A Farewell to Stimulus?

The IRS' UBS prosecution is working. In fact, it is working so well that the IRS has decided to open up shop across the globe to ferret out secret accounts held by US residents.

From Bloomberg:

The IRS will open offices in Beijing, Panama City and Sydney in connection with the probe, which has revealed accounts held in 70 countries and every continent except Antarctica, he said. The agency also intends to hire more than 800 new employees in the next year and add staff to eight existing overseas offices, including Hong Kong and Barbados.

So is this a good thing? It seems clear that the current administration is bent on closing the tax gap by actually enforcing the existing tax laws (Hint: recent estimates put the tax gap, the difference between what is owed and what is collected, at well over $300 Billion). Good. Better to collect from people who under pay now rather than punish compliant taxpayers with higher rates in the future (for instance, through the imposition of a crippling Value Added Tax).

But there is a dark side to the IRS' increased enforcement efforts. The IRS will be draining private investment funds to pay the US' ballooning debt obligations. In effect, money will be moved out of the capital markets and (theoretically) productive investment opportunities to the black hole of government spending. Translation? An effective tax hike.

Of course, in any normal times, requiring taxpayers to pay what they already owe is not a controversial position. However, when an economy is in a recession, government generally acts to stimulate private industry back into action. This stimulus is usually accomplished by issuing debt, expending funds, and hoping the multiplier effect does the trick (essentially, allowing the money to flow through to private entities who spend it on other items which helps boost GDP).

But when government simultaneously increases the effective tax rates, it acts to damper the stimulus and can prolong the recession. Some argue this is exactly what happened in Japan in 1997: Japan prematurely increased taxes which helped prolong its asset price bubble recession. Nothing about what subsequently happened in Japan is something we want to happen in the US.

So while the IRS' collection efforts are warranted, perhaps they are badly timed. Of course, it could turn out that the IRS' bounty will amount to a mere pittance. But if it is any serious amount of cash, the government may just be shooting its stimulus package in the foot.