Why is the IRS Putting Foreign Tax Collectors Ahead of US Interests?

It’s easy to complain about the IRS, but more often than not the bureaucrats are simply carrying out the bad policies imposed by Congress. There certainly are some egregious cases of IRS abuse, but it’s typically the fault of lawmakers for enacting bad law.

But such is not the case with a regulation currently under consideration which would require that American banks put foreign tax law above U.S. tax law. The regulation deals with the obscure issue of reporting requirements for bank deposit interest paid to foreigners, but the economic impact would be significant. Worst of all, the IRS is seeking to overturn existing law. In some ways, this is the tax equivalent of the EPA’s notorious power grab scheme to impose cap-and-trade with regulatory edicts.

A bit of background. On January 7th, the IRS proposed this regulation (REG-146097-09) to force American financial institutions to report any interest payed to foreigners. Typically, U.S. tax authorities only require information used for U.S. tax purposes. And since Congress wants to attract this investment to the American economy, the law has clearly stated for 90 years that foreigners won’t get taxed, leaving no need to collect any information about this income. But now, as part of global efforts to undermine tax competition and usurp fiscal sovereignty, the IRS is unilaterally asserting the right to demand this information. Only it’s not to enforce American law, but in order to hand the information over to foreign governments so that they can tax this U.S.-source income.

There is good reason why investors would want to protect their personal information.

In many places corruption runs rampant. If you know that any information acquired by your government may be sold to criminal gangs who look to kidnap children of business owners, then financial privacy also becomes a matter of human rights, or even life and death. Or if you live in Venezuela, you need to protect your assets from a thuggish dictator who might expropriate them on a whim. If foreign investors can no longer count on the U.S. as an attractive destination for their investment, one which protects their human rights, they will look elsewhere.

Despite the likely economic impact of the regulation, the IRS amazingly concluded that it was not a “significant regulatory action,” and thus did not conduct a cost-benefit analysis as required by Executive Order 12866. The order quite clearly defines a “significant regulatory action” as one having “an annual effect on the economy of $100 million or more or adversely affect in a material way the economy, a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local, or tribal governments or communities.” With trillions in foreign investment at stake, the IRS would have us believe that this regulation does not have an annual impact of $100 million or more, or would not “adversely affect in a material way the economy.” This disregard of legal requirements is something to expect from a banana republic, but it’s becoming disturbingly common as government gets more power in America.

Not only is the IRS dishonestly ducking Executive Order 12866, it is also blatantly flouting the expressed will of Congress. The last time the IRS tried to impose this reporting requirement, over 100 members of Congress voiced their objection, and it was eventually allowed to die without implementation. This time around, and lead by Congressman Posey, the entire bi-partisan Florida delegation in the House has already objected. Many more are expected to do so in the near future. Senator Marco Rubio, for instance, has just recently joined his Florida colleagues to condemn the regulation, noting that it “violates the long-standing intent of Congress not to require the reporting of interest earned by nonresident aliens,” and would “put our financial system at a fundamental competitive disadvantage.” Every time that Congress has addressed this issue, it has specifically chosen to keep America an attractive destination for foreign investment by not taxing interest paid to non-resident foreigners.