FROM THE OFFICE OF PUBLIC AFFAIRS

When I spoke to your annual conference last fall, I mentioned the creative dialog that has long existed between Treasury and TEI. Now that I have had six more months on the job, I have had an opportunity to observe this first hand, and that is why I appreciate the opportunity to meet with you today.

I want to touch on some issues of current interest. We were disappointed by the outcome of our government's appeal of the World Trade Organization's decision holding that our foreign sales corporation regime constituted an impermissible export subsidy that violates two WTO agreements. We are working with interested members of Congress, on a bipartisan basis, and with the business community, to devise solutions to this problem. Our goal continues to be a level playing field for United States companies, and I appreciate the assistance members of this organization have offered us on this issue.

After a series of corporate tax shelters were closed by either legislation approved by Congress or guidance issued by the Treasury and the IRS, the Administration included in its FY 2000 Budget proposals, released in February of 1999, a series of legislative proposals designed to curtail the proliferation of corporate tax shelters on a before-the-fact basis. At this point we had concluded that the ad hoc approach of past years, in which Congress or the Administration took action to close specific shelters as they came to our attention, was simply not working. We were outgunned and outmanned by tax shelter merchants. We were told that for each shelter we took action against, ten more were escaping without our notice. The situation was, and is, just like that of the mythical Hydra, except recast in the context of modern corporate finance. We were losing the battle for the integrity of our system of corporate taxation, and preservation of the corporate tax base.

We felt we had to do something to deter all participants in the shelter industry from designing, promoting, or entering into transactions devoid of economic substance, rather than wait for a plain brown envelope to be slipped over the government transom, or for a questionable transaction to show up on audit, with the prospect of years of litigation ahead, with the concomitant waste of productive resources for all parties. It is suggestive of the scale of the problem that specific shelters that have been addressed over the last few years were estimated to have cost collectively close to $80 billion over ten years.

Our goal then was to raise awareness that there was a problem and to explore the nature of the problem. Now, it is clear that there is widespread agreement and concern among tax professionals that the corporate tax shelter problem is large and growing, and we feel it is time to move ahead.

Curtailing the problem of transactions lacking economic substance requires that the tax shelter cost/benefit analysis be changed in a manner that affects the dynamics on both the supply and demand side of this 'market' -- making it a less attractive one for all participants -- 'merchants' of abusive tax shelters, their customers, and those who facilitate the transactions. We have a strategy for moving forward, consisting of three mutually reinforcing parts:

First, increasing disclosure of corporate tax shelter activities. On February 28, Secretary Summers announced the issuance of new regulations requiring promoters to register confidential corporate tax shelters and to maintain lists of investors, and requiring corporate taxpayers to disclose large transactions that have characteristics common to tax shelters. By definition, what we cannot see, we cannot act upon. Thus, a central element of our approach in curbing tax shelters is bringing these transactions to light and taking remedial action where appropriate. These regulations constitute a first step -- significant but quite incomplete.

Second, administrative reforms within the IRS and strengthened rules governing the practice of accountants and lawyers before the IRS. The administrative reforms, carried out as part of the IRS modernization mandated by the Restructuring and Reform Act of 1998, will provide the IRS with a more centralized approach to identifying, tracking, and taking appropriate action against abusive transactions.

The rules governing the practice of accountants and lawyers before the IRS are outdated. As Secretary Summers announced recently, the Treasury Department hopes to have a series of meetings with accountants and lawyers to discuss the problem of shelters and what might be the appropriate modifications to Circular 230. We see updating these rules as an essential step in improving upon the culture of compliance. We also were encouraged when Chairman Roth recently said he believed Congress should look at when a taxpayer may rely on a tax opinion.

Third, new legislation:

• to strengthen and better coordinate disclosure requirements;
• to provide increased penalties for abusive transactions;
• to codify the economic substance doctrine; and
• to provide consequences to all the parties to the transaction (e.g., promoters, advisors, and tax-indifferent, accommodating parties).

As I mentioned before, there is a great deal of consensus regarding significant aspects of the Administration's proposals on corporate tax shelters. Penalties, disclosure, and consequences for promoters are all core elements of a solution to the problem. We also, however, believe that codification of the economic substance doctrine is necessary.

Marketing of and participation in corporate tax shelters flourish today because:

• taxpayers and their advisors may be simply ignoring case law doctrines;
• an evaluation of case law has convinced the taxpayer and the taxpayer's advisers that a particular doctrine of case law does not apply because the facts of the transaction under consideration are distinguishable from prior cases; and
• taxpayers may be relying on decisions that are more favorable to the result they desire, while ignoring decisions less favorable (the "least common denominator" factor).

Increasing the substantial understatement penalty does little good if there is no finding of substantial understatement. Without codification of the economic substance doctrine, or a similar step, penalties will not be imposed on participants in shelters prior to a finding by the courts. Thus, we believe that enactment of only increased penalties and disclosure requirements, and consequences for promoters and tax-indifferent "enablers," will not place the bar for participation in abusive transactions high enough. As long as potential sanctions against abusive transactions are dependent upon successful litigation, taking years and requiring the devotion of immense private- and public-sector resources that could be deployed far more productively and positively in other endeavors, the corporate tax shelter industry will thrive.

The consequences of not taking action are grave. As Secretary Summers said recently, "Failure to address this issue in a meaningful way would put the fairness and efficacy of our tax system at risk."

I would like finally to discuss electronic commerce tax issues. As most of you know, the Supreme Court decided, several years ago in the context of mail order sales, that it would impose an unconstitutional burden on interstate commerce for one state to ask a seller physically located in another state to collect a sales tax on its behalf. As a result, purchases made on the internet, although in fact still subject to a tax (called a "use tax"), in practice enjoy virtual tax-free treatment because the seller is not obligated to collect the tax - as long as the seller does not have a physical presence such as a store or a warehouse in the purchaser's jurisdiction.

Internet businesses point to the burden that would be imposed if they were forced to collect sales taxes. They make the claim -- and rightly so -- that the enormous complexity of current state and local sales and use taxes would indeed make it excessively burdensome for a remote seller to have to collect taxes in multiple jurisdictions. The current network of sales taxes is too diverse and complicated -- there are over 6,000 separate taxing jurisdictions, each with its own definitions and rules. On the other hand, many state and local government officials are increasingly concerned that if electronic commerce continues to grow exponentially, as it has been, the tax base that supports our schools, our police and firemen, and other essential services will be seriously undermined. Sales taxes currently account for about one third of state and local tax collections. Main-street businesses are concerned about the unequal playing field -- if a book bought in one of their stores is taxed while one bought on-line is not taxed, in most cases it will grow increasingly difficult for them to compete.

I would like to highlight some components of the position the Administration representatives will be taking today in Dallas at the final meeting of the congressionally-appointed Advisory Commission on Electronic Commerce. We strongly support the growth of internet commerce. Electronic commerce and the associated explosion of the information technology sector are key sources of economic growth in the United States and around the world. Since issuing his, Framework for Global Electronic Commerce, in July 1997, the President and the entire Administration have focused on creating a policy environment in which this new medium of commerce will flourish.

This Commission was charged with examining some of the most difficult issues associated with this evolving marketplace. The three Administration representatives participated fully in the Commissions deliberations. They assessed the issues before the Commission on the basis of two fundamental principles:

• the internet and electronic commerce should not be subject to discriminatory taxes; and
• tax policy in this area should be neutral, nondiscriminatory, simple, certain, fair, and flexible.

Applying these principles, the Administration representatives reached the following conclusions regarding the key issues before the Commission:

1. Internet Access Taxes

It is critically important to encourage access to the internet. Because taxes on internet access would create an obstacle to Americans access to the internet, and in turn, their ability to participate in electronic commerce, these taxes should be prohibited permanently.

2. Multiple and Discriminatory Taxes

The current statutory moratorium on multiple and discriminatory taxes should be extended. Multiple or discriminatory taxes on electronic commerce plainly would hinder its development. This existing statutory moratorium should be extended and final protections against such taxes should be crafted after the States develop simplified sales tax systems.

3. State and Local Taxes on Telecommunications

States and local governments should work expeditiously, in conjunction with the private sector to simplify and reform these taxes. The goal of these reforms should be neutrality in taxation of telecommunications as compared to other sectors, as well as neutrality in taxation of providers of similar telecommunications services. This complex web of taxes is in large part a relic of the time when telecommunications services were a regulated monopoly -- taxes on these services were passed on to consumers through the regulated rate structure. Today, telecommunications on all levels have moved from regulated monopoly to competitive market, and the line between telecommunications and other types of services becomes less clear every day. State and local governments have recognized the pressing need for reform in this area. We believe that these governments, working in cooperation with businesses and consumers, can accomplish this goal.

4. State and Local Sales and Use Taxes

• States and localities should develop a simplified sales and use tax system within two years. During that time, the current rules governing this area -- which were established by the Supreme Court -- should remain unchanged.
• While this simplified system is being developed, States and localities should engage in a dialogue with businesses and consumers to address the complex and difficult issues regarding the application of these taxes to internet sales. These issues include:
• fairness to both internet businesses and bricks and mortar businesses;
• significantly reducing or eliminating the cost to businesses of collecting these taxes;
• the effect of these taxes on the international competitiveness of U.S. internet companies;
• whether lower-income Americans are paying, or will be required to pay, an unfair and disproportionate share of state and local sales taxes;
• ensuring protection of consumers privacy; and
• the feasibility of imposing and collecting sales taxes on goods delivered digitally over the internet (software, music, etc.).

Following development by the States of a simplified system, this issue should be addressed based on these considerations: The application of sales tax laws to internet transactions raises difficult issues. It is essential that we maintain the vitality of electronic commerce, which is one of the primary drivers of our economy. It also is essential that States and localities have the revenues they need to provide citizens with essential services -- such as education, police, and fire protection. Addressing this issue is extraordinarily complex for a number of reasons, including the fact that policymakers do not now have all of the information they need. Everyone agrees, however, that simplification is the key. So the States should proceed in developing a model act that produces real and effective simplification, while discussion on the other issues continues. While the model act is being developed, which is estimated to take two years, the current sales and use tax rules, established by the Supreme Court, should remain in place; they plainly have not hindered the growth of electronic commerce. In the event of any change in existing rules governing the application of sales and use taxes to internet sales, there should be full accountability so that citizens of each State can determine the appropriate consequences of any projected increase in revenue.

5. Federal Excise Tax on Communications

Phase out of this tax is a worthy policy objective and should be considered, but must be weighed against other worthy objectives including other proposed tax reductions, and must not be allowed to threaten the important priorities of maintaining fiscal discipline, paying down the national debt, extending the solvency of Medicare and Social Security, and maintaining core government functions such as health care and education.

This tax contributes more than $4 billion in revenue per year and $52 billion over ten years. Because of this substantial budgetary impact, phasing out of the tax cannot be considered in a vacuum, but must be weighed against other important priorities.

6. Customs Duties

The current moratorium on customs duties on electronic transmissions should be made permanent. Maintaining the moratorium on customs duties on electronic transmissions is a goal shared both domestically and internationally. There is a broad recognition that imposing customs duties on electronic transmissions would only undermine the ability to attract the investment and technology necessary to build and develop an e-commerce infrastructure.

7. International Taxation

Any taxation of electronic commerce should be neutral, nondiscriminatory, simple, certain, fair and flexible. Regarding international taxation of electronic commerce, our view is that any taxation of electronic commerce should be neutral and non-discriminatory. We must continue to work within the Organization for Economic Cooperation and Development (OECD) to agree on tax rules based on the principle of neutrality and other core principles, such as simplicity, certainty and fairness. We must also continue to work with non-OECD member countries. Global electronic commerce should not be impeded by globally inconsistent tax treatment and thus a global consensus must be reached regarding appropriate taxation.

As I just noted, the Advisory Commission on Electronic Commerce is holding its last meeting today. Representatives from industry and state and local governments have had opportunities to share their views on issues associated with electronic commerce. I would like to take this opportunity to recognize the hard work of many of the state and local representatives serving on the Commission, particularly the efforts of Governor Michael Leavitt, Chairman of the NGA.

Despite the Administration's substantial efforts to form a compromise position, through many meetings, telephone conference calls and exchanges of ideas, the commissioners have apparently reached an impasse and have not yet been able to bridge their differences in order to make recommendations to Congress. As a result, negotiations on a comprehensive set of recommendations that Governor Leavitt and others had crafted has stalled. This set of recommendations was based on a proposal endorsed by the business commissioners. We hope they can be revived, since there can certainly be no valid recommendations that do not take into consideration the needs of the state and local governments that provide essential civic services such as education and public safety -- just as there can be none that do not take into consideration the interests of all businesses, internet as well as bricks and mortar. We hope a compromise can be reached in the eleventh hour in Dallas.

Fundamentally, the issue of how e-commerce will contribute to the building and maintenance of our 21st century public services and institutions is a critical one. We cannot rush to judgment or let political rhetoric impede the resolution of these complex issues. We intend instead to continue our efforts to help the states and the business community arrive at a principled consensus.

Thank you.