It’s not every day that a U.S. senator, let alone a presidential candidate, sues the government to suspend the enforcement of a federal tax law. Yet that is exactly what Sen. Rand Paul of Kentucky is doing. He is one of seven plaintiffs challenging the constitutionality of the Foreign Account Tax Compliance Act. The lawsuit, Crawford v. United States, is currently before the U.S. District Court for the Southern District of Ohio. For good measure, the plaintiffs are also challenging the legitimacy of the foreign bank account reporting regime, as administered by the government’s Financial Crimes Enforcement Network. Although Tax Notes has previously reported on the case, the details are too juicy not to discuss further.
We already know that Paul is no fan of taxpayer information exchange. Since joining the Senate, he has single-handedly prevented all pending U.S. tax treaties from being ratified. Tax treaties are popular with the business community because they significantly reduce withholding rates and promote cross-border investment. Paul’s opposition to ratification appears limited to article 26, which concerns exchange of taxpayer information between contracting states. Although I consider his treaty freeze misguided, I suppose he deserves credit for consistency.
Treaty-based information exchange isn’t very useful in efforts to detect offshore tax evasion. The transfer of information is upon request. That means the tax authorities in Country X must identify, with some specificity, the taxpayer about whom they are seeking information from Country Y. Those safeguards reduce opportunities for fishing expeditions by tax authorities. Note that the U.S.-Switzerland treaty did absolutely nothing to prevent the rampant tax evasion witnessed in the UBS affair. (Nor did the treaty dissuade the roughly 35 other Swiss banks that have signed non-prosecution agreements with the DOJ admitting they helped U.S. account holders evade taxes.)
If Paul finds tax treaties distasteful, he must be apoplectic about FATCA.
FATCA is like article 26 on steroids. It takes exchange of information to a whole new and unprecedented level. Under FATCA, the transfer of taxpayer information is accomplished programmatically. Foreign banks must share all the relevant account data they possess on U.S. account holders, or face onerous withholding measures. The IRS need not single out particular persons of interest or state the basis for its suspicion. The bank data automatically shows up on the IRS network, in bulk, courtesy of foreign banks or governments transmitting it to us. It’s a tax dodger’s worst nightmare. For this reason, many observers view FATCA as the beginning of the end of bank secrecy.
So what about this lawsuit? What legal theory supports Paul and the other litigants' argument for stopping FATCA and FBAR in their tracks?
The complaint extensively criticizes the four years and $8 billion spent by the global financial sector in making its internal computer systems FATCA-compliant. The Joint Committee on Taxation estimates that FATCA will generate only $8.7 billion in additional tax revenues over a 10-year period. Looking at these costs and benefits, serious questions can be asked about whether FATCA delivers adequate bang for the buck. That’s legitimate. But it’s an economic objection, not a legal one.
The complaint correctly notes that U.S. citizens living abroad have encountered difficulties opening or maintaining foreign bank accounts. Some foreign banks prefer to turn away prospective American clients rather than comply with FATCA. The law has also caused problems for individuals with dual citizenship, or couples in which only one spouse is a U.S. citizen. And the complaint reminds us that the aggrieved people are “overwhelmingly middle-class Americans, not high income individuals.”
These are perfectly valid observations. But so what? No doubt FATCA is hugely burdensome. That problem is widely recognized. If inconvenience were actionable, FATCA might be the worst tax law ever. But where is the constitutional infirmity?
Perhaps the best articulation of the plaintiffs’ legal argument is as follows:
FATCA eschews the privacy rights enshrined in the Bill of Rights in favor of efficiency and compliance by requiring institutions to report citizens’ account information to the IRS even when the IRS has no reason to suspect that a particular taxpayer is violating the tax law.
In other words, the argument is that FATCA violates individual fundamental privacy rights by requiring foreign banks to collect and share information about income. A similar claim is made against FBARs and FinCEN. The government insists that no such privacy right exists.
In Paul’s view, we have a constitutionally protected right to be free from third-party reporting on any foreign bank accounts. Then how does one explain the parallel reporting requirements that domestic banks are already subject to? How to justify Form 1099? Why should it matter whether the bank account in question is in Basel or Boston?
And why stop at bank reporting? What about wage reporting? Do employers violate financial privacy rights by reporting wage earnings to the IRS? Income is income; why should information about earned income, constitutionally speaking, be treated any differently from information about investment income?
If this theory of financial privacy holds water it’s hard to justify any type of third-party income reporting -- which would be hugely problematic for our country's tax system. Take away reporting and you’re left with taxation on the honor system. Maybe that’s how Paul prefers it. Ironically, Paul’s basis for standing in this lawsuit is rather unique. Nowhere in the complaint is it alleged that he maintains a foreign bank account -- unlike the other six plaintiffs. Rather, he claims “irreparable harm” because he was unable to vote against any of the intergovernmental agreements that Treasury has signed with foreign governments. That may sound silly. But could Paul be on to something?
Remember: FATCA is not self-enforcing. It’s best viewed as a network of bilateral relationships, each requiring a formal IGA to give it effect. To date, the United States has signed about 115 IGAs. As a practical matter, no IGA means no enforcement mechanism for FATCA.
Unlike tax treaties, IGAs do not require ratification by the Senate Foreign Relations Committee. That means Paul is unable to place a procedural freeze on IGAs the same way he’s put a freeze on tax treaties. That pesky little detail has proved vital to the rise of FATCA and the global spread of similar information exchange mechanisms, such as the OECD’s common reporting standard, which can be thought of as FATCA for the rest of the known universe.
If the lawsuit survives the government’s motion for summary judgment -- which remains an open question -- one fascinating issue will be the odd-duck status of these IGAs. In many ways, they seem to resemble taxpayer information exchange agreements, which also don’t require Senate ratification on the grounds that they are manifestations of the executive branch’s ability to conduct foreign policy. In practice, however, TIEAs and IGAs aren’t so different from article 26 of your average tax treaty. Yet the latter requires ratification by the Senate while the former do not.
If nothing else, I’m hoping the complaint serves to clarify the unique status enjoyed by IGAs – instruments that didn’t exist until a few years ago.