NOTE: A version of the following commentary appeared in Forbes magazine online on April 14, 2014.
Markets everywhere breathed a sigh of relief in February when the GOP-controlled House of Representatives allowed the debt ceiling to be suspended without another tussle with the White House over spending. Whatever the political or budgetary merits, the world of finance and business cheered that the “full faith and credit” of the United States government would not be compromised by failure to meet all of its obligations on time.
The relief may have been premature.
In less than three months the Department of the Treasury will start trimming payments on portions of the $17.3 trillion-plus national debt, with unpredictable – and unstudied – consequences. Acting in violation of legal commitments to purchasers, the Department will chop 30% from interest payments due some foreign holders of hundreds of billions, perhaps trillions, of dollars’ worth of Treasury securities. Possible results of this consciously self-inflicted partial default could include mass dumping of bonds by jittery holders, a hike in the federal government’s debt service rate, a credit downgrade, and undermining the U.S. dollar’s status as the world’s reserve currency. The impact on the American and global economy is, literally, incalculable.
Why would Treasury Secretary Jack Lew do this? Because he’s required to under a law of which few Americans have ever heard.
Enacted in 2010 by an all-Democratic Congress with almost no legislative review, the “Foreign Account Tax Compliance Act” (FATCA) was slipped into an unrelated jobs bill as a minor budgetary pay-for provision. Set to go into effect on July 1, 2014, FATCA supposedly is aimed at American tax cheats with money stashed abroad. But instead of singling out suspected tax evaders, FATCA creates an NSA-style information dragnet requiring all non-U.S. financial institutions (banks, credit unions, insurance companies, investment and pension funds, etc.) in every country in the world to report data on all specified U.S. accounts to the IRS.
But how can an American law compel compliance by foreign institutions that even the Obama Administration admits are outside U.S. jurisdiction? Simple: the threat of economic sanctions. Non-U.S. institutions deemed “recalcitrant” would be subjected to 30% “withholding” from U.S.-sourced payments, effectively shutting them out of America’s financial market. Given our weight in global finance, the risk of such extrajudicial reprisal has terrified banks and governments worldwide.
Under FATCA, among the payments to be withheld are “any payment of interest, dividends, rents, [etc.] . . . if such payment is from sources within the United States.” No exception is provided for interest payments on U.S. government securities. This means that among the payments to be shorted will be debt service on some portion of the over $5.8 trillion of U.S. debt held abroad.
How much of that amount will be subject to the 30% slash? Nobody knows. Some is held by foreign governments (which are exempt from FATCA as written) and some by private institutions (which are required to either comply with FATCA, or to be in a country whose government agrees to mandate compliance by its banks). Only about two dozen countries have signed FATCA agreements, which incidentally are not treaties and have questionable legal status. At risk are tens, perhaps hundreds, of thousands of institutions that may hold bonds among their assets or on behalf of private investors.
Even foreign governments may not be entirely out of the woods either, depending on how their interest is transferred. While domestic U.S. payments are made through the Fedwire service, foreign payees’ money eventually is sent via the international SWIFT network to various non-U.S. banks – which might be subject to withholding if the receiving bank is deemed “recalcitrant.” Any payment to a “recalcitrant” bank might be sanctioned if the FATCA-exempt status of the beneficial owner is not easily established.
In the end, no one really knows how this will work, which is part of the problem. Foreign purchases of U.S. Treasury securities and the reliability of interest payments are essential to America’s financial stability. Even a slight market change in U.S. borrowing costs could have a disastrous impact on the deficit and our economy. Why play Russian roulette with the U.S. debt absent a big, identifiable, countervailing benefit?
FATCA presents no such benefit. Even the IRS’s internal Taxpayer Advocate Service says that “FATCA-related costs equal or exceed projected FATCA revenue.” IRS Commissioner John Koskinen recently confirmed his agency can’t make effective use of all the data expected. According to the Joint Committee on Taxation projected tax recovery from FATCA – which demands reports only of individuals’ assets, not of offshore corporate accounts – is only about $800 million a year, enough to run the government for just two hours. The tiniest blip in debt service rates would dwarf any hoped-for gain.
It’s not too late to avert what even compliance managers who expect to make a killing on FATCA already are calling an impending “train wreck.” FATCA’s effective date has been delayed before, and Congress should demand further suspension until the risks are thoroughly projected and quantified. It’s time to subject FATCA to the kind of examination it should have received before it was enacted, an examination is it unlikely to survive.
James George Jatras is a former U.S. diplomat and U.S. Senate staffer. Now a Washington-based government and media relations specialist, he edits RepealFATCA.com.