Letter to the IRS on Proposed Rulemaking

Submitted to:

Internal Revenue Service

1111 Constitution Avenue, N.W.

Washington, D.C.

Comments on:

Guidance on Reporting of Deposit Insurance Paid to Nonresident Aliens

Notice of Proposed Rulemaking

August 2, 2002, (67 FR 50386)

Submitted by:

Wayne T. Brough, Ph.D.

On Behalf of:

Citizens for a Sound Economy Foundation

1250 H Street, N.W., Suite 700

Washington, D.C. 20005

November 14, 2002

Citizens for a Sound Economy Foundation (“CSE Foundation”), is a nonprofit, nonpartisan organization with approximately 280,000 members. Its mission is to educate citizens on, and to promote the adoption of, free-market policies, which it believes inure to the benefit of consumers and citizens generally. CSE Foundation welcomes the opportunity to submit comments on the Internal Revenue Service’s proposed rulemaking, “Guidance on Reporting of Deposit Interest Paid to Nonresident Aliens,” (REG-133254-02). We have a number of concerns about the proposed rule and its adverse impact on the U.S. economy. Consequently, we request that the IRS withdraw the proposed rule.

The proposed regulation, which would require financial institutions to report interest on deposits in U.S. financial institutions paid to nonresident aliens, raises several concerns. Most directly, the proposed rule poses a threat to financial privacy and creates a significant compliance burden. Yet the rule would have significant indirect effects as well. First, the new reporting requirements could reduce the demand for deposits in U.S. financial institutions by nonresident aliens, which would have an adverse impact on U.S. consumers. Second, the new regulations may dampen tax competition at the international level, which could have effects on long-term economic growth. Finally, CSE Foundation views the proposed guidance as an unnecessary expansion of IRS operational requirements that is unnecessary for the agency’s fundamental mission. This may raise questions relative to both issues of congressional intent as well as the goals of the Government Performance and Results Act.

Most simply stated, the proposal would require U.S. financial institutions to report interest paid to foreigners on deposits they keep in U.S. institutions. This information would do little to assist the IRS in its mission of collecting tax revenue, because the interest payments in question are not considered taxable income here in the United States. In fact, the issue has been addressed a number of times in Congress, where there has been a longstanding policy that such deposits by nonresident aliens should not be taxed in order to attract foreign capital to the benefit of the American economy. Moreover, Congress has never mandated any reporting requirements on such income by nonresident aliens. The information collection proposed by the IRS is a departure from policies established by Congress that has no impact on revenue collection.

In light of concerns raised in Congress and the financial community, the IRS pared back its plan with the new Notice of Proposed Rulemaking that was published in August. Rather than a blanket requirement, the new reporting rules would apply only to foreigners from 15 countries. However, once the reporting requirements are established, it would be relatively easy to expand compliance to a larger group of nations. CSE Foundation views the long run implications and costs of the proposed rulemaking as ultimately affecting a much larger population. The proposed rule would be burdensome even if limited to the 15 countries listed; any expansion to additional nations would simply increase that burden.

The new IRS proposal also would have adverse effects on global tax policy by dampening forces that promote more competitive tax policies among foreign tax jurisdictions. New reporting requirements that provide information that can be shared between tax jurisdictions reduce incentives to promote competitive tax policies, as nations with significant tax burdens would have broader reach in their tax policies. Incentives to promote more efficient tax policies at a global level would be reduced because nations with high taxes would not face the threat posed by lower tax jurisdictions. This lack of competition places upward pressure on marginal tax rates globally.

The proposal would strike a significant blow against financial privacy, as the IRS embarks on the collection of new information. The information collected would be available not only to the U.S. government; it would be shared with foreign governments as well, some of which have different traditions when it comes to individual rights and liberties. Moreover, the new information collection marks a departure from early Treasury policy on information sharing, which opted for information sharing only on a case-by-case basis rather than automatic information sharing.

Even though the proposal applies to foreigners who earn interest in American financial institutions, the proposal poses a real cost to American citizens. The money that is earning interest in these financial institutions is working capital that expands the loanable funds available to Americans. Estimates suggest that foreigners have more than $1 trillion in U.S. financial institutions. Everything from car loans to mortgages to capital for business start-ups relies on the availability of loanable funds. As in any market, when a good becomes scarcer, the price increases. Should the new IRS proposal reduce foreign investments, the new scarcity in loanable funds will put upward pressure on interest rates for Americans seeking to borrow money, which can affect economic growth, particularly in a flagging economy.

The market for financial services is global in nature and highly competitive. New compliance burdens imposed in the United States would place American financial institutions at a competitive disadvantage as investment opportunities in other nations become more attractive. The United States has long been known as a place to do business. American companies and workers have enjoyed the benefits of capital looking for a safe and stable nation. However, in a dynamic global marketplace, foreign investment would decline quickly in response to new compliance burdens, to the detriment of the American economy and American consumers.

Beyond the significant policy and economic implications of the proposed rule, CSE Foundation is also concerned with potential administrative and compliance problems posed by the rulemaking. The information collection request is significant, and the estimate of 500 hours is low and should be re-evaluated. In addition, given the fact that this information is not required for the collection of revenue, this proposed rulemaking warrants a cost-benefit analysis to demonstrate that the benefits of this rule, in fact, would be greater than the cost it imposes on the economy.

Just as importantly, the proposed rule raises questions pertaining to the Government Performance and Results Act. As noted by the Government Accounting Office, “The Government Performance and Results Act of 1993 seeks to shift the focus of government decisionmaking and accountability away from a preoccupation with the activities that are undertaken – such as grants dispensed or inspections made – to a focus on the results of those activities, such as real gains in employability, safety, responsiveness, or program quality.” From this perspective, the proposed rule should be re-evaluated to determine whether it enhances the IRS’s ability to administer the tax laws effectively and fairly—objectives identified by the GAO as key performance measure for the IRS. The GAO noted that the IRS lacked specific strategies to achieve these objectives; expanding information collection requirements in areas that do not facilitate meeting these objectives diverts resources away from the IRS’s fundamental objectives while expanding the operational activities of the agency in areas that deviate from these objectives.

Finally, CSE Foundation has concerns about the impact of the proposed rule on sound tax policy. Tax laws should be revenue neutral, in the sense that they do not alter underlying economic behavior. The proposed reporting requirements would clearly alter behavior, making U.S. financial institutions less attractive in a global marketplace. Additionally, the Treasury Department has emphasized the importance of fundamental tax reform that seeks to establish a more efficient tax code. A basic measure of a tax code’s efficiency is the compliance costs for both consumers and the government. The new proposal needlessly expands the costs of compliance with federal tax laws and imposes new administrative costs on the IRS.

For the reasons outlined above, CSE Foundation respectfully requests the IRS withdraw the proposed rulemaking.