Will IRS Trigger Capital Flight?

Florida lawmakers are protesting a proposed IRS rule that they claim will drive capital flight from U.S. banks — especially in the Sunshine State.

The entire Florida House delegation — 19 Republicans and 6 Democrats — sent a letter to the White House last week opposing a plan to change the reporting requirements for foreigners' deposits in U.S. banks. They claim the rule would oblige the IRS to report those deposits to foreigners' home countries.

That would likely spur foreigners to pull out of the U.S. A key reason why they bank here is to keep their money safe from crime and corruption at home as well as autocrats such as Venezuela's Hugo Chavez.

"Because of the privacy laws of the United States, nonresident aliens are estimated to have deposited over $3 trillion in U.S. financial institutions," the lawmakers wrote in the March 2 letter. "During this time of economic concern, we urge that every effort be made to keep capital within the borders of the United States."

Sunshine State banks hold more than $60 billion in foreign deposits, at least 80% of which is from Latin America, the Florida Bankers Association said.

For some banks, they account for the bulk of deposits. Privately held BAC Florida Bank in Miami has $1.1 billion in capital and $800 million in deposits, 90% of which are foreign.

Florida's lawmakers cite a 2004 study by George Mason University's free market Mercatus Center regarding a similar IRS policy proposal. The center estimated that policy could result in $88 billion in deposits leaving U.S. financial institutions. This capital flight could impact the dollar negatively as well as scare off foreign investment,the study said.

"If we are going to start reporting these accounts back to third-world dictatorship countries, then people aren't going to want to put their money into our economy," said George Cecala, spokesman for Rep. Bill Posey, R-Fla. "Why would we want to discourage investment in this country?"

Fighting 'Tax Competition'

The IRS proposal is part of a broader global effort to fight "tax competition" i.e., people shifting their funds to nations with friendly tax and regulatory policies.

Foreign governments have long pressured the U.S. for this information, upset that so much of their citizens' cash is beyond their grasp. The U.S. in turn has forced UBS (NYSE:UBS - News) and other Swiss banks to disclose secret accounts held by Americans to reduce tax evasion.

A posting on the IRS website regarding the proposed regulation doesn't specifically mention turning over the information to depositors' home countries. It does cite "a growing global consensus regarding the importance of cooperative information exchange" as a rationale for the change.

Robert McIntyre, head of the liberal nonprofit Citizens for Tax Justice, says the U.S. needs the rule to help build an international consensus against tax evasion.

"We want other countries to tell us what our citizens are earning there and if we are going to get that kind of cooperation, then we need to cooperate with the other countries," he said.

It's a touchy subject, though. The IRS declined to comment.

The IRS does not tax the interest from these accounts because they aren't by U.S. citizens. The proposed change wouldn't alter this. The IRS would not get any extra tax revenue, just more data.

That loss of secrecy is what worries Florida Bankers Association President Alex Sanchez. He said that these depositors often don't trust their own governments.

"People have it here from Latin America for primarily two reasons: Number one, they are afraid of kidnappings," he said. "The second reason people have their money in the U.S. is the fact that they are afraid of financial or economic collapse (at home)."