Tax Analysts Blog

Tax Dodger Alert: Your Friend in the Senate

Posted on Nov 27, 2012

Rand Paul is an energetic young Senator with a bright political future. Like his father, GOP presidential candidate Ron Paul, he is a staunch Libertarian who defends small government and low taxes. These are legitimate objectives supported by millions of Americans. But Paul has displayed poor judgment by placing a freeze on the ratification of U.S. tax treaties.

Nevermind that tax treaties reduce taxes on business, facilitate cross-border investment, and make life easier for multinational corporations. What's at stake here is Senator Paul's ability to claim 'clean hands' when he next stands before the electorate. Intentionally or otherwise, Paul has become the best friend of America's tax cheaters.

Here are the details.

As most of you know, federal law imposes a tax on individual income regardless of where the money is earned. Whether your bank account is located on Mainstreet USA or in Zurich, Switzerland, the interest income is taxable. That's the law, like it or not. One sharp difference between a U.S. bank and one in Switzerland is that the former reports your income to the IRS, the latter does not.

Fiscal transparency -- here, taking the form of third-party reporting -- is a bedrock of modern tax administration. But the Swiss banking system is premised on opaqueness and secrecy. We know from the recent UBS scandal that thousands of Americans stashed large fortunes in Swiss bank vaults and failed to report the income on their U.S. tax returns. We also know that Swiss bankers encouraged them to do that.

The United States and Switzerland have a treaty that envisions information exchange between the two governments, but it didn't do much good in the UBS affair. That's because the treaty, in it's current form, allows the Swiss to turn a blind eye to American tax cheaters. So in 2009 the two countries negotiated a protocol to amend the treaty.

The protocol would fix the problem by authorizing the Swiss government to assist the IRS in obtaining financial data on American with offshore bank accounts. The protocol is good thing if you believe all Americans should obey U.S. law and pay their taxes. The protocol is a bad thing if you're a tax cheater with undisclosed Swiss bank accounts. It was something of a diplomatic coup that U.S. officials were able to convince their Swiss counterparts to sign on to the agreement.

The protocol, however, is being held up in the Senate because of one man: Rand Paul. What is the Senator's objection? It turns out he, like many Libertarians, is not a big fan of fiscal transparency. He vehemently opposes the very information exchange policy that would fix the UBS problem. He views the protocol as an invasion of privacy; offshore financial accounts are between you and your banker -- and nobody else. As he sees it, transparency equals tyranny because it denies people their freedom. (In this case, the freedom to evade taxes.)

Paul seems to be saying that cross-border information exchange with the Swiss -- or any other prospective treaty partner -- is a policy to be avoided because it leads to the collection of tax revenue, and that's conducive with the known evils of big government, statism, and socialism.

Listen. I'm no socialist. I don't like the government telling me what to do or how to run my life. But it simply isn't rational for a country to have an income tax system that allows its citizens to hide earnings in foreign banks. Consider this the first commandment of sound tax policy: That which is being taxed shall not be concealed. That's true whether you're talking income taxes, consumption taxes, or property taxes.

One cannot overcome this observation by bantering on about freedom and liberty. People aren't stupid; they know a red-herring when they see it. The UBS affair had nothing to do with personal freedoms and civil liberties. It had everything to do with people cheating on their taxes because they thought the IRS would never find out. Those thousands of Americans with undeclared UBS accounts were not freedom-loving patriots; they were deadbeat tax dodgers.

For what it's worth, I urge Senator Paul to continue his fight for a leaner federal government and a more efficient tax code. But he should end this ill-advised freeze on U.S. treaty instruments. Unless the Senator changes course, he's bound to earn what we can only presume is an unwanted designation: The best friend tax cheaters have in the Senate.

It's his reputation to lose.

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