Download How FIRPTA Reform Would Benefit the U.S. Economy

1
How FIRPTA Reform
Would Benefit the U.S. Economy
Martin Neil Baily
and
Matthew J. Slaughter
October 2009
Executive Summary
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FIRPTA is a dated feature of U.S. tax law that reduces foreign
investment in U.S. commercial real estate.
FIRPTA discourages foreign investment at a time when falling prices
and loan defaults in U.S. commercial real estate are a major threat to
America’s economic recovery. Many regional and community banks
are under stress and projected to fail because of the deteriorating
condition of the commercial real estate market.
FIRPTA distorts decisions because it imposes tax penalties on foreign
investment in commercial real estate that do not exist when foreigners
buy other U.S. assets.
Many foreign investment funds have patient capital that is sorely
needed in the commercial real estate market.
Inward foreign investment coming to the United States benefits
American companies, their workers, and workers’ standards of living,
by encouraging competition and the use of best business practices.
The United States will need to finance its large current account deficits
for many years to come. Foreign purchases of U.S. commercial real
estate will help provide this finance in the form of long-term, stable
funding.
The federal budget deficit is huge and must be reduced over time.
Reform or repeal of FIRPTA will lower tax revenues, but by a trivial
amount. The tax revenues from FIRPTA do not justify the costs it
creates and we urge policymakers to consider FIRPTA reform or
repeal.
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I. The History of FIRPTA and Its Distorting Effects
The Foreign Investment in Real Property Tax Act was enacted by Congress in 1980, motivated
by concerns that foreign investors buying U.S. farmland would unduly bid up U.S. farm prices
and thereby harm many family farmers. In practice, however, FIRPTA has covered virtually all
forms of U.S. commercial real estate including office buildings, hotels, and retail establishments.
How does FIRPTA work? For many decades, the United States generally has imposed no
jurisdiction to tax foreign persons on capital gains sourced in the United States on U.S. assets,
unless those gains are “effectively connected with a U.S. trade or business.” As discussed
below, this policy has supported a stance of openness to inward foreign investment and the many
benefits such investment brings to the U.S. economy. Thus, a non-U.S. investor faces no U.S.
tax liability from income realized in buying and selling a large number of U.S. assets including
U.S. Treasury bills, notes, and bonds; U.S. stocks and bonds of corporations; and the interest
earned on U.S. bank accounts.
FIRPTA imposed a different tax treatment on the U.S. asset class of commercial real estate. Its
main provision, Section 897, subjects foreign persons to U.S. taxation on transactions of U.S.
“real property interest” (generally defined as land, improvements thereto, or an ownership
interest in a U.S. real-property holding business) as if the capital gains were effectively
connected with a U.S. trade or business—regardless of whether the foreign person was in fact
engaged in such a trade or business with the U.S. real property interest. Thus, FIRPTA compels
a foreign person who sells any U.S. commercial real estate to pay U.S. taxes on the capital gains
(netted from any effectively connected expenses or losses) at the applicable U.S. income-tax
rates—currently up to 35% for individuals and 35% for corporations).1
The features just described of FIRPTA make it a discriminatory tax in two important ways.
First, for any given U.S. commercial real estate investment it forces a lower after-tax rate of
return on that property for a foreign owner than a U.S. owner. As will be discussed below,
FIRPTA thus makes U.S. commercial real estate less attractive to foreign investors than to
domestic investors—at a time where the United States needs commercial real estate foreign
investment for several important reasons.2
Second, FIRPTA means that foreign investors face a U.S. tax liability for capital gains on sales
of commercial real estate, whereas they face no such liability on U.S. Treasury securities, U.S.
corporate equities, U.S. corporate bonds. On these and many other U.S. assets foreign investors
do not face a U.S. tax liability when buying and selling. But FIRPTA does impose such a tax on
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In practice, FIRPTA is implemented by requiring the buyer of a U.S. real property interest from a foreign seller to
withhold 10% of the “total amount realized,” which is typically the full transaction price. This withheld tax
payment is then applied to the relevant U.S. income-tax liability for that foreign person, which must be determined
by that foreign person filing a U.S. income-tax return that year. Above and beyond the economic costs of FIRPTA
discussed in this report, the overall compliance burden of FIRPTA is widely regarded as high.
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The U.S. tax code, of course, is immensely complex and the actual taxes paid by a U.S. domiciled entity will
depend on a variety of factors. The provisions of FIRPTA, including the requirement on foreign entities to withhold
10 percent of the sale price of any real estate asset, make it likely that foreign owners will be penalized relative to
domestic owners.
2
foreign investors in U.S. commercial real estate. Non-U.S. investors in U.S. real property face
fundamentally different U.S. tax rules than the rules that apply to their investments in other U.S.
interests. As will be discussed below, this distortion induces foreign investors away from
commercial real estate and into other U.S. asset classes in a way that carries many costs.
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II. The Growing Pressures on U.S. Commercial Real Estate
The Slowly Improving Prospects for the Overall U.S. Economy
The US economic outlook is somewhat brighter today than it was earlier in 2009, which seems to
have been the nadir of this period of economic crisis. Several factors that were dragging the
economy downwards are now easing off, including greater stability in consumer spending, in
international trade, and in residential real estate.
Welcome though these signs of recovery are, the problems created by the massive financial crisis
are not over yet. The labor market remains in very poor shape and is likely to keep deteriorating
for a while. Since the onset of recession in December 2007 through September 2009, 7.2 million
U.S. payroll jobs—over 1 in 20—have been lost. The headline unemployment rate hit 9.8% in
September. The broader rate of “underemployment,” which counts workers who self-identify as
discouraged or involuntarily working part-time rather than full-time, hit 17.0% that month.
Many companies have been aggressively cost-cutting but do not yet see top-line growth.
And even though several large banks are reporting better earnings, the wave of small and
medium-size bank closures around the country is still expanding. There is still much to be done
before the U.S. economy is on a path of long run sustainable growth. High on this to-do list is
stabilizing commercial real estate.
The Widening Pressures on U.S. Commercial Real Estate
It is well known that residential real estate has contracted dramatically in recent years. The
collapse of construction is, of course, linked to prices. The S&P Case-Shiller index of U.S.
house prices has shown dramatic declines, with its seasonally adjusted 20-market national index
down 30.6% at the time of writing from its May 2006 peak (although with a slight uptick in
recent months from its maximum decline to date of 32.0%).
Even as residential real estate has been contracting, a similar contraction has gotten underway in
commercial real estate as well. The figure below shows the contributions to (or subtractions
from) GDP growth by the residential and nonresidential construction sectors from 2004 through
the first half of 2009. As the recession progressed from end of 2007, the collapse of residential
construction took large bites out of GDP growth—but in 2009 the contraction of nonresidential
real estate has come to play an even larger role. The shock to the economy from these
developments is hard to overstate. The construction sector swung from being a large source of
growth and dynamism before 2006 to a large net subtraction from growth and employment, and
this subtraction has now become much more acute for commercial real estate.
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Through the First Half of 2008, Non-Residential Construction Helped Offset the Housing Slump. After That,
Both Parts of Construction Pulled the Economy Down.
(Contributions to Change in Real GDP, from BEA)
1
0.52
0.27
0.27
0.03
0.56
0.49
0.36
0.5
0.04
0
Percentage
0
-0.31
-0.5
-0.45
-0.6
-0.59
-0.57
-0.81
-1
-0.66
-1.05
-1.24
-1.5
-1.33
Nonresidential Structures
-2
Residential Structures
-2.28
-2.5
2004
2005
2006
2007
I 2008
II 2008 III 2008
IV 2008
I 2009
II 2009
Today the dangers in non-residential commercial real estate may be even greater than those on
the residential side. Again, price declines are a key driving force. Through June of 2009, the
Moody’s/REAL All Property Type Aggregate Index of U.S. commercial-property prices had
fallen 26.9% in the past 12 months and 35.5% from its peak in October 2007. Declines are
pervasive across all parts of the country and all main categories of apartments, industrial, office,
and retail. In a July 2009 survey of commercial real estate companies, 93% of respondents
reported that commercial real estate asset values were worse or much worse than a year earlier.
This is virtually no improvement from the April 2009 survey, in which 99% reported year-overyear declines in values (and fully 69% reported values were much worse).
This dramatic fall in prices for commercial real estate is creating several economic pressures.
One is declining sales transactions and values. Moody’s reports that the number of transactions
has been running at about 400 per month in 2009, down steeply from over 2,000 per month
during much of 2007. A second emerging pressure is in financing. The commercial real estate
market is highly sensitive to credit conditions, both because any new projects require debt
financing and, more important today, because the existing portfolio of debt obligations must
gradually be refinanced. As the following figure shows, according the Federal Reserve at yearend 2008 there was about $3.5 trillion of U.S. commercial real estate debt outstanding.
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This $3.5 trillion in commercial real estate debt outstanding has grown dramatically, more than
tripling in the past generation. This debt is widely distributed across institution types:
commercial banks, thrifts, insurance companies, and holders of commercial mortgage backed
securities. It is also widely distributed across the United States. Unlike the troubles of recent
years with financial products related to residential real estate, the deteriorating assets and debt of
commercial real estate are widely held throughout the country.
In particular, many of the stressed and distressed loans in commercial real estate are not held by
large national and global banks, but rather by smaller community and regional banks. Deutsche
Bank recently estimated that regional and community banks hold between 60%-70% of all U.S.
construction loans, core commercial real estate loans, and multifamily residence loans—well
over $1 trillion in total commercial real estate loans. Moreover, the exposure of these smaller
regional and community banks is much higher than for the national and global banks, in terms of
what percentage of their total portfolio consists of the commercial real estate loans. Indeed,
Deutsche Bank calculates that 1,700 of these smaller institutions—with $1.5 trillion in total
assets—have in excess of 10% exposure to construction loans alone. Similarly, 2,355 banks with
$1.4 trillion in total assets have in excess of 20% exposure to core commercial real estate loans
alone. These exposures makes these smaller regional and community banks far more vulnerable.
The typical debt maturity of 10 years in this sector means that about $350 billion in commercial
real estate debt must be retired or rolled over each year. A huge amount of financing will be
necessary just to keep afloat the current level of commercial real estate debt outstanding and
thereby help stabilize the sector and the many key parts of the financial system it touches. Yet in
the July 2009 survey cited above, 71% of respondents found capital availability to be somewhat
or much worse than the year before—a time when credit conditions were already strained. The
New York Times recently reported estimates that fully 65% of commercial mortgages set to
mature in the next few years will not qualify for refinancing due in large part to stricter lending. 3
One of the reasons for the lack of credit, of course, is the rising risk of default. Many
commercial real estate loans are already in trouble, in part because the deep U.S. recession and
related business failures have escalated vacancy rates. According to a July 22 report in The
Financial Times, Colm Kelleher, Morgan Stanley’s chief financial officer, said he did not see the
light “at the end of the commercial real estate tunnel yet,” after the bank reported a $700 million
write-down on its $17 billion commercial property portfolio in the second quarter of 2009.
“Peak to trough, you have already had a pretty nasty correction in the market but it is still not
looking very good at the moment,” he said after Morgan Stanley reported its third straight
quarterly loss. Another bank, Wells Fargo, saw its non-performing loans in commercial real
estate jump 69% in the second quarter, from $4.5 billion to $7.6 billion, as the economic
downturn caused developers and office owners to fall behind in their mortgage payments.
These mounting problems in the commercial property market are shown in the chart below.
Through September, total delinquency rates of commercial mortgage-backed securities were at
5.5%, nine times their level of one year ago and already higher than the rates hit during the
previous national commercial-real-estate recession of the early 1990s. Delinquencies have been
3
“For Commercial Real Estate, Hard Times Have Just Begun,” by Terry Pristin, The New York Times, 9/2/09.
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spiking not just for very recent vintages but for older ones as well, consistent with the pervasive
national pressure in this industry.
U.S. government officials are increasingly voicing concerns about commercial real estate.
Federal Reserve Chairman Ben S. Bernanke pointed to the problems with loans this market as he
responded to questions in his Congressional testimony of July 21. He said that a continued
deterioration in commercial property, both in terms of sharply falling prices and sharply rising
defaults, would present a “difficult” challenge for the economy. He added that one of the main
problems was that the market for securities backed by commercial mortgages had “completely
shut down.” These concerns are shared by other key Federal Reserve officials: New York Fed
President William Dudley said in a recent speech that “More pain likely lies ahead for this sector
and for those banks with heavy commercial real estate exposure.”
More broadly, it has been reported that “U.S. banking regulators are girding for a rerun of the
housing-related losses now slamming thousands of banks that failed to set aside enough capital
during the boom to cushion themselves when the bubble burst.”4 In her October 14
Congressional testimony, FDIC Chairman Sheila Bair remarked that, “the most prominent area
of risk for rising credit losses at FDIC-insured institutions during the next several quarters is in
CRE [commercial real estate] lending.” Consistent with these concerns of key regulators, many
are now forecasting a large wave of bank failures due to commercial real estate. For example,
one major bank is now predicting that as a result of exposure to core commercial real estate
alone, “hundreds of banks, mainly smaller regional and community banks, are likely to fail.”5
“Fed Frets About Commercial Real Estate,” Lingling Wei and Maurice Tamman, The Wall Street Journal.
“The Outlook for Commercial Real Estate and Its Impact on Banks,” Deutsche Bank research report by Richard
Parkus, October 2009.
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III. How FIRPTA Reform Would Support U.S. Commercial Real Estate
FIRPTA Reform Will Help Stabilize Commercial Real Estate Asset Values and Refinancing
Pressures
It is clear that the U.S. commercial real estate market is struggling and threatens the overall U.S.
economic recovery. With the pressing need for large amounts of refinancing, the near-term
prognosis for this sector is not good. What is acutely needed is more capital. Some office or
retail space or other commercial properties may be permanently impaired, but most buildings
have considerable economic value and will be able to generate good returns once economic
conditions improve. And a strong recovery requires that there be new commercial real estate
investment as well, to accommodate new businesses and an expanding population. Patient
capital is clearly needed, both to purchase and hold existing assets that present value in the long
run and to finance new projects for new assets.
It is in the best interests of the American economy that there be a recovery of commercial real
estate, and additional capital from abroad can help create this recovery. Falling asset prices
mean there are sound deals for those strong enough to take on risk and patient enough to wait for
long-run returns. And, as described below, investors willing not only to hold properties but also
to invest in improving them can make an even bigger contribution to the U.S. economic
recovery. New investors are sorely needed for office buildings, and shopping malls, especially if
they have a commitment to restore and upgrade the facilities.
The attractiveness of U.S. commercial real estate has already been on the wane in recent years,
as is documented in the following chart that shows total foreign investments into U.S. real estate
in recent years (data from Real Capital Analytics).
$50
Billions
$40
$30
$20
$10
$0
03
04
05
06
07
08
YTD
09
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What is dramatically clear is that before the current economic crisis, inward real estate
investment had been rising, from about $11.0 billion in 2003 to $39.5 billion in 2007. But
amidst the crisis and recession of 2008 this investment dropped dramatically, to just $13.0
billion, and at the time of writing had been just $1.2 billion year to date in 2009.
Recall that FIRPTA imposes on any foreign buyer of U.S. commercial real estate a U.S. tax
liability on the sale of that commercial real estate asset that typically reaches 35%. FIRPTA
thereby lowers the after-tax rate of return that a foreign investor realizes on a U.S. commercial
real estate asset. This makes any U.S. commercial real estate asset unattractive to foreign
investors in two important ways: both relative to any domestic investor considering that
commercial real estate asset and relative to any other U.S. asset (such as U.S. equities or U.S.
Treasury securities) that foreign investor might consider. The net impact of this is clearly less
foreign investment into commercial real estate than there would be absent FIRPTA.
Investment funds have target rates of return for the investments they make. The target rate
depends upon the type of asset and the riskiness involved, but a reasonable target rate of return
for buying and holding commercial real estate is 10 percent. The expected rate of return on the
investment has to be above 10 percent before the fund is willing to make the purchase. Consider,
for example, a European pension fund that invests a portion of its assets in the United States and
is looking at a commercial real estate investment that is projected to earn a 12 percent rate of
return. If the fund has to pay a 35 percent tax on the returns, then that expected 12 percent return
will fall to 7.8 percent, well below the fund’s target. It will not buy the property. In fact the
expected before tax rate of return on a commercial real estate project will have to reach about
15.4 percent in order to yield the required return of 10 percent after taxes. Many projects that
could be attractive to a foreign fund will be rejected. The numbers in this example are
illustrative, but they accurately portray the disincentive FIRPTA creates. In the course of
preparing this study we interviewed the managers of a European pension fund that does invest in
U.S. assets, and they said that FIRPTA makes it unattractive to them to invest in commercial real
estate in the United States, except under very unusual circumstances.
It is difficult to quantify exactly how much foreign capital into U.S. commercial real estate is
deterred by FIRPTA. But there are at least three reasons to suspect that this amount is quite
large.
One is conversations with individual foreign investors, who regularly cite FIRPTA as an
important consideration in their portfolio choices. Second, a very large amount of foreign capital
has been invested into the United States overall in recent times. As the next section of this report
discusses, the very large U.S. current-account deficits of recent years have been financed by the
United States net selling hundreds of billions of dollars in assets each year to foreign buyers. Yet
as the above chart shows, currently very little of these foreign investments into the United States
are going into commercial real estate. And third, even acknowledging the recent global
recession there are large pools of savings around the world thanks to strong economic growth in
the past generation. Much of this savings seeks long-term investment opportunities in stable
environments—conditions well matched to U.S. commercial real estate.
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FIRPTA Reform Will Help Boost U.S. Commercial Real Estate Productivity
It is now well documented that that bringing best business practices into an industry forces all its
companies to adapt and become more efficient such that overall industry productivity rises. And
a related striking lesson is that best business practices come from all over the world, not just the
United States. In turn, faster productivity growth for the United States ultimately translates into
higher U.S. standards of living.6
The general benefits to productivity of inward investment apply to the many categories of
commercial real estate: office buildings, retail and industrial properties, hotels, and even
commercially owned residential apartment units. There are permanent long-run productivity
gains to be achieved if commercial real estate holdings were more open to foreign investors.
Consider, for example, hotels. Managing hotels and other commercial property involves
considerable skill and technology. For example, it is widely agreed among business travelers
that the hotels in the Four Seasons chain are among the best in the world. This chain is foreign
owned and has brought best-practice methods to high-end hotels, adding performance pressure to
competing U.S. chains like the Ritz-Carlton.
For commercial real estate, an important resource is patient capital. Investors willing to buy and
hold a property and invest in improving the quality will contribute to renovating and reviving
properties in the U.S. that may have fallen into disrepair in the current crisis. A number of the
foreign investors interested in U.S. real estate purchases are patient investors. They are pension
funds, sovereign wealth funds, and trusts held by wealthy families. Patience can be particularly
important in residential rental properties, where a well-funded owner looking for long term
appreciation can rehab buildings and help US cities that are now facing possible decay.
Consider as well the retail industry, which has become very global. We above mentioned WalMart as one of America’s companies that contributes to U.S. and global productivity growth.
But there are also many highly efficient retailers based abroad, some of which operate in the U.S.
and some that have not yet opened here. Familiar U.S. names include Benetton, H&M, and Ikea.
The UK grocery company Tesco is now experimenting with U.S. outlets. The German chain The
Metro Group is considered one of the world’s most successful and innovative grocery
companies, but it has no U.S. presence. Given the slump in U.S. retailing, there are certainly
many overseas companies that could fill vacancies in struggling malls.
6
Over a period of more than 10 years, the McKinsey Global Institute (MGI) made a series of studies of productivity
in different industries and in a variety of countries. MGI is the economic think tank of the consulting firm
McKinsey & Company and is financed by the company itself and not directly by clients. It provides a service to
McKinsey’s clients but also to policymakers and the public generally. Its reports are published and available on the
MGI website. The results of these in-depth studies were summarized by Nobel-laureate economist Robert Solow
and by Martin Baily, co-author of this study and long-time MGI advisor, in an article in the Journal of Economic
Perspectives (Summer 2001). They were also summarized in The Power of Productivity, by founding MGI director
William Lewis (University of Chicago, 2004).
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FIRPTA Reform Will Not Carry Large Fiscal Costs
We acknowledge that one likely implication of FIRPTA reform is lower federal-tax revenues.
Reducing federal tax revenue is a serious issue. As we have written elsewhere, one of the most
critical challenges facing American society is the need to credibly shrink the looming fiscal
deficits (deficits that left unchecked will grow unsustainable) in a way that supports economic
growth and we have suggested attacking this problem from both the spending and revenue sides.7
FIRPTA generates very little tax revenue, however. The Joint Committee on Taxation recently
estimated that outright FIRPTA repeal would cost $8.3 billion over 10 years, less than $1 billion
per year.8 Reform short of repeal would cost even less in fiscal revenue. Set against these small
fiscal costs are FIRPTA’s large economic distortions discussed in this report. On balance, we
think the sizable economic benefits of reforming FIRPTA would exceed the small fiscal costs.
7
Martin Neil Baily and Matthew J. Slaughter, Strengthening U.S. Competitiveness in the Global Economy, Private
Equity Council research report, Washington, D.C., December 2008. See, in particular, the chapter of this report
entitled, “The Challenge of Fiscal Policy.”
8
Letter from the Joint Committee on Taxation to Representative Eric Cantor, March 14, 2006.
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IV. A Benefit of FIRPTA Reform:
A More Sustainable U.S. Current-Account Deficit
in Line with Existing U.S. Investment Policy
Commercial Real Estate Can Be an Important Asset Helping Fund the Current-Account Deficit
Every year since 1976, the United States has run a trade deficit with the rest of the world; in
other words, the value of U.S. imports (goods and services) has exceeded the value of U.S.
exports (goods and services). The main cause of this trade deficit has been low U.S. national
savings relative to U.S. national capital investment. This trade deficit is closely related to the
current-account deficit, which equals the trade deficit plus net transfers to the rest of the world
and net income flows from international asset holdings. In 2006, the U.S. current-account deficit
reached a record high of $803.5 billion, and in 2008 it totaled $706.1 billion. The following
figure plots the annual U.S. current-account balance since 1976.
Source: U.S. Bureau of Economic Analysis
To finance this excess of imports over exports of goods and services that underlies the currentaccount deficit, each year the United States must, on net, sell an equivalent amount of assets to
the rest of the world. These asset sales reflect the rest of the world providing its savings to fund
U.S. capital investment in excess of U.S. national savings. So, for example, in 2008 the United
States sold, on net, $706.1 billion worth of U.S. assets to foreign investors to offset its equivalent
current-account deficit.9
9
Looking at countries, important buyers of U.S. assets have included countries such as China and Japan that have
been running offsetting current-account surpluses. Looking at institutions, important buyers of U.S. assets have
included the central banks of these current-account-surplus countries and, more recently, sovereign wealth funds
linked to rising prices for commodities such as oil and natural gas.
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What assets does the United States sell to foreign investors? Some are “portfolio” assets such as
U.S. Treasury securities, corporate stocks, corporate and other bonds, and bank loans and other
bank liabilities. Another important asset transaction that can help finance the current-account
deficit is the sale of U.S. commercial real estate. To finance current-account deficits,
commercial real estate investments can offer two big advantages relative to portfolio assets.
One important advantage, as discussed earlier, is the productivity benefits that foreign direct
investment in commercial real estate can brings to companies and to overall host countries
through high levels of R&D and capital investment. In turn, these investments support jobs in a
variety of industries, including and construction, management, and services positions. Portfolio
investments, by contrast, do not entail the degree of ownership control typically required for the
transfer and use of ideas and best practices that FDI brings.
The other important advantage is stability. Investments in commercial real estate are typically a
less-volatile form of international capital flows than is portfolio investment, thanks to the longterm focus that typically motivates these commercial real estate investors. Accordingly,
commercial real estate investments are less prone to sudden swings in investor demand and thus
in asset prices (e.g., currency values or bond rates) that can have large impacts on the real
economy in terms of output and employment.
But there is reason to question how strong demand for U.S. assets of all kinds will be in the
future. This is partly because the cumulative impact of the United States running decades of
current-account deficits is that the country shifted from being the world’s largest net creditor to
its largest net debtor. By year-end 2008, the net international investment position of the United
States stood at a record -$3.47 trillion. With the United States continuing to sell several
hundreds of billions of dollars of assets to the rest of the world each year to fund its currentaccount deficit, many have argued that global demand for U.S. assets relative to foreign assets is
on the wane. Evidence supporting this concern is the ongoing depreciation of the U.S. dollar.
Looking into the future, it is very likely that the United States will need to continue borrowing
large amounts from abroad. The ability of the United States to continue to smoothly finance
both its ongoing current-account deficits and its rapidly expanding fiscal deficits will depend, in
part, on foreign investors having many rather than few American assets to consider. The
likelihood of a gradual, orderly evolution of U.S. deficits will be higher the wider is the range of
U.S. assets the rest of the world can easily purchase—including U.S. commercial real estate.
This will be an important macroeconomic benefit of FIRPTA reform that expands commercial
real estate investment into the United States.
FIRPTA Is Inconsistent with America’s Policy Commitment to Open Investment
And an additional macro-level benefit of FIRPTA reform would be having the United States
better adhere to the spirit of current and long-standing U.S. economic policy aimed at open
global investment. As discussed in Section I of this paper, there are many U.S. assets of great
importance to the overall economy where U.S. investments of non-U.S. investors are simply
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exempt from U.S. taxation. FIRPTA is a glaring exception to this general U.S. economic policy
of granting foreign investors tax-free status when buying and selling U.S. assets.
As such, FIRPTA violates the spirit of current and long-standing U.S. economic policy aimed at
open global investment. This policy was last articulated in May 2007 in the Statement on Open
Economies by President Bush—a reiteration of U.S. commitment to open borders that had been
earlier articulated by Presidents Carter, Reagan, and Bush.
The 2007 Statement on Open Economies included the following passage.
The United States has a longstanding commitment to open economies that
empower individuals, generate economic opportunity and prosperity for all, and
provide the foundation for a free society. Economic freedom, supported by the
rule of law, reinforces political freedom by encouraging and supporting the free
flow of ideas … A free and open international investment regime is vital for a
stable and growing economy, both here at home and throughout the world … our
prosperity and security are founded on our country's openness. As both the
world's largest investor and the world's largest recipient of investment, the United
States has a key stake in promoting an open investment regime. The United
States unequivocally supports international investment in this country and is
equally committed to securing fair, equitable, and nondiscriminatory treatment for
U.S. investors abroad. Both inbound and outbound investment benefit our
country by stimulating growth, creating jobs, enhancing productivity, and
fostering competitiveness that allows our companies and their workers to prosper
at home and in international markets.
As valid as this Statement was in 2007, its message is even more important today amidst the
rising protectionist drift in policies around the world. Indeed, even before the protectionist
pressures of the global recession in many countries investment barriers were on the rise. In 2005
and 2006, the United Nations tracked record numbers of new FDI restrictions around the world.
In 2007 and 2008 at least 11 major countries, which together received 40.6% of all world inflows
of FDI in 2006, approved or are seriously considered new laws to restrict inward FDI.
In this increasingly protectionist global environment, the potential for FIRPTA to nudge other
countries to pursue their own investment barriers is all the greater. Given the growing
international-investment needs of the United States described in this section, such escalation
would be especially unwelcome.
14
V. FIRPTA Reform:
Conclusions and Policy Recommendations
FIRPTA is a dated feature of U.S. tax law that today limits foreign investment in U.S.
commercial real estate and thereby harms the U.S. economy. FIRPTA continues to discourage
foreign investors at a time when stresses in U.S. commercial real estate are a major threat to
America’s economic recovery. It limits the productivity benefits that inward investment tends to
bring to American companies, their workers, and workers’ standards of living. And it is
inconsistent with U.S. open-investment policies at a time when smoothly funding ongoing U.S.
current-account deficits requires foreign investors having access to many rather than few
American assets.
For all these reasons, FIRPTA needs to be reformed. This could mean outright repeal or, less
dramatically, an initial holiday could be implemented: e.g., declare that new foreign investments
in U.S. commercial real estate over the next five years would be exempt from FIRPTA. We
think that the sizable economic benefits of reforming FIRPTA would exceed the small fiscal
costs it would entail.