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92–724—PDF 2004

S. HRG. 108–456

AN EXAMINATION OF U.S. TAX POLICY AND

ITS EFFECT ON THE DOMESTIC AND INTERNATIONAL COMPETITIVENESS OF U.S.-BASED

OPERATIONS

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

JULY 8, 2003

(

Printed for the use of the Committee on Finance
COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

DON NICKLES, Oklahoma

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

RICK SANTORUM, Pennsylvania

BILL FRIST, Tennessee

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

TOM DASCHLE, South Dakota

JOHN BREAUX, Louisiana

KENT CONRAD, North Dakota

BOB GRAHAM, Florida

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

KOLAN DAVIS, Staff Director and Chief Counsel

JEFF FORBES, Democratic Staff Director

(II)
(III)

C O N T E N T S

OPENING STATEMENTS

Page

Grassley, Hon. Charles E., a U.S. Senator from Iowa, chairman, Committee

on Finance ............................................................................................................ 1

Baucus, Hon. Max, a U.S. Senator from Montana ................................................ 2

Hatch, Hon. Orrin G., a U.S. Senator from Utah ................................................. 5

AGENCY WITNESSES

Veroneau, John, General Counsel, Office of the USTR, Washington, DC .......... 6

PUBLIC WITNESSES

Hall, Dr. Robert, Hoover Institution, Stanford University, Stanford, CA .......... 11

Kobe, Kathryn, vice president, Joel Popkin and Company, Washington, DC .... 13

Lee, Thea, chief international economist, AFL–CIO, Washington, DC ............... 15

Berges, James, president, Emerson Electric, St. Louis, MO ................................ 17

Barrett, William, vice president, tax and trade, Applied Materials, Inc., Santa

Clara, CA .............................................................................................................. 18

Spitzer, Alex, vice president, Nestle Holdings, Norwalk, CN .............................. 31

Russell, Mark, vice president, tax, Electrolux Home Products, Cleveland, OH . 33

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Barrett, William:

Testimony .......................................................................................................... 18

Prepared statement .......................................................................................... 39

Responses to questions from Senator Hatch .................................................. 44

Baucus, Hon. Max:

Opening statement ........................................................................................... 2

Prepared statement .......................................................................................... 53

Berges, James:

Testimony .......................................................................................................... 17

Prepared statement .......................................................................................... 56

Bunning, Hon. Jim:

Prepared statement .......................................................................................... 64

Grassley, Hon. Charles E.:

Opening statement ........................................................................................... 1

Prepared statement .......................................................................................... 65

Hall, Dr. Robert:

Testimony .......................................................................................................... 11

Prepared statement .......................................................................................... 66

Responses to questions from Senator Hatch .................................................. 74

Hatch, Hon. Orrin:

Opening statement ........................................................................................... 5

Kobe, Kathryn:

Testimony .......................................................................................................... 13

Prepared statement w/attachment .................................................................. 75

Responses to questions from Senator Hatch .................................................. 137

Lee, Thea:

Testimony .......................................................................................................... 15

Prepared statement .......................................................................................... 139

Responses to questions from Senator Hatch .................................................. 142
Page

IV

Russell, Mark:

Testimony .......................................................................................................... 33

Prepared statement .......................................................................................... 143

Response to a question from Senator Hatch .................................................. 151

Spitzer, Alex:

Testimony .......................................................................................................... 31

Prepared statement .......................................................................................... 152

Responses to questions from Senator Hatch .................................................. 169

Veroneau, John:

Testimony .......................................................................................................... 6

COMMUNICATIONS

American Chamber of Commerce in Egypt ........................................................... 175

American Chamber of Commerce in Japan (ACCJ) .............................................. 176

American Chamber of Commerce in Kazakhstan ................................................. 178

American Chamber of Commerce in Sweden (AmCHAM) ................................... 180

Big-Ticket Leasing Coalition ................................................................................... 182

Boeing Company ...................................................................................................... 186

Christian Outreach Relief and Development (CORD) .......................................... 192

Corning Incorporated .............................................................................................. 193

Equipment Leasing Association ............................................................................. 196

Feulner, Gary R. ...................................................................................................... 203

National Association of Real Estate Investment Trusts ...................................... 209

Pricewaterhousecoopers .......................................................................................... 213

Section 911, opposition letter .................................................................................. 297

Smithfield Foods, Inc. .............................................................................................. 300
(1)

AN EXAMINATION OF U.S. TAX POLICY AND

ITS EFFECT ON THE DOMESTIC AND INTERNATIONAL COMPETITIVENESS OF U.S.-

BASED OPERATIONS

TUESDAY, JULY 8, 2003

U.S. SENATE,

COMMITTEE ON FINANCE,

Washington, DC.

The hearing was convened, pursuant to notice, at 10:05 a.m., in

room 215, Dirksen Senate Office Building, Hon. Charles E. Grassley (chairman of the committee) presiding.

Also present: Senators Hatch, Lott, Baucus, and Bingaman.

OPENING STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S.

SENATOR FROM IOWA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. This is the first of two hearings we have on the

issue of international competitiveness in U.S. tax policy. When we

speak of international competitiveness, we usually think of international tax rules affecting foreign activities of U.S. companies.

However, there is another side to international competitiveness,

and that is the concern of the ability of the United States-based

businesses to compete in foreign markets and against foreign competitors here on U.S. soil.

Today’s hearing is about the competitiveness of the U.S.-based

businesses. Next Tuesday, we will hold a separate hearing on the

competitiveness of U.S.-foreign activities.

Our review of international competitiveness has, in large part,

been driven by the recent WTO ruling on the FSC/ETI tax regime.

That regime in effect lowers the rate of income tax imposed on

goods that are manufactured here in the United States and exported for sale in the foreign market.

The purpose of FSC/ETI was to allow U.S. manufacturers to compete with European manufacturers who do not pay EU value added

taxes on their exports.

The WTO has ruled that FSC/ETI is an illegal export subsidy and has authorized the European Union to impose $4 billion of

sanctions against U.S. exports beginning next year. This morning,

we will receive an update from the USTR on which products could

be hit and when these sanctions could start.

We are faced with several choices, then. We can leave FSC/ETI

in place and absorb the sanctions, but that would be devastating

to the economy. Though I may not agree with every decision of the

WTO, I think it is important that we continue to adhere to a rules-
2

based trading system. After all, if we want other nations to comply

with WTO rulings that benefit us, it is only fitting to comply with

rulings against us.

I believe that we should honor our WTO obligations, repeal FSC/ ETI. But the next question is what to do with the $50 billion of tax

increases if we repeal it. Some have suggested that we use the proceeds to reform the international tax rules affecting foreign operations of U.S. companies. They claim that this is the best way to

shore up the U.S. economy, grow U.S. jobs, and enhance international competitiveness.

But others have sounded a sober warning, that repealing FSC/ ETI will be that $50 billion tax increase on U.S. manufacturing

and the U.S. jobs base at a time when manufacturing can least afford it. They believe the proceeds are better spent on tax relief here

at home rather than abroad.

Proponents of international tax reform say that this claim is

overstated, that FSC/ETI benefits very few companies and even

fewer jobs, and that FSC/ETI is not significant in redressing the

problems facing the U.S. manufacturing sector.

Now, these are opposing views, obviously. So the first panel in

today’s hearing will explore the problems facing American manufacturing, the significance of that sector to the overall economy,

and what is happening to employment in the manufacturing sector.

We will then address what role, if any, the FSC/ETI regime plays

in all of this, whether the regime should be replaced, and if so,

what should replace it.

The second panel will focus on the ability of U.S.-based businesses to compete against foreign competition here on U.S. soil.

It is my privilege now to turn to my friend, Senator Baucus, our

distinguished Ranking Member.

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR

FROM MONTANA

Senator BAUCUS. Thank you, Mr. Chairman. I deeply appreciate

your remarks.

Today the Finance Committee hosts, as you said, the first of two

scheduled hearings to consider the state of U.S. competitiveness at

home and abroad. American companies face increasing international competition. They face it because the number of global

competitors has increased, because we have increasingly opened

our markets, and because technology increasingly renders our national borders irrelevant.

Competition is generally a good thing. We must ensure that we

have policies in place so that the good does outweigh the bad.

Today’s hearing will examine the domestic implications of our

current international tax policy. We will look at the effects of that

policy on the competitiveness of U.S.-based operations and we will

look at the effect of that policy on investment in the U.S.

Last Thursday, the Bureau of Labor Statistics reported that unemployment jumped to 6.4 percent. For the first time in a decade,

the number of Americans looking for work exceeded nine million

people.

The manufacturing sector has been particularly hard hit. As this

chart shows, the chart at my right, the unemployment rate in the
3

manufacturing sector, which used to be below the national average,

has risen above the national average in this recession, shown by

the orange line, which is the manufacturing sector.

Nationwide, millions of jobs have been lost. Since July of 2000,

roughly two million jobs have disappeared from the Nation’s economy. Once again, the decline has been even worse in the manufacturing sector. Since July of 2000, manufacturing employment has

fallen by more than 2.6 million jobs.

More jobs have been lost in the manufacturing sector alone than

in all of the sectors of the economy combined, as some sectors have

actually produced new jobs in the same period.

This is an important point. Namely, if manufacturing jobs had

held even, there would be a net increase in the number of jobs. It

is just the decline in the manufacturing sector which has caused

the net decline to be so great.

The Nation lost 56,000 manufacturing jobs last month alone. As

the next chart shows, manufacturing jobs have declined continuously in each of the last 35 months.

As the next chart shows, the decline in manufacturing has been

widespread. Every State in the Union, except for Nevada, has lost

manufacturing jobs. That is, 49 out of 50 States have lost manufacturing jobs.

We need to do something about this. I might also add that in my

State of Montana, also, manufacturing jobs, which is about 25 percent of our State’s economy, has also experienced a significant decline in the number of jobs.

The loss of these jobs has nothing to do with America’s work

ethic. Our economy is made up of the hardest-working, most dedicated workers anywhere. Our Nation’s firms have experienced historic sharp declines in manufacturing jobs due in part to increasing

global competition and other related pressures on U.S. manufacturing.

These include non-tariff barriers and unfair trade practices. I

might at this point note that the average U.S. tariff on manufactured goods coming into the United States is about 2 percent,

whereas a tariff on our manufactured goods going to other countries can range from 15, 20, 30, to 40 percent. So, our country’s tariff is much lower than other countries’ tariffs on similar goods.

I might also add that other countries manipulate, I believe, their

currency, forcing their currencies low, and our relatively higher

dollar. I will not name countries which I suspect do this, but that

is part of the problem here today. However, that does not obviate

the need for our action today.

U.S. manufacturing jobs are especially important to the U.S.

economy. That is because manufacturing jobs create jobs in supporting industries and other sectors, and manufacturing is one of

the highest job creation multiplier effects. Every 16 million manufacturing jobs create another 9 million jobs in retail, wholesale, finance, and other sectors.

The recent steep job losses in the manufacturing sector, thus, affects the entire U.S. economy through reduced purchasing power,

through decreased consumption, and through a shrinking tax base.

So far, the U.S. Government has not done enough. This hearing

today will be a good first step.
4

Another purpose for our meeting today is to fashion a response

to an international tax case that the U.S. lost in the WTO. In a

dispute brought by the EU, the WTO found that Foreign Sales Corporation and Extraterritorial Income Act, otherwise known as ETI,

were impermissible export subsidy programs. It also found that

FSC/ETI did not qualify under an exception to the subsidy rules for

provisions to avoid double taxation of the same income. As a result, the WTO has authorized over $4 billion in sanctions

against U.S. exporters. The EU threatened to impose these sanctions on January 1 of next year if we have not made significant

process in complying with the WTO’s ruling by the fall.

I am disappointed with this issue at many levels. I am quite disappointed that the EU ever brought this case. The GATT Commission earlier ruled that our regime was permissible. The EU bringing this case thereby violates our long-term agreement with the EU

on our respective tax systems.

We had an agreement. They just willy-nilly, peremptorily, withdrew and changed their minds and brought this action. I think that

is highly unfair, it is wrong, and frankly I am very disappointed

that the U.S. Government has not fought that issue on the same

basis, that is, the WTO.

I am very disappointed that the EU has, nevertheless, pressed

the case as aggressively as it has. I believe this issue has contributed to the general souring of our usually close relationship with

the EU and undermines support for the WTO in the United States.

I do not want to understate that. I think that it has begun to undermine U.S. support for the WTO.

I am also disappointed with the administration, which has wholly ignored its obligations under the Trade Act of 2002. That Act required the administration to work to resolve this issue through

WTO negotiations. As far as I am aware, the administration has

done nothing on this score.

Instead, the administration chose to acquiesce, to bow to the EU,

to seek repeal of the FSC/ETI and other changes in the Tax Code.

Well, I think that is the wrong choice. It is clearly the wrong

choice. We are past that point and we now are at the point where

we have to debate the merits of the current strategy that we have

drafted in U.S. tax law.

But if we are going to repeal FSC/ETI, we should make sure that

we replace it with a worthy substitute. While examining alternatives, it is important to consider their effects on the U.S. economy in general, and in the manufacturing sector in particular.

Our proposed replacement legislation should partially offset the

loss of tax benefits to U.S. exporting companies once FSC/ETI is repealed. But it should also provide benefit to all domestic manufacturers. This could provide a needed boost for the U.S. manufacturing firms.

A suitable replacement to FSC/ETI would satisfy the rules of

international tax law, while seeking to maintain the health of the

U.S. manufacturing base. What we need now is to choose the best

plan for moving forward. To that end, I suggest a few guiding principles.

First, the EU is not required to impose the sanctions authorized

by the WTO. Retaliation would hurt EU companies as much, if not
5

more, than U.S. companies and it would decidedly be unhelpful in

bringing about a long-term solution. The only way to resolve this

matter once and for all is by working toward a solution, not playing

tit for tat.

The second principle to guide us through this matter, is do no

harm. In replacing FSC/ETI, we should seek to create incentives

for U.S. companies to retain their domestic operations.

This may sound obvious, but needs to be said because there are

proposals under discussion that would do harm, and I believe there

are workable options with far less drastic consequences. Those are

the options that we should pursue.

By offering tax and financial incentives to U.S. manufacturing

firms, we seek to neutralize the tax advantage that other countries

have. Thus, we hope to allow U.S. manufacturers to provide their

product at a competitive price and to keep jobs here in the U.S.

Finally, we must recognize that, whatever the solution to FSC/

ETI, it needs to be done now. The EU has been authorized to impose sanctions at any time and is carefully watching what we do.

We must work together to create a new set of rules to replace

the current system. Those rules should contain effective transition

relief, perhaps along the lines of the transition relief that the

United States afforded the EU in the bananas case.

We will need to confer with the EU on that end, but the EU

should well understand that businesses will need some time to adjust to the new rules, and our agreement with the EU on that score

will reassure businesses on both sides of the Atlantic. So, let us

begin to do something to help our Nation’s manufacturing sector.

Thank you, Mr. Chairman, for holding this hearing. I look forward to working with you in finding that resolution.

The CHAIRMAN. I want to compliment you on a very comprehensive statement.

Senator Hatch? I would call on Senator Bingaman, but I have

been informed you did not want to make an opening statement.

Senator BINGAMAN. If I could just hear the witnesses, Mr. Chairman.

OPENING STATEMENT OF HON. ORRIN G. HATCH, A. U.S.

SENATOR FROM UTAH

Senator HATCH. Well, thank you, Mr. Chairman. I want to thank

you for holding this hearing today. I am glad that we are here to

learn more about the problems of American manufacturers. I am

pleased that we are opening up the debate here on what we can

do to increase the productivity, increase the wages for U.S. workers.

We have the most productive workers in the world. I hope that

as we move forward with the phase-out of FSC/ETI, we keep our

eyes on the real prize, and that is higher wages, more productivity,

and better jobs for our citizens.

I believe the tax incentives for capital formation and for research, permanent incentives, are part of that solution. I hope that

we can finally pass the kind of international tax reform provisions

that Senator Baucus and I have worked on together over the years,

reforms that, in our opinion, are sorely needed.
6

When U.S. companies try to sell their products and services overseas, they run into unnecessary tax impediments right from the

start. Some of our big companies can invest millions of dollars for

tax experts and tax planning to solve some of these problems, but

for our small- and medium-sized companies and businesses, this

hurdle is just too high.

And while Congress can stop corporate inversions to Bermuda,

we cannot stop companies from just starting up in places like Germany or Ireland in the first place.

So we need a competitive Tax Code, a Tax Code that encourages

entrepreneurs to establish companies right here in the United

States. I hope that the testimony that we hear today will help point

us in the right direction for corporate tax reform and more U.S.

jobs.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator Hatch.

It is first necessary for us to receive a status report on FSC/ETI

from the U.S. Trade Representative’s office. We have John

Veroneau here who is going to present that status report. We

would have you go first, then there might be a question or two of

you before we go to the panel.

So would you proceed, Mr. Veroneau?

STATEMENT OF JOHN VERONEAU, GENERAL COUNSEL,

OFFICE OF THE U.S. TRADE REPRESENTATIVE

Mr. VERONEAU. Yes. Thank you, Mr. Chairman. Thank you for

your leadership in calling this hearing today. I was asked to provide a quick update, as you mentioned, Mr. Chairman, before the

hearing begins on the status of the case.

Also, let me say I appreciate your leadership and Senator Baucus’ commitment to find a bipartisan solution to this FSC/ETI problem.

The FSC/ETI dispute has been with us for about three decades,

going back to 1971 when the precursor to FSC was introduced into

the Tax Code. The current dispute dates back to November of 1997,

when the EU sought consultations and initiated a WTO proceeding

against FSC in the WTO.

The EU claimed that this was a prohibited export subsidy. Unfortunately, consultations regarding this matter were not successful

in finding a resolution. They sought a panel. A panel was

empaneled, and the panel ruled that FSC, indeed, was an unfair

and prohibited export subsidy.

In 2000, after appeals were exhausted and the appellate body

upheld the panel decision, there was a commitment by the administration to comply with the ruling and the administration, working

with Congress, developed ETI as a follow-on to FSC.

Unfortunately, the EU challenged the ETI fix as well and successfully challenged it before a panel. The panel ruled that it, too,

was a prohibited export subsidy and an appellate body found affirmed the essential findings of that panel.

The EU then sought to retaliate against us in a certain amount,

and that amount was ultimately determined by an arbitration

panel, which found that the EU was authorized to retaliate in the

amount of $4 billion.
7

Earlier this year in April, the EU published a final list of the $4

billion worth of U.S. exports that it would seek to retaliate against

absent U.S. efforts to comply with this case.

I am not here, Mr. Chairman, to do the EU’s bidding on this

matter. In an ideal world, we would have lots of time to address

this issue. But I am obviously obliged to provide my candid assessment to this committee as to the prospects for retaliation, and I

would refer to the EU Trade Commissioner’s statement in May as

the best evidence that they are glad to hold off on retaliating in the

short term in the hopes that we will comply with this ruling.

But I suspect that, by the end of this session, if we have not

demonstrated serious progress in passing legislation to replace

FSC/ETI, I think next January we face a very high likelihood of retaliation.

There are internal pressures within the EU to hold off on retaliation. It hurts consumers. Retaliation always has a certain amount

of self-inflicted wounds associated with it, as we find ourselves.

But I think those internal pressures to stave off retaliation will

be overcome if, by the end of the year, it is deemed that the U.S.

Government, both the legislative branch and the executive branch,

are not committed to enacting a replacement to FSC/ETI.

The CHAIRMAN. Thank you.

Senator Baucus?

Senator BAUCUS. Thank you, Mr. Chairman.

Mr. Veroneau, you heard my displeasure with the administration’s failure to try to seek a WTO solution here. I am not going

to go into that in any great length. The die is cast.

Mr. VERONEAU. Could I respond to that, Senator?

Senator BAUCUS. Yes.

Mr. VERONEAU. The phase that we are in in the Doha negotiations, different issues are at different phases. In the rules negotiation, we are at the issue identification phase. That was all that was

determined to be concluded before the Cancun ministerial in September.

We have, in fact, identified this. In March of this year, we identified this issue, FSC/ETI, as an issue that the United States intends

to pursue in these discussions. So, we have done, in my estimation,

Senator, all that we could be doing at this point in time, given that

the phase that we are in in the rules negotiation is simply issue

identification.

Rules, as you know, is an area where we are playing more defense than offense, since this is the area affecting our trade remedy

laws. So, we have not been anxious to press ahead in a rules negotiation since we are playing defense 99 percent of the time.

But we have identified FSC/ETI as an issue that we expect to address if and when the rules negotiations broaden. But we are,

frankly, playing mostly defense in that area.

Senator BAUCUS. Well, frankly, that is news to me. I am almost

astounded to hear what you just said. Because when I pressed the

administration, particularly the USTR’s office on this issue, I get

nothing back. I get no indications that this issue will be pressed

at all. This is the first time I have heard this.

Now, that is good news to hear this now. Does that mean if the

U.S. prevails we will not need this replacement tax legislation?
8

Mr. VERONEAU. Senator, I think Ambassador Zoellick, at several

meetings, has noted that we would identify this issue as part of

those rules negotiations, but that does not change the fact that

there is a timing problem.

Addressing FSC/ETI and its predecessors has been a negotiating

objective for both the Tokyo Round, the Uruguay Round, and now

the Doha Round. If past is prologue, we have not been successful

in securing a change in this.

Senator BAUCUS. How high a priority is this with the administration at the WTO level?

Mr. VERONEAU. How high is FSC/ETI?

Senator BAUCUS. Is it at the top of the list or is it at the bottom

of the list and just window dressing, just a talking point?

Mr. VERONEAU. It is not window dressing, Senator, but it is in

the rules context. As a proponent of the Dayton-Craig amendment,

I suspect you would agree that our primary goal in the rules negotiation should be to defend our trade remedy laws. If that is our

primary goal, then there are limits to how much we can expect as

demanders in the FSC/ETI context.

Senator BAUCUS. Well, I am very heartened to hear that it is

high on the list, if I hear you correctly. Is that correct, it is high

on the list?

Mr. VERONEAU. It is on the list.

Senator BAUCUS. It is not high?

Mr. VERONEAU. Well, what is high is the trade remedy. I think

you would agree that preserving our trade remedy laws is probably

a higher priority than securing a FSC/ETI change.

Senator BAUCUS. I do not agree with that.

Mr. VERONEAU. All right.

Senator BAUCUS. I do not, because as you well know, we had an

agreement with the GATT council that our regime was clearly consistent with WTO rules. They just totally reneged unilaterally.

Mr. VERONEAU. I was not there for the birth of that. I would just

say, Senator, that I think that the facts——

Senator BAUCUS. You do not have to be there at the birth. That

is what happened.

Mr. VERONEAU. I think those are facts that seem to be in some

dispute as to the extent of that agreement in 1981.

The other problem I should note, though, is there is a timing

issue. I think if we were to announce today that we were abandoning efforts to comply with FSC/ETI legislatively and that we

were seeking to address this solely through the Doha negotiations,

I think we would be inviting retaliation, Senator, because there is

a timing problem. When the Doha negotiations come to a conclusion is unclear.

Senator BAUCUS. Well, I am here to stiffen your spine and stiffen

the spine of our USTR so that they proceed vigorously, as you have

indicated that it has now on the list. I would just encourage you

to raise it higher on the list, give it higher priority to address,

while we in the meantime are also addressing replacement legislation.

Mr. VERONEAU. It is on the list, Senator.

Senator BAUCUS. On the list.
9

Mr. VERONEAU. It is on the list. I just want to be candid with

you, though, that we do not foresee the ability to negotiate this as

a way to stave off retaliation. Retaliation has been staved off heretofore because of a belief in the EC, in the EU, that this administration and this Congress are committed to finding——

Senator BAUCUS. Do you not think it would be better if we did

have a WTO solution where we would not have to pass legislation

which kowtows to the Europeans?

Mr. VERONEAU. In every negotiation there are trade-offs. We

would presumably have to trade something for this fix.

Senator BAUCUS. That applies to everything else at the WTO, not

just this issue.

Mr. VERONEAU. That is right, sir. So at some point in the negotiations there would be a question of, within the rules context, for

instance, or maybe outside the rules context, what would we trade

away for this.

Senator BAUCUS. Well, I am just re-expressing my disappointment with the administration for not being more vigorous about

this. I am heartened to hear you say it is on the list. That was

never told to me before. That is the first I have heard this.

Whenever I talked specifically with Ambassador Zoellick, he kind

of pooh-poohs it, pushes it off to the side, as has the administration

at other levels. But I am heartened to hear that now it is on the

list. That is progress.

Mr. VERONEAU. I think, Senator, Ambassador Zoellick has noted

that this is part of the issue identification, but that is the only

stage we are at at this point.

The CHAIRMAN. All right. Senator Hatch?

Senator HATCH. Mr. Veroneau, in your opinion, how would the

EU view legislation that provides a generous phase-out of FSC/ETI,

say, over a 3- or 4-year period? Would such a phase-out trigger retaliation?

Mr. VERONEAU. That is an excellent question, Senator. As I said,

I am in sort of a difficult bind here. I am not here to do the EU’s

bidding. I would like to have maximum flexibility.

I would say this. I think there is certainly an understanding that

tax laws, especially tax laws of this complexity, always entail

phase-outs. So, they will certainly be, and have to be, a phase-out,

and Ambassador Zoellick has pressed that, and will press that vigorously with his counterpart, Commissioner Lemeigh. There were

some statements earlier this year out of the Commission with regard to a House bill that provides for a five-, 6-year phase-out.

There was some suggestion that that would be, frankly, a bridge

too far. So, I think there is certainly an understanding that a oneor 2-year phase-out is a normal tax legislative aspect. Beyond that,

it becomes a little more cloudy, frankly, as to what would trigger

retaliation and what would not.

But I assure you that Ambassador Zoellick intends to pressure

very vigorously, understanding that this is complex legislation and

will require an appropriate phase-out period.

Senator HATCH. Thank you.

Thanks, Mr. Chairman.

The CHAIRMAN. Senator Bingaman, do you have a question of

Mr. Veroneau?
10

Senator BINGAMAN. No.

The CHAIRMAN. All right.

Senator BAUCUS. Mr. Chairman, might I just follow up briefly on

the excellent question raised by Senator Hatch?

The CHAIRMAN. Yes.

Senator BAUCUS. There was a 5-year phase-out period in the bananas case. Whenever I raised this with Ambassador Lemeigh, I

get the response, well, the U.S. is already at 2 years’ sanctions,

whereas this is not the case here with FSC/ETI. That is a distinction without a difference. I urge the administration—in fact, I ask

you now, will you commit to trying to get, say, a five-year transition period?

Mr. VERONEAU. Ambassador Zoellick will vigorously advocate for

the legislative solution that Congress devises. I cannot speak obviously for how the EU will respond, but I can assure you——

Senator BAUCUS. I am not asking how the EU responds. I am

asking what you are going to press for.

Mr. VERONEAU. We will press for the legislative package that

Congress passes and the President enacts. That is what Ambassador Zoellick will advocate for.

Senator BAUCUS. Do you personally think a 5-year phase-out is

reasonable, needed, necessary?

Mr. VERONEAU. I am not a tax expert, Senator.

Senator BAUCUS. But you are a negotiator.

Mr. VERONEAU. Yes.

Senator BAUCUS. You are an American. You can negotiate for us.

Mr. VERONEAU. My candid sense, Senator, is that a one- or 2-

year phase out is fully expected. There was a little bit of heartburn

expressed earlier this year with regard to the 5-year phase-out of

the House bill.

Senator BAUCUS. Europe got 5 years on bananas. Why can we

not get 5 years?

Mr. VERONEAU. I cannot sit here and say that we cannot. My

crystal ball is cloudy beyond 2 years, Senator, as to what would

trigger and what would not trigger.

Senator BAUCUS. I just want to stiffen your spine, Mr. Veroneau.

Be tough. Be an American. Fight for us.

Mr. VERONEAU. I am all for being tough and being American.

Ambassador Zoellick will fight for and defend the legislative package that emerges from Congress.

Senator BAUCUS. Good. Glad to hear it. Glad to hear it. Thank

you.

The CHAIRMAN. Thank you, Mr. Veroneau.

We are now fortunate to have at the table for testimony Dr. Robert E. Hall, Senior Fellow, Hoover Institute, Professor of Economics

at Stanford, and chairman of the prestigious National Bureau of

Economic Research, and Ms. Kathryn Kobe, chief economist and executive vice president, Joel Popkin Company, and former chairperson of the National Economics Club. Ms. Kobe has extensive experience in industrial economic analyses and is co-author of Securing America’s Future: The Case For A Strong Manufacturing Base.

These two witnesses will provide us with an overview of the current economy, manufacturing’s significance to the overall economy,

and the challenges facing American manufacturing today.
11

Then we have Ms. Thea Lee, chief international economist, AFL–

CIO. Ms. Lee will provide additional insights on the manufacturing

economy, and specifically the impact of repealing FSC/ETI on manufacturing employment.

We are also fortunate to have with us executives of two global

U.S. companies that have both U.S. as well as foreign manufacturing plants: James Berges, president of Emerson Electric, with

135 U.S. plants, including one in my home State at Marshalltown,

Iowa, and 185 plants in Europe, Asia, and Latin America; and Mr.

Bill Barrett, vice president of Applied Materials, a global semiconductor manufacturer based in Silicon Valley.

These last two will provide their insights on the state of the

manufacturing sector, the factors that they consider in selecting a

business activity location, and the effects of FSC/ETI repeal on

those decisions.

I think we will start with you, Dr. Hall.

STATEMENT OF ROBERT HALL, HOOVER INSTITUTION,

STANFORD UNIVERSITY, STANFORD, CALIFORNIA

Dr. HALL. Thank you, Mr. Chairman.

My testimony is on understanding the evolution of U.S. manufacturing. Much of the story appears in Figure 1, which is on the second page of the printed testimony, which shows what has happened

to the output of U.S. manufacturing.

The people who feel that there is a crisis in manufacturing have

a problem with this figure because what it shows is that manufacturing output in the United States—these are products produced in

the U.S.—has been growing rapidly, in fact more rapidly than

other sectors of the economy in terms of the volume of output. That

was particularly true in the 1990’s.

What is also important, however, is that the U.S. economy entered a recession in early 2001 and recessions differentially affect

manufacturing. As you can see in this figure, the decline in manufacturing output was about typical for a recession.

So, in other words, the overall health of manufacturing in terms

of output is a very strong upward trend of products produced in the

United States interrupted by a recession of about typical magnitude.

Now, a different perspective on manufacturing is shown in Figure 2, which shows the value of manufactured output as a fraction

of total output. That fraction has declined substantially, but the

reason it has declined is very simple. That is, that products produced in the United States have become exceptionally cheap, so we

have very rapid growth of output, but a declining value of that output. That is because productivity growth has been so exceptionally

rapid in manufacturing.

So then, turning to Figure 3, which documents the growth of

these——

Senator BINGAMAN. Mr. Chairman? Where are these figures? I do

not have that in front of me.

Senator BAUCUS. They are in his testimony. They are in his testimony.

Dr. HALL. Senator Bingaman, I have another copy here.

Senator BINGAMAN. Thank you.
12

Dr. HALL. All right.

Figure 3 on page 4 shows productivity. Productivity growth not

only is most rapid in manufacturing compared to any other sector

in the U.S. economy, but its growth has accelerated in recent years.

So, the performance of U.S. manufacturing on a trend basis has

been truly exceptional. The health of this sector is outstanding, except for the significant effects of the recession that began at the beginning of 2001.

Now, because productivity growth has been rapid, Figure 4

shows the total amount of work that goes into manufacturing. This

is the number of workers multiplied by the number of hours that

each worker works, so it is an overall index. You can see that there

is no trend there.

The manufacturing sector takes about the same amount of resources from our workers as it ever has, but once again you see a

recession. That recession, again, in terms of hours of work, is about

typical of the other recessions that are shown in that figure.

Now, another important fact about manufacturing and about produced goods in the United States is that there has been a big shift

in the pattern of world trade, which is documented in Figure 5 on

page 6, in which we get a larger and larger share of our manufactured products from other countries.

You can see that, prior to about the mid-1970’s, the U.S. actually

supplied more produced goods to the rest of the world than it absorbed from them. That changed rapidly, and all the more so, in

the 1990’s.

So, the 1990’s were an interesting period when the output of our

own products increased, yet in addition we are absorbing a large

amount of imported products from other countries.

The reasons for that are well-known. The U.S. economy now buys

many standardized, mass-produced products from the rest of the

world and we supply the rest of the world, in exchange, with two

things. One, is the specialized, high-tech products that we produce,

and we borrow from them.

The U.S. has by far the best investment opportunities of any

country in the world, and the result is that the rest of the world

invests in us. So we get these products, in part, in exchange for the

investments that the rest of the world makes.

Now let me turn to the current state of manufacturing. Figure

6 on page 7 of the written testimony gives a picture of what has

happened in terms of employment in various manufacturing industries. This pretty much tells the story of this recession.

This recession was concentrated in capital goods. The two large

industries that show the biggest decline there, and they are substantial declines, are machinery and computers. So, those are capital goods.

Also, the collapse of computer spending, which of course reached

a very high level prior to the beginning of the recession at the beginning of 2001 has declined, and with that, the production of machinery. Other products, especially food, you can see that the employment has actually declined very little.

Finally, one industry, a small industry, what remains of it in the

U.S., the apparel industry, of course, has been very severely af-
13

fected during this period by the specialization of other countries,

especially China, in producing mass-produced apparel.

So this reflects the various trends that I have talked about, together with the special factor of the recession. Let me just say that

this collapse, this decline, is small in comparison to others that

have occurred. So, let me conclude at that point since I have used

up my time.

Thank you, Mr. Chairman.

[The prepared statement of Dr. Hall appears in the appendix.]

The CHAIRMAN. Ms. Kobe?

STATEMENT OF KATHRYN KOBE, VICE PRESIDENT, JOEL

POPKIN AND COMPANY, WASHINGTON, DC

Ms. KOBE. Thank you. My name is Kathryn Kobe. I am the chief

economist at Joel Popkin and Company. I thank you, Mr. Chairman and Senator Baucus, for inviting me here today.

Generally, manufacturing, if you think of health of an economy

as how many jobs it can create, is not very healthy. Manufacturing

jobs have declined since the beginning of the recession by 2.2 million. Of the 3.1 million jobs that have been lost in the private sector, that is 70 percent of them.

However, even before the beginning, or the official beginning of

this recession, manufacturing lost about half a million jobs between

the middle of 1998 and the beginning of 2001. Currently, the number of manufacturing jobs is slightly below their levels in the 1961

recession.

Now, as Dr. Hall has mentioned, manufacturing has produced

stellar gains in productivity, and one does expect to see relatively

slow growth in employment when you see those kinds of gains in

productivity.

But if market share is an important measure, market share for

manufacturing, as far as its share of nominal GDP, has been slipping. It was producing about 20 percent of GDP in the early 1980’s.

By the early 1990’s, that was down to about 17.5 percent.

It stayed pretty constant through most of the mid-1990’s, but has

now slipped again and the most recent data we have is 2001. It

was 14 percent at that point. We anticipate that that share would

slip further.

The question arises, is this cycle different from other recessions?

We would say that it probably is looking somewhat different than

other recessions have. For one thing, the recovery is not coming

about the way past recoveries have been.

If you start looking at the recovery from the trough of the recession and track what manufacturing output looks like, you see that

in the 1960’s, 1970’s, and 1980’s, after about 17 months, manufacturing output had gained over 20 percent.

After the 1990 recession, it was much slower. As you will remember, that was called the ‘‘jobless recovery.’’ But after 17, 18 months,

output was up 7 or 8 percent. So far, it has been about a year and

a half since the end of 2001. We do not have the official trough

date for this recession, but that is the low point for the manufacturing IP.

However, it basically has not grown since then. It is up half a

percent since then. Consequently, it is looking much worse than in
14

the past recoveries for manufacturing and we do not really see

signs that this is starting to turn around.

Part of the question that was asked of me is, what is lost if we

lose manufacturing from the U.S. economy? We think we would

lose quite a bit. As Senator Baucus pointed out in his presentation,

manufacturing does have a very high multiplier. It has got a lot of

linkages in the U.S. economy.

Consequently, increased demand for manufactured goods causes

increased demand for other parts of the economy. That is much

more so than in any of the major service-producing sectors. It has

also got a lot of links to the rest of the world. Manufacturing is the

largest exporter to the world. Manufactured goods count for about

three-quarters of all of the U.S. exports.

Through most of the past two decades, manufacturing has maintained a pretty constant percentage of manufactured exports in the

world. It has been between about 12 and 13.5 percent, and that is

through 2001.

However, in 2002, we did see an increase in total manufactured

exports in the world, but U.S.-manufactured exports declined at

that point. Consequently, the U.S. share of manufactured exports

did show a bit of a decline, and its share dropped to about 11 percent.

Manufacturing has provided well-paying jobs and benefits to its

workers. On average in 2001, salaries and benefits averaged about

$54,000 for manufacturing workers. That compares to $45,600 for

the average private, non-farm sector overall.

Manufacturing offers job opportunities across the educational

spectrum. It has employed more than its share of workers with less

than a college degree, but it also employs a relatively large percentage of college-trained employees as well.

In 2000, manufacturing had on its payroll 16 percent of the

workforce without a college degree, and is the second-largest employer of that group in the country.

The first-largest employer of that group would be retail trade.

There is a significant difference between the levels of wages paid

in manufacturing in those paid in retail trade.

In fact, when manufacturing jobs are lost and those workers find

other jobs, you find that they take a loss in pay at that point, in

most cases.

But most importantly, manufacturing is a major force in inventing the future. They are the primary investors in R&D. They have

produced and paid for probably 60 percent of the R&D in the economy over the past 20 years. The private sector still is producing

about 60 percent of the R&D.

I will not go into how this innovation process is tremendously

beneficial to the U.S. That is covered in our paper. But we think

that would be a tremendous loss to the U.S. and would tend to

make the U.S.’s growth rate slow from the growth rates we have

enjoyed in the recent past.

I will bring my comments to a close at this point.

The CHAIRMAN. Thank you.

[The prepared statement of Ms. Kobe appears in the appendix.]

The CHAIRMAN. Ms. Lee?
15

STATEMENT OF THEA LEE, CHIEF INTERNATIONAL

ECONOMIST, AFL–CIO, WASHINGTON, DC

Ms. LEE. Thank you very much, Mr. Chairman, Senator Baucus,

members of the committee. I appreciate the opportunity to testify

today on behalf of the 13 million working men and women of the

AFL–CIO, and the unions of the Industrial Union Council on the

issue of U.S. tax policy and the state of American manufacturing.

We believe this hearing is timely, for several reasons. First, with

56,000 more manufacturing jobs lost last month, the 35th straight

month of industrial job loss, it is clear the crisis in this sector is

deep, prolonged, and requires immediate attention.

Second, the Senate will have an opportunity, through its debate

on a replacement for the FSC/ETI, to boost manufacturing in the

United States, while also bringing our Tax Code into compliance

with WTO rulings.

My testimony will focus on four key points: the dimensions of the

crisis in manufacturing, the arguments in favor of a manufacturing

tax benefit to replace the FSC/ETI, critique of an alternative plan

put forward by some in Congress to replace FSC/ETI with primarily offshore tax breaks, and the need to address the manufacturing crisis in a comprehensive way, including through health care

reform and reform of our flawed trade policies.

Last Thursday, we learned that another 56,000 manufacturing

workers lost their jobs in June alone. That was the 35th straight

month of lost manufacturing jobs, the longest such stretch since

the Great Depression.

This brings the total to 2.6 million manufacturing jobs lost since

July of 2000. Manufacturing jobs made up more than 90 percent

of the total U.S. job loss since March of 2001.

As this chart, which is included in my testimony, shows nearly

every State in the Nation has suffered heavy manufacturing job

loss, as Senator Baucus also said earlier.

Unless these trends are reversed, America’s working families and

the Nation’s economy will continue to suffer serious and long-term

damage. Manufacturing historically has been a major generator of

good, high-skilled, well-paid jobs with strong linkages to jobs in

non-manufacturing sectors, and it remains the mainstay of local

and State economies throughout the Nation.

Because productivity growth, and therefore the potential for noninflationary wage gains, has traditionally been greater in manufacturing than in services, the decline in manufacturing affects not

only workers in manufacturing, but also contributes to the stagnation of all workers’ wages.

Moreover, the massive scale of manufacturing plant closings and

job layoffs is contributing directly to the serious fiscal crisis afflicting virtually every State in the Nation.

The current debate on FSC/ETI repeal gives Congress a crucial

opportunity to help U.S.-based manufacturing by reorienting tax

policy to help, rather than harm, this important sector.

Replacing FSC/ETI with incentives to create and support U.S.-

based manufacturing jobs is vital for the health of the industry and

our entire economy.

We believe that H.R. 1769, the Crane-Rangel-Manzullo-Levin

bill, will help boost U.S.-based manufacturing, which is why the
16

AFL–CIO is strongly supporting it. We look forward to working

with a broad, bipartisan coalition in both the House and the Senate

to build support for that bill.

We are delighted to be here today on the panel with American

manufacturers who share our objective of protecting and strengthening U.S.-based production.

Representative Bill Thomas, last year, put forward a proposal to

repeal the FSC/ETI and replace it with a collection of corporate tax

cuts, most of which would mainly benefit companies with overseas

production facilities. We urge the Senate to reject that approach.

The Thomas proposal, quite simply, would ship more manufacturing jobs abroad. According to the New York Times, even supporters of the Thomas bill admit it would encourage American companies to invest and create jobs overseas.

This approach is entirely unnecessary and unacceptable, and

goes in the wrong direction. It is bad enough that the bureaucrats

at the WTO are requiring changes in our tax system, but it is even

worse that some in Congress would respond to this challenge by

making domestic manufacturing less competitive.

The Thomas approach, though it has not yet been formally reintroduced this year, appears to define enhancing American competitiveness as boosting the profitability of multinational corporations to produce anywhere they choose, so long as they keep an

American mailbox. We strongly encourage the Senate to reject it.

Our existing tax system, through Foreign Profit Tax Deferral, the

Foreign Tax Credit, and other provisions already places Americanbased manufacturers at a terrible disadvantage compared to multinational firms that generate most production offshore. These other

tax policies also urgently need to be fixed.

The manufacturing tax benefit, taken alone, will have only a

small effect on enhancing the competitiveness of U.S. manufacturing. It will improve our tax policy, but AFL–CIO believes Congress should make other significant policy changes as well.

As Senator Hatch said, America’s manufacturing workers are the

most productive in the world, but they operate under enormous

competitive disadvantages resulting from several factors in addition to tax policy, such as unfair trade agreements, an over-valued

dollar and foreign currency manipulation, as Senator Baucus said,

inadequate investment incentives, health care costs not borne by

overseas producers, and foreign government subsidies.

Unless these problems are addressed soon, American manufacturing capacity and jobs may end up permanently lagging and our

economic strength may be permanently weakened. U.S. productivity and wage gains have been largely driven by the performance

of our manufacturing sector, as Ms. Kobe said earlier.

We urge the Congress to start with passing a manufacturing tax

benefit, but to make that only the first step of a more comprehensive effort.

Thank you very much for your attention.

The CHAIRMAN. Thank you, Ms. Lee.

[The prepared statement of Ms. Lee appears in the appendix.]

The CHAIRMAN. Now, Mr. Berges, then Mr. Barrett.
17

STATEMENT OF JAMES BERGES, PRESIDENT, EMERSON

ELECTRIC, ST. LOUIS, MISSOURI

Mr. BERGES. Thank you, Mr. Chairman, Senator Baucus, members of the committee. Good morning. I am Jim Berges, president of Emerson. We are a $14 billion

global company headquartered in St. Louis, Missouri. Our annual

revenues are 55 percent in the U.S. and 45 percent international.

We have 320 manufacturing facilities worldwide, with 135 of

those in the United States. We employ over 100,000; 45,000 in the

United States.

I would like to make a few simple points in my limited time this

morning. First of all, as we have already heard, manufacturing in

the United States has taken a body slam in the last 3 years due

to the global economic downturn, sharply diminished capital spending, global over-capacity, and declining prices.

At Emerson, tragically, we have had to close 45 plants in the

United States and eliminate 15,000 jobs during this time just to

stay globally competitive in many of our markets. These plants and

jobs, contrary to Dr. Hall’s testimony, will not come back if and

when the economy recovers. They are gone.

I can tell you that no plant closure decision is taken lightly by

our management. It is extremely painful to lay off people who have

devoted their lives to manufacturing and to leave communities that

we have been part of for so many years. Frankly, I am more than

sick of it.

At a time when manufacturing is in crisis, repeal of FSC/ETI,

without some back fill for manufacturers in the United States, is

like kicking a dog when he is down. Such a policy choice by Congress will impose a $5 billion per year tax increase on the domestic

manufacturing sector and provide one more disincentive, among

many already, not to manufacture in the U.S.

Let me give you one example. At Emerson’s Fisher Controls facility in Marshalltown, Iowa, we employ over 1,000 highly-skilled machinists and others involved in the production, sales, and marketing of industrial control valves for the oil and gas industry.

Forty percent of the production from this plant is exported. The FSC/ETI provides a $4.4 million per year incentive to keep those

jobs in Marshalltown. Emerson is the direct beneficiary of the FSC/

ETI tax exclusion, but the benefits flow down to all of our domestic

suppliers and to untold service industries in and around

Marshalltown.

If FSC/ETI is repealed and no domestic manufacturing incentive

is provided as a replacement, the Marshalltown facility will have

to make up for the FSC benefits with cost cuts of over $7 million

to have the same after-tax earnings as before with the FSC benefit.

This will likely mean lost jobs in Marshalltown.

Our view is that Congress should fashion a WTO-legal incentive

for good public policy reasons, creating and maintaining high-paying domestic manufacturing jobs and a strong competitive industrial base in our country.

As Joel Popkin and Ms. Kobe have pointed out, economies without a growing and vital manufacturing sector are doomed to 1.5

percent growth annually. The argument that we should just get on

with the conversion to a service economy does not hold water. If
18

you want to see the effects of 1.5 percent growth on an economy,

just look at Japan and parts of Europe. It is not a pretty sight and

not one that I want to be part of.

Emerson and many other manufacturers both large and small

have worked with interested Senators and Representatives on a

WTO-legal, revenue neutral manufacturing tax exclusion proposal

as a replacement for FSC/ETI. Our ideas are based on the Canadian manufacturing and processing tax exclusion, which has existed there for over 30 years.

Under the proposal, all manufacturers and processors, including

agricultural processors, would receive a lower tax rate on their

qualifying business income.

The proposal is not export-dependent. It has been estimated to

be revenue neutral. It has a short transition time and would be

available to all manufacturers and processing done in the United

States. This includes small- and medium-sized manufacturers and

S corporations and partnerships, many of whom do not currently

benefit under the FSC/ETI regime.

Pure and simple, the proposal is designed to help revitalize all

U.S. manufacturing to provide incentives for investing in domestic

manufacturing and to create jobs. The response we have received

from policy makers from both parties has been very encouraging.

Copies of the proposal are attached to my written testimony. Mr.

Chairman, I would ask that they be included in the record of today’s hearing.

The CHAIRMAN. It will be included.

Mr. BERGES. As I have visited with key policymakers here in

Washington, I am always asked, Emerson is a global company.

Would you not rather see broad reform of our international tax

laws? My response is simple. These are good ideas, and if you want

to lower my company’s international tax rates, fine. But it will not

provide me any incentive to create or retain a single U.S. manufacturing job, period, full stop.

I do not mean to diminish the importance of international tax

simplification and its role in U.S. global competitiveness. Congress

obviously needs to address these important issues, but not at the

expense of sacrificing our domestic manufacturing base.

Mr. Chairman, I appreciate the opportunity to talk to you about

Emerson’s perspective this morning, and we look forward to working with the committee on a solution to the FSC/ETI issue.

[The prepared statement of Mr. Berges appears in the appendix.]

The CHAIRMAN. Senator Hatch is going to go, and he is going to

submit some questions to the panel for answer in writing.

[The questions appear in the appendix.]

The CHAIRMAN. Mr. Barrett, would you proceed? Thank you, Mr.

Berges.

STATEMENT OF WILLIAM BARRETT, VICE PRESIDENT, TAX

AND TRADE, APPLIED MATERIALS, INC., SANTA CLARA, CALIFORNIA

Mr. BARRETT. Mr. Chairman, Senator Baucus, and members of

the committee, I thank you for the opportunity to testify here today

on these important issues.
19

Applied Materials makes the systems that produce virtually

every new microchip in the world. Applied Materials was organized

in 1967 and has become the global leader in the worldwide semiconductor equipment industry.

We compete in nearly every segment of the industry with both

U.S. and foreign competitors in Japan and Europe. We currently

employ about 13,000 people, 10,000 of which are in the United

States. Approximately one-quarter of these employees are in the

manufacturing sector, located primarily in Texas. In fiscal year 2002, we had approximately $5 billion in sales and $1 billion in R&D expenditures. We have a global customer base

and a global service operation.

The company has a relatively simple corporate structure, with

R&D and manufacturing primarily in the United States, but we

have an incredibly complicated product that uses high-level physics

and chemistry.

When setting the stage for discussion of the U.S. taxation of multinationals, it is important to ask why companies operate offshore.

First and foremost, it is about accessing foreign markets. For Applied Materials, about 70 percent of our sales are exports. Following the sale to a customer, it is about servicing the product.

There is an interesting study that showed that 66 percent of U.S.

multinationals are in the manufacturing sector, but 56 percent of

their offshore operations are related to after-sale service of those

products. These statistics are certainly consistent for Applied Materials. The statistics also show that U.S. multinationals still perform

most of their manufacturing in the United States.

Companies also move offshore to access less expensive manufacturing when global competition and economic conditions reduce

profit margins. This cost benefit analysis also includes tax considerations, but it is not the only consideration.

The global business environment is changing. We have had a

major 3-year downturn in the semiconductor equipment industry.

Customers are entering into global partnerships to reduce their

costs of manufacturing.

Asia, and recently China, have emerged as lower chip manufacturing regions, which has put increasing pricing pressure on our

products. This is forcing even Applied Materials to consider lower

cost component manufacturing alternatives.

The FSC/ETI manufacturing benefit has historically produced

about a 3 to 4 percentage point tax rate reduction for the company.

In our best year, fiscal year 2000, that represented about $100 million for us. But, as we all know, the FSC/ETI issue was found to

be an unfair export subsidy under WTO rules.

The FSC/ETI issue, as well as Congress’ desire to improve and

simplify the U.S. taxation of international activity, has provided

the catalyst for tax reform. In this environment, two views have

emerged. H.R. 5095 was last year’s bill in the House, and it would

simplify the U.S. taxation of foreign operations and improved competitiveness of U.S. multinationals by repealing the Subpart F provisions which are antiquated and produce a tax disadvantage for

multinationals operating offshore.

The bill would also reduced foreign Tax Credit complexity, increase the Foreign Tax Credit carry-forward period, and would
20

eliminate the Foreign Tax Credit limitation on the Alternative

Minimum Tax.

The better view focuses on providing a manufacturing benefit to

offset the tax increase that will result from ETI repeal. H.R. 1769

would produce that type of relief and it would exclude 10 percent

of a U.S. producer’s manufacturing profits. It would also include

important transition rules.

Finding a suitable replacement to FSC/ETI for U.S. producers is

important for the following reasons: repealing ETI without some

offset would overturn 30 years of bipartisan U.S. tax policy; the repeal of FSC/ETI would be in response to a European threat of retaliation, not a change in U.S. policy.

With 6.4 percent employment, this is not the time to increase

costs for U.S. producers. Repeal of FSC/ETI can be compared with

an increase in tariffs, and economic studies clearly show that this

will have a negative impact to U.S. employment.

Finally, there remains a significant U.S. manufacturing and production based in the United States that would benefit from this

manufacturing credit.

I believe the differing views on tax policy can be reconciled, and

I believe that many of my Silicon Valley colleagues think the same

way.

Reconciliation can occur with a manufacturing tax rate reduction

patterned after H.R. 1769; simplification and enhancement of the

R&D credit patterned after H.R. 463 and Senate bill 664; repeal of

the Subpart F trading provisions; and, finally, enactment of the

homeland investment provisions patterned after Senate bill 596.

Applied Materials appreciates the opportunity to participate in

this hearing. These are important tax reform topics that we believe

are reconcilable. Simplifying the taxation of foreign income to help

U.S. multinationals compete offshore is probably a good idea in the

context of fundamental tax reform.

Enhancing the after-tax return for U.S. producers, in general, is

an obvious good thing for the United States and should be included

in international reform legislation. The centerpiece of any legislation must be to limit the tax increase in America’s most competitive manufacturers.

Legislation along the lines of a production activity exclusion accomplishes this and it has our full support. Thank you.

[The prepared statement of Mr. Barrett appears in the appendix.]

The CHAIRMAN. Thank you very much, to all five people testifying this morning.

I am going to ask my first questions of Mr. Berges and Mr. Barrett, but if anybody else wants to chime in on the panel, please do

that.

I want to take advantage of your two’s decision-making processes

as you decide to have a plant in the United States or jobs overseas.

What role, if any, does FSC/ETI play in that decision to locate

a business activity in the United States versus overseas? Then let

me have two subparts of that If you move an operation offshore,

do suppliers also move their operations offshore to follow you?
21

In regard to the second part, what do you mean when you say

‘‘FSC/ETI also benefits your suppliers?’’ I am not sure that was in

both of your testimonies, but I think you could both respond.

Mr. BERGES. I would be happy to go first, Senator. First of all,

if I go back to my example on Marshalltown, we have a $4.4 million benefit there, which is $7 million pre-tax. So if we were to look

at moving jobs out of Marshalltown, we would first have to overcome that $7 million incentive.

So, wherever we would go, just to be at parity with

Marshalltown, would have to have $7 million worth of lower cost

just to be at break even. Then we have to go beyond that to get

the savings that would justify shutting that facility and moving it.

In our decision-making process, the after-tax impact of the FSC

is a powerful incentive for us to stay in the locations we are in and

continue to export from there.

Second, the suppliers. Typically, when we move, our suppliers do

not move with us. This is one of my biggest concerns. We typically

develop a supply base in the country that we move to, which then

hurts our suppliers. Our suppliers are ultimately also our customers. We provide capital goods to the entire industry in the U.S.

Fifty-five percent of our sales are still here.

When we see the manufacturing base shrinking as a result of us

moving and our suppliers losing jobs, it eventually has a vicious

circle effect, comes back and bites us on demand for our products

in this country.

So the proposal that we have talked about, and I even think the

Crane-Rangel bill, benefits all manufacturers. You do not have to

set up a DSC. All manufacturers would receive a credit so you

would be able to spread this $50 billion around to even the small

and medium manufacturers who are our suppliers, and also our

customers.

The CHAIRMAN. Mr. Barrett?

Mr. BARRETT. An anecdote. Each year, I have a review with our

board of directors. One of the highlights is a review of the tax rate.

The last 2 or 3 years, we have been following the progress of the

WTO issues. I have been emphasizing, number one, the four percentage point tax rate benefit that the FSC/ETI provides.

I would really conclude by saying, if we wanted to make up that

difference, if it was repealed, the only way to make up that difference would be to move substantive manufacturing offshore.

The decision for a company like Applied to move offshore may be

more difficult than most. It relates a lot to the fact that we are a

high technology. Intellectual property is a very, very big issue for

us, so the decision to move offshore would not be an easy decision

for the company to make.

Also, the decision relates to proximity to customers. Again, if we

wanted to make up that difference, the four percentage point difference, and the company was willing to commit to a significant

movement offshore, it would be close to the customer, making sure

that we have the proper intellectual property rights protections,

those sorts of issues.

The supplier issue is an interesting one, too. In these down

times—I have been with the company 15 years—and never have I
22

seen more thought or investigation looking at alternative component manufacturers offshore.

Our machines are very big and bulky. A lot of components go

into making that machine. But we are seriously looking at lower

cost alternatives for those components, primarily in Asia.

The CHAIRMAN. Thank you.

My next question would be to the entire panel. It is taking off

from Dr. Hall’s testimony. Correct me if I am wrong, but it seems

to imply that, by historical standards, that nothing is dramatically

wrong with the manufacturing sector.

Yet, it seems like the testimony from Ms. Kobe and Ms. Lee

claims the opposite conclusion. I would like to have some sort of

discussion of the broad disparities of view.

Dr. HALL. I think it would be incorrect to say that it is my belief

that there is nothing wrong. Rather, we are in the middle of what

is, for manufacturing, a pretty serious recession.

It is like other serious recessions. If you look at all of my numbers for output in employment, what has happened after every previous recession is a recovery. Of course, there is a lot of speculation

about when that recovery will occur. Each dismal, new employment

number suggests that we have not had the recovery yet, yet forecasters are saying with some confidence that we will see it. It has

always happened before.

I think that is the most important thing to understand, is that

there are some very fundamental forces that bring about a recovery. It is a recovery in manufacturing, as well as elsewhere. But

I would not want to diminish the problems that exist today in manufacturing as a result of what is a pretty serious recession.

Mr. BERGES. Senator, my disagreement with Dr. Hall revolves

around a difference in this recession, which is the rate at which

jobs are leaving this country. We have not only the effect of dropping demand in this country and eliminating jobs, but jobs are fleeing this country at a very high rate, most of them to China and

other bases in Asia. This China capacity did not exist in the 1991–

1992 recession. It did not exist in the 1981–1982 recession. This is

a big difference.

Contrary to what he says about China specializing in standardized, mass-produced consumer goods, there are more wafer fabs

being built in China today for high-end semiconductors than anywhere in the world.

We see competition out of China on all of our high-tech products.

It is highly skilled, highly engineered. This is not Japan, 1952, selling toys over here. These are real serious, high-tech competitors.

The jobs are moving over there. They are going to stay over there.

They are not going to come back.

Dr. Hall, relying on previous recessions, I think, is ignoring the

rate at which China is developing as a highly sophisticated economy.

The CHAIRMAN. Ms. Lee?

Ms. LEE. If I may just agree with Mr. Berges here. I think one

of the differences between this and previous recessions is the impact of the global sourcing decisions and the huge propensity to import in the U.S. economy right now. That is what puts in real dan-
23

ger the recovery from the recession and the job creation potential

in the recovery.

If, as consumers begin to spend more money, if they are spending

money on imports at the same rate that we are seeing right now

and we are seeing the kind of growth in the merchandise trade deficit, including in the advanced technology products, the areas

where we traditionally thought the United States had some comparative advantage, then I think that the potential for the U.S.

economy to come out of the recession in a healthy way and to replace the manufacturing jobs that have been lost is really in question.

The CHAIRMAN. Go ahead, Ms. Kobe.

Ms. KOBE. I was just going to make one point. It has been the

1980’s since we have seen this level of job loss. Even then, you will

not quite match what we have seen in the last couple of years here.

I think that was also a period in which manufacturing was restructuring due to some competitive issues from abroad, but we

also did not get all of those jobs back. I think there is that danger

going on again here.

The CHAIRMAN. Very sobering testimony.

Senator Baucus?

Senator BAUCUS. Just to follow on, just very briefly, because I

have a few questions. Not long ago, some would suggest that, well,

it is all right if we lose manufacturing capacity because of future

services, so why not just go with the flow? What is wrong with that

argument?

Ms. KOBE. Well, I think services provides a fair amount of new

types of jobs in this economy. No one is discounting the advantages

that services provide in the U.S. But manufacturing provides a lot

of positive impacts in the U.S. as well, and one of those is the innovation process that I spoke of earlier in which manufacturing is a

key player. I think our trading partners recognize that.

You can look at the new auto policy that China is putting out.

It wants, as part of its guarantees to have foreign manufacturers

in China, that they bring some of their R&D facilities to China as

well.

People recognize the fact that rapidly changing part of the manufacturing sector, the high-tech goods that the U.S. is well-known

for exporting, is an important part of what the U.S. has had as an

advantage.

Senator BAUCUS. Does anyone else want to comment on that?

Mr. Berges?

Mr. BERGES. Yes. I would just like to quote out of the study that

Ms. Kobe—if it has not been entered into the testimony, it ought

to be—co-authored. They took the industrial production of various

countries against non-industrial production, and there is a very

nice correlation. When industrial production is not growing, the

rest of the economy is only growing 1.5 percent.

The multiplier effect of these industrial jobs is enormous. So

when the manufacturing industry is growing, the multiplier effect

on the service industry is huge.

Senator BAUCUS. Yes. As a rhetorical question, I agree with your

response very much.

Ms. Lee, briefly?
24

Ms. LEE. Just briefly. I agree with all of those: the productivity

growth, the linkages, the high wages, the trade balance impact of

manufacturing jobs makes them unlike the service sector.

But the third thing is what I started to say, too, which is that

it is not clear that the United States has any kind of permanent

comparative advantage in services, and that those jobs are now

also starting to go overseas.

Senator BAUCUS. Correct. It is like the old thing years ago. Well,

do not worry about Japan, because they do not produce software.

We do software, they do hardware. Now, everybody does everything. It is clear.

Ms. LEE. Our service sector surplus was $69 billion in 2001. In

2002, it fell to $49 billion.

Senator BAUCUS. Right.

Mr. Berges, you have talked a bit about the Canadian solution.

I am just curious of the degree to which the Canadian approach

and/or the Crane-Rangel bill that I am on, too, will offset the loss

created by repeal of the FSC/ETI.

Mr. BERGES. Well, our studies have determined that if applying

the Canadian effect to the ratios that we have suggested would be

revenue neutral for the Treasury, but would still provide the $5 billion annual benefit. It is going to spread it around some. Right

now, the $5 billion benefit is focused on large companies that can

afford to set up a DSC and do a lot of exporting.

There is a secondary effect to the suppliers. What we are proposing is a broad-based credit for all manufacturers. So, Emerson,

for instance, will take a haircut. We will not get nearly the benefit

out of the Canadian tax proposal that we get out of the FSC/ETI.

But our suppliers, our smaller suppliers and our smaller customers

will get a benefit. We think, indirectly, that is going to help us

enormously by helping revitalize the economy.

Senator BAUCUS. Mr. Barrett?

Mr. BARRETT. Yes. The PAE, the Crane-Rangel approach, my estimates are that it would provide about half the benefit that we

currently receive from FSC/ETI. So, I think it is important to combine that with the enhancement to R&D that I mentioned before.

Also, on the prior point, the value of high-tech related jobs, about

20 percent of our expenditures of sales is related to R&D. It might

be helpful for the public record. There was a study that was put

together by Pricewaterhouse that shows that linkage between manufacturing-related jobs and the high-value, high-paying jobs that it

generates.

Senator BAUCUS. I think the Chairman will put it in the record.

I am pretty sure he will.

[The information appears in the appendix.]

Senator BAUCUS. I might ask, too, there is some question of

whether this replacement legislation should apply to C corporations

or also to partnerships and other non-corporate entities.

Mr. Berges, your view?

Mr. BERGES. Well, we have proposed that it in fact applies to S

corporations, pass-through entities like S corporations and partnerships who currently do not benefit from the FSC/ETI regimen. But,

again, pointing out to you that many of our suppliers are S cor-
25

porations and partnerships that are small, family firms. We think

it is vital that we keep them viable in this country as well.

Senator BAUCUS. Does anybody disagree with that?

[No response.]

Senator BAUCUS. Does anyone want to amplify?

Mr. BERGES. Yes.

Senator BAUCUS. You just did.

Mr. BERGES. I did.

Senator BAUCUS. You have amplified. All right. Good.

It is a minor point, but Ms. Kobe, I wonder if you could comment

on Dr. Hall’s hours point. I am sorry. I do not mean to

mischaracterize your testimony. But he essentially pointed out that

the hours of manufacturing are not much different from the hours

in other sectors. I understand, Ms. Kobe, you have got a comment

on that.

Ms. KOBE. I looked at Dr. Hall’s hours chart briefly. The source

of those data are the same as the source of my employment data:

they both come out of BLS’s CES survey. They show essentially the

same pattern.

I think if you go and look at his data carefully, you will see that

you would have to go back to the early 1960’s to find hours numbers that are quite as low as are shown at the current first quarter

number that is at the end of his chart.

Senator BAUCUS. But you all agree that manufacturing is very

depressed and it is so serious, there is a real question of the degree

to which jobs will come back from overseas. I do not want to

mischaracterize anybody, but you would almost have to go to extraordinary lengths to maintain a manufacturing base in this country.

Dr. HALL. I profoundly disagree with that.

Senator BAUCUS. Oh, good. What do you have to say?

Dr. HALL. First of all, I think the notion that it is manufacturing

against services is not the right——

Senator BAUCUS. Nobody is going against services. They are

both.

Dr. HALL. Yes. Anyway, if you ask what the U.S. is really good

at, it is good at producing ideas. The ideas get embodied in Mr.

Barrett’s wonderful machines, and they get embodied in lots of

services and software type products, entertainment products. All

over the map, that is where the U.S. has its comparative advantage

in world trade.

What is happening, is a transformation in which there is a

growth in the idea-producing sector of the U.S. economy, whether

it is services or goods, and a replacement in the more boring products, the ones that are made in China.

If you look even in the chip industry, the Chinese are entering

the boring part, but Applied Materials is still in the exciting part

of that industry. That will continue to be the U.S. posture.

So, there will be a transformation of the U.S. economy toward

more and more employment in the idea-producing industries, and

less and less employment in apparel, which has practically disappeared, and in the strict manufacture of chips, another thing

which the Chinese will take over. But that does not restrict the

number of jobs that will be available in the United States.
26

Senator BAUCUS. But they are not going to be as high-paying

jobs, across the average. If that is the case, then why are other

countries not pursuing a service-based economy rather than a manufacturing economy? Say, Japan, China, et cetera.

Dr. HALL. Because they cannot compete with us. We own that

part of the world economy.

Senator BAUCUS. They cannot compete with us in what sectors?

Dr. HALL. Well, software is a very good example. The U.S. completely owns the worldwide software business.

Senator BAUCUS. That is not true. What about all of the software

engineers in India?

Dr. HALL. Well, they work for us.

Senator BAUCUS. The jobs are not here. They do not pay taxes.

Dr. HALL. Well, it is a very small fraction.

Mr. BERGES. No, that is not true. It is growing at an enormous

rate over there.

Senator BAUCUS. Anyway, you guys have different points of view.

We are not going to resolve that here. I appreciate it. Thank you,

Mr. Chairman.

The CHAIRMAN. Thank you.

Senator Bingaman, by order of arrival, then Senator Lott.

Senator BINGAMAN. Thank you all very much for being here.

Mr. Berges, you have proposed this broad-based credit for all

manufacturers. I think it is a very constructive proposal. I am concerned, though, that since our main focus really is, we want to

incentivize retention and creation of high-wage jobs of any kind in

this country. Why should it not be even broader than what you

have proposed and cover service sector jobs, too, to the extent that

they can qualify?

Mr. BERGES. Well, Senator, I certainly do not have any problem

with that. If there was to be legislation that lowered the corporate

tax rate for everybody, I would certainly support that.

What we tried to target was a revenue-neutral proposal that

would specifically address the FSC/ETI repeal, so we kept it inside

of the $50 billion bound. If Congress wanted to go beyond that, we

certainly would not reject it. I certainly think it would be great for

the U.S. economy if that happened.

Senator BINGAMAN. And your proposal is patterned after what

has been in place in Canada for the last 30 years, as I understand

it.

Mr. BERGES. Thirty years. Yes, sir.

Senator BINGAMAN. Do we have good comparative data as to

what has happened to the manufacturing sector in Canada under

that tax regime as compared to what we have seen here in the last

3 years?

Mr. BERGES. My understanding is that the manufacturing tax

credit in Canada was a very, very successful program. It was put

in place to keep flight from happening to the U.S., actually, was

the threat at the time. The flight slowed dramatically during the

time of this regime.

In fact, it is so popular, what the Canadian government is now

doing is similar to what you just suggested. They are going to restructure the Tax Code for all corporations, whether they be manu-
27

facturing or service related. So, my understanding is that it was

very successful.

Senator BINGAMAN. But they have that tax credit for manufacturing in place now still in Canada.

Mr. BERGES. Yes, but they are going to repeal it and replace it

with a broader restructuring.

Senator BINGAMAN. Right. You have cited what has happened in

your company in the last 3 years where you have had to close 45

plants in the U.S. We could look at what has happened in Canada

in the last three years and whether or not companies manufacturing in Canada have had to close at that same rate.

Mr. BERGES. My understanding is, they have not. I do not have

the statistics here in front of me, but there was a great deal of concern of flight out of Canada to the United States and frankly to

Mexico. My understanding is that the manufacturing sector in Canada has done very, very well, particularly in the last 10 years.

Senator BINGAMAN. Ms. Lee, did you have any thoughts about

this question of whether we should try to fashion a tax system that

would provide an incentive to keep either manufacturing or service

sector jobs here in this country?

Ms. LEE. Well, we do believe that there are unique advantages

to the manufacturing jobs, and there is an importance to retain

that sector specifically. As Mr. Berges said, if there were unlimited

funds, then all jobs are valuable, and we value the service sector

jobs as well and we organize many of those jobs.

But I think that we see the manufacturing sector in a particular

crisis and we see that those jobs are particularly valuable to the

overall health of the economy. So, we think it is warranted to target some assistance to those sectors. That is the sector that has

been, I think, the most vulnerable, certainly, to the pressures of

globalization.

Senator BINGAMAN. All right.

Let me ask about Ireland and the tax structure that they have

put into place. I think there is a lot of high-tech manufacturing

that has moved to Ireland. I know when I recently got a cell phone,

it was a U.S. manufacturer, but it was manufactured in Ireland.

I had a choice of either buying a phone manufactured in Ireland

or a phone manufactured in China, but there are no cell phones

manufactured in this country, as far as I could tell.

Mr. Barrett, have you looked at the tax structure in Ireland and

compared that to our tax structure as it relates to the high-tech industry to see what they are doing that we are not doing?

Mr. BARRETT. Yes. We have not moved manufacturing in any significant way offshore. We do have a couple of subsidiaries, one in

England and one in Israel, that we acquired, but that is the extent

of our offshore manufacturing.

We have looked at Ireland in the context of a distribution center

that distributes product throughout Europe. Indeed, historically

they would provide concessions, a tax rate concession, for companies to invest in Ireland.

They changed their law a couple of years ago. They now have a

12 percent corporate tax rate. So, that is basically how they attract

companies. But, yes, we have looked at it in the context of distribu-
28

tion. We are doing the same thing in Asia, and looking at Singapore as a distribution hub.

Senator BINGAMAN. I will stop with that, Mr. Chairman.

Senator LOTT. Mr. Chairman?

The CHAIRMAN. Senator Lott?

Senator LOTT. Thank you, Mr. Chairman. As a matter of fact, I

went to Ireland last year to take a look at what they did. It is very

interesting how they, for a while at least, became an economic miracle. They had a 10-year plan and they achieved it in 8 years. They

cut the corporate tax in half, as I recall.

Mr. BERGES. It is 10 percent, I think.

Mr. BARRETT. It is 12, now.

Senator LOTT. And they cut the capital gains about two-thirds,

I think. They also changed their education system. It is a very interesting thing, what they did there. They targeted their education

system toward emphasis on high-tech training that would fit in

with that.

Then they also intentionally, as Mr. Berges said, wanted to become the doorway for the United States into the EU. It worked

beautifully. By the way, they went from a country of only 2.8 million people to 4 million, now. Something like 59 percent of the population is under 30. It is an amazing thing. I think we ought to

emulate that.

Mr. BARRETT. The expatriates came back when they saw what

was happening.

Senator LOTT. Well, the young people came back from Boston.

Senator BAUCUS. How did they finance all that?

Senator LOTT. Well, they did the tax cuts and immediately started—there are some 500 U.S. companies there. They had such an

influx of industry and the creation of jobs, that the revenue went

way up. It is a novel idea. We might try that sometimes in the

United States. [Laughter.]

Senator BAUCUS. That is novel.

Senator LOTT. You ought to take a look at Ireland.

Senator BAUCUS. But I understand also the current generation

really bellied up to the bar and almost taxed themselves to pay for

the education for their next generation of kids.

Senator LOTT. Right. They have free education, kindergarten

through college.

Senator BAUCUS. Right.

Mr. BERGES. Senator, I believe that the EU set up Ireland 10 or

15 years ago as a special development zone, much like they did as

part of Spain.

Senator LOTT. They made off like bandits. Ireland and Spain are

doing great now and they are still getting money from the EU.

That will not last much longer.

But thank you all for your testimony. It has been very interesting. I guess the focus has been, what do we do to try to deal

with the impact of eliminating the FSC and ETI. I have heard suggestions that you go with the Crane-Rangel proposal, which I guess

would be to cut the corporate rate by 3 percent. Is that right?

Mr. BARRETT. It is 3.5 percent on manufactured products.
29

Senator LOTT. So it is 3.5 percent. Then there has been the

Hatch idea about the R&D proposal. Then there is the Thomas proposal that is much, much more complicated, shall we say.

I did not hear a lot of you indicating you thought that was the

solution, although I am not sure if we know exactly what he is

planning at this point now. Knowing Congressman Thomas, it will

be interesting and innovative when we do see what he finally proposes.

But what worries me, and I want to ask a broader question here,

today you are just trying to say, how can we minimize the damage

that this is going to do. But I do not think we are addressing the

long-term, bigger question of, why are we continuing to lose these

manufacturing jobs, and what can we do in a bigger sense?

I do not want to just offset what you might lose here. I would

like to do something that would stop the loss of manufacturing

jobs, or all jobs, to other countries around the world.

That has been driven, I guess, by all of the regulatory burden

you have to put up with in America, the excessive tax burden you

have to put up with in America, health care costs in America, the

labor cost because you have got people in other parts of the world

working at sub-minimum wage rates, a combination of all of those.

But, in a broader sense, I am interested, Mr. Berges, Mr. Barrett, Ms. Lee, if you all have got some answers to that, because I

do not want to just stop the bleeding that might occur by removing

the FSC and the ETI. I would like for us to get on the offense and

stop losing these jobs.

Of course, I always vote for the trade packages. I also am very

much an advocate of ‘‘buy America.’’ Unlike most Americans, including my own wife and kids, I drive an American vehicle. But I

do not know how much longer I can continue to do that if the cost

is higher, the fuel efficiency is not as good, and the product is not

as good.

Ms. Lee?

Ms. LEE. Well, Senator Lott, thank you for the question. Certainly, we do believe that the trade policies overall have been misguided in the sense that they have created the wrong economic incentives, both for manufacturers and for governments of other

countries, that we have designed these policies, in our view, to facilitate U.S. companies, multinational corporations, taking the jobs

offshore and bringing the goods back into the United States, facing

very, very low tariff rates.

At the same time, we have done very little to ensure that the

companies that move offshore are respecting the basic rights of

their workers, treating the environment right, and so on.

So the fact that we have regulation in the United States, we

think, is a good thing. We have regulations that protect the safety

and health of the workplace and the environment, and so on.

But we do not want those regulations to provide an undue burden on domestic manufacturers, and for that reason we do believe

that we need to address that issue in our trade policies as well.

In our view, current trade policies have been designed to address

the concerns of corporations producing offshore, but not to address

the concerns of creating and retaining strong jobs at home. So, that

is certainly one of the issues.
30

I think the over-valued dollar has put our domestic manufacturers at a terrible disadvantage. It is starting to come down, but it

is not coming down against China or Japan, some of the places

where we have the most severe trade problems. So, that is certainly an issue that we think would go a long ways to helping the

long-term competitiveness of American manufacturers.

Senator LOTT. Mr. Berges?

Mr. BERGES. Well, I agree with Ms. Lee and the comments you

made about the cost of doing business in the U.S. Certainly, you

did not include on the list the tort system. It is a very expensive

impediment that we have here that does not exist in the rest of the

world.

I guess, to your list, I would also add what Senator Baucus

talked about, the disparity of tariffs around the world, and encourage the Trade Representative to get on his horse and get some of

these free trade agreements accelerated. When we passed fast

track, U.S. industry was pleased with it. But so far, we have got

Singapore and Chile, I think, which is not exactly——

Senator BAUCUS. And Bahrain.

Mr. BERGES. And Bahrain. Not exactly the largest trading partners that we have. You would much see it focused on larger—

Brazil, for instance, would be a terrific place to start, and Thailand,

and other places where there are significant barriers to U.S. products, get those things down, get those tariffs down, and to work on

the non-tariff barriers as well.

Mr. BARRETT. It is interesting, because China is a big area of

focus for the semiconductor industry. It has just been amazing. If

you have been to Shanghai recently, it is just an amazing transformation. I went there in 1993 and it was completely different,

very few high rises. It looks like the Emerald City now, 10 years

later.

I think that, in the long term, it is good that these countries like

China are emerging. I think it is going to enhance the overall market for semiconductors, and in our business, also. So I think, long

term, it is a very good thing.

The complication of the Tax Code is a bugaboo for me. It has

been that way for years, because I am the guy in the trenches

doing the tax return. I think there is a lot we can do in terms of

simplification in the tax area, in general.

Hopefully, this exercise that you are going through now will

serve as a first step for some longer term thinking on what would

be a simpler, more direct, less complicated corporate tax system.

Senator LOTT. Well, I know my time has expired. I would like for

us to do it, rather than longer term, in the shorter term, because

we have got a problem now. I think we have put it off too long already. I do think we need legal reform, and I hope business, industry, and agriculture will get more serious in dealing with that need

for legal reform.

I do think we need some more common sense as it applies to regulations, including environmental and other problems in this country. The enemy is us, in many respects. I agree we should be a lot

more aggressive with our trading partners. I think they make out

like bandits.
31

They jerk us around all the time and they have done it in Democrat administrations and Republican administrations. I worried

about this problem in discussions with President Reagan, President

Clinton, and probably need to do it with President Bush.

I think it is time we tell these countries, they stop their barriers,

their tariffs, or else we are going to act immediately and punish

them severely. But I do not think we do that. I hope that Ambassador Zoellick will get a lot more aggressive, and do it quickly.

So I think, overall, you all need to give us this information now,

not longer term, because we are paying a tremendous price. We are

going to wake up 1 day and take the necessary action, but the

horse is going to be out of the barn and gone. But it is a good exercise. Maybe this FSC/ETI matter will drive us to think more innovatively about the future.

Thank you very much, Mr. Chairman.

The CHAIRMAN. Thank you, Senator Lott.

I am going to have to say thank you. We would like to continue

this discussion, but we have got one more panel and we have a vote

coming up shortly. So, I want to just say thank you.

It is our good fortune to have representatives of two foreign corporations that have made significant investments in the United

States. We have Mr. Alex Spitzer, senior vice president of the

Swiss-based Nestle Company. He is going to provide his views on

investing in the United States, the impediment to foreign investment, and Treasury’s earnings-stripping proposal.

Then we have Mr. Mark Russell, vice president of the Swedish

firm Electrolux, to provide us his views on both the earnings-stripping proposal, the repeal of FSC/ETI, and the effect of both on the

company’s investments in the United States.

I am going to start with Mr. Spitzer.

STATEMENT OF ALEX SPITZER, VICE PRESIDENT, NESTLE

HOLDINGS, NORWALK, CONNECTICUT

Mr. SPITZER. Good morning. My name is Alexander Spitzer. Mr.

Chairman, Senator Baucus, and members of the committee, I am

grateful for this opportunity to share with you my personal views

on international tax policy as it relates to U.S. operations of multinational firms, and in particular any impediments in the Tax Code

that may serve as a barrier to attracting international investment

into the U.S. manufacturing base.

I am senior vice president of Taxes for Nestle USA, and have

held the top job in the company for the last 18 years. Also, from

1996 to 2002, I served as president of the Organization for International Investment, OFII.

As you may know, OFII is the leading business association representing the interests of U.S. subsidiaries of foreign-based companies.

Nestle is a 140-year-old Swiss public company that is the world’s

largest food business. For more than 100 years, Nestle has been

growing its presence in the United States, where our 43,000 American employees manufacture a large range of products such as

Baby Ruth, Butterfinger, Poland Spring water, Coffee Mate,

Haagen-Dazs ice cream, Friskies pet food, and many more.
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We have 73 manufacturing operations in 33 States and support

a $2.5 billion annual payroll. In 2002, our U.S. employees manufactured $18 billion in products, including $600 million worth of exports. This March, Fortune Magazine named Nestle USA ‘‘America’s most admired food company for the sixth consecutive year.

Nestle USA is just one example of the thousands of U.S. subsidiaries that make significant contributions to the American economy.

Let me share with you five key statistics.

Fact one, employment. In 2000, 6.4 million American workers

were employed by U.S. subsidiaries of foreign firms. Over the last

5 years, U.S. subsidiaries’ employment has increased by more than

30 percent. These jobs are distributed across a range of industries,

with 43 percent of the jobs in manufacturing.

Fact two, compensation. U.S. subsidiaries of foreign companies

support an annual payroll of $330 billion. In 2000, compensation

per employee was 15.4 percent, or $6,800 higher at U.S. subsidiaries than at all private sector businesses in the U.S.

Fact three, exports. U.S. subsidiaries exported a record $165 billion of merchandise in 2000, 21 percent of total U.S. exports.

Fact four, taxes paid. U.S. subsidiaries’ Federal tax payments

have grown from $6 billion in 1991 to $28 billion in 2000, accounting for 14 percent of all corporate tax payments.

Fact five, investment in research and development, plant and

equipment. In 2000, U.S. subsidiaries invested $30 billion in research and development and $150 billion in plant and equipment

in the United States.

As the above statistics clearly show, U.S. subsidiaries make a

significant economic contribution to the United States and, therefore, are appropriately included in today’s discussion of the competitiveness of U.S. operations.

Mr. Chairman, as you know, the relationship between the U.S.

Tax Code and competitiveness has recently become a prominent

topic. Unfortunately, many commentators have chosen to define

competitiveness in ‘‘us versus them’’ terms, pitting companies

based in the United States against companies based abroad.

By including two U.S. subsidiaries in this hearing, you have rejected this narrow definition of competitiveness and have properly

framed the discussion. After all, it is the success and profitability

of all business activity in this country of both domestic and foreign

companies that most directly impacts the health of the U.S. economy.

The tax system clearly has an impact on the competitiveness of

U.S. operations. In my opinion, the desired goal for the United

States is simple, to have a tax system that promotes job-creating

investment. A tax system that is even-handed and non-discriminatory for both U.S. and foreign-based multinationals will spur the

greatest amount of economic activity and growth.

There has been a lot of debate over the last year concerning the

so-called earnings stripping rules that limit the deductibility of interest paid by United States subsidiaries to foreign related parties.

Some have proposed more sweeping changes in this area that

could seriously harm existing and new investments in the United

States. This committee has wisely chosen to appropriately focus
33

any further proposed changes to abusive transactions. This concludes my remarks.

Mr. Chairman, I want to again commend the committee for calling this hearing. Thank you for inviting me to add perspective of

United States subsidiaries of foreign companies to the broader context of the hearing.

I would be happy to answer any questions.

[The prepared statement of Mr. Spitzer appears in the appendix.]

The CHAIRMAN. Mr. Russell?

STATEMENT OF MARK RUSSELL, VICE PRESIDENT, TAX,

ELECTROLUX HOME PRODUCTS, CLEVELAND, OHIO

Mr. RUSSELL. Mr. Chairman, Senator Baucus, members of the

committee, thank you for the opportunity to voice the views of the

Electrolux Group on United States tax policy.

Electrolux is a Swedish-based multinational and is the world’s

largest producer of appliances and equipment for indoor and outdoor use. In the United States, Electrolux is often identified with

vacuum cleaners, but our product line goes well beyond that.

Electrolux is our biggest brand, but there are many other famous

brands in the group including Eureka, Frigidaire, Poulan,

Husqlvarna, and Weed Eater. We had worldwide sales in 2002 of $14 billion, and in the United

States our sales were $5.5 billion. The four largest manufacturing

operations of 111 worldwide are located in the United States and

account for 23 percent of the total value of Electrolux’s production.

In the United States, we employ 20,000 workers in dozens of

States and we purchase raw materials such as steel and plastics

and other finished components from domestic suppliers in the

range of $1.5 to $1.75 billion per year. In the past 5 years, we have

invested $700 million in plant and equipment in the United States.

With respect to international competitiveness, first, any changes

to United States laws governing international tax should not impede the creation of United States jobs and investment of debt and

equity capital into the United States by foreign companies, which

have a capital structure which has evolved for legitimate purposes

and is consistent with the recognized arm’s length standard.

Second, legislation should not target or discriminate against companies which were founded abroad and have deep historical ties to

their countries of incorporation.

I would like to briefly touch upon FSC and ETI. Legislation

which repeals ETI should be designed to help sectors of the United

States economy that currently benefit from ETI, and thus should

include foreign-owned companies which manufacture products in

the United States.

The FSC/ETI regime has been a factor in our decision to maintain and expand our production in the United States. Other countries offer subsidies and incentives to entice companies to locate operations there or have lower tax rates.

For example, Mexico and Canada have recently reduced their

marginal tax rates at 32 percent and 33.4 percent respectively,

which compares to the marginal income tax rate in the United

States of 39 percent when you consider State and local taxes. Without some alternative to the ETI regime, it would be more difficult
34

for foreign-owned companies to justify further expansion in the

United States.

Representatives Crane and Rangel have introduced H.R. 1769,

which would repeal current-law ETI benefits for transactions after

the date of enactment. This legislation recognizes the need to assist

those companies that currently benefit from ETI by providing transition relief until 2008.

In addition, it would provide a permanent new deduction which

reduces the effective corporate rate for United States manufacturers.

As the Senate Finance Committee continues its deliberations on

repeal of the ETI regime, it should not rule out transition relief

and corporate rate reduction for those companies making products

in the United States.

With respect to earnings stripping, Electrolux believes that beyond the context of inversions, the policy considerations related to

earnings stripping are not clear.

In particular, Electrolux believes that reforms to Section 163(j)

should target abusive transactions and not penalize legitimate

business transactions. Electrolux would not be affected by the earnings stripping proposal supported by this committee and the full

Senate because it has not entered into any transactions which can

be defined as an inversion transaction.

Electrolux commends the committee for addressing earnings

stripping in this narrow context. However, both the Treasury’s

earnings stripping proposal and H.R. 5095, as it was introduced in

the 107th Congress, raised serious policy concerns.

Both of these proposals unfairly target for adverse Federal tax

treatment foreign-owned enterprises that engage in legitimate

arm’s length transactions of the sort that United States-owned

businesses commonly undertake, both in the United States and

abroad.

In so doing, both proposals would serve to penalize those various

companies that are importing jobs into the United States. Both proposals are discriminatory, violate the arm’s length standard, and

would be in direct conflict with United States treaty obligations, including the United States-Sweden treaty.

Because it is very common for United States multinational corporations to capitalize their foreign subsidiaries in significant part

with debt as well as equity, these proposals create a substantial

risk of retaliation by our treaty’s partners.

Let me close by saying, as the committee works to address repeal

of ETI international tax reform, it should consider other incentives

to encourage investment in the United States, and also remove the

various disincentives.

Electrolux commends the Senate Finance Committee for including a provision in S. 1149, the Energy Tax Incentives Act of 2003,

which would provide a tax credit for manufacturers of energy-efficient appliances, including clothes washers and refrigerators.

This credit serves two purposes. First, the credit encourages investment in designing and manufacturing appliances which would

save energy. Second, the credit encourages companies like

Electrolux to continue manufacturing products in the United

States.
35

As Congress continues its consideration of the legislative response to the WTO ruling of the ETI regime as a prohibited export

subsidy, Congress should consider the role foreign-owned companies with substantial United States operations play in the United

States economy.

I would be happy to answer any questions the committee may

have.

[The prepared statement of Mr. Russell appears in the appendix.]

The CHAIRMAN. I will ask one question and then submit the rest

for answer in writing so my two colleagues can get in their questions before they have to go vote. The vote started about two minutes ago.

My question for each of you would be, how would the FSC/ETI

repeal affect your future expansion plans for your United States

operations?

Mr. RUSSELL. Well, I think the way we analyze capital investment, you do it on an after-tax cash flow basis, so any future investment or continued investment has to generate positive cash

flow. Therefore, any increase in tax liability obviously would affect

cash flow and it would affect future investment.

The CHAIRMAN. Mr. Spitzer?

Mr. SPITZER. That is true for us. As I mentioned, we have $600

million in exports annually, which is substantial. But Chairman

Thomas’ bill and the changes he has proposed to 163(j) would be

very negative to companies like Nestle.

We borrow to build factories and create jobs in the United States,

and that is all. What would happen as a practical matter, is that

our borrowing costs would go up and we would end up paying less

taxes, not more, if the proposals by Chairman Thomas and the

Treasury came to fruition.

The CHAIRMAN. Thank you. Senator Baucus?

Senator BAUCUS. Briefly, what advice do you have for us in Congress and the President to make investment more attractive here

in the United States for your companies, that is, to set up more

United States subsidiaries here?

Mr. SPITZER. As I said in my oral and written testimony, nondiscrimination and fairness between international foreign-based

companies and United States-based companies.

As a practical matter, though, I think the most effective way to

bring industry into the United States or keep it here is just to

abandon the corporate income tax and we could all get productive

jobs. But, as a reality, probably some sort of manufacturer-based

credit or incentive.

Senator BAUCUS. Where is the non-discrimination today, as you

see it, if any?

Mr. SPITZER. I see it, because we are a foreign-based company.

163(j) is one situation, the administration of transfer pricing

rules—not the rules themselves but the administration of them—

the penalty regimes.

There are many situations from a pure tax perspective where we

are disinviting foreign investment into this country. If we could

have some alleviation there, I think it would create more manufacturing, more jobs in this country. It is included in my written testimony.
36

Senator BAUCUS. Mr. Russell?

Mr. RUSSELL. I would agree with what Mr. Spitzer said. I think

we have to, as Senator Lott indicated, do something drastic in

terms of cutting the corporate rate, or providing a manufacturing

credit. I think that is the simplest and easiest thing for management to understand.

As you decide on where you are going to create plants and jobs,

that obviously is a key factor in the decision process. I saw a study

the other day. We have the highest corporate rates of any of the

G–7 countries, and I think we need to do something about that to

lower rates or to provide a manufacturing credit or we are going

to further drive manufacturing jobs offshore.

Senator BAUCUS. Thank you. Thank you very much.

The CHAIRMAN. The Senator from New Mexico.

Senator BINGAMAN. Thank you.

Let me just ask, Mr. Russell. You indicate problems with H.R.

5095, and also significant problems with what the administration

has proposed as part of their budget, indicating that, in your view,

both of those proposals would result in increased losses of manufacturing jobs in the United States.

I am just wondering, for example, in the case of the proposals

from the administration, what is the impetus behind those? I

mean, we, of course, just finished a major debate here on the socalled Jobs and Growth package. You are saying that you believe

what they said in the budget proposal we received from the administration will lose us jobs. What is the impetus behind it? At least,

what would you expect the administration would say in justification for their proposal?

Mr. RUSSELL. Well, I think the way I have heard it explained is

that the Treasury is concerned about inversions and it is concerned

about people creating debt in low-tax countries and siphoning off

some of the tax base into the low-tax countries.

They have used that as their policy justification for applying it

as a broad-based measure to everybody that is foreign-owned, and

without what I believe is any empirical evidence of it. Therefore,

I think that rather than targeting it to inverted companies, as you

folks have considered in the past, that this is something they feel

is an abuse without actually having any empirical evidence. I think

that is the impetus for it.

Senator BINGAMAN. It would seem to me that this is a very complex area of the tax law. At least, it seems so to me. I do not know.

Maybe it is easy for you folks. But it seems to me very complex.

It would seem that sitting down with representatives from some of

the key companies that work on these problems, and trying to get

some consensus on simplifying the law and dealing with the abuses

that both of you are talking about and are indicating you support

dealing with, would be the right way to proceed.

Has there been any effort to do that by Treasury, to actually sit

down and come up with some consensus proposals for solving these

problems?

Mr. RUSSELL. Well, I can tell you that we have met with folks

from Treasury and we have offered some suggestions to them about

how they could target the abusive situations and exclude us. We
37

have made some written statements to that effect and have had no

response from the Treasury on that.

Mr. SPITZER. I agree with Mr. Russell. We have met with Treasury a number of times. We would be happy to try to resolve any

abusive situations. We have asked Treasury for evidence and data

of abusive situations, other than inverters.

Companies like Nestle that have been doing business in this

country for 13, 15 years before the income tax, investing in this

country. We only invest and we only borrow to invest in businesses

and plants. The reason we have guaranteed debt, is so that our

parent can help us get the lowest possible borrowing rate, which

allows us to invest more.

There is no abuse going on in long-term, legitimate investors in

this country like Electrolux and Nestle. There are always a few bad

guys out there, but Treasury has not been able to entertain any

discussions with us to get to the problem.

If there is an abusive situation, we are happy to try to help resolve it because we do not like it any more than anyone else.

Senator BINGAMAN. Thank you very much, Mr. Chairman.

The CHAIRMAN. Thank you very much, gentlemen.

Mr. SPITZER. Thank you, Mr. Chairman.

Mr. RUSSELL. Thank you.

The CHAIRMAN. The committee is adjourned.

[Whereupon, at 12:00 noon the hearing was concluded.]

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A P P E N D I X

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