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UBS AG -- Phil Gramm

UBS AG
1501 K Street NW
Washington, DC 20005

February 19, 2003

The Honorable John W: Snow
Secretary
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Dear John:

I very much appreciate your taking the time to talk with me on the phone last week regarding my concern-over the IRS' proposal to require U.S. banks to report deposit interest payments made to non-resident aliens. This is a very important issue, and I appreciate your willingness to look further into it.

The IRS proposal, if implemented, will adversely affect foreign deposits in U.S. bans reducing bank reserves and bank loans at a time when the Administration is otherwise recommending measures to stimulate investment, productivity,-savings and job growth. The proposal is inconsistent with the clear intent of the U.S. Congress dating back to 1921 against taxing the interest of deposits held by non-resident aliens. Give this long-established policy, there is no statutory basis upon which the IRS can legitimately rely onto impose the proposed reporting regime on U.S. depository institutions.

Most importantly, this proposal will limit economic freedom and reduce the pressure that potential capital flight imposes on high-taxing countries worldwide. It also imposes a heavy burden on out depository institutions by forcing them to aid foreign governments m the enforcement of their tax laws, which is a policy specifically rejected by the Congress during its deliberations in 2001 over significant amendments to U.S. money laundering laws.

Attached is a copy of my eight primary arguments in opposition to this proposal. I would be pleased to discuss them in greater detail with you at any time and again very much appreciate your review of this proposal.

Yours respectfully,

Phil Gramm
Vice Chairman

**********

Presented to Senior White House Counsels On February 10, 2003

Eight Reasons to Reject the IRS Proposal to Require Banks to Report Interest Payments Made to Non-Resident Aliens

by Phil Gramm

1. Even if such data were collected and shared with the 14 European countries and Canada, no significant mount of new taxes would be collected by them bemuse there are numerous other countries where deposits can be held without loss of privacy and the accounts would simply move.

2. A reciprocal sharing of data with the 15 countries in question will not result in any additional tax collection for the United States. The 15 countries we would share the data with are among the highest taxing countries in the world. Not even proponents of the IRS policy would argue that Americans are seeking a tax haven in France or Sweden.

3. The adoption of a reporting policy for the interest payments on foreign deposits will produce a flight of deposits not Just by depositors from the 15 countries directly affected but by others who fear a future expansion of the policy to other countries. The FDIC, the State Bank Regulators and the New York Clearing House Association have all raised safety and soundness concerns about the proposed regulation.

A review of the available data quickly convinces the cautious analyst to conclude that no one knows what percentage of the $1.75 trillion of liabilities of U.S. banks to foreigners would respond to the imposition of a foreign tax on interest income and the loss of privacy which would occur from interest reporting to the IRS. But some things are certain the reporting to the IRS will cause deposits in U.S. banks to decline, reduce bank reserves, reduce domestic lending, and hurt the economy. The debate is about the magnitude of the effect not the direction of the effect.

For what it's worth, the original IRS proposal was proposed on January 17, 2001. U.S.banks lost $41 billion of time and savings deposits in the first quarter of 2001, according to the Fed Flow of Funds data. The stock market had peaked on March 24, 2000, almost a year earlier, and was in decline. We might have expected time and savings deposits to have risen as wealth fled the stock market. The withdrawal in the first quarter of 200! waseasily twice as large as any other quarter during this period.

The study by the Washington Economic Group, Inc. suggests that in the moderate case scenario, the original proposal might have sent U.S. GDP down by $25, 230 million and total wages down by $18,900 million. (Assuming Florida banks hold 1/10 of all non-resident alien deposits held in the U.S.)

4. The IRS proposal violates the clear intent of Congress. Congress has taken the extraordinary action of exempting from taxes interest on deposits held by non- resident aliens not once but three times (1921, 1976 and 1986). When Congress voted to eliminate the tax exemption in 1966, it delayed implementation over and over again until it reversed itself permanently in 1976. At the time the Joint Committee on Taxation concluded, "Congress has concluded that the elimination of the exemption would result in a significant decline in the substantial deposits by non-resident aliens and foreign corporations in banks in the United States." In addition, the Committee believed that uncertainty regarding the exemption was hurting the economy: "It is believed that the temporary nature of the exemption in recent years may have discouraged foreign investors from investing in fixed-term bank deposits."

If Congress exempted the deposits from taxation three times to encourage foreign nationals to place deposits in U.S. banks, how could it be the intent of Congress that we now help other countries tax those same deposits? As Tax Notes International concluded,"Collecting information concerning such deposit interest and passing it on to other countries will almost certainly have the same effect as imposing a tax on the interest."

Of equal importance as to the intent of Congress, in the money laundering bill Congress made clear its intent that the powers granted under the bill not be used to enforce the financial laws of foreign countries. The IRS proposal runs counter to: this principle. As members of the relevant committees of Congress have become aware that the IRS proposal has resurfaced, there has been a strong outpouring of opposition.

The IRS does not cite any statutory basis for its proposal. The reason for this glaring omission is obvious. There is no statutory basis for the regulation.

5. SBA opposes the proposed regulation because it imposes a heavy regulatory burden on small banks. SBA argues that the IRS is violating the Regulatory Flexibility Act by not doing a cost benefit study. Not even proponents of the proposed regulation would argue that the benefits in taxes collected in the U.S. would exceed the cost of compliance.

6. The U.S. has no treaty obligation to collect data on interest paid to foreign resident aliens. The original proposal did not even suggest a treaty obligation existed. An analysis of our commercial treaty obligations reveals that if we choose to collect the data for our own use that we are required to share it, but we are under no obligation to collect the data in the first place.

7. This proposed regulation was one of Clinton's midnight regulations. It is not and has never been the policy of the Bush administration.

8. Finally and most importantly, the ability of people to move their capital is the most effective check on excessive taxes and oppressive government. The United States of America is the world's greatest beneficiary of such capital movements. Why would we ever want to limit economic freedom and protect over-taxing governments around the world? Capital flight restrains taxes worldwide and protects all the things we value. In this important area, we must be extraordinarily careful. The EU has already stated that the adoption of the IRS proposal would be deemed to be concurrence with their own EU savings Tax Directive. If we do not want to under cut economic freedom, we must reject the IRS proposal. Do not amend it. Kill it. The benefits, if any, of the IRS proposal are so overwhelmed by the dangers it poses as to make its adoption unthinkable.
 

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