The Foreign Account Tax Compliance Act: Imperial Overreach

July 22, 2011 9:15 AM

Nobody loves a tax evader. Almost twenty years ago, I wrote that the United States must take effective steps—in an age of globalization—to ensure that Americans pay their personal income taxes to Uncle Sam.1 In particular, Americans should not be able to avoid personal taxes by hiding their foreign dividends and interest from the eyes of the Internal Revenue Service (IRS) by lodging the funds in overseas bank accounts. Our book outlined a cooperative approach whereby the US and foreign governments would jointly ensure full reporting of domestic income paid to citizens and residents of the other country. The cooperative approach never materialized, but over the last decade the IRS has insisted that US taxpayers report overseas bank accounts on their personal returns. Failure to report attracts a very stiff penalty. This was a useful step, though far short of cooperative arrangements with foreign governments.

In March 2010, the Obama Administration pushed a little-noticed amendment with a well-meaning title through Congress, the Foreign Account Tax Compliance Act, or FATCA. One provision of FATCA creates new and more sweeping reporting requirements for American taxpayers: In the future, any American with more than $50,000 of foreign assets (stocks, bonds, pensions, rental property, etc.) will need to report in detail the assets as well as the income they earn. But the act does not stop with new reporting burdens on American citizens and residents.

In addition, FATCA pursues a decidedly non-cooperative approach to foreign financial institutions to ensure that Americans don’t play hide-and-seek with the IRS. Foreign financial institutions (FFIs) of all description—banks, stockbrokers, hedge funds, pension funds, insurance companies, and trusts—will be required to report to the IRS annual information on all clients (both direct and indirect) who are US persons. The information required includes the name and address of the US client, the largest account balance during the year, and the debits and credits incurred by the account. Any FFI that fails to stand up and report will be hit with a 30 percent withholding tax penalty on all US payments of dividends, interest, and security proceeds. Under a notice issued by the IRS on July 14, 2011, FATCA will begin to take effect in stages, starting January 2013.

The withholding tax penalty in FATCA overrides multiple tax treaties, but that’s just the beginning of its non-cooperative, indeed imperial “solution” to possible tax evasion by Americans. Imagine the US reaction if a foreign power—say China, Japan, or Russia—enacted legislation requiring US financial firms to report similar information on their citizens, and imposed a stiff penalty on US firms that failed to comply. One hopes that Congress and the Administration would scream to the rooftops. That’s exactly the response of FFIs to FATCA, and once enforcement kicks in, the backlash will likely extend to political levels abroad. Not only does the FATCA legislation brush past tax treaties and foreign privacy statutes, it also imposes significant accounting costs on perhaps 100,000 foreign financial institutions. The likely result is that many FFIs will refuse accounts owned by Americans, sell any holdings of US stocks, bonds and real estate, and place new portfolio investments in more friendly locales. Along the way, foreign governments will complain bitterly about another flagrant piece of extraterritorial US legislation.

FATCA’s imperial overreach is no reason to ignore the potential significance of widespread tax evasion. What should be done? Congress should first pass a simple statute to delay the implementation of FATCA for five years. During that time, the Treasury Department should be instructed to negotiate cooperative, two-way, reporting agreements with foreign governments. The agreements would require financial institutions in both countries to report the holdings of foreign taxpayers who are citizens of the other country. To begin with, the reporting requirements should target only high net worth households, not all Americans and their foreign counterparts. After experience with this group, households with fewer holdings can be targeted on a random basis, both to determine the extent of underreporting and to encourage every taxpayer to report his or her global income and assets. Then, after five years, the Treasury should dispassionately evaluate the reporting burdens, both on foreign and US firms, and the additional revenue raised. At that point, a sensible decision can be made whether FATCA should be allowed to take effect.


1. Gary Clyde Hufbauer and Joanna M. van Rooij, U.S. Taxation of International Income, Institute for International Economics, Washington DC, October 1992, Chapter 4.