Mr. MARTIN. Thank you, Mr. Chairman. Mr. Hardiek, in looking at your testimony and the exhibit A you included, there are some questions that I would like you to answer. First of all, in determining the comparison between the tax treatment of the new $20 million facility in the United States and Canada, you show under item 2 the immediate deduction of the entire cost as an expense, which is allowed in Canada, and you show only the first year's depreciation as allowed in the United States, the first of 15 years depreciation that would be allowed in the United States. Isn't there some, what the economists call, present value to the remaining depreciation, and shouldn't you in fairness take that into account? Don't you consider that in determining whether you are going to build a facility? Mr. HARDIEK. You are absolutely correct. Down at the bottom I have tried to show that in terms of the timing difference, that the $8 million which is really the 20 million times the tax rate-$8 96 million is really a timing difference. So, yes, it could have been expressed another way in terms of asking what is the present value of the tax effect of deducting it in 1 year versus deducting it over 15 years. But you are absolutely right, a timing difference has less significance by quite a bit than a permanent tax difference. Mr. MARTIN. If that $8 million figure is the present value of the depreciation in the United States which is not taken in the first year, then it would seem to me that in fairness that reduces the relative advantage of making the investment in Canada by roughly $8 million, because that is a part of your consideration, that is an asset on the value of that future- Mr. HARDIEK. I am sorry, not actually present value. The $8.96 million is not a present value figure. That is just 46 percent of that amount. Mr. MARTIN. Roughly two-thirds of that? Mr. HARDIEK. I would say half. Mr. MARTIN. There would be some reduction of $4 to $6 million? Mr. HARDIEK. That is right. Mr. MARTIN. That still leaves you somewhere on the order of $10 million advantage for making the investment in Canada, even taking that present value into account. If that is so Mr. HARDIEK. That is on the first year. Mr. MARTIN. But that is first year, taking into account what the future depreciation in the United States is worth to you. Now, that is still a $10 million advantage to making the investment in Canada. Why do you have 90 percent of your research in the United States? Why have you not made it in Canada? Mr. HARDIEK. Well, we are looking at that, and when I first looked at this situation, the farm equipment business was very good. As you are probably aware, at the present time it is not very good, and we are not in a position to be expanding R&D facilities. If anything, we are contracting those facilities. Once the farm equipment business rebounds, we will give additional consideration to these computations to see whether it does make sense to put the facility in Canada. The real purpose of bringing this computation out was not of looking at it just from a Deere & Co. standpoint, but to make you aware of what other companies as well as Deere & Co. are doing and must do any time they decide whether to expand a research facility in the United States or whether it ought to be done in another country. Mr. MARTIN. You indicated you are spending about $242 million a year for research anyway. What you are now saying is that is not an expanded program, that is a reduced program, and some of that is contracted for other people's research? Mr. HARDIEK. I am saying we are merely reducing the amount of R&D that we do worldwide. Most of that reduction of course is coming in the United States. Mr. MARTIN. Item 10, you include the effect of the 1.861-8 regulations which is developed below. But you include the effect of that on line 10 as being $644,000. That is relatively small, but it is in proportion to the percentage of your sales which are overseas, is that correct? You are assuming 20 percent? Mr. HARDIEK. That is correct. Mr. MARTIN. Twenty percent of your sales overseas. Therefore, that would be larger for a company that had 60 percent of its sales. Mr. HARDIEK. That is right. If it were 60 percent, it would have doubled. Mr. MARTIN. But in relation to-60 percent triples it. Mr. MARTIN. In any case, the figure that you show there is relatively small in comparison, that is $644,000 is relatively small in comparison with the $10 to $14 million of disadvantage. And I guess that leads me to ask whether this 861-8 regulation is all that potent a factor by itself. Mr. HARDIEK. Well, you are looking at a study here done on Canada, and it is done on one facility. But it may be a much closer comparison when you look at France, Spain, Germany or the United Kingdom. I think Canada has been a leader in terms of countries that have tried to encourage more R&D in their country. For example, they have currently a proposal which would allow a 20-percent R&D credit on all R&D expenses, not only incremental R&D. So I think we are looking at a country here that is probably a leader in this respect-if you were making comparisons with other European countries, it might appear to be much bigger by comparison. Mr. MARTIN. Thank you. Mr. ANTHONY. Just one final question. For purposes of determining a U.S. company's net worth in reporting to its stockholders, that is U.S. stockholders, is all of the R&D expense allocated against the United States income? Mr. CHERECWICH. Sir, in our annual report in the footnotes we break down results between U.S. operations, foreign operations, and something that we call corporate. All of the R&D is included in the so-called corporate expense to distinguish it from general operating expense, and R&D is not broken out as to where it took place. Mr. ANTHONY. OK. The Oversight Subcommittee would like to thank both of you for your testimony and for helping us with these very complex issues. Inasmuch as I represent a farming community, I have seen a lot of John Deere tractors. I hope your company and the farming community both can help so you can do a lot more R&D, make more tractors, and my farmers can buy more of them. We will take a recess now to vote. [Recess.] Mr. ANTHONY. The subcommittee will resume. Our next panel consists of Mr. Robert S. McIntyre, director, Federal tax policy, Citizens for Tax Justice, and we have Mr. Robert McGarrah, director of public policy, American Federation of State, County & Municipal Employees, AFL-CIO. STATEMENT OF ROBERT S. MCINTYRE, DIRECTOR, FEDERAL TAX POLICY, CITIZENS FOR TAX JUSTICE Mr. MCINTYRE. Thank you, Mr. Chairman. I appreciate the opportunity to be here on behalf of Citizens for Tax Justice. Our coalition of labor, public interest, and citizens groups represents tens of millions of Americans who are very concerned about the kinds of issues which are being raised today, which involve both tax fairness and how the tax laws affect employment and economic growth in the United States. I would like in summarizing my statement to expand the discussion we have been hearing today and to give a rather different slant to some of the things that have been said. As you know, the United States gives very large tax incentives for companies to do research and development in the United States. In effect, the Federal Government allows writeoffs and credits that pay for, at least in the first year, somewhere between 46 and 71 percent of the costs of research and development incurred in this country. Now, the payoff for that is supposed to be increased economic growth, more jobs in the United States, and a healthier economy generally. Unfortunately, however the Federal Government also gives very large tax incentives for companies to move overseas the production jobs that result from their U.S. R&D. If, for example, a company sets up production in a low-tax foreign country, we typically will let the fruits of the company's research and development be shipped offshore with little or no tax penalty, and we will exempt the company's foreign income from U.S. tax indefinitely. Moreover, if a company sets up production in a high-tax foreign country, the U.S. Government, at least under the current rules, will agree to pay some of the company's foreign taxes. The low-tax country problem has received most of the attention recently. We have all read about Atari, Apple, Mattel, HewlettPackard, and other companies moving to the Far East, Mexico, and other places where they find both low wages and tax advantages. I am heartened to see that the tax reform proposal recently put forward by Representatives Gephardt, Pease, and others for consideration on the House floor soon includes some measures which would try to curb the tax incentives for companies to move to these low-tax countries. Under that amendment, deferral of tax on foreign profits would be eliminated, the ability of companies to ship the fruits of their R&D abroad tax-free would be eliminated, and so forth. We support these reforms, because we care about American production jobs. If Congress is to sustain its hope that the R&D incentives in the Tax Code will help create jobs, it needs to take these kinds of steps. Let me move on here to the 861-8 issue, which has been the focus of most of the testimony today. Although the moratorium on the 861-8 rules affects only American firms operating in foreign countries with high rates of taxation, the basic question here, as we see it, is conceptually similar to the issue with regard to companies that export jobs to low-tax countries: Does it make sense to provide tax incentives for American companies to use the fruits of their U.S.-performed, tax-subsidized R&D to create income and jobs abroad? In other words, do we want to subsidize foreign production, which is what the moratorium in effect does? Some of the witnesses here today have suggested that the 861-8 rules now suspended, are too tough, that they allocate too large a share of a company's R&D expenses to foreign-source income. We find that to be a very hard position for anyone to sustain. If you look at the mechanics of the rules, you will find, for example, that when a company has half of its sales here in the United States and half abroad, the maximum foreign allocation of R&D expense will be only 17.5 percent of the total. In many cases it will be far lower, because companies are allowed to show that their American R&D does not benefit foreign production, and if they make that showing they can reduce their foreign allocation even further. Companies also have said that we need to retain the moratorium's incentive to move production jobs abroad because otherwise we will lose R&D in the United States. They suggest that if the 861-8 regulations were put back into effect, we would see a shifting in R&D abroad. Well, the Treasury Department has done some theoretical analysis and has cited a number of studies that have surveyed companies. The conclusion of all has been that the incentive to shift R&D abroad from the 861-8 regulations is trivial at most because it is outweighed by other factors which encourage companies to keep their R&D here in most cases. It is also helpful to take a look at the data. In the 5 years that the 861-8 regulations were on the books, we find that the U.S. share of total R&D engaged in by American companies and their foreign affiliates went way up. We find that U.S. R&D increased 50 percent faster than R&D by foreign affiliates. So the data does not support any claim that we were losing R&D because of the 861-8 provisions. On the other hand, it does seem to us very likely that we may lose production jobs if the 861-8 rules remain suspended. So in conclusion, I want to say that we hope Congress will go forward with the reform proposals that have recently been been made to deal with the tax incentives to shift jobs to low-tax foreign countries. We also hope that the 861-8 regulations will be allowed to go back into effect. And we urge the Treasury Department to take another look at these regulations and strengthen them so they do the job they are supposed to do, which is to make sure that American companies don't get Uncle Sam in the position of paying some si their foreign taxes for them. Thank you. [The prepared statement follows:] STATEMENT OF ROBERT S. MCINTYRE, Director, Federal Tax PolicY, ÒPIZENS WOR TAX JUSTICE I appreciate the opportunity to appear before the Subcommittee today on benail of Citizens for Tax justice. Our coalition of acor, public interest, and citizens groups represents tens of millions of average American taxpayers, who have a vitai interest in assuring that the tax laws are fair and that they do not adversely affect employment and economic growth in the United States. Our testimony today concerns certain provisions of the US tax laws that grant special tax advantages to companies that engage in research and development in the United States and use the fruits of that R&D to support foreign manufacturing operations. It is our conclusion that these provisions violate sound tax policy principles, provide unwarranted tax benefits to some US. multinational corporations at the expense of average taxpayers, and create incentives for companies performing R&D in the United States to shift their manufacturing operations overseas. Our principal policy recommendations are: 1. Congress should consider ending the deferral of federal income tax on the overseas profits of subsidiaries of American corporations, in particular for income earned from operations in foreign countries with very low rates of taxation. A less dramatic, but helpful first step would be to require that companies that transfer the fruits of their US-performed R&D to foreign subsidiaries do so by licensing agree ments or other means that assure that the income the R&D generates abroad is sub ject to current US. taxation. 2. The moratorium on IRS enforcement of its 861-8e) regulations, which govern apportionment of R&D expenses between domestic and foreign-source income for purposes of the foreign tax credit limitation, should be allowed to expire. Moreover the Treasury Department should amend the regulations so that a fairer (and larger) proportion of R&D costs is apportioned to foreign-source income in most cases. INTRODUCTION When an American company performs R&D in the United States, the federal gov ernment provides the firm with an immediate tax deduction for the costs incurred, plus a 25 percent tax credit in certain cases. As a result, the government becomes a partner, sometimes the major one, in private R&D investments. For a corporation in the 46 percent tax bracket, the out-of-pocket, after-tax cost of $1 worth of R&D will be no higher than 54 cents and sometimes will be as low as 29 cents. The remainder is put up by the government. In return for its "investment," the government expects to share in the future profits (if any) that the R&D generates. Assuming that those profits are taxable, the government's profit share will be 46 percent. This is exactly equal to the government's share of the original R&D investment in situations where the R&D is not eligible for the 25 percent tax credit. Where the credit applies, the government's 46 percent profit share will be substantially less than its 71 percent share of the initial investment. This cost-sharing/profit-sharing approach is intended as a government incentive for private R&D. In effect, the government agrees to exempt from tax or even subsi dize the profits from R&D investments in hopes of stimulating greater private spending on R&D.2 1 The tax deduction for research and development expenses saves a 46 percent bracket corpo ration 46 cents for every dollar invested in R&D, leaving its out of pocket cost for each $1 in R&D at 54 cents. If applicable, the 25 percent tax credit for incremental research and expertmental expenses will bring the total tax savings from $1 in R&D to 71 cents, leaving the company's out-of-pocket cost at only 29 cents for a dollars's worth of R&D. These calculations do not include tax savings at the state level, which could add another 4 à cents in tax savings (after accounting for the deductibility of state taxes on the federal return) for each dollar invested in R&D. 2 As is illustrated in the example in section A below, the effective tax rate on profits from R&D investments can be substantially below zero, that is, "negative" tax rates are sometimes provided. |