Statement of Matthew McKenna, Senior Vice President of Finance, PepsiCo, Inc., New York, New York

Testimony Before the Subcommittee on Select Revenue Measures
of the House Committee on Ways and Means

May 09, 2006

Profile of PepsiCo

PepsiCo is a leading global food and beverage company with annual revenues of over $32 billion.  We manufacture, market and sell a variety of food products and carbonated and non-carbonated beverages.  Some of PepsiCo’s well known brands include Pepsi branded beverages, Quaker Foods, Tropicana, Frito-Lay and Gatorade.

The United States is PepsiCo’s single largest market.  PepsiCo and its affiliates do business in all 50 states and the District of Colombia and employ more than 60,000 people within the United States.  Over the past decade, PepsiCo has seen increased profits and a major expansion of its market presence in the U.S. and worldwide through acquisitions and product development.  I am proud that PepsiCo continues to build plants in the U.S., like the new Gatorade facilities PepsiCo is in the process of building, to serve our growing market.  PepsiCo also operates in over 200 countries.  During 2005, our operations outside the United States had growth of 21% and that growth continued in the first quarter of 2006.  International operations now represent 35% of total revenue and constitute 46% of PepsiCo’s overall growth.  Our international success has been built upon local businesses, serving local customers.  The cost of transporting our snacks and beverages, combined with the need to establish local brands, typically requires local sourcing in each country.  PepsiCo continues ambitious international expansion and is investing hundreds of millions of dollars in plants and equipment in both developed and developing markets around the world.

The United States Needs a Competitive Tax System

Today’s economy is truly global and is becoming more so every day.  In this environment, the United States cannot afford to have a tax system that forces U.S.-based businesses to face foreign competitors with one hand tied behind their backs.  Unfortunately, given the state of the U.S. tax laws, that is exactly how PepsiCo is forced to compete.

There are two areas where PepsiCo believes changes to the U.S. tax system would provide tremendous economic benefit.  The first is simple and straightforward:  a reduction in the corporate tax rate.  The second is more complex, but is critically important:  reform of the U.S. international tax rules.  These changes would help enhance the competitiveness of U.S. businesses and contribute to the continued growth of the U.S. economy through increased capital investment and increased U.S. jobs.

I. Reduction in Corporate Tax Rate

Lower corporate tax rate fosters competitiveness, investment and growth:  In the 1980s, the U.S. led the worldwide trend toward lower corporate tax rates.  Today, however, the U.S. has one of the highest overall corporate income tax rates (35% federal; 39.3% combined federal and state) among all countries in the Organisation for Economic Co-Operation and Development (OECD).  In contrast, the OECD trend has been to reduce corporate rates.  Ireland, for example, reduced its rate by approximately 48%, down to 12.5%, and now has the lowest corporate tax rate of all OECD nations.  This favorable rate has fostered foreign direct investment in Ireland and bolstered that country’s economy.  The average OECD rate is approximately 29.2% (combined central and sub-central tax rates), which is ten percentage points lower than the U.S. rate.. 

While the U.S. is clearly a leader in the global economy today, it must change in order to stay a leader. For U.S. companies to continue to be competitive with companies that reside in other large industrialized nations, and to foster foreign direct investment in the U.S., the corporate federal income tax rate should be reduced.  A lower corporate tax rate would allow businesses to operate in a more efficient manner, enhance certainty for business planning purposes and ensure that strategic decisions are driven by productivity, profitability and growth concerns as opposed to the preferences and obstacles of the tax code.

Expensing versus lower corporate tax rate:  The President’s Advisory Panel on Federal Tax Reform proposed an option that would provide immediate expensing for capital assets as a means of encouraging economic investment.  Capital investment clearly is important to the growth and expansion of U.S. businesses.  Over the past three years, PepsiCo has expended $5.7 billion on acquisitions and other investments in the U.S. and around the world.  At the same time, PepsiCo has returned $12 billion to its shareholders through dividends and share repurchases.  However, if I were given a choice between increased expensing and a reduction in the corporate tax rate, my preference would be a lower tax rate.

Increased expensing provides only a timing benefit.  In contrast, a lower corporate tax rate provides a permanent benefit.  Increased expensing does not affect a company’s book tax rate or net income for financial statement purposes.  Most importantly, a lower corporate tax rate allows businesses to choose how best to deploy their earnings – whether to invest in tangible assets or intangible assets and whether to return funds to shareholders so that they may invest those funds.  These decisions should be driven by the market and business plans  – not based on accounting timing and methods.

Credits and other tax preferences versus lower corporate tax rate:  The current U.S. tax code provides a variety of incentives to businesses through credits and other preferences, and PepsiCo benefits from many of these credits and preferences.    Nevertheless, if I were asked to choose between increased credits and other preferences or a lower corporate tax rate, again I would choose the lower tax rate.  As noted above, a reduction in the corporate tax rate would allow businesses to determine for themselves how best to deploy their earnings in order to maximize returns to the business and to the shareholders.

II. Modernize U.S. International Tax Rules

International competitiveness benefits the U.S. economy:  With over 95% of the world’s population living outside the United States, reform of the U.S. international tax rules is needed in order to protect and enhance the global competitiveness of U.S.-based businesses.  It is important to understand that foreign activity of U.S. businesses – and continued success of PepsiCo’s international investments – complements our U.S. activity; it is not a substitute for it.  Our foreign investment contributes to the U.S. economy and to U.S. employment.  The global success of U.S. businesses provides real benefits in terms of economic growth and jobs in the United States.  The United States must ensure that policies are in place to allow U.S. businesses to make the most of the tremendous opportunities that globalization and technological advances provide.

U.S. worldwide tax system creates the wrong incentives:  Today, the U.S. operates under a “worldwide” tax system in which U.S. resident companies are taxed on their worldwide income -- regardless of where it is earned.  The current system attempts to mitigate the potential for double taxation arising from overlapping source-country taxing jurisdictions.  It does so by providing for a foreign tax credit for taxes paid on income that is also subject to tax in the U.S.  In practice, U.S. companies are generally not taxed on business income earned by foreign subsidiaries until that income is repatriated to the U.S. as dividends. 

The current U.S. worldwide tax system incents U.S. companies not only to redeploy foreign earnings abroad rather than in the U.S., but also to keep any excess or idle foreign cash that may not even be needed for foreign investment overseas rather than returning it to the U.S.  These incentives and the resulting (and expected) reaction by U.S. companies are demonstrated by U.S. companies’ response to the temporary reduced rate of taxation on repatriated dividends under the provisions of the American Jobs Creation Act (AJCA).  To date, about $290 billion in AJCA repatriations have been announced by companies and as a result the U.S. Treasury has reportedly collected an additional $17 billion in taxes in a very short period of time.  This capital, which had been held offshore, is now available and has freed up cash in the U.S. for the support of jobs, acquisition of capital assets, payment of dividends to U.S. shareholders, pay-down of debt, strengthening of U.S. pension plans and other important uses that will help to strengthen and stimulate U.S. companies and the U.S. economy as a whole.

In addition, the complexity associated with the current tax system causes U.S. companies to engage in a greater degree of tax - distorted business planning, versus companies that are not subject to a complex worldwide system.  For example, companies can put great efforts into repatriating foreign earnings periodically in ways that do not trigger additional U.S. tax.  These incentives and behaviors distort the business and investment decisions of U.S. companies and ultimately are detrimental to the U.S. economy as a whole.

Finally, in addition to being overly complex and disincenting U.S. companies to act in a manner that supports the U.S. economy, the current tax system also puts U.S. companies at a competitive disadvantage, versus their foreign competition.  Under the current system, when foreign earnings are repatriated and U.S. tax is paid, U.S. companies are generally taxed at the higher of the source country or U.S. tax rate.  In contrast, under a territorial system many U.S. companies’ competitors are taxed only at the source country rate, even if it is lower than their tax rate at home.  Combined with the high rate of tax in the U.S., as discussed above, this puts U.S. companies at a significant competitive disadvantage.

U.S. should consider a territorial tax system:  The U.S. tax system differs significantly from the tax systems of many of our trading partners.  Two-thirds of the OECD countries operate territorial tax systems.  To create an efficient method of taxation that will enhance the competitiveness of U.S. multinationals and strengthen the U.S. economy in today’s global marketplace, we should examine the various territorial systems used by so many of the world’s developed economies.  Under a purely territorial system, a country taxes only income derived within its borders, regardless of the residence of the taxpayer.  Many countries tax resident corporations on a predominantly territorial basis by exempting dividends received from foreign subsidiaries from residence country tax – commonly referred to as a “participation exemption” system. 

We believe that a territorial system would allow U.S. multinationals to invest overseas in order to grow their businesses.  At the same time, it would remove the barrier or disincentive to repatriate earnings to the U.S. for investment here at home.

Of course, the extent to which a territorial tax system would enhance competitiveness depends upon the specific details of the system.  The key design issues with respect to a territorial tax system include (1) what income is exempt from tax, (2) how expenses are treated, and (3) what rules apply to tax passive-type income.  More work is needed to develop a territorial tax approach for the United States that would accomplish the objectives of reducing the complexity of the current U.S. international tax system, enhancing the competitiveness of U.S.-based companies operating in the global marketplace, and eliminating the disincentive to bringing profits home to the United States.

Some may argue that a territorial system that exempts active foreign income from U.S. tax is an invitation for U.S. businesses to invest overseas.  In fact, foreign investment is necessary in order for U.S. companies to maintain their competitiveness in today’s global economy.  It is a plain and simple fact that in order for U.S. companies to remain healthy, and even viable, they must compete with their foreign competitors and invest in the growing and emerging markets around the world.  Without tapping into that opportunity for growth, one can only imagine what would happen to the value of U.S. multinationals or what the stock market impact might be of the failure of U.S. multinationals to grow in these markets.  Adverse impacts to employment in the U.S. and to the U.S. economy in general would no doubt follow if U.S. companies could not compete effectively in the global economy.

Lastly, some would argue that exempting active foreign income from U.S. taxation is an invitation for U.S. companies to off-shore their U.S. business operations.  However, the global economy is a reality in connection with operating in and supplying not only foreign, but U.S. markets as well.  Foreign competitors are locating operations in advantageous jurisdictions around the world in order to supply and compete in both foreign and domestic markets.  The tax laws cannot be used to make U.S. companies more competitive and at the same time to stop U.S. companies from investing in operations overseas to supply foreign or U.S. markets.  However, what the U.S. tax system can do and should do is to allow U.S. companies to be competitive with their overseas competition and at the same time incent U.S. companies to employ as many people as possible in the U.S. to support those growing business operations around the world.

*****

In conclusion, a tax system that allows U.S. companies to be competitive on a worldwide basis, provides an incentive to maintain and increase jobs in the U.S. to support those businesses and allows for the repatriation of significant foreign profits to the U.S. is a win-win situation for the competitiveness of U.S. business and ultimately for the U.S. economy as a whole.  Similarly, a lower domestic corporate tax rate would allow businesses to operate in a more efficient manner, enhance certainty for business planning purposes and ensure that strategic decisions are driven by productivity, profitability and growth concerns as opposed to the preferences and obstacles of the tax code.  Congress has an opportunity to develop a system to sustain our competitiveness and growth for the generations to come.  We look forward to working with you on this critical initiative.