FROM THE OFFICE OF PUBLIC AFFAIRS

Thank you. I am pleased to be here with you today. I would like to thank Bob Vastine, President of the Coalition of Service Industries, for that kind introduction. And, I would like to thank him and Alan Lipner of the Tax Council, for their invitation and for making this joint gathering of your two organizations possible.

We come together at an exciting time. America is experiencing enormous progress and prosperity that few could have imagined at the beginning of this Administration. Indeed, we are in the midst of the longest economic expansion in our nation's history.

This prosperity is being fueled by both information technology and globalization. And today, I would like to talk to you about some high-profile tax issues that have arisen as a result of these two developments.

Information technology and globalization have ushered in an economic transformation as profound as that of the Industrial Revolution of the 19^th century. The scale of change is enormous, as are the potential benefits. Trade barriers have fallen, the market for capital is international, access to information from around the world is instantaneous, and economies are increasingly interconnected.

The challenge that we as policy makers face is to take this landscape, and use it to create the best conditions for stability and growth of the world economy. Some have urged us to do so by applying developments in the trade area to the tax area. And the tax area does have in common with the trade area certain guiding principles, including neutrality, about which I will talk more later. But it would be perilous to apply our trade rules and policies indiscriminately in the tax area.

For example, we need look only at our recent FSC experience to realize that our trade bodies may be the wrong fora in which to resolve disputes over tax differences. You are probably aware that the U.S. essentially argued in the FSC case that the OECD is the forum of choice for resolving tax issues.

Similarly, we must be careful about accepting on faith the sound byte that our tax rules should be more like our trade rules. For example, our trade policy generally encourages the elimination of tariffs as an inducement to greater trade. In the tax area, however, even though we use our tax treaty program to lower gross withholding taxes and thereby spur capital investment at the margins, we could not and should not pursue a policy that seeks to eliminate taxes on cross-border activity, at least as long as we need to raise revenue to fund programs demanded by the public. As EU Trade Commissioner Pascal Lamy said last week in Tokyo, a central dilemma with which we must grapple is how to "free up factors of production in the process of wealth creation whilst preserving the capacity of the state to harness and shape globalization to the public good."

To meet this challenge, and help create the best conditions for stability and growth, we have historically followed a number of policy goals in the international tax area.

• To meet America's revenue needs in a fair manner;
• To maintain neutrality and minimize distortions that can be created when tax considerations play an undue role in investment decisions;
• To minimize compliance and administrative burdens; and
• To conform with international norms, where possible.

I would add to these that we also need to:

• Avoid disadvantaging U.S. companies as they compete in the global marketplace;
• Maximize the coordination of our tax rules and policies with those of other countries so as to prevent both double taxation and unintended double non-taxation;
• And minimize inappropriate discrimination in the taxation of similarly situated taxpayers and transactions.

To illustrate how these policy goals are applied in practice, I would like to touch on four areas of current interest in the international tax area:

1. The debate with the EU over VAT policies on digitally delivered products.
2. International cooperation in the OECD on the subject of harmful tax competition.
3. The growing phenomenon of unintended double non-taxation through cross-border tax arbitrage.
4. Lastly, I will give you a status report on recent developments concerning the FSC.

One concern that cuts across all these issues is the importance of addressing them in a multilateral context. And time and again, the OECD has proven itself to be the forum in which they can best be addressed. Unfortunately, the OECD has been underutilized on some key issues lately. This is illustrated by the EU's handling of its recent VAT proposal.

We have several concerns about the European Commission's proposed directive under which (1) EU value-added-tax (VAT) would be imposed on purchases of digitally-delivered products by EU consumers from non-EU vendors, and under which (2) such non-EU vendors would be required to register in an EU country and collect and remit EU VAT.

Let me say first of all that we recognize that the proposal seeks to address what is perceived to be an uneven playing field between EU and non-EU vendors of digitally-delivered goods. Nonetheless, the Administration has serious concerns with both the substance of the Commission's proposal and the process by which the proposal was formulated.

Regarding the substance, we have four specific concerns, each of which has the potential to shift commercial activity away from the Internet.

1. Non-Neutrality

First, we are concerned that the proposal has the potential to operate in a non-neutral manner both in law and as administered. For example, under the proposal, books and newspapers delivered electronically would be subject to VAT at a rate higher than the rate on their physical equivalents.

In addition, the current proposal includes none of the administrative de minimus rules that apply with respect to physical goods. Thus, software delivered physically from outside the EU will not be subject to VAT if the price is less than the de minimus amount, while the same software delivered electronically would be subject to VAT.

2. Unintended Consequences

Our second concern is about possible unintended consequences of the proposal. Specifically, while the proposal is limited to indirect tax, we are concerned about the potential impact the proposal may have on areas outside of tax, such as trade, jurisdiction and privacy, that could be extremely damaging to the development of a truly global marketplace. For example, we would not want a proposal regarding the application of EU VAT to end or skew the current debate about which countries' consumer protection rules should apply to e-tailers or whether digitally-delivered products are goods or services for customs purposes. Compliance with the EU VAT proposal could ultimately require e-tailers to turn over to tax authorities the addresses and buying habits of their customers; we would not want this tax proposal to erode consumers' privacy rights or unintentionally encourage governments to track on-line activities.

3. Harm to Industry

Third, the draft directive may harm many companies in the private sector. For instance, in response to the Commission's action, other countries may adopt registration regimes for VAT and possibly other purposes. Registration thereby may be required in more than 100 countries, making e-commerce impractical for many, including European, firms. In addition, those companies that do obey the directive by registering may suffer because of the difficulties of enforcement. There could be an unintended shift on the part of consumers to seek out those sites that have not yet registered and do not collect taxes.

4. Administration and Enforceability

Finally, the proposal contains no specifics regarding the administration of the new system. Although under the proposal non-EU vendors would be required to collect and remit EU VAT on sales to EU final consumers, the proposal provides no guidance on how vendors are to determine either the VAT status-whether business or consumer-or the residency of the purchaser. Further, the proposal contains no specifics regarding audit or enforcement. We are concerned that the proposed regime may prove unenforceable or enforceable only through drastic methods, such as monitoring customer downloads or blocking access to a vendor's web site.

As for the process by which the proposal was formulated, we believe such complex, multi-jurisdictional questions should be handled within the OECD. The U.S., the European Commission, and the Member States have all been working within the OECD with other stakeholders, including the private sector, on the very complex substantive and administrative issues associated with e-commerce taxation. The OECD is and should be the forum in which we form the international consensus necessary to ensure that taxation does not hinder the further growth of the Internet and electronic commerce. The OECD process is proceeding well and should produce recommendations next year, including, among others, possible VAT collection mechanisms.

In response to our stated concerns, the European Commission has repeatedly answered that its VAT proposal is consistent with the OECD framework conditions agreed to in late 1998 in Ottawa.

Let me respond very directly to this point. We do not dispute that the Commission's proposal is consistent with the OECD framework condition that consumption taxes are due to the jurisdiction in which the product is consumed or used, nor do we dispute that the proposal is consistent with the framework condition regarding classification of digitally-delivered products as "other than goods" for VAT purposes.

Rather, as I just described, our opposition stems from the proposal's violation of the bedrock tax policy principle of neutrality, which is also an OECD framework condition agreed to by all OECD members. As the OECD framework sets forth, "taxation should seek to be neutral between... conventional and electronic forms of commerce. Business decisions should be motivated by economic rather than by tax considerations."

We are encouraged that the Commission has indicated that it intends to continue working within the OECD on this important issue and we remain hopeful that we can resolve our differences within the OECD. We fully recognize the difficulty and complexity of the issues with which the Commission is grappling. Nonetheless, we do not believe these justify the unilateral imposition of a non-neutral regime that is difficult to enforce and targeted at a sector that is just beginning to grow.

You can see from this discussion how our position on the EU VAT proposal implicates several of the policy considerations I mentioned earlier. To name just two: The policy that business decisions should be motivated by economic rather than by tax considerations; and the policy that we should maximize the coordination of our tax rules and policies with those of other countries. These very same policies have also motivated our efforts in the area of harmful tax competition.

On the release of the OECD's recent tax competition report, Secretary Summers said "The identification of tax havens and potentially harmful tax regimes is a crucial step in preventing distortions that could undermine the benefits of enhanced capital mobility of today's economy." This comment illustrates that, for regulators and policy makers who want to provide the healthiest framework for sustained economic growth, international activities present not only opportunities, but challenges as well, and our harmful tax competition initiatives are an important set of responses to these challenges. You can think of them as some of the rules of the road for responsible globalization.

Since much of the publicity surrounding the OECD's tax competition work has centered on its tax haven element, I would like to focus on that. But first, let me give you a bit of background.

Tax competition occurs when one country provides a tax inducement - i.e. a subsidy - to attract capital from another country. When practiced unfairly, tax competition can severely erode the capital tax base and undermine the fiscal stability of the losing country. As a country whose tax system is characterized by a relatively broad base and relatively low rates, the U.S. has much to gain from the elimination of harmful tax practices by tax havens and other jurisdictions. But for developing countries, this issue can be even more critical, as tax base erosion can translate directly into increased poverty. At a recent 60-nation conference on tax competition in Paris, delegates from developing countries warned against the threat that tax competition could contribute significantly to a backlash against globalization. And it is not in America's interest if developing countries reject globalization because of perceived tax base erosion through the use of tax havens and other harmful tax competition.

Ultimately, regardless of the country whose tax base is eroded, it is individuals and businesses, not governments, who are hurt by harmful tax competition. Tax competition forces countries to focus on funding government services less through the taxation of capital income, and more on the taxation of relatively immobile tax bases such as wages and consumption. And it forces tax rates up.

As with subsidies or tariffs, harmful tax competition distorts investment decisions and diverts capital flows to less-than-optimal uses. In tackling these practices we are seeking to help businesses compete on a level playing field and promoting the health of the global economy and financial system. Accordingly, in the same way that it is critical that governments build consensus to ensure that the taxation of e-commerce does not give rise to distortions, it is also important that we foster a climate of cooperation among nations to combat harmful tax competition.

The cooperation that has already resulted from this work is impressive. When the OECD last month published a report of its work on harmful tax competition, the tax haven list drew the most attention, but of even greater importance is the commitment of six-non-OECD members, including Bermuda and the Cayman Islands, to join OECD members in cooperating to eliminate their harmful tax practices. And every day, gratifying evidence of new cooperation by tax havens is surfacing.

Let me also note that, in addition to the OECD, our bilateral treaties are a natural area for coordination to eliminate some of the abuses facilitated by harmful tax competition. For example, the information exchange provisions of our tax treaties and tax information exchange agreements allow us to collect information to combat tax evasion and abusive tax avoidance. For this reason, we are paying great attention to our exchange of information programs, and carefully monitoring the efficacy of our current treaty relationships.

In addition to the policies relating to neutrality and international coordination, the base erosion concerns addressed by the tax competition work implicate the fundamental tax policy imperative of meeting our revenue needs in a fair manner. Another subject that implicates all of these policy concerns is the growing phenomenon of cross-border tax arbitrage.

Cross-border tax arbitrage involves the exploitation of differences in the tax laws of two or more jurisdictions where the tax results may be technically legal under the laws of each of the jurisdictions but where the laws interact to undermine the tax principles on which they are based. Tax arbitrage achieves many of the same results as harmful tax competition, but can be more insidious because, typically, arbitrage exploits a jurisdiction's laws in an unintended manner.

To policy makers, the fundamental question raised by cross-border arbitrage transactions is not whether they literally comply with the technical rules as they exist today, but whether the rules should be interpreted, clarified or modified so that the foreign aspects of the transaction are more clearly taken into account. In a globalized world, we cannot shut our eyes at the border. We take into account foreign tax consequences in our domestic laws to help prevent double taxation through the foreign tax credit. We must also take into account foreign tax consequences in our domestic laws to help prevent inappropriate double non-taxation. In the domestic context, we regularly apply the "matching principle" to help ensure symmetry between income and deductions. In the international context, our failure to do so can result in income without taxation anywhere in the world.

How should we address cross-border tax arbitrage? Well, we can do so unilaterally by amending our laws, and Congress has done so on numerous occasions. For example, in 1997, Ways and Means Committee Chairman Archer introduced what became Internal Revenue Code section 894(c), to address cross-border arbitrage involving treaties and our "check-the-box" regulations.

But coordinated action can be more effective. And so we are working in both the treaty context and in multilateral fora like the OECD to address this growing phenomenon.

Before closing, I would like to give you an update on the FSC issue. As you know, we are currently working with the Congressional tax leadership and the Joint Committee staff to develop a replacement for the FSC regime in response to the decision of the WTO. Congressional and Treasury staff have been working diligently to complete a draft of our proposal, and we are scheduled to hold a mark-up of that proposal tomorrow morning.

We have worked closely with Congressional leaders and the private sector to prepare a proposal that enjoys bipartisan support. But even as we work with Congress, we remain open to suggestions from our partners across the Atlantic. Our preference is to work with Europe and have a common view going forward. At the same time, prolongation of this dispute through WTO channels could erode support for the WTO and risk adverse consequences for transatlantic cooperation. I hope we can avoid those consequences.

In the new global economy, business transcends national borders. The global flow of capital, information, ideas and products is yielding enormous benefits for economies throughout the world. But these benefits bring concomitant challenges. Although these challenges may be new and unprecedented, we have firm principles upon which to stand as we meet them. In formulating policies that will foster the growth of tomorrow's industries, we must continue working together with our global partners in multilateral fora and join with them in reaffirming our commitment to the fundamental tax principles that I have outlined today.

Thank you very much for your attention, and I would be happy to take questions.