Obama Burdens the Banks
The costliest regulation you’ve never heard of.
There are a number of pricey regulations that have received attention of late: net neutrality, new ozone standards, countless regulations stemming from the passage of the Dodd-Frank bill. These rules typically garner a mention in the Wall Street Journal, a formal Office of Information and Regulatory Affairs (OIRA) review, and, in some cases, a lengthy Regulatory Impact Analysis.
However, the costliest proposed regulation to come down the pike in some time has nearly escaped detection. Early last year the Treasury Department published its “Guidance on Reporting Interest Paid to Nonresident Aliens,” which would require banks to report to the Internal Revenue Service the interest paid to foreign depositors with a U.S. bank account. While the Treasury and the regulatory apparatus insist that the cost and inconvenience of adhering to this regulation is next to nothing, the rule may cost the U.S. banking system hundreds of billions of dollars in lost deposits, in turn costing our economy billions of dollars, while providing no discernible benefit to banks, depositors, taxpayers, or the U.S. economy.
The notion that banks should report the interest paid on accounts held by nonresident aliens is not a new one: The Bush administration proposed this rule in 2002 for residents of 15 European nations in order to help our allies deter tax fraud, and with the hope that they might do the same for us. Foreigners have never paid U.S. taxes on interest earned in U.S. banks and would continue being exempt under the proposed rule; the sole requirement would be that banks report the interest paid to these account-holders to the IRS.
The Treasury estimates that the costs to comply with the regulation would be minimal, with banks needing no more than 15 minutes to comply, summing to a grand total (when multiplied by the roughly 8,000 banks and other depository institutions affected) of 2,000 hours of employee time, or somewhere just south of $100,000 per annum. The de minimis projected cost means that the regulation is not subject to the detailed cost-benefit analysis required for regulations costing more than $100 million.
If a few hours of filling out paperwork were the only cost incurred, then the lack of attention would be appropriate. But a much bigger problem—for banks and the economy—than the compliance costs is the threat of a massive capital flight. The United States is a very popular place for foreigners to park their savings, for a variety of reasons.
For starters, we offer a stable government that can be trusted to keep its hands off deposits—something that appeals greatly to residents of Venezuela, Argentina, Ecuador, and any number of other unstable countries. Second, the United States still offers at least a semifunctional financial market: Bank deposits are federally insured, inflation rates have been low and stable for decades, and there’s a reasonable expectation (though far from a guarantee) of avoiding a financial crisis on these shores.
As a result, a staggeringly large amount of savings from abroad is currently held in U.S banks. While the Treasury asserts that “deposits held by nonresident alien individuals are a very small percentage of the [total] deposits held by U.S. financial institutions,” that very small percentage amounts to more than $3.7 trillion, according to a 2011 Bureau of Economic Analysis report, hardly a pittance.
The massive amount of foreign savings here is a boon to the U.S. economy. Banks lend against these deposits, mainly to companies here in the United States. Jay Cochran, an economist at George Mason University, studied the impact that the more limited 2002 reporting requirements would have had on the banking system, estimating that it would have resulted in nearly $100 billion in deposits leaving the U.S. banking system. A reporting regulation that covers all foreign accounts would likely result in two to three times more capital flight.
The impact would be harmful not just for the banks but for the broader economy. The decline in profits in the banking sector alone from a roughly quarter-trillion-dollar capital flight would be in the range of $5-10 billion—which makes a mockery of the notion that the costs of the regulation are under $100,000.
The losses would be felt especially in Miami and Los Angeles, where deposits from Latin America are concentrated. The Florida Office of Financial Regulation surveyed 16 banks chartered in that state and found that an average of 41 percent of their deposits were from nonresident aliens, with one bank reporting the number at 92 percent. Our fractional-reserve banking system means that one dollar of deposits supports multiples of that in loans; a withdrawal of $200-300 billion in deposits would diminish lending in the ballpark of $1.5 to $2 trillion.