COMMITTEE ON WAYS AND MEANS BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois E. CLAY SHAW, Jr., Florida NANCY L. JOHNSON, Connecticut AMO HOUGHTON, New York WALLY HERGER, California JIM MCCRERY, Louisiana DAVE CAMP, Michigan JIM RAMSTAD, Minnesota JIM NUSSLE, Iowa SAM JOHNSON, Texas JENNIFER DUNN, Washington MAC COLLINS, Georgia ROB PORTMAN, Ohio PHIL ENGLISH, Pennsylvania WES WATKINS, Oklahoma J. D. HAYWORTH, Arizona JERRY WELLER, Illinois KENNY C. HULSHOF, Missouri SCOTT MCINNIS, Colorado RON LEWIS, Kentucky MARK FOLEY, Florida KEVIN BRADY, Texas PAUL RYAN, Wisconsin	CHARLES B. RANGEL, New York FORTNEY PETE STARK, California ROBERT T. MATSUI, California WILLIAM J. COYNE, Pennsylvania SANDER M. LEVIN, Michigan BENJAMIN L. CARDIN, Maryland JIM MCDERMOTT, Washington GERALD D. KLECZKA, Wisconsin JOHN LEWIS, Georgia RICHARD E. NEAL, Massachusetts MICHAEL R. MCNULTY, New York WILLIAM J. JEFFERSON, Louisiana JOHN S. TANNER, Tennessee XAVIER BECERRA, California KAREN L. THURMAN, Florida LLOYD DOGGETT, Texas EARL POMEROY, North Dakota
Allison Giles, Chief of Staff Janice Mays, Minority Chief Counsel  SUBCOMMITTEE ON SELECT REVENUE MEASURES JIM MCCRERY, Louisiana, Chairman
J.D. HAYWORTH, Arizona JERRY WELLER, Illinois RON LEWIS, Kentucky MARK FOLEY, Florida KEVIN BRADY, Texas PAUL RYAN, Wisconsin	MICHAEL R. MCNULTY, New York RICHARD E. NEAL, Massachusetts WILLIAM J. JEFFERSON, Louisiana JOHN S. TANNER, Tennessee
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records of the Committee on Ways and Means are also published in electronic form. The printed hearing record remains the official version. Because electronic submissions are used to prepare both printed and electronic versions of the hearing record, the process of converting between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process is further refined.

Advisory of March 27, 2002, announcing the hearing

Archer, Hon. Bill, PricewaterhouseCoopers LLP

Chorvat, Terrence R., George Mason University School of Law

Garrett-Nelson, LaBrenda, Washington Council Ernst & Young

Gibbons and Company, Hon. Samuel M. Gibbons

McIntyre, Michael J., Wayne State University

Cifrulak, Stephen D., Jr., Sewickley, PA, statement

FIRST IN SERIES ON THE EXTRATERRITORIAL INCOME REGIME

House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.

The Subcommittee met, pursuant to notice, at 2:05 p.m., in room 1100 Longworth House Office Building, Hon. Jim McCrery, (Chairman of the Subcommittee) presiding.

[The advisory announcing the hearing follows:]

Chairman MCCRERY. The Subcommittee will come to order.

We are told we are going to have a vote on the floor in about 10 or 15 minutes, so if we can get Members to take their seats as well as our guests, we will proceed and try to get through the first panel before that vote.

Good afternoon, everyone. Today the Select Revenue Measures Subcommittee begins its examination of the Extraterritorial Income (ETI) Exclusion Act which replaced the Foreign Sales Corporation (FSC) regime. I am glad that Chairman Thomas has asked our Subcommittee to delve into this difficult issue and hope that we are up to the task of finding a way to untie this Gordian knot.

As members of this panel are well aware, the United States has a world-wide tax regime, meaning U.S. companies pay tax on all of their income regardless of where it is earned. Some of the U.S.'s major competitors have territorial tax systems. Under such systems only income earned within the home country is taxed. Income earned outside of the home country generally is not.

Our international tax rules that provide for deferral for certain types of income earned abroad and which provide tax credits for income taxes paid to foreign countries are an endless source of complexity. Members of this Committee are interested in simplifying these rules to improve the competitiveness of U.S. multinational companies. I note that just last month Oversight Subcommittee Chairman Houghton introduced legislation on this difficult subject.

The ETI FSC rules are an attempt to address a slightly different issue impacting the ability of the U.S. companies to compete abroad. For reasons buried deep in the past, the agreement establishing the World Trade Organization (WTO) expressly permits countries to border adjust indirect taxes but not direct taxes, and upon this distinction lies the prospect of a trade war with Europe.

Many European countries have relied on value-added taxes, or VATs, for a significant share of their tax base. Under the terms of the WTO, the embedded VAT may be rebated when products are exported. By contrast, the United States raises most of its revenue from income taxes which are considered direct taxes and are not similarly rebatable on exported products.

In order to level the playing field, the United States has provided a tax benefit to our exporters in an attempt to replicate the benefits of border adjustability. But what was offered in incentives to U.S. exporters lacked compliance with world trading rules.

Domestic sales corporations were replaced by foreign sales corporations in 1984. In 2000, the WTO ruled the FSC rules, the Foreign Sales Corporation rules, constituted an impermissible export subsidy. Working with the Clinton Administration, the Congress repealed FSC and replaced it with the extraterritorial income regime, which itself has been found to be in violation of those same WTO rules.

The case is now before an arbitration panel. That body will, by the 29th of April, set the amount of retaliation that the Europeans may impose to mitigate the impact of our Tax Code's impermissible export subsidy. We fervently hope the Europeans will not immediately exercise their right to impose sanctions and recognize the strong commitment of this Congress and the President to make the necessary changes to the Tax Code as soon as practicable.

Today's hearing explores one way to bring our Tax Code into compliance with the WTO ruling. Some observers have suggested that the WTO Appellate decision provides a road map for how the ETI regime could be narrowly modified to come into technical compliance with the WTO's rules while still providing the same benefits to the same set of taxpayers. Others, however, suggest the latest Appellate decision provides little wiggle room for cosmetic solution and believe the WTO will be very skeptical of supposed solutions that do not fundamentally revamp our Tax Code.

We have a distinguished group of witnesses to help us examine these difficult questions, and I am particularly pleased to welcome back to 1100 Longworth two good friends and long-time leaders of the Committee on Ways and Means, Chairman Bill Archer and Chairman Sam Gibbons.

Before I introduce them more fully, though, I would like to yield to my good friend from Massachusetts who is substituting for my good friend from New York today as acting Ranking Member, Mr. Neal.

[The opening statement of Chairman McCrery follows:]

Mr. NEAL. Thank you, Mr. Chairman.

I agree with you. You couldn't have met two finer people or two better Chairmen. It is a great opportunity for Members of this Committee to finally question two Chairmen of this Committee. It is a rare opportunity we get, finally.

I do want to thank you, Mr. Chairman, for holding this important hearing today on ensuring the competitiveness of U.S. multinational businesses.

I also want to thank you and your staff in working in earnest on another topic of interest to me, the corporate expatriate problem. I understand a hearing will be held perhaps as early as the end of this month when a U.S. Department of the Treasury report on the issue is expected to be released. Either way, if that report is not available, I think our hearing would certainly be instructive for the Treasury officials doing the report since there really has been no public debate on this issue thus far.

I do want to get to the question-and-answer period with our respective guests today. But I do also want to thank you Mr. Chairman publicly for agreeing to proceed with hearings on that expatriate issue.

Chairman MCCRERY. I thank the gentleman for his comments and look forward to working with him and other Members of the Subcommittee on that issue.

Our first two witnesses today are well known to this Committee and undoubtedly to our audience and our guests today. This week is Masters week, as some of you know, some of you golf addicts like me know. I am looking forward to it. It is my favorite tournament of the year. It is in the opinion of a great many people the best-running golf tournament in the world, and one of the great things about the Masters is the chance for past champions to come back and mingle with younger golfers, give them the benefit of their experience and their knowledge of the Masters Tournament and the game.

Certainly today we have two past masters with us to share with us their experiences and their knowledge of the game, so to speak; and we couldn't have chosen two finer examples of the greatness embodied in the Members of the Committee on Ways and Means which I think and most people believe is the greatest Committee in Congress. I don't get any disagreement with our panel or from the dais.

So, welcome, gentlemen. We very much welcome you back. We hope you won't make this your last visit to the Committee on Ways and Means. We hope to see much more of you. Certainly appreciate your taking time out of your schedules to join us today and try to help us with this issue.

We do have a vote on the floor -- if it is just one vote. We could find out if it is just one vote. It is just one vote. So why don't I suggest that the Members of the Subcommittee run over and cast this one vote. Then we will be right back, and that way we can go full on.

Thank you. The Subcommittee will be in recess.

[Recess.]

Chairman MCCRERY. The Subcommittee will come to order. Welcome back, everyone.

Our first two witnesses today are the Honorable Bill Archer and the Honorable Sam Gibbons. Mr. Archer is presently Senior Policy Advisor, Washington National Tax Services for PricewaterhouseCoopers. Mr. Gibbons is Chairman of Gibbons and Company. Gentlemen, once again, thanks for coming.

Today we will begin with Chairman Archer. Mr. Archer.

STATEMENT OF THE HON. BILL ARCHER, SENIOR POLICY ADVISOR, PRICEWATERHOUSE COOPERS LLP (FORMER MEMBER OF CONGRESS)

Mr. ARCHER. Mr. Chairman, thank you so much. Congressman Neal and other Members of the Subcommittee, I think this is a extremely important hearing today; and I am honored to be a part of it. Thank you for inviting me.

I have a longer written statement, Mr. Chairman, which I would like to have inserted in the record; and I will shorten for my verbal presentation.

Chairman MCCRERY. Without objection.

Mr. ARCHER. Today I will discuss briefly our current international tax system and the role of the ETI, and I will also offer for the Committee's consideration four fundamental principles for international tax reform that I hope you will find useful during the course of your work.

For the record, let me note that, as you mentioned, Mr. Chairman, I am currently serving as Senior Policy Advisor to the firm of PricewaterhouseCoopers, but today I testify on my own behalf and not as the representative of any organization.

I am extremely pleased to have the chance to discuss with my former beloved colleagues -- and I mean that genuinely -- in this auspicious environment of the Committee on Ways and Means hearing room the critical issue of ensuring that U.S. international tax rules provide a level playing field for U.S. businesses to compete globally; and I think that is what this issue basically is all about. As President Bush stated early in his Administration, and I quote, "Open trade fuels the engine of economic growth that creates new jobs and new income in the United States and around the world." I believe we must have a tax system that frees American workers and businesses to participate fully and fairly in the benefits of an open global trading system.

Achieving that goal in a manner that honors our international trade commitments is a fundamental imperative for our country and for the world. I am confident that the Committee on Ways and Means will address this challenge by once again demonstrating its long-standing bipartisan commitment to putting first the interests of American workers, farmers and businesses.

As we all know, the World Trade Organization ruled on January the 14th, for the fourth time, that the U.S. Tax Code is inconsistent with our obligations to the WTO. I share the disappointment that you must have that Congress must once again confront this issue.

I had the distinct honor of chairing the Committee when we all worked together in a totally bipartisan manner to pass legislation in November 2000 that responded to an earlier WTO ruling when we repealed the FSC and enacted the ETI provisions. Unfortunately, the WTO ruled against the ETI; and by April 29th it will rule on sanctions. The amount and timing of any European Union (EU) retaliation remains unclear. What is clear are the serious risks posed by sanctions to our recovering U.S. economy and the orderly operation of the global trading system.

Chairman McCrery, when you announced this hearing you stated that it is critical that we make a prompt yet thorough inquiry into possible changes into the ETI system which are both WTO compliant and foster the competitiveness of American companies. I could not agree more. You asked for help in exploring the possibility of leaving the ETI in place but making modifications to it that address the objections raised by the European Union.

I have looked very carefully at the WTO decision, and let me state emphatically today that the Committee should not in my opinion consider another interim response to the WTO ruling. In my opinion, the ETI cannot be modified to preserve effectively its essential benefits and still be in compliance with the WTO.

I suppose that is really the guts of my comments today. I believe the Committee needs to consider fundamental reform of the ways that U.S.-based businesses are taxed. On this point I concur with Chairman Thomas, although I would add a note of caution that there will be winners and losers when you change the existing rules.

I believe that it is important to balance the needs of various affected industries and implement any proposed legislation in a manner that avoids disruption of current business plans and activities.

In my view, we force U.S.-based businesses to enter the global trading arena with one hand tied behind their backs relative to the tax codes of the countries where corporations are competing against us. The existing ETI provisions serve only in part to offset some of the anti-competitive features of U.S. international tax rules.

Under current law, a U.S.-based business operating internationally almost always pays a greater share of its income in foreign and U.S. tax than does a competing multinational corporation headquartered outside the United States.

In addition, the complexity and high compliance costs associated with U.S. international tax rules represent essentially an additional hidden tax on American businesses that operate abroad. It was most recently noted in a report that roughly 47 percent of the compliance costs under our Tax Code are a result of the way we tax foreign source income, and that should never be ignored. Because even though it is an administrative cost, it adds to the burden of our corporations that have to compete overseas.

You can witness the impact of an overly burdensome and complex tax regime on the U.S. economy in the area of corporate mergers and reorganizations. As this Committee knows from past hearings right in this room on international tax simplification, U.S. international tax rules can play a key role in determining the location of a corporate headquarters.

This was clearly the situation in the case of Chrysler when it became, as a result of our Tax Code, DaimlerChrysler instead of ChryslerDaimler, a German corporation, with the result that the culture that now permeates that organization is directed out of Germany, not out of the United States of America.

I do not believe that is in the best long-term interests of our country. In fact, recent studies have shown that between 73 and 86 percent of large cross-border acquisitions involving U.S. companies have resulted in a merged company being headquartered abroad. Of the world's 20 largest corporations, the number headquartered in the United States has declined from 18 in 1960, the period of time when our current code was put on the books in the early 1960s, to just 8 in 1996. So from 1960, 18 of the largest -- of the 20 largest corporations in the world were in the United States. Today, only six. And that tells a story in itself.

In conclusion, let me say that we must consider the bigger picture when discussing the current U.S. international tax system. Achieving a high standard of living for American workers and their families ultimately rests on the productivity of U.S. investments. The challenge is to design a tax system that raises revenue with the least damage to investment and growth in productivity.

With these larger issues in mind, I would like to offer four fundamental principles that I hope you would consider during your deliberations. I believe that these bedrock guidelines should be a part of the core criteria by which any proposal is judged.

First, if and to the extent that the ETI regime is repealed, any scored positive revenues such action generates should be reserved for measures to improve the competitiveness of U.S. corporations operating in the world marketplace.

Second, in designing international tax reform measures, the Committee should balance the needs of various affected industries. All industries are not alike in the way they are impacted.

Thirdly, also, the Committee should seize every opportunity presented during this process to fashion international tax rules that U.S. businesses can understand and the government can administer.

Finally, any repeal of the ETI should be accompanied by an adequate transition period to avoid disruption of current plans and business activities.

A successful U.S. response to the WTO's ruling against the ETI has the potential to address two key priorities for our country. First, we must make the United States more competitive internationally; and, second, we must address the underlying problems with the U.S. international tax rules that are resulting in fewer and fewer global business headquarters being located in our country.

Finally, although Ambassador Zoellick is making efforts to have the European Union defer any retaliatory action while the United States works to comply with our WTO commitments, there remains the real possibility that some action may be required this year. Because of the potential magnitude of this issue, it would be highly desirable for the Congress to work with the White House to put in place a joint bipartisan task force to make formal recommendations to the Congress on a solution. That task force should, in my opinion, include representatives of the White House, select Members of Congress from both parties, representatives of business, farmers and organized labor. I don't think it can come too soon to lay the groundwork for an ultimate solution to this problem.

For my part, I offer my assistance and the assistance of PricewaterhouseCoopers as the Committee considers any replacement of the ETI regime. I played a very big role, as you may remember, in the development of the ETI, working very closely with the Clinton Treasury and with both sides of the aisle. We did our best, but it was not upheld by the WTO. Now again it must be on the basis of full consideration on both sides of the aisle and the White House.

I thank you again for letting me come and testify, and I will be happy to answer any of your questions.

Chairman MCCRERY. Thank you, Chairman Archer.

[The prepared statement of Mr. Archer follows:]

Chairman MCCRERY. Now another gentleman with a long track record of examining this Nation's tax laws and regulations and one who has put, I know, a lot of thought into our tax system, Mr. Gibbons. We are very thankful to have you also with us.

You might notice that we allowed Mr. Archer to go over the 5  minutes. We will extend that same courtesy to you. The panels that are following, don't get any bright ideas. We are doing this for two former distinguished Chairmen of this Committee.

We certainly will allow you to speak for however long you wish, Mr. Gibbons. Please address the Committee.

STATEMENT OF THE HON. SAMUEL M. GIBBONS, CHAIRMAN, GIBBONS AND COMPANY (FORMER MEMBER OF CONGRESS)

Mr. GIBBONS. Mr. Chairman and Members of the Committee, let me thank you for allowing me to come back here in this position as a witness before the Committee. It is a high honor for me. I will try to do my best.

Like I think Mr. Archer and I both feel, we would prefer to have a dialogue with you which we hope our direct testimony will stimulate so that we can really pure out the knowledge that we have and the thoughts that we have in that dialogue. So I will try to keep my remarks brief; and, Mr. Chairman, just slam me with the gavel when you think I have gone too far.

Mr. Chairman, I don't disagree with a thing that Mr. Archer has said. We talked about this when he and I were both on the Committee. We fundamentally understand the subject matter, and I feel that it is our job and I am sure he feels it is our job to try and impart some of that knowledge that we accumulated on our years here so that you all can take some affirmative action on it.

Let me go back to the beginning. How did we get in this predicament? Well, it is certainly not your fault. It is not our fault. It is the fault of a long time ago, an innocent decision that was made at that time. And there were no villains in the whole process at all. Let me paint the picture.

In 1947, I was a young lawyer down in Tampa, Florida. I had just graduated from law school, spent 5  years in the Army, and was not focused upon Washington at all. But the world was in shambles. Europe looked like it was -- we knew it was prostate because we had destroyed it during World War II. We thought it was going Communist, because that was the emerging philosophy there. And Japan was in terrible shape, China. Every place on earth except the United States of America was in terrible shape.

The leaders at that time decided to convene here in Washington in 1947 a conference on what to do about rebuilding the world. Everybody came to Washington from all over the world, knowing that America was the number one economic engine of not only the United States but of the world; and they had been defeated or had worked with us in defeating the rest of the world in the war. So they convened here in Washington in 1947, and they eventually came out with something called the General Agreement on Tariffs and Trades (GATT) with its rules.

That graduated over a period of time into the World Trade Organization. But essentially the rules are the same as they started in 1947. They were rules that the United States of America imposed upon the rest of the world. Let's have no doubt about it. We are the ones that invented these rules that have us entrapped today.

The Europeans who had the strongest economy, such as it was, and it was in terrible shape, came along and in that 1947 agreement this distinction between indirect and direct taxes was made. And why was it made? Why did the United States impose that kind of rule? Well, that is the same kind of rule that we had developed in the United States in how we handle our sales tax. Today, and even then, if you buy something in New York with a high sales tax and you have it shipped to here in Washington, you don't pay any New York sales tax, and vice versa. If you buy something here in Washington with its relatively high sales tax and have it shipped to you in New York, you don't end up paying any Washington sales tax.

That is the same dilemma we are in this -- the world rules today. We imposed that rule on the rest of the world in 1947, and it hasn't changed.

Now, why did we do it? Well, we were trying to get rid of subsidies. We realized that the Tax Code could be used to subsidize businesses. So we got rid of them in the direct subsidies; and when we got to the subsidies that are embedded in the tax law we said, well, we will adopt the same rule that we have for our own domestic sales tax. That is how we got where we are today, and that is the same rule that comes back to haunt us.

Now the Europeans weren't plotting against us when they agreed to do that. They had the same kind of tax system in Europe, such as it was, as we had in this country -- high dependence upon excise taxes and a heavy dependence upon income taxes and various other nuisance taxes like alcohol and tobacco and excise taxes on fuel and things of that sort. So the tax systems were roughly the same.

In 1965, the French had had so much trouble with their own income tax system that they started experimenting, and they came up with something called a tax value added, TVA.

I first ran into it when I found myself without an overcoat in Paris with Martha, oh, sometime in the late 1960s or early 1970s. I had to go buy an overcoat. The embassy didn't want me shivering to death over there in that French weather, and I bought an overcoat.

Well, the fellow from the embassy who was with me jabbered off in French to the clerk there something about TVA. I didn't know what the heck they were talking about. Well, 2  months later I was sitting in my office in the Rayburn Building and in comes a check from a bank in New York for about 200 bucks. No letter going with it or anything else.

So I called the bank. I said, why did you send me $200? They said, well, that is the rebate on the French TVA tax that I had paid on the overcoat.

I called the colonel in who had been my escort. I said, how did we get into this? He said, I turned in all those papers that you gave me at the border when we left France and you got the tax back that had been collected on your overcoat.

Well, that got me to scratching my head. Attending conferences in Europe, I would meet with the European Commission and the European Council, and I would complain about this rebate, this unfair advantage that they had against Americans. They would say, it is a sales tax, just you all have got in the United States, State level. You rebate that same thing when you make the sales.

So it dawned upon me that we are up against something that was a little different, and the severity of it didn't dawn on me until American businesses kept coming to me saying, complaining, well, we are at a disadvantage. The Europeans can rebate their cost of government at the border on their products when they export them into the world market, and we Americans can't.

Well, about the early 1970s, I think it was, the Treasury Department came in. There were only 25 of us on the Committee. There was no lower level down here. They took us over to H-208 and explained to us what the problem was. We came up with this way to get around it, we thought. It was highly controversial within H-208, but there were no newspaper reporters around, nobody else. The doors were all closed, and we were just plotting up a solution ourselves behind those closed doors.

After a few hours of arguing back and forth, we finally adopted this monster that you all are dealing with right now. It has had to be changed over the years as one time after another that the monster got chopped down, and we had to fess up that, yeah, we have committed a tax subsidy under the income Tax Code. There isn't any way out of it. We imposed the rule on the world. It has come back to haunt us.

Everybody on earth has gone to a value-added tax. Instead of a TVA, it is a VAT; and only our country and Australia have not gone that route. So it is us against the world. We are eventually going to have to conform to their set of rules or suffer the consequences. That means that they can levy offsetting duties against our products if we continue to be the scofflaw in the international situation, so there is no way out of it.

Maybe some kind of temporary something can be negotiated with the rest of the world. I doubt it, but you can try. It will be very frustrating, and you are not going to get very far. The rest of the world is going to say, you know, Americans, if you don't like the rules, you join the club. You change your rules, you change your tax laws, and you can join the same club we are all in.

Now, what is that club? That club is -- let me take off these glasses, because they impede my ability to think.

If you manufacture these glasses in the United States and sell them abroad -- and nobody does that, but if you did, when they went abroad, they would go with the full cost of the U.S. government in here, the full tax cost of the U.S. government. It is a pretty substantial burden to have to carry and go overseas.

When you hit their border you would not only have your cost of government there, these glasses, but these glasses, when they pass that border, would pick up under their value-added tax, their cost of government. So these glasses would be burdened with two costs of government going from our country to their country. But coming from their country to our country, it is just the opposite. They take off the value-added tax, their cost of government, at their border. We have got nothing that effectively intercepts it on our side.

So what are we doing? We are exporting American jobs. Let me repeat that. What are we doing? We are exporting American jobs, good American jobs, because of the way we collect taxes.

Now, there is no solution through the income tax. We have tried it for 20 -- almost 26, 27 years. Every time we have tried it, the World Trade Organization says, you know, that is a subsidy. And honestly it is, under the current rules. But -- so, I don't know of anybody on this Committee that wants to continue to export American jobs, but that is what we are doing. That is what we have been doing for quite some time. That is what we are going to be doing at a greater rate unless we change our system.

So, men and women of the Committee on Ways and Means, the burden comes back to you. You can't judge it. You can't fix it. You can't flinch it. You got to do it. You have got to adopt some kind of tax system that will work in the world system.

We are a world power, but we are a limited world power. We are only 4 percent of the earth's population, something that never dawns upon most Americans. We are only 4  percent of its population, but we possess and control about 30 percent of its wealth. We are bleeding that away, and we are bleeding it away primarily not because we are not a productive nation, but because of our tax system.

I don't know what it costs to collect taxes in the United States at the Federal level, but it is horrible. It is far greater than what we pay the Internal Revenue Service (IRS). Because also out there is tax deductible -- are all of the tax firms that do tax law, all of the people that write books and write electronic programs and everything else. It is a huge, huge industry.

All of you, like Mr. Archer, who fill out your tax return -- I did it for years until I finally got audited and wised up and found out it was better for me to hire an accountant rather than explain to the IRS why I didn't fill out a tax return properly --

Chairman MCCRERY. You are going into areas now that this Committee is not prepared to discuss.

Mr. GIBBONS. They audited my tax return when I was first a Member of this Committee; and, believe me, that is an exquisite feeling if you have never been through it. I don't recommend it for anybody.

I want to say right now I didn't get caught, and I was clean, and Martha didn't have to pay anything, and I didn't have to pay anything. But it is an exquisite feeling to have the people walk in from the IRS and say, we are from the government. We are here to help you, and we are going to audit your tax return. We want all your books and records. And a cold sweat, even if you are a Congressman, breaks out all over you when that happens.

So that, you know, I do know something about what the cost of collecting taxes is. It is a huge drag upon the American economy, one that we insist on imposing on our economy; and we are going to reduce ourselves to a third-world nation if we continue down this path. That is how critical this issue is.

I have talked longer than Bill Archer, and I have talked longer than most of you care to listen to me. But thank you very much. If I can ever come back and spend time with you or go on a retreat with you, Bill and I will be glad to go. There is a lot there that we won't be able to say because you just haven't got the time to listen. But we are here to help you. We are here to work with you.

Chairman MCCRERY. Thank you very much, both of you. And quite the contrary, Mr. Gibbons, I think it is helpful for particularly the younger Members of the Committee to hear the history of how we got to where we are. It is very helpful for us to hear from the two of you who were intimately involved in various efforts through the years to make our tax system work within the confines of the rules of the World Trading Organization, whether it was GATT or WTO.

I want to begin the questions by exploring a little bit those efforts that you went through. Just to use the most recent example, back in 2000, when Chairman Archer worked with Charlie Rangel and Members on both sides of the aisle and with the Clinton Administration to try to figure out a way to replace the FSC with something that was workable and permissible under the rules and they came up with ETI, that process took nearly a year. It would have taken a lot longer except for the fact that everybody involved agreed where we wanted to go and everybody was in agreement that something had to be done. Everybody was in agreement that we wanted to keep American workers and farmers and businesses competitive and to keep Americans working. So we all worked together very expeditiously to go from FSC to ETI.

My question to you, though, relates to where we are today vis-à-vis the sanctions that may be imposed upon us in the not-too-distant future. Do you believe that a similar -- first of all, do you believe that a similar bipartisan effort is necessary to come up with any solution that we arrive at?

Mr. ARCHER. As I stated in my testimony, I believe that.

Chairman MCCRERY. Mr. Gibbons.

Mr. ARCHER. But I do not believe that it can be done in a rapid fashion. That is why I think you need to get started with the process by exploring the alternatives.

Chairman MCCRERY. That is my next question. Do you think we can get the parties together -- not just political parties but all the parties that have to be involved in such a tremendous effort and get something done before the end of this month when retaliation is due to come from the WTO, from the Europeans?

Mr. ARCHER. I doubt it. But it is my understanding of the signals that we have been getting from the Europeans, as particularly articulated by Lamy, that if there is a process under way which shows good faith for us to reform our tax system that they will not immediately retaliate.

Chairman MCCRERY. Mr. Gibbons, do you have an opinion on how long it is going to take us?

Mr. GIBBONS. I think you could work out the bipartisan part in the Congress and with the President. I don't think that is the big problem. I think the problem is, what are you going to do with the rest of the world? When I say the rest of the world, you know there are almost 160 members of the WTO. Everybody on earth that we have allowed in is in the WTO, and you have got -- and all of them have got a value-added type of system that they are working from, and we have got -- we depend heavily upon the income tax. They are just -- unless there is something within the psyche of those 157 other nations out there, I don't think you got much negotiating grounds.

Now, they want some things and we want some things, and maybe I think with a wink and a nod and a handshake you could work out something that would delay the impending execution of those dates if you could show good-faith effort that you were moving ahead. It isn't going to be easy. And the biggest part of the problem is not the technical problem but the political problem within the United States of moving from an income-based tax and a payroll tax to an indirect tax. That is the problem. And it is not an easy problem.

But, friends, they have got the goods on us. We have got to show some good-faith effort that we are ready to move and are willing to move. I don't know of any other short-term thing that could have happened. We have got to go to the WTO and tell them we would like to sit down and work this thing out and show some good-faith effort that we are willing to work it out. I don't think we can pass any more changes in the income tax law that will stand up more than to take the time to file a case in the WTO.

Chairman MCCRERY. Thank you. Mr. Neal.

Mr. NEAL. That was fine testimony, Mr. Chairman. I do not have any questions at this time.

Chairman MCCRERY. Mr. Hayworth.

Mr. HAYWORTH. Thank you, Mr. Chairman.

Mr. Chairmen, thank you for returning; and we appreciate your insight.

Chairman Archer, as you laid out the four principal ideas and guidelines for us in responding to the WTO, I was wondering, sir, if you could elaborate a bit more on principle number two: In designing international tax reform measures the Committee should balance the needs of various affected industries. For purposes of illustration only, could you elaborate a little bit on that?

Mr. ARCHER. That becomes the very difficult part of this process. I think politically, as you begin to move in to restructuring the Tax Code, you are going to find domestic winners and losers. You cannot duplicate as we did with ETI the benefits so that everybody was a winner. That was a big advantage that we had with the ETI. I don't think as you begin to move into a WTO-compatible system that you are going to be able to do that.

But I think you need to give very strong consideration to businesses where the differences are great, for example, between an extractive industry and a manufacturing industry. The differences are great between an industry that has to go overseas for most of its business because that is where the markets are and one that depends more upon the U.S. markets.

That is going to make your job very difficult. But I think you have to look at it, and you have to carefully assess it and reach the best possible result that you can.

Now, there are any number of options that you can use to address this problem. Again, the only thing that I don't think you can do, as I mentioned, is replicate the benefits for all of the people who are exporting from this country who benefit under the ETI and do it with a WTO-compatible result. I don't think that is possible. Today we don't have time to try to brainstorm all of the alternatives, and that is where both Mr. Gibbons and I -- and, by the way, I associate myself with his remarks, which I think were beautifully stated -- are available to the Committee in any way we can help.

Then I would add also that all of the technical expertise of PricewaterhouseCoopers is also available to you should you wish to draw on it.

But if you see ultimately fit -- and I am not recommending that you abolish the ETI, but if you come to the point where you have to do that, then whatever revenues result in the estimates that you will get from the Joint Committee on Taxation, you should put back as best you can into the system to reduce the barriers in our Tax Code to our corporations that are operating overseas.

Now, just to reach out and talk about one or two things, the way our subpart F operates, for example, can be changed to be very, very helpful. The way we require interest allocations can be changed. That will be very helpful. These will not duplicate the current benefits under the ETI, but they will move in the right direction. So there are things that can be done within the current system.

I must say that I agree completely with Chairman Gibbons that in the long term you are going to have to throw out the income tax system that we currently use in the corporate level and replace it. Because, to me, we must in a competitive global marketplace, have a Tax Code that at least gives us a level playing field against our foreign competitors.

What I have ascertained by looking at a number of different corporate structures is that, on average, our corporations pay an effective tax rate of around 39 percent. Now that is both Federal and State taxes. There are foreign competitors who, on average, pay a tax rate of about 24 percent. Now, that is a 15 percent margin of difference, and that goes against the bottom line.

If our corporations are faced with this type of competition over a long period of time, one of two things is going to happen: They are either going to go out of business because they can't sell their goods and services competitively in the world marketplace with this extra cost -- and I am not yet including what Mr. Gibbons and I referred to as the compliance cost, which are somewhere around $250 billion a year in this country. Now, not all of that is corporate, but that is an overall figure. But either they will decline and be defeated by their foreign competition or, what is more likely, is they will be taken over by foreign corporations like Chrysler was, like Amoco and Arco were, like Bankers Trust was by Deutsch Bank. Then the entire culture of that corporation is going to be removed into a foreign country, and I think that is the worst of all worlds for the United States of America.

Mr. GIBBONS. May I add it would not only be their headquarters, it will be American jobs that are removed --

Mr. ARCHER. Yes.

Mr. GIBBONS. And members. They are flowing out of this country like a flood right now. There is not a day that you pick up the news media that you don't see American jobs flying overseas. We have got to stem the flood. It is not the productivity of American labor that is at fault, it is not the productivity of our other systems, it is the tax system that is at fault, and there is no way we can escape that. The tax system has got to be changed.

Mr. HAYWORTH. Thank you both.

Chairman Gibbons, when you come to Arizona, chances are you won't have to buy an overcoat. We look forward to your visit.

Mr. GIBBONS. I spent some very happy hours in Arizona as a soldier. I kept all the Japanese out and not a single one of them penetrated our defense line.

Mr. HAYWORTH. We are very grateful for that; and, on a more serious note, we are very grateful for your service on June 6, 1944, and, subsequently, in the European theater, too, sir.

Mr. GIBBONS. I was adequately paid for it. And thank you, sir.

Chairman MCCRERY. Mr. Lewis.

Mr. LEWIS. Chairman Archer and Chairman Gibbons, it really is good to see you back here. I think we are hearing you loud and clear that there is not a Band-aid approach to this, to solving the problem. The ultimate answer is a change in the Tax Code.

I know, Chairman Archer, you have been a big advocate of a national sales tax and in doing away with the income tax. But that is what I am hearing you say. The only way we are going to solve this and solve it for good is to change the Tax Code. Is that what you are saying?

Mr. ARCHER. Well, first, let me say that I have been for replacing the income tax with another system that makes better sense for this country. I have not spoken out in favor of a vehicle that is a retail sales tax, but that is one way to do it.

In this instance, though, it seems to me that you have a great opportunity because you can address this problem in a limited way to the corporate Tax Code without having to get into all of the more difficult ramifications of the individual income tax; and, hopefully, you make a decision that will help this country and the workers, as Mr. Gibbons said, the standard of living of the workers and the jobs in this country for the next several generations.

Mr. GIBBONS. You see when all this first started the way you measured America's wealth was through the gross domestic product. Foreign trade or foreign commerce was an insignificant part of America's gross domestic product in the 1940s. Today, it is a huge amount of America's gross domestic product; and it is growing all the time. Like it or not, stop it or not, you can't stop it. We are internationalizing. We have got to be in the world system or we are going to suffer if we are not.

Let me say -- I will do a little advertising here -- when I could see the beginning of the end of my career here in Congress, I left you a heritage. I wrote it all out. It is all in the 1996 Congressional Record, complete with legislation and an explanation of what ought to be done. Now, I won't take up your time today because it is not the purpose of this hearing to explain how it could be done. But it can be done, and it will be done. It is a question as to how much longer we are going to bleed before we do it.

Mr. LEWIS. Thank you, sir. Thank you.

Chairman MCCRERY. In fact, Mr. Gibbons, another way of saying, your previous statement, that we represent only 4 percent of the world's population is 96 percent of the world's customers live outside the United States.

Mr. GIBBONS. Correct. That is it.

Chairman MCCRERY. Mr. Brady.

Mr. BRADY. Thank you, Mr. Chairman. And I want to welcome my fellow Texan, and Houston area Member of Congress, Bill Archer to the hearing.

To let you know how strong his heritage is, Mr. Chairman, in our part of the area I have the good fortune to represent a good part of the former part of Mr. Chairman Archer's district. And when you ask people there who your Congressman is, they will say, well our representative is Kevin Brady, but my Congressman is Bill Archer. That will continue for decades to come.

Two questions. Chairman Archer, a task force you recommend. How soon could a group meet, really thoroughly, examine the issue and report back a good substantive change to Congress? How long do you imagine that would take to really do a good job but move quickly?

Mr. ARCHER. I think that will depend on how rapidly there is the decision to put in place that task force.

I don't think it is too early, for example, for leaders of the Congress to talk to people in the White House as a first step and see about how this should be structured and how it should be moved forward. And by leaders, I mean, both Democrats and Republicans in the Congress.

What obviously will make it more unwieldy is to be able to take into consideration the views of organized labor, the views of the business community and the views of farmers. But I think that needs to be done before any final decision is made.

Mr. BRADY. Sort of a follow-up to that, that second question. How do we both stress the importance of bipartisanship and move in a timely way? How do we educate Members of both parties and leaders of both parties that not only is this a problem, but this is an opportunity to help make American companies more competitive and an opportunity to slow the merge than move overseas trend that is occurring?

How, in a period that can get pretty tense up here in Washington? How do we make sure that message gets heard and accepted by both parties?

Mr. ARCHER. Well, one method obviously is your intention to hold hearings on this issue. Well, actually there is a hearing right now. But the Chairman of the full Committee, I understand, plans on holding hearings on how is our foreign -- how do we tax foreign source income? What can we do about it, et cetera?

And I think at those hearings, obviously you are going to have witnesses who are going to be testifying. And hopefully the media will cover those events and that information will be made available to the American public. But, as so often is the case in Washington, that both Mr. Gibbons and I found over the years, and which you find today, is it is very, very difficult to let light overcome heat on issues. And the light is the information that is presented as objectively as possible for people to understand.

But, Mr. Gibbons is absolutely right. When all of this started, particularly back in the early 1960s, we were the receptacle of investment capital, here in the United States. And we had just come through the Marshall Plan period, and we had extended our capital to the rest of the world. We had massive trade surpluses. And we didn't need to be so concerned about the negative aspects of our Tax Code. We weren't really looking overseas. We didn't have a global marketplace as we do today. And today it is very different.

And if our corporations again have to compete with one hand tied behind their back, and their net is reduced by the extra operating cost that is represented both by taxes and compliance, then their cost of capital is going to go up.

As their net revenues and net profits go down, their cost of capital goes up and it just becomes a compounding problem over time. And I think this is a great window of opportunity. It will not be easy.

Mr. BRADY. Thank you, Mr. Chairman. Chairman Gibbons, anything to add?

Mr. GIBBONS. You know, excuse me. We often think of this as just a problem of the export industries in the United States who manufacture here. It is far beyond that. It is every American who works and sweats in the system. High-tech industry, low-tech industry, any kind of job that is at a competitive disadvantage because of the way our tax system works in the international marketplace.

Whether you are a person who is trying to fight against a losing a market overseas because your product is overtaxed when it goes to consumption overseas, or whether you are working in an industry, it might be the same industry who is competing against an import, you are affected by this.

Everybody that works is affected by this. It is not just an isolated problem that affects only the export industries. It is everybody that is involved in it.

That is what they have got to understand. I am talking about the great electorate out there. This is not a brand new problem. The Reagan Administration attempted to phase this in early in President Reagan's Administration. If you go back, you will find that they did a deep study into all of this. And they started to recommend to the Congress that we go to some kind of value-added tax system then.

But the Congress was in control of the Democrats. The White House was in control of the Republicans. They just didn't feel like that they could take that kind of political risk at this time. I don't know when we are ever going to get out of that political risk situation. But, you know, something has got to be done about it unless we are content to allow our system to continue to bleed, and us to become a third-rate economic power in the world. It is the tax system.

Mr. BRADY. That message is getting through loud and clear today. I hope we can replicate it. Thank you, Mr. Chairman.

Chairman MCCRERY. Thank you, Mr. Brady. And now a representative from one of our other greats, represented by the panel today, Mr. Foley from Florida.

Mr. FOLEY. Thank you very much, Mr. Chairman. I am trying to focus on FSC. But I can't get my mind off this coat you bought in 1960 where you got a $200 refund. I hope you still have that coat.

Mr. GIBBONS. That was a good French overcoat. I wore it for years.

Mr. FOLEY. Because I am a consumer, I want to see that coat.

Mr. GIBBONS. That was just the rebate. They kept most of the money over in France. But it was -- you know, prices have changed a lot since the late 1960s.

Mr. FOLEY. I am still remembering Dick Nixon's Pat analogy of the plain cloth coat. So I just want to see this coat, Sam.

Chairman MCCRERY. Mr. Foley, let's try to restrict our questions to the matter at hand.

Mr. FOLEY. The Chairman and I get along well. We are both Floridians. And I just wanted to enjoy a moment.

But you just mentioned something, Sam, that is very, very important. And I think it underscores the complexities here. Because a bipartisan group, after the WTO's refusal of FSC, when to the ETI, spent a lot of time on it.

I think the Europeans would like us to change our Tax Code, and they may help us do it. It seems like the only thing acceptable to them is a VAT concept.

It seems like everything else we create or try and put our hands around fails. So I would like both of the participants, Mr. Archer particularly, good to see you, both of your answers on, is the VAT system the only acceptable mechanism by which the WTO will give us a final resolution?

Mr. ARCHER. I think they would love for us to keep our system with the income tax system so they have an advantage on us. I don't think they want to force us into any other form of taxation.

They are sitting smiling like a Cheshire cat now, because as Sam mentioned, we created a system many, many years ago to which we didn't give adequate thought. And then we exacerbated it in 1986 in tax reform and made an absolute disaster out of the way that we tax foreign source income. I am not going to go back into all of that history.

But, we created this odium taxing our own corporations. And then the only way out for us was to create an export subsidy. And there is no doubt about it. We thought we were okay because we had an informal agreement with the Europeans back in the early 1980s that we weren't going to attack each other's tax systems and all of that. But that was before the WTO was created.

And we put ourselves in the position that in order to have a level playing field, we had to put into our code an export tax subsidy. And we have got to remove that in some way or another and we have got to replace it with something that gives us a better chance to compete.

A VAT is not the only way to do it. And we can, you know -- if you want me to continue to work with you personally, I will be glad to do it. There are a lot of options that can be considered. But, in the long term, and you have heard me say this on this Committee, and I say it because I personally believe it and have believed it. I am not like one of our colleagues who told me 1 day I am a very fair individual, all I want is a fair advantage.

I want a fair advantage for the United States of America. I wished we would not stop at a level playing field. I wish we would adopt a system that would give us a fair advantage under the WTO rules. And that can be constructed. But again, we don't have the time today to go into all of the details.

Mr. FOLEY. I would welcome that engagement because I think it is important. And I respect your expertise.

Chairman MCCRERY. If the gentleman will yield. We are going to have a hearing later at which we will explore some of those alternatives.

Mr. FOLEY. Thank you, Mr. Chairman. Mr. Gibbons.

Mr. GIBBONS. Well, sitting here trying to respond to your first observation. At that time, the French had a number of different rates at which they taxed under their TVA system, which is really a VAT system. But the French called it a TVA system. And I would imagine they classified my French overcoat bought somewhere near the embassy as a luxury item. And the tax on it may have been 50 or 60 percent.

Mr. NEAL. Mr. Chairman. Would you yield for 1 second, Mr. Foley? Mr. Gibbons, can I ask you a question? It is on everybody's mind in this hearing room. What did you pay for the coat?

Mr. FOLEY. That was the crux of my earlier observation.

Mr. GIBBONS. Damn if I know.

I remember Martha and I didn't have much spending money for the rest of the trip. And, you know, I -- at that time, the TVA might have been 50 or 60 percent. Because, they -- the French at the time were administering their code under -- they were taxing various items at different rates.

Mr. FOLEY. Well, it continues today because when you travel  --

Chairman MCCRERY. Mr. Foley, your time is up. Thank you very much.

Mr. GIBBONS. The final voice has spoken.

Chairman MCCRERY. Thank you very much for your testimony. We appreciate again your willingness to work with us to try to get through this problem that we have got with our Tax Code. And we welcome you back any time.

Mr. ARCHER. Mr. Chairman, if can I have one last quick thing. I know you have got other witnesses coming. I don't think that Mr. Gibbons and certainly I  mean to imply that the European credit invoice value-added tax system would ever be right for the United States. I do not believe it would be. And I want to make that very clear. That is an option that I do not think is a realistic one for this country.

Chairman MCCRERY. Thank you very much. And we look forward to seeing you again soon.

Our next witness is Ms. Barbara Angus, International Tax Counsel for the U.S. Department of the Treasury. Ms. Angus.

Ms. Angus, we will certainly put in the record any written testimony that you have for us. But if you would try to summarize that within 5 minutes. You may proceed.

STATEMENT OF BARBARA ANGUS, INTERNATIONAL TAX COUNSEL, U.S. DEPARTMENT OF THE TREASURY

Ms. ANGUS. Thank you, Mr. Chairman, Congressman Neal, and distinguished Members of the Subcommittee. I appreciate the opportunity to appear today at this hearing on whether the existing ETI regime can be modified in a manner that brings it into compliance with WTO rules without undermining the internal competitiveness of U.S. businesses and their employees.

Mr. Chairman, I would like to request your permission to read a letter that Assistant Secretary Weinberger sent to you yesterday regarding the matter that is before the Subcommittee today and that states the Administration's views.

Chairman MCCRERY. You certainly may do that.

Ms. ANGUS. To read the letter:

"Dear Chairman McCrery:

"Thank you for the opportunity to have a representative of the Treasury Department appear before the Select Revenue Measures Subcommittee on April 10, 2002, as your panel begins examining possible legislative solutions to the current FSC/ETI dispute. As representative of the Administration have said repeatedly, this is a very serious matter requiring immediate attention and we must pursue all available avenues to achieve an appropriate final resolution, a resolution that protects America's interests and satisfies our obligations under the WTO. We must continue to seek every opportunity to address the underlying issues in the ongoing trade dialogue. At the same time, we must begin work toward meaningful changes to our tax rules to respond to the decision in the FSC/ETI case.

"We want to applaud you for the work your Subcommittee is doing. With the possibility that the European Union could move to impose trade sanctions against exports from the United States as early as May, the urgency of the situation is clear. At the same time, we must not lose sight of the objective served by the ETI provisions and the FSC provisions that preceded them, which is to help level the playing field for U.S.-based businesses that are subject to the U.S. system of international tax rules.

"We understand your hearing will explore whether minor changes can be made to bring the current ETI regime into compliance with WTO rules. Given the analysis of the current WTO rules reflected in the decisions in the FSC/ETI case, we do not believe legislation that simply replicates FSC or ETI benefits will pass muster in the WTO.

"We must pursue all routes to resolving this matter promptly and fairly so that American workers and the businesses that employ them will not be disadvantaged. Addressing the decisions through the tax law without adversely affecting the competitive position of U.S.-based businesses in the global marketplace will require consideration of meaningful changes to our current international tax laws. We need to explore a whole range of possible tax legislative options. This includes consideration of changes that will help rationalize key components of our international tax rules within the existing framework. It also includes consideration of comprehensive and fundamental reforms of our international tax system.

"While we work toward the needed changes to our international tax rules, we also must continue to maintain a dialogue with the European Union. Given the importance of this matter, we must pursue a multifaceted approach to resolving it, including both tax and trade approaches. It is essential that we achieve a resolution of this matter that is clear, fair and final. We must take every step needed to ensure that this does not further escalate to the detriment of the global trading environment.

"Mr. Chairman, thank you again for this opportunity to discuss this matter and for the work your Subcommittee is doing. We look forward to working closely with Congress and all interested parties to develop and implement a solution that will protect America's interests and honor our obligations in the WTO.

Sincerely,

Mark A. Weinberger, Assistant Secretary (Tax Policy)."

Given the particular focus of this hearing, let me reiterate that we believe legislation that simply replicates FSC or ETI benefits will not pass muster in the WTO. We need to work together toward meaningful changes in our international tax rules in order to protect the competitive position of American businesses and workers and meet our WTO obligations.

I would be happy to answer any questions. Thank you.

Chairman MCCRERY. Thank you, Ms. Angus. And I gather from the letter that you read from Mr. Weinberger and from your own statements that the Administration is spending some time now looking at possible solutions to this matter on both the legislative front and the trade front, and you are actively pursuing within the Administration some recommendations that could be forthcoming sometime in the future on this matter?

Ms. ANGUS. Yes, Mr. Chairman. The Administration and all of the agencies are working together to explore all options for resolving this critically important matter. It is a complex matter that cuts across areas of expertise and we need to bring together all of that expertise to contribute to finding a solution now.

We believe the Administration, Congress and all interested parties must work together to resolve this matter. We intend to consult closely with Congress on consideration of the types of meaningful changes to our international tax rules that will be needed to address the decisions. We applaud you and Chairman Thomas for holding those hearings on this matter at this critical time.

Chairman MCCRERY. Thank you. Mr. Neal.

Mr. NEAL. Thank you very much, Mr. Chairman.

Ms. Angus, at a recent mark-up of this Committee where your colleague from Treasury, Pam Olson was in the witness chair, the Chairman of the full Committee stated his desire to have this Subcommittee investigate the expatriate issue and to report back fairly quickly on why and how these companies are leaving the United States, and why they are avoiding U.S. income taxes.

Your colleague, Ms. Olson, said at that time that the Treasury study would be a preliminary report with recommendations coming later. Is that still the expectation of your report on the corporate expatriate problem?

Ms. ANGUS. Yes. We intend to release our preliminary views by the end of April. This is a matter of priority for the Treasury Department. We believe that a detailed technical study can help to inform the debate over the appropriate response to these developments and will ensure that the government can act promptly and effectively.

Mr. NEAL. Thank you. When we last met, it was, I believe, the day before Treasury announced the study of the corporate expatriate issue. Since then, my staff has performed some research on a handful of these expatriate companies. And it has come to my attention that these expatriate companies enjoy in excess of $2 billion a year in Federal Government contract money.

In fact, one of these expatriates has a $40 million contract to help the IRS collect more tax revenue. Now, I find that more than a little ironic that we are awarding Federal tax revenues to companies who have decided they are exempt from paying it. I wonder if you can comment on whether the Treasury Department has considered a review of these particular contracts or the policy of awarding these Treasury contracts to expatriate companies?

Ms. ANGUS. Congressman, that is certainly something that I can look into and we can provide you a response. It is not something that is within my area of expertise. From my perspective, the work that we are doing within my group involves looking at these transactions from a technical perspective to understand the implications for our tax law, the implications for our economy, and to work to develop an appropriate response.

Mr. NEAL. I tried to be very precise in my questioning so as to not appear irresponsible. But with April 15th looming, and September 11th just behind us, it seems to me that there is an ideal opportunity to examine this question. Mr. McCrery has said he is going to hold hearings on it. The Chairman of the full Committee has indicated he is going to hold hearings on it. But this is a large issue that looms for the American people. The President, in the end, is going to get most of the defense build-up that he desires, rightly so. It is also, I think, understandable that the American people would ask: Who is going to help to pay for all of this?

So we have companies that are winning large contracts, and at the same time setting up foreign addresses so that they don't have to pay corporate income tax.

Ms. ANGUS. As I indicated earlier, we are studying this issue. We expect to have preliminary views by the end of this month. We do believe that we need to determine whether there are any inadequacies in our tax law that companies can take advantage of or exploit through those transactions. If those inadequacies exist, we need to know about that. And we certainly intend to work with the IRS and Congress to address those.

At the same time, we also believe we need to look at whether there are aspects of our international tax rules that are driving companies to feel they need to consider these transactions for competitiveness reasons. If that is the case, we also need to understand that and consider our approach to that issue as well.

Mr. NEAL. Thank you.

Chairman MCCRERY. Mr. Lewis.

Mr. LEWIS. Thanks, Mr. Chairman. Ms. Angus, last week an EU spokesman stated what we urgently need is a road map of what kind of measures the American Government plans to take to comply with the WTO ruling.

What does the -- what kind of road map can you give us today about what the Administration plans to do in moving forward on this?

Ms. ANGUS. Well, as Ambassador Zoellick has said, Commissioner Lamy wants to see us making progress toward resolving this matter. It is critically important that the Administration and the Congress work together with all interested parties to address this matter now.

This is an urgent matter requiring immediate attention. These hearings represent a very important first step. We must work together toward consideration of meaningful changes to our international tax rules. We need to do so as soon as possible in order to demonstrate real progress toward meeting our WTO obligations.

And as we do that, we believe it is important that we keep in mind the objective of ensuring that we don't adversely affect the competitiveness of American-based businesses.

Mr. LEWIS. Okay. Thank you.

Chairman MCCRERY. Thank you very much, Ms. Angus. And we look forward to working with you and others in the Administration as we wrestle with this problem.

Ms. ANGUS. Thank you.

Chairman MCCRERY. And now the third panel. LaBrenda Garrett-Nelson, Terrence Chorvat, and Michael McIntyre. If you would come to the front. Welcome. Our first witness on the third panel is LaBrenda Garrett-Nelson. She is a Partner with Washington Council, Ernst & Young.

And then Terrence Chorvat, Assistant Professor of Law at George Mason University. And Mr. Michael McIntyre, Professor of Law at Wayne State University, School of Law.

Ms. Garrett-Nelson, we will begin with you. You may proceed. Please summarize your testimony for us within about 5 minutes.

STATEMENT OF LABRENDA GARRETT-NELSON, PARTNER, WASHINGTON COUNCIL ERNST & YOUNG

Ms. GARRETT-NELSON. Thank you, Mr. Chairman and Members of the Committee.

I am LaBrenda Garrett-Nelson. And I am appearing today on my own behalf and not as a representative of any organization. The testimony that I offer relates to the legislative drafting implications of the WTO Appellate panel's report on ETI. I do not offer any specific legislative proposals. Rather, my testimony highlights three aspects of the Appellate body report that will become relevant if the decision is made to pursue a legislative solution to the FSC/ETI dispute.

First, that the legal analysis in the Appellate body report would prevent the United States from coming into compliance simply by making cosmetic changes to ETI.

Secondly, but significantly, for the first time, the Appellate body has provided guidance regarding the extent to which an export tax subsidy could be provided for foreign source income.

And last, but importantly, it should be kept in mind that there is nothing in the Appellate body report that would prevent the United States from amending its tax laws in a manner that could provide a benefit to the same general class of taxpayers that utilize the ETI regime. And that is relevant to the decision whether to pursue a legislative solution.

The Congress clearly retains the ability to develop legislation that would preserve the competitiveness of American companies.

Turning first to the basis for my conclusion that it will not be possible to simply make adjustments to ETI. Two of the principal legal issues before the Appellate body were, is there a subsidy? If so, is the subsidy export contingent? The Appellate body broke new ground, and in doing so, invalidated legal conclusions that had been formed as the basis of drafting decisions in developing the ETI statutory provisions.

On the threshold issue of whether a subsidy exists. When the Appellate body reviewed the FSC case, it applied a but-for test. It looked to see whether the FSC was an exception to a general rule with the result that more tax would been paid but-for the FSC.

In light of that but-for test, the ETI regime was drafted as a general rule with taxation cast as the exception. But when the Appellate body reviewed ETI, it decided that the but-for test should be limited to cases where the measure at issue is an exception and instead applied a new test, a test that compared the treatment of income under the ETI regime to comparable foreign source income.

And particularly because the ETI regime is elective, on that basis the Appellate body held that the ETI regime confers a subsidy.

On the question of export contingency. Before the Appellate body report on the ETI regime, it was unclear whether export contingencies could be cured by expanding the universe of beneficiaries. And in that regard, the ETI Act was drafted to apply to nonexport foreign sales of certain property produced abroad.

So the ETI regime is legally not contingent on exportation because the operative rule could apply to nonexport sales. Well, the Appellate body also decided against the United States on this issue on the grounds that for property produced within the U.S. exportation was required.

So, apparently to avoid a finding of export contingency, it would be necessary to apply a single operative rule without regard to whether property is produced within or without the United States. Now, there was the one instance in which the Appellate body did agree with an interpretation offered by the United States. That was on the ruling that there is an exception to the prohibition on export subsidies for a measure to avoid double taxation of foreign source income. And that is the exception based on what you may hear referred to as Footnote 59 in the relevant trade agreement.

I would point out with respect to Footnote 59, that it remains to be seen to what extent Footnote 59 would allow anything that looks like a replication of ETI. I say that for two reasons: First, because of the Appellate body's definition of foreign source income that could be treated under such an exception, and also because of the related requirement that with respect to export sales, arms-length pricing methods would be required to allocate income between foreign and domestic sources.

So in addition to the drafting possibilities presented by Footnote 59, I would remind the Committee again, that nothing in either the Appellate body report or the applicable trade agreements would prevent the United States from considering options for amending general tax rules that affect the competitiveness of American exporters.

It is clear, however, that either of these possible drafting approaches would take time to implement and develop. This ends my prepared statement. I would be happy to respond to questions you may have.

[The prepared statement of Ms. Garrett-Nelson follows:]

Chairman MCCRERY. Thank you. Mr. Chorvat.

STATEMENT OF TERRENCE R. CHORVAT, ASSISTANT PROFESSOR OF LAW, GEORGE MASON UNIVERSITY SCHOOL OF LAW, FAIRFAX, VIRGINIA

Mr. CHORVAT. First of all, I would like to thank Chairman McCrery and the Members of the Subcommittee for inviting me here to talk about the extraterritorial income regime and possible modifications to it.

My name is Terrence Chorvat, and I am Assistant Professor of Law at George Mason University. And for the record, I am testifying today on my own behalf and not as a representative of any organization.

As all prior witnesses have testified, the WTO panel has held that the FSC and the ETI regime violate the GATT Treaties. If the ETI and FSC regimes are not permitted under the GATT Treaties, what types of rules that promote exports are permitted? As described below, there are quite a number of ways the country can promote exports and not, at least as of yet, be held to violate free trade agreements.

As a number of commentators have pointed out, there have not been many decisions by the WTO with respect to income tax rules. And, therefore, we do not know how this jurisprudence will develop. Consequently any conclusions we express today are dependent upon how this body of law will develop in the future. In the last 10 to 15 years the European countries have been reducing their corporate taxes and their place relying more heavily on consumption taxes, like the value added taxes or VATs.

Under European VATs, when the product leaves the country or taxing jurisdiction then the VAT is refunded. This is because such taxes are intended to tax consumption that occurs within the country. If such consumption does not occur in the jurisdiction, it is not taxed there.

One can argue that this has the effect of encouraging exports, because exported products are not subject to the VAT. Importantly, because these taxes are indirect taxes, such export adjustment are permitted under the GATT Treaties. Such indirect taxes are viewed as being imposed on the ultimate consumer rather than on the producer, therefore, they are not viewed as export subsidies.

In addition, it appears that having an income tax system which exempts all foreign source income is also permissible. Such a system would impose lower taxes on exports than on domestically sold goods because income earned abroad would not be subject to tax. Many European countries have adopted territorial tax systems.

One of the key arguments for a regime like the ETI is that it would merely level the playing field for U.S. corporations selling abroad. Because European producers are able to receive tax deductions on some of the products they export, it seems U.S. producers should also receive tax concessions on exports to prevent distortions in the market.

Another set of rules which seems immune to challenge are the source rules found in Section 863(b) of the Internal Revenue Code. These rules define the source of income for the sale of property which is manufactured in the United States and sold abroad. They are often said to be export subsidies, because they allow U.S. taxpayers to increase their use of foreign tax credits, which can decrease the tax paid to the United States.

However, because those rules are fundamental source rules which apply both to imports and exports, they do not constitute a special regime. These are the only source rules that apply to these products manufactured in one country and sold in another. Hence, these rules should not fun afoul of the GATT Treaties as interpreted by the WTO.

The fundamental purpose of the deferral regimes found in the Tax Code, such as subpart F, is to eliminate a taxpayer's ability to avoid U.S. tax by shifting income to low-tax jurisdictions.

Generally, the United States allows income earned by foreign subsidiaries to be deferred until the income is repatriated to the United States. The exception to deferral are primarily related to passive income and other types of income that are easily manipulated. Active business income of a controlled foreign corporation or CFC is generally only subject to U.S. tax where there is an insufficient economic connection with the jurisdiction in which the CFC is organized.

On the other hand, the FSC and the ETI regimes were intended to exempt from U.S. taxation income from good manufactured in, or extracted from, the United States and sold abroad. Under the FSC regime, this required an exception to the subpart F rules. These two important portions of the U.S. system are in conflict.

Conflicts like this allow the Europeans to argue that the ETI and the FSC provisions are exceptions to the general patterns of taxation.

While then, what are our alternatives? There are four basic ones. First, repeal the ETI provisions and use the revenue to reduce other taxes. While this is the simplest response, it does not address the concerns that created the Domestic International Sales Corporation (DISC), the FSC, and the ETI regimes in the first place.

The second would be to adopt a territorial system. This would seem to be allowed under the GATT Treaties. However, it seems that as such a small portion of it, like the FSC or the ETI regimes changing our entire system of taxing foreign source income, just based on this seems a little bit extreme, although there might be good reasons for doing that.

The third is to adopt a system that involves significant reliance on indirect taxes such as VATs. That has also been discussed. But again moving to that system merely because of the ETI holding again seems a bit extreme, although there may be good reasons for doing that.

And the fourth is to repeal or to significantly alter subpart F. There are a number of provisions which one could either change within subpart F or get rid of entirely, that would -- probably be viewed as not an export subsidy, because they are, instead of adding something additional, they are paring away from what we already have.

However, again, we are not confident as to how the WTO panel would view that because there has not been much jurisprudence in that area.

None of these alternatives are simple replacements for the ETI regime. They all involve a change in rules as they apply to all taxpayers and not simply U.S. manufacturers.

And I would be happy to answer any questions on this.

[The prepared statement of Mr. Chorvat follows:]

Chairman MCCRERY. Thank you. Mr. McIntyre.

Mr. MCINTYRE. Thank you. I have a prepared statement that I would like to submit for the record.

Chairman MCCRERY. Without objection. Is your microphone on, Mr. McIntyre?

Mr. MCINTYRE. I believe it now is. Thank you.

I am here in part to make a plea for free trade. I was invited to a panel back in 1975 when DISC legislation was being considered. I said at that time that the DISC legislation was inconsistent with free trade, that it would be so found by GATT, and that even if it weren't, it would not be in the interests of the United States to be promoting an export subsidy. All theorists on free trade believe that tax subsidies for exports and tax impediments to imports make countries poorer.

If we want our country to be competitive in world markets, we need to embrace free trade. I have heard a lot of rhetoric today about free trade. But, when we get down to it, we have people telling us that the United States should want a "fair advantage," or at least some advantage, over our competitors. The implicit message we are getting is that we need to do something special in violation of free trade to help our economy and to help our businesses or we are going to end up as a third world country.

I don't think we are at risk of being a third world country. And if we were actually facing such a risk, there is nothing we could do with a small subsidy of this nature that would change that fate.

This is the strongest economy in the world. If people in other countries were listening to the kind of worry about competitiveness that we are hearing today they would be quite shocked. They think we are formidable competitors.

All of over the world, countries are wanting to emulate the American success. We have just come our of a decade of enormous growth, enormous vigor. And to have us be considering this free-trade issue as if we were at the bottom of the heap or just about to tumble off the top of the heap strikes me as missing the mark entirely.

I am very pleased, however, to see that everyone who has been involved in this discussion agrees that we cannot simply let the situation with ETI stand. Everyone seems to agree that this legislation, which was found to be in violation of our international agreements, has to be repealed. So that is the number one task, I believe, of the Congress -- to get rid of this legislation and to get rid of it as quickly as possible before it sours our relationships with our trading partners.

There are other options, of course, that one might consider in addition to the repeal of ETI. All of those options are more complex, they take a lot of time, they involve trade-offs, they involve political battles over who pays the tax and who gets the benefits.

Those battles are necessarily prolonged. All of the proposals that I have heard in this discussion, both today and in previous periods, have enormous effects on our State governments. And I am sure that our 27 Republican governors and our 21 Democratic governors and our independent governors would like to be heard on these issues.

These complex measures cannot be done quickly. We should take this opportunity to immediately repeal a subsidy that is in violation of our WTO agreement, and then in our leisure, we can examine the range of options that are before us.

In considering options, I think that we have to put the full set of options on the table, not simply that small set of options that are particularly appealing to a few of our multinational companies that have the ear of some people.

I think that we need to look at options that protect the American economy, not simply American business. American business is not synonymous with America. It is merely an important part of America. We need to have tax rules that are fair and reasonable and enforceable for our business interests. But, we don't want to have taxes that are driven only by the interests of business.

Our tax rules need to be driven by our concerns for the well-being of Americans generally. And I think that when we look at the full plate of options, what we would be looking for is some simplification in our system and for more coordination with our trade partners. When we look at trade issues, we always look at them as a cooperative matter. When we look at our income tax issues that related to trade, we also should look at them in a cooperative manner. Thank you very much.

[The prepared statement of Mr. McIntyre follows:]

Chairman MCCRERY. Thank you, Mr. McIntyre.

Well, I think what I have heard from all three of you is that in your opinion, it is impossible to exactly replicate the FSC or the ETI in terms of those American companies that will be advantaged under the current system; is that correct?

Ms. GARRETT-NELSON. I think that is correct, Mr. Chairman. It would be impossible to replicate the essential features of ETI, the targeted prescribed tax rate reduction for U.S. exports is clearly not permissible under the Appellate Panel opinion.

Mr. MCINTYRE. I agree with that fully. I would also say that it not be in the interests of the United States and the U.S. economy to try to replicate it, even if it were possible. But, I certainly agree it cannot be done consistent with our international obligations.

Mr. CHORVAT. I also second that. Any real attempt to try and replicate it I think is only going to irritate the WTO, because they will see through what we are trying to do. And they will rule against us and maybe even give us greater sanctions.

Chairman MCCRERY. Mr. McIntyre, I agree with your favor of free trade. And I admire your saying so.

Mr. MCINTYRE. Thank you.

Chairman MCCRERY. However, I don't think I agree with your conclusion that the ETI or FSC has nothing to do or should have nothing to do with our trade situation. And giving our domestic companies a level playing field in the arena of free trade.

Mr. MCINTYRE. It was not my intention to suggest that ETI or its equivalents had no effect on the particular companies that were trying to export. In large measure, I think that the tax benefits were not passed on to foreign consumers by way of lower prices, and, therefore, they had very little effect on total production in the United States.

I certainly agree that ETI and FCS were of assistance to U.S. exporters, probably reduced their capital costs to some degree. But, the problem is that if you provide a stimulus for exports and it actually works in increasing exports, there is a currency exchange affect. That always happens.

What that means is that imports now become cheaper. So if we have a business in the United States that is absolutely competitive right now making bread, and suddenly we have changed the exchange rate so that Canadian bread can come over here at a lower price, we have helped, perhaps, our aircraft industry with the export subsidy, but we have also hurt our bread industry.

The point about free trade is that there are all of those trade-offs. Any benefit that you get for one industry you are almost certainly going to lose in another industry.

Chairman MCCRERY. I don't disagree with that. And we all know that there are great many things that affect exchange rates, and we can't control all of those things. But what we can control is our own tax system. If we know that our domestic manufacturers who want to take advantage of foreign markets by selling in those markets are having to imbed in the cost of the product to the ultimate consumer a tax that we impose that their foreign competitors are not having to bear because of their nation's tax system, it seems to me we would want to address that.

Mr. MCINTYRE. That is a very clear statement of the issue, Congressman, and I appreciate that. Let me give you a couple of points on that. First, Australia was cited a little bit earlier as a country without a value-added tax. They very recently adopted one. No one thinks this has helped their exports. We should look at that. I think the Committee ought to have someone on the staff talk to some people involved in Australian government on that issue. I think that you will see that it is not the view of the Australians that adding this tax changed their export position at all. That is one part of the answer.

The second point is, I don't think I agree with the economic theory that you implied -- that was embedded in your comment -- that the corporate tax is passed on to consumers in the way of higher prices.

I think that the price of goods in foreign markets is determined by supply and demand. The U.S. corporate tax generally has no effect either on the supply or the demand in foreign markets, and, therefore, it has very little to do with foreign prices. For the most part, the corporate tax is absorbed in lower profits which is the intent, of course, of a profits tax.

Chairman MCCRERY. Well, we will have just have to disagree on that. There is no question in my mind that the level of taxation that a corporation has to pay is reflected, to some extent, in the price that they have to charge for the product. You are right, there are a great many other factors that determine the price that the market will bear.

But, it just may be that because of the price that the market will bear, our producers are unable to compete because they can't sell their product at a profit at the price that the market will bear there.

Mr. MCINTYRE. It is not my place, of course, to ask you a question. But, rhetorically, we just cut taxes on some high income people and some middle income people as well. But let's look just at the high income people. Some doctors received a substantial tax reduction. Is it your expectation that this tax cut has been reflected in lower fees that doctors are now charging?

Chairman MCCRERY. That could happen. But it could also happen that they would consume more and create more jobs. So there could be a good result in any number of ways by that tax cut. I thank you for asking that question.

Mr. Chorvat or Ms. Garrett-Nelson, do you have any comment on this discussion, before I go to Mr. Neal?

Ms. GARRETT-NELSON. Well, I don't know. Should I comment on the Australian VAT tax system? I would agree with you on that. I would take issue with you and I think -- I am not an economist and never want to be one. But I think some economists would also disagree with you, though, on the correlation or the degree to which there is a correlation between exchange rates and exports.

And I  read something recently, I think by Huffbauer suggesting that that view has been somewhat discredited. But I think your point, though, that we can agree on was that all options, legislative options should be viewed and reviewed at this time. I would strongly disagree that the ETI provisions should be repealed before the Congress determines that there is an appropriate legislative solution to replace it.

Chairman MCCRERY. Mr. Chorvat.

Mr. CHORVAT. Just one comment on essentially the incidence of the corporate tax. In other words, who is really paying the tax. That is one of the most knotty empirical problems that -- the odds are that it is probably allocated amongst consumers and labor and capital. Some of it -- we don't really know how much, but they probably think some of it.

Chairman MCCRERY. Thank you. Fortunately we don't have an economist on this panel who would take the time to explain that to us.

Mr. Neal.

Mr. NEAL. Thanks, Mr. Chairman.

Mr. McIntyre just three easy questions for you. Isn't it true that no major developed nation has a pure territorial tax system?

Mr. MCINTYRE. No country that I know of has a territorial system, as I have heard it described today. Certainly some of the discussion I have heard has suggested that Canada, for example, has a territorial system. That is a substantial misstatement of the Canadian system. It has some elements that some might properly be described as territorial, but it is essentially a global income tax system.

And an income tax by its very nature is a global tax -- an origin tax and not a territorial tax.

Mr. NEAL. Let me follow up on that. Isn't it true that a territorial system is of no benefit to the U.S. companies with only domestic operations?

Mr. MCINTYRE. Yes. Well, I would  have to give a qualified yes to that. A territorial system, as I have seen it described, and I am not being cute on that, it is just that there is a variety of territorial systems out there, does create a lot of opportunities for tax advance. So I think even a purely domestic company would almost certainly set up offshore leasing arrangements and the like to substantially reduce its U.S. source income when a territorial system.

So I would say that a domestic company, a purely domestic one, might engage in some forms of tax avoidance that we would find inappropriate and would cost the government some revenue, but the territorial system would certainly not improve its economic performance.

Mr. NEAL. Is it possible that under a territorial tax system that some companies actually might have a higher tax burden than they do now?

Mr. MCINTYRE. Again, that would depend on the territorial system. If we were having a territorial system that was very strict on not allowing deductions that related to foreign source income, some companies would pay higher taxes. There are lots of ways that one could design a territorial system that, for some taxpayers, would result in substantially a higher tax burden.

But, again, the impact would depend on the technical rules that were designed. In  a paper that my colleague here, Mr. Chorvat, wrote sometime ago looking at a territorial system, he tried to keep some elements of anti-avoidance rules in the system. And that is a commendable thing if you are going to adopt such a system.

On the other hand, I see from the testimony today Professor Chorvat was suggesting that Congress might manipulate the source rules so that some U.S. source income -- what we would generally think of as U.S. source income -- would not be taxed. So if you are going to manipulate the source rules so that a manufacturer in the United States doesn't produce U.S. income for us to tax, then, of course, the territorial system would be a very substantial drain on revenue and wouldn't raise taxes on people.

So you have to look to see the details of the particular proposal. But, a genuine effort at fully taxing territorial or U.S. source income would very likely raise taxes on some taxpayers.

Mr. NEAL. In fairness, let me ask the other panelists if you would like to comment.

Ms. GARRETT-NELSON. I am sorry. I was trying to follow your questions. And when Professor McIntyre started talking about tax avoidance I thought I perhaps didn't hear the question correctly. But he is correct that no two countries have the same type of territorial system. And it would depend entirely on how it is structured.

I would point out that the issues that would determine results like whether tax liability would be higher would depend entirely on the kinds of choices that are made, including the level of anti-deferral rules that might be employed in the context of such a system.

And those are the very same decisions that could be made within our current system. The underlying issues are the same. The source of income would be very important, for example. And you would face the same issues whether we have a territorial system or our current worldwide system.

Mr. NEAL. Okay. Mr. Chorvat.

Mr. CHORVAT. Actually in the article that Professor McIntyre was referring to, I basically argued that the difference between a territorial system and the system that we have now effectively for most U.S. multinational corporations isn't all that great for most of them. And that we would still have to have rules essentially like what we have now to get rid of the antiabuse -- to prevent abuse so that a pure territorial system -- very few, if any, countries have, and I don't think we would have a pure territorial system.

Mr. NEAL. Thank you all very much.

Chairman MCCRERY. Mr. Brady.

Mr. BRADY. Thank you, Mr. Chairman. Actually I agree with Professor McIntyre. There are a number of companies that don't pass their corporate taxes down to the consumers. I think we call them failed businesses. Overhead is overhead.

I hear consensus about the fact that it is not possible to replicate the ETI regime in a way that is WTO compliant. So it is important not only to know what to do, which is to bring about real change, but what not to do. I know that each of you have looked at and rejected a number of proposals that we are going to hear about for just tinkering. Can you share some of the proposals that you think will come to Congress to be considered as a tinkering and what you find objectionable to them?

Ms. GARRETT-NELSON. Well, I am not prepared to share conclusions about particular proposals. But, I can say that under the legal analysis in the Appellate body report, it is clear that whatever is put in place of ETI, assuming that that is the route the Committee goes down, much more economic substance will be required, or I should say, more substance would be required than has been required under the DISC or the FSC or ETI.

Even under a Footnote 59 approach, for example, it is clear that a requirement for export transactions that arms-lengths pricing be used, would mean that something would actually have to occur overseas. Some value would have to be maintained overseas in a way that is not required under current law.

And for that reason, we are clearly talking about going beyond what current law requires pure exporters to do.

Mr. BRADY. Great. Thank you. Mr. Chorvat.

Mr. CHORVAT. Yeah, just to sort of amplify that a little bit, if something is done it is going to have to be something that would also permit tax advantages, I guess in the most broad sense, to products which are entirely produced overseas and have nothing to do with what occurred here, I think that is part of what is going on is that we were giving tax advantages for things that were, to some degree, produced here and were used overseas.

Whatever happens, if it is going try to be compliant with the WTO, is not going to have to be focused on exports per se, but on something else, possibly in connection with the United States or being foreign sourced or something like that. But it cannot be something which has the word "export" in it or anything that could arguably be exports.

Mr. MCINTYRE. I would agree with that assessment that anything that was seen as providing a benefit primarily to U.S. businesses engaging in export activities would have some issues with the WTO. That is, anything that I would think that this Committee would be interested in doing in this area as a replacement for ETI would create a problem. But as was noted earlier, we have only had a few opinions from the WTO. I think we have got one clue, and that is that if the WTO thinks that this latest legislation is a runaround, we will lose. I thought we would lose with ETI, even though I admire the drafting skill of its authors. I was very confident that we would lose, and so told my students, because it seemed to me that the WTO's message was not that it had this little technical problem with FSC, it was that the WTO would not permit free trade to be undermined. That is, the WTO did not want to be the body that undermined free trade.

The Appellate body was saying that free trade is important to us, and we will make decisions based on whether we think they further free trade. I think that there was no doubt that they felt, and many others felt, and virtually everyone outside the United States felt, that the prior FSC legislation was inconsistent with free trade.

Mr. BRADY. I see my time is up. Thank you, Mr. Chairman. Thank you, members of the panel.

Chairman MCCRERY. Thank you Mr. Brady. And I want to thank all of the members of the panel for your excellent testimony and responses to our questions and for your excellent questions also.

Mr. MCINTYRE. Thank you very much.

Chairman MCCRERY. We hope you will continue to work with us as we try to get through this.

Mr. MCINTYRE. I am sure I will, and I am sure other panelists will be happy to do that.

Chairman MCCRERY. Thank you very much. Before the Committee adjourns, I would like to, without objection, introduce for the record the statement of my colleague from New York, Mr. McNulty, who unfortunately was ill today and had to miss the Subcommittee hearing. And with that, the hearing is adjourned.

[The statement of Mr. McNulty follows:]

Historically, there has been a broad bipartisan commitment to preserve the Foreign Sales Corporation (FSC) tax code provision and later the extraterritorial income (ETI) regime. We have worked together on the FSC-ETI issue in the past and I hope that we will continue to do so in the future.

I believe that the Administration should take the lead on this important issue just as prior Administrations have done. We had the opportunity to hear from officials from the Treasury Department and U.S. Trade Representative Office on this issue during a full Committee hearing on February 28, 2002. It is now the time for the Administration to develop a strategy for resolving this issue.

It is clear that we must respond to the World Trade Organization (WTO) ruling. However, the right solution is not an obvious one. As is often the situation, generalized or theoretical solutions may sound good, but the "devil is in the details." I look forward to the witnesses' discussion of the direction this Committee may take in the coming weeks.

Finally, I would suggest that the Committee Chairman and others not use the FSC-ETI controversy as an opportunity to quickly push-through proposals that would fundamentally alter our corporate income tax system. There is no consensus on a proposal to repeal the corporate income tax and substitute in a consumption tax, nor is there a consensus to limit our corporate income tax only to activities in the United States.

Such alternatives merit thorough evaluation of the potential impact on U.S. competitiveness worldwide and whether this action might result in creating unintended incentives for U.S. companies to move operations overseas. As time has proven, it is unlikely that the Congress could act on such proposals any time soon and the World Trade Organization is poised to issue its determination of sanctions at the end of this month.

I look forward to the expert testimony we will hear today on these and related issues. And, of course, I want to thank Subcommittee Chairman McCrery for setting up this important series of hearings.

[Whereupon, at 11:45 a.m., the hearing was adjourned.]
[Submissions for the record follow:]

Cifrulak, Stephen D., Jr., Sewickley, PA, statement