Foreign Relations of the United States, 1969–1976, Volume III, Foreign Economic Policy; International Monetary Policy, 1969–1972

11. Memorandum From the Assistant Secretary of the Treasury for International Affairs (Petty) to Secretary of the Treasury Kennedy¹

Washington, March 17, 1969.

SUBJECT

• Interest Equalization Tax

The Problem

The IET expires on July 31 of this year. In view of the necessity for Congressional consultations and the likely extensive drafting time, we must plan now for the extension.

Congress has never been favorably disposed toward the IET but rather has supported it because of its necessity. The tax was proposed in 1963 and the Act only passed a year later. The Act has been renewed twice, in 1965 for 18 months and in 1967 for two years. In the most recent extension, the maximum rate of tax was increased (from one percent to 1-1/2 percent per annum) and the President was given discretionary authority to vary the rate of tax.

Our problems with the balance of payments are still with us and undoubtedly will continue to be after July 31. Therefore, we will need the IET, at very least on a standby basis, as a means to restrain capital outflows from the United States. The IET has been very useful in effecting such restraint on portfolio outflows and bank lending to foreign borrowers and has supplemented both the Federal Reserve and Commerce Department programs. These are reasons enough to continue the tax.

The IET also will provide a very flexible policy instrument in the future when it may be appropriate to relax our monetary policy at least for domestic purposes. We would not want to be constrained from taking this action in fear of substantial capital outflows. Accordingly, extension of the IET will preserve our ability to carry out a relatively autonomous monetary policy.

In the prospective phasing out of our capital controls, there is the possibility that we may face large capital outflows by U.S. residents. There is undoubtedly substantial latent demand to purchase foreign securities or Euro-dollar convertible debentures issued by American corporations in recent years as well as to lend to major foreign borrowers. Therefore, to permit better phasing out of our capital controls and to mitigate these incipient outflows, we should retain a flexible IET.

Possible Legislation

The IET Act now on the books is a workable and effective instrument. There are a number of technical points, both substantive and non-substantive, which could be clarified in renewal legislation. However, if such amendments were to jeopardize the prospect of renewal, it would be entirely feasible to continue the IET without amendment.

Renewal is strongly recommended for the reasons cited above. If Congressional soundings indicate any substantial opposition or complications from an attempt to introduce amendatory legislation, then we should seek renewal without amendment.

The tax rate may now be varied from zero to 22.5 percent of the value of the security or loan subject to tax (equivalent to a maximum interest rate of 1-1/2 percent per annum). The President has the right to vary the rate by Executive Order. The maximum rate has proved to be effective in restraining almost all outflows for debt securities and loans and most equity securities other than speculative mining stocks. Accordingly, there is no reason to seek a higher statutory maximum rate or any change in the discretionary authority to alter the rate.

The IET rate now must move together for the tax on acquisition of both stocks and debt instruments. In the past, Treasury has always rationalized the IET rate in relation to debt issues. There is very little economic basis for holding that the IET rate should move together on both debt and equity issues. It thus might be preferable to consider having the tax move separately, at the discretion of the President, and possibly to set a higher maximum rate of tax for the purchase of equity securities. However, such a proposal would draw the opposition of the investment community as it has in the past, present substantial drafting and administrative problems and likely complicate renewal legislation. Accordingly, it appears favorable not to introduce any amendment in this area.

An amendment should be considered to give the President discretionary authority to exempt new issues from the application of the tax while retaining the tax on outstanding securities. We have such a precedent established in the present exemption of new Canadian offerings from the tax while the IET barrier still applies for outstanding Canadian securities. The introduction of such discretionary authority on a global basis among the developed countries wherein the IET applies, would give a new degree of flexibility for phasing out our capital controls. In particular, this would give more latitude to permit a limited amount of capital outflows for new financings in the U.S. markets without incurring substantial risk of large portfolio capital outflows to purchase outstanding foreign securities (particularly equities).

There are several other housekeeping and technical improvements that we could make in this legislation. For the most part, the matters are non-substantive, but they would close loopholes and improve administration. There are a number of substantive matters which should be handled by legislation (e.g., the IET status of leases, oil and gas interests and other hybrid ownership interests such as commodity futures; the treatment of captive foreign sales finance companies; and the treatment of foreign stock or debt obligations acquired out of foreign sourced borrowings). Among the substantive matters, it appears that amendments relating to the treatment of leases and captive foreign sales finance companies are the most important. In these two areas we find the greatest number of taxpayer questions and possible inequities in interpretations of the present statute. The current law is awkward in delineating conditions to grant partial exemption of individual countries from the application of the IET. At present, countries can be exempted only by classification as “less developed” or through the finding by the President that exemption in whole or in part is required in the interest of international monetary stability. Over the years we have had numerous requests (e.g., Bahamas, Iran, Ireland, Spain) for partial or total exemption from the IET. In most cases the requests have been founded more on political grounds than on any economic hardship. Any amendment to give the President greater discretion in granting partial exemption from the IET to particular countries would undoubtedly severely complicate renewal legislation and bring a host of foreign governmental requests for exemption. Accordingly, it is recommended that no amendment of this sort be considered.

Recommendations:²

1. That you authorize Messrs. Cohen and Petty to begin immediately soundings on the Hill of a proposal to renew the IET legislation for two years from its expiration on July 31, 1969. Such soundings would especially involve the schedule for public and executive hearings and the relation of such hearings to the schedule for tax reform hearings.

2. That the soundings include discussion of an amendment to give the President authority to exempt new issues while maintaining the tax on outstanding issues from countries to which the tax now applies.

3. That the soundings include discussion of technical amendments, including substantive changes relating to the treatment of leases and captive foreign sales finance companies.

1. Source: Washington National Records Center, Department of the Treasury, Secretary’s Memos/Correspondence, 1966-1970: FRC 56 74 7, Memo to the Secretary, March-April, 1969. Limited Official Use. Drafted by J. C. Colman on March 17. Sent through Volcker. A stamped notation indicates that Volcker initialed the memorandum. It is attached to Volcker’s March 18 handwritten transmittal note to Kennedy: “My only added thought here is that the ‘soundings’ should be coordinated with proposed announcement on controls. This extension should be proposed, in general terms, at time of relaxation.” Kennedy’s handwritten reply on Volcker’s note reads: “I agree. After the extension is proposed begin checking in Congress to determine whether any changes should be made.”
2. There is no indication of Kennedy’s approval or disapproval of the recommendations.