A new law aims to lure money from overseas investors
On the surface, the tax bill that President Reagan signed last month is a timid, election-year effort to shrink the fearsome federal budget deficit, expected to be about $175 billion for fiscal 1984. The legislation aims to boost Government revenues by $50 billion over the next three years through such steps as raising liquor taxes and reducing business deductions for luxury cars. But buried in the fine print of the 751-page 1984 Deficit Reduction Act is a fundamental change in the way the tax code treats foreigners who invest in the U.S. The measure could attract more money from overseas, which would help finance the U.S. budget deficit, hold down interest rates and perhaps spark a boom in the stock and bond markets. Indeed, the rally seemed to have already started last week.
Up to now, foreigners who bought American bonds or other financial assets in the U.S. were subject to a 30% withholding tax on interest earned. The new legislation ends the withholding, making the investments tax-free to overseas buyers. Suddenly America has become the largest and possibly the most alluring tax haven in the world.
The U.S. is already heavily dependent on foreign money. Last year alone some $86 billion poured into American investments from abroad. By enlarging the pool of capital available for lending, the inflow from overseas has helped ease pressure on interest rates. Without the foreign investment, the prime rate that U.S. banks charge corporate customers, now at 13%, might be 1 to 3 percentage points higher.
Foreign banks and other financial institutions have been big buyers of U.S. bonds. But most individual foreign investors, seeking to avoid the U.S. withholding tax, have favored certificates of deposit offered by overseas units of American banks and bonds issued by U.S. companies in foreign financial centers where taxes are minimal. Now that the American tax has been repealed, foreigners may develop a taste for bonds sold in the U.S. The prospect of increased foreign capital flows and stable interest rates could further fuel the bull market that was gathering force last week.
The U.S. Treasury Department urged Congress to repeal the withholding tax. Treasury officials want to sell foreigners more bonds as a way of reducing the interest rates that the Government pays to finance its deficit. Part of Treasury's motivation is political. The last thing Reagan needs in an election campaign is rising interest rates.
The tax repeal has stirred resentment abroad. One European government official accuses the U.S. of "robbing the rest of the world of capital." To keep from losing too much money to the U.S., foreign countries may have to raise their interest rates. In West Germany the central bank and the Finance Ministry have suggested that the government should consider exempting foreigners from tax on its bonds as a way of countering the U.S. strategy.