Scott Sumner  

Should America help corrupt officials hide wealth?

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The New York Times has a new piece discussing the importance of foreign buyers at the top end of the NYC real estate market:

The foreign owners have included government officials and close associates of officials from Russia, Colombia, Malaysia, China, Kazakhstan and Mexico.

They have been able to make these multimillion-dollar purchases with few questions asked because of United States laws that foster the movement of largely untraceable money through shell companies.

Vast sums are flowing unchecked around the world as never before -- whether motivated by corruption, tax avoidance or investment strategy, and enabled by an ever-more-borderless economy and a proliferation of ways to move and hide assets.


One can make a good argument that the benefits of privacy outweigh the costs. Unless of course it is other countries that try to provide privacy, then the US attitude changes just a tiny bit:

AT A recent conference for offshore wealth managers in Geneva, Basil Zirinis of Sullivan & Cromwell, a law firm, began his presentation with a discussion of events in Iraq, where Islamist fighters were advancing on Baghdad. Barack Obama, he claimed, was drawing a red line around the city and, if necessary, would "drop FATCA on them". Worse, they would get no deadline extension. The nuclear option, he added, was to treat them as if they were Swiss.

The analogy was tasteless, but also telling. FATCA stands for Foreign Account Tax Compliance Act, an American law passed in 2010 to crack down on the use of offshore banks, particularly in Zurich and Geneva, to hide taxable assets. . . . One senior banker denounces it as "breathtakingly extraterritorial".

. . .

FATCA has already sent a chill through the 7m Americans who live abroad. Thousands have been told by their local banks and investment advisers that they no longer want their custom because it is too much hassle. Many others will now have to spend thousands of dollars to straighten out their paperwork with the IRS, even if they owe no tax (and most do not, since they will have paid a greater amount abroad, which counts as a credit against tax owed in America).

A record 2,999 of these exasperated expats renounced their citizenship or green cards in 2013. More than 1,000 did so in the first quarter of 2014. (Before FATCA the number was a few hundred a year.)


Even worse, the law cannot even be justified on utilitarian grounds:

Related to that is the question of whether FATCA will pay for itself. Counting only the expense for American financial firms, the answer is maybe, if it brings in at least the $800m a year estimated by Congress. (The law was passed without any formal cost-benefit analysis.) However, the overall costs of complying, borne mostly by non-American banks, are likely to far exceed the extra tax receipts.

FATCA is about "putting private-sector assets on a bonfire so that government can collect the ashes," complains Richard Hay of Stikeman Elliott, a law firm. Mark Matthews, a former deputy commissioner of the IRS now with Caplin & Drysdale, another law firm, argues that the effort put into hunting offshore tax evaders is disproportionate: the sums they rob from the public purse "look like a pinprick" compared with other types of tax dodging, such as the under-declaration of income by small businesses.


There are two types of left-wingers. Some are idealistic reformers who favor redistribution because the poor get more utility from an extra dollar than the rich. Others are like former Chinese leader Mao, those who hate the rich so much that they are quite willing to make everyone suffer, just so that no one will become wealthy. It's not clear which philosophical justification was used for this law.

As more countries are pushed to share tax information systematically, the focus will turn to America's willingness (or lack of it) to reciprocate. Latin Americans, for instance, are big users of banks in Florida, but America remains choosy about which governments it will share data with, and how much. It also has only limited information to give on the owners of shell companies because it does not collect their names itself. In some respects, America is less upright than the tax havens it deplores.
It seems breathtakingly arrogant for the US to insist that other countries have the same privacy laws that we have. But this is worse. How would you describe a country that used its awesome power to intimidate small countries to abandon their long cultural tradition of protecting privacy, and then turned around and drew in vast amounts of ill-gotten gains from overseas by shielding those investments from public scrutiny?

Words fail me.


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COMMENTS (22 to date)
bill woolsey writes:

American Exceptionalism

Andrew_FL writes:

" Some are idealistic reformers who favor redistribution because the poor get more utility from an extra dollar than the rich."

Which is a gross abuse of and misinterpretation of the law of diminishing marginal utility.

I mean, really, statements like "A gets more satisfaction from X than B would" are basically complete gibberish. It means less than nothing.

MikeDC writes:

Why is it that some set of foreign governments (say, the EU) hasn't attempted a regulatory tit-for-tat on this issue. It need not be exactly the reciprocal set of regulations, but I can't for the life of me figure out why other countries don't retaliate.

Yes, the US might be the biggest fish in the pond, but even a minimal amount of cooperative action by our major trading partners would seem capable of putting a stop to these policies.

Scott Sumner writes:

Bill, Good example of that ideology.

Andrew, I think it's very likely that poor people get more utility from an extra dollar than rich people.

Mike, Many EC members are also cracking down on Switzerland. But yes, I wish countries would fight back. They are afraid. Just as our tech firms were afraid to fight against the NSA spying.

Levi Russell writes:

Who are these guys named "America" and "US?"

Oh, you mean US gov't politicians and bureaucrats. Of course they're using policy to benefit themselves at the expense of others. I can't imagine why any economist who understands public choice theory would be surprised (not that you are surprised).

TMC writes:

Obama did favor higher tax rates on the rich even if they did not produce more revenue - out of 'fairness'.

Andrew_FL writes:

Sorry Scott but I'm with Lionel Robbins on this one. Interpersonal comparisons of utility don't make sense.

Vivian Darkbloom writes:

I read that NYT article with a bit of skepticism. I'm sure some foreigners are evading home country income tax rules through the use of "shell companies"; however, what is a "shell company"? That sure sounds devious!

Standard international income and estate tax planning for foreign investment by wealthy persons into the US, particularly US real estate, involves the use of non-US companies. A wealthy individual who purchases US real estate directly is subject to US estate and gift tax with respect to that property. In contrast, ownership of US real estate through a foreign corporation is not subject to those taxes when the ultimate owner dies or the foreign corporation is disposed of. Those folks at the NYT should familiarise themselves with FIRPTA (Foreign Investment in Real Property Tax Act). Use of a foreign company to invest in the US is perfectly legitimate tax planning and there is nothing necessarily devious about it--it does involve *avoiding* US tax, but certainly does not imply one is *evading* US, or any other jurisdiction's, tax.

Also, many US celebrities are purchasing US real estate through "shell companies" in order to protect their privacy. Is the NYT going to pontificate about that, too? Every time I read something journalists at the NYT write about complicated tax stuff, they almost always mislead readers, if not get it completely wrong. Here's another recent example where the NYT wrongly claimed the Chinese are adopting a citizenship-based taxation regime:

http://www.taxanalysts.com/taxcom/taxblog.nsf/Permalink/UBEN-9SZEAG?OpenDocument

Shamefully, the NYT, despite overwhelming evidence they made a mistake, and having been told that, never published a correction.

Njnnja writes:

I'm actually less bothered by the fact that the U.S. is doing this to foreigners. After all, whatever privacy rights a person has as a citizen of country A don't apply to the government of country B. So if the NSA wanted to hack into the servers of Swiss banks to find non US citizens who are dodging US taxes I'm not sure what is wrong with that (unless one is morally opposed to the entire concept of espionage which I don't think is a realistic position to take). Or you would have to take the non intuitive position that it's ok to use spy craft to affect a foreign country's policies and steal state secrets but not for mere asset acquisition.

So if that is the next best alternative, then it makes sense for the U.S. Government to basically say "we want you to open all your books" since they have the ability to get that information anyways.

And yes the shoe can be on the other foot and the Swiss (or NK or Iranians) can and probably do spy on Americans. And that is why we need a strong military (in all respects, not just lots of big ships). Because you are only guaranteed rights by your own state, and in between states it is, and probably always will be a bit of the Wild West.

David S writes:

Re Scott's comment:

"I think it's very likely that poor people get more utility from an extra dollar than rich people."

Reality is more complicated. For example, you would no doubt consider me "rich". But if you give me an extra dollar, I will use it to create two dollars in a year - because I'm an entrepreneur, and that is what we do. By taking a dollar from me and giving it to your friends to consume (it is never given to the most needy, it is given to the friends of politicians) you are limiting my ability to create value and causing a net decrease in welfare.

The "poor" are not creating much value - almost by definition, that why they are poor, they consume what money they get. The "rich" are creating value, again almost by definition.

Hard working poor do exist, but they typically become rich by any reasonable standard. The idle rich do exist, but they are extremely rare.

And I note that the working poor and value creating rich are taxed much more heavily than the idle rich. So remember that when you vote for increased taxes, you are never hitting the idle rich. They're Senators, after all. You're choosing to tax the workers.

Scott Sumner writes:

TMC, Do you have a link for that?

Andrew, Then I guess I'm not with Robbins.

Vivian, You said:

"I'm sure some foreigners are evading home country income tax rules through the use of "shell companies""

So if the Swiss government were to demand we ended this privacy, should we comply with the Swiss demand?

Thanks for that info on China, I didn't know that.

Njnnja, Do we even need an NSA? Just asking.

David, You said:

"Reality is more complicated. For example, you would no doubt consider me "rich". But if you give me an extra dollar, I will use it to create two dollars in a year - because I'm an entrepreneur, and that is what we do. By taking a dollar from me and giving it to your friends to consume (it is never given to the most needy, it is given to the friends of politicians) you are limiting my ability to create value and causing a net decrease in welfare."

Many commenters don't know that I am a supply-sider who opposes all taxes on capital income. So while what you say is correct, it in no way contradicts my views on marginal utility. I don't have the policy views that you might assume I have.

I favor a progressive consumption tax, which would hit the idle rich.

Vivian Darkbloom writes:

Scott,

Exactly which "privacy" are you speaking of? Are you suggesting that FATCA requires foreign governments report the ownership of real estate by US persons to the US? That's news to me because I always thought that FATCA applied to "foreign financial assets" which excludes ownership of real estate. But, I'm retired and probably am not as well-versed any longer on tax law as you are. How do you expect me to keep up with your expertise on international law, much less macro economics? I obviously don't have as many hours in my day as you do, because I don't even have the time to watch all those movies. What's the secret? Maybe Noah Smith should weigh in here. I own a home in France. FATCA does not require that France report the ownership of that home to US authorities, whether I own that home directly or through a company.

In general, I believe that information exchange should be reciprocal, yes. And, regarding *income* it very often is, if the foreign jurisdiction insists on it. The US often requires more detailed reporting of foreign jurisdictions (particularly regarding tiered ownership structures through trusts, etc.), but that's largely, but not exclusively, because we (the US) insist on it, and other jurisdictions to date have not. Sure, this is partly because the US does have bargaining power. Where should use of that power begin and end? With trade agreements" Anti-ballistic missiles? Nuclear weapons?

Despite our superior bargaining power, there are a growing number of Inter-Governmental Agreements (IGA's) between the US and foreign countries that require reciprocal exchange. Here's an example of one with Canada:

http://www.fin.gc.ca/treaties-conventions/pdf/FATCA-eng.pdf


"So if the Swiss government were to demand we ended this privacy, should we comply with the Swiss demand?"

Nick writes:

Prof Sumner,
As a practical matter, Is the 'progressive consumption tax' you favor a progressive payroll tax? I seem to remember you writing something like that. How does that punish the idle rich? Inflation?!

Plus I feel like pairing that with no taxes on investment is just begging for tax avoidance. Maybe Vivian can weigh in...

Of course not every profession will be amenable to restructuring pay as investment gains, but that only makes the problem worse. The implicit subsidy for working in the fields where you can structure your earnings that way will be large.

Is this just a small price to pay for the growth we would get out of having zero taxes on investment income in your opinion? I feel like this progressive payroll tax would have to generate a lot of revenue to meet the govt commitments I happen to support. There is going to be a large incentive to avoid it for many of the most ambitious workers, at least the way I imagine it.

Sorry for the rant if I'm misremembering your position.

Vivian Darkbloom writes:

"Plus I feel like pairing that with no taxes on investment is just begging for tax avoidance. Maybe Vivian can weigh in..."

Sure, I'm glad to. If there were no taxes on investment, there would be no taxes on investment to avoid. :-))

Scott Sumner writes:

Nick, In the long run a payroll tax has exactly the same impact as a consumption tax such as a VAT. If the VAT hits the idle rich, so would a payroll tax. But yes, this is all very counterintuitive, because people are used to thinking of tax incidence in terms of income, not consumption.

Tax avoidance is of course an issue, which is why I favor tax simplification. It's much harder to avoid taxes in a simple tax regime than a complex tax regime.

Vivian, You said:

"I'm retired and probably am not as well-versed any longer on tax law as you are. How do you expect me to keep up with your expertise on international law, much less macro economics? I obviously don't have as many hours in my day as you do, because I don't even have the time to watch all those movies. What's the secret? Maybe Noah Smith should weigh in here. I own a home in France. FATCA does not require that France report the ownership of that home to US authorities, whether I own that home directly or through a company."

I'm afraid that I don't see how any of this has any bearing on anything I said in the post, or the comment section.

Nick writes:

Vivian,
I meant things like structuring a group of surgeons as highly paid employees of a single firm vs them all being owner operators of their own businesses who pay themselves very little in salary and simply issue the profits from having such an underpaid surgeon as dividends (since the shell company is 100% owned by its sole underpaid employee).

Prof Sumner,
Thanks for the answer. I guess I know that the VAT and a payroll tax are really the same. But, as a member of the idle rich who is doing his taxes at the moment, I was having a hard time seeing how I could possibly lose consumption if someone got rid of this large bill I'm about to pay. It equals 20% of my ordinary outlays. I guess I'm not consuming enough ... Which your system would reward. You've won me over to supporting my own interests.

Njnnja writes:

Do we even need an NSA?
I'm not sure if "need" is the right word. But ever since people have had messages they have tried to hide those messages, and people have tried to find them. I think SIGINT will always be with us, so I think the challenge is not so much whether we should have an NSA but rather what is acceptable for them. Kind of like how the US constitution doesn't deny political ambitions but rather utilizes them to get a balance of power.

So if we are going to have a group that does SIGINT, I think finding non citizens who are avoiding US taxes is about the most benign use of that group and is acceptable.

Vivian Darkbloom writes:

Nick.

You wrote:

"Vivian,
I meant things like structuring a group of surgeons as highly paid employees of a single firm vs them all being owner operators of their own businesses who pay themselves very little in salary and simply issue the profits from having such an underpaid surgeon as dividends (since the shell company is 100% owned by its sole underpaid employee)."

That doesn't sound very clever. If the corporation is not a "C corporation" (e.g., an LLC or SCorp), it makes little or no difference. If it is a C corporation, two levels of tax are incurred, not one (dividends are not deductible). Thus, the tax on C corporation income is actually *higher* in most instances even though dividends are taxed at "preferred" rates. This is why there has, over the past couple of decades or so, been a move to doing business other than through C corporations. Some professional service C corporations tried to actually do the opposite---pay out bonuses so that the corporation would get a deduction. But, alas, that is subject to challenge:

http://www.cpa.net/documents/PSAssociates.pdf

Once upon a time, the US tax code was much less complicated than it now is. Contrary to Scott's theory, my experience has been that the complexity is in good part due to the need to counter the tax avoidance that is child's play without those detailed rules---not the other way around. Most jurisdictions in Europe have relatively more simple codes than the US; but, do you really think the wealthy there engage in less "tax avoidance" as a result?


ThomasH writes:

Nick,
No, a progressive consumption tax is not the same as a progressive payroll tax. The idea is that you determine the base (consumption) as the difference between income and savings – think an unlimited 401 K plan. This would go along with elimination of taxes on business income with said income imputed to shareholders. This would not get away with all complications. Tax authorities would have to be on the lookout for hidden income (as now). Consumption by US residents or consumption within the US? Are there some kinds of consumption that we do not want to tax (fully?) such as medical expenses, charitable giving, education of self or children? But it still seems fairer than taxation of income.

Scott Sumner writes:

Vivian, You said;

"Contrary to Scott's theory, my experience has been that the complexity is in good part due to the need to counter the tax avoidance that is child's play without those detailed rules"

My experience has been just the opposite, almost none of my personal frustration with the tax code relates to provisions trying to prevent tax evasion.

Ray Lopez writes:

I have lived outside the USA for over ten years, and while I share Sumner's concerns about privacy, I have not found the numerous overseas bank reporting schemes (including FATCA's form W-9, and FinCEN Form 114) to be anything other than minor nuisances, certainly not worth giving up your passport over, and much less onerous than filing your US income taxes every year. Of greater concern would be if, as Vivian Darkbloom speculates, the US was to start counting foreign real estate as "financial assets" and asking for them to be recorded. This is because, as the NY Times article states, buying real estate is a classic way to 'launder money', since the purchase price is often not recorded and assessed value is often much less than market value, which is a good way to 'hide' money or make it 'disappear'. In fact, in certain countries like Greece there's no recording of real estate at the national level, nor even clearly defined property surveys, and since local records are a mess, it's never clear who owns what real estate (which cuts both ways in property disputes), and property is often paid for with a suitcase of cash, perfect for laundering money. For example, Russians constantly buy real estate in Greece.

Vivian Darkbloom writes:

@Scott, you wrote:

"My experience has been just the opposite, almost none of my personal frustration with the tax code relates to provisions trying to prevent tax evasion."

Try to stay on topic. Whether complexity causes increased tax avoidance (not evasion) was the issue you originally raised in your answer to Nick---not your personal frustrations. And, since we're talking about FATCA, perhaps you can fill us in on your experience with that. My experience has been over 35 years advising clients on complex international tax matters which. I'm sure, does not measure up to yours. It's relatively easy to *avoid* tax under "simple" tax systems and a lot of the detail and bells and whistles added to the Code are there to prevent that, whether it is immediately evident to you or not. Now you know why the comment I made above, which you quoted, is relevant.

@Ray, you wrote:

"Of greater concern would be if, as Vivian Darkbloom speculates, the US was to start counting foreign real estate as "financial assets" and asking for them to be recorded."

Vivian didn't so speculate. Vivian merely stated a simple fact that FATCA does not cover the mere ownership of real estate because it is not defined as a "financial asset" under those rules. However, now that you've raised the issue,I will now speculate that someday, in my lifetime, such reporting may be required. Further down the road they may also require that reporting be done on the jewellery I own and the bicycle I ride. I hope by then I'm gone.

BTW, I found completing the FinCen Form pretty easy, too. It's done electronically and it would be a big help if a form with prior data filled-in were to be e-mailed to me each year so that all I have to do is update it.

But, that's not where the complexity is. Complexity here arises because some clever folks might want to avoid reporting by investing in more sophisticated products than just bank and securities accounts. Say, various annuities, life insurance products or investing indirectly through partnerships, trusts, etc.
Complicated rules are needed to prevent such "avoidance" and it's a huge headache and very costly for foreign reporting banks. So, while complexity is needed to prevent avoidance, the issue is---is it worth the cost and the hassle? How much avoidance is one willing to tolerate? That's a much different question and I think FATCA has already reached the point where the marginal burdens exceed the marginal benefits. In other words, more simplicity here would likely result in more avoidance but greater economic savings.

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