USA: No Overt Capital Controls…Yet
By Mark Nestmann • April 2, 2010
Over the last week dozens of readers have sent me a link to an article with the provocative title of "It's Official—America Now Enforces Capital Controls." In the article, author Tyler Durden states that the Foreign Account Tax Compliance Act (FATCA) (part of the HIRE Act signed last month by President Obama):
"requires that foreign banks not only withhold 30% of all outgoing capital flows (likely remitting the collection promptly back to the US Treasury) but also disclose the full details of non-exempt account-holders to the US and the IRS."
Mr. Durden is a terrific writer, and the series of articles he wrote analyzing the real causes of the crash of 2007-09 is the best explanation of these events I've read. However, his article on capital controls is highly misleading.
I wrote about the implications of FATCA immediately after its enactment here. It's a terrible law that will make it much more difficult for U.S. citizens to invest, do business, or even live outside the United States. But it doesn't impose capital controls, although it's an important step in this direction.
Along with requiring U.S. citizens and permanent residents to disclose a great deal more information about their offshore investments than they currently do, FATCA also imposes a 30% withholding tax on certain types of U.S-source income and gross sales proceeds to foreign financial institutions (FFIs) and certain foreign non-financial entities (FNFE). The only way to avoid the tax is for the FFI or a "withholding agent" for the FNFE to enter into an information reporting agreement with the IRS. These rules become effective in 2014.
If entering into such an agreement violates foreign law…well, too bad. Indeed, the HIRE Act states that if a FFI refuses to enter into an agreement with the IRS, it must close all accounts owned by U.S. taxpayers.
So, FATCA isn't about capital controls, at least not directly. It's about enforcing IRS rules. You can still have money offshore if you report it and pay tax on it. The challenge will be to find a bank that will let you open and maintain an account.
Nor is this type of withholding new. Numerous categories of U.S.-source income are already subject to a 30% withholding tax. This withholding can often be reduced or eliminated if a tax treaty exists between the United States and the country in which the recipient of the income resides. There's also a 30% withholding tax imposed on U.S. source income and gross sales proceeds payable to FFIs if the FFI fails to sign a "qualified intermediary" (QI) agreement with the IRS. The QI rules have been in effect since 2001.
However, with this law, if the government ever imposes capital controls or foreign exchange controls, it will have a much more complete picture of assets U.S. taxpayers have stashed overseas. It could then try to force repatriation of these funds, although as a first step I believe the government will simply impose a tax on all outgoing capital flows, as Mr. Durden postulates. Fortunately, we're not there...yet.
To recap, I think the main effect of the HIRE Act will be to make offshore financial services much more difficult for U.S. citizens and permanent residents to obtain. It will also isolate the United States economically. That has important consequences for the U.S. dollar and the market for U.S. Treasury debt. Even without this law, the Treasury is already having problems finding buyers for the gargantuan U.S. budget deficit, as international investment manager Eric Roseman recently described here.
One final note: if the U.S. government ever imposes foreign exchange or capital controls, it will be in response to overwhelming popular demand. Those with investments outside the United States, or outside the U.S. dollar, will be labeled "greedy unpatriotic speculators." The average Joe will believe the media hype and political posturing, and thus be manipulated into supporting them.
That's what happened in Venezuela. And it could happen in "Amerika," as well.
Copyright © 2010 by Mark Nestmann
(An earlier version of this post was published by The Sovereign Society, http://www.sovereignsociety.com)