Tax Analysts Blog

God Bless America ... The Tax Haven

Posted on Jul 3, 2009

The Fourth of July is a special occasion. It serves as a moment when our nation can reflect on the greatest of American virtues: baseball, apple pie, and bank secrecy. That's correct ... bank secrecy. The U.S.A. is the biggest tax haven in the world due to our bank secrecy regime. Ponder that as you are enjoying your weekend barbecue.

My last post spoke critically of Switzerland's bank secrecy laws. I expressed skepticism that the recent crackdown on tax havens would reach fruition. I applaud the effort, but won't hold my breath waiting for meaningful results. Fairness demands we not discriminate. So today -- on the eve of our nation's birthday -- I take a shot at U.S. bank secrecy. Most of the American public is blissfully unaware such laws exists. Let's change that right now.

Here are some facts.

If I walk to the bank down the street and open a savings account, the person behind the counter will ask me a few simple questions. These include whether I'm a nonresident alien (NRA). That's not because the bank teller might want to deport me; it's because the IRS doesn't tax the interest income earned by NRAs. You might think it's unfair that NRAs don't have to pay U.S. tax on interest from U.S. banks. It is one heck of a sweetheart deal. (I wish my savings income was exempt, but no such luck.)

In addition, our laws don't even require that U.S. banks inform the IRS about interest on deposits held by NRAs. This policy of not reporting such income opens the door to cross-border tax evasion on a massive scale. Bear in mind that the income an NRA receives from a U.S. bank will be fully taxable in his or her country of residence. But that tax almost never gets paid. The residence country doesn't know about the income and the U.S. government intentionally doesn't collect the information. This where U.S. tax law starts to look shockingly similar to Swiss bank secrecy -- perhaps not in design, but definitely in outcome.

What happens if tax collecters in another country -- let's say Norway -- call the IRS and request info on my cousin Olaf from Oslo, who happened to open a nice big savings account while visiting me last year? Well, not much happens. There's nothing the IRS can tell their Norwegian counterparts even if they wanted to. The IRS doesn't have any information on cousin Olaf because nothing was reported from the bank. The bank possesses precise information on how much interest was earned, but U.S. law makes sure that information stays bottled up inside the bank.

This, my friends, boils down to taxation on the honor system. And we know where that gets us. It should come as no surprise that cousin Olaf doesn't report a penny of his U.S. income back home in Norway. And because he's not required to file a U.S. tax return, the interest is exempt from U.S. tax. So the interest doesn't get taxed anywhere.

Okay, technically that's not bank secrecy in the same sense as the Swiss use the term. But as a practical matter there's no difference. Both the Swiss and U.S. systems achieve the same result, which is that an investor can hide money in foreign bank accounts where the income doesn't get taxed because the government never knows about the account. Functionally that's bank secrecy.

Our lawmakers don't give a hoot about this blatant tax evasion because it's some other country's tax base that's being eroded. Congress' attitude can be accurately summed up as follows: "Screw Norway -- our banking sector needs all the capital it can get." Defenders of this policy would suggest that it's cousin Olaf's personal decision whether to declare his U.S. income on his Norwegian tax return. Well, gosh. That argument sounds remarkably similar to what we hear from defenders of Swiss bank secrecy. ("It's up to each UBS account holder whether to declare their income to the IRS.")

In case you were wondering, the only exception to these U.S. bank secrecy rules concerns Canada, with whom the U.S. has a special agreement in place to share tax information on a reciprocal basis. For all other countries, it's too bad. The U.S. has dozens and dozens of tax treaties and tax information exchange agreements with key trade partners, but none of those instruments (apart from the one with Canada) changes the results for interest income on bank deposits.

[Note: Shortly after President Obama was inaugurated, officials from Mexico's Finance Ministry contacted the U.S. Treasury Department to try to get the same deal as Canada. They were concerned that wealthy Mexicans, including participants in powerful drug cartels, have amassed enormous wealth that's being sheltered tax-free in U.S. banks. Let's hope the effort succeeds. If bloodthirsty Mexican druglords can't be locked away in prison, at least they should be taxed on their ill-gotten profits.]

The bottom line is that U.S. law knowingly facilitates cross-border tax evasion -- and has done so for many, many years. We tolerate it because our banks need the money.

Now, about those nasty Swiss....

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