Bring U.S. tax law into the 1990s.

The U.S. tax law for operations outside the U.S. is outdated. The law is structured on a set of fundamentals that came out of the mid-1960s, when the U.S. was the largest supplier to the world's capital markets. But today, the U.S. is the world's largest debtor. U.S. investment abroad has grown nine times since the mid-'60s, but foreign direct investment in the United States has grown 40 times. Our exports 25 years ago doubled our imports. Now we have the largest deficit in balance of trade in the world. You might think that deficit results from oil imports. it doesn't. The percentage of oil imports relative to total imports has stayed absolutely the same through that entire period.

International trade was a small part of our total GNP back in the 60s. We almost ignored the foreign aspects of business and the tax law. U.S. multinationals had more than 70 percent of their entire business in the United States. But today, U.S. corporations conduct more than 50 percent of their business outside the U.S. IBM, for example, has almost two-thirds of its business outside the U.S, In the 1960s, 18 of the world's top 20 industrial corporations were American companies. Today, only nine are American.

That's the bad news. The good news is that most economists say that we have a very good chance of returning to outward investment at a greater pace than inward investment by the end of the decade. But our tax law, unless it is amended to take into account the reality of international business today, will make it difficult for U.S. business to achieve that objective.

One of the major problems is that the U.S. taxes a business on its worldwide income. But many other countries consider their foreign business earnings to be exempt. in these countries, if foreign business is taxed at all, it's taxed at the source. When income is returned to the home countries, it is considered an increment of wealth to the home country and is not taxed again. Yes, the U.S. does have a foreign tax credit system. But over the last five to six years, that system has not only been made very complex, but has in fact been shattered. Now, a U.S. company's book effective tax rate is often higher than that of other multinationals based in other countries because of U.S. tax rules on foreign-source income.

Europe has gone in a different direction. As Europe reaches 1992, the EC has removed numerous tax barriers. It will allow tax-free mergers between Belgium and Britain, for example. Companies will he able to move dividends, royalties, and interest tax free inside Europe. And, of course, for business outside of the EC, the EC has the value-added tax, which allows companies to make adjustments for their sales taxes at the border. But our major tax, the income tax, does not give us this flexibility.

In the future, U.S. tax policy-makers need to take into account the way other countries tax their multinationals. Otherwise, tax competition will leave America short-changed.

Joint ventures

Until 1985, it was almost unheard of in my company to go into joint ventures. IBM wanted to own 100 percent of the companies it invested in. Today, we're forming about 300 joint ventures a year, many of them outside the U.S. But because U.S. tax law is based on a period of time when very few companies formed joint ventures, it imposes tremendous impediments. For instance, if you set up a joint venture and transfer people and technology to the joint venture, you're penalized unless you set up a royalty relationship. That impedes the formation of a joint venture. Your foreign partner says, "Look, I'm putting my technology in. But I'm not receiving a royalty, so I'm not going to let you draw out royalty income. That's your investment in the joint venture."

Technology

The government is reworking the rules on research and development - the rules on what's a super product and how much you have to charge a related company for that super product. U.S. tax rules governing computer software development are at a crisis. The government wants to capitalize software development, for tax purposes, and not allow such costs to be deducted. Again, the thinking is focused on "shrinkwrap," off-the-counter PC type of software, without considering the large software systems, which can be very expensive.

No other country would consider subjecting their premiere technologies to such harmful tax rules. A cautionary note: the U.S. must tread very carefully in this area if we are going to retain a leadership role in the world's economy.

State taxes

There are a few states left California being the leading example - that still think they have the right to tax foreign business through the dividend remittances. Probably no other state income tax provision is so universally distasteful to American business. It provides an obvious competitive tax advantage to foreign-based companies, whose non-U.S. income is not similarly taxed by the states.

With so many states today facing budgetary crises, it is important that they react prudently and avoid expanding their tax bases in this discriminatory fashion.

What can we expect?

Not a pretty picture, but there's hope. The House Ways and Means Committee will have two hearings this year, and is trying to put out two bills. One is for simplification. A middle-sized company involved in international business cannot comply with tax laws in the United States today. You pay significant fees to a major public accounting firm to comply, but there comes a point when it's not feasible to pay any more fees. You have to give it short shrift.

The second is for competitiveness. You know, there are Congressmen who will say to you, "I don't believe taxes impede your competitiveness. It's your own damn fault." It may be our own damn fault, but they're certainly not helping us.

So, my message to you is: get out the message that you can't carry the burden of U.S. taxes on foreign operations that are greater than the taxes you have to pay overseas. Work through your organizations, as we are working at Finandal Executives Institute, to let Congress know that you can't have a further impediment to the way you operate. It's time to bring our tax law into the reality of the 1990s.

--Robert N. Mattson

Mr. Mattson is assistant treasurer of IBM. He served as chairman of FEI's Committee on Taxation from 1987 to 1989, and continues as an active member of the committee. This article is based on his comments before FEI's Connecticut/Westchester Chapter.