March, 2004

An Economic Analysis of the Proposed IRS Rules Governing the Reporting of Deposit Interest Paid To Nonresident Aliens

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The proposed IRS regulations create new "reporting requirements for interest on deposits maintained at U.S. offices of certain financial institutions and paid to nonresident alien individuals that are residents of certain specified countries." (See, Federal Register 67 (149): 50386-50389) ". . . [T]he proposed regulations provide that, if a nonresident alien who is a recipient of U.S. bank deposit interest is a resident of a country for which reporting of such interest is required, a copy of Form 1042-S [must be filed]."

The estimates in this study indicate that the rule is likely to generate a minimum deposit outflow from U.S. depositories of $88 billion. The subsequent adjustments that will be set in motion by this rule are quite likely to lead to unwelcome changes in U.S. depositories' balance sheets, and/or in the cost of funds obtained through deposits. These unwelcome adjustments are also likely to affect the dollar adversely, and to retard foreign investment (both direct and indirect) in the U.S. from citizens of the listed as well as non-listed countries.

Such adjustments might be worthwhile U.S. policy objectives if they were outweighed by benefits U.S. citizens or depositories received as a quid pro quo from our international partners who are seeking the imposition of this rule. However, the IRS has presented no such offsetting considerations in its proposed rule, nor are such offsetting benefits likely ever to emerge. Such an uneven outcome is understandable once one considers that the overarching goal of the rule is to help Europe end "harmful" tax competition among nations. It is well to recall, however, that "harmful" in this context means harmful to the tax collector not the taxpayer. The flip side of harmful tax competition, in other words, is competition that benefits individual depositors and depositories.