The United States' aggressive financial disclosure law, the Foreign Account Tax Compliance Act (FATCA), unquestionably got off to a rocky start. Its implementation has been much delayed as Treasury Department regulators struggled to enforce what has proven to be a fundamentally flawed law from its conception. Now finally entering into force, FATCA faces a new set of challenges as its many unintended consequences begin to blow back on the U.S. government in the form of political uproar and serious legal challenges.
A Troubled Start
FATCA was passed into law as an afterthought to “pay for” unrelated legislation. Members of the U.S. Congress at the time were desperate to find a way to demonstrate competence in the face of a global recession, and to do so without explicitly raising taxes to pay for the effort. Putting the squeeze on tax cheats seemed like an obvious choice. No one likes evasion, so it was thought that the legislation wouldn’t be controversial. And since the Democrats controlled all branches of government at the time, FATCA was simply never granted the careful deliberation such a massive undertaking deserves.
As so often happens with government policy, the FATCA's goals were not matched by the reality of its methods. It did much more than crack down on tax cheats. It called for complete upheaval of the entire global financial sector in pursuit of the narrow interests of a single country.
Subsequent years have proven FATCA's tiny projected benefits to be vastly outweighed by its significant costs, a fact which a sober and deliberative legislature would have been able to predict before unleashing it upon the world. The foreign financial institutions and governments inconvenienced by the law don't have a vote in the United States, however, so the political consequences of this particular oversight would be negligible if not for the presence of other aggrieved parties in the form of law-abiding Americans living, working, or investing overseas.
FATCA Victims Fight Back
It has many practical flaws, but FATCA's most egregious error is conceptual. It falsely assumes that any American with an overseas bank account is engaging in questionable tax practices and for all intents and purposes treats both them and their institution as if they are presumed guilty. As a consequence of FATCA's overbearing approach, millions such Americans are being denied – or having to pay much higher costs for – basic banking services, such as the ability to establish savings accounts or secure mortgage loans.
FATCA and similar aggressive efforts to curb tax evasion are sold to the public on the myth that large numbers of wealthy Americans have stashed funds offshore to avoid paying taxes. The reality is far different. Not only is tax evasion extremely rare in the U.S., which rivals Hong Kong, Switzerland, and Singapore for having the highest compliance rate in the industrialized world, but most Americans using offshore financial services do so because that is where they live and work. They are teachers, accountants, and writers. And among the wealthy Americans who do use offshore financial services, they do so primarily for tax-compliant investment reasons.
All of these individuals have been swept up in the FATCA net, but some are fighting back. Americans living abroad have only marginally more political clout than the foreign banks, whose concerns utterly fail to sway the American political class, but they have something those institutions do not: U.S. legal and voting rights.
FATCA's Legal Woes
Two major lawsuits making their way through the courts are threatening the very foundations of FATCA. One has been brought recently by Senator Rand Paul, a candidate for president in the Republican primary, who argues that the Treasury Department has exceeded its authority during FATCA's implementation. The other was initiated last year and challenges the Constitutionality of FATCA's invasive reporting requirements and draconian penalties.
Sen. Paul's suit could strike a serious blow to FATCA. As written the law requires the IRS to work directly with tens of thousands of institutions that are expected to spy on the U.S. customers on behalf of tax collectors. The information demanded under threat of serious financial sanctions was often more than local privacy laws permitted institutions to divulge, which put them in an impossible position and threatened viability of the legislation.
To circumvent the problem, regulators tasked with implementing FATCA took it upon themselves to rewrite the law. They came up with the idea of signing intergovernmental agreements (IGAs), which would allow institutions to first transmit collected information to their local authorities, who would then share it with the IRS. The agreements, and the subsequent changes to local laws they sometimes required, saved institutions from having to choose between violating privacy protections or suffering serious financial penalties from the U.S.
But to get other governments on board, the United States had to promise reciprocal efforts not authorized by legislative text, and which American lawmakers would be very unlikely to support. Politicians in Washington want other nations to collect information on Americans, but they have no interest in similarly burdening U.S. institutions just to help foreign governments collect more revenue.
The IGAs themselves are the subject of Sen. Paul's challenge, which asserts that the Executive branch has violated the Constitution by failing to submit the agreements to the Senate, where two-thirds support is required before treaties can become law. The Obama administration insists that the IGAs do not constitute treaties and are instead mere executive agreements, but the substantive policy changes they contain are more characteristic of traditional treaties and demonstrate why legislative input is mandated in the process.
U.S. courts are often reluctant to step into the middle of a dispute between the other two branches of government, so despite the merits of the case it is anyone's guess how they will come down on the issue. Still, the implication of finding in favor or Senator Paul would be significant for those impacted by FATCA, as it would unravel years of costly work for both those implementing and complying with the law. The current Congress is much more hostile to FATCA and is unlikely to approve the IGA agreements if they are forced through the Senate. Without the agreements FATCA will once again face serious practical impediments, perhaps even forcing Congress to revisit the legislation.
While the courts hesitate to get in between the political branches, they are willing, depending on the issue, to be more proactive in the defense of citizens’ rights. That could prove decisive for FATCA, as the second legal challenge is being pursued on behalf of Americans living overseas who have been negatively impacted by the law. In addition to also questioning the violation of the Senate’s treaty power as Paul’s suit does, they allege that the law infringes on privacy rights and that its excessive penalties violate the U.S. Constitution’s prohibition against cruel and unusual punishment.
Potential Fallout
These are serious challenges that strike at the core of the law. They are also being argued by an accomplished litigator with an impressive record. Jim Bopp, who is leading the case on behalf of overseas Americans, has won 9 out of the 13 cases he has argued before the Supreme Court, including the high-profile fight over free speech and campaign contribution limitations which resulted in a major piece of legislation being overturned.
Even a partial ruling against the law from either of these cases could prove fatal for FATCA.
The law was too poorly conceived and hastily passed to withstand such a blow without crumbling entirely. Lawmakers will then have to decide whether they want to double-down on the mindless pursuit of revenue at any cost, or whether to admit their error and reverse course before more damage is done.
The U.S. courts aren't the only ones taking a critical look at FATCA either. A challenge to their government's FATCA IGA from Canadian citizens – some of whom didn't know they still held U.S. citizenship after emigrating as young children, or were still considered U.S. tax persons under the worldwide American tax system – alleges the agreement infringes on Canada's sovereignty and violates their personal privacy rights. The case should see its first ruling soon, and could lead the way to similar challenges in other nations.
There's no doubt that FATCA was ill-conceived and doesn't come close to positively balancing its costs and benefits, but an equally irresponsible strategy on the part of Treasury Department regulators to invent new provisions of the law extended that folly. Offshore institutions that have spent millions complying with FATCA, and the governments that have worked to accommodate its invasive demands, may yet find it was all for naught.
2016 Elections
As these court cases are working their way through the process, the United States also is getting closer to a pivotal election year. The Republican Party is well positioned to hold power in the House of Representatives, has a good chance of retaining power in the Senate, and is an even bet to capture the White House. This is important because Republicans are generally hostile to FATCA. The Republican National Committee has even taken the unusual step of adopting a resolution of disapproval, and Senator Paul has also introduced legislation to repeal FATCA.
So while FATCA faces legal threats, it also faces political threats. Total GOP control after the 2016 elections almost certainly would create an environment very favorable to some sort of legislation, either calling for full or partial repeal. Indeed, Senator Rand Paul already has introduced a bill to gut the law.
Conclusion
Ironically, while FATCA is increasingly unpopular with Americans, politicians from other nations, along with their allies at international bureaucracies such as the Organization for Economic Cooperation and Development, want to use the law as a template for a system of mandatory global information sharing.
If successful, a global version of FATCA would severely undermine privacy and create massive opportunities for data hacking and identity theft, not to mention cripple tax competition and provide sensitive information to governments that are either corrupt or venal.
Depending on legal or political developments in the United States, however, these plans may run into a huge obstacle. It’s very difficult to have OPEC without Saudi Arabia and it’s very difficult to impose a worldwide tax cartel without the United States.
By Dan Mitchel and Brian Garst
Dan Mitchell is a Senior Fellow at the Washington-based Cato Institute and Chairman of the Board of the Center for Freedom and Prosperity.
Brian Garst is the Director of Government Affairs for the Center for Freedom and Prosperity, which works to promote tax competition, financial privacy and fiscal sovereignty.
