117. Current Economic Developments1
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CONGRESS ASKED TO CONTINUE INTEREST EQUALIZATION TAX
Secretary Fowler announced on January 25 that Treasury is sending to Congress a bill: a) to extend the Interest Equalization Tax for another two years, b) to give the President authority to vary the effective annual rate of the tax between zero and two percent per year, and c) to raise the effective rate to two percent retroactive to the date of submission.2 Unless extended, the IET would expire July 31, 1967.
The Interest Equalization Tax is an essential part of the US balance-of-payments program. As it now stands, it seeks to abate the outflow of dollars from the US by adding approximately one percentage point to the annual interest costs to foreigners from developed countries (excluding Canada from all new issues and with a limited exemption for Japan) who borrow in the US for periods of one year or longer. Similar provisions apply to the purchase of foreign equities by US residents. The tax has been useful in holding down our balance-of-payments deficit by limiting [Page 339] new foreign borrowing in US capital markets, in limiting purchases by US residents of outstanding foreign issues, and in reinforcing the Federal Reserve voluntary restraints program on capital outflows by financial institutions. The extension is necessary while pressure continues on our balance of payments, while capital markets abroad continue to be insufficiently responsive to domestic and international needs, and as a reinforcement to the continuing voluntary program administered by the Federal Reserve Board.
Rates of Tax
The maximum effective rate of 2 percent per year would be double the rate under the present law. To achieve this objective, the tax on the acquisition by a US person of a debt obligation of a foreign obligor would be increased in accordance with a table on the basis of the period remaining to maturity, to achieve such an effective rate. Debt obligations with a period remaining to maturity of less than one year will continue to be exempt from the tax. The tax on an acquisition by a US person of stock of a foreign issuer covered by the tax would be increased from 15 percent to 30 percent.
Flexibility
The bill would give the President authority to increase or decrease, by Executive Order, the rates of tax if he finds that the rates currently in effect (whether such rates are those set forth in the statute or a prior Executive Order) are lower or higher than those necessary to limit the total acquisition by US persons of stock of foreign issuers and debt obligations of foreign obligors within a range consistent with the balance-of-payments objectives of the US. The proposed flexibility would thus facilitate the lowering of interest rates in the US, providing protection in the case of a possible emergence of a wider difference in the yield on investments in this country and elsewhere, and providing a tool that could be used sensitively to affect yields on the foreign investment of US funds in response to changing needs and comparative costs of money here and abroad.
To ensure that the proposed flexibility does not induce accelerated purchase by US residents of foreign debt obligations or foreign equities prior to enactment of the legislation, the bill sent to the Congress would make the new rates effective January 26, 1967.
Exemptions
Loans connected with exports continue to be exempt from the IET so as to assist the American business community in keeping US exports—a major favorable element in our balance-of-payments accounts—at a high level. There is no change in the exemption afforded direct investments. Moreover, loans to and investments in less-developed countries [Page 340] are exempt from the tax, as before. The existing exemption for new Canadian security issues is continued, as is the limited exemption for loans to Japan.
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