A New Year’s Gift from Bill Clinton: An IRS Poison Pill

by | Jan 1, 2002

Politicians in Washington have spent two months fighting over how best to stimulate the economy. Yet while they squabble over tiny tax cuts that might — at best — add $20 billion to the national output (a drop in the bucket for a $10 trillion economy), the Internal Revenue Service has been trying to sneak […]

Politicians in Washington have spent two months fighting over how best to stimulate the economy. Yet while they squabble over tiny tax cuts that might — at best — add $20 billion to the national output (a drop in the bucket for a $10 trillion economy), the Internal Revenue Service has been trying to sneak through a regulation that could drivemore than $500 billion out of America.

Released last January, three days before President Clinton left office, the proposed regulation would require American banks to report any interest income they pay to foreigners with U.S. accounts. The IRS says it will pass this information to foreign tax collectors. It has yet to explain why U.S. banks should help other governments tax income earned in America — or why such a rule should be put into effect now.

Indeed, the regulation makes so little sense and has drawn such universal ire that it’s easy to see why the Clinton administration waited until the last minute to introduce it.

More than 99 percent of the people who sent letters or e-mails to the IRS during the public-comment period condemned it. Every single speaker at a public hearing held last spring opposed it. More recently, representatives of more than three dozen major think tanks sent a letter to lawmakers denouncing the regulation and urging its withdrawal.

They realize something the IRS seems to have overlooked: that the regulation would damage the economy. Foreigners have nearly $1 trillion deposited in U.S. banks. These funds help families get mortgages, consumers get car loans and businesses get money to create jobs. Yet the IRS regulation could drive as much as two-thirds of that money from the U.S. economy. Foreign investors worried about excessive taxation and corruption in their home countries will shift their funds to places such as Switzerland, Hong Kong and the Cayman Islands if the IRS implements this regulation.

Moreover, the proposed rule is a flagrant abuse of the regulatory process. Government agencies are supposed to issue regulations that help enforce the laws enacted by Congress. This IRS regulation, however, seeks to overturn existing law. On several occasions, lawmakers have debated how best to treat foreign-owned bank deposits. In each case, they decided against taxing foreign investment and against requiring that interest income be reported to foreign governments. But the IRS apparently has decided we need to help foreign tax collectors more than we need to preserve jobs and growth in America.

The proposed regulation also undermines U.S. sovereignty. Foreign governments shouldn’t be allowed to tax interest paid to bank accounts in America or to impose any of their laws on U.S. soil. Governments can tax money earned inside their borders if they wish, but no foreign government should be able to tax money earned in America.

The potential damage this regulation could cause renders the so-called stimulus debate completely absurd. Republicans and Democrats have spent weeks fighting over how to arrange the proverbial deck chairs on the Titanic, yet hardly anyone pays attention when the IRS tries to steer the economy into an iceberg.

Fortunately, the regulation hasn’t been implemented. But this simply means the strong opposition of banks and free-market think tanks has temporarily stalemated the IRS. Treasury Secretary Paul O’Neill should have rescinded the proposed regulation as soon as he took office, but for some reason, he hasn’t. Neither he nor President Bush are obliged to implement the anti-growth proposals they inherited from their predecessors, and no one can explain the delay.

It’s time for a little leadership here. Secretary O’Neill needs to kill this regulation outright — and if he’s reluctant, President Bush should simply tell him to do it. Believe me, you couldn’t devise a simpler “stimulus” plan.

Daniel J. Mitchell, Ph.D. is McKenna Senior Fellow in Political Economy in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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