The debate over a U.S. deficit-reduction package thus far has focused on domestic considerations, largely ignoring the international ramifications. One proposal under review -- a securities transfer tax -- may appear to affect only a small group of Americans. In fact, such a tax would affect all of us adversely, by making it more difficult 1) for the United States to attract foreign investment and 2) for U.S. businesses and financial institutions to compete internationally.
Continued large U.S. trade imbalances imply that the United States will have to attract considerable foreign capital for the foreseeable future. Because of the ease with which the U.S. has obtained such investments -- more than $800 billion net during the 1980s -- there is a tendency to assume that foreign capital will continue to come to this country, irrespective of our policies or our economic and financial performance.
However, a unique combination of forces was at play in the 1980s that will not hold in the 1990s. As oil prices plummeted, Japan, West Germany and other countries in Asia and Europe supplanted OPEC as the world's creditor nations. Investors from these countries, as well as financial intermediaries, were eager to rechannel funds away from the debt-burdened developing countries to the United States, especially as U.S. economic and financial performance improved. And the removal of a 10 percent withholding tax on U.S. securities in mid-1984 sparked foreign investors' appetites for U.S. securities.
More recently, the allure of the United States as a haven for international funds appears to have lessened, as business opportunities abroad have expanded. Capital spending in the European Community, Japan and other parts of Asia recently has been the strongest in more than a decade. And in light of the historic developments in Europe and the pressures on Japan to upgrade its public infrastructure, the demand for funds in those countries is unlikely to diminish anytime soon. Consequently, much of the capital they previously exported may stay at home. Bond yields already have risen considerably worldwide in response to the heightened demand for capital, but much more abroad than at home.
Because the United States no longer is a high interest rate country, it is more difficult to attract foreign capital. Foreign purchases of U.S. securities already have shrunk considerably so far this year. Thus, as the U.S. economy eventually recovers from its current slump, one may well ask: Will U.S. businesses be crowded out of global capital markets by the strong demand for funds and higher interest rates abroad?
The profound changes in Europe and other parts of the world make it imperative that we put our fiscal house in order quickly. A deficit-reduction package clearly would help, by freeing scarce domestic savings to finance much-needed business investment, assuming that the package includes spending cuts. The willingness of the administration and Congress to compromise on spending cuts and revenue-enhancement measures is a positive development. But the most difficult choices have yet to be made: Which items should be cut and which should be taxed?
The budget deficit must be reduced in a way that will enhance our country's ability to compete internationally in both goods and services. In this regard, the proposal to tax securities transactions in the United States is particularly disturbing.
First, the record of taxing securities transactions is one of failure. The most recent attempt was in the beginning of 1989, when the West German government imposed a 10 percent withholding tax on interest income. The result was a massive outflow of capital, as foreign purchases of domestic securities came to a halt, while German residents' purchases of assets outside the country soared. Domestic bond yields rose sharply, while the deutsche mark plummeted. Within six months, the tax was repealed. A similar fate befell the Australian authorities when a withholding tax was proposed in July of 1986, only to be withdrawn in a matter of weeks.
Second, many take the preeminent role of U.S. financial institutions for granted. This concerns me. If the experience of the Swiss is any indication, a securities transfer tax could jeopardize the standing of U.S. financial institutions. Switzerland's traditional role has diminished considerably in the past decade, partly because a transfer tax on Swiss securities has made it more difficult to attract investors as other countries have liberalized their financial systems. Consequently, the need to amend the tax is being reviewed, especially in light of 1992 reforms that will permit EC-wide universal banking.
Finally, U.S. financial institutions are at a competitive disadvantage versus European and Japanese institutions because of an outdated regulatory system that has unduly fragmented the financial services industry. To impose a securities tax now would further penalize these institutions for conducting business in the United States and would encourage them to move more of their operations offshore. We should not forget that the imposition of the since-repealed Interest Equalization Tax in this country in the early 1960s fostered the rapid growth of the Eurodollar markets during the next two decades.
In sum, because of the radical changes in political, economic and financial systems around the world, the United States no longer has the luxury of formulating policy in a vacuum, where international considerations can be ignored. To do so would only compound the problems we are attempting to surmount. Rather our budgetary reforms must facilitate the necessary infusion of foreign capital, while also making our businesses and financial institutions more competitive.
The writer is chairman and chief executive officer of Salomon Brothers Inc.