August 15, 2002

August 15, 2002 | Commentary on Taxes

ED081502: IRS Plays While O'Neill Is Away

Treasury Secretary Paul O'Neill has spent a lot of time traveling the world lately, following his well-publicized trip to Africa with visits to nations such as Brazil, Uruguay and Argentina. But perhaps he should spend more time at home. In particular, he needs to provide some adult supervision at the Internal Revenue Service, which seems intent on enhancing its bad reputation.

Its heavy-handed tactics and disregard for civil liberties are so legendary that IRS Commissioner Charles Rosetti felt it necessary to launch a campaign a few years ago to make the agency appear more "customer friendly."

This must have been his idea of a joke. In recent months, the IRS has announced that it wants to reinstate its infamous "lifestyle" audit program -- an initiative that would give agents the right to question your friends, neighbors and business associates about you, even if there's no evidence you underpaid your taxes.

The agency also is trying to get millions of credit-card records from foreign banks because it thinks some account holders might be Americans. Yet it offers no evidence that specific taxpayers are using these accounts to evade taxes -- which shows how much regard it has for the Bill of Rights.

The most recent IRS outrage is a proposed regulation that would require U.S. banks to report how much interest they pay depositors from 15 nations, including France and Germany. But this attack on financial privacy is completely unnecessary: The IRS admits this information isn't needed to enforce U.S. tax law and is being requested solely for the benefit of foreign governments.

It's clear, though, that the regulation could cause significant damage. For instance, it would:

Make it harder for Americans to get loans. Foreigners deposit money in U.S. banks because they know their money will be safe and that their privacy will be respected. But if the IRS regulation is finalized, foreign governments will try to tax the interest paid to their citizens' accounts, even though that income is earned in America.

Foreign depositors likely would respond by withdrawing their money from American banks and depositing their funds in privacy-protecting banks in Switzerland, Hong Kong or the Caribbean. Foreigners have about $1 trillion invested here, so the impact could be significant. This would mean less money for car loans, less money for mortgages and less money for small businesses.

Hurt American financial markets. Banks will suffer the most if this regulation goes into effect. They will lose deposits and be forced to buy new software and hire new personnel to handle the complicated reporting requirements. These costs will be passed on to depositors and borrowers. And you'd better believe this flight of capital would affect your 401(k) plan. The Dow Jones Industrial Average already has lost about 35 percent of its value, and the NASDAQ about 75 percent, but it can get worse.

Disregard existing law. Regulatory agencies are supposed to enforce laws, not create them.

Lawmakers have reviewed the tax treatment of bank-deposit interest paid to foreigners on many occasions and always declined to tax the income or require reporting the interest. Why? Because they wanted those deposits creating jobs in America. The proposed regulation would frustrate Congress' intent to encourage foreign deposits, but IRS bureaucrats apparently think their ideological agenda supersedes the democratic process.

Hinder tax reform. The IRS regulation is a slap in the face to those who support tax reform. All proposals to fix the tax code, such as the flat tax, are based on common-sense principles such as taxing income only once and taxing only income inside our borders. But the new regulation would sabotage tax reform, as it would help foreign governments double-tax income earned in America.

It's time for Secretary O'Neill to put the interests of American taxpayers first and withdraw the IRS proposal. You don't need an "economic summit" to realize that reining in the IRS may be one of the best ways to boost our economy.

Daniel J. Mitchell, Ph.D. is the McKenna senior fellow in political economy at The Heritage Foundation, a Washington-based public policy research institute.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

Originally appeared on the Knight-Ridder wire.