of research oriented activity. In 1982, 3.6 percent of sales was spent for research. This percentage increased in 1983 to 3.73 percent. Over the past several years, the chemical industry in the United States has shifted from the production primarily of basic chemicals to the substantial production of specialty chemicals. It is clear that this trend will continue, leaving less-developed countries as a primary source of basic chemicals. The production of specialty chemicals requires an extensive research effort, and this efffort will accelerate in the coming years. The regulations as promulgated by the Treasury Department are detrimental to these goals.

The chemical industry is a strong, favorable contributor to the U.S. balance of trade. In 1982, chemical industry exports exceeded imports by $10.5 billion. In the same year, the merchandise trade balance showed a $32 billion deficit. The 1983 trade deficit will increase over the 1982 deficit by something more than 50 percent. In 1982, the chemical industry's exports dropped by 6 percent, while the industry's trade balance declined 12 percent. Current projections indicate a further drop in exports of 7 percent. A strong export position for the chemical industry is positioned upon an outstanding private sector research effort. As already indicated, the industry must increasingly export specialty products as gas-rich countries assume the commodity export markets. Development of specialty chemicals for the export market will occur only if a strong research effort is successful.

It is important to understand that our plea is not for a special advantage for research expenses, but only to insure that they may at least be treated as effectively deductible business expenses. The deductibility of research expenses is sound accounting practice and accords with Generally Accepted Accounting Principles. To effectively deny the deduction is to effectively proscribe the activity.

Other nations offer strong incentives for research and experimental expenditures. For a taxpayer whose further expenditures for research in the United States will be denied even a tax deduction, a country that offers research incentives becomes extremely attractive.

Moreover, to the extent the cost of research increases as a result of unfavorable tax impact, the effect will, in all likelihood, be to not do research in the United States. Probably the research will be done, possibly not even by U.S. enterprises but by non-U.S. concerns. U.S. based chemical companies must be competitive on a worldwide basis. Failure to remain competitive will not only imperil our export position, but will open U.S. domestic markets to import of foreign produced chemical products.

To the extent the research is done outside the U.S., the technicians and scientists employed are foreign. The technology that is developed will be foreign. It is not unlikely that the plants in which the technology will be first employed will be foreign. The provisions in the 1.861-8 Treasury Regulations work in direct opposition to the incremental credit for U.S. based research and experimental expenditures. On one hand, the credit acts to create an insentive for research by lowering its cost, while the allocation acts to deny any deduction for the cost.

As a nation, we need a strong private sector research establishment. New technology is the source of continued economic growth and carries the seeds of jobs for the future. It is imperative that U.S. policy encourage domestic research activity.

In summary, the Chemical Manufacturers Association strongly believes that the moratorium should be extended. This action would prevent any reduction of research and experimental programs that might occur because of additional cost when the Treasury rules are applied. Research programs have to be planned far in advance, and any uncertainty as to the law in the future will have a deterrent effect on long-range planning.

The Chemical Manufacturers Association recommends that the moratorium on the Treasury Department's Regulation section 1.861-8 be made permanent.

Chairman RANGEL. Thank you.

Mr. Danielian.

STATEMENT OF RONALD L. DANIELIAN, EXECUTIVE VICE PRESIDENT AND TREASURER, INTERNATIONAL ECONOMIC POLICY ASSOCIATION

Mr. DANIELIAN. Thank you.

I am Ronald L. Danielian, executive vice president and treasurer of the International Economic Policy Association. I have a summary of my statement.

The International Economic Policy Association is a nonprofit, business-supported, research group based in Washington. For over a quarter of a century, we have analyzed public policy issues in the international economic arena. Our first involvement with international tax questions that affected the competitiveness of U.S. firms was before the Ways and Means Committee in June 1961, and we have consistently maintained that the health of American firms abroad and at home is one key to competing in the world.

The ability of U.S. business to retain capital and reinvest it for future growth is vital to remaining competitive in new product areas, to revitalizing traditional product areas, and to providing increased employment for the U.S. work force.

For a U.S. company, total net investable funds consist not only of those amounts earned in the United States, but also those earned abroad from assets located in foreign nations. These foreign assets are an integral part of the U.S. employment chain since one-third of U.S. exports go to American subsidiaries and affiliates abroad and investable funds flow back into the United States from dividends, branch earnings and royalties.

In fact, from 1948 through 1982, U.S. investments abroad returned-net of capital outflows associated with the investments$211.7 billion as shown in the table attached to my statement. The figure would be higher if royalty returns from unaffiliated foreigners are included. These returns are funds that can be used here in the United States to increase employment and maintain our competitive edge as we become more interdependent in the world today. And they also help our balance-of-payments.

The role of U.S. tax policy must include encouraging economic activity such as R&D and increasing employment here at home. At the very least, it should not hinder or jeopardize these goals. The Treasury has estimated that there would be a $100 to $240 million increase in tax liabilities if the moratorium were lifted. While this may be viewed as small, it means that the longstanding principle of eliminating double taxation would be broken. We do not believe it is in our interest to double tax capital which will constrict investment.

The Treasury study estimates a reduction in R&D spending of up to $260 million. This translates into a job loss of up to 92,823 persons. That is a maximum outside limit: Any job loss would be distributed as follows: Nineteen percent in the Mid-Atlantic StatesNew York, New Jersey, and Pennsylvania-24 percent in the Pacific States-mainly California-21 percent in the East North Central States-mainly Ohio, Illinois, and Michigan-and 12 percent in the South-primarily the South Atlantic States and Texas.

Many studies have shown that for the most part R&D is undertaken in the market where it is used. Thus, we believe that just as income is taxed where earned, R&D should be allocated where undertaken.

As R&D is forced offshore, there will be a loss in income from royalties and fees by American parent companies. The balance-ofpayments will suffer as the $5.6 billion in royalties and fees from affiliated foreigners and the $1.6 billion from unaffiliated foreigners is cut back. Furthermore, the nominal 46 percent taken by the U.S. tax man will be lost.

We believe that because of these reasons the moratorium under the 1981 act should be made permanent.

Thank you, Mr. Chairman.

[The prepared statement follows:]

STATEMENT OF RONALD L. DANIELIAN, EXECUTIVE VICE PRESIDENT AND TREASURER, INTERNATIONAL ECONOMIC POLICY ASSOCIATION

Mr. Chairman, the International Economic Policy Association is a nonprofit, business-supported, research group based in Washington. Since 1957 it has analyzed public policy issues in the international economic arena. These have included international trade, investment and balance of payments issues, problems of natural resource vulnerability, and international tax questions that affect the competitiveness of U.S. firms. The health of American firms abroad and at home is a key to competing in the world today.

The ability of U.S. business to retain capital and reinvest it for future growth is vital to remaining competitive in new product areas, to revitalizing traditional product areas, and to providing increased employment for the U.S. workforce. For a U.S. company, total net investable funds consist not only of those amounts earned in the United States, but also those earned abroad from assets located in foreign nations. These foreign assets are an integral part of the U.S. employment chain, since onethird of U.S. exports go to American subsidiaries and affiliates abroad and investable funds flow back into the United States from dividends, branch earnings, and royalties. In fact, from 1948 through 1982, U.S. investments abroad returned (net of capital outflows associated with the investments) $211.7 billion as shown in the attached table. The figure would be higher if royalty returns from unaffiliated foreigners are included. These returns are funds that can be used here in the United States to increase employment and maintain our competitive edge as we become more interdependent in the world today.

In an effort to maintain equitable tax treatment, U.S. companies operating abroad receive a credit for taxes paid to a foreign country. This, in essence, eliminates the imposition of double taxes on the same income, an objective that has been unquestioned by liberals and conservatives alike. Now, however, this principle is in jeopardy along with the goal of encouraging research and development and increased employment at home.

On May 27, 1983, Assistant Secretary of the Treasury for Tax Policy John Chapoton testified about extending the 25 percent tax credit for increased research spending that the Congress adopted in the Economic Recovery Tax Act of 1981. He said that this credit is of significant benefit to the United States because it encourages experimentation that may lead to innovations that enhance national productivity. He further indicated that the need for such activities cannot be disputed because innovation is essential if the United States is to retain and improve its competitive position in the world economy. We agree wholeheartedly with his view and believe strongly that that is the exact intent of legislation which makes permanent the moratorium on the arbitrary allocation rules established under Section 861 of the Regulations, as amended. This committee is reviewing whether or not to have still another two-year moratorium. Since this creates uncertainty for investment planning, we favor the approach of S-654 and H.R. 1887 to make the moratorium permanent.

When the cost of research and development here in the United States must be apportioned to foreign income, it reduces normally allowed credits for foreign taxes paid to foreign governments. Since foreign governments frequently will not recognize the validity of the allocation required by the Section 861 regulations, this raises the possibility of double taxation on the same income. It also reduces the available after-tax monies for further research and development expenditures and helps in shifting research and development offshore. At the same time that we are encouraging domestic R&D through the Economic Recovery Tax Act of 1981, we discourage it by an allocation of R&D expenditures to foreign-source income. For the lack of a consistent and coherent foreign economic policy, we have managed to create a curious "Catch 22" position.

Finally, if companies are forced to revert to the regulations, the results can produce allocations that defy logic. For instance, when a company performs U.S. ballistic R&D here at home and automotive parts R&D abroad, the U.S. costs must be allocated to the foreign automotive parts income because both activities are in the same SIC code. There are some alternative computations that can be used to try and

alleviate these kinds of conundrums but our members tell us that they are so complicated as to virtually negate their application.

This committee has already heard about the National Research and Development Study conducted by Arthur Anderson & Company which looks into the effects of lifting the moratorium on the Treasury Department's 861 regulations. A significant finding of the study was that "lifting the moratorium will encourage an expansion of foreign R&D investments in the future." We understand that some companies have decided to undertake new R&D Activities overseas, at least in part because of the possible effect imposition of the 861 regulations would have once the moratorium lapses. We do not believe this is good public policy.

A Department of the Treasury study entitled, "The Impact of the Section 861-8 Regulations on U.S. Research Development," completed in June of 1983, concludes with a statement that the Treasury recognizes the reduction in R&D may adversely effect the competitive position of the United States. "Accordingly, the Treasury supports a two-year extension of the present moratorium." More important, the Treasury study showed that there would be a $100 to $240 million increase in tax liabilities if the moratorium were lifted. While this may be viewed as small, it means that the longstanding principle of eliminating double taxation would be broken.

The Treasury study estimated that there would be a reduction of up to $260 million in R&D spending. Using just this amount as a guide and based on National Science Foundation data, up to 92,823 persons would lose their jobs. Nineteen percent of this job loss would fall on the Middle Atlantic states (New York, New Jersey, and Pennsylvania), 24 percent on the Pacific states (mainly California), 21 percent on the East North Central states (mainly Ohio, Illinois, and Michigan) and 12 percent in the South (primarly the South Atlantic states and Texas).1

We also believe that the Treasury study points to some inconsistencies. It states that it is appropriate on tax policy grounds to allocate domestic R&D to foreign sales even though such allocations can seem to be arbitrary as they are based on sales or gross income apportionment irrespective of where the R&D was performed. However, the study quotas at length from several reports 2 which found that foreign R&D operations are usually created to serve and support foreign manufacturing. Only 20 percent of the cases investigated by Ronstadt involved R&D that was substitutable for U.S.-performed R&D. This relatively limited connection between U.S. and foreign R&D is also evident in the study by Jack Behrman and William Fischer. In looking at U.S.-Canadian R&D relationships, they found that the R&D typically had little overlap with the R&D program in the parent country. Thus, these studies indicate that R&D for the most part is undertaken in the market where it's going to be used and thus supports another principle that should be followed. We believe that just as income is taxed where earned, R&D should be allocated where it is undertaken. To do otherwise on an arbitrary formula basis does not approximate real world relationships and can create unwarranted hindrances on the market allocation of investable funds.

Finally, the Treasury study does not address the possible reduction of fees and royalties from the R&Ď research that it says would flow abroad as a result of the 861 regulations. At the present time, any research and development done in the United States but used abroad is generally paid for by those using it, whether or not they affiliated or unaffiliated with the originating company. On a parent-subsidiary basis, in 1982 the U.S. earned a total of $5.6 billion in royalties and license fees, service charges and rentals ($3.2 billion in royalties and fees alone). Furthermore, an additional $1.6 billion was paid to U.S. companies from unaffiliated foreigners. It is safe to say this income stream (which is taxed in the United States when paid) could be reduced in the future if R&D was shifted to foreign locations. Instead, the foreign location host government would receive the tax revenues from the royalties and license fees obtained as a result of developing and selling the R&D. We believe the effect of this lost future income and tax was not considered in the Treasury study. In nominal terms, the United States collects 46 percent of the royalties and

'The assumption is made that job loss would be proportionate to the distribution of R&D funds nationally based upon the latest detailed data for R&D by states and area in Research and Development in Industry, 1979, National Science Foundation, January 1980, NSF 81-324. This document is also available for 1980 (January 1981) but without regional breakdowns.

2 Robert C. Ronstadt, "International R&Ď: The Establishment and Evolution of Research and Development Abroad by Seven U.S. Multinationals," Journal of International Business Studies, 1978; Jack Behrman and William Fischer, "Overseas R&D Activities of Transnational Companies," Oelgeschlager, Gunn & Hain, Cambridge, 1980.

3 In line with the studies in footnote 2, such research and development used abroad is undertaken for the U.S. market in the first place and its foreign use is ancillary to its domestic development. This is also compatible with the product cycle theory of trade and investment.

license fees paid to the United States and this would certainly be jeopardized if R&D is forced abroad through these regulations.

While the R&D share of the U.S. gross national product turned up slightly in 1982, at 2.7 percent it is still below the 1964 high of 3 percent. Business Week has noted that "the proportion of civilian spending [on R&D], exclusive of defense and space research, probably still trails . . . competing nations" such as Japan or West Germany. A country that fails to maintain or in fact inhibits its R&D investments for the future, reduces its ability to compete and increase employment. We believe that the moratorium under the 1981 Act should be made permanent.

DIRECT INVESTMENT CAPITAL OUTFLOW, INCOME AND NET BALANCE, 1948-82

! Excludes fees and royalties from unaffiliated foreigners. A U.S. business presence abroad helps to acquaint foreigners with U.S. products and styling and sell our management skills and processes. Such fees and royalties amounted to $15.4 billion from 1960-82

2 Excluding funds borrowed abroad for use by US foreign companies which were included in the original outflow figures. Such funds were significant amounts during the period of U.S. direct investment controls (1968-72).

3 There was a net inflow from equity and intercompany accounts rather than outflows for investment because of selloffs of petroleum affiliates in Canada and Netherlands Antillean financing actions.

Source: Survey of Current Business, U.S. Department of Commerce, GPO, Washington, D.C., June 1981, 1983, March 1982 and other selected

issues.

Chairman RANGEL. Neither one of you believe that there should be any allocation of R&D expenses overseas. Is that correct?

Mr. WHITE. That is my view.