- The Washington Times - Thursday, January 2, 2003

Three days before Bill Clinton left office, the Internal Revenue Service proposed a regulation that would require the reporting of interest paid to bank accounts held by nonresident aliens. Strong opposition forced the IRS to withdraw the regulation in July 2002, but this proved to be a hollow gesture since the Service immediately reissued the proposed rule with a few cosmetic alterations.
This regulation will hurt America by driving capital from U.S. banks. This is why lawmakers decided not to impose U.S. tax on these accounts and not to require this income to be reported. The IRS regulation, however, would overturn existing law and enable foreign governments to tax the income since any information collected automatically would be provided to the 15 nations listed in the proposed regulation.
This IRS regulation undermines President Bush's pro-growth, pro-competition tax policy. Unfortunately, the Treasury Department is defending the IRS regulation pursuing a Clinton administration scheme even though it will hurt the economy (and harm the president's re-election chances). The arguments used by Treasury are either misleading or inaccurate. For instance:
Treasury myth: The IRS regulation will have no effect on the economy.
Fact: The regulation will drive a significant amount of capital from the U.S. economy. It is true that it is difficult to measure the degree of capital flight. But even low-range estimates tens of billions of dollars indicate a substantial and negative impact on financial markets and segments of the economy (such as real estate and small business) that depend on access to capital. The regulation ultimately has the potential to drive hundreds of billions of dollars from the U.S. and endanger the safety and soundness of U.S. banks, particularly since many foreigners who invest in the U.S. economy correctly fear that the IRS intends to extend the reporting requirements to depositors from all nations. The Conference of State Bank Supervisors, who regulate more than half the banks in the U.S., has expressed its concern to this effect. The regulation will also impose large costs of U.S. financial institutions and make U.S. banks less competitive in their efforts to attract foreign customers.
Treasury myth: The IRS regulation will help enforce U.S. tax law since other nations will reciprocate and provide information about U.S. investors to our government.
Fact: The 15 nations listed in the IRS regulation are almost all high-tax nations that suffer from capital flight. It is highly unlikely that a U.S. taxpayer would "hide" money in uncompetitive jurisdictions like France and Sweden. The types of Americans with bank accounts in these jurisdictions would be executives working overseas in those nations, and such people are not high-risk for tax compliance.
Moreover, the United States already has implemented hundreds of pages of "qualified intermediary" rules, which force banks in every other country to report American investors. We also have pressured virtually every overseas financial center into signing agreements to provide information to the U.S. Treasury. The bilateral strategy is far more effective and poses no dangers to American interests.
Treasury myth: The IRS regulation will catch Americans who pretend to be nonresident aliens in order to obtain preferential tax treatment.
Fact: Nothing in the regulation improves the identity verification procedures currently required by the government. A U.S. taxpayer pretending to be a nonresident alien thus has nothing to fear if the regulation is adopted.
Treasury myth: The IRS regulation will help fight money-laundering.
Fact: Nonresident alien bank accounts already are subject to the full range of know-your-customer requirement and other anti-money laundering rules that apply to all U.S. bank accounts. The proposed regulation does not include any new anti-money laundering provisions. The only thing the regulation will accomplish is to collect information on interest payments so this information can be forwarded to foreign governments for tax purposes.
Treasury myth: The proposed regulation will help the war on terrorism.
Fact: Treasury bureaucrats used this argument to mislead outgoing Secretary Paul O'Neill, but it has no basis. As explained above, the regulation has no effect on know-your-customer rules. Moreover, U.S. law-enforcement people already have extensive procedures for working with foreign intelligence/law enforcement services. Creating a global network of tax police will hurt the war on terror by diverting resources. We want our law enforcement people catching terrorists, not helping foreign governments tax income earned in America.
Treasury myth: The proposed regulation does not undermine the president's position against the EU Savings Tax Directive.
Fact: The Bush administration has rejected a European Union request for the U.S. to join a cartel for the purpose of double-taxing cross-border savings, but the IRS regulation undermines that position.
The European Commission specifically cites the proposed regulation in a Dec. 3 report on the status of the proposed cartel. EU officials repeatedly have stated that the proposed regulation is an "equivalent measure" and thus can be interpreted as a sign of U.S. support.
Career bureaucrats traditionally have been a thorn-in-the-side of Republican presidents. Protected by lax civil-service rules, this permanent army of paper pushers is free to pursue an ideological agenda.
But the fight over the IRS's proposed regulation is particularly worrisome because Treasury political appointees people who should be loyal to George Bush are actively working with the bureaucrats to implement this misguided Clinton policy. Hopefully, the new Treasury secretary will have something to say about this matter.

Daniel J. Mitchell is the McKenna senior fellow in political economy at the Heritage Foundation.

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