Special Report

New IRS Rule Benefits Only Foreign Dictators

The Internal Revenue Service is doing its part to drive foreign investment from the U.S.

By 3.8.12

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Since when is it the U.S. government's job to report on the financial activities of foreign nationals to their home governments? It is now. The IRS has rolled out a new rule that will force deposit institutions, such as banks and credit unions, to report how much interest nonresident aliens have earned on their U.S.-held accounts to the IRS, who will then report it to their home country governments.

The rule isn't tailored to accommodate special circumstances, which means U.S. banks might be forced to report the earnings of foreign dissidents made in the U.S. to their home regime. The IRS and the rule's supporters say this fear is baseless. But even if it were tailored to prevent disclosures to certain "unfriendly" regimes, it's worth remembering how quickly friends become adversaries. Libya's Muammar Gaddafi went from friend to foe almost overnight. If the rule had been in place a few years ago, Syria's Bashir al-Assad might now have a wealth of data about his opponents' finances.

Why is the U.S. government subsidizing the tax collection efforts of foreign regimes? Because the U.S. wants other governments to do the same for it. The IRS taxes Americans globally, and through the Foreign Account Tax Compliance Act (FATCA) of 2010, wants to require any transnational financial companies to report account information on U.S. clients. The IRS claims that it's only fair to require U.S. banks to fulfill a similar requirement.

But the FATCA is already an extraterritorial power grab of doubtful legitimacy. In December 2011, the United States led the charge at the United Nations against the attempt by Eritrea to impose a Diaspora Tax on its citizens abroad. The Security Council resolution was passed on the grounds that it violated human rights. The U.S. has not imposed a Diaspora Tax on its citizens. They are free to leave the country as they wish -- unless they happen to earn more than $9,350 abroad, at which point they are subject to significant punishment from the IRS for failing to file a tax return.

The FATCA was passed and new IRS regulations were proposed with hardly any foreign consultation. Foreign governments are furious, and for good reason. The head of Canada's banking association has said the FATCA is "conscripting financial institutions around the world to be arms of U.S. tax authorities." Implementing the law would even violate privacy laws in countries like Singapore and Hong Kong. Nonetheless, the IRS wants to impose a 30 percent tax on any U.S. assets held by firms that fail to comply. It's hard to think of a better way to scare foreign investment away from our shores.

The IRS doesn't tax foreigners' interest on U.S. deposits, but this new reporting rule would actually be worse than if it did. Conservative estimates of a previous version of the rule, which affected just 15 countries, found that it will suck at least $87 billion out of the economy. This is because foreigners often invest in the U.S. because their money is protected from their home government. Consider that as much as one third of all bank deposits in Florida are owned by foreigners, which might be surprising until you look immediately south, to Cuba, Venezuela, and beyond. Many Florida banks could go under if this rule goes ahead.

These costs are also a problem for the IRS. Executive Order 12866 requires that any regulation with "an annual effect on the economy of $100 million or more" to be subject to a cost-benefit analysis. Yet the IRS hasn't performed any such analysis for its proposed rule. It is easy to see why. The costs, as we have already seen, are likely to be huge. The benefits? They amount to some goodwill from the few legitimate foreign governments that take an interest in offshore holdings of their citizens (most, like the United Kingdom, do not), and a lot of goodwill from dictators who will use this information to monitor and punish dissidents.

This rule's timing couldn't be worse. The unfolding European debt crisis could send capital flooding into the U.S. Yet rather than let the money roll in, the IRS wants to discourage foreigners from investing in the American economy, by imposing extra costs on the fragile banking system, to the benefit of no one -- except dictators.

If IRS officials think that is prudent policy, Congress should ask them to explain why. It is high time for reform of this agency, before it impoverishes us all.

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About the Author
Iain Murray heads the Center for Economic Freedom at the Competitive Enterprise Institute and is the author of Stealing You Blind: How Government Fatcats Are Getting Rich Off of You.