A Brotherhood of Taxes The Internal Revenue Service is gearing up a regulation that would threaten financial privacy, further the goals of an international tax cartel, and deal a blow to the U.S. economy, all in one fell swoop.

by Wayne T. Brough, CSE


Starting with a warmed-over Clinton-era tax proposal, the Internal Revenue Service is gearing up a regulation that would threaten financial privacy, further the goals of an international tax cartel, and deal a blow to the U.S. economy, all in one fell swoop. The proposal, which is unnecessary for U.S. tax policy, expands the operational requirements of the IRS even as it scrambles to ensure compliance with the overly complex and inefficient federal tax code.

The proposal first saw the light of day back in January 2001, part of a flurry of “midnight regulations” rushed out the door by agency heads one step ahead of President Clinton’s departure. Issued by the Department of Treasury, the IRS proposal sought to establish “guidance on reporting of deposit interest paid to nonresident aliens.” More simply stated, the proposal would require U.S. banks and financial institutions to report interest paid to foreigners on deposits they keep in U.S. institutions. Interestingly, this information would do little to assist the IRS do its job—the interest payments are not considered taxable income here in the United States.

In light of concerns raised in Congress and the financial community, the IRS pared back its plan with a new proposal that was released in August. Rather than a blanket requirement, the new reporting rules would apply only to foreigners from 15 countries. And it is not as if the proposal targets despots or drug dealing cartels in the Third World; the majority of the countries are members of the European Union, which has been aggressively seeking to establish a tax cartel that reduces tax competition between nations. In the past, the Europe’s zest for taxation has been tempered by the fact that capital is mobile, and investments flowed out of Europe to more business-friendly climates. The new IRS proposal provides the EU information to staunch the flow of capital by assisting foreign tax collectors expand their control over their citizenry.

The proposal would, however, strike a significant blow against privacy, as the IRS embarks on the collection of new information. The information collected would be available not only to the U.S. government, it would be shared with foreign governments as well, some of which have different traditions when it comes to individual rights and liberties. And though the most recent version of the plan is more limited in reach, once the plan is adopted it will be relatively easy to expand the list of countries that must comply with the new laws.

Even though the proposal applies to foreigners who earn interest in American financial institutions, the proposal poses a real threat to American citizens. The money that is earning interest in these financial institutions is working capital that expands the loanable funds available to Americans. Estimates suggest that foreigners have more than $1 trillion in U.S. financial institutions. Everything from car loans to mortgages to capital for business start-ups relies on the availability of loanable funds. As in any market, when a good become scarcer, the price increases. Should the new IRS proposal scare off these foreign investments, the new scarcity in loanable funds will put upward pressure on interest rates for Americans seeking to borrow money, which is not the smartest policy option in a flagging economy.

The United States has long been known as the place to do business. American companies and workers have enjoyed the benefits of capital looking for a safe and stable nation. Yet recent trends raise questions about this important advantage held by the United States. The corporate tax code has become so complex that corporations—even U.S. corporations—are looking elsewhere for business opportunities. The new IRS proposal further weakens the promise of doing business in America, as IRS agents do the bidding of their foreign counterparts.

Tax policy is truly in need of reform. The EU approach to reform is to “level the playing field” by bringing everyone up to the same standards of taxation. Tax competition is derided as a “race to the bottom” that leaves all nations without the revenues needed to fund government activities (at least government activities on the grandiose scale of Europe’s public sector).

To date, the American approach to tax reform is unclear. The IRS appears to be gearing up a massive information collection effort in order to more effectively enforce the current tax code and then some. This does little to eliminate the harmful biases in the tax code against saving or alleviate the inequities created by a tax code driven by politics rather than policy. Instead of expanding the IRS to meet the exigencies of an unbearable tax code, it would be far wiser to shrink the tax code to something the IRS could handle. The administration should be pursuing such options as a simple flat tax instead of beefing up the role of the IRS in a worldwide tax cartel aimed at shoring up the revenues of bloated governments.


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