Sunday, March 11, 2012

Countries don't help each other to tax, and they should.

Despite the compelling idea that a central mark of statehood is the power of the sovereign to impose taxation, it is surprising how little states help each other to tax.  Tax information exchange is virtually the only way to impose income taxation coherently in a world of footloose capital.   Yet while countries have cooperated to some extent in signing some bilateral and some multilateral information sharing covenants, in most cases they seem to do very little sharing of necessary information.

This is mostly because of the onerous identification requirements countries have imposed on themselves before they will divulge taxpayer information to each other, even under an agreement to do so.  Under the current status quo, the government that seeks information can typically only obtain it by requesting it on a case by case basis, i.e., by identifying a specific taxpayer suspected of specific tax avoidance or evasion activity.  This is hard to do when the major difficulty of mobile capital that information sharing is meant to resolve is the impossibility states face in finding out about taxpayer's offshore assets.  Worse, even when identification is possible, the other state can deny the request if local laws prohibit disclosure of taxpayer information.

That makes specific request-based information exchange "a charade," in which countries appear to agree in principle but in practice do little but defect.   The result is, countries don't help each other very much at all, and so all continue to struggle to tax effectively.

The best way to fix this problem is automatic or spontaneous information exchange.  This would mean that countries would as a matter of routine gather information about the home countries of anyone receiving income from sources within their jurisdictions, and report that this income was received to the recipients' home countries.  In simple form this means that governments would require payors of income, such as banks (paying interest on savings accounts) and mutual funds (paying dividends to shareholders), to let the government know when they make payments to their payees (such as on a form 1099), and in so doing take note of the residence of these payees.  Governments then would sort the payments by residence of the payees and send periodic reports to the home countries to apprise them that the payment has been made.

Not only is this not difficult to do, it is not untested.  Canada and the U.S. have this arrangement, and it has been called "the best existing example of what an automatic exchange of information protocol would look like."  It's a strange arrangement, in that it only requires U.S. payors to report payments made to Canadians: for now, U.S. banks are not required to report any payments made to non-Canadian foreign payees if no U.S. tax is owed (typically the case).  In turn, the U.S. government apparently only turns the pertinent info over to Canada, and not to any other country even if it has such information (possible under an odd twist to the disclosure rule that permits banks to simply collect and report residence information on all payees, rather than segregate the Canadian accounts and only turn those over).

There is no good reason not to extend this rule to all foreigners, and the only reason the U.S. has not done so is political malfunction--each time some legislator sensibly suggests that the rule be expanded to all foreigners (which happens periodically), the idea is discarded amongst cries (by lobbyists and their representatives in Congress) that the U.S. ought not to be in the business of helping other countries enforce their tax systems, that such aiding and abetting would hurt U.S. banks by subjecting them to standards more strident than their foreign competitors.

Thus the consensus seems to be that every country has an inviolable right to tax, but no country has any obligation to help the others exercise that right, and indeed, a country that does do that is only hurting itself.  That is an odd status quo.  The Canada-U.S. arrangement (along with some other similar arrangements like the European savings directive) suggests that there is something fundamentally untrue about the status quo story.  Countries can help each other, and they should help each other, and it is likely even the case that they must help each other, if any of them are to continue to have anything that resembles a coherent income tax system going forward.


  1. A couple of comments on this from a Canadian perspective. One is the Canada Revenue Agency requires Canadian financial institutions to report back on all non resident payees. Thus I believe Canada is able to share non resident payee information with other countries as well such as Mexico.

    The interesting thing is the US refusing to allow this agreement to be used a form of FATCA "deemed compliance" which is leading many Canadian to believe that the US is instead trying to demand information on US Persons residing IN Canada even if they are Canadian citizens, permanent residents etc. Many Canadians I have discussed this issue with consider that if this is what the US is trying to attempt then it is a complete affront to Canadian soveriegnty. For one thing the Canada Revenue Agency really doesn't know whether someone is a US Person and the domestic tax reporting and withholding system in Canada is totally different from that of non residents.

    1. You're quite right that Canada seems to be much more cooperative in collecting at least, and presumably sharing as well, information with other countries. It's true that a bank in Canada might not know whether an accountholder is a U.S. person, any more than a bank in the U.S. might know whether an accountholder is Canadian. Banks in the U.S. are therefore allowed to collect citizenship status on all account holders and turn the lot over to the IRS, which would then turn over the information as to the Canadian accountholders to Canada, and presumably file away or throw away all the information on the rest. I don't know whether banks routinely exercise this option, how (or how well) they otherwise comply with the bank reporting requirement as an empirical matter, or how much of a burden this is to U.S. banks or would be to Canadian banks. As to the feared attack on sovereignty you express, you may be interested in a paper I wrote on this subject, which you can find at

    2. Thanks for the link to your paper I will have to read it tommorrow.

      I am probably going to have a lot more to post in the future so I will just make a few comments for tonight. One is I think some of the issues going on between Canada and the US in cross border taxation are quite interesting and not at least from what I have tried to research are being discussed much of anywhere. However for tonight there are a couple of key points I will make.

      As a long as the United States has had an income tax it has applied to all United States "Citizens" on all of their worldwide income. However, Canada's income tax has always and only applied to those with permanent residential "ties" to Canada. In fact when the Canadian income tax was first introduced their was no such thing as Canadian citizens in fact for several decades more until the 1940 Canadian were technically still British subjects.

      During much of the period of time of the US having an income tax dual nationality was not permitted by most countries including Canada and the US. You were a Canadian citizen or American citizen but not both. Additionally there were very few US Citizens living as "permanent residents" outside of the US.

      A large number of US citizens immigrated to Canada for political and in some cases economic during the Vietnam war years. Most of these people became Canadian citizens with the express intention and desire to no longer be US citizens(Something from a legal perspective is unclear as a matter of US nationality law). However, many are concerned that under increased information sharing with FATCA they will somehow be reclassified as US Persons. Now perhaps that is paranoid but I can say there been have anti FATCA meetup groups that have had over 200 attendees and from what I have been able find out from individual attendees these are mostly well educated people not militia movement survivalist types. The fact that many of these people became Canadian citizens for political reasons(I saw from one person all the nasty letters they sent to Henry Kissinger accusing him of personally being a war criminal back in the 1970s). I know coming from the US this must all of seem surreal but I think there is literally the early stages of political revolt going on here in Canada over FATCA and I have personally been around enough political revolts that whatever the benefits of tax information sharing they are going to be quickly drowned out by the cries to kill FATCA. The fact that the political and legal establishment in the US keeps on going around saying FATCA is a done deal and therefore there nothing anyone can do about it only makes the political revolt sharper. I know I sound crazy saying all this but I have never seen anything in my life that is generating as much controversy here in Canada among at least the people directly affected by it as this FATCA legislation.

  2. If the U.S. were content to get information about U.S. residents with bank accounts that are in Canada there would be no problem. Such a situation would indeed meet the definition of having a foreign bank account. However the U.S. is not content with such a definition of what constitutes a foreign bank account. Instead the U.S. definition does not depend upon residence but citizenship. In other words any U.S. citizens who has a bank account in a non-U.S. jurisdiction is deemed to have a foreign bank account even though that U.S. person may be a legitimate resident of the country. If one accepts this definition then that means that all non resident U.S. citizens are actually U.S. criminals because they are by definition guilty of tax evasion. FATCA is a way for the U.S. government to prevent tax evasion. Of course FATCA does not discriminate between U.S. citizens who are living abroad and have no ties with the U.S. from those who are living in the U.S. and using offshore bank accounts to hide or shelter their income from the IRS.

    The U.S. connection of citizenship with financial reporting obligations has the effect of forcing non-U.S. resident citizens to live as if they have never left the U.S. Such a life then means that U.S. citizens who live abroad are exposed to U.S. legislative risk the violation of which can means stiff and ruinous penalties. It also means that these U.S. citizens inherently become currency traders since all of their non-U.S. income must be reported in U.S. dollars with taxes paid in U.S. dollars. Non resident U.S. citizens are then faced with the burdensome and expensive task of having to harmonize the desparate tax systems of the U.S. and their country of residence. The final insult is that U.S. citizens who live abroad are subject to double taxation based upon their choice to live outside of the U.S. borders.

    U.S. extraterritorial application of its financial reporting laws to its non resident citizens has the effect of turning these citizens into second class citizens in their country of residence because of the discriminatory treatment that they receive from the financial industry of their country of residence. This U.S. law even turns into second class citizens those people who are returning to their country of birth if they have any indicia that show they are U.S. persons for tax reasons. Now isn't that a sad state of affairs?

    U.S taxation of its non resident citizens is immoral because it amounts to double taxation. In subjecting its non-resident citizens to U.S. taxation the U.S. is showing that it doesn't understand anything about taxation. For one thing it shows that it refuses to acknowledge the connection between taxation and the provision of services, which is the underlying pact between a citizen and the government. Secondly the U.S. shows that it does not understand that the power of taxtion can only be exercised over economic activity that is denominated in your own currency. In other words taxation can only be exercised over the wealth that is generated by your own economy and not the economy of another country.

    Under FATCA and citizenship based taxation the U.S. is actually colonizing the world through its expats.

  3. In response to Julian Hudson's post. I am one of those caught in the US citizenship based taxation trap. Although I was born in the US, I've been living in Canada for over 42 years, all of my adult life, and am a Canadian citizen. When I recently found out about citizenship based taxation I was shocked. Although I don't owe any taxes to the US, have no financial ties to the US, I am still required to file. Worse yet, is the FBAR requirements. My registered retirement savings plan which I have spent years accumulating legally under Canadian law, is considered an off-shore foreign account by the IRS. This is absurd. My life is in Canada and I have a basic human right to have accounts in the country in which I live, work, pay taxes and am a citizen. The US is the only democracy on earth that has this ludicrous law, that treats anyone who dares to leave the US and have a live elsewhere as a criminal and tax cheat.