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Obama's International Tax Proposals: Where Would They Take Us?

TAX ANALYSTS

ROUNDTABLE ON
OBAMA'S INTERNATIONAL TAX PROPOSALS:
WHERE WOULD THEY TAKE THE UNITED STATES?

Washington, D.C.
Friday, June 12, 2009

CHRISTOPHER E. BERGIN, Moderator
MARTIN A. SULLIVAN, Panelist
MARK WEINBERGER, Panelist
GARY HAUFBAUER, Panelist
LEE SHEPPARD, Panelist

PARTICIPANTS:

SHELDON COHEN
EILEEN O'CONNOR
BARBARA ANGUS
CHUCK MARR
ROGER WHEELER
HERMAN BOUMA
DREW LYON
DAVID ROSENBLOOM
JANE GRAVELLE
ROSANNE ALTSCHULER
JOSEPH CALIANNO
JOHN SAMUELS
MONTE JACKEL
STEVE ENTIN
PAUL NOLAN
BOB GOULDER
KIM BLANCHARD
KENNETH KIES
PHIL WEST
CHESTER ABELL
PETER MERRILL
DAVID FRIEDEL
CHUCK WHEELER
* * * * *

PROCEEDINGS

(9:00 a.m.)

MR. BERGIN: Good morning, everybody.

SPEAKER: Good morning.

MR. BERGIN: Welcome to the latest in Tax Analysts series of discussions on key issues in tax policy and tax administration. The topic for today is President Obama's international tax proposals. We will discuss what's right with them, what's wrong with them, and where they would take us.

I'm Chris Bergin, the president of Tax Analysts, the nonprofit publisher of Tax Notes, Tax Notes Today, State Tax Notes, Tax Notes International, and many other fine print and online products on federal, state, and international taxation. We also recently began sponsoring TAX.com, a Web site for the citizen taxpayer, which is informative and fun. I invite you all to check it out.

This is our seventh year of conducting discussions on tax policy. If you are new to our discussions, let me say it's great to have you here. Let me also just take a moment to explain our process today.

I will open things up with some brief remarks, and I promise to be brief, to introduce our topic. I will then introduce our distinguished panel of speakers. Each of them will address aspects of our topic and speak for about 10 minutes. After that, we will open up the discussion to all of you and we encourage all of you to participate. Whether you are seated at the table or away from it, just wave, and I'll find you. It's a little bright, but it'll work out.

We are streaming audio of this event on our Web site, and we will post both the audiocast and a transcript there. For media purposes, we are on the record. So, when I recognize you, please tell us who you are. Also, please speak into a microphone. For those away from the table, we have hand-held mikes that we will quickly get to you. And considering the size of the audience here, which is marvelous, by the way, please keep your questions and observations brief. We only have two hours, and we want everybody who wants to ask a question to get a chance to do so. I will moderate the discussion, and we will end by 11:00.

Now, onto our topic, which obviously is a hot one. Say what you want about President Obama, but he sure knows how to get our attention. Just look around the room at the individuals who have taken time from their busy schedules to discuss the important issues at hand. For me, drawing attention to the U.S.'s international tax regime, which we might all agree is a mess, is a good thing: It leads to good and necessary discussions, such as the one we will have here today.

The president's proposals really come in two parts: First, what some of us call the UBS provisions, are mostly about U.S. citizens who cheat on their taxes by concealing foreign bank accounts, and, second, the corporate part, dealing with multinationals that mostly use current rules to their advantage, sometimes with spectacular brilliance. Of the two, the corporate part is the most controversial, and it's also where most of the money is, and that is where we're going to start today. We can certainly talk about the individual part, and if we decide that we haven't given the individual part enough time today, I assure you that Tax Analysts will host another conference.

Now, let me do the best thing that I can do to move this discussion along, and that is to mostly get out of the way. Please allow me to introduce our speakers in the order in which they will speak.

Marty Sullivan is a contributing editor of Tax Analysts, who, with all due respect to the other economists in the room, is my favorite economist.

(Laughter)

MR. BERGIN: He has also written extensively on issues we will discuss today.

John Samuels is vice president and senior tax counsel at the General Electric Corporation, and he has long been one of the most respected corporate representatives in Washington.

Mark Weinberger is the global vice chairman for tax at Ernst & Young LLP, and he was assistant secretary of the Treasury for tax policy under President George W. Bush.

Lee Sheppard is, well, Lee Sheppard.

(Laughter)

MR. BERGIN: But I will remind you that she is a contributing editor at Tax Analysts, as well, who has written extensively on the issues we will discuss today.

Let me take a second to just thank this marvelous panel for agreeing to do this. It's an all-star lineup. And we'll start with Marty.

Marty, would you please get us started?

MR. SULLIVAN: Thanks. Thank you, Chris. As leadoff batter, I've been asked to provide a non-technical explanation of the major provisions of the Obama plan. I'll do that first. And then, as the token economist on the today's panel, I'll provide some economic prospective on the proposals, and I'll do this all in less than 10 minutes.

First, the big picture. We are talking about how to tax the foreign profits of U.S. corporations. The main question is this: After foreign governments impose their tax on foreign profits, should the U.S. government impose any additional tax? Simple enough.

The current state of affairs is that very little U.S. tax is imposed on foreign earnings, and foreign tax rates are generally lower than the U.S. rate. The Obama administration argues that the favorable taxation of foreign profits provides an incentive for U.S. multinational corporations to shift employment out of the United States by subjecting foreign profits to U.S. tax as they are earned. In other words, by eliminating deferral, Congress could eliminate the favorable tax treatment of foreign investment.

Now, until May 4, when President Obama provided specifics of his plan, the business community feared he would eliminate deferral outright, and during the campaign and even after the inauguration, the Obama team kept repeating their mantra they wanted to level the playing field between domestic and foreign investment. But when it announced its plan, the administration did not go all the way and eliminate deferral. Instead, it compromised and opted for a set of proposals that would limit the benefits of deferral, a compromise somewhere between current law and the elimination of deferral.

Now, let me give you a few details on how the administration plans to implement this compromise. I will quickly describe four of the most important components of the plan. They account for $190 billion out of the entire $210 billion the administration hopes to raise from international reforms. And the effective date of all these proposals is the beginning of 2011.

Okay, the first proposal, according to the official Treasury Department explanation, would "reform business activity entity classification rules for foreign entities." Well, what the heck does that mean? Let me explain.

In 1997, the Clinton Treasury screwed up big time --

(Laughter)

MR. SULLIVAN: When it unintentionally opened a huge loophole in the tax rules designed to limit deferral.

(Laughter)

SPEAKER: Tell us what you really think.

MR. SULLIVAN: Before Treasury's mistake, profits in high-tax countries could not easily be shifted to low-tax countries by using related party loans without triggering U.S. tax. The Treasury mistake changed all of that and allowed U.S. corporations to shift profits out of high-tax countries by engaging in purely artificial transactions with subsidiaries and low-tax countries.

In 1998, the Clinton administration tried to undo its mistake, but the cat was out of the bag, and Congress wouldn't allow it. Now, a decade later, the Obama administration, with this proposal, is taking another crack at the problem, and proposes to return to the pre-1997 rules.

The Treasury estimates this proposal will raise $86.5 billion by 2019. This extraordinarily large amount of revenue is surprising because, as multinationals are quick to point out, foreign governments and not the U.S. treasury will be the main beneficiaries of this proposal. That's because under the proposal, multinationals would lose some of their ability to strip profits out of high-tax countries into tax havens, and I'm looking forward to seeing the Joint Taxation Committee's estimate on this proposal and see how different it is from Treasury's.

The second proposal I'll talk about, according to the official Treasury Department explanation, would "reform the foreign tax credit by preventing the splitting of foreign income and foreign taxes." Well, what does that mean? Let me explain.

Some multinational corporations have been using complex tax planning techniques to claim foreign tax credits on profits that are not subject to U.S. tax. This creates an outrageous situation. Not only are foreign profits free of U.S. tax, but the U.S. treasury is relieving the multinationals of the burden of paying that foreign tax. So, the net burden on these foreign profits is zero. What's particularly galling about this practice is that the U.S. government, in effect, is shelling out cash to subsidize foreign investment.

So, for example, let's say a subsidiary in Luxembourg is paying 10 percent tax on profits. Multinationals would not only avoid U.S. tax, but it would also get the U.S. government to foot their foreign tax bill. The Obama proposal to shut down this loophole is estimated to raise $18.5 billion.

The third proposal, according to the official Treasury explanation, would "defer deduction of expenses except R and D expenses related to deferred income." Basically, this proposal is about penalizing deferral by denying deductions for interest on a domestic tax return.

Let's say a corporation that normally deducts $1 billion of interest on its corporate tax return. Under U.S. foreign tax credit rules, a certain portion of that interest would be deemed to be related to foreign income. Let's say $200 million. Now, let's also assume that the corporation only repatriates one-quarter of its profits from the subsidiaries. Under this proposal, only one-quarter of foreign-related interest deductions, one-quarter of that $200 million would be deductible.

Now, this type of matching proposal would make sense if it was done properly. That is, if the deductions were properly allocated between foreign and domestic profits and if foreign governments, as well as the U.S. government, recognized this allocation. But figuring out the right amount of deductions to disallow is a tricky business, and it is certainly wrong if the interest and expense is allocated using the water's edge method instead of the worldwide method.

And the proposal does not make adjustments for the lack of conformity between domestic and foreign accounting. This proposal raises only $60 billion. It does reduce the benefits referral and it does increase the effect of the tax rate on foreign profits, but it does so in a haphazard and non-neutral manner. As a result, some multinationals will only have small increases, while others, in effect, will have all the benefits of deferral eliminated.

The fourth proposal, according to the official Treasury explanation, would reform the foreign tax credit by determining the foreign tax credit on a pooling basis. Well, what does that mean?

Under current law, U.S. multinationals engage in a practice called cross-crediting, so, they don't pay any U.S. tax on repatriated foreign earnings. When their ability to cross-credit is exhausted, they usually leave the remaining profits offshore. Under the Obama proposal, multinationals would no longer be able to cross-credit. Instead of being free of tax, any profits that are repatriated into the United States will be subject to a new tax equal to the difference between the U.S. rate and the average foreign rate. Now, that's a mouthful.

So, for example, if the U.S. rate is 35 percent and the average foreign tax rate is 20 percent, the U.S. corporation would now pay a new tax of 15 percent on the repatriated profits, and this proposals raises $24.5 billion. It unfortunately imposes a new penalty on repatriation of dividends from foreign subsidiaries to the U.S. parent. This is a very strange outcome. Reducing the tax penalty on foreign profits into the United States should be the major objective of any tax reform. This proposal increases the penalty. Locking out foreign profits will discourage the efficient allocation of capital, and it will increase the pressure for another legislated one-time, temporary reduction in the tax rate on repatriated profits.

Now, let's get away from the details. Let's look at the proposal again as a package, as a whole. My approach here will be evaluated on two different levels.

On the first level, we're going to ask the age-old question of whether or not foreign investment should get favorable tax treatment relative to domestic investment. On the second level, we'll deal with a more mundane issue, but no less important. Once we make the policy decision about what the size of the differentials should be, if any, between domestic and foreign investment, what specific changes in law do we implement to make that happen?

On the big-picture question of whether foreign profits of U.S. multinationals should be taxed at the domestic or a foreign rate, there are two, polar-opposite points of view.

The first school of thought now represented most prominently by the president himself says that favorable treatment of foreign profits provides an incentive for U.S. multinationals to shift jobs out of the United States, so, the government should limit deferral of taxes on foreign investment.

The second school of thought says the opposite; basically that in order to compete with other non-U.S. multinationals, U.S. multinationals must have the same favorable foreign investment rules. Not only will these rules help U.S. shareholders, but they'll also help U.S. workers because the offshore operations of U.S. multinationals are complimentary to U.S. job creation.

So, which point of view is correct? Does deferral create jobs or does it hurt jobs? And the answer to the question, at least on a (off mike) basis is that both points of view are legitimate, both arguments are correct. There are both job-creating and job-killing aspects of U.S. tax law. So, even though advocates will argue very vociferously one way or the other, in effect, both are right, at least in theory. So, to resolve the question of the effect of taxation on multinational jobs, we have to look at the problem empirically. So, enter the economists. Economists to the rescue.

(Laughter)

MR. SULLIVAN: Now you're in trouble.

(Laughter)

SPEAKER: You're here to help.

MR. SULLIVAN: I'm here. So, we're going to ask the economists which of these two effects is stronger, and if the economists can answer these questions, they will be the heroes because they'll resolve this whole controversy in international taxation.

Well, I've been doing this for about 25 years, and I think it's safe to say economics is not an exact science, and it's not really up to this task of disentangling these effects.

And just to give you an example, since the 1960s, economists have been trying to figure out whether the tax on domestic profits affects domestic investment. Now we're asking them to figure out whether the tax on foreign profits affects domestic investment. Well, they haven't solved that first problem yet. It's been about 50 years. So, to expect them to resolve this one, I think, is a little farfetched.

But my hunch, based on admittedly unsophisticated econometric techniques, that is I just look at the data a lot, eyeball it and drink a lot of coffee, is this.

(Laughter)

MR. SULLIVAN: The effects, both positive and negative, of international tax rules on jobs are small. Now, if you would entertain this possibility that the effects of international tax rules on jobs are not significant, this whole issue becomes a lot simpler.

The current debate about international taxation is not a battle over jobs it's about money. The Obama administration wants $20 billion a year in extra taxes from big corporations. That's easy to understand. Big corporations want to keep their effective tax rate low in order to keep their reported profits high and their stock price high. That's easy to understand. You don't have to bring jobs into this. It is clear, however, even though jobs may not be moving in response to taxes, profits definitely are. Numerous analyses of the data by me and my other economists consistently show this.

One of the most striking examples is the rate of profit for U.S. subsidiaries in Ireland. That rate of profit is twice as high as the worldwide average and four times as high as the rest of Europe. The revenue loss from profit shifting from high to low-tax countries surely costs the U.S. treasury tens of billions of dollars a year. The disparity between the U.S. tax rate and the effective tax rate fuels profit shifting. A reduction in this ridiculous amount of profit shifting is a good reason for the United States to lower its statutory corporate tax rate. And, for me, it's a good reason to support the general thrust of the Obama proposals to reduce the benefits of deferral.

Now, once we've decided -- let's just take it for granted for a minute that we agree with Obama that there should be a compromise between current law, the generous aspects of current law and complete elimination of deferral. How should we go about that?

Well, as I've outlined in articles I've written for our publications and I've mentioned briefly before, the last two proposals, I believe, are unduly complex, non-neutral, arbitrary, and create a great deal of uncertainty for taxpayers. I don't think this is the right way to go about achieving this policy objective. Nobody wants more complexity and more confusion. Nobody wants more unfairness and more distortion, and nobody wants to heighten the barriers on the distribution of profits back to the United States.

So, the good news I'll leave you with is I believe that Obama could achieve the same policy objective much more simply, and there is a proposal in the 2000 report by the Clinton administration to Congress on international taxation that proposed combining a repeal of deferral with a lowered tax rate on foreign earnings, like 15 percent or 20 percent. Now, this would be a fair and more neutral way of achieving the administration's policy objective and it would not exacerbate the problem of locked-out foreign profits.

In conclusion, I'll just say, given our gaping budget deficits and the need to stem the outflows of taxable profits from the United States, the general direction of the Obama international tax plan is a good one, but to minimize the adverse side effects, the specific proposal should be scrapped in favor of a simpler approach that would achieve the same objectives.

MR. BERGIN: Thank you, Marty. I'll now turn to John Samuels. Mr. Samuels?

MR. SAMUELS: Thanks, Marty. I wasn't sure if that was an endorsement or not.

MR. SULLIVAN: Good.

MR. SAMUELS: Well, I'd like to thank Tax Analysts for putting this conference on today. You guys play a very important role in fostering public dialogue and debate on important issues of tax policy like the ones we're going to discuss today. It's a real public service.

Now, I hope we can find some common ground on these issues this morning, although, I'd certainly be surprised if we agree on everything. Particularly Lee and I, but maybe.

(Laughter)

MR. SAMUELS: I expect they'll be some lively and hopefully enlightening debate because where there's heat, there's usually light.

Now, I'd like to begin by focusing on some areas where I hope we can find some agreement.

First, I'm sure we can all agree that it's time, indeed, well past time to take a fresh look at the international tax system. Its basic architecture was put in place in 1962, more than 47 years ago. The world and the U.S. role in the world economy are both quite different today than they were almost a half-century ago.

So, the administration's initiative to reexamine our international tax rules is a welcome development, and I applaud that.

Second, I hope we can all agree that the goal of any reconsideration of our international tax system should be to advance the welfare of the United States, specifically to advance national and not global welfare. To increase the standard of living in the United States, both for our current citizens and residents and for future generations. A goal that I am certain is shared by the administration.

Okay, so, if the business community and the administration agree that our international tax system needs to be changed and that the goal of that change should be to advance our national welfare, why hasn't business exactly embraced the administration's proposals for reform?

Let me offer two, broad reasons before delving into specific concerns raised by the proposals.

First, the process for developing these proposals was flawed. Because they were developed as part of the budget process, they appear to have been motivated almost entirely by the need to raise revenue with little, if any, consideration given to the competing consideration of how they might affect the competitive position of U.S. companies in the global economy and the critically important question of how they might advance the welfare of the United States. Simply put, the line item in the budget plan for international tax reform had a suspiciously smooth and level revenue trajectory, leading one to believe that at the time the budget was released, specific international reforms had not yet been identified, thus leaving a $210 billion hole in the budget that had to be filled by finding unidentified revenue-raisers in the international tax area.

Now, this kind of piecemeal, revenue-driven approach to an international tax reform falls far short of the kind of broad, comprehensive, and deliberative process that's demanded by a subject as fundamentally important to the United States as a reconsideration of our international tax system.

Now, let me say here the business community would welcome the opportunity to work with the administration and Congress on a broad reform of our tax system. A reform that has advancing U.S. welfare as its ultimate goal, and given the government's need for money, revenue, everything should be on the table. Let me repeat that, everything should be on the table.

Rahm Emanuel, the president's chief of staff, was recently quoted as saying, "All roads lead to tax reform." I think he was right. But it's critically important that the approach to that reform by considered and deliberate and not a piecemeal process that is driven exclusively by the need to raise revenue.

The second and most important and fundamental shortcoming of the administration's proposals is that they ignore international tax norms, which may be a byproduct of the revenue-driven process that led to their selection. If I have one overarching message this morning, it's the U.S. tax policy cannot be set in a vacuum.

For most of our history, we've gotten away with designing our tax rules with little regard for what the rest of the world was doing. Indeed, our refusal to consider how other countries were designing their international tax systems when we formulated U.S. international tax policy represents a national arrogance bordering on tax chauvinism. We have single-mindedly clung to a worldwide residence-based tax system largely premised on the outmoded, academic doctrine of capital export neutrality.

And as a result, today, the U.S. tax system is out of step with the tax system of virtually every major industrialized country in the world. Twenty-five of the twenty-nine OECD countries have adopted territorial tax regimes, leaving the United States as the only major industrialized country taxing the worldwide income of its resident multinationals. And the average corporate tax rate in OECD countries has steadily declined. It is now 50 percent lower than the U.S. rate. Nor has any country adopted anti-deferral rules that are nearly as broad and far reaching as the U.S. subpart F regime. We no longer have the luxury of ignoring what the rest of the world is doing. This is not 1962.

The world's economies have integrated, and the U.S. no longer occupies the dominant role in the world economy that it did 50 years ago. U.S. companies face fierce and unprecedented foreign competition both at home and abroad. So, if we want to enhance U.S. living standards, we cannot continue to ignore how other countries are changing their tax laws and their tax systems to advance their competitiveness and enhance the living standards for their citizens and residents when we set our own tax policy.

And here's the rub. By continuing to rely on the doctrine on capital export neutrality, instead of minimizing the differences between the U.S. tax system and the tax systems of our major trading partners, the administration's proposals actually exacerbate them, creating new and substantial tax disparities that would make the United States an even greater tax outlier from the rest of the world. This increased tax isolationism would create new and perverse incentives that would geometrically compound the already inordinate complexity of our tax system and result in new and significant economic distortions that could seriously harm the domestic economy.

Now, let me turn to some of the specific distortions that would result from these proposals. Let me begin with the proposal that Marty described that would postpone deductions for domestic expenses that are allocated to deferred foreign income.

At first blush, this proposal appears to make a lot of sense. It appeals to our sense of symmetry and to the principle of matching expenses with the income they help produce that has become so familiar in the domestic context. If foreign income is not subject to current U.S. tax, why should the U.S. allow a current deduction for expenses associated with that income? Why not wait until the foreign income is repatriated and subject to U.S. tax to allow a deduction for the expenses related to that income?

As Marty suggests, as a matter of pure tax policy, in an ideal world where countries had harmonized tax systems and cooperated multilaterally to allow deductions for expenses imputed to their country by another country, the proposal has some theoretical appeal. The problem is we do not live in an ideal world. So, let's consider the proposal in light of the world we do live in, and let's start by looking at international norms. Do other countries deny deductions for domestic expenses allocated to deferred or exempt foreign income? It's a lot of loose talk about whether they do or don't. And, if not, why not? And why should we care what other countries do anyway?

Well, first, the facts. To determine what other countries do, GE recently completed a study in which we asked prominent, independent tax advisers in 24 countries whether the tax laws of their country denied or postponed deductions for domestic expenses allocated or apportioned to exempt or deferred foreign income. The countries surveyed represent the source of more than 85 percent of all non-U.S., outbound FDI, and to avoid any confusion or ambiguity, we requested and received written memoranda from each of these advisers confirming their conclusions. The results were very clear: No major industrialized country in the world denies deductions or domestic expense for domestic expenses allocated to the deferred or exempt income earned by the foreign subsidiaries of their resident multinational companies. Nine countries with territorial regimes that completely exempt foreign business income from home-country tax require no allocation apportion of expenses to exempt foreign income, including the United Kingdom, Spain, Canada, Russia, Sweden, Austria, and the Netherlands. Seven other countries with territorial regimes also did not require any allocation apportionment of domestic expenses to exempt foreign income, but subject a small portion of foreign income, usually 5 percent, to home-country tax when the foreign income is repatriated as dividends as a modest proxy for expense allocation. These countries include France, Germany, Italy, Japan, Belgium, and Norway. Similarly, most of the countries that still have worldwide tax systems do not deny deductions for expenses allocable to deferred foreign income, including China, Ireland, Korea, India, and Taiwan, and only one of these countries actually allocates expenses in computing its foreign tax credit limitation, and that's Taiwan.

Now, only three countries collectively represent less than 5 percent of all non-U.S. outbound FDI have some form of limitation on the deductibility of the expenses based on offshore investment: Australia, Hong Kong, and Singapore.

Finally, and perhaps most significantly, three of the most important countries in the global economy recently considered and explicitly rejected rules that would have denied deductions for expenses allocated to exempt foreign income: The United Kingdom, Japan, and Canada. I don't have enough time, but I could go into the reasons why, and I think they are very enlightening.

So, other countries allow their resident, multinationals to fully deduct their domestic expenses and continue to have their foreign profits exempt or deferred from home-country tax. However, under the administration's proposal, U.S. companies would be forced to choose between not being able to fully deduct their domestic expenses on the one hand or repatriating 100 percent of their foreign profits and subjecting them to the full 35 percent U.S. corporate tax rate on the other, which is why many people consider the expense disallowance proposal to be the backdoor repeal of deferral.

And now to prove that the law of unintended consequences is still alive and well, I'd like to drill down a little further and focus on some anomalies that would result if the expense disallowance proposal were to be adopted.

First, it would actually provide an incentive for U.S. companies to invest overseas instead of in the United States.

For example, assume a U.S. company was considering building a debt financed plant in the United States or in Germany. If the plant were built in the United States, a portion of the U.S. company's interest expense would be nondeductible. However, if the plant were built in Germany, the U.S. company could fully deduct its interest cost against its German tax base, providing the U.S. company with an incentive on the margin to build the plant in Germany.

Similarly, U.S. companies would have an incentive to move jobs overseas, where salaries would be fully deductible, rather than keeping them in the U.S., where a portion of the compensation expense would be nondeductible. Perhaps even more perversely, the expense disallowance proposal would have the odd and almost certainly unintended consequence of putting U.S. companies at a competitive disadvantage in their home market here in the United States.

For example, assume a U.S. bank or financial services company with deferred foreign income was competing in New York with the U.S. subsidiary of a foreign bank to make loans to New York residents and businesses. A portion of the U.S. company's interest expense and the money it borrowed to make loans to its New York customers would be nondeductible. In other words, the U.S. bank or financial services company could not fully deduct the cost of its raw material. By contrast, the foreign bank's U.S. subsidiary could fully deduct its interest expense against the 35 percent U.S. corporate tax imposed on its U.S. income because it would not have any deferred foreign income to which it had to allocate its U.S. interest expense, providing the foreign bank with a significantly lower after-tax cost of funds that would enable it to gain market share. And not allowing U.S. companies to fully deduct their interest and other expenses would also set them up as very attractive takeover targets for foreign companies.

For example, assume a U.S. company had significant nondeductible interest expense because the interest was allocated to deferred foreign income. A German company could acquire the U.S. company and easily substitute fully deductible German debt for the nondeductible U.S. debt, simply by issuing new debt in which it could claim a full interest deduction in Germany, and then using the proceeds of that new debt to pay off the U.S. company's nondeductible debt. A simple refinancing transaction that would generate very substantial tax savings.

Alternatively, if the Germany company wanted an interest deduction in the United States either because that's where its tax base was or wanted the deduction against the higher U.S. rate, after the acquisition, the German company could convert the U.S. company's nondeductible debt into fully deductible debt by transferring the ownership of the U.S. company's foreign operations to direct German ownership. So, after the acquisition, the U.S. company would no longer have any deferred foreign income, and, therefore, would be entitled to a full interest deduction in the United States on its previously nondeductible debt.

Well, an investment banker might describe these tax savings as synergies; they would represent nothing more than the fruits of financial engineering from exploiting the new tax arbitrage opportunity that would be created by the expense disallowance proposal. An opportunity that would create a new and powerful incentive for the takeover of U.S. companies, effectively putting a for-sale sign on corporate America. And, of course, the expense disallowance proposal would make the United States an even more unattractive place for a multinational corporation to locate its headquarters than it is today.

Why would a global business even consider establishing its headquarters operations in a country where it would have to choose between having its worldwide income subject to an immediate 35 percent U.S. tax rate on the one hand, or having a portion of its domestic expenses disallowed on the other? Unfortunately, I'm afraid this question answers itself.

Finally, the expense disallowance proposal has at least one other unintended consequence that would significantly weaken the U.S. economy, and Marty referred to this, it's disparate sectoral impact.

Now, the expense disallowance proposal has been described by many as being a middle ground between the complete repeal of deferral on the one hand and the status quo of current law on the other. However, cutting back on deferral by denying deductions for domestic expenses has a widely disparate and ad-hoc impact on different industries, depending on the ratio of expenses to income in a particular industry and the extent to which the companies in that industry have global operations.

Now, one sector of the economy that would be hit disproportionately hard by the expense disallowance proposal is the U.S. financial services sector, and that's because the raw material of U.S. banks and financial services companies is borrowed money. So, financial services firms have disproportionately large expenses relative to other industries.

Now, a recent study prepared by PriceWaterhouseCoopers, a very well-respected accounting firm, based on 2004 IRS data, shows that the expense disallowance proposal would be the equivalent of eliminating 51.2 percent of the current law benefit of deferral on average for all industries if expenses are allocated to foreign income the same way they are under House Ways and Means Committee Chair Charles B. Rangel, D-N.Y. However, the effects of the proposal vary widely by industry, and because of its relatively heavy interest expenses, the financial services sector would lose 96.1 percent or nearly all of the current law benefit of deferral under this proposal, nearly twice the benefit lost by all industries.

Now if, unlike the Rangel bill, the administration's proposals ultimately interpreted not to allocate expenses to deferred income that are directly allocable to foreign income under current law, such as branch expenses, it would be the equivalent of eliminating 35.6 percent of the current law benefit of deferral across all industries on average and 70.5 percent of the current law benefit for the financial services sector. Still, twice the average benefit lost across all industries.

Now, the disproportionate tax increase on the U.S. financial services sector would severely impact its competitive position because its product is the ultimate commodity, money. It's impossible for U.S. banks and financial services companies to differentiate their dollars from European bank's euros or an Asian bank's yens, and, as a result, customers make their decisions based entirely on price. A few hundred basis points can make the difference between winning and losing market share. So, in the finance services industry, taxes, like all costs, really matter.

And, finally, it's ironic that the expense disallowance proposal, hits financial services firms so hard, because in no sense are they shipping jobs overseas. Financial services cannot be exported and have to be supplied locally. It would be impossible to provide home mortgage loans to customers in the U.K. or equipment leases to local businesses in Japan from the United States. These foreign employees of U.S. financial services firms have to be there to sell there. In no sense are their jobs substitutes for U.S. jobs. Indeed, the success of U.S. banks and financial services firms in global markets supports literally thousands of high-paying jobs here in the United States.

So, it's a very strange industry, indeed, to target with a disproportionate loss of the benefits of deferral.

I'm going to spend just a couple of minutes, if I can, on the check-the-box proposal, and the best way to do that is to ask a few questions about the so-called abusive transaction the administration singled out as the reason for its proposal, a transaction in which a U.S. company reduced its German tax liability by borrowing from a related Cayman Islands finance company.

The first question is: What's wrong with a transaction in which a U.S. company reduces foreign taxes? At first blush, this would appear to be a good thing for the United States. The U.S. company is more competitive, and U.S. tax revenues should increase both from smaller, foreign tax credits and higher capital gain taxes on the incremental appreciation and the shares of the U.S. company attributable to the foreign tax savings. But surprisingly, the Treasury scored the check-the-box proposal as raising $87 billion, and, Marty, yesterday, the Joint Taxation Committee scored it as raising $31 billion, $55 billion less than Treasury's estimate.

Now, from my perspective, it's very hard to see where any of this revenue is going to come from. If the check-the-box proposal is enacted and the look-through rule of 956 is allowed to expire, these inter-company financing structures will be quickly unwound. No one is going to leave a structure in place to get interest deductions at the 30 percent German rate that's generating subpart F income that's subject to tax at the 35 percent U.S. rate. So, there's not going to be much revenue collected from new subpart F inclusions. And if the revenue estimators are assuming repealing check-the-box will result in higher revenues because U.S. companies will be paying high foreign taxes and, therefore, will have less of an incentive to shift profits out of the United States through transfer-pricing strategies, they're also mistaken.

Transfer-pricing decisions are made on the basis of marginal and not effective tax rates. Because the amount of foreign tax reduction that can be achieved by the check-the-box strategies is limited by foreign thin cap rules, check-the-box transactions do not reduce the marginal tax rate of companies like the German company below the 30 percent German statutory rate. So, transfer pricing incentives are the same with or without check-the-box. And, of course, there are no flows between the U.S. company and the Caymans finance company that would be influenced by transfer pricing. So, it's very hard to see where this revenue is going to come from.

Indeed, the Joint Taxation Committee staff a few years ago scored a very similar proposal as raising only $1.2 billion over 10 years, a result that seems a lot closer to reality. More fundamentally, I think the check-the-box proposal begs the question of whether foreign to foreign-related party payments should be treated as subpart F income at all, particularly when these payments reduce foreign taxes and come out of active foreign profits. The 2000 Treasury white paper on subpart F pay on to deferral, even that questioned whether the wisdom of treating foreign to foreign transactions as subpart F income by correctly observing that intercompany loans and other transactions that allow U.S. companies to shift profits from high-tax jurisdictions to low-tax jurisdictions, without changing the location of real investment, may actually reduce the significant economic distortions that result when real investment like plan equipment is moved to low-tax countries, and the administration spin describing the check-the-box proposals as a loophole that allows unintended U.S. tax avoidance is both misleading and rewrites history. First and most importantly, it's foreign and not U.S. taxes that are being avoided in these transactions.

And, second, Marty, while maybe Treasury didn't fully appreciate the international implications of the check-the-box rules in 1997 when it put those regs out, it certainly did by 1998, when 9811 was published, and much importantly, the legislative history of section 954(c)(6), the look-through rule, makes it abundantly clear that not only did Congress understand how taxpayers would be using the check-the-box rules to avoid subpart F inclusions, it actually ratified these transactions by enacting the look-through rule so taxpayers would not have to rely on more cumbersome and expensive check-the-box transactions to avoid subpart F. The Senate Finance Committee report on 954(c)(6) could not be more clear.

And, okay, finally, what about international tax norms? I'm making a big deal out of those. Can foreign multinationals use intercompany loans to reduce the foreign taxes imposed on their overseas operations?

The answer to this question, GE recently undertook a second study in which we asked prominent, independent tax advisers in the same 24 countries surveyed in the expense allocation study whether multinational companies headquartered in their countries could use offshore finance companies to reduce foreign taxes imposed on their overseas operations without incurring any home country tax under the equivalent of their subpart F regimes. Precisely the fact pattern that the administration aimed at in its proposal, and to avoid any confusion or ambiguity, we again requested and received written memoranda from each of these advisers confirming their conclusions.

Once again, the results were clear. Foreign multinationals headquartered in the vast majority of major industrialized countries can and routinely do use intercompany loans from related finance companies located in low-tax countries to reduce the foreign taxes imposed on their overseas operations without triggering any home-country tax. Countries whose multinationals employ these foreign tax reduction strategies include the U.K., France, Germany, Spain, Italy, Canada, Hong Kong, Switzerland, Belgium, Russia, Sweden, Austria, the Netherlands, Australia, Ireland, Singapore, Norway, and Finland. And if there's any doubt that foreign multinationals are engaged in strategies to reduce their foreign taxes, consider this fact: In 2007, 24 percent of the inbound investment in the United States came through three countries: The Netherlands, Switzerland, and Luxembourg. It's highly doubtful that the source of this inbound investment originated in these countries. Instead, the real investors are sophisticated, foreign multinationals, who I'm sure are complying with law, who are using these three, low-tax countries to reduce the U.S. tax on their income from their investments in the United States in full compliance with 163(j).

So, the reality is multinational companies around the world are taking steps to reduce foreign taxes on their overseas income and in transactions that are transparent to and enabled by their home country's tax systems.

Now, some may call this a new race to the bottom, but that would be true only if the goal of the race is for countries to extract as much tax revenue as possible from the overseas operations of their multinational corporations. Instead, assume for a moment that the goal of the race is for countries to maximize the welfare of their citizens and residents and that countries believe that the success of their resident multinationals and global markets actually strengthens their domestic economies and contributes to the goal of increasing the welfare of their citizens, then maybe it's a race to the top.

MR. BERGIN: Thank you, John. Mark?

MR. WEINBERGER: Great. Thank you. I, too, would like to compliment Tax Analysts on holding these forums and the great articles around the debate.

As John and Marty were talking, I slowly looked through my talking points and ticked off the issues that I was going to cover, and I'm left with this [holds up blank notepad].

(Laughter)

MR. WEINBERGER: Which is good news for all of you because I may get you back on schedule. In fairness, John did tell me just before we started that he'd eat into my time a little, so, I was aware.

SPEAKER: (Off mike).

MR. WEINBERGER: Yes. I didn't know he'd take Lee's, as well, but --

(Laughter)

MR. WEINBERGER: It does open me up though to Marty started the debate talking about the economists' role in this, and I spend a lot of time on airplanes now in my global role, and I did hear two economists talking about the current state of the economy, and I'll quickly share it. It was really typical economists. There was a pessimist economist and an optimist, and the pessimist economist said, Boy, I've never seen the economy so bad, it is absolutely incredible; it just can't get any worse. And the optimist said, Oh, come on, sure it can.

(Laughter)

MR. WEINBERGER: So, that's hopefully what we'll get out of the economists during this debate.

I will make just six very, very high-level observations, and then leave open the discussion, as John did a great job, of talking about the technical aspects of the proposals and to the actual dialogue. And obviously, some of them will be repetitive of Marty and John.

But first is that we do have to take the emotion out of this debate. This is a fundamental change in tax policy that will have real-world consequences. This is a big change, and we cannot label all of these proposals simply as loophole-closers, abusive, and tax breaks for companies to move overseas. That is not what the debate is about. There are legitimate issues that are put on the table by the administration to look at things that are unintended consequences of some of the laws that have been enacted, and they should be looked at. Whether they deal with tax havens, whether they deal with offshore accounts, whether they deal with international rules that are being used, it's unintended, and that's a fair debate, but all of these proposals do not come under that category, and, Chris, the way you teed this up, I think was important to separate the two. A lot of times, they get commingled, and I think we need to do that. It's very important to separate the two.

Similarly, I don't think U.S. multinationals can safely say there's no need for reforms in the tax rules, that these all work exactly as intended, they're easy to follow, and we really shouldn't revisit it. As John said, it is absolutely time to revisit the tax rules for a whole host of reasons. So, that's the first high-level observation I would make.

The second is we can't get lost in the trees and miss the forest. In order to really understand the magnitude of these changes, it's so easy for us, and we all often do get devolved into the discussion, as Marty correctly outlined, as where the one particular proposal creates jobs, loses jobs, has the intended effect, doesn't have the intended effect, what is the score, 80 billion versus 50 billion. What you really need to do is step back and look at these proposals in their entirety.

We're talking about in the president's budget $210 billion, a little less under the Joint Taxation Committee's scoring, on the international proposals we're talking about, plus another $200 billion of tax increases elsewhere. It's $400-some billion. We collect currently $300 billion a year generally in corporate taxes. So, it's over a 10 percent increase in taxes annually, and that may be the right answer. We are going to have to collect more revenues, but you have to step back and look at it at least from a comprehensive standpoint and not get lost in the details of when you'll legislate each one of these proposals.

I liken it to, and maybe you've heard it. I've actually used this when I worked in the Clinton administration on the Entitlement Commission. The same example in the entitlement area, but I'll use it here in the tax area, as well. It reminds me of the story about the frog and jumping into hot water. If you drop a frog into hot water, it'll immediately recognize the danger and jump out. If you drop it into cold water and slowly turn up the heat, it won't recognize it; it will slowly paralyze itself and die.

And if you look at each one of these proposals on their own, not one of them will dramatically change the international landscape of what we're talking about in U.S. competitiveness or anything else, but when you add up the cumulative affect of all these proposals and then say in 2011, they're going to take affect, just as we're, hopefully, coming out of this economic downturn, somebody needs to step back and not look at these as just pay-fors for other initiatives, but what will be the effect so that we are not the frog in 2011 that looks back and can't jump out of the water.

And so, I think that at least I know that's Pollyannaish, I know that we don't often legislate by looking at the broader picture, but these are such big changes in policy that we're talking about that it's going to be, I think, hopefully, critical to do.

The third point I'd make is that, taken as a whole, and John did this extremely well, I mean, these are fundamental changes in tax policy, and Marty alluded to it, too. They do go back to the compromise that was struck in the 1960s, when we put deferral in place, and they do unwind that compromise. And, in doing so, there are going to be significant questions that each one of these proposals raised, and if you've read through Marty's articles and Lee's articles in Tax Notes, you can disagree or agree with the conclusions, but they raise a lot of the right questions and identify things that we have no answers to. And, so, to go ahead and move forward at this point in time with enacting proposals that we really don't have any true sense as to what are the consequences would be -- in my view, something we ought to seriously think about.

The other point is when we came up with this compromise in the 1960s of deferral, it's kind of the position from a competitiveness, export-neutrality, import-neutrality balance that Marty referred to. We were able to pretty much, to John's point, legislate "in a vacuum."

We were the dominant economy in the world. Arguably, even during the 1986 [tax reform] Act, and we didn't look much else at what's going on in the world, we probably were dominant enough to enact laws that didn't have to worry about what was going on in the rest of the world. And you fast-forward to today and look at what's going on around the world and it is, at best, naive to think about us legislating without looking at the type of studies that John eluded to, but also what are the real-world consequences of these proposals?

In the 21st century, growth will be driven by the emerging markets. There's no doubt about it. Actually, in 2007, 44 percent of global GDP [gross domestic product] growth came from the emerging markets. China alone had 27 percent of the global GDP growth, and Africa is growing at over 5 percent a year.

Now, if you look at this year, I would say 100 percent of the GDP growth could come from emerging markets because they're the only ones that are growing. The rest of the world is actually contracting. That's where demand will ultimately be, and, so, when we look at the marketplace for the world, it will change going forward. Do I or anybody around here have all the right answers today for what the tax system should be to capture that? Probably not, but at least we have to recognize that as we move forward.

Another interesting fact that I was looking at was the emerging markets had 70 countries in the Global Fortune 500 in 2007. So, 70 countries were hosted in the Global Fortune 500 from emerging-market countries. There were 20 a decade ago. So, that's a 250 percent increase over 10 years, and the proposed estimates of where we're going is that within the next 10 years, one-third of Global Fortune 500 companies will be hosted in emerging markets. That's 125 of the Fortune 500. That's the type of companies of tomorrow that we're going to be competing against in the world for jobs, for businesses, and for market share. Ninety-five percent of the world's consumers are outside the United States. Things that are really important to bring to the debate.

I think it was Marty who said the president has focused really intently on the export neutrality argument about whether or not when we enact laws, we're making it easier for U.S. companies to invest overseas than here. It looks at us competing against ourselves. We really need to look at us competing against other countries' companies, as well, and that's the other part of the debate I think that needs to be had.

I guess the fifth point or my sixth, as John alluded to, as well, but we really are moving in a different direction than the rest of the world from a tax policy standpoint. In my current role, I do get to spent -- "get to spend" is not how I'd put it, but a lot of time overseas. I meet with many of the tax administrations around the world, and, clearly, the trend is obvious. I mean, you know the kind of talking-point trend that you hear all the time. There is a move more towards lower marginal corporate tax rates around the world. Ninety percent of the OECD countries have reduced their corporate tax rates in the last nine years alone. We are the only country that has a greater than 30 percent corporate tax rate and worldwide taxation.

Now, you can argue whether or not where we stand competitively against other systems. John's got some studies, and I'm sure others have, as well, but regardless of where you stand today, there's no doubt that these proposals would move us further away from competitive. So, if we're more competitive today, balance the playing field in favor of foreign companies. If we're less competitive today, it makes us even more noncompetitive. No one could argue with that statement.

So, I do think it's important to look at what the rest of the world is doing, and I do think when you look at it and you question why are we moving in a different direction than everyone else, what do they see that we don't see, one of the things you [do is] compare the policies around what's going on in the stimulus bills around the world right now it's a fight to get investment back in the countries and that's what you're seeing most countries fall on and look to, and that's why you're seeing the lower marginal corporate tax rates in some cases. And I think that part of the debate has really not yet brought to the forefront here.

The last point that I think was not covered that I'll make is that in some of the administration have been clear, and they're not wrong, that we do need to raise revenue. There is no doubt that we are in a world of hurt from a budget standpoint. We will have a $1.8 trillion deficit this year, 12 percent of GDP. The largest since World War II. You look back at the last recession in the early '80s. That was a big recession. The deficit as a percentage of GDP was only 6 percent. We're double that. That's huge.

By 2030, under the most basic and probably conservative estimates, we will have about 18 or more percent of GDP spent just on our entitlement programs: Social Security, Medicare, Medicaid, and veterans' benefits. If you look at the historical average of how we tax ourselves and what level, it's been 18 percent. It's actually about 15 percent this year because corporate profits are down. But we have traditionally taxed ourselves at a ceiling of about 18 percent. It went up a little bit and down a little bit, but that's the average.

If all of that 18 percent is consumed by entitlement spending, there would be no money left for anything else that we do as a government, including defense, roads and bridges, anything for our children, or the whatnot, and I can tell you having worked in both administrations, having been around and worked in the Senate, there's really no huge interest in cutting entitlement and expenditures in either party. And, so, maybe you get some money from there, but you ain't going to do it all on that side of the equation. So, you will have to look at tax increases.

So, then you step back, and I guess the last point in summation would be you look at the proposals that are on the table that raise this $400-some billion plus the $900-some billion on increase on individuals that we're talking about. They still don't come close to filling the hole that we need to really run our government over the long-term at the pace we want to.

And, so, you say even with all this pain and all the potential and unintended consequences, even with all the hard, difficult process of legislating all these things through the system, we're still at ground zero. We haven't gotten anywhere. I think it really does tee up the issue of stepping back and looking at the larger picture, especially as the president has on the table -- the numbers I gave you are current law. Remember, he also has a $1 trillion-plus proposal for healthcare for universal coverage, a $600-some billion proposal for increased spending on climate change, a $200 billion for education reform, tax cuts for the middle class at $3.5 trillion, all not even in those numbers.

And, so, this goes back to my story of the frog. We're either going to go ahead and piecemeal and try and fund all these initiatives and enact these policies or we're going to step back and recognize they don't even get us where we need to go, we need to think more fundamentally about what is the prize, how do we want to raise this revenue, and I think a number of things should be on the table, frankly, and they should be what Charlie Rangel has put on the table and corporate reform and looking at those tradeoffs. It should be new revenue sources. And I think that, inevitably, we will get to discussion of broader revenue sources around things like the big word no one likes to discuss, the value added tax and the like. But I think that debate is coming.

So, anyway, with that, I think those are my open issues that (off mike) covered, and I'll turn it over to Lee.

MR. BERGIN: Thank you, Mark. I appreciate it. Lee?

MS. SHEPPARD: So, I am here to re-inject the emotion back into the debate.

MR. BERGIN: What a surprise.

MS. SHEPPARD: And before I fricassee a couple of frogs here. What I -- you know I've been running around giving speeches on the bailout for about six months, and what I love about this is we're arguing about $200 billion dollars or less. I can find you that money in the TARP programs. I mean let's -- you know I'll pull off a couple of bad asset guarantees, and accelerate a couple of liquidations, create a couple of bad banks. You can get $200 billion dollars like that. And besides the Fed probably created that this morning anyway.

Now, I -- we are with this stuff in budget mode. So, even if -- yes, do we need to talk about the international system that we've got? Do we need to get it on the same plane as the rest of the world? Yes, in the long run we do. Are we going to do it now, between now and October? Even though Jupiter is retrograde? No, we are not going to do that. You know we are in budget mode, we need these plug and play things, and that's what these things are. I mean the stuff we're talking about is patches on the present system. Even though yes, of course it's reform if you're not paying any tax on your cross-border income, and you're suddenly being asked to pay some; that is reform to you. But it's not really reform these are patches, these are what the worldwide residential system would look like if you closed up some of the -- you know, we don't use the word "loopholes" actually very much at Tax Analyst. That's sort of a newspapery word.

But if you patched up some of the known long-running problems yes, that's what this would look like. And then you may decide, well we don't like that system. But that's a decision for another day; we're in plug-and-play mode. And sort of you know worse if you're on the company side of this equation. You're in a situation where Congress is going to have a substantial amount of control over what happens.

So, you know when the administration made its proposals, and I'm looking at Chairman Rangle's draft, and people are saying, well there's no detail in the administration proposals and I'm sitting there going, Well, come on, kids, it's already in draft. There it is right there.

I mean Congress is going to have so much control over this because of the Obama administration's modus operandi, which is -- they tell Congress what they want, and they leave it to Congress to draft the details, which means that there's no reason to expect that this is going to look any better than the stimulus bill, or the climate change bill, or any other large congressionally controlled bill that you don't like the looks of.

It also means that you're likely to get -- because I think a lot of this stuff is going to be enacted. I think it's the multinationals turn to pay, and that's just a political judgment. That's got nothing to do with competitiveness or anything else. You're likely to get the repeal of the worldwide interest allocation provision, Section 864(f). Our economist has written a nice article about that. That does interact with this stuff that's proposed, and it makes it more of a revenue grab. But you know of the three main things that we're talking about, I like the three main things we're talking about.

I -- you know, if I was sort of looking at them and saying, Well if I had to choose one, what would I choose? You know, but I do like them technically there are better ways maybe to do them. But you can't say, like on the expense allocation, I mean, this is matching income and expense. And you can't say, well the worldwide system that said you could defer foreign active income, and we're going to claw back passive income however that's defined. We always meant that you could pack all the expenses into the United States, and leave the income out there, and not repatriate it, and never pay U.S., you know, incremental tax on it. That -- I -- somehow I don't think that's the way it was meant to work.

Now, if you look at what's been proposed, it is very complicated, and you may just want to find another way to do it. You could do it as an interest deduction haircut since we're mostly talking about interest deductions here. We're talking about some sort of management, you know, administration -- administrative expenses if somebody is managing here, and it's allocable to a foreign subsidiary. But mostly we're talking about interest, and you could always haircut interest deductions in the United States, because most of people's interest deductions, even if they're borrowing for the whole world there -- a lot of their borrowings are going to be in the United States because it's a good place to borrow. What was I -- did I have something else on that one?

And even if you had, and I'll get to that in a minute, even if you had a territorial system, you'd have to have either some actual expense allocation, or some proxy for it. But the expense allocation is very complicated because, you know, as we've got it drafted, they want you to go look back and rebuild your earnings and profits. And everybody in an accounting firm here can tell you that people don't have some little ledger of earnings or profits. You know, it's always a rebuild, and you know our international provisions are certainly administratively a mess, so why do we want to complicate them further? If we want an expense allocation, we could you know do a haircut.

On the foreign tax credit blending, I have never understood, and nobody has ever been able to explain to me, why of the few remaining countries that tax on a worldwide basis -- and Britain and Japan are about to go -- why we don't have a per-item limitation, or a per-country limitation. You know, why so much cross crediting was allowed. And so foreign tax credit blending makes a lot of sense to me, because it's also the way that companies look at it themselves. I mean you're in Germany because you have to be in Germany, or some high-tech sort of place. And -- but you're looking at all your operations around the world, and you're looking at your blended rate around the world. And it's fair to say fine, you're paying tax around the world at 20 percent or something effective rates. When you bring money back, we're not going to ask questions about where you brought it back from, we're not going to let you cherry-pick. You're just going to bring it back at 20 percent and you're going to pay residual U.S. tax on the remainder. And that's been in the law forever, residual U.S. tax. Nobody pays it, but it has been in the law forever.

And a lot of this -- that's what a lot of this is about. This about stuff that has been in the law forever, but folks in this room -- you know and we love our readers, and we want to create jobs for them. Folks in this room have figured out workarounds, you know, and they've figured out how not to pay these things.

On the check-the-box, you know, I do have a bone to pick with check-the-box, because know the Clinton administration people who put it in, they were very smart people, and they knew what they were doing, and they were warned about it by prominent former officials. Ken [Kies] went in and said, on the foreign side, don't do this. You know it's a world of trouble.

What I would do on that, and then -- well, I'm not going to talk about the revenue estimates, somebody else can. It's actually -- I like that one and it actually does not bother me that the revenue estimate came down on that, because then you can have a rational discussion on that rather than saying, Oh, you're just doing this as a revenue grab. You're just making us uncompetitive so you can get $80 billion dollars for it.

If all it was about is that 98-11 example, that internal interest example. Then, you know, so what. I mean, everybody's stripping income, we're just stripping income out of this other country, what's it to you? That was the argument that was used in 1998. That isn't -- and there is -- I'm a person who doesn't want to recognize internal interest charges anyway. I mean -- (off mike) a lot of our problems come from separate-company accounting. And this is the weird kind of perverse problem about this, is that this is trying to reinforce separate company accounting, which we should really, really, really get rid of.

And if you look at the way the expense allocation stuff is in draft in the Rangle bill, and the foreign tax credit blending stuff, is in draft in the Rangle bill, you see sort of a little move toward trading all of the CFC's as one big company. Come on, let's go further. Let's do that all the time, you know, let's treat them like the accounting rules treat them.

If all it was about was this interest thing, and the British the other day -- they were trying to write a set of CFC rules that look like ours, they wanted some sort of income-based rules rather than entity-based rules. And they were going to just ignore those internal interest charges, because, you know, why are you doing them? You're either -- you're mostly probably doing them to strip income out of other countries, in which case it becomes the other countries' problem if they're silly enough to allow a deduction for interest paid through a related party.

Or you're doing them because you're genuinely running a Treasury function, and you want to charge your subsidiaries interest because you want to measure things that way. Fine, but tax laws should be ignoring that stuff. But that's not all check-the-box is about. Check-the-box has no limits on it, which means that you can use it to do things like wash out effectively connected income. And you should not be allowed to do that, so when you look over at 954(c)(6), yes 954(c)(6) it, you know -- the Congress will not use the word ratified, they endorsed the check-the-box result by saying, Look, if you couldn't check the box on your little affiliate there because it has some kind of local license or it's a bank or something, we're going to let you have this, saying look-through E-type result, okay fine.

But 954(c)(6) has limits on it. You're not allowed to wash ECI, you're not allowed to wash out what would other (off mike) subpart F income. There were technical corrections to put limits on it; Treasury has a bunch of anti-abuse power. So, what I would say to the people who still want check the box is, if you're not doing something other than just you know what the look-through rule does, then fine, I will repeal foreign check-the-box, and I will make you a trade. I will make section 954(c)(6) with its limits on it permanent, and get rid of foreign check-the-box, which was a bad idea to begin with.

All right, let's see, where do we begin. Let us talk about competitiveness. How am I doing on time here?

MR. BERGIN: Okay.

MS. SHEPPARD: Okay. I want to talk about competitiveness --

MR. BERGIN: I lost control a long time ago.

MS. SHEPPARD: You lost control a long time -- fine I'm just going to keep yapping until people get sick of looking at me and start throwing things.

On the competitiveness front, we do need to be on the same system as the rest of the world, but that's territorial with VAT -- with a value added tax. But, you know what are we -- you know are we an outlier? Yeah, we're an outlier; we've been an outlier for some time on this worldwide-versus-territorial-type stuff. But if you said to the United States Congress right now, and I was thinking about this the other day, I was thinking I was in a territorial -- a country that was about to go over to a territorial system trying to explain this to a local -- and if you said to the United States Congress, we can't have this worldwide residence-based system, because it makes us an outlier to the rest of the world, the Congress would say, you know, We're still on -- not on the metric system. We're still using measurements that have to do with some old king's nose and his finger and the tip of his nose to the end of his arm, and his foot and things like that. How many years ago did General Motors convert to metric measurements for its car parts, when Canada went, right? Like 40 something years ago, something like that?

Well, yeah, I understand that, but even they figured out that they had to be on the world system. But if you said to Congress, we're an outlier, they would say, but we're the United States, gosh darn it, and we can do whatever we want. I mean, that argument, it's almost like what we're going to have to do is do this, put these things in place. You know, shore up the residence-based worldwide system, make the multinationals very unhappy that they're paying more, and then have the territorial discussion after Britain converts, and that's sometime this summer. After Japan converts, and I think that's in the fall.

It -- you're -- it's -- there's going to have to be a external sort of push to get them to have that discussion, and you're certainly not going to have that discussion while you're in budget mode, and while you've got big you know banks, and derivative dealers basically sucking money out of the rest of the economy.

There is a big -- it's interesting -- what I think is interesting about the sectoral imbalance, and that brings me to the sectoral imbalance. We can discuss value-added tax later; I think we have a big cultural problem with the value-added tax. I like the idea of a value-added tax as a policy person, you know -- as a fashionista needs to, I think I would have to buy a few more things in Europe before we put that into effect. But, if you would have said to the people in the White House, you've got a big sectoral imbalance in this thing, and what's going to happen is that finance is really going to get raked by this, not merely because they borrowed to no end, but because of some other ramifications that we can get into if we want to, upfront tax credit. They have to operate everywhere so that blended rate really hits them.

So -- but if you said to the people in the White House, look you know finance is going is kind of taking the chaps from this, but tech is not going to pay because they don't borrow, they've got lots of research and development expenses that they can all pack into the United States exempting all the future income from those developments. And a lot of them are only in tax havens so that blending doesn't affect them, because they just don't have that high tax issue. If you said, finance is going to pay and tech isn't, I'm not sure that they would say they didn't like that idea because finance is a sector that is sucking up all of the revenue now. I mean, I don't for a minute believe, oh yes, we're going to take this money; we're going to put it in a box and use it for health-care reform. You know, no, it's been spent already.

But one of the things that is interesting, getting back to sectoral imbalances and competition, is that the Obama administration is not -- and as far as you know paying attention to the whole issue of U.S. companies -- U.S.-parented multinationals competing with foreign parented multinationals. Now, as far as foreign takeovers are concerned, I can think of a foreign -- a couple of foreign takeovers I'd like to happen right now, but I don't think anybody would pay any money for them. You know, just take this off our hands, absorb its bad losses, you know here you go. How would you like a really, really big bank? Took a moderate-sized car company, we've got other stuff you could take, if you wanted to suck up the losses, here you go.

Foreign-parented companies are using interest deductions to strip income out of the United States, section 163(j) is not a material impediment to that. Yet, but we don't see the Obama administration wanting to do anything about Section 163(j), and it's -- that's not a difficult problem to solve, particularly if you wanted to solve it in the way that most of these foreign-parented companies are used to in their own countries, which is interest haircuts, and cutoff's and things like that.

I mean they're all dealing with thin cap rules in Europe, and they are dealing with those thin cap rules in the context of a system, and I'm not sure our system is so different. That says, look if you call it debt, we'll say it's debt. And all they -- there's no reason we can't put those kinds of rules in place.

Also, on the competitiveness point, if you compare the United States with our foreign-parented competitors, American companies have a bunch of bad habits that are uncompetitive that have nothing to do with the tax law, and that costs a lot of money. Our executive compensation is outrageous, and we -- right now in Germany they are having a row about an executive who got a severance payment. Okay. Anybody want to guess the amount of that severance payment that they're fighting about? $5 million dollars, I mean, that's not even the pay packet of an executive in the United States, let alone before you get to the options and all the stuff that's all done in those little graphs in their financial filings.

Our companies have big tax departments and do a lot more tax planning than European companies. Europeans right now are thinking about going to a consolidated tax base and formulary portion in Europe, because they don't want our transfer-pricing rules, because they don't want to have to hire 50, and 100, and whatever number-person tax departments.

European companies are also not in the habit of suing each other every time a pin drops. And suing is expensive. I mean we've got whole industries where a big federal lawsuit against a competitor is a day at the office. And that's not a productive use of anyone's time, when you have your business guys and you've got to prep them for depositions, and send them off to court, and let the other side interview them and stuff like that. That chews up a lot of their time that they're supposed to be spending in the basic business.

So, let's see, where am I here? How am I doing?

MR. BERGIN: We need to wrap it up.

MS. SHEPPARD: Okay, well the other thing that we're not thinking about in all this -- and, you know, we have sort of a do-it-yourself territorial system now -- and that is -- that is not even my phrase. The Bush administration admitted that in their 2007 report on this whole thing. There's a bunch of things that we're not thinking about, and the Obama administration is not thinking about that going territorial would make a lot worse. And that is the transfer price and rules. And the Obama administration has a little thing on the transfer-pricing rules; they want to assign a bigger value to intangibles on their way out the door, which is not even asking the right question. Because what you should be worried about is the future income from the things.

But yes, the transfer pricing, the whole separate accounting concept, is a mess; it is unenforceable and it is insane, and if you go to a territorial system, because a territorial system gives -- to use the dressy term for it, it gives you capital import neutrality. That means you get the full benefit of the lower rate in Ireland, or wherever you shifted your income to. That makes the transfer-pricing problem worse, if you can imagine that. It also makes the problem of the source rules worse, and we have to understand it. And it also makes this when we get back to the Obama administration expense allocation proposal, we've got a bunch of those rules we've got and they want to use, and so does the Rangle bill. They want to use the existing expense allocation rules to figure out what gets allocated to what that's a mess, too.

You know and you're making -- you're going to cause bigger fights about those rules then you have now. But the source rules, I mean nobody talks about that, we have all these -- we publish all this stuff. We buy paper after paper after paper about international reform -- should we have territorial or quasi territorial. Or should we do what France does? Nobody says, Gee, what about the source rule that is administrative that assigns the income from a derivative to where the customer says they are.

You know, there -- we've got a whole bunch of source rules that are a problem. And we have to understand that in our -- to use the corny phrase, globalized economy source -- is really, really arbitrary. It's not just financial income, I mean, when subpart F was originally designed, and we do have think about what of it we want to salvage. And you've got to have a clawback rule in any system. All of the territorial systems that Europe has they don't have -- they may not have good clawback rules, especially after the Cadbury Schweppes case basically blew up their clawback rules, and said, Oh, you can only do that if the thing that you shifted income to has no employees, no desks, no phones. Oh, great.

You have to have clawback rules in any system. But the clawback rules were designed with a recognition that financial types of income and passive types of income were easily movable. But now we're seeing manufacturing income, especially when you get into contract manufacturing, and when you get into your ways of stripping income out of countries where you -- high-tax countries where you have to sell, you see manufacturing income sort of deconstructed into, well, we just paid that guy a fee to make our product but the intangible's over here, and the distribution company's over here, and oh, this thing over here manages it, and oh, this there here owns the raw materials. You had that deconstructed, so you can't even say all the manufacturing income belongs in this country or in that country.

And then you have to start asking yourself questions about well, what do we do about the source rules? Because source is just arbitrary, and if you've got mobile financial types of income, maybe you should just say, Look, you're a United States resident, you own it, it's got a source in the United States, we don't care where you parked it, its source is here, and we're taxing it here.

On the rates, and then I'll shut up. A rate buydown was always available. I mean there's a rate buydown in the -- and rates is mostly a concern of financial intermediaries, because they pay the rack rate, they don't have depreciable assets. Well, actually they do, but they don't think they do, they just carry them on $.90 on the dollar in their books. They have depreciating assets.

A rate buydown was always available in the same way the Europeans do it, you give up the accelerated depreciation, you give up section 199. Where you give up some of your other things, or you say to the Obama administration, all right, in the short run go ahead and enact these things. But, you know, here's what we'll put on the table for a rate buydown. If you want that, you can have that. And when you think about 199, I mean I believe that the Obama administration did not suggest either of these things because of the optics. I mean when you're taking over big manufacturers because they've become feeble you kind of don't want to say, oh, and by the way if they ever make money again, they'll have to pay more tax on it.

But section 199, which everybody in this room can agree was a manufacturing deduction, for those who don't speak in code sections. Everybody in this room can agree that it was stupid thing to do, okay? It is the second biggest corporate tax benefit in the code. It's very expensive, and it isn't you know -- I'm going to leave it to other people to talk about the job thing, but it isn't -- it's mostly just kind of sad because -- because it tells us how little Congress understands about how the economy works that we're giving a manufacturing deduction to folks who grind coffee beans. I love their coffee, they make very nice coffee, but I really don't consider people who grind coffee machines need to be manufacturers.

But it was an act of desperation, that's the sad part, you know, by people who need to sort of have things clearly explained to them about how some jobs aren't coming back, and how the way the world works, and what they need to do to cope with it. Thank you.

MR. BERGIN: Thank you, all right we'll obviously I'm a diligent timekeeper. But you will -- you must admit they were great presentations, and you get caught up listening to them. Okay. We still have some time for questions, and you guys could really help me out here by keeping your questions short. We've got about a half an hour left. So, do I see any hands? State your name, please?

MR. HAUFBAUER: Gary Haufbauer, Peterson Institute for International Economics. This isn't a question; it's a very short comment. But I think Mark and John hit it on the head, and the head is this.

In this country the attitude towards a multinational corporation is if you see it, beat it with a stick. When you go to Brazil, or China, India, countries I go to all the time, it's, Give it a big kiss, bring it here, and that's an enormous difference in attitude.

The second disease of the mind we have in this country is that if we set a corporate rate, that ought to be the world's corporate rate. Obviously that doesn't play, it doesn't even play between Nevada and California, but that's the second disease of the mind.

When we look at the revenue received, and we're kind of looking at this at the institute. About one-third of the revenue by business is earned by the big corporations, John and his friends. One-third by all the rest of the corporations and one-third by past communities. Past pay no tax; the biggies and the medium-size pay about the same effective rate about 25 percent in a good year. So, the whole proposal here is to hit the big guys with a stick, and that's the -- that's our competitive trust in this country. And its just absolutely nuts, but the worst thing about it from the Obama administration standpoint is that he is spending his most precious asset, political capital, on this distracting battle. We do that often in this country, but this is a pure distraction from what Mark and others and Lee have hinted at. The only way we're going to deal with our revenue problems is a VAT or something like a broad tax. And it's just a simple as that and that's where the president should be, and the best thing I can see out of this false battle is exactly what Mark said, make it bad enough and it'll get worse, we'll finally cure it.

MR. BERGIN: Jane?

MS. GRAVELLE: Jane Gravelle, Congressional Research Service. I want to make a quick comment, and then I want to ask a question here.

The quick comment is, having watched this debate for at least 30 years now, a capital import neutrality is a completely meaningless concept. If I had time and a blackboard, I could prove it with arithmetic.

Capital export and neutrality is a meaningful concept, so is national neutrality. But the real question is have we achieved these goals, be it worldwide efficiency, or national -- maximizing national wealth given the other problems we face, including the lack of international coordination. That's the real issue; international competitiveness is something I don't know what it means, because we're not competing with the rest of the world to export to Mars. We're trading with each other, and we want to get those strengths efficient and desirable. So, I think we need to get the debate on the right terms.

Now, here's a question I'd like to ask of particularly John Samuels, I think, and Mark. Aside from economic issues, which I actually don't think are all that likely to make the republic fall, there is this question of this massive profit shifting that's going on. Are we just going to throw in the towel and say, Go to it? Or are we going to try to do something about it? Or are there alternatives that you would propose to tackle this issue of artificial profit shifting other then the proposals that have been made? Taxing all incomes from tax havens broadly defined currently, taxing a portion of it. I mean what can we do about this massive problem?

MR. SAMUELS: Should I respond?

MS. GRAVELLE: Sure.

MR. BERGIN: Sure.

MR. SAMUELS: First, Jane, you have to differentiate by what you mean by profit shifting. If it's a shift from a high-tax foreign country to a low-tax foreign country, I'm not at all concerned about it.

MS. GRAVELLE: I'm speaking also about shifting out of the United States --

MR. SAMUELS: Well, I'm speaking -- let's first address the -- when you talk about all the income that's reported in the havens on the data. Those aren't manufacturing plants in the Caymans.

MS. GRAVELLE: I doubt it.

MR. SAMUELS: I can assure you there aren't. What they are, are financial flows from other countries that are reducing their taxes. That is, I would submit, not a problem for the United States. In fact, I would submit that probably helps the U.S. welfare, and I think that's the measure of by the way of international competitiveness in my view, advancing U.S. standards of living.

In terms of shifting income from the U.S. to outside the U.S., I think that is an issue, a very real issue. And I don't think actual territoriality makes it worse, because I think we have a de facto territorial system today with deferral and APB 23 elections.

But its the worse de facto territorial system in the world because we have a lockout effect. Unlike the rest of the territorial systems that let capital come back to the United States, our "self-help territorial system" imposes an enormous burden on U.S. companies by forcing us to keep our profits outside the United States. I think transfer pricing from the United States and particularly in the area of intangibles is something that needs a good hard look as part of broad tax reform.

MS.GRAVELLE: Any ideas specifically?

MR. SAMUELS: Not on the record.

MR. BERGIN: Good reminder, we are on the record.

MR. DILWORTH: Bob Dilworth. I have a question for the audience, because I'm in the throes of trying to write an article. I think the foreign tax credit proposal is actually point-blank inconsistent with the entire treaty network. Because, Lee, you wonder why we don't have a per-item, I agree it's an interesting question. But this proposal prevents the per-item credit, and I think that's going to be the problem under the bilateral network.

It maybe a good idea to go to a worldwide pooling system. John, you've spoken eloquently for many years on that. But we have this sort of weird system now where we have the foreign tax credit broken down into,whatever it is separate bilateral treaties that work only with respect to the taxes paid by a resident of that country to that country. So, there is no credit mechanism that allows you to say, Well, I'm going to take a German tax dividend and decide that I'm going to say it really came from Ireland. It just -- somebody ought to check in with the OECD. Question?

MS. SHEPPARD: I routinely beat up on the OECD and I don't have any brief for treaties, but if treaties was what you're worried about then that's just going to take you to a further territorial system. I mean, I think that one of the reasons Britain is converting is because the European Court of Justices is basically beating up on them about having a credit system, even though under the European Treaty of Rome you're allowed to have both systems since the majority are on the territorial system and you're talking about these cross-border tax disputes. It's better to be on the same system, and it's a lot simpler not to be on the credit system because the credit system is extremely complicated.

But no, I wouldn't you know elevate treaties over everything else. But and this country doesn't but other countries do do that too. You know they basically say the treaty is superior to domestic law, but you know if that's your big concern then just get on the same system as them.

MR. BOUMA: Excuse me, Herb Bouma of Buchanan Ingersoll and Rooney. I just wanted to also make the comment that I think the president's section 902 proposal is conceptually inconsistent with his check-the-box subpart F proposal, because with respect to the section 902 proposal you're going to have mandatory amalgamation but with respect to the subpart F proposal check-the-box; they're going to prohibit amalgamation. And just the two proposals seem to me to be conceptually inconsistent.

MR. BERGIN: Let me just remind the audience that we have handheld mics. If anybody has a question out there, feel free to ask it.

MR. LYON: Yes, it --

MR. BERGIN: Here, here.

MR. LYON: A similar point that I wanted to make; Drew Lyon PriceWaterhouseCoopers. You're trying to find what the overarching theory of these proposals is which is difficult. It's a little more like at best there are four competing theories, and like a Chinese menu you pick one from column a, one from column b, one from column c. The inconsistency between the pooling of foreign credits and the check-the-box, and the existing subpart F rules is one of the inconsistencies.

John mentioned on the expense disallowance, now you'll disallow the expense even though the foreign income is subject to foreign taxes and that expense is not allowed to be deducted anywhere.

Jane talked about capital export neutrality as possibly the overarching theory. But in that case you wouldn't have the pooling of foreign tax credits if you're bringing back income that was taxed at 40 percent in Japan, and now maybe you're only going to be given a 20 percent foreign tax credit, so that discourages investment in the high-tax country.

So, you know we're interested in coming up with a better system that it seems is if everything was formulated on you know how can you get revenue if they do "X"? You know let's tax it if they do "Y", let's tax "Y".

MR. ROSENBLOOM: Yes, David Rosenbloom of Caplin and Drysdale. It seems like I've seen this movie before. But here's a thought that occurred to me, I wonder if anyone else has this sense. I think the U.S. tax system is anti-competitive for multinationals, but in a completely different sense that John is talking about.

I have no way of proving this, but I have the sense that unlike other countries, our tax system has fostered a couple of frauds that are highly distractive from the standpoint of U.S. business. In that a lot of companies pay a huge amount of attention to their tax planning and their tax situation in this country. I think it's way disproportionate to what you find in other countries.

And I sort of suspect that that's to the detriment of the overall performance of the companies as businesses. I just think a lot of money is spent on tax planning, huge amounts of effort are put into it, people look to the tax department as an earnings center.

MR. BERGIN: Yeah, profit center.

MR. ROSENBLOOM: I think all of that is profoundly unhealthy and that I sort of suspect that it contributes to paying less than adequate attention to the products that these companies are supposed to be making and earning in their core businesses. And in that sense I think our tax system has been truly been anticompetitive.

MR. BERGIN: That's a great comment, and the brainpower dedicated is it's incredible.

MR. BLOOMBERG: And the cost of outside advisers I might add?

MR. BERGIN: I'm not going there.

SPEAKER: Outrageous, it's outrageous.

MR. ENTIN: Steve Entin from the Institute for Research on the Economics of Taxation. My second year in Washington in 1976 (off mike) [they] tried to get rid of deferral, and we had all these arguments and now we're having them all again.

It might help if we did have some theories of how some of these things work. I think we're doing a very superficial analysis in the Congress and the administration working on the emotional level. I don't think we can wait for Congress to get out of budget mode; Congress is always in budget mode. We do need some theories to what's going on. It would differ on the capital export neutrality that's based on the assumption that capital is being formed. And we only have to worry about where it's being put if the tax law change affects the amount of capital that would be created, or it affects the -- who owns it, or where they're headquartered. That's quite another question, and that basic fact needs to be worked in.

I don't know how to get Congress to look more deeply at these issues, unless people do put up a fuss. And to say that Congress is just going to go ahead and we might as well not try to stop them from beating up on one sector versus another, or if an ugly corporation is to be taxed more heavily then a pretty corporation. This is not the way we ought to be making policy.

The one last comment is on the specific proposal to allocate the deductions. To the income, this makes no economic sense. It's an accounting convention, it's the lazy way out, but if I'm spending $100.00 in year 1 on a machine, and I'm earning $10.00 a year in years 2 through 11, and you make me defer that $100.00 over the 10 years without taking account of the time value of money, you've violated something very real. Expenses should be taken when they're done, and income -- and revenue should be taxed when they're received, and this allocation business is an artificial enforcement arrangement that is not really economic. There are economic conditions here that the accountants just don't deal with.

MR. BERGIN: Thanks Steve. Ken?

MR. KIES: You know --

MR. BERGIN: This is Ken Kies.

MR. KIES: I'm Ken Kies; I'm from the Federal Policy Group. The Congress spent a lot of time working with models, and studying stuff. And I remember in '95 when [Then-Rep.] Dick Armey had this proposal for indexing depreciation, which we scored as costing about half a trillion, which back then was real money.

And the -- so Army made us meet with the economist who had told him this actually raised money. And so we met with this guy whose name will go unmentioned, but we said, well, what are your assumptions in your -- he said my model proves that this happens. I said, well what are your assumptions in your model? And after a long discussion we finally learned that one of his assumptions was an unlimited supply of capital. And that he assumed that there would be massive investment in the United States. And so I said, well how much investment are you expecting per year, and it was about $2 trillion. And so I asked my guys, I said, what's the worldwide savings rate, and it was slightly below $2 trillion. So, the only way this would actually work in practice, is if we were importing intergalactic capital.

Now the only reason I mention this is we've actually had what economists dream about in the case of deferral, and that is a real-live test. We repealed deferral for the shipping industry in 1986, and almost every single U.S. multinational in the shipping industry was purchased by a foreigner. So, this -- all this theoretical discussion is great stuff, but we've actually tried this.

We tried it for real, and it was a dismal disaster. And it was so bad that the Navy in about 2000 go so concerned about the size of the U.S.-owned foreign flight fleet, which they have to call upon in times or war or international disaster that they commissioned a study by an MIT professor who was not a tax guy, but he was an expert in shipping named Henry Marcus and he produced a lengthy report, which concluded that the reason this happened was we repealed deferral.

So, if we want to try this again, that's fine but we've already seen what the consequences are once, and the problem with this, unlike something like 956 Cap A, which had completely unintended consequences, and we had to repeal it. The problem with doing this is we won't be able to reverse the consequences once they've occurred. Because once U.S. multinationals are acquired, the headquarters jobs are gone, the R&D goes, the suppliers become nationals of the country of incorporation and they don't come back.

So, this is a great theoretical discussion, but we've already been there for real once, and it was really an ugly outcome.

MR. BERGIN: Thanks Ken, in the audience?

MR. FRIEDEL: Thanks. David Friedel of PriceWaterhouseCoopers. In terms of international norms, a question for Mark, I think, and John also. Thoughts about the U.S. transitioning to IFRS and how that accounting standard might play in?

MR. BERGIN: John, you want to go first?

MR. SAMUELS: Well, yes sure.

MR. BERGIN: Okay.

MR. SAMUELS: Let me qualify my response by saying I'm not an accountant but --

MR. FRIEDEL: Neither am I.

MR. SAMUELS: The only aspect of IFRS that I think might have implications in the international area is how they treat the equivalent of permanently reinvested income. Do they have a provision like the U.S. accounting principles board APB 23 that says if you permanently reinvest your foreign earnings, you don't have to record a current U.S. tax expense, which many companies do, which explains a low book rate but not a low burden because of the repatriation tax.

IFRS as I understand it has a very comparable standard that allows foreign multinationals to not have to book a home country tax -- of course most of them now don't have to pay any home country tax when they bring their foreign profits back as I think about it. In the case of when the U.K. and Japan, when they were worldwide systems, they were able to not record a current tax for their deferred foreign income.

And I would just like to follow up with -- to say I agree with David Rosenbloom's comment. I want to associate myself with his comment, particularly about the outrageous cost of -- no but I actually agree that way too much time, and effort, and capital in this country is spent on taxes and tax planning. Particularly in the international area, and I think it's a direct outcome not just of the complexity of our system, but really, I think, more importantly the fact that our system differs from the systems of the rest of the world. So, you get all these brilliant people trying to find the seams, and if there was a harmonization of tax systems, a lot of that complexity would go away.

And it would still be complex but the point [accountant] Dan Frisch made, and the terrific article he wrote in Tax Notes 10 years ago, or 12 or maybe 15 or 20 years ago, that the real problem with international complexity isn't the individual systems, it's the fact that they don't mesh. And I would further note that the rest of the world systems are beginning to mesh, with the exception of the United States.

MR. ABELL: Chester Abell, Earnst and Young. I'd like to just comment on the IFRS rules and I do run our tax accounting practice, so I know a little bit about the tax accounting world. But I think when we're talking about harmonization, it's exactly right. We're talking about harmonization for accounting purposes, for the reasons why we're sitting here talking about harmonization for tax reasons. And in fact when you put everyone on the same basis, everyone then becomes in essence on a platform that's at least understood.

The problem with that is that nothing's equal and nothing ever will be completely equal but in effect one set of accounting standards is only going to work, when there's one set of tax standards, quite frankly. Because of the fact that you're going to have to keep separate sets of books, you're going to have continue to have separate statutory reporting considerations, and everything else.

So, I think that as we've said today the need for reform comes with putting everything on the table. With putting accounting and tax on the table, and when you look to tax, and you're look into tax rates you've effectively got to look to the entire tax rates, whether it be indirect or income tax. It's hard when you're starting to patchwork these things to in effect ever get a system of quality.

But with respect to earning stripping, with respect to asset stripping, it's dumb to take advantage of in effect differential tax rates. And that goes away or is withdrawn if everyone's on the same system. But you've got to do that with respect to all taxes, with respect to accounting systems, and a number of other things. So, very very complicated obviously, we've been talking about (off mike) indicate for years and years.

MR. BERGIN: Yes, Lee?

MS. SHEPPARD: I like IFRS, but it does -- correct -- somebody correct me if I'm wrong on this, because I'm digging it from memory. It does recognize intercompany transactions, and GAPP does not, and, you know, I think the tax laws should go as far as it can towards ignoring it, or company transactions.

MR. BERGIN: Thanks.

MR. ABELL: Well, what IFRS rules do is in effect, the accounting side of it continues to be eliminated on intercompany transactions gain or loss is eliminated. However, taxes recorded is required to be recorded on those transactions, which causes obviously fluctuation, volatility, in effect, of tax rates. The U.S. however, the FASB has considered and is to the extent that they decide to go with convergence has already discussed moving towards that system of in effect recognizing the tax effects of intercompany transactions.

MR. NOLAN: Paul Nolan, I'm with McCormack. I have a question for Mark and John. Given that there is a motion in the issue, given that we are in patch mode, or plug-and-play mode as Lee described, how do we turn the debate to the topics that we've been talking about, the deeper competitive issues, and the beginning of a true discussion about comprehensive tax reform, given the environment and the sense of crisis right now in Congress?

MR. SAMUELS: I'll defer to Mark on that now.

MR. WEINBERGER: Yes, thanks. There's no -- obviously there's no single answer. I really think that when you look at how legislation is going to get done this year, you know the president has staked his whole first term on healthcare, and that will be the driving piece. And these pieces are tagged along to health care.

And so the question will be I think truly in the end of the day for the business community to figure out what's the most harmful, and the least harmful, and whether nobody wants to say it on record or not. Some things are going to get done here, because whether there's this new -- I don't want to describe what I would call this new pay-go proposal, but this new pay-go proposal that's being out there, or whether it's existing fiscal constraint the Blue Dogs are going to require. You're going to see an increased attention to paying for whatever gets done. And so I think to hold your head in the sand and say nothing will get done will certainly not be acceptable.

And the question is with these international tax proposes that we'll have fundamental real-world consequence and are harder to undo. I think you know the argument has to be made as to why those should be deferred for a larger discussion. I think that's how you have to think about it.

MR. ROSENBLOOM: Yes, in light of that comment, which I think makes a lot of sense. One of the mysteries of these proposals is why the inbound investors are missing in action almost entirely? Does anybody have any -- this is a question. Does anybody have any sense why if we're in revenue-raising mode that the U.S. multinational community should be the sole target and perhaps some individuals? But I just don't understand that.

MR. WEINBERGER: We need to --

MS. GRAVELLE: And I think the Treasury did a study when they were unable to uncover any evidence that there's a serious profit-shifting problem. I don't know if that played a role or not. They found it for -- corporations but not for U.S. subsidiaries or foreign multinationals.

MR. WEINBERGER: It sounds like the Pink Panther.

MS. GRAVELLE: Well, I mean I don't know. I mean very capable people did this study I think. And so I think -- I'm just speculating on what it --

MR. WEINBERGER: And I don't have a great answer, but it's kind of the one thing I do worry about,frankly. What this is some ways is protection is improve the tax code by saying we want to bring U.S. jobs back here, and keep them here.

When you start also then looking at trying to tax foreign inbounds it's going to -- this will escalate, it can't be good for anyone to think about it solely in those terms in any regard. I think one of the reasons, just to be frank, why these are on the table. Look at the president's campaign rhetoric. There's a backing of that rhetoric, there was nothing about inbounds in that rhetoric.

MR. BERGIN: I think we're going to go a little long.

MR. WEINBERGER: That probably is part of it.

MR. BERGIN: Ken?

MR. KIES: Ken Kies, we figured out the answer over here as to why they're not touching the inbound investments and that's because we need their money, okay? And that's probably accurate. Mark, I'll challenge you on whether this stuff's going to happen this year.

If [Sen. Max] Baucus [D-Mont.] comes out next week and as they have said covers healthcare purely with healthcare proposals. That maybe the only thing that gets done this year, if it gets done, and I think that's about 50/50. That then puts us into next year, where they have to deal with the 2001 and 2003 expiring provisions and while this is optimistic, because things could get worse. We might actually debate these provisions in the context of a much more comprehensive look at our tax system.

So, I'm actually slightly optimistic that the universal outcry from the business community, which is registering on the hill about how bad these provisions, would be, particularly if enacted in isolation. It may cause them to hold them at bay, and then have a more intelligent debate come next year.

MR. WEINBERGER: And just to clarify, I'm talking in principle that there's 200 other billion dollars worth of tax increases that in addition to the international proposals, you do have expired provisions, which under pay-go will be paid for. So, there's a lot of things on the table, whether these get done or not is -- I don't know.

MR. KIES: Well, but just so we don't get too enamored by the president's pay-go initiative, it has about $3 trillion in exceptions for it. That's not a number I just made up, that's the real number. In fact it's slightly larger then that. So, pay-go -- this whole -- if I hear one more bluedog talk about how much they care about pay-go, I think I'm going to shoot myself. No, it's not a promise, okay? It's just in case anybody's wondering, but it's been a laugher in terms of whether there's any seriousness there.

MR. MERRILL: I think one thing that we all agree one is that there's --

MR. BERGIN: Peter.

MR. MERRILL: This is Peter Merrill, PriceWaterhouseCoopers. So, these proposals are driven by --

MR. BERGIN: Thank you.

MR. MERRILL: Budget process as opposed to a considered study of tax reform in international tax policy. And given that it is driven, the economics that are really important are the revenue estimates. And as Marty pointed out, the disparity in the revenue estimates between Treasury and the Joint Taxation Committee on check-the-box turned out to be $50 billion. They thought they were 85 billion, but they've revised their number from 2005 from a billion to $31 billion.

These are gigantic you know changes in numbers and differences between the professional staffs at the Joint Taxation Committee and Treasury. And decisions that members are going to make that have deep effects on international tax policy are going to be driven off estimates that folks have made. And you know I think the conclusion from this is the estimators have an incredibly difficult and extremely important job.

They really need to be supported, I believe, with more staff and more resources. And I think the tradeoff for that should be more transparency in the process. Because none of us that are economists on the outside have a clue as to why there are differences between their estimates what assumptions and methodologies were used? And you know that to me is a very severe weakness in the process.

MR. BERGIN: Thanks, Peter. I'm going to take one last quick question from the audience.

MR. WHEELER: Chuck Wheeler, Austin and Berg. A comment, I hope that as we go through this, we don't focus just on the international tax and the tax policy. We look at what where the president started with, which was on making U.S. jobs. And if all we focus on is making U.S. Jobs is bringing back supposed jobs that have left the country. That is not really looking at U.S. jobs. Should the tax system be looking at how we create more jobs in this country? Do we continue with our consumer-driven society or look to bringing investment into the U.S. from whatever sources we can find it? So, I think it's a much bigger debate then just looking at the U.S. jobs "leaving".

MR. BERGIN: Okay. As usual, I'm going to give Lee the last word.

MS. SHEPPARD: This is on the value added tax, because you know when you look at Europe, and when you look at Japan, people pay high prices for everything, and they have better-quality stuff from our companies than is sold in the United States. But that is a cultural thing that they are used to. And value-added taxes are 11 percent of gross domestic product, across all of the countries that have them. Whereas the consumption tax, the equivalent consumption tax here is less then 5 percent. And we consume basically what the rest of the world makes.

So, if we want to go to the system the rest of the world has with the value-added tax, and the territorial system, we will stop consuming, because if you look at the way people consume in those countries, they're not in the shopping mall every weekend. And that's a real question, I mean that might annoy them, like saying, What do you mean, you're not going to keep buying this stuff that we export?

You know Germans are taking it in the chops right now because they have an export-driven economy. So, it is a very interesting question about are you going run your economy off consumption then, are you going to run the rest of the world off the basis of your economy borrowing to consume?

MR. BERGIN: Well, this was terrific. Thank you, everybody. I just want to thank the staff at Tax Analysts who put a lot of work into this, especially Bob Goulder who heads up our international publications. And thank this terrific panel, and this terrific audience. Thanks a lot for coming.


(Whereupon, at 11:04 a.m., the PROCEEDINGS were adjourned.)

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