Is FATCA the Worst Part of the Internal Revenue Code?

I’ve argued that subsidies for the Paris-based Organization for Economic Cooperation and Development are the most destructively wasteful outlays in the federal budget. At least on a per-dollar-spent basis.

But what if we did the same exercise on the tax side of the fiscal ledger. What’s the most damaging provision of the tax code?

In a TV interview earlier this year, I said I was most upset by all the corruption in Washington that is made possible by a Byzantine tax code. But that’s an overall observation, not a specific feature.

Today’s question deals with the part of the tax system is most harmful to the economy, on a per-dollar-collected basis.

If you asked me to make that choice five years ago, I probably would have picked the death tax, though I’ve had some experts tell me that “depreciation” is even worse.

But I think today we have a new champion (so to speak). A little-known law called the Foreign Account Tax Compliance Act almost surely wins the prize. And it’s not just cranky libertarians such as myself that think the law is bad news.

The U.K.-based Economist is one of the most establishment publications in the world, yet even that magazine has concluded that the law “is doing more harm than good.”

Here are some excerpts from the article, starting with a basic description of the law.

Basil Zirinis of Sullivan & Cromwell, a law firm, began his presentation with a discussion of events in Iraq, where Islamist fighters were advancing on Baghdad. Barack Obama, he claimed, was drawing a red line around the city and, if necessary, would “drop FATCA on them”. …The analogy was tasteless, but also telling. FATCA stands for Foreign Account Tax Compliance Act, an American law passed in 2010 to crack down on the use of offshore banks… It is feared and loathed by moneymen because of its complexity, its global reach and the high cost of compliance. One senior banker denounces it as “breathtakingly extraterritorial”. …FATCA turns foreign banks and other financial institutions into enforcement arms of America’s Internal Revenue Service (IRS). They must choose between turning over information on clients who are “US persons” or handing 30% of all payments they receive from America to Uncle Sam.

The law has a wide range of victims.

Financial institutions obviously are seriously impacted, and the damage isn’t limited to banks in places such as Switzerland.

The financial industry is struggling to work out which funds, trusts and other non-bank entities count as “financial institutions” under the law. There is also confusion over who is a “US person”. The definition is broad and includes not only citizens but current and former green-card holders and non-Americans with various personal and economic ties to the United States. Some Canadian “snowbirds” who travel to America for part of each year could be caught in the net, says Allison Christians, a tax professor at McGill University. As the complexities of implementation have grown apparent, the American authorities have had to extend several deadlines.

Americans who live in foreign countries are being adversely affected as well (and I’ve shared some of their horror stories).

FATCA has already sent a chill through the 7m Americans who live abroad. Thousands have been told by their local banks and investment advisers that they no longer want their custom because it is too much hassle. Many others will now have to spend thousands of dollars to straighten out their paperwork with the IRS, even if they owe no tax (and most do not, since they will have paid a greater amount abroad, which counts as a credit against tax owed in America). A record 2,999 of these exasperated expats renounced their citizenship or green cards in 2013. More than 1,000 did so in the first quarter of 2014. (Before FATCA the number was a few hundred a year.)

And keep in mind that for every American who officially gives up his or her citizenship, many more are doing it without informing the IRS.

The law is even victimizing organizations that don’t deserve the slightest hint of sympathy.

FATCA also places a burden on the IRS, by generating an unwieldy amount of information. The agency is being given far more to do with far fewer people (thanks to budget cuts), leaving it “on the verge of collapse”, according to a former senior official.

As an aside, don’t believe the nonsense about the IRS budget being inadequate.

Returning to our topic, one of the big problems is that FATCA was approved without even the tiniest shred of cost-benefit analysis.

The government, for all intents and purposes, is willing to impose immense damage on the private sector in hopes of collecting a tiny amount of tax revenue.

The law was passed without any formal cost-benefit analysis… However, the overall costs of complying, borne mostly by non-American banks, are likely to far exceed the extra tax receipts. FATCA is about “putting private-sector assets on a bonfire so that government can collect the ashes,” complains Richard Hay of Stikeman Elliott, a law firm. Mark Matthews, a former deputy commissioner of the IRS now with Caplin & Drysdale, another law firm, argues that the effort put into hunting offshore tax evaders is disproportionate.

And it’s worth pointing out the projected revenue from FATCA – about $870 million per year – is just a tiny fraction of the $100 billion that Obama was claiming on the campaign trail.

But here’s the part that has me most worried.

The OECD wants to use FATCA as a stepping stone to its Dystopian dream of global information sharing between governments.

Another question is whether FATCA might be subsumed into a scheme being promoted by the OECD, a club of mostly rich countries, whereby signatories would share data on financial accounts annually.

And that could be bad news for one of the world’s biggest tax havens. Yes, I’m referring to the United States.

As more countries are pushed to share tax information systematically, the focus will turn to America’s willingness (or lack of it) to reciprocate. Latin Americans, for instance, are big users of banks in Florida, but America remains choosy about which governments it will share data with, and how much. It also has only limited information to give on the owners of shell companies because it does not collect their names itself. In some respects, America is less upright than the tax havens it deplores.

It would be very bad for our economy if we started sending confidential financial information to corrupt governments such as Mexico. Foreigners would pull their money out of American financial institutions and move it to other havens.

With all this background, you can understand why I was so critical of FATCA in this interview with a Chinese TV station.

P.S. You probably won’t be surprised to learn that Rand Paul is leading the fight against FATCA and other schemes to give governments more extra-territorial tax powers. As you can see, he’s even getting left-wing cartoonists upset.

Other lawmakers also now understand that the statist campaign against tax competition is bad news for America. Marco Rubio, for instance, deserves credit for trying to stop the Obama Administration from coercing American banks into obeying foreign tax law.

Policy makers should repeal FATCA, of course, but the real problem is that the tax code is biased against capital formation and also has a punitive policy of worldwide taxation.

That’s why the long-run answer is tax reform. All pro-growth tax reform plans, such as the flat tax and national sales tax, get rid of double taxation and they’re also based on the common-sense principle of territorial taxation. With such systems, the government doesn’t need to know about your personal financial affairs, regardless of whether you have accounts in Geneva, Illinois, or Geneva, Switzerland.