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.

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Obama Has United the World…in Opposition to Bad U.S. Tax Policy

Last year, I came up with a saying that “Bad Government Policy Begets More Bad Government Policy” and labeled it “Mitchell’s Law” during a bout of narcissism.

There are lots of examples of this phenomenon, such as the misguided War on Drugs being a precursor to intrusive, costly, and ineffective money laundering policies.

Or how about government healthcare subsidies driving up the price of healthcare, which then leads politicians to decide that there should be even more subsidies because healthcare has become more expensive.

But if you want a really stark example of Mitchell’s Law, the internal revenue code is littered with examples.

The politicians created a nightmarishly complex tax system, for instance, and then decided that enforcing the wretched system required the erosion of civil liberties and constitutional freedoms.

The latest example of this process involves the Foreign Account Tax Compliance Act, a piece of legislation that was imposed in 2010 because politicians assumed they could collect lots of tax revenue every single year by getting money from so-called tax havens.

This FATCA law basically imposes a huge regulatory burden on all companies that have international transactions involving the United States, and all foreign financial institutions that want to invest in the United States. It is such a disaster that even the New York Times has taken notice, recently reporting that:

…the Foreign Account Tax Compliance Act, or Fatca, as it is known, is now causing alarm among businesses outside the United States that fear they will have to spend billions of dollars a year to meet the greatly increased reporting burdens, starting in 2013. American expatriates also say the new filing demands are daunting and overblown. …The law demands that virtually every financial firm outside the United States and any foreign company in which Americans are beneficial owners must register with the Internal Revenue Service, check existing accounts in search of Americans and annually declare their compliance. Noncompliance would be punished with a withholding charge of up to 30 percent on any income and capital payments the company gets from the United States. …The I.R.S., under pressure from angry and confused financial officials abroad, has extended the deadline for registration until June 30, 2013, and is struggling to provide more detailed guidance by the end of this year. But beginning in 2012, many American expatriates — already the only developed-nation citizens subject to double taxation from their home government — must furnish the I.R.S. with detailed personal information on their overseas assets. …He said his sense was that Fatca required companies “to prove your innocence.” …Then there is a question of reciprocity: Would the United States accept the same demands for information from the tax authorities in other countries — say Russia or China?

It’s worth noting at this point that FATCA only exists because of bad tax law. If the United States had a simple and fair flat tax, there would be no double taxation of income that is saved and invested. As such, the IRS wouldn’t have any reason to care whether Americans had bank accounts and/or investments in places such as London, Hong Kong, and Panama.

But as is so often the case with politicians, they choose not to fix bad policy and instead decide to impose one bad policy on top of another. Hence, the crowd in Washington enacting FATCA and sending the IRS on a jihad.

By the way, the New York Times was late to the party. Many other news outlets already have noticed that the United States is about to suffer a big self-inflicted economic wound.

Indeed, what’s remarkable about Obama’s FATCA policy is that the world is now united. But it’s not united for something big and noble, such as peace, commerce, prosperity, or human rights. Instead, it’s united in opposition to intrusive, misguided, and foolish American tax law.

Let’s look at some examples.

o From the United Kingdom, a Financial Times column warns that, “This summer, the senior management of one of Asia’s largest financial groups is quietly mulling a potentially explosive question: could it organise some of its subsidiaries so that they could stop handling all US Treasury bonds? …what is worrying this particular Asian financial group is…a new law called the Foreign Account Tax Compliance Act…the new rules leave some financial officials fuming in places such as Australia, Canada, Germany, Hong Kong and Singapore. Little wonder. Never mind the fact that implementing these measures is likely to be costly. …Hence the fact that some non-US asset managers and banking groups are debating whether they could simply ignore Fatca by creating subsidiaries that never touch US assets at all. “This is complete madness for the US – America needs global investors to buy its bonds,” fumes one bank manager. “But not holding US assets might turn out to be the easiest thing for us to do.”

o From India, the Economic Times reports that, “FATCA, or the Foreign Account Tax Compliance Act, will require overseas banks to report U.S. clients to the Internal Revenue Service, but its loose definition of who is a U.S. citizen will create a huge administrative burden and could push non-residents to slash their U.S. exposure, some bankers say. …Bankers say the scheme will be extremely costly to implement, and some say that as the legislation stands, any bank with a client judged to be a U.S. citizen will be also obliged to supply documentation on all other clients. “FATCA will cost 10 times to the banks than it will generate for the IRS. It is going to be extremely complicated,” said Yves Mirabaud, managing partner at Mirabaud & Cie and Swiss Bankers Association board member.”

o Discussing the impact in Canada, Reuters notes, “The new regulation has drawn criticism from the world’s banks and business people about its reach and costs. ..”Hundreds of millions of dollars spent on developing compliance processes to target Canadian citizens would not be a useful exercise, and they are, for the most part, people who actually have no tax liabilities because they do not earn income in the United States,” [Canadian Finance Minister] Flaherty said.”

o A Taiwan news outlet said, “Taiwan’s domestic banks will reportedly reduce holdings of American bonds worth an estimated NT$100 billion (US$3.33 billion) due to the U.S. government’s recent decision to impose 30% tax on foreign-investment income in U.S. securities as bonds. Taiwan’s eight government-linked banks reportedly hold U.S. financial products worth over US$2 billion… On April 8, 2011, the U.S. government issued a notice advising foreign financial institutions to meet certain obligations under the Foreign Account Tax Compliance Act (FATCA), under which foreign financial institutions are subject to complex reporting rules related to their U.S. accounts.”

o From the Persian Gulf, the Bahrain Daily News noted, “A US law…has drawn the criticism of the world’s banks and business people, who dismiss it as imperialist and “the neutron bomb of the global financial system.” The unusually broad regulation, known as FATCA, or the Foreign Account Tax Compliance Act, makes the world’s financial institutions something of an extension of the tax-collecting Internal Revenue Service – something no other country does for its tax regime. …Even the European Commission has objected, and experts say other countries may create their own FATCA-style regimes for US banks or withdraw from US capital markets. In a barrage of letters to the Treasury, IRS and Congress, opponents from Australia to Switzerland to Hong Kong assail FATCA’s application to a broad swath of institutions and entities.”

o A story from Singapore finds, “For many years, thousands of foreign investors have put their money into American shares or other investments. Now, however, a somewhat obscure law called the Foreign Account Tax Compliance Act (FATCA) may make investments in the United States for everyone, from billionaires to the man on the street, here in Singapore far less attractive. …some banks or investment managers may advise customers not to invest in the US. … “private bankers are publicly advising their clients to clear their portfolios of all US securities”. A fund manager here told me his company is also advising clients to avoid US investments, and other companies may similarly start telling large clients as well as smaller ones the same story. Investors could then see recommendations not to invest in the US, and they may put their money elsewhere. …As consulting firm PwC said, “some institutions could decide that complying with the due diligence and verification provisions may not be cost effective” so they may stop making investments in the US. Banks or other asset managers may similarly decide it is easier not to offer US investments than to try and comply with the FATCA.”

o From Switzerland, a story “about the backlash from United States expats and the financial sector to the Foreign Account Tax Compliance Act (FATCA)” reports that, “Growing numbers of American expatriates are renouncing their US citizenship over a controversial new tax law and ever more burdensome fiscal and reporting obligations. …banks and business people who are supposed to enforce it on behalf of the US tax man are worried about its costly administrative burden… it’s just too expensive. The consequence will be that they cut out US clients and stop investing in the US. …Three or four years ago no one talked about renouncing nationality – now it’s an open discussion. That’s a major shift in mentality.

o Writing about the reaction from Europe, one columnist noted, “FATCA encourages foreign financial institutions to limit their exposure to U.S. assets. In a joint letter to the Treasury and the IRS, the European Banking Federation and the Institute of International Bankers, which together represent most of the non-U.S. banks and securities firms that would be affected by FATCA, warned that “many [foreign financial institutions], particularly smaller ones or those with minimal U.S. investments or U.S. customers, will opt out of U.S. securities rather than enter into a direct contractual agreement with a foreign tax authority (the IRS) that imposes substantial new obligations and the significant reputational, regulatory, and financial risks of potentially failing those obligations.” A widespread divestment of U.S. securities by institutions seeking to avoid the burdens of FATCA could have real and harmful effects on the U.S. economy.”

These press excerpts help demonstrate the costs of FATCA, but what about the benefits? After all, maybe the law will lead to lots of good results that offset the high regulatory costs and lost investment for the American economy.

Well, the only “benefit” anybody had identified is that FATCA will transfer more money from the productive sector of the economy to the government. Indeed, Obama argued during the 2008 campaign that cracking down on “tax havens” with proposals such as FATCA would give politicians lots of additional money to spend.

But when the legislation was approved in 2010, the Joint Committee on Taxation estimated that the new law would raise only $8.7 billion over 10 years, not the $100 billion that Obama claimed could be collected every single year. This video has some of the damning details.

One final point demands attention.

While it appears that the rest of the world is against FATCA, that’s not completely true. Some international bureaucrats in Paris, funded by American tax dollars, actually want the rest of the world to adopt the same Orwellian system. Here’s a blurb from the New York Times story.

Jeffrey Owens, a tax expert at the Organization for Economic Cooperation and Development, said catching tax evaders was “a concern that many member countries share.” If countries could agree to new global reporting standards for exchanging information, he said, then “maybe there’s a way forward.”

In other words, the pinhead bureaucrats at the OECD think FATCA’s such a swell idea that they want to create a global network of tax police. So not only would America erode the sovereignty of other nations because of our bad tax law, but those other nations would be able to impose their bad tax law on income earned in America!

And just in case you think that’s just irresponsible demagoguery, it’s already beginning to happen. Check out this IRS regulation, proposed by the Obama Administration, that would require American banks to put foreign law above American law.

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FATCA Law is an International Version of Obamacare’s 1099 Provision, a Nightmare for Cross-Border Economic Activity that Is Undermining Investment in America

One of the tax increases buried in Obamacare was an onerous and intrusive “1099” scheme that would have required businesses to collect tax identification numbers for just about any vendor and then send paperwork to the IRS whenever they did more than $600 of business.

o Send one of your sales people to New York for a couple of nights? They would have to get the tax ID for the hotel and submit a form to the IRS.

o Buy a printer for the office? The printer company would need to provide a tax ID and the purchaser would have to submit a form to the IRS.

o Have a retirement dinner for somebody in the accounting department? Get the restaurant’s tax ID and submit another form to the IRS.

This system was seen as a nightmare, even leading to rather amusing cartoons mocking the law and showing how it would expand an already abusive IRS. And in a rare fit of common sense, the 1099 requirement was repealed earlier this year.

That’s the good news. The bad news is that an international version of Obamacare’s 1099 scheme also was enacted early last year. But since the burden is largely falling on foreigners, there’s no groundswell among voters to repeal the law – even though it will impose far more damage on the American economy.

Known as the FATCA (the acronym for the Foreign Account Tax Compliance Act), this law was included as a revenue-raising provision to pay for one of Obama’s failed stimulus bills.

But while the bill didn’t create jobs, it has created a giant nightmare for all sorts of people and firms – including foreign financial institutions that may now decide that it’s no longer worth the trouble to invest in America.

Consider these excerpts from a shocking story in the Financial Times.

…one of Asia’s largest financial groups is quietly mulling a potentially explosive question: could it organise some of its subsidiaries so that they could stop handling all US Treasury bonds? Their motive has nothing to do with the outlook for the dollar. …Instead, what is worrying this particular Asian financial group is tax. In January 2013, the US will implement a new law called the Foreign Account Tax Compliance Act. …the new rules leave some financial officials fuming in places such as Australia, Canada, Germany, Hong Kong and Singapore. …implementing these measures is likely to be costly; in jurisdictions such as Singapore or Hong Kong, the IRS rules appear to contravene local privacy laws. …Terry Campbell, head of Canada’s banking association, points out, the rules are essentially akin to “conscripting financial institutions around the world to be arms of US tax authorities”. …the IRS is threatening to impose a withholding tax of up to 30 per cent on sales of US assets by groups that it deems to be “non-compliant” – and the assets could include US shares or US Treasury bonds. Hence the fact that some non-US asset managers and banking groups are debating whether they could simply ignore Fatca by creating subsidiaries that never touch US assets at all. “This is complete madness for the US – America needs global investors to buy its bonds,” fumes one bank manager. “But not holding US assets might turn out to be the easiest thing for us to do.” …“Right now my board is probably as concerned about political risk in America as Indonesia, from a business perspective – perhaps more so,” says the head of one large global bank. It is a complaint that American politicians ignore at their peril.

Many people, when hearing about foreign banks resisting demands by the IRS, might automatically assume the issue involves jurisdictions with strong human rights laws with regards to financial privacy, such as Switzerland or the Cayman Islands.

There are plenty of those stories, to be sure, but American tax law has become so bad that the IRS is causing headaches and anger even in nations with high taxes and weak protection of client data.

Here’s an excerpt from an article from the Financial Post in Canada.

Toronto-Dominion Bank is putting up a fight against a new U.S. regulation that would compel foreign banks to sort through billions of dollars of deposits to find U.S. citizens who might be hiding money. According to Bloomberg News, TD has complained that the proposed IRS rule is unreasonable because it would require the bank to make US$100-million investment in new software and staff. Other lenders resisting the effort include Allianz SE of Germany, Aegon NV of the Netherlands and Commonwealth Bank of Australia, Bloomberg said. Now the Canadian Bankers association has joined the fray. In an emailed statement the CBA called the requirement “highly complex” and “very difficult and costly for Canadian banks to comply with.” …According to the New York-based Institute of International Bankers, major global banks would end up spending US$250 million or more to comply with the regulation in terms of new technology employee training.

The vast majority of Americans are very fortunate that they don’t have any personal interactions with the IRS’s onerous international tax rules. But that doesn’t mean they shouldn’t care. The tax treatment of cross-border economic activity can have enormous implications for America’s prosperity, as I’ve already explained in my discussions of a reckless IRS regulation that could drive more than $100 billion of capital out of American banks.

But that’s just the tip of the iceberg. FATCA is far more onerous and extensive, so the damage will be much greater. Not surprisingly, the law utterly fails to satisfy any sort of cost-benefit analysis.

From the perspective of politicians, the “benefit” is more tax revenue. So how does FATCA score on this basis? During the 2008 campaign, Obama claimed this policy would generate $100 billion of additional revenue every year. When it came time to score the legislation, however, the Joint Committee on Taxation predicted that the law will generate only $870 million per year. That’s a big drop-off, even by the shoddy standards of Washington.

Yet for this tiny amount of revenue, the law imposes a giant regulatory burden on all individuals, companies, and institutions that meet two criteria: 1) They have some form of cross-border economic activity, and 2) They have a business or citizenship relationship with the United States.

Americans living overseas are one of the groups that will be severely penalized. Simply stated, foreign financial institutions are treating U.S. citizens like lepers because they don’t want to deal with the IRS and be deputy enforcers of terrible American law. Here are comments from some of Americans living in other nations (all of whom wish to remain anonymous because they fear being targeted by a thuggish IRS).

o  From an American with a spouse working in Germany – “…when he went to create an account, he discovered that the bond fund could not be sold to US citizens.”

o  From a non-profit group operating in Europe – “…we received notification from [bank redacted] that they were terminating our account.”

o  From an American working in Switzerland – “I’m in the process of having my…accounts with [bank redacted] forced closed, except for the mortgage. I’ve been unable to open an account with any other Swiss bank.”

o  From an American living in Belgium – “…my portfolio of investments held at their bank was blocked. …He advised me that as of that
date, I could no longer trade, but could only hold, sell or transfer my portfolio. I was banned from trading in either US stocks or all others.”

o  From a retired teacher in Germany – “I was denied the policy because I am an American citizen. My agent very clearly said that he could sell the policy that I wanted to any other nationality, except me-because I was American!”

o  From an American working in Saudi Arabia – “As a resident of Saudi Arabia, I have twice been rejected as a customer, purely on the basis of my US citizenship. In both instances, I was told that increased administrative and compliance burdens imposed by US authorities have led the banks in question to refuse to open securities accounts for American citizens.”

o  From an American in Japan – “All of these banks and institutions are cutting me off from participation in any but the most simple of basic bank account. Why? Because they do not want to take the time and instill the systems and carry the cost of reporting the income of each of their US citizen clients to the US government.”

o  From an American married to a European – “I have been unable to gain legal advice in Switzerland regarding US Wills and Guardianships because [bank redacted] lawyers are ‘not permitted to speak to Americans about legal, tax or banking matters in specific terms.'”

o  From an American married to a European – “The company who has been holding my modest UK share portfolio wrote to me in September 2010 saying they were closing my account. They were removing all US persons from their client base due to the increased reporting and audit costs placed on them by the Fatca legislation.”

o  From an American in Europe with a foreign spouse – “They sent me a letter saying: Our records show that you are an American citizen. Because of various strict new American rules regarding securities accounts held by American shareholders, we are closing such accounts including yours.”

o  From an American assigned overseas by his company – “I was extremely surprised and outraged by the fact that not one bank (including foreign branches of US banks!) would allow me to open a simple savings account to pay my rent and bills. All of the banks cited my US citizenship and the difficulties they experience with the US government.”

o  From an American in Spain – “I have been forced to close a U.S. bank account due to being an overseas citizen and cannot open new bank or brokerage accounts in the U.S. I am also being denied the opening of new brokerage accounts in Spain.”

Last but not least, another set of victims are foreigners who legally reside in the United States. That makes them tax residents according to American tax law, which means that they also are lepers from the perspective of foreign financial institutions.

Let’s close this lengthy post by including this letter from a Danish bank to a Danish citizen living in the United States. Once again, identifying information is redacted because the person did not want to suffer IRS persecution (it should disturb all of us, by the way, that there is such universal fear of IRS thuggery).

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