SECTION 911: MAKING A DIFFERENCE FOR U.S. COMPANIES AND AMERICAN WORKERS OVERSEAS

Washington, DC
30 June 1999

Remarks of Mr. David Hamod
Executive Director
Section 911 Coalition

Thank you, Mr. Chairman, for the opportunity to testify today. My name is David Hamod, and I serve as Executive Director of the Section 911 Coalition. Our coalition consists of business organizations, non-profit entities, and companies that have come together in recent years to call attention to the importance of the Section 911 foreign earned income exclusion. The Coalition has some 75 members, including representatives of more than 75 American chambers of commerce overseas and nearly 550 American and international schools abroad. (A list of Section 911 Coalition members is attached to this testimony as Appendix A.)

In recent years, the stock market notwithstanding, exports have been the most impressive engine of growth for America's economy. It goes without saying that exports don't just happen by themselves. Independent studies and raw statistical data show a direct correlation between the number of Americans working overseas and the level of U.S. exports. Any business owner will tell you that to generate business, you've got to put your sales people in the field. Experience shows that Americans abroad are the best salesmen and saleswomen for U.S. goods and services overseas. The bottom line, Mr. Chairman, is this:

Americans Abroad = U.S. Exports = U.S. Jobs.

In the ongoing battle for international market share, the Section 911 exclusion has proved to be one of the most important weapons in America's trade arsenal. By helping to maintain U.S. citizens "in the field" around the world, where they promote America's national interests on a daily basis, Section 911 has had a direct impact on the competitiveness of American workers and U.S. companies operating in foreign markets.

Two years ago, the Ways and Means Committee responded very positively to an initiative by Americans worldwide to increase the foreign earned income exclusion. Under your leadership, Mr. Chairman, the Committee (and ultimately, Congress) increased Section 911 by $2,000 per year, leveling off at $80,000 in calendar year 2002. Beginning in calendar year 2008, the $80,000 exclusion will also be adjusted for inflation for 2008 and subsequent years.

We are very grateful for this increase, which has helped to shore up temporarily the backsliding that the foreign earned income exclusion has experienced for more than a decade. But as you have said yourself, Mr. Chairman, our work is not yet done. The changes of two years ago represent an important step in the right direction, but U.S. companies overseas and American workers abroad must continue to make their case to Congress to level the international business playing field for the United States.

Even with the positive changes enacted under the Taxpayer Relief Act of 1997, the Section 911 exclusion continues to lose ground. According to PricewaterhouseCoopers LLP, the 1999 exclusion amount, in real dollars, is 45 percent below its level in 1983 ($80,000 in nominal dollars and $134,197 in 1999 dollars), following passage of the Economic Recovery Tax Act of 1981. The real value of the exclusion is projected to continue falling after 1999 and is expected to stabilize in the year 2007 at approximately $65,150 in 1999 dollars. Looked at from a "purchasing power" point of view, the value of the exclusion will have plummeted in real dollars from $134,197 (1983) to $65,150 (2007), a devastating loss of nearly $70,000 in 1999 dollars. Under these circumstances, Mr. Chairman, the Section 911 Coalition is very concerned about "locking in" indexation of the exclusion at an unacceptable level from the year 2008 onwards. (A copy of the June 28, 1999 report by PricewaterhouseCoopers LLP - The Effect of Inflation on the Foreign Earned Income Exclusion Amount - is attached to this testimony as Appendix B.)

Ideally, Congress should remove the limitations on the Section 911 exclusion in order to give American workers an equal footing in the global marketplace. None of America's major trade competitors tax foreign earned income, and the U.S. should also move to an unlimited exclusion. (The only countries that tax on the basis of citizenship rather than residence, like the United States, appear to be Bulgaria, Gabon, Honduras, Indonesia, Jamaica, Kenya, Korea, Philippines, Senegal, and Zambia.) Reinstating the unlimited exclusion today would be a forward-looking measure and would do more to move the United States toward a consistent foreign trade surplus than would many other proposals under consideration by Congress.

We realize, however, that removing the cap on the foreign earned income exclusion may not be possible at a time when Congress is grappling with so many major budgetary considerations. This is especially true because under the current revenue estimating procedure, the unlimited exclusion, in the short-term, would somewhat curtail tax revenues. Our Coalition would argue, however, that in the medium-term and long-term, net revenue gains would be substantial and would more than compensate for short-term losses.

With this in mind, Mr. Chairman, the Section 911 Coalition proposes an interim measure for the Committee's consideration. This step is designed to restore value to the exclusion that has been eroded over the years as a result of inflation.

We propose that the foreign earned income exclusion be adjusted, beginning in calendar year 2000, to compensate for the effects of inflation since 1983, when the Deficit Reduction Act of 1984 froze the exclusion at $80,000. This indexation would help to stop the deterioration of Section 911, and it would also be consistent with the inflation adjustments made in many other dollar amounts in the individual income tax system -- the standard deduction, personal exemption, tax bracket amounts, earned income credit, phase-out of itemized deductions and personal exemptions, and so on.

Enactment of this measure would represent an important step forward for U.S. companies and American workers overseas. Our Coalition believes that by making American workers more affordable in the global marketplace, Congress would pave the way for more U.S. citizens overseas to buy American, sell American, specify American, hire American, and create opportunities for other Americans abroad. In short, this measure represents a relatively small investment that will position the United States to compete in the twenty-first century and yield billions of dollars worth of dividends to the U.S. economy in the years ahead.

1. Section 911: The Big Picture

Section 911 provides for a foreign earned income exclusion of up to $74,000 annually to Americans working overseas, thereby assisting them to compete against comparably qualified non-Americans (who pay no taxes on income earned abroad). A U.S. citizen or resident alien whose tax home is outside the United States and who is a bona fide resident of a foreign country or who is present in a foreign country for 11 months out of 12 (330 days in any 365 day period) may exclude from gross income up to $74,000 per year of foreign earned income, plus a housing cost amount.

The foreign earned income exclusion has been part of the Internal Revenue Code since 1926, when it was unlimited for bona fide residents of a foreign country. (For a short history of the foreign earned income exclusion, see Appendix C.) Congress enacted the exclusion more than 70 years ago in an effort to "encourage citizens to go abroad and to place them in an equal position with citizens of other countries going abroad who are not taxed by their own countries." (Senate Report No. 781, 82nd Congress, 1st Session, 1951, pp. 52-53.)

America's trade competitors realized long ago that encouraging their citizens to work overseas has a pronounced, salutary impact on their domestic economies. Sending their workers abroad has become an integral part of these nations' export strategies. To facilitate this "export" of their citizens (and thus the export of products and services), other governments do not tax their citizens on the money they make while working abroad. This makes these citizens extremely competitive in foreign markets.

U.S. Government tax policies, by contrast, have generally discouraged Americans from working abroad. Alone among the world's industrialized nations, the United States still taxes its citizens on the basis of citizenship rather than residence. Further, overseas Americans must also pay U.S. income tax on benefits, allowances, and overseas adjustments. The practical effects of this tax policy are clear: Americans overseas are at a significant competitive disadvantage and are being priced out of foreign markets because prospective employers must provide more income to compensate American workers for these additional tax burdens.

Overseas employers are faced with a choice: They must pay an American worker more than they would pay other comparably qualified nationals (so that the American may keep a comparable after-tax income) or they must utilize a tax equalization program to keep the employee whole for his or her additional tax burden. Both approaches involve additional costs to the employer -- a burden that many employers are unwilling to accept even if the American worker is more productive and has better professional qualifications than the competition.

For those companies that have a tax equalization program in place, where the company pays any actual taxes for its overseas employees, the Section 911 exclusion helps to mitigate the tax burden mentioned above -- thereby cutting company costs and enabling it to be more competitive abroad. For companies that do not utilize a tax equalization program -- and most small and medium-sized companies working overseas fall into this category -- the Section 911 exclusion is most helpful to the employee, who is responsible for paying his own taxes. The current exclusion helps to make a difference in both cases, but the difference may still not be substantial enough to enable an American worker overseas to defend his or her job against foreign nationals.

The cost of hiring or maintaining an American worker is inordinately high because non-salary, quality-of-life items must be included in the worker's taxable income, often adding as much as 50 - 100 percent of base pay. Such "income" includes reimbursement for the cost of children's schooling, cost-of-living allowances, home leave, emergency travel, and other necessary and often expensive aspects of living overseas. Because so many overseas contracts today are decided on the basis of cost, and when companies' profit margins grow tighter and tighter, many employers (including American employers) simply aren't prepared to cover the additional tax burden to "Hire American."

A Section 911 Coalition member offered this case in point:

A large American company recently won a multi-billion dollar, multi-year overseas contract to supply telecommunications equipment and services. The U.S.-based company would prefer to have Americans heading its overseas operations but, because the U.S. tax system effectively prices Americans out of the international job market, the company tends to hire Europeans instead. The President of this company's international operations is British, and his Vice President is Dutch. Not surprisingly, the Human Resources Director, who answers to the Vice President, is also from Holland. He has hired approximately 2,000 technical employees for this project, most of whom are Dutch. In addition, Volvos were purchased instead of U.S.-made vehicles because they are considered "more suitable" for the technical employees. If the U.S. tax system were more like those of America's trade competitors, who maintain an unlimited foreign earned income exclusion, most of these 2,000+ jobs would have gone to Americans rather than Europeans, and a large number of American cars would have been exported and purchased instead of Volvos.

Section 911 is important because it makes a substantial difference in our nation's efforts to compete on the international business playing field. Without this exclusion, there is good reason to believe that many thousands of Americans currently overseas would be priced out of the global marketplace. This would be a devastating blow to America's national interests because Americans abroad:

In addition, for U.S. companies to continue expanding their market share worldwide, they must think and act globally. To stay competitive internationally, American managers need the kind of "hands on" experience that can only be gained by living and working abroad. In recent years, for example, two of the traditional Big Three automobile companies promoted their CEOs directly from European positions to corporate headquarters. This clearly demonstrates recognition by these companies of the role that international experience plays in their economic futures.

In short, Mr. Chairman, Section 911 helps to protect against replacement of Americans abroad by third country nationals who pay no taxes at all on their overseas income. Given the tens of thousands of overseas business opportunities that are of interest to U.S. companies and U.S.-based institutions each year, increasing the Section 911 exclusion stands to make a substantial difference for American influence abroad, U.S. exports, U.S. jobs, and overall American competitiveness.

2. Who Benefits from Section 911?

The loss of U.S. market share and the cutback in American jobs overseas represent a setback for American competitiveness. However, this tells only part of the story. The other part, of more immediate concern here at home, is the impact felt in communities all across the United States as jobs created or sustained by exports would disappear.

All Americans abroad, whatever their background, are helping to fuel the economy in the United States. By securing employment overseas, they free up jobs for other Americans back home, thereby reducing unemployment. They also support the American economy by repatriating much of their overseas earnings back to the United States. Most important of all, perhaps, Americans working overseas serve as the front-line marketing and sales force for U.S. exports. Unless all Americans support competitiveness through exports, our nation's trade deficit will surely continue. I noted earlier that exports are the engine of growth for the U.S. economy, and it is generally accepted that small and medium-sized companies provide the fuel for this engine. When the engine of growth is stalled out by constrictive U.S. tax laws that are no longer appropriate, Americans everywhere pay the price.

For years, supporters of Section 911 have emphasized that the exclusion is especially important to small and medium-sized companies operating in overseas markets. "Real world" experience has borne out that:

  1. Small companies, when trying to gain a foothold overseas, are more likely than large companies (many with an established overseas presence already) to draw on U.S.-based personnel to penetrate foreign markets.

  2. Small and medium-sized companies, because they lack the world-class name recognition that might provide them with open access to foreign customers, traditionally rely very heavily on Americans overseas to specify and purchase their products.

  3. Small and medium-sized companies are, by necessity, much more sensitive to individual cost elements and the financial bottom line. Without the $74,000 Section 911 exclusion to help make overseas Americans more competitive with foreign nationals, relatively few of these small and medium-sized companies would be able to hire Americans to fill overseas slots.

In 1995, the Section 911 Coalition commissioned two independent studies to look at the impact of the foreign earned income exclusion on U.S. business. (A one-page summary of each study is attached to this testimony as Appendices D and E.) One study was conducted by Price Waterhouse LLP (Economic Analysis of the Foreign Earned Income Exclusion), while the other was undertaken by professors at The Johns Hopkins University School of Advanced International Studies - SAIS (The Importance of Section 911 for U.S. International Competitiveness). Both studies reinforced the long-held view that Section 911 is especially important to the "little guy" trying to do business overseas. (This also applies to American schools abroad, whose efforts to provide educational services overseas have played an instrumental role in promoting an American lifestyle and U.S. products.) The studies indicated that:

This latter finding reinforces a 1993 U.S. Treasury Department study which noted that Section 911 is an important mechanism for mitigating the tax liability of lower income taxpayers working abroad. (U.S. Department of the Treasury, Taxation of Americans Working Overseas - Operation of the Foreign Earned Income Exclusion in 1987, January 1993.) These facts do not support the negative "spin" that some would put on the foreign earned income exclusion -- the wrongheaded suggestion that the exclusion benefits only the so-called corporate "fat cats."

It is also important to note, however, that more senior (and consequently more expensive) managers working overseas tend to be best positioned to benefit the U.S. economy most. The senior managers are more likely to influence the buying and hiring decisions of their company, and they are also more likely to assist other U.S. companies trying to do business abroad. In addition, they are the ones most apt to gain the international experience required by future senior executives for American companies looking to compete successfully in the increasingly global economy.

Nevertheless, it is often very difficult to persuade key employees to adjust their career paths and family situations by leaving corporate headquarters and the United States. And from the companies' perspective, despite the many advantages of hiring American peak performers to head overseas offices, current tax policies tend to make this option prohibitively expensive.

3. Nuts and Bolts: How Section 911 Works

The cost of hiring an American varies widely around the world depending on such factors as local housing costs, local standards of living, availability of schools and recreation facilities, remoteness and hardships, and so forth. Nevertheless, it may be instructive to look at a typical example of how the foreign earned income exclusion works. The American Business Council of the Gulf Countries, an Executive Committee member of the Section 911 Coalition, provided the following example.

The cost for a grade school student to attend the American School in Dubai is approximately $10,000 per year -- not for an exclusive private school, but for the only American curriculum school there. If an employer reimburses this cost for two children, the employee has an additional $20,000 of imputed taxable "income." This places an additional tax burden on the individual of up to $8,000.

If the employer chooses to make the reimbursement of this schooling cost tax-neutral to the employee, the total reimbursement cost to the company could exceed $33,000 (including the compounding effect of tax reimbursements, which are also considered taxable "income" to the employee). This represents a $13,000 (65 percent) additional cost to the company to provide education for the American employee's children (compared to providing the same education for children of a comparable European employee) -- simply because of U.S. tax policy.

If the employer provides an annual trip back to the United States for home leave for the employee and family (spouse and two children), the employee has an additional $10,000 or more of taxable "income." Emergency and sympathy travel generate taxable income; cost of living adjustments are considered taxable income; hardship allowances are taxable income; tax reimbursement is taxable income.

In other words, as this typical example shows, taxable compensation that does not represent either "perks" or disposable income to the employee typically absorbs a very large part of the current $74,000 exclusion. This is a burden borne solely by Americans, significantly hampering their ability to compete in the international arena.

The National Constructors Association, another member of the Coalition's Executive Committee, asked one of its member companies in recent years to compare the annual costs of employing an engineer with and without the benefit of Section 911. The results of this comparison are striking:

                             Hong Kong   United Kingdom  Saudi Arabia     Chile

Engineer's Base Pay          $112,800       $100,000       $121,824    $100,000

Tax Cost to Company
with 911 Exclusion            $11,743        $34,275        $11,433      $4,843

Tax Cost to Company
without 911 Exclusion        $103,513        $51,151        $66,019     $27,413

Increased Tax Cost
to Company                    $91,770        $16,876*       $54,586     $22,570*

  *In high tax countries, these savings may not be typical but may be realized in certain
     dual-contract situations.
   It should also be noted that the tax burden shown above includes taxes on allowances.

While the Section 911 exclusion is particularly helpful in low-tax foreign jurisdictions like Saudi Arabia and Hong Kong, it can also make a very substantial difference in those nations with relatively high levels of individual income tax. Filings of Internal Revenue Service Form 2555

provide an adequate measure of those Americans abroad utilizing the Section 911 exclusion. According to IRS figures, nearly two-thirds (61.8 percent) of Forms 2555 filed in 1987 were submitted by Americans in just 15 nations. (Internal Revenue Service, SOI Bulletin, Winter 1992-93, p. 86.) The vast majority of these nations -- led by Germany and the United Kingdom, with Canada and Japan not far behind -- are considered relatively high-tax jurisdictions. This was consistent with the 1995 Price Waterhouse LLP findings which note that, absent Section 911, required compensation would increase by an average of 8.6 percent in Australia, 8.0 percent in Japan, 5.4 percent in Switzerland, 4.5 percent in France, 3.3 percent in Canada, and 3.1 percent in Germany. (In Economic Analysis of the Foreign Earned Income Exclusion, Price Waterhouse LLP calculated the average change in compensation required if Section 911 were repealed for all expatriates at all income levels in each of the 15 nations.)

According to the Price Waterhouse LLP study, Section 911 can be beneficial in high-tax countries for a number of often overlooked reasons, including:

In short, no matter where in the world U.S. companies and American citizens work, the Section 911 exclusion can make a substantial difference for U.S. competitiveness.

4. Voices from Abroad: Americans Speak Out on Section 911

By their very presence overseas, U.S. citizens help to promote America's national interests. This is true of all Americans abroad -- whether they are representatives of major U.S. corporations, cultural or religious institutions, service providers, educators, entrepreneurs, heads of charitable organizations, or homemakers. Americans abroad foster a positive image of the United States throughout the world while also contributing to our nation's economic and cultural well-being at home.

Based on 1995 survey feedback received by professors at The Johns Hopkins University (SAIS), Americans who use the foreign earned income exclusion come from all walks of life and can be found in all parts of the globe. From these expatriates' comments, a sampling of which are provided below, it is also clear that Section 911 makes a substantial difference in the lives of Americans abroad.

When I first arrived here, Americans from our firm in the U.S. totaled 90 percent of our professional staff. As time progressed, because of the high cost of the tax equalization program, we first changed to hiring local Americans [those not recruited from the United States] and some foreign nationals. Each year as the cost of Americans increased (the reduction to $70,000 exclusion really hurt) we have slowly reduced our American percentage to today's 28 percent. These professionals not only 'buy American' for our company needs, but as consultants to local businesses also recommend American products to foreign companies. Without U.S. taxes overseas, we would double the number of Americans employed.

In 1988 when I joined [Company X] our U.S. imports were 0. Since starting our major import program in 1991 we are now (1994) importing over 120 containers of U.S. product annually plus air freight delivery of U.S. produce and beef on a weekly basis.

Without the tax exclusion, we would not be able to attract U.S. citizens to work at our school and they would be replaced by locally hired Mexican nationals. U.S. textbooks and supplies would probably be discontinued and Spanish materials would be used in their place.

It becomes very obvious to me around October of each year when the physicians submit their budget requests to me how nationality affects one's thinking. The American (or American trained) physicians will request U.S. manufactured supplies, equipment and pharmaceutical items. Likewise the Germans, British and French physicians request those that they are more familiar with.

As we are strictly tuition based, an increase in personnel costs is directly reflected in the cost of tuition. In the past we have chosen to hire less expensive teachers from other countries. If we raise tuition, many companies will not send families to Korea. American businesses need a high quality school in Seoul in order to convince their best people to come. Were we to lose our Section 911 it would have a serious impact on the competitiveness of other American businesses in Korea.

If the exclusion is lost, the company will probably lose the American management it prides itself on and turn to Saudis or British nationals. If this happens, the odds of Americans ever working for this company again will be nil."

Under [President] Carter, the tax exclusion was eliminated, U.S. companies pulled out of many foreign locations (or greatly reduced their expatriate contingent) and U.S. overseas schools suffered tremendous enrollment / revenue losses. The losses were compensated by increasing host country populations in the schools, an effect which is still felt today, particularly in Latin America.

We constantly hear it clearly stated by business people here that they would not be here if they did not have access to an American educational program. During the last draw down of the exclusion in the late seventies, the availability of teachers willing to come overseas to work dropped significantly. They saw no advantage to being overseas.

Elimination of the Section 911 exclusion and even the current limitation dictates that we recruit on a cost-effective basis; i.e., lower cost nationalities due to tax advantages. This will be particularly true for our smelter project in [country X] which requires an expatriate staff of about 185. Projections are that between 60 - 80 percent will be TCNs [third-country nationals].

Administering an overseas school in 1980 in Bangladesh when the foreign earned income exclusion was taken away, I observed first hand the impact on American business, especially on the construction industry. I was building a new school at the time for $4,000,000, half of which was financed by the U.S. government. There were 2 bidders: a U.S. company and a Korean company. The Americans lost the contract on price, and the difference was the tax on U.S. personnel! . . . . It was proven back then that abolishing the 911 exemption cost money: it didn't gain a dime. Have we learned nothing from experience?

The Section 911 Coalition believes that having Americans overseas is not just helpful, it is essential. In effect, taxation of foreign earned income amounts to a shortsighted, indirect tax on U.S. exports and American culture. This is a debilitating and entirely self-inflicted wound -- a policy which discriminates against America's companies, U.S. workers, and American educational institutions abroad.

5. Tax Policy Implications of Section 911

The concept of a foreign earned income exclusion has been part of U.S. tax law for more than 70 years. During that time, the exclusion has undergone a number of configurations. The debate over whether to increase Section 911, decrease Section 911, or maintain it at current levels centers on an evaluation of basic tax policy rationale for and implications of such an exclusion.

The results of the 1995 Price Waterhouse LLP study suggest that the traditional standards for evaluating income tax provisions -- fairness and economic efficiency -- justify exclusion of the portion of foreign earned income attributable to the additional costs of living abroad. The Section 911 exclusion is an approximate method for meeting the equity and efficiency standards and also satisfies a third tax policy objective: simplicity.

Fairness
Price Waterhouse LLP noted that the concept of "ability to pay" taxes is inherently subjective, but that it has generally been recognized that an individual's costs associated with earning income reduce the ability to pay taxes and should be deducted. By this logic, individuals on international assignment should not be taxed on that part of their compensation which reasonably reflects the added costs of working abroad (extra housing costs, the education of children, home leave, cost-of-living adjustments, etc.).

Economic Efficiency
This standard dictates that the tax law not interfere with the efficient allocation of resources. Economic efficiency suggests that in foreign markets, American workers should be allowed to compete according to prevailing rules. Absent Section 911, Price Waterhouse LLP found, the tax law would frequently discourage U.S. companies from hiring Americans in overseas positions, causing foreign nationals to be hired even where Americans would, but for taxes, be preferred.

Simplicity
By all accounts, the Section 911 exclusion simplifies deductions revolving around doing business overseas, especially when compared to the 1978 rules that the current exclusion replaced.

Three additional tax policy standards are often used to evaluate U.S. tax provisions that affect international income: competitiveness, harmonization, and protection of the U.S. tax base. Once again, Price Waterhouse LLP found that the Section 911 exclusion clearly meets these standards.

International competitiveness
This standard requires that U.S. capital and labor employed in foreign markets bear the same tax burden as foreign capital and labor in those markets. Price Waterhouse LLP noted that for Americans abroad,

the competitiveness standard would be achieved if the United States excluded all foreign earned income without the $70,000 limitation in present law. In this way, Americans working abroad would be subject only to foreign income taxes on their foreign earned income in exactly the same manner as foreign workers are taxed.

Harmonization
Price Waterhouse LLP pointed out that Section 911 provides a "glaring example of the failure on the part of the United States to harmonize with international tax practice. As noted by the General Accounting Office, the United States is the only major industrial power that taxes its individuals on the basis of citizenship rather than residence. In today's global economy . . . the failure of the United States to harmonize the tax treatment of expatriate workers means that U.S. citizens are more expensive to employ abroad than citizens of many other industrial nations. In summary, the principle of tax harmonization strongly argues for complete exclusion of foreign earned income" as was the case in the United States during the period 1926 - 1952.

Protecting the U.S. Tax Base
This standard is intended to prevent U.S. source income from escaping the income tax net. The Section 911 exclusion does not undermine the U.S. tax base because the exclusion has been carefully designed to prevent U.S. source income from escaping U.S. taxation.

In summary, according to the Price Waterhouse LLP study, "an unlimited foreign earned income exclusion would be consistent with the international tax policy standards of competitiveness, preservation of the U.S. tax base, and harmonization. Thus it would be appropriate to lift the . . . cap on the foreign earned income exclusion to better achieve these tax policy objectives."

6. Conclusion: Increasing Section 911 = Increasing Business and Jobs

As I noted at the outset of my remarks today, Americans Abroad = U.S. Exports = U.S. Jobs. Perhaps more than any other provision of law, Section 911 helps to put U.S. citizens "in the field" around the world where they buy American, sell American, specify American, hire American, and create opportunities for other Americans. As such, Section 911 has a direct impact on the competitiveness of American workers and U.S. companies operating in foreign markets -- a substantial growth area for the United States as we move into the twenty-first century.

To help place America on a more level footing with our trade competitors, the Section 911 Coalition encourages Congress to adjust the foreign earned income exclusion, beginning in calendar year 2000, to compensate for the effects of inflation since 1983, when the exclusion was frozen at $80,000. This will not make American workers and companies as competitive as an unlimited exclusion would, but it is certainly an important step in the right direction. U.S.-based jobs are on the line, especially for small and medium-sized businesses, and we look forward to an opportunity to work with the Ways and Means Committee to strengthen Section 911 - an unheralded but vital part of the U.S. tax code.

Thank you, Mr. Chairman, for the opportunity to testify today. I would be pleased to answer any questions that you or the Committee might have.

APPENDIX A

Section 911 Coalition Members

American Business Council of the Gulf Countries
American Citizens Abroad
American Consulting Engineers Council
American Express
American Institute of Architects
American International School of Budapest
Asia Pacific Council of American Chambers of Commerce
Ass'n of American Chambers of Commerce in Latin America
Association of Americans Resident Overseas
BDM International, Inc.
Baker Hughes, Inc.
Bechtel Group, Inc.
Booz-Allen & Hamilton Arabia
Brown and Root / Halliburton
COLSA International
CRSS - Metcalf & Eddy Joint Venture
Caltex Petroleum Corporation
Caterpillar, Inc.
Chicago Bridge & Iron Company
Chrysler Technologies Corp. - Middle East Ltd.
Coalition for Employment through Exports, Inc.
Coopers & Lybrand L.L.P.
Culligan Italiana SpA
Cummins Engine Company, Inc.
Deloitte & Touche LLP
Democrats Abroad
Dillingham Construction International, Inc.
Dresser Industries, Inc.
Economic Strategy Institute
Employee Relocation Council
European Council of American Chambers of Commerce
FMC Arabia Ltd.
Federated League of Americans Around the Globe
Federation of American Women's Clubs Overseas
Fluor Corporation
Foster Wheeler
Hoechst Celanese Corporation
Hughes Saudi Arabia Ltd.
Intercom International Consultants
Int'l Engineering & Construction Industries Council
International School of Islamabad
International School of Tanganyika
International Schools Services
J.A. Jones Construction
John Brown Constructors
Juraid & Company
Lockheed Middle East Services
Loral Corporation
M.W. Kellogg Company
Mansour General Dynamics Ltd.
McDonnell Douglas Middle East Ltd.
Middle East Policy Council
National Constructors Association
Occidental Petroleum Corporation
Oracle Corporation
Parsons Brinckerhoff
Parsons Corporation
Republicans Abroad
Saudi American Bank
Saudi Arabian International School - Dhahran
Saudi Arabian International School - Riyadh
Science Applications International Corporation
Small Business Exporters Association
Sogerep, Ltd.
Stafford & Paulsworth
Stone & Webster, Inc.
U.S. Chamber of Commerce
United Technologies
Unocal Corporation
Verdala International Schools
Vinnell Corporation - Saudi Arabia
Vinnell Corporation - U.S.A.
Westinghouse Electric Corporation
World Federation of Americans Abroad

APPENDIX B

PRICE WATERHOUSECOOPERS L.L.P.
The Effect of Inflation on the Foreign Earned Income Exclusion Amount

Introduction
This report updates information on the effect of inflation on the real value of the foreign earned income exclusion amount, which was originally included in an October 1995 report (entitled Economic Analysis of the Foreign Earned Income Exclusion) prepared by Price Waterhouse LLP for The Section 911 Coalition.

Under the provisions of Section 911 of the Internal Revenue Code, a U.S. citizen or resident alien whose tax home is outside the United States, and who meets a foreign residence or foreign presence test, may exclude from gross income in 1999 up to $74,000 per year of foreign earned income plus a housing cost amount. Historically, the principal rationale for the exclusion has been to make the tax treatment of Americans working abroad more competitive with that of foreign nationals and, thereby, to promote exports of U.S. goods and services.

History of the Foreign Earned Income Exclusion
The foreign earned income exclusion originally was enacted in 1926 to help promote U.S. exports. From 1926 to 1952, the exclusion was unlimited, corresponding to the present day practice of other major industrial countries. From 1953 to 1977, the exclusion was limited to $20,000 per year; however, for Americans working abroad for more than three years, the exclusion was increased to $35,000 from 1962 to 1964 and subsequently reduced to $25,000 from 1965 to 1977.

In 1978, the Foreign Earned Income Act replaced the Section 911 exclusion with Section 913, a series of deductions for certain excess costs of living abroad.

The Economic Recovery Tax Act of 1981 restored Section 911 and increased the exclusion to $75,000 in 1982 with scheduled increases to $95,000 in 1986. The legislative history indicates that Congress was concerned that the rules enacted in 1978 made it more expensive to hire Americans abroad compared to foreign nationals, reduced U.S. exports, rendered the United States less competitive abroad, and due to the complexity, the new rules required many Americans employed abroad to use professional tax preparers.

Among a number of other deficit reduction measures, the Deficit Reduction Act of 1984 delayed the scheduled increases in the foreign earned income exclusion, freezing the benefit at $80,000 through 1987. The Tax Reform Act of 1986 reduced the exclusion to $70,000 beginning in 1987. The exclusion remained at this level through 1997.

Present Law
The Taxpayer Relief Act of 1997 increased the $70,000 exclusion to $80,000 in increments of $2,000 beginning in 1998. The following table shows the exclusion amounts specified by the Act.

  Table 1    Present Law Section 911 Exclusion Amounts


   Calendar Year   Exclusion Amount
     1998               $72,000
     1999               $74,000
     2000               $76,000
     2001               $78,000
     2002-2007          $80,000
     2008
       and thereafter   $80,000 adjusted for inflation

As noted in the table, beginning in 2008 the $80,000 exclusion for foreign earned income will be adjusted for inflation. Thus, for any calendar year after 2007, the exclusion amount will be equal to $80,000 times the cost-of-living adjustment for that calendar year. The cost-of-living adjustment will be calculated using the methodology that adjusts the income brackets in the tax rate schedules (Section 1(f)(3) of the Internal Revenue Code). The Consumer Price Index for all urban consumers (CPI-U) that is published by the Department of Labor will be used to determine the adjustment. Specifically, the cost-of-living adjustment for a calendar year will equal the CPI-U for the preceding calendar year divided by the CPI-U for calendar year 2006 (the base year). The Internal Revenue Code further specifies that, in making this calculation, the CPI-U for a calendar year is to be calculated as the average of the CPI-U as of the close of the 12-month eriod ending on August 31 of such calendar year. Finally, the Taxpayer Relief Act of 1997 stipulates that if the adjusted exclusion amount is not a multiple of $100, then it is to be rounded to the next lowest multiple of $100.

For this report, we have estimated the inflation-adjusted exclusion amounts for 2008 and 2009 to be $82,000 and $84,200, respectively. These estimates assume that the CPI-U will increase by 2.6 percent annually beginning in calendar year 2000. This assumption is based on the Congressional Budget Office's (CBO) most recent published economic projections (The Economic and Budget Outlook: Fiscal Years 2000-2009, January 1999, Table 1.4).

Effect of Inflation
Figure 1 shows the exclusion amount in both nominal and real (1999) dollars. The nominal dollar line shows the exclusion amounts specified by legislation. The effect of the Taxpayer Relief Act of 1997 is shown starting in 1998 when the exclusion amount begins to increase in $2,000 increments from the $70,000 amount established by the Tax Reform Act of 1986. In 2002, the exclusion amount reaches $80,000 and remains at that level until 2008 when the exclusion amount begins to be adjusted for inflation.

As illustrated in Figure 1, the real value of the exclusion has dropped substantially. In real 1999 dollars, the 1999 exclusion amount of $74,000 is 45 percent below its level in 1983 ($134,197 in 1999 dollars) when the nominal dollar amount of the exclusion ($80,000) reached its highest level after the 1981 Act.

Figure 1 also shows that the real value of the exemption is projected to continue to fall after 1999, even though the Taxpayer Relief Act of 1997 eventually will raise the exclusion amount to $80,000.

The provision to adjust the exclusion amount for inflation will stabilize the real value of the exclusion amount beginning in 2008. Based on the CBO's projection that consumer prices will be 2.5 percent higher in 1999 than they were in 1998 and that annual price increases will amount to 2.6 percent thereafter, the value of the exclusion amount will stabilize at approximately $65,150 in 1999 dollars-an amount that is 12 percent below the current exclusion amount in real terms and 51 percent below the 1983 peak as measured in 1999 dollars.

Conclusion
Since the Section 911 exclusion amount has not been automatically indexed for inflation in the way that the Internal Revenue Code adjusts the income tax tables and other dollar amounts, the real value of the exclusion has dropped substantially. If the $80,000 exclusion that was in effect in 1983 had been continually adjusted for inflation, the exclusion would be approximately $134,000 in 1999. Based on current CBO projections of inflation, the exclusion amount in the year 2000 would be nearly $138,000.

APPENDIX C

THE FOREIGN EARNED INCOME EXCLUSION
A Short History

The foreign earned income exclusion has been part of the Internal Revenue Code since 1926, when it was unlimited for bona fide residents of a foreign country. Congress enacted the exclusion more than 70 years ago in an effort to "encourage citizens to go abroad and to place them in an equal position with citizens of other countries going abroad who are not taxed by their own countries." (Senate Report No. 781, 82nd Congress, 1st Session, 1951, pp. 52-53.)

Limiting the foreign earned income exclusion is a concept that goes back to 1953, when Congress first capped the exclusion. In the immediate aftermath of World War II, there may have been a good reason for limiting the exclusion. However, times have changed dramatically since the 1950s, when the U.S. economy was a global colossus with no serious competition, and

U.S. tax policy has not kept pace with the changing times.

In 1978, the Foreign Earned Income Act replaced the exclusion with a series of deductions for certain expenses associated with living abroad (former Section 913). American workers and U.S. companies in overseas markets were hit hard by the 1978 amendments and lost considerable overseas market share as a result. Recognizing this, Congress in 1981 restored the flat earned

income exclusion (Section 911) at $75,000 per year for 1982 with scheduled increases to $95,000 in 1986. Noting that the rules enacted in 1978 reduced exports, Congress in 1981 "was concerned with the increasing competitive pressures that American businesses faced abroad. The Congress decided that in view of the nation's continuing trade deficits, it is important to allow Americans working overseas to contribute to the effort to keep American business competitive" through Section 911. (Joint Committee on Taxation, General Explanation of the Economic Recovery Tax Act of 1981, JCS-71-81, December 29, 1981, p. 43.)

The exclusion was revisited in 1984 and 1986. The Deficit Reduction Act of 1984 delayed the scheduled increases in the exclusion, freezing the benefit at $80,000 (the 1983 benefit level) through 1987. The Tax Reform Act of 1986 reduced the exclusion to $70,000, and it remained at that level through 1997. The Taxpayer Relief Act of 1997 increased the $70,000 exclusion to $80,000 in increments of $2,000 per year, beginning in 1998. In addition, beginning in the year 2008, the $80,000 exclusion will be adjusted for inflation.

Because the exclusion has not been adjusted for inflation over the years, its real value has dropped substantially. According to a June 28, 1999 report by PricewaterhouseCoopers LLP, the 1999 exclusion amount, in real dollars, is 45 percent below its level in 1983, following passage of the Economic Recovery Tax Act of 1981. (The exclusion in 1983 was $80,000 in nominal dollars and $134,197 in 1999 dollars.) If the $80,000 exclusion that was in effect in 1983 had been continually adjusted for inflation, the exclusion would be approximately $134,000 in 1999, rising to nearly $138,000 in the year 2000.

The real value of the exclusion is projected to continue falling after 1999 and is expected to stabilize in the year 2007 at approximately $65,150 in 1999 dollars. Looked at from a "purchasing power" point of view, the value of the exclusion will have plummeted in real dollars from $134,197 (1983) to $65,150 (2007) -- a devastating loss of nearly $70,000 in 1999 dollars.

* * *

Many Members of Congress serving today were not witness to the extensive Congressional debates which resulted in the enactment of the exclusion in 1981. As a result, this short history should provide some insights into why the exclusion came about, why it provides a return to the U.S. economy that far exceeds its estimated revenue losses, and why the Section 911 exclusion has such an impact on U.S. business competitiveness overseas.

In the 1970s, in an effort to move away from the foreign earned income exclusion, Congress took steps that proved to be disastrous. The Tax Reform Act of 1976 generally reduced the exclusion to $15,000 per year. While this cut in the exclusion did not take effect in the end, it nevertheless had a "chilling" effect on U.S. companies' efforts to send American workers abroad. A 1978 General Accounting Office (GAO) survey of 183 U.S. companies found that more than 80 percent of these companies felt that reducing the exclusion along the lines of the 1976 Act would result in a reduction of U.S. exports by at least five percent. (U.S. GAO, Impact on Trade of Changes in Taxation of U.S. Citizens Employed Overseas, ID-78-13, February 21, 1978.)

Two years after the 1976 Act, the situation went from bad to worse. The Foreign Earned Income Act of 1978 repealed the foreign earned income exclusion and put in its place Section 913, composed of five factors: 1) A cost-of-living deduction based on the differential between U.S. and overseas costs of living; 2) A housing deduction; 3) A deduction for schooling expenses where a U.S.-type school was not within a reasonable commuting distance; 4) A travel expense deduction for an annual round-trip visit to the United States; 5) A deduction for work in a hardship area.

The 1978 Act, compared to prior law, represented a 23 percent reduction in the tax benefit of the exclusion. To determine the impact of this reduction, the GAO conducted a survey in 1980 of 33 key firms in four industries. The GAO found that additional costs attributable to the 1978 Act was a primary reason why these firms had decreased their employment of Americans abroad. The numbers decreased absolutely from 1979 to 1980 in three of the industries and, during the period 1976 to 1980, the relative number of Americans abroad dropped compared to third country nationals. (U.S. GAO, American Employment Abroad Discouraged by U.S. Income Tax Laws, ID-81-29, February 27, 1981.)

As a result of these findings, the 1981 GAO report produced the following recommendation:

"We believe that the Congress should consider placing Americans working abroad on an income tax basis comparable with that of citizens of competitor countries who generally are not taxed on their foreign earned income."

The GAO went on to say that "complete exclusion or a limited but generous exclusion of foreign earned income for qualifying taxpayers . . . would establish a basis of taxation comparable with that of competitor countries and, at the same time, be relatively simple to administer."

Findings in a 1980 report by Chase Econometrics provided more evidence of the dangers for U.S. competitiveness of restricting the foreign earned income exclusion. As a result of the changes in 1976 and 1978, Chase noted, a significant number of Americans working overseas would be forced to return home. Chase determined that a ten percent drop in Americans overseas would lead to a five percent drop in U.S. exports. The study went on to say that the "drop in U.S. income due to a five percent drop in real exports will raise domestic unemployment by 80,000 [persons] and reduce federal receipts on personal and corporate income taxes by more than $6

billion, many times the value of increased taxes on overseas workers." (Chase Econometrics, Economic Impact of Changing Taxation of U.S. Workers Overseas, June 1980, p. 2.)

The U.S. & Overseas Tax Fairness Committee, an ad hoc group established in the late 1970s to defend the foreign earned income exclusion, noted in 1980 that "of all the current U.S. disincentives that discourage trade, none is easier to eliminate than the U.S. practices of taxing foreign earned income . . . and none will produce faster or more substantial results for our balance of trade." In an effort to show what damage the 1976 and 1978 Acts had done as of 1980, the Committee cited the example of the U.S. construction and engineering industry operating in the Middle East. American companies in this sector "had over ten percent of the

construction volume in the Middle East four years ago and now has less than two percent -- almost entirely due to the current U.S. tax treatment of overseas Americans," the Committee noted, "and industry is finding it very difficult to recapture its former standing." (U.S. & Overseas Tax Fairness Committee, Press Release, June 16, 1980.)

* * *

The message is as clear today as it was in 1980: Changes in the foreign earned income exclusion generate a substantial and direct impact -- positive or negative -- on the ability of U.S. companies and American workers to compete in overseas markets.

APPENDIX D

HIGHLIGHTS OF THE PRICE WATERHOUSE STUDY
"Economic Analysis of the Foreign Earned Income Exclusion"

Price Waterhouse LLP, in a study prepared in 1995 for the Section 911 Coalition, found that:

APPENDIX E

SECTION 911 SURVEY RESULTS ARE IN
Survey Finds Exclusion is Especially Important to Small & Medium-Sized Companies

The Section 911 Coalition has announced the findings of its "American Competitiveness Survey." With nearly 150 companies and associations responding to the survey, it represents the largest and most broad-based Section 911 survey ever conducted.

The six-page survey examined the importance of the $70,000 foreign earned income exclusion (under Section 911 of the U.S. Tax Code) and its impact on America's global competitiveness. A report prepared by economists at the Johns Hopkins University School of Advanced International Studies, Drs. Charles Pearson and James Riedel, found that:

The survey results strongly suggest that the Section 911 exclusion plays a key role in America's competitiveness and the creation of U.S. jobs through exports. For further information, please contact the Section 911 Coalition.

   Section 911 Coalition
   1101 30th Street, N.W.  Suite 500
   Washington, DC  20007
   USA
   
   Tel: +1 (202) 887-1887
   Fax: +1 (202) 887-1888