WASHINGTON -- Internal Revenue Service (IRS) bureaucrats have until the witching hour of midnight New Year's Eve to satisfy their fellow tax collectors in Europe and close down the American tax shelter, which has benefited both the U.S. economy and European investors. Here is a cautionary tale of how the new international bureaucracy works.
More than two years ago, the IRS proposed a new regulation to force American banks to disclose interest paid to depositors from 15 high-tax European countries. Dec. 31 is the deadline for a European Union (EU) directive firming up taxation, and it needs the Americans to get on board. Even if they don't, however, a new attempt surely will be made.
That this proposal has survived in a purportedly free-market Republican administration is remarkable. It was inherited by President Bush when he took office, found among the detritus of midnight regulations left by the Clinton administration in its final days. It would shut down the world's most important tax shelter, mobilizing the U.S. government to collect foreign taxes at a staggering cost to the American economy.
Forty-six House members (41 Republicans and five Democrats) wrote the president a letter last April 5 asserting that "the regulation flagrantly violates the intent of Congress" and asking him to withdraw it. He did not. Why wouldn't George W. Bush immediately scrap this Clinton legacy? Considering the magnitude of his burdens, it is doubtful he is more than dimly aware of the issue.
Paul O'Neill, the now departed secretary of the Treasury, was made aware of the issue but shrugged it off. The issue has been debated fiercely at the staff level with Bush's economists fighting the regulation. At a Dec. 5 IRS hearing, it was opposed by all witnesses -- representing free-market think tanks, banking trade organizations, small business organizations, the Small Business Administration's advocacy group, state bank supervisors and conservative organizations.
Still, the regulation survived. Its critics believe it was kept alive by Josh Bolten, the low-profile but powerful White House domestic policy chief. Worse yet, they feel the final decision, in effect, may be made by Bolten. Such a decision would fly in the face of predictions that billions of dollars in foreign investments would immediately flee the U.S. Since Congress and the Reagan administration in 1984 established a policy of not taxing interest earned by foreigners living abroad, more than $1 trillion has been attracted to the U.S.
Stephen Entin, a pioneer supply-side economist and Treasury official in the Reagan era, put it simply in his Dec. 5 testimony: "The regulation will chiefly help foreign countries enforce their tax laws, to the detriment of investment in the United States, and will do little or nothing to help the IRS enforce U.S. tax law . . . Only the most careless of . . . foreign investors would continue to hold deposits in the United States." Entin's estimate: U.S. gross domestic product would be reduced by 0.8 percent, a loss of $80 billion.
As is their wont, IRS bureaucrats and their Treasury allies are silent. The only public support for the regulation comes from the Left. Robert McIntyre of the Citizens for Tax Justice, a most aggressive critic of Bush tax policy, contends that "we have a major stake in helping other countries stop cheating by their citizens." In other words, it is the duty of the IRS to crack down on Europeans trying to escape the continent's onerous tax burden.
The claim that the regulation is somehow attached to the war against terrorism collides with the fungibility of money in the global economy. Under the proposed regulation, funds now parked in Florida would soon find their way to Hong Kong, where they could not be tracked.
If midnight strikes Tuesday night without the American tax shelter being shut down, a temporary victory for financial privacy will have been struck to the discomfiture of tax collectors on both sides of the Atlantic. Nevertheless, uncomfortable questions persist as to how the Bush administration functions. The regulation could have been withdrawn any time during the last two years with a stroke of the presidential pen. That it was not suggests an offhand treatment of basic philosophy.