NCPA - National Center for Policy Analysis

Should U.S. Banks Collect Tax Information for Europe?

March 5, 2003

Investment from abroad has been a significant source of capital for U.S. businesses. Foreigners have invested more than $1 trillion since 1984, under a policy of not taxing interest they earn on U.S. bank deposits. (See Figure I.)

However, this influx of capital is jeopardized by a proposed Internal Revenue Service regulation (133254-02), which would require banks to report interest paid to nonresident aliens.

If the regulation becomes effective, foreign account holders may move their funds to friendlier countries. Stephen Entin of the Institute for Research on Economics of Taxation estimates the regulation's annual cost may amount to $80 billion in lost output, or 0.8 percent of U.S. gross domestic product.

The rule is objectionable for other reasons, including:

  • The IRS lacks statutory authority to impose the regulation, and it is contrary to the administration's policy that taxpayer information should be kept confidential.
  • It will impose significant regulatory costs on banks, but because the IRS claims it is not a "major" rule, it has not performed the cost-benefit analysis required for other rules.
  • It hinders jurisdictional competition because the information will be shared with foreign governments, enabling high-tax jurisdictions to tax income earned outside their borders.
  • And it would sabotage tax reform by helping foreign governments double-tax income earned in America.

For example, the European Union would like the United States to join a cartel that would double-tax cross-border savings. The Bush administration has rejected the EU request, but the EU considers the proposed regulation supportive of its cartel.

The regulation is a slight modification of a rule proposed by the Clinton administration. It limits information collection to residents of 15 developed countries, including some EU members. However, it is clear that the IRS intends to eventually extend the regulation to citizens of all nations.

Source: Andrew F. Quinlan (president, Center for Freedom and Prosperity), "The IRS vs. Foreign Investment," Brief Analysis No. 431, March 5, 2003, National Center for Policy Analysis.

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