The Remittances Tax: High Paperwork, Low Payoff

One piece of the “One Big, Beautiful Bill Act” passed by the House of Representatives on May 22 is a new 3.5 percent excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. on remittances: non-commercial transfers of money from people working in the US to people abroad (for instance, family members). The taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. is likely to create collateral damage by imposing compliance burdens on people who are not the intended target of the tax while struggling to collect revenue from the intended targets. Tax policy is often an inefficient way for government to accomplish nontax priorities, and that is likely to be the case here.

The bottom line: this is a small tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. with a big compliance burden. Its primary impact will be far more paperwork, not more revenue.

The tax on remittances was originally written as a 5 percent levy in the first version of the bill, but was reduced to 3.5 percent in a series of edits known as a manager’s amendment.

Collateral Damage: American Citizens and Investors

The intended base of the tax is international money transfers from the US sent and received by non-American nationals. While the charge is intended to target noncitizens (and perhaps particularly people working in the country without permission), its downsides are more extensive. It also places a compliance burden on many people who are not intended targets of the legislation: for example, Americans or foreign account holders making routine international transfers for other purposes than remittance, such as investment.

The requirements on Americans will fall on both financial institutions and individuals. Even the text of the bill itself suggests some of the compliance burdens at hand. Financial institutions will need to work with the US Treasury to become a qualified remittance transfer provider (RTP). Qualified institutions would then be required to automatically deduct the tax from any amount exceeding $15 transferred internationally, unless the sender can prove their citizenship.

Financial institutions have some means to determine if a transaction qualifies as a remittance (as required by the Electronic Funds Transfer Act of 1978). However, doing so at the scale and accuracy needed to make an effective tax base is another matter. Determining whether a client qualifies as a US national will be difficult. Financial institutions frequently already collect IRS Form W-9 under current law, which provides some information, but a W-9 alone may not be enough to satisfy the new national status verification requirements. In the case that someone cannot immediately prove citizenship but does so later, they may be able to secure a refund when they file their annual income tax return. And in addition to collecting and using the customers’ information, banks will also be required to submit large databases with lists of transactions and the associated personal information associated to the Treasury.

All the above are compliance requirements placed on American citizens. The tax involves additional paperwork and diminished privacy, and even a convoluted reimbursement process in cases where it is misapplied.

Perhaps an even more harmful consequence of the excise tax will be its dissuasion of foreign investment into the country. It makes it more difficult for foreigners to use US banks, even for purposes unrelated to immigration or remittance.

One example would be an international investor who maintains an account within the United States for the purpose of business. If this investor wishes to transfer funds to another account outside the country, it may bear the appearance of a remittance. But it is not one: the investor is withdrawing his or her own money, not transferring funds to others. An RTP may have difficulty verifying this, wrongfully charging someone withdrawing investment returns. In this case, the tax may function even as a de facto capital control, bearing the appearance of a capital outflow tax. This could disincentivize further and future foreign investment in the United States.

Another potential problem would be for businesses with international operations or supply chains. For instance, a small business in the Detroit-Windsor, Ontario area may have hundreds of transactions with Canadian and US customers, suppliers, and employees. Many of those business transactions will need to prove they are non-remittance in nature. And a larger business with thousands or tens of thousands of employees both in the US and elsewhere may do thousands of international transactions a day, most for reasons other than immigration or remittance. Creating a detailed accounting of these transactions, all to prove they do not incur tax, is a waste of everyone’s time.

Americans familiar with the Foreign Account Tax Compliance Act (FATCA), another deeply cumbersome set of reporting requirements, may see an echo of FATCA in the proposed remittance tax. FATCA’s rollout was frequently delayed by practical difficulties, and ultimately has exasperated a great many Americans without raising much revenue.

Why the Tax Still Won’t Catch Its Target

In addition to the inconveniences and harms to unintended targets, the tax may do a poor job of collecting the intended revenue. Remittances are a particularly slippery tax base. One reason they are difficult to tax is that they tend to be small amounts, many of which avoid detection by the formal banking system, much less the government.

One of the simplest options of avoidance is physical cash, which fully maneuvers around any system for quantification or taxation; it may be brought across borders by people or through packages. Another method of evasion is the transfer of value through digital assets such as cryptocurrency. A further option would be to transfer value by sending high-value physical goods. And, perhaps most conveniently, a non-US national can simply ask an American to wire money on their behalf to avoid paying the tax.

All in all, non-US nationals who send money abroad regularly or in large sums have several means of continuing the practice without paying a 3.5 percent tax. People who more frequently send money abroad will find maneuvers to circumvent the charge, resulting in low revenue generated from the target tax base. The Joint Committee on Taxation estimates the tax will generate just $26 billion over the next 10 years, though actual collections will depend a great deal on avoidance behaviors.

The end result is that the tax will have a high ratio of compliance costs to revenue generated. Much of the paperwork from the tax will be from Americans showing they don’t owe the fee.

A Nonneutral Base

Taxation of remittances, in the US context, is nonneutral (and presumably, deliberately so). That is, it influences behavior by applying inconsistent principles to economic activity. It discourages an arrangement where a household is split between the US and another country, with earners in the US supporting consumers elsewhere, relative to other potential options, such as locating the household entirely in one country.

Hypothetically, a remittance tax could be a patch towards tax neutrality in a country with a large federal consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. , like a value-added tax (VAT.) A worker could effectively avoid VAT by working in a VAT country and paying for consumption outside the VAT area, potentially even consuming zero-rated exports from the VAT country. This is a potential issue for countries with federal consumption taxes to consider. But the US has no VAT, and in our context, a tax on remittances is nonneutral.

Nonneutrality is likely the intent of the policy, which comes contemporaneously with nontax policies intended to reduce immigration. However, in this case, like many others, nonneutral tax policy is a poor tool for pursuing nontax objectives. Tax Foundation generally argues this, but its deficiencies are particularly acute in this case: transactions are plentiful, often difficult or impossible to count, and difficult to exert jurisdiction over. By contrast, the physical question of which people are in which locations is better answered in the physical world with well-considered, orderly, and fair processes.

All in all, the remittance tax policy is a miss, even judging it by its intended goals. When the tax system generates much paperwork showing tax is not due, that is a sign of costs to citizens greatly exceeding benefits to government. Pennies on the dollar from foreign workers are not worth the requirements on tens or hundreds of millions of people.

Share this article