On July 1, 2014 a new law is going into full effect that is taking aim at income tax evasion centering on foreign financial accounts. The law, which began rolling out in 2010, is known as the, Foreign Account Tax Compliance Act, or more commonly as FATCA.
The law requires that any foreign financial institutions that have operations in the US become a Qualified Intermediary, and share information about their US-based customers in much the same way that American financial institutions do.
Most Americans are virtually ignoring the implementation of this law – after all, the majority of citizens are not affected because they do not have financial accounts outside the US. But the effects of this law could go well beyond holders of foreign bank accounts. It has the potential to have an impact on every corner of life in the US.
What will FATCA do?
The US has one of the most strict tax codes in the world. It is almost alone in levying income tax on its citizens living abroad, which is significant because there are an estimated six to seven million Americans living in foreign countries.
FATCA essentially deputizes foreign financial institutions by forcing them to act as information gathering sources for the IRS. They will be required to provide asset and income information to the IRS for income tax compliance purposes. The reporting requirements will include both US citizens with accounts in foreign countries, and US citizens living abroad and holding foreign accounts.
FATCA will require foreign financial institutions to report directly to the IRS on incomes and asset holdings of at least $50,000.
How can the US government enforce this kind of compliance in foreign countries?
As the world’s largest economy, many institutions around the world do business in the US. The US government could effectively sanction financial institutions with operations in the US. One such sanction would include requiring non-compliant foreign financial institutions to be subject to a withholding tax of 30% on any income that they earned in the US. There are even whispers of asset seizures and other measures as they become necessary.
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A new law that is this dramatic in its scope is bound to attract criticism, and FATCA certainly has. Some of the issues identified include:
Cost of compliance is one of biggest issues. Both the financial cost and legal compliance issues (in the host country) will fall on the financial institutions. Though the new law is expected to raise something on the order of $800 million per year over the next decade, the cost of compliance is believed to be well above this. Specific estimates are not yet available since the law has not yet been implemented. It’s not even certain how much it will cost the IRS in order to monitor and process for required compliance.
Capital flight. The cost of compliance will raise the cost of foreign institutions doing business in the US. However the threat of a 30% withholding tax on a foreign institutions earnings in the US may be more than enough to convince those institutions to close up shop in the US entirely.
The net result of such a capital flight by foreign institutions will not only weaken America’s global financial position, but it can also hurt the economy as jobs and capital leave the country with the fleeing institutions.
An act of fiscal desperation
Considering the obstacles, does FATCA even make sense? In the grand scheme of things, not really. But to a government desperate for tax revenues, anything goes – even if it doesn’t make any economic sense at all. It’s implementation is following a similar path to other recent government actions.
Consider the following:
- The concept of gathering information from financial institutions all around the globe is similar to the NSA spy-on-everybody program.
- It may require foreign financial institutions to violate laws in their own countries, including privacy laws that may be very different from those that exist in the US.
- It proposes to create Inter-Governmental Agreements (IGAs) that will enable tax information sharing agreements between cooperating governments.
All of these provisions hold the very real possibility of affecting not just tax cheats, but ordinary law-abiding citizens. And all for additional revenue of $800 million per year, against a federal budget in excess of $3.5 trillion.
That’s pretty desperate.
Punishing low tax countries – and the people who invest in them
Given the paltry revenue that will be raised as a result of implementing FATCA, there could be a hidden agenda that’s much broader in scope.
People, capital, businesses, and jobs tend to migrate to countries that have the lowest taxes. The US is not one of those countries. This is at least part of the reason why US-based multinational companies move operations overseas. FATCA may be a legal attempt to repatriate at least some of the capital that has been lost as a result of tax migration.
Since low tax countries typically also have simpler tax codes, they’re unlikely have any interest in reciprocal information gathering agreements with high tax countries like the US. That lack of compliance would enable the IRS to place sanctions on financial institutions from those low-tax countries with operations in the US.
In theory at least, this will weaken the low tax countries, while strengthening the position of the high tax countries whose financial institutions have greater incentive to comply with US law.
We’ve covered a good bit about the negatives that are already known about FATCA. But there may be unforeseen consequences that the people behind the bill aren’t considering.
Some possibilities include:
Americans renouncing their citizenship. Until just a few years ago, the idea of Americans renouncing their citizenship was close to absurd. After all, everyone else wanted to be here. But the number of Americans doing just that is on the rise. According to an article by the BBC, the number of US expatriates renouncing their US citizenship climbed to 1,131 in the second quarter of 2013, up from 189 in second quarter of 2012. Compliance with the US tax code is commonly cited as a reason for the renunciation. And though the number is small, it almost certainly takes in a disproportionate number of wealthy individuals who stand to be most affected by FATCA. Eventually, those taxpayers – and their high incomes – will be lost to US tax rolls forever.
Trouble for Americans overseas. Reports are building that Americans living in foreign countries are unable to open up accounts with financial institutions. With the pending rollout of FATCA, many foreign financial institutions are simply refusing to do business with American clients.
Collapse of the dollar. One of the reasons why the US dollar maintains its status as the international reserve currency is that it has traditionally been easy to use. FATCA will make transacting in dollars – at least when it involves US citizens – more difficult. As there are already countries and groups of countries flirting with the idea of using an alternative currency, FATCA could speed the process. A move away from the dollar by one or more major countries could cause the value of the dollar to collapse, and eventually end its tenure as reserve currency. The economic implications of that outcome for the US can’t even be reliably calculated, but you can rest assured it will be completely negative.
Retirement plans. Any financial activity that causes a disruption in either international commerce or the financial markets will have a negative impact on investing of all stripes, but especially in regard to retirement accounts. Since America is rapidly aging, IRAs and 401(k) plans have become virtually the most important investment accounts. A significant decline in the financial markets as a result of miscalculations on FATCA will affect all Americans, even those without international financial accounts. Learn how to diversify your retirement with gold.
Wouldn’t lower tax rates and a simpler tax code work better?
FATCA is ridiculously complicated, contains numerous disincentives for both people and institutions, and will likely result in several predictably negative outcomes. It seems that before we consider implementing this kind of tax monstrosity, it might be completely more effective to lower tax rates and simplify the tax code.
For starters, how about lowering tax rates to a level where we’re no longer threatened by capital flight to low tax countries? The more money that stays in the US, the larger the tax base is, the faster the economy will grow, and the higher tax revenues will be – even with lower rates.
We can also do with a healthy dose of tax simplification. In 2013, Forbes reported that the US tax code contains close to 4 million words and is growing steadily. A tax code that could be easily understood by the average citizen would eliminate the need for costly accountants and tax attorneys, and likely make people more willing to comply.
FATCA looks for all the world like business as usual in Washington – just keep adding more complexity and eventually they’ll get the whole machine to work efficiently. By now we should know that that’s not going to happen. FATCA looks like deeply flawed legislation that will enrich accountants and tax attorneys, while weakening the US economy and standing in the world, make life more difficult for American citizens, and bring in very little money to the public treasury.
What are your thoughts on FATCA?
Do you see anything good coming out it?
Or do you agree that it’s bad legislation?
If so, weigh in with your comments below, and contact your Congress people, or write to President Obama and register your disapproval.