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United States. It was hoped that this agreement would bring to an end the recurrent monetary crises which had been plaguing international finance and which threatened to upset the conduct of international trade.

However the hope for stability did ot materialize. The growing accumulation of surplus Euro-dollars, fed by increased U.S. investment abroad and rising erosion of the dollar. In February, 1973, just 14 months after the first devaluation, the United States again resorted to devaluation, but this time unilaterally. This devaluation—amounting to about 10 percent-took competitors by surprise, engendered considerable ill feeling, but still did not restore confidence in the dollar. Far from it, throughout the spring and well into the summer the value of the dollar continued to slide, so much so that by mid-summer 1973 it was generally considered to be overvalued. However, the conditions that led to undermining of the dollar still remained uncorrected. U.S. overseas investment flows continued, leading to the accumulation of ever growing amounts of dollars abroad.

The deficit in the balance of payments showed little improvement. And to make matters worse, the national crisis of confidence stemming from Watergate and related developments, as well as the accelerating pace of inflation within the U.S., further undermined foreign confidence in the U.S. position. Although the value of our export trade benefited somewhat from devaluation, the full impact on our trade was slow in coming, and relatively minor in scale.

Perhaps more significant is the fact that devaluation is a double-edged sword, making essential raw material imports more costly at the same time that exports become relatively cheaper. Moreover, the advantage which one country gets over another by devaluing its currency is of necessity a short term one. When the industrialized nations abandoned the system of fixed exchange rates that had governed international trade ever since the Bretton Woods agreement and adopted a system of floating exchange rates, clearly devaluation was available as a temporary cure for every country. It is a game at which ny one country cn play. With inflation raging in Japan and the European Economic Community in the late summer of 1973, the dollar slide finally stopped. Since then there has been a steady improvement in its position in relation to other currencies, and a corresponding weakening of those currencies against the dollar.

This situation was accelerated by the oil crisis which has threatened to wipe out the foreign exchange reserves of the Common Market countries of Europe and of Japan, but which has put the dollar in a better position since the United States is less dependent on Middle East oil. As a result of these new developments, the effective value of the dollar in relation to other hard currencies is just about up to where it was before the official devaluation of last February-and any advantage which might have accrued to our export trade, has just about disappeared.

INVESTMENT FLOWS CONTINUE

Just as devaluation has not and cannot by itself bring about basic changes in the conditions which lie behind U.S. foreign trade problems or resolve the problems inherent in U.S. foreign trade policy, neither have there been any significant changes in the U.S. direct foreign investment picture.

One of the most important factors leading to the recent imbalance of trade, increased imports and loss of employment in the United States has been the steady and indeed, unstanched flow of capital and technology overseas, a flow which continues to grow year by year. By the end of 1972 the book value of direct investments overseas by U.S. corporations amounted to more than $94 billion, an increase of $8 billion or approximately ten percent more than the level of investment the year before.

More than 40 percent of this investment was in manufacturing industries. Investment in manufacturing industries. Investment in manufacturing accounted for nearly half of the total growth in investment in that year, up from the previous five year average, when manufacturing accounted for only 43 percent of the growth each year. In addition most of the new manufacturing investment-approximately 83 percent-was in the developed countries, primarily in Europe. Japan, and Canada, while only 17 percent of the total is located in the less developed countries.

The reasons for the continuing flow of direct investment overseas are easy to understand:

1. There has been no change in the tax laws and or in regulation of accounting procedures. The same tax incentives and tax accounting rules which made foreign investment attractive in the past remain on the books. Indeed the ad

ministration has indicated that what few controls on investment there are will be removed and that no future change in the tax laws is contemplated. As long as U.S. corporations can get a better tax break by investing overseas they will continue to do so. Presently there are several important tax advantages to a company to locate overseas. One is the provision that permits a corporation with foreign affiliates to take a dollar-for-dollar tax credit against its U.S. domestic tax liability for all taxes paid to a foreign government. This is different from the procedure that applies when a manufacturer has his plant in the United States. In that case he can take a deduction, not a credit, for state and local taxes as a cost of doing business. A direct tax credit, however, provides greater benefits than a tax deduction-and is therefore an incentive to overseas investment.

Also, the foreign investor does not have to pay any tax on the earnings of his overseas affiliates, unless and until they are repatriated as dividends to the United States. This of course is an incentive to retain earnings overseas and to use them for additional investment. Indeed this is just what has happened. The change in the direct investment position between 1971 and 1972 was marked by a substantial increase in the proportion of reinvested earnings as compared to new net capital outflows from the United States. In 1971, reinvested earnings accounted for $3.2 billion or about 39 percent of the total direct foreign investment. In 1972, however, reinvested earnings increased to $4.5 billion, and accounted for 58 percent of the total.

2. The trade barriers which have worked to force U.S. companies to establish plants overseas at the risk of losing their foreign markets if they did not, still remain and will probably stiffen as a result of the world wide oil crisis. For many years the Common Market countries and Japan have maintained an ingenious assortment of nontariff barriers which discriminated against U.S. made products. It is these barriers, which the multinational companies claim have been the primary determinant of investment plans. Rather than lose their export market to foreign competitors, U.S. companies have established plants overseas. In many cases these plants have produced goods for third country markets and even for shipment back to the U.S. It has not seemed to bother them that the United States is the only country practicing an open door policy, while all of its major competitors are taking a protectionist stance-long after the need for protection had disappeared.

Although the recent international textile agreement is an indication that other nations have become aware of the necessity to correct an essentially unfair system and to provide for orderly marketing arrangements, for the most part there has been no significant progress toward the elimination of trade barriers. As long as this situation continues, U.S. companies will continue to build new plant and equipment overseas, and if necessary close down plants within domestic plants in the U.S.

3. The cost of labor is still lower overseas than it is in the United States, even though, in some countries of Europe, labor has made substantial progress in recent years.

Some wage levels have increased in the past two years more rapidly than in the United States, but the U.S. still boasts a higher standard of living, and the highest wages in the world. The table below compares the average wage in manufacturing with average wages paid by our major competitors, as well as in some of the less developed countries.

It is worth noting that recent U.S. productivity increases have matched those of our competitors. Moreover, because U.S. wages have not increased as rapidly as those in the Common Market and in Japan, U.S. unit labor costs rose only 1 percent in 1972, compared with a 14 percent growth in 11 of the other major nations.

SITUATION WORSENED BY THE OIL CRISIS

Three years after the Industrial Union Department first launched its efforts to call national attention to the impact of changing world trade patterns, and to ask for a redirected, constructive foreign trade policy, the nation is still faced with the same problems, and the basic causes of those problems still remain unresolved. Now, today, the oil crisis threatens to make the situation much worse. Whatever progress, however slight, had been made toward a reduction of international trade barriers is now in jeopardy. Whatever the effect of devaluation, it has proved only a temporary pain killer. Whatever improvement was made in U.S. employment is endangered.

There is reason to believe that the tough stance taken by the U.S. labor movement was beginning to have some effect on foreign nations, as they realized that they could not forever discriminate against this country. Today however, the astronomical increase in the price of oil is making them reexamine their positions. Since most of the industrialized countries, particularly EEC and Japan, are heavily dependent on oil imports to supply their energy needs, they must somehow earn the foreign exchange necessary to pay for those oil imports. They cannot afford to spend national reserves either on other imports nor on anything but essential commodities.

As a result we can expect to see increasing barriers to the import of U.S. made goods. Furthermore, in order to earn the dollars to use for the purchase of oil, most countries will try to further expand their exports to the United States. This, coupled with a currency devaluation which will temporarily improve the competitive position of their products, will result in additional import pressure.

Therefore, in addition to new trade barriers we can also expect a further tide of imports. The impact on U.S. employment, on jobs already threatened by our domestic energy problems, could well be disastrous.

Thoughtful attention must be given immediately to these new pressures on our foreign trade policy if the U.S. economy and U.S. jobs are to be safeguarded.

How U.S. TAX LAW WORKS AGAINST U.S. INTERESTS

THE FOREIGN TAX CREDIT IS A BOON TO OIL MULTINATIONALS

Riddle: How is an energy crisis related to a foreign tax credit?

Answer: Through discouraging investment in the United States.

For nearly a year now, the public has been deluged by article after article on the oil industry, oil companies, and the energy crisis. Every newspaper, every magazine, and every radio and television network has been analyzing the problem-has been asking how we got into this mess and how we are going to get out of it. The oil companies, for their part, are taking full page advertisements in newspapers and magazines to tell their version of the story. Most of us are left wondering why we are standing in line for an hour to buy gasoline at 50 cents or more a gallon.

THE ENERGY CRISIS AND U.S. INVESTMENT

There is no one simple answer. But if you have managed to wade through some of the millions of words on the subject, some things become pretty clear. What is clear is that the oil companies have been reluctant to make sufficient investments within the United States. We can see the results of this lack of investment. For example:

Production of crude oil within the United States has been declining since

1970.

Few new refineries have been built within the United States for a long time, and U.S. refinery capacity has not nearly kept up with growing demand. Almost all oil is imported in the U.S. on tankers registered in foreign countries. The U.S. has negligible oceangoing shipping capacity for oil. Investment is the key to understanding why the situation is what it is today. Keeping up or expanding production requires far more investment in the United States than has been made in domestic exploration and in research and development for new techniques of producing oil in the United States. Keeping U.S. refinery capacity expanding as fast as demand requires investment in the capital equipment to build new refineries and to expand and modernize older facilities. Importing oil on U.S. flag ships requires investment in ships built in U.S. shipyards.

As the oil companies are fond of saying, there has not been sufficient incentive to invest in producing or refining in the United States. We would agree that there has been a lack of incentive, but we would not agree as to the reasons why.

The oil industry lays the blame for the lack of incentive to invest in the United States on prices which it says were too low, or environmental safeguards which were felt to be too stringent, or oil company profit margins which it claims were too low.

THE CULPRIT-THE FOREIGN TAX CREDIT

But these are not the real problems. The real problem is the U.S. tax code. U.S. tax laws give U.S. multinational corporations every incentive to invest abroad and little reason to invest in the United States.

This is true for the shipping of oil as well as for production and refining. Oil companies have consistently refused to use U.S. ships. They cite the high cost of American labor for building ships and for crews. But, again, the real reason lies in our tax laws, particularly the foreign tax credit.

The concept of the foreign tax credit seems reasonable on the surface, but it has a treacherous interior. Although the oil companies are undoubtedly the most expert manipulators of the possibilities for tax avoidance inherent in the foreign tax credit-witness the average of 8.3 percent of income paid as U.S. taxes for 1972 the foreign tax credit is not a special tax break to the oil industry. It applies to all companies (or people) who earn income and pay taxes outside of the United States.

The idea behind the foreign tax credit is to prevent double taxation of U.S. companies. The proponents of the foreign tax credit claim that it makes neutral, as far as taxes are concerned, the decision between investing in the United States and investing in a foreign country. A U.S. company with income earned outside of the United States is allowed to subtract all income taxes it has paid to foreign governments from the taxes it would owe to the U.S. Government.' This is distinct from the way a domestic company would treat its state and local taxes. These are considered a cost of doing business, a deduction from gross income just as rent or labor costs are a deduction for a business; or just as city and state taxes and property taxes are a deduction for an individual. But the foreign tax credit does not operate in this manner. Under the foreign tax credit, the company subtracts every dollar paid in foreign taxes from the taxes owed in the U.S., not from gross income. In effect, the U.S. Treasury gets what is left over after all foreign governments are paid.

As a concept, this seems quite simple. This is how it works: If a U.S. company earns $100 in a country with a 40 percent tax rate, the foreign government gets $40 in taxes. When that income is reported for U.S. tax purposes, the U.S. Treasury gets $8-the difference between 48 percent rate in the United States and the 40 percent rate in the foreign country. If the foreign country had a 48 percent tax rate, the company would pay no taxes to the U.S. Government on the $100 earned abroad.' In theory, if the foreign tax rate is higher in the U.S. tax rate, the foreign rate is paid. If the foreign rate is lower than the U.S. tax rate, the foreign rate is paid and the difference to make up the 48 percent rate-is paid to the United States. In theory, then, a company would never pay less than 48 percent in taxes. No refunds are supposed to be given a foreign tax rate of 53 percent should not entitle the company to a 5 percent rebate.

But that is in theory. In fact, two provisions of the foreign tax credit turn what seems to be a straightforward dollar for dollar credit-a bad enough law in itself into a system which can be used as a gigantic tax dodge. While the law provides that the foreign tax credit is limited to taxes owned on income earned outside of the United States, these provisions allow the sharing of the tax credit among all foreign earned income. We feel certain that these two provisions, taken together, are responsibile for the reluctance of certain companies, particularly within the oil industry, to invest in the United States. Specifically, the law provides:

1. The "overall limitation" option. This allows tax credits in excess of U.S. tax liability-stemming from a 50 or 60 percent tax rate in the foreign country, for example-to be used to shelter income earned in other foreign countires-with a lower tax rate-from U.S. taxation.

2. The timing options. Excess or leftover tax credits can be applied with a two-year carryback and a five-year carry-forward option.

1 Taxes paid to foreign governments are defined quite broadly. Foreign taxes which qualify for crediting are: (1) foreign taxes on profits of foreign branch operations, (2) foreign withholding taxes on dividends paid by foreign corporations (not necessarily subsidi aries) to U.S. stockholders, and (3) foreign taxes paid by foreign subsidiaries on profit underlying dividends paid to U.S. parent corporations. This means that foreign subsidiaries credit both foreign income taxes and foreign withholding taxes on dividends.

2 If foreign taxes were a deduction rather than a credit, the companies would pay 28.8% U.S. tax instead of 8% with a 40% foreign tax, and 25% U.S. tax instead of no U.S. tax -with a 48% foreign tax rate.

It is clear that any large U.S. based company operating in several countries has tremendous flexibility; it has tremendous potential for avoiding U.S. income taxes on all income earned outside of the United States. But because the application of the foreign tax credit is limited to tax due on foreign income, an investment problem is created in the United States.

A hypothetical example will illustrate how the disincentive to U.S. investment

occurs:

Imagine a U.S. company which does a major amount of business in a foreign country called "Overseas" which has a 60 percent tax rate. If $200 is earned in "Overseas," the company pays the "Overseas" government $120 in taxes. The company's U.S. tax liability on the $200 profit would be $96, but the company uses $96 of the $120 paid to "Overseas" as a foreign tax credit. Thus, no money is owed to the U.S. government as taxes. Let us assume that the company has no other foreign operations. This means that the company has $24 in foreign tax credit which it cannot use the difference between the $120 paid to the "Overseas" government and the $96 which would have been owed to the U.S. government if no allowance were given for foreign taxes. The $24 cannot be applied to profits earned from operations with the U.S.

Now let us assume that this company is expanding. After 5 years of operations in "Overseas", it must choose a site for a new operation-let's call it operation-2. Operation-2 is of such a nature that it can be conducted in a wide variety of countries-either in the United States or in a foreign country. If the company locates operation-2 in the United States, the company would pay $48 federal tax for every $100 of profit- the normal corporate profit rate. But let us look at what happens if the company locates operation-2 in another country called "Foreignland," where businesses are only taxed at a 10 percent rate. For every $100 of profit erned in "Foreignland," the company pays $10 to the "Foreignland" government in taxes. Under the theory of the foreign tax credit, the company would compute its U.S. tax on the $100 earned in operation-2 as $48, subtract the $10 paid to "Foreignland" as a foreign tax credit, and owe $38 in U.S. tax. But that is not what actually happens, because this is where the "overall limitation" comes in.

A CHOICE OF TAXES

Companies which have operations in more than one foreign country can choose between two methods of U.S. taxation, the per-country limitation and the overall limitation. With the per-country limitation, tax is computed separately for each country of operation. Under the overall limitation, income and credits from all foreign operations are lumped together. Thus a foreign tax credit which is left over from one foreign country can be used as a credit against taxes due from operation in another foreign country, if the overall limitation is chosen. Our hypothetical company will clearly choose the overall limitation. Now let us assume that the "Overseas" operation earns $200 per year and the new "Foreignland" operation earns $100 per year. In that case, the $38 in tax the company would owe the United States on its "Foreignland" operations ($48 U.S. tax less the foreign tax credit of $10 paid to "Foreignland") would be still further reduced by the $24 leftover foreign tax credit from "Overseas" operations. This would reduce the company's U.S. tax liability to $38 less $24 or $14 for the $100 of "Foreignland" profit. But this is still not the end of the story.

The company had been operating for 5 years in "Overseas" with no use for its leftover foreign tax credits. But these credits are good for five years after they accrue. If we still assume that the company had earned $200 per year for each of the past five years in "Oversea,s" there would be $120 of unused foreign tax credit ($24 per year for 5 years). This $10 could be applied as credit against the remaining $14 which we computed the company would owe as U.S. taxes on "Foreignland" profit of $100. Thus the U.S. tax liability is reduced to zero for the first five years of operations in "Foreignland.”""

Even after the five year carry-forward expires, the company will only be paying a total of $24 of tax on its operations in "Foreignland"-$10 to "Foreignland" and $14 to the United States. Chart 1 summarizes just what happens to the 48% corporate tax rate under the assault of the foreign tax credit. If operation-2 had been located in the United States instead of in "Foreignland," the company

In fact, only $70 of the $120 available from Overseas operations will have been used, so the company could quickly open a third operation and profit even further from the tax situation.

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