Insight

Tax Collector for the World

By John Berlau jberlau@InsightMag.com

Thanks to a Bill Clinton ‘midnight regulation,’ U.S. banks may may have to report financial data about their foreign depositors to countries such as Russia and even China.

During the last month of his administration, Bill Clinton worked desperately for a historical legacy on the world stage. But peace talks with Israel and the Palestinian Authority broke down, and Chile balked at signing a trade agreement with labor and environmental conditions attached.

Then, on Jan. 17, three days before his administration ended, Clinton’s Treasury Department and Internal Revenue Service announced an international bequest of considerable significance. The gift was a “midnight” regulation requiring U.S. banks routinely to provide data on their foreign customers to countries ranging from socialist Sweden to communist China.

If it goes into effect, the new regulation should garner considerable appreciation from foreign bureaucrats and tax collectors. To escape high taxation by Europe’s welfare states or outright confiscation by Marxist and other dictatorships, foreigners have been putting their earnings into U.S. bank accounts, where the currency is relatively stable and their privacy was protected. Congress has encouraged this practice since 1921 to attract capital to the U.S. economy by exempting from U.S. taxation the interest earned on deposits of nonresident foreigners. But high-tax countries in Europe, as well as the Paris-based Organization for Economic Cooperation and Development, have attacked the United States and other (relatively) low-tax jurisdictions for fostering “harmful tax competition.”

Critics say the new IRS regulations were a Clinton-administration attempt to bypass the specifics of U.S. law which bars the IRS from requiring the reporting of interest earned by foreign depositors on U.S.-based accounts except in certain exceptional circumstances. The Clinton regs make an end run around the intent of the rule by extending the exception cases to all foreign depositors so that the IRS can “facilitate, whenever possible, the effective exchange of all relevant tax information” with more than 60 countries that have tax treaties with the United States. The countries then can do with the information what they wish, taxing the interest earned by their citizens from U.S. banks. And, in the case of such treaty partners as China, Russia and Venezuela (see chart), subjecting their citizens to even sterner punishments for “economic crimes” against their masters.

The IRS already exchanges bank information routinely with Canada, and it can ask banks for information on specific foreign customers who are suspected of crimes. But the Clinton regulation represents a dramatic change, requiring banks to participate in a “data dump” on customers from treaty countries regardless of circumstances, observes George Guttman, a veteran IRS reporter for the journal Tax Notes.

“The only people who benefit from these regulations are foreign tax collectors,” says Dan Mitchell, a senior fellow in political economy at the Heritage Foundation. “Countries don’t have an obligation to enforce each other’s laws. … Why on Earth should we help another country enforce bad tax law?” Mitchell also is cofounder of the Alexandria, Va.-based Center for Freedom and Prosperity, which is coordinating opposition to the IRS regulations and other international efforts to thwart tax competition.

And opposition has emerged to the IRS rules from financial institutions that run the gamut from small banks and credit unions to international bankers. They say that not only would the reporting requirements impose high compliance costs, they also would cause fearful foreigners to pull their money out of the United States and put it in safe havens such as the Cayman Islands, Panama or Switzerland, which have a reputation for protecting privacy. This would put at risk an estimated $1.7 trillion in U.S. bank assets from foreign depositors.

In Florida, foreign accounts are estimated to represent as much as one-third of bank deposits. So it is not surprising that members of the Sunshine State’s congressional delegation who were at each other’s throats during the presidential recounts signed a joint letter warning Treasury Secretary Paul O’Neill that the new IRS regulations “may well do significant damage to the U.S. banking industry and to many of the nation’s communities if the proposal is not withdrawn.” The letter was signed by most Republicans in the Florida congressional delegation, as well as liberal Democratic Reps. Robert Wexler and Peter Deutsch.

Now that the rules have attracted so much attention, it seems no one wants to defend them. Clinton administration Treasury secretary Larry Summers and his deputy, Stuart Eizenstat, did not return Insight’s phone calls for comment. An IRS spokeswoman also declined comment, telling Insight that “regulations are issued by the Department of the Treasury.” But the regulations formally cite the desires of “Treasury and the IRS” and are signed by the IRS deputy commissioner.

Though an agency under the Treasury Department, the IRS operates semiautonomously. It still is headed by Clinton appointee Charles Rossotti, despite potential ethical conflicts from his ownership of as much as $80 million worth of stock in American Management Systems (AMS), a large IRS technology vendor (see “A Taxing Dilemma,” April 23). “The IRS is going off on an ideological exercise that’s flouting congressional intent and the rule of law,” says Mitchell. “This regulation is a test: Who is in charge, the Bush appointees or the Clinton career bureaucrats?” So far, it’s hard to tell. Treasury spokeswoman Tara Bradshaw says officials are “in the process of reviewing” the regulations.

Rossotti may have a financial, as well as ideological, interest in the regulations. Although the IRS says in its regulations that it plans to share information with treaty partners, it is requiring banks to report the interest on accounts from citizens of all countries. In comments to the IRS and Treasury, banking groups have said that calculating and reporting interest payments of citizens of all foreign countries would require expensive computer upgrades and software, particularly for smaller banks. “Credit unions do not generally have data-processing systems that have been programmed to identify nonresident-alien individuals’ accounts and prepare IRS [forms],” notes the Credit Union National Association in comments to the IRS. “For credit unions that are automated, and many smaller ones are not, new software would have to be purchased or current systems would have to be substantially altered at an appreciable cost to the credit union.” Robert Brookes, president and chief executive officer of Eagle National Bank, a community bank in Miami, said the regulation would cost his bank $100,000 in the first year and $35,000 in succeeding years in compliance costs.

Naturally, this new burden to banks would create a new line of business for information-technology consulting companies such as AMS, and Rossotti could see his stock soar as a result of the regulation. Having long provided systems integration and software to both the IRS and the banking industry, AMS seems well-positioned to serve the banks hit by the IRS reporting requirements. A recent company press release boasts that AMS has worked with more than 350 banks and financial-services institutions and is “providing leading technology and services to the financial-services industry.”

Mitchell says he doesn’t know Rossotti’s motivation or level of involvement in the regulations but believes Rossotti should sell his AMS stock to avoid the appearance of a conflict of interest. He expresses concern that the IRS deliberately understated the compliance costs. “It’s clear that they did that to evade the law for writing cost-benefit analyses, but I assume that’s just standard bureaucratic chicanery.”

Miami banker Brookes says that whatever the IRS motivation, his bank and his city will suffer because of the rule’s compliance costs and because of capital loss. “I’d have to sell off loans, sell off investments, call loans and basically stop doing what I’m doing now, which is using my nonresident-alien money to lend to the local community for local projects,” he says.

Brookes and other Florida bankers say they already are getting frantic calls from their Latin American depositors and say the proposal is preventing new foreign accounts from being opened. This is because some citizens of Latin American countries literally fear for their lives if their financial information is shared with their governments. Miriam Lopez, president and chief executive officer of Miami’s TransAtlantic Bank, says there had been a surge of new accounts from Venezuelans anxious about the election as president of Hugo Chavez, a close friend of Cuba’s Fidel Castro and of the Chinese government (see “Fidel’s Successor in Latin America,” April 30). Even in a relatively free country such as Colombia, Lopez says, her customers fear that terrorist gangs could get hold of financial information once the U.S. government supplies it. “In Colombia, you can be kidnapped and held for ransom for $30,000; forget about $1 million.”

And Latin America isn’t the only region where the IRS plans for data exchange could put human rights at risk. Increasingly, critics of the Chinese government, particularly those who live in Hong Kong, are putting some of their money in U.S. banks to avoid Beijing’s watchful eye. “If those organizations [depositing in U.S. banks] are considered a political-opposition movement or potentially a political-opposition movement, then sharing their financial information with the Chinese secret-police gestapo would be very, very damaging and would jeopardize the survival of those organizations,” says Ning Ye, a Chinese dissident living in exile in the United States who is president of the Free China Movement.

-- Anonymous, July 07, 2001

Answers

Well, if we needed proof that Clinton was an ass...

[BTW, I reformatted that article for ya.]

-- Anonymous, July 07, 2001

Zank you, dahlink.

-- Anonymous, July 07, 2001