A Shortsighted Tariff

October 28, 1963

The mere proposal by the President on July 18 of a retroactive tax on American purchases of foreign securities has already done great harm. It has brought about paralysis in such investment, created world uncertainty, and undermined confidence in the dollar. If the Administration does not withdraw the proposal, Congress should reject it promptly.

The proposal has now received impressive criticism from many quarters, but the most thorough analysis I have seen was in the Congressional testimony on Aug. 21 on behalf of the Investment Bankers Association of America by Amyas Ames, its president, and by Andrew N. Overby, chairman of its foreign-investment committee and former Assistant Secretary of the Treasury and deputy managing director of the International Monetary Fund. Let me summarize the chief points:

1—The proposed tax will adversely affect the U.S. balance of payments in the long run and will not significantly improve it in the short run.

Private foreign investment is an asset-creating expenditure. Current net capital outflows are offset by income from previous investments. From 1958 through 1962, income from all private foreign investment amounted to $15.4 billion compared with an aggregate net outflow for new investment of $16.6 billion. Moreover, in 1962 alone income amounted to $3.8 billion as compared with a net outflow of $3.3 billion.

Trade follows credit. With the dollars they obtain from U.S. purchases of their securities, foreigners buy our goods and services. Often the connection is direct. The Japanese Telephone Co. (KDD) raised $25 million through sale of securities in this country to lay a 3,000-mile submarine telephone cable from Tokyo to Hawaii. All of the money raised is being spent in America making jobs for American workmen. Apart from such examples of direct connection, our foreign investments provide foreigners with the necessary dollars to purchase our exports. If other things remain unchanged, our exports will tend to be reduced by the same amount as we reduce our foreign investments.

2—The proposed law is not addressed to the fundamental causes of the balance-of-payments deficit. The great “leakage” comes from foreign aid and other government programs totaling $4 billion in 1962 and overseas military expenditures reaching some $3 billion. There is little hope of correcting our balance-of-payments deficit unless we reduce these expenditures substantially, improve our cost position in relation to our competitors abroad, and increase the attractiveness of foreign investment in the United States.

3—The proposed tax would be more accurately described not as a tax at all but rather as a new protective tariff to limit the importation of foreign securities. So viewed, the so-called “tax” represents a retreat from our long-standing policy of freedom for capital movements.

4—The United States capital market, and foreign economies dependent upon it, may be seriously damaged. The U.S. is now the only free capital market in which the amount and terms on which an issuer can sell its securities are limited only by the marketplace. This is a precious national asset. It should not be dissipated without convincing reasons of national interest.

5—The proposed tax may create fears of further restrictions. We must not impair the value of the dollar as the key currency of the world. Diminished confidence in the dollar can only have an adverse impact on our balance of payments.

6—The proposed tax is discriminatory. It selects only one aspect of private expenditure abroad—private portfolio investment—for restriction through a special tariff while leaving unaffected private expenditures abroad for tourism, direct foreign investment, and commercial bank loans.

7—The proposed tax is administratively complex.

I have only one serious reservation to this admirable analysis. I wish it had recognized more clearly that the basic cause of our so-called balance-of-payments problem is our domestic inflation, reflected through our huge past and prospective budget deficits and our cheap-money policies. We are driving dollars and investment abroad as much by holding down long-term interest rates as by holding down short-term interest rates.