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IRS Public Hearing Testimony

Testimony before
The Internal Revenue Service

Proposed Regulation on Reporting of
Deposit Interest Paid to Nonresident Aliens

Daniel J. Mitchell
McKenna Senior Fellow in Political Economy
The Heritage Foundation

My name is Daniel Mitchell, McKenna Senior Fellow in Political Economy at the Heritage Foundation, and I am here to state my strong opposition to the proposed regulation to require the reporting of bank deposit interest payments to nonresident aliens. My opposition is based on four concerns:

    1. The proposed regulation likely will drive hundreds of $billions out of U.S. financial institutions – and out of the U.S. economy.

    2. The proposed regulation is not required by law. Indeed, the proposed regulation blatantly ignores clear congressional intent.

    3. The proposed regulation reflects bad tax policy.

    4. The regulation is burdensome.

Regarding the first issue, America is a safe haven for international investors. The anti-tax competition bureaucrats at the Organization for Economic Cooperation and Development and the European Union may frown upon our attractive tax and privacy laws, but they have been extraordinarily beneficial for the U.S. economy. Estimates indicate that we have attracted about $1 trillion of nonresident alien deposits to our economy. These funds are a source of capital that generate jobs, promote business expansion, and boost our financial markets.

There can be no question, however, that a substantial amount of this capital will flee the U.S. economy if the IRS forces financial institutions to act as informers. There are many jurisdictions that would welcome these investors and their funds, countries and territories that respect financial privacy and understand that it is not their role to enforce the misguided tax laws of other nations.

But this is not just an issue of tax policy. In many nations, people have a legitimate fear of corruption, expropriation, and criminal activity. Information exchange for many of these people, quite literally, can be a life-or-death issue. Needless to say, these people are not going to keep their funds in U.S. financial institutions if the IRS undermines client confidentiality.

The fact that capital will flee the U.S. is widely recognized by the financial industry. I attach a sampling of quotes from the comments that have been made on this proposed regulation:

American Bankers Association

  • "…the unilateral imposition of these information requirements on US banks will drive low cost bank deposit funding to foreign banks…"

New York Clearing House

  • "…confidentiality is a critical factor in determining where foreign investors will conduct financial transactions."

California Bankers Association

  • "It is likely that customers will remove their deposits away from US banks and into jurisdictions that have no such reporting requirements. This is contrary to the interests of banks and could have negative ramifications on the economy."

Institute of International Bankers

  • "Unilaterally imposing information reporting requirements…would strongly encourage [NRA depositors] to withdraw their funds and transfer them to the many jurisdictions that do not impose such requirements. In this regard, we understand that the 1996 promulgation of a similar rule regarding Canadian depositors caused just such an outflow of individual deposits from the United States."

Institute of International Bankers

  • While it is not possible to determine the precise amount of foreign individual deposits in the United States, our informal inquiries indicate that individual deposits comprise a significant portion of the total $1.6 trillion of bank deposits held by foreigners in the United States."

Conference of State Bank Supervisors

  • Legitimate deposits of nonresident alien individuals generally represent a stable source of funds for state-chartered banks and state-licensed foreign banking organizations because of the favorable economic and political environment in the United States. Imposing a reporting requirement on income that currently is not taxable could erode this favorable environment. Thus, to the extent the proposed regulations deprive these institutions of a stable source of funds, the regulations likely will impose a direct cost on the banking system of the United States."

Florida International Bankers Association

  • "The total estimate of foreign liabilities [bank accounts] in the U.S. as of April 2000,…according to "Bank Reported Data" obtained from the U.S. Treasury website, was in excess of $1.4 trillion, over $1 trillion of which consisted of deposit accounts…"

Independent Community Bankers of America

  • "…new reporting requirements on legal foreign deposits would act to discourage nonresident aliens from depositing their assets in U.S. financial institutions. Foreign deposits under U.S. management are largely a function of the confidentiality, privacy, and stability of the U.S. banking system."

America's Community Bankers

  • "Nonresident aliens from unstable or repressive nations that have tax treaties with the United States could have a well-founded fear regarding IRS information sharing. As a result of IRS sharing of information, their wealth could be expropriated, and they – or their families – could be threatened with criminal prosecution, violence, or kidnapping from their home countries.

Independent Bankers Association of Texas

  • "We believe that the proposed reporting requirements will drive these deposits out of our domestic banks and into the financial institutions of countries likely to maintain the confidentiality of those relationships."

Regarding the second issue, the proposed regulation is an abuse of the rule-making process. Regulations are supposed to implement the laws approved by the legislative branch. This proposed regulation flagrantly ignores the laws Congress has enacted and clearly seeks to replace legislative intent with regulatory edicts.

On several occasions, Congress has visited the issue of how to tax – or not tax – the bank deposits of nonresident aliens. In each instance, because of the desire to lure capital to the U.S. economy, Congress has chosen not to tax the income and not to require that the income be reported to foreign governments.

At times in our history, Congress has chosen to classify this income as "foreign source," and at times they have decided to exempt this income from tax. In all cases, though, they clearly made those choices based on the desire to keep money in the U.S. economy. To somehow claim that this proposed regulation is consistent with congressional intent is therefore completely baseless and borders on deliberate disregard for the truth.

Many of the comments on this proposed regulation have made this point quite clearly. A few of these observations are reprinted below:

American Bankers Association

  • "This present law has its origins in and is presently built upon a policy designed to encourage investment in the US and strengthen US competitiveness. The Proposed Regulations, if adopted, would threaten this longstanding policy and risk serious financial harm to many US banking institutions."

Florida International Bankers Association

  • "Requiring U.S. banks to therefore report to the IRS interest income payable by them to an NRA [non-resident alien] individual serves no good purpose, sine the IRS does not tax such interest income anyway."

Florida International Bankers Association

  • "...it is not the function of the IRS to compile and maintain a comprehensive and expensive database of non-taxable bank interest paid by U.S. banks to NRA individuals who might or might not be declaring such income back in their home country…"

Miller & Chevalier

  • "Section 871(i) of the Code provides that U.S. bank deposit interest paid to NRA individuals is exempt from U.S. tax if such interest is not effectively connected with the conduct of U.S. trade or business. As a corollary to exempting NRA interest from U.S. tax, the Code also provides specific exceptions to the normal gross income withholding tax and information reporting requirements for interest paid on NRA deposits {Code 1441(c)(10), 6049(b)(2)(c)}. In particular, sections 6049(b)(2)(c) and (b)(5)(B)(iv) of the code specifically provide that NRA deposit interest shall be exempt from information reporting, 'except to the extent otherwise provided in regulations.'"

Miller & Chevalier

  • Those regulations are intended, though, "to ensure that persons claiming exemptions from U.S. tax in fact qualify for the exemptions that they claim."

Miller & Chevalier

  • Regarding the claim that the regulations will help catch US taxpayers claiming to be foreign in order to avoid tax: "For those few U.S. persons that succeed in falsely claiming NRA status, the information reports required under the proposed regulations would be based on the same false residence information that the depositor included on the Form W-8BEN."

Miller & Chevalier

  • "In general, however, it does not appear that US treaty partners typically compel their financial institutions to report all interest payments to US residents and then compile and send that information to the IRS. Thus, the proposed regulation would establish a one-sided "exchange" of information in which interest paid by US banks to NRAs would automatically be transmitted abroad, while the foreign competitors to US banks would not be required to report their interest payments to NRAs."

Miller & Chevalier

  • "Neither US treaties nor international norms support Treasury's initiative automatically to collect and exchange information that would not normally be collected under US domestic laws or administrative practice."

Independent Community Bankers of America

  • "…since nonresident alien interest payments on U.S. deposits are not subject to tax in the U.S., the Internal Revenue Service would not further any U.S. financial interest in requiring these new reporting requirements."

America's Community Bankers

  • "The proposed regulations would contravene and explicit congressional policy of encouraging foreigners to deposit funds in U.S. banks, which is expressed in the exemption of deposit interest payments from 30% withholding and information reporting."

Independent Bankers Association of Texas

  • "…since the interest paid on these accounts in not subject to taxation in the U.S., there is no apparent domestic fiscal impact to remotely justify this additional expense to our banking industry."

Florida International Bankers Association

  • "…ensuring foreign tax compliance by their clients in not the duty of the U.S. banking industry…"

Regarding the third issue, the proposed regulation runs counter to good tax policy. More specifically, the regulation runs afoul of two important principles. First, it is based upon the worldwide, or residence-based theory of taxation. Second, it assumes that a tax system should be biased against income that is saved and invested.

On the first point, a worldwide system is inferior to a territorial system for several reasons. A worldwide system is anti-competitive since it makes it very difficult for taxpayers to shift their activities to a lower-tax environment. A worldwide system is anti-privacy since it requires the collection and sharing of private financial information. A worldwide system is anti-sovereignty since it creates an incentive for international bureaucracies like the OECD and EU to engage in fiscal imperialism against jurisdictions that refuse to conspire against the interests of taxpayers. A territorial system, by contrast, avoids all these problems. A government is allowed to adopt any type of tax or impose any level of tax under a territorial system, but there is no effort to impose its tax laws on income earned in other jurisdictions. Returning to the proposed regulation, the only government that has the right to tax bank deposit interest earned in the United States is the United States. Other governments, of course, can enact laws seeking to tax their citizens on income they earn in the United States, but our government has no obligation to help enforce the bad tax laws of other nations.

On the second point, public finance economists increasingly agree that it is economically destructive to impose a harsher tax penalty on income that is saved and invested as opposed to income that is consumed. This is because every economic theory – even Marxism – agrees that capital formation is the key to long-term growth and rising living standards. This means that all income should receive IRA treatment, ideally by providing universal and unlimited "Roth IRA" treatment of savings. Income would be taxed the year it is earned, but there would be no second layer of tax if the taxpayer decides to save and invest some of that after-tax income. Returning to the proposed regulation, this widely shared principle explains why bank deposit interest should not be taxed, regardless of whether the recipient is a U.S. resident or non-U.S. resident.

 Last but not least, the IRS failed to perform the required cost-benefit analysis required by the Congressional Review Act. This is a regulation that, if implemented, would drive hundreds of billions of dollars out of the U.S. economy. As such, it clearly qualifies as a "major rule" and a "significant regulatory action."

 A sampling of the comments provided from the financial services industry confirms the burden of this proposed regulation and illustrates why this proposed regulation is bad process as well as bad policy:

Navy Federal Credit Union

  • "…the Agency's proposal concerning joint account holders will be burdensome and costly to implement."

American Bankers Association

  • "…the costs and administrative burdens created by the Proposed Regulations for the banking industry, and, ultimately, bank customers, significantly outweigh any benefits likely to be realized by the Service [IRS]."

Florida International Bankers Association

  • "…the regulatory burden imposed on its member banks as a result of the proposed rules will be significant for those banks with a lot of NRA individual depositors – and not the small amount optimistically cited by the IRS in the proposed regulations (15 minutes per bank?)."

Miller & Chevalier

  • "Under the Congressional Review Act…, 'major rules' such as these proposed regulations must be filed with Congress along with a report discussing, among other things, a cost-benefit analysis of the rule. Similarly, Executive Order 12866 defines "significant regulatory action" as "any regulatory action that is likely to result in a rule that may…adversely affect in a material way the economy, a sector of the economy, productivity, competition, jobs…or State [or] local governments or communities.'"

Independent Community Bankers of America

  • "Currently, bank compliance with these regulations for nonresident aliens are open to audit and inspection by the Internal Revenue Service and bank regulators at any time."

California Credit Union League

  • "These proposed regulations would impose a tremendous regulatory burden upon these credit unions…"

Credit Union National Association

  • "We believe the costs associated with compliance under the proposal will be substantial.

Credit Union National Association

  • "We also question the IRS's Special Analyses accompanying the proposal regarding whether the rule is a significant regulatory action, the applicability of the Administrative Procedure Act and the applicability of the Regulatory Flexibility Act."

Independent Bankers Association of Texas

  • "This new burden will prove both cumbersome and expensive for our banks, and those costs will be passed along to bank customers."

Washington Credit Union League

  • "This proposed rule represents a costly compliance burden for all U.S. financial institutions."

Ohio Credit Union League

  • "…not in support of the interim final rule and objects to the burdensome requirements contained in the rules."

Miller & Chevalier

  • "This type of regulation is exactly the sort that the Congressional Review Act and the Executive Order sought to subject to closer study, and we urge the Treasury Department to examine the potential ramifications more carefully and submit the required report for major rules for Congress' review."

In conclusion, I recommend that the proposed regulation be withdrawn. Thank you very much for this opportunity to share my views on this proposed regulation. I will be happy to answer any questions.

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