The IRS Has Unleashed a Massive New Regulation
As Americans prepare to celebrate Independence Day, the Internal Revenue Service has unleashed a massive new regulation under the guise of reducing tax evasion. The Foreign Account Tax Compliance Act - FATCA - took effect July 1, imposing substantial new compliance requirements and paperwork burdens on foreign financial institutions, which must now track the financial activity of U.S. citizens and report that information to the IRS. While there is scant evidence that this regulation will add significantly to federal revenues, there is more than a sinking feeling that the new law infringes upon the civil liberties of American citizens.
Like many of the edicts emanating from Washington recently, FATCA came into being with little public debate or analysis of its impact. Instead, this mammoth expansion of IRS power was tucked into a 2010 jobs bill, the HIRE Act, and passed without fanfare. And like something that NSA might concoct, the new regulations require information-gathering on American citizens on a global scale. Just how much information is the IRS gathering? Here is what foreign financial institutions are required to provide for compliance under FATCA:
1. The name, address, and TIN [Tax Identification Number] of each account holder that is a specified U.S. person;
2. The name, address, and TIN of each substantial U.S. owner of any account holder that is a U.S.-owned foreign entity;
3. The account number;
4. The account balance or value (determined at such time and in such manner as the Secretary provides); and
5. The gross receipts and gross withdrawals or payments from the account (determined for such period and in such manner as the Secretary may provide).
The burdens and complexities of FATCA are already generating unintended consequences that are hurting Americans living abroad. Many of the millions of Americans living overseas are finding their money is no good as banks and other financial institutions do not want their business due to the paperwork and compliance hassle of dealing with the American IRS. Yet for all the new surveillance and paperwork requirements, the Joint Committee on Taxation estimates that the increase in federal revenues due to these new regulations will be far less than 1 percent. While the new law does virtually nothing to staunch the deficit or mounting debt burden, it does create a costly compliance system. One study suggests that the new law could cost major financial institutions more than $100 million to comply, with global compliance costs reaching as high as $8 billion a year. Had Congress requested a cost-benefit analysis, this rule may not have been implemented.
Given the onerous compliance requirements and the potential for the new U.S. regulation to violate local privacy laws, it is worth questioning why foreign financial institutions would agree to become an enforcement arm of the IRS. The hammer held by the IRS under FATCA is a 30-percent withholding penalty against any U.S.-sourced income being paid to a foreign financial institution. Given this excessive penalty, foreign financial institutions are required to play along if they want access to U.S. financial markets. To date, the IRS lists more than 77,000 institutions and roughly 100 nations that are working to implement FATCA.
While the desire to avoid a 30-percent withholding penalty is an important reason to comply, there are other forces at work that are just as troubling. In order to simplify compliance with FATCA, many nations are entering into intergovernmental agreements (IGAs) with the U.S. Treasury department. A key aspect of these agreements is that not only will these nations provide information to the IRS, but the U.S. will reciprocate with information about any of those nations' taxpayers with accounts in the United States. This "transparent" global tax policy is something high-tax nations have long pursued. High-tax nations with expanding welfare states and bloated public sectors have been working to form a tax cartel to eliminate the threat posed by the temptation of lower-tax nations. Indeed, in the name of tax cooperation, the G20 nations and the Organisation for Economic Co-operation and Development are currently working on their own information-sharing standards.
All of this could have been avoided if Congress were serious about tax reform. Unlike most of the world, the IRS taxes Americans based on worldwide income. Regardless of where the income is earned, Americans must report it and are liable for any taxes. This means Americans living abroad still must pay U.S. taxes on top of any foreign taxes for which they are liable. The majority of the world, on the other hand, relies on a territorial tax system, meaning that taxes are only collected in the place where the income is earned. Rather than construct an edifice for global sleuthing that costs billions of dollars for virtually no return, the U.S. could have simply adopted the dominant territorial system for taxation, eliminating the problem altogether.