-13 Despite the difficulties which democracies sometimes have in making decisions, over the long run a lasting and self-sustaining process of economic development can best be built through a system which rests on the consent of the governed, and gives people faith in their institutions. People must have faith in their institutions if there is to be economic growth. The failure of Cuba's command economy can be traced to a failure of Cuba's Marxist government to give people faith in Cuba's future. Cubans increasingly shudder at the bleakness that will prevail even by the year 2000 if the current regime continues. Without freedom, even Castro's call of last year for "ten years of austerity" will not bring a return to economic growth. Castro's eagerness to earn hard currency and "normalize" his relations with the West, thereby regenerating growth, comes from his belief that he can have both growth and the command economy. But he is missing the point, just as the Soviet Union and Nicaragua have: growth cannot come through political tyranny and total bureaucratic control. To re-establish a productive future, Cuba would indeed need to normalize relations with the West, but that cannot come without freedom as well. we can all learn from the mistakes of the command economy. In simple terms, the lesson is that over-bureaucratization is the death knell of initiative, investment, and growth. Let's turn now to a review of economic progress in the Caribbean Basin. Although the region still faces major problems, some of which are beyond the control of the countries themselves, there has been considerable progress on the economic front in recent years. In Central America, the dramatic decline in the region's GNP has been arrested. The Caribbean Basin as a whole (excluding Nicaragua) grew 1-2% in 1984 and is estimated to have grown modestly again in 1985. are encouraged at this economic upturn, but we also see it as insufficient over the longer run. Clearly, greater economic progress is needed. We Perhaps the most important achievement of recent years has been a new spirit of private enterprise shared by both governments and the private sector. While it is impossible to quantify this, I believe most people who know the region sense a major change in attitudes. Increasingly, there is an awareness that it is the private sector which is overwhelmingly the source of investment, jobs, innovation and growth. Increasingly, the role of government is seen as providing a framework within which the private sector can operate efficiently, rather than as the engine of economic activity. -14 This is a crucial change. For, although attitudes are unquantifiable, they are the basis for people's decisions and actions. If these attitudinal changes continue and grow, then the region ultimately will develop institutions which attract capital and technology, not repel it; which encourage innovation and risk-taking, not capital flight; which foster savings and investment, not decay and decline. Chairman PICKLE. Thank you, Mr. Taylor. I am going to go right on down the list, and then we will come back to questions for all. Is that satisfactory to the committee members? All right. Then the next gentleman will be Mr. Stephen Shay, representing the Department of Treasury. Mr. Shay. STATEMENT OF STEPHEN E. SHAY, ACTING INTERNATIONAL TAX COUNSEL, DEPARTMENT OF THE TREASURY Mr. SHAY. Thank you, Mr. Chairman. I am submitting a rather lengthy testimony and welcome the chance to simply summarize it. Although the free trade area was the centerpiece of the Caribbean Basin Initiative, it also included a tax benefit. That tax benefit was what is known as the convention tax deduction. This, we feel, is a significant potential benefit to Caribbean Basin countries. Since the enactment in the original Caribbean Basin legislation, another potential tax benefit has been made available to countries in this region. The Foreign Sales Corporation Act was structured so that there is an incentive for companies to establish themselves in foreign jurisdictions. Qualifying Caribbean Basin countries would prove suitable locations for many of those corporations. Finally, I would like to come back to a very significant and possibly the most significant potential tax benefit, which is included in the House-passed tax reform bill. Before I get to that in particular, though, I think it is important to note that the benefits with respect to both the convention tax deduction and the foreign sales corporation qualifying jurisdiction provisions are conditioned on the Caribbean Basin country's having a tax information exchange agreement with the United States. We feel that that is a very important concomitant of extending tax incentives, given the fiscal constraints that we are operating under. We think it is both appropriate and important that we be able, as we extend tax benefits to the countries of the region, to be sure that we can administer and enforce our tax laws in an appropriate way with the cooperation of those same countries. If I could, I would like to just take a moment and focus on the provision in the tax reform bill that this administration believes has a very significant potential to provide assistance to the countries in the region, and that involves section 936 of the code. A provision of the tax reform bill would modify section 936 and provide a mechanism for funds to generate what is known as qualified possession source income to be invested in Caribbean Basin countries. For the first time, those funds, which are known by their acronym as "QPSII" funds, that are held by the Puerto Rican Government Development Bank may also be used, if the bill were passed, to finance investments in active business assets in qualifying Caribbean Basin countries, and the passive income from those funds would continue to be tax exempt under the normal section 936 mechanism. The potential funds that are available under this provision through the Puerto Rican Government Development Bank are in the aggregate amount of $700 million. The investment of such a large amount of funds would be very beneficial. Although there is no guarantee that the whole amount would go into Caribbean Basin countries. The potential to have access to that large amount of funds could mean a very significant increase in economic activity. I want to emphasize that this provision, really this package that was in the House bill, has the President's endorsement, we believe it has solid bipartisan support, and the wholehearted approval of the Government of Puerto Rico. As part of that package to promote the goals of this initiative, the Governor of Puerto Rico has spearheaded what has become known as a twin plant initiative, whereby Puerto Rico would encourage investment in Caribbean Basin countries by giving benefits to section 936 companies that also establish companion plants in the region. In that regard, the Governor of Puerto Rico has indicated that Puerto Rico is committed to the very ambitious goal of infusing $100 million of new investment into the Caribbean Basin area each year. That $100 million, as I understand it, would be either from Government Development Bank funds or from new investment from companies that have agreed to participate in the twin plant initiative. Finally, I would just like to address the question that was asked by the committee in connection with my testimony, and that was whether or not the tax incentives are sufficient to induce Caribbean Basin countries to be willing to enter into tax information exchange agreements. I would first like to emphasize that, in connection with the Caribbean Basin Initiative, the first effort on our part was to find the tax incentive that was appropriate to the region. While we felt it appropriate and important to condition that benefit on tax information exchange agreements, I wouldn't want our motives to get mixed up. We were not trying to first put a carrot out in order to get the tax information exchange agreements. It is really quite the reverse. To provide potential development incentive to these countries, which is the important part of the Caribbean Basin Initiative, was our first thrust. It is really a need to protect our own revenue system, which is the engine that makes available all these other benefits, made us feel it is important to condition those benefits as well on tax information exchange agreements. With that, Mr. Chairman, I would stop here and be pleased to answer any questions after others have summarized their testimony. [The prepared statement follows:] Release Upon Delivery STATEMENT OF STEPHEN E. SHAY ACTING INTERNATIONAL TAX COUNSEL BEFORE THE SUBCOMMITTEE ON OVERSIGHT OF THE HOUSE COMMITTEE ON WAYS AND MEANS Mr. Chairman and Members of the Subcommittee: I am pleased to have the opportunity to address this Subcommittee on the current status of the Treasury Department's efforts to negotiate and conclude agreements to exchange tax information ("tax information exchange agreements") with designated beneficiary countries under the Caribbean Basin Initiative ("CBI") legislation. This Administration believes that the combination of tax information exchange and the directly related tax benefits are an important element of the overall CBI program. International tax information exchange is important both to the United States and to our trading partners and allies on pragmatic grounds and as a matter of principle. We consider exchange of tax information between nations with economic interrelationships to be a basic principle of international economic relations. We intend to continue to pursue improved tax information exchange in relations with our Caribbean neighbors as well as with our trading partners throughout the world. In this era of mutual economic and political interdependence, one member of a family of nations should not base its economic development on the systematic erosion of another member's legitimate tax base. The tax base of the United States, in particular, supports not only the important governmental functions common to sovereign states generally, but also supports a foreign aid program that provides very significant assistance to other countries in need. In addition, the United States funds a worldwide security shield that protects all friendly nations. The connection in the CBI between tax benefits and tax information exchange is not a product of academic theory, but is based on very real needs of the United States. In an era of fiscal limitations, we cannot afford to extend tax benefits for economic development activity if tax shelter promoters and tax |