The Independent Market Observer

5/28/14 – The Real Problem with FATCA

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on May 28, 2014 1:30:00 PM

and tagged Politics and the Economy

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My post the other day about the Foreign Account Tax Compliance Act (FATCA) generated a lot of interest among readers, both in the U.S. and abroad. In concluding that FATCA wouldn’t have a material effect on the value of the dollar or the U.S. economy, I was addressing a fairly restricted set of circumstances. Given the depth of interest in this topic, and the fact that the law does have serious implications—just not for the dollar—let’s dig in a bit more.

FATCA’s impact on investors

The law is an attempt to stem tax evasion by U.S. citizens and entities that hold assets and investments outside the country. So far, so good (and also consistent with yesterday’s post, about the government’s increasingly aggressive efforts to raise revenue). Per the IRS’s Summary of Key FATCA Provisions, U.S. taxpayers will be looking at a minimum $10,000 fine for not reporting foreign financial assets, plus a 40-percent penalty on taxes due. This is not small change.

The real teeth in the law, though, are directed at foreign financial firms, which are required to identify U.S. taxpayers, monitor and report directly to the IRS on their accounts, and, in the event of any uncertainty, withhold 30 percent of the investment income from those accounts and pay it directly to the U.S. Treasury.

What do we lose?

  • As a U.S. citizen, you’ve lost any sense of privacy or limitation on government access to your financials outside the country. The IRS now has an official stick to hit you with if you don’t “voluntarily” report those assets.
  • Foreign financial institutions—banks in other countries—are now the deputy sheriffs. They’re not only encouraged but required to identify U.S. taxpayers, which means they’ll be scrutinizing accounts much harder, demanding more information, and, if none is provided, taking the money and sending it to the U.S. Treasury. The presumption of innocence has been replaced with a presumption of guilt, and these financial institutions have, essentially, been given the power of judge, jury, and executioner.
  • FATCA will also make it harder for American citizens and companies to do business abroad, and this will be damaging.

A move toward a more punitive system

But the real issue here, in my opinion, is that FATCA has reset the bar for how the U.S. government can deal with revenue collection. Despite its fearsome reputation, the IRS has, up to this point, overseen a largely voluntary system. FATCA is the first step in making the system much more punitive, in requiring taxpayers to prove their innocence rather than the government to prove their guilt—even before any taxes are assessed.

FATCA marks a real change in the rules. And if it can be done with foreign institutions, it can certainly be done here as well. What if banks and brokerages were required to ensure that clients have paid their taxes—and if not, to withhold client funds until such proof is provided? This type of move would be consistent with FATCA, with the government’s need for more revenue, and with the general shift toward raising taxes and fees across the board.

This, not the effect on the dollar, is the real problem with FATCA.

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