 600 million, to be
dated February 21, 1991, and to mature
August 22, 1991
(CUSZP
No. 912794

1).

The bills will be issued on a discount basis under competiand 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, QQQ
and in any higher $5, 000 multiple,
on the records either of the
Federal Reserve Banks and Branches, or of the Department of the

tive

Treasury.
The

bills will

be issued for cash and in exchange for
February 21, 1991. Tenders from Federal

Treasury bills maturing
Reserve Banks for their

account and as agents for foreign
authorities will be accepted at
the weighted average bank discount rates of accepted competitenders. Additional amounts of the bills may be issued to
Federal Reserve Banks, as agents for foreign and international
to the extent that the aggregate amount
monetary authorities,
of tenders for such accounts exceeds the aggregate amount of
Federal Reserve Banks currently
maturing bills held by them.
million as agents for foreign and international
hold $965
and $4, 813 million for their own account.
monetary authorities,
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
and

international

series).

own

monetary

TREASURY'8

13-, 26-,

AND

52-REEK BZLL OPPERZNGS,

Page

Each tender must state the par amount of bills bid for,
which must be a minimum of $10, 000. Tenders over $1p, ppp 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. 154. Fractions may not be used.
A single

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.
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
competitive tenders.
A

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.

deposit need accompany tenders from incorporated banks
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.
No

and

1/91

trust

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

will be
maturing
new

made

for differences between the par value of the
exchange and the issue price of the

bills accepted in

bills.
If a bill 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.
purchased

at issue,

and

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.
8/89

'=3

apartment of the Treasury ~ Washington,
~&AT. g;I~

FOR RELEASE AT

February

4:00 P. M.

CONTACT:

13, 1991

D.C. ~ Telephone 568-2041
Office of Financing
202/376-4350

TREASURY TO AUCTION 2-YEAR AND 5-YEAR NOTES
TOTALING $21, 000 MILLION

will auction $12, 000 million of 2-year notes
000
million
of 5-year notes to refund $9, 962 million of
$9,
securities maturing February 28, 1991, and to raise about $11, 050
million new cash. The $9, 962 million of maturing securities are
those held by the public, including $696 million currently held
by Federal Reserve Banks as agents for foreign and international
monetary authorities.
and

The Treasury

The $21, 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 aver-

age prices of accepted competitive

tenders.

In addition to the public holdings, Federal Reserve Banks,
for their own accounts, hold $1, 100 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
of the offerings and in the official offer-

attactied highlights
ing

circulars.

oOo

Attachment

NB-1133

HIGHLIGHTS OF TREASURY OFFERINGS TO THE PUBLIC
OF 2-YEAR AND 5-YEAR NOTES TO BE ISSUED P'EBRUARY 28,

1991
February

Amount

Offered to the Public

Descri tion of Securit
Term and type of security
Series and CUSIP designation
date

Maturity

Interest Rate
yield

Investment

or discount
Interest payment dates

Premium

Minimum

denomination

available

of Sale:
of sale
Competitive tenders

Terms
Method

Accrued
by

tenders

interest payable

investor

Pa ment Terms:
Payment by non-institutional

investors

(CUSIP No. 912827

Yield auction
Must be expressed as

yield,
decimals, e. g. ,
Accepted in full
age price up to

with two

7. 10%
at the aver$1, 000, 000

None

Full

yield,
decimals, e. g. ,
Accepted in full
age price up to
an annual

with two

7. 10%
at the aver91, 000, 000

None

to be
with tender

payment

submitted

Wednesday,

a) funds

(CUSIP No. 912827

8)
February 29, 1996
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
The last calendar day of
August and February through
February 29, 1996.
$1, 000

Receipt of tenders

due from

Series L-1996

February 28, 1993
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
The last calendar day of
August and February through
February 28, 1993.
$5, 000

Acceptable

b) competitive
Settlement (final payment

5-year notes

2-year notes

Series X-1993

Deposit guarantee by
designated institutions
a) noncompetitive

$9, 000 million

$12, 000 million

an annual

Noncompetitive

13, 1991

Full payment
submitted

to be

with tender

Acceptable
February

prior to 12:00 noon,
prior to 1:00 p. m. ,

20, 1991

EST
EST

February 21, 1991
prior to 12:00 noon, EST
prior to 1:00 p. m. , EST
Thursday,

institutions):
immediately

available to the Treasury
b) readily —collectible check

Thursday,
Tuesdav.

February

28, 1991

Thursday,

February

28, 1991

of the Treasury

lepartment

EMBARGOED

Nashlngton,

O.C. ~ Telephone S66-204t

UNTIL GIVEN

EXPECTED AT
FEBRUARY

10:00 A. M.

20, 1991

TESTIMONY OP NICHOLAS P. BRADY
BEPORE THE
HOUSE APPROPRIATIONS COMMITTEE
FEBRUARY 20, 1991

of the Committee, I am pleased to
discuss President Bush's FY 1992 budget and
other issues. My comments will concentrate on selected features
of the budget. Director Darman will discuss the budget in detail
and Chairman Boskin will review the economic forecast.
We meet today at a difficult
time. We are at war in the
Gulf, the economy is in recession, and problems inherited from
the past continue to occupy our attention.
We cannot shirk our
responsibility to make government a positive and effective force
in dealing with the current problems that we are expected to
address, while at the same time investing for America's future.

Mr. Chairman
meet with you to

and Members

economic and budget realities constrain our
actions, I believe that this budget achieves the goals of meeting
our ongoing responsibilities,
addressing problems inherited from
the past, and building a base for future economic growth and
Although

competitiveness.

The need to restrain government spending and abide by the
terms of the budget agreement is an over-arching concern.
Over
the next five years, the Federal government will borrow in the
credit markets a half trillion dollars less than it would have
borrowed in the absence of the budget agreement.
Although a
sharp rise in the near-term deficits may obscure our efforts,
there is widespread consensus that this budget agreement is an
effective effort to deal with the deficit.

Furthermore,

important

budget

process reforms were adopted

to ensure that the deficit reduction targets are met. These
process reforms are an integral part of the agreement and it is
essential that both the letter and spirit of these reforms are
adhered

to.

NB-1134

represent

a large diversion

of our national

savings

away

from investment in new plant and equipment,
research and
and other uses which would directly enhance
development,
In
productivity and competitiveness and create economic growth.
make
it
more
difficult
to
short, deficits
manage our
macroeconomic affairs and ultimately they reduce our economy's
growth potential.
Our 1992 budget priorities have been set
deficits on a downward path. Our plans

budget

to keep future
for dealing with

current problems, as well as the need to improve economic growth
and prepare our economy for the international
challenges of the
future, have been shaped by this necessity. Given the overall
budgetary constraint, this necessarily requires a re-ordering of

priorities.

demands
Although the pressure to deal with contemporaneous
always great, the Bush Administration
believes that we must
also look to the future. Toward this end, we have made a number
of proposals for addressing the economy's long-term growth

potential.

Since productivity is the critical element in the long-term
well-being of the American economy and the key to our
international competitiveness, it must be a central focus of
attention. Although many factors affect productivity, three of
the most important are education, investment, and technologyAnd, as I will discuss later, this budget addresses all three of
these elements.
Of course, the long-run cannot begin until we get past the
short-run.
In the near-term there are several uncertainties that
affect our-budgetary situation. The most important are the depth
and duration of the recession and the length oR the war in the
Gulf.
A

further uncertainty

is the unpredictable

course of the

S&L

cleanup.

The Administration
anticipates a recovery from the recession
beginning by mid-year and a brisker upturn in the latter part of
the year, which should bring the unemployment rate down and put
us back on a growth track.

President Bush's budget sets an important marker which we
believe must be adhered to namely, to hold spending growth below
the rate of inflation.
In other' words, the real level of
spending growth is
The reason is simple:
spending must decline.
Unless we can hold the level of
what has fueled the deficit.

—

spending below the inflation
kind of progress on reducing

people expect of us.
To

fulfill

rate, we cannot hope to make the
deficit which the American

the

our responsibility

the promises

made

OBRA,

to the economy
is essential that

and make good
we

get the

It will not be easy.
spending.
have already done a good deal of the hard first steps and
economic recovery can do much of the rest.
deficit

down

controlling

Within the context of spending restraint and deficit
this budget shows there is still room for action and
initiative. We have just put forward a comprehensive plan for
fundamental
reform of the banking system.
Such a reform is
necessary to build capital in the banking industry, protect

reduction,

taxpayers

and

depositors,

and remove

archaic restrictions

banking activities.
Our goal is to provide the American people
with the best quality financial services available, and to
provide our banks with the tools to meet the challenge of
international competition.
I have appended a summary of our
reform proposal to my testimony.

In addition, the President has proposed extension of the
targeted jobs tax credit, to help deal with the problem of
unemployment
among the economically disadvantaged,
and extension
of the low-income housing credit, to encourage private
construction of low-income housing. We are also asking for
extension of the solar and geothermal energy credits to encourage
investment in renewable energy technologies.

Together,

these proposals

address

some

of the issues facing

us today--problems
of financial institutions, unemployment,
housing and energy.
However, as I mentioned earlier, we also
have a responsibility
to deal with the long term. Toward this
end, President Bush has put forward in this budget initiatives to
improve our Nation's educational system by providing
opportunities for individual choice, and to improve and expand
our Nation's transportation
In addition, we are asking
system.
Congress to support the following initiatives designed to induce
long-term economic growth and competitiveness:

critical to

providing

permanent research and experimentation
(R&E) credit.
Research and experimentation
are essential to
innovation and growth.
We believe that the R&E tax
A

credit is

effective

method

of promoting

private

research and development.
But
if we are to derive
permanently

to be enacted
its maximum benefit3. Enterprise Zones. The problems of the inner city and
rural America demand a new approach. We believe that
enterprise zones can be an effective method of
targeting private resources to areas that are
experiencing economic distress.
4. Permit withdrawals from IRAs for first-time home
buyers. Owning a home is part of the American dream.
But many younger people increasingly find it beyond
their reach. We believe that permitting penalty-free
withdrawals from individual retirement accounts for
first-time buyers will not only bring home ownership
within the means of more people, but also provide a
greater incentive for young people to open and
contribute to IRAs.
5. A capital gains tax differential. We believe that
entrepreneurial
activity is the engine that drives the
economy in the long run, creating new inventions,
products, and services that sustain growth. This is
in the capital gains tax is important.
why a reduction
We are hopeful that Chairman
Greenspan, working with
can illuminate and
Congress and the Administration,
help resolve the disagreements on this issue.
We believe that these incentives
will help achieve our
economy's long-term growth potential and provide the tools to
meet the competitive challenges of the future.
In closing, I would like to turn briefly to the
international sphere. It is increasingly clear that we live in
an integrated world economy and that the economic health of other
nations is essential to our own. The budget reflects this.
Funding is provided for President Bush's Enterprise for the
Americas Initiative, to help improve trade and investment for our
a
neighbors in the Western Hemisphere.
We are also lending
helping hand for economic reform in Eastern Europe, through
direct aid and technical assistance. And we continue to support
the critical role of the international financial institutions,
including

the

IMF and

Mr. Chairman,

needs

the World Bank.

would

now

be happy

to take

your questions.

of the Treasury

~ payment

Washinlton,

O.C. ~ Telephone $66-2Oe&

Contact:

TEXT AS PREPARED
FOR IMMEDIATE RELEASE

Cheryl

Crispen

202-566-2041

THE HONORABLE JOHN ROBSON
DEPUTY SECRETARY OF THE TREASURY

MT. RUSHMORE

COMMEMORATIVE

FEBRUARY 15'
%ASHINGTONq

COIN LAUNCH

1991

D. CD

And many thanks to Donna
Thank you, Cathi (Villalpando).
have done a tremendous
Mint
who
S.
Pope and her staff at the U.
all the
job. Finally, I'd like to welcome our honored guests
people who make the U. S. Commemorative Coins Program a success.

Today, we are meeting at a time of international
More than half a million Americans -- and their allies
20 nations -- are fighting in the Persian Gulf against
Our hopes and
and for freedom, decency and humanity.
out to those brave men and women every day. They are
nation's best, and they deserve nothing less than our

support.

Elsewhere

in the world,

formerly

shackled

nations

crisis.

from over

aggression
prayers go
the
unstinting

are

now

Eastern
struggling to solidify their own emerging democracies.
Europe and Latin America are on the threshold of democratic
government and free market economies -- proving that ideas of
individual and economic freedom are alive and well
That's why this ceremony is so appropriate.
For, we are
coins
the
four
the
honoring
here to introduce
great Americans of
Jefferson, Lincoln and Theodore
Mt. Rushmore -- Washington,
Roosevelt -- men whose values, ideas and actions laid the
our nation's commitment to
groundwork for, and perpetuated,
protect freedom, democracy and economic competition here at home
and abroad.

But as we honor past greatness, we must also look forward.
In his State of the Union Address, President Bush said we must
invest in the future. And investing in the future is a central
Coin Program.
theme in the Commemorative

Since 1982, the Commemorative Coin Program has earned more
than $180 million to reduce the national debt.
It also has
contributed over $190 million to many non-profit programs of
national importance.
NB-1135

the preservation and improvement of Mt. Rushmore
deserves to be part of that effort. Through
your work in the numismatic community, the spectacular Mt.
Rushmore monument will be cleaned, restored and ready for its
50th anniversary this summer -- and prepared to inspire millions
of visitors well into the 21st century.

Clearly,

National

Rushmore

Monument

look forward to the 50th Anniversary celebration at Mt.
in July. It will be the culmination of your dedicated

efforts to

this celebration a success.
Thank you for the great work you' ve done.
Our common
efforts have contributed significantly to securing in the
national consciousness the democratic ideals and principles that
then I
And if past is prologue,
keep America free and strong.
know we can continue to depend on your future contributions.
make

Thank you.

Department

of the 7reasury

FOR IMMEDIATE

February

Washington,

RELEASE

O. C. ~ Telephone 566-2D44

CONTACT:

1~, 1991
TAX INFORMATION

UNITED

STATES

AND

Bob Levine

(202) 566 —"0'1

EXCHANGE AGREEMENT BETWEEN
COSTA RICA ENTERS INTO FORCE

The Treasury Department announced today that the United
States and Costa Rica have exchanged diplomatic notes that
activate an agreement to exchange tax information (the
"Agreement" ) that satisfies the criteria set forth in the
Caribbean Basin Economic Recovery Act of 1983. The Agreement
signed in San Jose on March 15, 1989 and is effective February
12, 1991.

was

With the Agreement in effect, Costa Rica qualifies as a
jurisdiction in which Puerto Rican financial institutions may
make certain investments
of funds derived from U. S. section 936
companies.
Such funds may be used to finance investments
in
qualifying development projects in Costa Rica.

Another
be considered

benefit of the Agreement is that Costa Rica will now
part of the "North American Area" for purposes of

determining whether U. S. taxpayers may deduct expenses incurred
in attending conventions, business meetings, and seminars.
Therefore, convention expenses incurred by U. S. taxpayers for
meetings in Costa Rica that are otherwise deductible as ordinary
and necessary business expenses will be allowed without regard to
the additional limitations applicable to foreign convention

deductions.

Finally, Costa Rica will now qualify as a foreign country in
a foreign sales corporation may incorporate and maintain an
office as provided in the foreign sales corporation provisions of
the Tax Reform Act of 1984.

which

The United States also has Tax Information Exchange
Agreements in effect with Barbados, Dominica, The Dominican
Republic, Grenada, Jamaica, Trinidad and Tobago, Mexico and
Bermuda.
All but the final two are Caribbean Basin Initiative

countries.

number of copies of the Agreement
A limited
from the Treasury Public Affairs Office, Treasury
D. C. 20220.
Room 2315, Washington,
oOo

4B-1136

are available
Department,

iepartment of the Treasury

Washington,

O.C. ~ Telephone SSI-204t

STATEMENT OF
THE HONORABLE PETER K. NUNEZ
ASSISTANT SECRETARY QF THE TREASURY FOR ENFORCEMENT
UNITED STATES DEPARTMENT QF THE TREASURY
BEFORE THE HOUSE COMMITTEE QN BANRING, FINANCE, AND URBAN AFFAIRS
SUBCOMMITTEE OF FINANCIAL INSTITUTIONS
SUPERVISION, REGULATION AND INSURANCE
1991
FEBRUARY

19,

Introduction
I would like to thank
Mr. Chairman and Members of the Committee,
to testify about H. R. 26, introduced by
you for this opportunity
Chairman Annunzio,
and H. R. 950, introduced by Mr. Wylie,
legislative proposals relating to money laundering and Bank
Secrecy Act enforcement and to international anti-money

laundering

cooperation.

In recent years Treasury has found this Committee to be an ally
in the fight against money laundering.
In 1986, in 1988, in
1990, and now. in 1991, this Committee has been willing to tackle
legislative solutions to deal with the ever-changing money
We share
the commitment to close the doors
laundering landscape.

of legitimate financial institutions to money launderers and to
see that banks and other financial institutions
are equally
committed to being active partners with law enforcement.
Treasury also shares the concern that law enforcement needs to be
balanced with other legitimate considerations such as the cost to
In this difficult time for the banking
financial institutions.
industry, this issue of balance takes on pressing significance.
Role of the Assistant Secretar
for Enforcement

Assistant Secretary for Enforcement, I have been delegated by
the Secretary of the Treasury government-wide
responsibility for
Bank Secrecy Act enforcement
and for coordinating
policies
affecting Treasury investigatory re&~~nsibility for the crime of
Treasury' s Fi narc ~~1 Crimes Enforcement
money laundering.
Network (FinCEN) reports directly t:o the E.-sistant Seer~. tary for
Enfot. cement.
Within my office, the Office of Financial
Enforcement has primary
esponsibili'y fo' supervision of Bank

Sect. ecy Act enforcement

and

money

laundering

activities.

me today are Brian Bruh, Di ector of FinCEN and peter
Djinis, Acting Director of the Office o Financial Enforcement.
FinCEN, as most of you know, has been established
within Treasury

With

NB-113i

at Secretary Brady's initiative to provide a multi-source data
access and financial analysis service to Federal State, local
and foreign law enforcement
to assist in the investigation and
prosecution of money laundering and other crimes. In performing
this analysis function, FinCEN builds on Treasury~s experience
over the years in analyzing Bank Secrecy Act and other financial
data.
The Office of Financial Enforcement
is responsible for Bank
Secrecy Act enforcement and compliance, including the
of administrative
promulgation
rulings, the assessment of civil
penalties, international law enforcement initiatives aimed at
combating money laundering,
and monitoring
a series of
delegations to IRS and to the regulatory agencies which examine
the various types of financial institutions
subject to the
currency reporting and recordkeeping provisions of the Bank
Secrecy Act.
for examination of
Treasury has delegated responsibility
compliance with the Bank Secrecy Act to the regulatory agencies
For
according to the types of institutions they examine.
instance, the Federal Reserve Board is responsible for state
chartered member banks, the FDIC for state chartered banks that
are not Federal Reserve members, and the Comptroller of the
for the
Currency for national banks.
Compliance responsibility
various miscellaneous or non-bank financial institutions subject
to the Bank Secrecy Act such as transmitters of funds, check
cashiers, foreign currency brokers, and casinos rests with the
IRS Examination Division.
Charter

Revocation

I would like to turn to the bills under consideration by
this Committee.
Both H. R. 26 and 951 are rooted in and expand
H.
R.
a
bill that passed the House overwhelmingly last
upon
3848,

Now,

year, but

was

Administration

not enacted.

generally

I
supports
As

testified last March,
these initiatives.

the

that banks, including saving
associations and credit unions, convicted of money laundering or
Bank Secrecy Act violations could be placed into conservatorship
or, if a bank and more than one senior official or director were
convicted, the bank could forfeit its national charter or lose
its federal deposit insurance. We agree with the objective of
these provisions -- to send a loud and clear message to banks and
bankers that money laundering and compliance programs that leave
institutions vulnerable to money laundering will not be
tolerated. We also agree that in egregious cases where banks
have, in effect, become criminal enterprises, banks convicted of
the bills both
Furthermore,
should be closed.
money laundering
and
procedural
considered
provide that relevant factors will be
no
in
way
automatic
is
safeguards followed to insure that closing
upon conviction.

Both H. R. 26 and 950 provide

Non-Bank

Financial

Institutions

of provisions in the bill deal with the difficult issue
laundering through businesses such as foreign currency
exchanges, casas de cambio, issuers and redeemers of traveler' s
checks, check cashers, and transmitters of funds'
These
institutions are among what Treasury refers to as the
miscellaneous or non-bank financial institutions subject to the
Bank Secrecy Act recordkeeping
and reporting requirements.
As I testified last year, it is undisputed
that as Bank Secrecy
Act compliance by banks has improved, drug money launderers have
and will continue to turn to other methods to convert street
currency into monetary instruments and even transmit abroad the
proceeds of drug sales.

number
money

is responsible for examining these
is an enormously difficult job given the
of institutions, and the fact that the industries

The IRS Examination

institutions.

This

Division

sheer number
are largely unregulated.

Simply put, Bank Secrecy Act
requirements
and IRS compliance review alone cannot turn this
situation around. What is needed is state licensing and
regulation as set forth in section 10 of H. R. 26 and 951.

bill provides for

development of model state legislation
includes licensing, licensing standards, state penalties
for Bank Secrecy Act violations, and criminal penalties for
operating without a license
One year after the date of
enactment, the Secretary of the Treasury would be required to
report to Congress concerning progress made in developing a model
statute, the adequacy of the activities of the states to enforce
such statutes, and the resources made available to the
appropriate state agencies for enforcement.
The Secretary would
make recommendations
in this report on incentives for or
sanctions against states that had failed to enact and enforce a
statute or to apply adequate resources for enforcement.
We agree that,
based on our experience with these institutions
Treasury, perhaps through IRS, would be the appropriate Federal
agency to undertake this task. Ho~ever, we are concerned that a
one-year time frame may be insufficient for the states to enact
and enforce statutes or for Treasury to do an adequate review of
the systems of fifty states.
The

which

we believe this is a wood pr~t osal that will focus
the attention of state governments on this problem, place the
.here we believe
emphasis on state licensing and enforcement
it
should be, and lead to a regulatory system that will complement
Treasury's Bank Secrecy Act enforcement program for these

Nevertheless,

institutions.

Even licensing and regulation,
however, are not enough.
addition, non-bank financial institutions must also be required
to take affirmative measures to ensure that they are not

victimized by money laundering.
To this end, they must be
required to take anti-money laundering measures comparable to
those taken by banks and be subject to sanctions for failure to
do so. Therefore, as I will discuss shortly, Treasury seeks
authority to require these institutions to report suspicious
transactions and have anti-money laundering compliance programs.
Failure to take such steps would subject these institutions to
the sanctions of the Bank Secrecy Act.

Section 15 — CTR Exem tions
There are a few sections in the bills that Treasury cannot
For instance, section 15 calls for banks to require
support.
that customers on a bank's list of businesses exempt from the
file a statement with
Currency Transaction Reporting requirements
the bank annually regarding entitlement to the exemption.
Section 15 also would require that the list of exempt customers,
which is required to be kept by Treasury regulations,
be filed
annually with Treasury.
already has the ability to effect these measures under
legislative authority, and has considered and rejected
such measures in the past. Our conclusion is that annual
certification and centralization of exemption lists would be
overly burdensome and that the costs would not be justified by
the resulting law enforcement benefit.

Treasury

current

provision in the Anti-Drug Abuse Act of 1986 required that
prior to being placed on an exempt list customers execute a
statement describing why the person is entitled to an exemption.
There is no need for bank customers to sign a new statement each
year because under Treasury guidelines, banks should annually
review the continued appropriateness
of exemptions, both with
respect to the nature of the customer's business and the
exemption amount.
Banks must obtain a new exemption statement if
the bank discovers that the information to which the customer
attested has changed.
With respect to filing of exemption lists centrally, maintaining
a centralized automated list would be a very expensive
undertaking which Treasury does not believe is justified at this
time. FinCEN is currently conducting a thorough review of the
entire exemption system. This review should be completed before
any decision is made on the need for this provision.
Section 14 — Prosecutorial Guidelines
the most concern is
The provision that gives the Administration
section 14, which provides that the Secretary of the Treasury,
with respect to civil enforcement, and the Attorney General, with
respect to criminal enforcement, shall submit their decision
guidelines on enforcement of the
whether to issue prosecutorial
to public
Bank Secrecy Act and the crime of money laundering
public
comment is
comment.
The question to be addressed by the

whether compliance and cooperation with law enforcement would
enhanced by issuance of public prosecutorial
guidelines.

public

of prosecutorial guidelines would be
plainly and simply is a bad idea. No
rulemaking process is necessary to reach this conclusion.
Guidelines exist for the civil enforcement of the Bank Secrecy
Act. Those guidelines are flexible and do not give rights to
third parties. Certainly, the degree to which a financial
institution cooperates, makes timely reports of violations, and
takes measures to lessen its vulnerability
to money laundering,
are all factored into a decision whether to proceed against a
bank civilly or criminally.
Treasury and the Justice Department
are not about to issue these guidelines, which also include
sensitive information, to be broadcast to potential violators.
The concern underlying
this provision appears to be the
Administration's
opposition to a statutory safe harbor from
prosecution for financial institutions that report suspicious
transactions.
We agree with the Justice Department
that whether
a bank's suspicious transaction
report was timely should not
become yet another legal issue in a money laundering
case
The
financial institutions conduct on the whole will be viewed in
assessing whether there was corporate intent. We are confident
that absent unusual circumstances, if a bank took appropriate
measures to guard against money laundering and nevertheless
discovered that it was used by money launderers, it would not be
prosecuted following a report of the illegal activity to federal
The

unprecedented

law

issuance
and

enforcement.

to Financial Privac Act
A provision
that would be helpful to encourage the reporting of
suspicious transactions would be an expansion upon the suspicious
transaction exception in the Right to Financial Privacy Act.
Since the inception of the Right to Financial Privacy Act, there
has been an exception that allows financial institutions
to
report, in good faith, possible violations of law or regulation
to federal authorities without notice to the suspected customer
and free from civil liability under the RFPA. At the
Administration's
request, Congress further clarified this
provision in the Anti-Drug Abuse .".=' of 1986 and 1988 to specify
what information
a financial
institution could give regarding the
customer and the suspicious acti' it@, and that the protection
pre-empted any state la~. requirin~ notice 'o the customer.
These
changes were added to ensure that financial institution" would
not be inhibited from reporting suspected violations, especially
and Bank Secrecy Act reporting violations.
money laundering
Nevertheless,
there are other concerns beyond liability under
privacy laws that may complicate treatment of suspicious
transactions.
For instance, financial institutions
may risk
defamation actions or, if they sever relations with a customer,
Ri ht

risk liability under the Fair Credit Reporting Act or for
breach of contract.
Financial Institutions also should be free
to sever relations with a customer based on their suspicions
without fear of liability.

may

would address these concerns by extending the
Administration
suspicious transaction protection to a financial institution that
severs relations with a customer or refuses to do business
because of activities underlying a suspicious transaction report.
It should also be specified that the financial institution that
acts in good faith in reporting a suspicious transaction is
protected from civil liability to the customer under any theory
of state or Federal law, not just under financial privacy laws.
A similar
provision was contained last year in H. R. 3848, but is
not in the bills before us now.

The

The protection should also be extended to the wide range of bank
and non-bank institutions
subject to the Bank Secrecy Act, 31
U. S. C. 5312. Currently,
the protection applies only to financial

institutions as defined in the RFPA -- banks, credit unions,
savings associations.
Nevertheless, non-bank financial
institutions may similarly be inhibited from reporting suspicious
transactions by fear of civil liability for defamation or breach
of contract or under financial or consumer privacy laws.
International

Funds

Transfers

bills require Treasury to have final regulations relating to
records maintained by banks and non-bank financial institutions
with respect to international
funds transfers, particularly
by
wire, by a certain date -- H. R. 26 by May 1, 1991 and H. R. 951 by
October 1, 1991. The section responds to the number of major
money laundering
schemes involving the wire transfer system in
recent years.
Both

In October 1990, Treasury issued a notice of proposed rulemaking
setting forth the provisions for enhanced recordkeeping for both
domestic and international
funds transfers.
The comment period
on this proposal closed on January 15, 1991, and we are in the
process of reviewing over 300 comments received in response to

that notice.

In the interim,

Treasury has determined that for the foreseeable
will not require reporting, as distinct from
recordkeeping, of funds transfers, international
or domestic.
The volume of fund transfer transactions
and the difficulty posed
of detecting through automated methods a money laundering scheme
when it is already in mid-course,
FinCEN
led to this decision.
continues to study the feasibility of developing a suspicious
wire transfer profile.

future,

Modifications to the proposed rule are under study. Our goal is
to insure that adequate information exists in an accessible form
for investigators to follow the trail of funds i»oney

laundering and other financial crimes cases. We hope to develop
requirements
that will meet this objective at the least possible

for financial institutions.
Treasury's preference would be for Congress to remove any
statutory deadline for this rulemaking, or at a minimum, to adopt
the October date for a final rule in H. RE 950. This would give
us the latitude to renotice a revised funds transfer regulation
for comment, if necessary'
Section 32 — GAO Stud
burden

does not believe that a GAO study on the utility of Bank
Secrecy Act reporting, called for in section 32 of H. R. 950, is
necessary because, to a large extent, it would duplicate ongoing
efforts by Treasury. A section in the Crime Control Act of 1990
signed into law in November, requires Treasury to submit a
comprehensive
study on the uses of Bank Secrecy Act and 8300
information (cash reports by trades or businesses other than
financial institutions) to Congress at the end of May and
biannually after that for four years. This study is underway and
should obviate the need for a GAO study.
FinCEN also has
recently completed a report on the utility of Bank Secrecy Act
reporting which Treasury will make available to the Committee

Treasury

Section

International Discussions
Treasury agrees with the general approach of section 22 of Nr.
Wylie's bill to assure that other countries of the world,
especially financial center countries, continue to join with us
anti-money programs and cooperating in
in effecting comprehensive
international money laundering cases. The section directs the
Secretary of the Treasury to enter discussions with countries
are engaging in activities involving the
whose institutions
narcotics sales to encourage the
proceeds of international
countries to develop comprehensive anti-money laundering measures
in drug and money
and to cooperate with U. S. authorities
laundering cases. Treasury would report periodically to the
Banking Committees on the progress of these discussions and
action to Congress with respect to
recommend appropriate
countries which had made inadequate progress.
~~~inistration to continue
This proposal, in effect, direct~
what it has been doing in the interna tional arena in recent
years. Treasury, Justice and the =t. a te De| artment working
together have made an important cont. xbutxo~ "o the wor. ldwzde
progress that has been made in addres sing the problem of
international money laundering.
that this progress starts
Section 22 reflects the understanding
with persuading countries that international
money laundering
is
problem from which no country is immune; that it is in
country's own best interests to take effective measures to
address the problem domestically and to cooperate in
22 —

international cases.
process.
The section also recognizes that this is an evolutionary
measured
concretely
in
the
be
can
number
of
This progress
significant international initiatives to address international
such as the UN Narcotics Convention, which
money laundering,
recently came into force, and the ongoing G-7 Financial Action
Task Force, the Caribbean Drug Money Laundering Conference, the
to draft model legislation, and other initiatives
OAS initiative
in the European Community and the Council of Europe.
individual countries are taking major
action in response to the FATF and
regulatory
legislative
-- Switzerland, Canada, France,
commitments
other international
Italy, Spain, Luxembourg, to name a few. Progress can also be
cases that have
measured by recent international
money laundering
been brought to a successful conclusion through the cooperation
of foreign law enforcement, such as Operations C-Chase and Polar
In addition,

many

and

Cap.

Section 22 would replace section 4702 of the Anti-Drug Abuse Act
of 1988, commonly known as the Kerry Amendment.
That section
requires Treasury to enter agreements with countries to require
records of currency transactions over $10, 000 in United States
dollars and to share those records with U. S. law enforcement
agencies upon request in drug cases. The sanction for failure to
enter an agreement is that the financial institution of a country

would

be precluded

from the U. S. banking

system.

Section 22 would be a significant improvement over section 4702.
Section 4702 focuses on what is a very small, although necessary,
element of a comprehensive money laundering program, large dollar
currency recordkeeping.
In addition, sanctions under section
4702 have posed an impediment to reaching 4702 agreements.
The
statute is perceived by many countries as having an improper
extraterritorial effect. Countries that have taken measures that
meet and go beyond 4702 will not enter section 4702 agreements
because of the perceived extraterritorial
principle at stake.
Moreover, the sanctions contemplated by section 4702 would be
difficult to enforce and, in our view, would have a detrimental
effect on U. S. economic interests that may exceed the damage to
the sanctioned party.
Treasury suggests that section 22 be recast as a sense of the
Congress resolution, in effect expressing a Congressional
recommendation
rather than a direction to enter these
discussions.
A direction
to enter discussions or negotiations
with foreign governments
raises the concern of improper
interference with the President's foreign policy making
should be made to the President
The recommendation
authority.
of the Executive Branch will
who in the efficient administration
determine the agencies to give effect to the recommendation.
Treasury, Justice and State jointly, are the three agencies that
are working in tandem in this area.

FATF

I spoke a moment ago of the success of the G-7 Financial Action
Task Force on money laundering
in furthering the goal of forging
a network of countries committed to effective anti-money
laundering measures.
In Treasury's view the most important
legislative amendments in this session of Congress relate to
implementation
of the recommendations of that group. Treasury
has submitted proposed legislative language to this end to the
subcommittee staff.

of background, the FATF was convened by the 1989 G-7
to study the state of international cooperation on money
laundering and measures to improve cooperation in international
money laundering
cases. The group was composed of fifteen
financial center countries and the European Community.
After
numerous meetings of experts from law enforcement,
justice and
finance ministries, and bank supervisory authorities, in April
1990, the group issued a comprehensive report with 40 action
recommendations
for comprehensive domestic anti-money laundering
programs and improved international
cooperation in money
laundering investigations,
prosecutions, and forfeiture
The recommendations
proceedings.
of the group have become the
world model for effective anti-money laundering measures.
By way
Summit

of state and government
Action Task Force at the
Houston Economic Summit in the summer of 1990, and the financial
ministries of non-G-7 participants also endorsed the report. The
Houston Summit reconvened the Task Force for another year.
The
mandate of the reconvened Task Force is to study possible
complements to the original recommendations,
to assess
of the recommendations,
implementation
and to study how to expand
the number of countries that subscribe to the recommendations.
The reconvened Task Force is currently meeting.
The original
members have been joined by seven other European countries,
and
by Hong Kong, New Zealand, and the Gulf Cooperation Council.

President

endorsed

Bush and the other

the report

heads

of the Financial

By their
members

the United States and the other Task Force
endorsement,
are committed to take necessary legislative and
regulatory measures to implement the recommendations.
Most of
the countries are in the process of developing the necessary
legislation.
As can be expected, ~ st ~f the recommendations
reflect measures already in place in the tt~ited States because
the United States was among the first countries to recognize the
need for a comprehensive
regulatory and 1 ~islative rest-ense to
Nevertheless,
to fully measure up to the
money laundering.
recommendations,
our program requires some legislative
refinements.

First, the Task Force recommendations provide that the same
anti-money laundering measures recommended for banks be put in
place for non-bank financial institutions,
such as the
to report suspicious transactions possibly indicative
requirement

-10and to create anti-money
money laundering
laundering programs.
The world experience mirrors the experience in the United States
that as banks become more effective in guarding against money
laundering, money launderers turn to non-bank financial

As we have discussed,
institutions.
many of these institutions
are subject to the recordkeeping and reporting requirements of
the Bank Secrecy Act, but unlike banks are not required to report
suspicious transactions nor to have compliance programs to guard
against money laundering.

Treasury proposes an amendment to the Bank Secrecy Act to
authorize the Secretary to require, by regulation, the reporting

of suspicious transactions by any financial institution subject
to the Bank Secrecy Act. Also in furtherance of the FATF
recommendations,
a financial institution,
bank or non-bank,
should be prohibited from warning its customer if it made a
suspicious transaction report. As just noted, under the RFPA, a
financial institution may report a suspicious transaction free
from civil liability for not notifying its customer, but is not
specifically prohibited from warning the customer. The FATF
concluded that in order for suspicious transactions reporting to
be effective there must be a prohibition
from notifying the
persons involved in the suspicious transaction.
Tracking the language of another FATF recommendation,
Treasury
also proposes an amendment to the Bank Secrecy Act to authorize
the Secretary to require financial institutions
subject to the
Bank Secrecy Act to have anti-money
laundering programs which

include, at a minimum, development of internal policies,
procedures, and controls, designation of a compliance officer,
ongoing employee training program, and an independent
audit
function to test the program.
The Secretary would be able to
promulgate minimum standards for such procedures.

recommendation
was based on the regulations
the U. S.
regulators have in place pursuant to 12 U. S. C. 1818(s) to
ensure Bank Secrecy Act compliance.
The Secretary already has
authority under 31 U. S. C. 5318 to promulgate regulations that
require financial institutions to maintain procedures to ensure
compliance with requirements
of the Bank Secrecy Act. This
amendment
would eliminate the requirement
that the procedures be
linked to a Bank Secrecy Act requirement,
e. , currency
transaction reporting.
The proceduros would be directed at money
laundering generally, whether or not a customer dealt in cash.
For instance, this authority could be used to require that
anti-money laundering programs include "know your customer"
procedures.

This

FATF

bank

of the Treasury envisions that the proposed
authority could be used with respect to any institution subject
to the Bank Secrecy Act under 31 U. S. C. 5312 whether or not that
institution is required to report currency transactions under the
Bank Secrecy Act.
The Department

-11—
These are important to the U. S. financial enforcement program and
enactment will demonstrate the commitment of the Congress to
stand behind the United States' endorsement of the report.
It
will also demonstrate that the United States is not just willing
to "teach" effective anti-money laundering measures in
international forums, but to learn from the experiences of

others.

Conclusion

Finally, I would again like to express the Treasury's
appreciation to the Members and staff of this subcommittee who
have committed their time and attention to combating money
laundering -- an area which is a critical one for law
enforcement.
Our partnership
in the legislative arena has
severely restricted the available avenues for drug and other
has the
The pending legislation
types of money launderers.
potential to restrict further their ability to operate, and the
Treasury Department stands ready to assist in any way as the bill
moves through the legislative
process.
This concludes my prepared remarks, I will be happy to respond to
any question you may have.

EB
I&

FOR

', »r'i'.

the Tr«azure

I YMEDI ATE

February

Bureau nl'(he f'ubi&c Deb(

RELEASE

l~'ashinyon,

RESULTS QF TREASURY'S AUCTION

c f Financ

Office

CONTACT:

19, 1991

DC 2l"239

OF 13-WEEK

21, 1991 and mature on
accepted today (CUSIP: 912794WK6).

May

BILLS

23, 1991 were

OF ACCEPTED

RANGE

COMPETITIVE

BIDS:

Discount
Rat

Investment

5. 924
5. 944
5. 944

6. 09%
98. 504
6. 114
98. 499
Average
6. 11%
98. 499
S1, 000, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 90%.
The investment
rate is the equivalent coupon-issue yield.
Low

High

(in thousands)

TENDERS RECEIVED AND ACCEPTED

Boston
New

York

Philadelphia

Cleveland
Richmond

Atlanta

Chicago
Louis
Minneapolis
Kansas City

St.

Type

Competitive
Noncompetitive

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

An additional
issued to foreign
:

22, 360

22, 260
408, 535

1, 031, 035
$29, 511, 365

TOTALS

~~cgt~cC
38, 955
7/989/380
23, 005
38, 840
39, 380
31/430
71( 875
11 595

8, 5?5
36, 525

Dallas
San Francisco
Treasury

Subtotal,

lidtLJBI
38, 955
25(831, 290
23, 005
38, 840
139, 380
33, 430
1, 369, 375
11, 595

927 050

S9, 647, 355

Se, 991, 030

2, 463(385

2, 463, 385

$5, 269, 975

192

192 94
$9, 64. , 355

S29, 511, 365
$26, 060 thousand

of bi 1 ls ill be
for new cash.

official institutions

. ".93--98. 50'

. "'. 9 - - 9 8 . 5 1 '

8, 525
36, 525

$25, 133, 985
1 721 0 5
S26, 855, 040

202-376-43:0

for $9, 6&7 million of 13-week bills to be issued

Tenders
on February

of the Treasury

Department

FOR RELEASE AT

Februa

4: 00

P . ."'.

Washington,

CO".

19, 1991

.AC. :

O. C. ~ Telephone 566-204
ice o -=-'."an=-'""g

202/3 6-~350

TREASURY'S WEEKLY BILL OFFERING

of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling
approximately S 18, 400 million, to be issued February 28, l991.
This offering will result in a paydown for the Treasury of about
million, as the maturing bills are outstanding in the
S 650
Tenders will be received at Federal
amount of S 19, 045 million.
Reserve Banks and Branches and at the Bureau of the Public Debt,
Washington, D. C. 20239-1500, Monday, February 25, 1991,
prior to 12:00 noon for noncompetitive tenders and prior to
time, for competitive tenders.
1:00 p. m. , Eastern Standard
The two series offered are as follows:
The Department

bills (to

date) for approximately
additional amount of bills
million, representing
S 9, 200
mature
and
to
May 30, 1991
dated November 29. 1990,
in the amount
outstanding
(CUSIP No. 912794 WL4 ), currently
bills to be
and
original
additional
of S 10, 465 million, the
freely interchangeable.
91-day

maturity

bills (to maturity date) for approximately
representing an additional amount of bills
million,
$9, 2pp
and to mature August 29, 1991
1990
dated August 30,
in the amount
(CUSIP No. 912794 WT7 ), currently outstanding
of $1p, 631 million, the additional and original bills to be
freely interchangeable.
The bills will be issued on a discount basis under competi182 -day

tive

and noncompetitive

bidding,

and

at maturity

their par

amount

Both series of bills will be
will be payable without interest.
issued entirely in book-entry form in a minimum amount of $10, 000
on the records either of the
and in any higher S5, 000 multiple,
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 Februar, 28, 1991. Tenders from Federal
Reserve Banks for their own account and as agents for foreign
monetary authorities will be accepted at
and international
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
to the extent that the aggregate amount
monetary authorities,
of tenders for such accounts exceeds the aggregate amount of
Federal Reserve Banks currently
maturing bills held by them.
$1, 410 million as agents for foreign and international
and S 4, 333 million for their own account.
monetary authorities,
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).

4B-1139

TREASURY'S

13-, 26-,

AND

52-WEEK BZLL pppERZNGS,

Page

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. 154. 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.
and dealers who make primary
Banking institutions
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
Others are only permitted to submit tenders for their
furnished.
Each tender must state the amount of any net long
own account.
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.

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
competitive tenders.
A

issue price as determined

in the auction.

and

trust

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

Public announcement will be made by the Department of the
of the amount and yield range of accepted bids. Competitive bidders wil' 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.
Treasury

Settlement

for accepted tenders for bills to be maintained

will be
maturing
new

made

for differences between the par value of the
exchange and the issue price of the

bills accepted in

bills.

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
Accrual-basis taxpayers, banks, and other
the bill matures.
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.
8/89

L VL7&
Dt l&~rt»tt nt

i/t

thc l'rcasury

Bureau of the f'ublic Debt

RESULTS OF TREASURY'S AUCTION

DC 'it". 39

Office -"' =inan=i. ;~
2~2-3?6-4350

19, 1991

February

4 ashtngton.

CONTACT'

RELEASE

FOR IMMEDIATE

OF 26-h&EK

BILLS

Tenders for $9, 627 million of 26-week bills to bc issued
on February 21, 1991 and mature on August 22, 1991 were
accepted today (CUSIP: 912794XD1).
RANGE

OF ACCEPTED

COMPETITIVE BIDS'.

Investment

Discount
Rate
5. 914

97. 012
97. 007
5. 92%
High
97. 012
91'L
5.
Average
Tenders at the high discount rate were allotted 19%.
coupon-issue yield.
The investment rate is the equivalent
Low

184
6. 194
6. 184
6'

(in thousands)

TENDERS RECEIVED AND ACCEPTED

Loc

Boston
New

York

Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

18, 795

TOTALS

Type

Ccr. petitive

Publ'c

"'-1
. '. 40

.'„".ign
.

$24, ~88, 955

$5, 219, 290
1

"7
/

c.'''ci

"" t.".ou

$9, 62/, 6, 0
o

sand
P

8~'~C

2, 3 0, 003

28. ~96/305
"..

$6, 504, 8SO

2, 350, 000

T 'TALS

$8.',

$9/626/640

$25/374/545

Federa' Reserve
Official
Foreign
'
-.
ns t i .:t i ons

'. n ' add'. iona.'

115, 025

689 165
$20, 496, 305

285 590

?;oncompetitive

236/495
17, 040
6, 420
42, 640
18/795

586, 525

Treasury'

16 I 665
30, 530
37, 430
32, 750

44(490

Dallas
San Francisco

zest.

8, 351/805

25/659, 770
16, 665
30, 530
37, 430
32/750
845
224,
1,
1. , 040
6, 420

Philadelphia

Subtotal,

31, 880

bi'. '. s

'v,

~c'~'

I bc

c&s,'.

C)
rn

WASHINGTON,

FOR IMMEDIATE

D. C

20220

RELEASE

February

FEDERAL FINANCING

BANK

19, l991

ACTIVITY

Charles D. Haworth, Secretary, Federal Financing Bank
(FFB), announced the following activity for the month of
January 1991.

of obligations issued, sold or guaranteed
other Federal agencies totaled $181.1 billion
on
January 31, 1991, posting an increase of $2. 0 billion
from
the level on December 31, 1990 ' This net change was the
result of a decrease in holdings
loans
of $500. 9 million and in holdings ofof agency-guaranteed
agency assets of
$155. 1 million, while holdings of agency debt increased
by $2, 635. 2 million.
FFB made 21 disbursements
during
January.
by

FFB holdings

FFB holdings on January
in the bank's history.

31, 1991, were the highest

Attached to this release are tables presenting FFB
January loan activity and FFB holdings as of January 31, 1991.

page 2
FEDEfVJ FINANCING

BANK

AM3UNI'

FINAL

INTEREST

IÃIKREST

OF ADVANCE

MATURITY

RATE

(semi-

(other than
semi-annual)

annual)

CREDIT UNION MPIINISTRATION

Central Li
+Nate
+Nate
+Nate
+Note

1991 ACI'IVITY

JANUARY

NATIONAL

'di

Facili

f539
f542

$15/ 000' 000

00
8 g 120 ~ 000 00
2, 500, 000. 00
15, 000, 000. 00

4/2/91
4/3/9 1
2/4/91
4/29/91

6 ~ 762%
6 ~ 783%'

53, 940, 651, 055. 74
750, 000, 000. 00
400, 000, 000. 00
1/15

6.761%
6.465%
6.349%
6.511%
6.852%
6.465%

1/2
1/3
1/4
1/28

4540
4541

6.761%
6.486%

RESOIIJZION TRUST CORPORATION

Note No.
Advance
Advance
Advance
Advance

91-01
g1
g2
g3
g4

1/3 1

500 g 000 ~ 000 00

4/1/91
4/1/91
4/1/91
4/ 1/9 1

1/8
1/15
1/2 1

179, 000, 000. 00
187, 000, 000. 00

1/21/91
1/31/91

1/2
1/14

TENNESSEE VALLEY AU'IHOIK'IY

Short-term Bond 475
Short-term Band 476
Short-term Bond 477
Short-term Bond 478
AGENCY

1/31

188 000 000 00
238, 000, 000. 00

2/7/9 1
2/16/91

1/1

105 ~ 000 000 00
375 J 000 000 00

1/1/06
1/30/06

6 426%

6.532%

ASK;IS

FARMER'S HCNE

RHIF —CEO 457551
RHIF — CBO 457552

+rollaver

1/30

g
g

8 249%
8 ~ 202%

8 ~ 4 19%' ann
8 ~ 370% ann

FEDERAL FINANCING

JANGLY

BA'K

1991 ACIIVITY

AKXJNI'

FINAL

INTEREST

IVER EST

OF ADVANCE

KQURI'IY

RATE

(semi-

(other than
semi-annual

annual)

U. S.
Advance

New

York

¹5

*Ehsin Electric ¹137
Mt. Nheeler Power ¹326
«United Power Assoc. ¹145A
Power
¹159A
Continental Tele. South ¹351

~ted

Nate A-91W3

~turity

1, 260, 420. 35

5/15/91

6. 542%

6, 138, 514.68
1, 241, 000. 00

3/3+93

12/31/18

1/30

4~302~000 F 00
1,798, 000. 00
19,000, 000 F 00

12/31/19
12/31/19
12/31/18

8. 178%
7. 374%
8. 222%
8.222%
8. 242%

1/31

643, 474, 813.34

4/30/91

6.532%

1/31

extensicn

1/3
1/8
1/28

+28

8.096% qtr.
7.307% qtr.
8. 139% qtr.
8. 139% qtr.
8. 159% qtr.

)

Page
FEDERAL FINANCING

(in millions)

~ro ra

Agency Debt:
Export-Import
NCUA-Central

Januar
Bank

Liquidity Fund
Resolution Trust Corporation
Tennessee Valley Authority
U. ST Postal Service

sub-total*
Agency Assets:
Farmers

Home

Administration
Org.

DHHS-Heagth Maintenance
DHHS-Medical Facilities

Rural Electrificatj. on Admin. -CBO
Small Business Administration

sub-total*
Government-Guaranteed
DOD-Foreign Military

Loans:
Sales
DEd. -Student Loan Marketinq Assn.
DHUD-Community
Dqv. Block Orant
DHUD-Public Housing Notes +
General Services Administration
+
DOI-Guam Power Authority
DOI-Virgin Islandy
NASA-Space Communications
Co. +
DON-Shzp Lease Financina
Rural Electrification
Administration
SBA-Small Business Investment
CosSBA-State/Local Development Cos.
TVA-Seven States Energy Corp.
DOT-Section 511
DOT-WMATA

sub-total*
grand total*
figures may no
o a
ue o
+does
not include capitalized Wou»n&
interest

1991

2
11,370.
80. 0

55, 590. 7
14, 101.0
6, 697. 8
87, 839. 6

December

BANK

31 1990

Net Chan e
1 1 91-1 31 91

2
$11,370.
81.5

53, 000. 0
14, 055. 0
6, 697. 8
85, 204. 5

'91

Net Change

10 1 90-1 31 91

0. 05
-1.
590. 7

30. 4
23. 4
14, 109.0

2, 635. 2

13, 881. 7
0
120.
-0—0-

-281.
0
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)epartment of the Treasury

Nashinoton,

D.C. ~ telephone SIS-204$

STATEMENT OF THE HONORABLE
DAVID C. MULFORD
UNDER SECRETARY OF THE TRF~URY
FOR INTERNATIONAL AFFAIRS BEFORE THE
SUBCOMMITTEE ON INTERNATIONAL
DEVELOPMENT, FINANCE, TRADE AND MONETARY POLICY
COMMITTEE ON BANKING, FINANCE AND VEGAN AFFAIRS
UNITED STATES HOUSE OF REPRESENTATIVES
FEBRUARY 20, 1991

Chair and Members of the Committee,

Madam

it is

a great pleasure

to testify before you today
In the coming months, this Committee
will consider a wide range of issues, including a number of
legislative proposals that are critical to the international
economic policies of the United States. Many of these issues and
much of the legislation
will involve issues for which the Treasury
has the primary responsibility
in the U. S. government.
The full plate which you will have before you reflects the growing
importance of the interrelationship
between the world economy and
our well-being at home. A few vital statistics highlight this
essential realityU. S. trade, which equaled roughly 8 percent of GNP in 1970,
now

accounts for over 16 percent of our national

The

external sector accounted for
in 1990.

more than

growth

income.

40 percent

of our

of every four new jobs in the United States
is related to merchandise exports.

Roughly

one out

review with you a number of areas in which the Treasury is
engaged that bear on our ability to foster a sound world economy
monetary system that promotes U. S.
and stable international
political and economic interests. I will also inform the
Committee of other areas in which Treasury is involved, including
the Persian Gulf crisis, efforts to open markets overseas, and the

Let

operations

of the Exchange Stabilization

Fund

(ESF).

Before proceeding with this review, however, let me note that
during the seven years which I have been Assistant Secretary and
Under Secretary of the Treasury I have consulted extensively with
this Committee on a number of major policy issues. This has
enabled me to learn from you as well as to take account of your
views. we have made some important progress on macroeconomic

policy issues and international debt. For my part, I certainly
hope that this close consultative arrangement that we have
I am confident that you share this
established will continue.
hope.

Polic

Economic

relations with the major industrialized

Our economic

---

Coordination
G-7

France, Germany, Italy, Japan, and the United
Kingdom
comprise one pillar in our efforts to maintain growth
and stability in the world economy.

nations

Canada,

In the 1970s through the mid-1980s, the world saw firsthand the
consequences of uncoordinated economic policies in the major

countries.

Divergent economic conditions, coupled with wide fluctuations
in currency values, including the sharp appreciation of the
dollar, resulted in large trade imbalances.

For example, the dollar rose around 100 percent against many
major European currencies in the early 1980's and the U. S.
trade position moved from near balance to a deficit of some
$160 billion, 3-1/2 percent of our GNP.
These developments led to unemployment
in many important
sectors of our economy and a rapid build-up in the external
indebtedness of the United States.

Since 1985, however, the G-7 countries have created a mechanism-the economic policy coordination process -- to establish the
consistent policies necessary for sustained growth with low
inflation, reduced trade imbalances, and greater stability of
exchange markets.
As part of this process, the G-7 have
intensified their cooperation on exchange markets. The G-7's
record of success has been impressive.
The major

expansion
growth.

countries have achieved the longest postwar
on record -- eight consecutive years of sustained

rates better reflecting underlying competitiveness
are now in place, contributing to greater stability of
exchange markets.
For example, the annual range in the
movement of the deutschemark
against the dollar was
25 pfennigs in 1990 (15.5 percent), down from 100 pfennigs in
1985 (35 percent) and 35 pfennigs in 1987 (19.5 percent).
As a result, trade imbalances have been reduced sharply in
the United States and Japan. Also, the long-awaited
reduction in Germany's surplus is now occurring, influenced
importantly by reunification.
Exchange

are now in a period where economic conditl. ons
This situation
in the major industrial countries are diverging.
is posing important new challenges to the coordination process.
In the months ahead, there will be a need to intensify efforts to
develop consistent mutually supportive policies that will sustain
global growth with low-inflation, continue the adjustment of trade
financial and
imbalances and maintain stable international
currency markets.

At the same time,

te nat

ona

Moneta

Fund

IMF

The IMF is another critical pillar of our efforts
sound world economy.
The Fund's chief mandate in

promote

recent years has

been to extend its limited resources in support of comprehensive
In
economic reforms in a large number of member countries.
effect, the IMF provides countries with policy advice and seed
money, which helps them put in place the appropriate policies to
put their economic house in order.

In so doing, the IMF is supporting
interests throughout the world.

U. S. foreign

economic policy

, the IMF is playing the lead role in
restructuring Eastern European economies away from central
Over the past year, IMF
planning towards private markets.
support has been critical to the reform efforts of Poland,
Czechoslovakia and Hungary, and to unlocking substantial
additional resources for them from other contributors.
Estimates suggest the IMF may commit up to $10 billion in

In Eastern

~~o

1991 in Eastern Europe.

kly dp d
procedures and policies in order to provide timely support to
countries adversely affected by Iraq's brutal aggression.
To
date, the IMF has disbursed $2. 2 billion in increased
financing to help countries address higher oil import costs.
p

e 'ca, in particular, the IMF is providing
essential support for economic policy reforms, and for debt
and debt service reduction under the U. S. -led international
debt strategy.

In africa, the IMF is extending concessional resources to
help the poorest countries of the world achieve sustained
growth and alleviate widespread poverty.

resource needs of the IMF are periodically reviewed to ensure
that the Fund has adequate resources at hand to fulfill its
Last year, the IMF
important systemic responsibilities.
membership concluded negotiations to increase Fund resources from
$130 billion to about $195 billion, a 50 percent increase -- the
first such increase since 1983. The U. S. share of the increase is
The

some $12

billion, for

authorization

and

which we

appropriation

will be seeking Congressional
as part of the FY 1992 budget.

cost-effective organization.
First, no
are
associated
with the use of the IMF
net budgetary outlays
quota. Each time the IMF uses dollars, we get in return a liquid,
interest bearing reserve claim which we can automatically draw.
Second, the IMF leverages our resources, which is especially
For every dollar
important at this time of budgetary restraint.
we put in, others put in four.
Third, the United States has
effective veto power over key IMF decisions, which uniquely
positions the United States to influence the policy direction of
the IMF in a manner consistent with our interests.
Finally, as
part of the recent quota negotiations, we secured agreement on a
strengthening of the IMF's arrears strategy, in order to ensure
that our increased contribution is used wisely.

The IMF

Madam

working
The

an extremely

Chair and Members of the Subcommittee, we look forward to
with you on the IMF quota increase in the months ahead.

Multilateral

U. S.

Develo ment Banks

MDBS

participation in the World Bank Group and the regional MDB
is based on the same premise as our participation in the
IMF
to promote a sound world economy and increased prosperity
for all countries. In an interdependent world this means
furthering an international economic framework that is open and
market-oriented to promote the efficiencies in production that
trade fosters. These gains from trade make for a world-wide
improvement
in living standards.
MDB lending-supports
this general objective by mobilizing private
sector and government resources to finance the basic
infrastructure and service projects that improve productivity and
living standards in developing countries.
Loans from the World
Bank and the regional MDBs have financed rural electricity, basic
health care, agricultural extension, education, water and
sewerage, environmental
and resource management,
telecommunications,
private sector investment, and public sector

—

groupings

projects.
Project viability, however, is determined not only by the rate of
return on a specific project, but also is dependent upon the
environment
in which a particular project exists. Therefore, the
MDBs also engage in adjustment
to support sectoral and
lending
macro economic reforms to improve the domestic policy and
institutional environment with the goal of moving a national
reform

economy

toward

self-sustaining

economic growth.

growing developing country economies
directly help the U. S. economy: they contribute to an expansion
of employment in the United States through increased exports.

Stronger,

stable,

contracts resulting from MDB projects are
in the MDBsa direct and tangible benefit of U. S. participation
First,
These contracts are composed of three related elements.
there is the procurement stemming directly from MDB provided
finance. U. S. businesses secured roughly $2. 0 billion in
contracts from the MDBs last year. This compares with U. S. budget
expenditures for the MDBs averaging about $1.6 billion annuallySecondly, since the MDBs only provide a portion of the finance
needed for a project, there are other procurement possibilities
generated by non-MDB finance for a project. Finally, the business
contacts established through U. S. business participation in
In sum, MDB
bidding on MDB projects lead to follow on business.
projects are an important nexus for the development of U. S.
exports and jobs in the export sector, the value of which far
exceeds our financial support for these institutions.
Financing the operations of these institutions is shared by all
member countries.
U. S. interests in developing
Consequently,
countries can be pursued through these institutions without the
United States bearing the full burden.
This is particularly
important during periods of severe budgetary constraint.
In addition, the business

For their market-related lending operations the MDBs leverage the
callable capital guarantees of member countries to borrow funds on
private capital markets. Hence, the majority of MDB loans are
financed with relatively small cash outlays from MDB members, and
are cost effective when compared with UPS. bilateral economic
assistance.
Periodically we need to increase the capital base of the marketrelated "hard-loan windows" and replenish the resources of the
concessional "soft-loan windows" of these institutions.
This year
we will be seeking Congressional
approval for U. S. participation
in a Special Capital Increase (SCI) of the Asian Development Bank
(ADB). Depending on the outcome of negotiations,
we may also be
seeking Congressional authorization to participate in the sixth
replenishment
of resources for the African Development Fund
(AFDF). There have also been serious discussions between the
management
and executive directors of the International
Finance
Corporation (IFC) regarding substantive justifications for an IFC
capital increase.
he nte nat onal Debt Strate
Our work to promote strong developing country economies through
financial institutions has been profoundly
the international
affected over the last decade by external debt problems. The
United States has assumed a leadership role in crafting an
international strategy for addressing these debt problems.
This
evolving strategy has produced results. We have protected the
international financial system from risks of insolvency while

focusing increasingly on supporting economic reform and sustained
Most recently, the Brady Plan has
growth in debtor countries.
proven effective in facilitating financing agreements that
recognize the need to reduce debt burdens.
Seven countries have reached agreements with their commercial
banks on packages that include debt/debt service reduction.
These
countries account for almost half of the total commercial bank
debt of the major debtor countries.
The benefits are substantial.
The Mexican agreement

interest payments by 33
bank debt was reduced by
billion in principal

reduced annual

percent ($1.5 billion); commercial
32 percent; and the burden of $42
payments was removed.

The Costa Rican agreement reduced that country's commercial
bank debt by 62% and cut annual debt service payments by 744.

Morocco, and Uruguay have also reached
involving significant reductions in debt burdens, and
several other countries are continuing discussions with their
banks.

Chile, Venezuela,
agreements

These Brady Plan agreements enable debtor countries and commercial
banks to address their disparate needs.
Furthermore, these
agreements are producing results for debtor economies by helping
restore investor confidence and stimulate new investment flows.

rise for the Americas Initiative
In a further effort to strengthen the

Ente

economies of our neighbors
in Latin America and the Caribbean and to improve trade
opportunities in the hemisphere, President Bush announced last
June the new Enterprise for the Americas Initiative.

This region

is of vital interest to the

of slow growth

Latin America
hemisphere as a whole.

States. Ten years
the economies of
opportunities for the

United

and debt overhang have plagued
and the Caribbean and thwarted

Enterprise

problems

through

are making real progress in implementing the vision laid out in
the Initiative.
To increase trade and move toward the goal of a
hemispheric free trade system, we are pursuing a Free Trade
The goal of this
Agreement with Mexico, with Canada as a party.
agreement is to foster sustained economic growth for all three
countries, which together compose a market of over 360 million
This FTA should expand and lock
people and $6 trillion in output.
in recent trade and investment liberalizations achieved by the
Salinas Administration.
We

are also negotiating framework agreements on trade and
investment to establish the basis for progress with other
countries in the region. These agreements establish fora for
addressing technical issues and beginning to remove barriers to
trade and investment.
Such framework agreements have been signed
since June with five countries -- Colombia, Ecuador, Chile,
Honduras, and Costa Rica -- adding to those already in place with
Mexico and Bolivia. Negotiations are underway with a number of
additional countries, including Jamaica, Venezuela, Peru,
Nicaragua, Panama, El Salvador, Guatemala, and a group of
countries composed of Argentina, Brazil, Uruguay, and Paraguay.

The dramatic progress we are seeking on trade will take time to
develop.
The potential for action on investment
is more
immediate.
Latin American and Caribbean countries are competing
for scarce capital with other dynamic economies. They need to
attract private investment both from abroad and at home, and to
reverse capital flight, which in many cases is believed to be as
large as their total external debt. The Inter-American
Development Bank is developing an investment sector lending
program to help countries to open and liberalize their investment
The IDB has begun evaluating the necessary changes to
regimes'
achieve meaningful reform in individual countries, and we hope
that the first investment sector loans will be moving forward over

the next several months.

reduction proposed under the Initiative will be an
important incentive for countries to carry out investment reforms'
The IDB has taken action to join the IMF and World Bank in
providing support for commercial bank debt reduction.
We expect
the
first
to
be
beneficiary.
On
bilateral
Uruguay
debt, we gained
authority from Congress during the last session to undertake
reduction of concessional PL-480 debt for countries pursuing
strong economic reform programs, including liberalization of their
We will be discussing
investment regimes.
such debt reduction
countries
as they become eligible.
with individual
We will be
seeking comparable legislation permitting the reduction of AID
debt this year.
The debt

Our

initiative will also provide significant benefits for the

Interest payments on the
environment within the Hemisphere.
reduced PL-480 and AID debts will be dedicated by debtor

to support a broad range of local environmental
projects or programs. We expect local non-governmental
organizations with expertise in the environment, and conservation
to play a strong role in determining the use of these

governments

funds.

environmental

fully the investment and debt elements of the
will be seeking additional authority from Congress
as a matter of priority.

To implement

Initiative,

act to authorize the reduction of
concessional AID debt and the sale of a portion of Eximbank
and CCC loans.
I want to ask for the support of this
Committee for action on Eximbank debt.
These sales would
facilitate debt-for-equity, debt-for-development,
and debtfor-nature swaps in eligible countries.
Congress must also

to highlight for this Committee our request that
authorize U. S. contributions of $500 million over
five years to the Enterprise for the Americas Investment Fund
that the President proposed be established in the IDB. We
are working with the IDB and other creditor governments to
identify productive uses for this Fund. We are also seeking
contributions from other countries to meet the goal of a $1.5
billion fund over five years. In sum, we envision that the
Fund would make available grants and loans for: technical
assistance to help build the expertise needed to undertake
privatization and other investment related reforms; worker
retraining and relocation necessary due to investment
reforms; and enterprise development to assist very small
firms in building equity and attracting investors.
I hope we can count on your support for this important Initiative.
want

Congress

Environmental

Considerations

has been an extremely important element in our
overall approach to economic issues in recent years. Economic
progress will be sustainable only in the context of sound
environmental
practices. Hence, environmental considerations must
be integrated more effectively into the on-going operations of the
international financial institutions.
framework for
This concern led us to negotiate an environmental
the IDA 9 Replenishment Agreement in 1990. It is the reason we
are now taking such a strong stance on these issues in negotiating
of the Asian Development Fund and the African
replenishments
of the European Bank for
Development Fund and the establishment
great weight we
Reconstruction and Development.
It underlies the
impact assessment,
have given to three key issues: environmental
protection of tropical forests, and promotion of energy efficiency
and conservation measures.
The environment

result of our efforts, we believe the World Bank and the
Inter-American Development Bank are ready to implement new
environmental
impact assessment procedures in line with
legislation introduced in this sub-committee in the last Congress.
The World Bank is reassessing its forest policy and taking a new
look at energy efficiency and conservation alternatives.
It has
created a special unit for energy efficiency and conservation for
its operations in Eastern Europe and is restructuring its Energy
Sector Management Assistance Program-

As a

These reforms represent a significant strengthening
of
environmental
capability in the MDBs. However, additional effort
is still needed to assure their effective implementation.
This
we
influence
year
will look for new opportunities to
energy policy
We
and promote more energy efficiency and conservation projects.
will seek more rapid progress on environmental impact assessment
in the Asian and African Development Banks and further
improvements
and refinements,
if they are needed, in the
procedures already being adopted by the World Bank and the InterAmerican Development Bank. We will continue our efforts to secure
greater protection for tropical forests, including reform of the
Tropical Forestry Action Plan.

also want to encourage innovative programs that can be a
catalyst for more rapid environmental progress within developing
countries. That is why we have encouraged debt-for-nature swaps
and put so much emphasis on the environmental
element of the
Enterprise for the Americas Initiative.
In addition, we have
offered to provide up to $150 million in parallel financing to the
World Bank's Global Environmental
Facility over its three life.
Our objective in the facility is to foster greater interest in
pilot projects that can become part of regular lending programs in

future years'

States is also at the forefront in encouraging the IMF
to enhance its environmental focus. Widespread recognition has
emerged that IMF macroeconomic policy advice and prescriptions
can
have at times an important, though indirect, impact on
In particular, the IMF is now
environmental
protection.
discussing the establishment of a group of economists that will
serve as a liaison with other organizations on environmental
The United

research

the Fund on addressing environmental
concerns.
country documents now discuss environmental
concerns. The IMF has also strengthened its collaboration with
the world Bank with respect to taking into account structural
protection into its work.
measures for environmental
and advise

Also, most

Treasur

IMF

artment

Role in the Gulf Crisis

Department is playing an important role in the
efforts of the United States and the international coalition of
its allies to enforce the U. N. Security Council's resolutions
The Treasury

10
aimed at obtaining
from Kuwait.

Iraq's unconditional

and complete

withdrawal

of the Gulf
key aspect of our contribution is our chairmanship
Crisis Financial Coordination Group. This Group was established
in September by President Bush to complement the diplomatic and
military efforts of the international coalition against Iraq.
The purpose of the Group is to mobilize and channel extraordinary
assistance to the front line states, namely Egypt, Turkey, and
Jordan. By offsetting the effects of the crisis on their
economies, this assistance enables the front line states to
continue their effective enforcement of the U. N. -mandated economic
sanctions against Iraq.

The Group has met four

February
March.

Another

times, most recently in Washington

meeting

is tentatively

brings together under
leadership 26 countries, the European
Cooperation Council. Representatives
Monetary Fund and World Bank provide
support.
now

planned for early
Department
Commission, and the Gulf

Treasury

of the International
technical and analytical

Through this successful initiative,
the United States has obtained
from other creditors commitments of $14. 7 billion for the front
line states and other countries whose economies are seriously
affected by the crisis. Of this amount, $6. 7 billion has already

been disbursed,

with substantial

in the coming weeks.

additional

disbursements

expected

Within the framework of the Gulf Crisis Financial Coordination
Group, the 'treasury Department is keeping economic developments in
the front line states under continuous review to ensure that the
economic effects of the crisis are offset to the maximum extent
possible. This should help maintain effective enforcement of the
economic sanctions against Iraq and facilitate the task of
economic recovery and reconstruction in the post war period.
Ne

otiations to 0

en Markets

Overseas

Treasury is engaged in a number of comprehensive negotiations to
open markets overseas for U. S. exports, investment and financial
services. Let me briefly discuss our negotiations with Japan,
Korea and Taiwan.

respect to Japan, we are addressing market access problems ln
the Working Group on Financial Markets (the so-called "Yen/Dollar"
talks) and the Structural Impediments Initiative (or "SII").
There has significant progress in liberalizing Japan's financial
markets since our talks in this area began in 1984- However, the
pace of change has been relatively slow ----particularly compared
and U. S. firms
to liberalization in London and New York
With

11
continue to face numerous access problems.
We will continue
to
press the Japanese to accelerate their efforts towards true
liberalization in order to create a level playing field for U. S.
firms in Japan.

are also in the

critical first

year of the follow-up process of
the underlying causes of our
persistent external imbalances, with the objective of reducing
these imbalances further and opening markets. This initiative,
which was patterned after the "Yen/Dollar" formula, resulted in a
Joint Report last summer, containing commitments by both
countries. Japan's commitments include increasing spending on
public infrastructure,
making the keiretsu system more open and
transparent, and increasing the availability of land. If fully
implemented,
the SII commitments will result in a more open, fair
and transparent
Japanese economic system. Although there has been
progress on implementing these commitments, much more needs to be
done.

the

SII,

which

aimed

at addressing

respect to Korea and Taiwan, we have made substantial
progress on financial policy issues. Negotiations on exchange
rates had the desired effect of prompting appreciation in both the
Korean won and the Taiwanese dollar to reflect more fully the
strength of the two economies. This contributed to substantial
declines in the large external surpluses of both countries, and
particularly in their bilateral surpluses with the United States'
More recently, we have been engaged in discussions with both Korea
and Taiwan on a broader range of financial issues.
Our objectives
are twofold: to encourage liberalization of the Korean and
Taiwanese banking, securities, and exchange markets; and to obtain
full equality of competitive opportunity for U. S. financial
institutions in those markets. We have had some success in these
talks -- for example in easing the criteria on bank branching and
beginning to open the Korean and Taiwanese capital markets -- but
much work remains to be done.
With

There are clearly limits to what we can achieve bilaterally
without additional leverage or a stronger set of international
rules than currently exist. Our efforts within the Uruguay Round
to negotiate a financial services agreement could complement our
bilateral efforts, but only if certain basic conditions are met.
we must be careful not to lock ourselves
Essentially
into a
commitment to maintain our open markets without adequate
commitments
from other countries to open their markets.
These
should provide real liberalization,
arrangements
deal effectively
with the problem of free riders, and assure that financial experts
oversee the operations of the financial services agreement,

including dispute settlement.
If these fundamental conditions
not met, a financial services agreement would not be in U. S.

interests.

are

12
Exchan e

Stabilization

Fund

Department has a mechanism which enables the
Secretary to undertake foreign exchange operations in order to
financial policy of
support certain aspects of the international
the United States outlined above. That entity is the Exchange
Stabilization Fund (ESF). It is the only instrument within the
U. S. Government which is constituted and empowered to respond
rapidly and flexibly to international financial disruptions.

The Treasury

uses of the ESF have been to finance intervention in
the foreign exchange market and to extend, under exacting
standards, short-term "bridge loans" to assist countries in
dealing with problems of indebtedness.
In recent years there have
been bridge loans to a number of Eastern European countries,
including Poland. The Polish arrangement served to support a
reform program that incorporated a novel stabilization fund and
has led to current efforts to reduce Poland's debt, as provided by
Congress.
The primary

Secretaries of the Treasury are sensitive to the need to employ
judiciously the broad authority provided by statute for use of the
resources of the ESF- They are equally sensitive to the need to
keep Congress informed of their exercise of this authority and of
the financial condition of the ESF, which is extremely sound. I
would note in this regard that I provide regular reports to
appropriate Congressional bodies, including this Subcommittee.
Conclusion

Chair, it should be clear that Treasury is indeed
in a number of areas that bear significantly on the
ability of the United States to promote a sound, environmentally
safe, world economy and stable international monetary system.
Treasury relies heavily on the international
financial
institutions (IFIs) to carry out these objectives, as well as U. S.
humanitarian
interests. The successful operation of IFI
activities makes one additional contribution:
the promotion of
peace and democracy among nations.
By now Madam

engaged

These are important

Chair.

It is criticalmatters,
that

as I am sure you will agree
the Executive and Legislative

Madam

Branches

of our government coordinate their activities closely on these
issues. That is why I put considerable effort into strengthening
the consultation process between this Committee and Treasury.
I
believe it is essential that this relationship continue.

DEBT NEW

UBLI
Department

of the Treasun,

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

RESULTS OF TREASURY'S AUCTION

Tenders

to be issued

were accepted
The

today

interest rate

on the notes
and corresponding

202-376-~350

OF 2-YEAR NOTES

will be 6 3/4%. The range
prices are as follows:

Price
99. 816
99. 779
99. 779

Yield
High

Average

at the

Boston
York

Philadelphia
Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

5allas

Francisco

Treasury

TOTALS

6. 85%
6. 87%
6. 87%

high yield were

TENDERS RECEIVED

San

Office of Financing

(CUSIP: 912827ZY1).

Low

New

DC 20239

for $12, 062 million of 2-year notes, Series X-1993,
on February 28, 1991 and mature on February 28, 1993

of accepted bids

Tenders

M'ashinyon,

CONTACT:

20, 1991

February

AND

allotted 71%.

ACCEPTED

Received
31, 580
37, 242, 585
28, 650
33, 660
52, 380
43, 860
1, 519, 450

61, 465
21, 400

72, 705

18, 230
639, 395

302 885
$40, 068, 245

(in thousands)

31, 580
11, 033, 765

28, 650
33, 660
47, 320
36, 410
235, 020
56, 175
21, 380

71, 405
18, 230

145, 845
302 885
$12, 062, 325

$12, 062 million of accepted tenders includes $917
noncompetitive tenders and $11, 145 million of
of
million
competitive tenders from the public.
In addition, $725 million of tenders was awarded at
average price to Federal Reserve Banks as agents foz' fozeign
An additional
$9pp million
international monetary authorities.
at
the
average
Fedez. al
accepted
price
from
also
was
tenders
of
account
in
own
exchange
their
for
for
maturing
Reserve Banks
The

securities.
NB-1143

epartment of the Treasury

FOR IMMEDIATE

February

%ashlnytoq, iO. C.

RELEASE

CONTACT:

20, 1991

UNITED

Telephone $66-2041

Bob Levine

(202)566-2041

STATES RATIFIES CONVENTION ON MUTUAL ADMINISTRATIVE
ASSISTANCE IN TAX MATTERS

The Treasury Department today announced that the United
States has ratified the Convention on Mutual Administrative
Assistance in Tax Matters (the Convention).
On February
13,
1991, the U. S. Mission to the Organization for Economic

Cooperation and Development
instrument of ratification,

30, 1991.

(OECD), presented the OECD with the
signed by President Bush on January

developed by the OECD and the Council of
for
the exchange of tax information between any
Europe, provides
Exchange of Information under the
two parties to the Convention.
Convention will be similar to information exchange taking place
currently under a network of bilateral tax treaties; similarly,
the Convention provides for the protection of the confidentiality
The United States will issue an
of tax information exchanged.
administrative procedure generally providing for notification to
tax information
a U. S. resident or national before transmitting
The Convention,

requested

another

country

under

the Convention.

The United States has entered a reservation on any form of
assistance relating to taxes of possessions, political
subdivisions, or local authorities; therefore, the United States
will not exchange tax information regarding state and local
taxes. Also, although the Convention provides for assistance in
collection of taxes and in the service of documents, the United
States has entered reservations on these forms of assistance and,
therefore, will not provide these types of assistance under the

Convention.

will apply only to OECD or Council of Europe
member countries that agree to be bound by it. The Convention
will be effective for the United States after ratification by
four other member countries of the OECD or the Council of Europe.
The Convention

NB-1144

pa~~nt

40 the TteaiurY ~ Washington,
J

O. C. ~ Telephone

586-214

PREPARED

DIRECTOR,

STATEMEBT OF

RICHARD

NEWCOMB

OFFICE OF FOREIGN ASSETS CONTROL

DEPARTMENT

OF THE TREASURY

before the
SUBCOMMITTEE

COMMITTEE ON ENERGY AND COMMERCE
ON COMMERCE,
CONSUMER PROTECTION AND
U.
HOUSE OF REPRESENTATIVES

February
o
Madam

Chairwoman

21, 1991

c Sanctions

and members

COMPETITIVENESS

of the subcommittee:

is R. Richard Newcomb and I am the Director of the
My name
Office of Foreign Assets Control at the United States Department of
the Treasury. I am here today to appear before the subcommittee to
adminisdiscuss the Treasury Department's role in formulating,
tering, and enforcing the sanctions against Iraq and Kuwait.
("FAC") has primary
The Office of Foreign Assets Control
responsibility within the Executive branch for implementing the
financial and trade sanctions against Iraq and measures to protect
the assets of the legitimate Government of Kuwait. In addition to
these programs, FAC also administers economic sanctions programs
against Libya, Iran, South Africa, Cuba, Vietnam, Cambodia, and
North Korea and administers
certain residual World War II asset
The Office was also
controls affecting the Baltic Republics.
economic
the recently-concluded
responsible
for administering
sanctions programs against the Sandinista regime in Nicaragua and
the Noriega regime in Panama.

I will discuss the objectives, scope, and
of the blocking controls affecting Kuwaiti and Iraqi
government-owned
assets in the U. S. and how we have addressed
various problems and issues that have arisen. As you requested, I
will also address and discuss (a) whether the authority of the
President is adequate to seize U. S. property of the Government of
Iraq and to protect fully the U. S. national interest and (b) what
the government is doing to identify Iraq's efforts to acquire
its war
and other resources to support
equipment,
technology,
This

morning

implementation

effort.

NB-1'L45

the Iraqi invasion of Kuwait on August 2, the
president,
acting under authority of the International Emergency
Economic Powers Act ("IEEPA"), declared a national emergency and
issued Executive Orders No. 12722 and No. 12723 ("the August 2
Executive Orders" ), froze all Iraqi and Kuwaiti government-owned
assets within the jurisdiction of the United States or under the
control of U. S. persons and imposed an immediate and comprehensive
trade embargo against Iraq.
Following

August 6, the United Nations Security Council, to bring the
invasion and occupation of Kuwait to an end and to restore the
and territorial
independence,
integrity of Kuwait,
sovereignty,
decided that all U. N. member states shall impose sweeping economic
On August
sanctions against Iraq and occupied Kuwait.
9, the
President issued Executive Orders No. 12724 and No. 12725, this
time acting under authority
of IEEPA and the United Nations
Participation Act, which broadened the U. S. sanctions with respect
to both Iraq and Kuwait to include a complete prohibition on trade
and trade-related
activities with any person located within the
On

territories of Iraq or
of Iraqi and Kuwaiti
earlier.
The August

Kuwait, in addition to continuing
government-owned
assets imposed

9 Executive

the freeze

seven

days

order with respect to Iraq:

prohibits exports and imports of goods, technology, and
services between the United States and Iraq, and any activity that
promotes
or is intended
to promote such exportation
and
importation;

prohibits any dealing by a U. S. person in connection with
property of Iraqi origin exported from Iraq after August 6, 1990;
-- prohibits transactions related to travel;
-- prohibits transactions related to transportation to or from
Iraq, or the use of vessels or aircraft registered in Iraq by U. S.
persons;

prohibits the performance by any U. S. person of any
contract in support of projects in Iraq;
prohibits the commitment or transfer of funds or other
financial or economic resources by any U. S. person to the
Government of Iraq, or any other person in Iraq; and
blocks all property of the Government of Iraq located in
the United States or in the possession or control of U. S. persons,
including their foreign branches on or after August 2, 1990.
The August 9 Executive Orders were issued to put additional
pressure on Iraq and to ensure that the U. S. sanctions program
conforms to U. N. Security Council Resolution 661 '

objectives of the Executive Orders are to deprive Iraq of
any economic or financial
benefits that, might result from its
illegal invasion and occupation of Kuwait and to preserve and
protect the assets of the Government of Kuwait for the benefit of
their rightful owner. Iraqi assets blocked in the U. S. and in all
U. N. member
states may be used as a source of funds to pay
claimants and creditors of Iraq when hostilities have ceased.
The

The August 2 Executive Orders immediately froze, by operation
of law, all property and interests in property, of the Governments
of Iraq and Kuwait that were in, or thereafter come within, the
jurisdiction of the United States or under control of U. S. persons.
transfers of property or interests in property
Any unauthorized
subject to the blocking orders occurring after the effective date
are deemed to be null and void. This means that a U. S. financial
institution, for example, which transfers blocked funds after the
effective date without authorization from FAC can be penalized for
violating the sanctions.
The blocking

places

the

of Iraqi
legal

primary

assets by Executive Order
responsibility
of identifying
and

and Kuwaiti

immobilizing
blocked assets upon the persons most knowledgeable
concerning the ownership of the property,
e. , upon the holders
themselves.
This approach obviates the need for the Treasury

basis, to locate and identify precisely
specifically
each asset subject to the blocking and
allows initial
efforts to concentrate on areas where
transfers or evasions are most likely to occur. Blocking by
Executive Order rather than by individual order permits prompt,
orderly, and systematic identification and resolution of the most
and
that
pressing
interpretative
questions
ruling
requests
inevitably arise immediately after the blocking orders are issued.
The need to quickly address these complicated and fact-intensive
problems proved especially critical with respect to the Kuwaiti
assets since the freeze was intended primarily as a protective
of the Kuwait governmental
measure, and complete immobilization
assets in the U. S. for a prolonged period would have diminished
their value and disrupted a number of markets.
Department,
and

on an emergency

beforehand
enforcement

On the morning
of August 2, immediately after the President
signed the blocking orders, FAC began contacting major U. ST money
center banks and requested that the Federal Reserve Bank of New
York ("the FRBNY") notify Federal Reserve member banks of the

blocking. We also began a series of what have since become regular
consultations with the FRBNY, and various U. S. Government agencies,
including the Departments of State, Commerce, and Defense, the
Customs Service, the FBI, the NSC, and members of the intelligence
and law enforcement communities.
Since the morning of August 2, we
have also met with hundreds
of U. S. and foreign businesses,
official agencies, and individuals affected by the sanctions, in
addition to responding to several thousand telephone inquiries and
pieces of correspondence.
Additionally, we have an ongoing program

in place with foreign embassies which enables us to act in concert
with all governments worldwide to ensure the uniform application of

all

resolutions.

U. N.

issued a press release announcing the first of
a series of general licenses designed to address many of the most
Most of
immediate and pressing problems relating to the freeze.
the
preserve
and
safeguard
to
the
need
these licenses addressed
without
causing
value of the frozen assets and investments
innocent
third
of
interests
the
harm
to
irreparable
and
unnecessary
individuals
and
businesses
U.
S.
parties, including those of many
These licenses have
and of the legitimate Government of Kuwait.
addressed problems such as: what to do about Iraqi and Kuwaiti oil
already en route to the U. S. on the effective date; how to complete
or unwind variously affected financial or securities transactions
into prior to the effective date; what types of
entered
transactions or investments by blocked companies or investment
portfolios owned or controlled by the Government of Kuwait to allow
to continue unimpeded; and what to do about payments due under
letters of credit involving U. S. banks for goods or services
These
exported to Iraq or Kuwait prior to the effective date.
issued
general licenses, as well as the specific licenses we have
on a case-by-case basis, have been carefully crafted to ensure that
the
with
are consistent
transactions
thereunder
permitted
realizable
not
confer
objectives of the sanctions and do
any
benefit on the Government of Iraq. These licenses have been fully
incorporated into a comprehensive body of implementing regulations
published on November 30, 1990, for Kuwait and on January 18, 1991,
On

August

for Iraq.

in the program

began meeting regularly with
the
process of identifying and
begin
clarifying the status of Kuwaiti-owned entities around the world,
licensing
limited operation of Kuwait entities within U. S.
jurisdiction under the effective contro1 of legitimate governmental
authorities,
and generally
coordinating
the efforts of our
respective governments concerning the sanctions. We have received
excellent cooperation from the Kuwaiti authorities.
This has
proved to be an understandably
painstaking and tedious process as
the legal, financial, and commercial information required to make
these determinations must be precise and accurate.
Moreover, it
must be obtained from various locations worldwide and some of the
records have been destroyed or are under the control of Iraqi

Very early
Kuwaiti Embassy

officials to

authorities.

In the first few weeks our efforts regarding Kuwait focused
heavily on identifying and clarifying the status of Kuwaiti-owned
banks and financial institutions
this informaand communicating
tion through the Federal Reserve System. By October 4, we were
able to issue a general notice clarifying the status of 94 major
banking and non-banking entities or corporate groups operating in

the U. S. about which blocking inquiries

to update
available.

this

list periodically

had been
new

received.

information

4e plan

becomes

Working closely with the Kuwaiti Ambassador to the U. S. , His
Excellency Saud Nasir Al-Sabah, and his staff, we have developed a
close working relationship
with
officials of the
numerous
legitimate Government of Kuwait. The Central Bank of Kuwait has
posted a special representative to Washington to serve as a liaison
for ongoing sanctions issues. Following coordination with the Bank
of England and the French Treasury, we recently issued a license
allowing the Central Bank to make use of its U. S. assets and
authorizing U. S. persons to conduct normal business with the bank
through its temporary London headquarters.
The Central Bank has
agreed not only to serve as lender-of-last-resort
for Kuwait's
commercial
banks but also to guarantee
the payment of their
outstanding obligations to creditors and account holders worldwide,
with exceptions I will note.
We

are currently

processing applications

from the seven major

to settle their pre-embargo obligations
and to manage the investment of their assets subject to U. S. jurisdiction. This should result in the settlement of many millions of
dollars in claims of creditors of Kuwait in the U. S. and worldwide.
We are hoping
to issue licenses late this month allowing a threeweek window for claims to be presented to the seven blocked Kuwaiti
banks and for the banks to complete preparations
to commence
settlement of their obligations.
The only exceptions will be
interbank obligations denominated
in Kuwaiti dinars and other
Once
deposits originally held on deposit in Iraq or Kuwait.
licenses have been issued, we will be sending letters to those
claimants of whom we are aware, detailing the names and addresses
of contacts at each of the banks handling settlement procedures.
Settlement dates are being closely coordinated with the Government
of Kuwait, our other Gulf coalition partners, and other allies.
assets frozen by the
The Kuwaiti and Iraqi government-owned
The frozen Kuwaiti
August 2 Executive Orders are substantial.
investments total in the billions of dollars and consist primarily
of bank deposits, debt and equity securities (involving both direct
investment and portfolio holdings), and real estate. Most of these
assets are owned or controlled by licensed Kuwaiti governmental
entities such as the Kuwait Investment Office and the Kuwait
Investment Authority.
The blocked Iraqi assets may total as much
as a billion dollars or more. They are primarily bank deposits and
a formal
blocked oil payments.
On February 11, 1991, we initiated
assets
as
well
as U. S.
or
inventory
blocked
census
of these
'P"
I YP"
regulations requiring the filing of reports by March 1 by all U. S.
holders of Iraqi property and U. S. claimants against Iraq as to the
full extent of such assets and claims.
Kuwaiti banks

to allow

them

must be filed by every UPS. national who had a
of
on January 16, 1991, against the Government
losses
Claims may relate to
government entity.

Claims reports

claim outstanding
Iraq or an Iraqi

to expropriation, nationalization, or other measures affecting
property rights; losses for breach of contract or debt defaults;
compensation for injuries to persons or loss of life; and any other
losses or injuries suffered in Iraq, Kuwait or elsewhere,
attributable to the Government of Iraq or an Iraqi government
entity, whether or not arising from actions relating to Iraq's
Claims may also relate to losses suffered by
invasion of Kuwait.
joint venture, corporation or other entity
a foreign partnership,
in which U. S. nationals have a significant interest.

due

The census of blocked property requires all person who since
August 2, 1990, have held property subject to Executive Orders No.
12722 and No. 12724 to report (1) the name and address of the Iraqi
Government entity which has an interest in the property, and of any
other entities or persons, whether Iraqi or non-Iraqi having an
interest in the property;
(2) the value of the property on
the
date
of acquisition; (3) a description of
or
on
August 2, 1990,
the property; (4) for property acquired after August 2, the circumstances of acquisition; (5) the number, total amounts, and nature
of all increases and credits or decreases in value of the property;
(6) location of the property; and (7) any claims asserted against

the property.

of U. N. sanctions
the lead in the implementation
against Iraq and occupied Kuwait, the United States has utilized a
wide array of diplomatic, administrative,
and enforcement tools to
deter would-be violators of the global trade and financial
embargoes.
The U. S. sanctions initiatives have been augmented by
Treasury and State Department meetings with the United Nations, the
Organization of Economic Cooperation and Development, the European
Community
and member states' central banks through the Bank for
International
governments.
individual
Settlements,
and
with
Bilateral approaches to host governments
by U. S. embassies
worldwide
are another facet of this coordinated approach to
international sanctions implementation.
The State Department has
utilized this approach in hundreds of demarches to foreign
In taking

governments.

The focus on deterring
sanctions leakages has been most
striking in the financial arena, where Iraq has been denied access
to its own funds abroad, and more importantly, to the considerable
financial assets of Kuwait. All major banking centers in the world
have followed the U. S. lead in freezing Iraqi and Kuwaiti assets in
their financial institutions and in permitting the payment of
letters of credit in favor of Iraq only into blocked accounts.
Iraq's central bank, Markaz, and its two primary international
banks, Rafidain and Rasheed, have been effectively cut off from the
international financial community, so that Iraqi financial flows
have been reduced to a mere trickle of their pre-August
levels.
to
monitor all
Central banks around the world have worked together

attempted

further.

Iraqi

banking

transactions

to reduce

this flow

even

are working closely with the Federal Reserve Bank of New York
the domestic bank supervisory and regulatory agencies and in
close cooperations with the domestic and foreign financial
institutions where Iraqi deposits are known to be located to ensure
that Iraqi deposits remain blocked and that Iraq is deprived of use
of the international banking system and financial resources.
We
are in routine bilateral and multilateral contact with our counterparts in foreign governments to ensure that the goals of the
sanctions program are fully implemented and enforced and that
issues are fully coordinated.

and

to the concern you expressed about the adequacy of
the President's authority to seize assets of the Government of Iraq
in the United States, the statutes pursuant to which FAC implements
and enforces sanctions
against Iraq include the International
Emergency Economic Powers Act ("IEEPA") and the United Nations
Participation
Act ("UNPA").
As noted
above, the President
exercises the authority to block Iraqi governmental
property
pursuant to IEEPA, which grants the President the authority to
. . . prohibit. . . transactions
in
exchange
foreign
. . . transfers of credit or payments . . . involv[ing] any
interest of a foreign country or a national thereof, [or]
the importing or exporting of currency or securities; and
. . . nullify, void, prevent or prohibit, any acquisition,
withdrawal,
holding,
withholding,
transfer,
use,
transportation, importation or exportation of, or dealing
in, or exercising any right, power, or privilege with
respect to, or transactions involving, any property in
which any foreign country or a national thereof has any
interest; by any person, or with respect to any property,
subject to the jurisdiction of the United States. (50
U. S. C. 1702 (a) (1) (A) —(B) . )
This authority provides the President with the ability to
in property
within
the
restrict or prohibit transactions
jurisdiction of the United States with respect to which a foreign
government or its nationals have an interest.
Blocking property
does not involve any modification of the ownership status of the
With regard

blocked property.

Blocking authority is exercised by the President pursuant to
which
by the issuance of one or more Executive Orders,
declare the existence of a national emergency with respect to a
particular country and impose sanctions to deal with the emergency.
IEEPA

August 2, the
President imposed an immediate trade embargo against. the Government
assets
of Iraq and blocked all Iraqi and Kuwaiti government-owned
within the jurisdiction of the United States or under the control
of U. S. persons.
The objectives of the blocking orders were to
deprive Iraq of any financial or economic benefits as a result of
its illegal invasion and occupation of Kuwait and to preserve and
protect the assets of the Government of Kuwait for the benefit of
their rightful owner.

Following

the

Iraqi

invasion

of Kuwait

The term "blocked property" has been defined in the Iraqi
Sanctions Regulations (31 C. F. R. 575--"ISR") to mean "any account
or property in which the Government of Iraq has an interest, and
with respect to which payments,
transfers, exportations, withdrawals, or other dealings may not be made or effected except
pursuant to an authorization or license from FAC authorizing such
action. " (31 C. F. R. 575. 301. )
The property
subject to these
blocking restrictions, the types of interests in property which
trigger blocking, and prohibited transfers have also been broadly
defined
in the ISR to implement
the President's
statutory
authority
(31 C. F. R. 575. 315, 575. 308, 575. 317. ) The Kuwaiti
Assets Control Regulations (31 C. F. R. Part 570) impose the same
restriction, for protective rather than punitive purposes, on
dealings in property in which the Government of Kuwait has an

interest.

Property is blocked by action. of the President's Executive
orders based on the existence of an interest of the Iraqi or
Kuwaiti Government,
not based on specific action by FAC. Where
necessary, FAC enforces the President's blocking order by serving
blocking notices and securing blocked propertyActivities taken
to secure blocked property at the time a blocking notice is served
may include padlocking
offices, conducting inventories of blocked
and moving
property,
blocked property
These
into storage.
activities are encompassed by the broad statutory authority
accorded the President under IEEPA.
Because the sanctions against Iraq and occupied Kuwait are
authorized pursuant to the UNPA as well as IEEPA, the President,
also has the authority granted by UNPA to seek forfeiture of any
property involved in a criminal violation of the sanctions (22
U. S. C. 287c(b)). Title to forfeited property passes to the United

States.

or freezing, foreign-owned assets in the U. S. is
different from vesting such assets. Vesting involves
the actual seizure or confiscation of title to the property.
Blocking simply involves immobilizing
the property.
Questions
involving who has, or should have, title to the property then
become a separate issue. Such questions are complicated and factintensive and frequently must be addressed on a case-by-case basis
Blocking,

fundamentally

or ultimately

decided in claims settlement

proceedings.

to declare war against Iraq, the President
receive additional authorities pursuant to the Trading with
the Enemy Act ("TWEA"). TWEA provides the President with the
authority to vest in the any agency or person "any property or
interest of any foreign country or national thereof" and to order
the property to be "held, used, administered,
liquidated, sold, or
otherwise dealt with in the interest of and for the benefit of the
United States. . . . " (50 U. S. C. App. 5(b). )
Vesting involves a
transfer in ownership of property by Presidential action. Thus,
TWEA provides
authority in a declared war for the vesting of
foreign-owned assets in the United States should the President find
this in the national interest.

would

Congress

were

The Administration
is not now requesting
Congress
to modify the present ownership

governmental property
U. S. Government.

authority

status

vesting Iraqi governmental

from the

property

Iraqi

in the

assets, which
represent an
irrevocable, final action terminating Iraqi title to the assets.
Vesting
Iraqi assets would eliminate
a potentially
useful
bargaining tool in eventual normalization negotiations with Iraq.
Unlike the August 2, 1990 blocking of Iraqi
merely preserved
the status quo, vesting would

In addition, absent a consensus on vesting among the cooperating
nations implementing U. N. Security Council Resolution 661, the mere
specter of a U. S. vesting would weaken unity and threaten to
unleash international
competition to control Iraqi assets for
claims settlement purposes. This would be particularly troublesome
where two nations have blocked the same assets.

regard to the concerns you expressed about the Iraqi
efforts to break the embargo and support the war effort, we have
undertaken
a major initiative
to identify front companies and
agents used to acquire technology, equipment, and other resources.
This is called the Specially Designated Nationals or "SDN" program.
As in the case of current sanctions against Cambodia, Cuba, Libya,
to "specially
North Korea, and Vietnam,
FAC has the authority
designate"--i. e. , to identify publicly and to block--any person,
whether an individual or a business who is directly or indirectly
of Iraq, or who acts or
owned or controlled
by the Government
purports to act for or on its behalf. The Iraqi SDN program will
be modelled after the SDN program used with great effect against
former Panamanian dictator Manuel Noriega and his supporters.
The term "specially designated national" is not used in the
Iraqi Sanctions Regulations (31 C. F. R. Part 575, 56 Fed. ~Re . 2112
relies rather on the
Such designation
(January 18, 1991)).
With

definition of the
the Regulations:

Government

The term

of Iraq provided

"Government

Section 575 ' 306 of

of Iraq" includes:

(a) The state and the Government of Iraq, as well as
subdivision,
agency, or instrumentality
any political
thereof, including the Central Bank of Iraq;

association, corporation,
partnership,
other organization substantially owned or controlled
the foregoing;
(b)

Any

or
by

(c) Any person to the extent that such person is, or
has been, or to the extent that there is reasonable cause
to believe that such is, or has been since the effective
to act
date [August 2, 1990], acting or purporting
directly or indirectly on behalf of any of the foregoing;
and

(d) Any other person or organization determined by
the Director of the Office of Foreign Assets Control to
be included in this section.

In practice, a Specially Designated National of the Government

of Iraq ("Iraqi

Iraqi government body, representative,
or front (whether open or covert) that is
agent, intermediary,
located outside Iraq and functions as an extension of the
Government
of Iraq.
It may be a firm created by the Iraqi
or it may be a third-country company that otherwise
government,
becomes owned or controlled
or that
by the Iraqi government,
operates for or on behalf of the Government of Iraq.
Since the Iraqi government tends to operate its international
fronts as interlocking networks of companies and key individuals,
it is important to recognize that under this program any identified
Iraqi SDN is by definition the "Government of Iraq. " Furthermore,
another person cannot be owned or controlled by an Iraqi SDN or act
for or on the SDN's behalf without also'becoming an Iraqi SDN. For
example, if "ABC of England" is an Iraqi SDN and "XYZ of Panama" is
owned or controlled by or operates for or on behalf of "ABC, " then
"XYZ" would
also be defined as an Iraqi SDN.
It is the
relationship between entities rather than the country of residence
or incorporation that determines SDN status.
Thus the same SDN
criteria would apply regardless of "XYZ's" location.
The effect of being
listed as an Iraqi SDN is four-fold:
as an Iraqi government
(1) the SDN is exposed internationally
front; (2) U. S. persons will be prohibited from any trade or
transactions with the SDN; (3) the SDN's property, including
financial assets, within U. S. jurisdiction (which includes U. S.
banks' corporate branches overseas) will be blocked; and (4) other
governments
will be urged to take similar steps or other
actions
against the SDNs subject to their jurisdiction.
appropriate
SDN")

U. S. company

could be designated as an Iraqi
and, as such, would have its assets blocked by FAC and, in
effect, would be put out of business. Note that, because of the
definition of "Government of Iraq" in the ISR, a U. S. firm that
has not been designated an SDN, but in which the Government of Iraq
holds a controlling interest, is already subject to blocking.
For
example, in September 1990 FAC served a blocking notice covering
all bank accounts and tangible property of the Natrix-Churchill
Corporation
of Solon, Ohio.
Public sources of information
demonstrated
that the company is owned by Iraqi-controlled
companies in England.
A

or individual

SDN

For U. S. persons, dealing with an Iraqi SDN is equivalent to
doing business with the Government of Iraq--an activity that is
prohibited by Executive Orders No. 12722 and No. 12724, and the
Iraqi Sanctions Regulations. Such violations are subject to severe
penalties.
Pursuant to the Iraq Sanctions Act (Pub. L. 101-513,
Sec. 586E), civil penalties of up to $250, 000 may be imposed
administratively.
Criminal fines of up to $1, 000, 000 per violation
on both individuals
and
and corporate entities,
may be imposed
prison sentences of up to 12 years are authorized for individuals,
including officers, directors, and agents of a corporation, who are
knowingly involved in a corporate criminal violation.

of
FAC is conducting
and coordinating
ongoing investigations
substantive violations of the embargo, such as illegal exportation
of U. S. -origin goods via third countries and illegal provision of
FAC's Enforcement Division
brokerage services by U. S. persons.
maintains daily operational liaison with the U. S. Custom Service
of mutual
and the Federal Bureau of Investigation on investigations
activities
with
interest. Similarly, FAC routinely coordinates it
the Departments of State, Defense, Commerce, and Justice, and the

intelligence community.
been?
How effective have economic sanctions
In his State of the Union message, President Bush said
".. . . these
the
Iraq is feeling
sanctions
are working.
heat. . . Iraq's leaders. . . are cut off from world trade, unable " to
sell their oil and only a tiny fraction of goods get through.
Thank

you.

I will

be pleased

to respond to

any

questions.

DEBT NEW

UBLI
D&

partment

of the Treasun

FOR IMMEDIATE

February

Bureau of the Public Debt

RELEASE

were accepted
The

Office of Financin.

for $9, 040 million of 5-year notes, Series L-1996,
today

28, 1991 and mature
(CUSIP: 912827ZZ8).

interest rate

on the notes
and corresponding

Yield
Low

7. 504
7. 51%
7. 51%

TENDERS RECEIVED AND ACCEPTED

York

Philadelphia
Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

on February

will be 7 1/24. The
prices are as follows:
Price
100. 000

99. 959
99. 959
$5, 000 was accepted at lower yields.
Tenders at the high yield were allotted
High

Average

Location
Boston

Received
9 , 605

27, 614 212

9 , 930
19 , 462
26 , 123
12 , 187
1, 089 , 868
17 , 827
7 , 037
18 , 605
5 , 515
326 , 939
28 615
$29, 185, 925

29, 19"6

ranctc.

54%.

(in thousands)
Acce ted
9, 603
8, 770, 852

9, 930
19, 462

25, 203

10, 727
103, 248
13, 827
7, 037
18, 605
5, 515
16, 939
28 615

$9, 039, 563

$9, 040 million of accepted tenders includes
million of noncompetitive tenders and $8, 696 million
competitive tenders from the public.
The

$344

In addition, $362 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign 'in,

international monetary authorities.
An additional
$200 milli".
of tenders was also accepted at the average price from Federal
Reserve Banks for their own account in exchange for maturin:

securities.

NB-114 6

OF 5-YEAR NOTES

on February

of accepted bids

New

DC 20239

202-376---'350

RESULTS OF TREASURY'S AUCTION

to be issued

El'ashinyon,

CONTACT:

21, 1991

Tenders

lo~eht

of the treasure

weehlnoepp,

ncaa ~

ve&ethene see-eo4~

L-

FOR

IMMEDIATE

Februarv

RELEASE

22. 1991

Release of U. S. Reserve Assets

Monthly

The Treasury Department today
month of January 1991.

released

for the

U. S.

reserve assets data

indicated in this table, U. S. reserve assets amounted to
$85, 025 million at the end of January 1991, up from $83, 340 million
As

l990.

December

U. S. Reserve

(in millions

Total

End

Reserve

Month

Assets

of dollars)

Special

Gold

Drawing

Foreign
Currencies

Reserve

Position

Assets

Stock 1/

83, 340

11, 058

10, 989

52 217

9, 076

85, 025

11, 058

10, 922

53, 577

9, 468

Rights

2/3

IMF

1990
December

1991

January

1/ Valued at $42. 2222 per fine troy ounce.
2/ Beginning

July l974, the

based on a weighted

selected

position
1974.
3/ Includes
4/ Valued

member

in the

IMF

average

countries.

IMF

allocations

adopted a technique for valuing the
of exchange rates for the currencies

also are

SDRs by

SDR

The U. S. SDR holdings
and reserve
valued on this basis beginning July

the

at current. market exchange

IMF

rates.

plus transactions

in SDRs.

of the Treasury ~ 4fashinoton, D.c. ~ Telephone S66-204$

apartment

FOR IMMEDIATE

February

Oy(

RELEASE

Barbara Clay
202/566-5252

CONTACT:

25, 1991

Phone:

LICENSED SETTLEMENT OF KUWAITI

BANK OBLIGATIONS

The Office of Foreign Assets Control of the Department of
the Treasury ("OFAC") announced that, at the request of the
Central Bank of Kuwait, it has licensed seven blocked Kuwaiti
banks to settle directly most types of obligations arising
prior to the August 2, 1990 Iraqi invasion of Kuwait. The
licenses were issued pursuant to the Kuwaiti Assets Control
Regulations, 31 C. F. R. Part 570, to Al Ahli Bank of Kuwait,
The Bank of Kuwait & The Middle East, Burgan Bank, Commercial
Bank of Kuwait, The Gulf Bank, The Industrial
Bank of Kuwait,
and Kuwait Real Estate Bank.

The licensed banks may immediately take preparatory
steps
toward settling most types of pre-August 2, 1990 obligations,
such as gathering information on claims, arranging credit

facilities,

liquidating and transferring blocked assets.
On March 18, 1991, the banks may begin to use their blocked
assets to settle those obligations.
Excluded from OFAC's
general settlement authorization are obligations denominated
in Kuwaiti dinars, and claims related to deposits (except
interbank deposits) held in Kuwait or Iraq. As required by
U. S. and U. N. sanctions, no transfers may be made to the
Government of Iraq, persons in Iraq or occupied Kuwait, or
entities operated from Iraq or occupied Kuwait.
and

of England has also granted today the approvals
of the
necessary in the United Kingdom for implementation
seven banks' settlement programs in coordination with the
Central Bank of Kuwait. The Central Bank of Kuwait has added
its payment guarantee for all valid obligations covered by the
OFAC licenses,
although it has notified OFAC of its belief that
the blocked banks will be able to satisfy the licensed
settlements directly.
The licenses authorize U. S. persons to engage in all
transactions necessary to settlement of the Kuwaiti banks'
obligations, although any attachment of, or setoff against,
the banks' assets (all of which constitute blocked property)
is prohibited without separate OFAC authorization.
The Bank

Information

the proper bank

notice to appear this week, or
(202) 566-2701.
NB-11&3

may

officials to
be requested

whom

covered

from OFAC

,"~%*,

DEBT

UBLI
~

De[)artment of the Treasury

FOR IMMEDIATE

l~ao
:tl of thyj Public

Debt

"R
~L4;:

EW
~ ii'ashintFton,

DC 20239

RELEASE

F9bI061F 25, 1991

fL:i

CONTACT:

202 —376 — 350
'

7
75

g j

RESULTS OF TREASURY'S AUCTION
7

Office of Fin-'-ncing

OF 13-WEEK

BILLS

(

Tenders for $9, 204 million of 13-week bills to be issue. 4
on February 28, 1991 and mature on May 30. 1991 were
accepted today (CUSIP: 912794WL4).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

5. 99%
6. 01%
6. 01%

Investment
Rate

Price

6. 17%
98. 486
6. 19%
98. 481
High
6. 19%
98. 481
Average
$1, 000, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 'l%.
The investment rate is the equivalent coupon-issue yield.
Low

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco

Treasury

TOTALS

Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

NB-111, 9

Received
42 , 830
31, 040 , 890
17 , 015
44 , 335
150 , 855

(in thousands)
Acce ted
42, 830
7, 601, 600

17, 015
44, 335
91, 855
34, 660
255, 750
18, 380

34 , 660

1, 863 , 950
58 , 280

9 , 480
37 , 010
23 , 140
1, 013 , 650
815 675

9, 480

37, 010
23, 140

$35, 151, 770

211, 900
815 675
$9, 203, 630

$31, 146, 975

$5, 198, 835

$32, 768, 670

621 695
$6, 820, 530

2, 132, 700

250 400
$35, 151, 770

250 400
$9, 203, 630

1 621 695

UBLI
of the Treasury

Department

FOR IMMEDIATE

February

DEBT NEW
~

Bureau of the Publk

RELEASE

ii'ashi~ltQDC 20239

Offype of Financing

CONTACT:

25, 1991

RESULTS OF TREASURY'S AUCTION
'

2O2-376-. 35O

OF 26-WEEK
it&.
~URY

BILLS

for $9, 214 million of 26-week bills to be issued
28, 1991 and mature on August 29, 1991 were
accepted today (CUSIP: 912794WT7).
Tenders

on February
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate

Price

6. 00%
6. 27%
96. 967
High
6. 01%
6. 28%
96. 962
Average
6. 01%
6 ' 28%
96. 962
$50, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 38%.
The investment rate is the equivalent coupon-issue yield.
Low

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia

Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

NB-1150

Received
32, 285
26, 730, 435

10, 575
32, 295
88, 270
31, 070
1, 796, 935
39, 600
5, 580

(in thousands)
Acce

32 , 285

8, 180 , 650

$29, 980, 640

10 , 575
32 , 295
57 , 270
30 , 450
98 , 935
17 , 600
5 , 580
42 , 705
14 , 235
68 , 725
622 430
$9, 213, 735

$25, 690, 905

$4, 924, 000

$26, 878, 240

$6, 111,335

2, 200, 000

902 400
$29, 980, 640

$9, 213, 735

42, 705

14, 235
534, 225
622 430

1 187 335

R
~&4,:

1 187 335

902 400

larttneni of ihe Treasury

p. g.

Nashlneion,

Telephone SIS-204&

until Given
Expected at 10:00 a. m. , February 26, 1991
ENLbargoed

TESTIMONY OF
THE HONORABLE

NICHOLAS

BRADY

SECRETARY OP THE TREASURY

BEPORE THE SENATE COMMITTEE ON
BANKING~

HOUSING~

MODERNIZING

over 18 months
and Enforcement

undertake

AFPAIRS

URBAN

THE PINANCIAL

February

Chairman

AND

26, 1991

Riegle, Senator Garn,
ago the Financial

SYSTEM

of the Committee,

and members

Institutions

Reform,

Recovery,

Act of 1989 (FIRREA) asked the Administration

a broad study

the Administration

of our financial

realized that

system.

was time

Congress

and

for a fundamental

of the basic laws governing depository institutions
the taxpayer's exposure through deposit insurance.

reexamination
and

Earlier this month, we delivered to Congress our final
legislative proposal will be
report. The Administration's
Today I will describe our recommendations
submitted shortly.
to
But before doing so, I'd like to describe some of
the Committee.
the disturbing
ss-1151

conditions

I see

today in our banking

system

because they leave taxpayers

disturbing
and

businesses

underserved,
and unable

uncompetitive

role in stimulating

and

the banking

and

largest.

consumers

industry

to effectively perform its essential
sustaining

economic growth.

States does not have a single

Today, the United

the world's

overexposed,

years ago

Twenty

we had

bank among

seven.

of pure size is not the whole story. But
against the backdrop of an economy that is twice the size of our

course, the question

nearest competitor's,

wonder

absence of U. S. banks from the

Surely that

if anyone can
list of world

statistic tells

explain the complete

leaders.

us something.

Some have

that the "T.p 25" list does not matter. To me, it is
strong evidence that something is very wrong. Would we be

suggested

comfortable
No

pharmaceutical

companies?

start with,

have

left

that prohibit banks from providing
markets,

lines.

that even keep
Banks in California,
and

in Birmingham,
laws

computer

top 25?

manufacturers?

not.

Obviously

in the world's

with no aerospace companies

mainly

touch with
consumers,

England,

antiquated
new

laws on the books

products

them from branching

Michigan

in their natural

across state

and Utah can open branches

but not in Birmingham,

enacted in the 1920s and 30s

Alabama.

These

are wholly out of

reality, and impose unnecessary costs on banks
costs that have been estimated at $10 billion

and

annually.

Consumers

have long since begun

conduct their financial

cards, cash machines
when

and where

affairs their

and

they want.

from the banks,

the 800

own way,

number

Customers

to ignore

them and

using credit

to effect transactions

have increasingly

turned

get auto loans from GMAC and Ford
Motor Credit, checking services from Vanguard and Fidelity mutual
away

business

funds,

and Goldman

and now

loans through

General

Electric Credit Corporation

Sachs, and they save at Merrill Lynch and Sears

Roebuck.

have a deposit

its original

system that has wandered

insurance

away

of protecting only the small depositor,
and now covers almost every depositor, large and small, insured
and uninsured.
This system has protected large, sophisticated
investors who don't need the protection, and exposed the taxpayer
from

to potential

purpose

losses.

collapse,
insured deposits
we still allow state banks to invest federally
directly in real esta' e and other risky investments -- practices
chartered banks to engage in.
we don't allow federally
Despite the hard lessons

Small banks
imposed
seem

find themselves

on them by innumerable

to require multiple

learned

from the S&L

choking

on unnecessary

state

reports

and

on every

federal statutes

paperwork

that

possible subject.

that is in the grasp of no less than
four separate federal regulators, so that its ability to run its
day-to-day affairs and respond quickly to changed conditions
We

have an industry

such as the

Lilliputian

credit crunch
restrictions.

-- is

hamstrung

that is so

by a myriad

that, in some
regions, it has withdrawn from its crucial role of extending
credit to worthy borrowers to finance economic activity and job
We

have an industry

weakened

growth.

it all

failures that totalled 198
in the 38 years from 1942 to 1980, but that reached 206 in 1989
alone; higher interest rates and transaction charges due to
inefficiency and higher costs; and a bank insurance fund that is
What

does

add up

to?

Bank

stress.

under

It's
to correct

a bleak

picture that

demands

action

prompt

action--

it.

Our banks

hold $2. 8

trillion in deposits.

That means that

there is simply no bank insurance fund large enough to protect
the taxpayer, unless and until we address the underlying
problems.

reform,
branching

and a
and

to have deposit insurance reform, supervisory
recapitalized BIF. But we also need interstate
broader financial activities so that our banks can
need

financially strong again. If we leave the job half done
if we tinker with the problem -- then we' ll probably be back
again, sooner or latec, recapitalizing BIF, perhaps the next time
with taxpayer money.
I don't relish that prospect any more than
become

you do

This

fight

among

not just another round in the biannual,

financial

services companies over banking reform.

This time, the country needs results.

choice of financial

products

when

Consumers

well-capitalized

in good times and bad.

is strong

need a broader

they go to the bank.

Businesses and workers need strong,
can keep lending

intramural

The

banks

that

nation needs a

to compete toe to toe with
rivals have to offer. And most of
the best our international
all, the taxpayer needs to be spared the prospect of another

banking

costly

system that

and unnecessary

enough

cleanup.

at their core;
to deal with them decisively and comprehensively; and to turn
this situation around. The laws must be changed to foster a safe
and financially strong banking system where the number of costly
The time has come

failures is dramatically
the reality of today.
their customers.

to address these

reduced.

It is

problems

Banking

time to

regulation

let the

must

fit

banks catch up with

The Administration's

first,

ecific

Reforms

proposal

addresses

three interrelated

etitiveness
caused by outdated legal restrictions
and financial strength,
that have prevented banking organizations from responding to the
evolution of financial markets and technology; second, an
overextended de osit .'nsurance s stem, resulting in excessive
exposure for taxpayers and weakened market discipline for banks;
and third, a fra ented re ulator
s stem that has created
duplicative rules and has often failed to produce timely remedial
action.

problems:

a banking

system with reduced

Restored

Com

com

etitiveness

of the banking industry has been
the erosion of the traditional bank franchise.

The competitiveness

undercut

Banks

reliable businesses they once were.
Old laws designed to assure strong banks have in fact become
barriers that impede banks from adapting to changed market
circumstances.
The result has been financial fragility and loss.
are no longer the steady,

inefficient and costly
restrictions on geographic diversification.
Interstate banking
was prohibited until recently; interstate branching remains
virtually prohibited; and even in-state branching continues to be
Banks have operated

under extremely

restricted in

of states.

a number

While banks have been confined

consumers

have

800 number,

public

The

continue

not.

With

consumers

can

artificial

boundaries,

credit cards, cash machines,
now

"bank" anywhere

and

the

in the country.

not bound by our banking laws. Yet the banks must
to labor under these antiquated restrictions, which have

to cost $10 billion each year, against a pre-tax
industry profit figure of $25 billion for all of 1989. And these
costs are passed on to the consumer in higher transaction costs
and higher interest rates.
been estimated

restrictions have denied banks the ability to follow
their best traditional customers into new markets. As a result,
banks have increased their concentration on the remaining less
attractive segments, which in many cases are riskier. The result
Legal

has been diminished
and soundness

How

do we reverse
and

this trend?
competitive,

How

which

the safety

do we make banks

to lend in good times
need to overhaul outdated

is plain: we
realities of the current marketplace.

Greenspan

has undercut

captured

this

I'd like to quote.

need
He

better able to attract

and more ready

answer

the

which

of the banking system.

steadily profitable

capital,

profitability,

and bad?

laws

The

to recognize

I think that Chairman
perfectly in earlier testimony,
said that:

technology

Developments

in computer

have reduced

the economic role of commercial

These permanent
environment
and

and communications

and fundamental

changes

cannot be halted by statutory

banks.

in the

prohibitions,

the longer the law refuses to recognize that

fundamental

less relevant

and permanent

changes have occurred,

will be as a force for stability

the
and

fairness in our financial markets.
Attempts to hold the present structure in place will be
defeated through the inevitable loopholes that
competitive

innovation

develop,

forced by competitive necessity will
although there will be heavy costs in terms of

competitive

fairness

critical to

a safe and

respect for law which is so
sound financial system.

and

should begin by authorizing

nationwide

banking

and

safer through diversification,
reduced operating costs.
and more efficient through substantially
This is not a radical new idea. A majority of states have
Thirty-three
already embraced the concept of interstate banking.
states -- two-thirds of the country -- have voted to permit
nationwide interstate banking, while another 13 states permit
regional interstate banking.
But the laws on the books impose
enormous costs on the system by virtually prohibiting
interstate
These laws block interstate banking companies from
branching.
achieving enormous immediate cost savings through such measures

branching,

which

will

make banks

common

management

consolidated

and

systems.

data processing

are directly available

to reduce transaction and
overhead costs, to lower interest rates and to build both profits

These savings

and

capital.
But well-capitalized

banking

organizations

also be

must

to use their franchise to participate in the full range
of financial services in their natural markets -- but to do so

allowed

safely outside the bank
safety net.
Neither

outside the federal deposit insurance

and

The taxpayer

should

not back these

new

activities.

the taxpayer bear the cost of a banking

should

system

that has been artificially

restricted into unprofitability

at this time
strong, well-capitali

banks need

And

banks as well

agreements

and

financial

capital,

Overextended

and commercial

so long as they are willing

Deposit insurance
guarantees

that will maintain

original

when

deposit insurance

investors.

has dramatically

own

banks.

well beyond

of protecting small depositors.
the deposits of wealthier individuals,

large institutional

firms to

osit Insurance

coverage has expanded

purpose

allow

to adhere to

well-capitalized
De

should

its

Instead,

corporations,

This broad extension

increased taxpayer

exposure.

now

its

Left to
funding

higher

own

costs

But our overextended

the market would have imposed

workings,
on

institutions

for excessive risk taking.

deposit insurance

system has undermined

the

discipline that should have constrained the increased
riskiness of weak banks. With easy access to federally
guaranteed funds and little to lose, these weak, undercapitalized
banks have had a perverse incentive to take excessive risk with
other people's money, exposing the taxpayer to even greater

market

losses.
Reduction

address the problems
in overextended

of overextended

coverage, without

for small depositors
in the banking

deposits,
through"

and

covera

in overextended

eliminate

would

In addition,

for retirement

Protection of Uninsured

by reining

the basic protection
coverage for brokered

fund managers

$100, 000 per person per institution,

institution

would

losing the benefits of stability

for certain pension

coverage.

This proposal

deposit insurance

reducing

and without

system.

would

with "pass-

limit coverage to

plus a separate

$100, 000 per

savings.
De

ositors.

would

also curtail

virtually all uninsured
depositors in bank failures. Protecting uninsured depositors
should be the exception, not the rule, and should occur only
where there is genuine risk to the financial system.
The system
that we have proposed would eliminate routine protection of
the routine practice of protecting

depositors.

uninsured

Criticism has come from both sides of this issue. One side
charges that we have not totally eliminated the so-called "too
big to

fail" policy,

under which uninsured

protected in large bank failures

depositors

are fully

in order to avoid massive damage

to the financial syst~. m. But no government among the leading
industrial nations has deprived itself of the ability to protect
depositors

uninsured
should

not be the

The

when

the system

first to try

is threatened.

None.

the experiment.

protect all deposits in
are to protect any -- in order to be

other side claims that

should

all institutions -- if we
fair to large depositors in smaller banks. But what about
fairness to the taxpayer? It is bad enough that there are times
when it is impossible to avoid bailing out large depositors
in
certain bank failures; but should the taxpayer foot the bill for
all large depositors in all bank failures as a result? Extending
the safety net to insure all deposits is a backward step.
My

point is that the American people should not be asked to

choose between

a system

that offers insufficient

protection to

instability, and one that
protects every depositor in every failure at great cost to the
the financial

taxpayer.

capitalized

system and threatens

Instead,

banks tha'

have proposed

a system

are less likely to
11

with strong,

fail,

well-

and a supervisory

system that intervenes

promptly

and

decisively before failure can

occur.

of the heat surrounding this issue is over the question
of who should pay for protecting uninsured depositors when they
are protected to avoid damage to the system. The practice in
Much

some

other countries

is for the taxpayer to

pay because

of the

benefits to the financial system and to the entire
for this
We recognize that there are arguments
economy.
position. However, our proposal reflects the view that the
banking industry should pay because it directly benefits from
fundamental

systemic

stability

ital and su ervision. Reducing
itself cannot resolve our current

Stren thened role of ca
overextended

problems.

coverage by

Deposit insurance

will

still protect --

and should

protect -- a substantial part of each bank's funding base. It is
therefore critical to strengthen the role of capital and improve
supervision to make deposit insurance safe for the taxpayer.
It puts the
Capital is the single most important protection.
shareholders'

own money

invest prudently.
ahead

And

at risk and thus provides incentives to
it acts as a buffer that absorbs losses

of the deposit insurance
The proposal

creating incentives

fund.

would make bank supervision

for banks to build
12

and maintain

effective

high levels

of capital,
intervention

and providing

swifter

and more

certain regulatory

against banks with too little capital. Indeed, the
failure to take prompt corrective action in the past allowed some

institutions to fail when they could have been saved, and
fostered low capital levels that create incentives for firms to
take excessive risk.

The proposed

new

system would

address

these

creating a regime of specific supervisory actions
that are triggered by declines to increasingly lower levels of
problems

capital.
's -based

remiums.

Assessing

risk-based

premiums

which

to levels of capital would also help.
Because capital is a crucial measure of risk, firms would be
rewarded with lower premiums for maintaining higher capital.
In
addition, an FDIC demonstration project would test the
feasibility of using private reinsurers to provide market pricing
for risk-based premiums.
would

vary according

s ate

act'v't'es.

to authorize

have authority

states should no longer
risky activities for state banks that
Finally,

receive federal deposit insurance.
A balance was struck
in
FIRREA for state thrifts between the benefits of the dual banking
system and the interest of the federal government.
We should

strike this

same

balance for federally
eamlined

lator
13

insured

S stem

state banks.

regulation

Bank

losses created

I' ve

problems

and supervision

reduces taxpayer

But in the face of the

deposit insurance.

outlined

above,

has not been successful

our fragmented

regulatory

the weakening

in stemming

In recent years, banks have experienced

industry.

exposure to

system

of the banking
record loan

failures that are rapidly depleting the bank insurance
fund. There is not a satisfactory regulatory mechanism for
Moreover, with as many as
promptly correcting banking problems.
four banking regulators involved in the affairs of a single
no single regulator has had either the full
banking organization,
information or the clear authority and responsibility for the
decisive, timely action necessary to deal with weak institutions.
losses

and

Our
number

proposal would streamline

of different

discipline

ways

and apply

that

prompt,

the regulatory

system

further supplement

would

in a

market

decisive corrective action to

weak

institutions.
First, to improve authority,
accountability, and responsibility, there would be a single
federal banking regulator for each banking organization.
Second,
and unsound

the current

system of three federal

to two:
all state banks

national

reduced

FDIC would

would

focus on

its

of failed institutions.
FIRREA, where

the

bank

regulators

banks would remain

to the Fed.

would

under Treasury,

and

part of this plan, the
primary function as insurer and resolver
This approach parallels that taken in

thrift regulator

and

insurer were separated.

f.corn its role as the primary

Except for receding

for state non-member banks, the
of its existing examination and enforcement
supervisor

federal

FDIC would

retain all

powers.

Finally, the Bank Insurance Fund is at its lowest level in
history as a percentage of insured deposits. The Federal Deposit
Insurance

Corporation

projected that

(FDIC) has

still

further over the next

two

funds,

the FDIC could find

itself

losses, resulting

years.

with too

in possible exposure

The Bank Insurance

Fund must

said that

should

Without

will decline

infusion

little

cash to pay for

for the taxpayer.

therefore be recapitalized.

satisfy a number of objectives.
First, the Fund must have sufficient resources so that the FDIC
can do its job of resolving failed institutions.
Next, the Fund
should be recapitalized with industry funds, but in a way that

have

does not further

Finally,

any plan

impair the health

the plan should rely on

Last

fall,

as part of the

of the banking

GAAP

Omnibus

industry.

accounting.
Budget

Reconciliation

Act

1990), the FDIC was granted additional legal
authority it needed to recapitalize the fund. For the last two
months, the FDIC has been working with industry groups to develop
a plan.
Over last weekend, we have received the outline of a
proposal from the FDIC. We are reviewing this proposal, and
of 1990

(OBRA

expect to work with Chairman

Seidman

to include legislation

appropriate

when

the FDIC plan is finalized.

like to respond to two criticisms
that have been made -- I think with little merit. The first is
that we are somehow repeating the mistakes that contributed to
the S&L disaster.
That is simply not the case. The banks are
totally different from the S&Ls. By a wide margin, banks are
better capitalized, better managed and better regulated than the
S&Ls. To be precise, the banks have over $200 billion in equity
capital, plus another $50 billion in reserves. The S&Ls had less
than $10 billion in equity in 1987, the year losses mushroomed.
Before concluding,

to reform is distinctly

different.
The S&Ls were permitted to use federally insured deposits to
In effect, we
engage in risky activ-:ties inside the institution.
let S&L owners go to the casino with Uncle Sam's checkbook in
hand.
By contrast, we have proposed that new financial
activities for banking organizations take place only in
separately capitalized affiliates, with stringent firewalls and
In addition,

our approach

strict supervision.
activities
by a

only

substantial

It is

And we

banks

ve gone even further

that exceed

minimum

in limiting

new

capital requirements

amount.

important

the specter of the

that

do not learn the wrong

S&L problem.

inaction and procrastination

With the banking

are the enemy.
16

lesson from

system,
would

be ironic

memories

of the

changes

costly
A

S&L

cleanup prevent

us from making

that could save the taxpayer

and unnecessary

necessary

from another

cleanup.

is that

second criticism

are

somehow

embarking

on a

risky "deregulation"

of the banking industry, again along the
lines of the S6L problem. That just doesn't square with the
facts. The proposal represents sound and prudent regulation,

with badly needed

reforms

to protect the taxpayer.

Benefits of Reform

close my remarks with a discussion of the wide range
of interests that benefit from the Administration's
plan. The
Let

first

and most obvious

group are taxpayers.

Strong, well-

capitalized banks and a well-capitalized deposit insurance fund
are the best protection for the taxpayer -- they result in more
profitable banks, fewer failures, and a strong buffer ahead of
the taxpayer to absorb whatever losses do occur.
The second group

consumers,

both individuals

and

foster the delivery of a wider range
of more convenient services for consumers everywhere in the
country, with important protections to prevent confusion between
Consumers would also benefit
insured and uninsured products.
lower interest rates and lower
from increased convenience,
businesses.

Our plan would

costs as a result of the

transaction

enormous

available.

savings

third group is businesses and workers, who need to be
able to count on bank credit in both good times and bad. Strong,
well-capitalized banks can act as shock absorbdrs in bad times to
The

help customers

work through

also keep lending

Strong banks can

problems.

temporary

in an economic downturn,

often forced to contract and stop lending

whereas

are

weak banks

in order to continue to

As a result, loans are called less
capital requirements.
often, fewer bankruptcies occur, and jobs are preserved.

meet

The fourth

group

is the

banks themselves,

not a "big bank"

bill,

including

small

for
small banks.
The capital-based nature of the plan particularly
benefits smaller banks, which have higher capital levels than
larger banks. Let me state again: Well-capitalized firms will
be rewarded with lower insurance premiums, greater ability to
This

banks.

engage

new

activities,

expect that strong,
continue

well-managed

more than hold

their

regulatory

freedom.

I fully

institutions will
against larger rivals.

smaller
own

They

years. For example, the evidence is that,
states such as California and New York enlarged within-state

have done so
when

and more

with nothing

branching

for

powers,

Gerry Corrigan

many

smaller banks continued

of the

New

York Fed,

"I am

to prosper.
absolutely

that literally thousands of small- and medium-sized
will continue to flourish. " Our proposal does not
18

To quote

confident

institutions
aim at

the

reducing

of small banks.

number

Our

will lead to

proposal

earlier resolution of weak banks, many of which are anything but
small. The fact is that our plan favors strong banks, not big
banks; well-managed
well-managed

Finally,

banks,

not weak banks.

Well-capitalized,

smaller banks would prosper under our proposal.

the Administration's
The world's

nation as a whole.

proposal

would

benefit the

leading economy demands

a world-

class banking system.
as

Mr. Chairman,

I said earlier, this is

replay of the biannual,
This time, the country'

choice of financial

products

results.
when

is strong

the best our international

all, the
costly

taxpayer

needs

and unnecessary

enough

rivals

need a broader

well-capitalized

in good times and bad.

system that

banking

Consumers

they go to the bank.

Businesses and workers need strong,
can keep lending

just another

fight over banking reform.

intramural
needs

not

have

The

banks

that

nation needs a

compete

to offer.

toe to toe with
And

most

to be spared the prospect of another
cleanup.

artment of the Treasury

Woshjneton, O. C.

l'eleyhone SIN-204'

Statement of
Charles H. Dallara
Secretary of the Treasury

The Honorable

Assistant
for International Affairs
Before the Subcommittee on
Commerce, Consumer Protection, and Competitiveness
of the
Committee on Energy and Commerce
UPS. House of Representatives
February 26, 1991
Madam

Chair and Members of the Subcommittee:

to appear before the Subcommittee
welcome the opportunity
U. S. investment policy and issues related to the

to discuss

implementation

of the Exon-Florio provision.

Forei n direct investment
olic
Decisions with regard to foreign direct investment in the
United States are made against the backdrop of an investment
policy which has been in place without fundamental change for 200
years. U. S. policy towards foreign direct investment is centered
on twc key tenets:
1) the United States welcomes foreign direct
inves:~ent and 2) we seek to liberalize investment regimes
abroad. At the same time, it is important that we ensure that
our open investment policy does not compromise our national

security.

rationale for our investment policy is plain: It fosters
efficiency, stimulates economic growth, enhances our
This
international competitiveness, and increases employment.
international investment policy reflects the reliance on market
economic
forces which underlies all of the Administration's
"Economic
Report of the
policies. In this regard, the 1990
President" said:
Increases in direct investment by U. S. and foreign firms
reflect the increasing integration of the global economy
and benefit both host and investor nations.
Foreign investment brings in capital which provides more jobs
for American workers. What is important are the jobs and job
skills resulting from investment, not the nationality of the
investor. For example, Madam Chair, between 1980 and 1987,
foreign direct investment in Illinois accounted for roughly
one-fourth of the total new jobs generated in Illinois, according
Zn
to estimates to the Illinois Office of Research and Analysis.
fact as of 1988, Illinois ranked fifth in the United States in
terms of foreign investment ($16.2 billion) and fourth in
The

economic

NB-]]52

firms (207, 000). Foreign-owned firms
in the top 14 states provided jobs for 2. 5 million American
workers.
The complement to our open investment policy is liberalizing
the investment regimes of our trading and investment partners.
This also can contribute to job creation in the United States.
There is no question that we are living in a global economy.
Firms compete in a global market place. In 1988, exports of U. S.
companies to their foreign subsidiaries accounted for 30 percent
of U. S. merchandise exports. In these circumstances, freedom to
invest other countries' markets may be a vital contribution to
As these companies gain greater
the viability of U. S. companies.
access to markets abroad, exports from U. S. parents to their
foreign subsidiaries translate into more jobs in the United
employees

of foreign-owned

States.

data and trends
direct investment:
As of the third quarter of 1990, the book value of foreign
direct investment in the United States was $421 billion, an
increase of some $20 billion during 1990. Through the third
quarter of 1990, the United Kingdom with investments of $122
billion is the largest investor.
During the first three quarters of 1990, U. S. foreign direct
investment increased by nearly $40 billion to $411 billion.
Because U. S. foreign direct investment abroad in 1990 has
increased faster than foreign direct investment here, the gap
in the book value between foreign direct investment here and
abroad is narrowing.
As of the third quarter, the foreign direct
investment gap was $10 billion compared to nearly $30 billion at
the end of 1989.
While foreign direct investment in the United States is
important in terms of investment and the resulting jobs,
technology, and competitiveness it brings to the economy, the
presence of foreign direct investment in the U. S. is not
overwhelming.
And proportionately
it has a significantly lesser
role in the U. S. economy than in the economies of our major
trading partners, with the exception of Japan.
Charts in the appendix provide additional data.

Forei

Doubts about o en investment

Despite the benefits of foreign investment, the growth of
foreign investment in recent years has prompted new doubts in
some quarters about the desirability
of our open investment
policy. Because of the surge of Japanese investment here
concentrated in certain sectors and geographic areas, special
concern has been expressed over investment from Japan.

policy
Much of the impetus for a change in our investment
focuses on the absence of a level playing field. I share this
concern and, as I will describe below, we are working actively to
gain greater access to foreign markets, particularly Japan's.
But I believe that it makes little sense for the Un&ted States to
restrict foreign domestic investment in our market because
policies abroad deny U. S. business equivalent access. Instead,
our response is to attack restrictive investment regimes and to
do all we can to move our investors to a position where have the
abroad as do the domestic
same rights and opportunities
Let me briefly describe our efforts to do so.
investors.

restrictive
In the General Agreement on Tariffs

Efforts to liberalize
o

forei

investment
and Trade

ractices
(GATT), we

are seeking a binding, enforceable, legal obligation to
prohibit certain government measures imposed on
investment.
For example, we are seeking to prohibit
measures that require the use of local parts instead of
reduce American
Such foreign requirements
imported parts.
exports and harm U. S. workers. This area, known as
Trade-Related Investment Measures (TRIMs), is a high
priority for us in the Uruguay Round.
o In the Organization for Economic Cooperation and
Development
(OECD) we are pressing for firmer member
country commitments not to discriminate against foreign
These commitments are embodied in the OECD's
companies.
In current negotiations,
National Treatment Instrument.
measures that
new
of
we are seeking a standstill
companies and a roll
foreign-owned
discriminate against
and their
companies
American
ones.
back of existing
abroad are
American
companies
if
employees will benefit
because they
merely
disadvantage
competitive
not put at a
are foreign.
o Bilaterally, we have negotiated a number of investment
principles.
treaties which provide a framework of agreed
allow
is
to
U. S.
treaties
these
of
theme
An underlying
on
to
compete
and
equal
businesses
firms to establish
terms with domestic firms. For example, last year we
concluded negotiations with Poland of an Economic and
One of the benefits of that
Business Relations Agreement.
S. firms to compete on a
U.
enables
agreement is that it
and other foreign
Polish
basis with
non-discriminatory
agreements
with other
similar
firms. We are negotiating
entered
have
into
and
Eastern European countries,
negotiations with a number of Latin American countries.
o

the Structural Impediments Initiative (SII) w'th
Japan, we are seeking removal of barriers to foreign
direct investment in that country.
Through

an as focus

Much of the
on the SII discussions.
States stems
United
the
in
investment
direct
unease about Japan's
-markets
Japan's
that
from concerns about a lack of reciprocity
has
Administration
The
are not open to U. S. direct investment.
regime.
Japan's
investment
made particular efforts to liberalize
Our efforts are directed not just at legislative barriers, but in
the SII discussions, at internal, structural barriers to foreign
direct investment.
In recognition that access to Japan's market was limited by
external trade and investment
more than the traditional
legislative barriers, President Bush and then-Prime Minister Uno
launched the Structural Impediments Initiative in July 1989. The
talks have been moving ahead despite the extraordinarily complex

would

like to

expand

nature of the issues involved.

In a market as developed and complex as that of Japan, the
only really viable way of making a direct investment is through
mergers and acquisitions.
Although Japan needs to liberalize the

legal framework for foreign direct investment, the heart of the
lies in the relationships among Japanese corporations and
their willingness to open up to foreign investors.
(companies holding
In Japan, a web of cross-shareholdings
is an effective
each others' equity) and long-term shareholdings
barrier to foreign acquisitions.
About 70 percent of all
Japanese equities are held off the market in long-term
are
arrangements
These shareholdings
shareholding arrangements.
a fundamental
part of the Japanese keiretsu system of industrial
organization.
Keiretsu are groups of industrial, commercial, and
financial companies joined by formal and informal ties that
govern the production, distribution,
and sale of a significant
portion of goods in the Japan economy. These keiretsu are a
significant barrier to the ability of U. S. companies to access
the Japanese market through trade and investment.
We have made progress
in opening Japan to foreign investors.
We obtained
commitments from the Japanese government to submit a
bill to eliminate the government's current authority to block
foreign investment on broad economic grounds.
Japan also agreed
to make keiretsu more transparent, in particular to improve
disclosure which many observers believe is key to a more open
investment climate.
But much more is required.
In the latest SII talks, we have
suggested measures that would lessen the effect of
cross-shareholding,
improve the proxy voting system, and enhance
other shareholders'
rights. We believe that these measures, if
enacted, will increase the ability of U. S. companies to make

problem

strategic investments

in Japan.
the importance of limiting Japanese
We are also stressing
sectoral restrictions on foreign investment only to those sectors
that directly affect essential national security interests.
Currently, Japan's sectoral restrictions on foreign direct
investment cover investments in agriculture,
forestry and
fisheries, mining, oil, leather and leather products
manufacturing.
Investment issues will remain a
priority of the SII
talks. We have made Japan negotiatorshighfully
aware of the
importance we attach to investment, not only in the SII talks,
but through other contacts as well. We welcome the support we
have received from Congress in this effort.
Exon-Florio rovision
The Exon-Florio provision authorized the President, or his
designee, to investigate foreign acquisitions to determine their
effects on national security. It also authorized the President
to take such action as he deems appropriate to prohibit or

suspend

such acquisitions

he found

that:

is credible evidence to believe that the foreign
investor might take action that threatens to impair the
national security; and
Existing laws, other than the International Emergency Economic
Powers Act and the Exon-Florio provision, do not provide
adequate and appropriate authority to protect the national
security
The President could direct the Attorney General to seek
The
appropriate judicial relief -- including divestment.
President's findings are not subject to judicial review.
By Executive Order 12662 of December 27, 1988, the President
designated the Committee on Foreign Investment in the United
States (CFIUS) to receive notices and other information, to
should be undertaken,
determine whether investigations
and once
an investigation
has been completed to prepare a report and a
recommendation
to the President.
There

Other Laws

Exon-Florio is by no means the only statute available to
Other laws, some of which
U. S. national security.
distinguish between foreign and domestic investment, include:
The Executive orde"s
o Protection of classified information.
that constitute the
and Defense Department regulations

protect

abilitY of
Industrial Security Program restrict thesecurity
clearances
foreign-controlled companies to obtain
classified
necessary to carry out contracts involving
information.

Under the Arms Export Control Act,
o Arms Export Control.
the U. S. Department of State with
must
provide
firms
defense

notice 30 days prior to a planned transfer of
for the
A license is required
ownership to a foreign person.
can
be
and
a
person,
to
foreign
data
transfer of technical
reasons.
security
national
denied for foreign policy or
The Defense Production Act, now lapsed,
o Defense priority.
of
empowered the government to require priority performance
defense-related contracts.
Act empowers the
The Export Administration
o Export control.
government to subject the export of sensitive and
high-technology products and information to licensing and

written

other requirements.
CFIUS 0 erations
the
Let me now turn to CFIUS operations.
As mentioned,
notices
and
President delegated to CFIUS his authority to receive
determine
conduct investigations
of foreign acquisitions to
effects on national security.
CFIUS agencies are Treasury (chair), Defense, State, USTR,
Commerce, OMB, CEA, and Justice.
Other agencies participate when
a transaction falls within their sectors of expertise.
For
the
invite
we
example, if a transaction is in the energy sector,
transactions
Department of Energy to participate.
And when
involve advanced technology, we invite the Office of Science and
Technology Policy to augment the expertise of CFIUS agencies in
appraising the complexity and importance of the technology in
question.
Within CFIUS, Treasury serves as the secretariat.
It
receives notifications of transactions, decides what Executive
Branch agencies other than the eight CFIUS agencies need to be
brought in for technical advice, serves as the contact point for
the private sector, establishes a calendar for each transaction,
and xn general supervises the process.
The Exon-Florio provision provides for a 30-day initial
review and, if necessary, a 45-day investigation.
For those
transactions for which an investigation is completed, a
Presidential decision must be announced within 15 days. In
total, the process does not exceed 90 days.
How notifications
are handled

is initiated

receipt of a written
The proposed regulations provide
or by
may be given only by a party to the transaction
Notice from third parties is not
a CFIUS member agency.
CFIUS review

notification
that notice

of a transaction.

accepted.
do not
Notification is voluntary.
Many foreign acquisitions
involve issues related to national security and, consequently,
parties to the transaction may decide not to notify CFIUS.
In order to perform our review for national security, we have
asked that notifications include the following:
o A description of the parties to the transaction;
o Details on the acquisition arrangements;
of the foreign parent and the
o Identification
ultimate beneficial owner and information on them;
o Other filings with U. S. Government agencies which
have been made or are contemplated;
o A list of contracts, both classified and
unclassified, with Department of Defense or other
U. S. Government agencies;
o The plans of the acquiring company for the U. S.
company.

notification is received, Treasury, as a first step,
period
If so, the 30-day review the
decides if it is complete.
evaluate
begins. During that period CFIUS agencies
transaction.
Once a

the 30-day period CFIUS agencies, through Treasury,
to the
typically engage in a dialogue with the parties
This
notification.
transaction regarding issues raised by the
written
cpestions
dialogue takes place initially in the form of
in addition to that
and answers to clarify or solicit information
contained in the notice. Subsequently, the dialogue may extend to
inviting the parties to the transaction to Treasury to meet with
CFIUS staff for clarification and exchange of information.
During this time, there is also close coordination and frequent
exchanges of information and views among CFIUS agencies.
At the end of the 30 days, any given transaction has been
CFIUS at that
viewed from many national security perspectives.
point has a good sense of the national security aspects of the
transaction, and agencies present views on whether to move to the
45-day investigation stage.
During

If no agencies request an investigation, the parties to the
transaction are notified that there are no national security
issues sufficient to warrant an investigation and that action
under the Exon-Florio provision is concluded with respect to the
notified transaction.
If agencies decide to request an investigation, the request
is in the form of a letter to Treasury from a Presidential
CFIUS then decides
appointee, generally an Assistant Secretary.
at the Assistant-Secretary level whether to initiate an
begins the statutory
A decision to investigate
investigation.
investigation period which is not to exceed 45 days.
CFIUS must send the
At the completion of the investigation,
CFIUS is
President a report and a recommendatxon.
If,thehowever,
Secretary of the
unable to reach a unanimous recommendation,
Treasury, as chairman, must submit a CFIUS report to the
President which sets forth the differing views and presents the
issues for decision. The President then has 15 days to announce
his decision on the case.
La se of Exon-Florio authorit
As you know, Exon-Florio authority
lapsed with the expiration
of portions of the Defense Production Act on October 20, 1990.
We were advised by involved
Congressional staff that
Exon-Florio authority would, in their view, be renewed.
After
consultations with Congressional staff, the business and legal
communities, and other CFIUS agencies, Treasury announced on
November 6, 1990, that CFIUS would continue to operate on an
informal basis in accordance with Exon-Florio criteria.
Since the lapse, CFIUS has provided a process of review that
is close to that of Exon-Florio. At the end of 30 days, if no
agencies believe there are national security concerns that
warrant further review, we so advise the parties to the
transaction.
This allows them to proceed, knowing the
transaction does not pose problems from a national security
standpoint.
On the other hand,
if there are problems, or aspects of the
transaction that require greater research, we will initiate the
45-day extended investigation period.
Although the President's
authority under Exon-Florio is not currently available, parties
to transactions have conveyed a willingness to cooperate with
CFIUS in the expectation that Exon-Florio authority would be
renewed.

the longer the period of lapse extends, the more
to continue to operate under interim
arrangements.
Eventually the Exon-Florio process would be
However,

difficult

becomes

We believe that it would be unwise to allow the
situation to continue and we support extension
uncertain
present
Exon-Florio
in
its current form.
of

undermined.

of Exon-Florio 0 erations
of
We have received over 530 notices since the inception
been
have
transactions
twelve
that
total,
Of
Exon-Florio.
In
subject to a 45-day investigation and sent to the President.
interfere.
to
not
chose
he
transactions,
twelve
those
seven of
The
The President chose to prohibit one transaction.
notifications to CFIUS of the remaining four transactions were

Summa

withdrawn.

in
last fall, there has been a noticeable reduction
This
transactions.
of
CFIUS
to
notifications
of
the number
reduction has continued into 1991. During last January CFIUS 13
received 25 notifications, while this January CFIUS received
firm conclusions at this
I would not wish to draw
notifications.
activity as
point, but the drop off may reflect reduced economic
well as a reduction in asset values and liquidity in major
investing countries, such as Japan.
Criticism of CFIUS
subject to the
The seemingly small number of transactions
has
President
the
and the fact that
45-day investigation,
criticism.
of
been
points
prohibited only one transaction, have
The argument is made that CFIUS cannot possibly be doing its job
only blocked one deal and CFIUS has only
if the President has transactions.
investigated twelve
is misdirected, or
I would suggest that this criticism
Exon-Florio.
reflects a misunderstanding of
Exon-Florio allows us to assure that foreign direct while
investment does not pose a threat to national security
sustaining our open investment policy. Indeed, CFIUS's impact

Beginning

goes beyond

statistics:

in the
Exon-Florio has resulted in greater awareness
aspects
security
national
of
business and legal communities
of transactions;
o CFIUS serves as a mechanism for case-by-case review of
laws to protect
transactions designed to confirm that to
the task for the
security are appropriate and adequate
transaction under consideration;
information and data
o CFIUS has access to substantial
sources and has developed an efficient system for evalua ing
o

-10CFIUS may also ask the parties
When necessary,
transactions.
in order to clarify
to a transaction to meet with CFIUS
answers to questions raised by CFIUS, to demonstrate and
of the
explain technology, and to elaborate upon toaspectstransactions
put
As a result, CFIUS is able
transaction.
This
30-days.
initial
the
in
scrutiny
detailed
through
significantly reduces the transactions subject to a 45-day
investigation;
in
o Exon-Florio has also produced a marked improvement
co-ordination and information sharinp within the Executive
Branch on national security implications of foreign purchases
For example, the Defense Investigative
of U. S. businesses.
of pending transactions brought to its
CFIUS
informs
Service
The
information is involved.
because
classified
attention
the
such
other
agencies,
has
also
resulted
in
CFIUS process
of
learning
Department,
State Department and the Commerce
transactions which involve export of munitions and sensitive
technology subject to license.

Transaction
The most recent withdrawal
of a CFIUS notification occurred
last week. FANUC, Ltd. and Moore Special Tool Company informed
CFIUS that FANUC had decided not to proceed with the proposed
acquisition of 40 percent of Moore's stock.
Your letter of invitation to testify asked that I address the
FANUC/Moore transaction.
I will do so briefly.

FANUC

Moore

is a manufacturer of machine tools and measuring
in Bridgeport, Connecticut, with annual ' sales of $40
million. Some 60 percent ($24 million) of Moore s annual sales
are to the export market, and 40 percent ($17 million) to the
domestic market.
At this sales level, Moore is a small but
important manufacturer in the U. S. market.
Of Moore's total
domestic sales, the Department of Energy buys about three
machines annually, each valued at $1-1.5 million.
Energy
purchases from Moore have included jig grinders, coordinate
measuring machines, and lathes.
These machines are used in the
production of nuclear weapons.
Moore approached FANUC after its attempts to find a U. S.
investor were unsuccessful.
Initially, FANUC sought to lend
from
money to Moore, but this was not a viable alternative
Moore's perspective because it was having difficulty servicing
its existing debt. Subsequently, Moore and FANUC agreed that
FANUC would purchase
an equity share in the company.
From Moore's perspective,
approaching FANUC was logical.
with Moore for about, two years
FANUC has been closely involved
Moore

machines

-11during which time the two companies have worked together to
provide FANUC digital controllers for Moore machines.
Digital
controllers instruct machine tools to cut, shape, and bore to

fine tolerances.

a working relationship with FANUC as a keg to
the next generation of machine tools and maintaining
the competitiveness of Moore machines.
chose FANUC because
it considered FANUC controllers the best Moore
in the market and
necessary to maintain Moore's excellence.
The Committee carefully scrutinized all aspects of the
transaction to determine if the standards for blocking under
Exon-Florio were met and forwarded its report to the President.
Moore viewed

developing

February 19, 1991, FANUC and Moore announced that FANUC
not to pursue further the investment in Moore. They
requested that their notification be withdrawn from CFIUS
consideration.
That request was granted on February 20.
On

had decided

Conclusion

In concluding,

would

1) an open investment

like to

points:
policy is critical to sustaining the
to expand, to become more competitive,

ability of our economy
and to create jobs;
and
2) Exon-Florio legislation

make

two

is needed to continue our national
This will be done in the
security reviews of transactions.
context of our open investment policy.
An investment
climate is inherently fragile, and therefore
There are dangers in tampering
requires a long-term commitment.
with such a commitment.
We must take care not to signal
foreign
investors that their investments and their benefits to the
at
economy may not be welcomed in the United States, particularly
is
and
our
a time when competition for capital
intensifying,
It is too early to say
savings rate remains relatively low
whether the fall in the rate of foreign direct investment in the
United States is an aberration or an indication of future trends.
However, it does suggest that it is not preordained that the
United States will be the country of choice for foreign direct
in mind when making
investment.
It is important to keep this
investment
policy.
decisions with respect to our foreign
I will be happy to take your
This concludes my statement.
questions.

APPENDIX

CHARTS

FOREIGN

DIRECT INVESTMENT

AFTER INCREASING DURING 1980s, IN 199Q FOREIGN
INVESTMENT FLOWS TO U. S. SIGNIFICANTLY DECREASED
80

0C
cg

US flows abroad greater
than foreign flows to US

E
CO

a) 40
Q
O

Q)
CD

C
C5

~ 20
C
C

1980

1982

1984

Foreign Investment
in the U. S.
1990 data through 3rd quarter only
Source: Survey of Current Business

1986
U. S. Investment
Abroad

1988

1990

-13-

UK, JAPAN,

NETHERLANDS LARGEST
FOREIGN INVESTORS IN THE US
8c

122

$76

Japan

Netherlands

Canada

Germany

$23

Switzerland

France

Other Countries

100

$ Billions
FDI position through 3rd Quarter 1990
Source: Bureau of Economic Analysis

120

140

160

FOREIGN-OWNED FIRMS ACCOUNT FOR
ONLY A SMALL PART OF US ECONOMY
1988 Data, Except

for Gross Product

(1987)

4.3%

1o/o

95.7%

95.9%

Industries
Chm Product
All

industries
Employment (t}
All

(1}

14 7/

87.8%

85.3O/o

Manufacturing
Firms - Sales (2}

Manufacturing
Firms - Assets (2}

Foreign-Owned
(1) Nonbank US Affiliates/Nonbank

12.2%

Firms

US Businesses

(2) US Affiliates/All US Firms (Manufacturing)
Source: Survey of Current Business

US-Owned Firms

1988 FDI ACCOUNTED FOR OVER
2.5 MILLION JOBS IN TOP 14 STATES
IN

390

California
330

New York

Texas

—

Illinois
196

New Jersey

178

Pennsylvania

167

Ohio
North Carolina

Florida

Georgia
108

Michigan

102

Massachusetts

Tennessee
Virginia

100

200

300

400

Employees (Thousands)
nonbank US affiliates
Source: Bureau of Economic Analysis
Employment

500

-16-

FOREIGN INVESTMENT IN THE US
TOP 14 STATES - 1988
California

Texas
New York

$18

Alaska

$16

Illinois

$16

Ohio

$15

Louisiana
New

$14

Jersey

$12

Pennsylvania
North Carolina

Florida
$10

Georgia
Michigan
Virginia

Tennessee

Gross Property, Plant & Equipment ($
Source: Bureau of Economic Analysis

Billions)

-17FQFIEIGN INVESTMENT HELPED US MAINTAIN DOMESTIC
INVESTMENT DESPITE DECLINING SAVINGS RATE
20

US sent excess

savings overseas
I
I

I
I
I

I
gl

r
~
~

I
~
~

I
I
I

I
I

I
~
~

A
~

~ ~

I
I
I
I

~
~

I I

I
I
I
I

I
I

I
I
I

~
~ ~
1~

l
I

Foreign investment
needed to fill gap

1960

1965

1970

Gross Domestic
Saving

1975

1980

Gross Private
Domestic Investment

Part of difference be@veen Gross Savings 8
Investment due to statistical discrepancy
Source: 1991 Economic Report of the President

1985

1990

US NEEDS FOREIGN INVESTMENT BECAUSE US SAVINGS
RATE SIGNIFICANTLY BELOW MAJOR TRADING PARTNERS
Average Gross Savings Rates 1981-88

31.4

Japan

W. Germany

20.3

Canada

19.8

France

16.8

U. K.

16.1

U.S.

15.6
Italy

% of GNP
Source: OECD

EXCEPT FOR JAPAN, OTHER MAJOR TRADING PARTNERS
ACCEPT HIGHER LEVELS OF FOREIGN INVESTMENT
1986 Data {asset data not available for France)
10

Japan

27
21

France

Germany

Sales
Source: Julius

8, Thomsen,

20
Percent

Mfg Employment

Foreign~ned

Firms,

Trade 8, Economic Integration, Tokyo Club papers
2, Royal Institute for International Aftrs, 1988

Assets

artment of the TreasurY
FOR RELEASE AT

February

Nashineton,

4:00 P. M.

CONTACT:

26, 1991

D.C. ~ Telephone $66-2041
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 S17, 200 million, to be issued March 7, 1991 '
This offering will result in a paydown for the Treasury of about
S2, 150 million, as the maturing bills are outstanding in the
amount of S19, 360 million.
Tenders will be received at Federal
Reserve Banks and Branches and at the Bureau of the Public Debt,
Washington, D. C. 20239-1500 Monday, March 4, 1991,
prior to 12:00 noon for noncompetitive tenders and prior to
1:00 p. m. , Eastern Standard
time, for competitive tenders.
The two series offered are as follows:

91-day bills (to maturity date) for approximately
million, representing an additional amount of bills
S8, 600
dated June 7, 1990,
and to mature June 6, 1991
(CUSIP No. 912794 WM 2 ). currently outstanding
in the amount
of S20, 977 million, the additional and original bills to be
freely interchangeable.
182-day

bills for

dated March 7, 1991.
No. 912794 XE 9).

approximately
and

S8. 600

mature

million, to be
5, 1991 (CUSZp

September

The bills will be issued on a discount basis under competitive 'nd noncompetitive bidding, and at maturity their par amount
will De payable without interest.
Both series of bills will be
issued entirely in book-entry form in a minimum amount of S10, 000
and in any higher S5, 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
March 7, 1991.
Tenders from Federal
Treasury bills maturing
as
Reserve Banks for their own account and
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
to the extent that the aggregate amount
monetary authorities,
of tenders for such accounts exceeds the aggregate amount of
Federal Reserve Banks currently
maturing bills held by them.
million
as
agents for foreign and international
hold S 1, 030

authorities, and S 4, 459 million for their own account.
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
monetary
Tenders

series).

we-1353

TREASURY'S

13- 26-

AND

52-REEK BILL OFFERINGS

PRg~ 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
A single
two decimals, e. g. , 7. 15%. Fractions may not be used.

the names of the customers and the amount for each customer are
Others are only permitted to submit tenders for their
furnished.
Each tender must state the amount of any net long
own account.
bills being offered if such position is in excess
the
position in
of $200 million. This information should reflect positions held
as of one-half hour prior to the closing time for receipt of
Such positions would include
tenders on the day of the auction.
"when
issued"
bills acquired through
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.
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
competitive tenders.
A

issue price as determined

in the auction.

and

1/91

trust

TREASURY'S

13-, 26-,

AND

52-MEEK BILL OFFERINGS,

Page 3

Public announcement will be made by the Department of the
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.
Treasury

Settlement

for accepted tenders for bills to be maintained

will be
maturing
new

made

for differences

bills accepted in

bills.

between the par value of the
exchange and the issue price of the

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
Accrual-basis taxpayers, banks, and other
the bill matures.
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.
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
Department

the Public Debt.
8/89

ta tment of the treesury
Embargoed

until

~ NCIshlngton,

Given

Expected at 10:30

a. m. ,

February

D.C. ~ Telephone %IS-204'

27, 1991

TESTIMONY OF
THE HONORABLE

NICHOLAS

P-

BRADY

SECRETARY OP THE TREASURY

BEFORE THE HOUSE COMMITTEE
BANRINGg

FINANCE~

MODERNIZING

Committee,

Recovery,

time for a fundamental

depository

institutions

Wylie,

and members

of the

Institutions

Reform,

Act of 1989 (FIRREA) asked the

to undertake
and

SYSTEM

ago the Financial

and Enforcement

Congress

AFFAIRS

27, 1991

Congressman

over 18 months

Administration
system.

Gonzalez,

URBAN

THE FINANCIAL

February

Chairman

AND

a broad

study of our financial

the Administration
reexamination
and

realized that

was

of the basic laws governing

the taxpayer's

exposure

through

deposit insurance.

Earlier this mon h, we delivered to Congress our final
legislative proposal will be
report. The Administration's
submitted shortly.
Today I will describe our recommendations
to
But before doing so, I'd like to describe some of
the Committee.
the disturbing conditions I see today in our banking system

because they leave taxpayers

disturbing
and

businesses

underserved,
and unable

uncompetitive

role in stimulating
Today,

the world's

and

overexposed,

the banking

consumers

industry

to effectively perform its essential
sustaining

economic growth.

the United States does not have a single bank
25

largest.

Twenty

years ago

we had

seven.

among

of pure size is not the whole story. But
against the backdrop of an economy that is twice the size of our
nearest competitor's, I wonder if anyone can explain the complete
absence of U. S. banks from the list of world leaders.

course, the question

Surely that

statistic tells

us something.

Some have

that the "Top 25" list does not matter. To me, it is
strong evidence that something is very wrong. Would we be

suggested

comfortable
No

with no aerospace companies

pharmaceutical

computer

top 25?

manufacturers?

not.

Obviously

companies?

in the world's

start with,

have

left

antiquated

laws on the books

that prohibit banks from providing new products in their natural
markets, and that even keep them from branching across state

lines.

Banks in Texas, Ohio,

Birmingham,

laws

England,

mainly

touch with
consumers,

and

California

but not in Birmingham,

enacted in the 1920s and 30s

can open branches
Alabama.

These

are wholly out of

reality, and impose unnecessary costs on banks
costs that have been estimated at $10 billion

and

annually.

Consumers

have long since begun

affairs their

conduct their financial

cards, cash machines

they want.

when

and where

away

from the banks,

Motor

and

the 800

and now

business

loans through

them

and

using credit

to effect transactions

have increasingly

get auto loans from

Credit, checking services

funds,

own way,

number

Customers

to ignore

from Vanguard

and

turned
and Ford

GMAC

Fidelity

mutual

Electric Credit Corporation

General

Sachs, and they save at Merrill Lynch and Sears

and Goldman

Roebuck.

from

its original

and now
and

have a deposit

purpose

who

to potential

that has wandered

system

of protecting

covers almost every depositor,

only the small

large

This . ystem has protected

uninsured.

investors

insurance

don't need the protection,

and

small,

away

depositor,
insured

large, sophisticated
and exposed

the taxpayer

losses.

collapse,
insured deposits
we still allow state banks to invest federally
directly in real estate and other risky investments -- practices
chartered banks to engage in.
we don't allow federally
Despite the hard lessons

Small banks
imposed
seem

find themselves

on them by innumerable

to require multiple

reports

learned

from the S&L

choking

on unnecessary

state

and

on every

federal statutes

paperwork

that

possible subject.

that is in the grasp of no less than
four separate federal regulators, so that its ability to run
day-to-day affairs and respond quickly to changed conditions
such as the credit crunch -- is hamstrung by a myriad of
We

have an indus' ry

Lilliputian

its

restrictions.
that is so

that, in some
regions, it has withdrawn from its crucial role of extending
credit to worthy borrowers to finance economic activity and job
We

have an industry

weakened

growth.

it all

does

add up

to?

Bank

stress.

under

It's
to correct

a bleak picture

that

demands

action

prompt

action--

it.

Our banks

hold $2. 8

trillion in deposits.

That means that

there is simply no bank insurance fund large enough to protect
the taxpayer, unless and until we address the underlying
problems.

reform,
branching

and a
and

need

have deposit

insurance

reform,

supervisory

recapitalized BIF. But we also need interstate
broader financial activities so that our banks can

financially strong again. If we leave the job half done
if we tinker with the problem -- then we' ll probably be back
again, sooner or later, recapitalizing BIF, perhaps the next time
with taxpayer money.
I don't relish that prospect any more than
become

you

de
This

fight

among

not just another

financial

Businesses

products

costly

taxpayer

when

Consumers

is strong

needs

and unnecessar

need a broader

they go to the bank.
banks that

well-capitalized

need strong,

The

nation needs a

toe to toe with
rivals have to offer. And most of

the best our international

all, the

results.

in good times and bad.

system that

banking

needs

and workers

can keep lending

intramural

services companies over banking reform.

This time, the country

choice of financial

in the biannual,

round

enough

compete

be spared the prospect

of another

cleanup.

at their core;
to deal with them decisively and comprehensively; and to turn
this situation around. The laws must be changed to foster a safe
and financially
strong banking system where the number of costly
The time has come

failures is dramatically
the reality of today.
their customers.

to address these

reduced.

It is

time

problems

Banking

regulation

to let the

banks

must

catch

fit

up with

ecific

The Administration's

first,

problems:
and

financial

Reforms

proposal

a banking

system with reduced

caused by outdated

strength,

three interrelated

addresses

com

etitiveness

legal restrictions

that have prevented banking organizations from responding to the
evolution of financial markets and technology; second, an
overextended de osit insurance s stem, resulting in excessive

for taxpayers and weakened market discipline for banks;
s stem that has created
and third, a fra ented re lato
duplicative rules and has often failed to produce timely remedial
exposure

action.

Restored

The competitiveness

undercut

Com

etitiveness

of the banking industry

the erosion of the traditional

bank

has been

franchise.

Banks

under

extremely

restricted in

of states.

a number

While banks have been confined

have

consumers

800 number,
The

With

can

consumers

public

not.

artificial

boundaries,

credit cards, cash machines,
now

"bank" anywhere

not bound by our banking

laws.

and

the

in the country.
Yet the banks must

to labor under these antiquated restrictions, which have
been estimated to cos'-. $10 billion each year, against a pre-tax
industry profit figure of $25 billion for all of 1989. And these
costs are passed on to the consumer in higher transaction costs
and higher interest rates.
continue

and soundness

How

of the banking system.

do we reverse

steadily profitable

and

this trend?
competitive,

How

do we make banks

better able to attract

to lend in good times and bad? The
outdated laws to recognize
we need to overhaul
answer is plain:
I think that Chairman
the realities of the current marketplace.
Greenspan captured this need perfectly in earlier testimony,
He said that:
which I'd like to quote.

capital,

and more ready

Developments

in computer

have reduced

the economic role of commercial
and fundamental

These permanent
environment
and

technology

and communications

banks.

in the

changes

cannot be halted by statutory

prohibitions,

the longer the law refuses to recognize that

fundamental

less relevant

and permanent

the

changes have occurred,

will be as a force for stability

and

fairness in our financial markets.
Attempts to hold the present structure in place will be
defeated through the inevitable loopholes that
innovation forced by competitive necessity will
competitive

develop,

although

there will be heavy costs in terms of

respect for

competitive

fairness

critical to

a safe and sound financial

and

should begin by authorizing

nationwide

law which

is so

system.

banking

and

safer through diversification,
and more efficient through substantially
reduced operating costs.
This is not a radical new idea. A majority of states have
already embraced the concept of interstate banking.
Thirty-three
states -- two-thirds of the country -- have voted to permit
nationwide interstate banking, while another 13 states permit
regional interstate banking.
But the laws on the books impose
enormous costs on the system by virtually prohibiting
interstate
branching.
These laws block interstate banking companies from
achieving enormous immediate cost savings through such measures
branching,

which

will

make banks

common

management

and

consolidated

data processing

systems.

are directly available

to reduce transaction and
overhead costs, to lower interest rates and to build both profits

These savings

and

capital.
But well-capitalized

banking

organizations

must

also be

to use their franchise to participate in the full range
of financial services in their natural markets -- but to do so
allowed

safely outside the bank and outside the federal deposit insurance
safety net. The taxpayer should not back these new activities.
Neither should the taxpayer bear the cost of a banking system
that has been artificially restricted into unprofitability.

at this time

And

strong,
banks

when

well-capitalized
as well

agreements

banks need

financial

Overextended

Deposit insurance

and commercial

so long as they are willing

that will maintain

capital,

large institutional

deposit insurance

has dramatically

own

osit Insurance

coverage has expanded

investors.

firms to

banks.

well beyond

original purpose of protecting small depositors.
guarantees the deposits of wealthier individuals,
and

allow

to adhere to

well-capitalized
De

should

Instead,

corporations,

This broad extension

increased

its

taxpayer

exposure.

now

its

Left to
funding

higher

own

costs

But our overextended

workings,
on

the market would have imposed

for excessive risk taking.

institutions

deposit insurance

system has undermined

the

market

other people's money,

exposing the taxpayer

even

greater

losses.
Reduction

address the problems

in overextended

of overextended

coverage, without

for small depositors
in the banking

covera

in overextended

system.

eliminate

would

for retirement

Protection of Uninsured

by reining

the basic protection
coverage for brokered

fund managers

and

$100, 000 per person per institution,

institution

would

losing the benefits of stability

for certain pension
through" coverage.
In addition,
deposits,

This proposal

deposit insurance

reducing

and without

would

with "pass-

limit coverage to

plus a separate

$100, 000 per

savings.
De

ositors.

would

also curtail

virtually all uninsured
depositors in bank failures.
Protecting uninsured depositors
should be the exception, not the rule, and should occur only
where there is genuine risk to the financial system.
The system
that we have proposed would eliminate routine protection of
the routine practice of protecting

uninsured

depositors.

Criticism has
charges that

big to

come from both

have not

fail" policy,

sides of this issue.

totally eliminated

under which uninsured

One

side

the so-called "too

depositors

are fully

protected in large bank failures in order to avoid massive damage
to the financial system. But no government among the leading
industrial nations has deprived itself of the ability to protect
uninsured
should

depositors

not be the

The

when

the system is threatened.

first to try

None.

the experiment.

protect all deposits in
are to protect any -- in order to be

other side claims that

should

institutions -- if we
fair to large depositors in smaller banks. But what about
fairness to the taxpayer? It is bad enough that there are times
when it is impossible to avoid bailing out large depositors
in
certain bank failures; but should the taxpayer foot the bill for
gJ, large depositors in all bank failures as a result? Extending
the safety net to insure all deposits is a backward step.
My

point

is that the

American

people should

not be asked to

policy that puts the financial system at risk
Instead, we have
and one that puts the taxpayer at risk.
banks that are
proposed a system with strong, well-capitalized
choose between

less likely to fail, and a supervisory system that intervenes
promptly and decisively before failure can occur.
11

of the heat surrounding this issue is over the question
of who should pay for protecting uninsured depositors.
The
practice in some other countries is for the taxpayer to pay
Much

because of the fundamental

benefits to the financial

to the entire
this position.

recognize that there are arguments

banking

systemic

economy

industry

reflects the

our proposal

However,

shou). d pay because

system and

view

for

that the

directly benefits

from

stability.

ital and su ervision. Reducing
itself cannot resolve our current

Stren thened role of ca
overextended

coverage by

Deposit insurance

problems.

will

still protect --

and should

protect -- a substantial part of each bank's funding base. It is
therefore critical to strengthen the role of capital and improve
supervision to make deposit insurance safe for the taxpayer.
Capital

is the single

shareholders'

most important

own money

invest prudently.

And

ahead of the deposit

The proposal

protection.

puts the

at risk and thus provides incentives to
it acts as a buffer that absorbs losses

insurance

fund.

would make bank supervision

creating incentives for banks to build
of capital, and providing swifter and

and maintain

effective

high levels

certain regulatory

against banks with too little capital. Indeed, the
failure to take prompt corrective action in the past allowed some
intervention

institutions

to fail

when

they could have been saved,
12

and

fostered low capital levels that create incentives for firms to
take excessive risk. The proposed new system would address these
problems by creating :~ regime of specific supervisory actions
that are triggered by declines to increasingly lower levels of

capital.
isk-based

remiums.

risk-based

Assessing

premiums

which

to levels of capital would also help.
Because capital is a crucial measure of risk, firms would be
In
rewarded with lower premiums for maintaining higher capital.
addition, an FDIC demonstration project would test the
feasibility of using private reinsurers to provide market pricing
vary according

would

for risk-based premiums.

state ct'v'ties. Finally, states should no longer
authority to authorize risky activities for state banks that
s

have

receive federal deposit insurance.

balance was struck in

for state thrifts between the benefits of the dual banking
We should
system and the interest of the federal government.
strike this same balance for federally insured state banks.
FIRREA

3. Streaml'
Bank

regulation

losses created
problems

I' ve

ed Re ulato

and supervision

deposit insurance.

outlined

above,

S stem

reduces taxpayer

But in the face of the

our fragmented

exposure

regulatory

system

has not, been successful

fund.

the weakening

failures that are rapidly depleting
There is not a satisfactory regulatory
correcting banking problems.

promptly

four banking

regulators

organization,

information

Our

single regulator

or the clear authority

proposal

would

of different

discipline

ways

and apply

streamline

that

prompt,

with as

Moreover,

many

in the affairs of a single

involved
no

for

mechanism

and

has had either the full

responsibility

decisive, timely action necessary to deal with

number

record loan

the bank insurance

and

banking

of the banking

In recent years, banks have experienced

industry.

losses

in stemming

weak

the regulatory

would

for the
institutions.

system

further supplement

in a

market

decisive corrective action to

weak

institutions.
First, to improve authority,
accountability, and responsibility, there would be a single
federal banking regulator for each banking organization.
Second,
and unsound

the current

system of three federal

to two:
all state banks
reduced

FDIC would

national
would

focus on

its

of failed institutions.

bank

regulators

banks would remain

under Treasury,

and

part of this plan, the
function as insurer and resolver

to the Fed.
primary

would

that taken in
FIRREA, where the thrift regulator and insurer were separated.
Except for receding from its role as the primary federal
supervisor for state non-member banks, the FDIC would retain all
of its existing examination and enforcement powers.
This approach parallels

Finally, the Bank Insurance Fund is at
history as a percentage of insured deposits.
Insurance

Corporation

further over the next

two

funds,

the FDIC could find

itself

years.

in possible exposure

The Bank Insurance

Without

with too

lowest level in

The

projected that

(FDIC) has

still

losses, resulting

its

Federal Deposit

will decline

an infusion

little

cash to pay for

for the taxpayer.

therefore be recapitalized.

Fund must

have said

that

does not further

any plan

should

impair the health

the plan should rely

Finally,
Last

fall,

as part of the

of the banking

GAAP

Omnibus

industry.

accounting.
Budget

Reconciliation

Act

(OBRA

Before concluding,

that have been

made

-- I

I'd like to

respond

think with

little

to two criticisms
merit. The first is

that

are

the mistakes that contributed

repeating

somehow

disaster. That is simply not the case. The banks are
totally different from the S&Ls. By a wide margin, banks are
better capitalized, better managed and better regulated than the
S&Ls. To be precise, the banks have over $200 billion in equity
capital, plus another $50 billion in reserves. The S&Ls had less
than $10 billion in equity in 1987, the year losses mushroomed.

the

S&L

to reform is distinctly

different.
The S&Ls were permitti. d to use federally insured deposits to
In effect, we
engage in risky activities inside the institution.
let S&L owners go to the casino with Uncle Sam's checkbook in
hand.
By contrast, we have proposed that new financial
activities for banking organizations take place only in
In addition,

separately

our approach

strict supervision.
activities
by a

only

substantial

It is

affiliates,

capitalized

And we

banks

that exceed

that

important

we do

S&L problem.

inaction and procrastination
memories

changes

costly

ve gone even further
minimum

in limiting

and
new

capital requirements

amount.

the specter of the

firewalls

with stringent

of the

S&L

not learn the wrong lesson from
With the banking

are the

cleanup prevent

would

be ironic

us from making

necessary

enemy

changes that could save the taxpayer

and unnecessary

cleanup.

system,

from another

is that

second criticism

are

somehow

embarking

on a

of the banking industry, again along the
lines of the S&L problem. That just doesn't square with the
facts. The proposal represents sound and prudent regulation,
with badly needed reforms to protect the taxpayer.
risky "deregulation"

Benefits of Reform

close my remarks with a discussion of the wide range
of interests that benefit from the Administration's
plan. The
Let

first

and most obvious

group are taxpayers.

Strong, well-

consumers,

both individuals

and

The

Our plan

would

third group is businesses

and workers,

who

need

able to count on bank credit in both good times and bad.
17

to be
Strong,

well-capitalized

banks can

act as shock absorbers in
problems.

temporary

work through

help customers

bad times

Strong banks can

also keep lending in an economic downturn, whereas weak banks are
often forced to contract and stop lending in order to continue to
meet

capital requirements.

often, fewer bankruptcies
The fourth

This

banks.

group

As a

occur,

is the

result, loans are called less
jobs are preserved.

and

banks themselves,

not a "big bank"

bill,

including

with nothing

small

for

of the plan particularly
benefits smaller banks, which have higher capital levels than
small banks.

larger banks.
in

Let

activities,

new

for

when

many

powers,

Gerry Corrigan

greater ability to

regulatory

I fully

institutions will
against larger rivals.

and New York enlarged

to prosper.

smaller banks continued

of the

freedom.

their own
They
years. For example, the evidence is that,

states such as California

branching

firms will

smaller

more than hold

have done so

Well-capitalized

premiums,

and more

expect that strong, well-managed
continue

nature

state again:

with lower insurance

be rewarded
engage

capital-based

The

New

York Fed,

"I am

absolutely

within-state
To quote

confident

that literally thousands of small- and medium-sized
will continue to flourish. " Our proposal does not
reducing

the

number

of small banks.

Our

institutions
aim at
proposal will lead to

earlier resolution of weak banks, many of which are anything but
small. The fact is that our plan favors strong banks, not big
banks; well-managed

banks,

not weak banks.
18

Well-capitalized,

well-managed

Finally,

smaller banks would prosper under our proposal.

the Administration's

nation as a whole.

The world's

proposal

benefit the

would

leading economy demands

a world-

class banking system.
as

Mr. Chairman,

I said earlier, this is

replay of the biannual,
This time, the country

choice of financial

intramural
needs

products

fight over banking reform.

results.
when

well-capitalized

in good times and bad.

system that

banking

is strong

need a broader

Consumers

they go to the bank.

Businesses and workers need strong,
can keep lending

enough

The nation

compete

rivals

all, the

be spared the prospect

costly

needs

and unnecessary

cleanup.

have

banks

that

needs a

toe to toe with

the best our international

taxpayer

just another

not

to offer.

And

most

of another

&artment

of the TteasurY

Weshlnlton,

O.C. ~ Telephone S66-2044

For Release Upon Delivery
Expected at 10:00 a. m.
February 27, 1991

STATEMENT OF
MICHAEL
GRAETZ
DEPUTY ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON FINANCE
UNITED STATES SENATE

Mr. Chairman

and Members

of the Committee:

pleased to present the views of the Administration on a
of proposals to provide tax relief to members of the Armed
Services. Most of the proposals listed in the Committee's
hearing announcement are specifically designed to benefit
military personnel participating in Operation Desert Storm,
although some of the proposals would grant tax relief to all
military personnel.
Before discussing these proposals in detail,
I would like to make a few general observations.
number

DESERT STORM TAX LEGISLATION

In the current crisis in the Persian Gulf area, the
President and the Congress have acted quickly to ensure that the
tax relief afforded by the Internal Revenue Code is available to
the military men and women serving in that area and to expand in
some respects the scope of that relief.
On January
21, 1991,
shortly after the commencement of hostilities, the President
signed Executive Order 12744, designating the Persian Gulf area
as a combat zone. This triggered the exclusion from taxable
income of combat pay under section 112 of the Internal Revenue
Code, the postponement under section 7508 of the time for filing
tax returns or taking other actions required under the tax laws,
and other tax relief that I shall describe below.
Within a few days thereafter, Congress passed and, on
January 30, 1991, the President signed into law legislation
NB-1155

(P. L.

102-2) that extended the coverage of section 7508 to include
individuals serving in the "Persian Gulf Desert Shield area" (as
designated by Executive Order) at any time back to August 2,
1990. This legislation also liberalized prior law by causing
interest on overpayments of tax generally to be credited to the
taxpayer during the section 7508 suspension period. Finally,
this legislation extended the section 7508 suspension period to
in the United States with
include periods of hospitalization
On February
14, the President signed
certain limitations.
Executive Order 12750, designating the Persian Gulf Desert Shield

area.

OVERVIEW OF TAX PROVISIONS
MILITARY PERSONNEL

Over

APPLICABLE TO DESERT STORM

the course of time, Congress has enacted a

number

to provide tax relief to members of the Armed Forces in time
of war. The oldest of these dates from World War I, and most
were in place long before the Vietnam War began.
Today, the
The
Internal Revenue Code incorporates many of these provisions.
laws

most important

follow:

Section 112 excludes from the income of members of the Armed
Forces all or a portion of compensation received for active
service in a combat zone or while hospitalized as a result of
wounds, disease or injury incurred while so serving.
Section 7508 postpones the time for filing returns, paying
taxes, claiming refunds, and taking any other action required or
permitted under the tax laws by disregarding the period that a
member of the Armed Forces serves in a combat zone or is
hospitalized as a result of injury incurred while so serving and
the next 180 days thereafter.
Section 692 a eliminates certain income tax liabilities of
a member of the Armed Forces who dies while serving in a combat
zone or as a result of wounds, disease or injury incurred while

so serving.
The tax liabilities affected are those for the year
of death and any prior year ending on or after the date the
member first served in the zone.
Uncollected taxes for prior
years are also forgiven.

Section 2201 provides that virtually all of the Federal
estate tax does not apply to a citizen or resident of the United
States if that person was killed in action while serving in a
combat zone, or died as a result of wounds, injury, or disease
suffered while serving in a combat zone. This provision does not
eliminate estate taxes that are credited to the states on account
of state death taxes.

ection 3401 a 1 excludes from the definition of wages for
purposes all compensation paid for active service in
a month for which the employee is entitled to the benefits of
section 112.
ection 6013 f allows the spouse of a member of the Armed
Forces (or of certain civilian employees of the Federal
Government)
who is in missing status as a result of service in a
combat zone to elect to file a joint return under certain

withholding

circumstances.

allowances and in-kind benefits, including, for example, the
value of quarters, subsistence and a variety of travel expenses,
medical benefits and household expenses.
The committee report
accompanying the adoption of section 134 contains a list of about
30 military benefits that are specifically excluded under this

provision.

In addition to the tax relief provisions found in the
Internal Revenue Code, the Soldiers' and Sailors' Civil Relief
Act of 1940, continued in effect in subsequent legislation and
now found in U. S. C. Title 50, Appendix,
contains two important
provisions affecting the calculation and collection of the tax
liabilities of members of the Armed Forces. Section 513 of the
Act, 50 U. S.C. app. g 573, defers the collection of income tax
from any person in military service for a period extending up to
six months after the termination of service if the person' s
ability to pay the tax is materially impaired by such service.
Section 206
accrues during the period of deferral.
No interest
of the Act, 50 U. S. C. app. $ 526, generally sets a limit of six
percent on the rate of interest that may be charged to a person
in military service during the period of service on liabilities,
including tax liabilities, incurred prior to entry into military

service.

ANALYS

OF PROPOSALS

as we turn to address
relief for military personnel, a
Kuwait.
The thoughts of each of
women serving our country in the
Today,

additional

proposals

for tax

in
ground
us are with the brave men and
war

underway

Gulf region.

to our military personnel is generally best
-- rather than tax
served by relying on direct appropriations
benefits -- to compensate our troops for their sacrifices. Tax
relief may be discriminatory, with income tax relief generally
most benefitting those with higher incomes and with special tax
provisions serving only those whose particular circumstances
enable them to take advantage of targeted tax relief.
Evenhandedness

to this cautionary note, our testimony today has
First, we
also been guided by a number of general principles.
believe that relief provisions that materially complicate the
ability of the taxpaying public to comply with the tax laws
Proposals that would necessarily add lines to
should be avoided.
the tax forms in widest use, such as the Form 1040, or complicate
Second, we
the instructions to those forms, should be resisted.
burdens
on
the
compliance
should try to avoid placing high
private sector. Former employers and others who have had an
with a member of the
employment or other business relationship
be
unnecessarily
burdened
in the process of
military should not
In addition

tax relief.
for military
We also believe that relief provisions
personnel should not produce unfair tax advantages relative to
similarly situated taxpayers who do not qualify for the relief.
Today's gesture of goodwill should not become a permanent source
of tax inequities.
Historically, military personnel actually
serving in a combat zone have received the greatest tax relief.
Proposals that offer to extend tax relief to military and other
personnel in more usual circumstances deserve close scrutiny.
Likewise, we should endeavor to ensure tax fairness between
reservists and other military personnel.
Even within the combat
zone, proposals whose benefits inure mainly to a few individuals
are less attractive than those with a wider scope of relief.
providing

Finally, review and modification of benefits available to
military personnel serving in the Persian Gulf conflict should be
done in a coordinated,
rational way and not on a piecemeal basis.
Further, modifications to the benefit structure that result in
increased costs must fit within the parameters of the 1990 Budget
Act. This means that discretionary expenditures (net of offsets)
must fit within the spending caps, and revenue losses and
mandatory expenditures,
must be paid for on a pay-as-you-go

basis.

The Administration
welcomes the opportunity to participate
in a process that reviews benefit proposals comprehensively,
applies rational criteria to their assessment, and fits them
within the Budget Act. To that end, Administration
representatives are currently scheduled to meet with the
Republican and Democratic Desert Storm Task Force Chairmen,
Senators McCain and Glenn, on Thursday, February 28, 1991.

this

comments

Committee

on legislative proposals being considered
today are subject to two qualifications:

these proposals must be considered in the
comprehensive context I have described; and

the Administration

reserves the right to withdraw its
support for particular measures if the overall package
does not meet the tests suggested.

In the remainder of my statement,
specific items listed by the Committee

I will

address the
in the hearing
announcement.
I also understand that the Committee has requested
the Administration
s position on S. 252, introduced by Senator
Warner on January 23. Accordingly, our comments on S. 252 are
included in this statement.
Combat

Enlisted personnel

Exclusion
in the

Section

Armed

income all compensation received
zone or while hospitalized as a

Forces

ll
may

exclude from

for active service in a combat
result of wounds, disease or
injury incurred while serving in a combat zone. In the case of
hospitalization, this exclusion is unavailable for any month
beginning more than two years after the date of termination of
combatant activities in the zone. Personnel performing service
in direct support of military operations in the combat zone who
qualify for hostile fire or imminent danger pay are also entitled
to this benefit.
current

law, commissioned officers are entitled to the
exclusion on identical terms as enlisted personnel, but the
amount excluded is limited to $500 per month.
Under

osa
The proposal would increase the exclusion
commissioned officers to $2, 000 per month.

'stration

amount

for

Position

consideration ought to be given to a direct
combat pay for commissioned officers in lieu of an
expanded income tax exclusion, the Administration
supports this
proposal so long as appropriate offsets are provided.
The
exclusion amount for commissioned officers was last increased to
$500 in 1966, in connection with the Vietnam War. The increase
in military wages and in price levels since that time justifies
Although

adjustment

increase in the exclusion amount to $2, 000, so that the
exclusion can once again provide relief comparable in real terms
to that which it formerly provided.
an

Penalt -free Withdrawals
Em

from IRAs and uglified
lo er-S onsored Retirement Plans b
0 eration Desert Storm Personnel

Law

Individuals are permitted to make contributions to IRAs up
to the lesser of $2, 000 or the individual's compensation for the
year. Contributions to IRAs are deductible if the taxpayer does
not participate in a qualified retirement plan or has adjusted
Earnings on
gross income below a stated threshold amount.
amounts held in IRAs are tax-deferred.
Retirement plans sponsored by employers are accorded special
tax treatment if certain qualification requirements are met.
Specifically, contributions to qualified plans are deductible up
to specified limits, the participants are not taxable on the
contributions or benefits provided until amounts are actually
distributed, and earnings on amounts held in trust are taxexempt.

Withdrawals are permitted from IRAs at any time, but are
permitted only from certain types of employer-sponsored
plans and
then only under circumstances specifically enumerated by the
plan. Withdrawals from IRAs, except those from nondeductible
contributions, are subject to income tax. Similarly, withdrawals
from qualified plans, except those from after-tax employee
contributions, are subject to income tax. In general,
withdrawals from IRAs and qualified plans prior to age 59-1/2 are
also subject to a 10 percent additional tax.

Pro osal

The proposal

Administration

permit Operation Desert Storm personnel
withdrawals from IRAs and employer-sponsored

would

penalty-free
qualified plans.
make

Position

There are currently before the Congress
proposals to permit penalty-free withdrawals

a wide variety

from IRAs for a
illness or
unemployment,

variety of circumstances, including
disability, and for such worthwhile expenditures as children s
education.
The Administration
has opposed each of these
proposals.
In general, the special tax benefits accorded
individual retirement accounts and employer-sponsored
qualified
plans are incentives directed toward retirement savings.
Therefore, the Administration does not support any withdrawals
from IRAs or qualified plans which would result in premature
consumption of retirement savings.
The President's FY 1992
Budget proposal which would permit penalty-free IRA withdrawals
for first-time home purchases is fully consistent with this

position as
retirement

constitutes

homeownership

savings.

uglified Veteran's

a principal

source of

Mort a e Bonds

Qualified veterans' mortgage bonds are general obligation
bonds of a state, the proceeds of which are used to finance
mortgage loans to veterans.
The issuance of qualified veterans'
mortgage bonds is currently limited to those states that had
qualified veterans' mortgage bond programs in effect before June
22, 1984 (Wisconsin, Texas, Oregon, California and Alaska).
Loans financed with qualified veterans' mortgage bonds may be
made only to veterans who served on active duty before January 1,
1977. The loan must be made with respect to a principal
residence and must be applied for before the later of 30 years

after the veteran leaves active service or January 31, 1985.
Each state program is subject to an annual volume limitation

based on issuance levels between January 1, 1979 and June 22,
1984. In addition, 95 percent of the net proceeds of an issue of
qualified veterans' mortgage bonds must be used for the purpose
of the issue; ice. , to make mortgage loans to veterans to
purchase principal residences.

sa
The proposal

veterans'

mortgage

n'st

would

bonds

permit

states to issue qualified

to veterans of Operation Desert Storm.

'on Position

When Congress
opposes this proposal.
out the issuance of veterans' mortgage bonds in 1984, it
stated that its reason for doing so was concern about "the
increasing volume of veterans' mortgage bonds being issued by a
number of States (more than $3. 5 billion in the years 1980
through 1982) and the potential for expansion of veterans'
mortgage bond programs to states that had not issued those bonds
in the past. " Congress decided to limit the issuance of these
bonds to preexisting state programs, to amounts based on previous
volume levels, and to veterans who served in active duty before
1977 to limit the potential Federal revenue loss from expansion
of veterans' mortgage bond programs. The Administration believes
these concerns are as valid today as they were in 1984 when the

The Administration

phased

restrictions

were imposed.

Additionally,
mortgage
and no

bonds

limitation

rules for qualified veterans'
limitation on the income of the veteran
the purchase price of the residence.

the proposed

impose
on

Veterans with substantial family or other wealth would therefore
be able to use government subsidized mortgages to purchase
expensive homes without any showing of the need for such subsidy
Moreover, much of the Federal
on the part of the veteran.
revenue loss from such a tax-exempt bond program would benefit
rather than the intended
bondholders and financial intermediaries
beneficiaries. The Administration feels this would be an

inefficient allocation of

government

resources.

Further, the Administration believes that this proposal
duplicate an existing direct subsidy
would substantially
entitlement program that more efficiently channels Federal
The VA
resources to facilitate homeownership by veterans.
veterans
to
mortgage guarantee program is already available
It guarantees a
(provided that they qualify for a mortgage).
portion of the mortgage, effectively allowing veterans to
and generally provides an
purchase a home with no downpayment,
interest rate below the private market rate. The percentage
subsidy decreases with the size of the loan.
Income Exclusion

Current

for Persian Gulf

POWs

and MIAs

Law

Regulations under section 112 provide
Forces in active service in a combat
a prisoner of war or missing in action is
active service in the combat zone for the

Armed

that a

member

of the

zone who there becomes

to continue in
period for which the
deemed

is entitled to that status for military pay purposes. In
the case of the Vietnam conflict only, section 112(d) adds
certain additional relief provisions.
Under one of these
provisions, the exclusion amount is not limited for commissioned
officers who are in missing status (which includes prisoners of
war). Under another, an unlimited exclusion is provided to
civilian employees of the Federal Government who are in missing

member

status.

Pro osal
The proposal would extend additional relief provisions
similar to section 112(d) to commissioned officers and civilian
employees of the Federal Government in missing status in
Operation Desert Storm.

Administration

Position

The Administration

supports

this proposal.

Inclusion of 0 eration Desert Storm Service in
Calculations under uglified Pension Plans

Internal Revenue Code and ERISA provide rules for
determining what years of service are required to be taken into
account under a qualified pension plan for participation, vesting
and benefit accrual purposes.
These rules generally do not
require that periods of absence due to military service be taken
The

into account. However, other laws may require periods of
military service to be taken into account under an employer's
defined benefit pension plan where the reservist is reemployed by
the employer following military service (see Alabama Power Co. v.
Qgyjy, 431 U. S. 581 (1977) (requiring such periods to be taken
into account under a defined benefit pension plan); compare
v. Chemi-trol Chemical Co. Inc. 754 F. 2d 169 (6th Cir.
1985) (permitting such periods to be ignored for purposes of
determining benefit allocations under a discretionary profitsharing

plan).

Under the Code, annual contributions
to a defined
contribution plan are limited to the lesser of $30. 000 or 25
percent of compensation for the year. This limit could preclude
or reduce significantly contributions to an employer's qualified
plan during a period of military service where the reservist is
no longer receiving the same compensation
from the employer as he
or she was receiving before being called up to military service.

under

The proposal

qualified

service.
s

would

pension

permit an employer to take into account
plans periods of absence due to military

ation Position

The Administration
supports permitting employers to take
periods of absence due to military service into account under an
employer's qualified pension plan and otherwise to facilitate
continuing participation in qualified plans during such periods.

In the case of defined contribution

plans,

would require a modification of the present
imposed on such plans to permit an employer

the proposal

limitation
to impute
compensation at the pre-military service level during the period
of military service. In that regard, a similar provision
(Section 415(c)(3)(C)) exists under present law which applies in
cases of periods of absence due to permanent and total

disability.

law

10
Above-the-Line

ent

Deductions

for Reservists

are generally allowed to deduct trade or business
expenses "above the line" (i.e. , in arriving at adjusted gross
arrangement with the employer
income) only under a reimbursement
the expenses.
substantiate
to
the
employee
which requires
employee trade or business
Otherwise, virtually all unreimbursed
expenses as well as any expenses that are reimbursed under a
nonaccountable plan must be treated as miscellaneous itemized
deductions, deductible only to the extent that the taxpayer's
total miscellaneous itemized deductions exceeds two percent of
adjusted gross income. In addition, generally only 80 percent of
the otherwise allowable cost of food, beverages and entertainment
is allowable as a miscellaneous itemized deduction.
Employees

Pro osal

deduction to all
The proposal would allow an above-the-line
military reservists for expenses, such as the cost of uniforms,
and travel and meals while away from home, in connection with

their reservist duties.
Administration

Position

The proposal
opposes this proposal.
not benefit reservists who have been called to duty
stations in the Persian Gulf area because they are not generally
incurring expenses of the type addressed by the proposal.
Instead, the proposal primarily would benefit reservists in the
United States in peacetime as well as during the current
conflict. It would complicate the administration of the tax laws
and taxpayers'
attempts to comply by adding provisions to both
The
the individual income tax form and its instructions.
limitations on deductions of employee business expenses were
enacted to simplify tax reporting and reduce recordkeeping
reservists from
requirements.
We do not believe that exempting
tax rules that apply to other employees, including other
government employees and members of the military, would promote
are a better
equity in the tax laws. Direct appropriations
method of insuring a strong and effective reserve force.
The Administration

would

Extend EITC

Current

to Milita

Personnel

Stationed Overseas

Law

a refundable earned income tax credit
Low-income workers with
(EITC) to certain low-income workers.
qualifying children may be eligible for an EITC of up to 17.3
percent of the first $7, 140 in earned income. The maximum amount

Current

law provides

of the

is $1, 235 for 1991.

The EITC is reduced by an amount
equal to 12. 36 percent of the excess of adjusted gross income
(AGI) or earned income (whichever is greater) over $11, 250. The
EITC is not available to taxpayers with AGI over $21, 245.

EITC

Families eligible

for the EITC may also qualify for two
eligibility criteria, income and
are the same as those for the EITC. An
additional credit is provided for qualifying children under the
age of one, as of the close of the taxable year of the taxpayer.
The maximum credit for 1991 is $357. A credit is also available
to taxpayers for qualified health insurance expenses that include
coverage for a qualifying child. The credit percentage is six
percent of earned income and the phaseout rate is 4. 285 percent.
For 1991, the maximum credit is $428.
In order to be eligible for the EITC, qualifying children
must have the same principal place of abode as the taxpayer for
more than one-half of the taxable year and such abode must be in
the United States. Thus, military families stationed overseas
are not eligible for the EITC.
supplemental
credits.
phaseout requirements

The proposal

military

personnel

would

The

extend

stationed

eligibility

overseas.

for the EITC to

tion Position
The Administration
supports this proposal, subject to
offsetting the revenue loss involved. In this connection, the
Defense Department and the Treasury Department have identified
certain potential improvements in reporting of relevant
information to military personnel.
Such reporting would serve to
notify military employees that certain items excluded from gross

income, such as combat zone compensation,
quarters and
subsistence (whether provided in-kind or by basic allowances in
lieu of these in-kind benefits), are included in the computation
of earned income for EITC eligibility purposes. Such amounts
would also be reported to the Internal Revenue Service.

xtension of the Period of Unem lo ent Com ensation for
Se grated from the Armed Forces
ndividuals Involuntaril
Separated

military

after being separated
to 13

weeks

personnel

from
unemployment

military

are unemployed for 4 weeks
service are eligible for up

who

compensation.

12
o osa
The proposal

would

conform the military

unemployment

to the civilian regime; i. e. , former service
compensation one week
members would qualify for unemployment
after separation from active military service and the maximum
period of unemployment compensation would be extended from 13
weeks to 26 weeks.
compensation

Adm'nistration

regime

Position

supports this proposal provided that
and the enhanced benefits are
offsets
are
provided
appropriate
three
categories of separated service
limited to the following
activated reservists, involuntarily separated
members:
personnel, and personnel extended beyond their regular release
The Administration

date.

Rollovers of Milita
Se aration Pa into
Eli ible Retirement Plans S. 252
Current

Law

Generally, current income tax and, if otherwise applicable,
early distribution penalties may be avoided on distributions from
qualified pension plans and other tax-preferred retirement
are "rolled
programs (including IRAs) if these distributions
over" to another retirement plan. There are a number of
technical requirements that must be satisfied under current law
in order to qualify for rollover treatment.
Pro osal

252 would exclude military separation pay from current
tax to the extent the pay is rolled over to a taxpreferred retirement program.
The severance pay rollover
generally would be required to satisfy the requirements of
existing law for pension rollovers, and the penalties for early
withdrawal from retirement programs under existing law would
income

Administration

Position

The Administration
As we
does not support this proposal.
understand it, military severance pay is awarded to those who
have been involuntarily
denied a military career in recognition
of the Federal Government's responsibility to help military men
and women ease their transition into civilian life. To permit

deferral of current income tax on this pay would benefit those
individuals who could afford to satisfy their transition expenses
with other funds.

13
INTERNAL

REVENUE

SERVICE ACTIVITY

In conclusion, I would like to mention certain efforts by
the Internal Revenue Service to respond to tax questions raised
Since August of 1990, the Service has
by Operation Desert Storm.
endeavored to develop procedures and guidance designed to ease
the tax burdens of our troops in the Persian Gulf area and their
families, as well as others affected by the crisis. To date,
this has resulted in the completion of several important projects
including the issuance of guidance in the form of answers to
frequently-asked
questions arising from the Persian Gulf crisis,
guidance to enable military personnel and others serving in
Operation Desert Storm to file early for tax refunds, and the
announcement
of a special procedure that will ensure that
applications for federal tax exemption of organizations set up to
help participants in Operation Desert Storm are reviewed and
processed quickly.
The Service has also made available free
electronic filing to families of individuals serving in Operation
Desert Storm. In addition, the Service is nearing completion of
several other important projects, including a pamphlet containing
a series of questions and answers and proposed regulations
relating to the combat zone compensation exclusion and section
7508. The Internal Revenue Service is committed to continuation
of its policy of addressing tax matters affecting Armed Forces
personnel in the Persian Gulf fairly and expeditiously.

This concludes
answer any questions

prepared

remarks.

the Committee

may

I will be pleased to

have.

artment of the Treasury

Nashineton,

O.C. ~ Telephone $66-204'

TEXT AS PREPARED
FOR RELEASE UPON DELIVERY
EXPECTED AT 2 P. MD
FEBRUARY

27, 1991

STATEMENT BY
THE HONORABLE DAVID C. MULFORD
UNDER SECRETARY FOR INTERNATIONAL AFFAIRS
DEPARTMENT OF THE Tf~URY
BEFORE THE SUBCOMMITTEES ON THE WESTERN HEMISPHERE
INTERNATIONAL ECONOMIC POLICY AND TRADE
COMMITTEE ON FOREIGN AFFAIRS
U.
HOUSE OF REPRESENTATIVES

AND

Mr. Chairman

and Members

of the Subcommittees:

I want to thank you for the opportunity to discuss the
status of the Enterprise for the Americas Initiative.
I have
found my previous appearances on the Initiative before these
Subcommittees very valuable, and I look forward to similarly

useful exchanges
Announced

today.

President

Bush

last June, the Enterprise

for

Initiative (EAI) focuses on building more productive
relations with our neighbors in Latin America and the Caribbean.
The President cited the Initiative in his State of the Union
address and will be submitting to Congress very shortly
legislation providing for implementation of all of its elements.
To underscore the importance the President places on this
legislation, I want to quote what he said to President Gaviria
of Colombia in their meetings on February 26: "I am absolutely
committed to its passage. "
The priority placed by the President on gaining necessary
authorities and moving forward on full implementation of the
Initiative is well founded. The United States economy is linked
to these countries through a wide array of trade and investment
ties, which the President's Initiative is uniquely positioned
to deepen and expand for our mutual benefit. This is a region
with which we share a common cultural heritage, and whose many
to democratic values,
new leaders have shown a strong commitment
market-based economic reforms and measures to attract
the Americas

investment.
NB-1156

These new leaders will help drive the successful
of the proposals contained in the Initiative.
implementation
to Mexico and South America, President Bush
trips
recent
In his
was impressed with the commitment on the part of leaders in the
region to pursue reforms that will improve their economic

competitive in attracting capital.
we are committed to pressing
To respond to this determination,
forward on every front to make the President's vision for the

prospects

and make them more

reality.
The Initiative proposes action in three areas -- trade,
investment, and debt -- thereby joining in a single endeavor
the three economic issues of greatest importance to the region.
I want to review these fundamental pillars with you briefly.
Trade: The President set the goal of a hemispheric free

hemisphere

trade system to increase trade and boost the economic
To work towards
potential of countries in the hemisphere.
this goal, we are negotiating a series of trade and
investment framework agreements with individual countries
and groups of countries in the region.
Successful
conclusion of the Uruguay Round will also make an important
contribution to this process.

Investment:
To help countries attract needed capital for
growth, the President suggested that the Inter-American
Development Bank (IDB) develop an investment sector lending
program to encourage countries to liberalize their
investment regimes.
In addition, the President proposed the
creation of a $1.5 billion multilateral investment fund,
managed by the IDB, to provide additional
support for
countries undertaking investment reforms'

Debt: The President recommended that the IDB join the IMF
and World Bank in providing support for commercial bank debt

reduction.
He also proposed to reduce the bilateral
debt
owed to the U. S. Government by countries in the region which
meet certain eligibility requirements.
The stock of
concessional AID and PL-480 debt would be substantially
reduced, and remaining dollar payments would be applied

directly to retire principal.
Interest payments on this
reduced debt would be made in local currency to support
environmental
projects in each country. A portion of nonconcessional Eximbank loans and CCC assets would be sold,
reduced or cancelled as part of an overall effort to
facilitate debt-for-equity, debt-for-nature, and debt-fordevelopment

swaps'

Efforts to implement the trade, investment, and debt
pillars of the Initiative began immediately after its
announcement.
Significant progress has been made to date.

Advancin

Free Trade

are engaged in discussions with countries throughout the
region to liberalize trade and investment and move toward the
goal of a hemispheric free trade system.
We

President Bush stated when he announced the Initiative
that the United States stands ready to enter into free trade
agreements (FTAs) with Latin American countries, in particular
with groups of countries that have associated for the purpose
of trade liberalization.
Our long term goal is to establish a
hemispheric free trade area. The first step in this process
will be an FTA with Mexico and Canada. FTAs will progressively
eliminate obstacles to the flow of goods, services and
investment, provide for the protection of intellectual property
rights, and establish fair and expeditious dispute settlement

mechanisms.

Eventual free trade agreements will bring substantial
benefits to the United States as well as the other countries
involved.
FTAs will result in increased U. S. exports, both in
the short and long term. The U. S. labor force will experience
significant job growth as a result of increased productivity
and output of the UPS. economyU. S. consumers will also
benefit from improved access to low cost foreign imports, and
U. S. producers will benefit from reductions in the cost of
intermediate inputs.
Our trading partners will experience a
rise in real wages, increased investment, and increased export
opportunities as a result of FTAs with the United States.
Presidents Bush and Salinas announced last June 11th that
Mexico would be the first country in this process.
Two weeks
ago, Canada joined us in these trade talks, to negotiate a
trilateral agreement. Such an agreement would foster sustained
economic growth for all three countries, which together compose
a market of over 360 million people and $6 trillion in output.
I should note that in order to achieve this agreement, we will
need fast-track authority.
Without such authority,
our
ability to negotiate such an agreement under the Initiative will

be severely

undermined'

Meanwhile, to advance towards our goal of hemispheric free
trade, the Administration is negotiating framework agreements
with individual countries and groups of countries in the region.
Framework agreements establish fora for addressing and
consulting on bilateral trade and investment issues. They
contain immediate action agendas listing specific trade and
investment issues of concern to both parties and areas in which

liberalization

needed.

Through

these agreements,

can

for free trade agreements and
the appropriate time arrives.
Chile has expressed an interest in FTA negotiations and we are
using the framework agreement to explore this possibility.
Framework agreements have been signed since June with five

discuss the requirements
facilitate negotiations

when

countries -- Colombia, Ecuador, Chile, Honduras, and Costa
Rica -- adding to those already in place with Mexico and
Bolivia. Negotiations are underway with a number of other
countries, including Jamaica, Venezuela, Peru, Nicaragua,
and a group of countries
Panama, El Salvador, Guatemala,
Brazil, Uruguay, and Paraguay.
composed of Argentina,

successful conclusion of the Uruguay Round will make an
important contribution to our goals of trade and investment
liberalization under the Initiative. We continue to work with
Latin American and Caribbean countries towards this end. We
have made a special effort to propose tariff cuts on products
of interest to Latin America in the context of Uruguay Round
tariff negotiations.
A

Better Climate for Investment
While it will take time to open borders and extend free
trade throughout the hemisphere, the potential for increasing
investment flows to the hemisphere is more immediate.
Latin
American and Caribbean countries are already competing for
capital with other dynamic economies, and they need to move
quickly to attract private investment both from abroad and at
home.
The Inter-American
Development Bank is developing an
investment sector lending program to encourage countries to
liberalize their investment regimes. The IDB has begun
evaluating the need for reform in individual countries, and we
anticipate the first investment sector loans moving forward in
Creatin

the next few months.

additional means to support investment policy reform
efforts, the President outlined his proposal for a multilateral
investment fund in his June statement.
This proposal is under
discussion with the IDB and other creditor governments.
We
see the fund supporting investment policy reform efforts, by
making technical assistance grants for privatization
and other
investment-related
reforms.
As an

The fund

should

spur

human

capital development

through

grants for worker retraining and education in support of
investment reforms.
To combat micro and small-sized enterprises'
lack of access to capital, the fund also could provide them
with credit and equity financing channelled through arrangements
organizations and
to be developed with local non-governmental
envision
the fund
other financial intermediaries.
would
We
in
the
region
placing special emphasis on smaller countries
such as those in Central America and in the Caribbean.

Accordingly, we are asking that Congress authorize a U. S.
contribution of $500 million, to be made available in five
annual installments
of $100 million each, beginning in fiscal
year 1992. We expect other countries to contribute two-thirds
of the fund's capital, to meet the goal of a $1.5 billion fund
over five years.
Reducin

Debt Burdens

Debt reduction

countries

economies.

in the region

The overhang

resources available

tool for encouraging
to sustain their efforts to reform their
of external debt has constrained the
growth and tested the resolve of nearly
region. By easing the burden of debt on
help them attract new investment capital

an important

for

every government in the
their economies, we can
and make the rewards of reform more immediate.
The reduction of
Initiative complements

official bilateral

debt proposed

under the
the Brady

the international efforts under
to address countries' commercial bank debt problems.
Bilateral debt reduction under the Initiative will be
particularly important for the relatively small countries that
owe a substantial
portion of their external debt to official
creditors, rather than to commercial banks.
The reduction of concessional debt under the Initiative aims
to change dramatically the current situation in which countries
to adjust their debt
must seek repeated Paris Club reschedulings
service payments to their ability to pay. The stock of
concessional debt will be substantially reduced at the outset,
depending on the individual circumstances of each country.
Moreover, new dollar payments on this reduced debt will be
As a result, a country' s
applied to retire principal.
Plan

concessional debt will be eliminated
shorter period.

within

a designated

and

This new approach would result in significant benefits for
debtor countries by making debt burdens more manageable,
eliminating the debt overhang, and improving investor confidence.
would also be assured of
As a creditor, the U. S. Government
repayment of a realistic sum, thereby maximizing its return in
the medium term.
As you know, last year's Farm Bill provided the authority
to reduce PL-480 (food assistance) debt for countries pursuing
strong economic and investment reform programs, and to establish
the mechanisms for channelling local currency interest payments
to support environmental projects. The President will soon
sign an Executive Order establishing the inter-agency procedures
will implement this authority.
through which the Administration
Pursuant to this order, we will be discussing PL-480 debt

reduction
We

with

individual

countries

believe that Chile, Jamaica

as they become eligible.
and

Bolivia could qualify

for debt reduction in the next few months. Given their good
standing with the IMF and World Bank, and their agreements with
commercial banks, these countries' current eligibility depends
of investment reforms. All
primarily on their implementation
three have liberal investment regimes and are discussing
possible additional measures with the IDB. Other countries
could also move to qualify for PL-480 debt reduction in the
near future.
To implement fully the debt reduction elements of the
Initiative, we need authority from Congress to reduce foreign
economic assistance obligations to AID in the same manner as
provided for PL-480 assistance in the 1990 Farm Bill. PL-480
debt constitutes only about one-fourth of the concessional debt
owed to the U. S. Government by Latin American and Caribbean
countries. A far larger share of this debt (some $5 billion)
is owed to AID. Substantial debt relief for these countries,
therefore, will need to involve action on AID debts as well.
will also be seeking authority to sell, reduce or
cancel a portion of assets held by CCC as a result of its
credit guarantee programs and a portion of Eximbank loans to
facilitate debt/equity, debt-for-nature and debt-for-development
will propose
The Administration
swaps in eligible countries.
these
objectives.
legislation in the coming days to accomplish
We

ort for the Environment:
In addition to substantial reduction of their concessional
debt, and possible swaps of their Exim and CCC obligations,
countries will benefit from U. S. willingness to direct local
currency denominated interest payments on the reduced PL-480
and AID debt instruments
to support environmental projects.
These interest payments will be deposited in an environmental
Su

fund in the debtor country, created under the environmental
framework agreement negotiated with the country.
Local
committees composed of debtor country and U. S. government
representatives and local non-governmental
representatives

should be in the majority)
environmental
funds'

will determine

the use of these

(who

creating a dedicated stream of payments to support
projects, the Initiative will provide the
continuity essential for sustained environmental progress.
The absolute amounts provided to environmental
projects under
the Initiative will be significant in relation to current levels
of environmental funding in most Latin American countries.
If
more creditor countries decide to provide comparable support,
the total amount of environmental
funds will increase
substantially.
The Initiative will also play a crucial
strengthening
institutional development in the environmental
area, by supporting local organizations active in the field.
By

environmental

of our key objectives here is to encourage grassroots
America to protect and preserve the
environment.
The active involvement
of local non-governmental
organizations (NGOs) therefore is an essential component of
One

efforts within Latin
this initiative.

will also create an Environment for the Americas Board
This Board -- composed of U. S. Government
representatives and non-governmental
representatives -- will
advise the President on negotiations of the environmental
framework agreements,
ensure that local administering bodies
are properly constituted and review countries' annual programs
for use of the funds.
We

in Washington.

We worked closely with this Committee
on the legislation
passed into law last fall to authorize PL-480 debt reduction
and on the authorization
passed by the House on AID debt. We
were pleased with the results of that process and look forward
to working closely with you on new legislation.
I think we agree
on the importance of reducing the debt burdens of Latin
American and Caribbean countries which are pursuing strong
economic policies, while we also provide critical support for
grassroots environmental projects in these countries.

Advancin

Our

Vision for the Hemis here

significant progress in recent months in
the Initiative forward, we cannot pause in our efforts.
Expectations in Latin America and the Caribbean are high: they
welcome U. S. recognition of the importance of its neighbors
President
and the need to address their pressing problems.
Bush delivered this message directly to key Latin heads of
state during his December trip to the region, vowing that the
implementation
of this initiative will not be tied up in
bureaucratic red tape on our part. At the same time, he was
impressed by the commitment of Latin American leaders to
implement economic policies that will help them compete for
scarce capital and achieve growth. Latin American and Caribbean
leaders welcomed the Initiative, and I would like to submit
their statements for the record.
While we have made

moving

Continued dedication of this kind in Latin America and the
Caribbean is absolutely fundamental to the success of the
Initiative. We, too, must follow through on our commitments and
move together with countries in the region and the IDB to
undertake the substantive work that must be done. We look to
Congress to support this historic effort for the Americas by
enacting the legislation necessary to implement the remaining
debt. and investment provisions, and as I noted earlier, fasttrack authority will also be critical.

I value our continuing dialogue on these issues and hope I
on your timely support for this important
count
Initiative.
can

}epartrnenC of Che Treasury

Washlngjon,

D.C. a Telephone SIS-2D44
Contact:

AS PREPARED FOR DELIVERY
EMBARGOED UNTIL
m.

10:00 a.

Barbara Clai.

202-566-525"

THE HONORABLE JOHN ROBSON
DEPUTY SECRETARY OP THZ TREASURY
WELCOMING REMARRS
AT THZ WHITE HOUSE
WEDNESDAY i FEBRUARY 2 7 i 1 9 9 1

THE CONFERENCE

Secretary Eagleburger, and thank you to our
distinguished guests who have come from throughout the nation
and the world -- to join us for this conference.
Thank you,

Lincoln once said education is the most important
the
subject
American people can be engaged in. And that is the
central purpose of this Conference at the White House -- to see
if the people of the United States can engage more broadly and
aggressively in providing management training, business
education, and economics education for the people of Central and
Eastern Europe.
Abraham

We see this initiative
as a continuation of the commitment
this country has already made to assisting the emergence of
democracy and free market economies in the region -- a commitment
marked by very tangible contributions
and by
by our government
the involvement of many of you in this room.
But the path to the free market, after a half-century under

command

economies,

difficult journey.
That is why we must find

a long and

is why we are here.
ways
to
to
bear
the
bring
great
today, and after this conference,
That

resources in management training
for the benefit of the people of Central

American

and economics education
and Eastern Europe.

are blessed in this country ~ith splendid insti. utions,
immense resources, and diverse skills with which to teach others
free market economy -- all
how to operate in a competitive
wav fr=~ basic accoun ing and inve. .tory ~~nage. -. ent to
sophisticated concepts in advanced economics.
«a, - "o use
Now is time for us to get to work a.-.d find ne
these considerable asse s.
We

ss-1157

this Conference to be concrete and
intend to define the needs for management training
and market economics education of Central and Eastern Europe and
identify some specific ways to meet those needs.
We

have designed

practical.

We are looking for results.
And one way to accomplish
results is to set specific goals. Thirty years ago, President
Kennedy motivated the nation by setting the specific goal of
putting a man on the moon by the end of the decade. That goal

was

accomplished.

So, we, too, have set some specific goals in management
training and economics education to be accomplished over a threeyear period:
Expose at least 10 million citizens of Central and Eastern
Europe to television and other media programs that explain
the workings of a free market economy;

Train or retrain
entrepreneurs;

at least 50, 000

managers,

Educate 10, 000 college-age students
and economics; and

management

workers

and

in the fundamentals

Train at least 200 teachers in management and economics, so
that they can go back to become the core faculties of the

future.

of these goals will not be easy, but we
are confident that the resources and the commitment are here to
do the job. And we must recognize, too, that our goals can only
be achieved if the governments and people of the beneficiary
countries contribute substantially to their accomplishment.
The accomplishment

time for us take the first steps to push this
It's time to knit together the resources and
forward.
the energies necessary to accomplish the education and training
So now

initiative

goals

goals,

is the

have

set.

look forward to working with all of you to attain these
I am confident we will do

it.

and

Now I would like to introduce
and another of
my colleague
the three coordinators for East European Assistance, Michael
Boskin, the Chairman of the Council of Economic Advisors, who
will act as the host of the first morning panel session.

Ladies and gentlemen,

Michael

¹¹¹

Boskin.

cirtment of the Treasury
EMBARGOED

Nashinyton,

O.C. ~ Telephone 566-20m

U"TIL GIVEN

EXPECTED A.
FEBRUARY

9:30

A. Y. .

27, 1991

III

STATEMENT BY JAMES H. FALL,
DEPUTY ASSISTANT SECRETARY FOR DEVELOPING
V.
DEPARTMENT OF THE TREASVRY
BEFORE THE
HOVSE BVDGET COMMITTEE

February

NATIONS

27, 1991

Mr. Chairman and members of the Committee,
is a pleasure
to have the opportunity to comment on the Treasury Department's
role in encouraging and facilitating financial support for
Operations Desert Shield and Desert Storm. As recent events have

underscored, the strong support of our allies has been crucial in
reaching the objectives of dislodging the Iraqi military from
Kuwait, restoring the legitimate government of that country, and
laying the groundwork for greater regional stability in the

future.

financial support from our allies has sharply reduced
the budgetary cost to the American people of our efforts. This
is an important objective of the U. S. government and, as you have
heard from others today, we have been remarkably successful in
generating strong financial support -- both in level of
to date.
and pace of disbursements
commitments
There have been intensive interagency consultations aimed at
for Operations Desert Shield and
maximizing foreign contributions
Desert Storm. The Treasury Department has played an active part
in these efforts, along with the State Department, the Defense
Department, NSC, and OMB. Treasury has also used the regular G-7
fora to
Finance Ministers' Meetings and other international
attain USG objectives.
In September, Treasury Secretary Brady visited several of
our allies in Europe and Asia to encourage financial and economic
support for the U. S. military presence in the Gulf and for those
countries severely affected by the crisis, particularly through
their support for the U. N. sanctions. At the same time,
Secretary of State Baker traveled to Europe and several Gulf
states with a similar message. These meetings accomplished much
in confirming the support of our major allies and in producing
the initial commitments of military and economic assistance.
The

As noted in the recent press release from the white House,
these approaches and subsequent contacts resulted in 1990
costs
commitments of $9. 74 billion by our allies for incremental
incurred by Operation Desert Shield. This represents about 88
percent of estimated total incremental costs for that period.
Additional commitments for the first three months of 1991 have
reached $43. 8 billion, bringing the total for the period August

through

March

to approximately

$53

billion.

Secretary Brady used the opportunity of a visit by Finance
Minister Hashimoto of Japan to New York during the most recent
G-7 Finance Ministers' Meeting in late January to consult with
The
the Japanese authorities on additional commitments.
government of Japan responded by offering $9 billion to support
Desert Storm in the first quarter of this year. This amount
represents a part of the $43. 8 billion committed so far for the
period through

March.

technical issues. The Treasury
of
accounts
system
is normally the initial recipient
of all foreign cash contributions for U. S. military activities
during Operations Desert Shield and Desert Storm. Under a law
passed last year, the Defense Cooperation Account has been
established at the Treasury to receive monetary contributions and
proceeds for Operations Desert Shield and Desert Storm. Using
the same interagency consultation process mentioned earlier, we
actively coordinate with the Department of State, Defense, and
OMB to ensure
that those monies received from foreign
contributors are credited against their commitments to the United
States for 1990 and for 1991.
Let

Department's

address

some

Aside from the military

the Treasury

Department
with the State
economies are most
seriously affected by the crisis. Key economies in the region,
such as Egypt, Turkey, and Jordan, were particularly
hard hit by
Saddam Hussein's attack on Kuwait and the imp'osition by the U. N.
of economic sanctions against Iraq. To complement the military
and diplomatic leadership of the United States, President Bush
announced on September 25 the creation of the Gulf Crisis
Financial Coordination Grou to: 1) maintain and support
effective implementation of U. N. economic sanctions against Iraq;
international resolve in mobilizing financial
2) demonstrate
assistance for the front line states; and, 3) establish an
informal coordination process to secure appropriate
responsibility-sharing
among creditors and donors for those

component,

is also actively engaged in a complementary
Department to assist those countries whose

countries

hardest hit by the

crisis.

effort

The Coordination Group has met four times, most recently in
Washington on February 5. The next meeting will take place on
March 11. Participants
include 26 countries, the European
Commission, and the Gulf Coordination Council.
Representatives
of the International Monetary Fund and the World Bank also atten~

to provide technical

The Coordination

and

analytical

support.

Group assists in quantifying
the
most seriously affected by the

needs of those countries

financial

crisis,

international resources to meet these needs and
encouraging the creditors and donors to direct these resources i. .
countries. The Group relies
a balanced manner to the individual

generating

on traditional
and does not

distribution.

bilateral channels between
pool or centralize resources

two-thirds
are being

Moreover,

disbursed,

states.

for further

has secured $14. 7 billion in
$11.4 billion has been pledged to
line states of Egypt, Turkey, and Jordan. Close to
of the assistance for which terms have been determined
made available in the form of cash or in-kind grants.
$7. 3 billion of the total commitments have already been
$4. 9 billion of which has gone to the front line

To date the Coordination
commitments.
Of this amount,

the front

donors and recipients,

Group

Also in response to suggestions made by President Bush and
Treasury Secretary Brady at the time of the Annual Meetings of
the World Bank and IMF, these institutions have taken rapid and
concrete action to adapt their lending procedures to permit them
to counter more effectively the economic effects of the crisis on
a broad range of countries.

Specifically, an oil import element has been incorporated
into the IMF's Compensatory and Contingency Financing Facility
used to compensate member countries for
(CCFF), traditionally
which
external shocks
reduce their foreign exchange earnings.
New potential
financing is estimated at up ter $5 billion,
depending on recipient countries having satisfactory energy
policies and an IMF program
For its part, the World Bank estimates that its commitments
to countries most affected by the crisis will increase by
Priority is being given to
$4 billion over a two year period.
and promptly implement
second-tier
countries
develop
helping
adjustment policies to strengthen their economies over the longer
run. As part of this effort, the Bank plans to increase its
Increased
concessional lending to lower middle-income countries.
Bank's
World Bank and IDA lending can be accommodated with the
The Bank is in the middle of a
current financial resources.
1988
and, therefore, has resources
in
capital increase approved
sufficient to meet increased demands.

In sum, our success in meeting the objectives of the
Coordination Group has been notable.
U. N. sanctions against

Iraq

Our ability to
have been imposed with significant success.
support key economies in their efforts to enforce the sanctions
is contributing to fulfillment of the U. N. mandates for Iraq to
withdraw from Kuwait and has helped to prepare the basis for

stability

in the region at the conclusion

of the war.

'Zamomics in Srunsi 4Qi" %uuigc nun t 8ainiry
%arfigt Economics Zd'ucution in Central and Eastern Europe'

Confcrc~IIt

Gay

~~c~@g

february 26 27, 1991
-

FOR IMMEDIATE
FEBRUARY 28,

RELEASE

1991

CONTACT:

BARBARA C LA Y
U.
TREASURY

202-566-5252

CONFERENCE HELD AT THE WHITE HOUSE ON MANAGEMENT TRAINING
ECONOMICS EDUCATION IN CENTRAL AND EASTERN EUROPE

AND

MARKET

Conference at the White House yesterday addressed specific
goals for management training for the emerging democracies of
Eastern and Central Europe.

exposing millions of people in that region
to the basic concepts of market economics;
retraining managers, workers, and entrepreneurs; and

Those goals included

via television

training
training

and

teachers

and

students

in management

and economics.

The Conference assessed urgent and long-term management
needs and recommended a mechanism for information-sharing
coordination of management training needs and resources.

training
and
The

conferees also agreed that the broad participation of American
industry would be the key to the success of this initiative.

The Conference

expose as

training

was an

many

initiative

East Europeans

the Bush Administration

as possible to American

management

economics education.
It brought together
200 leaders, including presidents and deans from

and market

approximately
major American

universities, CEOs and other high-level corporate
of
foundation presidents and representatives
representatives,
non-profit organizations, as well as leaders from the U. S.
Poland,
government and from Bulgaria, Czechoslovakia,
Hungary,
Romania,

and Yugoslavia.

in the region are on record as favoring more widespread
in the basic principles of market economics to
accelerate the pace of economic reforms and reduce the chances of
retrogression once reforms are in place. Since business
management
training and market economics education are two areas
in which the United States has a strong comparative advantage
relative to other countries, the United States is uniquely
equipped to play a pivotal role.
Leaders

training

Conference participants noted that the initiative could include:
providing support for the development of television materials
that introduce the basics of market economics and management;
teaching courses and workshops to students and workers in Centr;~1
and Eastern Europe; bringing teachers and students to the t;nitei
States for internships and academic programs; and providing

multilingual

curricula,

texts

and

other materials.

was hosted by the President's
Coordinators for
East European Assistance -- Deputy Secretary of State Lawrence S.
Eagleburger, Deputy Secretary of the Treasury John E. Robson, and
Chairman of the President's Council of Economic Advisers Michael
J. Boskin -- as well as Administrator of the Agency for
International Development Ronald W. Roskens, and Director of the
U. S. Information Agency Bruce S. Gelb.

The Conference

the speakers at the Conference were President Bush;
Treasury Secretary Nicholas F. Brady; John Brademas, President
New York University;
Drew Lewis, Chairman of the Citizens

Among

Corps and Chairman of Union Pacific; George Varga,
and CEO of Tungsram; Rand Araskog, Chairman and Chief

Democracy

President
Executive of ITT; and Thomas Langfitt, President and CEO of Pew
Charitable Trusts.
The Conference was moderated by David
of U. S. News and World Re ort, and former
Gergen, editor-at-large
White House Director of Communications.

States is committed to continuing
forward.
President Bush has visited Central
twice in the past 18 months to highlight our
reform. Since 1989, the Bush Administration

The United

to help

move

reform

Eastern Europe
strong support for
has:
and

Supported democratic reform through, for example, support in
monitoring elections; assistance to national legislatures
and an independent
media; help in drafting constitutions and
laws; and programs of English language and educational
reform.
Supported

bilateral

economic reform through, for example, major
commitments
involving about $1.5 billion in grants

other assistance to Central and Eastern Europe; creation
of Enterprise Funds in Poland, Hungary and Czechoslovakia to
nurture the development of a healthy, competitive private
sector; technical assistance for management training and
market economic education; privatization
and restructuring
of enterprises; and development of agriculture, business,
and

sectors.
Mobilized multilateral
su ort by initiating the "Group of
24" to support economic reform in Eastern Europe. The Group
of 24 has resulted in many billions of dollars in bilateral
financial pledges to Eastern Europe from other bilateral
financial,

and housing

as well as strong support from the IMF, the World
Bank, and other multilateral
economic organizations.

donors,

trade and investment agreements, GSP,
OPIC, Eximbank and other means, humanitarian
assistance,
particularly food and medical supplies where needed.
Provided,

through

an expansion of trade and investment
ortunities, and sponsored programs in the

Supported

o
and the environment.

oOo

areas of energy

scirtment of the Treasury
.=OF!

~-~l

':"AS:. A: ' 2: CQ
'

NOON'

'91

TREASURY'S

Washington,
'ZX.'AC.

O.C. ~ Telephone
:

566-204".

ce o .=. na.-. c. -.. =
""2/3 6-4350
'

52-WEEK BILL OFFERING

The Department of the Treasury, by this public notice,
invites tenders for approximately S 10, 750 million of 364-day
Treasury bills to be dated March 14, 1991,
and to mature
March 12, 1992
YD
No.
912794
(CUSIP
0). This issue will
million of new cash for the Treasury,
provide about S 850
as the maturing 52-week bill is outstanding in the amount of
Tenders will be received at Federal Reserve
S9, 910 million.
Banks and Branches and at the Bureau of the Public Debt, WashingThursday, . larch 7, 1991,
ton, D. C. 20239-1500,
prior to
12:00 noon for noncompetitive tenders and prior to 1:00 p. m. ,
Standard
Eastern
time, for competitive tenders.
The bills will be issued on a discount basis under competitive and noncompetitive bidding, and at maturity their par amount
will be payable without interest.
This series of bills will be
issued entirely in book-entry form in a minimum amount of S10, 000
and in any higher S5, 000 multiple,
on the records either of the
Federal Reserve Banks and Branches, or of the Department of the

Treasury.

bills will be issued for cash and in exchange for
bills maturing March 14, 1991 '
In addition to the
maturing 52-week bills, there are S 19, 871 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
The

Treasury

Federal Reserve Banks currently hold S 1, 657 million as
and
monetary authorities,
agents for foreign and international
These amounts represent
S 6, 633 million for their own account.
the combined holdings of such accounts for the three issues of
maturing bills.
Tenders from Federal Reserve Banks for their
moneown account and as agents for foreign and international
bank
at
the
will
be
weighted
average
accepted
tary authorities
Additional
discount rate of accepted competitive tenders'
amounts of the bills may be issued to Federal Reserve Banks,
monetary authorities,
as agents for foreign and international
to the extent that the aggregate amount of tenders for such
accounts exceeds the aggregate amount of maturing bills held
For purposes of determining such additional amounts,
by them.
foreign and international monetary authorities are considered to
million of the original 52-week issue. Tenders for
hold S 354
bills to be maintained on the book-entry records of the Department of the Treasury should be submitted on Form pD 5176-3.
week.

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page

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
A single
two decimals, e. g. , 7. 154. Fractions may not be used.

bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.

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

competitive

tenders.

issue price as determined

in the auction.

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.
No

1/91

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page

Public announcement will be made by the Department of the
of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejec-ion
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.
Treasury

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
funds
on the issue date, in cash or other immediately-available
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.
If a bill is

and is held to maturity,
as
ordinary income on the
the amount of discount is reportable
Federal income tax return of the owner for the year in which
Accrual-basis taxpayers, banks, and other
the bill matures.
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.

purchased

at issue,

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
Department

the Public Debt.
8/89

r
t

iartmeni of the Treasury,

.Jr
'I

Washington,

"--=Z6
I

"a"-"

991

O.C. ~ Telephone

S66-2D4&

"- 'r(
1

. . :-::-AS2

es' ee
20

—566 —Si73

Statement
Nicholas F. Brad'.
Secretary of the Treasury

pleased with today's timely announcement bg the regulators on
guidelines to clarify certain regulatory and accounting policies.
with the
..or the past several months, Treasury has been meeting
to
regulators, business leaders and bankers on credit av ailability
crunch.
credit
the
to
find a coordinated and sensible approach
lenders to make
We hope that the actions taken today will encourage
reviews in a
their
perform
examiners
prudent loans and assure that
balanced, sensible way.
'
commitment
I commend and stress the importance of the regulators
000 bank
7,
the
nearly
to promptly communicate these policies to
banks
een
be
examiners in the field. Confidence and understanding
are essential to sound lending
and their regula ory examiners
practices and to prudent, evenhanded, common-sense im lementation
of supervisory practices.

T E
Department

of the Treasun

FOR IMMEDIATE

March

4, 1991

~reaa)oft&
JJ

Public Debt

, ~-, ,

RELEASE

,',

ll'ashinyon,

CONTACT:

RESULTS OF TREASURY'S AUCTION

DC )t1"39

Office of Financing

OF 13-WEEK

202-376-4350

BILLS

for $8, 699 million of 13-week bills to be issued
7, 1991 and mature on June 6, 1991 were

Tenders
on March

accepted today (CUSIP: 912794WM2).

RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Low

High

Average

6. 08%
6. 09%
6. 09%

Investment
Rate

6. 28%
6. 29%
6. 29%

Price
98. 463
98. 461
98. 461

accepted at lower yields.
Tenders at the high discount rate were allotted 20%.
rate is the equivalent coupon-issue yield.
The investment

$1, 010. 000

was

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia

Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

Received
32 , 715
40, 767 , 875
27 , 800
42 , 665

50 , 665
32 , 925

2, 395 , 330

62 , 930

10 , 235

49 , 200

31 , 110
766 , 190
858 000

(in thousands)
32, 715
7, 413, 225
25, 945
42, 665
50, 665
28, 925
60, 330
19, 930
10, 235
49, 200
31, 110
76, 190

$45, 127, 6'0

858 000
$8, 699, 135

$40, 992, 165
1 708 190
$42, 700, 355

$4, 563, 660
1 708 190
$6, 271, 850

2, 326, 930

100 355

100 355
$8, 699, 135

$45, 127, 6'0

additional $25, 845 thousand of bills will be
issued to foreign official institutions for new cash.
An

LI DEBT NEW
Department

FOR IMMEDIATE

March

of the Treasury

4, 1991

Bureau of the Public Debt

RELEASE

~ lW'ashint,

CONTACT:

RESULTS OF TREASURY'S AUCTION

ton, DC "t~ "l9

Office of Financing

202-376-4350

OF 26-WEEK

BILLS

for $8, 623 million of 26-week bills to be issued
7, 1991 and mature on September 5, 1991 were

Tenders
on March

accepted today (CUSIP: 912794XE9).

RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate

Price

6. 05%
6. 35%
96. 941
6. 06%
6. 36%
96. 936
High
6. 06%
6. 36%
96. 936
Average
$10, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 88%.
The investment rate is the equivalent coupon-issue yield.
Low

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Received
28, 510
28, 595, 460

(in thousands)
Acce ted

28. 510
7, 641, 600
12, 420

Chicago
St. Louis
Minneapolis
Kansas City

12, 420
34, 650
40, 375
30, 575
1, 212, 870
35, 965
6, 120
45, 360

TOTALS

672 515
$31, 482, 125

672 515
$8, 623, 265

$27, 299, 485

$4, '40. 625

Philadelphia
Cleveland
Richmond

Atlanta

Dallas
San Francisco
Treasury
Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

17, 880
749, 425

220 695

34, 650
40, 375
28, 575
37, 870

15, 965
6, 120
37, 360
17, 880
49, 425

1 220

695

$28, 520, 180

$5, 661, 320

2, 150, 000

811 945

811 945
$8, 623, 265

$31, '82, 125

additional $234, 055 thousand of bills will be
issued to foreign official institutions for new cash.
An

NB-1162

' 'e„. . ~
~.

~ yartment

of the TreeIIIry

Nashlnoton,

Cl. C. ~

Telephone SII-204'

STATEMENT BY
THE HONORABLE NICHOLAS F. BRADY
SECRETARY OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS
COMMITTEE ON APPROPRIATIONS
U.
HOUSE OF REPRESENTATIVES

MARCH

Mr. Chairman

and Members

5, 1991

of the Committee:

It is

a pleasure to testify before you today on the critical role
the international
financial institutions (IFIs) as instruments
to achieve U. S. economic policy objectives in the world economy,
and international
and bilateral efforts underway to support
economic reform.
of'

the world community finds itself at the dawn of a new
order of' multilateral cooperation.
This order, emerging from the
fundamental
economic and political changes underway throughout
the world, holds forth the prospect for durable global peace and

Today,

prosperity.
Many East European

statist

and

Latin American

leaders are rejecting

approaches to organizing economic development.
A
revolution of thought is sweeping these countries, as well as
those in Africa and Asia. People throughout the world are
beginning to recognize that market economies are the best means
to secure prosperity and freedom.

Interdependence
amongst our economies is growing, and no longer
can any one country -- not even the United States -- achieve its
economic policy objectives in isolation.
Economic issues
increasingly dominate the international agenda.

confront us with both unique opportunities and
challenges.
We will all need to work together
as we approach the
future to secure the gains of the new order. In so doing, we
will also need to call increasingly upon the IFIs to play a
continuing central leadership role in helping to manage the world
economy and implement U. S. policy objectives.
Multilateral efforts are critical to supporting strong
economic policies and sustained growth throughout the world.
Our close relationship
with Latin America and the Caribbean,
however, also warrants a distinct bilateral approach on the part
of the United States to advance hemispheric prosperity.
We are
pushing ahead on the President's
Enterprise for the Americas
These developments

N8-1 ' 63

political and economic evolution --now underway throughout
and
both multilateral
world is still young.
Our support
-bilateral
for the process of economic reform will be an

the

The

important determinant
world order.

in the success and longevity

Global Role of the International

Financial

of the

new

IFIs

Institutions

are fortunate to be able to rely on the international
financial institutions as vehicles for pooling multilateral
efforts. Over the years, these institutions have served U. S.
policy well. They have helped us to reconstruct the world from
the ashes of World War II, reform the international monetary
system, address the problems of external indebtedness in the
They have done so in
developing countries, and tackle poverty
market-oriented
corner
sound
of the world by promoting
every
economic policies, consistent with U. S. foreign economic policy

interests.
Through their essential support for
institutions have strengthened U. S.

these

a sound world economy,
growth, which supports

our
economic well being.
In 1990 alone, the external sector
Estimates
accounted for more than 40 percent of the U. S. growth.
suggest that roughly one out of every four new jobs in the United
States is related to merchandise exports.

recently,

the international

financial

institutions

have

demonstrated anew the vital contribution they are making
promote a sound world economy and to support U. S. foreign
economic and national security objectives.

institutions have been at the front of international
efforts to address the serious economic consequences of the Gulf
crisis, and stand ready to assist the region in the aftermath of
the war. In response to U. S. proposals, the International
Monetary Fund (IMF) adapted its procedures to provide fastdisbursing assistance, and has already committed $2. 8 billion of
increased financing to help countries offset higher oil costs.
The World Bank has intensified its lending plans for the front
line states such as Turkey and Egypt, as well as other countries
These

seriously affected
Bangladesh.

by the

crisis

such as the Philippines

and

IFIs are playing a leading role in Eastern Europe's bold and
dramatic effort to restructure economic and political life. The
IMF is currently backing sweeping reforms in Poland, Hungary,
and
Czechoslovakia; and support for Bulgaria and Romania should soon
be in place. Most recently, the IMF has completed negotiations
on a new $2 billion three year program for Poland to support

The

the Inter-American Development Bank (IDB) are important
agents in mobilizing private sector and government resources to
finance the basic infrastructure and service projects that
improve productivity
and living standards.
Last year the World
Bank Group provided $6. 0 billion and the IDB $3. 8 billion to
support policy reforms and projects for the region. The IMF,
World Bank, and Inter-American
Development Bank will be critical
to our efforts to encourage further reforms, creating a
productive environment for the success of the President's
Enterprise for the Americas Initiative (EAI).
and

In Africa, the IFIs are at the center of a concerted
international strategy designed to provide concessional resources
to help the poorest countries of the world achieve sustainable
growth, meet basic human needs, and alleviate widespread
suffering.
Total IMF commitments to these countries under the
concessional Enhanced Structural Adjustment Facility (ESAF), and
its predecessor facility, exceed $3. 5 billion. Last year, the
World Bank Group and African Development Bank Group made total
commitments of $7. 2 billion to the region.

the institutions are to meet the global challenges of the
1990s in a manner that serves our foreign economic policy
interests, we must stand squarely behind them and ensure that
they have adequate resources to do their job.
und

resource needs of the IMF are reviewed periodically to ensure
that the Fund has sufficient financing to fulfill its global
Last year, the IMF concluded negotiations on a
responsibilities.
50 percent increase in its resources from $130 to $195 billion.
The U. S. share of the increase is some $12 billion at current
exchange rates, for which we will be seeking Congressional
appropriations and authorization as part of the FY 1992 budget.
The

The increase in IMF
Passage of this legislation is essential.
resources is vital if the Fund is to provide financial assistance

the world and to secure U. S. objectives in the new
As I have already observed,
order of multilateral cooperation.
the IMF is providing vast amounts of resources in Eastern Europe,
Latin America, Africa, and Asia, to promote comprehensive marketoriented reforms and to address the costs of the Gulf crisis.
Overall Fund lending is expected to more than double in 1991 to
$16 billion in disbursements and remain high in subsequent years.
In addition to bolstering Fund liquidity to meet these near-term
financing demands, the quota increase will provide for adequate
Fund resources over the medium term.

throughout

increase will also help the Fund to keep pace with the
Over time, the size of the Fund's
growth in the world economy.
to roughly 4 percent of world
fallen
significantly
has
quotas
If the Fund is to be an effective lender of last
imports.
resort, it must be perceived as being of a meaningful size
relative to the problems at hand in the world economy in order
for countries to adopt appropriate adjustment measures and to
catalyze resources from other lenders.
The quota

the United States, as the leading and largest member
of the IMF, has a special responsibility to do its part in the
Failure of the United States to support the quota
organization.
legislation would seriously erode the effectiveness and
credibility of the IMF.
In this context, the United States, with some 19 percent of the
IMF's voting power, has effective veto over key IMF decisions,
such as quota increases and amendments to the IMF's Articles,
This veto power has often
requiring an 85 percent majority.
proven essential to ensure that the Fund operated in a manner
consistent with overall U. S. interests.
Furthermore,

is also extremely cost-effective in supporting U. S.
interests. First, the transfer of dollars to the IMF is like
putting money into a checking account which is interest-bearing
and can be drawn automatically.
In recognition of this unique
monetary character of the IMF, Congress has agreed repeatedly
over the years that use of the U. S. quota involves no net
budgetary outlays.
Under the recent budget summit agreement, a
specific provision was made to account for the unique budgetary
treatment of the quota increase. While use by the IMF of the
U. S. quota will increase Treasury's borrowing requirements,
the
interest earned on our position in the Fund offsets this cost.
Furthermore, the IMF leverages our scarce resources, which is
For
particularly important at this time of budget restraint.
The IMF

every dollar

put in, others put in four.

the quota negotiations, a number of steps were taken to
ensure that U. S. resources would be used far more effectively by
the IMF. Thus, at U. S. insistence, as an integral part of the
quota negotiations, the United States gained agreement on a
strengthened strategy to tackle the large and growing problems of
arrears in payments to the Fund. In recent years, arrears to the
During

Fund have grown
IMF

reserves.

some $5

billion, roughly twice the level of

arrears strategy is designed to protect the
financial position and to ensure that additional
contributions are wisely spent. This strategy is well balanced,
combining incentives for countries to clear their overdue
obligations with disincentives to deter new arrears cases.

The strengthened

Fund's

Mr. Chairman and Members of the Committee, the IMF is serving
vital U. S. interests throughout the world.
is an extremely
cost-effective organization.
To ensure continued strong U. S.
leadership in this critical global organization, I urge you to
support the proposed increase in the U. S. quota share in the IMF.

tilateral

Mr. Chairman,

appropriating
Administration

contributions

Develo ment Banks

MDBs

as you know supporting the MDBs requires
U. S. financial resources annually.
This year the
is requesting $1, 685 million for U. S. paid-in

to the

MDBs:

$1, 286. 8 million to meet previously

to the

payments

$70. 1
$1, 060. 0
$57. 3
$20. 5
$8. 9
$70. 0

agreed scheduled

MDBs;

million
million
million
million
million
million

World Bank

International

Inter-American

Development Association
Development Bank (IDB)

for Special Operations
Bank
European Bank for Reconstruction
IDB Fund

African Development

and

Development

$25. 5 million for the first installment to a Special Capital
Increase (SCI) for the Asian Development Bank (ADB);
$187. 5 million to cover U. S. funding shortfalls in the
agreed payments schedules to the Asian Development Fund
($175 million) and the Inter-American Investment Corporation

($12. 5 million); and
$185 million for "other" MDBs.
Of special note among previously authorized MDB programs, the
$70 million funding request for the European Bank for
Reconstruction and Development (EBRD) represents the second
installment of the U. S. contribution to this new institution.
The Bank

will hold

April 15

and

its inaugural meeting next month
is expected to begin operations

The
a market economy.
only promote economic and

early

significant contribution to
of the countries of the region
to the Bank will not
U. S. contribution
political stabilization in a region of

expect the Bank to
the unprecedented transformation
summer.

make

the world that is very important to us,
U. S. business interests in the region.

will also help promote

Special Capital Increase for the ADB, in which Japan, Sweden,
the United States participated, was approved by the ADB Board
of Governors in 1988. Japan sought the increase to make up for
the decrease in its percentage ownership that resulted from the
entry of China in the Bank and a previous SCI for several
European countries.
The United States joined in the increase to
maintain parity with Japan.
When the ADB was established
in 1966, the United States and
Japan, as the two pre-eminent economic powers in the region, each
subscribed to the same number of shares in the Bank's capital
stock. The presumption was that equal ownership would be
reflected in equal influence in the policies and operations of

The
and

the Bank.

most notably
Although the situation has changed since then
with Japan's rapid growth and the expansion of its influence in
Asia -- the United States' involvement and stake in the economic
and political development of the region remains strong.
Keeping
our relative share in the ownership of the Bank's capital will
enable us to maintain our influence in the ADB. We will thus
avoid ceding a measure of our influence in Asia in general, the
world's most rapidly growing region.
Mr. Chairman,

want

to thank

you and your Committee

leadership last year in reducing significantly
in providing scheduled payments to the MDBs.
important

year.

that

clear

up our remaining

for your

the U. S. shortfall
I believe it is

funding

shortfall this

It is true that because of exchange rate changes and lower-thanexpected lending levels in the past the Asian Development Fund
(ADF) has managed to mount a credible lending program despite
U. S. funding shortfalls.
The ADF has now reached the point,
however, where it must receive the U. S. funding shortfall in full
near the beginning of FY 1992, or cease its lending operations
early in calendar year 1992. This must not happen because the
ADF provides
financing on concessional terms to its developing
member countries, which are among the poorest in the world.
We
have a strong stake in encouraging their economic growth and
development,
and the ADF makes a major contribution to achieving

this objective.
The $12. 5 million funding request for the Inter-American
Investment Corporation (IIC) represents the fourth and final
installment for the institution s initial capitalization.
The
U. S. payment can be invested in equity operations, and, as part
of the capital base, can be borrowed against to fund additional
IIC activities.
The IIC is helping to meet the capital needs of
the region by mobilizing from private sources up to an average of
four times the amount of IIC commitments.
IIC operations also

help ful

f ill the

U. S. economic

policy obj ective of expanding the
as
the
sector
engine of sustained growth.

size of the private
In late February, the U. S. met all of its major policy objectives
for the sixth replenishment of the African Development Fund
(AfDF), and as a result, agreed to support a 3. 5 percent real
increase in the resources of this institution.
In the near
future, the Administration will submit a budget amendment
requesting that $135 million be transferred from the MDB "other"
category to the AfDF to provide for U. S. participation in AfDF-6.
Full implementation of the agreement will result in a fundamental
in the quality of this institution's
improvement
operations and
signals a new commitment by the donor community and management to
make the AfDF a more effective and productive development
institution.
The bulk of the Fund's resources will now be allocated to
countries that are providing the economic environment conducive
to development and growth. Countries not pursuing sound economic
policies will be restricted to core operations that can be
successfully even in the face of adverse economic
implemented
circumstances and policies. To improve loan quality, donors
agreed on new Board procedures allowing executive directors with
economic or technical concerns on a loan to return it to the Loan
We also
Committee so that these concerns may be addressed.
Fund's
environmental
staff,
the
reached agreement to strengthen
and increase emphasis on protection of forests and promotion of
energy efficiency and conservation.
in the MDB other category could be
Up to $50 million remaining
allocated to the International Finance Corporation (IFC) for a
capital increase. No decision has been made at this time about
however.
U. S. participation,
The IFC serves our policy goals in promoting the private sector.
Nevertheless, the IFC could be more effective in both promoting
needed developing country policy changes, and in encouraging the
rest of the World Bank group to give higher priority to the
private sector. The United States is, therefore, reviewing the
IFC capital increase proposal in the broader context of the need
for the entire World Bank group to give significantly greater
priority to private sector developments in the 1990s. The World
Bank's private sector activities should be strengthened and
enhanced, and there should be better coordination between the
World Bank and the IFC on key policy issues regarding private
in
We also want the IFC to be more selective
sector development.
the countries and sectors in which it operates.
'o

Strate

international community has called on the IMF and World Bank
pivotal roles in its efforts to address external debt
problems of developing countries.
The

assume

debt strategy, which has been shaped in large
part through U. S. leadership, has proven effective. Under the
debt strategy, we have seen real progress in reducing the debt
burdens of countries with strong economic reform programs.
Seven countries have reached agreements with their commercial
banks on packages that include debt and/or debt service
These countries account for almost half of the total
reduction.
The benefits
commercial bank debt of the major debtor countries.
For example:
are substantial.

The

international

The Mexican

agreement

reduced

annual

interest

payments

by 33
by

percent ($1.5 billion); commercial bank debt was reduced
38 percent; and the burden of $42 billion in principal
payments

was removed.

The Costa Rican agreement reduced that country's commercial
bank debt by 62 percent and cut annual debt service payments
by 74 percent.

Morocco, the Philippines, and Uruguay have also
reached agreements involving significant reductions in debt
burdens, and several other countries are continuing discussions
with their banks.

Chile, Venezuela,

These debt reduction agreements enable debtor countries and
Furthermore,
commercial banks to address their disparate needs.
these agreements are producing results for debtor economies by
helping restore investor confidence and stimulate new investment

flows.

of the IMF and World Bank is vital to achieving these
agreements.
The economic reform programs countries undertake
with these institutions enable countries to gain credibility with
The IMF has
their creditors and to proceed with negotiations.
committed $2. 8 billion and the World Bank $2. 7 billion to support
specific debt and debt service reduction instruments in countries
that have reached agreements with their commercial banks under
the strengthened debt strategy.
Under the President's new
Enterprise for the Americas Initiative, the Inter-American
Development Bank is joining the IMF and World Bank in providing
support for these commercial bank packages.
The ongoing support of these institutions
will help debtor
countries achieve real gains through economic reform and
commercial bank debt reduction.
The United States is also leading the effort to reach a consensus
with other major creditors to reduce Poland's official debt.
Reduction of Poland's large debt overhang is essential to support
the dramatic economic reforms Poland is undertaking.
The United
States has favored a substantial reduction of Poland's debt, and
we have been encouraged by recent progress with other key
creditor governments, although the final components of a package
and the extent of debt relief have not yet been determined.
The support

r the Americas Initiative
further effort to strengthen the
ise

In a
economies of our neighbors
in Latin America and the Caribbean and to improve trade
opportunities in the hemisphere, President Bush announced last
June the new Enterprise for the Americas Initiative (EAI).

This region

is of vital interest to the

of slow growth

States. Ten years
the economies of
opportunities for

United

and debt overhang have plagued
Latin America and the Caribbean and thwarted
the hemisphere as a whole.

for the Americas Initiative aims to address these
action in three areas -- trade, investment, and
debt. It thereby joins in a single endeavor the three economic
issues of greatest importance to the region. It also seizes, in
terms of timing and concept, on important developments already
underway in the region -- including the spread of democracy and a
clear commitment on the part of many leaders in the region to
pursue reforms that will improve their economic prospects and
make them more competitive
in attracting capital.
We are making
real progress in implementing the vision laid out
in the Initiative.
To increase trade and move toward the goal of
free
a hemispheric
trade system, we are pursuing a Free Trade
The goal of this
Agreement (FTA) with Mexico and Canada.
agreement is to foster sustained economic growth for all three
countries, which together compose a market of over 360 million
This FTA should expand and
people and $6 trillion in output.
recent
trade
and
investment
liberalizations achieved by
lock in
the Salinas Administration.
As you know, the President has just
sent a formal request to Congress seeking an extension of fast
track authority, which will enable us to negotiate effectively
The

Enterprise

problems

through

such an FTA agreement.

In announcing the Initiative, the President also indicated our
willingness to enter into an FTA with countries or groups of
countries throughout the region. We are negotiating framework
agreements on trade and investment to establish the basis for
These agreements establish
progress with a range of countries.
the context for addressing technical issues and beginning to
We are using the
remove barriers to trade and investment.
framework agreement with Chile to explore their interest in an
FTA.

Latin
Rapid progress can also be made on the investment front.
American and Caribbean countries are competing for scarce capital
with other dynamic economies.
They need to attract private
investment both from abroad and at home, and to reverse capital
flight, which in many cases is believed to be as large as their
total external debt. The Inter-American Development Bank is
developing an investment sector lending program to help countries
to open and liberalize their investment regimes. The IDB has
begun evaluating the necessary changes to achieve meaningful

10
reform in individual countries, and we expect that the first
investment sector loans will be moving forward over the next
several months.
proposed under the Initiative will be an
incentive for countries to carry out investment
reforms. We gained authority from Congress during the last
session to undertake reduction of concessional PL-480 debt for
countries pursuing strong economic reform programs, including
liberalization of their investment regimes. We will be
discussing such debt reduction with individual countries as they

The debt reduction

important

eligible.
The Initiative will also provide significant benefits for the
environment within the hemisphere pursuant to EAI Environmental
Framework Agreements negotiated with each eligible country.
Interest payments made in local currency on the reduced PL-480
AID debts will remain in the country to support
and, eventually,
a broad range of environmental
projects. We expect local nongovernmental
organizations with expertise in the environment and
conservation to play a strong role in determining the use of

become

these environmental

funds.

President transmitted to the Congress last week legislation
seeking authority from Congress to implement fully the investment
and debt elements of the Initiative.
is also
The Administration
reductions
and
the
requesting funding for implementation of debt
creation of a multilateral investment fund to support policy
reform.

The

of these resources -- $309. 7 million -- would cover the
cost under the new credit reform budget procedures of reducing
PL-480 and AID debt, and selling Eximbank loans and CCC assets in
FY 1992.
The remaining $100 million is the first installment
of the U. S.
contribution to the multilateral investment fund which the
President proposed be established in the Inter-America
Development Bank (IDB). We have been discussing in detail this
proposal with the IDB and other creditor governments.
The Fund
would make technical assistance grants to implement investment
reforms, build privatization expertise, and develop human
capital. It could also provide micro and small-sized enterprises
with credit and equity financing, addressing their lack of access
to capital in the region. We envision the Fund placing special
The bulk

on smaller countries in the region, such as those in
Central America and the Caribbean.
We will be seeking $500
million in total over a five year period.

emphasis

Protectin the Environment
In recent years the issues of protecting the environment has
taken on added importance.
Treasury has taken an active role in
championing this important U. S. policy goal in the IFIs.

objective has been to
of these institutions and

Our

improve
make

the environmental

them more

performance

effective agents of

focus is on: establishment of
impact assessment (EIA) procedures, protection of
tropical forests, and promotion of energy conservation and
efficiency, including integrated least-cost planning and
renewables.
We have pressed hard to mobilize more support
for
these issues over the past year: at the annual meetings of the
MDBs, in the Joint World Bank/IMF Development
Committee, and at
the Economic Summit in Houston last July.
reform.

environmental
environmental

Our

The EIA process is particularly
We have a legislative
important.
mandate to bring about a fundamental
reform in this area by the
end of this year.
Significant progress has been made in
the EIA process in both the World Bank and the
implementing
Inter-American Development Bank. Our overall assessment is that
effectively functioning EIA systems should be in place by the end

of this year.

The Asian Development Bank has upgraded its environmental
and made budgetary provision for increases in environmental

staff.

has said it will seek
issues.
environmental

to strengthen its procedures for
At this point, however, we are
will have in place by the end of

appraising
not yet certain that the Bank
the year an EIA system that meets our
EIA was highlighted
Fund Replenishment

judgment,

unit

criteria.

as a key element of the African Development
concluded in Rome
that it will be extremely

Agreement

however, is
meet our criteria

last month. Our
difficult for the

We intend
to
by the end of this year.
closely with both the African and Asian banks over the
next year to help them improve their capability in this area.
Energy efficiency and conservation is another area in which we
have an important legislative mandate.
In response to our
efforts over the past year, the World Bank has restructured its
Energy Sector Management Assistance Program (ESMAP) and created a
special unit for energy efficiency and conservation for its
operations in Eastern Europe. It is reassessing the approach it
has taken to energy issues in the past.
We have also continued
our efforts to encourage greater
protection for tropical forests. This has included our effort to
reform forest policies in both the World Bank and the InterAmerican Development Bank and an initiative to reform and
strengthen the Tropical Forestry Action Plan (TFAP). A meeting
designed to broaden public participation in TFAP is scheduled for
later this month in Geneva. We hope this meeting will produce a
more open process and provide the international
impetus that is
needed to help preserve large areas of primary tropical moist

AFDB

work more

forests.

Significant

progress is

progress
needed.

is being
We

still

made

these issues, although more
with specific loans,

have problems

the MDBs need to place more emphasis
conservation.
I believe, however, that

and

institutionalizing

on energy
we

are at,

efficiency and
the point of

in the way the MDBs
issues.
What
we
are
able to accomplish
environmental
address
half
will
be
critical in that respect.
over the next year and a
to influence policies and
We will look for new opportunities
procedures and promote specific projects, particularly in energy
efficiency and conservation and in forest programs.
fundamental

changes

have also offered to provide up to $150 million
financing to the World Bank's Global Environmental
the three year life of the facility. This is meant
greater interest in pilot projects that can become
regular lending program in future years.

in parallel
Facility over
to foster

part of the

States is also at the forefront in encouraging the IMF
to enhance its environmental focus. Widespread recognition has
emerged that IMF macroeconomic policy advice and prescriptions
can have at times an important, though indirect, impact on
environmental
protection. In particular, the IMF has decided to
establish a group of economists that will serve as a liaison with

The United

other organizations

on environmental
research and advise the Fund
environmental
concerns. Also, most IMF country
documents now discuss environmental
concerns. The IMF has also
strengthened its collaboration with the World Bank with respect
to taking into account structural measures for environmental
protection into its work.
on addressing

Reducin

Povert

alleviation of poverty has long been a driving force in the
of the IFIs. Many developing countries face macroeconomic
structural imbalances requiring the adoption of comprehensive
adjustment measures.
In this context, the U. S. is working to
ensure that IFI programs both protect and designed to help the
poorest segments of the population.
In the IMF, with our urging,
there is now a heightened emphasis of incorporating measures to
establish social safety nets to mitigate the affects of poverty
on the poorest and to help countries meet basic human needs.
The World Bank, consistent with the objectives of U. S.
legislation, is embarking on an effort to design assistance
strategies that will contribute more effectively to the reduction
of poverty. In negotiating the ninth replenishment of resources
for the International Development Association (IDA-9), the United
States and other donors agreed that a borrower country's economic
performance, including efforts to alleviate poverty, will receive
greater weight as criteria for allocation of resources.

The
work
and

The World Bank's 1990 "World Development Report" (WDR) focussed
on identifying
the key factors associated with reducing poverty.
Bank management
in response to a request from the U. S. and

other executive directors -- prepared a paper elaborating the
operational implications of the 1990 WDR. We generally endorse

the recommendations enunciated in the Bank paper, particularly
the recommendation that borrowing countries formulate their own
"National Strategy for Development and Poverty Elimination" with
the support and encouragement of the Bank. However, we have
expressed concern to the Bank that these measures can only be
implemented
if the Bank addresses seriously the issues of
adequate incentives for Bank staff and the implications of the
staff-intensity of the proposed recommendations.
This is an
issue that we will be monitoring closely, Mr. Chairman.
C

nclusion

briefly reviewed the role of the
international financial institutions (IFIs) in promoting U. S.
-- from their financial support to
national security interests
regions of the world such as the Persian Gulf, Africa, and Latin
America, to their involvement in functional issues like
I
protecting the global environment and alleviating poverty.
have also presented an overview of President Bush's Enterprise
for the Americas Initiatives
I have also discussed their
important role in promoting a stronger economy in which U. S. jobs
and exports can thrive.
The relationships
between U. S. national interests and the
activities of the IFIs are inextricably linked. Your strong
leadership, Mr. Chairman, and that of your Committee, has been
and will continue to be vital to the success of these programs.
Mr. Chairman,

have

portment of the Treesiiry ~ Washington,

John E. Robson

The Honorable

Deputy
U.

Secretary of the

of the Treasury

Department

Before the Committee
U.

House

O.C. ~ Telephone 566-2041

on Small Business

of Representatives

March

5, 1991

Mr. Chairman, members of the Committee,
appear before you today to address issues relating
availability of bank credit.

pleased to
to the
am

the last several months there has been
considerable discussion about the credit crunch and its impact on
the economy.
As we all know, accessible, affordable bank credit
is important to all businesses, large and small. And a safe and
financially strong banking system is the best assurance for the
During

availability

of credit.

Mr. Chairman, you and the Committee are to be commended
for your work during the last Congress in researching the factors
that promote a sound, financially strong and competitive banking
system.
Your Task Force report on "The International
Competitiveness of U. S. Financial Institutions" was very helpful
to us in the preparation of the analysis and recommendations
contained in our study, "Modernizing the Financial System, " on
which Secretary Brady testified before the House Banking

Committee

last

week.

Strong, competitive institutions are necessary for the
banking system to play the critically important role as a "shock
absorber" in our economy. When the economic needs of industry
expand, the banks are there to provide the credit necessary for
growth and capital investment.
And, when the economy contracts,
our banks are needed to patiently work with borrowers on their
NB-1164

capital needs and to absorb some of the shock from
falling sales and property values.
Today, I would like to give some opening comments

working

and
thrift
bank
and
then my colleagues representing the four
the Federal Reserve, the FDIC, the
regulatory agencies
Comptroller of the Currency, and the Office of Thrift Supervision
(the "Regulatory Agencies" ) will discuss more fully the
specific recommendations and proposals. My comments are in the
spirit of the Treasury's role in this effort. We served as a
"catalyst" in working with the Regulatory Agencies who actually
and are now acting to
developed the united set of recommendations
them
and
effectively.
implement
promptly

Factors Contributin

to the Credit

Crunch

For the last several months our country has experienced
a declining economy and our citizens have been preoccupied with
our service men and women in the Persian Gulf. This has had a
deleterious effect on consumer confidence and has negatively
impacted many borrowing decisions including home and automobile
sales and corporate capital expenditure plans. Thus, demands for
credit, have fallen. Likewise, with a softening economy, real
estate markets are experiencing increasing vacancy rates and
falling rents. Commercial banks, as in all downturns, have seen
a rise in non-performing
assets and the need for greater loan
-loss reserves
while at the same time they are working
diligently to raise capital to meet international standards.
Recognizing

these trends,

the Federal Reserve has

to lower short-term interest rates and reduce
the reserves that banks are required to maintain on deposit at
the Federal Reserve. These steps are meant to address both
credit demand by lowering rates and credit supply by freeing up
reserves that banks can then lend to sound borrowers.
Re lationIs Im act on the 8u l of Credit
However, even before the invasion of Kuwait, businesses
and banks perceived a more stringent regulatory approach.
It
must be said first that this approach was in substantial
measure
due to the application of prudent regulation in more severe
economic conditions, where the creditworthiness
of borrowers and
the values of real estate and loans had in fact deteriorated,
necessitating larger loan loss reserves. Praise, not criticism,
should be given to the bank regulators for vigilance in difficult
economic conditions.
No one wants a return to the dangerous
laxity that marked the savings and loan collapseHowever, the application of prudent regulation also requires
balance, common sense, and a recognition that banks, borrowers,
and economic sectors experiencing temporary difficulties may need
responded

by moving

some

flexibility to

regulatory judgment
in those situations.

work through their
should and can be

problems

and

quite responsibly

that
exercised

It is

in these areas of permissible and appropriate
regulatory judgment where the perception has been created among
banks and businesses that examiners are inflexible and overly
harsh. This perception -- right or wrong -- began to create an
atmosphere of risk-adversity,
apprehension and hesitation among
lenders, and has resulted in the constraint of bank credit even
to sound borrowers.
This undesirable atmosphere appears to have
been created in a number of areas of the country and seems to be
largely traceable to the examiners' overly pessimistic and rigid
application of regulatory guidelines in areas where supervisory
latitude exists and judgment can be properly employed.

in the past, examiners reviewed appraisal
information and also looked to the income generating capability
of a real property in order to determine adequate reserves.
However, regulators and bankers have recently reported a trend
toward using only worst case, liquidation-type
of valuations.
Another instance might be the case where an examiner has
instructed bank management to make a significant reduction in a
loan concentration over a short period of time. Under that
circumstance, many bankers will cease making or renewing any
loans -- even sound ones -- in that concentration area.
For example,

not the intention of the Regulatory
However, these
Agencies to create a repressive lending climate.
perceptions are not facilitating the proper atmosphere to
encourage bankers to work with borrowers experiencing problems
and to avoid shutting off credit to sound borrowers,
especially
those in sectors of the economy experiencing temporary problems.
in their statement released last Friday, the
And, commendably,
Regulatory Agencies stated that they "do not want the
availability of credit for sound borrowers to be adversely
affected by supervisory policies or depository institutions'
misunderstandings
of them. "

Certainly,

rovin

was

the Credit Climate

Following President Bush's State of the Union Address
urging "sound banks to make sound loans, " Secretary Brady
suggested to the leadership of the Regulatory Agencies that they
get their heads together and sort through the many
the
recommendations
from the Regulatory Agencies themselves,
business community and the bankers to address these issues.
a
On Friday, March 1, 1991, the Agencies announced
address
crunch.
to
credit
The
the
package
of
proposals
package
is the result of several weeks of work to determine what existing

supervisory

reassessed

and examination
and clarified.

policies

and

guidelines

should be

address a number of the areas of concern
the
community and the private sector.
both
regulatory
by
This includes guidance on the use of appraisals by examiners and
The proposals

raised

other valuation issues -- especially in troubled real estate
markets; broader disclosure to inform the investment community as
to the true earning power of loans which have been technically
placed in the non-performing assets category; continued prudent
lending by institutions operating under a capital plan or with a
loan concentration; clarification on the disclosure of credits in
(HLTs); and, the need for clear and
Highly Leveraged Transactions

effective communication between bankers and their regulators.
Furthermore, the Regulatory Agencies will continue to review
their supervisory practices to determine what other policies
require modification.

These Pro osals are not

may

'Forbearance~~

It is

important to properly characterize the actions
the Regulatory Agencies last week and to address
the concerns expressed by some that this is a kind of improper
and risky forbearance.
Such concerns have no foundation in fact.
In no part of this package of recommendations
from the Regulatory
Agencies is there any -- I repeat -- ~an proposal to create
fictitious capital, permit accounting practices not in accord
with generally accepted accounting standards, or otherwise
encourage "toying" with the books. This package encourages the
application of common sense and judgment in supervisory actions
and promotes lending to sound borrowers.
To condone an approach
of discredited forbearance would not be in keeping with the
reforms implemented under the Financial. . Institutions Reform,
Recovery, and Enforcement Act of 1989 (FIRREA) or that we are now
asking the Congress to consider as a part of our recommendations
to modernize the financial services industry
Furthermore, it
would ignore the disciplines of the market place and protect
institutions which operate in an unsafe and unsound mariner. That
is not the case here.
undertaken

ortance of Communication

Mr. Chairman, in the past, I have served as head of a
federal regulatory agency and as chief executive officer of a
company operating in a regulated industry
Thus, I believe I can
speak with some perspective on the dynamics of the regulatory
process. In order to achieve policy goals it takes clear
communication and a great deal of management effort to achieve
the desired policy objective.

prudent

I cannot emphasize enough that the encouragement of
lending activities rests on the shared confidence and

understanding
among both examiners and those whom they regulate.
The guidance released last Friday must be clearly communicated
to
the more than 6, 700 field examiners and to the financial
institutions, and implemented in an even-handed, common sense
manner.
I am pleased that each Regulatory Agency has committed
to make a special effort in disseminating these initiatives.
These steps alone will not end the credit crunch.
they should have a very positive impact on the
regulatory environment -- giving greater confidence to lenders
that extending credit to sound borrowers will not result in
regulatory retribution -- giving greater assurance to examiners
that their exercise of appropriate judgment, balance and
recognition of economic reality will not result in criticism from
their superiors -- and giving greater confidence to borrowers to
come forward in the expectation that sound projects will be
funded.
So, it is my hope that when combined with steps already
taken by the Federal Reserve to lower interest rates and reduce
bank reserve requirements,
these efforts will result in greater
credit availability to sound borrowers.

However,

I
questions'

would

be pleased

to respond to the Committee's

sartmeni of the Treasury

Nashlneton,

D.C. ~ Telephone

SII-204'

STATEMENT BY
THE HONORABLE NI CHOLAS F BRADY
SECRETARY OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS
COMMITTEE ON APPROPRIATIONS
UNITED STATES SENATE

MARCH

Mr. Chairman

It is

and Members

5, 1991

of the Committee:

to testify before you today on the critical role
of the international financial institutions (IFIs) as instruments
to achieve U. S. economic policy objectives in the world economy,
and international
and bilateral efforts underway to support
a pleasure

economic reform.

the world community finds itself at the dawn of a new
order of multilateral cooperation.
This order, emerging from the

Today,

fundamental

economic and

political

changes

throughout
global peace and

underway

holds forth the prospect for durable
prosperity.
Many East European and Latin American leaders are rejecting
statist approaches to organizing economic development. A
revolution of thought is sweeping these countries, as well as
those in Africa and Asia. People throughout the world are
beginning to recognize that market economies are the best means
to secure prosperity and freedom.

the world,

confront us with both unique opportunities and
as we approach the
challenges.
We will all need to work together
future to secure the gains of the new order. In so doing, we
will also need to call increasingly upon the IFIs to play a
continuing central leadership role in helping to manage the world
economy and implement U. S. policy objectives.
These developments

efforts are critical to supporting strong
economic policies and sustained growth throughout the world.
with Latin America and the Caribbean,
Our close relationship
however, also warrants a distinct bilateral approach on the part
Multilateral

We are
of the United States to advance hemispheric prosperity.
Enterprise for the Americas
pushing ahead on the President's

NB-1165

Initiative announced in June 1990. This Initiative will respond
to difficulties faced by Latin America and the Caribbean over the
past decade and support the commitments of many of the region's
new leaders to undertake
economic reforms.
the
The political and economic evolution now underway throughout
and
world is still young.
Our support -- both multilateral
bilateral -- for the process of economic reform will be an
important

determinant

world order.

in the success and longevity

Global Role of the International

Financial

of the

Institutions

new

IFIs

are fortunate to be able to rely on the international
financial institutions as vehicles for pooling multilateral
efforts. Over the years, these institutions have served U. S.
policy well. They have helped us to reconstruct the world from
the ashes of World War II, reform the international monetary
system, address the problems of external indebtedness in the
developing countries, and tackle poverty.
They have done so in
every corner of the world by promoting sound market-oriented
economic policies, consistent with U. S. foreign economic policy

interests.
Through their essential support for a sound world economy, these
institutions have strengthened U. S. growth, which supports our
economic well being.
In 1990 alone, the external sector
accounted for more than 40 percent of the U. S. growth.
Estimates
suggest that roughly one out of every four new jobs in the United
States is related to merchandise exports.
More recently, the international
financial institutions have
demonstrated anew the vital contribution they are making to
promote a sound world economy and to support U. S. foreign
economic and national security objectives.
These institutions have been at the front of international
efforts to address the serious economic consequences of the Gulf
crisis, and stand ready to assist the region in the aftermath of
the war. In response to U. S. proposals, the International
Monetary Fund (IMF) adapted its procedures to provide fastdisbursing assistance, and has already committed $2. 8 billion of
increased financing to help countries offset higher oil costs.
The World Bank has intensified its lending plans for the front
line states such as Turkey and Egypt, as well as other countries
seriously

Bangladesh.

affected

the

crisis

such as the Philippines

and

IFIs are playing a leading role in Eastern Europe's bold and
effort to restructure economic and political life. The
IMF is currently backing sweeping reforms in Poland, Hungary,
and
Czechoslovakia; and support for Bulgaria and Romania should soon
be in place. Most recently, the IMF has completed negotiations
on a new $2 billion three year program for Poland to support
The

dramatic

structural reforms. Final approval by the IMF Executive Board is
expected soon. In Eastern Europe overall, the IMF may commit
$8 billion in 1991. Moreover, the World Bank is planning to lend
$9 billion to Eastern Europe over three years, and the IFC will
play a key privatization role. In addition, the European Bank
for Reconstruction and Development (EBRD) will be ready to assist
the region later this year.
These institutions
are also providing essential support for
economic policy reforms and development in Latin America and the
Caribbean -- particularly
in the context of the international
The IMF serves as
debt strategy and the President's Initiative.
the primary catalyst for establishing the broad basis for sound
economic policies designed to mobilize savings and investment and
to reverse capital flight. The IMF has committed $12. 5 billion
to support economic policy reform in the region. The World Bank
and the Inter-American
Development Bank (IDB) are important
agents in mobilizing private sector and government resources to
finance the basic infrastructure and service projects that
Last year the World
and living standards.
improve productivity
Bank Group provided $6. 0 billion and the IDB $3. 8 billion to
The IMF,
support policy reforms and projects for the region.
World Bank, and Inter-American
Development Bank will be critical
to our efforts to encourage further reforms, creating a
productive environment for the success of the President's
Enterprise for the Americas Initiative (EAI).
In Africa, the IFIs are at the center of a concerted
international strategy designed to provide concessional resources
to help the poorest countries of the world achieve sustainable
growth, meet basic human needs, and alleviate widespread
suffering.
Total IMF commitments to these countries under the
concessional Enhanced Structural Adjustment Facility (ESAF), and
its predecessor facility, exceed $3. 5 billion. Last year, the
World Bank Group and African Development Bank Group made total
commitments of $7. 2 billion to the region.
If the institutions are to meet the global challenges of the
1990s in a manner that serves our foreign economic policy
interests, we must stand squarely behind them and ensure that
they have adequate resources to do their job.
Fund
IMF
e at onal Moneta
The resource needs of the IMF are reviewed periodically to ensure
that the Fund has sufficient financing to fulfill its global
responsibilities.
Last year, the IMF concluded negotiations on a
50 percent increase in its resources from $130 to $195 billion.
The U. S. share of the increase is some $12 billion at current
exchange rates, for which we will be seeking Congressional
appropriations and authorization as part of the FY 1992 budget.
The increase in IMF
Passage of this legislation is essentials
resources is vital if the Fund is to provide financial assistance

the world and to secure U. S. objectives in the new
order of multilateral cooperation.
As I have already observed.
the IMF is providing vast amounts of resources in Eastern Europe,
Latin America, Africa, and Asia, to promote comprehensive marketoriented reforms and to address the costs of the Gulf crisis.
Overall Fund lending is expected to more than double in 1991 to
$16 billion in disbursements and remain high in subsequent years.
In addition to bolstering Fund liquidity to meet these near-term
financing demands, the quota increase will provide for adequate
Fund resources over the medium term.
throughout

increase will also help the Fund to keep pace with the
the world economy
Over time, the size of the Fund's
quotas has fallen significantly to roughly 4 percent of world
imports.
If the Fund is to be an effective lender of last
resort, it must be perceived as being of a meaningful size
relative to the problems at hand in the world economy in order
for countries to adopt appropriate adjustment measures and to
catalyze resources from other lenders.

The quota
growth in

the United States, as the leading and largest member
of the IMF, has a special responsibility to do its part in the
organization.
Failure of the United States to support the quota
legislation would seriously erode the effectiveness and
credibility of the IMF.

Furthermore,

In this context, the United States, with some 19 percent of the
IMF's voting power, has effective veto over key IMF decisions,
such as quota increases and amendments to the IMF's Articles,
requiring an 85 percent majority.
This veto power has often
proven essential to ensure that the Fund operated in a manner

consistent with overall U. S. interests.

is also extremely cost-effective in supporting U. S.
First, the transfer of dollars to the IMF is like
putting money into a checking account which is interest-bearing
The IMF

interests.

automatically.
In recognition of this unique
monetary character of the IMF, Congress has agreed repeatedly
over the years that use of the U. S. quota involves no net
budgetary outlays.
Under the recent budget summit agreement, a
specific provision was made to account for the unique budgetary
treatment of the quota increase. While use by the IMF of the
U. S. quota will increase Treasury's borrowing requirements,
the
interest earned on our position in the Fund offsets this cost.
Furthermore, the IMF leverages our scarce resources, which is
particularly important at this time of budget restraint.
For
every dollar we put in, others put in four.
During the quota negotiations,
a number of steps were taken to
ensure that U. S. resources would be used far more effectively by
the IMF. Thus, at U. S. insistence, as an integral part of the
quota negotiations, the United States gained agreement on a
strengthened strategy to tackle the large and growing problems of
arrears in payments to the Fund. In recent years, arrears to the
and can be drawn

Fund have grown
IMF

reserves.

billion,

some $5

roughly

twice the level of

The strengthened

Fund's

e al Develo ment Banks

Mul

as you

Mr. Chairman,

U. S.

appropriating
Administration

know

the MDBs requires
resources annually.
This year the
$1, 685 million for U. S. paid-in

supporting

financial

is requesting

to the

contributions

MDBs

MDBs:

$1, 286. 8 million to meet previously
to the MDBs;

payments

$70. 1
$1, 060. 0
$57. 3
$20. 5
$8. 9
$70. 0

million
million
million
million
million
million

World Bank

International

Inter-American

agreed scheduled
Development Association
Development Bank (IDB)

for Special Operations
Bank
European Bank for Reconstruction
IDB Fund

African Development

and

Development

$25. 5 million for the first installment to a Special Capital
Increase (SCI) for the Asian Development Bank (ADB);

$187. 5 million to cover U. S. funding shortfalls in the
agreed payments schedules to the Asian Development Fund
($175 million) and the Inter-American Investment Corporation

($12. 5 million); and
$185 million for "other"

special note

MDBs.

previously authorized MDB programs, the
request for the European Bank for
Reconstruction and Development (EBRD) represents the second
installment of the U. S. contribution to this new institution.
Of

$70 million

The Bank

among

funding

will hold

April 15

and

its

inaugural

is expected to

significant contribution to
of the countries of the region
to the Bank will not
U. S. contribution
political stabilization in a region of

expect the Bank to
the unprecedented transformation
summer.

to a market

The
economy.
and
economic
only promote

meeting next month
begin operations by early

make

the world that is very important to us,
U. S. business interests in the region.

will also help promote

Special Capital Increase for the ADB, in which Japan, Sweden,
the United States participated, was approved by the ADB Board
of Governors in 1988. Japan sought the increase to make up for
the decrease in its percentage ownership that resulted from the
entry of China in the Bank and a previous SCI for several
The United States joined in the increase to
European countries.
maintain parity with Japan.
When the ADB was established
in 1966, the United States and
Japan, as the two pre-eminent economic powers in the region, each
subscribed to the same number of shares in the Bank's capital
stock. The presumption was that equal ownership would be
reflected in equal influence in the policies and operations of

The
and

the Bank.

the situation has changed since then -- most notably
with Japan's rapid growth and the expansion of its influence in
Asia -- the United States' involvement and stake in the economic
and political development of the region remains strong.
Keeping
our relative share in the ownership of the Bank's capital will
enable us to maintain our influence in the ADB. We will thus
avoid ceding a measure of our influence in Asia in general, the
world's most rapidly growing region.
Although

Mr. Chairman,

want

to thank

you and your Committee for your
the U. S. shortfall

leadership last year in reducing significantly
in providing scheduled payments to the MDBs.
important

year.

that

clear

up our remaining

I believe it is

funding

shortfall this

It is

true that because of exchange rate changes and lower-thanlevels in the past the Asian Development Fund
(ADF) has managed to mount a credible lending program despite
U. S. funding shortfalls.
The ADF has now reached the point,
however, where it must receive the U. S. funding shortfall in full
near the beginning of FY 1992, or cease its lending operations
early in calendar year 1992. This must not happen because the
ADF provides
financing on concessional terms to its developing
member countries, which are among the poorest in the world.
We
have a strong stake in encouraging their economic growth and
development,
and the ADF makes a major contribution to achieving
expected lending

this objective.
The $12. 5 million funding request for the Inter-American
Investment Corporation (IIC) represents the fourth and final
installment for the institution s initial capitalization.
The
U. S. payment can be invested in equity operations, and, as part
of the capital base, can be borrowed against to fund additional
IIC activities. The IIC is helping to meet the capital needs of
the region by mobilizing from private sources up to an average of
four times the amount of IIC commitments.
IIC operations also

help fulf ill the U. S. economic policy objective of expanding the
size of the private sector as the engine of sustained growth.

In late February, the U. S. met all of its major policy objectives
for the sixth replenishment of the African Development Fund
(AfDF), and as a result, agreed to support a 3. 5 percent real
In the near
increase in the resources of this institution.
future, the Administration will submit a budget amendment
requesting that $135 million be transferred from the MDB "other"
category to the AfDF to provide for U. S. participation in AfDF-6.
Full implementation of the agreement will result in a fundamental
operations and
in the quality of this institution's
improvement
signals a new commitment by the donor community and management to
make the AfDF a more effective and productive development

institution.

of the Fund's resources will now be allocated to
countries that are providing the economic environment conducive
to development and growth. Countries not pursuing sound economic
policies will be restricted to core operations that can be
successfully even in the face of adverse economic
implemented
circumstances and policies. To improve loan quality, donors
agreed on new Board procedures allowing executive directors with
economic or technical concerns on a loan to return it to the Loan
We also
Committee so that these concerns may be addressed.
staff,
reached agreement to strengthen the Fund's environmental
of
and
promotion
forests
of
protection
on
and increase emphasis
energy efficiency and conservation.

The bulk

to $50 million remaining in the MDB other category could be
allocated to the International Finance Corporation (IFC) for a
capital increase. No decision has been made at this time about
however.
U. S. participation,
The IFC serves our policy goals in promoting the private sector.
Up

Nevertheless, the IFC could be more effective in both promoting
needed developing country policy changes, and in encouraging the
rest of the World Bank group to give higher priority to the
private sector. The United States is, therefore, reviewing the
IFC capital increase proposal in the broader context of the need
for the entire World Bank group to give significantly greater
priority to private sector developments in the 1990s. The World
Bank's private sector activities should be strengthened and
enhanced, and there should be better coordination between the
World Bank and the IFC on key policy issues regarding private
in
We also want the IFC to be more selective
sector development.
the countries and sectors in which it operates.

al Debt Strate

international community has called on the IMF and World Bank
to assume pivotal roles in its efforts to address external debt
problems of developing countries.

The

debt strategy, which has been shaped in large
U.
S.
part through
leadership, has proven effective. Under the
debt strategy, we have seen real progress in reducing the debt
burdens of countries with strong economic reform programs.
Seven countries have reached agreements with their commercial
banks on packages that include debt and/or debt service
The

international

reduction.

commercial

account for almost half of the total
of the major debtor countries. The benefits

These countries

bank debt

are substantial.

For example:

reduced annual interest payments by 33
($1.5 billion); commercial bank debt was reduced by

The Mexican agreement

percent
38 percent; and the burden of $42 billion in principal
payments

was removed.

The Costa Rican agreement reduced that country's commercial
bank debt by 62 percent and cut annual debt service payments
by 74 percent.
and Uruguay have also
Morocco, the Philippines,
reached agreements involving significant reductions in debt
burdens, and several other countries are continuing discussions
with their banks.

Chile, Venezuela,

These debt reduction agreements enable debtor countries and
commercial banks to address their disparate needs.
Furthermore,
these agreements are producing results for debtor economies by
helping restore investor confidence and stimulate new investment

flows.

support of these institutions will help debtor
countries achieve real gains through economic reform and
commercial bank debt reduction.

The ongoing

The United States is also leading the effort to reach a consensus
with other major creditors to reduce Poland's official debt.
Reduction of Poland's large debt overhang is essential to support
the dramatic economic reforms Poland is undertaking.
The United
States has favored a substantial reduction of Poland's debt, and
we have been encouraged by recent progress with other key
creditor governments, although the final components of a package
and the extent of debt relief have not yet been determined.

'se for the Americas Initiative
In a further effort to strengthen the economies of our neighbors
in Latin America and the Caribbean and to improve trade
opportunities in the hemisphere, President Bush announced last
June the new Enterprise for the Americas Initiative (EAI).
This region is of vital interest to the United States. Ten years
of slow growth and debt overhang have plagued the economies of
Latin America and the Caribbean and thwarted opportunities for
the hemisphere

as a whole.

for the Americas Initiative aims to address these
and
problems through action in three areas -- trade, investment,
debt. It thereby joins in a single endeavor the three economic
issues of greatest importance to the region. It also seizes, in
terms of timing and concept, on important developments already
underway in the region -- including the spread of democracy and a
clear commitment on the part of many leaders in the region to
pursue reforms that will improve their economic prospects and
make them more competitive
in attracting capital.
We are making
real progress in implementing the vision laid out
in the Initiative.
To increase trade and move toward the goal of
a hemispheric
free trade system, we are pursuing a Free Trade
Agreement (FTA) with Mexico and Canada.
The goal of this
agreement is to foster sustained economic growth for all three
countries, which together compose a market of over 360 million
This FTA should expand and
people and $6 trillion in output.
lock in recent trade and investment liberalizations achieved by
the Salinas Administration.
As you know, the President has just
sent a formal request to Congress seeking an extension of fast
track authority, which will enable us to negotiate effectively

The

Enterprise

such an FTA agreement.

10
reform in individual countries, and we expect that the first
investment sector loans will be moving forward over the next
several months.

Initiative will be an
important incentive for countries to carry out investment
reforms. We gained authority from Congress during the last
session to undertake reduction of concessional PL-480 debt for
countries pursuing strong economic reform programs, including
liberalization of their investment regimes. We will be
discussing such debt reduction with individual countries as they
become eligible.
The Initiative will also provide significant benefits for the
environment within the hemisphere pursuant to EAI Environmental
Framework Agreements negotiated with each eligible country.
Interest payments made in local currency on the reduced PL-480
AID debts will remain in the country to support
and, eventually,
a broad range of environmental
projects. We expect local nongovernmental
organizations with expertise in the environment and
conservation to play a strong role in determining the use of

The debt reduction

proposed

these environmental

funds.

under the

President transmitted to the Congress last week legislation
seeking authority from Congress to implement fully the investment
and debt elements of the Initiative.
is also
The Administration
requesting funding for implementation of debt reductions and the
creation of a multilateral investment fund to support policy
reform.

The

of these resources -- $309. 7 million -- would cover the
cost under the new credit reform budget procedures of reducing
PL-480 and AID debt, and selling Eximbank loans and CCC assets in
FY 1992.

The bulk

$100 million is the first installment of the U. S.
contribution to the multilateral investment fund which the
President proposed be established in the Inter-America
Development Bank (IDB). We have been discussing in detail this
proposal with the IDB and other creditor governments.
The Fund
would make technical assistance grants to implement investment
reforms, build privatization expertise, and develop human
capital. It could also provide micro and small-sized enterprises
with credit and equity financing, addressing their lack of access
to capital in the region. We envision the Fund placing special
emphasis on smaller countries in the region, such as those in
Central America and the Caribbean.
We will be seeking $500
million in total over a five year period.
The remaining

objective has been to improve the environmental performance
institutions and make them more effective agents of
these
of
reform. Our focus is on: establishment of
environmental
environmental
impact assessment (EIA) procedures, protection of
tropical forests, and promotion of energy conservation and
efficiency, including integrated least-cost planning and
We have pressed hard to mobilize more support
renewables.
for
these issues over the past year: at the annual meetings of the
Committee, and at
MDBs, in the Joint World Bank/IMF Development
the Economic Summit in Houston last July.

Our

We have a legislative
The EIA process is particularly
important.
mandate to bring about a fundamental
reform in this area by the
end of this year.
Significant progress has been made in
the EIA process in both the World Bank and the
implementing
Inter-American Development Bank. Our overall assessment is that
effectively functioning EIA systems should be in place by the end

of this year.

The Asian Development Bank has upgraded its environmental
and made budgetary provision for increases in environmental

staff.

unit

has said it will seek
environmental
issues.

to strengthen its procedures for
At this point, however, we are
will have in place by the end of

appraising
not yet certain that the Bank
the year an EIA system that meets our

criteria.

as a key element of the African Development
Our
Agreement concluded in Rome last month.
judgment, however, is that it will be extremely difficult for the
AFDB to meet our criteria by the end of this year.
to
We intend
work more closely with both the African and Asian banks over the
next year to help them improve their capability in this area.
EIA was highlighted
Fund Replenishment

Energy efficiency
have an important

conservation

is another area

in which we
In response to our
efforts over the past year, the World Bank has restructured its
Energy Sector Management Assistance Program (ESMAP) and created a
special unit for energy efficiency and conservation for its
operations in Eastern Europe. It is reassessing the approach it
has taken to energy issues in the past.
and

legislative

mandate.

have also continued our efforts to encourage greater
protection for tropical forests. This has included our effort to
reform forest policies in both the World Bank and the InterWe

Development Bank and an initiative to reform and
strengthen the Tropical Forestry Action Plan (TFAP). A meeting
designed to broaden public participation in TFAP is scheduled for
later this month in Geneva. We hope this meeting will produce a
more open process and provide the international
impetus that is
needed to help preserve large areas of primary tropical moist
American

forests.

Significant

progress is

progress
needed.

is
We

being made on these issues, although more
still have problems with specific loans,

the MDBs need to place more emphasis
conservation.
I believe, however, that
and

on energy

efficiency

« and

are at the point
institutionalizing
fundamental
changes in the way the MDBs
address environmental
issues. What we are able to accomplish
over the next year and a half will be critical in that respect.
We will look for new opportunities
to influence policies and
procedures and promote specific projects, particularly in energy
efficiency and conservation and in forest programs.
we

in parallel
Facility over
to foster

part of the

States is also at the forefront in encouraging the IMF
to enhance its environmental focus. Widespread recognition has
emerged that IMF macroeconomic policy advice and prescriptions
can have at times an important, though indirect, impact on
environmental
protection. In particular, the IMF has decided to
establish a group of economists that will serve as a liaison with

The United

other organizations on environmental research and advise the Fund
on addressing environmental
concerns. Also, most IMF country
documents now discuss environmental
concerns. The IMF has also
strengthened its collaboration with the World Bank with respect
to taking into account structural measures for environmental
protection into its work.
Reducin

Povert

The alleviation of poverty has long been a driving force in the
work of the IFIs. Many developing countries face macroeconomic
and structural
imbalances requiring the adoption of comprehensive
adjustment measures.
In this context, the U. S. is working to
ensure that IFI programs both protect and designed to help the
poorest segments of the population.
In the IMF, with our urging,
there is now a heightened emphasis of incorporating measures to

establish social safety nets to mitigate the affects of poverty
on the poorest and to help countries meet basic human needs.

consistent with the objectives of U. S.
legislation, is embarking on an effort to design assistance
strategies that will contribute more effectively to the reduction
of poverty. In negotiating the ninth replenishment of resources
for the International Development Association (IDA-9), the United
States and other donors agreed that a borrower country's economic
performance, including efforts to alleviate poverty, will receive
greater weight as criteria for allocation of resources.

The World Bank,

The World Bank's 1990 "World Development Report" (WDR) focussed
on identifying
the key factors associated with reducing poverty.
Bank management
in response to a request from the U-S. and
other executive directors
prepared a paper elaborating the

operational

implications

of the 1990

WDR.

generally

endorse

s 0

briefly reviewed the role of the
international financial institutions (IFIs) in promoting U. S.
-- from their financial support to
national security interests
regions of the world such as the Persian Gulf, Africa, and Latin
America, to their involvement in functional issues like
I
protecting the global environment and alleviating poverty.
have also presented an overview of President Bush's Enterprise
for the Americas Initiative.
I have also discussed their
important role in promoting a stronger economy in which U. S. jobs
and exports can thrive.
The relationships
between U. S. national interests and the
activities of the IFIs are inextricably linked. Your strong
leadership, Mr. Chairman, and that of your Committee, has been
and will continue to be vital to the success of these programs.
Mr. Chairman,

have

portment of the Treosury
FOP. RELEASE AT

Washinyton,

4:00 P. M.

O.c. ~ Telephone 566-2041
Of f ' ce of Financ'. ".202, '376-4350

';a
.
=c.". 5, 199 '

TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury. by this public notice,
invites tenders for two series of Treasury b'lls totaling approx=Ma ch 14, 1991,
This
mately S 17, 200 million, to be issued
offering will result in a paydown for the Treasury of about S -", 675
million, as the maturing bills are outstanding in the amount of
.enders will be eceived at Federal Reserve
S 19. 871 million.
Banks and Branches and at the Bureau of the Pub' ic Debt, Washing"cn, D. C. 20239-1500, Monday, March 11, 1991,
p 'or
12:00 noon o" noncompetitive tenders and pr'or to ':00 p. m. ,
t'me, for competi. .e tenders.
Fastern Standard
. he t;;c
=e=. es offered are as follows:

91-day bills (to maturity da. e) for approximately
8, 600 million, representing an additional amount of bills
dated December 13, 1990, and to mature June 13, 1991
(CUSIP No. 912794 WN 0). currently outstanding
in the amount
of S 10, 056 million, the additional and orig'nal bills to be
reely interchangeable.
S

182-day bills for approximately S 8, 600 million, to be
dated March 14, 1991,
and to mature September 1", 1991 (CUS:.
.'&o. 912794 XF 6) .
The bills will be issued on a discount
and noncompetitive
bidding, and at maturity

basis under competiti. e
their par amount will
be payable without interest.
Both series of bills will be issued
entirely in book-entry form in a m'nimum amount of S10, 000 and in
on the records either of he Federa'
any higher S5, 000 multiple,
Reserve Banks and Branches, or of he Department of the Treasur. '.
The bi''s w''1 be issued for cash and in exchange for
In addition to the
Treasury b''ls maturing March 1', 1991.
13-week and 26-week bi' ls, there are S 9, 910 million of
ma uring
The disposition of this latter amount was
maturing 52-week bills.
announced last week.
Tenders from Federal Reserve Banks for the' "
own account and as agents for foreign and 'nternat'onal
monetar;
author ties will be accepted a. the weighted average bank discoun:
"-tes of accepted competit've tenders. Additional amounts of
bills mav be issued to Federal Rese ve Banks, as agents or ore
. .e
and international
monetary authorit. es, o he ex. ent tha
a-. ==egate amount o tenders for such accoun-s e..ceeds the aggre.
purposes of de"e"gate amount o= ma ur'n b'' ls he d by them. =-r
'.
".
an"
e"nat ona' mc.-.~. -ar;.
==e gn
mining s ch ad=it onal amounts,
',
mi''
-.
ho'
168
ion o. he ori inal
o
d S
a hc"ities a=e cons dered
Fe"era' Reser. ;e Banks current'y hc d
13-week and "6-week ssues.
mil' ion as age-. . :s for fo e g. . a d nternational
mone -ary
S 1, 5:
autho" 'es, and S ", 708 million ==r their z-n account.
. hese
amounts represent the ccmbined holdings of such accounts for
three issues of matur'ng bills. Tenders fcr bills to be maintained
on he book-entry records of the Department of the Treasury sh-. ld
be submitted on Form PD 5176-1 ( or 13-week series) or Form
PD 5176-2 (for "6-week ser'es).

. .

™~

TREASURY'8

26-

AND

52-REEK BILL OFFERINGS

P+g~

Each tender must state the par amount of bills bid fore
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
Fractions may not be used. A single
two decimals, e. g. , 7.

15:.

bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.
and dealers who make primary
Banking institutions
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
Others are only permitted to submit tenders for their
furnished.
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

Such positions would include
tenders on the day of the auction.
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

competitive

tenders.

issue price as determined

in the auction.

and

1/91

trust

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

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.

bill is

purchased

at issue,

and

of the Treasury Circulars, Public Debt SeriesNos. 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
Department

the Public Debt.
8/89

;

5510

Report on Tax Issues Relating to the 1988/89
Federal Savings and Loan Insurance Corporation
Assisted Transactions

Department of the Treasury
March 1991

Report on Tax Issues Relating to the 19SS/S9
Federal Savings and Loan Insurance Corporation
Assisted Transactions

On September 18, 1990, the Resolution Trust Corporation (RTC), in accordance with the
requirements
of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRREA), issued a report to the Congress and the Oversight Board of the RTC on the 1988/89
Federal Savings and Loan Insurance Corporation (FSLIC) transactions. '
The RTC Report
recommended further study of certain tax issues relating to the 1988/89 FSLIC transactions.
The
Treasury Department has examined whether legislation or other action is appropriate to address the
tax issues raised by the RTC Report. This report analyzes the tax issues raised by the RTC Report
and provides the Treasury Department's views on those issues.

I. INTRODUCTION
Until it was abolished by FIRREA, FSLIC insured the deposits of its member savings and loan
associations and was responsible for insolvent member institutions. During 1988 and 1989, FSLIC
resolved 199 insolvent financial institutions in 96 assisted transactions.
The assistance agreements
with respect to the 1988/89 transactions obligated FSLIC to make ongoing assistance payments to
the 91 institutions remaining after the restructuring of the insolvent financial institutions that i~ore
involved in those transactions.

FIRREA abolished FSLIC and established the FSLIC Resolution Fund (FRF) to assume all
of the assets and liabilities of FSLIC (other than those expressly assumed by or transferred to R'I'C).
FRF is administered exclusively by the Federal Deposit Insurance Corporation (FDIC). Thus, under
FIRREA, the FDIC (through FRF) has assumed responsibility for FSLIC's obligations under thc
1988/89 assistance agreements.
It is estimated that the cost of assistance with respect to the 1988/89 transactions v, ill exceed
$69 billion without considering the tax benefits involved in those transactions. ' In structurin
the
1988/89 assisted transactions, FSLIC increased its reliance on long-term assistance. As a result,

See Repon to rhe Oversight Board of rhe Resolution Trust Corporation and rhe Congress on lllE
1988/89 Federal Saplings and Loan Insurance Corporation Assistance Agreements (RTC Report).
See RTC Report (vol. I) at 9 and 68.

only a portion of the total estimated assistance with respect to these transactions
far (approximately $14.6 billion as of January 1, 1991).

has been

pai«hus

The most significant forms of continuing assistance provided in the 1988/89 transactions
described below.

Promissory notes. Promissory notes were provided to offset negative
generally bear interest at a specified cost of funds index plus a spread.

are

net worth and

2. Capital loss protection.

In virtually all of the larger 1988/89 transactions, FSLIC agreed
to pay acquirers assistance in an amount equal to the difference between the book value of "covered
assets" and the proceeds received upon disposition of the assets. This type of assistance is designed
to protect the acquirer from losses incurred with respect to covered assets.
The assistance
agreements generally grant FSLIC the right to purchase covered assets at market or book value.
In addition, many of the assistance agreements permit FSLIC to order the assisted institution to write
down the value of covered assets on their books to fair market value in exchange for a payment in
the amount of the write-down. Some assistance agreements limit the amount of such a write-down
to a percentage of book value or by other factors.

Typically, covered assets are assets that were owned by the acquired institution and that were
classified as nonperforming or troubled at the time of the assisted transaction.
In some cases,
covered assets include assets that were expected to become troubled within a relatively short period
of time. Some assistance agreements specifically identify the covered assets and others identify
these assets by category. Covered assets usually include some combination of real estate, loans in
various stages of default, delinquent loans (i. e. , usually loans at least 90 days past due),
noninvestment grade securities, and investments in subsidiaries.
Most agreements also permit or
require the assisted institution to provide financing to facilitate the sale of a covered asset. In some
cases the assistance agreements provide for these purchase money loans to become covered assets.

3. Guaranteed

FSLIC generally guaranteed the acquirer a minimum
yield maintenance.
return or yield on the book value of covered assets. This type of assistance is designed to ensure
that the acquirer would earn a minimum return over a base rate on covered assets. Any reduction
in the amount of covered assets, whether by way of a write-down, purchase by FSLIC (now the
FDIC), or other disposition, reduces the base on which yield maintenance payments are determined.
In general, guaranteed yields exceed the amount of market yield that the institution could otherwise
earn on the assets.

4. Indemnification and reimbursement Pom losses. The assistance agreements generally
obligate FSLIC to reimburse acquiring institutions for amounts incurred and paid in connection with
the satisfaction, settlement or compromise of certain claims and for reasonable costs and expenses
related to such claims. These claims include unreserved claims, challenges to the transaction, and
claims involving unassumed or undisclosed liabilities and nonexistent assets. The agreements also

' For

a more detailed discussion of the assistance provided in the 1988/89 transactions
Report (vol. I) at 30-49.

see RTC

-3require FSLIC to reimburse acquiring institutions for reasonable costs and expenses incurred by the
institutions in pursuing related claims (e. g. , counterclaims) undertaken with FSLIC approval.

The timing and structure of the 1988/89 assisted transactions can be attributed to t'ai o factors.
First, FSLIC did not have the financial resources required to liquidate insolvent institutions even
where liquidation would have minimized the cost of resolving the institutions.
Consequently. in
order to resolve insolvent institutions, FSLIC resorted to long-term assistance. Second, the special
tax benefits provided to troubled financial institutions were due to expire on December 31, 1988.
This resulted in an increase in the number of assisted transactions completed in 1988.' The
Technical and Miscellaneous Revenue Act of 1988 (TAMRA) postponed the expiration of these
special tax benefits, but significantly reduced the amount of tax benefits available to assisted
transactions occurring after 1988.

II. OVERVIEW OF SPECIAL

TAX BENEFITS AVAILABLE IN
CONNECTION WITH THE 1988/89 ASSISTED TRANSACTIONS
Prior to their repeal by FIRREA, the following three provisions of the Internal Revenue Code
(the Code) provided the special tax benefits available in the 1988/89 transactions:
Under old section 597 of the Code, qualifying assistance payments to a financial
institution acquired in an assisted transaction prior to January 1, 1989, are excluded
from the institution's income, and the institution is not required to reduce the tax basis
of its property or other tax attributes on account of the receipt of such assistance. In
addition, the general rule disallowing deductions for expenses and interest relating to
tax-exempt income (section 265) does not apply to deductions allocable to amounts
excluded from gross income pursuant to old section 597. Generally, in the case of any
assisted transaction after December 31, 1988, and before May 10, 1989 (the effective
date of the repeal of tax benefits available to troubled financial institutions), the assisted
institution is required to reduce its net operating losses, built-in losses, and interest
expense deductions by 50 percent of any assistance paid to the institution.
Under section 368(a)(3)(D) of the Code, the acquisition of a troubled financial institution
in a FSLIC-assisted transaction could qualify as a tax-free transaction without regard to
the generally applicable requirement that the shareholders of an acquired corporation
have a meaningful ownership interest in the acquiring corporation for the acquisition to
qualify for tax-free reorganization treatment.
Under section 382(I)(5)(F) of the Code, a corporation could acquire a troubled financial
institution in a tax-free reorganization under section 368(a)(3)(D) v, ithout triggering the
limitations that would otherwise apply to the net operating losses, built-in losses, and
excess credits of the troubled financial institution.

' See

RTC Report (vol. I) at 3-4.

Prior to the enactment of old section 597 in 1981', the tax treatment of a payment from
FSLIC to a financial institution was unclear. The payment could be treated as gross income or as
a contribution to the capital of the institution. If treated as a contribution to capital, the payment
was not included in gross income, but the institution was required to reduce the basis of its property
After the enactment of old section 597, however, financial
by the amount of the contribution.
assistance payments made by FSLIC to certain troubled financial institutions were not included in
the gross income of the institutions, and the institutions were not required to reduce the tax basis
of property on account of the receipt of those payments.
The tax benefits available in 1988/89 assisted transactions represent a significant portion of
the total cost of those transactions to the fisc. FSLIC estimated in early 1989 that the tax benefits
After reducing this
attributable to the 1988/89 assisted transactions would equal $8.5 billion.
amount by FSLIC's estimate of the portion of those tax benefits that will accrue to its benefit under
tax sharing agreements, FSLIC's total estimated cost to the Treasury of the tax benefits attributable
to the 1988/89 assisted transactions is $4.2 billion in foregone revenues. '

IH. TAX ISSUES RAISED BY RTC REPORT
The special tax provisions that applied to assisted transactions prior to FIRREA raise numerous
tax issues. While many of these tax issues are not free from doubt, the resolution of most of them
has not been controversial.
The RTC Report, however, identifies a select set of tax-related issues
that, depending on how they are resolved, may materially affect the cost of the 1988/89 transactions,
most importantly:

1. The

extent to which an assisted institution should be allowed to deduct losses and expenses
even though the FDIC compensates or reimburses the institution for the losses or expenses; and

2. The extent to which the earnings on assets covered by yield maintenance
exempt from tax.
The remainder

of this report analyzes these issues

views

thereon. '

' Old

section 597 was enacted pursuant

and provides

the Treasury

guarantees

are

Department's

to the Economic Recovery Tax Act of 1981.

'See

Report to the Congress: Thrift Resolutions, United States General Accounting Office
(September 1990). For a more detailed discussion of the tax rules applicable to troubled financial
institutions see Staff of the Joint Committee on Taxation, Current Tax Rules relating to Financially
Troubled Savings and Loan Associations (February 16, 1989).

' In

the 1988/89 transactions, the assistance agreements generally require the assisted institutions
to share a portion of their tax benefits with FSLIC. See RTC Report (vol. I), at 6, 47-49. Many
assisted institutions that have entered into tax sharing arrangements with FSLIC are members of an
affiliated group of corporations that files consolidated federal income tax returns. In many of those
cases, the tax benefits that are subject to sharing are used by an affiliate of the assisted institution,

-5-

IV. DEDUCTIBKII'Y OF REIMBURSED LOSSES

AND EXPENSES

The critical tax issue raised by the RTC Report is the extent to which financial institutions may
deduct losses and expenses even though they receive assistance payments from the FDIC as
compensation for those losses or expenses. In considering this issue, first this report provides an
overview of the federal income tax considerations relating to the deductibility of covered losses and
expenses, describing briefly the types of transactions in which covered losses and expenses arise.
Second, the report considers the incentive effects of the deduction of covered losses and expenses
on assisted institutions.
Third, the report analyzes the arguments for and against the deductibility
of covered losses and expenses. Finally, the report presents the Treasury Department's views on
the appropriate response to this issue and considers potential legislative clarification.

Overview of Federal Income Tax Considerations

Sale or other disposition of covered assets

Generally, a taxpayer incurs a loss for tax purposes on the sale or other disposition of property
to the extent that the taxpayer's adjusted basis for the property exceeds the amount realized on the
When an institution sells a covered asset, the question arises whether it is entitled to
disposition.
claim a tax loss to the extent the tax basis of the covered asset exceeds the proceeds from the sale
even though it receives assistance payments to compensate for that loss. The following two types
of transactions are at issue:

(i) Sale to third party. If an institution sells a covered asset to a third party, the question is
whether it may claim a tax loss even though it receives tax-free assistance payments from the FDIC
to compensate for that loss and therefore experiences no economic loss. Assume, for example, that
an institution sells a covered asset with a book value and tax basis of $100 to a third party for $40.
Under the 1988/89 assistance agreement, the FDIC pays the institution $60 in tax-free assistance
as compensation for the loss. The institution might nonetheless claim a $60 loss for tax purposes.
Although, as this report discusses in detail, the issue is not free of doubt, the IRS has issued one
unpublished ruling allowing the tax loss. The rationale for allowing the loss is that, under the law
The
applicable to the 1988/89 transactions, assistance payments are excluded from income.
institution
has
the
experienced
no
economic
allowance of tax losses in such cases, even though
loss,
in
which
are
described
the
next
section.
effects,
produces unintended and disadvantageous

rather than by the institution itself. In some cases, the other members of the affiliated group are
not reimbursing the assisted institution for their use of its tax benefits. The RTC Report expressed
concerns regarding these tax sharing arrangements and recommended that the FDIC and the Office
of Thrift Supervision review the tax sharing arrangements to ensure that they are consistent with
sound banking practices. See RTC Report (vol. I), at 118-120. As this does not raise issues of tax
policy, this report does not address the issue.

See

I.R.C. g 1001.

(ii) Sale to the FDIC. Because it may be argued that all payments made with respect to
covered assets constitute "assistance" provided under the 1988/89 agreements, institutions may claim
that they are entitled to a tax loss equal to the entire tax basis of the covered assets if they sell the
assets to the FDIC for market value or their book value. Assume, for example, that an institution
owns a covered asset with a fair market value of $90 and a book value and tax basis of $100, and
that the FDIC purchases that asset from the institution for its $100 book value pursuant to one of
the 1988/89 agreements. The institution may argue for a $100 tax loss even though the institution
receives $100 from the FDIC for the asset. The rationale for this view is that the entire amount
paid by the FDIC should be treated as federal financial assistance and therefore disregarded in deterIf this argument prevails, the covered asset
mining the institution's tax loss from the transaction.
would be treated as having been sold for $0 and the institution would be entitled to a loss equal to
its entire tax basis in the asset. Alternatively, the institution might claim a $10 loss, on the ground
that it would claim a loss in this amount had it sold the asset to a third party for its $90 fair market
value and received $10 in assistance payments from the FDIC. In most cases, the FDIC's contractual rights to repurchase covered assets are at fair market value ($90 in the example), but in
some cases the FDIC has a contractual right to repurchase covered assets at book value.

Wntedown

of covered

assets

When an institution is ordered to write down a covered asset, the FDIC is generally required
to make an assistance payment to the institution in the amount of the write-down.
If the covered
asset is a loan ("covered loan" ), the issue is whether the institution must take the assistance payment
into account in applying its method of accounting for bad debts. If an institution uses the reserve
method of accounting for bad debts and the assistance payment made on account of the write-down
is ignored for tax purposes, the institution may be entitled to charge the write-down against its
reserve as a bad debt loss, potentially increasing the institution's addition to its reserve for bad debts
and the deduction it may claim therefor.
If an institution uses the specific charge-off method of
accounting for bad debts and the assistance payment made on account of the write-down is ignored
for tax purposes, the institution may be entitled to claim a bad debt deduction on the write-down of
a covered loan.

In the case of covered assets other than loans or covered loans with respect to which bad debt
losses may not be claimed on the write-down, the issue is whether the assistance payment made in
connection with the write-down must be taken into account in determining whether the institution
is entitled to claim a loss on the subsequent disposition of the asset. As a result, in the case of an
asset other than a loan, the tax considerations implicated by a write-down of the asset are similar
to those raised above in cases where contemporaneous assistance payments are made to compensate
for a loss on the sale or other disposition of a covered asset, although the legal analysis of the two
transactions might diverge.

' See I.R.C.

"See I.R.C.

593 and Treas. Reg.

166.

1.593-7(b)(2).

Reimbursed

expenses

There is also an argument that expenses incurred but reimbursed by the FDIC should be
deductible for tax purposes. Assume, for example, that an institution incurs legal expenses of $100
in connection with defending a claim relating to a covered asset and that these expenses are
reimbursed by the FDIC. The institution has not, in reality, borne any expense in connection N ith
defending the claim, but may nevertheless
claim a deduction for the legal expense it the
reimbursement is ignored for tax purposes.
In terms of the potential cost to the government, the deductibility of losses on the disposition
of covered assets is much more important than the deductibility of reimbursed expenses. The polici

considerations

raised by the two issues, however, are quite similar.

Incentives

To the extent that tax deductions are allowed for losses on covered assets that are compensated
by FDIC payments, institutions have a perverse incentive to hold covered assets and to minirni. e
their value when sold. In the typical case, as long as an institution holds a covered asset, the yield
guarantee protects the institution from any loss of income and on disposition the institution is
guaranteed to receive book value through a combination of sales proceeds and FDIC payments. The
FDIC, and not the institution, bears the economic burden corresponding to any reduction in value.
Indeed, the institution and its affiliated corporations will tend to benefit as tax losses are enhanced.
The institution, therefore, has an incentive to minimize the value of covered assets in order to
maximize its tax loss and the attendant tax savings. Similarly, to the extent that tax deductions are
allowed for expenses that are reimbursed with FDIC payments, institutions have an incentive to
maximize, rather than minimize, those expenses. Unless the tax rules are clarified to provide that
covered losses and expenses are not deductible or such incentives effectively are reversed through
renegotiations, only the exercise of the FDIC's contractual rights to repurchase covered assets can
stop the potential waste.

Current Law: Arguments
In the case

For and Against Deductibility

of the sale or write-down

of a covered asset, the assisted institution

generally

receives compensation from the FDIC for any loss. Similarly, the FDIC generally is required under
the assistance agreements to reimburse institutions for a variety of expenses. The deductibility of
these losses and expenses turns on the appropriate
the FDIC. However, the tax law is not clear.

" Many

tax treatment

of the legal arguments discussed below are raised

in one

of the financial assistance

paid by

of the consultant's reports prepared

to the RTC in connection with the preparation of the RTC Report. See RTC Report
(vol. I), Appendix V. Contrary arguments have been presented by the lav firms Skadden, Alps,
Slate, Meagher & Flom and Johnson & Gibbs, which represent taxpayers v ho acquired thrift
institutions in 1988. See letter dated November 6, 1990, from Skadden, Arps, Slate, Mcagher &
Flom to Kenneth W. Gideon, Assistant Secretary (Tax Policy); letter dated December 18, 1990,
from Johnson & Gibbs to Michael J. Graetz, Deputy Assistant Secretary (Tax Policy).
and submitted

Considerations

generally applicable to covered losses and expenses

Legislative background

The question whether covered losses and expenses reimbursed by the FDIC are nevertheless
deductible for tax purposes depends upon a construction of the provisions of old section 597, enacted
in 1981. Under old section 597, money or property received from FSLIC pursuant to section 406(f)
of the National Housing Act is excluded from the gross income of a domestic building and loan
association.
A companion rule in old section 597(b) prohibits a reduction in the tax basis of the
Prior to the
assets of an assisted institution on account of the receipt of exempt assistance.
enactment of old section 597, the tax treatment of a payment from FSLIC to a financial institution
was unclear. The payment could be treated as gross income or as a nonshareholder contribution to
the capital of the institution. If treated as a nonshareholder contribution to capital, the payment was
not included in gross income, but the institution was required to reduce the basis of its property
'4
by the amount of the contribution.

When Congress enacted old section 597, it decided that assistance payments should be
excluded from gross income and should not be subject to the basis reduction rules applicable to
nonshareholder contributions to capital. The statutory rule prohibiting basis adjustments apparently
was intended to ensure that the exclusion from gross income provided by old section 597 would be
permanent rather than temporary.
It also appears that the special tax rules that applied to the
acquisition of troubled financial institutions were designed to make the net operating losses of those
institutions available to acquirers in assisted transactions.

In enacting the special tax rules applicable to the acquisition of troubled financial institutions,
Congress intended to facilitate the provision of financial assistance by FSLIC and to encourage the
merger of troubled financial institutions into stronger institutions. The legislative history, however,
does not suggest that Congress explicitly considered the implications of the basis adjustment
prohibition beyond this point.

"This exemption

was extended to FDIC assistance to banks in

' See

I.R. C.

I.R.C. g 362(c).

See

1988. See

4012(b)(2) of TAMRA.

118.

"First,

the exclusion of assistance payments from income without requiring a reduction in the
acquired institution's net operating losses prevents those losses from being absorbed or otherwise
reduced as a result of the assistance payments. Second, the special reorganization rules that were
applicable to the acquisition of a troubled domestic building and loan association in an assisted
transaction allowed the limitations of section 382 to be avoided in cases where it would have been
impossible to do so otherwise.

"See

H. R. Rep. No. 215, 97th Cong. , 1st Sess. 283-4 (1981). See also Staff of the Joint
Committee on Taxation, General Explanation of the Economic Recovery Tax Act of 1981 151-3
(December 29, 1981).

goal of the exclusion of income and the elimination of basis adjustments
found in old section 597 was to ensure that FSLIC (and subsequently FDIC) assistance would not
be reduced by the imposition of income taxes. There is no indication that Congress believed that
the deductibility of covered losses and expenses was necessary either to fulfill this purpose or to
facilitate the resolution of troubled financial institutions. Moreover, we suspect that Congress i~ ould
have expressed a contrary view if it had explicitly considered the deductibility of covered losses and
expenses and the perverse incentives associated with the deductibility of those losses and expenses.
At the time of their enactment, old section 597 and the accompanying legislation to facilitate
mergers and acquisitions of savings and loan institutions were estimated to produce an annual
revenue loss of approximately $5 million. Old section 597 and its legislative background fail to
provide conclusive authority for the deduction of covered losses and expenses.

The fundamental

Deductibility

of Losses:

The amount realized

Under current law, a taxpayer is generally required to overcome two hurdles in order to claim
a deduction for a loss on the sale of an asset. The first hurdle requires the taxpayer to establish that
a loss was realized on the sale. As a general rule, a taxpayer realizes a loss on the sale or other
disposition of property to the extent that the taxpayer's adjusted basis for the property exceeds the
amount realized on the sale or other disposition.
A taxpayer's adjusted basis for an asset is
A taxpayer's amount realized from the sale or
generally determined by the cost of the asset.
other disposition of an asset generally equals the amount of money received plus the fair market
value of any other property received on the disposition.
Therefore, an assisted institution would
not be entitled to claim a tax loss on the sale or other disposition of a covered asset if assistance
payments made to the institution as compensation for that loss are included in the amount realized
from the sale. This treatment arguably is the most reasonable as it characterizes the transaction for
tax purposes in accordance with its economic substance by denying the selling institution a deduction
for a loss that it does not bear economically.

Upon any acquisition of covered assets, the acquiring institution acquired both the asset and
FSLIC's agreement to provide compensation for any loss on the disposition of those assets.
Consequently, the right of an institution to receive assistance on the disposition of a covered asset
may be considered an integral part of that asset. Indeed, this view is consistent with private rulings
that the IRS has issued holding that the right to receive assistance with respect to covered assets is
taken into account in valuing those assets for purposes of determining whether the built-in deduction
limitation of the consolidated return regulations applies to those assets.

"I.R. C. 1001.
" I.R. C. $ 1012.
" I.R. C. $ 1001(b).
&

"See, e. g.

8914021 {December 29, 1988) and 8914020 (December 29, 1988).
There is little doubt that a payment received from the FDIC to purchase a covered asset constitutes
an amount realized on the sale of the asset, at a minimum to the extent of the fair market i alue of
the asset. As noted previously, because all FDIC payments with respect to covered assets arguably
, private letter rulings

-10Old section 597 does not appear to prohibit the inclusion of assistance in amounts realized.
By its terms, old section 597 only excludes from gross income amounts that would be gross income
but for the exclusion. The amount realized on the sale of an asset is included in gross income only
Therefore, old section 597 can reasonably be
to the extent it exceeds the basis of the asset sold.
read to exclude only amounts of assistance that otherwise would produce taxable gain on the
disposition of covered assets. In addition, the basis adjustment prohibition of old section 597 applies
only to assistance that is excluded from gross income under old section 597. Thus, if assistance
paid as compensation for a loss on the sale of a covered asset were treated as an amount realized
on the sale, old section 597 would not apply to the assistance to the extent that it merely reduced
the tax loss from the sale.

Perhaps the strongest argument of the proponents of deductibility is that disallowing a
deduction for covered losses and expenses is tantamount to taxing the assistance, thereby denying
the permanent exclusion that Congress intended.
Under this argument, the basis adjustment
prohibition of old section 597 is viewed as a prohibition of any reduction of tax attributes that would
have the effect of taxing FSLIC assistance. Assume, for example, that an assisted institution sells
an asset with a book value and an adjusted basis of $100 for $60, and that the FDIC pays the
institution $40 of assistance to compensate for the loss. If a deduction for the $40 loss reimbursed
by the FDIC is disallowed on account of the assistance payment, the institution is in the same
position that it would have been in if it had realized $40 of taxable income from the assistance
the
Notwithstanding
payment and recognized a $40 taxable loss on the sale of the property.
superficial appeal of this argument, we do not believe that Congress intended the provisions of old
section 597 to require deductibility of the reimbursed loss in such a case. It is quite reasonable to
view that provision as prohibiting the reduction of FSLIC or FDIC assistance through taxation
without, at the same time, reading the provision to create tax incentives for increasing losses and
minimizing value in assisted transactions.

General principles governing

the treatment

of compensated

losses and reimbursed

expenses

If, contrary to the above analysis, assistance received from the FDIC as compensation for a
covered loss is not treated as an amount realized, the selling institution will be treated as realizing
a loss from the sale for tax purposes.
The fact that the institution has realized a loss for tax
purposes does not, however, necessarily mean that a deduction for the loss will be allowed. In
order to claim a deduction, the institution must clear a second legal hurdle. Under section 165(a)
of the Code, a deduction is allowed for any loss sustained during the year only if the loss is not
constitute "assistance" for purposes of old section 597, institutions may take the position that they
are entitled to claim a tax loss equal to the entire tax basis of a covered asset when they sell the
asset to the FDIC. The portion of the payment that does not exceed the fair market value of the
covered asset, however, clearly represents consideration paid for the asset and must be treated as
an amount realized for tax purposes.

"Under section 61(a)(3) of

the Code, gross income includes gains derived from dealings in
Under section 1001(a) of the Code, a taxpayer recognizes gain on the sale or other
property.
disposition of property only to the extent that the amount realized from the sale exceeds the basis
of the property sold.

-11compensated for by insurance or otherwise. In other contexts, this rule has been interpreted
a deduction for a loss that is compensated for by tax-free assistance. -"

to bar

Similar principles apply to the deductibility of covered expenses. Generally, the Code allows
taxpayers to claim a deduction for the ordinary and necessary expenses incurred in carrying on a
trade or business.
It is well established, however, that ordinary and necessary business expenses
are not deductible to the extent that they are reimbursed, even if the reimbursement payments are
excludable, under specific provisions of the Code, from the recipient's income.
Amounts that
are subject to reimbursement are in the nature of advances on the credit of the party responsible for
making the reimbursement. ~

Therefore, unless the provisions of old section 597 are interpreted to require that assistance
payments be ignored in applying the principles that generally govern the deductibility of losses and
expenses, the better view is that no deduction should be allowed for covered losses and expenses
because those losses and expenses are compensated for or reimbursed with assistance payments.
The proponents of deductibility, however, argue that assistance payments made with respect to
covered losses do not represent compensation "by insurance or otherwise" within the meaning of
section 165(a) of the Code because the assistance payments are not payments in the nature of
insurance, but rather are part of an arm's length bargain that induced the acquirer to enter into the
assisted transaction. ~

~ See Rev. Rul. 76-144, 1976-1 C. B. 17

(disaster losses compensated for by tax-exempt disaster
relief payments were not deductible). See also Shanahan i. Commissioner, 63 T. C. 21 (1974);
Treas. Reg. $ 1. 165-1(d)(2)(i). In addition, see note 24, below, for analogous authority regarding
the deductibility of reimbursed business expenses under section 162 of the Code.

See

I.R. C.

162.

See, e. g. , Manocchio v. Commissioner, 710 F.2d 1400 (9th Cir. 1983) (flight training expenses
were not deductible to the extent reimbursed by tax-free veterans assistance); Rev. Rul. 80-173,
1980-2 C. B. 60, 61 (similar facts, but stressing that in such a case a taxpayer "suffers no economic
detriment and incurs no expense"); Wolfers v. Commissioner, 69 T. C. 975 (1978) (expenses for
increased rent, moving costs and professional fees were not deductible to the extent reimbursed by
tax-free relocation assistance); Rev. Rul. 78-388, 1978-2 C. B. 110 (moving expenses were not
deductible where taxpayer had a fixed right to reimbursement with tax-free relocation assistance).
See, e. g. , Manocchio, id. at 1402, quoting Glendinning,
F.2d 950, 952 (2d Cir. 1932).

McLeish

Co.

Commissioner,

This argument relies, in part, on Idaho First National Bank i. Commissioner, 95 T. C. 185 (1990),
where the Tax Court stated that "[t]he FDIC insures depositors, not banks, and an FDIC assistance
" Two points should be noted when considering the quoted
payment is not an insurance payment.
passage. First, the passage appears in the opinion's findings of fact v ithout any legal anal' sis and
does not appear to be a finding that was required for the court to reach its decision. Second, the
assisted transaction at issue in that case did not require the FDIC to reimburse or other&, ise
compensate the assisted institution for any losses incurred on the disposition of its assets. The 1:DIC

-12While it is indisputable that the capital loss coverage provided in many of the 1988/89
transactions was part of an agreed package of consideration, that fact is not dispositive. First, loss
reimbursements paid by the FDIC may qualify as compensation for purposes of section 165(a) even
Second, even if the payments must resemble
if the payments are not in the nature of insurance.
insurance, the assistance that FSLIC agreed to pay under the 1988/89 assistance agreements with
respect to covered losses shifted the risk of those losses to FSLIC and, as such, bears a striking
resemblance to insurance.
If, as part of one of the 1988/89 transactions, FSLIC had agreed to
pay a third party to insure the assisted institution against some risk, would the fact that the insurance
represented part of the consideration provided in connection with the acquisition of the assisted
institution cause the insurance to be characterized as something other than insurance for tax
purposes? We think not and cannot readily distinguish such a fact pattern from the one at hand.

Other considerations

The only existing administrative guidance explicitly addressing the deductibility of covered
This memorandum concludes that
losses and expenses is an IRS technical advice memorandum.
the assisted institution may deduct losses and expenses that are reimbursed with assistance payments
from FSLIC. A technical advice memorandum, however, generally is not considered authoritative
Nonetheless, this ruling provides some support for the position of those arguing that
guidance.
covered losses and expenses are deductible.

assistance provided in that transaction took the form of a contribution to the assisted institution
immediately prior to its acquisition.
Under these circumstances, we do not believe that the Tax
Court's decision in Idaho First National Bank should be accorded any precedential value with
respect to the issue under consideration.

" Compare

Forward Communications Corp. v. United States, 608 F.2d 485, 501 (Ct. Cl. 1979)
(insurance is merely "one example" of the forms of compensation that will prohibit a deduction for
a loss under section 165(a)) with Shanahan v. Commissioner, supra (the only form of compensation
that will prohibit a section 165(a) deduction is compensation that is similar to insurance).

~ The

resemblance should be sufficient for capital loss coverage to be considered similar to
insurance for purposes of section 165(a). See, e. g. , Estate of Bryan v. Commissioner, 74 T.C. 725
(1980) (reimbursement of amounts embezzled from client out of trust fund maintained through
annual contributions required of all practicing attorneys treated as compensation similar to insurance
for purposes of the estate tax counterpart to section 165(a)).

"See

technical advice memorandum
8637005 (May 30, 1986). We also understand that the
deduction of reimbursed covered losses was permitted in one closing agreement entered into by a
taxpayer and the IRS.
Generally, a technical advice memorandum (or private ruling) is not precedent and may be relied
upon only by the taxpayer to whom it is issued. See I.R. C. 5 6110(j)(3); Treas. Reg.

f 301.6110-7(b).

-13Assisted institutions may also argue that the deduction of covered losses and expenses is
supported by legislation enacted subsequent to the enactment of old section 597. For example,
Congress enacted legislation in 1986 providing that an otherwise allowable deduction would not be
disallowed under section 265(a)(1) solely because it is allocable to income that is exempt from tai
under old section 597. ' Generally, section 265 of the Code disallows a deduction for any expense
that is allocable to exempt income. The purpose of section 265 in disallowing deductions for
expenses incurred to earn exempt income is to prevent taxpayers from deriving a double tax benefit
from an exclusion from income.
It may be argued that the legislative decision to exclude
assistance exempt under old section 597 from the ambit of section 265 represents a decision to
approve a double benefit analogous to the allowance of a deduction for covered losses and expenses,
and that this decision supports the conclusion that Congress had a similar result in mind ~hen it
enacted old section 597.

As a matter of statutory interpretation,
however, the situations in which postenactment
expressions of intent by a subsequent Congress are relevant in ascertaining the intent of a prior
Congress are limited. We believe that, in this case, the actions or intent of the 99th Congress in
enacting statutory provisions related to old section 597 should not be accorded any weight in
assessing the intent of the 97th Congress, when it enacted old section 597, regarding the treatment
of covered losses and expenses since the 99th Congress did not directly consider the treatment ot
those losses and expenses.

Similarly, in 1988, Congress amended old section 597 to reduce the tax benefits associated
with the exclusion of assistance payments from income.
This legislation, in general, required
that certain tax attributes of an assisted institution be reduced to the extent of 50 percent of any
assistance that is received by the institution and is excluded from gross income under old section
597 (the "attribute reduction rule" ). Proponents of the deductibility of covered losses assert that this
legislation indicates that Congress believed that covered losses and expenses are deductible because
otherwise the attribute reduction rule would have the effect of reducing an assisted institution's tax
attributes for assistance payments that provided the institution with no tax benefits. This argument,
of course, assumes that the attribute reduction rule would apply to reimbursements of covered losses
represent gross income
and expenses. The rule would apply, however, only if those reimbursements
are treated either as an
that is exempt from tax under old section 597. If those reimbursements
for
a
loss, they would not be treated as
amount realized on the sale of an asset or as compensation
gross income that is subject to exemption under old section 597.
legislative developments involving old section 597 do provide
some measure of support to those asserting the deductibility of covered losses and expenses, that
support is not determinative because Congress, when it enacted the subsequent legislation, did not
In sum, while the subsequent

" See $ 904(c)(2)(B) of the

Tax Reform Act of 1986. Congress subsequently amended section
"
904(c)(2)(B) by striking out "Section 265(a)(1)" and inserting in its place "Section 265, thereby
providing that the provision applied to all of section 265. See $ 4012(c)(2) of TANlRA.

See, e. g. , Rev. Rul. 83-3, 1983-1 C. B.

7", modified

See old section 597(c), as amended by TAMRA.

by Rev

Rul. 87-3 . 1987-1 C. B. 131.

-14provide a specific and official expression of its intent regarding the treatment of covered losses and
expenses. Furthermore, we are impelled, once again, to state that, in our view, it seems likely that
if Congress had specifically considered the issue, it would have expressed a contrary view.

Special considerations

applicable to write down

of covered

assets

When an institution is ordered to write down a covered asset, the FDIC is generally required
If the covered
to make an assistance payment to the institution in the amount of the write-down.
asset is a loan (i. e. , a covered loan), the issue is whether the institution may claim a bad debt loss
on the write-down of the loan.

Under the Code, a taxpayer is allowed a deduction for any debt that has become wholly or,
It is likely that assisted
to the extent provided in regulations, partially worthless during the year.
institutions will argue that they are entitled to claim a bad debt loss when they are ordered to write
down covered loans. Under Treasury regulations, loans made by a bank or other regulated financial
institution are conclusively presumed to be worthless to the extent that they are written off on the
institution's books in response to an order of the institution's supervisory authority.
Arguably,
the order to write down a covered loan represents an order that triggers a conclusive presumption
under Treasury regulations that the debt is worthless to the extent of the write-down.

It does not appear, however, that a write-down ordered pursuant to rights granted under

The purpose of
assistance agreement should trigger the conclusive presumption of worthlessness.
the conclusive presumption is to conform tax and regulatory standards to the extent possible.
When an institution is ordered to write down a covered loan in accordance with the requirements
of an assistance agreement, the write-down does not reflect an exercise of regulatory standards by
the institution's supervisory authority in its capacity as such. Rather, the write-down is a product
of rights and obligations created pursuant to an arm's length transaction between the institution and

FSLIC.

the conclusive presumption
including the value of the collateral

of worthlessness

does not apply, all "pertinent evidence,
and the condition of the debtor, are taken into account in

In the case of covered assets other than loans or covered loans with respect to which bad debt
losses may not be claimed on the write-down, the issue is whether the assistance payment made in
connection with the write-down is taken into account in determining whether the institution is
entitled to claim a loss on the subsequent disposition of the asset. Therefore, in those cases, the tax
considerations
implicated by a write-down of the asset are similar to those raised where
contemporaneous
assistance payments are made to compensate for a loss on the sale or other
disposition of a covered asset.

' I.R.C.

166.

"See Treas. Reg.
"See Rev.

1.166-2(d)(1).

Rul. 80-180, 1980-2 C.B. 66.

-15determining worthlessness. ~ A taxpayer is not entitled to claim a deduction for a bad debt loss
if the taxpayer has a reasonable prospect of being made whole for the loss. Accordingly, it is
appropriate in valuing a covered loan to take into account the institution's right to receive assistance
compensating it for any loss on the disposition or write-down of the loan. ~

Clarifying the Tax Treatment

of Reimbursed

Losses and Expenses

The RTC Report identified the acceleration of covered asset dispositions as one of the best
options available for reducing the overall cost of the 1988/89 transactions.
The RTC Report also
recognized the severe adverse impact that the deduction of covered losses and expenses could have
'
on the cost of the 1988/89 transactions, stating that clarification of this issue is "vital. "

From the point of view of sound tax and financial policy, taking into account both the costs
to the government and the appropriate economic incentives for assisted institutions, it is clear that
assisted institutions should not be allowed to deduct losses or expenses that are reimbursed by the
FDIC. Unfortunately, as a legal matter, the deductibility of covered losses and expenses under
existing law is less clear. Although the IRS has never taken a published position allowing these
losses, it has issued at least one technical advice memorandum holding that the covered losses and
expenses are deductible. In addition, IRS personnel apparently conveyed informally both to FSLIC
and to potential acquirers that covered losses and expenses would be deductible. Material provided
by FSLIC to prospective acquirers explicitly indicated that such losses would be deductible, although
that same material indicated that the economic benefits of such deductions would flow to FSLIC and

See Treas. Reg. $ 1. 166-2(a).

"See, e. g. ,

Aerotron Grantor and Stockholder Trust v. Commissioner, 56 T. C. M. 789 (1988);
Exxon Corporation v. United States, 7 Cl. Ct. 347 (1985), rev'd and remanded on other grounds,
785 F.2d 277 (Fed. Cir. 1986). See also Treas. Reg. 1. 166-2(b). But see Rev. Rul. 80-24, 1980-1
C. B. 47, 48 (which relies on Zeeman v. United States, 275 F.Supp. 235 (S.D. N. Y. 1967),
remanded on other grounds, 395 F.2d 861 (2d Cir. 1968)), for the proposition that a creditor may
deduct a bad debt loss on a note, regardless of whether the creditor has a reasonable prospect ol
succeeding in a suit against the seller of the note for rescission of the sales contract, where the
rescission suit does not deal with "the debt owed by the debtor to the creditor or with collateral,
guarantees or indemnity contracts directly related to the debt as such". The FDIC's obligation to
reimburse an institution for any loss on a covered loan, however, effectively constitutes a guarantee
of that loan and, as such, should be taken into account in determining whether the loan is worthless.

The IRS has taken into account an institution's right to assistance in valuing covered assets tot
other purposes. See authority cited at note 20, above.

"See RTC

Report (vol. I), at 72.

See RTC Report (vol. I), at 117-118.

not the acquirers. ~ Under these circumstances, acquirers
deductibility of covered losses as part of the consideration
acquisition of the troubled financial institutions involved in
that denying institutions deductions for losses and expenses
be perceived by some as a repudiation of the government's

in the 1988/89 transactions regard the
they received in connection with the
those transactions. ~ We are cognizant
that are reimbursed by the FDIC will

agreements.

Nonetheless, the Treasury Department has concluded that assisted institutions should not be
allowed to deduct losses and expenses that are reimbursed by the FDIC. In reaching this
conclusion, the Treasury Department has carefully weighed the costs to the government of allowing
institutions to deduct reimbursed losses and expenses against the costs of creating a perception that
the government is not adhering to its bargain. The costs to the government of allowing assisted
The costs of the perverse
institutions to deduct covered losses and expenses is considerable.
incentives that would accompany the deductibility of covered losses and expenses would likely dwarf
the cost of the tax benefits associated with those deductions. Such perverse incentives are not only
financially costly, but they also create the perception that the government is incapable of soundly
managing the savings and loan failures. That the government may be perceived as reneging on its
deal is unfortunate, but the costs of avoiding that perception are unacceptable.
Under these circumstances, the Treasury Department does not and should not feel bound by
and informal advice conveyed to acquirers by government
one technical advice memorandum
personnel. The acquirers in the 1988/89 transactions were generally represented by sophisticated
counsel who know well that they are not entitled to rely on informal advice either from the IRS or
other government agencies or on technical advice memorandums or on private letter rulings issued
The failure of acquirers, for whatever reason, to obtain private
by the IRS to other taxpayers.
rulings or closing agreements confirming the deductibility of their covered losses and expenses
represents an assumption of the risk that the government might someday challenge those deductions.
The Treasury Department does not believe that the American people should bear the burden of
exculpating those taxpayers from their assumption of this risk. The IRS is prepared to challenge and
litigate, if necessary, the deductibility of covered losses and expenses.

While the Treasury Department has determined that assisted institutions should not be allowed
to deduct covered losses and expenses reimbursed by the FDIC, our decision does not settle the
issue. Our view will surely be challenged in the courts and that litigation could drag on for a
number of years. The uncertainty that this environment creates will make it very difficult for the
RTC to implement measures to reduce the cost of the 1988/89 transactions.
Therefore,
congressional clarification of this issue is extremely desirable, if not essential. We do not believe

and Instructions for the Preparation and Submission of Proposals for the
Acquisition of one or more Savings Institutions in the Southwest (prepared by the Federal Home
Loan Bank Board and FSLIC).

See Information

Acquirers of troubled thrifts also take comfort from a statement by the Joint Committee on
Taxation suggesting that such losses are deductible, even though that statement was made in
See Staff of the Joint
February 1989 and therefore obviously not relied upon by taxpayers.
Troubled
Savings and Loan
Committee on Taxation, Current Tax Rules Relating to Financially
Associations 38-39 (February 16, 1989).

Congress, when it enacted the special tax benefits that were available in the 1988/89
transactions, intended to sanction the deductibility of covered losses and expenses. But, if so,
Congress should tell us now so we can avoid costly litigation. Otherwise, Congress should enact
clarifying legislation disallowing deductions for covered losses and expenses.
that

V. TREAT1VHWT OF YIELD MAViTENANCE
A.

Overview

In the 1988/89 transactions, FSLIC generally guaranteed the acquirer a minimum return or
yield on the book value of covered assets. FSLIC agreed to pay yield maintenance to induce
acquirers to purchase the assets (and thereby avoid the burden of purchasing those assets itself)
because it believed that the acquiring institutions were better positioned to manage the assets
properly. The guaranteed yields are based on a specified base rate (e. g. , the Texas Cost of Funds)
plus additional amounts ranging up to 275 basis points. In most transactions, the additional basis
points decline over the term of the assistance agreement.
The guaranteed yield was set so as to
provide the acquiring institution with sufficient income to cover high funding and operating costs,
including the costs of managing the covered asset portfolio. In most cases, the guaranteed yield is
significantly higher than the yield the institution would receive on a market investment of an amount
'
equal to the book value of the covered assets.

Clarifying Tax Treatment

of Yield Maintenance

Guaranteed yield maintenance has created incentives for institutions to engage in behavior that
tend to increase the costs to the government of the 1988/89 transactions.
First, yield
maintenance gives the assisted institution an incentive to delay disposition of covered assets since
the institution cannot readily replace the high tax-free guaranteed yields with comparable taxable
yields. Second, the assisted institution has an incentive to minimize actual yield on these assets.
This results in larger tax-free yield maintenance payments, thereby minimizing the taxable income
of the institution or increasing tax losses that may be used to offset its other income or income of
affiliated entities.
Apparently, the adverse incentives attributable to yield maintenance are being
compounded by the fact that some assisted institutions are taking the position that actual yield on
covered assets is not taxable to the assisted institutions, on the ground that these institutions collect
actual yield as agents of the FDIC. This view, which in substance treats actual yield as if it were
tax-free assistance, is at odds with both the language and purpose of old section 597(a). That
will

~ See RTC Report (vol. I), at 33-34 and 72-73, for a more detailed discussion of yield maintenance.
See RTC Report (vol. I), at 73-74.
Although assistance agreements provide for a declining yield spread over time, this has not yet
materially reduced yield maintenance payments, and, therefore, has not thus far tended to mitigate
the adverse incentives.
See RTC Report (vol. I), at 74.

"Se~ RTC Report (vol. I),

116-117.

-18defines assistance as amounts received from FSLIC (or the FDIC) pursuant to section
406(f) of the National Housing Act. The actual yield earned by an institution from its investments
is not "received" from the FDIC and is therefore not received "pursuant to" section 406(f) of the
National Housing Act. The RTC Report recommends that appropriate authorities clarify that only
the net difference between guaranteed and actual yield constitutes tax-free assistance income.
The
Treasury Department will issue an administrative pronouncement holding that the actual yield on
assets covered by a yield maintenance guarantee is taxable to the assisted institution.
This result
is sufficiently clear under present law that confirming legislation is not necessary.

provision

"See, e.g. ,

406(f)(1) and (2) of the National Housing Act, 12 U. S.C. g 1729(f)(1) and (2)
for determining the terms and conditions of assistance received pursuant to

(FSLIC is responsible
section 406(f)).

See RTC Report (vol. I), at 116-117.

Department

of the Treasury

Washington,

D.C. 20220

Official Business
Penalty for Private Use, $300

THE SECRETARY OF THE TREASURY
wASHINGTQN

.'1arch e, 1991

Dear

18, 1990, the Resolution Trust Cor. poration
("RTC") issued a report tn the Congress and the Oversight Board
The RTC Repor. t
of the RTC on the 1988/89 FSLIC transactions. cer. tain
tax issues
further study and clar. ification of
recommended
relating to the 1988/89 FSLIC transactions.
has examined whether legislation
The Treasury Department
address the tax issues raised
to
or other. action is appropriate
is a report
Enclosed for your consideration
by the RTC Report.
issues.
those
that analyzes and provides our views on
The critical tax issue raised by the RTC Report is the
involved in the 1988/89
extent to which financial institutions
they
even though
expenses
and
deduct losses
transactions
may
for
compensation
as
FDIC
the
receive assistance payments from
are
deductions
tax
that
To the extent
those losses or expenses.
insticompensated by FDIC payments,
are
that
losses
for.
allowed
to
and
assets
covered
tutions have a perverse incentive to hold point
sound
view
of
of
From ttte
when sold.
min imi e the i r value
On

September

«b

for
the appropriate
and
government
assisted insti:utions
it is cle. r that
assis ed institutions,
or expenses that
losses
for
should not be allowed a tax deduction
legal ma ter,
as
are reimbursed by the FDIC. Unfortunately,expenses a under
existing
of covered losses and
the deductibility
law is less clear.
the

Department
Treasury
be allowed
not
should
institutions
FDIC.
the
that are reimbursed by
The

economic

incentives

that assisted
concluded
and expenses
losses
to deduct

has

of these institutions will
expectations regardargue that our decision is contrary to their
that, absent a
We felt, however,
ing the 1988/89 transactions.
in order to
directive to the contrary,
clear congressional
deducsanction
not
could
we
protect the general taxpayer, expenses and the perversetheeconomic
and
tibility of covered losses
such deductibility.
from
follow
incentives that
Some

financial institutions seem likely to challenge
as a result, the Treasury Department's decision regarding
deductibility of covered losses and expenses
does not settle
issue. The IRS is prepared to challenge and
Howof covered losses and expenses.
the
deductibility
litigate
Certain

our conclusion,

and,
the
the

ever, the uncertainty
avoided.

of years

of litigation

can and

should

Congressional clarification of this issue seems not only
If Congress did intend in 1981 when it
desirable but essential.
enacted the special tax benefits available in the 1988/89 transactions or desires now to sanction the deductibility of covered
losses and expenses, prompt legislative clarification should be
enacted so that we may avoid embarking on a course of costly
litigation.
Otherwise, I urze Congress to enact clarifying legislation disallowing deductions for covered losses and expenses.

Sincerely,

Nicholas

~nclosure

F. Brady

i)'

partment of the Treasury

Bureau of the Public Debt

R ashington. DC

'20'239

hz)

-„;,
=&I

- IlI:- T;-. =USURY

FOR RELEASE AT 3:OO PM
March 6, 1991

Contact: Peter Holienbach
( 02) 3. 6-q i0

PUBLIC DEBT ANNOUNCES ACTIVITY FOR
SECURITIES Ib' THE STRIPS PROGRAil FOR FEBRUARY 1991
Treasury's Bureau of the Public Debt announced actin iv, figures for the month of February
of securities within the Separate Trading of Registered Interest and Principal of Securities
program, (STRIPS).
Dollar Amounts in Thousands

$495, 965, 885

Principal Outstanding
(Eligible Securities)
Held in Unstripped

$375, 643, 135

Form

$120,322, 750

Held in Stripped Form

Reconstituted

1991,

$5, 774, 680

in February

Th» accompanying table gives a breakdown of STRIPS activity by individual loan description.
The balances in this table are subject to audit and subsequent revision. These monthly figures are
included in Table Vl of the Monthl Statement of the Public Debt, entitled "Holdings of Treasury
"
Securities in Stripped Form. These can also be obtained through a recorded message on

(202) 447-9873.
oOo

PA-46

TABLE Vl

—HOLDINGS

OF TREASURY SECURITIES

STRIPPED FORM. FEBRUARY

2'. i~~i

(In thousands)
P inCipal Amount
1/taturitv

Loan Descnption

ii4'0

Note A-1995
Note

1/1 5/94

5/95

Portion Held in
Stnpped Form

56.658, 554

$5.591,354

51,067, 200

6.933,861

6.491.461

442. 400

127016

5. 81 1.886

1, 315,200

233.901

722.000

5/1 5/95

B-1995

Outstanoino

Portion Held in
Unstnpped Form

Total

8'o Note C-1994

»-1i4%

Date

955, 901

Reconstituted
This Month'

-0539,040

0—

3/15/95

9-1/2% Note D-1995

11/15/95

7, 318,550

6.387, 350

931.200

50, 400

8-7/8% Note A-1996

2/1 5/96

8, 575, 199

8.351, 199

224. 000

8.000

7.3/8% Note C-1996

5/1 5/96

20, 085, 643

19 871,243

214.400

7-1I4% Note D-1996

11/1 5/96

20, 258.810

19,967,610

291.200

9,921.237

9, 848, 037

73.200

9,362, 836

9, 330,836

32.000

9, 808.329

9, 792, 329

16,000

10-1/2% Note C-1995

5/1 5/97

8-1/2% Note A-1997
8-5/8% Note B-1997

8/1 5/97

8-7/8% Note C-1997

6-1/8% Note A-1998

2/15/98

9, 159,068

9, 156, 188

2.880

9% Note B-1998

5/15/98

9, 165,387

9, 135,387

30,000

9-1/4% Note C-1998

8/15/98

11,342, 646

11,213,846

128,800

9, 902.875

9, 896,475

6, 400

8-7/8'/0 Note D-1998

1/1 5/97

1/1 5/98

2, 000

-00-

—

-0-00-

—

8-7/8% Note A-1999

2/15/99

9.719,623

9, 716,423

3,200

9-1/8% Note B-1999

5/15/99

10,047, 103

9, 178,303

868, 800

8% Note C-1999

8/15/99

10, 163,644

10,081,644

82, 000

-0-0-

11/15/99

0, 773.960

10.765, 960

8.000

-0—

A-2000

2/15/00

10,673,033

10.673, 033

8-2000

5/1 5/00

10,496, 230

10,454, 630

41,600

—0—

Note C-2000

8/15/00

11,080, 646

1,080, 646

—0—

-0-

11,519,682

—0—

-0—

11,312,802

—0—

8, 301,806

3, 703,406

4, 598,400

/8'o Note D-1999
6-1/2o/0 Ncte

8-7/8'/0 Note
8-3/4o/0

8-1/2% Note D-2000
7-3/4'/0

1/1 5/00

2/15/01

Note A-2001

11-5/8% Bond 2004.

12% Bond 2005

1/1 5/04

-0-

5/15/05

4, 260, 758

1,654, 808

2.605, 950

10-3/4% Bond 2005.

8/15/05

9,269, 713

8, 329,713

940, 000

9-3/8% Bond 2006 . .

. 2/15/06

4, 755, 916

6, 005, 584

1,676, 784

4, 328,800

269,600

. .

11-3/4% Bond 2009-14

1/1 5/1

667, 799

2, 078.359

10,589,440

156,800

1,725, 276

5, 424, 640

62, 080

6, 899,859

2, 149,459

4, 750,400

19,200

2/1 5/16

7, 266.854

6, 782, 054

484, 800

472, 800

. 5/15/16

18,823, 551

16,825.951

1,997,600

-0-

2/15/1 5

10-5/8% Bond 2015

. 8/15/15

7-1/2'% Bond

.
.

18,864, 448

14,641, 168

4, 223, 280

462, 400

. 5/15/17

18, 194, 169

6,273, 209

11,920, 960

630,560

. . . . . 8/15/17

14,016,858

9,320, 858

4, 696,000

. . . 5/15/18

8, 708, 639

2.587,039

6, 121,600

49,600

9,032, 870

1,428.070

7, 604, 800

187,400

1,531,200

2016.

. 1

8-3/4% Bond 2017. . .

2017. .

9-1/8% Bond 2018. .

8-7/8% Bond

9% Bond 2018 . .

2/15/19

19,250, 798

5, 221.998

14,028, 800

20.213,832

10,819,912

9,393,920

10,228, 868

3,474, 868

6, 754, 000

10,158,883

3,729, 763

6,429, 120

8/15/20

21,418,606

14,581,646

6, 836,960

113,600

11,113,453

11,020, 653

92, 800

-0-

495,965,885

375,643. 135

120,322, 750

5,774,880

Total

312,800

. 2/15/20

8-3/4% Bond 2020 . .
7-7/8% Bond 2021 . .

. . . . . 5/15/20

8-1/2% Bond 2020
8-3/4% Bond 2020 . .

. 8/15/19

. .

8-1/8% Bond 2019 . .

1. 1987, secunties held

t/15/18

11/15/18

8-7/8% Bond 2019 . .

' Effective May

1 2,

11/15/15

9-7/8% Bond 2015 . .
7-1/4% Bond 2016. .

-0-

7, 149,916

11-1/4% Bond 2015

9-1/4% Bond 2016 .

. . 2/15/21

stnpped form were eligible for reconstitution

Note; On the 4th workday of each month a recording of Table 1/t will be available after
The balances in this table are subject to audit and subsettuent adjustments.

to their unstripped

form.

3:00 pm. The telephone

number is (202) 447-9873.

partment of the Treasury
TEXT AS PREPARED
EMBARGOED UNTIL 6:00

March

6, 1991

Washinyton,

O.C. ~ Telephone

Contact:

p. m.

Cheryl

$86-201'

Crispen

202-566-2041

REMARKS BY THE
HONORABLE NICHOLAS F
BRADY
TO THE
NEW YORK STOCK EXCHANGE BOARD OF DIRECTORS
D. C.
WASHINGTON,
MARCH

1991

Thank you, Bill, and welcome to the Treasury Department's
Cash Room. This magnificent room is one of the most historic in
the Treasury Department.
For more than a century, the Cash Room
was Treasury's bank lobby, where the public redeemed silver and
gold certificates and cashed government checks until 1976.

Ulysses S. Grant held his Inaugural Ball in this
4, 1869. Two thousand tickets were sold to men
only, and each gentleman was permitted to bring two ladies'

President

room on March

The six thousand guests apparently created quite a crush
here in the Cash Room, and afterwards there was a slight problem
in the cloak room. Some celebrants went home without their
coats; others waited until 4 a. m. to retrieve their coats; and
the most successful climbed over a transom from an adjacent room,
ended their
and using the principle of first-come, best-dressed,
evening by moving up the fashion scale. Well, we won't have that
problem tonight, and I know all of you want to be in your
appointed places for the President's speech about one hour from
now.

Accordingly,
minutes to address
facing our nation:
governing

financial

important
NB-1167

brief. But I do want to take a few
of the most important economic issues
the need for fundamental reform of the laws
services in our country.
be

one

last
an extensive study, the Administration
the Treasury's report to the Congress recommending
reforms to our 40- and 50-year old banking laws.

Following

delivered

I' ll

month

are important
services sector, but also for
Businesses must be able to count on our
particularly banks, in bad times as well
These recommendations

financial

not just for the
the economy as a whole.
financial services firms,
as good.

weak banks
As we have seen in the current economic downturn,
are forced to pull back just when their good customers need them
most. When loans stop at the first sign of trouble, jobs are
imperiled.
If we expect to exert world economic leadership in
the 21st century, we must have a modern, world-class financial
services system in our country
Some have questioned whether this is the time for
fundamental
reform: Are we taking on too much? Shouldn't we
hear the winds of politics and make sure we don't offend
established interests? This reaction reminds me of the reception
in the report of the President's Task
given the recommendations
Force on Market Mechanisms following the market break in October

1987.

of you will remember that the immediate conventional
wisdom was that the recommendations
were too radical -- that they
wouldn't be adopted.
However, the central finding of that report
has never been challenged:
What had been seen traditionally
as
separate markets -- the markets for stocks, stock index futures,
and stock options -- were in fact one market.
Many

But our recommendations,
once seen as too challenging of the
that be, have in fact largely been put in place. Let' s
think back. There were four major proposals:

powers

First, circuit breakers

should be implemented to protect the
system.
The exchanges themselves -- led by the New York
-Stock Exchange
have established circuit breakers that have
proven themselves to be an effective mechanism in subsequent
market disruptions.
The public has been protected.

market

Second, clearance and settlement

systems

should be improved,

third, large trader information in the stock markets should
be reported.
These two recommendations
were the central
provisions of the Market Reform Act of 1990 that was signed by
President Bush last year.
Finally, we recommended that margins should be harmonized
across geographical marketplaces that were in fact one market.
The Bush Administration
has been working to address this issue,
and just today a compromise has emerged which, if enacted, would
achieve this objective.
and

the compromise, which was passed by the Senate
Agriculture Committee today, the Federal Reserve will be given
over stock index futures, just as we recommended in
new oversight
the 1987 report. The Fed is specifically charged to take
systemic risk into account, which means it can consider the need
for consistency between stock and stock index futures margins.
will still be conducted by the futures
Day-to-day margin-setting
exchanges.
Under

point is this: I am confident that we will achieve
reform of financial services laws because our
for
financial services reform, like those for financial
proposals
market reform, address the reality of the modern marketplace.
Increasingly, the financial services market is, in fact, one
market, and our laws must be modernized to deal with this
My

fundamental

reality.

Consumers need a broader choice of financial products when
Businesses and workers need strong, wellthey go to the bank.
capitalized banks that can keep lending in good times and bad.
The nation needs a banking system that is strong enough to
rivals have
compete toe-to-toe with the best our international
offer. And most of all, the taxpayer needs to be spared the
prospect of another costly and unnecessary cleanup.

chart the future of our financial services
is much to worry about in the banking world.
state of banking in the U. S. leaves taxpayers overexposed,
and the industry
consumers and businesses underserved,
As a result, banks are unable to
increasingly uncompetitive.
effectively perform their important role in stimulating and
sustaining economic growth.
For those
industry, there

who

The

Today, the United States does not have a single bank among
Of
Twenty years ago we had seven.
the world's 25 largest.
whole
But
the
course, the question of pure size is not
story'
against the backdrop of an economy that is twice the size of our
nearest competitor's, I wonder if anyone can explain the complete
absence of U. S. banks from the list of world leaders.
To me, it is
Surely that statistic tells us something.
Would
we be
wrong.
is
very
strong evidence that something
world's
top 25?
comfortable with no aerospace companies in the
A
No computer manufacturers?
companies?
No pharmaceutical
didn't
not.
stack
Obviously
up?
that
national stock exchange

left out-of-date

laws on the books that
prohibit banks from getting into new financial markets, and even
Banks in
keep them from branching across state lines.
in Birmingham,
branches
California, Michigan and Utah can open
These laws are totally
England, but not in Birmingham, Alabama.
expenses
And they impose unnecessary
out of touch with reality.
on banks and consumers that have been estimated to cost $10
billion annually

In addition,

have

Consumers have long since begun to ignore these artificial
restrictions, using credit cards, cash machines, and the 800
number to handle their financial affairs when and where they

have increasingly turned away from the banks,
get auto loans from GMAC and Ford Motor Credit, checking
services from Vanguard and Fidelity mutual funds, business loans
through General Electric Credit Corporation and Goldman Sachs,
and they save at Merrill Lynch and Sears Roebuck.

Customers

want.

and now

from

have a deposit insurance system
purpose of protecting

its original

that has

wandered

away

only the small depositor.

This safety net now covers almost every depositor, large and
The
small, sophisticated and trusting, insured and uninsured.
system has bailed out large, money-vise investors who don't need
the protection, and exposed the taxpayer to potential losses.

that is in the grasp of no less than
day-to-day
federal regulators.
Its ability to run
-affairs and respond quickly to changed conditions
such as the
credit crunch -- is hamstrung by a myriad of Lilliputian
We

have an industry

four separate

restrictions.

What does this all add up to? Bank failures totalled 198 in
the 38 years from 1942 to 1980, but reached 206 in 1989 alone.
Interest rates are higher for consumers due to inefficiency and
higher costs. And the bank insurance fund is under stress.

do we reverse this trend?
How do we help make banks
steadily profitable and competitive, better able to attract
capital, and more ready to lend in good times and bad? The
answer is plain:
We need to overhaul
outdated laws to recognize
How

the modern marketplace.

trillion in deposits. That means that
there is simply no bank insurance fund large enough to protect
the taxpayer, unless and until we address the underlying
problems.
We need to have deposit
insurance reform, supervisory
reform, and a recapitalized Bank Insurance Fund. But we also
need interstate branching and broader financial activities so
that our banks can become financially strong again.
Our banks

hold $2. 8

leave the job half done -- if we only tinker with the
then we' ll probably be back again, sooner rather than
later, recapitalizing the Bank Insurance Fund again, perhaps the
next time with taxpayer money. That's a prospect no one could

If we
problem -relish.

The time has come to address these problems
to deal with them decisively and comprehensively;
country's financial services system back where
number one in the world.

at their core;
and to put this
belongs:

The timing is right.
By facing up to the reality of the
marketplace today, we can help to ensure financial security for
financial system that is
We can create a modern
the future.

internationally
competitive, that will protect depositors and
taxpayers, serve consumers and strengthen the economy. This is
goal worthy of all our efforts, and with your help, we will get

done.

Thank you.

artment of the Treasury

Washington,

O. C. ~ Telephone
Contact:

TEXT AS PREPARED
EMBARGOED UNTIL DELIVERY

1:30 p. m.

Expected

Cheryl

566.204;

Crispen

202-566-2041

THE HONORABLE NICHOLAS P- BRADY
SECRETARY OF THE TREASURY
GREATER NEW YORK SAVINGS BONDS KICKOFF
THURS DAY J MARCH 7 ~ 19 9
NEW YORK, NEW YORK

It's a pleasure to be in
you, Walter (Shipley).
to help launch the nation's largest geographic campaign
Unites States Savings Bonds.
Thank

York

New

for

count on the Greater New York Campaign for
Last year, you really came through with 110, 000 new or
increased savers and 800 contributing companies.
That's a real
victory for the Savings Bonds Program, and it proves that our
We

success.

can always

message of thrift and
the American people-

fiscal responsibility

still hits

home

with

This year, a new campaign is underway -- with ambitious new
goals and an aggressive plan to achieve them. And there is a new
national campaign team, under Ed Hennessy's leadership, to make
1991 the 50th successful year for U. S. Savings Bonds.

President

When

19'1, it

Roosevelt bought

the

first

Savings

Bond in

great tradition.
Over the last
50 years, Americans have turned to bonds for safe and competitive
investments to guard their future.
the tradition

President Bush is behind
100 percent.
The President appreciates
you' re doing to make the 50th anniversary
a success.
Today,

the Savings

all

the beginning

was

continues,

and

Bonds program

billion invested in Savings Bonds,
Throughout the nation,
Americans are using Savings Bonds to set their money aside for
homes and education and retirement
funds. -- all the while
increasing financial stability for the United States.
Savings Bonds help the nation save hundreds of millions of
dollars in debt costs every year. That means direct savings for
Americans

and

UPS.

have over $125

their investments

taxpayers,

are secure.

as well as lower budget

deficits.

most importantly,
Savings Bonds are a significant part
nation's
of the
saving ethic. A saving economy is a strong
economy, and Savings Bonds can help Americans attain a savings
rate that will buttress our economic strength.
That's why the Greater New York Savings Bonds Committee is
And

Savings
Through your leadership and commitment,
Bonds have become an integral part of the savings and investment

so important.

fabric of our nation.

I'd like to

turn to another issue of paramount
the need for
importance to the nation's economic future:
fundamental
reform of the laws governing financial services
our country.
Now,

As President Bush indicated
in his address to a Joint
Session of Congress last night, we are committed to working just
as hard on domestic issues as we have worked to secure peace in
the Persian Gulf region. And one of the President's top domestic
priorities is to ensure a sound financial services system.

extensive study, the Administration
last month
the Treasury's report to the Congress recommending
reforms to our 40- and 50-year old banking laws.

Following

delivered
important

are important
services sector, but also for
Businesses must be able to count on our
particularly banks, in bad times as well
These recommendations

financial

not just for the
the economy as a whole.
financial services firms,
as good.

As we have seen in the current economic downturn,
weak banks
are forced to pull back just when their good customers need them
most. When loans stop at the first sign of trouble, jobs are
imperiled.
If we expect to exert world economic leadership in
the 21st century, we must have a modern, world-class financial
services system in our country.

Consumers need a broader choice of financial products when
they go to the bank.
Businesses and workers need strong, wellcapitalized banks that can keep lending in good times and bad.
The nation needs a banking system that is strong enough to
compete toe-to-toe with the best our international
rivals have
offer. And most of all, the taxpayer needs to be spared the
prospect of another costly and unnecessary cleanup.

For those
industry, there

chart the future of odr financial services
to worry about in the banking world.
state of banking in the U. S. leaves taxpayers overexposed,
consumers and businesses underserved,
and the industry
increasingly uncompetitive.
As a result, banks are unable to
effectively perform their important role in stimulating and
sustaining economic growth.

who

much

The

Today, the United States does not have a single bank among
Of
world's
Twenty years ago we had seven.
25 largest.
the
course, the question of pure size is not the whole story. But
against the backdrop of an economy that is twice the size of our
nearest competitor's, I wonder if anyone can explain the complete
absence of U. S. banks from the list of world leaders.
To me, it is
Surely that statistic tells us something.
strong evidence that something is very wrong. Would we be
comfortable with no aerospace companies in the world's top 25?
A
No computer manufacturers?
companies?
No pharmaceutical
national stock exchange that didn't stack up? Obviously not.

left out-of-date

laws on the books that
financial
markets, and even
new
into
getting
prohibit banks
Banks in
keep them from branching across state lines.
California, Michigan and Utah can open branches in Birmingham,
These laws are totally
England, but not in Birmingham, Alabama.
expenses
And they impose unnecessary
out of touch with reality.
cost
estimated
to
$10
been
have
that
consumers
banks
and
on

In addition,

have

from

billion annually.

to ignore these artificial
machines, and the 800
cash
restrictions, using credit cards,
number to handle their financial affairs when and where they
Customers have increasingly turned away from the banks,
wants
and now get auto loans from GMAC and Ford Motor Credit, checking
services from Vanguard and Fidelity mutual funds, business loans
through General Electric Credit Corporation and Goldman Sachs,
and they save at Merrill Lynch and Sears Roebuck.
Consumers

from

have

long since begun

have a deposit insurance system
purpose of protecting

its original

that has

wandered

away

only the small depositor.

This safety net now covers almost every depositor, large and
The
small, sophisticated and trusting, insured and uninsured.
don't
need
investors
who
money-wise
out
bailed
has
large,
system
losses.
to
potential
the protection, and exposed the taxpayer

that is in the grasp of no less than
day-to-day
Its ability to run
four separate federal regulators.
-such as the
affairs and respond quickly to changed conditions
-of
Lilliputian
is hamstrung by a myriad
credit crunch
We

have an industry

restrictions.

does this all add up to? Bank failures totalled 198 in
the 38 years from 1942 to 1980, but reached 206 in 1989 alone.
Interest rates are higher for consumers due to inefficiency and
higher costs. And the bank insurance fund is under stress.
What

How

do we

steadily

capital,
answer

reverse this trend? How do we help make banks
profitable and competitive, better able to attract

to lend in good times
need to overhaul outdated

and more ready

is plain:

the modern marketplace.
Our banks

hold $2. 8

trillion

in deposits.

and bad?

laws

The

to recognize

That means that

there is simply no bank insurance fund large enough to protect
the taxpayer, unless and until we address the underlying
We need to have deposit
insurance reform, supervisory
problems.
reform, and a recapitalized Bank Insurance Fund. But we also
need interstate branching and broader financial activities so
that our banks can become financially strong again.
whether this is the time for
Some have questioned
fundamental
reform: Are we taking on too much'? Shouldn't
hear the winds of politics and make sure we don't offend

interests?
I am confident that we will achieve fundamental reform of
financial services laws because our proposals for financial
services reform address the reality of the modern marketplace.
Increasingly, the financial services market is, in fact, one
market, and our laws must be modernized to deal with this
established

reality.

leave the job half done -- if we only tinker with the
then we' ll probably be back again, sooner rather than
later, recapitalizing the Bank Insurance Fund again, perhaps the
That's a prospect no one could
next time with taxpayer money.

If we
problem -relish.

The time has come to address these problems at their core;
to deal with them decisively and comprehensively; and to put this
country's financial services system back where it belongs:
number

one in the world.

The timing is right.
By facing up to the reality of the
marketplace today, we can help to ensure financial security for
the future.
We can create a modern
financial system that is

internationally
competitive, that will protect depositors and
taxpayers, serve consumers and strengthen the economy. This is a
goal worthy of all our efforts, and with your help, we will get

done.

In closing,

effort that

you

let

for all of the time and
The success
Bond program.
and we' re very grateful for all

thank you again

put into the Savings

of the program depends on you,
that you do. Thank you.

¹¹¹

BLI DEBT
DePartment

FOR IMMEDIATE

March

7, 1991

Bureau of the Public Debt

o! the Treasuri

RELEASE

E
~

Sl'ashint, ton. DC 't~2'39

CONTACT:

RESULTS OF TREASURY'S AUCTION

Office of Financing

202-376-4350

OF 52-WEEK

BILLS

for $10, 833 million of 52-week bills to be issued

Tenders

14, 1991 and mature on March 12, 1992 were
accepted today (CUSIP: 912794YDO).

on March
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate

Price

6. 45%
93. 883
6.
47%
93. 863
High
6. 46%
93. 873
Average
Tenders at the high discount rate were allotted 31%.
The investment rate is the equivalent coupon-issue yield.
6. 05%
6. 07%
6. 06%

Low

TENDERS RECEIVED AND ACCEPTED

Received
24, 035
28, 613, 205

Boston
New

York

Philadelphia
Cleveland

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive

Subtotal,

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

(in thousands)
24, 035

15, 420

9, 546, 305
15, 420

7, 740
33, 280
9, 300
589, 420

7, 740
33, 280
9, 300
70, 420

25, 640
32, 695
20, 655
2, 064, 870
28, 935

Richmond

369 335

25, 640
29, 935
20, 655
660, 920
20, 175

369 335

$31, 834, 530

$10, 833, 160

$28. 167, 500

$7, 166, 130

812 730
$28, 980, 230

730
$7, 978, 860
8 2

2, 500, 000

354 300

$31, 834, 530

$10, 833, 160

additional $375, 700 thousand of bills will be
issued to foreign official institutions for new cash.
An

NB-] 169

R
~4,.

iclrimeni of the treasury

FOR IMMEDIATE

March

1991

NashlnSton,

RELEASE

CONTACT:

TREASVRY PARTICIPATING

The Treasury

short-term

Department

multilateral

O.C. ~ Telephone $86-204~

IN BRIDGE

LOAN

Barbara Clay

202-566-525"

FOR ROMANIA

today its participation
loan for Romania.
The

announced

bridge
multilateral arrangement, coordinated by the Bank for
International Settlements, will total up to $300 million,
the U. S. share $40 million.
U. S.

oOo

B-1170

ith

in this arrangement reflects support for
economic reform program.
The Treasury loan will be
from disbursements
from the International
Monetary Fund.

participation

Romania's

repaid

in a

Nrimeni of the Treasury

FOR IMMEDIATE

7, 1991

March

RELEASE

Nashlneton,

Contact:

O.C. o Telephone SII-20m"

Desiree Tucker-Sorini
(202) 566-8773

Statement by
Nicholas F. Brady
Secretary of the Treasury

is to be commended for its bipartisan vote to
billion
in funding for the Resolution Trust
provide $30
Corporation (RTC). We appreciate the leadership of Chairman
Riegle and Senator Garn in guiding this bill through the Banking
Costs resulting from delays in
Committee and the full Senate.
providing RTC funding are mounting at the rate of $8 million per
day, and we urge the House to act swiftly to avoid further
unnecessary cost to the taxpayer.
The Senate

1171

NB —

eriment of the Treasury

NashlnStotl, D.C.

i %1!

FOR IMMEDIATE

8, 1991

March

RELEASE

TREASURY

LIPTS

Telephone $44-2041

CONTACT:

RUWAIT

Barbara Cl~y
202-566-5252

TRADE AND TRAVEL RESTRICTIONS

trade and travel restrictions have been eased by the U. S.
Treasury Department in light of a March 2nd U. N. Security Council
resolution calling for cooperation in Kuwait's reconstruction.
Kuwaiti

the request of the Government of Kuwait, Treasury's Office of
Foreign Assets Control (OFAC) amended its Kuwaiti Assets Control
Regulations today, authorizing by general license transactions
involving import, export, contracting, travel, and
transportation.
The transfer of blocked Kuwaiti government
assets continues to require a license. Assets were frozen by the
President's August 2nd executive order at Kuwait's request to
protect them during Iraq's invasion and occupation.

of the funds and other assets of the Government of
Kuwait will soon follow.
Prior to unblocking, such assets remain
subject to the Kuwaiti Assets Control Regulations and the
licenses issued thereunder.

The unblocking

In that connection,
payments

remains

orderly

the settlement
blocked
Kuwaiti banks,
by

unaffected.
The licensing
settlement of certain pre-embargo
oOo

48-11

(

process involving certain
previously licensed by OFAC,
of these banks allows the
banking

transactions.

LI DEBT E
Department

of the Treasur

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

Washinyon,

CONTACT:

11, 1991

March

RESULTS OF TREASURY'S AUCTION

DC 20239

Office of Financing

202-376-4350

OF 13-WEEK

for $8, 602 million of 13-week bills to
14, 1991 and mature on June 13, 1991 were

Tenders
on March

BILLS

be issued

accepted today (CUSIP: 912794WNO).
OF ACCEPTED

RANGE

COMPETITIVE

BIDS:

Discount
Rate

5. 84%
5. 86%
5. 85%

Investment
Rate

Price

6. 03%
98 ' 524
6. 05%
98. 519
High
6.
98. 521
04%
Average
Tenders at the high discount rate were allotted 37%.
rate is the equivalent coupon-issue yield.
The investment
Low

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia

Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

Received

30, 885
24, 435, 035
23, 195
53, 535
58, 105
29, 940
1, 455, 590
64, 980
12, 100

51, 940

27, 415
652, 755

(in thousands)
30, 885
7, 130, 770
23, 195
53, 410
58, 105

28, 940
154, 790
27, 420
12, 100
48, 940
27, 415
125. 865

880 430
$27, 775, 905

880 430
$8, 602, 265

$23, 583, 495

1 810 825
$25, 394, 320

$4, 409, 855
1 810 825
$6, 220, 680

2, 221, 355

160 230
$27, 775, 905

160 230
$8, 602, 265

additional $10, 770 thousand of bills ~ill be
issued to foreign official institutions for new cash.
An

NB —11&

LI
Department

FOR IMMEDIATE

March

Bureau of the Public Debt

of the Treasuv

RELEASE

Kashinyon, DC '20239

CONTACT:

11, 1991

RESULTS OF TREASURY'S AUCTION

'R~

DEBT

Office of Financing

202-376-4350

OF 26-WEEK

BILLS

for $8, 616 million of 26-week bills to be issued
14, 1991 and mature on September 12, 1991 were
accepted today (CUSIP: 912794XF6).
Tenders

on March
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Low

5. 90%
5. 91%
5. 91%

Investment
Rate
6. 184

Price
97. 017
97. 012
97. 012

6. 19%
6. 194
Average
Tenders at the high discount rate were allotted 68%.
The investment rate is the equivalent coupon-issue yield.
High

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia

Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

Received
35, 775
22, 413, 800

18, 070
38, 780

44, 270
38, 060
1, 836, 190

41, 340
9, 210

58, 970
23, 965
685, 155

647 770
$25, 891, 355

$21, 558, 110

(in thousands)
35, 775
7, 061, 040
18, 070
38, 780
42, 670

37, 740
466, 590
22, 100

9, 210

58, 970
23, 965
153, 155

647 770

$8, 615. 835

1 348 975

$22, 907, 085

$4, 282, 590
1 348 975
$5, 631, 565

2, 000, 000

984 270
$25, 891, 355

984 270
$8, 615, 835

additional $108, 830 thousand of bills ~ill be
issued to foreign official institutions for new cash.
An

NB-11 (4

TABLE

A
I

it'hAi". ( f'Pearl 5

'10

GULF CRISIS FINANCIAL ASSISTANCE, ;
,
($ Billions —;)s()( 3/I I /9

I;, I: T', :-ASUi"

Oonor/Creditor

9.8

EUROPEAN
COMMUNlTY

3.2

JAPAN

2.2

OTHER

0.5

Commitments

GULF STATES

TOT&.":

)

!a&x3~ i

AI&I!

I5,$F)'.Ii4i

', gg:lj'„.

Includes alI commitments to date for extraordeary economic assistance in f 990 and
Ooes not indude contributions to the rnultinatiorraf force, existing bilateral
assistance. or funds made available by the IMF and World Bank.

1991.

TABLE B

GULF CRISIS FINANCIAL ASSISTANCE
($ Billions
Donor/Creditor

Total
Commitments

—as

of 3/ 1 I /91)

mitrnen

Humanitarian"

Egypt/Turkey/Jordan

Other Sta&es

GULF STATES

9.8

6.2

0.0

3.6

EUROPEAN
COMMUNITY

3.2

2.3

0.7

0.2

JAPAN

2.2

2.0

0. 1

OTHER

0.5

0.3

0. 1

TOTAL

15.7

.:.

:-;,'10.

Includes atl commitments to date Ior extraordrnary economic assistance in t 990 arid
Does rtol include cortlribLrtions to the multinational lorce, existing bilateral
assrstartce, or lunds made available by the IMF and World 8ank.
l»eludes both utiatlocated commitments «»0 multita terai hurnanrtar ian assistance.

t99t.

TABLE C

GULF CRISIS FINANCIAL ASSISTANCE
($ Billions

Donor/Creditor

— as

ol 3/

l l

/91)

Commitments

Disbursements

GULF STATES

9.8

EUROPEAN
COMMUNITY

3.2

JAPAN

2.2

0.8

OTHER

0.5

0.2

TOTAL:,

', '.

:'. ',

. ':I; "--,::;

6.2

". :.g5"!7 . . :., -;;:
:;„.

Includes all commitments to date for extraordioary economic assistance lt 1990 and
Ooes not include contributions to the multinational force, existing bitateral
assistance, or funds made available by the IMF and World Bank.

1991.

Table 1

GULF CRISIS FINANC)AL ASSISTANCE
COMMITMENTS FOR 1990-91
DISBURSEM NTS THROUGH 3l) 1/91
(US$ Millions)

E
KX)no ICreditor

urke I

Commitments

G CSTATES
;, Saudi Arabia,

Disbursements

6168

;:,, '"'.2848*,;:,

Kuwait

„:

2500
.

'. -'; t

EC
EC Budget::::. . . ;.
Bilateral:

t',

880:.'. I;
'",

3034

805'.

.'-,

. ::

3463
';. ';1788
855
'820 ''

"'::.'It: . 624
.

Italy

0'her EC 2I

tI,

' 's

184

Norway

Swt zer land
Other 3I

)%It s s)I ~ »liat &&~Ills

144

va'

a&l

' I 'sl

)

's'

".
Ss.
"aa- ss)'&S&:'
&s

0
P»&

62
5

171

11 741

3959

2848

f-ssr llaaltlaala. . aL. Dtaba&uta.

a)SIStraaaC

I&ra&I

Jaa

asr&r

~luJc

Juc ra& r~afarc. Based m Jataa ~n&attcJ
l.ctaaarsa. Hoeocco, PekaCea, aaaaaaalm. aad Syraa
cs&II&t»»)c»ats

ra&

s'i'&Ilr Itsul &sssa) lu IIIC aaullaaarataaaaaal

tbc Gall Crais

'
s

''ss

(.&rs u
Grasp

r'»ncaa-. aal Caaaaralanal~

p»".

1334
s

~ &

{yQ

1618
1439
1324
624
500

2413

'". ;

. " 805

60
0
0

~ II&I J»alaur sira&s. urs aru ls&4alur III s»)sass»I&ra

I&ay I»&t satuA suna

3684
, . ",, ~439,

''" 3191

"-:.'

0 ': : ':;;

120

'TOTAL COMMITMENTS

, '.

1
Y

102

6248

;;: 4601. .„"„'

413

Kola

Distmrse ments

9744

1403»". :,,:;
763
619 -'

2126
RS

Commitments

3218

;:.

'va)s t

. ',

)

189

JAPAN

TOTAL.

2785
"-r".

619 '--"~;
~

Disbursements

3576
1773. '", -'.-',
1184

Germany

}ulster

I'.",'- . ,

1123

Commitments

2229
499
'
200 -"'::.: """t,. ,'0
1190
360

France

ALL OTHE

O~tl

dan

360

. &&

37
.103

2226

800

512
115

158

106
120

G/'

171

15700

partmeni of the Treasury

Washlnyton,

O.C. ~ Telephone

SII-20''

EMBARGOED UNTIL GIVEN
EXPECTED AT
P. M.

2:00

MARCH

12, 1991

OF NICHOLAS F. BRADY
BEFORE THE
COMMITTEE ON WAYS AND MEANS
U.
HOUSE OF REPRESENTATIVES

TESTIMONY

MARCH

12, 1991

Mr. Chairman and Members of the Committee, I am pleased
to meet with you to discuss the economy, President Bush's FY 1992
budget and the revenue proposals contained therein.

thinking on the 1992 Budget has been
guided by the need to restrain government spending and abide by
the terms of the budget agreement hammered out by Congress and
Our work and

the Bush Administration
the Federal government

last October.

will borrow

five years,
in the credit markets a half
Over the next

trillion dollars less than it would have borrowed in the absence
of the budget agreement.
And, although a sharp rise in the nearterm deficits may tend to obscure the significance of this
achievement, there is widespread consensus, both here and abroad,
that this budget agreement is an effective force for fiscal
stability.
Furthermore,

important

budget

process reforms,

particularly the so-called "pay-as-you-go" provisions, were
adopted to ensure that the deficit reduction targets adopted in
the budget agreement are met. These process reforms are an
integral part of the agreement and it is essential that Congress
and the Administration
adhere to both the letter and spirit of
these reforms. They have received a positive reaction from the
markets and have contributed to the lowering of interest rates.
ECONOMIC

POLICY GOALS

AND

THE BUDGET

President Bush's budget, in which spending increases at
less than the inflation rate, sets an important standard to which
we must adhere.
In other words, the real level of spending must
is simple: spending growth is what has
reason
decline. The
fueled the deficit. Deficits have a corrosive effect on economic
activity. They crowd private borrowers out of financial markets
xH-1175

divert our national savings away from investment in new
plants and equipment, research and development, and other uses
and create economic
which would directly enhance productivity
and

growth.

our 1992 budget priorities have been
set to keep future budget deficits on a downward path. Our plans
for dealing with current problems, as well as the need to improve
economic growth and prepare our economy for the challenges of the
future, have been shaped by this necessity.
With

this in

mind,

Most economists anticipate an end to the current
recession by mid-year and a resumption of moderate growth as the
The return to positive growth will be based on
year progresses.
strong exports, a resumption of consumer and business spending as

confidence is gradually restored following the victory in the
Gulf, and the stimulative effect of this year's deficit. Lower

interest rates
this turnaround.

and improving

inflation

results will contribute

there will be proposals for various
programs which have, in the past, been suggested to "jump start"
the return to growth. While such suggestions have an important
goal, the resumption of strong economic growth, they tend to be
inefficient and often take effect long after the recovery phase
is underway. Moreover, in the current budgetary setting, they
would trigger the mandatory pay-as-you-go provisions enacted in
Nevertheless,

OBRA

90.

This does not

mean we should

rest

on our

oars.

And

will have a definite impact on the
turnaround.
First, the Federal Reserve has lowered the Federal
funds rate seven times in the last four and one-half months.
Some pundits have said this 200 basis-point
reduction will have
no effect, that it is merely "pushing on a string".
They are
dead wrong.
in
Americans who have received downward adjustments
their variable rate mortgages and home equity credit lines or who
now can buy a car or a house with substantially
lower monthly

steps

now

are under

way which

Lower interest rates and monthly payments
payments understand.
have made a difference before and they will now. And for
American businesses, lower interest rates mean lower capital
costs and a greater incentive to invest.

Second, we have undertaken a review of the regulations
covering bank lending with a view toward making sure these
regulations are based on common sense. The results of this
review, which included senior officials of the OCC, the Federal
Reserve and the FDIC, have resulted in a number of regulatory
policy clarifications which will have an effect on the so-called
credit crunch. A copy of these clarifications is attached to my
testimony.

banks

These changes
ought to be making

President

create the climate in which commercial
loans to sound borrowers.

I would now like to take a few minutes to discuss
Bush's budget deals with longer term growth.

PROPOSALS ADDRESSING

With

institutions,

LONG- TERM INVESTMENT

respect to problems

just put

AND

how

GROWTH

facing the Nation's

financial

forward a comprehensive plan for
fundamental
reform of the banking system.
These reforms will
update archaic laws which place costly and unneeded restrictions
on banking activities, will make banks safer and sounder to
we

have

protect depositors and taxpayers, and will restore international
competitiveness of our financial firms'
Our goal is to provide
top quality, convenient financial services to the American people
and capital for U. S. corporations to compete in global markets.
In addition, President Bush has proposed in his budget
initiatives to improve our Nation's educational system by
for individual choice, and to improve and
providing opportunities
Nation's
our
transportation
system.
expand
We are asking Congress
and this Committee to support
the following initiatives designed to induce long-term economic
a permanent
and enhance our Nation's competitiveness:
research and experimentation credit, family savings accounts,
enterprise zones, the allowance of withdrawals from individual
retirement accounts for first-time home buyers, and a capital

growth

gains tax rate reduction

Incentives

for individuals.

for Research

and Experimentation

Technological change plays a central role in economic
growth.
The Government has an important function in promoting
In order to do so, we believe
innovation and basic research.
(R&E) tax
that the twenty percent research and experimentation
should
be
after
extended
1991,
is
set
to
expire
which
credit,
Research is inherently a long-term process.
permanently
Extending the R&E tax credit permanently will permit businesses
to begin projects without having to worry that the credit will be
In addition, the current allocation
withdrawn
in the future.
rules for R&E under section 861 should be extended for another

year.

Family Savings Accounts

goal for the 1990s is to increase the rate
of savings in the U. S. Savings finance investment and growth
which means more jobs. We believe that the Federal Government
should foster an environment that is conducive to saving, and we
propose the creation of the Family Savings Account (FSA) to allow
nondeductible contributions of up to $2, 500 per taxpayer with a
After meeting the required
maximum of two accounts per family.
seven-year holding period, all savings, including the accumulated
earnings, can be withdrawn tax-free.
An

important

The new FSAs will provide a simple and understandable
for Americans to save. The time limit is short enough to
focus attention on specific personal goals -- saving to buy a
home, preparing for eduction costs or for building a financial
reserve to protect against unexpected events. This is a program
that Americans can understand and in which they can participate
without having to wait for long periods to have access to their
savings.
It will work.

program

Enterprise

Zones

To help economically distressed areas share in the
benefits of economic growth, we propose to designate up to fifty
Federal enterprise zones which will benefit from targeted tax
incentives and Federal, state, and local regulatory relief. The
incentives are: (1) a wage credit of up to $525 per worker; (2)
elimination of capital gains taxes for tangible property used in
an enterprise zone business; and (3) expensing by individuals
of
contributions to the capital of corporations engaged in the
conduct of enterprise zone businesses.

Penalty-Free

IRA Withdrawals

for First-Time

Home

Buyers

a home is part of the American dream.
However,
people increasingly find home ownership beyond their
reach. We propose allowing individuals to withdraw amounts of up
to $10, 000 from their individual retirement accounts for a
"first-time" home purchase. The 10-percent additional tax on
early withdrawals imposed under current law would be waived for
eligible individuals.
Our proposal is designed to enhance the
Owning

many

younger

attractiveness

IRAs by making

them more

flexible.

Capital Gains Tax Rate Reduction for Individuals

is
Reducing the capital gains tax rate for individuals
important to restore economic growth and competitive strength

activity, and investment in
savings, entrepreneurial
industries.
At the same time,
and
processes
new products,
investors should be encouraged to extend their horizons and
To
search for investments with longer term growth potential.
encourage Americans to invest for longer periods of time, we
believe that the tax rate for capital gains on real estate,
timber, homes, farms, land and corporate stock should be reduced
based on the length of time an asset has been held.

promoting

In his State of the Union address,

President

Bush

acknowledged the existence of divergent opinions on the impact of
a capital gains tax rate reduction on economic growth and
The President requested Federal Reserve Board Chairman
revenues.
that
We are hopeful
Alan Greenspan to study these matters.
Chairman Greenspan, working with Congress and the Administration,
surrounding a
can illuminate and resolve the disagreements

reduction

questions.

in the capital gains tax

Mr. Chairman,

would

now

rate.

be happy

to take your

OCC

FDIC

OTS

FRB

Joint Agency News Release
Washington,

ISSUE JOINT SUPERVISORY POLICIES

REGULATORS

regulators of banks and thrift institutions
joint statements and guidelines to clarify certain
regulatory and accounting policies. The agencies said the intent
of this effort is to contribute to a climate in which banks and
thrifts will make loans to credit-worthy borrowers and work
constructively with borrowers experiencing financial
difficulties, consistent with safe and sound banking practices.
.he policies encourage increased disclosure about the condition
of financial institutions'
loan portfolios, facilitate extensions
o' credit to sound borrowers and the workout of problem loans,

The

four federal

today issued

better assure sound assessments
that secures loans.
and

of the value of real estate

regulatory agencies that issued today's statements are
the Office of the Comptroller of the Currency (OCC), the Federal
Deposit Insurance Corporation (FDIC), the Federal Reserve Board
(FRB), and the Office of Thrift Supervision (OTS). Together, the
four agencies supervise the activities of the nation's 12, 000

The four

commercial

banks

thrift institutions.

2, 400

and

joint policy statements cover a wide
including the following specific points:

The

range of issues,

The
ec
guidelines
of
proposed
agencies are considering the merits
addressing the accrual of income on loans that have been
partially charged off. The agencies and the Securities and
Exchange Commission will both solicit public comment on the

guidelines.

proposed
o

The

joint

statement clarifies that the supervisory evaluation of real
estate loans is based on the ability of the collateral to
generate cash flow over time, not upon its liquidation
value.
(more)

Comptroller

of the Current

Federal Deposit insurance Gorpoaten

Fedeal ReMrve guard

Offec of That Supervsion

'ssues

to on cc a asse s and
This guidance covers a range of
accounting issues, including cash basis income recognition
loans, treatment of multiple loans to one
on nonperforming
borrover, and acquisition of nonaccrual assets.

dan e

u ed de

orma

The four

agencies also issued a general

statement

that stressed

the importance of financial institutions working with borrovers
The general
be experiencing temporary difficulties.
statement discusses previously released policies that deal with
increased disclosure on nonaccrual loans and guidance on the
application of the definition of Highly Leveraged Transactions
(HLTs). The statement also addresses regulatory policies on
capital levels and loan concentrations, as they relate to
institutions' ability to make loans to credit-worthy borrowers.

who may

vill

clarifications and statements to field
institutions.
The agencies may also
issue more detailed guidance on the issues covered in today' s
joint statements. Copies of the general statement and the joint

The

agencies

examiners

and

send the

depository

policy guidelines

released today are available

FDIC, FRB, and OTS.

¹ ¹ ¹ ¹

from the OCC,

OCC

FDIC

OTS

FRB

GENERAL STATEMENT

Recent credit problems have underscored the importance of
prudent lending practices to the overall safety and soundness of
the nation's financial system.
The emergence of credit problems
in a number of sectors of the economy has prompted many
depository institutions to review their lending practices as
well as their capacity to meet credit demands.
Many institutions
have wisely tightened credit standards where such standards had
become too loose.
Others have reduced the pace of lending in
response to the need to shore up their capital positions and
strengthen their balance sheets.

institutions
In
in their lending practices.
may have become overly cautious
sor„e instances this caution has been attributed to concerns on
the part of lenders that the regulators of depository
institutions are applying excessively rigorous examination

is possible,

however,

that

some

depository

standards.
The

Federal banking

availability of credit
affected by supervisory

and thrift regulators do not want
to sound borrowers to be adversely

the

policies or depository institutions'
about them. As a result, the agencies today
misunderstandings
are issuing a series of guidelines and statements that are
intended to clarify regulatory policies in a number of areas and
reduce concerns depository institutions may have about extensions
Specifically, the guidelines and
of credit to sound borrowers.
statements released today: (1) encourage enhanced disclosure to

COmptroller

of the Currency

Federal Deposit Insurance Corpoabon

Federal ReMrve Board

Office ot Thntt Supervision

(2) facilitate extensions of credit to sound
borrowers and the workout of problem loans, and (3) better assure
sound assessments of the value of real estate by depository
institutions and Federal examiners.

the public,

Recent concerns related to a tightening of credit have
focused the agencies' attention on regulatory policies and their
effects on institutions' willingness to extend new credit and to
The guidelines and statements
work with troubled borrowers.
released today, which have been under development for some time,
are not intended, nor are they expected, to "solve" all credit
availability problems. When combined with other steps that have
been taken (such as lower money market interest rates and changes
in reserve requirements),
these initiatives should help
facilitate prudent credit extensions to sound borrowers.
Enhanced disclosure will help to ensure that the public
better informed about the nature of institutions' portfolios.

issued by the Office of the Comptroller
of the Currency (OCC) on suggested disclosures of more detailed
information about nonaccrual loans in public financial
statements, and recent banking agency guidelines on Highly
Leveraged Transactions, should help by differentiating
among
broad groups of assets with varying degrees of risk.

The new guidance

recently

Depository institutions have traditionally worked with their
borrowers who are experiencing problems.
In the current economic
environment,
it is especially important for institutions to avoid
shutting off credit to sound borrowers, especially in sectors of
the economy that are experiencing temporary problems.
with sound banking practices, depository
institutions, including those with low capital positions, should
fashion with borrowers
work in an appropriate
and constructive

Consistent

Such efforts
be experiencing temporary difficulties.
include reasonable workout arrangements or prudent steps to
restructure extensions of credit. Institutions that have in

who

may

map

place effective internal controls to manage and reduce excessive
concentrations over a reasonable period of time, need not,
automatically refuse credit to sound borrowers because of the
borrower's part, icular industry or geographic location.
the Federal bank and thrift
regulatory agencies aim to facilitate the workout of problem
loans by addressing the income accrual treatment of formally
restructured debt and acquired nonaccrual loans consistent, with
Further, there is a
generally accepted accounting principles.
clarification of the accounting treatment of multiple loans to a
single borrower when some, but not all, of the loans to the
borrower are troubled.
The documents

released today

agencies have also clarified when payments may be
recognized as income on a cash basis for loans that have been
In addition, the agencies are developing
partially charged-off.
guidelines that address how institutions can accrue income on
loans that have been partially charged-off.
The

the agencies are also clarifying their policies on
supervisory valuation of real estate. The policies provide
the evaluation of loan loss reserves or net carrying values
real estate loans should reflect a realistic market analysis
not be based solely on liquidation values.

Finally,

the

that
for
and

c osu e to

Nonaccrual

vary widely

generating

loans

with respect to their quality and cash
capacity. Consequently, the simple total of such

loans on an institution's books may not be a good indicator
of the institution s financial position. One method to
address this is to provide more information to the public on
these assets. For example, useful supplemental disclosures
might include information on the amount of charge-offs taken
on nonaccrual loans, the amount of cash payments received on
these assets, and the portion of these loans that generate
substantial cash flow.

recently issued a Banking Bulletin that contains
suggestions for the voluntary disclosure of additional
information on nonaccrual loans. The Federal regulatory
agencies fully support the voluntary disclosures of the type
suggested by the OCC and described in the attached
statement.
OCC

B. Disclosure of Hi hl Levera ed Transactions
HLTs
The Federal banking agencies have previously developed a
uniform supervisory definition for HLTs. The purpose of the
definition is to provide a consistent means to monitor loans
to HLT borrowers. The agencies have recently provided the
attached additional guidance to examiners and bankers on the
application of this definition.
This guidance stresses that
the HLT designation does not imply a supervisory criticism
of the credit.
The guidance

also

makes

clear that certain extensions

of credit, such as loans to debtors-in-possession
(DIPs), do
not fit the definition of HLT loans and should not be so
reported. The criteria for the removal of a loan from HLT
status have been expanded in the attached document.
The
agencies will continue to review these criteria to determine
if other steps are warranted in view of the characteristics
and performance of HLT credits, including the quality and

reliability
2.

of the borrower's

cash flow.

ssues

to be some concern that any new lending
that fail to meet minimum capital
by institutions
While it
requirements will result in supervisory criticism.
is essential that depository institutions that fail to meet
minimum capital standards
take effective and timely steps to
address this deficiency, such institutions are not
necessarily required to cease prudent, low-risk lending
activities. Institutions should attain capital compliance
in a prudent manner that strengthens their financial
conditions.
Institutions that seek to improve their
capital-to-assets ratios through shrinking their balance
sheets should avoid actions that raise their risk exposure,
assets or of core
such as the sale of all high-quality
deposits. Such actions by themselves, or the refusal to
lend to sound borrowers, fail to achieve the important
objective of improving the quality of under-capitalized
institutions' portfolios.
There appears

agencies share common procedures to address capital
In general, each
deficiencies at depository institutions.
to prepare a plan that
agency requires such institutions
details the steps they will take to attain the minimum
capital levels. Approved plans generally do not preclude a
continuation of sound lending activities, including prudent
steps to work with borrowers encountering financial
The

difficulties.
there appears to be some concern that
with loan concentrations are automatically
The benefits of adequate portfolio
good loans.

Similarly,

institutions
turning

down

diversification are well recognized by depository
institutions and their regulators.
Although the regulatory
agencies have not established rigid rules on asset
concentrations, they are in agreement that, as a matter of
should
sound operating policy, depository institutions
establish and adhere to policies that control "concentration
risk. "
Institutions that have in place effective internal
controls to manage and reduce undue concentrations over a
reasonable period of time, need not automatically refuse
credit to sound borrowers. The purpose of institutions'
policies should be to improve the overall quality of their
portfolios. The replacement of unsound loans with sound
loans can enhance the quality of a depository institution's
portfolio, even when concentration levels are not reduced.

Reco nition

of Income

Certain

Non

erformin

Loans

Questions have been raised regarding the recognition of
This
income on loans that have been partially charged-off.
subject is not explicitly addressed in the agencies'
regulatory reporting requirements.
The agencies wish to
clarify that payments can be recognized as income on a cash
~bas's for loans that have been partially charged off, without requiring that the prior charge-off first be
recovered, so long as the remaining book balance is deemed

fully collectible.
The agencies, along with the Securities and Exchange
Commission (SEC), each plan to solicit public comment on
proposed guidelines which would allow certain nonperforming
loans to be placed back on accrual status once the loans are
reduced to an appropriate level through charge-offs.
Any

issued will be based on the comments
received from the public and on-going discussions between
the agencies and the SEC.
formal

guidance

The agencies

have released

today supervisory guidance
on a variety of other issues related to nonaccrual assets
and formally restructured
debt. These guidelines include a
discussion of regulatory requirements related to cash basis
income recognition, multiple loans to one borrower, and the
acquisition of nonaccrual assets.

of Real Estate

In recent months, there have been significant declines
In response to
in real estate values in certain markets.
these declines, examiners have reviewed the adequacy of
institutions' loan loss reserves and, where they believed it
appropriate, have required additional reserves based on, in

part, their estimates of real estate values.
These actions have focused attention on the techniques
used to assess the value of real estate, especially
It is important that valuation
commercial real estate.
techniques reflect not only existing market conditions, but
also reasonable expectations of the property's performance
in the market over time. The Federal regulatory agencies
are reiterating their policy on the assessment of real
estate values and the establishment of loan loss reserves.

thrust of this guidance is to ensure that
loans not be assessed solely on the basis of
liquidation values but also on the income-producing capacity
of the properties over time. Supervisory evaluations should
take into account the lack of liquidity and cyclical nature
The basic
income property

of real estate markets and the temporary imbalances
supply and demand for real estate that may occur.

Review o

The agencies

'n s

erviso
want

in the

make

clear their policy that

any

request a review of any major decision
reached as part of the supervisory process, including those
related to asset classification and required reserve levels.

institution

may

partment of the TreasurY

FOR IMMEDIATE

March

NashlnSton,

SIS-204i

Barbara Clai
202-566-5252

RELEASE

CONTACT:

12, 1991

TREASVRY AMENDS

O.C. ~ Telephone

IRANIAN

TRANSACTION

REGVLATIONS

Department's Office of Foreign Assets Control today
Iranian Transactions Regulations to clarify the
circumstances under which Iranian oil may be imported into the
United States. Specific licenses will be issued on a case-bycase basis for these imports.

The Treasury
amended its

. S.
under license from the
now permitted
in settlement of cases before the Iran-U. S.
Claims Tribunal or if all payments due to Iran go to the
Tribunal's Security Account at The Hague. The unlicensed
importation of Iranian-origin oil into the United States has been

Iranian

Treasury

oil

prohibited

imports

are

Department

since October, 1987.

Security Account was established in 1981 after the signing of
the Algiers Accords. The Accords freed American hostages and
provided for the settlement of claims between the two countries.
Tribunal awards are paid to U. S. claimants using funds from the
Security Account. In selling oil for importation into the a.Unit=
ard
States, Iran would produce revenues to satisfy a Tribunal
awards.
future
or replenish the Security Account against
Prohibitions on the unauthorized importation of Iranian-origi;.
goods and services contained in the Regulations remain in effe=-.
For more information about the sanctions program contact the
Office of Foreign Assets Control at (202) 535-2071.
The

oOo

partment of ihe Treasury ~ Nashlnlton,
FOR RELEASE AT

March

12, 1991

4:00 P. M.

CONTACT:

D.C. o Telephone $56-2041
Office of Financ'ng
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 S 16, 800 million, to be issued March 21, 1991.
This offering will result in a paydown for the Treasury of abou
$2, 575million, as the maturing bills are outstanding in the
amount of S 19, 386 million.
Tenders will be received at Federal
Reserve Banks and Branches and at the Bureau of the Public Debt,
D. C. 20239-1500, Monday, March 18, 1991
Washington,
prior to 12:00 noon for noncompetitive tenders and prior to
1:00 p. m. , Eastern Standard
time, for competitive tenders.
The two series offered are as follows:

91 -day bills (to maturity date) for approximately
400
million, representing an additional amount of bills
S 8,
dated December 20, 1990 and to mature June 20, 1991
(CUSIP No. 912794 WP 5 ), currently outstanding
in the amount
of $10, 521 million, the additional and original bills to be

freely interchangeable.

million, to be
182 -day bills for approximately
S 8, 400
SePtember 19, 1991 (CUSIP
dated March 21, 1991
and to mature
No. 912794 XG 4 ).
The bills will be
and noncompetitive

issued on a discount basis under competibidding, 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 S10, 000
and in any higher S5, 000 multiple,
on the records either of the
Federal Reserve Banks and Branches, or of the Department of the
Treasury.

tive

bills will

be issued for cash and in exchange for
Tenders from Federal
March 21, 1991.
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
The

Treasury bills maturing
Reserve Banks for their

Federal Reserve Banks, as agents for foreign and international
to the extent that the aggregate amount
monetary authorities,
of tenders for such accounts exceeds the aggregate amount of
Federal Reserve Banks curren
maturing bills held by them.
hold S 1, 936 million as agents for f=re'gn and internationa'
and S 4, 205 million for their own account.
monetarv authorities,
Tenders for bills to be mainta'ned 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-REEK BILL OFFERINGS

Page

bidder, as defined in Treasury s single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.

and dealers who make primary
Banking institutions
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

competitive

tenders.

issue price as determined

in the auction.

1/91

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

will be made by the Department of the
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.
Public announcement

easury of the amount

Settlement

and

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
funds
on the issue date, in cash or other immediately-available
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the

bills accepted in exchange and the issue price of the
new bills.
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
Accrual-basis taxpayers, banks, and other
the bill matures.

maturing

persons designated in section 1281 of the Internal Revenue Code
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.

must

8/89

oeyartment of the Treasury
EMBARGOED
MARCH

Woihlnlton,

El.C. ~

Telephone sii-moos

UNTIL GIVEN

14, 1991

STATEMENT TESTIMONY OF NICHOLAS
BRADY
SECRETARY OF THE TREASURY
BEFORE THE
COMMITTEE ON APPROPRIATIONS
SUBCOMMITTEE ON TREASURY, POSTAL SERVICE
AND GENERAL GOVERNMENT

March

Mr. Chairman

and Members

14, 1991

of the Committee,

it is

pleasure

to appear before this Subcommittee to discuss the operating
budget request for the Department of the Treasury for FY 1992.
Since we met a year ago, significant events have taken place
As part of the
in both the international
and domestic arenas.
international coalition, we have addressed the situation in the
Persian Gulf. We have taken a positive step toward responsibly
managing Government by forging a budget agreement that adds
discipline to Government spending.
Seeking peace, stimulating
economic growth, and responsibly managing Government spending are
challenges for our nation.
has supported Operation Desert Storm by
economic sanctions against Iraq, by assessing the
impact of the conflict on the "front line" countries

The Department

enforcing
economic

and

processing and investing foreign contributions
by coordinating,
for Operation Desert Storm. These efforts which helped win the
war must be continued in new ways for us to win the peace.

The Administration
anticipates a short-lived recession with
recovery beginning at mid-year and the economic pace picking up
later in the year. This should bring unemployment down and
enhance growth.

I testified before

the Senate and House Budget
Committee on the need to
Committees and the House Appropriations
restrain Government spending and abide by the budget agreement so
The Treasury
that future budget deficits can be controlled.
budget request presents an honest approach to responsible
every opportunity
we are targeting
More importantly,
spending.
available to promote fiscal responsibility and provide innovative
responses to today's problems.

Last month,

that the savings and loan cleanup and the safety
and soundness of our banking system are near the top of
everyone's list of domestic issues which require thoughtful,
In that regard,
responsible analysis and workable solutions.
have recently proposed a comprehensive
plan for banking reform
that preserves deposit insurance for small savers, strengthens
We

NB-1178

know

banks by

outdated

attracting
laws, and

capital, increases competition by moderni»ng
streamlines the regulatory structure.

In addition to the banking reforms, we have asked Congress
to support initiatives to stimulate growth and competition that
include: family savings accounts to increase national saving; a
tax credit to promote
permanent research and experimentation
private research and development; first-time home buyer
withdrawal from IRAs; and reduction in the capital gains tax.

functions are broad and
critical to the Nation s economic well being. These critical
activities include:
The Department

of the Treasury's

developing

international

developing

economic

policies;

effects of tax

borrowing

money

Government

and

debt;
0

monetary,

financial

and

trade

policies that consider the economic
policy;
needed to operate the Federal
accounting for the resulting public

and budget

collecting the proper amount of tax revenue, at the
least cost to the public and with the highest degree of

public confidence;
improving

practices
0

producing

Federal cash management

collection

and debt

governmentwide;

currency

and

coin for the Nation's

commerce;

carrying out activities that include collecting revenue
from imports; collecting excise taxes on alcoholic
beverages and tobacco products;

controlling the sale and registration of firearms and
prosecuting their illegal possession and use; oversight
of drug interdiction programs and prevention of money
laundering; oversight of strategic exports programs;
preventing counterfeiting; training Federal law
enforcement officers and protecting the President and
Vice President;
administering embargoes and economic sanctions against
foreign countries to further U. S. foreign policy and
national security goals; and
0

regulating
chartered

national

thrifts.

banks and Federal

and

State

to carry out these essential Government
are requesting a total FY 1992 budget of $9. 6
162, 999 full time equivalent positions.

To continue

functions,

billion

and

Fiscal Year 1992 budget request has the following major
objectives:
The

Modernize

Information

aggressively

upgrade

S stems.
Treasury plans
and integrate our existing

systems

to ensure they will perform in the electronic
environment of the next century.
For example, this
budget requests funds to continue our commitment to

completely overhaul and modernize the IRS' tax
administration
system.
The goal of Tax System
Modernization
(TSM) is to place IRS on par with the
highest financial processing standards in American
business.
We undertake
this while recognizing that no
other organization anywhere has the same complexity,

statutory environment of financial
transactions.
Ultimately, we expect TSM to relieve IRS
of its manual processes so that we can dedicate our
personnel to even higher standards of service quality.
ove Mana ement of the Nat'on's F'nances.
The
Financial
Management
proposed budget for the
Service (FMS) includes funding to determine the best
budget and asset and
approach to merge governmentwide
liability data bases, to enlarge current efforts to
establish financial management evaluation criteria and
Funds are also requested to
improve data standards.
implement the Credit Reform Act of 1990 to more
accurately account for the costs of direct and
guaranteed loans, and to comply with the Cash
Management
Improvement Act of 1990 which requires
payment of interest when the Federal Government does
not provide, or the States do not disburse, Federal
volume

funds

and

in a timely and efficient manner.

ternal Cont o s. Funds are requested to
strengthen Treasury's internal controls and fully meet
the requirements of the Federal Managers' Financial
Integrity Act. These funds include continued
development of financial systems at IRS and Customs to
Further, these funds also
enhance resource allocation.
public debt accounting
new
a
of
support the completion
system that will improve automated controls and
ove

management

information.

ncrease Enforcement

and thoughtful

way,

of the Tax Laws. In an orderly
our service coverage and

we want

operations to keep pace with the economy. As more
returns are filed, more follow-up is required in every

service and enforcement function so that we maintain a
high level of voluntary compliance with the tax laws.
We continue
to give special emphasis to Accounts
Receivable, the collecting of back taxes. We also must
be responsive to growing requests from business
organizations to help them determine what is proper
compliance with a variety of tax code provisions.
Internally, the IRS must support higher Government
and
standards for financial systems accountability,
continue to address the higher threat of narcotics
We
crime to the integrity of tax administration.
consider all of this proposed spending to be a wise and
necessary

investment.

the War on Dru s. The War on Drugs
will continue as a national priority in FY 1992.
Treasury is a major participant in the War on Drugs and
is committed to working with the Office of National
Drug Control Policy.
In support of key priorities of
the National Drug Control Strategy, Treasury continues
as a major participant in the Organized Crime Drug
Enforcement Task Force (OCDETF) and the High Intensity
Law

Enforcement

and

Trafficking Area (HIDTA) Programs. The Customs
Service will continue to strengthen the President's War
on Drugs through its narcotics interdiction efforts.
Part of this strategy is the successful cross
designation of 1, 000 Customs special agents with the
Drug Enforcement Administration
(DEA). Funds are
requested to enable Customs to fly the air assets that
will come on-line in FY 1992, to expand the Canine.
Training Center and to provide service to the importing
Drug

community.

Funds are also requested for the Bureau of
Alcohol, Tobacco and Firearms (ATF) to combat violent
crimes by preventing armed career criminals from
obtaining firearms to commit drug related crimes.
Funding for ATF also will provide for the collection of
an estimated $13.5 billion in excise taxes on alcohol
and

tobacco.

its

to
at the Federal
Law Enforcement Training Center (FLETC) facilities.
FY 1992 FLETC request provides the resources to
continue facility expansion initiated in previous
The Department continues
law enforcement

consolidated

years.

commitment

training

Our

Financial Crimes Enforcement Network (FinCEN)
budget request provides funding for the operation and
of the FinCEN intelligence information
improvement
system providing financial intelligence to deter money
laundering and other financial crimes.
The

The Secret Service budget request provides
protection for the President, Vice President and their
families, as well as candidates and nominees for the
1992 Presidential Campaign.
In addition, the Secret
Service will be aggressively utilizing manpower and
resources to combat fraud against financial
institutions as a direct result of new authority
provided by the Appropriations
Committee this past
year.
and Coina e. The
Meet the Nation's Demand for Currenc
budget for the U. S. Mint will provide for production of
sufficient coinage to meet expected demand. The Bureau
of Engraving and Printing (BEP), which does not require
will meet the demand for
annual appropriation,

currency.

Fo ulation and Mana ement Overs'
The Departmental
0 e at'ons.
e a tmenta
will
budget request
permit the Department

Polic

financial

economic,

In summary,

represents
0

and

the Department's

a commitment

to:

tax policies.
budget

of
Offices
to carry out

request of $9. 6 billion

of the tax laws,
the administration
collection of revenues and responsiveness to the

modernize

public;

improve

the management

of the Nation's

finances;

strengthen internal controls to facilitate the
responsible management of the Nation's financial

resources;
enhance

the war on drugs;

and

essential Government services.
I will be
Mr. Chairman, that concludes my opening remarks.
Subcommittee
other
to answer any questions that you or the
0

happy
members

manage

may

have.

LI DE T
Department

of the Treasury

Bureau of the Public Debt

RELEASE

FOR IMMEDIATE

March

E
~

4'ashint, ton. DC '20'239

CONTACT:

18, 1991

RESULTS OF TREASURY'S AUCTION

Office of Financing
202-376-'350

OF 13-WEEK

BILLS

for $8, 438 million of 13-week bills to

Tenders

21, 1991 and mature on June 20, 1991 were
accepted today (CUSIP: 912794WP5).
on March
RANGE

be issued

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate

Price
98. 534
5. 98%
98. 526
6.
02%
High
98. 526
6. 02%
Average
Tenders at the high discount rate were allotted 38%.
coupon-issue yield.
The investment rate is the equivalent

5. 80%
5. 83%
5. 83%

Low

TENDERS RECEIVED AND ACCEPTED

New

York

Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury

TOTALS

Type

Competitive
Noncompetitive

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

$26, 674, 040
1 386 510
$28, 060, 550

$4, 449, 710
1 386 510
$5, 836, 220

2, 204, 780

397 370
$30 662 700

397 370
$8, 438, 370

42 , 295
27, 752 , 690
26 , 985
45 , 405
48 , 600
32 , 300
1, 357 , 965
60 , 670

Philadelphia

Subtotal,

10 , 420
41 , 505
24 , 695
611 , 425
607 745
$30, 662, 700

Acce ted
42 , 295
7 322 , 720
26 , 985
45 , 405
48 , 600
30 , 680
158 , 465
17 , 430
10 , 420
41 , 505
24 , 695
61 , 425
607 745
$8, 438, 370

Received

Location
Boston

(in thousands)

additional $6, 530 thousand of bills will be
issued to foreign official institutions for new cash.
An

Ne-1179

apartment

of the Treciaury

Nashlneton,

O.C. ~ Telephone $56-2041

Text as prepared

for release upon delivery
expected at 2:00 p. m.
March 14, 1991

UNDER

STATEMENT BY
THE HONORABLE DAVID C. MULFORn
SECRETARY OF THE TREASURY FOR INTERNATIONAL
AFFAIRS
BEFORE THE SENATE FOREIGN RELATIONS COMMITTEE
MARCH

14, 1991

for the opportunity to discuss the proposed
negotiation of a free trade agreement (FTA) between the United
States, Mexico and Canada. I ould also like to take this
opportunity to place our discussion today in the broader
perspective of the Administration's
Enterprise for the Americas
Initiative. We look forward to more consultations | ith you as
you review. both these ef forts.
Thank

you

The FTA proposal reflects an emerging global recogni: ion that
open markets for trade in goods and services and investment
are a
po~er ful impetus for gro| th and st ~bi 1 i ty. We must not
underestimate
Just a
the magnitude of this change in percep'ion.
fet years ago there
as no such consensus.
FTAs and other
ambitious trade and investment agreements seemed beyond our
1

reach.

The ne~ awareness of the importance of open markets creat s
unpcecedented opportunity
to conve t sound economi" pcinciples
into reality.
needs your suppoct
To do this, the Administration
foc an extension of the fast track author i ty for the
implementation
This authocity is essen" ia'
of trade agreements.
foc the president to maximize the Administration's
nego iat'ng
leverage and cr d. bi lity and to exert '. S. le~".. ec-hip in
~ i 1 1 allo~ the .-'. !min is tc at ion an",
~or ld economy.
An extension
Congr ss to cwork together to seize the oppor ~n i i to fa=':. ion a
he ' u=. ua r Round,
hcough
ne~, more open trade env i conment
free trade agreement ~ith the United States, '1exico, and . anada,
for the Americas Initiative.
and the Enterprise
an

NB-1180

is at the foref ront of the shi f t toward more open i
market-oriented
development strategies.
Its courageous s«Ps
stabilize the economy through its structural reform program and
Mexico

the negotiation

creditors

under

a financing package
ith its commercial bank
the Brady Plan have put Mexico firmly on the path

th. A successful FTA would be a
Mexico's potential as
and strengthen
an economic partner of the United States.
Now is the time for
the United States to create a permanent economic relationship
based on open markets between our countries.
A North
American free trade agreement would create an open
market encompassing some 360 million consumers and $6 trillion in
output.
Mutual liberalization
of trade and investment
restrictions betw, een the United States, Mexico, and Canada will

sustainable
tow, ard long-term
complement to these measures

grow,

help our firms become more competitive internationally
and
stimulate economic growth and productivity across North America.

Benefits for the United States
An

reduces or eliminates trade and investment
can make an important contribution
to economic
Since Mexico initiated a policy of lowering trade
in connection with World Bank loans and joining the
Agreement on Tariffs and Trade (GATT) in 1986, U. S.
to Mexico have more than doubled, growing from $12. 4
to $28. 2 billion in 1990. Reducing tariffs further would
additional gains: currently our exporters face a trade
tariff of ten percent in Mexico; ours is four percent.

FTA which

restrictions

growth.

barriers

General

exports

billion

generate
weighted

Mexico's demand for
As Mexican economic growth accelerates,
capital goods and machinery should respond quickly. U. S.
industry is in a good position to fill much of this demand with
increased exoorts thereby creating more U. S . jobs. In addition
to the increased demand for goods, the overall demand for
services should rise. The FTA can be an effective vehicle for
ensuring that U. S. firms can compete on an equal basis in this
growing

market.

An important
area in a comprehensive FTA is financial
services, an issue for which Treasury will have lead
responsibility.
U. S. financial service firms could gain
significant benefits given the diversity and scope of their
oroducts. Therefore we will seek improved access, national
treatment and equivalent competitive opportunities
for U. S. banks
and securities firms in the Mexican market.
Greater openness in
this sector will enhance financial intermediation in North
America and increase the overall efficiency of all markets

concerned.

An FTA would
also help U. S. industry maintain global
competitiveness.
The two countries already engage in a
trade and
considerable amount of complementary intra-industry
investment particularly
through the special maquiladora program.

industries

specialization,
advantage.

competitive

through an FTA can make U. S.
further intra-industry
by promoting
on each country's comparative

barriers

Lo»er trade and investment

capitalizing

Foreign investment is an important issue for us to consider.
the debate has often centered on the notion that
Unfortunately
foreign investment means the export of jobs. This is not the
case. Our trade interests are closely linked to our investment

interests.

Foreign

investment not only strengthens
the host country' s
but also strengthens
U. S. businesses'
ability to compete
globally. Therefore foreign investment can actually serve to
protect and generate jobs for U. S. firms. This is particularly
the case »ith U. S. investment in Mexico in part because Mexico
spends 70 cents of each dollar of imports on U. S. goods. More
broadly, one of the main goals of the Enterprise for the Americas
Initiative, »hich I »ill discuss later, is to encourage open
investment regimes throughout all of Latin America.
economy,

Finally, an FTA »ould also increase overall economic
efficiency through the economies of scale provided by a larger

market.

U. S. , Canadian,

lo»er-priced

products

and

Mexican

consumers

»ider diversity.

»ill

enjoy

Benefits for Mexico
An

already

FTA»ill

complement

the economic

»ill solidify

reforms Mexico has
gro»ing confidence in the

accomplished and
This confidence, combined »ith improved export
economy.
opportunities and a more open investment environment, »ill lead
to substantial inflo»s of foreign capital, including reflo»s of
flight capital. We estimate that since the June, 1990
announcement
of the t»o presidents of their intent to negotiate
about $5 billion in foreign direct
an FTA, Mexico has attracted
investment and other net private capital inflo»s (about half for
each) .
Mexican

the
In the longer term, an FTA »ould help institutionaliz
market-opening
policies that Mexico has been implementing . The
FTA »ould also provide
important incentives for Mexico to
maintain sound macroeconomic policies and strengthen its ability
Increased capital
to finance its balance of payments position.
inflo»s should offset any short term deterioration in the trade
balance. Increased imports and dir ct investment »ould
contribute to expanded production capacity and strengthened

internat ional competitiveness.

other open market policies '&ex;co has
and real »ages for
»ould increase job opportunities
implemented
contribute to
stimulus»ould
Such a gro»th
Mexican»orkers.
of living.
standards
higher real income levels and improved

Finally,

an FTA and

Why

an FTA

arrangement
for our future trade
ith Mexico? Compared to more limited
of a comprehensive FTA is the best

the optimal

investment relations
trade agreements, pursuit
means to ensure maximum benefits
and

from

negotiations.

First,

balanced

beneficial

comprehensive
FTA negotiations
would produce a
agreement with commitments on all sides for mutually

liberalization.

Second, the FTA negotiations would not only meet the trade
objectives sought in the multilateral Uruguay Round negotiations,
For example, we vill seek
but also go beyond those objectives.
tariffs
rather
than just a reduction; and
elimination
of
gradual
on investment
we will seek the greatest
possible liberalization
treatment, well
and national
such as right of establishment
Round's
trade-related
investment
narrower focus on
beyond the
measures.

Third, an FTA is the most effective strategy for encouraging
continued liberalization
in Mexico and encouraging other
developing nations in Latin America to follow Mexico' s example.
Mexico is an important cornerstone for our comprehensive Western
Mexico' s trade barriers are already low by
Hemisphere policy.
developing country standards, and it has taken many of the
preliminary necessary steps to liberalize foreign investment
regulations and stabilize macroeconomic policies that we would
look for before considering a trade agreement.
the Enterprise

Link with

for Americas

Initiative

to appropriate economic policies is
achieve sustainable economic growth
and enjoy the full benefits of an FTA.
Fncouraging Latin
American countries to adopt such policies is a key objective of
the President' s Enterprise for the Americas Initiative.
That
Initiative, which has been enthusiastically greeted throughout
Latin America, joins in a single endeavor the three economic
issues of greatest importance to Latin America: trade,
investment, and debt.
On trade,
the ultimate goal of the Initiative is to establish
a free trade system
hich links the entire Western Hemisphere.
FTA negotiations
with Mexico are a major first step. To move
Trade and Investment
forward in this process, we are establishing
countries to
Caribbean
Councils with many Latin American and
discuss trade problems and explore liberalization.
Having

essential

a firm commitment
any country to

for

to help

Initiative includes
countries compete for capital in a

investment,

resources.

developing

countries

the

two

specific proposals
of scarce
Bank is

world
First, the Inter-American Development
sector lending program
an investment

to liberalize

their investment

regimes.

to encourage

Second, the President proposed the creation of a Multilateral
Investment Fund in the IDB to provide additional support for
investment reforms.
The Fund «ould make technical assistance
reforms,
grants for privatization and other investment-related
support human capital development through grants for «orker
retraining and education, and improve micro and small-sized
enterprises' access to capital by providing them «ith credit and
has asked Congress to
The Administration
equity financing.
authorize U. S. contributions to this Fund. As part of the fiscal
We «ill be
year l992 budget, «e have requested $100 million.
seeking $500 million in total over a five year period . We
believe that this fund «ill prove critical to the ability of
in the region to take meaningful
goverments
steps to reform their
We
investment regimes and attract needed capital for gro«th.
Fund's
t«o-thirds
of
the
countries
to
contribute
other
expect
capital, to meet the goal of a $1.5 billion fund over five years.
regard to debt, the Initiative «ould involve the
reduction of debt o«ed to the U. S. government of countries
pursuing strong economic reform programs, including measures to
authority from Congress
We gained
regimes.
open their investment
last year to undertake reduction of concessional PL-480 debt.
reduce
the United States «ould significantly
Under this program,
Continued dollar
the stock of PL-480 debt of eligible countries.
the
ne«, reduced
retire
to
be
directly
«ould
applied
payments
With

debt.

The

Initiative

«ill also

provide significant benefits For the
the hemisphere pursuant to Environmental

«ithin
environment
Frame«ork Agreements negotiated «ith each eligible country.
Interest payments made in local currency on the reduced debt «ill
remain in the country to support a broad range of environmental

projects.

President recently transmitted to Congress a legislative
proposal authorizing the reduction of AID debt and the
channelling of local currency interest payments to support the
in a manner similar to that conceived for PL-480
environment
debt. PL-480 debt constitutes only about one-fourth of the
concessional debt o«ed to the U. S. Government by Latin American
Substantial debt relief for these
and Caribbean countries.
countries, therefore, «ill need to involve action on AID debts as
The

«ell.

addition, this proposal «ould provide authority to sell,
reduce, or cancel a portion of assets held by the Commodity
Credit Corporation as a result of its credit guarantee prog rams
and a portion of Eximbank loans to facilitate debt, 'equity,
s«aps in eligible
and debt-for-deve'opment
debt-for-nature,
countries.
In

Conclusion
In concluding,

I «ould like to emphasize

the importance

in our economic relations
ith Latin Amer ica.
to lay the basis for greater U. S. trade
We have the opportunity
with Mexico awhile at the same time helping Mexico
and investment
stagnation to
move away from decades of closed, state-controlled
open market-oriented
development.
This ill benefit all three of
first steps
Mexico has taken the all-important
our countries.
itself. But the central question is: Would the United States be
better off a decade from now ~ith an FTA or by sitting back and
hoping Mexico continues to liberalize and takes into account U S.
economic interests?
In my view, , the answer is clear. With your
support, and your support for extension of fast track negotiating
authority, we can actively set the course for improved prosperity
across the Hemisphere.

seizing

this

moment

iorimeni of the Treasury

Nashlne jon, D.C.

»Rebirth of a Nation:

Difficulties of Transition in Eastern

The

Presented

J. French

Telephone $54-2040

and Central

Europe"

Hill

Deputy Assistant Secretary
U. S. DepartILent of the Treasury

before

The Vanderbilt University School
Harch 15, 1991

Nashville,

Law

Tennessee

It is a thrill for me to address this distinguished group
gathered on the campus of my
gg~. It was here at
Vanderbilt that I developed my abiding interest in foreign policy
and economics.
Needless to say, our assemblage today to discuss
eastern Europe and the Soviet Union is an indication of the
comparative
rapidly changing syllabus for the undergraduate
economics course probably underway just a fev yards away. My
remarks will deal with the economic transition of Europe's
emerging economies -- but the lessons are equally applicable to
reform efforts in the Soviet Union.
These observations are based
upon my travel throughout
the region over the last few months.

1980's will

go down in history as the Decade of
Democracy.
Latin America, Europe and even parts of Africa saw
remarkable gains in political pluralism and individual freedoms
but nowhere was this more pronounced than in central and
eastern Europe and the Balkans.
The

in his inspiring essays,
the movements of a
t
ev
vere
remarkably peaceful.
freedom
to
totalitarianism
from
people
dash toward
This
Once started, the speed vas breathtaking.
freedom is epitomized in Ash's quip made famous by playvright,
"In Poland it took ten years, in
turned President, Vaclav Havel:
perhaps in
Hungary ten months, in East Germany ten weeks:
days!"'
It actually took
Czechoslovakia it will take ten
twenty-four days from meetings in the smoke-filled basement of
As Timothy

Timothy

Random

Garton Ash chronicled

Garton Ash,

a
rs w
House, 1990), p. 78.

essed

te
(New

York:

the Magic Lantern Theater (which served as the Civic Forum's
to the Presidency.
headquarters)

of democracy began with a Polish Pope making his
Poland in June 1979, which inspired the courage
necessary to form Solidarity in 1980. The decade ended with
people poking their heads out from beneath the weight of the Iron
Curtain.
From the Baltic to the Adriatic, once again people
breathed the air of freedom -- the freedoms we take for granted:
The decade

first visit to
of association,

thought,

prayer,

and

own

Today, I would like to reflect on the
freedom for the emerging economies of east

Balkans,

financial

private property.

first

year or two of
central Europe and the
the important role of the

specifically highlight
sector for their future success.

and

Rebirth of a Nation
Like our forefathers in the coffeehouses of Boston or
Philadelphia, the Poles in the Lenin Shipyard, those gathered in
Heroes Square in Budapest, the journalists, artisans, and actors
in The Magic Lantern all began with a political debate about
self-determination. ~ The formation of political parties and the
drafting of resolutions and platforms all came first and in a
fury. Interestingly, each of these movements cautiously
projected a gradual transition to actual democratic power -- to
the running of a government chosen by the people and responsible

for an economic program. However, once started, an avalanche
thundered downhill.
Solidarity was first with its overwhelming
Parliamentary victory on the June 4, 1989 -- sadly, the same day
that another vibrant group of democrats were crushed on the other
side of the globe -- the Tiananmen Square Massacre. On the
thirty-third anniversary of the 1956 Revolution, Hungarians
adopted a slate of anti-communist
amendments
and moved rapidly
went-toward national elections in March 1990. And so
Romania in May, followed by Czechoslovakia and Bulgaria in June.

first

of freedom and self-government have been
exhilarating and frustrating as these countries continue the
exorcism that started with their peaceful revolutions.
Many
eastern Europeans describe themselves as Cain and Abel -- Jekyll
and Hyde, both as a people and individually.
The new democrats
pass private property statutes, declare and construct independent
judiciaries, move to end central planning, and price controls;
but the old nomenklatura ask, "who sells the property, decides
the cases, plans the production and sets the prices, if not a
These

months

not dealt with East Germany as a result of her
with West Germany on October 3, 1990 -- less than one
year after the first breach of the Berlin Wall.
have

reunification

ministry?"
In short, many would argue that the eastern and
central Europeans are attempting to "plan" their market economy!
Czechoslovak Finance Minister Vaclav Klaus described his personal

rejection of this philosophy

in Reason Magazine

in June 1990:

want a market economy without any adjectives.
Any
compromise will only fuzzy up the problems we have.
To
pursue a so-called third way is foolish.
We had our

experience with this in the 1960s when we looked for
socialism with a human face. It did not work, and we must
be explicit when we say that we are not aiming for a more
efficient version of a system that has failed. The market
is indivisible; it cannot be an instrument in the hands of
central planners. ~
seeming contradiction is a rejection of all things
"
"central.
This manifests itself in often mindlessly moving
authority to state and local officials. What will be the
authority of the central governments and what will be reserved
This debate is especially
for state and local governments?
pronounced where old duchies and kingdoms and ethnic populations
have spoken up for the first time since World War II, especially

Another

in Czechoslovakia
Union.

and Yugoslavia

and,

of course, in the Soviet

After 200
Doesn't this debate sound more than familiar?
years in the U. S. we still have a vigorous and useful debate over
and
Federalism.
As eastern European union members, authors,
have learned, democracy is hard work.
actors turned-politicians
solutions,
They are often so quick to reject "central" government
that approaches to national debts, fiscal and monetary policy and
other "national" problems are mired in as many solutions as there
are states or republics or ethnic groups. Our forefathers
struggled through seven long years of confederation before we had
our endearing and timeless Constitution. We fought a Civil War
more costly in American lives than all combined wars before and
since -- to make the notion of one country a permanent fixture of
As Shelby Foote noted in the PBS
our national character.
television series on the Civil War, only after the War was our
country referred to as "The" United States, rather than "These"

United

States.

International
But, in today's world of interdependence,
reform programs, and
Monetary Fund (IMF) and World Bank-supported
economic
powerhouse,
the
in
membership
with an eye toward future
to do too
want
countries
the European Community, none of these
Thus, they are trying to become
much fighting
or experimenting.
Kevin Acker,
d
Number

55 (Winter

"Poisoning

*1k

of the Soul,

1991), pp. 63-64.

New

Leaders

of Russia

democracies and free market economies
quickly as possible.

simultaneously

and

The rebirth of a
In my view, we must practice patience.
nation is as difficult, if not more so, than our own birth as a
nation. Forty years of communism and propaganda and fear is bad;
forty years of "you will do as you are told" combined with a
driving desire to escape centralized direction and "do it our
way" in Slovenia, Slovakia, Croatia, or Lithuania make for
difficult transitions. As Alexander Hamilton wrote to a friend
in 1782, "Quit your sword, my friend; put on the toga. Come to
Congress, we have fought side-by-side to make America free; let
us hand-in-hand
struggle to make her happy. " That's where each
of the countries is today.

their people happy, following the assurance of the
freedom of
basic rights of property, self-determination,
association, speech, and religion, one must have an econom that
th
th
*h
pt
Here the challenges of
aforementioned political reforms.
maintaining international
creditworthiness,
freeing the market of
state controls, and raising living standards come together in a
din of conflicting economic exigencies and prescriptions.
Let me cite a few colorful examples of government officials'
propensity to become "Hyde" and seek to "plan" their market
To make

gth

economy.

Despite no doubt countless hours of reading or studying
comparable economics, one Finance Ministry official
requested a meeting with the appropriate U. S. official
responsible for the setting of commodity prices.
Another official asked which U. S. government agency
determined credit quality for corporate bonds to be

issued.

was disturbed about a large number of "stock
exchanges" spontaneously starting outside the capital
city and not waiting for a central exchange to be

One group

established.
Yet another

official voiced

sold in a state enterprise
enacted.

point

While there are many anecdotes

is that these great countries

concern about shares being
before a securities law was

about the transition, the
with their rich heritage are

4Richard B. Morris, ed. , Alexander Hamilton and The Foundin
of the Nation (New York: Dial Press, 1957), p- 86-

attempting to skip over decades of economic and financial
development.
Unfortunately,
while often beautifully educated,
much of the business and entrepreneurial
talent in these
countries possess little or no practical knowledge about business
Thus, what is desperately needed on the
or market economies.
part of business and government leaders are the basics. Let me
use the financial sector to illustrate some needs and to offer

to satisfy

some

possible

Anal

sis of the Financial Sector

ways

them.

Fiscal Polic — All of these emerging economies are seeking to
Each
adopt a Value Added Tax (VAT) like their EC neighbors.
desires a tax system which encourages capital formation, savings
and investment.
Most currently have tax contribution systems
enterprises
whereby the most profitable state or socially-owned
turn over most of their income (often over 1004) to the
These funds are funneled into the state for
government.
subsidies for the industrial, public, defense sectors and to
local authorities for housing, education, and the like.
Incentives to encourage efficiency, productivity, and
Indeed, the incentive
are non-existent.
entrepreneurship
structure is such that it tends to encourage waste, inefficiency,
and stagnation.
The countries are not moving rapidly enough to
Unraveling the byzantine
adopt necessary tax reform measures.
subsidies
is a complex and
and
web of confiscatory
taxes
politically difficult task, but it is critical to the restoration
As Hamilton said, in 1791~ "Power
of a credible government.
without revenue, in a political society, is a name. "
The design of a tax system must carefully balance revenue
needs, resulting economic incentives, fairness, and the overall
Revenues should be geared toward
burden of its administration.
fundamental
needs and ideally should be as low as possible. This
is especially challenging in a transition from a bloated, subsidy
But, it is important that a slim,
budget to a market economy
balanced budget be crafted so as not to exacerbate inflationary
pressures.

These economies are in critical need of savings and
revenue could be collected from
investment.
As significant
taxes like a VAT, the tax burden
efficient, consumption-oriented
on entrepreneurial
effort and savings and investment should be
should adopt a
light. For example, in my view, these countries
--taxes
on capital
no
and
154
than
no more
low flat rate tax
be a
would
likely
gains, interest and dividend income. This
Likewise,
powerful inducement for savings and capital formation.

Ibid.

p. 84.

taxes should not burden the export sector of the economy which
brings in badly needed foreign exchange.
This brief outline of a tax policy may strike you as
"unfair" in its simple, regressive structure.
However, one only
need study the economic record of the developing countries which
have adopted low tax, pro-growth policies compared with those
developing nations who have endorsed a strategy of high taxes
with the resulting stagnation.
a good example. The colony's low, flat rate tax
structure has generated unprecedented economic growth. Economic
growth produces increasing standards of living for all citizens
and allows for necessary expansion of the public sector.
High
tax, redistribution strategies have resulted in stagnating
economic growth, a reduced standard of living and negative growth
in public services. Per capita income in 1990 was $10, 916 in
Hong Kong compared with $340 in India and $315 in the People' s
Republic of China. The last time Hong Kong had a per capita
income level near $300 was in 1960.
Hong

Kong

of the growth model assert that one cannot
duplicate a "Hong Kong" in Europe due to different cultural
backgrounds.
I disagree. Why is it that Chinese living just a
few miles away produce barely 34 per capita of their Hong Kong
neighbors or that Indians in business outside of India are some
of the world's most industrious and successful business people.
The answer lies in proper economic policies, not in people' s
heritage. When a proponent of welfare statism queried pro-growth
economist Melvyn B. Krauss, "But, how many Hong Kongs can the
world have?", Dr. Krauss replied, "As many as the world will
Opponents

allow

itself. "

large state indebtedness

accrued over the past forty
years of inefficient and counterproductive
action should be
shifted from the bankrupt enterprise sector to the new national
governments.
Subsidies should be phased out and assets should be
transferred to private hands. A credible fiscal policy will
foster confidence, economic growth, and eventual discharge of
accumulated national debts.
The

Moneta
Polic — The critical long-term success of the eastern
and central European economies depends on having money that is a

true store of value, that serves effectively as a medium of
exchange, and that acts as a meaningful unit of account. For
example, Poland's action to give the zloty these three functions

and

povert
Melvyn B. Krauss, Develo ment Without Aid: Growth
Hill
Book Company,
Government
New press, McGraw
(New York:

1983) p.

ix.

with availability of ample goods, few
lines, and the zloty's new found convertibility.
By contrast, Yugoslavia,
rich with advantages in a skilled
labor force, foreign exchange reserves, and a much greater
decentralization of the enterprise sector, is utterly debilitated
by an overvalued dinar and a complete lack of an enforceable
monetary policy.
While inflation appears lower (annual rates of
140% in 1990 versus 2665% in 1989) and banks are complaining
that
credit is tight, nothing could be further from the truth.
In fact, the National Bank of Yugoslavia continues to
has been rewarded

shortages,

foreign exchange liabilities.
This,
with the socially-owned enterprises not collecting their
receivables nor paying their payables, allows the country to
avert economic reality and generate huge underground inflation by
running what some have termed "one of the largest check kiting
schemes in the world. " This manifests itself in an official rate
of 10 ' 4 dinars per dollar compared with a street or black market
rate 30% greater, a hoarding of consumer durables, and a drop in
the country's large foreign exchange reserves.

guarantee
combined

bank domestic

and

In formulating monetary policy, the parallel goals of
political reform and economic reform can be in conflict. It
takes courage to create a truly independent central bank which
can achieve monetary policy objectives in the face of resulting
unemployment
and fear of the unknown.
But, the benefits are not

to be feared, but, rather welcomed
goods, and a credible currency.

price stability,

ample

Bankin
8 stem — Unfortunately,
the most ignored link in the
reform chain is the banking system.
It has never functioned in
any

of these countries

as an efficient allocator of credit to

investment projects.
Instead, it was an arm of the
central bank, which simply printed money to support state-owned
businesses, collectivized agriculture and the overhead of
military and Communist Party technocrats.
In several countries
where efforts have been made over the years to separate
commercial banks from the central bank (by the creation of a socalled "two-tiered" banking system), one is left with "banks"
which were often created and managed by their largest borrowers.
The borrowers then received subsidies in the form of "loans"
guaranteed by the state and further loans to pay the interest.
Thus, the lack of independent
credit analysis and improper
corporate governance have littered the landscape with financial
dinosaurs.
These dinosaur banks effectively have no capital, no
credibility, no expertise, and are tightly linked with failing
state-owned enterprises.
worthy

It is

that each of these governments adopt
prudential standards for capital adequacy,
for responsible management, and market-based lending
fundamental

strict, enforceable
incentives

standards.
foreigners,

banks should

Private banks started by local residents, by
or by joint ventures, should not be delayed.
be allowed

even encouraged

-- to

become

These

full

service depository institutions.
There are few branches, no
credit cards, no checking accounts (in Poland and Hungary), no
automated tellers, and customer service is a "thing of the
future. " Nonetheless in each country there are a few brave souls
attempting to computerize, introduce new products and begin

marketing.

of eastern and central Europe will see their
political reforms significantly weakened without access to
capital. Without a thriving, private enterprise sector, there
will be no alternative employment for the millions of displaced
workers.
The small entrepreneur
needs capital to expand, to
finance a shop or store, to purchase a privatized state asset and
to start anew. Coherent investment decisions will not be made
until projects are evaluated on the basis of financial merit
rather than political connections.
In my view, this will simply
not happen with the existing state banks. New banks and foreign
banks must be rapidly integrated into these economies, to foster
competition and provide debt and equity finance.
The

countries

about the dinosaurs, the state banks? They cannot be
in isolation from the privatization of the enterprise
sector. Here is where the World Bank can be helpful. Structural
and financial sector adjustment loans can be used to restructure
state enterprises, thus improving a bank's prospect for
World Bank loans can also facilitate the
repayment.
restructuring of bank balance sheets. Also, these loans can be
used to help modernize bank data processing and record keeping
systems, and to support fundamental workforce training.
What

considered

Privatization Efforts — Because state-controlled banks are
inextricably linked to other state-controlled enterprises, it is
necessary to make some observations about plans for
privatization.

First, the emerging governments appear too obsessed with the
privatization of the large, state monopolies.
Assessing their
potential, valuing the assets, and attempting to privatize by way
of a public offering like the British model is made immensely
cumbersome and complex by lack of skilled management;
few
accounting standards or trained accounting professionals; the
absence of an operating market economy with a convertible
currency within which one might even try to judge future
performance; a bureaucracy trying to plan a capital market with
ambiguous notions of a "fair" distribution;
and, the simple fact
that most of these entities are hopelessly bankrupt and
effectively "owned" by the state banks -- which, in turn, have
negative

net worth.

Instead, the focus should be on prompt development
"private enterprise" by the following:

First,

subsidies

shops and stores
-- small
should simply be given

viable without

to their current

state

managers

and

employees.
(It should be noted that some countries are
attempting to give pre-World War II owners a chance to "claim"
their prior possessions). Forcing these businesses to have new
productive'~
owners by way of an auction is bureaucratic and counterNor does it in any way improve a small shop's
potential success. Better to have happy, motivated new "owners, "
producing revenues, paying taxes, and feeding, housing, and

clothing their families'

Next, the innate entrepreneurship
of the eastern and central
Europeans should not be discouraged by imposing heavy taxes,
excessive regulations, permits, and redtape.
I was shocked when
President Gorbachev condemned the so-called "black marketeers" in
the Soviet Union. These entrepreneurs
are his private sector,
who are the only ones who can distribute
goods effectively and
employ the growing number of displaced workers.

Third, while some of the large-scale state enterprises will
be competitive in the global marketplace,
most should simply be
dissolved. It is important to let market forces work. Take the
case of the "State Crop Dusting Company" in Hungary:
it has 260

employees -- 12 pilots, 10 co-pilots, 6 mechanics, 4 ground crew,
and 228 administrative
Can you
people, including 4 economists.
imagine almost 90% of your employees as non-productive
overhead
and four economists in a crop dusting business!
This kind of
gross over-staffing is common throughout east and central Europe.
In my view, if a pilot and a mechanic want to leave and start
their own business, just let them go, and give them a chance to
purchase or lease a plane.
In other words, one should be
flexible and not attempt to program a sale of an entire company,
if it has no hope for a successful future as an ongoing entity.

For those state companies with some hope of building
successful domestic and export businesses, one should encourage
access to foreign capital and technology.
Foreign expertise and
ownership should not be burdened with so many hurdles that no one
dare jump.
Flexible structures should be developed to accomplish
long-term goals: in my view, the state, as "seller", should be
willing to receive non-voting equity shares (or, some kind of
deferred instrument) instead of demanding all cash. The cash is
desperately needed by these companies and their managements

Conversation with Mr. Peter Rona, a member of the board of
directors of the First Hungary Fund, and former president and chief
executive officer of IBJ Schroder Bank and Trust Company.

foreign, domestic or joint -- to improve production and workforce
The state is far better off having productive
training.
companies employing people, exporting
products, paying taxes&
and thus improving the standard of living of its citizens.
Capping foreign ownership and taking all of the working capital
will not produce a long-term success or attract badly needed
foreign capital and expertise.
Certain sectors -- airline, railway, steel, oil
However,
inevitably may obtain more sustained state support.
each government should carefully reevaluate the reasons for such
continued state assistance.
The companies should be restructured
and commercialized,
possibly with financial assistance from the
their
World Bank and
restructuring should be coordinated with the
effort to privatize the state banks. Of course, truly
unproductive operations should be put into bankruptcy.
Markets — Every one of the emerging countries is out to
To the
reclaim a page from its past -- its stock exchange.
that
capitalism
citizens, the stock exchange stands as a symbol
has returned. However, exchanges should serve a role greater than
mere symbolism.
Ca

ital

While each country is in a whirlwind to form a regulatory
commission, trading rules, clearing houses, purchase electronic
is
trading computers and to reclaim their pre-war building,
important to remember the basics: that stock markets help
companies raise capital, secondary trading affords liquidity and
attractive opportunities for savers, and these markets perform

the role of efficient allocator of resources. However, before
these functions can come into play, one must have private
companies to have stock listings and one must have capital for
there to be investment.

While stock exchanges can be conduits for foreign and
domestic capital and serve the important liquidity and asset
valuing function of markets, I caution that they are not
essential to a privatization program, nor are they the perfect
device to impose an "equal" or "fair" distribution of state
assets. In fact, to the contrary, illiquid markets dominated by
new issues of dubious quality and no track record can "backfire"
to the political detriment of the economic reforms. Instead, one
should initially encourage domestic and foreign capital to
support both private enterprise and privatization through a
transparent and efficient investment and tax system. Further,
each government should develop and implement prudential
accounting standards and work to minimize unnecessary regulation

or other legacies from the past.

For former state enterprises, the result will be new private
joint stock companies owned in some combination by the state,
(either directly or through convertible instruments such as

11
or options),

shares, warrants

direct foreign capital, foreign

banks (resulting from debt-for-equity
swaps), and employees.
a
track
a
develops
record
under new management
as
company
Then,
can
and in the hard reality of a market economy, the government
register its shares and sell them pro rata to the owners or to
and the employees.
The result will be more successful
management

Disclosure and accounting
frequent public offerings.
standards will have been in practice and understood.
Only then
can the benefits of liquidity and capital-raising
functions of
public markets really be fulfilled.
and more

Role of the United States
The U.

has a clear objective: To help the
economies help themselves.
At the end
the U. S. created the Marshall Plan in Europe

government

people in these emerging

of World War II,
The goal in the countries of
and sent General McArthur to Japan.
both the vanquished and the victorious was to rebuild from the
vast rubble that remained, and in the case of Germany and Japan,
to foster the permanent institutions of democracy. These
objectives were carried out by the one nation rich enough to
shoulder the task, the United States.
The end of the
Today, our world is distinctly different.
"
not of
Cold War calls for a "Marshall Plan of Ideas,
in Europe the physical
We are not rebuilding
construction.
destruction of a hot war, but the psychological destruction of a
cold one. As President Havel said in his New Year's address in
We have
1990, "We are living in a decayed moral environment.

ill,

because we have become accustomed
become morally
one thing and thinking another. "

to saying

burden does not fall solely to the United States
Instead, the European Community
as the lone wealthy nation.

Today,

this

in the Group of 24 industrial countries) join the
United States in this effort. The G-24 has already mobilized
approximately $20 billion in grants, 9 credits, guarantees, and
These resources combined
technical assistance for the region.
Monetary Fund and
with those of the World Bank and International
those available
than
the private sector are many times greater
War II
post-World
for reconstruction efforts in the immediate
(plus others

period.

civil
In every conceivable area -- customs, environment,
and the financial
aviation, law, agriculture, infrastructure,
advice and
professional
sector, the U. S. Government is providing
p. 62.
Economic Re ort of the President
Economic Advisers, 1991), p. 229.
Pol c

Review,

(Washington:

Council

counsel to newly elected and appointed government officials in
these aspiring market economies. In fiscal year 1990, Congress
In this
appropriated $418 million to assist Poland and Hungary.
fiscal year 1991, Congress authorized $369 million for Poland,
Hungary, Czechoslovakia,
Bulgaria, Romania, and Yugoslavia.
Additionally,
$70 million was approved for our initial capital
subscription to the new European Bank for Reconstruction and
Development
in London. The Bush
(EBRD) to be headquartered
Administration's
budget for fiscal 1992 released last month calls
for an additional $400 million to be made available for
assistance to the region.

assistance to the financial sector as
I will highlight both the efforts of the U. S. public
Using our

sectors.
Fiscal Polic

an example,
and private

— To assist these
new tax policies,

governments in designing and
the U. S. Treasury is forming a
regional tax policy advisory team. With legal, accounting, and
economic expertise, this team will be on call to finance
ministries and legislative committees for policy and technical
expertise. Likewise, we have Treasury professionals from the
Internal Revenue Service (IRS) and the Financial Management
Service to assist in the improvement and design of tax collection
systems and the design and issuance of public debt, respectively.
implementing

Financial Advisors — To directly aid the key financial
institutions, the Treasury is engaging experienced financial
advisors who will live in the eastern European capitals as policy
advisors to the ministries of finance, central banks, commercial
banks. At the invitation of the governments, these long-term
advisors will help guide policy direction, provide common sense
approach to market economics, and will provide advice in the
critical area of policy execution.

Lon -Term

Additionally,

the Treasury

is considering

engaging

bank restructuring
specialists to work full time with the World
Bank and a country's finance ministry and central bank to more

expeditiously

facilitate private capital

being invested in the
This will include advice on resolving the
largest bankrupt state banks, updating technology and accounting
systems, and breaking up the incestuous links between borrowers

banking

sector.

and bank management.

Financial Workforce Trainin — We are supporting critically
needed workforce training of all types for the tens of thousands
of bank employees in these countries. This training includes
short-term courses in specialty areas like company valuation and
support for newly created, private institutes of banking and
finance to be located in Katowice (Poland), Budapest, Prague, and
Belgrade.

said,

consider financial sector reform of
fundamental
importance to these emerging economies.
Working with
the World Bank and IMF, we are providing experts to assist in the
design of bank supervision and examination policies and in
As

have

training.
Securities and Ca ital Market — The U. S. government is
providing extensive legal and management training to assist in
the creation and implementation
of stock exchanges in Warsaw,
Bratislava,
Budapest,
Prague,
Sofia, Ljubljana, Zagreb, and
Belgrade. The Securities and Exchange Commission (SEC) has
contributed a great deal of energy in supporting these efforts.
For example, in April, the Commission is hosting a conference in
for developing market officials. This training
Washington,
D AC.
session will be accompanied by internship programs in brokerage
firms, stock exchanges, and at the SEC.
Contribution b the U. S. Private Sector — The U. S. Treasury, as
the coordinator of financial sector assistance, has developed a
program where we believe government expertise makes sense and
adds value:
tax policy and administration,
customs, and basic
banking and securities laws and supervisory procedures.
But, our
objective is also to bridge the Atlantic for private American
firms and educators to participate in the economic transformation
and development
of the former eastern bloc. Only through
sustainable, long-term economic relationships in the private
sector will market forces take root and produce lasting results.
The long-term financial advisors I described in financial
policy, bank credit, accounting, and privatization are all being
obtained from the U. S. private sector. Likewise, the advice and
assistance in bank and finance training will be "hands-on" and
will be provided by professional bank training experts.
In addition to the engagement of U. S. private experts in
accounting, mergers and acquisitions, banking, corporate
finance, I would like to highlight three volunteer organizations
which are providing incalculable expertise to the eastern
law,

Europeans.

First,

V
which
Services Vo unteer Co s
Development
(US
was created by the U. S. Agency for International
now
a
Vance,
State
Cyrus
of
AID). Chaired by former Secretary
senior partner at Simpson, Thacher & Bartlett and John Whitehead,
a former Deputy Secretary of State and partner at Goldman Sachs,
the FSVC takes teams of bankers, lawyers, and accounting
professionals to foreign countries and addresses reform issues in
the financial sector. They have had successful trips to Poland,
Yugoslavia and, this week, they are in Czechoslovakia.
Hungary,

Next,

at the direction of
d

Chairman

Richard Breeden,
1

the

LUgllla

Markets Adviso
Committee
EMAC .
With a particular focus on
stock exchange and securities development, this committee of
bankers, academics, and accountants has been very active in
designing market regulation, underwriting and disclosure

standards,

and

clearance and settlement

systems.

Finally, I would like to mention the Citizens Democrac
d
h
dbyf
p
current Union Pacific chief executive, Drew Lewis, the CDC is to
'

foster voluntary

to f*

efforts in

improving business management and
economics education.
Just last month, President Bush hosted a
White House conference in business management and economics
education, which drew together 200 university, foundation and
corporate leaders to exchange views on how they could make a
difference in central and eastern Europe. The conference set
ambitious goals through our private sector efforts. They are:
exposing at least ten million citizens to television and other
media programs explaining the working of a free market economy;
training or retraining at lest 50, 000 managers, workers and
entrepreneurs;
educating 10, 000 college-age students in the
fundamentals
of management and economics; and training at least
200 teachers in management and economics, so that they can go
back to become the core faculties of the future.

Conclusion

In closing, the challenges are great. Creating democracies
free market economies simultaneously present unique
circumstances and difficult choices for legislators and
government ministers.
To jump in a short span of months from a
system of "you pretend to pay me, and I' ll pretend to work" to
the untidy world of capitalism at work is a shock.
and

But, with patience and perseverance these countries can
enterprising members of the greater world market. I am a
short-term pessimist and a long-term optimist.
With luck,
political stamina, and the right policy choices, perhaps one or
more of these budding economies could well become a model of free
market success, achieving standards of living equal to the finest
on earth.
It is in the realm of possibility. We may read in ten
or twenty years of "the Hungarian Miracle or the Polish Miracle"
or how these countries have become a European equivalent of the
"Asian Tigers. " I urge each of you to go and experience the
change.
You will return filled with admiration
for their courage
and patriotism.
See what freedom can do. You will never take
yours for granted again.
become

Report On The Taxation of
Social Security and Railroad Retirement Benefits
in Calendar Years 1987 and 1988

Report to the Congress,
the Secretary of Health and Human Services
and the Railroad Retirement Board

Department

of the
Mar

THE SECRETARY OF THE TREASURY
WASHINGTON

l4arch

The Honorable

Thomas

l991

S. Foley

Speaker of the House of Representatives
D. C. 20515
Washington,
Dear Nr.

Speaker:

Subsection (e) of Section 121 of Public Law 98-21, the
Social Security Amendments of 1983, provides that "the Secretary
of the Treasury shall submit annual reports to the Congress and
to the Secretary of Health and Human Services and the Railroad
Retirement Board on:

transfers

under this subsection during the
year, and the methodology used in determining the
amount of such transfers and the funds or account to
which made, and

(A) the

made

(B) the anticipated operation
the next five years. "

of this subsection

during

Pursuant to that section, I hereby submit the "Report on
the Taxation of Social Security and Railroad Retirement Benefits
in Calendar Years 1987 and 1988. "

Copies of the report are being sent to the President
of the Senate, Secretary Louis W. Sullivan of the Department of
Health and Human Services, and Chairman Glen Bower of the
Railroad Retirement Board.

Sincerely,

Nicholas
Enclosure

F. Brady

THE SECRETARY OF THE TREASURY
WASHINGTON

&larch

The Honorable

President

Washington,
Deac Mr.

Danforth

of the Senate

1991

Quayle

D. C. 20510

President:

Subsection (e) of Section 121 of Public Law 98-21, the
Social Security Amendments of 1983, provides that "the Secretary
of the Treasury shall submit annual repocts to the Congress and
to the Se"retary of Health and Human Seri "os and :he R~i'road
Peticement

Board on:

(A) the

transfecs

yeac,

and

which

made,

amount

made

this subsection

during the
the
used in determining
or
account
to
the
funds
and

under

the methodology

of such transfers
and

(B) the anticipated operation
the next five years. "

of this subsection

during

Pursuant to that section, I heceby submit the "Report on
Railcoad Reticement Benefits
the Taxation of Social Security and
in Calendar Years 1987 and 1988. "

Copies of the repoct are being sent to the Speakec of
the House, Secretary Louis W. Sullivan of the Department of
Health and Human Services, and Chairman Glen Bower of the
Railcoad Retirement Boacd.

Sincerely,

Nicholas

Enclosure

F. Beady

TABLE OF CONTENTS
~Pa

CHAPTER 1:

I.
I

INTRODUCTION

AND SUMMARY

Introduction
Summary

CHAPTER 2:

METHODOLOGY AND ESTIMATES OF BENEFIT
TAXATION FOR THE INITLV. CALENDAR YEAIK
1987 AND 1988 TRUST FUND TI4QVSFERS

Methodology

11.

Estimates of Benefit Taxation in 1987 and 1988

CHAPTER

3: ADJUSTMENTS TO TRANSFERS FOR

ACTUAL
1987 AND 1988 TAX RETURN INFORMATION

Tax Return Data

II.

Actual Income Tax Liabilities in 1987 and 1988

CHAPTER 4:

CHAPTER 5:

ADJUSTMENTS TO TRANSFERS FOR ACTUAL
1984-1986 TAX RETURN INFORMATION

FORECAST OF TRANSFERS TO TRUST FUNDS
FOR 1989-1993

Table of Contents

CHAPTER 6:

—Continued

~Pa

DISTRIBUTION OF TAXABLE BENEFITS AND TAX
LIABILITY ATTRIBUTABLE TO TAXATION
OF BENEFITS IN 1988

Income Tax Model for Distributional
Social Security Beneficiaries
Using the Individual

II. Distribution of Total and Taxable Benefits
I

I. Distribution of Total

by Adjusted

and Taxable Benefits byExpanded

Analysis

Gross Income Class

Adjusted Gross

Income Class

APPENDIX:

COMPARISON OF TAX PAIMMETERS SHOWN
IN PRIOR REPORTS WITH REVISED RESULTS
FOR 1984, 1985, AND 1986

ENDNOTES

BIBLIOGRAPHY

LIST OF TABLES

~Pa

Comparison of Assumptions Used to Estimate Initial Trust Fund
Transfers for Calendar Year 1987 with Actual Results

Table 2

Comparison of Assumptions Used to Estimate Initial Trust Fund
Transfers for Calendar Year 1988 with Actual Results

Table 3

Adjustments
Comparison

to Trust Funds For Calendar Year 1987 Based on
of the Initial Transfers with Actual Results

Adjustments
Comparison

to Trust Funds for Calendar Year 1988 Based on
of the Initial Transfers with Actual Results

Table

Table 4

Table

Table 6

Table

Table 8

Table

Table 10

Adjustments to Trust Funds for Calendar Years 1984 through 1986
for Overpayments of Individual Income Taxes to Trust Funds

Forecast of the Net Transfers for Calendar Years 1989-1993 due to
the Social Security Amendments of 1983

Distribution of Total and Taxable Social Security and Railroad
Retirement Benefits in 1988 by Adjusted Gross Income Class

Distribution of Taxable Social Security and Railroad Retirement
Benefits and Resulting Tax Liability for Tax Returns with Taxable
Benefits in 1988 by Adjusted Gross Income Class

Distribution of Total and Taxable Social Security and Railroad
Retirement Benefits in 1988 by Expanded Adjusted Gross Income
Class

Distribution of Taxable Social Security and Railroad Benefits and
Resulting Tax Liability for Tax Returns with Taxable Benefits in
1988 by Expanded Adjusted Gross Income Class

List of Tables-Continued

~Pa

Appendix

Table A. 1:

Table A. 2:

Table A. 3:

Comparison of Tax Parameters Shown in Report on Taxation of Social
Security and Railroad Retirement Benefits in Calendar Year 1984 with
Revised Results

Comparison of Tax Parameters Shown in Report on Taxation of Social
Security and Railroad Retirement Benefits in Calendar Year 1985 with
Revised Results

Comparison of Tax Parameters Shown in Report on Taxation of Social
Security and Railroad Retirement Benefits in Calendar Year 1986 with
Revised Results

CHAPTER

INTRODUCTION

AND SUMMARY

INTRODUCTION
Beginning in January 1984, social security and railroad social security equivalent
benefits have been partially taxable for high-income taxpayers. The Treasun Department
is required to estimate the individual
income tax liabilities attributable to the benefits
payable during each calendar quarter and transfer these amounts to the Federal Old-Age and
Survivors Insurance (FOASI), Federal Disability Insurance (FDI), and Social Security
Equivalent Benefit Account (SSEBA) trust funds at the beginning of the quarter. Both the
taxation of benefits and the transfers of taxes to the trust funds are required by the
Social Security Amendments of 1983 (P. L. 98-21), as amended by the Railroad Retirement
Solvency Act of 1983 (P. L. 98-76) and the Consolidated Budget Reconciliation Act of 1985
(P. L. 99-272). Further, the 1983 Act required adjustments in the amounts transferred to
the trust funds in the event that the estimates of the tax liability attributable to the
benefits, made before the year's tax returns become available, are subsequently shown to
be incorrect.

The 1983 Act also required the Treasury Department to submit annual reports to the
Congress, the Secretary of Health and Human Services, and the Railroad Retirement Board
containing a description of the methodology used to estimate the transfers of income tax
to the trust funds and a forecast of transfers over the five subsequent years.
The
Treasuv, Department's Office of Tax Analysis (OTA) is responsible for preparing these
annual reports, as well as for estimating
transfers to the trust funds and making
adjustments to the transfers based on actual tax return data. This report describes the
methodology used to determine the transfers to the trust funds of calendar year 1987 and
1988 income tax liabilities, adjustments to the transfers for those and prior years, and a
forecast of transfers between 1989 and 1993.
The amounts transferred to the three trust funds are calculated as the difference
between tax liabilities with and without the inclusion of benefits in taxable income for
returns with taxable social security or railroad social security equivalent benefits.
To
determine if any benefits are taxable, a taxpayer must complete a separate worksheet
The taxpayer adds both tax-exempt
contained in tlie instructions to the tax return.
interest income and one-half of social security and railroad social security equivalent
benefits to adjusted gross income (AGI). If this sum exceeds $25, 000 ($32, 000 for joint
filers), then the taxpayer must include in AGI the lesser of one-half of the benefits or
one-half of the excess. Thus, a maximum of 50 percent of the social security and railroad
social securiti equivalent benefits are includable in AGI. For taxpayers with incomes
slightly above the threshold amounts or v ith relativeli large benefits, the percentage of
such benefits includable in AGI can be lower than the 50 percent maximum.

SUMRtARY
The initial transfers to the three trust funds of income tax liabilities attributable
to the Social Security Amendments of 1983 were based on estimates derived from the OTA's
Individual Income Tax Model. The Tax Model contains information from a stratified random
sample of tax returns, various imputations of data not available from tax returns, and a
tax calculator which computes changes in tax liabilities attributable
to changes in the
(ax laws.
For both l987 and 1988 liabilities, estimates were made at the end nt the
preceding calendar year and were modified as new information was obtained.
At the
beginning of each quarter, the trust funds received amounts equal to one-fourth of the
estimated change in calendar year income tax liabilities due to taxation ot benefits.
Chapter 2 contains a description of the methodology used to derive estimates ot beneti(
taxation for the initial calendar year 1987 and l988 trust fund transfers.
Tax return data from l987 were received from the Internal Revenue Service (IRS) hi
the OTA in l989
The initial calendar ~ear l987 transfers of $;, 29 million (o the three
trust funds were $l39 million higher than the amount nt (ax liability calculated trom
actual 1987 tax return data. Transfers to the FOASI, FDI, and SSEBA (rus( tunds were
initially
overstated
$39 million, and $I 8 million, respectively
by $82 million,
Correcting adjustments were made in the July l989 trust fund transfers.
I

During l 988, $3, 498 million was transferred to the three trust funds, hased on OTA's
estimates. Data from the l988 tax returns became available in l 990. The l 988 tax returns
showed that the initial transfers to the trust funds fell short of the actual incnrne (ax
liability hy $275 million.
This shortfall chiefly reflected an underpayment
to (he FOASI
trust fund of $326 million.
Transfers to the FDI and SSEBA trust tunds were ini(ialli
&»ers(a(ed by $42 million and $9 million, respectively
Correcting adjustments were ma~le
in the October l990 trust fund transfers.
The l98, and 1988 adjustments are descrihed in
Chapter 3.

Adjustments were made in October I 989 (o correct for overpaymen(s ot $I, 363 million
trust funds which had occurred during prior reconciliations.
Because ( t
processing error, reconciliations for 1984 through l986 inadveaen(ty
credited the three
trust tunds with certain additional income tax receipts, largely attributable
to lump-sum
distributions from pensions. These adjustments are described in Chapter 4.
(o the

Transfers to the three trust funds tor calendar years (989 through l993, including
(he adjustments already made for previous years and an anticipated adjustment for
iH i,
are estimated to be $24, 32 million. The Iorecasts for l98» (hrough 1993 are described in
Chap(er s
I

Chap(er 0 presents the Jis(ribu(ion hi income class ( (axpaiers ~ho includ s»cial
~~hen re(iirns
'e&:uri(i nr railroad social securiti equivalen( henefi(s in (axahle income.
(n the
elassitied according to AGI. nearly halt of the (ax Iiabili(i attrihu(ed
HoNei r.
"delusion n( benetits is paid bi filers w((h AGI less than $'0. 009.
Prnpnrtinn of benefits includable in AGI varies among taxpayers. T~o-(hirds nf (axpalers

-3those with higher incomes) include the statutory maximum
-- 50 percent of benefits
Among the remaining taxpayers with taxahle benefits
percent.
(generally, those with lower incomes), the rate of inclusion averages about
Thus, the average rate of inclusion for those taxpayers with AGI less than $50.000 is
ahout 33 percent, whereas it is about 50 percent for those with AGI greater than or equal
to $50, 000. When the income classifier is expanded to include the non-taxable portion i~t
benefits, only about one-third of the tax liability resulting trom the taxation ol
benefits is paid by filers with AGl plus non-taxable benefits of less than $50, 000.
with taxable benefits (generally,

—in AGI.

CHAPTER 2:

METHODOLOGY AND ESTIMATES OF BENEFIT TAXATION
FOR THE INITIAL CALENDAR YEAIK 1987 AND 1988
TRUST FUND TI&NSFERS

METHODOLOGY
The Treasury Department's Office of Tax Analysis (OTA) is responsible for estimating
the tax liability
attributable
to the social security and rail road social security
1
equivalent benefits received by high-income beneficiaries.
The OTA provides the
information to the Treasury Department's Office of Finance and Planning, which has the
authority to transfer funds from general revenue to the trust funds.
The OTA estimated the 1987 and 1988 tax liability effects attributable to the
inclusion of benefits in adjusted gross income (AGI) using the Office's Individual Income
3
Tax Model. This Tax Model contains information from a stratified random sample of 75, 000
returns selected from the IRS's Statistics of Income file for 1985, various imputations of
data not available from tax returns, and a tax calculator which computes changes in tax
liabilities attributable to changes in the tax code. Records on the Tax Model file are
extrapolated to future years. Computations based on the Tax Model are weighted to produce
results that are representative of the entire population of taxpayers.

Because returns do not provide sufficient data to estimate the revenue effects of the
partial inclusion of social security and railroad retirement benefits in AGI, imputations
were added to the Tax Model to compensate for the missing items. First, the Tax Model was
modified to include data on social security and railroad retirement benefits. The Social
Security Administration and the Railroad Retirement Board provided information on the
total amounts of benefits. These amounts were distributed among appropriate taxpayers,
using the most recent Current Population Survey data from the Census Bureau as a guide.
Second, an imputation was made for tax-exempt interest on state and local obligations
because it is included in the benefit inclusion formula but was not tabulated by the IRS
prior to tax year 1987.

The data items on the Tax Model were adjusted for three types of growth. First,
total expenditures
on social security and railroad social security equivalent benefits
were projected to grow according to the most recent forecast provided by the Social
4
Securiti Administration and the Railroad Retirement Board. Second, an adjustment was
The current structure of the
made to capture the maturing of the beneficial, population.
social security system ensures that for the near future net beneficiaries subject to tax
Finally, the
hai e both greater benefits and higher incomes than prior entrants.
their
real
value.
The
thresholds were adjusted to reflect the effect of inflation on

-5-

thresholds
which trigger taxation of social security
and railroad
social security
equivalent benefits are not adjusted for inflation.
As the real value of the thresholds
erode, the number of filers who must include benefits in AGI increases.

The tax calculator then utilizes the information (including the imputations and
extrapolations discussed above) from each potential filing unit to calculate the Federal
income tax liability. For purposes of making the initial l 987 and l988 transfers, the Tai
Model was used to estimate tax liabilities with and without social security and railroad
social security equivalent benefits included in AGI. The Tax Model takes account ot
changes in other tax provisions indirectly affected bi the inclusion of these benefits in
AGI. Usage of deductions and credits, as well as calculations of alternative minimum tax
liabilities, can be affected by the inclusion of benefits in AGI. These effects can be in
Thus, as AGI increases it becomes more difficult to meet the
opposing directions.
criteria for deducting medical, casualty and certain miscellaneous expenses.
But the
increased tax liability resulting from the inclusion of benefits in AGI enahles some
taxpayers to use credits which otherwise might not be usable in that year. The Tax Model
calculates both the percentage of total benefits included in AGI as a result of the
special benefit inclusion formula and the marginal tax rates applicable to the taxable
hene

fits.

ESTIMATES OF BENEFIT TAXATION IN 1987 AND 1988
Estimates of the additional
tax liability from the partial taxation of asocial
securiti and railroad retirement benefits for calendar year 1987 were made in late I98|
and were adjusted as new information was obtained. Similarly, estimates of calendar year
l988 liability were initially made in late l987 and were adjusted during the year to
reflect new information.
The amounts transferred to the trust funds each quarter equaled
one-fourth of the estimated change in calendar year tax liability as a result of the
Social Security Amendments of 1983, plus adjustments for prior transfers. The transfers
ivere allocated to the following trust funds based on OTA estimates:

Federal Old-Age and Survivors

Federal Disability

Insurance

Social Security Equivalent

Insurance

(FOASI);

(FDI); and
Benefit Account (SSEBAi.

compares the assumptions used to estimate the initial transfers for calendar
year l987 with the actual results. The top section of the table indicates that for FOASI,
ii was initially estimated
that 6. 3 percent of the $l82, 838 million of benefits paid oui
in l987 wi~uld he included in AGl at a marginal tax rate of 26. 8
l'ahle

TABLE

Comparison of Assumptions Used to Estimate Initial Trust Fund
Transfers for Calendar Year 1 987 with Actual Results 1/

Total
Benefits
Paid
($millions)

Trust Fund

Benefits

Tax Rate on
Benefits

Includable
in AGI

(%)

Includable
In AGI

Initial Transfer Assum

Federal Old-Age and Survivors Insurance (FOASI)
Federal Disability Insurance (FDI)
Railroad Social Security Equivalent Benefits (SSEBA)
Total

(%)

Transfer
Amount
($millions)

tions 2/

26. 8
26.0
26. 7

3,088

20, 1 38
3 823

6.3
3.0
4.6

206, 799

5.9

26. 8

3,291

1 82, 838

1 56

Actual Results 3I

olit-Age and survivors Insurance (FoAsl)
Federal Disiit»lily Insuiaiice (FDI)
It.«lined Soc«il Security Equivalent Benefits (SSEBA)

Fu&1«ial

Total

183,140
20, 499
3 729

6.7
2.5
3.6

24. 6
22. 9
21.8

3,006
117

207, 368

6.2

24. 5

3, 152

Di. t&,« trni«it ol trii Treasury
Ollice ol Tax Analysis

each quarterly trans'ler. This lable presents a weighled average ol these quarterly
non-resident aliens are
Rounding ol results may prevent exact matching ol total. Benefits paid to

tl Dilleront assiiinptio»s were used
ti, «i slur as i»»lirioiis

lor

riot »lcl«(I&'. &I in the total benefits paid.

the Social Security Administration and the Railroad
2I Source: The total benelits paid data were estimates provided by
data came from the Individual Income Tax Model ol the Office of Tax Analysis.
Hut ii i«»e»t 0»;iid, the other
enl lo the Social Securit Bulletin
lotal benelits paid data are from the 1989 Annual Statistical Su
Retirement Board; the other data come from the Internal Revenue
trio Social Si c«r ily Adr»inisrr ation and the Railroad
S»I VICC 5 Iflltivld«al Master File data.

3r s»iiico

T lie

-8The estimates assumed that
percent, yielding an initial transfer of $3, 088 million.
railroad retirees would include a smaller proportion of benefits in AGI: 4. 6 percent of
the $3, 823 million paid out in railroad social security equivalent benefits were estimated
to be included in AGI at a 26. 7 percent marginal tax rate, yielding a $4, million transfer
Relative to retirees, recipients of social securiti disability
io the SSEBA trust fund.
insurance benefits have lower incomes. As a result, smaller tax parameters were used in
the estimation of the initial transfer of disability benefits:
3.0 percent of the $'0, 138
million in FDI benefits were included at a 26. 0 percent marginal tax rate resulting in a
transfer of $156 million.

The parameters used to estimate the initial transfers for calendar year 1988 are
shown in the top section of Table 2. The percentage of total benetits includable in AGI
was increased from its l987 level, while the marginal tax rate applicable to benefits iias
estimated to decline. The thresholds for taxation of benefits are fixed in nominal terms,
hut certain
other tax parameters
(notably the tax rate structure) are indexed tor
intlatinn.
As a result, more benefits become suhject to tax each year at a lower marginal
r~te. Wlarginal tax rates were also estimated to decline between 1987 and 1988 in response
to the continued implementation
of the Tax Reform Act of 1986, lt was estimated that b. ~
percent of the $194, 659 million in FOASI benefits payable in l988 v ould he includable in
AGI atnonillion.
a marginal tax rate of 24. 6 percent, and that 3.5 percent of the $21, 4i I million in
FDI benefits would be includable in AGI at a marginal tax rate of 23. 5 percent. Thus, in
1988, $3, 285 million was transferred to the FOASI account, and the FDI account received
$173
The tax parameters applied to railroad social security equivalent benefits were
adjusted primarily to rellect data from 1984 and 1985 tax returns indicatine that railroad
As a result. th»
retirees paid less taxes on benefits than had been previously estimated.
benefits includable in income was noi
percent of railroad social security equivalent
changed from its 1987 level of 4. 6 percent, and for the first time. the marginal tax rate
estimated to be applicable to railroad social securiti equivalent henefits was reduced (&~
.i i~iel (23 percent) below the rate applied to other benetit tripes. As a result, $40
niillion was transferred to the SSEBA trust fund in 1~88.

TABLE 2

Comparison of Assumptions Used to Estimate Initial Trust Fund
Transfers for Calendar Year 1988 with Actual Results 1I

Trust Fund

Total
Benefits
Paid

Benefits
Indudable

($million)

in AGI(rtti)

Tax Rate on
Benefits
Includable
in AGI(%)

Initial Transfer Assum

Federal Old-Age and Survivors Insurance (FOASI)
Federal Disability Insurance (FDI)
Railroad Social Security Equivalent Benefits (SSEBA)
Total

Transfer
Amount
($million

tions 2/

4.6

24. 6
23.5
23.0

3,285
173
40

6.5

24. 5

3,498

194,659
21,467
3 934

6.9
3.5

220, 060

Actual Results 3/

Federal Old-Age and Survivors Insurance (FOASI)
Federal Disability Insurance (FDI)
n;ulfi)1(l social security Equivalent Benelits (ssEBA)
Total

194,984
21,671
3 889

7.2
2.8
3.7

25.8
21.7
21.5

3,61 1

220. 544

6.7

25. 6

3,773

131
31

Dupailineiit ot the Treasury
Oflice ol Tax Analysis

were used lor each quarterly transler. This lable presents a weighted average of these quarterly
Ir.uislor assumplions. Rounchngof results may prevent exact matching of totals. Benehts paid to non-residents have been
subtracted from Ihe total benefits paid.
I/ Ditle&ont assuinplions

soui co: The total benehls paid data were estimates provided by the Social Security Administration and the Railroad
Ri.'tiff. iTloilt Board; the other data came Irom the Individual Income Tax Model of the Oltice ol Tax Analysis.

3I Source: The total benefits paid data are from the 1989 Annual Statistical Su ement to the Social Securit Bulletin
illa sori il Security Administration and the Railroad Retirement Board; the other data come lroin lhe Internal Revenue
Sar woe's liidividual Master File data.

CHAIPTER

ADJUSTMENTS TO 'H4Q4SFERS FOR ACTUAI. 1987 AND
1988 TAX RETUIVl INFORMATION

TAX RETURN DATA
The Social Security Amendments of 1983 require adjustments to the trust funds if
actual tax return data subsequently
reveal errors in the initial transfers.
To calculate
the additional tax liability for calendar year 1987 and I988 resulting from partial
taxation of social security and railroad social security equivalent benefits, the IRS
created a data file based on Form l040 records. All filers who reported taxable social
security or railroad social security equivalent benefits on their Form 1040 in l987 or
1988 are included in this data file. While the Form l040 provides information on the
total amount of benefits includable in taxable income, it does not indicate whether the
filer received FOASI, FDI or railroad social security equivalent
benefits.
Such
information is necessary for the appropriate allocation of revenues among the trust funJs.
To obtain this information, the Form 1040 records belonging to those beneficiaries who
reported taxable benefits were matched to the Form 1099 records provided by the Social
Security Administration
and the Railroad Retirement Board. (While the actual Forms
1099-SSA sent to taxpayers do not disclose whether the amounts shown are for retirement or
disability benefits, the Form l099 records provided by the Social Security Administration
to the IRS do include the source of benefits. )
Using this matched file of Form l040 and Form l099 records, the IRS calculated for
each benefit type the number of tax returns with benefits which might be includable in
adjusted gross income (AGI), the gross dollar amount of benefits paid to beneficiaries who
filed tax returns, and the amount of benefits included in AGI. Next, for each taxpayer on
the file, taxable income was computed with benefits excluded from AGI. Using the new
measure of taxable income, the tax liability was recalculated. The difference between the
filers
with taxable benefits
actual tax liabilities and their liabilities re-estimated
of
revenue
attributable
to the taxation
excluded from taxable income represents the amount

of benefits.
The special IRS file of social security and railroad retirement beneficiaries was
expanded in 1987 to include information from Schedule D on long-term capital gains income.
This information was necessary because the maximum tax rate on long-term capital gains
income was limited to 28 percent in 1987. In order to take advantage of this provisinn,
long-term capital gains income had the option of computing their iax
taxpayers with
2~
liability on Schedule D, without reference to the normal tax tables. Approximately
percent of returns with taxable social securiti or railroad social securiti equivaleni
benefits computed their tax liability on Schedule D. (In contrast, only 3 percent ol g11

-12tax filers used this option. ) Failure to account for this treatment would have resulted
in an understatement
of the taxes attributable to the inclusion of benefits in AGI in
1987. In 1988, capital gains income was taxed at the same rates as ordinary income, and
the additional information from Schedule D was no longer necess~.

ACTUAL INCOME TAX LIABILITIES IN 1987 AND 1988
The lower section of Table 1 shows the additional tax liability attributable to
partial inclusion of social security and railroad social security equivalent
benefits
calculated from actual 1987 tax returns. In 1987, the Social Security Administration and
the Railroad Retirement Board paid out $207, 368 million in FOASI, FDI, and railroad social
security equivalent benefits.
As a result of the Social Security Amendments
of 1983,
$12, 844 million in benefits (6.2 percent of the total) were added to AGI for calendar year
1987. On average, these benefits were taxed at a marginal rate of 24. 5 percent, yielding
For all trust funds, initial transfers exceeded
$3, 152 million in additional revenues.
these actual receipts by $139 million.

of the reconciliation

of estimated

and actual 1987 tax liability, the
July 1, 1989 transfer included a total downward adjustment of $139 million to the FOASI,
FDI, and SSEBA trust funds. The adjustments to the FOASI, FDI, trust funds were $82
million, $39 million, and $18 million, respectively (see Table 3).
As a result

Actual results from the 1988 tax return data are shown in the lower section of Table 2.
In 1988, the Social Security Administration
and the Railroad Retirement Board paid out
544
million in FOASI, FDI, and railroad social security equivalent benefits. While
$220,
total expenditures on benefits increased by 6 percent between 1987 and 1988, the amount of
benefits includable in AGI increased by 15 percent to $14, 734 million (6. 7 percent of the
total). On average, these benefits were taxed at a marginal rate of 25. 6 percent, yielding
In total, rei enues to the trust fund were
$3, 773 million in additional revenues.
to the FOASI account was partially
understated by $275 million. A sizable underpayment
offset by overpayments to the other two trust funds.

The initial transfers to the FOASI account fell short of actual liabilities bv $326
million because the marginal tax rate applicable to social security retirement benefits was
underestimated.
The actual marginal tax rate was 25. 8 percent, exceeding both the
estimated tax rate for 1988 and the actual 1987 level by 1.2 percentage points. Although
counter to initial expectations, the increase in the marginal tax rate between 1987 and
of certain
1988 probably reflects timing effects caused by the delayed implementation
provisions in the Tax Reform Act (for example, rate increases on capital gains income)
which u, ere of particular importance to high-income elderly.

-13TABLE 3
Adjustments to Trust Funds for Calendar Year 1987 Based on
Comparison of the Initial Transfers With Actual Results
(S millions)
Adjustment
Initial

~Fn

~Tr

Actual

Transfer

Federal Old-Age and
Survivors Insurance (FOASI)
Federal Disability Insurance (FD I)
Railroad Social Security
Equivalent Benefits (SSEBA)

Total

(Change from

~Amoun

3, 088

3, 006

-82

156

117

-39

-18

3, 291

3, 152

-139

Department of the Treasury
Office of Tax Analysis

TABLE 4

Adjustments to Trust Funds for Calendar Year 1988 Based on
Comparison of the Initial Transfers With Actual Results
(S millions)
Initial
T~ru

Transfer

Fund

Federal Old-Age and
Survivors Insurance (FOASI)
Federal Disability Insurance (FDI)
Railroad Social Security
Equivalent Benefits (SSEBA)
Total

Department of the Treasury
Office of Tax Analysis

3.285
173
40

3, 498

Actual
Amount

Adjustment
(Change from
Initial Transfer

3, 611

326

-42

CHAFI ER 4:

ADJUSTMENTS TO TRANSFERS FOR ACTUAL
)984-1986 TAX
RETURN INFORMATION

During the spring of 1989, the Office of Tax Analysis and IRS
initiated a
comprehensive
review of the methodology used in the reconciliation process.
This revie& revealed Qn
error in the calculation of actual tax liabilities, beginning with
the first recpnciljation
of l984 tax liabilities. As a consequence, certain additional taxes
attributable to
treatment of lump-sum distributions of pensions and accumulation
distributions ot' trusts
were erroneously transferred into the trust funds at the time of the
reconciliations for
tax liabilities in l984, l985, and l986. These additional taxes,
although included as a
separate line entry on the Form l040, do not affect the calculation of
adjusted gross
income, taxable income, or the taxation of benefits. Thus, they should not be
included in
measures of the tax liabilities attributable to the inclusion of benefits in adjusted
gross
income. The additional taxes represent a very small share of total individual income tax
receipts. However, because of their nature a sizable proportion ot these additional iaxes
are paid by filers with taxable social security or railroad social security equivalent
benefits.
In l987, recipients with taxable social securitv or railroad social securiis
equivalent benefits paid $244 million in additional taxes -- or about 8 percent ot the
total amount of income taxes transferred to the trust fun'.

The error was discovered in sufficient time to correct the l987 reconciliation.
However, a review of the computer programs for l984 through l 986 verified that the error
had occurred, undetected, in those years. Based on data from the Statistics of Income
(SOI) stratified random samples of individual income tax returns for 1984 through I~86, ihe
trust funds received overpayments of $l, 363 million -- or about l4 percent of the total
amount of income taxes transferred during this period. The additional taxes ~ere larger in
the pre-l987 period because of the treatment of lump-sum pension income prior io the
passage of the Tax Reform Act of l986.
Adjustments were made to the trust funds in October l989 to correct tor these
overpayments.
The adjustments were based on the SOl stratified random samples ot iax
returns for l 984 through l986. The SOI files identify the total amount of additional taxes
paid by filers who also reported a tax on social security or railroad social securiii
equivalent benefits. These totals were allocated among the trust funds using parameters
derived from the l987 IRS file of tax returns of social securitv and railroad retirement

beneficiaries.

The third column of Table 5 shows the adjustments io the trust funds for (he erronenus
crediting of additional income taxes. The adjustments to the FOASI and FDI accounts were.
respectivelv, -$l, 319 million and -$40 million. The adjustments to the railroad reiiremeni
accounts were significantly smaller: -$4 million trom the SSEBA and -$l million from ihe
The railroad retirement adjustments were small hecause
Railroad Retirement Account.
railroad retirees are not entitled to lump-sum pension distribution.
Any additional i.ixes

-l5-

-16TABLE 5
Adjustments to Trust Funds for Calendar Years 1984 Through 1986
for Overpayments of Individual Income Taxes to Trust Funds
Adjustments
Overpayments
Correcting
of Additional
Annual

Initial

Trust Fund

Transfers

Federal Old-Age and Survivors Insurance (FOASI)
1 984
2, 754

1985
1986

3, 133
3, 353
Subtotal

9, 240

Taxes

Final
~Transfer

-43

-372

145
29
131

-481
-466
-1,319

2. 916
8.052

-14
-14
-40

94
90
104
288

32
28
94

2, 339
2, 797

Federal Disability Insurance (FDI)

1984
1985
1986

186
218
Subtotal

Railroad Retirement Tier

1984
1985
1986
Subtotal
Total,

All

-81

234
638

-114
-116
-311

68
77
69
214

-33
-43
-39
-115

-2
-5

3, 008
3, 428
3 656
10,092

-157
-12
-126

-384
-497
-482

-295

-1,363

Trust Funds

1984
1985
1986
Total

2, 467
2, 919
3 048
8, 434

Department of the Treasury
Office of Tax Analysis
1/ Includes

transfers and adjustments to both the Railroad Retiremen, Account and
Social Security Equivalent Benefit Account (SSEBA).

", e

'. ,

paid by railroad retirees were most likely attributable to trust income or pension lump-siim
distributions from other jobs or the employment of their spouses.

Previous reports have contained tables showing the tax liabilities and the tax
parameters associated with the inclusion of benefits in adjusted gross income for l984,
l985, and 1986. On the basis of this new information, the marginal tax rates applicable io
benefits have been revised downward for these three years. Appendix Tables A- l through A-.
compare the revisions with the results shown in previous reports. The marginal tax rate
applicable to social security retirement benefits is reduced by between 4 to 5 percentage
points for these years. The marginal tax rates for disability and railroad social security
equivalent benefits decline by between l and 3 percentage points as a consequence ot the
new information.

CHAPTER 5:

FORECAST OF 'H~SFERS TO TRUST FUNDS
FOR 1989-1993

The Social Security Amendments of l983 required that the annual report include a
The forecast is
forecast of transfers to the trust funds for the next five years.
produced by the Office of Tax Analysis using the methodolog~ described in Chapter 2.
Forecasts of social securiti and railroad social security equivalent benefits are ohtaincil
from the respective agencies, and the percent of aggregate retirement benefit includable
the
in adjusted gross income (AGI) and marginal tax rates are obtained by extrapolating
Individual Income Tax Model in accordance with the Administration's
budget forecasts. In
addition, the estimates of future transfers reflect the information obtained from the IRS
computation of marginal tax rates and benefits includable in AGI reported on tax returns
for calendar years l987 and 1988.
The estimated transfers for calendar years l989- l993 are presented in Table 6. The
net transfer is significantlv smaller in l989 than in subsequent years due to tiin negative
correcting adjustments which occurred in that year: the (987 adjustment (-$I39 million)
l986 (-$I, 363 million). In l990,
in l984 through
and the corrections for overpayments
tor
total transfers of current-year liabilities are augmented by the positive adjustment
l988 ($275 million). The projected transfer for l991 includes an estimate that small
adjustments will be necessary when 1989 tax return data become available. It is estimated
that the l983 Act will result in $24, 732 million being transferred to the FOASI, FDI, anil
SSEBA trust funds in calendar years I989-(993.

TABLE 6

Forecast of the Net Transfers for Calendar Years 1989-1993
Due to the Social Security Amendments of 1983 1/
($ millions)

Initial

Transfers

Total
Transfers

Estimated Transfers
Trust

1989

F&)r&&l

Federal Old-Age ar)d Survivors Insurance (FOASI)
Fed& ral D&;)I))l)ty Insurance
fin&I&»ad ft&.'t&«i&)le&&t T)er

0 kllr&)

)&&&. );&I

(FDI)

(' Sf I/Aj

Ihi»l«) i) &I

I I &.'I

()If&«'
1/

&)I

Tra», , t&.'&s

1989-1993

1993

4, 772

5, 115

5 490

5, 959

23, 702

140

181

204

226

842

187

5, 741

6, 236

«&.'») «.' ll Acco&) &) t

4, 941

5, 345

24, 732

tile T«.'i&-&)&y

&)I

1,&x

1992

2, 366

2, 469
D&.'I)il&t»&&.'»t

1991

Sec&)«ty Equivalent

f3&'»&'i&t~

1990

A&&, )ly;,

le&

;

1989 «»&I 1990 have already been rr)ade «»d

)»cl&)&t&' adjustments
to I&&)ur year transfers for actual tax return
)t, ) Il&&) L'. st)&)), )t&)s I&&& 1991-1993)»elude ar)t)cipated adjust&»er)ts. Includes oft&c&. ot Tax
Analysis' estimates of taxes
»ttr)t)ut, )t)l&. t &a&lroad social sec&)rity equ&val&. 'r)t be»el&ts received t)y non-res&der)t al&er)s.
&I,

CHAFI'ER 6:

DISTRIBUTION OF TAXABLE BENEFITS AND TAX LIABILITY'
ATTIUBUTABLE TO TAXATION OF BENEFITS IN 1988

USING THE INDIVIDUAL INCOME TAX MODEL FOR
DISTRIBUTIONAL ANALYSIS OF SOCIAL SECURITY BENEFICIARIES
This chapter contains an analysis of the distribution bv income class ot returns with
taxable social security or railroad social security equivalent benefits in l988. The
analysis is based on the Office of Tax Analysis' Individual Income Tax Model. Because ot
sampling error in the underlying Statistics of Income data file, the Tax Model provides a
less precise measure of taxable benefits than the special IRS data base which contains the
7
However, the Tax Model utilizes more
returns of all taxpayers with taxable benefits.
well
as
as
data
from the Current Population Survev,
extensive data from tax returns,
permitting comprehensive distributional analyses. Using the Tax Model, it is possihle to
retirem«ni
tax filing units with social security or railroad
analyze all potential
henelits, including units who did not file a tax return in l988 because they had n~i tax
iabili(y.
l

DISTRIBUTION OF TOTAL AND TAXABLE BENEFITS BY ADJUSTED
GROSS INCOME CLASS
Table 7, 29 million "potential" tax filing units received social security
or railroad retirement benefits in l988. About 4 million filing units, or l4 percent ot
Two thirds of all potential filing units iiiih
the total, reported taxable benefits.
benefits had adjusted gross incomes (AGIs) less than $I0, 000 and thus were generally not
As explained, the income test for the taxation of henetits
suhject to tax on benefits.
includes tax-exempt interest, so it is possible for some taxpayers with AGls signiticanili
helow the income thresholds to be liable for taxes on benefits. However, this numbei is
small, as shown in Table 7. Fewer than 20, 000 tax filers with taxable benefits have AGls
helow $l0, 000. One-third of the filing units with AGls between $20, 000 and $30, 000 and
nearlv all these filing units with AGIs greater than $30, 000 were subject to some tax nn
benefits.
As shown

Since each filing unit may contain more than one beneficiary, the numher ot
Because
heneficiaries paying income tax on their benefits cannot be determined preciselv
with
joint returns of married couples constitute about two-thirds of the 4 million returns
benefits, it is reasonable to assume that no more than about 6. 6 mil li&iri
t arable
heneticiaries are taxable on their benefits. In l988, about 40 million persons (including
hene fits.
or disability
retirement
received
settings)
in institutional
tliose living
suggesting

that hetween

IO and

Ib. & percent ot heneficiaries paid taxes on their hen«tits.

TABLE 7
Distribution

of Total and Taxable Social Security and Railroad Retirement Benefits in 1988
By Adjusted Gross Income Class

All

Adjusted Gross
Income Class

Returns with Benefits 1/

Number

Amount

of
Returns

of
Benefits

(000

($ millions)

($000)
Under 10

19,259
4, 861
2, 069
1,867
743

10-20
20-30
30-50
50-75
75-100
100-200

264
243

200 and over

~11

Total

29,419

Returns with Taxable Benefits
Number
Amoun of Benefit
of
Returns
Total
Taxable

(000)

($millions)

%millions)

117,563

42, 941
17,029
16,130
6,893
2, 700
2, 611
1 427

705
1,859
743
264
243

100
692
6,279
16, 123
6,893
2, 700
2, 611

~11

~1427

. 934
6,369
3,435
1,349
1,306
714

207, 294

4,024

36,825

14,361

32
222

Department ol the Treasury
Office of Tax Analysis

1/ Figures cover individuals, other than those
because their taxable incomes were too low.

living in institutional

Source: Oflice of Tax Analysis' Individual Income Tax Model.

settings. who did not actually file tax returns

-23As Table 7 shows, fewer than 100,000 tax filers with taxable benefits have AGls bein«
$20, 000. In contrast, 705, 000 filers with taxable benefits, or I 8 percent of all
recipients with taxable benefits, have AGIs between $20, 000 and $30, 000. An additional
l. 9 million filers with taxable benefits report AGI between $30, 000 and $50, 000.

Combining these income classes, two-thirds
below $50, 000.

of recipients

with taxable benefits have AGls

Table 8 covers only those returns with taxable benefits. Taxable benefits are divided
by total benefits received to derive inclusion rates, shown in the fifth column of Tahle
8. On average, taxpayers with taxable benefits include 39 percent of benefits in AGI.
Taxpayers whose AGls exceed $50, 000 generally include 50 percent of benefits in AGI. At
33 percent, the inclusion rate is lower for those with AGIs below $50, 000, indicating that
One-third ot all
they tend to be in the phase-in region for taxation of benefits.
taxpayers with taxable benefits are in the phase-in region for the taxation of benefits.
Among these taxpayers, the rate of inclusion of benefits averages about 22 percent. The
other two-thirds of taxpayers with taxable benefits (generally, those with higher incomes)
include the statuton maximum 50 percent of benefits in AGI.
taxable social security and railroad social security equivalent benefits
represent a relatively small proportion of any taxpayer's AGI, regardless of ho«close the
On average, taxable benefits
income of the beneficiar is to the income thresholds.
constitute about 6 percent of AGI, with the greater share of taxable income derived from
For recipients «ith taxable
interest, dividends, capital gains, earnings and pensions.
The
benefits, about half of AGI consists of interest, dividends, and capital gains.
importance of labor income in AGI varies according to marital status, ranging from )t
percent among single filers to 2' percent among married filers.
In general,

DISTRIBUTION OF TOTAL AND TAXABI. E BENEFITS
ADJUSTED GROSS INCOME CLASS

B%'

EXPANDED

according to an expanded
social security and railroad social securiti
AGI classifier. , which adds non-taxable
equivalent benefits to AGI. The inclusion of all benefits in the income classifier shifts
the distribution upward. As Table 9 demonstrates, among those «ith expanded AG Is between
$20, 000 and $30, 000, only 6 percent paid taxes on benefits. In the $3Q, 000 to $5Q, QQQ
class, 62 percent of filing units «ere subject to taxes on benefits.
In Tables

9 and lQ, returns of beneficiaries are distributed

filers «ith AGls helo«VQ, QQQ pay 46 percent of the iax
attributable to the Social Security Amendments of l983 (see Table 8). 44'ith the expanded
in Table lQ,
AGI classifier, this proportinn falls to 33 percent, as demonstrated
thai the expanded AGl classifier used in Tables 9 and lQ still excludes certain income
items, such as tax-exempt interest income, «hich affect the relative well-being iit the
Kl

ith AGI as the classifier,

higher-income

elderly

TABLE 8
Distribution of Taxable Social Security and Railroad Retirement Benefits
and Resulting Tax Liability for Tax Returns with Taxable Benefits
In 1988 by Adjusted Gross Income Class

Adjusted Gross
Income Class

Number
of

Adjusted

Returns

Income
($millions)

000)

($000)

97
705
1,859
743

Under 20

20-30
30-50
50-75
75-100
100-200

264
243

200 and over
Total

Gross

1, 190
18,454
72, 387
44, 440
22, 379

113

32,964
~67 13

4,024

258, 953

Benefits
Taxable
Total
Amount

Amount

($ millions)

Rate
(percent)

~1427

934
6, 369
3,435
1,349
1,306
714

36,825

14,361

6,893
2, 700
2, 611

Department ef the Treasury
Office of Tax Analysis

Inclusion

32
15
40
50
50
50
50

792
6, 279
16, 123

Source: Olfice of Tax Analysis' Individual Income Tax Model.

254

Tax on Benefits

Additional

Amount

($ millions)

40
201
1,466

Tax
Rate
(percent)

18
22
23
29

985
405
423
201

30
32
28

3,721

TABLE 9
Distribution

of Total and Taxable Social Security and Railroad Retirement
By Expanded Adjusted Gross Income Class 1/

All

Returns with Benefits 2/

Expanded

Number

Amount

Adlusted Gross

of
Returns

of
Benefits
($millions)

Income Class 1/

($000)
Ui&dor

(000)

10-20
20-30
30-50
50-75
75-100
100-200
200 'iiid over
Total

I) L,'p

71,213
49, 434
36,416

29,419

207, 294

32, 124
10,224
3,364
2, 961
1 558

1988

Returns with Taxable Benefits
Number
of

Returns

(000)
13

Amount of Benefits

Total

Taxable

($millions)

122

58
165
1,547
16,948
10,224
3,364
2, 961
1 558

4, 024

36,825

34
247
2, 022
1,003

314
269

crit ol the Treasury
et Tax Analysis

ir ti»

t ) I I i(. L.'

1/ F xpandud

14,006
6, 558
3, 900
3, 247
1,003
314
269
122

Benefits

Adliisted Gross Income is AGI plus the untaxed portion of benefits.

"I Fi&turos cover

other than those living in institutional
t&ec,iiise ttieir taxable incomes were too Iow.
individuals,

Source ()tfio~, ot Tax Ari;ilysis' tiidividuat Income Tax Moitot

settings, who did not ictually file tax returns

57
368
5, 114
4, 867
1,671
1,481

779
14,361

TABLE 10
Distribution of Taxable Social Security and Railroad Retirement Benefits
and Resulting Tax Liability for Tax Returns with Taxable Benefits
In 1988 by Expanded Adjusted Gross Income Class 1/

Expanded
Adjusted Gross
Income Class 1I

Number
of

Returns

Adjusted

Gross

Total

368
5, 114
4, 867
1,671

($millions)

5, 628
70, 107
54, 372
25, 120
34, 634
68 782

223
1,547
16,948
10,224
3, 364
2, 961
1 558

4, 024

258, 953

36,825

Total

NIA

($ millions)

47
247
2, 022
1,003
314
269
122

200 and ovor

Amount

100-200

Amount

(000)

20-30
30-50
50-75
75-100

Rate
(percent)

Tax on Benefits
Tax
Amount
Rate
($millions)
(percent)

Income

(000)
Unr1or

Benefits
Taxable

310

Inclusion

1,481
779

48
50
50
50

77
1, 133
1,332
482
476
220

22
27
29
32
28

14,361

3, 721

[)~. p, « t» ««

t t of t lie Treasury
of
Office
T,ix Ar)alysts

Loss Ili, i» $10 nttlltntt
1I Exl&;iiidod Adlustod Gross Income ts AGI plus the untaxed portion of benefits.

Source Ollico of Tax Aitalysis' I»dlvldual Income Tax Model ruiis

Additional

APPE&DI Y

REPORTS
PARAMETERS SHO~ I& PRIOR
COMPARISON OF TAX
FOR 1984. 1985. and l986
%1TH REVISED RESULTS

TABLE A-1

Comparison

Shown in Report on Taxation of
Social Security and Railroad Retirement Benefits
in Calendar Year 1984 With Revised Results
of Tax Parameters

Tax Rate on
Benefits
Includable

Total

Benefits

Bene[its

Includable

Paid
Tr

FIVE&(tru

i(l fli.'Ilf(.'(11&&(al T(er

Amount
($ mill(ons)

(%)

Shown in 1984 Re nrt 1/

Tax Parameters

F(.(t(. r;&I OI(I -A&3(. and Survivors Insurari&:(i [FOASI)
F&&&I&. rat [)(.„&ta(l(ty Insi&r, &rice (FDI)

rn AGI

in AGI (%[&)

($m&ll&ons)

i&'. ~t F&&(i&t

Transfer

2, 711

34. 1
30.5

4 024

5. 0
1.9
2. 8

179, 196

4. 7

33.9

2, 851

29. 4
27. 5
30.4

2, 339
94
34

29. 4

2, 467

157,301
17,871

31.

105
35

Revised Tax Pararnet&. r s
f
I

(. (Ii i, il
i iti i, il

A(li;iri&1 Siir vivors Insui;&rico (f [)A~l)

[)(,.

&I&(l(ly l(a. &&((&a»&'. &.'

Fl, ail((&, i(l ft( ti(i (»i'(it 1iur

(f DI)

Tol, &l
[ 3 i ' I &, i ( I ( 11 ( ' ' I 'I () I

I I a a}

T i L', a « i

157, 301
17,871
4 024

5.0

179, 196

[)II(&» ((I T.ax Aii;&lysis

Railroad
I/ Sea&roe IJ S [3&.I&. a(l(»&. (at ol ttie Treasi&ry, Otl«:&. ol Tax Arialysis, Re &ort on the Taxat&u(a &&t ."(&cial Secur~it and
Service's
Individiial
rri;il
Revenue
I»I(.
fla'tl(i'(11&.'(ll [3('&i(.[its iri C;ali. (i&1.&r Ye'ar 198.1, M, a(& ti 1987, Table 1 Rev&s('d tax data [rom
have been
M. &, I( ( f il&i;arid St, at(sties ot l(&come — 1984 l»&I(v«I&&.al Income T, ix R&.'l&&(ns B&.'net(ts paid lo non-residents
lioin It&&a lot, al tier&a[its p
fl, ail(i&ad f le Il(»iiii'(it [3(&.&((I

siit&ti, ii I(

l(«(i(
c

« i(i&

", Ii, aiisli. rs
(b'. i[ [3A)

I i ti&i&li I&i&i

&(&1

D;ata on non-resident

[ie(i tits

I(&&(»

ttie Social Security Administration

fta(l(on&1 Ri ti(or(in»t Acco&irit, &rail (»&. f3ailroad

Social Security

I»i&, &I( ril

and the

Benefit

Comparison

of Tax Parameters

Shown in Report on Taxation of

Social Security and Railroad Retirement Benefits
in Calendar Year 1985 With Revised Results

Total
Benefits
Pa&d
Tf&i'

Fii»&1

(sm&ll&ons)

Tax Rate on
Benefits

Benefits
Includable

Includable

in AGI (&Vo)

in AG I (&tt))

Tax Parameters Shown i» 1985 Re
Fe&1&!r;&I Old-Age

ariel S&irvivors

f &!&Ii!r;&I Di. ;&t&ilily

Insiir;iric:e (FDI)

ft;«lr&);&&I Rulirer»i&r&l

Insurance (FOASI)

Tot;&I

Transfers
Amount
($mitlions)
rt 1/

166,748
18,800
4 186

5. 6
2. 0

35.2
27. 9

3, 278
104

274

189, 731

34.8

3, 416

Revised Tax Pararr&&!I&!rs

«I

i, il Ol&l-Ail&!

ail&1 Siir vivors Insurance (f OA~&)
i, ())s;&t&&l&ty l»siir, &&i«:.' (FDI)
fl, iili», iil ftet&«!&»&!»I 1 ii!& 1 /
f

f &. &I)

166, 748
18,800
4 186

30.0

2, 797

2. 0
3.0

24. 1
25. 8

90
32

189,734

5. 2

29. 7

2, 919

s»iir&:i! U. S. [1&.f), «&&»e»t »t the T«;isury, Otlice ot Tax Analysis, R port on the Taxation ol Social Securit and Railroad
'&i)&'&it Bell&'f)ts i&& c. ;&ter&&tar Year 1985, Au&3»st 1987, T;&t&le 1
Revised lax data from Ir&ternal Revenue Service's Individual
ari&1 st, &listi . s ot t»co»&e — 1985 ln&livi&l&i, il income Tax Returns.
Benetits paid lo non-residents have been subtracted
ill &I) ' l»l, &l t)i'»t'. Iil' f) &)&1 D &l t of& nof& —res)&tent t&i!»&'. lit s lro&» tl&e Social Secur&ly Adrninisti;&lion
and the Railroad

R&'lii

f1&.'i&i&!&)i&'&ir f1&), &i

lii&. liiil&!s t&. «&stc

(SSF t&A)

is lo t)»lli

tt&i. Ftai&«),

«t ft)'ri«!i»)

&&I

Ac co&ii&t, iii

ttie Railroad Social Security

fits&&var&&i&t

Benefit A«;ou&it

TABLE A-3
of Tax Parameters Shown in Report on Taxation of
Social Security and Railroad Retirement Benefits
in Calendar Year 1986 With Revised Results

Comparison

Tax Rate on

Total

Benefits
Paid
Trust Fund

($millions)

Benefits
Includable

Includable

in AGI (%0)

in AGI

Results Shown

Feder;il Old-Age and Survivors Insurance (FOASI)
Federal Disability Insurance (FDI)
Railroad Soc(al Security Equivalent Benefits (SSEBA)

Bene tits

1986 Re ort

(%)

Initial

ransfers
millions

176,340
1 9, 826
3 672

6. 1

31.2

3, 382

2. 6
3.0

22. 6

118

275

199,838

5.7

30.8

3, 530

Revised Results 1/

Fe(ter;il Ol(t-A(I('. aiid Survivors Insurance (FOASI)
Feder;il Dis;ibility Insurance (FDI)
Ha(lro;i(t S(i(:(,il Security Equivalent Benelits (SSEBA)

176,340
19,826
3 672

6. 1

269

2916

2. 6
3.0

20.0
25. 7

104
28

199,838

5.7

26. 6

3,048

D(;liai tiii(. iil ol tlie Treasury
Office (&I T, ix Aii;ilysis

Source:

U. S. D(. p,~(tment of the Treasury, Office ot Tax Analysis,

Re rt on the Taxation ot Social Securit and Railroad
Retirement Beiiulits in calendar Year 1986 February 1989, Table 1. Revised tax data from Internal Revenue Service's Individual
Master File and Statistics of Income -1986 Individual Income Tax Returns. Benefits paid to non-residents have been subtracted
from total b(.'(&(.'f(ts paid. Data on non-resident benefits from the Social Security Administration and the Railroad Retirement Board.
1/

ENDNOTES

l. The IRS

data are not available until approximately one and one-half years after the
close of the applicable calendar year due to the normal lags in tax return filing,
processing. transcription. and analysis.

2. OTA does not estimate

the liability

attributable to the receipt of social security
benefits by non-resident aliens. One-half of any social security benetit received bi
a non-resident
alien is subject to a 30 percent tax rate, and this amount is
automatically withheld by the Social Security Administration.
Each month. the Social
Security Administration
sends a certification of the amount withheld to the Treasur
Department's Office of Finance and Planning, and the transfer of the withheld amount
from the FOASI and FDI trust funds to general revenues and back again to the FOASI and
FDI trust funds is effected. (In practice. the monies never leave the trust fund. )
Since the Social Security Administration
has information
on the actual amounts
withheld. OTA does not estimate these withheld amounts.

Similarly. the Railroad Retirement Board automatically withholds taxes on railroad
social security equivalent benefits received by non-resident aliens.
However. a
different procedure is used to transfer these amounts to the SSEBA. QTA includes an
estimate of the withheld amounts in its initial transfers to the trust funds and
verifies these estimates by reference to the Form 1042 filed by the
subsequently
Railroad Retirement Board. In 1987 and again in 1988. $1 million in withheld taxes
was transferred to the SSEBA.
With one exception, the tables in the report do not include benefits received by
non-resident aliens or the taxes attributable to these benefits. Table 6. showing the
5-year OTA projections of estimates of transfers to the trust funds, includes a
benefits
to railroad social security equivalent
forecast of the taxes attributable

received by non-resident

A detailed description

Wyscarver

aliens.

of the Individual

Income Tax Model can be found in Cilke and

(1987).

These forecasts do not include benefits received by non-resident

5. These parameters do not appear to be sensitive to changes
the passage of the 1986 Act.

aliens.

in pension

laws. following

Prior to 1986. the non-SSEBA portion of railroad retirement Tier 1 benefits was taxed
to the
The taxes attributable
as social security benefits.
in the same manner
non-SSEBA portion of Tier I were transferred to the Railroad Retirement Account.

-33-

-34Further, the SSEBA trust fund was not established until October 1984. The tax
to all Tier 1 benefits was transferred
liability attributable
to the Railroad
Retirement Account for the first nine months of 1984. Subsequent adjustments to the
trust funds reflect the account to which transfers were originally made.

of Tables 2 and 7 shows that the Tax ~1odel underestimates the amount
of taxable benefits by $373 million. However. the marginal tax rates estimated bi the
A comparison

Tax Model are slightly higher than those from the special IRS data base. thus reducing
the differences in the computation
of the 1988 tax liability due to taxation ot
benefits.

This study was prepared by Janet Holtzblatt of the Office of Tax Analysis
under the direction of James R. Nunns. Typing assistance was provided
by Connie Haftman and Dolores Perticari.

BIBLIOGRAPHY

Cilke. James C. and Roy A. Wyscarver. "The Individual Income Tax Simulation ~Iodel.
In
Com endium of Tax Research 1987. (edited bv T. Neubig and C. E. Steuerle). ~~'ashington.
D. C. : Government Printing Office, 1987.
U. S. Department of Health and Human Services. Social Security Administration.
1988 Annual
Statistical Su lement to the Social Security Bulletin. Washington, D. C. : Government
Printing Office, December 1988.

U. S. Department of Health and Human Services. Social Security Administration.
1989 Annual
Statistical Su lement to the Social Security Bulletin. Washington, D. C. : Government
Printing Office, December 1989.
U. S. Department of the Treasury. Office of Tax Analysis. Re ort on the Taxation ot Social
Securit and Railroad Retirement Benefits in Calendar Year 1984. March 1987.

U. S. Department of the Treasury. Office of Tax Analysis. Re ort on the Taxation of Social
Securit and Railroad Retirement Benefits in Calendar Year 1985. August 1987,
U. S. Department of the Treasury. Office of Tax Analysis. Re ort on the Taxation of Social
Securit and Railroad Retirement Benefits in Calendar Year 1986. February l 989.

-35-

Taxation of Technical Services Personnel:
Section 1706 of the Tax Reform Act of 1986

A Report to The Congress

Department of the Treasury
March 1991

Taxation of Technical Services Personnel:
Section 1706 of the Tax Reform Act of 1986

A Report to The Congress

Department of the Treasury
March 1991

DEPARTMENT OF THE TREASURY
WASHINGTON

March

ASSISTANT SECRETARY

The Honorable

1991

Dan Rostenkowski

Chairman
Committee on Ways and Means
House of Representatives
Washington D. C. 20515

Dear Mr. Chairman:

personnel).
Pursuant to that section, I hereby submit the "Taxation
of Technical Services Personnel:
Report on Section 1706 of the
Tax Reform Act of 1986. "
I am sending a similar letter to Senator Lloyd Bentsen,
Chairman of the Committee on Finance

Sincerely,

Kenneth

Gideon

Assistant Secretary
(Tax Policy)
Enclosure

DEPARTMENT OF THE TREASURY
WASHINGTON

March

ISTA N T SEC R ETA R Y

1991

The Honorable Lloyd Bentsen
Chairman
Committee on Finance

United States Senate
Washington D. C. 20510
Dear Mr. Chairman:

Section 6072 of Public Law 100-647, the Technical and
Miscellaneous Revenue Act of 1988, provides that the Secretary of
the Treasury shall conduct a study of the treatment provided by
section 1706 of the Tax Reform Act of 1986 (relating to treatment
of certain technical personnel).
to that section, I hereby submit the "Taxation
of Technical Services Personnel:
Report on Section 1706 of the
Tax Reform Act of 1986. "
Dan
I am sending a similar letter to Representative
Rostenkowski, Chairman of the Committee on Ways and Means.
Pursuant

Sincerely,

Kenneth

Gideon

Assistant Secretary
(Tax Policy)
Enclosure

TABLE OF CORI'ENTS
RT

ARY

CHAPTER 1: EXECUTIVE SUhQvfARY. . . . . . .
BACKGROUND OF REPORT
I.
REPORT MANDATE
II.
III. EVALUATION OF ISSUES
IV.
OPTIONS FOR FURTHER CONSIDERATION

P RT

CHAPTER 2: SOURCES OF EMPLOYEE MISCLASSIFICATION
OVERVIEW
I.
DETERMINATION OF EMPLOYEE STATUS
II.
III. DIFFERENCES IN TAX TREATMENT BETWEEN EMPLOYEES
AND INDEPENDENT CONTIMCTORS
Differences Favoring Independent Contractor Status. . . . . . .
A.
B.
Differences Favoring Employee Status
C.
Five Hypothetical Examples of Differential Tax Treatment. . .
D.
Validity of Differences

I.
II.
III.

3: ORIGINS OF SECTION 1706 .

SECTION 530
SECTION 3509
SECTION 1706

ART THREE'

I N

CHAPTER 4: GENERAL POLICY ISSUES
OVERVIEW
I.
EFFICIENCY OF LABOR MARKETS
II.
Arrangements Between Workers and Firms
Government Policy .
B.
NEUTRALITY IN TAX TREATMENT
A.
Maintaining Labor Market Efficiency

B.
IV.
V.

INF RMATI N

BA K R

CHAPTER

3
3
4

Tax Equity. . .
ADMINISTRATIVE COSTS
NON- TAX POLICIES

CHAPTER 5: TAX COMPLIANCE ISSUES .
OVERVIEW
I.
RATE OF MISCLASSIFICATION
II.

ll
ll
12
12
12
14
15

26
29
29
31
32
35

37
37
37
37
40
40
40
42
45
46

47
47
47

RATE OF NONCOMPLIANCE
A.
1985 TCMP
B.
1984 SVC-1 Employee Survey
C.
Summary. . . . . . . . . . . .

50
51
54
55

CHAPTER 6: TAX ADMINISTRATION ISSUES
OVERVIEW
I.
ADMINISTRATIVE PROBLEMS WITH SECTION 1706
II.
III. ADMINISTRATIVE PROBLEMS WITH COMMON LAW TESTS OF
EMPLOYEE STATUS

57
57
57

PART F

APPENDI

APPENDIX A: DIFFERENCES IN TREATMENT OF EMPLOYEES AND
DETAILED ANALYSIS
INDEPENDENT CONTRACTORS —
OVERVIEW
I.
II.
FEDERAL TAX LAW. . . . . .
A.
Employment Taxes .
B.
Income Taxes

III.

Determination

of Employee Status.

OTHER LAWS
A.
Federal Labor Laws
Patent and Copyright Laws . .
C.
State Laws
D.
Determination of Employee Status
SUMMARY

B.
IV.

63
63
63
63
66
75
78
78
80
80
81
82

APPENDIX B: COMMON LAW FACTORS USED TO DETERMINE EMPLOYEE
STATUS

APPENDIX C: ADDITIONAL BACKGROUND TO TCMP AND
I.
TCMP
SVC-1 .

SVC-1. . . . . .

83
85
85
86

LIST OF TABLES
Chapter 2
2-1

2-2

2-3

2-4

2-5

2-6

Major Differences in Treatment of Employees and Independent
Federal Tax and Other Purposes

Contractors for

Comparison of Income and Taxation of $1,000 of Total Compensation for an
Employee or Independent Contractor, Worker with a Typical Mix of Fringe
Benefits and no Worker Expenses . .

Comparison of Income and Taxation of $1,000 of Total Compensation for an
Employee or Independent Contractor, Worker with a Typical Mix of Fringe
Benefits, no Worker Expenses, and 5 Percent Non-Compliance by the
Independent Contractor

Comparison of Income and Taxation of $1,000 of Total Compensation for an
Employee or Independent Contractor, Worker with a Typical Mix of Fringe
Benefits and Worker Expenses of 10 Percent .

Comparison of Income and Taxation of $1,000 of Total Compensation for an
Employee or Independent Contractor, Worker with Only Statutory Benefits and
no Worker Expenses

Comparison of Income and Taxation of $1,000 of Total Compensation for an
Employee or Independent Contractor, Worker with Only Statutory Benefits, no
Worker Expenses, and a "Wedge" Between Employee and Independent
Contractor Total Compensation

Chapter 5

5-1

Percentage of Employers with Some Misclassified

5-2

Reporting

Appendix
A-1

of Income

Employees,

by Industry.

and Expenses by Employees and Independent

Contractors

49
52

Tax-Favored Benefits Available to Employees and Independent

Contractors

PARy

BACKGROUND OF REPORT

Despite the wide variety of relationships between workers and firms, there are generally
only two classifications of workers for Federal tax purposes: self-employed workers (sometimes
called independent contractors) and employees.
The proper classification is self-evident for

for others, it is ambiguous. When the proper classification is ambiguous, the
potential for worker misclassification increases.
Inadvertent misclassification may occur if
employers lack sufficiently detailed guidance to determine the correct classification. In addition,
the various legal, economic, and tax consequences of the alternate classifications may provide
incentives for deliberate misclassification.
many workers;

Historically,

misclassification

of employees as independent

was a concern

contractors

because self-employed workers faced significantly lower Social Security and Medicare tax rates
than the combined rate for employers and employees.
Misclassification was perceived as
Now that self-employed workers face
producing large losses of employment tax revenues.

Social Security and Medicare tax rates comparable to the combined rate for employees and
employers, concern about misclassification has shifted to potential losses of all tax revenues.
Income and employment tax revenues may be lower due to differences in the income and
employment tax bases and differences in compliance between employees and the self-employed.
In the late 1960s, when significant

employment

tax rate differentials

Revenue Service (IRS) began to increase its employment
which previously had been sporadic, to address the misclassification
Internal

still existed, the

tax enforcement

of workers.

activities,

Classification

of a worker directly affects employment tax obligations and indirectly affects a worker's income
tax treatment.
As a result of the IRS' actions, the number of reclassifications increased
substantially.

Many reclassifications

resulted in large retroactive assessments

against employers.

took several actions to address taxpayer concerns about worker
reclassification. In section 530 of the Revenue Act of 1978 (section 530), it provided statutory
relief from reclassification for certain employers involved in employment tax controversies with
Congress subsequently

IRS. Section 530 generally prohibited the IRS from challenging an employer's erroneous
treatment of an employee as an independent contractor for employment tax purposes if the

the

employer

had a reasonable

It also generally
addressing

prohibited

the status

basis for such treatment
the IRS from issuing

and certain other requirements

regulations

of workers as employees or independent

were met.

or publishing revenue rulings
contractors for employment tax

purposes.
extended

In 1982, Congress
Section 530 was initially intended as an interim measure.
it indefinitely, and also limited employer liabilities in certain cases of retroactive

reclassification.

Section 1706 of the Tax Reform Act of 1986 (section 1706) removed the statutory relief
of section 530, but only for taxpayers that broker the services of technical services workers, i.e. ,
engineers, designers, drafters, computer programmers, systems analysts and other similarlyskilled workers engaged in a similar line

of work. Thus, section 1706 only applies in

(1) technical services workers, (2) companies
or broker the services of the workers.

party situations involving

(3) firms that supply

multi-

that use the workers, and

as employees or
independent contractors, nor does it change the legal status of anyone covered by the provision.
It only permits the IRS to interpret and enforce the underlying rules for employment tax
purposes for the covered technical services workers without regard to section 530. However,

Section 1706 does not change

the rules

for classifying

workers

in practice the worker's employment

tax classification generally determines whether the worker
is treated as an employee or independent contractor for Federal income tax purposes.

II.

REPORT MANDATE

This report was prepared in response to a congressional mandate in the Technical and
Miscellaneous Revenue Act of 1988 (TAMRA). Section 6072 of TAMRA directed the Secretary

of the Treasury or his delegate to conduct a
the Tax Reform Act of 1986 (TRA 1986).

III.

study

of the treatment provided by section 1706 of

EVALUATION OF ISSUES

According to the Conference Report on TAMRA, ' the Treasury report was to include
an evaluation of five issues. These issues, and the general findings of the report with respect

to each, are described below.

H. R. Conf. Rep. No. 1104, 100th Cong. , 2d Sess. 167-68 (1988).

'li

ini

difficulties in the administration

The Conference

Report questioned whether there were
of the provisions of section 1706. The report finds that:

Section 1706 itself presents few administrative
section 530;
Section

1706 actually

improves

in comparison

problems, particularly

of the present-law

the administrability

rules

with

for

as employees or independent

classifying individuals

contractors by partially repealing the
prohibition in section 530 against the issuance of guidance; but
The occupations covered by section 1706 could be clarified (see Chapter 6, section II).
n

me b

of income

whether there were any abuses in the reporting

questioned

that would justify the adoption
by independent

r .

of section 1706, including

any evidence

contractors when compared to employees.

The Conference
by independent

Report
contractors

of greater noncompliance

The report finds that:

Existing IRS data suggest that there are errors in the classification of employees as
independent contractors and in the reporting of income by such individuals, which may

call for legislative or administrative
Underreporting

of income

changesby such individuals,

and the more favorable treatment

of independent contractor trade or business expenses, reduce tax revenue;
Misclassification of employees as independent contractors increases tax revenues,
however,
individuals,

and tends to offset the revenue

because direct compensation

loss from undercompliance

to independent

by such

contractors is substituted

for tax-favored employee fringe benefits;
Evidence suggests that compliance is somewhat better for technical services workers who

are classified as independent contractors than for workers in general who are classified
as independent contractors (see Chapter 5).

hillin

Conference
personnel

tion 17

o e w rk. The
the effect of section 1706 on the ability of technical services

on he

bili

hni

rvi

r onn

Report questioned
to get work. The report concludes that:

Section 1706 does not affect the cost to firms of technical services workers relative to
other workers, and does not affect the demand for firms' products; it is unlikely,
therefore, that section 1706 affects the overall ability of technical services workers to get
work;

Section 1706 may, however, have had some transitory effects on the ability of some
workers to find work in their accustomed classification (see Chapter 4).
Admini trabili

inde

of the

resent-law

standards

for cia i in

individuals

as em lo ees or

The Conference Report questioned whether the present law standards
The
between employees and independent contractors were administrable.

ndent contractors.

for distinguishing
report finds that:

The task of classifying workers as employees or independent contractors under the 20factor common law tests generally used under present law can be difficult, in particular
in the multi-party situations affected by section 1706;
Section 530 has exacerbated this problem by preventing the IRS from issuing guidance

in this area for over ten years; and

Section 1706 may have improved tax administration by permitting the IRS to issue
guidance with respect to certain workers and by denying the section 530 safe harbors to
certain employers (see Chapter 6, section III).
ui

of distin

uishin

between inde endent contractors who work throu h brokers and those

The Conference Report questioned the equity of providing rules that distinguish
between independent contractors who work through brokers and those who do not. The report
finds that:

who do not.

This distinction unnecessarily

limits the beneficial effects

an adverse effect on the efficiency

of section 1706, and

of the labor markets for

may have

such workers;

Data are not available, however, to determine whether the distinction can be justified on
the basis

IV.

of differences

in compliance rates between the two groups (see Chapter

4).

OPTIONS FOR FURTHER CONSIDERATION

The significance of the effects of section 1706 must be viewed in the context of existing
substantive tax differences between independent contractors and employees, especially with
respect to the exclusion of fringe benefits from gross income, the deductibility of employee
business expenses, and differences in the Social Security and Medicare tax base. In that context,

and based on the findings

consideration

for further

and analysis:

Eliminate
workers

of this report, the following options are presented

the difference

working

in treatment

through

brokers

under
and

section 1706 between

those not working

through

difference is difficult to justify on equity or other policy grounds.
Clarify the occupations covered by section 1706. Difficulties
occupations covered by section 1706 present an administrative

technical

services

brokers.

This

(See Chapter 4. )
in determining

problem.

the

(See Chapter

6.)
~

Repeal the prohibition

in section

530 against the issuance of guidance by the IRS

concerning employee status. This prohibition has significantly

reduced taxpayers'

ability

contractors and has
to classify workers correctly as employees or independent
exacerbated the difficulty of applying the 20-factor common law standards. (See Chapter

6.)

PART

T~O

BACKGROUI'G) Vm ORMATiON

CHAPTER 2: SOURCES OF EMPLOYEE MISCLASSIFICATION

OVERVIEW
A wide variety
in the modern

service-recipient,

of relationships

between service-providers

exists

and service-recipients

They differ with respect to the degree of control exercised by the
whether the services are full-time or part-time, the method of compensation

economy.

(e.g. , salaried versus hourly), the level of material support provided by the service-recipient,
many other factors.

and

are generally grouped into one of
employees and independent contractors.

Despite this diversity, service-providers

two broad categories for Federal tax purposes:

or independent contractors results when
service-recipients and service-providers misapply the tests used to distinguish employees from
contractors under the Code.
Deliberate misclassification
of employees as
independent
independent contractors results in part from the fact that there are numerous differences under
Misclassification

individuals

as employees

the Internal Revenue Code (Code) between the treatment

of employers

and employees,

on the

contractors and their clients, on the other, and from the perception
that these differences systematically favor the second group.

one hand, and independent

Differences in treatment between employers and employees, on the one hand, and
independent contractors and their clients, on the other, also occur under a number of other
Federal and State laws, primarily those dealing with workers' compensation and unemployment
insurance,

labor-management

relations,

employment

discrimination,

and other labor issues.

to benefit from these differences in non-tax treatment can also
contribute to misclassification for Federal tax purposes, since inconsistent treatment of an
individual under these laws and Federal tax laws might invite scrutiny.
Misclassification

designed

contractors is problematic
to the extent that it circumvents a policy decision to limit certain tax benefits or burdens to one
group or the other, or results in a loss of revenue through noncompliance.
Misclassification

individuals

as employees or independent

This chapter provides a general description of the factors used to distinguish employees
from independent contractors under Federal tax and other laws, and of the differences in the
treatment of employees and independent contractors that may encourage misclassification under

each. A more detailed description of these issues is provided in Appendix

II.

DETK1VdINATION OF EMPLOYEE STATUS

The status of an individual as an employee or independent contractor for purposes of
Federal employment, income and other tax laws is, with few exceptions, determined under the
common law tests for determining

on whether the service-recipient

whether an employment

exists. These tests focus

relationship

has the right to direct and control the service-provider,

not only

by the work, but also as to the details and means by which
that result is accomplished.
Over the years, the IRS has identified 20 important factors useful
in determining whether the common law tests have been satisfied. These factors are listed in

as to the result to be accomplished

Appendix

The status of an individual

as an employee or independent contractor for purposes of
Federal and State labor and related laws is generally determined under standards that resemble
the control-based common law standards applied under the Code. Depending on the purpose of
the law involved, however, different factors are often emphasized

Thus, IRS determinations
persuasive

of employee

but not determinative

in making this determination.

status based on the common

in other areas, and it is possible for an individual

classified as an employee for some purposes and as an independent

III.

law tests are generally

DIFHDU NCES

IN TAX TREATMENT
INDEPENDENT CONTRACTORS

to be

con~ctor for others.

BETWEEN

EMPLOYEES

A'ND

favor status as either an employee or an independent
contractor. Employers and employees are treated differently than independent contractors and
their clients under a number of Federal and State laws, however. Thus, depending on individual
Current law does not consistently

circumstances,

misclassification

service-recipient,

may sometimes

be advantageous

to the service-provider,

the

or both.

Differences Favoring Independent

Contractor Status

Federal Tax Law. Prior to 1982, compensation earned by independent contractors was
taxed at substantially lower rates under the Social Security and Medicare tax provisions of the
Code than wage income, apparently creating a significant incentive for misclassification.
Subsequent legislation has essentially eliminated this important difference. The Social Security,

To some extent, however, the rate differential may have been offset by differences in the

compensation

base to which the taxes applied.

13
Medicare, and income tax provisions of the Code may still favor classification as an independent
contractor, however, where an individual has a small or unpredictable cash flow or significant
employee business expenses. This is primarily because:

(1)

Independent

contractors

deduct trade or business

face significantly
expenses

fewer restrictions

on their ability to

In particular,

than employees.

employees

may not deduct their trade or business expenses unless they "itemize"

generally

their deductions

on their tax returns,

and then only to the extent the expenses

exceed two percent of their adjusted gross incomes from all sources. They must
also satisfy additional requirements before they may deduct their automobile
depreciation, home office, home computer and certain other expenses. These
are difficult for many employees to meet and in some cases
requirements
constitute an effective barrier to a deduction.

(2)

The estimated tax system used to collect Social Security, Medicare, and income
taxes from independent contractors largely avoids the problem of over-withholding that can result when an employee

incurs large business

expenses,

has net

income that fluctuates during a year, or is employed for only part of a year. It
also generally permits later and less frequent payments than the withholding
system used to collect such taxes from employees.

As an essentially

checks against

voluntary

underreporting

reporting

system,

of income

tax system

also provides

the withholding

system

the estimated

and taxes than

fewer

and may,

therefore, be favored by service-providers and service-recipients willing to violate the law and
risk detection on audit; it also does not ensure the collectability of taxes to the same extent as
the withholding
system.
Finally, the withholding system involves overhead costs, which
employers

may seek to shift to employees

by classifying

them as independent

contractors.

The unemployment insurance tax provisions of the Code (and corresponding State laws)
contractor.
Independent
may in some cases also favor classification as an independent
contractors and their clients generally are not subject to unemployment insurance taxes. On the
insurance
other hand, independent contractors generally are not eligible for unemployment
benefits. Other things being equal, employers will have an incentive to classify a worker as an
contractor in order to avoid unemployment insurance taxes on an employee's wages
costs of remitting such taxes and complying with other associated
(and the administrative
Workers may prefer to be classified as independent contractors if they
statutory requirements).
independent

are not (or perceive that they are not) dependent

on a single employer

for their income.

~h'

. Slt

dFdllb

dlkdl

contractor.

Such laws typically do not apply to independent
contractors, providing protection only to employees. This is generally beneficial to clients of
independent contractors, since it may allow them to avoid the direct costs of providing additional

classification

as an independent

to the independent contractors, as well as the administrative cost of
explaining the benefits and assuring that various other statutory requirements have been met.
Thus, the difference in treatment may provide an incentive for employers to misclassify
Employees may also prefer to be misclassified as
employees as independent contractors.
independent contractors in order to avoid coverage under these laws, if they are not willing to

benefits and protections

pay the indirect cost for the specific protection provided.

Differences Favoring Employee Status

The Social Security, Medicare, and income tax provisions of the Code may, on the other
hand, favor classification as an employee in cases where an individual prefers to receive some
of her compensation in the form of fringe benefits rather than cash. This is because, under the
Code, an employer may provide fringe benefits, such as pensions, accident and health and
group-term life insurance, on a tax-favored basis to its employees but not to its independent
contractors. Such benefits are generally excluded from employees' gross incomes subject to
income tax as well as wages subject to Social Security and Medicare taxes. While independent
contractors can generally establish their own fringe benefit plans, amounts used to purchase such
benefits generally cannot be deducted or excluded from gross income subject to income tax, or
from compensation

-subject to Social Security and Medicare taxes.

provided for certain

of the most significant benefits,

insurance;

Limited exceptions are

including pensions and accident and health

amounts used to purchase these benefits can to some extent be deducted or excluded

from gross income subject to income tax by independent contractors, although they cannot be
deducted or excluded from compensation subject to Social Security and Medicare taxes.

contractor to participate in a plan
This is
as an employee, however, since that might involve additional costs to the employer.
particularly true if the independent
contractor is highly compensated, in which case her
participation might require the employer to provide additional benefits to its non-highly
An employer may be reluctant to allow an independent

coverage and nondiscrimination requirements of the
Code. Also, short-service independent contractors may not derive any significant benefits from
participation, and may therefore prefer to receive additional cash compensation, instead.
compensated employees under the minimum

The various differences in tax treatment between employees and independent
discussed above are summarized in Table 2-1.

Five Hypothetical

contractors

Rcamples of Differential Tax Treatment

The preceding discussion indicates that Federal and State tax, labor and related laws do
not systematically favor classification of an individual as an employee or independent contractor.
The most beneficial classification for a particular individual depends instead on her circumstances, preferences, and negotiating skills. This section illustrates the effects of these differences
using five hypothetical examples.

Each example begins with $1,000 which an employer or service-recipient could spend
on worker compensation.
In the employee situation, most of the $1,000 is used to pay the
employee her normal salary plus holiday, vacation and sick pay. The remainder is used to pay
taxes (including Social Security and Medicare taxes, and State and Federal
employment
or voluntarily-provided
unemployment insurance taxes) and to provide statutorily-required
fringe
benefits (including contributions to retirement plans, health insurance premiums, and workers'
The employee pays any Federal and State income taxes and the
employee share of the Social Security and Medicare taxes due on her salary, and also pays any
work-related expenses (for tools, etc. ).'
compensation

premiums).

contractor situation, the $1,000 spent for worker compensation by the
client is generally assumed to be paid to the independent contractor, although, depending on the
knowledge and relative negotiating skills of the two parties, some might be retained by the
client. The amount, if any, retained by the client is assumed to pass directly to the client's
"bottom line" and, therefore, to be subject to Federal and State corporate income taxes.
In the independent

In order

contractor,
(although

to maintain

the independent

the tax treatment

the comparison

between

the employee

and

the independent

to incur the same costs as the employee
may be different) and is assumed to purchase directly the same

contractor

is assumed

Since the examples show the impact of additional income to the employee or independent
contractor, a 28 percent Federal income tax rate and a 7.5 percent State income tax rate are
assumed to apply to the additional taxable income. The assumed Federal corporate income tax
rate is 34 percent, and the assumed State rate is eight percent. The various tax rates are based
on those that would be paid by or for a middle-income worker.

Table 2-1
Major Differences in Treatment of Employees and Independent
for Federal Tax and Other Purposes
~Em

io eee

Inde

Contractors

ndent Contractors

Frin e B nefits'
Value of many employer-provided fringe benefits
excluded &om income and employment tax bases

Qualified retirement plan contributions excluded from
income but not self-employment tax base

25 percent of health insurance costs deducted &om
income but not self-employment tax base
Few other fringe benefits excluded from income or
self-employment tax bases

Tr e

Ex ns

May be deducted &om income tax base only by itemizers
and only to the extent expenses exceed two percent of
adjusted gross income

May be deducted from income tax base

May not be excluded from employment

May be excluded &om self-employment

tax base

Certain expenses subject to additional business purpose
requirements

Administrative
Withholding involves more administrative
employer but less for employee

Costs

costs for

Estimated tax system involves more administrative
costs for independent contractor but less for client

Estimated tax system allows modest delay in tax
payments relative to withholding
~Com

liooce
Somewhat more ability to be noncompliant due to lack
of withholding, larger trade or business expenses, and
somewhat more limited business purpose requirements
with respect to such expenses

Non-Tax Differencess

Less flexibility in choosing among fringe benefits; value
of employer contributions to retirement plan may be lost
if worker changes jobs &oquently

May be unable to obtain fringe benefits, including
statutory fringe benefits such as unemployment
insurance and workers' compensation

Administrative (and other) costs associated with Federal
and State laws applicable to employees, e. g. , minimum

May be unable to negotiate worker protections such as
minimum wage and overtime

wage
RflBlCGi

fCESUiy

Office of Tax Policy

For a detailed comparison of the tax treatment of fringe benefits and business expenses,
provided fringe benefits may be subject to nondiscrimination

Some of the non-tax differences, such as minimum
to occupations covered by section 1706.

requirements

sE'e Appendix

A. Employer-

and other limits.

wage laws, may be more applicable to less advantaged workers than

17
benefits

that the employee

assumed that the independent

could when purchasing

x m

—T

receive as employer-paid fringe benefits.
It is further
contractor can purchase these benefits at the same cost an employer

would

for all of its employees as a group.
Mix

f Frin

Example 1 (Table 2-2) shows a situation
in which an employee receives a typical mix of fringe benefits but does not incur any deductible
1

The employer pays the employer share of Social Security and
Medicare taxes, as well as the total cost of workers' compensation premiums and Federal and
State unemployment insurance taxes. The employer also makes contributions to retirement and

trade or business

expenses.

medical insurance plans for the employee, each costing six percent of total compensation.
The
employee receives regular, vacation, holiday and sick pay of $806, out of which the employee's
share

of Social Security

and Medicare taxes, as well as Federal and State income taxes, are paid.

The independent contractor receives the entire $1,000 in cash. Out of that, she pays Federal and
State income taxes, Social Security and Medicare taxes, buys health insurance, and contributes
to a tax-favored "Keogh" retirement plan. As shown in Table 2-2, the independent contractor
pays $12 more in Federal income tax, $4 more in State income tax, and $18 more in Social
Security and Medicare tax.

Taxes are higher for the independent contractor in Example 1 because the part of her
cash income that was used to provide fringe benefits in the case of the employee is subject to
Social Security and Medicare taxes, and some is also subject to income taxes. Current Federal
law attempts to equate the tax rate for employees and self-employed persons for Social Security
and Medicare tax purposes. Nevertheless, there are differences in the tax base. Self-employed
persons may not exclude the value of fringe benefits they purchase for themselves from the
Social Security and Medicare tax base (other than the employer portion of Social Security and
Medicare taxes), while the value of employer-provided fringe benefits is typically excluded from
that base in the case of employees. Hence, in Example 1, the Social Security tax is $18, or 15
percent, higher for the independent contractor than for the employee. The income tax system
does provide deductions for self-employed
the equivalent

to the employer

portion

persons for contributions

of Social Security

to retirement plans (and for

and Medicare

taxes), but it only

fringe benefits would likely
In practice, the lower after-tax price for voluntarily-provided
result in greater expenditures for these items in the employee case. Conversely, the lower aftertax price of certain trade or business expenses for independent contractors would likely result
in higher trade or business expenses for such individuals.

This assumption is made for simplicity and may be approximately correct for small
employers. For large employers, economies of scale are probably important.

Table 2-2

EXAMPLE 1: COMPARISON OF INCOME AND TAXATION OF $1,000 OF TOTAL COMPENSATION
FOR AN EMPLOYEE OR INDEPENDENT CONTRACTOR,
WORKER WITH A TYPICAL MIX OF FRINGE BENEFITS AND NO WORKER EXPENSES

Indcpcndent

Employer/Employee

Contractor

Service
~Em

Money Payment or Regular Salary.
Holiday/Vacation/Sick
Pay.

io m

~Em

io m Combina

733
73
806

. ..

MONEY PAYMENT OR TOTAL SALARY. .
Employer-Paid Taxes and Benefits. .
TOTAL COMPENSATION TO WORKER. ... .
Retained by Scrvicc Recipient.
TOTAL COMPENSATION.

..
-

TAXES AND STATUTORY BENEFITS, TOTAL. ..
Federal Incornc Tax 1/ 2/
State Income Tax 1/ 3/
Social Security (FICA/SECA) 4/
Unemployment Insurance (FUTA and State) 5/
Workers' Compensation

VOLUNTARY FRINGE BENEFITS, TOTAL. ...
Retirement/Keogh

Worker Combine

1,000

194
000
1,

1,000

405
209
60
123

120

120
60
60

60
60

Contribution

Health Insurance Premiums

331
209
60
62

~Rmi ienr

0
0
0

427

221
64
141

221

120
60
60

120

64
141

60
60

WORKER EXPENSES (DEDUCTIBLE), TOTAL. ....
Income and Social Security Tax Compliance Rate. ..

For Worker
Total Compensation less
Taxes and Statutory Benefits.

100.0%

595

573

475

573

475

453

Money Income less

Worker Taxes.
Money Income less Worker Taxes,
Worker-Paid Benefits, and Worker Expenses.

For Em lo er Service Reci ient
Retained by Service Recipient less Taxes.
Department

...

of the Treasury

Office of Tax Analysis
Note: Detail may not add to totals due to rounding.

2/
3/

Taxable amount is money payment to the worker less deductions consistent with worker status. Employee has itemized deductions
for state income taxes (for federal tax purposes but not for state tax purposes) and for worker expenses in excess of 2 percent of
adjusted gross income (assumed to be 4 percent of money payment). Independent contractor deducts worker expenses, Keogh
contributions, 25 percent of health insurance premium, and 50 percent of SECA tax.
28 percent rate for the worker, and 34 percent rate for the service recipient.
7.5 percent rate for the worker, and 8 percent rate for the service recipient.
7.65 percent rate for the employee and for the employer, or 14.12955 percent rate ([100%-7.65%]x15.3%) paid entirely by the

contractor.
Assumed to be 0.55 percent of total salary.
Assumed to be 1 percent of total salary.
independent

5/
6/

for 25 percent of medical insurance costs (and then only in some
circumstances), and it does not permit a deduction for the cash equivalent of other fringe
insurance and
benefits, which in this example only consist of the costs of unemployment
workers' compensation.
permits

a deduction

2—
N n m lian . Independent contractors may have greater opportunity than
employees to be less than fully compliant with tax laws. Employees are subject to withholding,
and the amount of their wage income is reported with great precision to the IRS. Independent

Ex m

contractors may be able to omit some of their income on their tax returns, although that becomes
more difficult when their gross income is reported to IRS on information returns (generally
Forms 1099-MISC). Even if independent contractors report 100 percent of their income,
however, they may be able to lower their reported tax liability by overstating expenses. Since
the workers in Example 2 do not have trade or business expenses, the noncompliance consists
solely

of the failure to report all of gross income. Example 2 (Table 2-3) illustrates the effect

of a lower compliance rate

on the independent

contractor's tax liabilities.

Example 2 is the same

as Example 1, except that the independent contractor is assumed to report only 95 percent of her
As a result of this underreporting
net income from self-employment.
by five percent, the
independent contractor's Federal and State income taxes are now virtually the same as for the

' At greater
employee, although the Social Security tax is still $11, or nine percent, higher.
levels of noncompliance, the taxes of the independent contractors would be lower than those of
the fully compliant

Ex
differentially

employee.

—Trade

r Bu ine

affect the tax treatment

nse .

of employees

Employee

business

and independent

expenses

contractors.

can also

Example 3

(Table 2-4) is similar to Example 1, except that the worker is now assumed to have expenses
equivalent to ten percent of total compensation. The independent contractor is able to deduct all
of these expenses in calculating income subject to both income and Social Security and Medicare
taxes. In contrast, the employee's Social Security and Medicare taxes are not adjusted at all to
reflect these expenses.
itemizes deductions

For income tax purposes, these expenses may be reflected if the worker

on her income tax return,

extent that they, together

with

other miscellaneous

See Table 5-3 for a summary

but, even then, they are only deductible

deductions,

of the compliance rates

to the

exceed two percent of her

found in one recent IRS study.

See Table 5-2 for a summary of compliance rates actually found in one IRS study. For
technical services workers in that study, reporting of gross receipts was 97.0 percent, and
reporting of net income (i. e. , gross receipts minus business expenses) v as 83.4 percent.

Table 2-3

EXAMPLE 2: COMPARISON OF INCOME AND TAXATION PF $1,000 PF TP TAL CPMPENSATION
FOR AN EMPLOYEE OR INDEPENDENT CONTRACTOR,
WpRKER WITH A TYPICAL MIX OF FRINGE BENEFITS, Np WORKER EXPENSES&
AND 5 PERCENT NON-COMPLIANCE BY THE INDEPENDENT CONTRACTOR
Independent

Employer/Employee

Contractor

Service
~Em

io er

io ee Combined

733
73
806

Money Payment or Regular Salary.

Holiday/Vacation/Sick

~Em

Pay ..

MONEY PAYMENT OR TOTAL SALARY. ...
Employer-Paid Taxes and Benefits.
TOTAL COMPENSATION Tp WORKER. ....
Retained by Service Recipient.
TOTAL COMPENSATION

TAXES AND STATUTORY BENEFITS, TOTAL. ....
Federal Income Tax I/ 2/
State Income Tax I/ 3/
Social Security (FICA/SECA) 4/
Uncmploymcnt Insurance (FUTA and State) 5/
Workers' Compensation

VOLUNTARY FRINGE BENEFITS, TOTAL. ..
Retirement/Keogh

Contribution

Health Insurance Premiums

331
209
60
62

Worker Combined

1,000

405
209
60

0
0
0

123

ienr

733
73
806

4
120
60
60

~R&ei

120
60
60

404
209

404

134

120
60
60

120

209

60
60

WORKER EXPENSES (DEDUCTIBLE), TOTAL. ....
Income and Social Security Tax Compliance Rate. ..

100.0%

95.0%

For Worker
Total Compensation less
Taxes and Statutory Benefits.

595

596

Money Income less
Worker Taxes.

475

596

475

476

Money Income less Worker Taxes,
Worker-Paid Benefits, and Worker Expenses.

For Em lo er Service Reci ient
Retained by Service Recipient less taxes.

of the Treasury
Office of Tax Analysis

Department

Note: Detail may not add to totals due to rounding.

Taxable amount is money payment to the worker less deductions consistent with worker status. Employee has itemized deductions
for state income taxes (for federal tax purposes but not for state tax purposes) and for worker expenses in excess of 2 percent of
adjusted gross income (assumed to be 4 percent of money payment). Independent contractor deducts worker expenses, Keogh
contributions, 25 percent of health insurance premium, and 50 percent of SECA tax.
28 percent rate for the worker, and 34 percent rate for the service recipient.
7.5 percent rate for the worker, and 8 percent rate for the service recipient.
7.65 pcrccnt rate for thc employee and for the employer, or 14.12955 percent rate ([100%-7.65%]x15.3%) paid entirely by the

contractor.
0.55 percent of total salary.
Assumed to be 1 percent of total salary.
independent

5/
6/

Assumed to be

Table

EXAMPLE

COMPARISON OF INCOME AND TAXATION OF $1,000 OF TOTAL COMPENSATION
FOR AN EMPLOYEE OR INDEPENDENT CONTRACTOR,
WORKER WITH A TYPICAL MIX OF FRINGE BENEFITS
AND WORKER EXPENSES OF 10 PERCENT
Indcpcndent

Employer/Employee

Contractor

Service
~Em

io er

Money Payment or Regular Salary

Holiday/Vacation/Sick

~Em

io ee Combined

733
73

Pay

MONEY PAYMENT OR TOTAL SALARY. . .. .
Employer-Paid Taxes and Benefits. . . .
TOTAL COMPENSATION TO WORKER. . . . . . .
Retained by Service Recipient. . . . . . . . . . . . . . . . . . . . . . .
TOTAL COMPENSATION.

TAXES AND STATUTORY BENEFITS, TOTAL. . .
Fcdcral Income Tax 1/ 2/
State Income Tax I / 3/
Social Security (FICA/SECA) 4/
Unemployment Insurance (FUTA and State) 5/
Workers' Compensation

VOLUNTARY FRINGE BENEFITS, TOTAL. .
Retirement/Keogh

Contribution

Health Insurance

733
73
806

1,000

381
197
57
127

381
197

120

120
60
60

1,000
1,000

308
191
55
62

191

0
0

382

123

120
60

120
60
60

WORKER EXPENSES (DEDUCTIBLE), TOTAL. . . . .
Income and Social Security Tax Compliance, Rate. . .

Worker Combined

194

Premiums

~Reei ienr

60
60

0
100.0%

57
127

100

100.0%

For Worker
Total Compensation

loss

Taxes and Statutory Bcncfits.

618

619

498

619

398

399

Money Income less

Worker Taxes.
Money Income less Worker Taxes,

Worker-Paid

Benefits, and Worker Expcnscs. . .

For Em lo er Service Reci ient
Retained by Scrvicc Recipient less Taxes.

Department

of thc Treasury

Offic of Tax
Note:

Analysis

Detail may not add to totals due to rounding.

Taxable amount is rnoncy payment to the worker less deductions consistent with worker status Employee has ltcmizcd deduct ionb
for state income taxes (for federal tax purposes but not for state tax purposes) and for worker expcnscs in excess of 2 percclll of
adjusted gross income (assumed to be 4 percent pf mpney payment). Indcpcndcnt contractor deducts worker cxpcnscs, Keogh

25 pc:rccnt of health insurance premium, and 50 percent of SEC A tax.
28 percent rate for the worker, and 34 percent rate for thc scrvicc recipient.
7.5 pcrccnt rate for thc worker, and 8 percent rate; for thc service rccipicnt.
7, 65 percent rate for the employee and for the emplpyer, pr 14. 1'2955 percent rate ([100%-7.65%]x15.3%) paid cntircly by the
independent contractor.

contributions,
2/
3/

Assumed

to bc 0. 55 percent of total salary.
to bc 1 percent of total saiarv

22
adjusted gross income from all sources. In Example

assumed that the effective deduction
so that only the excess over that level

3, it is

floor is equivalent to four percent of total compensation,
is deductible. As a result of the differential treatment of these trade or business expenses, the
extra Federal income tax paid by the independent contractor has been reduced from $12 to $6,
and the extra State income tax has been reduced from $4 to $2. The extra Social Security tax
has been reduced from

Eff

$18 to $4, however.

of Ex nses

n Noncom

liance R tes. The noncompliance

rate for net income

does not equal the noncompliance rate for gross income. The rates are equal only
when gross income and net income are equal because the worker has no trade or business
generally

expenses. When the worker has such expenses, the noncompliance rate for net income exceeds
the noncompliance rate for gross income. The higher the level of expenses, the greater the
difference between noncompliance

rates becomes.

Consider a worker with gross income of

$1,000 and expenses of $400; net income is $600. If the worker understates gross income
ten percent, net income will be understated by 16.7 percent. '
The noncompliance

rate for net income and the difference between the gross and net

income compliance rates will be greater

if the worker can use the existence of trade or

business

expenses to understate net income further by overstating expenses. In the example above, if the
worker both understates gross income by ten percent and overstates expenses by ten percent, net
income will be understated by 23.3 percent.

Exam le 4 —
Statutoril

-R

uired Frin

e Benefits Onl . In Example 4 (Table 2-5), the

employer is assumed

not to provide any voluntary fringe benefits. In addition to salary, the
employer pays only for the employer portion of Social Security and Medicare taxes, the Federal
and State unemployment taxes, and workers' compensation insurance premiums.
Since fringe
benefits, which cause the disparity between Social Security and Medicare tax levels for

contractors, have been greatly reduced, there is only a $1 difference
in Social Security and Medicare taxes between the employee and the independent contractor.
The additional Federal income tax paid by the independent contractor is $4, and the additional
employees and independent

Net and gross income are both understated by $100. The noncompliance
income is $100/$1, 000; the noncompliance rate on net income is $100/$600.

rate on gross

Gross income is understated by $100. Expenses are overstated by ten percent, or $40.
Net income is understated by $140. The noncompliance rate on net income is $140/$600.

Table 2-5

EXAMPLE

COMPARISON OF INCOME AND TAXATION OF $1,000 OF TOTAL COMPENSATION
FOR EMPLOYEE OR INDEPENDENT CONTRACTOR,
WORKER WITH ONLY STATUTORY BENEFITS AND NO WORKER EXPENSES

Independent

Contractor

Service
~sm

io er

Money Payment or Regular Salary.

Holiday/Vacation/Sick

MONEY PAYMENT OR TOTAL SALARY. . ..
Employer-Paid Taxes and Benefits.
TOTAL COMPENSATION TO WORKER. .. .. .
Retained by Scrvicc Recipient.
TOTAL COMPENSATION.

Workers' Compensation

io ee Combined

916
0
916

Pay

TAXES AND STATUTORY BENEFITS, TOTAL. . . .
Federal Incptnc Tax I/ 2/
State Income Tax I/ 3/
Social Security (FICA/SECA) 4/
Uncmploymcnt Insurance (FUTA and State) 5/

~Em

~Reei ienr

Worker Combined

916

1,000

916

1,000

84
1,000

1,000

376
237
69
70

460
237
69

140
5

0
0

452

241

141

VOLUNTARY FRINGE BENEFITS, TOTAL. . .
Rctiremcnt/Keogh
Health Insurance

Contribution
Premiums

WORKER EXPENSES (DEDUCTIBLE), TOTAL. .. . .
Income and Social Security Tax Compliance Rate. . .

100.0%

For Worker
Total Compensation

less

Taxes and Statutory Benefits.

548

Money Income less

Worker Taxes.
Money Income less Worker Taxes,

Worker-Paid

Benefits, and Worker Expcnscs. . .

548

For Em lo er Service Reci icnt
Retained by Service Recipient less Taxes. . .

of thc Treasury
Office of Tax Analysis

Department

Note: Detail may not add to totals duc to rounding.

2/
3/

Taxable amount is money payment to thc worker less deductions consistent with worker status. Employcc has itemized deductions
for state income taxes (for federal tax purposes but not for state tax purposes) and for worker cxpcnscs in excess of 2 percent of
adjusted gross income (assumed to bc 4 percent pf mpncy payment), Independent contractor deducts worker expenses, Keogh
contributions, 25 percent of health insurance premium, and 50 percent of SECA tax.
28 pcrccnt rate for the worker, and 34 pcrccnt rate for the scrvicc recipient.
7.5 percent rate for tbe worker, and 8 percent rate for thc scrvicc recipient.
rate for thc employee and for the employer, pr 14. 12955 pcrccnt rate ([100%-7. 65% ]x15.3% ) paid entirely by the
contractor.
Assumed to bc 0.55 percent of total salary
Assumed to bc 1 pcrccnt of total salary,

7.65 percent
indcpcndcnt

5/
6/

24
State income tax is

$1. The

situation

illustrated

in Example 4 is typical

many temporary

whose fringe benefits are often restricted to those required by law.

employees,

Note that in Example 4, as a result of higher cash wages exactly offsetting the reduction
in fringe benefits, both workers' total current tax bills have increased compared with the workers

1. For

in Example

the employee,

combined employer-employee

percent. For the independent

—Lower

the sum

the Federal and State income taxes and the

Social Security and Medicare taxes has increased by $53, or 13
contractor, the combined bill has increased by $25, or six percent.

Example 5 (Table 2-6) is
similar to Example 4, except that the independent contractor's compensation is slightly lower
because she has been unable to negotiate from her client the equivalent of the value of the
employer's costs for workers' compensation and unemployment insurance (i. e. , her bargaining

m le

Inde

power is lower than in Example

nden

4). Since

ctor

tion.

this wedge between total employee compensation

and

contractor is small, the resulting tax differences are also small.
contractor now has less income, her Social Security and Medicare taxes

total payments to the independent

Because the independent
are now slightly lower ($1) than those paid by the employer and the employee.
Also, the
independent contractor's Federal and State income taxes are now the same as those of the
employee. However, because the client must pay income tax on the funds it has retained, the
combined income taxes of the independent contractor and her client are still $6, or two percent,
higher than those

of the employee.

These examples illustrate that the difference in income, Social Security and
Medicare taxes paid by employers and employees, on the one hand, and independent contractors
Summary.

and their clients,

proportion

on the other, on the same amount

of compensation the

individual

of total compensation

takes as fringe benefits, the extent

depends

on the

of the individual's

expenses, and the relative compliance of employees and independent contractors.
With typical patterns of fringe benefits and worker expenses, independent contractors and their
clients tend to pay higher levels of taxes, especially Social Security and Medicare taxes, than
work-related

" U. S. Department

on its First Survey
88-260,
page 8 (1988).
of Pay and Employee Benefits in the Temporary Help Supply Industry,

of Labor, Bureau of Labor Statistics, BLS Reports

Employees with substantial trade or business expenses and sufficient bargaining power
may be able to negotiate with their employers to structure computer and auto expenses as
required business expenses. In such a situation, the worker would still be subject to the twopercent floor, but would be able to deduct expenses that would normally not be deductible.

Table 2-6

COMPARISON OF INCOME AND TAXATION OF $1,000 OF TOTAL COMPENSATION
FOR EMPLOYEE OR INDEPENDENT CONTRACTOR,
WORKER WITH ONLY STATUTORY BENEFITS, NO WORKER EXPENSES,
AND A WEDGE BETWEEN EMPLOYEE AND INDEPENDENT CONTRACTOR TOTAL COMPENSATION

EXAMPLE

Indepcndcnt

Contractor

Service
~Em

io er

Pay

MONEY PAYMENT OR TOTAL SALARY. .. ..
Employer-Paid Taxes and Benefits.
TOTAL COMPENSATION TO WORKER. .. . .. .
Retained by Scrvicc Recipient
TOTAL COMPENSATION.

TAXES AND STATUTORY BENEFITS, TOTAL. . . .
Federal Income Tax I/ 2/
State Incornc Tax 1/ 3/
Social Security (FICA/SECA) 4/
Unemployincnt Insurance (FUTA and State) 5/
Workers' Compensation

io ee Combined

916
0
916

Money Payrncnt or Regular Salary

Holiday/Vacation/Sick

~Ern

~Reoi ienr

Worker Combined

916

986

916

986

1,000

1,000
84

376
237
69
70

460
237
69
140

6
4
1

445
237
69
139

451
242

70
139

VOLUNTARY FRINGE BENEFITS, TOTAL. . .
Rctircment/Keogh

Contribution

Health Insurance Premiums

WORKER EXPENSES (DEDUCTIBLE), TOTAL. . . . .
Income and Social Security Tax Compliance Rate. . .

100.0%

For Worker
Total Compensation

less

Taxes and Statutory Benefits.
Money Income less

Worker Taxes.
Money Income less Worker Taxes,

Worker-Paid

Bcncfits, and Worker Expenses. . .

For Em lo er Service Roci ient
Retained by Scrvicc Recipient less Taxes. . .

of thc Treasury
Oflice of Tax Analysis

Department

Note: Detail may not add to totals duc to rounding.

Taxable amount is money payment to thc worker less deductions consistent with worker status. Employee has itemized deductions
for state income taxes (for fcdcral tax purposes but not for state tax purposes) and for worker expcnscs in cxccss of 2 percent of
adjusted gross income (assurncd to bc 4 percent of rnoncy payment). Independent contractor deducts worker cxpcnscs, Keogh
contributions, 25 percent of health insurance premium, and 50 percent of SECA tax.

28 percent rate for thc worker, and 34 percent rate for thc service recipient.
7.5 percent rate for the worker, and 8 pcrccnt rate for the service recipient.
7.65 percent rate 1'or thc employee and for thc employer, or 14. 12955 percent rate ([100%-7. 65% ] E15.3%) paid entirely b) the
indcpcndcnt contractor.
Assumed to bc 0.55 percent of total salary

Assumed

3/
4/

to bc

percent of total salary

26
employees

and employers,

provided

that the income and expenses

are reported

correctly

contractors receive few fringe benefits that are not statutorily-required
(as is
typical for temporary workers), however, and have few or no trade or business expenses, they
and their clients may pay about the same level of taxes as employees and employers, provided

When independent

that the income and expenses are reported correctly.

Validity of Differences

It is evident from the preceding discussion that a mere change in classification of an
as an employee or independent contractor can result in differences in the total tax
liability of the individual and the service-recipient, regardless of whether there has been any
individual

While such differences may seem arbitrary or unfair
whose relationship with a service-recipient places them close to the line

change in their economic circumstances.
in the case

of individuals

between employee and independent

for more "typical" employees
partial disallowance

contractor status, these differences can generally be justified

and independent

contractors.

of trade or business expense deductions,

business purpose requirements

on those deductions,

For example, withholding,
and the imposition

may be more administratively

the

additional

appropriate

for employees than independent contractors, on the assumption that independent contractors
typically have more volatile net incomes and larger trade or business expenses, and typically
change jobs more frequently than employees.
Similarly, the special treatment accorded to
employee fringe benefits under the Code, and the special protections for employees found in
Federal and State labor laws, may be justified if employees typically have less bargaining power
than independent contractors and are more dependent on a single business for their livelihoods.
Even if these assumptions

"typical" employees and independent contractors are
correct, the fact that a single broad distinction is drawn under the Code between employees and
independent contractors means that some "atypical" individuals may not be treated properly.

For example, withholding

regarding

and the partial disallowance

of trade or business expense deductions

(except as a compliance measure) for an employee who regularly incurs
large expenses and changes jobs frequently: in such situations it might be preferable to treat the
individual as an employee for one purpose and an independent contractor for another. Similarly,
may not be appropriate

power or financial sophistication may
be better off being treated as employees under the fringe benefit provisions of the Code and
under Federal and State labor laws. Nevertheless, the costs of such inappropriate results in
independent

contractors who lack significant bargaining

The higher levels of Social Security taxes may in some cases result in a comparable
increase in Social Security benefits.

27
some cases must be balanced against the benefits of maintaining

a single standard

that applies

for all purposes.

Of course, it may be that these assumptions
employees and independent

regarding

contractors are not generally

the characteristics

correct.

If this

of "typical"

is the case, and the

results in too many cases, it may be desirable
or even to reexamine the need for the current-law

current scheme therefore results in inappropriate

to develop new definitions

of employee

For example, if most independent
contractors lack the means or the foresight to provide for their own retirement income or health

distinctions between employees and independent

contractors.

coverage, there may be no reason to limit the fringe benefit provisions of the Code
to employees, except perhaps in the case of wealthier or more sophisticated individuals.
Similarly, there may be no reason for the differences in treatment of employees and independent
contractors with respect to the excludability of fringe benefits from the Social Security and
insurance

Medicare tax base, which arose at a time when fringe benefits made up only a small portion of
total income.

CHAFI'$W 3' ORIGINS OF SECTION 1706

SECTION 530

In the late 1960s, the IRS began to increase its employment
which had previously been sporadic, to address the misclassification

tax enforcement

activities,

of employees as independent

contractors.

Since, as noted above, independent contractors and their clients at that time faced
significantly lower Social Security and Medicare tax rates than employers and employees, such
misclassification was perceived to produce large revenue losses. As a result of the IRS' action,
the number of reclassifications increased substantially.
Many of these reclassifications

in large assessments

resulted

against the employers

Medicare, and Federal unemployment
Medicare, and income taxes.

involved

Social Security,
employee Social Security,

for employer

insurance taxes, and unwithheld

Taxpayers complained to Congress that the reclassifications amounted to a change of
position by the IRS in how it was applying the common law tests for determining an individual's

or an independent contractor.
House and Senate conferees reporting
on the Tax Reform Act of 1976 urged the IRS "not to apply any changed position or any newly
stated position which is inconsistent with a prior general audit position in this general area to
past, as opposed to future[, ] taxable years" until the completion of a study by the Joint
status as an employee

Committee on Taxation on the independent

contractor issue.

The Joint Committee asked the General Accounting Office (GAO) to examine the IRS
administration of employment taxes. This study was completed by the GAO in 1977. The
contractor status dealing with
that a safe harbor test of independent
study recommended

situations

where an individual

carries her own trade or business be added to Code, and that

" See IRS Annual Reports for 1971-1978.
" See Staff of the Joint Committee on Taxation,

96th Cong. , 1st Sess. , General Explanation
of the Revenue Act of 1978, 300-01 (Comm. Print 1979); H. R. Conf. Rep. No. 1800, 95th
Cong. , 2d Sess. 271 (1978); H. R. Rep. No. 1748, 95th Cong. , 2d Sess. 5-6 (1978); S. Rep.
No. 938, 94th Cong. , 2d Sess. 604 (1976).

H. R. Conf. Rep. No. 1515, 94th Cong. , 2d Sess. 489 (1976).

" GAO,
Service:

Tar Treatment of Employees and Self-Employed Persons by the Internal Revenue
Problems and Solutions, GGD-77-88 (1977).

30
certain other changes be made to reduce the financial burden
assessments. The study also found that employees misclassified
average reported 96 percent

of retroactive employment
as independent

of their wages. This finding, however,

tax

contractors on

was based on payments

by
Noting limitations in

a sample of only five employers involved in employment tax audits.
the GAO sample, the IRS undertook its own study. Based on payments by a sample of 2, 600
employers to 7, 109 individuals that it had previously proposed to reclassify as wages, the IRS
found an average income tax reporting compliance rate of 76.2 percent and an average

It also found that compliance
tax reporting compliance rate of 70.0 percent.
rates varied less by industry than by the size of payment and other factors, with small payments
and those likely to have been made in cash much less likely to be reported.
employment

In the Revenue Act of 1978, Congress, without mentioning

the GAO study, provided

relief for certain taxpayers involved in employment tax controversies with the IRS.
Section 530 of the Act prohibits the IRS from challenging an employer's treatment of an
individual as an independent contractor for employment tax purposes if the employer (1) has a
reasonable basis for such treatment and (2) consistently treats the individual, and any other
individual holding a substantially similar position, as an independent contractor.
Section 530
does not merely provide relief from retroactive assessments: as long as these requirements are
met with respect to an individual,
the IRS is prevented from correcting an erroneous
classification of that individual. Section 530 applies solely for purposes of the employment tax
provisions of the Code (e.g. , Social Security, Medicare, unemployment insurance taxes, and
income tax withholding).
It does not affect an individual's classification as an employee for
income tax purposes; treatment of an individual as an employee for income tax purposes may,
however, violate the consistency requirement noted above and thereby cause the employer to lose
statutory

" Id. at 25 and 71. A larger

sample showed compliance rates

of only 87 percent. 1d. at

25.
See id. , Appendix V; Hearings Before the Subcommittee on Select Revenue Measures
of the House Ways and Means Committee, 96th Cong. , 1st Sess. (June 20, 1979) (Statement of
Donald C. Lubick, Assistant Secretary of the Treasury (Tax Policy)).

" Revenue

Act of 1978, Pub. L. No. 95-600, g 530, 92 Stat. 2763, 2885 (1978). These
requirements must be met before the commencement of any IRS compliance procedures with
respect to an individual. Rev. Proc. 85-18, $ 3.03(C), 1985-1 C.B. 518.

31
protection under section 530. Section 530 treats reasonable reliance on any of the following as
a reasonable basis for treating an individual as an independent contractor:

judicial precedent, published rulings, or letter rulings or technical advice memoranda
issued to or with respect to the taxpayer;

(2)

(3)

a past IRS audit in which there was no assessment attributable to the employment tax
treatment of the individual or of individuals holding positions substantially similar to that
of the individual; or
a long-standing recognized practice of a significant segment of the industry in which the
individual

was engaged.

The IRS has issued a series of revenue procedures
section 530.~

since 1978 explaining

the application

Section 530 was originally described as an interim measure to provide relief until
"Congress ha[d] adequate time to resolve the many complex issues involved in this area", and
was scheduled to expire after 1979. It was instead extended through a series of public laws, and
was made permanent in the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA).

II.

SECTION 3509
In TEFRA, Congress added section 3509 to the Code to mitigate the problem

of large

faced by employers who were not entitled to relief under
section 530. Under prior law, in the event of a misclassification an employer could be held
liable for the full amount of unwithheld income taxes and the unwithheld employee share of
Social Security and Medicare taxes. In addition, the employer remained liable for Federal

retroactive employment

unemployment

insurance

tax assessments

tax and the employer

of Social Security

Rev. Proc. 78-35, 1978-2 C. B. 536, was issued soon after enactment.
version is Rev. Proc. 85-18, 1985-1 C. B. 518.

Staff of the Joint Committee on Taxation, 96th Cong.
of the Revenue Act of 1978, 300-01 (Comm. Print 1979).

, 1st

The current

Sess. , General Explanation

Pub. L. No. 96-167, $ 9(d), 93 Stat. 1275, 1278 (1979); Pub. L. No. 96-541,
Stat. 3204 (1980); Pub. L. No. 97-248, $ 269(c), 96 Stat. 325, 552-53 (1982).
Pub. L. No. 97-248,

270(a), 96 Stat. 325, 553 (1982).

taxes.

and Medicare

)

1, 94

32
The employer bore the burden of proving that the
employee had paid income and Social Security and Medicare taxes on the wages in order to

Penalties and interest could also be assessed.
abate any liability.

for failure to withhold income,
Social Security or Medicare taxes on payments made to an individual whom it misclassified as
an independent contractor to 1.5 percent of the wages paid to the individual plus 20 percent of
the employee portion of Social Security and Medicare taxes on those wages. ~ Section 3509
has no effect on an employer's own liability for Federal unemployment insurance taxes or the
employer portion of Social Security and Medicare taxes; it also does not apply in cases of
intentional disregard of the withholding requirements.
As a quid pro quo for limiting the
employer's liability for failure to withhold employee taxes, section 3509 prohibits the employer
Section 3509 generally

limits an employer's

liability

from reducing

employee,

employee.

III.

and

by recovering any tax determined under the section from the
the employer no credit for any income taxes ultimately paid the

its liability
gives

SECTION 1706

Section 530 affects different taxpayers differently, depending on whether they satisfy the
conditions for relief contained therein. In particular, some taxpayers that have consistently
misclassified their employees as independent contractors are entitled to relief under section 530,
while other taxpayers in the same industry (that, for example, have sometimes taken more

In many cases, the misclassified employee had paid SECA taxes on the wages.
employer could not require the employee to provide evidence of this payment, however.

The

~ If the

employer did not comply with the information reporting requirements associated
with the treatment of an individual as an independent contractor, these percentages are doubled
to 3.0 and 40 percent, respectively.

" If

an employer's liability is determined under section 3509, the employee is liable for the
entire amount of unwithheld Social Security and Medicare taxes, unreduced by any amount paid
by the employer. Rev. Rul. 86-111, 1986-2 C.B. 176.

Code $ 3509(d)(1). In some instances, an employer would be better off under the old
rules, e. g. , if it can establish that its workers have paid their income taxes in full despite its
Section 3509 is a mandatory
failure to withhold, and therefore have its liability abated.
provision, however.

33
conservative

on classification

positions

consistency requirements

issues)

are not, because

they

cannot

satisfy

the

of the section.

In the mid-1980s, some employers in the technical services industry complained that this
difference in treatment under section 530 created an unfair advantage for certain of their
competitors. According to the staff of the Joint Committee on Taxation,

Congress was informed that many employers in the technical services industry
that did not qualify for relief under section 530 nonetheless had claimed that their
workers were independent contractors, despite the fact that such workers would

be classified as employees under the common-law test. It is further contended
that some of these employers were relying on erroneous interpretations of section
530, while others simply perceived that the IRS would not aggressively enforce
employment tax issues.

The dispute was primarily between two groups of taxpayers, both of which were engaged in the
business of arranging for the provision of services by technical services personnel to other
One group (sometimes called "technical service firms") generally treated the
companies.
service-providers as their employees, and they argued that the other group (sometImes called
"brokerage firms" or "job-shops") achieved unfair cost savings by treating the service-providers

as independent

contractors.

As explained

in Chapter

2, however,

misclassification

contractor does not necessarily result in any cost savings unless the
of income or similar compliance problems
is accompanied by underreporting

employee as an independent

misclassification

contractors, or unless the client is able to pay the independent contractor less
than the sum of the cash compensation and fringe benefits it would have paid to an employee.

by the independent

As a result of these complaints,

Congress in TRA 1986 excluded taxpayers that broker

of engineers, designers, drafters, computer programmers, systems analysts and
"other similarly skilled workers engaged in a similar line of work" from the safe harbor

the services

" Staff of the Joint Committee
of the

Tax Reform Acr

of 1986,

on Taxation, 100th Cong. , 1st Sess. , General Explanarion
1344 (Comm. Print 1987).

The first group is represented in part by two trade associations, ADAPSO and the
National Technical Services Association (NTSA). The second group is represented in part by
the National Association of Computer Consultant Businesses (NACCB).

34
provided

by section 530, effective for payments

made after December

31, 1986.~ Section
(1) technical services

1706 applies exclusively to multi-party situations, i. e. , Sose involving
workers, (2) a company that uses the workers, and (3) a firm that supplies the workers. The
effect of section 1706 is to deny relief solely to the firm that supplies the workers. Section 1706
did not affect the application of section 3509 to such firms.
Congress

may have believed

of section 530 relief to

that the denial

this group

taxpayers would cause most or all technical services workers to be reclassified as employees.

Section 1706 does not, however, actually require that the individuals listed in the provision be
treated as employees:
it merely requires them to be classified as employees or independent
contractors for employment tax purposes under the usual common law tests, and permits the IRS

to issue guidance with respect to such classification.

Since the enactment of section 1706, the IRS has increased its enforcement activity in the
It has also
employment tax area across the board, including the technical services industry.
issued guidance on the proper classification of technical services workers as employees or
independent contractors.

Pub.

L. No. 99-514,

1706, 100 Stat. 2095, 2781 (1986).

See H. R. Conf. Rep. No. 841, 99th Cong. , 2d Sess. II-834 (1986); 132 Cong. Rec.
S8088-89 (June 20, 1986) (floor Statement by Sen. Moynihan introducing predecessor to section

1706).

" Notice 87-19, 1987-1 C.B. 455. As described

57, however, there was some
initial confusion over this point after the enactment of section 1706.

" Rev. Rul. 87-41, 1987-1 C.B. 296.

in footnote

PART THREE
DISCUS SION OF ISSUES

4: GENERAL POLICY ISSUES

OVERVIEW

Differences in treatment between employees and independent contractors under Federal
and State tax and other laws were described in Chapter 2. This chapter addresses the policy
issues underlying these differences in treatment. This report proceeds from the assumption that
the government's basic role is to maintain the efficiency of labor markets by not interfering in

of firm/worker arrangements unless specific policy goals require
intervention. The source of this diversity and its importance to the efficient functioning of labor
markets is discussed in Section II of this chapter. Neutrality in the tax treatment of employees
and independent contractors, addressed in Section III, in most circumstances is necessary to
maintain the efficiency of labor markets and is required to insure tax equity between the two
These tax policy issues are illustrated using the examples presented in
groups of workers.
Chapter 2. An additional goal of tax policy, addressed in Section IV, is to minimize tax
the

natural

diversity

compliance costs for firms, workers, and tax administration agencies while maximizing taxpayer
compliance. Finally, the non-tax policies of the Federal and State governments affecting labor
markets are described in Section

II.

EFFICIENCY OF LABOR MARKETS

labor markets have a diversity of arrangements between workers and
firms. The diversity arises naturally from differences in workers' skills and preferences and
differences in firms' organizations and production processes. Workers search out firms that
Well-functioning

offer arrangements

that best match the worker's skills and preferences.

Likewise, firms search

best match the firms' needs.

Searching by workers
and firms is accomplished through labor markets, which may be informal or well organized.
However organized, the more efficiently labor markets work-that is, the more closely workers'
the greater will be workers' real income and
skills and preferences are matched to firms' needs —
out workers whose skills and preferences

firms' productivity.

Arrangements

Between Workers and Firms

W rk rs' kills and Preferences. The significant differences in the level and range of
workers' skills are important determinants of the occupations and industries that workers enter,
as well as the particular firms for which they choose to work. There are also significant
differences

in preferences

across workers.

For example,
37

some workers

prefer

a stable

38
with a firm, with a low risk

of being

laid off, while other workers prefer greater
variety in their work or greater autonomy over their work, than could normally be provided by
a single employer. Other things being the same, workers with the first set of preferences are

relationship

firms. Workers with the
second set of preferences, in contrast, are more likely to work as independent contractors for
a number of firms (service-recipients), perhaps working for none of the firms for any extended
It is important to
period of time, and perhaps working for more than one simultaneously.
more likely to enter long-term employer/employee

arrangements

with

recognize that these differences in arrangements between workers and firms would arise in a
well-functioning labor market even in the absence of any government policies that affect the

The different arrangements
workers and firms.
labor market.

Workers'

preferences

vary in many

exist because they are to the mutual benefit of

other respects.

Workers

may differ in their

of work.

For example, some workers may want to alternate
between long periods of intense work effort and leisure rather than working conventional 40-

preferences

about the timing

hour weeks.

Workers may also have different preferences over the form of compensation they receive.
Workers may prefer cash compensation because they place a low value on the fringe benefits
supplied by the employer, or because employers provide more of the fringe benefits than
workers prefer. For example, some workers may consider themselves unlikely to need medical
care, so place little value on employer-paid health insurance. Other workers may already have
health insurance coverage through a spouse's employer and as an employee be unable to decline

the coverage and receive the employer's
may also value pensions

quite differently.

savings in the form

of cash compensation.

Workers

A worker who knows she will change employers

before eligibility for pension benefits becomes vested would place no value on the employer's
Each of these preferences increases the likelihood that a worker would
pension contributions.
prefer to be an independent contractor. ~
Finally, workers may differ in their aversion to possible health and safety risks associated
with certain jobs. Since the insurability of such risks are quite different for employees and
independent contractors, workers who are risk-averse are more likely to be employees.

Note that cafeteria plans blur the distinction between the benefit flexibility of employees
and independent contractors.

39
'

irm

about the characteristics

d Pr

ani

u tion

Just as individuals

of firms, firms have preferences about

have preferences

of workers.

the characteristics

These preferences are determined by a firm's organization and production processes and
therefore vary widely across firms. A firm's preference for workers determines the mix of
worker skills and preferences best suited to the firm.
Firms may differ in the amount of firm-specific knowledge they require of their workers.
Firms that require relatively little firm-specific knowledge may be less willing to make long-term
employment commitments to their workers than firms that require relatively high levels. Firms
may also have different costs of providing fringe benefits to their employees; larger firms
generally can provide benefits at lower costs.
Firms
for their product may also differ among firms.
experiencing greater variability may be less willing to make long-term employment commitments
to their workers, or at least to some of their workers, than firms with relatively more stable
Firms may differ in the production processes they use to produce similar
product demand.
goods, leading to differences in the most suitable skill levels of their workers. Differences in
the way that firms organize themselves also can result in differences in the firms' abilities to
in the demand

Variability

determine

the tasks for which they are paid.

whether their workers actually accomplish

Firms

costs may hire those workers they believe will require less monitoring
or workers who are more willing to be monitored.

with higher monitoring

and supervision,

m nts

tween W rk r

Firm .

The differences

in workers'

skills and

processes will lead to a diversity of
arrangements between workers and firms. These differences in workers and firms are found in
so that a simple characterization of the diversity in firm/worker
numerous combinations,
and in firms'

preferences

organization

is not possible.

arrangements

firms that demand a high degree

Generally,

require workers to have a high level
long-term

and production

employer/employee

of control over their production process or

of firm-specific knowledge are more likely to enter into

arrangements

with workers.

Such arrangements

are also more

likely for firms that have a sufficient scale to provide fringe benefits to workers at a lower cost
The workers who enter such
similar benefits directly.
than the worker faces purchasing

Conversely,

are likely to be more risk-averse, or to have higher preferences for fringe benefits.
firms that can provide fringe benefits only at high costs or that have high costs of

monitoring

and

arrangements

supervising

with

workers.

independent

contractor

Firms are also more likely to enter independent

contractor

workers

are

likely

to prefer

40
where they have a high degree of variability over time in their
need for workers with specific skills. The workers who enter such arrangements generally
in circumstances

arrangements

prefer more variety

and autonomy,

greater flexibility

in scheduling

work, and more cash

than they would receive as employees.

compensation

Although firms generally enter into arrangements

with workers directly, third parties may

be involved in certain circumstances. For example, short-term arrangements for experienced
or higher-skilled workers are often a small segment of these labor markets, so the cost to firms
and workers of locating each other and making matches may be quite high. Third parties such
as temporary worker organizations and brokers reduce such costs by gathering the necessary
information and making it available to firms and workers.

Government

Policy

The diversity of arrangements between workers and firms reflects the outcome of well
functioning labor markets. This report proceeds from the assumption that a fundamental goal
of government policy should be to maintain the efficiency of labor markets, which generally
requires noninterference with diversity. Government intervention in labor markets is warranted
only in those relatively narrow and well-defined

instances in which imperfections

in the markets

or in which overriding social goals can be achieved, cost effectively,
such intervention.
Section V of this chapter briefly discusses such government

result in inefficiencies
through

intervention

IH.

NEUTRALITY IN TAX TREATIHFAT

Maintaining

Labor Market Efficiency

Tax treatment that is neutral between employee and independent contractor status is
necessary to maintain labor market efficiency. Tax treatment that is not neutral creates artificial
incentives for workers to be classified as employees rather than independent contractors, or vice
versa.
Although particular firms and workers may gain by responding to such artificial
incentives, the economy as a whole does not; aggregate labor market efficiency is reduced, as
are aggregate worker real income and firm production.
Determining

the efficiency effects

workers is difficult because the underlying

is unknown,

of section 1706 on the market for technical services
efficiency of the market to which section 1706 applies

and because that market had already been affected by prior legislation

by the time

41
section 1706 was enacted.

" Thus,

the previous efficiency

of the market could not be

taken for

granted.
Determining

the efficiency effect

section 1706 is limited to situations

of section 1706 is also complicated

separate category of workers for employment

legislation,

the limitation

a third-party

involving

tax purposes;

could cause a non-neutrality

by the fact that
The limitation creates a

broker.
depending

on the effect

of prior

in the market.

1706 may also have indirectly affected worker classification.
Publicity
section 1706 made workers and firms aware of the common law tests and the

Section
surrounding

correct interpretation

of section 530. Workers

and firms that had incorrectly

section 530 required certain workers to be classified as independent

believed

that

contractors learned that it

At the same time, by removing the relief in section 530 from employer penalties for
misclassifying technical services workers as independent contractors, section 1706 increased the

did not.

risk to some employers

of misclassification.

It is reasonably certain that section 1706 reduced efficiency in some cases and increased
it in others. There is not enough information, however, to reach any conclusions about the
overall effect of section 1706 on labor market efficiency.
The TAMRA conferees requested an evaluation of the extent to which Section 1706 has
had a chilling effect on the ability of technical services personnel to get work. Assuming that,
prior to the enactment of section 1706, the compensation level of technical services workers did
not depend

on their worker classification

(although

the compensation

mix may have varied),

section 1706 should not have affected the total demand for technical services workers. As long
as the total compensation of independent contractors and employees is the same (although

forms), there is no reason to expect the total demand
services workers to decline.

perhaps

paid in different

for technical

section 1706 probably did not reduce the overall demand for technical services
workers, it may have resulted in some workers being unable to find work with their accustomed
form of compensation and working conditions. Removing the safe harbor provision of section
Although

The prior legislation includes income and employment tax and labor law, section 530
restrictions on issuing guidance about classification under employment laws, and section 3509
Each of these pieces of legislation may have
reductions in employer costs for misclassification.
reduced or increased the underlying market efficiency.

530 for technical services workers focused employers' attention on the need to classify workers
correctly. Some independent contractors may have been able to continue their current work only
as employees. If the classification change required the workers to accept a package of fringe
benefits in lieu of some amount of cash compensation, the value to them of their entire
compensation package may have changed. They would have been better off to the extent that
they considered the fringe benefit package and its accompanying tax-preferred benefits more
than the loss in cash income.

valuable

For example, workers who would previously

have

to be classified as employees, but were not because of resistance from servicerecipients, would be better off. Conversely, workers who did not find the substituted fringe
benefit package more valuable may have found the value of their income reduced. Similarly,
workers who would not have preferred to be classified as employees include those with
considerable trade or business expenses, whose opportunity to deduct these expenses would have
become constrained, and those who tended to understate receipts or overstate deductions. In
addition, workers whose classification was questionable and who were used to working through
brokers may have found that work as independent contractors could no longer be secured
through a broker; these workers may have been able to continue work as independent contractors
by contacting service-recipients directly.

preferred

Tax Equity

Equitable tax treatment

requires that taxpayers in equivalent

situations,

with the same

incomes, be taxed equally. Thus, providing equivalent tax treatment to employees and independent contractors is required to insure tax equity between the two groups of workers.
The
examples presented in Chapter 2 can be used to illustrate potential inequities in the tax treatment

of employees

and independent

1706 does not systematically

contractors.

As the discussion in Chapter 2 concluded, section

favor either status.

T ical Mix f Frin e Benefi . Example 1, which is summarized in Table
2-2 in Chapter 2, shows the situation of an employee who receives total compensation of $1,000,
The worker does not have any
consisting of wages and a typical mix of fringe benefits.
Worker with

expenses, such as union dues, home office expenses, or travel
expenses. The independent contractor receives the entire $1,000 in cash, out of which Federal
and State income taxes and the Social Security and Medicare taxes for self-employed workers

potentially deductible work-related

" See Section III.C of
examples.

Chapter 2 for a description

of the approach taken

in developing

these

43
are paid, health insurance is purchased,
plan are made.

and contributions

of Table 2-2,

As shown in the bottom portion

to a tax-favored

the money income

"Keogh" retirement

of the self-employed

worker, after paying taxes and purchasing medical and retirement benefits, is $22 or about five
percent ($22/$475) lower than that of the employee. The $22 is the net of $34 of additional
taxes less $12 saved by not purchasing unemployment insurance and workers' compensation.
Thus, the self-employed worker' has $22 less money income despite not having the protection

of either unemployment

insurance or workers' compensation.

As explained in Chapter 2, taxes

worker because that part of cash income which would have
fringe benefits is subject to Social Security and Medicare taxes and

are higher for the self-employed
purchased

employer-paid

some is also subject to income taxes. Thus, in Example 1, the differential treatment of certain
fringe benefits for tax purposes, especially for Social Security and Medicare taxes, causes an
inequitable

of taxes

distribution
ll

between employees and independent

lgd

and where income is reported on tax returns differ for employees

contractors.
d

and independent

py
contractors,

(see Chapter 2 and Appendix A). Thus,
independent contractors may have greater opportunity than employees to be less than fully
compliant with tax laws. If the situation in Example 1 is maintained, except that the independent
contractor understates net income from self-employment by five percent, the after-tax money
with stricter rules generally

income

2-3). If the

contractor

the independent

to employees

underreporting

be equal. That situation is
of net income were to exceed five

have a higher

after-tax

contractor and the employee

the independent

in Example 2 (Table

illustrated

percent,

applying

would

money

income than the

employee.

W~kE

«d

klyl

ldp

are not taxed equally.
Example 3 (Table 2-4) illustrates the same situation as Example 1, except that the worker has
This level of worker
work-related expenses equal to ten percent of gross compensation.
expenses is just sufficient to make the money income net of taxes and worker expenses of the

for employees,

workers

who have such expenses

contractors

than

independent

contractor equal to that of the employee. At higher levels of worker expenses, the
contractor would have a higher after-tax income.

independent

" Note, however

that because the independent contractor's Social Security taxes are being
paid on a higher level of income, his or her future Social Security benefits might also be slIghtli

higher.

V lun

Ben fi

In Example 4 (Table 2-5), the employer provides only
those fringe benefits mandated by Federal or State law:
Social Security and Medicare;
unemployment insurance, and workers' compensation.
Otherwise, the facts are the same as in

Frin

In Example 1, the net after-tax income of the independent contractor was $22, or
about five percent, lower than that of the employee. In Example 4, with no voluntary fringe
benefits, the results are reversed; the independent contractor's money income is $8, or 1 percent,

Example

of the employee. The

contractor's greater after-tax income
is due to the cost of the employee's coverage under unemployment insurance and workers'
compensation and the income tax treatment of the employer's payments for that coverage.

greater than the income

independent

does not arise directly from the difference in income stemming from the cost of
unemployment insurance and workers' compensation. Although the independent contractor has
a higher after-tax income because she does not make payments for such coverage, the

Inequity

contractor also is not eligible for the benefits from these programs. The inequity
is due to the exclusion from the employee's taxable income of the employer payments for
unemployment insurance and workers' compensation.

independent

The examples indicate that the difference in after-tax income between
employees and independent contractors would typically be quite small, if firms classify workers
correctly. The differences may be significant, however, for certain sets of worker preferences.
Thus, a worker who has substantial business expenses and no desire for employee benefits may
have much higher after-tax income as an independent contractor. Conversely, a worker who has
few business expenses and a strong desire for all the employee benefits that a firm offers may
have much higher after-tax income as an employee.
$ummary.

While it is possible for one set of tax differentials

to offset another exactly, as Examples
2 and 3 illustrate, such exact offsets are unlikely in practice. The typical situation is for the
combined effects of the various differentials in tax treatment not to leave employees and
independent contractors treated exactly equally, and, therefore, to create inequities.
Even in cases where differences in the after-tax income of the worker are small, the
consequences of a retroactive IRS determination of misclassification may be significant for the
firm. Because the firm did not provide employee benefits to the independent contractor, the cash

to the independent contractor generally had equalled the sum of the wage payment
which would have been received by an employee and the amount the employer would have spent
for employee benefits. With reclassification, the entire amount of cash compensation paid to the
independent contractor is deemed to have been wages that the firm would have paid to the
worker as an employee, and the employer's liability for Social Security and Medicare taxes and
compensation

for the withholding
employee

of income taxes is larger

and divided

the worker's

than

compensation

if the firm

had treated

the worker as an

into taxable wages and non-taxable

fringe

benefits.
workers as employees nominally shifts much of the tax compliance burden
to employers and permits tax collection through withholding, which is extremely efficient.
Similarly, employers incur the direct compliance costs of supplying legally-required as well as
Classifying

voluntary,

compliance

but somewhat
burdens

regulated,

fringe benefits.

are shifted to employees

However,
reduced

through

the extent

levels

to which

of compensation

such

is not

known.

IV.

ADMINISTRATIVE COSTS

compliance with tax laws is necessary, the administrative costs of compliance
divert resources from other uses. A goal of tax policy is, therefore, to minimize tax compliance
costs while achieving the desired level of efficiency and equity in the tax system. While the
principles are clear, implementing them can be difficult. The inherent tradeoffs between low
Although

costs, efficiency, and equity help explain
treatment of employees and independent contractors.

compliance

For example, the Federal Social Security

some of the differentials

in the tax

and Medicare system generally taxes employees

on their stated salaries; it does not permit adjustments

for various work-related

expenses which

of this simplification, the income to which the Social Security
Medicare taxes are applied in the case of employees may be mismeasured:
that is, it may

employees may incur. As a result
and

differ from their economic incomes.

The mismeasurement

may

be significant

in a small

percentage of cases, and both the tax liability and the effective tax rate may be higher than if
employees were taxed, as independent contractors are, on their net income from employment.

of employees are greatly reduced as a result of
but at the cost of a certain degree of equity.

In this situation,

simplification,

the compliance

burdens

the

However, the benefits of excluding employer-paid fringe benefits from Social Security
and Medicare income bases for employees but not completely for independent contractors may
reduce or even outweigh the extra tax burden on employees from the failure to exclude
employees' work-related expenses from the employee's Social Security, Medicare, and income
tax bases. Moreover, workers' eventual disability or retirement benefits may be increased as
the result of the differential in Social Security tax treatment, thus partially offsetting any
potential equity loss.

46
Similarly, for income tax purposes, an employee cannot deduct any employment-related
expenses unless she itemizes deductions on her income tax return and unless these expenses
exceed two percent of income from all sources. Moreover, there are classes of expenses for

is further limited or effectively prohibited.
In contrast, an independent
contractor has much greater freedom to take such deductions for income (and Social Security
and Medicare) tax purposes.
There are, however, compliance costs to the independent

which a deduction

The costs include the burden of maintaining complete
sets of records which might not otherwise have to be maintained, the burdens and expense of
filing more complicated tax returns, and the costs of being excluded from using the highly
efficient payment system provided by the withholding of taxes by, and payment through, an
employer. In addition, the costs to the government of assuring compliance with tax laws through
examination of a sample of workers' tax returns and matching information from various

contractor associated with this freedom.

information documents against the information reported on workers' tax returns is usually higher

for self-employed

taxpayers.

NON- TAX POLICIES

Federal and State governments

of non-tax policy objectives which affect
increase the efficiency of labor markets by reducing or
have a number

Some of these may
removing imperfections, and others may achieve various politically-determined
goals. While
these policies may have important effects on workers' choices of arrangements with firms,
because this report focuses on specific tax policies, these non-tax policies are merely listed here.
The policies are: retirement security; access to health care; protection of workers (occupational

labor markets.

health and safety); unemployment
and nondiscrimination

Much

security; employment

in employment

of the legislation

practices.

implementing

standards

(minimum

wage and hours);

non-tax policies applies only to employees,

not to

The definition of an employee may
vary under different legislation, however, so that, for example, a limited number of workers
might be deemed independent contractors for tax purposes, while being deemed employees under
wage and hours legislation. Such differences may be warranted by the differences in policies
of the various legislation, but they do impose additional compliance costs on both firms and

independent

contractors or other self-employed

workers.

workers. Much of the additional cost stems from the confusion caused by seemingly inconsistent
treatment, as Examples 2 and 3 illustrate.

" Legislation

implementing

these policies is summarized

in Chapter 2 and Appendix

CHAFI'ER 5: TAX COMPLIANCE ISSUES

OVERVIEW

The TAMPA conferees questioned whether there were abuses in the reporting of income
by independent contractors (as compared to employees) that justified the adoption of section
1706. This question has been evaluated in terms of whether there was a significant revenue loss
attributable

to noncompliance

that section 1706 could have been expected to reduce.

Whether

(1) the extent of the misclassification of technical services workers
covered by section 1706 and (2) the noncompliance rate of such misclassified employees relative
to the rate that would be expected if they were properly classified. This chapter provides data
this is true depends in part on

relevant to these questions.

II.

RATE OF MISCLASSIFICATION

of employees as independent contractors is
Recent studies of this problem include the IRS' Strategic Initiative on Withholdsignificant.
ing Noncompliance (SVC-1).
IRS studies suggest that misclassification

The revenue effect also depends on the existence of other differences in the level of tax
paid by employees and independent contractors, e. g. , the proportionately larger tax expenditures
associated with employee fringe benefits. These differences are discussed in Chapter 2 and
Appendix A to this report. They are not taken into account here, however, because their use
is not considered abusive within the meaning of the TAMRA conferees.

" At the initial

stage of this study, it was determined that existing IRS data would be used
in addressing these questions, and that no new surveys would be undertaken to measure the
compliance of technical services workers or the population of those who had been affected by
section 1706.

" See also GAO,

Returns Can Be Used to Identify Employers Who Misclassify
Workers Appendix Il, GGD-89-107 (1989). In that study, individuals receiving more than
$10,000 in income reportable on Form 1099 from one payor were identified. A random sample
of 408 of the payors was interviewed. The interviews indicated that 157 (138-176 at a 95
percent confidence level), or 38 percent, misclassified at least some of their employees as
independent

Information

contractors.

48
The employer portion of SVC-1 examined employment tax and withholding compliance
for tax year 1984 for a sample of 3,331 employers.
It includes an estimate of the percentage
of employers that misclassified at least some of their employees as independent contractors.

Some of the results for different sectors are shown in Table
were considered

employees

common

misclassified

law tests (regardless

of whether

5-1. For

purposes

they were determined

to be employees under the
section 530 applied), but had been treated as
Employers were considered to have misclassified

contractors by their employers.
employees if they misclassified one or more of their employees, regardless
they misclassified.

independent

of the table,

of the total

number

Table 5-1 does not provide definitive proof that misclassification is a bigger problem
among employers subject to section 1706 than among other employers. The table indicates that
misclassification rates among employers in the service sector were not much higher than among
employers in other sectors in the sample population. 4' It is difficult to estimate the percentage

of misclassified employees in each sector reliably because the SVC-1 survey was designed to
determine the frequency of employers that misclassify, rather than the frequency of misclassified
employees. It appears, however, that the percentage of service sector employees who were
misclassified

sectors in the sample population, suggesting that
employers in the service sector that had misclassified employees tended to misclassify a larger

" The

was higher

than

in other

were selected at random from employers with previous employment tax
records (Form 940 or 941E) listed on the business master file (BMF) for 1984. Form 941 is
the Employer's Quarterly Federal Tax Return. State and local governments and other employers
that generally only withhold income taxes and do not pay FICA or FUTA taxes instead file
Form 941E, Quarterly Return of Withheld Federal Income Tax. Thus, the employer sample
does not include organizations with no employees or those that were legally required to file a
Form 941 or 941E for 1984, but had no previous records on the BMF.
employers

The employer portion of SVC-1 also measured compliance with reporting requirements
with respect to employment tax returns and W-4 submittals, and compliance of U. S. citizens
claiming exemption from withholding on foreign-source income.

" Misclassification

rates were not separately calculated for the section 1706 group because,
the SVC-1 sample contained very few workers in technical fields (only about 0.4 percent), and
because the SVC-1 survey did not gather sufficient data to identify employers in these fields that
were actually subject to section 1706.

Table 5-1

Percentage of Employers with Some Misclassified Employees, by Industry

Number of Employers
in Sam le

Industrn

Number of Employers,
Weighted to Represent
Total P ulation

Number of Employers
with Misdassified
Employees, Weighted
to Represent Total
Po ulation

Percentage of
Employers in Total
Population with
Misclassified

16.7%

16, 819

6,080
3, 324

276

7, 624

1,228

16. 1%

Agriculture

286

36, 435

Mining, Oil, Gas

260

Mining, Other

19.8%

Construction,

Heavy

288

13,247

1,571

Construction,

Other

205

249, 409

50, 446

Manufacturing

261

235, 593

37, 154

Transport,

Air

272

2, 662

529

Transport,

Other and Public Utilities

79,995

8, 700

11.9%
20. 2%
15.8%
19.9%
10.9%

Whttlesale

and Retail Trade

781, 123

74, 855

9.6%

241, 665

46, 629

19.3%

121

Finance, Insurance and Real Estate

Sefvlces

124

848, 514

130,828

15.4%

Government

282

68, 521

6, 595

9.6%

437

2, 569, 958

324, 550

12.6%

3, 331

5, 151,525

692, 489

13.4%

Stat Elsewhere

Classified

TOTAL
parlntent

Stturee

«reaaury

Strategic Initiative on V'tthholtting

Noncompliance

(SVC-l) Employer Survey.

50
This may reflect the fact that the service sector contains a
of their employees.
number of smaller employers, and studies suggest that smaller employers
disproportionate
misclassify a larger percentage of their employees.
gt may also reflect somewhat greater
difficulty in applying the common law tests of employee status in the service sector. )

percentage

For several reasons, no strong conclusions can be drawn from the SVC-1 data regarding
current misclassification patterns among employers subject to section 1706. First, there have
been significant changes in the tax laws and IRS enforcement activity since 1984, which may
have affected employers' abilities and incentives to misclassify workers. 4' Second, the SVC-1
survey covered a relatively small sample of employers and has a relatively high sampling error
for small populations.
service-recipients

Third, the population from which the sample was drawn included mainly
that reported having at least some employees, and did not include service-

recipients that treated all

of their workers as

independent

contractors.

Finally, misclassification rates for employers subject to section 1706 could not be
The service sector misclassification rate may be
specifically determined from the data.
indicative of the rate for employers subject to section 1706, since service brokers would tend

to be classified in the service sector. The service-recipients
including manufacturing

may be in any industry,

however,

There may be reason to believe that, regardless of the
the relatively independent nature of the work done by

or government.

sector to which they are allocated,
employees covered by section 1706, and the frequently temporary nature of the employment
relationship, may create a misleading appearance of independent contractor status under the
common law tests. -In addition,

the particular

greater ease with which independent

importance

of computers

in this area, and the

contractors can deduct their legitimate

computer-related

expenses, may create an incentive to misclassify such employees as independent

III.

contractors.

RATE OF NONCOMPLIANCE
Misclassification

can cause compliance

greater tendency to underpay

problems

misclassified

their taxes, whether due to underreporting

employees

have a

of income, overstate-

Service firms in the SVC-1 sample accounted for about 19 percent of reclassified workers
but only ten percent of W-2 forms. In contrast, the percentage of employers in the service
sector that had at least one misclassified employee was only slightly higher than for all
employers in the survey (Table 5-1).

" See

generalEy Appendix

51
ment

of deductions,

consistently

nonpayment

of reported liabilities, or other factors. In fact, IRS

find lower compliance

rates for non-wage

income. ~

compensation

studies

income than for wage

Recent studies include the 1985 Tax Compliance Measurement Program (TCMP)
and the employee portion of the 1984 SVC-1 survey. The 1985 TCMP is more comprehensive,
but is less useful for the specific purposes of this report than the 1984 SVC-1 survey because
the former covers all workers rather than just misclassified

employees-the

only group actually

affected by section 1706.

1985 TCMP

The 1985 TCMP measured

wages, Schedule C gross profit, and other categories

income and deduction reported by a randomly-selected sample of 50, 000 individual taxpayers,
compared them to the correct amounts (determined after an examinations of the taxpayers'
returns), and expressed the ratios as voluntary

reporting

percentages

(VRP).

" Data

from the

of taxpayers from which
Table 5-2. For purposes of this table, the

survey were then used to estimate the values for the entire population

the sample was selected.

The results are shown in

sample data have been divided between employees and independent

technical services workers and other

workers. "

contractors,

~ and

between

In addition to the IRS and GAO studies cited above, these include IRS studies of (1) 1975
and 1976 information returns (covering filers receiving commissions or fees); (2) 1979 Forms
1099-NEC (covering filers receiving nonemployee compensation); and (3) 1977 delinquent
Forms 1099-MISC (follow-up study covering U. S. residents required to file Form 1040).

" See

generally Fratanduono & Bucci, Trends in the Voluntary Compliance of Taxpayers
Rko File Individual Income Tax Returns, in Department of the Treasury, Internal Revenue
Service, 1989 Update, Trend Analyses and Related Statistics, Document 6011 (1989).

For this purpose, employees are defined as individuals with over $10,000 in wage income
and more wages than Schedule C income, while independent contractors are
defined as those with over $10,000 in Schedule C income (as examined), more Schedule C
Using this definition,
income than wage income, and less than $5, 000 in wage payments.
three percent of the taxpayers in the entire weighted TCMP sample were
approximately
independent contractors, 55 percent were employees, and 41 percent did not fall into either
For technical services workers, two percent of the sample were independent
category.
contractors, 92 percent were employees, and six percent did not fall into either category.

(as examined),

See Appendix C for a definition of technical services worker used for this purpose.

Table 5-2
Reporting of Income and Expenses by Employees and Independent

Other Workers

Technical Services Workers

Examined
~billions

Reported
~billions

Voluntary
Reporting
Percentagf;

Contractors

Examined

Reported
~billions

~billions

Voluntary
Reporting
I'ercentagf;

Employees
Wages, Salaries and Tips
Schedule C Gross Receipts
Schedule C Gross Profit
Schedule C Total Deductions
Schedule C Net Profit
Adjusted Gross Income

Total Taxable Income

171.1
3.0
2.2
1.9
0.4
170.9
178.6

171.1

3. 1
2.4
1.6
0.9
173.0
180.4

100.0%
95.2%
94.3%
117.3%
50.6%
98.8%
99.0%
Independent

Wages, Salaries and Tips
Schedule C Gross Receipts

1. 1
4.4

Schedule C Gross Profit

3.8
2.0
2. 1
3. 1
3.4

Schedule C Total Deductions
Schedule C Net Profit
Adjusted Gross Income

Total Taxable Income
partment o

reasury

Source: Taxpayer Compliance Measurement

Program (TCMP) for Tax Year 1985.

1.1
4.5
4.0
1.8
2.5
3.7
4.0

100.4%
97.0%
95.9%
113.4%
83.4%
83.9%
85. 1%

1521.9
37.9
23.9
22. 1

1534. 1
39.2
25.4
18.9

3.0

7.8
1,592.0
1,660.0

1,566.9
1,638.4

99.2%
96.5%
94. 1%
116.9%
38.7%
98.4%
98.7%

Contractors

17.2
190.2
113.4
72. 1
47.3
74.0
79. 1

16.9
202. 0
124.9
65.5
65.6

95.0
100.2

101.0%
94.2%
90.8%
110.0%
72. 1%
77.3%
79.0%

53
Table 5-2 shows that the VRPs for the Schedule C income (and total taxable income) of
the independent
contractors included in the 1985 TCMP were generally worse than the
comparable VRPs for the wages (and total taxable income) of employees, but that both measures
were generally better for technical services workers than for other workers. It also shows that
underreporting of income was not the only reason for the independent contractors' low VRPs:
in particular,

the low VRPs for their net Schedule C income also resulted from the overstatement

of Schedule C gross
profit), and the overstatement of other Schedule C deductions (resulting in underreporting of
Schedule C net profit). The overstatement of Schedule C deductions contributes about two-thirds
of the total understatement of net profit shown for technical services independent contractors.
Some of the reported overstatement of deductions may have been attributable to inadequate
of

the cost

of goods sold

and/or

operations

(resulting

in underreporting

record-keeping.

contractors, the actual reporting of Schedule C income may have been
Table 5-2 shows that wages and salaries tend to be slightly
slightly better than indicated.
overreported by independent contractors, whereas Schedule C gross receipts tend to be slightly
Some of the wage and salary overreporting may be due to Schedule C income
underreported.

For independent

as wage or salary income, however, which may lead to failure to
collect any Social security or Medicare tax on that income. Thus, actual Schedule C VRPs may
be somewhat higher than shown on Table 5-2. Also, it may be particularly hard for IRS
being reported

incorrectly

examiners to detect wage and salary underreporting when the underreporting is due to collusion
between employers and employees. Thus, actual wage and salary VRPs may not be as high as
reported as shown on Table 5-2.

General conclusions drawn from the TCMP data with respect to workers actually covered
by section 1706 are subject to several reservations. First, it was impossible to calculate separate
VRPs for such workers, so a broader group of technical services workers was used a proxy.

The compliance patterns in the two groups may have been different. Second, there have been
significant changes in the tax laws and IRS enforcement activity since 1985 that may have
their income or overstate their
incentive and ability to underreport
affected individuals'
Specifically, the tightening of the requirements for certain business deductions in
TRA 1986 may have reduced the extent to which itemized deductions and Schedule C deductions
deductions.

See Appendix C for a description of the occupations included in this group.

are overstated.
individuals

54
Third, the population

from which

the sample was drawn includes only
for whom a return was filed, and thus the data do not measure compliance in the so-

Fourth, as indicated above, it was not possible to distinguish
misclassified workers from other workers in the TCMP sample. Therefore, the data relates to
the relative compliance of independent contractors generally, rather than the narrower group of

called "underground"

economy.

employees actually affected by section 1706. Finally, the VRPs are not adjusted
to reflect TCMP audit sustension rates and, therefore, may not indicate the actual revenue

misclassified

potential from legislative or administrative

changes affecting compliance.

1984 SVC-1 Employee Survey

As explained

above, the SVC-1 survey

compliance for a sample

examined

employment

tax and withholding

of businesses for tax year 1984. The employer portion of the

survey

(by their employers) as independent contractors.
A follow-up survey of 3,260 misclassified employees was also conducted to determine their level
of individual reporting compliance. Data covering the 2, 406 employees for whom a Form 1099
had been filed were then weighted to represent values for the entire population of misclassified

identified employees who were misclassified

92.6
For other workers, the VRP was 77 percent of
percent of their misclassified compensation.
misclassified compensation. Other data from the employee portion of the SVC-1 survey suggest
employees.

Misclassified

that information

misclassified

reporting

employees. "

technical

services

workers

may also play a substantial

See, e.g. , the discussion of the two-percent

were found to have reported

role in subsequent

compliance

floor on itemized deductions and sections

280A and 280F in Appendix A.
Forms 1099 had been filed for 37 of the 43 technical services workers and 2, 369 of the
3,217 other workers in the misclassified employee sample. The sub-sample used to generate the
estimates in the table was limited to employees for whom a Form 1099 had been filed because
these are the only employees covered by section 530, and the issue for resolution is whether
section 530 protection for misclassified workers has permitted significant compliance problems
to develop.

The survey found that information returns were filed for 84 percent of misclassified
employees in the sample whose payments exceeded $600. While 77.2 percent of the
misclassified compensation for which a Form 1099 was filed was reported, only 28. 8 percent
of the misclassified compensation for which no Form 1099 was filed was reported. This
contrasts with the results of a 1977 study, in which misclassification was not an issue, which

55
The data from the employee portion of the SVC-1 generally suffer from the same
problems as the TCMP data described above. In addition, the small number of technical
services workers covered by the survey means that any differences found between them and
other workers have a high sampling error. The TCMP data also indicate that Schedule C

reporting

both income and deductions

for workers

whose primary

source of income is

Schedule C income is superior to that of workers who have only occasional Schedule C income.
This is true for both technical services workers and other workers.
There is no way to
determine from the data whether there are differences in Schedule C reporting for correctly
classified

contractors

independent

and those who are incorrectly

classified.

Furthermore,

workers covered by section 1706 may have more than one job during a year, and may be
misclassified in one job but not another. Thus, correct classification may not result in correct
reporting

of the entire Schedule C amount.

Summary

The 1985 TCMP and the 1984 SVC-1 misclassified employee survey suggest that there
is more underreporting of income by independent contractors than by employees. They do not,
however, support assertions that technical services workers are less compliant than other
workers. Taken together, the 1985 TCMP and 1984 SVC-1 data suggest that the reporting of
income by workers covered by section 1706 is at least as good as, and perhaps
superior to, reporting by other misclassified workers, but not as good as the reporting of wage
and salary income.
The 1985 TCMP also indicates that overstatement of deductions is
non-wage

responsible for much

of the

services (and independent

found that

reported.

understatement

of net profit for independent contractors

in technical

contractors in general).

83.2 percent of

the compensation

for which no Form 1099 MISC was filed was

TAX ADMINISTRATION

ISSUES

OVERVIEW

The TAMRA conferees questioned whether there were problems with the administration
of section 1706 itself, or with the common law tests that employers subject to section 1706 must
generally

use in classifying

workers as employees

or independent

contractors.

This chapter

addresses these issues and concludes that both the scope of section 1706 and the common law
tests could be further clarified.

II.

ADMINISTRATIVE PROBLEMS WITH SECTION 1706
Compared

to section 530, section 1706 raises few administrative

or interpretive

issues.

Those that have arisen concern primarily its effect (including its relationship to the common law
tests for determining employee status) and its scope (including the occupations covered under

it).
Many taxpayers

were initially confused about the effect of section 1706, believing that

covered by the provision be treated as employees. Apparently,
some service-recipients reacted by treating all their technical services workers as employees,
even though that was sometimes contrary to the results under the common law tests. This

it required that the individuals

misconception

probably

sprang from some imprecise language

provision" and an IRS publication issued soon after enactment,

in the legislative

history

of the

plus the common misconcep-

530 had previously required that these individuals be treated as independent
contractors regardless of whether there was a basis for doing so. This misconception has been
largely corrected through a combination of industry education and IRS guidance, which
tion that section

~ See footnote 31 above.
a revised Publication 15 (Circular E) which
discussed section 530 and Stated that "[i]fyou have any reason for treating a worker other than
as an employee you will not be liable for employment taxes on payments to the worker. This
relief is not available, however, for any arrangement you may have for services provided to you
"
by certain technical personnel, such as engineers, computer programmers, and systems analysts.
In Resource Technical Consulrants (U. S.A. ), Inc. v. Baker, 88-1 U. S.T.C. 9111 at 83, 033
(S.D. N. Y. 1987), the district court found that "the Circular makes no misstatements and is at
"
worst confusing.
In January,

1987, the IRS published

[

58
services workers would "be classified as independent
employees under generally applicable common law standards. "5'
that tecllnical

explained

Many taxpayers are still confused about the scope

it covers.

occupations
programmers,

The provision

mentions

systems analysts and other similarly

work. " These terms are not defined

sources. "

contractors

of section 1706, in particular about the

"engineers,

designers,

drafters,

computer

skilled workers engaged in a similar line

in the legislative history, however, and are not well defined

Nor do they correspond well to industry usage or to the occupational
categories used by the IRS for Schedule C purposes. The phrase "similarly skilled workers
engaged in a similar line of work" is particularly vague, since it is not clear how much similarity
is required.
For example, are scientists included if they are engaged in engineering-type
in other

or are they excluded because they do not have similar skills
to engineers? Are architects included because they often perform drafting, or was the term
"drafting" meant to be read more narrowly for purposes of section 1706? These problems have
made it difficult in some cases for employers to identify covered workers and for the IRS
systematically to target such workers for enforcement or even to gather sufficient data on their

activities, such as oil exploration,

levels

III.

of compliance.
ADMINISTRATIVE PROBLEMS WITH COMMON LAW TESTS OF EMPLOYEE
STATUS

As explained in Chapter 2, whether an individual is an employee for Federal tax purposes
is generally determined under the common law tests for determining whether an employment
relationship exists. As explained in Chapter 3, section 530 allows employers to rely on their
own erroneous classification under some circumstances.
Section 1706 denies this relief to
certain employers in the technical services field, and thus requires these employers to apply the
common law tests in all cases. In a sense, section 1706 restores pre-section 530 law for these

employers.

" Notice 87-19, 1987-1 C.B. 455; News Release IR-87-8

(January 21, 1987); News Release
87-68 (May 21 1987) This guidance also clarified that section 1706 applies only to brokers
or job-shops, and does not apply to service-recipients generally.

of Labor, Employment &
(4th ed. 1977 & Supp. 1986).

See, e.g. , U. S. Department
Dictionary

of Occupational

Titles

Training

Administration,

59
The common law tests, like most facts-and-circumstances
tests, lack precision and
predictability.
Since they were developed in an entirely different context from Federal tax law
(primarily the law of employer liability for employee torts), they may also produce inappropriate
results for some tax purposes. As then-Assistant Secretary (Tax Policy) John Chapoton stated
in

1982, "[i]n many cases, applying the common law test in employment

yield clear, consistent,

correct classification.

or satisfactory answers[,

] and

tax issues does not

reasonable persons may differ as to the

of the common law tests is no doubt one problem, a bigger
problem may be the large number of factors with which taxpayers and the IRS must contend,
and the consequent difficulty in determining the relative weight of any one factor. ~ Thus, an
important feature of many proposed legislative solutions has been to limit the number of factors
the subjectivity

Although

to be taken into account.

The common law tests may be particularly difficult to apply in the multi-party contract
situations, which are the only situations covered by section 1706. This is because the servicebroker and the service-recipient often share control over the service-provider's performance of

Hearings Before the Subcommittee on Oversight of the Internal Revenue Service of the
Committee on Finance, 97th Cong. , 2d Sess. (April 26, 1982). See also Hearings Before the
Subcommittee on Commerce, Consumer and Monetary Affairs of the Committee on Government
Operations, 101st Cong. , 1st Sess. (May 16, 1989) (acting Commissioner of Internal Revenue
stating that "[o]ne of the most difficult and controversial issues in the employment tax area is
the definition of 'employee' under the so-called 'common law rules'. . . . IRS' preference has
been and continues to be for a legislative solution. ").

" See, e. g.
Workers

GAO, Information

Returns Can Be Used to Idenrig Employers Rko Misclassig

3, GGD-89-107 (1989).

In an August 5, 1987 letter to Lawrence B. Gibbs, Commissioner of Internal Revenue,
Frank S. Swain, the U. S. Small Business Administration Chief Counsel for Advocacy, requested
that the IRS clarify which factors are important, and which are not important, in determining
employee status in the technical services area.

See, e. g. , the proposals

described in Hearings Before the Subcommittee on Select
Revenue Measures of the Committee on Ways and Means, 97th Cong. , 2d Sess. (June 11, 1982)
(joint Statement of John E. Chapoton, Assistant Secretary of the Treasury (Tax Policy), and
Roscoe L. Egger, Jr. , Commissioner of Internal Revenue).

as well as sharing other incidents of employment. ~ In some cases, both may
employer.
While the parties may request a
legitimately be considered the individual's
to be
letter from the IRS, this may be too difficult and time-consuming
determination
sole
Moreover, even if the service-recipient is considered the individual's
practical.

services,

employer,

the broker may have sufficient control over payments

treated as her "imputed employer" and be subject to a withholding

made to the individual

to be

Finally, even
if the broker is considered the sole employer, the client may be treated as the employer for
certain employee fringe benefit purposes under the leased employee rules.
requirement.

Problems with the common law tests have been exacerbated by the fact that labor markets
have undergone significant changes —
including the proliferation of multi-party arrangements—

since the enactment

of section 530

1978, during which period section 530 has virtually

prevented the IRS from issuing any general guidance reflecting its interpretation

of the

common

This has made it very difficult for taxpayers and IRS personnel alike to analyze
employment relationships consistently, and has greatly reduced employers' ability to predict
when the common law tests require a particular worker to be treated as an employee or
independent
contractor.
The enactment of section 1706 has permitted the IRS to issue
law tests.

guidance" in some very narrow circumstances,

only, and significant gaps therefore remain.

The situation becomes even more complicated when the individual operates through a
corporation. See Appendix A for a discussion of the relevance of incorporation in this context.

" For a third-party

broker with dozens of independent contractors at many different clients,
even if a sampling is
the number of determination letter requests (Form SS-8) to be completed —
used —
can be very large if the firm wants to cover all typical factual settings. Moreover, client
projects often last only weeks or months, making it difficult to obtain a ruling before the
independent contractor changes job settings.

~ Code

3401(d)(1) Treas. Reg. f 31.3401(d)-1(f). See Otte

v. United States,

419 U. S.

43 (1974).

" See Code f 414(n). Section 1706 does not affect

the application of section 414(n). Staff
of the Joint Committee on Taxation, 100th Cong. , 1st Sess. , General Explanation of the Tar
Reform Act of 1986, 1345 (Comm. Print 1987).

" See, e.g. , Rev. Rul. 87-41, 1987-1 C.B. 296.

PART FOUR
APPENDICES

APPENDIX A

DIFFERENCES IN TREATIW~ OF EMPLOYEES AND
INDEPENDENT CONTRACTORS-DETAILED ANALYSIS
OVERVIEW
Employees

and

face significantly

employers

different

treatment

from

independent

contractors and their clients under a wide range of laws, including Federal and State employment
tax, income tax and labor laws. Differences that significantly favor one group over the other
deliberate

may encourage

misclassification

an individual

or independent

as an employee

This appendix describes the major differences in treatment between employees and
on the one hand and independent contractors and their clients on the other, and the

contractor.
employers

It also compares the relative advantages of both types

factors used to distinguish

between them.

to determine whether current law creates unnecessary

treatment

and attempts

misclassification.

It concludes that current law does not consistently

incentives

for

favor one classification

over the other.

II.

FEDERAL TAX LAW
A.
i

Security

Taxes

Employment
1

and

Compensation

rit

Medicare

taxes

ar . Wages paid to employees are generally
under

paid to independent

the

Federal

contractors,

Insurance

by contrast,

Security and Medicare taxes under the Self-Employment

subject to Social

Contribution
is generally

Contributions

Act

(FICA).

subject to Social

Act (SECA).

Since 1990, the combined tax rates on employees and their employers on the one hand
and independent contractors and their clients on the other have been virtually identical under
Prior to 1983, the tax rates on independent contractors were
both FICA and SECA.

See Code Subtitle A, Chapter 2, and Subtitle C, Chapter 21.

The combined Social Security and Medicare tax rate for 1991 is the same (15.3 percent)
under both. Code $g 1401, 3101 and 3111. Under both, only the first $53, 400 of compensation
is subject to Social Security tax, while the first $125,000 is subject to Medicare tax. Code
$g 1402(k) and 3121(x), as added by the Omnibus Budget Reconciliation Act of 1990 (OBRA
1990), Pub. L. No. 101-508, 104 Stat. 1388 (1990); Notice, 55 Fed. Reg. 45856 (October 31,
63

lower, even though they were generally eligible for the same Social Security and
In 1982 testimony, Treasury recommended that the rate
Medicare benefits as employees.
differential be reduced to "help neutralize the decision whether to hire an independent contractor
significantly

or an employee, and relieve pressure on the question of employment status. "~ 1983 legislation
mostly eliminated the rate differential effective in 1984, and made other conforming changes that
became fully effective in 1990.~

Some differences still remain, however. In some cases they can be significant. While
the gross tax base is generally the same under FICA and SECA, items that reduce FICA

subject to SECA tax unless they are deductible on
In particular, contributions to a qualified pension plan or

wages generally do not reduce compensation

Schedule C for income tax purposes.

an accident and health plan generally are not includible in employee FICA wages, but are subject

to SECA tax.

Contributions

to certain nonqualified

plans may also receive more favorable

1990). While, technically, the employer pays half of the FICA taxes imposed on an employee's
Special
wages, the economic effect is the same as if the employee paid the entire amount.
deductions are also provided to self-employed individuals subject to SECA, which produce
nearly the same effect as the fact that employees are not subject to income or FICA taxes on the
employer's share of FICA. Code $$ 164(f) and 1402(a)(12).

" In 1980, for example,

the combined FICA tax rate (employer and employee) was 12.26
percent, while the combined SECA tax rate was 8. 1 percent.

Hearings Before the Subcommittee on Oversight of the Internal Revenue Service of the
Committee on Finance, 97th Cong. , 2d Sess. (April 26, 1982) (Statement of John E. Chapoton,
Assistant Secretary of the Treasury (Tax Policy)).

" Social Security

of 1983, Pub. L. No. 98-21, g 124, 97 Stat. 65, 89 (1983).
See also H. R. Conf. Rep. No. 47, 98th Cong. , 1st Sess. 125-26 (1983).
Commissioner

" Compare

Amendments

v. Braddock, 95

T.C. No. 45 (1990).

Code gg 1402(a) and 3121(a)(5); see Code g 62(a)(6). Health and accident plan
contributions are included in SECA compensation even though they are partially deductible for
income tax purposes. See Code $$ 162(1)(4). The treatment of pension plan contributions may
be explained by viewing contributions by self-employed persons as essentially elective.
Employee elective contributions are includible in FICA wages. Code 5 3121(v)(1). This
explanation does not apply to accident and health plan contributions, however, since these may
Code
be excluded from FICA wages even when provided under an elective arrangement.
$

3121(a)(5)(G).

under FICA.

" These

are to a limited extent offset, however, by the fact
that trade or business expenses may be deducted from compensation before SECA compensation
is calculated, but cannot be so deducted for FICA purposes, and that excess FICA taxes may be
treatment

imposed

on the employer

when

advantages

an employee

changes jobs in mid-year.

Finally,

unlike

employees, independent contractors who are eligible for Social Security benefits can sometimes
avoid application of the Social Security earnings test through the use of deferred compensation. ~'
m l

m n In

. The first $7, 000 of wages paid to

an employee is generally

(FUTA). ~

subject to tax under the Federal Unemployment Tax Act
Under the integrated
Federal/State system, part of the tax is ordinarily paid to the State of employment, while part
is paid to the Federal government; the combined rate averaged approximately 2. 8 percent in

There is no analogue to section 3121(v)(2) in SECA. OBRA 1990 deleted an analogous
rule for corporate directors in section 1402(a) for tax purposes; however, a similar rule still
exists for purposes of the Social Security earnings test. See Social Security Act $ 211(a), 42

U. S.C.

411(a).

This results from the fact that, in computing FICA taxes on a new employee's wages,
an employer generally may not take into account the fact that the employee has already earned
wages in excess of the taxable wage base. Treas. Reg. f 31.3121(a)(1)-1(a)(3). If this results
in an overpayment,
the employee may be entitled to a refund, but not the employer.
Code
g 6413(b); Treas. Reg. $ 31.6413(c)-1; Rev. Rul. 55-584, 1955-2 C. B. 394. SECA taxes are
also considered income taxes, which are collected through the estimated tax system. Thus, while
FICA taxes are generally collected and deposited with the Federal government every pay period,
SECA taxes are generally paid quarterly. Compare Treas. Reg. $$ 1. 1401-1(a) and 31.6302(c)1. Similarly, SECA taxes may be contested in the Tax Court, while FICA taxes may not.

Under the Social Security earnings test, benefits through age 69 are reduced by a fraction
of the payee's other earnings in excess of an exemption amount. Social Security Act $ 203, 42
U. S.C. f 403. In the case of an independent contractor, deferred compensation is generally
taken into account for this purpose when it is received, whereas, in the case of an employee,
deferred compensation is generally taken into account when earned. Compare Social Security
Act $$ 209 and 211, 42 U. S.C. g$ 409 and 411 {as noted above, an exception is provided for
deferred directors' fees). Therefore, some independent contractors defer receipt of compensation
that would otherwise reduce their Social Security benefits until after age 70.

See generally Code Subtitle C, Chapter 23.

1990. The Federal portion of the tax is paid quarterly.

contractors are not subject
to FUTA tax, but likewise generally are not eligible to receive any unemployment benefits.

Income Taxes
11

withholding
through

Independent

'on M

hanism

whereas

system,

Income taxes on employees are collected mainly through the
income taxes on independent contractors are collected mainly

Both systems
imposed on service-recipients.

the estimated

requirements

tax system.

are backed up by information

Employers are generally required to withhold a portion

reporting

of their employees' wages as they
of the employees' income taxes.

are paid and remit it to the Federal government as payment
Withholding rates are specified in tables and procedures published by the IRS, and are calculated
to collect approximately the same amount of tax as the employees will ultimately owe with
respect to the wages if they work all year at the same wage level.
Withholding must
generally be done at the same rate each pay period,
and the amounts withheld must generally
be deposited, along with FICA taxes, soon thereafter in a Federal depositary. ~ Withholding
can generate significant overhead expenses.
contractors and their clients
Independent

Eligibility is a matter of State rather than Federal law. See footnotes 140 and 143 below
for a discussion of State eligibility standards.

" See generally

Code $ 31 and Subtitle C, Chapter 24.

Code

3402; IRS Publication 15 (Circular E), Employer's Tax Guide (Rev.

January, 1991). Withholding rates are generally based on the employee's rate of compensation,
marital status, and the number of allowances claimed on Form W-4. Withholding rates may be
increased if an employee anticipates receiving additional income during a taxable year that is not
subject to withholding, or reduced if large deductions are anticipated.

But see, e.g. , Announcement 85-113, 1985-31 I.R.B. 31 (special accounting
fringe benefits); cf. Code g 3501(b).
The actual schedule depends on the size of the payroll.

" Some argue that the government

See Treas. Reg. 5

rule for

31.6302(c)-1.

is the main beneficiary of withholding, in that it enables
tax authorities to shift a large portion of the collection burden to the private sector. On the other
hand, it is not clear that withholding is any more burdensome on employers than increased
estimated tax payments (which would be necessary without withholding) would be on employees.
Withholding may also provide benefits to some employers because they have the use of withheld
Moreover,
funds for a short period of time before they must remit them to the government.

67
generally

are not subject to a withholding

requirement

with

respect to their compensation

income.
Unless certain exceptions apply, both employees and independent contractors must pay
their estimated income tax liabilities for the current year in quarterly installments throughout the

year. ~ The installments are due on April 15, June 15, September 15, and January 15 of the
following year. The amount of each installment is generally one quarter of the lesser of the
taxpayer's income tax liability for the prior year, or 90 percent of her liability for the current
year. Because of withholding, however, employees generally do not have to make any estimated
This is because withholding

tax payments.

necessary under the estimated
estimated

tax obligations.

tax payments

if they

generally

requires earlier payments

than would be

tax system, and these amounts are credited towards employees'

" Thus,

are generally

employees

to make estimated

only required

have significant non-wage income.

Employers generally
"
W-2.
Similarly, clients

must report all wages paid to an employee

must

report

generally

all compensation

annually

on Forms

to independent

paid

contractors annually on Form 1099-MISC; no Form 1099-MISC is generally required, however,
for payments to a corporation, payments that are not made by a business (e. g. , homeowners'

to a house painter), or payments to a service-provider aggregate less than $600 in a
The administrative burden is about the same for each.
calendar year.

payments

Copies of Form W-2 must be sent to the employee and to the Social Security
Administration.
The Social Security Administration subsequently sends information from the
forms to the IRS. Also, the employee is required to attach any copies she receives to her
income tax return.

Using this information,

the IRS can determine

employers may be able to shift some of their administrative
in the form of lower compensation.

" See generally Code $$ 6315
" Code 6654(g).

and

6654.

Code $ 6041A; Treas. Reg. f$ 1.6041-1(a) and 1.6041-2.
$

6041; Treas. Reg. $f 1.6041-1 and 1.6041-3.

Code $ 6051; Treas. Reg. $$

wages have been

costs of withholding

" Code

whether

31.6051-1 and 31.6051-2.

to the worker

68
While 1099s must be sent to the independent contractor and the IRS, there is
that they be attached to an individual's return.

underreported.

no requirement

e or B siness Ex ense Deductions.

fewer restrictions

significantly

Under current law, independent

on their ability

to deduct trade or business

contractors face
expenses

than

contractors) generally may not deduct
their trade or business expenses unless they itemize their deductions on their Federal income tax
returns, and even then only to the extent they exceed two percent of their adjusted gross income

employees.

In particular, employees (but not independent

from all sources.

automobile,

Also, they must satisf'y additional requirements
home office and certain other expenses.

before they may deduct their

contractors' trade or business expenses are generally deductible "above-theline", i.e. , as a direct reduction in their business income reported on Schedule C. Employees'
trade or business expenses, by contrast, are generally only deductible "below-the-line", i. e. , as
Independent

itemized

expenses.

Especially for lower-income

employees,

is often more favorable than itemization of expenses; such
benefit from their trade or business expenses. ~ In addition,
business expenses have generally been deductible only to
miscellaneous itemized deductions) exceed two percent of the
from all sources.

use

the standard

deduction

effectively get no tax
since 1986, employees' trade or
the extent they (plus any other

individuals

employee's adjusted gross income

floor generally does not apply to an employee's trade or business
in such case, generally no
expenses to the extent they are reimbursed by her employer:
deduction is necessary, because the reimbursement is not included in the employee's taxable
income in the first place. Only reimbursement
arrangements that require the employee to
This
account to the employer for any expenditures are eligible for this treatment, however.

The two-percent

" Code

62(a).

See Rev. Proc. 90-64, 1990-53 I.R.B. 27, for the standard deductions in effect for 1991.
reversed the earlier trend to conform the treatment
persons as much as possible.

Code $ 67. This requirement
employees and self-employed

~ Code

1.62-2; cf. Treas. Reg. f 1.132-5(a)(1)(v) (similar

rules for
working-condition
fringe benefits). Somewhat different accounting rules apply depending oii
whether the expense is subject to the substantiation requirements of section 274(d), and whether
the arrangement is a per diem or mileage plan. See Code 5 62(c); Treas. Reg 55 1.62-2(e) and

1.274-5T(g)

62(c); Treas. Reg.

and

(j).

69
prevents

from excluding

employees

have deducted.

" Client

from income amounts

reimbursements

greater than that which they could
are always included in an independent contractor's

Inadequate
gross income, and the expenses for which they are made must be deducted.
accounting by the independent contractor to the client is therefore generally irrelevant in this
context.

contractors, employees may not deduct interest expenses incurred in
their trade or business of being an employee: such interest is considered a personal expense.
Unlike independent

Entertainment

purpose requirements

expenses generally

of section 274(a). The

on the one hand and independent

for this purpose.
on an employer's

may not be deducted

unless they satisfy the business

rules applicable to employees and their employers

contractors and their clients on the other are about the same

" Special exemptions

are provided, however, for food or beverages furnished
business premises primarily for its own employees, and for recreational or

" Excess reimbursements

must be returned to the employer. If the accounting requirements
are not met, the employee may still be able to deduct the underlying expenses. They will,
however, be subject to the two-percent floor. In addition, failure to account will shift the burden
of complying with various requirements of section 274, including the business purpose
requirement of section 274(a), the substantiation requirement of section 274(d), and the 80Code
percent deduction limit of section 274(n), from the employer to the employee.
$ 274(e)(2), (e)(3)(A) and (n)(2)(A); Treas. Reg. f$ 1.274-2(f)(iv), 1.274-5T(f)(2) and

31.3401(a)-4.
As with employees, however, if an independent contractor does not adequately account
to her client, the burden of complying with various requirements of section 274 will shift from
the client to her. Code f 274(e)(3)(B) and (e)(9); Treas. Reg. $ 1.274-2(f)(2)(iv); see Treas.
Reg. $ 1.274-5T(h)(3) for the definition of an adequate accounting for this purpose; see also
Treas. Reg. $ 1.274-2(f)(2)(iv)(a) and (c)(1) (definitions of adequate accounting and
of section 274(d) are an
requirements
The substantiation
reimbursement
arrangement).
these
requirements even if she
to
exception; an independent contractor continues to be subject
makes an adequate accounting to her client. See Treas. Reg. $ 1.274-5T(h)(2); Rev. Proc. 63-4,
Q&A-28 and 29, 1963-1 C. B. 474; Smith v. Commissioner, 80 T. C. 1165 (1983). This
reflects the fact that, while employees generally need not deduct
distinction presumably
reimbursed expenses because the reimbursements are simply excluded from their gross income,
independent contractors must generally deduct the amounts.

~ Code

163(h)(2)(A).

See footnotes 95 and 96 above for rules relating
substantiation in the case of reimbursed expenses.

to the allocation

of the

burden

70
for their benefit.
Independent contractors may, however, benefit
from both as long as they are not provided primarily for the contractors' benefit.
social activities primarily

expenses, business gifts, and expenses associated with "listed
automobiles, computers, cellular telephones and property used for

Travel and entertainment
property"

(including

also may not be deducted unless the taxpayer has adequate records or other
evidence to substantiate their amount and business purpose, within the meaning of section
274(d). '~ Again, the rules applicable to employees and their employers on the one hand and

entertainment)

independent

certain

contractors and their clients on the other are about the same.

simplified

substantiation

methods

that

are unavailable

Employers may use

to clients

independent

they may rely on records maintained

by their employees
with respect to the use of listed property, and they can avoid any substantiation requirements
with respect to the use of vehicles by adopting a policy statement prohibiting personal use and
meeting certain other requirements. ' ' Presumably, these methods are denied to clients of

contractors, however.

In particular,

contractors

because clients generally do not provide them with the property
necessary to perform their jobs, and, in any event, cannot supervise their use of the property

independent

very closely.

Finally, business meal expenses generally may not be deducted unless the taxpayer or one
of its employees is present. Independent contractors may be treated as employees for this
purpose only if they render "significant services" to the taxpayer. '~
Home office expenses and rental and depreciation expenses associated with listed property
(as described above) may be subject to special deduction limits unless they meet certain business

Code

'~ See

274(e)(1) and (e)(4).

footnotes 95 and

96.

Treas. Reg. $$ 1.274-5T(e)(2) and 1.274-6T. The latter rule applies to both employees
and sole-proprietors.
Treas. Reg. g 1.274-6T(e)(2)(i). The employer can also shift the burden
of compliance to its employees by treating the use of listed property as personal use and
including it in the employees' incomes without regard to the working condition fringe benefit
rules

of section 132.

Code y 274(k); Staff of the Joint Committee on Taxation, 100th Cong. , 1st Sess. ,
General Explanation of the Tax Reform Act of 1986, 69 (Comm. Print 1987).

'~ These limits were significantly

1986. The limits for
employees and independent contractors are generally the same except that, in the case of home
office expenses, the employee's business use must also be "for the convenience of the
employer", '~ and, in the case of listed property such as home computers, such use must be
"for the convenience of the employer and required as a condition of employment. "' These
standards are difficult for many employees to meet. '~
use requirements.

tightened

in TRA

. Independent contractors are generally not taken into account under the
employee fringe benefit provisions of the Code. On the one hand, this means that independent
n fi

contractors'

clients generally are not required to include them in any pension or welfare benefit
plans they provide for their employees in order to maintain the plans' tax-qualified status, and
the independent contractors have correspondingly greater freedom to structure their own benefit

contractors may be unable to
participate in such plans even if they want to (and their clients agree), and some of the benefit
arrangements they establish for themselves as sole proprietors or partners may not be taxarrangements.

favored.

On the other hand, this means that independent

(Such arrangements

may also be more costly, since they usually cannot benefit from

the economies that some employers

able to achieve through group purchase arrangements. )

The Code provides tax-favored treatment for a wide range of common employee fringe
benefits, including pension plans, life insurance and health and accident plans. In many cases,
such treatment is not available for benefits provided to highly compensated workers unless the
employer also provides comparable benefits to a minimum

workers.

number

of its nonhighly compensated

Generally, only an employer's common law employees (and individuals

treated as such

See generally Code f$ 280A and 280F. Generally, in the case of a home office, the
space must be used exclusively on a regular basis as the taxpayer's principal place of business.
(i. e. , more than 50
In the case of listed property, the property must be used predominantly
percent of the time) in the taxpayer's trade or business.
See Code

f 280A(c)(1).

'~ See 280F(d)(3)(A); Treas. Reg.
f

1.280F-6T(a)(2).

See, e. g. , Rev. Rul. 86-129, 1986-2 C. B. 48. On the other hand, the Tax Court's "focal
point" test has made it difficult for independent contractors to establish their home office as their
principal place of business if they render services elsewhere. E.g. , Baie v. Commissioner, 74
T. C. 105 (1980); bur see Soliman v. Commissioner, 94 T.C. 20 (1990) (apparent abandonment
of "focal point" test).

72
are taken into account for this purpose. In additioil, these same provisions
generally prohibit an employer from offering tax-favored benefits to its independent contractors.
A list of tax-favored benefits, and the conditions under which they may be offered to employees
contractors, are shown in Table A-1. '
and independent
(The table does not include
benefits such as workers' compensation. )
statutorily-required

under the Code)'

Taken together, these rules tend to encourage employers to admit a new worker into an
existing fringe benefit plan if she is classified as an employee, and to discourage (if not actually
prohibit) them from doing so

if she is classified as

an independent

contractor.

Classification as

contractor may, therefore, be beneficial to the client; in cases where the worker
would prefer additional cash or a different benefit package to the fringe benefits offered under
the employer's plan and can negotiate to receive some or all of the compensation the client
an independent

would otherwise have spent on the benefits, classification as an independent

contractor may also

be beneficial to the worker.
contractor who is unable to participate in her client's plans generally can
establish her own benefit arrangements in her capacity as a sole proprietor (or as a partner, if
she is in business with other individuals). '~ As indicated in Table A-l, the most significant
An independent

types

of fringe benefits

can generally

may be available on a tax-favored basis.

establish

their own pension

plans,

For example, sole proprietors

subject to essentially

the same rules as

These include leased employees subject to section 414(n) and so-called "statutory
employees" treated under sections 3121(d) and 7701(a)(20) as employees for purposes of FICA
and certain employee benefit provisions of the Code. Cf. Staff of the Joint Committee on
Taxation, 100th Cong. , 1st Sess. , General Erplanation of the Tax Reform Act of 1986, 1345
(Comm. Print 1987) (section 1706 not to affect application of section 414(n)). Note that, in
some cases employees may also be deemed to be self-employed. See, e. g. , Code $ 1372 (certain
S corporation shareholders treated as partners)
~

Provisions that merely specify the accounting treatment of benefits provided to
employees, and do not grant tax-favored treatment, generally also apply to independent
contractors. E.g. , Code g$ 83, 280G and 457; Treas. Reg. gg 1.83-1(a)(1) and 1.457-2(d);

Prop. Treas. Reg.

1.280G-1, Q&A-15.

Sole proprietors
treatment

and partners

of proprietors of incorporated

are proprietors of unincorporated
businesses is discussed in section

businesses.
II.C. below.

The

Table A-1

Tax-Favored Benefits Available to Employees and Independent

Contractors

hvailabihty

To Employee
' PIan
in Em lo

B~t~ef's s

Employcc achicvcment awards'

May be rcquircd

life insurance

May be required

Death benefits'

Generally optional

Accident and health insurance'

Generally optional

Group-term

Tuition remission'

May be required

Meals and lodging'

Optional

To Independent
Contractor in Oient's

To Independent
in

Limited deduction only

Group legal services'

May be required

Cafctcria plans'

May bc required

assistance'

May bc required

Optional

Dcpcndcnt carel

May bc required

Optional

fringes

May bc required

Optional

Qualified employee discounts'

May be required

Educational

No-additional-cost

Working condition fringes

De minimis fringes'

Optional

Generally optional

Optional

Free parking'

Optional

athletic facilitics'

Optional

Qualified pensions and annuitiaf

May bc required

Opt'ional

Tax-sheltered

May be required

On-premises

New-product

testingi

annuitics'

Qualified and incentive stock options'

Employee stock purchase plans
Voluntary

cmployces' beneficiary
assoc iat ions'

Pl n

Optional

May be rcquircd
May bc required

oi
KRI U W
Of%(x or Tax policy

In this table, optional means that thc benefit is not required to be provided under any minimum
while may be required
means that it may have to bc provided.

coverage or nondiscrimination

rules,

Code $$ 74(c) and 274(j)(3)(B).

b. Code $ 79(d); Treas. Reg. $ 1.79-0(b).

c. Code

$ 101(b)(3)(A); Treas
pension plan, how ever.

Reg. $ 1. 101-2(f)(l). Discrimination

rules may apply if the benefits are provided under s qualified

d. Code )II 105(g), 106. and 162(1)(1)l T cas. Reg. $ 1.105-1(a). Coverage
is self-funded.

and discrimination

Code g 105(h).

requirements

may apply

if the plan

Code $ 117(d)(2)(A).

f. Code

119.

g. Code $ 120(c)(1), (c)(2) and (d)(1).
h.

Code $ 12'i(b)(1) and (d)(1)(A); Prop. Treas. Reg. g

Code $ 127(b)(2) and (c)(2); Tress. Rcg. $

Code g 129(d)(2), (d)(3), (d)(8) and (e)(3).

1.127-2(h)(1)(iii).

1.132-1(b)(1)and (3).

Code $ 132(c), (f) and (h)(1); Trees. Reg. $

1.132-1(b)(1)and (3).

m. Code g 132(d); Trees. Reg. $

1.132-1(b)(2) and (4).

Code $ 132(e); Trees. Reg. $

1.132-1(b)(2) and (4).

~-4.

k. Code $ 132(b), (f) and (h)(1); Tress. Reg.

1.125-1,

Certain nondiscrimination

o. Code

132(h)(4); Tress. Reg. $ 1.132-(b)(2) (flush language).

p. Code

132(h)(5); Tress. Reg. $ 1.132-1(b)(1)and (3).

rules apply to eating facilities, however.

q. Trees. Rcg. gg 1.132-1(b)(2) (flush language) and 1.132-5(n).

Code $g 401(a)(4), 401(c) and 410(b); Treas. Reg. gg

Code $ 403(b); Treas. Reg. g 1.403(b)-1(a)(1).

t. Code $$ 421-22A; Tress. Reg.
u.

Code $ 423; Tress. Reg.

v. Code

1.421-7(h).

1.423-2(e)(2).

501(c)(9);Tress. Reg. f 1.501(c)(9)-2(b).

1.72-17(a) and 1.401-10(b).

75
employer-sponsored

plans.

In lieu

from income for employer-provided

the exclusion

accident and health insurance, they can often deduct up to one-quarter of their medical insurance
expenses, without regard to the 7.5 percent floor in section 213 (unless they are covered under
an employer-sponsored
plan directly or through their spouse).
They can also provide

themselves certain fringe benefits, including working condition and de minimis fringes, on a pre-

Other benefits must generally be purchased

tax basis.

out

of after-tax income.

In addition,

II above, the tax benefits for sole proprietor and partnership plans are
generally limited to the income tax provisions of the Code, and do not apply for Social Security
in Section

explained

and Medicare tax purposes.

of Employee Status

Determination

contractor for purposes of the
under the common law tests for

The status of an individual as an employee or independent
Federal

few exceptions,

tax laws is, with

whether a master-servant

determining

~k,

provisions
including

determined

(employment)

relationship

di w

exists.
4

pl y

of the Code. The original Social Security Act simply defined an "employee" as
"an officer of a corporation". '" Treasury regulations issued in 1936 used common

law standards

to determine

of different standards,

employee status.

The lower courts, however,

applied a variety

some relying less than others on common law precedents.

In 1947

plans of sole proprietors who have no
In a sense these rules are more favorable:
nonhighly compensated employees resemble elective arrangements like IRAs and section 401(k)
plans, but are subject to higher dollar limits on contributions.
ironer

Code $ 162(1)(6), as amended by OBRA 1990 $ 11410. This provision is due to expire
December 31, 1991, however.

Social Security Act $ 1101(a)(6), Pub. L. No. 74-271, 49 Stat. 620, 647 (1935). FICA
was in Title VIII of the original act. SECA was enacted on August 28, 1950.

'" Reg. 91, article
alia, that

3, 1 Fed. Reg. 2049, 2052 (Nov. 11, 1936). The regulations state,
"[i]n general, if an individual is subject to the control or direction of another merely

as to the result to be accomplished by the work and not as to the means and methods for
accomplishing the result, he is an independent contractor. An individual performing services
" This closely resembles
as an independent contractor is not as to such services an employee.
the language in the current regulations.

See United S(ates

Webb,

397 U. S. 179 (1969), for a description of this case law.

76
Court issued a pair of opinions that attempted to clarify the governing stailIn them, the Court applied an "economic reality" test that resembled the common
dards.
law tests, under which "employees are those who as a matter of economic reality are dependent

the Supreme

on the business to which they render services.

"'"

The IRS (and the Social Security Administration)
to their
proposed amendments
regulations to incorporate the Court's new economic reality test, but these never took effect:
Congress reacted immediately by passing (over President Truman's veto) the so-called Gearhart
Resolution, endorsing

~tRt.

the use

of common

law tests.

gill

employee if, under the usual common law tests, the relationship
person for whom she performs

Such a relationship

generally

services is the legal relationship

exists

if the person for

idhid~i

tgt

between the individual

of employer

and the

and employee.

whom the services are performed

has the right to control and direct the individual

who performs the services, not

by the work but also as to the details and
means by which that result is accomplished.
That is, an employee is subject to
the will and control of the employer not only as to what shall be done but [also]

only as to the result to be accomplished

how it shall be done.

Over the years, the IRS has identified 20 important factors for determining when the common
law tests are satisfied.
These factors, which are listed in Appendix B, are used in resolving
issues raised in rulings and other guidance, including guidance on the status of technical services

Bartles v. Birmingham, 332 U. S. 126 (1947), and United States v. Silk, 331 U. S. 704
(1947). See also Harrison v. Greyvan Lines, 331 U. S. 126 (1947).

'" Bartles, 332 U. S. at 130.
'" H. R.J. Res. 296, Pub. L. No. 642, 62 Stat. 438 (1948).
'" Treas. Reg. )f 31.3121(d)-1(a)(2), 31.3306(i)-1(b) and 31.3401(c)-1(b).
'" Internal Revenue Manual 4600 (Employment Tax Procedures), Exhibit 4640-1; see also
Rev. Rul. 87-41, 1987-1 C.B. 296. These factors were originally
Security Administration in determining entitlement to benefits.

compiled

by the Social

of section 1706.'~ No one factor on

workers issued after the enactment

this list is determina-

than others.

tive, though some are more important

Congress and the courts have overridden

the common law tests in some situations.

For

example,

certain occupations

performed

contractors under the Code; these include certain door-to-door
by independent
and real estate agents.
Conversely, certain occupations generally performed by

salesmen

generally

performed

by employees

are nevertheless

treated

independent

contractors are nevertheless

treated as performed by employees for employment tax
These "statutory employees" include certain full-time life insurance salesmen, agent-

purposes.
drivers and commission-drivers
homeworkers

and traveling

ti n. An employee generally

tax purposes to that

of an

on the relationship

between the individual

an employment

independent

relationship

or through a corporation
1706 reiterates this point.

of specific

kinds

of products,

or city salesmen. '~

f In

I v n

in the distribution

engaged

cannot change her status for Federal

contractor via incorporation.
performing

The common law tests focus

the services and the service-recipient;

exists, it is generally irrelevant whether payments are made directly
controlled by the individual.
The legislative history of section

See Rev. Rul. 87-41, 1987-1 C. B. 296. See also Moore, Defining the Employee:
Common-Law Rules, Direction, February, 1988, at 13. Mr. Moore is the technical assistant for
Federal employment tax in the Office of the Assistant Chief Counsel (Employee Benefits and
Exempt Organizations) of the IRS. See generally Annotation, Determination of EmployerTax Purposes, 37
Employee Relationship for Social Security Contribution and Unemployment
A. L. R. Fed. 95 (1978), and Annotation, What Constitutes Employer-Employee Relationship for
Purposes of Federal Income Tax Withholding, 51 A. L. R. Fed. 59 (1981).
See Code $ 3508; see also Code

1372.

See Code $ 3121(d); Treas. Reg. $ 31.3121(d)-1(d); Rev. Rul. 90-93, 1990-45 I.R. B.
4. Full-time life insurance salesmen may also be treated as employees for certain fringe benefit
purposes. Code f 7701(a)(20).

and

'~ E.g. , Sargenr i. Commissioner, 93 T.C. 572 (1989); Rev. Rul. 87-41, 1987-1 C. B. 296;
Rev. Rul. 74-330, 1974-2 C.B. 278 (examples (1) and (2)).

H. R. Conf. Rep. No. 841, 99th Cong. , 2d Sess. II-835 (1986); 132 Cong. Rec. S808889 (June 20, 1986); see Rev. Rul. 87-41, 1987-1 C. B. 296; and Private Letter Ruling 9002017
(October 12, 1989).

78
contractor

also generally cannot change her status for Federal tax
purposes to that of an employee of her client via incorporation; she may, however, be treated
as an employee of her own personal service corporation for certain purposes, and derive certain
An independent

tax benefits as a result.

The effect depends on whether the personal service corporation elects
to be taxed as a Subchapter S corporation under section 1362 of the Code. If it does not, the
individual will generally be treated as an employee of the corporation for tax purposes, and can
thus take advantage, inter alia, of various employee benefit provisions of the Code. She will,

floor on itemized deductions or other limits on
employee trade or business expense deductions to the extent she causes such expenses to be
deducted at the corporate level. Although any income received and retained by the corporation
will be taxed at (usually higher) corporate rates, in practice this problem can be minimized by
distributing as much income as possible in the form of compensation.
not be subject to the two-percent

moreover,

If
individual

the personal

service corporation

does elect to be taxed as an S corporation,

will also generally be treated as an employee

but with one important

exception:

assuming

of the corporation for tax purposes,

her ownership

the

interest exceeds two percent, she

as a employee for purposes of the employee benefit provisions of the
The treatment of trade or business expenses is roughly the same as for a C

will not be treated

Code. '"

corporation.

III.

OTHER LAWS

Federal Labor Laws

Most Federal labor laws apply only to employees and do not protect independent
contractors. This is generally beneficial to the independent contractors' clients, who may save
the direct costs of providing additional benefits to the individuals
plus any associated

costs, but may not be beneficial to the independent
need the protection and can share in their clients' cost savings.

administrative

See Spicer Accounting,

Inc. v. United States, 918 F.2d 90 (9th Cir. 1990).

Code $ 1372
Code

contractors unless they do not

67(c); Temp. Treas. Reg.

1.67-2T(b).

79
Employers must generally give their employees
beneficiaries the right to continue coverage under an employer-sponsored

and

QQBRA.

the

employees'

health plan after their

This
coverage has ceased, if coverage ceases on account of certain qualifying events.
requirement applies to employees and independent contractors (provided the plan covers at least
some common law employees). '~
E~ERI

A. Pension and welfare benefit plans are subject to various coverage, funding,

fiduciary, reporting, and other requirements under the Employee Retirement Income Security
These labor provisions of ERISA do not apply to plans benefiting selfAct of 1974.'

contractors) unless they also cover employees, and
provided under ERISA extend only to employee-partici-

employed individuals
many

(including independent

of the specific protections
The tax provisions of ERISA are

pants. "'

Idp

included in the Code.

Mbylh

Kly

Labor Relations Act, and therefore generally may not engage in collective bargaining or similar
requireprotected activities.
They also receive no protection under the nondiscrimination
ments of the Age Discrimination in Employment Act'" or Title VII of the Civil Rights Act

Code $ 4980B, as added by the Consolidated Omnibus Budget Reconciliation Act of
1985 (COBRA), Pub. L. No. 99-272, Title X, 100 Stat. 222 (1986), and amended by TAMRA

f 3011.
Code

4980B(f)(7); Prop. Treas. Reg.

1. 162-26, Q&A-16(b).

Pub. L. No. 93-406, 88 Stat. 829 (1974), codified ar 29 U. S.C. $$ 1001 et seq.

ERISA g$ 3(3) and (6), 4(a) and 4021(a), 29 U. S.C. $$ 1002(3) and (6), 1003(a) and
1321(a); 29 C.F.R. f 2510.3-3.

NLRA $ 7, 29 U. S.C. $ 157. See Nonh American

Van Lines,

Inc.

NLRB, 869

F.2d

596 (2d Cir. 1989).
ADEA g$ 4(a) and (11), 29 U. S.C. $$ 623(a) and 630(f). See Hyland v. New Haven
Radiology Assocs. , P. C. , 794 F.2d 793 (2d Cir. 1986).

of the Occupational Safety and Health Act, '" or the
overtime requirements of the Fair Labor Standards Act, '3' among others.

of 1964,'~ the safety requirements
wage and

minimum

Patent and Copyright Laws

An employer is generally considered the author

of an employee's

of any work prepared

during the course

for purposes of the Federal copyright laws; no such presumption
exists with respect to work prepared by independent contractors.
By contrast, generally no
legal distinction is drawn between employees and independent contractors under the Federal
In practice, however, independent contractors may find it somewhat easier to
patent laws.
secure patent protection for on-the-job creations than employees, since this issue often turns on
a court's analysis of the implicit bargain struck between the parties.
employment

State Laws

Many State laws also impose different requirements

one hand and independent

are generally required

on employers and employees on the

contractors and their clients on the other.

In particular,

employers

to contribute a portion of the wages paid to each of their employees to

Civil Rights Act (1964) g 701(f), 42 U. S.C. $$ 2000e(f). See Wheeler v. Hurdman,
F.2d 257 (10th Cir. ), cert. denied, 484 U. S. 986 (1987).

825

OSHA $$ 3(6) and 5(a)(1), 29 U. S.C. $$ 652(6) and 654(a)(1).

FLSA gf 3(e)(1), 6 and 7, 29 U. S.C. $$ 203(e)(1), 206 and 207. See Walling v.
Portland Terminal Co. , 330 U. S. 148 (1947). Recent legislation has created an exemption from
FLSA for technical services workers who are employees. Pub. L. No. 101-583, 104 Stat. 2781

(1990).

Copyright Act gg 101 and 201(b), 17 U. S.C. f$ 101 and 201(b) (work-for-hire). See,
e. g. , CCNV v. Reid, 104 L.Ed. 2d 831 (1989); and Aldon Accessories Ltd. v. Speigel, Inc. , 738
F.2d 548, 552 (2d Cir. ), cert. denied, 469 U. S. 982 (1984).

'" See, e.g. , Francklyn
and

B.F.

Gladding

v. Guilford Packing Co. , 695
& Co. v. Scientific Anglers, Inc. , 248

F.2d 1158, 1160-61 (9th Cir. 1983);
F.2d 483 (6th Cir. 1957).

This is especially true of the so-called "shop right" doctrine, under which an employer
or client may claim royalty-free use of an invention. See, e.g. , Hobbs v. United States, 376
F.2d 488, 495 (5th Cir. 1967), and Crom v. Cement Gun Co. , 46 F. Supp. 403, 404 (D Del

1942).

81
State workers'

compensation

and unemployment

funds.

Clients

independent

contractors

to do so, and, as a consequence, independent contractors generally
are not eligible for benefits under these systems. Employee wages may also be protected under
As with
State wage payment laws, while payments to independent contractors are not.
Federal labor laws, this exclusion is generally beneficial to the clients of independent
are not required

generally

contractors, but may not be beneficial to the independent contractors themselves
not need the protection and can share in their clients' cost savings.

Determination

unless they do

of Employee Status

The status of an individual as an employee or independent contractor for purposes of
Federal and State labor and other laws is generally determined under standards that resemble the
control-based common law standards applied under the Code.
Depending on the purpose

of the
tion.

however, different factors are often emphasized

law involved,

Thus,

IRS determinations

of employee

status

in making this determina-

are generally

persuasive

but

not

See, e. g. , N. Y. Workmen's Compensation Law $ 210 (McKinney 1965), and N. Y.
insurance).
See also text
Labor Law $$ 560 and 570 (McKinney 1988) (unemployment
accompanying footnote 80 above.

See, e. g. , N. Y. Workmen's Compensation Law $ 50 (McKinney 1965) (requirement
employer provide security for payment of wage compensation).

that

"' See generally

Annotation, Trucker as Independent Contractor or Employee Under $ 2(3)
of the National Labor Relations Act g9 U. S. C. S. $ 152(3)), 55 A. L. R. Fed. 20 (1990);
Annotation, Determination of "Independent Contractor and Employee" Status for Purposes of
g 3(e)(1) of the Fair Labor Standards Act (29 U. S. C. S. g 203(e)(l)), 51 A. L.R. Fed. 702
(1990); Annotation, Who is "Employee" Within the Meaning of Age Discrimination in
Employment Act (29 U. S. C. S. $$ 621-634), 69 A. L.R. Fed. 700 (1990); Annotation, Who is
"Employee as Defined in $ 701(f) of the Civil Rights Act of1964, 42 U. S. C. S. g 2000e(f), 72
A. L.R. Fed. 522 (1990); and Annotation, Right to unemployment compensation or social security
of one working on his own projects or activities, 65 A. L.R. 2d 1182 (1990).

:„. d:

F~l:

g. ,

Id M

C. . 796Fgd70. 1266C;

1986) (ERISA); Weisel v. Singapore Joint Venture, Inc. , 602 F.2d 1185 (5th Cir. 1979); Dunlop
Cola Bottling Co. , 529 F.2d 298 (6th Cir. 1976) (NLRA); Brennan».
v. Dr. Pepper-Pepsi
Gilles 4 Cotting, Inc. , 504 F.2d 1255 (4th Cir. 1974) (OSHA); Spi ride v. Rei nhardr, 613 F.2d
826 (D. C. Cir. 1979) (Title VII); and EEOC v. Zippo Mfg. Co. , 713 F.2d 32 (3d Cir. 1983)
(ADEA).
Q~~w: see, e. g. , Taylor v. Employment Division, 597 P. 2d 780 (Or. 1978);
Starinieri, v. Unemployment Compensation Board of Review, 289 A. 2d 726 (Pa. 1972); and

82
and, in some cases, a worker can simultaneously
purposes and an independent contractor for others.
determinative,

IV.

be an employee

for some

SUMMARY
Current

Independent

favor employee

law does not consistently

or independent

contractors and their clients are treated somewhat

contractor

status.

more favorably with respect to

taxes, and significantly more favorably with respect to their trade or business
expense deductions. On the other hand, employees and employers are treated more favorably
with respect to the taxation of some fringe benefits. Similarly, clients of independent contractors
do not bear as great a burden as employers under Federal and State labor laws, but independent
contractors also do not enjoy the same benefits or protections under those laws as do employees.
employment

Laeng v. Workmen's Compensation Appeals Board, 494 P.2d 1100 (Cal. 1972); cf. Cumming
v. District Unemployment
Compensarion Board, 382 A. 2d 1010 (D.C. 1977) (self-employed
status does not per se disqualify claimant)
~

APPENDIX B
COMMON LAW FACTORS USED TO

DETE~~E EMPLOYEE

STATUS

Workers are generally considered employees for Federal tax purposes if they:

1.
2.

3.
4.
5.
6.
7.
8.

9.
10.

11.
12.

13.
14.
15.
16.
17.
18.
19.
20.

Must comply with employer's

instructions

about the work.

Receive training from or at the direction of the employer.
Provide services that are integrated into the business.
Provide services that must be rendered personally.
Hire, supervise, and pay assistants for the employer.
Have a continuing working relationship with the employer.
Must follow set hours

of work.

Work full-time for an employer.
Do their work on the employer's

premises.

Must do their work in a sequence set by the employer.
Must submit regular reports to the employer.

Receive payments of regular amounts at set intervals.
Receive payments for business and/or travelling expenses.
Rely on the employer to furnish tools and materials.
Lack a major investment in facilities used to perform the service.
Cannot make a profit or suffer a loss from their services.
Work for one employer at a time.

Do not offer their services to the general public.
Can be fired by the employer.

May quit work at any time without incurring

liability.

Source: Exhibit 4640-1, Internal Revenue Manual 4600 (Employment
Rev. Rul. 87-41, 1987-1 C.B. 296.

Tax Procedures),

and

APPENDIX C
ADDITIONAL BACKGROUND TO TCMP AND SVC-1

TCMP

The definition of "technical services worker" for purposes of Table 5-2 is based on the
occupation of the primary taxpayer determined in the course of the TCMP audit. Unweighted
frequencies for the occupations included in the analysis are as follows:

Frequency

102
1,327
27

79
204
8
182

27
176
94
11
8

39
4
47
12

6
98
4

216
2, 684

Occupation
Architects
Engineers
Surveyors and Mapping Scientists
Computer Scientists
Operations and Systems Researchers and Analysts
Mathematical Scientists
Physical Scientists
Life Scientists
Engineering Technologists and Technicians
Drafting Occupations
Survey and Mapping Technicians
Biological Technologists and Technicians (Except Health)
Chemical and Nuclear Technologists and Technicians
Mathematical Technicians
Science Technologists and Technicians, Not Elsewhere Classified
Air Traffic Controllers
Radio and Related Operators
Legal Technicians
Programmers
Technical Writers
Technicians, Not Elsewhere Classified

Total

II.

SVC-1
Unweighted

frequencies

for the "technical services" occupations included in the SVC-1

survey are as follows:

Frequency
1

4
10
5
15

Occupation
Architects
Engineers
Physical Scientists
Engineering Technologists and Technicians
Air and Ship Officers and Technicians
Radio Operator,
Technicians, e.g. , Embalmer/Morticians,
Computer Programmer

Total

The following occupations were included in the TCMP analysis, but did not appear in the SVC-1
sample of misclassified employees:
Computer Scientists and Specialists;
Operations and System Researchers and Analysts;
Mathematical Scientists including Mathematicians, Actuaries and Statisticians,
Life Scientists;
Science Technologists and Mathematical Technicians.

Department

of the Treasury

Washington,

D.C. 20220

Official Business
Penalty for Private Use,

$300

Study of the Effect of the
Minimum Participation Requirements
on Government Contractors

Department of the Treasury
March 1991

Study of the Effect of the
Minimum Participation Requirements
on Government Contractors

Department of the Treasury
March 1991

DEPARTMENT OF THE TREASURY
WASHINGTON

March
ASSISTANT SECRETARY

1991

The Honorable Lloyd Bentsen
Chairman
Committee on Finance

United

States Senate

Washington

D. C. 20510

Dear Mr. Chairman:

Section 6056 of Public Law 100-647, the Technical and
Miscellaneous Revenue Act of 1988, provides that the Secretary of
the Treasury shall conduct a study on the application of section
401(a)(26) of the Internal Revenue Code of 1986 to Government
contractors that are subject to Federal prevailing wage
requirements.

to that mandate, I hereby submit the "Study of
Participation Requirements on
Government Contractors. "
I am sending a similar letter to Representative Dan
Rostenkowski, Chairman of the Committee on Ways and Means.
Pursuant

the Effect of the

Minimum

Sincerely,

Kenneth

Assistant

Gideon

Secretary

(Tax Policy)

Enclosure

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

March

1991

The Honorable Dan Rostenkowski
Chairman
Committee on Ways and Means
House of Representatives
Washington D. C. 20515

Dear Mr. Chairman:

to that mandate, I hereby submit the "Study of
the Effect of the Minimum Participation Requirements on
Government Contractors. "
I am sending a similar letter to Senator Lloyd Bentsen,
Chairman of the Committee on Finance.
Pursuant

Sincerely,
/

Kenneth

Assistant

/
L Q

Gideon

Secretary

(Tax Policy)

Enclosure

STUDY OF THE EFFECT
OF THE MINIMUM PARTICIPATION RRQUIRR ITNTA
CONMACTORA
ON GO

I. INTRODUCTION
Under the minimum participation requirements
of section 401(a)(26), ' a qualitied
retirement plan must cover at least 50 employees or, if fewer, at least 40 percent of all
employees of the employer. Under the Davis-Bacon Act and the McNamara-O' Hara Service
Contract Act (as well as under other related Federal statutes), a government contractor is
required to pay certain of its employees at least the wage that prevails in the locale where the
employees perform their services for the contractor. The required prevailing wage may be
determined in part by reference to a contribution to fund fringe benefits, including retirement
benefits under a qualified plan.
As part of the Technical and Miscellaneous Revenue Act of 1988, the Congress directed
the Department of the Treasury to study the effects on government contractors of the minimum
participation requirements of section 401(a)(26). Specifically, the Treasury v as directed to
consider the employee benefit aspects of the Federal prevailing wage requirements, the need (if
any) for special treatment of prevailing wage employees in applying the minimum participation
requirements, and possible methods for modifying plans to satisfy the minimum participation
requirements in the absence of such special treatment.

The specific issue to be considered is whether present law provides government
contractors sufficient flexibility to satisfy both the Federal prevailing wage requirements and the
minimum participation requirements of section 401(a)(26). In the past, it has been common for
government contractors to maintain multiple plans, with at least one plan that covers office and
supervisory staff and another plan that covers prevailing wage employees. In addition, several
multiple employer plans exist that cover solely prevailing wage employees subject to the Dai isBacon Act.

Some have raised the concern that certain government contractors may have difficulty
satisfying section 401(a)(26) in the common situation where the contractor maintains a separate
plan for office and supervisory staff, as described above. This separate plan may fail minimum
participation if the office and supervisory staff plan does not cover 50 employees or 40 percent
of the employer's workforce (including both office and supervisory staff and prevailing wage
It is this concern, in particular, that the Congress asked the Department of the
employees).
Treasury to explore in its study.

'Unless otherwise specified, all statutory
1986, as amended (the Code).

references are to the Internal

Revenue

Code of

Page 2

II. FEDERAL

PREVAILING WAGE REQ

There are two Federal statutes that impose prevailing wage requirements on goi ernment
contractors, the Davis-Bacon Act and the McNamara-O' Hara Service Contract Act of 1965.'-

A. Davis-Bacon Act
The Davis-Bacon Act was enacted in 1931. It imposes certain standards with respect to
any contract in excess of 2, 000 dollars' that is entered into for the actual construction,
alteration, or repair of a public building or a public work, and that is financed in whole or in
part with Federal funds (whether directly, by guarantee, or otherwise). '
In general, the statute requires that prevailing wages be paid to laborers and mechanics
under covered contracts.
The Department
of Labor (DOL) issues prevailing wage
determinations by geographic locale and by class of laborer. The prevailing wage may include
a basic wage rate and a fringe benefit amount.

The prevailing wage determinations set the minimum level of wages that must be paid
by any bidder on a particular contract. Under the Davis-Bacon Act, the Congress sought to
ensure wage protection and equity for local contractors, laborers, and mechanics involved in
Federal construction activity. The intent is to protect local contractors from outside contractors
that secure Federal contracts solely because their bids are based on wage levels lower than those
prevailing in the locale where construction occurs. The Act is also intended to protect the wage
standards of local craftsmen because government contractors might deny them work by recruiting
labor from distant labor areas with lower wage standards.

'Other Federal statutes may apply to government contractors as well. For example, the Fair
Labor Standards Act (FLSA) generally applies to all government contractors. In addition, while
not discussed in the text of this study, the Walsh-Healey Public Contracts Act (41 U. S.C. ( 35
er seq. ) sets basic labor standards for workers performing on contracts in excess of $10,000 for
the manufacture and furnishing of goods to the Federal government.
However, the Walshunder
the
minimum
required
the FLSA be met and
Healey Act requires only that
wage generally
does not require a prevailing wage or fringe benefit.

'The President's budget for fiscal year 1992 generally would raise the minimum threshold
to 250, 000 dollars. Executive Office of the President, Budget of the United States Government
for Fiscal Year 1992, at II-319 (1991).

'See 40 U. S.C. $ 276a et seq. (1989). While the statute itself applies to directl~ funded
Federal projects, numerous other laws require contractors to comply v ith its provisions.
29 C. F.R. $ 5. 1 (1990) for a list of some of these related statutes.

5ee

Page 3

The definition of prevailing wage was amended in 1964 to include fringe benefit
Permissible fringe benefits include medical and hospital benefits, pensions on
payments.
retirement or death, compensation for injuries or illness resulting from occupational activity,
insurance to provide any of the foregoing, unemployment benefits, life insurance, disability and
sickness insurance, accident and holiday pay, costs of apprenticeship and other similar programs,
and any other bona fide fringe benefits.
Thus, a contractor may offset its prevailing wage obligation through the payment of
certain fringe benefits, as long as such benefits are not otherwise required under Federal or state
statute (e. g. , the employer share of the tax imposed under the Federal Insurance Contribution
Act (FICA)).

The modified definition of prevailing wage was adopted in order to modernize the Act
by recognizing that certain fringe benefits had become an integral part of the wages of
employees. ' The Congress determined that if fringe benefits were not considered, an unfair
advantage would be conferred on those contractors that do not provide such benefits in locales
where the benefits prevailed as a part of the compensation package.

1. Mechanics of prevailing

wage determinations

As indicated above, the DOL has jurisdiction over matters pertaining to the Davis-Bacon
Act and thus is responsible for determining a prevailing wage for each classification of laborer
or mechanic in a particular locale. In addition, the amount of the prevailing wage will vary
depending on the type of construction (i. e. , residential, building, highway, or heavy). Thus, for
example, in area 1 of state X, the prevailing wage for a carpenter performing residential
construction could be expressed as a $15 basic hourly rate and a $4 fringe benefit rate. The type
of fringe benefit is not designated. Notwithstanding the separate components used by DOL in
arriving at a total prevailing wage, the controlling figure is the total of $19. While a contract
will specify that prevailing wages will be paid, there is generally nothing in the contract, and
nothing in the Act itself, that requires the $4 to be paid in fringe benefits. Thus, a contractor
would be permitted to pay the entire $19 in cash wages.
Alternatively, the contractor could
reduce the cash portion and increase the portion of the prevailing wage attributable to fringe
benefits, provided that the contractor complies with the requirements of the statute with respect
to such benefits.

'See 1964 U. S. Code Cong. & Admin. News 2339, '340.
'Regardless of what the contractor decides to pay in fringe benefits and cash wages, overtime
pay generally is calculated based upon the DOL-specifiied cash portion of the prevailing wage.

'The provision of the prevailing wage in the form of fringe benefits that are excluded from
the definition of wages" for employment tax purposes may have the effect of reducIng the

Page 4

2. Requirements applicable to fiinge benefit contributions
The DOL requires that certain standards be met for a contractor to be able to claim credit
against the prevailing wage for employer contributions made on behalf of an employee to a
fringe benefit plan. No prior approval from DOL is required for fringe benefit plans that
provide "bona fide" benefits and that are funded under a trust or insurance program. Except as
specified below, these requirements apply to all fringe benefit plans and not just qualified
retirement plans. '

Conformance

with

ERISA

In order to be a bona fide plan, the plan must meet all applicable requirements
Employee Retirement Income Security Act of 1974, as amended (ERISA).

of the

b. Permissible eligibility rules
A plan is bona fide notwithstanding
the fact that it contains eligibility rules that exclude
certain employees (e. g. , restrictions relating to age, length of service, or union membership).
However, no credit is given with respect to contributions on behalf of a laborer or mechanic
unless the contractor makes payments or incurs costs with respect to such employee. Similarly,
if a plan requires a participant to be employed on the allocation date under the plan in order to
be entitled to a benefit, no credit is given unless the laborer or mechanic is employed on such
date.

c.
fide.

Tbning

of contributions

A contractor must contribute on a regular basis to a plan in order for the plan to be bona
The DOL requires that contributions be made no less frequently than quarterly.

The DOL allows a profit-sharing
plan to be a bona fide fringe benefit plan
the fact that the amount of the contribution to such plan is based solely on the
notwithstanding

The
employer's employment tax liabilities with respect to prevailing wage employees.
Department of the Treasury is aware that some government contractors have attempted to
increase the portion of the prevailing wage provided in the form of such excludable fringe
benefits in order to escape employment tax liabilities with respect to nonunion prevailing wage
Nothing in the above discussion is intended to imply that such practices are
employees.
permissible.

'The regulations
5. 2 et seq.

relating to fringe benefit plans under the statute are found at 29

C. l-. R

Page 5

discretion of the employer. Such a plan is permitted if the contractor regularly and irrevocably
contributes to an escrow account during the period of covered work. The amount contributed
must be adequate to meet the anticipated rate of contributions to the plan at the end of the year.
of profits or contributions, the funds in escrow may be
Upon the annual determination
However,
transferred to the plan as an offset against the employer's obligation to contribute.
such amounts may only be used to the extent they do not exceed the obligation related to that
portion of the total hours worked by the employee during the year attributable to covered work.
If excess amounts exist, they must be paid to the laborer in cash if they are to be credited
against the prevailing wage.

d. Individual accounting
A contractor must meet its prevailing wage obligations with respect to each laborer and
mechanic employed on the project. Therefore, the DOL requires the contractor separately to
determine the amount contributed for each laborer and mechanic (e. g. , no averaging of
contributions is allowed). The amount contributed must represent the actual rate of costs or
contributions required to provide benefits for a particular laborer.

e. Annualization
Except with respect to certain defined contribution plans discussed below, thc DOL
allows credit for contributions to a plan based on the effective annual rate of contributions for
all hours worked for the contractor during the year. For example, a contractor may not claim
a $4-per-hour contribution to a pension plan unless that same $4 rate is paid for all hours worked
during the year with respect to that employee (regardless of whether the work is covered under
the statute). If the $4 is not paid on this basis, the creditable amount of the contribution rate is
reduced. This requirement ensures that covered wages do not subsidize fringe benefits provided
during periods when the employee is not performing covered work.
Assume a contractor's contribution
The following example illustrates this requirement.
with respect to a particular employee for a pension benefit is $4 per hour and is paid only for
work covered under the Davis-Bacon Act. The employee works 400 hours for the contractor
during the year. If the employee was employed for 100 hours on work covered under the
statute, only $1 per hour may be credited.

to the annualization requirement is provided for contributions to certain
defined contribution plans. The DOL permits a contractor to take full credit at the specified
hourly rate for contributions to defined contribution plans with certain vesting schedules. A p]an
meets this vesting requirement if it provides for the full vesting of a participant's benefit after
The rationale for this
an employee works 500 or fewer hours for the contributing employer.
exception is that this type of plan will provide workers with a greater likelihood of vested
benefits. Under a plan meeting these requirements, the DOL does not permit a contribution rate
in excess of the maximum permitted under the Code.
An exception

Page 6

f. IrrevocabNty

of contributions

In order to offset the obligation to provide a prevailing wage, contributions to fringe
benefit plans must be irrevocably contributed by the contractor. Thus, for example, amounts
in escrow in excess of those necessary to fund a discretionary profit-sharing plan may not be
returned to the employer.

B. McNamara-O' Hara

Service Contract Act

The McNamara-O' Hara Service Contract Act (the McNamara-O' Hara Act) was enacted
in 1965 and imposes prevailing wage requirements with respect to any Federal contract in excess
of $2, 500, the principal purpose of which is to furnish services through the use of service
The purpose of the Act is to prevent the Federal government's purchasing power
employees.
from being used to unfairly depress wages and other standards of employment.

1. Mechanics of prevailing

wage determinations

Like the Davis-Bacon Act, the McNamara-O' Hara Act is administered by the DOL. The
McNamara-O' Hara Act requires that affected contractors comply with DOL prevailing wage
determinations when performing work on Federal service contracts. There are two types of
prevailing wage determinations under the Act. The first is a prevailing wage determination based
on wages paid to classes of service employees in a particular locale. These are determined by
the DOL after due consideration of the rates applicable to such service employees if directly
hired by the Federal government.
The second type of prevailing wage determination is the collective bargaining a reement
set forth the wage rates and fringe
or successorship determination. These determinations
benefits, including accrued and prospective increases, contained in a collective bargaining
agreement that applied to service employees who performed services on a predecessor contract
in the same locale. Thus, contractors performing contracts subject to the McNamara-0'fiara
Act generally are obliged to pay service employees wages and fringe benefits not less than those
to which such employees would have been entitled under a collective bargaining agreement if
they were employed on like work under a predecessor contract in the same locale.

'Credit is not lost if a prevailing wage employee forfeits his or her benefit under a fringe
benefit plan. However, the amount of the forfeiture must be used to fund future contributions
for which the contractor is not permitted to take credit.

"See 41 U. S.C.
1st

350 et seq.

"See H. R. Rep. No. 948, 89th Cong.
Sess. 3-4 (1965).

1st Sess. 2-3

(1965); S. Rep. 4'o. 798, 89th Cong.

Page 7

A prevailing wage determination contains a cash amount and an amount representing the
cost to the contractor with respect to a specific type of fringe benefit. Thus, the McNamaraO' Hara Act may require that an ambulance driver in a particular locale receive a wage of $10
an hour in cash and $2 an hour in health coverage. The types of fringe benefits permitted under
the McNamara-O' Hara Act generally are the same as those permitted under the Davis-Bacon Act
(e. g. , pension benefits). Similarly, the fringe benefit may not otherwise be required under
Federal or state law.

The manner in which a contractor gains credit under the McNamara-O' Hara Act differs
in one major respect from the Davis-Bacon Act in that the contractor is not permitted to
substitute fringe benefit payments for the cash portion of the prevailing wage. That is, if the
wage determination requires a $10 an hour cash wage and a $2 an hour contribution for health
coverage, the contractor is not permitted to pay less than $10 in cash to the service employee.
However, the contractor may pay the remaining $2 to the employee entirely in cash, entirely in
fringe benefits, or in some combination of the two.

2. Requirements applicable

to fringe benefit contributions

must be met in order for the
As under the Davis-Bacon Act, certain requirements
contractor to take credit against the required prevailing wage for contributions to a fringe benefit
In general, the requirements are similar to those under the Davis-Bacon Act. Thus,
plan.
the contribution generally must be irrevocably made to a bona fide fringe benefit plan, fund, or
program. Such a plan must be in writing and must be communicated to employees. It must also
contain a definite formula for determining the amount to be contributed by the contractor and
a definite formula for determining the benefits of each covered employee.

In order to be a bona fide plan, a plan providing pension benefits must meet I.RISA
requirements and be qualified under the Code. Contributions to individual retirement accounts
are permitted.

The eligibility rules generally are the same as the rules under the Davis-Bacon Act.
In this regard,
Similarly, contributions must be made no less frequently than quarterly.
however, no specific rules relating to discretionary profit-sharing plans are set forth.
the contract period, a contractor employs an employee part of the time on
service contract work and part of the time on other work, the contractor may only credit against
the hourly amount required for the hours spent on the contract work, the corresponding
proportionate part of a weekly, monthly, or other amount contributed by the contractor for such
fringe benefits. For example, if an employee works on service contract v ork 30 hours per v. cck
and on other work 10 hours per week, and a pension contribution of $40 is made on a weekly

during

"See 29 C. F.R.

4. 170 (1990) for

an extensIi e discussion

of these requIrements.

Page 8

basis for such employee, the creditable amount of the contribution would be the proportionate
amount of such contribution (i. e. , $30 out of the total $40). No exceptions are specified to this
rule.

Page 9

PARTICIPATION REQ
The minimum participation requirements of section 401(a)(26) were enacted as part of
the Tax Reform Act of 1986. Under these requirements, a retirement plan maintained by an
employer is not entitled to tax-favored treatment unless the plan benefits at least 50 employees
or, if fewer, 40 percent of all employees of the employer.
Section 401(a)(26) generally is
effective for plan years beginning after December 31, 1988.
Each qualified plan of an employer must separately satisfy section 401(a)(26). Thus, if
maintains two qualified plans, each plan must meet the minimum participation
requirements without regard to those employees benefitting under the other plan. Assume, for
example, that an employer with 100 employees maintains two plans, one covering 50 employees
and the other covering 20 employees.
The plan covering 20 employees does not meet the
minimum participation requirements notwithstanding
the fact that when considered together, the
two plans cover more than 50 employees and, indeed, more than 40 percent of the employer's

an employer

workforce.

The proposed regulations under section 401(a)(26) contain a definition of what constitutes
a separate plan. Under this definition, a plan (or portion thereof) is treated as a separate plan
For
if plan assets are segregated to benefit a particular employee or class of employees.
example, if only a portion of the assets under a defined benefit plan is available on an ongoing
basis to provide the benefits of certain employees and the remaining assets are only available in
limited cases (but are available to provide benefits for another group of participants), there are
two separate plans each of which must meet the minimum participation requirements.

section 401(a)(26)(1) grants the Secretary of the Treasury authority to treat
each separate benefit structure under a plan as itself a separate plan for purposes of applying the
minimum participation requirements.
In the Conference Report to the Tax Reform Act of 1986,
Congress explained, "Thus, for example, a plan that provides two different formulas for
Under
calculating participants' benefits or contributions may be treated as at least two plans.
such an approach, a plan that satisfied minimum participation as a whole nonetheless could fail
to satisfy section 401(a)(26) if it included any separate benefit structure that covered fewer than
50 employees or 40 percent of the employer's workforce.
In addition,

The potential application of the minimum participation requirements to separate benefit
structures as envisioned in the statute and legislative history caused particular concern to
government contractors. A plan covering office and supervisory staff in most cases provides for
different contributions

and benefits from those provided

under a plan covering prevailing

'-'Prop. Treas. Reg. g 1.401(a)(26)-2(c).

"H.R. Conf. Rep. No. 841, 99th

Cong. , 2d Sess. II-422 (1986).

age

Page 10

employees. Thus, if either plan failed minimum participation, the contractor could not remedy
this failure by merging the two plans, because each plan would continue to be a separate benefit
structure that itself would have to satisfy minimum participation.
As currently proposed, the regulations under section 401(a)(26), however, decline to
exercise the authority granted the Secretary under the statute to treat separate benefit structures
The
as separate plans for purposes of applying the minimum participation requirements.
of
the
has
benefit
determined that the potential abuses of separate
Department
Treasury
structures that concerned the Congress are adequately addressed in the Treasury's proposed
regulations under section 401(a)(4) governing nondiscrimination
in qualified retirement plans.

Thus, under the proposed regulations, a plan does not cease to be treated as a single
separate plan merely because it includes two or more separate benefit structures, for example,
where the plan provides different rates of contribution to different employees under the plan.
In addition, a defined contribution plan (i. e. , a plan that maintains a separate account for each
participant) does not constitute separate plans merely because it includes more than one trust,
provides for separate accounts, permits employees to direct the investment of amounts allocated
As a result, a defined contribution plan
to their accounts, or permits distributions in kind.
that is a money purchase pension plan may be tested as a single plan for purposes of the
the fact that the employer varies its
minimum
notwithstanding
participation requirements
contribution rate by class of laborer (e. g. , carpenters versus bricklayers), and each laborer's
benefit under the plan is maintained in a separate account.

If a

plan benefits employees of more than one unrelated employer and those employees
are not included in a unit of employees covered by one or more collective bargaining
agreements, the plan is a multiple employer plan. A multiple employer plan is treated as
separate plans, each of which is maintained by a separate unrelated employer. Each such plan
requirements
must separately satisfy the minimum participation
by reference solely to that

employer's

employees.

"Although as originally proposed the regulations under section 401(a)(26) had previously
accepted Congress's invitation to subject separate benefit structures to minimum participation
requirements, these proposed regulations were withdrawn and reissued in substantially modifiui
form in conjunction with Treasury's issuance of proposed regulations under section 401(a)(4).
See 55 Fed. Reg. 19935 (May 14, 1990).

"Prop. Treas. Reg.

1.401(a)(26)-2(c)(2}.

"Prop. Treas. Reg.

1.401(a)(26)-2(d)(4).

Page 11

Certain plans are excepted from the application of the minimum
participation
These plans include those not benefitting highly compensated employees and
requirements.
certain underfunded defined benefit plans. In addition, a plan generally is excepted from the
minimum participation requirements if it is a multiemployer plan (i. e. , a plan covering union
employees that is maintained by more than one employer pursuant to one or more collective
bargaining agreements).

In general, all employees of the employer must
a plan meets the minimum participation requirements.
from consideration if the employee is described in one
employees who have not met the plan's minimum age
aliens with no United States source earned income,
pilots.

be considered when determining whether
However, an employee may be excluded
or more of the following categories: (1)
or service requirements, (2) nonresident
and (3) certain employees who are air

to a collectively
In addition, in applying the minimum participation requirements
bargained plan (i. e. , a plan covering union employees that is not otherwise exempt by reason
of being a multiemployer plan), employees not covered by the collective bargaining agreement
Likewise at the employer's option, employees
may be disregarded at the employer's option.
covered by a collective bargaining agreement are not taken into account in applying the
The effect of
to plans covering nonunion employees.
minimum participation requirements
these provisions are illustrated by the following example. If an employer with 100 employees
maintains two plans, one covering 20 employees and the other covering 50 employees, the 20However,
participant plan ordinarily does not satisfy the minimum participation requirements.
are
union
than
more
50
employees
if the 20-participant plan covers union employees and no
covered under the collective bargaining agreement, the plan will satisfy minimum participation
if the employer elects to exclude nonunion employees from consideration. This result occurs
because the 50 employees who are not covered under the collective bargaining agreement may
be disregarded in determining whether that plan satisfies minimum participation (i. e. , 20 is 40
percent of the 50 remaining employees who are covered under the collective bargaining

agreement).

"Prop. Treas. Reg.

1.401(a)(26)-l(b).

"Prop. Treas. Reg.

1.401(a)(26)-6(b)(1) to (3).

employer
minimum

under certain conditions an
have not satisfied the highest

In addition,

exclude from consideration employees who
age and service conditions permitted under section 410(a)(1). Prop. Treas. Reg.
may

f 1.401(a)(26)-6(b)(1)(ii).
"Prop. Treas. Reg.

1.401(a)(26)-6(b)(5).

"Prop. Treas. Reg.

1.401(a)(26)-6(b)(4).

Page 12

IV. DISCUSSION
It is the conclusion of the Department

AND CONCLUSION

of the Treasury

that no change in current law is
warranted. Current law and regulations grant government contractors broad latitude to structure
their qualified retirement plans in a manner that simultaneously
satisfies both the minimum
participation requirements of Code section 401(a)(26) and the prevailing wage requirements of
the Davis-Bacon and McNamara-O' Hara Acts. As discussed earlier, the regulations under
section 401(a)(26) as currently proposed do not prevent an employer from maintaining separate
benefit structures —
including different levels of contributions or benefits —
under a single plan.
Likewise, the Davis-Bacon and McNamara-O' Hara Acts do not require that the portion of the
prevailing wage determined by reference to fringe benefits be provided in a separate plan, or
even that such portion actually be provided in the form of fringe benefits as opposed to cash.
Thus, there are no irreconcilable differences between the minimum participation requirements
of Code section 401(a)(26), on the one hand, and the prevailing wage requirements of the DavisBacon and McNamara-O' Hara Acts, on the other hand, that would prevent a government
contractor from complying with both sets of requirements.

A. Prevailing

Wage Employees Covered Under a Collective Bargaining Agreement

In the case of prevailing wage employees covered under a collective bargaining
impose virtually no restrictions on an
agreement, the minimum participation requirements
employer's ability to use qualified plan contributions to satisfy its prevailing wage obligations.
A qualified plan that covers only such employees should automatically satisfy section 401(a)(26)
because employees not covered under the collective bargaining agreement may, at the employer's
In addition, if the
option, be disregarded in applying the minimum participation requirements.
plan is a multiemployer
plan, it generally is exempted from the minimum participation

requirements

B. Prevailing

altogether.
Wage Employees Not Covered Under a Collective Bargaining

Agreement

In the case of prevailing wage employees who are not covered under a collective
bargaining agreement, the employer is free to structure its qualified retirement plans in a manner
without sacrificing the ability simulrequirements
that satisfies the minimum participation
For example, if the employer has
taneously to satisfy the prevailing wage requirements.
different classes of prevailing wage employees and each class separately constitutes fewer than
50 employees or 40 percent of the employer's workforce, section 401(a)(26) still permits the
employer to establish a single plan that covers all its prevailing wage employees, even though
different levels of contributions or benefits are provided to each class of prevailing wage
~ Similarly, if an employer's prevailing wage employees as a group
employees under the plan.

The fact that the plan must also satisfy the minimum coverage and nondiscrimination
requirements of sections 410(b) and 401(a)(4) should not prevent the employer from meeting its

Page 13

fewer than 50 employees or 40 percent of the employer's workforce, section
401(a)(26) still permits the employer to cover the prevailing wage employees under the same
is not subject to prevailing
plan with its other employees whose compensation
wage
requirements, even though different levels of contributions or benefits are provided to prevailing
wage and non-prevailing wage employees under the plan. ~
constitute

C. Non-Prevailing

Wage Employees

A similar analysis applies in the case of non-prevailing wage employees. If an employer
maintains a separate plan for its office and supervisory staff who constitute fewer than 50
employees or 40 percent of the employer's workforce, section 401(a)(26) still permits the
employer to merge that plan with a plan covering the employer's prevailing wage employees,
even though separate benefit structures, including different levels of contributions or benefits,
are maintained for each group of employees under the plan. The resulting merged plan covering
both prevailing wage and non-prevailing wage employees generally would be treated as a single
plan under section 401(a)(26) and, as a result, should satisfy the minimum participation requirements.

If none
prevailing wage obligations with respect to each class of prevailing wage employees.
of
within
the
meaning
of the prevailing wage employees were highly compensated employees
section 414(q), the plan would automatically satisfy minimum coverage and nondiscrimination.
If the prevailing wage employees included one or more highly compensated employees who
otherwise might cause the plan to fail minimum coverage under section 410(b), the employer
could exclude those employees from the plan and instead meet its prevailing wage obligation by
providing them with an additional cash payment. Similarly, if the prevailing wage employees
included one or more highly compensated employees who otherwise might cause the plan to fail
nondiscrimination
under section 401(a)(4), the employer could set the contributions or benefits
of those employees at a lower level under the plan and instead provide them with an additional
cash payment.
See supra note 22 and infra note 24.

"See supra

note 22. As explained in that footnote, a plan covering prevailing wage
requirements of sections
employees can satisfy the minimum coverage and nondiscrimination
410(b) and 401(a)(4) without impairing the employer's ability to meet its prevailing wage
obligations. The same analysis applies in the case of a merged plan that covers both prevailing
wage and non-prevailing wage employees. It should be noted, however, that any dIffIculty in
on account of a highly compensated nonsatisfying minimum coverage or nondiscrimination
prevailing wage employee would have predated the merger and thus would not have been
occasioned by either the minimum participation rules of section 401(a)(26) or the prevailing
wage requirements of the Davis-Bacon or McNamara-O' Hara Act.

Department

of the Treasury

Washington,

D.C. 20220

Official Business
Penalty for Private Use,

$300

iUaI. I
Department

of the Treasury

FOR IMMEDIATE

March

D
Bureau of the Public Debt

RELEASE

ll'ashinyon,

CONTACT:

18, 1991

RESULTS OF TREASURY'S AUCTION

DC 20239

Office of Financing
202-376-4350

OF 26-WEEK

BILLS

for $8, 404 million of 26-week bills to be issued
21, 1991 and mature on September 19, 1991 were

Tenders
on March

accepted today (CUSIP: 912794XG4).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

5. 81%
5. 824
5. 82%

Low

High

Average

Investment
Rate

6. 08%
6. 10%
6. 10%

Price
97. 063
97. 058
97. 058

$3, 000, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 59%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED

Location

Received
32 , 410
151
23,
, 710
18 , 015

Boston
New

York

Philadelphia
Cleveland

27 , 425
37 , 430
29 , 620

Richmond

Atlanta

1, 500 , 375

Chicago
St Louis
Minneapolis
Kansas City
~

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive

Subtotal,

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

35 , 110
6 , 370
41 , 890

(in thousands)
32, 410
7, 343, 715
18, 015
27, 425
36, 430
27, 620
274, 325
18, 060
6, 370
41, 890
15, 335
134, 475

15 , 335
720 , 975
428 370
26 i 045/035

$8, 404, 440

$21, 746 , 330

$4, 105, 735

968 375
$22, 714 , 705

428 370

968 375

$5, 074, 110

2, 000, 000

1 330 330

$26, 045, 035

$8, 404, 440

additional $43, 470 thousand of bills will be
issued to foreign official institutions for ne cash.
An

NB-1182

artment of the Treasury
PREPARED
EMBARGOED

March

FOR DEL

UNTIL

18, 1991

~ Washinngton, D.

c. ~

Telephone 585-204~

ERY

12:30 P. M. (P. S.T. )

THE HONORABLE

MZCHOLAS

BRADY

SECRETARY OF THE TREASURY
RZIGLRKS TO THE COY2tONWEALTH CLUB
SAN FRANCZSCO,
CAI, ZZORNZA
MARCH

1S, 1991

Thank you, Vickie (Zen3cins).
Secretary Shultz, members of
the CctTzonwealth Club and honored guests -- thank you f r ~o
generous welcome.
I ar pleased to have th's opportunity to
discuss our nation's economic pr'or'- 'es with such a

distinguished

audience.

Ih1s ls a t. ;.. e when a'' ~=..e . cans can share ''n -he z newed
,"ride -e feel as e 'el=ome cu. men ard 'cmen home f-. om
Persian Gulf. I ' s not on', a very pr"ud mo-. ent =oz t.".e Unl ed
State~ -- a moment c. renewed patr otism -- bu. a'so a time of
restored confidence in ouz abil' y to meet the hal'enges that wc
wil' face as America prepa=es for th next ientu=;.

that the Gu'f War is beh'nd us, we can
attention to other prior'-'es, both '.". e=n~"icnal and do=esti=
Mucn oz our e fort must be focussed on -he need to encourage
&Jow

economic

fo:

growth

The broad

both

coopera-

home

and a ound

on fozged
The United

'.-.

the wor'd.

he Gul

sis

bodes wel'

States has ]oined with the
the wor'd economy.
allies to encourage the erne-gence of democracy and marketoriented econom c syste. .s all over the wcr'd, but par icular'y
~ill mean
. .astern Eu"opa and
.".ese developments
tl.". Ker ia.
"e
'mens
nat'o. -.=-,
of
developing
.
ci
not only be=ter prospec s or
but also new ma=kets f or Amer =an exports, creating growth

oppor

unities for our

own

economy.

sa'd

rece n ' g add essed
"~ur '=--: pr'==
s to ge =.-. s
:oln= Sess.
on == Congress,
'
'
'
"
a-e
«-s
-.
ar. =i= "„
an end
r=
.".g aga .-. . .'!is: e==nc.
~opera=e
ive gw w+
..e =e-' "n to
gz'c' ".". as -.".e ye " p ogr sses.
stac'
'er
and mo e
e oi'
l be oased on s-"ong expo=-s, lc
prices, increased credit avai'abi' ty and 'ower .".terest a as
in addition, the success of Desert S or. and the President's
leadership have renewed cars -.. ;e" and business co idence.
At home,

a« -he Pres dent

h n he

But the most important, economic development is the
President's budget agreement with Congress which has reformed
Federal government spending and created the framework for future
economic growth.

.hink about
billion reduction

:. federal
in

agreement mandates a $492
borrowing over the next five years
spending shall be governed by the

The 1990 budget

and dictates that federal
Since these reforms, the Federal
principle of pay-as-you-qo.
This
Funds rate has fallen from 84 in October 1990 to 64 today.
Bush's
Remember,
plan.
President
was not an accident.
This was
prior to the budget agreement, the Chairman of the Federal
Reserve, Alan Greenspan, said a "credible, enforceable reduction
he
in the budget deficit" would result in lower interest rates.
President forged just such an enforceable reduction package and
interest rates have dramatically declined.

Over the next five years, t?;e Federal government will borrow
in the credit markets a half tril'ion dollars less than it would
The
have borrowed in the absence of the 1990 budget agreement.
jntere~v rate decline that fo] lowed. makes jt clear that the
budget agreement has received a positive reaction from the
markets.

Those who don't think this will help stimulate economic
growth are dead wrong.
Americans who have received downward
adjustments in their variable rate mortgages and home equity
credit lines certainly understand what
means.
Those who can
lower monthly payments
buy a car oz a house with substantially
know what
means.
Lower interest rates and monthly payments
have always made a difference before and they will now.

And for American businesses,
lower interest rates mean lower
capital costs and a greater incentive to invest. And that means
more j obs and more economic activity.
Althougn these developments are encouraging,
this does not
mean we have rested on our oars.
And, we are taking additional

steps which will strengthen
the long-term.

the economy both in the short-run

and

to Congress a 1992 budget that
maintains spending at less than the inflation rate, meaning that
the real level of spending will decline. The President has
reaf firmed his commitment to restrain government spending and
stick to the pay-as-you-go provisions of the 1990 budget act
Now Congress must also adhere to these provisions.
President

Bush submitted

In addition to controlling the deficit, we will continue to
pzess for initiatives that will induce long-term economic growth
and ennance this country's competitiveness.
We are again asking
Congress to support the following initiatives as part of the
budget:
a permanent research anN experimentation
credit, fa-'l,"
savings accounts, enterprise zones, the allowance of withdrawals
from individual
retirement accounts for first-time home buyers,
and a capital gains tax rate reduction for individuals.
These
priorities can be met while still keeping future budget deficits
on a downward

path.

As a further step toward encouraging
the economic
turnaround,
the Adzinistration has taken steps to alleviate the
credit crunch. Together with the Federal Reserve, the FDIC, the
Comptroller of the Currency and the Office of Thrift Supervision,
we initiated
a review of the regulations covering bank lending.
Our goal has been to ensure that key regulations
are truly based
on common sense.
As the President said in the State of the Union
address, "Sound banks should be making sound loans, now. " We
should not foster an atmosphere of risk-adversitv
apprehension
and hesitation among lending institutions.

application of prudent reg la. 'on requires balance and
common sense.
There needs to be a recognition that banks,
borrowers, and economic sectors experiencing temporary
Difficulties may reed some f'ex bility to work through their
problems -- and that regulatory ;udgment should and can be qu'te
responsibly exez. cised in those situations.
Our review has
resulted in a number cf regulatory policy clarifications that
The

were announced

on March

.hese
steps alone will n=t end the credit crunch. However,
sense bank regulations combined with strict adherence to

common

the pay-as-you-go provision of the 1990 budget agreement, and the
Fed's action to lower intezest rates and reduce bank reserves,
should contribute to a renewal of U. S. consumer and industrial

activity.

Although the plan to ease the credit crunch addresses a
short-term problem in the economy, we must also come to terms
with longer range problems.
One of the Administration's
top
domestic priorities is to modernize our antiquated 40- and 50year old banking laws. This is important not just for the
financial services sector, but for the economy as a whole.
Businesses must be able to count on our financial services firms,
particularly banks, in bad times as "e'1 as good.

seen n the cuz". ent econo-. .. ic dow-. . tur. -. , weak banks
are forced to pul.' back just w.".en t".. eir good c stomers need the. .
obs are
mos
4hen loans stop a the first sign of t-cuble,
As we have

Zf we expect to exert world economic leadership in
imperiled.
the 21st century, we must have a modern, world-class financial
services system in our country. Right here in the United States.
whether this is the time for
Some have questioned
reform: Are we taking on too much? Shouldn't we
fundamental
listen to the winds of politics and make sure we don't offend
established interests? This reaction reminds me of the reception
in the report of the President's Task
given the recommendations
Force on Market Mechanisms f ollowing the stock market break in

October 1987.

of you will remember that the immediate conventional
were too radical -- that they
wisdom was that the recommendations
wouldn't be adopted.
However, the central finding of that report
as
Nhat had been seen traditionally
has never been challenged:
-the markets for stocks and stock index
separate markets
-once
Those recommendations,
fact
were in
one market.
futures
fact
have
in
seen as too challenging to the vested interests,
largely been put in place.
is this: I am confident that we will achieve
My point
fundamental
reform of financial services laws. Our proposals for
banking reform are based on the same principles that governed the
financial market reform. They address the reality of the modern
marketplace.
Increasingly, the financial services market is in
fact one market, and our laws must be modernized to deal with
this reality.
Consumers need a broader choice of financial products when
they go to the bank. Businesses and workers need strong, wellcapitalized banks that can keep lending in economic downturns.
The nation needs a banking system that is strong enough to
rivals have to
compete toe-to-toe with the best our international
offer. And most of all, the taxpayer needs to be spared the
prospect of another costly and unnecessary cleanup.
As we chart the future of our financial services industry,
there is much to worry about in the banking world. The state of
banking in the U. S. leaves taxpayers overexposed, consumers and
businesses underserved, and the industry increasingly
uncompetitive.
As a result, banks are unable to effectively
perform their important role in stimulating and sustaining
Many

economic growth.

Today, the United States does not have a single bank among
the world's 25 largest. Twenty years ago we led the standings
with the top three and had seven banks in the top 25. Of course,
the question of pure size is not the whole story. But against
the backdrop of an economy that is twice the size of our nearest
competitor's, I wonder if anyone can explain the complete absence
of U. S. banks from the list of world leaders.

Surely that statistic tells us something.
To me, it is
evidence
that
strong
something is very wrong,
Mould we be
comfortable with no aerospace companies in the world's top 25?
No pharmaceutical
companies?
No computer manufacturers?
Of
course not.
This is not a size issue, but a competitiveness issue.
Foreign banks are increasing lending in the United States as
American banks lose market share here at home.
Even U. S.
investors are not rushing to invest in U. S. banks. Our country' s
largest bank recently turned to foreign sources for a capital

infusion.

our banks -- large and small -- are
being asked to compete in a highly competitive world financial
services market with one hand tied behind their backs. For
example, we have out-of-date laws on the books that prohibit
banks from getting into new financial markets, and even keep them
from branching across state lines.
Banks in California, Michigan
and Utah can open branches 'n Birmingham,
England, but not in
The simple

B irmingham,

fact is,

Alabama

totally out of touch with reality. And they
unnecessary expenses on banks and consumers that have been
estimated to cost $10 billion annually, compared to total
Taking the simple
industry pre-tax profits of just $25 billion.
step of permit"ing interstate branching would significantly
improve the soundness of our banking system and cou'd lead to
lower interest rates for American borrowers and lower transaction
These laws are

impose

costs for depositors.

have long since begun to ignore the artificial
restrictions on banking practices, using credit cards, cash
machines, and the 800 number to handle their financial affairs
turned
Customers have increasingly
when and where they want.
Ford
from
CMAC
and
away from the banks, and now get auto loans
Motor Credit, checking services from Vanguard and Fidelity mutual
funds, business loans through General Electric Credit Corporation
Consumers

and Coldman

Roebuck.

Sachs, and they save at Merrill

Lynch

and

Sears

also have a deposit insurance system that has wandered
away from its original purpose of protecting only the small
depositor. This safety net now covers almost every depositor,
large and small, sophisticated and trusting, insured and
uninsured.
The system has bailed out large, money-vise investors
who don't need the protec ion, and exposed the taxpayer to
potential losses.
We

that is in the grasp of no
Ets ability to run
less than four separate federal regulators.
day-to-day affairs and respond quickly to changed conditions-such as the credit crunch -- is hamstrung by a myriad of
And

competing
What

finally,

have an industry

restrictions.
does this all

add up

to?

Bank

failures totalled 198 in

the 38 years from 1942 to 1980, but reached 206 in 1989 alone.
Interest rates and transactions costs are higher than they need
to be, due to inefficiency and higher costs. And the bank
insurance fund is under stress.

How do we help banks provide
do we reverse this trend?
better and less expensive services to the consumer, attract
capital, and lend when the economy is weak? The answer is plain:
We need to overhaul
our outdated laws which hinder the banks
ability to provide consumers with better services, lower costs,
As we
and the funds necessary to stimulate economic growth.
strengthen our banking system, we strengthen the ability of banks
to raise capital and compete internationally.

How

That means that
Our banks hold $2. 8 trillion in deposits.
there is simply no bank insurance fund large enough to protect
the taxpayer, unless and until we address the underlying
reform, supervisory
we need to have deposit insurance
problems.
reform, and a recapitalized Bank Insurance Fund. But we also
need interstate branching and broader financial activities so
that our banks can finance economic growth.

Nell-capitalized banks should be allowed to participate in
the full range of financial services in their natural markets-but to do so safely, outside the bank and outside the federal
deposit insurance safety net. The taxpayer should not back these
Neither should the taxpayer bear the cost of a
new activities.
banking system that has been artificially restricted by outmoded,
outdated

laws.

Deposit insurance coverage has expanded well beyond its
Our legislation
original purpose of protecting small depositors.
will address the problems of overextended deposit insurance yet
continue protection for small depositors, without losing the
benefits of stability in the banking system. It would eliminate
coverage for brokered deposits, and for large sophisticated fund
managers who use "pass-through" coverage'
We would also curtail the routine
practice of protecting
virtually all uninsured depositors in bank failures. Protecting
uninsured depositors should be the exception, not the rule, and
should occur only where there is a genuine risk to the financial
The system we have proposed would eliminate routine
system.
protection of uninsured depositors.
But it would still allow the
monetary

authorities

to respond to

a banking

crisis.

Many have asked about the too big to fail doctrine.
They
are conccrnad that big bank depositors are favored over small
Let me be very clear, under our plan all
bank depositors.
insured depositors will be safe and the banking system will be
sound.
The best way to treat large and small banks fairly is to
greatly reduce failures of all banks and particularly those which
would threaten systemic stability,
That is precisely the aim of

our banking

legislation.

the Administration
is proposing favor strong,
Most
banks, not necessarily large banks.
are
and
banks
the
best-capitalized
community
in the
regional
country, and win in head-to-head competition with the money
center banks in states that have within state branch banking.
The changes

well-capitalized

legislation "ould
creating incentives for
Our

make

banks

effective
high
certain

more
bank superv'sion
to build and maintain

levels of capital. It will also provide swift and
sanctions against banks with too little capital by creating a
regime of specific supervisory actions that are triggered by
declines in capital levels.
Finally, the Bank Insurance Fund (BIF) is at its lowest
level in history as a percentage of insured deposits. The
Federal Deposit Insurance Corporation (FDIC) has projected that
it will decline still further over the next two years. Without
an infusion of funds, the FDIC could find itself with too little
cash to pay for losses, resulting in possible exposure for the
The Bank Insurance Fund must therefore be
taxpayer.
recapitalized with industry funds'
The time has come to address these problems at their core;
and to put this
to deal with them decisively and comprehensively;
country's financial services industry back where it belongs:
number one in the world.
leave the job half done -- if we on'y tinker with the
If wa
problem -- then we' ll probably be back again, sooner rather than
later, recapitalizing the Bank Insurance Fund again, perhaps the
next time with taxpayer money. That's a prospect no one could

relish.

to the reality of the
markatplaca today, we can help to ensure financial security for
financial system that is
We can create a modern
the future.
protect depositors, save
will
that
competitive,
internationally
The timing

taxpayars

money,

is right.

facing

serve consumers

and

strengthen

the economy.

Modernizing our financial services industry, encouraging
sound lending practices, holding down the Federal Governments'
spending, pushing for lower U. S. interest rates and encouraging
the winds of freedom and free markets around the world will
contribute to the strength of our economy. With President Bush's
leadership we can achieve these policy objectives and provide for
a secure economic future, not only for all Americans, but for all
nations. With your help we' ll get it done.
Thank you.

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Citation Information
Document Type: Transcript

Number of Pages Removed: 35

Author(s):
Title:

White House Conference on Eastern European Management

Date:

1991-03-05

Journal:

Volume:
Page(s):
URL:

Federal Reserve Bank of St. Louis

https://fraser.stlouisfed.org

Ipartment of ihe TFeasory
FOR RELEASE AT

19. 1991

&arch

4: 00

Woshlneion, D.C. ~

P M.

CONTACT:

0 ice o= ='nancin™
.
202, '376-4350

TREASURY'S WEEKLY BZLL OFFERZNG

The Department of the Treasury, by this public not'ce,
invites tenders for two series of Treasury bills total'ng
approximately S 16, 000 million, to be issued «a=oh 23, L99L.
This offering will result in a paydown for the Treasu=r of abcuS 3, 250 million,
as the maturing bil's are ou. s.anding 'n he
amount of S '9, 259 million.
. enders .~i'-' be race' red a- =. "era'
Reser re Banks and Branches and a. ".he Bureau == he p '=' = =eb".
Washington
D. C. 20239-1500, ."."nda r, &a=:.". 5,
prior to 12:00 noon for noncompe ' "i.re ende=s and r.'o: -. o
. .-. e, o= c"~=eti
1:00 p. m. , Eastern
S tandard
The two series offered are as follows:

S 8, 000

dated

91-day

bills (to

million,

urity date) for approximately
an additional amount of bills

representing

27, 1990. and to mature
J~~ne
1991
912794 WQ 3) . cur ently outstand' . .g '.". he amount
million, the add' "=ona' an" ==. - na' b ' ' s =o '"e
'.". erchan
oab' e

December

(CUSZP No.
of S 9, 3 0

==ee'

- ~a-"-. —. a- )
S 3, 000
million, represent. ng an aCd =. onal amount
dated Seotembe
5ep= -oe=
, '. .'90, and "o ma=u=
outs. anding in he
( CUSZP No. 912794 WU 4), currently
of S LO, 630 million, the add' ional and original bill3

-dav b'

(

freely interchangeable.
The bills will be issued on
"ive and noncompeti. ' ve b' dding,

.
a
and

will be payable without interes. .
issued entirely in book-entry form
and in any higher S5, 000 mult'pie,
Federal Reserve Banks and Branches,
Treasury

bills will

amoun"
o be

-=" ,".=

'oa- — .". e=
~atur. - r the

Bo:h series o= bi'ls
in a minimum amoun. of S;C, CCC
on the records eithe= of :he
or of the Department of the

or
fo= cash and in exchange
28, 1391.
.
.enders from =ede=~'
own account and as agents for fore' --. ,
and international
monetary authorit'es wi'1 be accepted a
the weighted average bank d' scount =a es o acce ". d compe". The

be issued

Treasury bills maturing
Reserve Banks for their

'lac-ch

.'ve enders. Addi". 'ona'
:edera' Reserve Banks, as

amounts

he b

''-

~a r

agent~

ne ag-=
. - =.-.a
acne=a=r autho-i" es, == "..e ex- ".
ende s === -uch accoun=s exceeds =he a, -= a e

a.-, .c

hold S 2, '46 mil'. on as agen:—
and S 3. 405 million for the r own account.
monetary authorities,
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).

TREASVRY S

AND

llfEEK

BILL OFFERINGS

Page

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
A single
two decimals, e. g. , 7. 154. Fractions may not be used.

bidder, as defined in Treasury s single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.

and dealers who make primary
Banking institutions
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
Each tender must state the amount of any net long
own account.
position in the bills being offered if such position is in excess
This information should reflect positions held
of $200 million.
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.

issue price as determined

in the auction.

and

1/91

trust

TRFASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page

Settlement

for accepted tenders for bills to be maintained

bills.
If a bill is

at issue, and is held to maturity,
as ordinary income on the
reportable
the amount of discount is
Federal income tax return of the owner for the year in which
Accrual-basis taxpayers, banks, and other
the bill matures.
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.
purchased

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.
Department

8/89

of the Treasury

Department

NeshlnSton,

D.C. ~ Telephone $44-2041

FOR RELEASE UPON DELIVERY
EXPECTED AT 10:00 A. M.

20, 1991

MARCH

TESTIMONY

OF KENNETH

GIDEON

ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT

OF THE TREASURY

BEFORE THE
COMMITTEE

FINANCE

UNITED STATES SENATE

Mr. Chairman and Members of the Committee, I am pleased to
discuss with you today the revenue proposals contained in
President Bush's FY 1992 budgets
The Administration's

budget

agreement

developed

1992 Budget abides by the terms of the
last year. We view the budget process

particularly the "pay-as-you-go" provisions, as an
part of the agreement.
It is essential that Congress
the Administration
adhere to both the letter and spirit of

reforms,

integral

and

these reforms.

The revenue proposals in the budget which I will discuss
today address the need to promote long-term economic growth as
well as addressing current problems.
These proposals are
financed through a combination of initiatives which raise
revenues and decrease spending.

Incentives

for Research

and Experimentation

We recommend
that the 20 percent research and
experimentation
(R6E) tax credit, which is set to expire af'ter
1991, be extended permanently
Research is inherently a
long-term process. To obtain full value for this incentive, it
must be reliable and dependable -- not subject to the
uncertainties of an annual debate on renewal.
In addition, the
current allocation rules for R&E under section 861 should be
extended for another year.

Family Savings Accounts
We

savings
NB-1185

hope to improve our country's low
by creating a new savings vehicle,

rate of personal

the Family Savings

contributions to an FSA of up to
Account (FSA). Nondeductible
$2, 500 per taxpayer would be permitted with a maximum of two
accounts per family. After meeting the required 7 year holding
period, all savings, including the accumulated earnings, can be
withdrawn tax free. Withdrawals
of savings within 3 years of the
time the contribution was made will result in a 10 percent excise
tax penalty and an income tax on the accumulated earnings.
Earnings on funds withdrawn between 3 and 7 years after
contribution will be subject only to income tax with no excise
tax penalty-

are explicitly a savings -- not a retirement
The time limit to obtain full benefits is short enough
program.
to focus attention on specific personal goals -- saving to buy a
for education costs, building a financial reserve
home, preparing
to protect against unexpected events, or any high-priority
objectives. FSAs will not undermine the basic retirement focus
of existing IRAs and pension plans; they will supplement those
long-term savings plans with a vehicle suitable for shorter term
needs.
FSAs

From the Government's
perspective, the FSA does not cause
large revenue losses at the beginning of the program because the
contributions are not tax deductible.
Instead, the earnings
created by the contributions to FSAs will be exempt from taxes.
This approach is prudent because we can evaluate the impact on
revenues and savings as we proceed without incurring large
front-end revenue losses.

Enterprise
To help economically

Zones

distressed

areas enjoy the benefits of

economic growth, we recommend designation of up to 50 Federal
enterprise zones which will benefit from targeted tax incentives

Federal, state, and local regulatory relief. The Federal tax
incentives would be: (i) a wage credit of up to $525 per worker;
(ii) elimination of capital gains taxes for tangible property
used in an enterprise zone business; and (iii) expensing by
individuals of contributions to the capital of corporations
engaged in the conduct of enterprise zone businesses.
The
willingness of states and localities to "match" Federal
incentives will be considered in selecting the enterprise zones
to receive these additional Federal incentives.
and

for First-Time Home Buyers
We propose to allow individuals
to withdraw amounts of up to
$10, 000 from their IRAs for a "first-time" home purchase.
The 10
percent additional tax on early withdrawals imposed under current
law would be waived for eligible individuals.
Our proposal is
designed to enhance the attractiveness of deductible IRAs by
Penalty-Free

making

them more

IRA Withdrawals

flexible.

Since

home

equity

is itself

significant

of retirement

for many Americans, we do
for this purpose undermines

Proposals

Provisions

saving
withdrawals

form

not believe that allowing
the retirement saving objectives of IRAs.

The budget

following

on Expiring

contains proposals to extend for one year the
that would otherwise expire at the end of

programs

fiscal 1991:

housing credit encourages the private
sector to construct and rehabilitate the Nation's
housing stock and makes it available to low-income
families. In addition to tenant-based housing vouchers
and certificates, the credit is a mechanism for
providing Federal assistance to rental households.
Geothermal and solar energy credits are intended to
encourage investment in renewable energy technologies.
Increased use of solar and geothermal energy would
reduce our Nation's reliance on imported oil and other
fossil fuels and would improve our long-term energy
security, while also reducing air pollution.
The targeted jobs tax credit is intended to encourage
workers who otherwise
employers to hire disadvantaged
We do not believe
find
be
unable
to
employment.
might
reduced
in the
should
be
incentives
creation
job
The low-income

current economic climate.

deduction for health insurance costs of
self-employed individuals reduces the disparity in the
tax treatment of such costs between self-employed
individuals and owners of incorporated businesses.

The 25 percent

Special

Needs Adoption

again urge the enactment of an income tax deduction (up
of $3, 000 per child) for expenses incurred in
When
connection with the adoption of special needs children.
combined with the current outlay program under the Adoption
Assistance Program, the proposal would assure that reasonable
expenses associated with the process of adopting a special needs
child do not cause financial hardship for the adoptive parents.

a maximum

Capital Gains Tax Rate Reduction

for Individuals

the capital gains tax rate for individuals is
important to restore economic growth and competitive strength by
activity, and risky investment
promoting savings, entrepreneurial
At the same time,
in new products, processes and industries.
investors should be encouraged to extend their horizons and
Reducing

To
with longer term growth potential.
to invest for longer periods of time, we
believe that the tax rate for capital gains on assets such as
real estate, timber, homes, farms, land and corporate stock
should be reduced based on the length of time an asset has been

search for investments
encourage

Americans

held.

Under our proposals, the capital gains tax rate would be
Individuals would
reduced by means of a sliding-scale exclusion.
be allowed to exclude a percentage of the capital gain realized

the disposition of all assets qualifying as capital assets
Individuals would
current law, except for collectibles.
their current marginal rate on capital gains (either 15 or
28 percent) to the reduced amount of taxable gain.
The amount of
the exclusion would depend on the holding period of the assets.
Assets held 3 years or more would qualify for an exclusion of 30
percent. Assets held at least 2 years but less than 3 years
Assets held at least 1
would qualify for a 20 percent exclusion.
year but less than 2 years would qualify for a 10 percent
upon

under
apply

exclusion.

For example, individuals subject to a 28 percent tax on
capital gains (i. e. , taxpayers in the 28 and 31 percent tax
brackets for ordinary income) would pay rates of 25. 2, 22. 4 and
19.6 percent for assets held 1, 2, or 3 years, respectively. The
corresponding figures for individuals subject to a 15 percent
rate would be 13.5, 12. 0 and 10.5 percent.
For the balance of 1991, the 30 percent exclusion would
apply to all qualified capital assets held at least 1 year. For
assets disposed of in 1992, the 30 percent exclusion would apply
to assets held at least 2 years, and the 20 percent exclusion
would apply to assets held at least 1 year but less than 2 years.
The general rule would apply in 1993 and all years thereafter.
The excluded gains would be subject to the alternative minimum
tax. Prior depreciation deductions would be recaptured.
The Administration
believes that this capital gains proposal
would lower the cost of capital and stimulate investment,
reduce
the lock-in effect, and lower the double tax on corporate stock
investment.
Given that there are divergent opinions on the
relative strength of these effects, however, President Bush
requested Federal Reserve Board Chairman Alan Greenspan to study
these matters. We hope that the Congress will work with Chairman
Greenspan and the Administration
to illuminate and resolve the
disagreements surrounding the revenue, distributional
and
macroeconomic effects of a capital gains tax rate cut.
The president's budget contains several additional proposals
to increase revenues. I would like to mention three today.
Other proposals not discussed in my written statement are
described in the Treasury's "General Explanations of the

President's Budget Proposals Affecting Receipts" which was
released with the Budget in February.
Additional Internal Revenue Service Funding
The budget calls for an increase in Internal Revenue Service
-- one in the
funding for tax law enforcement.
Two initiatives
area of field examinations and the other in the area of
collection of accounts receivable -- are expected to add $700
million to receipts over the budget period.
Medicare Hospital

Insurance

(HI) for

State

and Local Employees

propose extending

coverage by Medicare Hospital Insurance
government employees.
State and
local government employees are the only major group of employees
One out of six State and local
not assured Medicare coverage.
government employees are not covered by voluntary agreements or
However, an estimated 85 percent of these employees
by law.
receive full Medicare benefits through their spouse or because of
Over their working lives, they
prior work in covered employment.
contribute on average only half as much tax as paid by workers in
the private sector. Extending coverage would assure that the
remaining 15 percent have access to Medicare and would eliminate
the inequity and the drain on the Medicare trust fund caused by
those who receive Medicare without contributing fully. The
addition of two million State and local government employees as
contributors to Medicare would increase revenues by $7. 3 billion
over the budget period.
We

(HI)

to all State

and

local

Special Occupation Taxes

of
To increase compliance rates and revenues, distributors
alcoholic beverages would be required to verify prior to sale
that their retail customers pay the special taxes in connection
It is expected that this measure will
with liquor occupations.
increase revenues by about $100 million over the budget period.
The proposal would be effective beginning October 1, 1991.
Conclusion

the controversy which has surrounded capital
gains estimates, the budget has been formulated to meet
"pay-as-you-go" requirements without relying on the revenues
which we believe would be generated by our capital gains
proposal. The reductions in mandatory program outlays outlined
in the budget together with the proposals increasing revenues
which I have described are more than sufficient to fund the items
which reduce receipts, even if revenues from capital gains are
disregarded.
Recognizing

look forward to working with the Congress
to enact a budget which fully complies with
last year's budget agreement. We believe that our budget
proposals meet that goal and urge the Committee to report
legislation embodying those proposals.
Mr. Chairman,
and this Committee

I would be pleased to answer any questions
Mr. Chairman,
which you and other members of the Committee may have.

of the Treasury

apartment

EMBARGOED

Washington,

O.C. ~

telephone 566-244~

UNTIL GIVEN

20, 1991

MARCH

STATEMENT TESTIMONY OF NICHOLAS F. BRADY
SECRETARY OF THE TREASURY
BEFORE THE
COMMITTEE ON APPROPRIATIONS
SUBCOMMITTEE ON TREASURY, POSTAL SERVICE
AND GENERAL GOVERNMENT

March 20,

1991

it is my pleasure
to appear before this Subcommittee to Committee,
discuss the operating
budget request for the Department of the Treasury for FY 1992.
Since we met a year ago, significant events have taken place
in both the international
and domestic arenas.
As part of the
international coalition, we have addressed the situation
in the
Persian
Mr. Chairman

and Members

of the

Gulf.

We have taken a positive
step toward responsibly
Government by forging a budget agreement that adds
discipline to Government spending.
Seeking peace, stimulating
economic growth, and responsibly managing Government spending are

managing

challenges

for our nation.

The Department

enforcing

economic

has supported Operation Desert Storm by
economic sanctions against Iraq, by assessing the
impact of the conflict on the "front line" countries

coordinating, processing
for Operation Desert Storm.
by

be continued

war must

new

investing

and

foreign contributions
These efforts which helped win the
ways for us to win the peace.

and

The Administration
anticipates a short-lived recession with
recovery beginning at mid-year and the economic pace picking up
later in the year. This should bring unemployment down and

enhance

growth.

Last month,

I testified before the Senate

and House Budget
and the House Appropriations
Committee on the need to
restrain Government spending and abide by the budget agreement so
that future budget deficits can be controlled.
The Treasury
budget request presents an honest approach to responsible
spending.
More importantly,
we are targeting
every opportunity
available to promote fiscal responsibility and provide innovative

Committees

to today's problems.
We know that the savings
and loan cleanup and the safety
and soundness of our banking system are near the top of
everyone's list of domestic issues which require thoughtful,
responsible analysis and workable solutions.
In that regard,
have recently proposed a comprehensive
plan for banking reform
that preserves deposit insurance for small savers, strengthens
responses

banks by

outdated

attracting
laws,

and

capital, increases competition by modernizing
the regulatory structure.

streamlines

In addition to the banking reforms, we have asked Congress
to support initiatives to stimulate growth and competition that
family savings accounts to increase national saving;
include:
tax credit to promote
permanent research and experimentation
private research and development; first-time home buyer
withdrawal from IRAs; and reduction in the capital gains tax.
The Department of the Treasury's functions are broad and
critical to the Nation s economic well being. These critical

activities include:
0

developing

international

developing

economic

policies;

effects of tax

borrowing

money

Government

and

debt;

monetary,

financial

and

trade

policies that consider the economic
policy;
needed to operate the Federal
accounting for the resulting public
and budget

collecting the proper amount of tax revenue, at the
least cost to the public and with the highest degree of

public confidence;
0

improving

Federal cash management

and debt

collection

practices

governmentwide;

producing

currency

carrying out activities that include collecting revenue
from imports; collecting excise taxes on alcoholic
beverages and tobacco products;

administering

and

coin for the Nation's

commerce;

embargoes and economic sanctions against
foreign countries to further U. S. foreign policy and
national security goals; and
regulating national banks and Federal and State
chartered thrifts.

to carry out these essential Government
are requesting a total FY 1992 budget of $9. 6
billion and 162, 999 full time equivalent positions.
To continue

functions,

The Fiscal Year 1992 budget request has the following major
objectives:
Modernize Information S stems. Treasury plans to
aggressively upgrade and integrate our existing systems
to ensure they will perform in the electronic
environment of the next century.
For example, this
budget requests funds to continue our commitment to

and statutory environment
of financial
transactions.
we
Ultimately,
expect TSM to relieve IRS
of its manual processes so that we can dedicate our
personnel to even higher standards of service quality.
volume

'nances. The
ove Mana ement of the Nation's
proposed budget for the Financial Management
Service (FMS) includes funding to determine the best
budget and asset and
approach to merge governmentwide

liability data bases, to enlarge current efforts to
financial management evaluation criteria and

establish

Funds are also requested to
improve data standards.
implement the Credit Reform Act of 1990 to more
accurately account for the costs of direct and
guaranteed loans, and to comply with the Cash
Improvement Act of 1990 which requires
Management
payment of interest when the Federal Government does
not provide, or the States do not disburse, Federal
funds in a timely and efficient manner.

rove Inte nal Cont ols. Funds are requested to
strengthen Treasury's internal controls and fully meet
the requirements of the Federal Managers' Financial
Integrity Act. These funds include continued

development of financial systems at IRS and Customs to
Further, these funds also
enhance resource allocation.

the completion of a new public debt accounting
system that will improve automated controls and
information.
management
support

Inc ease nforcement of the Tax Laws. In an orderly
and thoughtful
way, we want our service coverage and
operations to keep pace with the economy. As more
returns are filed, more follow-up is required in every

function so that we maintain a
compliance with the tax laws.
to give special emphasis to Accounts
the collecting of back taxes. We also must

service and enforcement
high level of voluntary

continue
Receivable,
be responsive to growing requests from business
organizations to help them determine what is proper
compliance with a variety of tax code provisions.
Internally, the IRS must support higher Government
and
standards for financial systems accountability,
continue to address the higher threat of narcotics
We
crime to the integrity of tax administration.
consider all of this proposed spending to be a wise and
necessary investment.

Law Enforcement
and the War on Dru s. The War on Drugs
will continue as a national priority in FY 1992.
Treasury is a major participant in the War on Drugs and
is committed to working with the Office of National
In support of key priorities of
Drug Control Policy.
the National Drug Control Strategy, Treasury continues
as a major participant in the Organized Crime Drug
Enforcement Task Force (OCDETF) and the High Intensity
The Customs
Drug Trafficking Area (HIDTA) Programs.
Service will continue to strengthen the President's War
on Drugs through its narcotics interdiction
efforts.
Part of this strategy is the successful cross
designation of 1, 000 Customs special agents with the
Drug Enforcement Administration
(DEA). Funds are
requested to enable Customs to fly the air assets that
will come on-line in FY 1992, to expand the Canine
Training Center and to provide service to the importing

community-

tobacco.

its

consolidated

years.

commitment

training

Our

Financial Crimes Enforcement Network (FinCEN)
request provides funding for the operation and
of the FinCEN intelligence information
improvement
system providing financial intelligence to deter money
laundering and other financial crimes.
The

budget

The Secret Service budget request provides
protection for the President, Vice President and their
families, as well as candidates and nominees for the
1992 Presidential Campaign.
In addition, the Secret
Service will be aggressively utilizing manpower and
resources to combat fraud against financial
institutions as a direct result of new authority
Committee this past
provided by the Appropriations
year.
and Coina e. The
Meet the Nation's Demand for Currenc
budget for the U. S. Mint will provide for production of
sufficient coinage to meet expected demand. The Bureau
of Engraving and Printing (BEP), which does not require
will meet the demand for
annual appropriation,

currency.

Formulation and Mana ement Overs' ht o
Offices
The Departmental
e artmental 0 erations.
budget request will permit the Department to carry out
economic, financial and tax policies.

In summary,

represents
o

the Department's

a commitment

budget

to:

request of $9. 6 billion

the administration of the tax laws,
collection of revenues and responsiveness to the

modernize

public;

the

of the Nation's

finances;

improve

strengthen internal controls to facilitate the
responsible management of the Nation's financial

management

resources;
0

enhance

the war on drugs;

and

essential Government services.
I will be
Mr. Chairman, that concludes my opening remarks.
to answer any questions that you or the other Subcommittee
0

happy
members

manage

may

have.

Irtment of the Treesiiry

Washlneton,

O.C. ~ Telephone Sdd-2041

991

e 4

It is

time to

and

IRCOJXII

* I

\ I Y
IUIIOIJM
that date back to the 1930s.
to protect depositors
Banks must be
taxpayers.

~~
A

strong,

essential to

at'
a strong,

and

'v banking
economy.

growing

outmoded

the

way

system

financial

e
W

NB-1187

d'n

the economy slows,

when

costing jobs.
h'nd
te nat'ona corn e 'to
Our banks are a
Not one of the 25 largest banks in the world is
American, compared to seven of 25, including the top
three, just 20 years ago.
hurting

businesses

and

The

Benefits of Reform

safe

internationally

competitive banking
otect de osito s and ta a ers, se e consumers,
industry will
benef t wo kers and bus'nesses, and st en then our nation.
A

modern,

rotect

and

ositors

and

Depositor confidence

ers:

safe, competitive,

wel

system;

limitations

tax

failures;

bank
and a

strong,

protection will

taxpayer

and

result from:
A

-ca italized banking

er ex osure to losses

11-ca italized insurance

from

fund.

Serve consumers:
An

efficient, integrated

financial

services system will

mean:

will have access to a wider ran e of
services at the least possible cost.

Consumers
Consumers

enefit
A

worke s

healthy

also will enjoy the convenience
usinesses:

banking

will ensure:

Jo s
the

S a

first

markets
good.

competitive

system with strong,

ese ed because loans are not called at
sign of economic downturn.

bus'nesses
ou

that lack access to securities
b n

in bad times as well as

en
A

financial services system provides a
for a world-class economy:

world-class

foundation

banks

International

f»

economic leadership

century will require

'nternatio
y

in the 21st
a

The

eI Savernin

cform

eserve de osit insurance for small savers
First, we will
while
rotectin ta a ers b reduc n the overextended de osit
'nsurance s stem. Deposit insurance, originally intended to
protect small depositors who could not protect themselves, has
been expanded so that large, sophisticated investors receive
unneeded protection.
This reform will restore market discipline
over risky activities that have increased the possibility of
taxpayer exposure to losses in the banking system.

st -- e
b
c '
e
e
not by raising capital
but with a plan to attract capital to the banking
This will include rewarding well-capitalized
banks

Second,
n

standards,
industry.

with new

activities that will attract still further capital,

taking prompt
banks.
Third,

and

corrective action to address under-capitalized

we w'

"""'1'~ '*'

't've

mode

niz

regulatory

we w'

responsibilities

the
s
em b
Currently, overlapping
lead to confusion and uneven results.
'

OF THE L GISLATION

KEY ELEMENTS

EPOSIT INSURANCE

COVE

coverage for small savers.

Preserves deposit insurance

erson

00 000

er inst'tut'on

et'

savin s

ement

SOIl

period.

year phase-in

Two

er inst't t'on

A husband
and wife will be able to have
as $400, 000 in insured deposits in any one
institution ($200, 000 each). While this reduces
the amount of deposit insurance available at any
one bank, if the couple needs more than $400, 000
coverage, they can still go to another bank to get
an additional
$400, 000 insured coverage.

Example:

much

chan e in cu

Eliminates

ent

eatment

coverage for "

Reduces deposit
pension plans.

insurance

e ed de

coverage for

Eliminates

s-th

most professionally

os'ts".

for professionally

Eliminates

~gsS .

of cor orate accounts.

ank

'nvestment

ou h" covera e
managed pension

managed

cont

for deposits of
plans.

Exceptions:
oo

Continues

state

and

deposit insurance

local

government

coverage for
pension plans

for

Continues deposit insurance coverage
escrow and similar types of accounts

Continues coverage for self-directed pension
plans (such as IRAs and small company
Keoghs).

FDIC to perform 18 month study of feasibility,
costs
and benefits of implementing
system-wide limitation of
coverage for every depositor; Fed to undertake survey
to gather data on ownership of deposits and report in

year.

one

II.

BIO TO

an e

'nsured

cur

and uninsu

otect'n
e os tors in ever case.
u 'nsu ed de os'tors on

routine

permitted

u d

Treasury and the Fed could order
e
s ts
consultation with OMB and FDIC.
Three year phase-in

ve a

un'

period.

IS
establishment

of a

stem

Requires

Effective two years after enactment.
Risk categories must use

to ov
i
c to resolving a
east ost
failed institution.
Maintains ability to intervene in cases where there is
a threat to our financial system (same power afforded
to governments of every other industrialized nation).
FDIC

III.

PA L

liminates

e' s

as fundamental

measure.

IV-

RESTRICTIONS

FED

Maintains
exposure.

NSURED

dual banking

STATE BANK ACTIVITIES

but limits

system,

taxpayer

states' ability to authorize risky
activities for federally insured state banks.

Limits the

state-chartered banks and their
subsidiaries vill not be able to undertake principal
activities vhich are not permissible for federally
insured national banks, unless they meet their capital

Federally

insured

requirements

and

from the FDIC.

obtain permission

ook for risky stateon the
Tax a ers shou d o
chartered bank activities that are covered by federal

deposit insurance.

MPROVED

SUP ERV S

that fall be w minimum ca ital standards a e
ub'ect to om t co ct've ction - including, for
example, dividend cuts — aimed at preventing failure.
Generally, requires a ua on site examinat'ons for
Banks

banks.

Smaller hanks

that maintain

(less than $1 billion in assets)
capital need only have

required

exams once every

Capital standards

must

18 months.

reflect interest rate risk.

d't

Recognizes

National

insurer

Credit Union Administration

and

regulator.

'
Protects taxpayer by
insurance fund assets over

'ons.
(NCUA)

double

12 year

remains

count'

period.

Revises the Board of Directors of NCUA to include the
Director of the Office of Depository Institutions
Supervision as a Board member.

VII.

8ERVICE8

INANC

'ts

NOD

anc a
e v c s o be conducted on
in
se grate
ca ita ' ed ' anc'a a
ates and onl
o well-ca 'tal'zed ba ks.
e

new

Only banks

Requires

access to deposit insurance

have

coverage.

appropriate

activities are not
insurance

Creates "

structure

affiliates
insurance.

Allows

firewalls

conducted

safety net.
'

which

are well-capitalized)

~g~"

(DHC)

s
through

new

the federal deposit

vice
will permit a single

engaging
e

to ensure that

under

in banking,

fund

(FSHC)

company

securities,

a " 've

(if
'

own

and

FSHC's
banks
'
d

on lending inside FSHCs (23a
cannot
Banks
put deposit insurance funds at

Tighter limits

23b).
risk in

services.
Broad regulatory authority to prevent unfair
competition, conflicts of interest, and unfair
Banks cannot use deposit
banking practices.
insurance funds to gain an unfair competitive
advantage in other financial services activities.
Strict disclosure laws to ensure that customers do
non-bank

financial

not confuse insured

products

with uninsured

products.

Regulatory authority to limit disclosure
public customer information.

of' non-

lending

affiliated

fail to

its

FSHC,

any

company.

maintain

covered b

commercial

capital restoration requirements on FSHCs that
specified levels of capital in banks
they own. They must either build up the capital of the
bank to the required level, sell the bank, divest
themselves of non-bank financial activities, or become
subject to holding company capital requirements and
much greater regulation.
Similar prompt corrective action applies to commercial
firms that own FSHCs that fail to maintain specified
capital levels in banks they own.
Provides for functional re ulation of new activities
allowed in subsidiaries.
Requires insured depository institutions and affiliates
to prominently disclose in writin to each of their
customers that any securities or insurance
roducts
offered, recommended, or sold by the institutions or
affiliates are not deposits and therefore are not
Imposes

by a bank,

federal de osit insurance.

Insurance
Banks and insurance companies
full two-way street.

can

affiliate

on a

Insurance affiliates of banks continue to sell
insurance in any state, but banks themselves can
only sell insurance in states where state-

sell insurance.
National banks can sell insurance wherever state
banks are allowed to sell insurance, but
interstate authority to sell insurance in towns of
chartered

banks can

5, 000 or less would be eliminated.

Securities
Banks and securities companies
a full two-way street.

could

affiliate

Certain securities activities are moved out of
banks into subsidiaries or affiliates.

Est

real estate development by state or national
banks. Real estate development and brokerage
cannot be financial activities in new FSHC.
Existing real estate brokerage activities of
state-chartered banks are left undisturbed.

VIII. NATIONW

BANK N

Authorizes
companies

'onw'de

u 1

following

Authorizes

ban

for

ch'

a e

bank holding

period.

for national

banks

any state in which the financial services holding
company in the same state could acquire a bank.

Removes

banks.

barriers to interstate

branching

state

R GVLA

Generally, preempts state anti-affiliation provision,
but continues policy of having states determine
limitations on direct bank marketing of real estate and
insurance products.

Preserves procedures

for enforcing the

Community

Act (CRA).

Reinvestment

States may tax interstate branches to the
they tax interstate banks.

same

extent

(the Federal Reserve, the Office of the
Comptroller of the Currency, Federal Deposit Insurance
Corporation and Office of Thrift Supervision) into two
regulators, vith the same regulator responsible for a
bank holding company and its principal subsidiary bank.

f ~ 1bM ~ ~ y
nst'tut'on Su ervis'o -- as a bureau of
the Treasury vhich replaces the Office of the
Comptroller of the Currency and the Office of Thrift

osit

Supervision.
S

ate-chartered

regulated
Nationa
banking

the

banks
d

(including savings banks) vill be
ra Rese ve.

vill

banks
agency

be regulated
the Off'ce of

by a new
De

ositor

federal

Inst' ution

~Thr'fts and their holding companies vill be regulated
Institution Su erv's'on.
by the Of 'ce o De ositor

There

the insurer.

XI.

RECAPITALIZATION

reduction

OP BANK

FDIC examination

N8URANCE

PUND

authority

BIP

Includes necessary legislative language to implement
FDIC proposal for industry financed recapitalization

BIF.
FDIC

billion

FDIC

vill

pay

interest

equal to the Treasury
maturity-

at a rate
of comparable

on any such borrovings

rate for borrovings

this nev authority vill be secured
of insurance premiums in
sufficient to service and retire the debt in

borroving

under

by the FDIC's dedication

amounts

accordance vith
Annual

vill

will be authorized to borrow up to a maximum of
from the Federal Reserve banks.

$25

Any

premiums

be capped

its

terms.

paid by the BIF insured institutions
an aggregate of 30 basis points.

FDIC's existing authority
and the Federal Financing

borrow

Bank

vill

from the Treasury
not be affected.

XII.

ROVISIONS

FOR

MALLER

Increases the exemption in the Home Mortgage Disclosure
Act for small depository institutions
from $10 million
to $50 million and eliminates duplicative reporting.
o

Treasury,

and

the appropriate

federal banking agencies

to review whether it is feasible to reduce the number
of reporting requirements for institutions with assets
less than $50 million.

XIII. FOREIGN

BANKS

Foreign banks are provided national
Treasury's proposed reforms.

treatment

under

Iriment of the Treasury
FOR RELEASE AT

March

20, 1991

4:00 P. M.

Washineton,
CONTACT:

O.C. ~ Telephone

sii-204$

Office of Financing
202/376-4350

TREASURY TO AUCTION 2-YEAR AND 5-YEAR NOTES
TOTALING $20, 000 MILLION

The Treasury will auction $11, 500 million of 2-year notes
$8, 500 million of 5-year notes to refund $18, 826 million of
securities maturing March 31, 1991, and to raise about $1, 175
million new cash. The $18, 826 million of maturing securities are
those held by the public, including $2, 014 million currently held
by Federal Reserve Banks as agents for foreign and international
and

monetary

authorities.

The $20, 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 aver-

prices of accepted competitive tenders.
In addition to the public holdings, Federal Reserve Banks,
for their own accounts, hold $1, 876 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 offerage

ing

circulars.

oOo

Attachment

NB-1188

HIGHLIGHTS OF TREASURY OFFERINGS TO THE PUBLIC
OF 2-YEAR AND 5-YEAR NOTES TO BE ISSUED APRIL 1, 1991

March
Amount

Offered to the Public

Descri tion of Securit
Term and type of security
Series and CUSIP designation
date

Maturity

Interest Rate

yield
or discount
Interest payment dates
Minimum denomination
availabl
Investment

Premium

of Sale:
of sale
Competitive tenders

Terms
Method

Noncompetitive
Accrued
by

tenders

interest payable

investor

Pa ment Terms:
Payment by non-institutional

investors

$11, 500 million

$8, 500 million

2-year notes
Series Y-1993

Series M-1996

the average of accepted bids
To be determined at auction
To be determined after auction
September 30 and March 31
$5, 000
Yield auction

a) funds

(final payment
institutions):

to the Treasury
readily-collectible check

Yield auction

None

to be
with tender

Full payment

submitted

March

Monday,

Thursday,

Accepted in full at the average price up to $1, 000, 000

to be
with tender

Full payment
submitted

Acceptable

26, 1991

prior to 12:00 noon,
prior to 1:00 p. m. ,

immediately

available

$1, 000

None

Accepted in full at the average price up to $1, 000, 000

Tuesday,

Settlement

the average of accepted bids

To be determined at auction
To be determined after auction
September 30 and March 31

Must be expressed as
an annual yield, with two
decimals, e. g. , 7. 10%

Receipt of tenders
due from

(CUSIP No. 912827 A3 6)
March 31, 1996
To be determined based on

Must be expressed as
an annual yield, with two
decimals, e. g. , 7. 10%

Acceptable

b) competitive

5-year notes

(CUSIP No. 912827 A2 8)
March 31, 1993
To be determined based on

Deposit guarantee by
designated institutions
a) noncompetitive

20, 1991

EST
EST

April 1, 1991
March 28, 1991

March

Wednesday,

27, 1991

prior to 12:00 noon,
prior to 1:00 p. m. ,
Monday,

Thursday,

Apr

EST
EST

i l 1, 1991
28, 1991

March

lrement of the Troesiiry
FOR IMMEDIATE

March

20, 199l

Wclshlneton,

RELEASE

O.C. ~ Telephone $4I-20~
CONTACT:

Barbara Clay
202-566-5252

of Polandis Debt
Poland owes approximately $33 billion to Paris Club creditor
governments,
including roughly $3. 8 billion to the United
The Reductioa

Addendum:

States. ~

Paris Club of creditor countries has agreed to reduce
the value of Poland's debt obligations by 50 percent in two
stages, or the equivalent of $16.5 billion on a net present
value basis.
The

Paris Club agreement permits creditor governments to
choose from a number of equivalent options: principal
reduction, interest reduction, and capitalization of
interest at low interest rates.
As a result, the value of the debt will be reduced by
50 percent on a net present value basis, even though
the nominal stock of debt will not be reduced by as

The

much.

During the
have agreed

The

first

three

critical years, all creditors

to reduce Poland's

percent.
United States vill increase

70 percent

its

interest

debt

payments

relief for

net present value basis through:

on a

by 80

Poland

10 percent of Poland's debt to the
United States to enable the Government of Poland to
foundation, and
fund a Polish environmental
A

vrite-off of

Bilateral debt reduction equivalent

the original

operation.

debt, within

the tvo-stage

60 percent
Paris Club

This additional United States action vill reduce Poland's
debt to the United States from $3. 8 billion to $1. 14 billion
on a net present value basis.
The nominal stock of Poland's debt to the United States
will be reduced only to about $1.4 billion.

additional U. S. action will increase the total debt
reduction under the multilateral agreement to 52 percent in
real terms.

The

President is encouraging other creditors to take
similar additional action to move the level of debt
reduction beyond that level.

The

NOTES

estimates

of Poland's debt to the United States

($2. 9 billion) were provided by
capitalized

include the interest
agreement.

USG

agencies and did not

under

earlier Paris

Club

"Present value" calculates the value of future payments in
today's dollars. The value of future payments ~f:er the
Paris Club action will be 50 percent of the value of the
today's scheduled payments.
+3

After accounting for the 10 percent write-off, the remaining
90 percent of the debt will be reduced by two-thirds on a
net present value basis, within the two-stage Paris Club
process (the equivalent of a 60% reduction of the original
stock). The result of these two actions produces the 70
percent reduction on a net present value basis.

of the Tl'easury

apartment

Washington,

D.C. ~ Telephone 566-204'

UNTIL GIVEN
EXPECTED AT 2: 00 P. M.

EMBARGOED

SENATE

TESTIMONY OF
THE HONORABLE ROBERT R. GLAUBER
UNDER SECRETARY OF THE TREASURY
BEFORE THE
COMMITTEE ON BANRINGi HOUSINGS AND URBAN AFFAIRS

March

21, 1991

Chairman Riegle, Senator Garn and members of the Committee,
thank you for the opportunity to provide the Administration's
views on our comprehensive
legislative proposal to reform the
banking laws, "The Financial Institutions Safety and Consumer
Choice Act of 1991" (FISCC). As you know, Secretary Brady

recently testified before the full Banking Committee to set forth
reasons requiring the enactment of this
legislation.
I will not repeat the details of his testimony
today, but I would like to reiterate some of the key reasons why
we believe this legislation
is essential. I would also like to
discuss several important aspects of the legislation that were
not described in detail in previous testimony, particularly the
recapitalization of the Bank Insurance Fund. Finally, I would
like to lay to rest several misconceptions that have arisen since
were released to the public.
our recommendations
the fundamental

Time

to Fix the

Mr. Chairman,
I want to stress
problem on our hands that demands a
picture we see is not a pretty one.
at its lowest level in history as a
deposits, and the 206 bank failures

the total number of failures
1942 and 1980.

S stem

that

we have a fundamental
The
solutions
comprehensive

The Bank Insurance Fund is
percentage of insured
in 1989 alone were more than
in the thirty-eight year period

between

less competitive as
to new products in the
traditional banking
financial services
the
securities industry and other parts of
-products that are off limits for banks due to
industry
competitive position has
outdated laws. Our international
have
no banks among the top 25 in
we
where
the
point
declined to
some regions have
slowed,
has
the world. And as the economy
-have not been able to
banks
weak
experienced "credit crunches"
lend even to good customers, hampering a speedy recovery.
At the same time,

banks have become
business has migrated

KJB-1190

to fix these

problems across
fundamental
the board. A piecemeal approach such as merely recapitalizing
cannot
the Bank Insurance Fund will not work, because
eliminate the massive taxpayer exposure we now face. Put another
way, with over $2 trillion in insured deposits, there is no
deposit insurance fund large enough to cover the losses inherent
in a banking system that we allow to become weak, inefficient,
The time has come

and uncompetitive.

Fundamenta
We

believe comprehensive

fundamantal

objectives.

Reforms

reform must accomplish

First,

three

make deposit insurance
That means stronger

we must

safe for taxpayers and depositors.
supervision, better capitalized banks, and the return of deposit
insurance to its original purpose of protecting average
It also means a well capitalized
depositors in this country.
bank insurance

fund.

it is

time to modernize archaic laws to let banks
their customers and deliver more efficient products
to consumers across the country —which translates into greater
convenience, lower interest rates and transaction fees for
customers, and more bank capital.
Third, we need to restore the preeminent international
position of our banking industry.
Our economy is twice the size
of our nearest competitor, and a world class economy demands a
world class banking system.

catch

Second,
up with

outlined

in previous

testimony,

believe our

legislation will help accomplish each of these objectives. Let
me focus today on several aspects of the legislation
that require
more detailed explanation.
The place to begin is improved
supervision.

Prom

Corrective Action

system must be better designed to catch
early, before they mushroom into costly failures. The
legislation's proposed system of Prompt Corrective Action will do
just that, and we urge the Subcommittee to study these provisions
carefully. The combination of rules and flexibility will help
foster two desirable results: regulators will be able to take
action much more swiftly as capital declines, and there will be
more pressure to take such swift action because of the
presumptions built into the statute.
More important,
banks will
be much more likely to maintain strong levels of capital if they
face the certainty of decisive regulatory action as their capital
declines.
The regulatory

problems

will like this system, because it will be
that
statutory
presumptions will reduce regulatory
argued
"
But that is in part its purpose -- open-ended
"flexibility.
flexibility can be the enemy of decisive corrective action.
Critics will also claim that capital is not a good leading
indicator of problems, and that prompt corrective action relies
exclusively on capital. Both allegations are false. Numerous
studies have shown that capital is an excellent leading indicator
of problems in banks, and a simple one to measure. But it is not
a perfect early warning system, and our legislation specifically
recognizes its limits -- even a well-capitalized bank will
trigger prompt corrective actions under the new system if it is
in an unsafe and unsound condition due to loan concentrations or
other supervisory problems.
Prompt corrective action does pot
rely exclusively on capital.
educt'o
Overextended
e osit Insurance
Not everyone

legislation recognizes the importance of stopping the
of deposit insurance coverage to large,
sophisticated depositors.
For example, we have eliminated
insurance coverage for brokered deposits and have carefully tried
to eliminate so-called "pass through" coverage for depositors
that are least in need of protection.
Defined benefit pension
The

creeping expansion

professional management,
from the Pension Benefit
need of deposit insurance
however, the legislation
protection for self-directed defined
individuals individuals choose their
risk of any loss.
plans with
guarantees
hardly in
same time,

employer
Guaranty

liability,

and

Corporation are
protection as well. At the
would preserve pass-through
contribution plans, where
and bear the
own investments

use of multiple insured accounts has gotten
It is time to impose limits, and ours is $100, 000
out of hand.
per depositor per bank for most accounts, with a separate
While this limit is
$100, 000 in coverage for retirement savings.
important, it is obviously not radical -- a couple can still get
up to $400, 000 in insurance coverage in each bank, which is
hardly a small sum. Insurance for business accounts would not
Those who suggest that such clearly reasonable limits
change.
would destroy the banking system or deprive the elderly of safe
places to invest are just plain wrong -- and worse, are

Likewise,

banks'

stirring up depositor fears.
Finally, the FDIC's current "too big to fail" policy must be
The legislation would therefore essentially eliminate
changed.
the FDIC's discretion to protect uninsured depositors in bank
failures. But it would also preserve the government's ability to
protect the financial system when necessary, even if that
requires the rare protection of uninsured depositors.
irresponsibly

and

needlessly

believe that this balance struck between direct taxpayer
exposure and the stability of the financial system is the correct
one. Nevertheless, our recommendations have been criticized for
not going far enough to prevent taxpayer exposure through deposit
insurance -- that the government should never protect uninsured
But it would be foolhardy for the government to give
depositors.
up its ability to protect the financial system, a restriction
that no other governmnent has embraced.
Others argue that we should simply expand the safety net to
for
deposits in all banks in order to create "fairness"
cover ~a
-what
foolhardy
would
be
That
equally
uninsured depositors.
Why should the taxpayer have to
about fairness to the taxpayer?
pick up the tab to protect an uninsured depositor who knows his
or her deposits are uninsured when deposited in a bank?
We

hest way to address this problem is to stop banks from
failing so frequently, which is exactly what other parts of this
legislation would do. The next best way is to reduce the
systemic risk that creates the need for extraordinary government
Our legislation includes
action to protect uninsured depositors.
technical changes to laws governing the clearing system that are
a step in the right direction.
Restored Com etitiveness
The

turn now to the need to restore the competitiveness
of our banking system. Our banking laws are archaic. They
simply do not reflect the way that banks now do business, and
they impose substantial and unnecessary costs. The system needs
an overhaul, which the proposed legislation would accomplish.

Let

Nationwide bankin
and hranchin . Interstate branching is a
perfect example. The geographical debate is essentially over
because states have already broken down most of the barriers to

interstate branching is still virtually
totally unnecessary costs on banks.
The legislation would end these artificial barriers, but in
a way that recognizes the legitimate interests of state
intrastate
governments.
A state would still be able to restrict
branching of all state and national banks operating within its
borders. It would also have the ability to establish activities
restrictions for all of its own state banks and all in-state
branches of banks chartered in another state. States would be
encouraged to enter into reciprocal arrangements to examine the
out-of-state branches of each other's banks. The Community
Reinvestment Act would continue to apply, and states could
continue to apply state consumer protection laws to branches of
all out-of-state banks. Finally, states could tax branches of
all banks, state or national, to avoid any adverse revenue impact
interstate

prohibited,

resulting

banking.

Yet

imposing

from changes

in the law.

Critics argue that these proposed changes will end the need
for small banks and will draw funds out of local communities and
deprive rural areas of much needed sources of credit. There is
no credible evidence to support these hypothetical
fears. The
trend towards interstate banking and statewide branching have had
not restricted credit availability in smaller communities.
Smaller banks have continued to compete extremely effectively
with larger banks, and in states like New York, larger banks have
actually decreased the number of their branches in recent years
in the face of stiff competition from community banks. We
believe that a more efficient banking system will mean more
efficient banks of all sizes.
Se 'ces o din Com a ies. The legislation
repeals key elements of the Glass-Steagall Act and modernizes the
Bank Holding Company Act of 1956 to become the Financial Services
Holding Company Act of 1991. Again, these changes reflect the
reality of the way that banking organizations already do
business.
Banks are already in many aspects of the securities
and insurance businesses through a patchwork system created by
changes to state laws, exceptions in federal laws, and legitimate
regulatory interpretations.
But this hodgepodge system is costly
and burdensome,
with numerous Lilliputian restrictions that keep
our financial companies from competing fairly and effectively.
The new Financial Services Holding Company Act would require
all bank holding companies to become financial services holding
These new companies could engage in all of their
companies.
present financial services activities, and those who maintained
well capitalized banks could engage in a broad range of new
financial activities through affiliates -- securities activities,
insurance activities, and any new activities that are determined
to be "of a financial nature" over time.
But important safeguards would be in place to protect banks
from risks associated with new activities and to prevent unfair
competition.
Any new activities would be carried out in
separately capitalized affiliates whose capital could not be
double counted as capital of the bank. As mentioned above, only
banks could take advantage of
companies with well-capitalized
these new activities, and only if their banks were not in an
unsafe or unsound condition and were not engaging in unsafe or
If the bank's capital level should decline or
unsound practices.
the
if it otherwise falls into an unsafe or unsound condition,
face
or
the
holding company would have to fix the problem
prospect of strong remedial action. This could include
divestiture of either the new financial activities or the bank
capital
itself, or, if that did not occur, holding company
closer
much
supervision.
and
dividend restrictions,
requirements,

In addition, a number of strict firewalls would exist
version
A strengthened
between the bank and its new affiliates.
the
type of
of Section 23A of the Federal Reserve Act expands
It also amends the
transactions subject to its provisions.
such as
companies
other
cover
to
affiliate
of
definition
percent by the
80
than
less
owned
subsidiaries of banks that are
bank. In addition, banks would have to give prior notice to the
regulator of any loan exceeding 5 percent of capital. At the
same time, under revised Section 23B of the Federal Reserve Act,
bank loans to customers of affiliates would also have to be
conducted on an arms length basis.
would apply to sales of non-deposit
products not only by banks, but by affiliates of banks-customers would have to sign plainly worded forms acknowledging
that such products were not covered by federal deposit insurance.
Regulators would have the explicit authority to limit the
disclosure by banks of nonpublic customer information to
customers.
And most important,
they would have broad regulatory
authority to impose limits on transactions between banks and

Strict disclosure rules

affiliates to
and unsafe

prevent

and unsound

conflicts of interest, unfair competition,
banking practices.

Diversified Holdin Com anies. The bill would also allow
diversified holding companies to own financial services holding
companies.
These diversified holding companies would have no
limits on the types of activities in which they could engage.
They would provide a critical new source of capital for banks,
since 80 percent of the capital in this country is in commercial
companies.
But these companies must be prepared to put up this
capital if they want to own banks
again, their ownership of
banks would be contingent on maintaining high bank capital
levels, and they would be subject to similar prompt corrective
action penalties if bank capital should ever drop and the holding
to restore capital.
company was unwilling
All of the firewalls that apply to bank transactions within
the financial services holding company would apply to bank
transactions with affiliates in the diversified holding company—
— with one crucial difference.
No bank, and no bank affiliate
within a financial services holding company, could provide loans
of any kind to the diversified holding company or its
subsidiaries.
The bank simply could not become a commercial
company's "piggy bank" for private sources of credit.
We believe
that this prohibition along with the other safeguards described
above will be more than adequate to protect against abusive

—

lending

practices.

lato

est ctur'n

As we have outlined in previous testimony,
the legislation
will also propose a streamlining of the regulatory structure.
A
bank and its holding company would generally be regulated by one
federal regulator that would have full supervisory responsibility
and accountability
for that organization.
At the same time, the
number of bank regulators would be reduced from four regulators
to two, with the Board of Governors of the Federal Reserve
regulating state banking organizations, and the the new Office of
Depository Institutions under Treasury regulating all Federal
banking organizations and all thrifts.

The Federal Deposit Insurance Corporation would refocus its
resources on its primary role of insuring banks and resolving
failed institutions.
While its day-to-day role in regulating
certain state banks would end, it would maintain its current
authority to examine all banks and their affiliates for insurance
purposes.
There would be no cutback in FDIC regulatory
authority, and indeed, there would be expanded FDIC authority to
check the riskiness of state-chartered banks that maintain
federal deposit insurance.

u d

Finally, I would like to discuss the FDIC proposal to
recapitalize the Bank Insurance Fund (BIF), which is included in
the legislation.
As the Committee is well aware, the BIF is at
its lowest level in history as a percentage of insured deposits,
and is projected to decline still further over the next two
years. Without an infusion of funds, the FDIC could find itself
with too little cash to pay for losses, resulting in possible
exposure for the taxpayer.
Since last fall, the FDIC and the banking industry have been
in discussions over how best to recapitalize the BIF. As
these discussions proceeded, we set out four objectives that we
believe a BIF recapitalization plan should meet. These
engaged

objectives are:

First, the
FDIC

plan should provide

its job.

sufficient resources for the

Second, the plan should be financed by the industry.

Third, the plan should be structured to avoid further
And
impairing the health of the banking industry.
Fourth, the plan should rely on generally accepted
accounting principles.

Several weeks ago, the FDIC circulated an outline of a
recapitalization proposal. This outline contained a broad range
of funding options, including authority to borrow from, and to
sell stock to, the Federal Reserve, the Treasury, the banking we
industry, and the public. Following receipt of this outline,
The
worked with the FDIC to narrow the range of funding options.
This
result is the proposal incorporated in the legislation.
FDIC
the
and
Chairman
FDIC
of
the
plan has the full support
We believe
board, and the full support of the Administration.
that it satisfies the four objectives I just described -- perhaps
the plan relies on industry funds, not taxpayer
most importantly,
funds.

The plan would give the FDIC authority to borrow up to $25
from the Federal Reserve banks, for use as loss funds.
These borrowings would bear interest at Treasury rates. The FDIC
that
would be required to increase premiums and dedicate them
the
in amounts sufficient to assure
is, to set them aside
Thus,
payment of interest and principal on any such borrowings.
the Federal Reserve would be assured of repayment.

billion

the FDIC's current borrowing
to permit the FDIC to use the
to pay for losses, as
new Federal Reserve borrowing authority
intended.
First, the legislation would exclude any new borrowing
from the Federal Reserve from the existing limitation on
Without this provision, the FDIC would not have
obligations.
access to the funds. Second, the legislation would allow the
FDIC to count the unused portion of its existing $5 billion line
of credit for purposes of calculating compliance with the
obligation limitation.
Without this provision, the FDIC would be
unable to continue to use its existing authority to borrow for
working capital purposes from the Federal Financing Bank.
The plan would also modify
limitation in two ways, in order

Finally, the legislation would impose an aggregate ceiling
insurance premiums for BIF-insured institutions of 30 basis
points. Since the new risk-based premium authority discussed
above would allow the FDIC to vary premiums depending on the
riskiness of the institution, the FDIC would retain the authority
to assess individual institutions more than 30 basis points. The
ceiling would apply in the aggregate to all BIF-insured
on

institutions.

The Committee will recall that the ceiling on premiums was
lifted just last fall, as part of the Omnibus Budget
Reconciliation Act of 1990. The reasons for reimposing the
ceiling are two. First, there is widespread agreement among the
bank regulators,
including Chairman Seidman, that a cap on
premiums is important to allow the industry to continue to
attract capital. Moreover, it is the FDIC s view that raising
premiums to more than 30 basis points could cause substantially
more bank failures, and thus be counterproductive.
Second, the

lifted in order to permit the FDIC to craft a
recapitalization plan. Now that such a plan is in place, we join
the FDIC in urging the Congress to reimpose a ceiling of 30 basis
points.
Mr. Chairman, I would also like to address the specific
questions raised in your letter of invitation.
As you know, the
Administration's
projections are that the BIF will decline
substantially over the next five years, reaching a negative net
worth of over $22 billion by the end of 1996. These projections
are based on a computer model that applies historical failure and
loss rates to banks according to their capital levels. This
projection assumes a modest recession roughly 6 months in
old ceiling was

duration.

are also aware, in addition to the Administration s
there are a number of other projections for BIF,
which reach widely disparate conclusions.
This only proves what
-Chairman Seidman of the FDIC often says
there can be little
certainty in projecting BIF losses, particularly more than two
years out. Attached as Exhibit A to my testimony, you will find
summarized the results of BIF projections made by the
as
Congressional Budget Office, the FDIC, and the Administration,
well as a description of the methodology used by the
Administration.
I would point out that the plan included in our
legislation is adequate to deal with each of these scenarios.
As you

projections,

The time has come

We
industry.
"Financial Institutions

banking

to address the urgent

problems facing the
strongly urge Congress to adopt the
Safety and Consumer Choice Act of 1991."

EXHIBIT

COMPARISON OF BIF ESTIMATES
($ in billions)
1991

1992

1993

1994

1995

1996

4.4
1.4
3.9
0.0

(2.2)
(2.8)
2.4
(5.8)

(9. 1)

(15.5)

(22. 2)

(2.6)

(1.0)

(19.3)
0.9

n/a

62.4
96.6
65.0
90.0

62.4
66.9
30.0
70.

62.4
44. 6

56. 1
37.2

40.6
37.2

40. 6
29.7

n/a

12.0
13.0
10.0
13.9

12.0
9.0

12.0

6.0

11.5
5.0

8.8
5.0

8.5
4.0

6.5

n/a

10.8

n/a

15.9
12.4

9.2
3.9

6.7
(2.7)

5.0
(3.9)

(I 3)
(4.0)

(1.5)

n/a

23
30
19.5

30
19.5

19.5

23
27
19.5

3.9%
4.5%
4.5%

6.6%
4.5%
4.5%

7.3%
4.5%
4.5%

7.0%
4.5%
4.5%

6.7%

Fund Net Worth

OMB
CBO
FDIC —base
FDIC —pessimistic
Assets

4.2

of Failed Banks

OMB

CBOil
FDIC —base
FDIC —pessimistic

Losses on Failed Banks

OMB
CBO
FDIC —base
FDIC —pessimistic
Net Outla s excl.

FFB interest

OMB
CBO
FDIC
Premium

Assessments

OMB
CBO
FDIC
De

(5.7)

21.25
21.25

19.5

sit Base Growth

OMB
CBO
FDIC

ll Estimate based upon data supplied in CBO testimony

of January 29, 1991.

4.5%
4.5%

6.5%
4.5%
4.5%

METHODOLOGY

POR

BIF

ESTIMATES IN

in the President's

Estimates

call report data

on commercial

1992

BUDGET

budget were derived
banks

from

actual

failure model adjusted the capital levels of
banks by predicting loan loss rates and earnings
1993.
through

bank

individual

This model assumed a continuation of recent patterns, with
the following exceptions (to simulate a moderate recession):
Nonperforming

loan rates double

(on average);

and

Loss rates and time required to dispose of assets are
greater than the FDIC's historical experience,
reflecting weaker real estate markets.
Banks were put into groups

medium,

banks
The

small,

according to their size (large,

and savings hanks) and
with capital & 0%, 0-34, 3-6%,

failure rate for

banks

1987 to 1990 was applied.

capital ratio

6%).

(i. e. ,

in each of these groups during

of failures was smoothed out over the period
1991 and mid-95. Failures assumed to decrease

The timing

between

significantly thereafter (by over 40 percent).
A loss rate was applied
to each of the groups of failed
banks; this loss rate averaged 20 percent.
Using recent experience as a guide, assumptions were made
regarding types of bank resolutions, marketable vs. illiquid
assets, and the pace of asset sales to estimate the FDIC's
working capital needs resulting from failures occurring
between 199