Why FATCA might be good for developing countries

Recently I wrote a post explaining that I feel cautious about the burden that compliance with an automatic tax information exchange standard would place on developing countries. Since then a new paper by Itai Grinberg has popped up called Emerging Countries and the Taxation of Offshore Accounts.

This amused me. I encountered Grinberg a couple of times when I was an NGO tax justice policy adviser and he a US Treasury official who was, in general, dead set against the NGO policy prescriptions I was advocating. Now both of us are academics and, freed from our respective party lines, it turns out that I’m sceptical of this one, while he is a rabid enthusiast! Here’s what Grinberg says that has challenged my thinking a little.

First, he restates the argument made by Tax Justice Network and many other NGOs, as follows:

Under pressure from the G-20, an international standard requiring governments to exchange tax information upon request emerged. On its own, however, information exchange upon request is inadequate to combat offshore tax evasion because it requires the requesting tax administration to know which foreign jurisdiction to ask for information about which taxpayer, and to have other details that prove a credible suspicion of tax evasion.

That makes complete sense, but as I wrote last week, my concern is about whether developing countries are yet ready to engage in anything more sophisticated. Automatic information exchange would require a lot of effort on their part to compile and send information, let alone use what they receive. Here Grinberg has a number of strong arguments, given that large multinational banks will in any event have to compile information from overseas in order to comply with the US’ Foreign Account Tax Compliance Act (FATCA) rules:

1. There is a narrow window of opportunity

Grinberg sketches out the current dynamics created by FATCA. The original legislation obliged overseas banks to report directly to the US government on the financial affairs of US citizens, but this would often breach their domestic legal obligations. The US government’s agreements with European countries have instead created a model in which banks report to their own governments, who then exchange the information with the US. (Bizarrely, at present domestic US law prevents it from supplying the same information that it expects to receive from these governments, but plans are afoot to change this so that the exchange is reciprocal).

The US-EU approach is similar to the automatic exchange model within the EU, and it could therefore be a suitable basis for a multilateral regime to develop. This would be preferable on a number of levels, says Grinberg, including reduced compliance burdens for governments and financial institutions from a standardised approach, and the possibility that developing countries could benefit by participating.

But there isn’t much time to transform the current piecemeal approach into a global, multilateral one. The information exchange system develops through “punctuated equilibrium” such that its current rapid evolution will not continue indefinitely, and will give way to a period of stasis.

Furthermore, Switzerland has pursued a different approach to comply with FATCA,in which banks do send information directly to the US in the manner envisioned by the original FATCA legislation (and not entirely automatically). That’s in addition to its secrecy-preserving agreement with the UK. So there is a risk of divergent standards becoming consolidated, which would make any move to one global standard harder.

I can accept the idea that, while this might not be the ideal time for developing countries to move to automatic exchange on their own terms, they may need to consider their options from a “now or never” perspective. It’s for this reason that Grinberg’s paper is framed with a sense of pressing urgency.

2. Banks are likely to put in place the systems anyway

According to Grinberg, large multinational financial institutions would,

likely implement standardized processes for obtaining proof of residency and tax identification numbers (or dates of birth) as part of their account-opening procedures across jurisdictional boundaries. They would similarly have incentives to undertake firm-wide IT projects aimed at enabling information reporting on dividends, interest, other income, and account balances to governments in a standardized way, with respect to all accounts the financial institution manages.

In other words, this is an opportunity for developing countries to start gathering better data on taxpayers within their borders at minimal cost:

Coercing financial institutions by means of FATCA to use a simple, standardized system for reporting on income from capital,intended to facilitate automatic record-matching, may function like a program for upgrading the capacity of some domestic tax administrations.

3. Automatic exchange may strengthen tax authority independence

Grinberg argues that it might be easier for a tax authority to challenge a powerful taxpayer based on information received automatically from abroad than purely on its own initiative:

In a country struggling with corruption or fears those in power may abuse that power, an automatic information exchange system may reduce the pressures on a semi-autonomous tax administration because, unlike information exchange upon request, investigations begun as a result of automatic information exchange are less likely to be perceived as politically motivated. Similarly, a tax administration may find it less difficult to open an audit of politically connected persons when information that suggests such an audit should be conducted is provided from abroad.

It’s easy for tax and development commentators to forget that the tax policymaking and administration apparatus in developing countries is not one uniform lump, but rather different people and institutions with different preferences and facing different incentives. A prod from the outside might be just what one set of people in a country needs to achieve its own objectives.

But I’m not wholly convinced yet. A cost-benefit analysis to test these theories, especially the third, against the compliance cost for developing countries seems important. And this is still a case of policy developed outside developing countries with little input from their side. That’s not a reason to rule it out as such, but it is a reason to think long and hard and, maybe, ask some developing country tax officials themselves..