I’m not a big fan of the Internal Revenue Service, but I try not to demonize the bureaucrats because politicians actually deserve most of the blame for America’s complex, unfair, and corrupt tax system. The IRS generally is in the unenviable position of simply trying to enforce very bad laws.

But sometimes the IRS runs amok and the agency deserves to be held in contempt by the American people

Let’s look at a grotesque example of IRS misbehavior. It deals with a seemingly arcane issue, but it has big implications for the US economy, the rule of law, and human rights.

On January 7, the tax-collection bureaucracy proposed a regulation that, if implemented, would force American financial institutions to put foreign tax law above US tax law. Banks would be required to report to the IRS any interest they pay to foreigners, but not so the US government can collect tax, but in order to let foreign governments tax this US-source income.

This isn’t the first time the IRS has tried to pull this stunt. At the very end of the Clinton years, the agency proposed a rule to do the same thing. But the bureaucrats were thwarted because of overwhelming opposition from Capitol Hill, the financial services industry, and public policy experts. There was near-unanimous agreement that it would be crazy to drive job-creating capital out of the US economy and there was also near-unanimous agreement that the IRS had no authority to impose a regulation that was completely inconsistent with the laws enacted by Congress.

But like a zombie, this IRS regulation has risen from the grave.

I’m not sure what is most upsetting about this proposed rule, but there are five serious flaws in the IRS’s back-door scheme to turn American banks into deputy tax collectors for foreign governments.

1. The IRS is flouting the law, using regulatory dictates to overturn laws enacted through the democratic process.

Ever since 1921, and most recently reconfirmed by legislation in 1976 and 1986, Congress specifically has chosen not to tax interest paid to non-resident foreigners. Lawmakers wanted to attract money to the U.S. economy.

Yet rogue IRS bureaucrats want to impose a regulation to overturn the outcome of the democratic process. Heck, if they really think they have that sort of power, why don’t they do us a favor and unilaterally junk the entire internal revenue code and give us a flat tax?

2. The IRS has failed to perform a cost-benefit analysis, as required by executive order 12866.

Issued by the Clinton Administration, this executive order requires that regulations be accompanied by “An assessment of the potential costs and benefits of the regulatory action” for any regulation that will, “Have an annual effect on the economy of $100 million or more or adversely affect in a material way the economy, a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local, or tribal governments or communities.”

Yet the IRS blithely asserts that this interest-reporting proposal is “not a significant regulatory action.” Amazing, we have trillions of dollars of foreign capital invested in our economy, perhaps $1 trillion of which is deposited in banks, and we know some of which definitely will be withdrawn if this regulation is implemented, but the bureaucrats unilaterally decided the regulation doesn’t require a cost-benefit analysis.

During a previous incarnation of this regulation, the IRS’s failure to comply with the rules led the Office of Advocacy at the Small Business Administration to denounce the tax-collection bureaucracy, stating that “…there is ample evidence that the impact of the regulation is significant and that a substantial number of small businesses will be impacted.”

3. The IRS is imposing a regulation that puts America’s economy at risk.

According to the Commerce Department, foreigners have invested more than $10 trillion in the U.S. economy.

And according to the Treasury Department, foreigners have more than $4 trillion in American banks and brokerage accounts.

We don’t know how much money will leave America if this regulation is implemented, but there are many financial centers – such as London, Hong Kong, Cayman, Singapore, Tokyo, Zurch, Luxembourg, Bermuda, and Panama – that would gladly welcome the additional investment if the IRS makes the American financial services sector less attractive.

4. The IRS is destabilizing America’s already shaky financial system.

Five years ago, when the banking industry was strong, the IRS regulation would have been bad news. Now, with many banks still weakened by the financial crisis, the regulation could be a death knell. Not only would it drive capital to banks in other nations, it also would impose a heavy regulatory burden.

How bad would it be? Commenting on an earlier version of the regulation, which only would have applied to deposits from 15 countries, the Chairman of the Federal Deposit Insurance Corporation warned that, “[a] shift of even a modest portion of these [nonresident alien] funds out of the U.S. banking system would certainly be termed a significant economic impact.” He also noted that potentially $1 trillion of deposits might be involved. And a study from the Mercatus Center at George Mason University estimated that $87 billion would leave the American economy. And remember, that estimate was based on a regulation that would have applied to just 15 nations, not the entire world.

So what happens if more banks fail? I guess the bureaucrats at the IRS would probably just shrug their shoulders and suggest another bailout.

5. The IRS is endangering the lives of foreigners who deposit funds in America because of persecution, discrimination, abuse, crime, and instability in their home countries.

If you’re from Mexico you don’t want to put money in local banks or declare it to the tax authorities. Corruption is rampant and that information might be sold to criminal gangs who then kidnap one of your children. If you’re from Venezuela, you have the same desire to have your money in the United States, but perhaps you’re more worried about persecution or expropriation by a brutal dictatorship.

There are people all over the world who have good reasons to protect their private financial information. Yet this regulation would put them and their families at risk. The only silver lining is that these people presumably will move their money to other nations. Good for them, bad for America.

Let’s wrap this up. Under current law, America is a safe haven for international investors. This is good news for foreigners, and good news for the American economy. That’s why it is so outrageous that the IRS, unilaterally and without legal justification, is trying to reverse 90 years of law for no other reason than to help foreign governments.

By the way, you can add your two cents by clicking on this link which will take you to the public comment page for this regulation. Don’t be bashful.

One last point. The Obama Administration says this regulation is part of a global effort to improve tax compliance. But unless Congress changes the law, the IRS is not responsible for helping foreign tax collectors squeeze more money out foreign taxpayers. Moreover, the White House has been grossly misleading about U.S. compliance issues (as this video illustrates), so their assertions lack credibility.

Bruce Reed, who has served as chief domestic policy adviser to President Clinton, CEO of the Democratic Leadership Council, and executive director of President Obama’s deficit-cutting commission, has been named chief of staff to Vice President Biden.

In 2004 Bruce Reed joined Ron Suskind and David Frum at a Cato Policy Forum on “wonks vs. hacks.” Video here.

In 2006 he joined Markos Moulitsas, Harold Meyerson, and Nick Gillespie in an online debate at Cato Unbound titled “Should Libertarians Vote Democrat?”

On Saturday, inspired by Fareed Zakaria’s writings on “illiberal democracy,” I expressed concerns about the prospect of quick elections in Tunisia, a country that has not had a free press, an independent judiciary, or other elements of liberalism. Khelil Bouarrouj, a Tunisian-American libertarian, thinks I am overly pessimistic. Here’s what he wrote me:

While Tunisia has never been a true democracy, the largely educated middle class in the nation is well-learned when it comes to the principles of a free society. The regime’s authoritarianism does not speak for the courageous Tunisian lawyers, activists and students; along with the general professional class. Tunisians know what a free press looks like. They’ve seen it around the world when they travel and social networks have served as a dissident channel. And let me add without hyperbole that on Saturday Tunisians awoke to a free press. The usually propagandistic state television changed its logo (which was a regime ensign) and became a voice for free debate with call-ins from average Tunisians. The private media was hosting panel discussions and it was stunning: people have shaken off the fear, and educated journalists and other civil society individuals were openly debating and discussing a whole host of issues. The newspapers that were published that morning ceased with self-censorship, and their coverage and editorials became free forums. A casual reader and observer of the press/​media would conclude that it is dominated by a liberal social class with strong democratic values and articulation. In short, the past absence of an institutionalized free press does not mean that Tunisians do not understand the merit of free debate and differing voices. They always have and needed only the opportunity to breathe, which they have now seized.

This lesson, I believe, applies to democracy as well. The fact is that liberal social norms have been ingrained in Tunisian culture: a secular state, equal rights for women, higher education, religious tolerance, etc. I do not state this as a patriot, who has certainly been emotionally moved in recent days, but as an observer who has numerous family and friends in the nation and been engaged in countless political discussions.

The images of the protesters themselves tell a story. Unlike in other Arab nations, the opposition was not uncouth Islamists but a liberal middle class and students. The demonstrations at colleges had Arab youth spell out the word freedom (which was widely evoked during the month), and this was not just a slogan but a genuinely understood ideal. The nation is ready to be a true democracy and truly entrench democratic values. The cultural ethos is already democratic and this is what led to the protests, defining their voice and even the demand that the transition government adhere to the very letter of the constitution. After the president fled, the prime minister took over but Tunisian lawyers immediately declared it unconstitutional (as it was), along with buzzing messages on Facebook by the newly energized populace, and within hours the premier handed power to the speaker of the parliament according to the constitution. The high court has declared that elections shall be held in 60 days per the constitution as well.

Tunisians wanted to start off right with respect for the rule of law. And that’s just it: this nation has been democratic at heart; the recipe for democracy if you will, and the rule of law is understood, respected by Tunisians and had been upheld even under the past regime with the obvious exception of the corrupt and now dethroned ruling elite. Tunisians precisely threw them out because of their repressive rule and flagrant abuse of the law. And the fact is that the people are so committed to a free, democratic Tunisia and the rule of law that they did not acquiesce to an unconstitutional transfer of power, even though they had achieved their main objective of expelling the president and the premier was going to reign solely as a temporary president until elections are held.

Again: people wanted to start a new dawn without compromise on the rule of law. It is no trivial matter that even in the excitement and shock of victory people still thought about the constitutional provision and demanded it be respected. One may have believed that the people would have been elated and surfeit to achieve a monumental victory, unprecedented in the Arab world for a popular revolt to bring down an Arab tyrant, and not bothered with a provision, which would appear to be minor in context of the historic day and new beginning, and which is ultimately inconsequential since the caretaker would leave after elections. But they were not, and that speaks volumes. I have been glued to Facebook updates, the best pulse of the nation right now, and after the premier assumed power Tunisians immediately noted that this is unconstitutional and began to demand his removal. Tunisians wanted the constitution to be respected from Day One and it was the people who made it happen, again. On Facebook, the sentiment is unanimous: a clean break with the ruling party, respect for the rule of law, free and fair elections, and upholding the constitution. After such a dear victory, the widely heard pronouncement is that the people will not be complacent and are ready and willing to eagerly guard their rights and see to it that a democracy worthy of its name will be planted in Tunisia.

After Friday, the Tunisia people have earned with great sacrifice their freedom, and the people are determined that their God-given rights shall not slip an inch and are closely watching the transition as the proverbial vanguards of liberty, and the people will see to it that their hope will be made concrete. The nation is ready and while no democracy is perfect and all democracies are often in a state of oscillation, Tunisia is the best bet and hope for the Arab world’s first real liberal democracy. And I believe it will be a model for the rest of the region.

In the wake of President Zine el-Abidine Ben Ali’s abdication in Tunisia on Friday, both President Obama and Secretary of State Hillary Rodham Clinton stressed the need for quick elections in a country that has never known democracy, freedom of the press, or the rule of law:

Secretary of State Hillary Rodham Clinton … reacted Friday to Ben Ali’s departure with a statement condemning government violence against protesters and calling for free elections.

“We look to the Tunisian government to build a stronger foundation for Tunisia’s future with economic, social and political reforms,” she said.…

President Obama condemned the use of violence against the protesters and urged the government to hold elections that “reflect the true will and aspirations” of Tunisians.

I’m reminded of Fareed Zakaria’s concerns about the blithe promotion of elections in his article “The Rise of Illiberal Democracy” (pdf; later expanded into a book, The Future of Freedom: Illiberal Democracy at Home and Abroad):

…for almost a century in the West, democracy has meant liberal democracy—a political system marked not only by free and fair elections, but also by the rule of law, a separation of powers, and the protection of basic liberties of speech, assembly, religion, and property. In fact, this latter bundle of freedoms—what might be termed constitutional liberalism—is theoretically different and historically distinct from democracy. As the political scientist Philippe Schmitter has pointed out, “Liberalism, either as a conception of political liberty, or as a doctrine about economic policy, may have coincided with the rise of democracy. But it has never been immutably or unambiguously linked to its practice.” Today the two strands of liberal democracy, interwoven in the Western political fabric, are coming apart in the rest of the world. Democracy is flourishing; constitutional liberalism is not.…

Constitutional liberalism, on the other hand, is not about the procedures for selecting government, but rather government’s goals. It refers to the tradition, deep in Western history, that seeks to protect an individual’s autonomy and dignity against coercion, whatever the source—state, church, or society. The term marries two closely connected ideas. It is liberal because it draws on the philosophical strain, beginning with the Greeks, that emphasizes individual liberty. It is constitutional because it rests on the tradition, beginning with the Romans, of the rule of law.…

Since 1945 Western governments have, for the most part, embodied both democracy and constitutional liberalism. Thus it is difficult to imagine the two apart, in the form of either illiberal democracy or liberal autocracy. In fact both have existed in the past and persist in the present. Until the twentieth century, most countries in Western Europe were liberal autocracies or, at best, semi-democracies. The franchise was tightly restricted, and elected legislatures had little power.… Only in the late 1940s did most Western countries become full-fledged democracies, with universal adult suffrage. But one hundred years earlier, by the late 1840s, most of them had adopted important aspects of constitutional liberalism—the rule of law, private property rights, and increasingly, separated powers and free speech and assembly. For much of modern history, what characterized governments in Europe and North America, and differentiated them from those around the world, was not democracy but constitutional liberalism. The “Western model” is best symbolized not by the mass plebiscite but the impartial judge.…

It is odd that the United States is so often the advocate of elections and plebiscitary democracy abroad. What is distinctive about the American system is not how democratic it is but rather how undemocratic it is, placing as it does multiple constraints on electoral majorities.…

While it is easy to impose elections on a country, it is more difficult to push constitutional liberalism on a society. The process of genuine liberalization and democratization is gradual and long-term, in which an election is only one step. Without appropriate preparation, it might even be a false step.…

Today, in the face of a spreading virus of illiberalism, the most useful role that the international community, and most importantly the United States, can play is—instead of searching for new lands to democratize and new places to hold elections—to consolidate democracy where it has taken root and to encourage the gradual development of constitutional liberalism across the globe. Democracy without constitutional liberalism is not simply inadequate, but dangerous, bringing with it the erosion of liberty, the abuse of power, ethnic divisions, and even war.

Let’s hope that the new leaders and the newly active citizens of Tunisia focus on developing freedom of the press, civil liberties, the rule of law, and constitutional limits on the power of government–including economic policies (pdf) more conducive to growth and progress–even as they move toward holding elections.

“Faced with rising international food prices,” Steven Mufson writes in the Washington Post, “governments around the world are cooking up measures to protect domestic supplies and keep a lid on prices at home.” Instead of export bans, subsidies, and price controls, governments might better consider the role of their central banks in creating money out of thin air and causing price inflation. Cato senior fellow Gerald P. O’Driscoll, Jr., made that point at the blog ThinkMarkets:

“Prices Soar on Crop Woes” reads the headline in today’s Wall Street Journal.

Global output of key crops such as corn, soybeans and wheat is down, and their prices are up, respectively, 94%, 51% and 80% from June lows. Today’s PPI report has wholesale prices up 1.1% in December after rising 0.8% in November. The Journal reminds us that in 2008 high food prices sparked riots around the world.

Meanwhile Fed officials tell us they don’t expect inflation. It is not an issue of expecting inflation, but of observing it here and now. The Fed prefers, of course, to look at “core” inflation rates, which are much lower. A former Fed colleague explained to me the central bank does so on the theory that people do not need to drive to work and can stop eating.

In our global economy, easy US monetary policy has thus far mainly affected commodity prices (including now food), real-estate in Asia and now broader price measures in Asia. It is implausible that the US would remain unaffected. Food, energy and clothing prices are all rising. I don’t think many households are presently gripped with a fear of deflation.

In the Mises/​Hayek theory of economic fluctuations, the transmission of monetary shocks works through producer prices and incomes, and only later consumer prices. No measure of consumer prices, and certainly not a subset of consumer prices, is an adequate gauge of inflation.

(For another take on rising food prices, you can read the views of Paul Krugman and Lester Brown, who say that at last — at last! — we really are running into those “binding resource constraints” that Brown has been predicting for his entire life and that will finally require us to start living at Chinese levels.)

Stuart Reid’s Twitter points to this Condi Rice discussion with Katie Couric in which the following exchange takes place over the decision to invade Iraq:

RICE: …I’m also, frankly, just very glad [Saddam Hussein is] out of power. Now, to be frank, we tried to take him out of power without going to war. We tried to take him out of power by — we got a report from an Arab state that shall remain nameless that he would take a billion dollars to lead — to leave. We said, deal. Right? (Laughter.) We tried to (find ?) him –

COURIC: Has that — has that been made public before?

RICE: Yeah, I — it may be in President Bush’s book. I’m not sure. I don’t remember. But we did. We said, if he’ll go, everybody’s happy.

A colleague intrepidly Googled this, and turned up this 2007 article in the Washington Post. The article reports that for a billion dollars and if allowed to “keep information on weapons of mass destruction,” Saddam Hussein told Egypt’s Hosni Mubarak that he would have been willing to go into exile. President Bush’s own book, per Secretary Rice’s mention, covers the matter in this way:

…Our last ditch hope was that Saddam would agree to go into exile. At one point, an offer from a Middle Eastern government to send Saddam to Belarus with $1 to $2 billion looked like it might gain traction. Instead, in one of his last acts, Saddam ordered the tongue of a dissident slashed out and left the man to bleed to death. The dictator of Iraq had made his decision. He chose war.

Lots of people like to make fun of President Bush’s prose style, but even for him (or his ghostwriter) this is pretty peculiar. First of all, it isn’t clear why “person who cuts off dissidents’ tongues and leaves them to bleed to death” is mutually exclusive with “person willing to take a billion or two dollars and go into exile.” Saying Saddam cut a dissident’s tongue out doesn’t necessarily bear on his willingness to take a payout and go into exile.

Second, it’s almost certain that this was pursued and didn’t go anywhere, but if there was anything approaching a realistic opportunity to make this happen, we really missed out on the bargain of the century here. You’re looking at something like 500%-1000% returns, not counting several thousand American and a‑hundred-or-so-thousand Iraqi lives saved.

Thirdly: Belarus?

Over at Downsizing Government, we focused on the following issues this week:

• The White House and Congress need to restructure our military responsibly, based on a realistic assessment of available means and achievable ends, with the savings being returned to U.S. taxpayers.
• Policymakers in a position to do something about the Federal Aviation Administration need to start thinking bigger: privatization.
• While new House Agriculture Committee chairman Frank Lucas may be a “Wheat Champion,” he sure isn’t a Taxpayer Champion — at least not on agricultural issues.
• Rep. Kevin Brady (R‑TX) has introduced the Cut Unsustainable and Top-heavy Spending (CUTS) Act, which would cut spending by $44 billion annually.
• A perfect illustration of why government subsidies for economic development are immoral.