TEXT AVAILABLE OF LANGDON'S TESTIMONY ON CFC INCOME.

ON: H.R. 2889, THE "AMERICAN JOBS AND MANUFACTURING PRESERVATION ACT OF 1991," AND RELATED ISSUES

BY: LARRY R. LANGDON, DIRECTOR, TAXES AND LOGISTIC, HEWLETT-PACKARD COMPANY

DATE: Thursday, October 3, 1991

ECAT is an organization of the heads of 65 large U.S. international business enterprises. Their annual worldwide sales total about $1 trillion and they employ over 5 million persons.

ABOUT ECAT

In October 1967, a number of United States business leaders joined together because of a shared concern that a new worldwide trade war was in the making. Proposals to severely restrict imports into the United States were moving through the Congress. Threats of retaliation by foreign nations were being openly voiced.

These businessmen felt that a combination of restrictions and retaliations could destroy two decades of progress in the expansion of trade and investment and would damage other areas of international cooperation. To help prevent this, they formed the Emergency Committee for American Trade.

The bills then in Congress did not succeed but the threat to trade and investment continued and the founders of what came to be known as ECAT were joined by others until the Committee reached its present size.

ECAT's members account for major segments of the manufacturing, banking, processing, merchandising and publishing sectors of the American economy. Their combined exports run into the tens of billions of dollars. The jobs they provide for American men and women including the jobs accounted for by suppliers, dealers and subcontractors -- are located in every state of the nation and cover skills of all levels. Their worldwide sales in 1990 totaled over $1 trillion and they had over 5 million employees.

The members of ECAT are practical businessmen. They are not free trade theorists. They believe in and support measures designed to expand international trade and investment.

The members of ECAT are adherents of the principles of the free enterprise market economy. They believe that international trade expansion means increased sales and profits and lower unit costs, that it means job opportunities for all American workers, that it fights inflation and that it is an essential spur to the technological advancement upon which America's economic progress so heavily depends.

They further believe that private foreign investment benefits the American economy and that the trade and investment activities of multinational companies are vital contributions to the well-being of the United States and other nations.

ECAT members are active supporters of legislative and other measures that facilitate U.S. exports, including support for adequate export financing facilities. They are opposed to various disincentives to exports, including questionable uses of export controls for public policy purposes. They additionally are opposed to changes in U.S. taxation of foreign-source income that unfairly penalize their competitiveness in world markets.

The members of ECAT realize that the peaceful expansion of world trade and investment is threatened from many sources. They have called for international agreements to deal with unfair trade practices, including both bilateral and multilateral agreements to protect intellectual property rights. They have encouraged businessmen overseas to support policies that assure fairer treatment of American goods in foreign markets and to oppose restrictions on American-owned companies.

The work of ECAT depends primarily on the actions of its members. The Committee provides a means of expressing commonly-held views on measures that will help or harm American trade and investment, but the members themselves present their opinions to government officials and to the public.

Members of ECAT, supported by experts from within their companies and from the small ECAT staff, have made their views known through testimony before Congressional committees, through contacts with Administration officials, through consultations with government leaders, through liaison with other organizations and through public information programs.

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SUMMARY

1. ECAT is opposed to H.R.2889.

2. U.S. multinational companies contribute enormously to the U.S. economy through their overseas business operations, primarily through their U.S. exports to their overseas subsidiaries and through the repatriation of profits earned overseas by their subsidiaries.

3. U.S. firms invest abroad for a variety of business and government reasons. Without these investments, U.S. access to foreign markets would be substantially reduced with a consequent diminution of the U.S. economy. There would be far fewer exports and the U.S. capital stock would be reduced by the amount of repatriated foreign profits.

4. U.S. firms invest abroad to produce for overseas local markets that cannot be supplied solely through U.S. exports. U.S. official statistics show that, excluding Canada, 93% of sales by the overseas manufacturing subsidiaries of U.S. firms were to local or third-country markets.

5. On a net basis, the overseas operations of U.S. multinational companies contributed an annual surplus to the U.S. balance of payments of about $90 billion each year during the 1980's. Of the $90 billion, about $65 billion represented net exports and $25 billion represented repatriated profits from the overseas subsidiaries of U.S. multinational firms.

6. U.S. multinationals account for approximately 75% of total U.S. exports each year. The bulk of their exports are to their overseas subsidiaries, who are the largest overseas customers of U.S. goods.

7. The increased tax payments call for in H.R.2889 would harm the competitiveness of U.S. firms vis-a-vis their overseas competitors with no subsequent benefit to the U.S. economy.

8. The Ways and Means Committee Report on a bill identical to H.R.2889, that was adopted by the Committee, but that was rejected by the Senate and in Conference, expressly acknowledged that this legislation could place U.S. companies at a competitive disadvantage to foreign manufacturers.

9. Passage of the bill would add another costly burden to U.S. firms and the IRS in administering an already very complicated set of rules for the taxation of foreign source income.

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Mr. Chairman, I am Larry R. Langdon and I am Director of Tax and Logistics for the Hewlett-Packard Company.

It is my pleasure to be here today to testify on behalf of the Emergency Committee for American Trade (ECAT) against H.R. 2889, a bill to amend the Internal Revenue Code of 1986 to end deferral for United States shareholders on income of controlled foreign corporations attributable to property imported into the United States.

ECAT is an organization of the CEO's of 63 large U.S. firms with very extensive worldwide business operations. ECAT member companies have worldwide sales of over $1 trillion, and they employ more than 5 million persons. ECAT members account for a substantial share of total U.S. exports and of U.S. manufacturing production.

Hewlett-Packard is a major designer and manufacturer of electronic systems for measurement and computation. Our sales last year were $13.2 billion. Of this, $7.2 billion, or 55% of our total sales, represented sales to customers outside of the United States. Some $2.7 billion of this amount were U.S. exports. Hewlett-Packard invests abroad to satisfy foreign markets, and this investment spurs U.S. exports to those markets. On both of these counts, Hewlett- Packard believes it is typical of other large U.S. corporations that operate on a worldwide basis.

Over the years, both the foreign tax credit and the foreign tax "deferral" provisions of the Internal Revenue Code have been eroded, with a concurrent increase in the rate of U.S. taxation on foreign source income. Unfortunately for the U.S. competitive position in world markets, other governments have not similarly disadvantaged their corporate citizens.

H.R. 2889 appears to be based on the twin assumptions that U.S. investments overseas, and particularly those that might result in exports to the United States, are bad for the U.S. economy, and that providing for current U.S. taxation of the profits earned by U.S. subsidiaries from exports to the United States will somehow rectify this bad situation.

Before commenting on the provisions of H.R. 2889, I think it useful to examine these assumptions.

An ECAT study based on official U.S. government statistics shows that, excluding Canada, 93% of sales by U.S. overseas manufacturing subsidiaries were to local or third-country markets. Of the 7% that is sold to the United States, a large share is in U.S. industries that are besieged by import competition from abroad. Increasingly, these imports represent efforts to realize the benefits of global economies of scale through the allocation of specific parts, assemblies, or portions of production lines to different affiliates.

More important to the U.S. economy is the clear finding of the ECAT study that U.S. multinational companies contribute enormously to the U.S. economy through their overseas business operations, primarily through their U.S. exports and through the repatriation to the United States of profits earned overseas by their subsidiaries.

U.S. multinational companies account for approximately 75% of total U.S. exports. The bulk of that total represents exports from U.S. parents to their overseas subsidiaries. These subsidiaries constitute the single largest overseas market for U.S. exports.

On a net basis, the ECAT study shows that during the 1982-1988 period the net exports of U.S. multinationals contributed an annual average $65 billion surplus to the U.S. balance of trade -- this at a time that the U.S. balance of trade was in enormous deficit.

In addition to the $65 billion annual average merchandise trade surplus during that period (the latest for which statistics were available), U.S. multinational corporations repatriated net profits from their overseas subsidiaries and affiliates at an annual average of about $28 billion.

Taken together, the net annual average contribution of U.S. multinational corporations to the U.S. balance of payments and to the U.S. economy was over $90 billion each year during the 1980's. These are dollars that are invested in the United States just as dollars earned purely domestically are.

The trade and payments statistics offer overwhelming evidence of the critically important benefits to the U.S. economy of the overseas investments by U.S. firms. Without these overseas investments, the U.S. private sector would be far less robust, would employ far fewer workers, and would progressively become far less competitive in the U.S. as well as in foreign markets.

Today there really is a global marketplace, and the U.S. place in it is under constant challenge by our foreign competitors. In this increasingly competitive environment, the U.S. private sector is doing all it can to retain and increase market share in order to survive and to prosper in the interests of its employees and shareholders. H.R. 2889 works at a cross-purpose to these interests.

H.R. 2889 would change longstanding U.S. tax policy. Historically, the United States has not taxed active business income earned by foreign subsidiaries from unrelated party sales until the income is returned to the United States. Our trading partners follow the same practice. By contrast, H.R. 2889 seeks to impose current tax on what it calls foreign subsidiaries' "imported property income," even if that income is derived from unrelated party sales and even if that income is not returned to the United States.

In general, "imported property income" would be any income earned by a foreign subsidiary from the manufacture, sale, or licensing of any property that is imported into the United States. Furthermore, income earned by the foreign subsidiary from the sale of property to an unrelated foreign person would be imported property income (and subject the subsidiary to current U.S. tax) if it were "reasonable to expect" when the property was sold that it would be imported into the United States or used as a component in imported property.

H.R. 2889 also would create a new separate foreign tax credit limitation for imported property income -- in other words, yet another "basket."

Some additional technical aspects of the bill are commented on later. First, however, it is important to emphasize that the underlying policy of the bill is totally misguided.

H.R. 2889 is touted as the "American Jobs and Manufacturing Preservation Act of 1991." One of its underlying premises seems to be that U.S. businesses establish foreign subsidiaries to manufacture products for sale into the United States primarily in order to avoid U.S. tax. Thus, the bill assumes that if such foreign subsidiaries can be made subject to an additional U.S. tax -- a penalty, if you will, for locating overseas -- the incentive for locating overseas will be eliminated and U.S. manufacturing and jobs will be "preserved."

But this reasoning belies even the most basic understanding of the international marketplace. The simple fact is that enactment of H.R. 2889 would not help to preserve American jobs and manufacturing -- it would help eliminate them.

It should be obvious, first, that business decisions to commit capital to the establishment of business operations overseas are made for many different reasons, only one of which may or may not be tax related. Historically, a much more important reason for foreign investments are tariff and other import restrictions that deny or limit export access to overseas markets. Proximity to natural resources and the avoidance of transportation costs are other basic reasons for investment abroad.

In today's global market, such traditional factors as those just mentioned have been multiplied by a panoply of national and regional economic policies that confront U.S. companies with the basic decision of either manufacturing locally or being effectively shut out from the market. Two illustrations of such policies are domestic content requirements and health regulatory requirements. Both necessitate local manufacture as a condition of selling in protected markets. The elimination of such requirements is a major negotiating objective of the United States in the Uruguay Round and in the negotiations for a North American Free Trade Area.

As a matter of economic survival, many U.S. companies are forced to globally source the manufacture of products lines. Economies of scale and demand factors, for example, may dictate that it is competitively uneconomic to manufacture a product both in the United States and abroad. Thus, a plant in the United States may be particularly suited for manufacturing one set of products for worldwide distribution and a plant overseas may be chosen to manufacture another set of products for such distribution (including in the United States). As stated previously, however, U.S. government statistics show that only 7 percent of the sales of U.S. foreign manufacturing subsidiaries (excluding Canada) are into the U.S. market, the rest being into foreign markets.

Global sourcing is not uniquely a U.S. phenomenon. It is a global practice on the part of business in all nations of this world. It is critical to competitiveness and economic survival for many firms. To try to limit global sourcing by whatever measure is a prescription for economic stagnation and the dimunition of U.S. competitiveness.

U.S. businesses and those of other nations establish operations overseas for all of the foregoing -- and many more -- sound economic reasons. At bottom, however, it all comes down to one fundamental point: U.S. businesses and those of their foreign competitors locate overseas to try to achieve a competitive edge and a competitive share of the international marketplace. If a foreign competitor operates in a more favorable foreign economic environment than does a U.S. business -- whether because of market or cost factors or because the United States imposes a tax on the U.S. business that the foreign competitor does not bear -- the foreign competitor's goods can and will take market share away from U.S. companies.

The Ways and Means Committee Report related to a bill identical to H.R. 2889 that was adopted by the Committee in 1987, but that was rejected by the Senate and in Conference, expressly acknowledged that this legislation could place U.S. companies at a competitive disadvantage to foreign manufacturers.

H.R. 2889, like the 1987 bill, ultimately fails to recognize today's global business realities. Instead, it assumes that U.S. goods and services are paramount in the marketplace and that U.S. companies have the luxury of choosing between locating facilities in the U.S. or abroad. Whether that luxury ever existed is debatable. It certainly does not exist today.

What would happen if the new tax on U.S.-owned foreign subsidiaries proposed by H.R. 2889 is enacted? The result the bill hopes for is that U.S. jobs would be "preserved". This objective is laudatory. But the cold, hard reality of the international marketplace is that H.R. 2889 will not preserve U.S. jobs -- it will merely cause U.S.-owned foreign operations to become more marginal and thus lose U.S. market share to foreign competition. Foreign-owned businesses would not be burdened by the H.R. 2889 tax. Undoubtedly, they would not understand why the United States would impose such a tax on their U.S. competitors, but they would take advantage of the situation nonetheless. The United States might as well hand U.S. market share to foreign competitors.

Taxes affect the profitability of a business investment. At the margin, they may help determine WHETHER a plant will be built, but not WHERE it will be built. Increased U.S. taxes on foreign source income may reduce the number of U.S.-owned foreign plants, but those plants will not be shifted to the United States. They most likely will be replaced by non-U.S. companies to satisfy local demand.

Let me give you just one actual example. An electronics company owns a foreign subsidiary that operates a factory in Malaysia just down the street from a factory owned by a Japanese company. Under H.R. 2889, the U.S. company's subsidiary would be subject to current U.S. tax on its profits from products sold into the U.S. market, while the Japanese company would not be subject to either the U.S. tax or any Japanese tax. (Because of a tax sparing treaty between Japan and Malaysia, the Japanese company can repatriate profits back to Japan tax-free.) Under H.R. 2889, the U.S. Congress would be handing the Japanese company a made to order marketing strategy -- the ability to lower prices to the U.S. market, gain market share at the expense of U.S. competitors, and maintain its overall level of profitability at our expense. The current tax that would be imposed on the U.S. company's subsidiary under H.R. 2889 would make it difficult to combat these tactics. Presumably, in the long run and in absence of competition from the U.S. company, the Japanese company would raise its prices to prior or higher levels. But in the long run, no U.S. manufacturing would be preserved, no U.S. jobs would be preserved, and the U.S. business's foreign operations would be damaged.

U.S.-owned foreign manufacturing plants substantially increase U.S. exports. Foreign plants serve as an important market for semi- finished goods produced in the United States. The plants also serve to open up foreign markets to U.S. produced finished goods which would not otherwise be salable in the local markets due to tariff restrictions or the lack of a significant physical presence in the local market. The chemical industry, for example, has consistently maintained a positive trade balance of about $8.5 billion per year, and its foreign plant locations are an important reason for that record. To the extent that foreign plants are not built, not expanded, or are closed due to the increased tax burden that H.R. 2889 would create, industry's ability to export will be jeopardized. The inevitable result will be fewer U.S. plants and fewer U.S. jobs.

Finally, and very importantly, H.R. 2889's misguided policy would lead to yet another dose of increased Internal Revenue Code complexity and increased taxpayer compliance burdens -- something everyone can agree is undesirable. H.R. 2889 would graft new rules onto the existing Subpart F and foreign tax credit provisions -- which already are among the most complicated provisions in the Internal Revenue Code. The bill is also extremely far-reaching in its scope, extending even to income earned by foreign subsidiaries from the sale or licensing of tangible or intangible property to unrelated FOREIGN persons where it is "reasonable to expect" that the property will be imported into the United States or used as a component in imported property. The vagueness of the "reasonable to expect" test will create enormous uncertainty and an unwarranted administrative burden. While many of our member companies may be able to devise a destination test, both the companies and the IRS would be hard- pressed to audit it properly. A foreign agent of a U.S. parent's foreign subsidiary, for example, would not ordinarily come under the jurisdiction of the IRS, and it is doubtful that accurate auditing could occur without IRS access to such foreign agent's records. This and other compliance problems suggest that this proposal will merely increase the rapidly growing set of compliance problems already faced by the IRS and taxpayers.

H.R. 2889 also will create yet another foreign tax credit basket -- in this case, for "imported property income." Collecting, monitoring, and reporting the additional foreign tax credit data required under the bill will further increase the required U.S. tax compliance efforts. This means that yet another kind of income not ordinarily monitored for standard financial accounting purposes will have to be monitored solely for U.S. tax purposes.

In conclusion, ECAT strongly opposes H.R. 2889 because it will hurt the international competitive posture of U.S.-owned businesses without attaining its objective of preserving U.S. manufacturing and jobs. We can only reiterate that the realities of the global marketplace require U.S. businesses to establish foreign manufacturing operations in order to enhance worldwide sales and remain competitive. U.S. business would prefer to perform all of its manufacturing operations in the United States and to supply foreign markets through exports from the United States. However, basic resource and other economic considerations having nothing to do with taxes require investments abroad as the primary means of satisfying local foreign demand.

The additional tax that would be imposed by H.R. 2889 on U.S.- owned businesses -- but not on foreign-owned business --will put U.S. businesses at an obvious competitive disadvantage and help to cause their U.S. market share to be ceded to foreign competition. In the end, by weakening U.S. businesses in this way, U.S. manufacturing and jobs will be lost.