Defending Citizenship-Based Taxation

The U.S. practice of citizenship-based taxation has been condemned by many and there are proposals out there as I write this to change the system to one based on residency.  Nearly unique in the world, the U.S. is one of only two countries that uses citizenship (or semi-citizenship in the case of Green Card holders) as a basis for taxation.  This mean that an American citizenship is subject to U.S. tax and reporting requirements regardless of where he or she lives in the world even if her income and assets were not earned in and have no connection to the U.S..

Most Americans abroad, in my experience, are "accidental migrants".  They left the U.S. for one reason or another and then a certain number of them stayed on and chose to build a life in another country or even in many countries.  Nothing particularly nefarious about any of it and, frankly, taxes were the last thing on their minds when they bought that plane ticket or when they landed that job after graduation.

With that in mind, let's turn to a defense of citizenship-based taxation which was recently published by Michael Kirsch of Notre Dame Law School.

It was a good read, a nicely written document with clear arguments.  Kirsch springs to the defense of citizenship-based taxation on these grounds:

Membership:  American citizens abroad retain ties to the United States and are still considered part of the nation.  Moreover these connections matter because:

"Whereas a citizen living abroad in the early 20th century might have gone years without having meaningful connections with U.S. society or contact with persons living in the United States, the growth of the Internet has enabled citizens abroad to stay up-to-date with national and local news in the United States, and to communicate with family and friends in the United States via Skype video calls, text messages, email and other forms of instantaneous communication, thereby strengthening potential ties to U.S. society."

Therefore, where a duty of citizenship is to support the community, and where it can be shown that one's membership and connections to that community are still active, it is reasonable, he says, to expect everyone, including the population living abroad, to support the homeland community in some way even if they derive no direct benefit from the taxes they pay.

This is a very compelling argument.  Yes, there are ties and they are meaningful for many of us. Does it follow that these emotional ties to the homeland should translate into some sort of personal sacrifice in the name of national solidarity?  Maybe.  Where this argument breaks down for me is the rhetoric coming out of the homeland, from both politicians and the general public, that paints American citizens abroad as traitorous Benedict Arnold's, tax evaders until proven otherwise, and folks who should lose their U.S. citizenship following marriage to a foreigner, naturalizing in another state or residing long-term in another country.

There is strong evidence that Americans in the homeland do not consider Americans abroad to be entirely a part of the American nation.  This is reinforced by the American political system which (unlike some other democratic nation-states) does not permit direct representation in the homeland parliament.  The fact that it has been almost impossible for American abroad to have any voice whatsoever in decisions made in the home country that directly affect them, and that even very modest proposals to at least study these matters have fallen on deaf ears, are strong signals that the United States does not consider Americans abroad to be full citizens and members in good standing of the American political community.

For Kirsch's argument to have any plausibility whatsoever, the rhetoric must change and clear unambiguous signals sent to the American communities abroad that they are valued members of the nation.  Since that has not happened, an appeal to solidarity simply will not work.  Instead there is a sense that American abroad may love the homeland, but the homeland does not return that sentiment and is simply using FATCA and citizenship-based taxation to extract resources in order to punish Americans who leave the country.

Future emigration:  Kirsch's second argument in favor of citizenship-based taxation is a projection into the future.  He concedes that while today's American emigrants may not be motivated to move abroad for tax reasons, a switch from citizenship-based to residency-based taxation would provide incentives for many more Americans to leave the U.S.  He is not just referring to potential loss of the idle rich:

"However, for citizens who are retired (or otherwise derive most of their income from investments), or for those whose profession provides geographic flexibility, the prospect of moving abroad to save significant amounts of income or estate taxes would be inviting."

So he's talking about the international retirement migrants, the IT workers, the English teachers, the itinerant "creatives" and other working people who might be encouraged to move to low-tax jurisdictions if they were no longer subject to U.S. worldwide tax and reporting requirements.

Where I think this argument breaks down is in the communication gap that I've already discussed in another post.  The vast majority of lower and middle-income Americans went abroad (and go abroad even today) assuming that the United States has a residency-based tax system like the other 99% of countries in the world.  It has come as a great surprise to them to learn that the U.S. has a citizenship-based taxation system that applies to them.  Furthermore, most Americans in the homeland are completely unaware of how the United States' tax system applies to Americans living outside the United States and are flabbergasted when you explain it to them.  I can attest personally to the fact that newly arrived Americans abroad in France are still quite likely to have never heard of an FBAR, much less be aware that they must file 1040's on their French income.

It is a fact that Americans have been going abroad for years with the assumption that filing and paying taxes in the host country was sufficient to meet their obligations.  Has this led to mass emigration on the part of America's middle class?  Clearly not.

So moving from a citizenship-based tax system to one based on residency would simply be de jure recognition of the de facto situation.  Let me repeat: the American tax system has been citizenship-based in principle but residency-based in practice for years.  As a practical matter it has been almost impossible to enforce citizenship-based taxation and for the most part the American government never really tried to do so until recently.  He is correct to say that awareness is growing but no one has any hard evidence to demonstrate that a significant number of US citizens and Green Card holders abroad (not to mention immigrants in the U.S.) do understand their obligations and there has been no effort whatsoever on the part of the U.S. government to spread the word.  Americans abroad are still primarily getting their information via word of mouth and the occasional article or blog post - not the most efficient or effective method to raise awareness and encourage compliance.

What Kirsch misses, I think, is just how revolutionary these efforts to enforce citizenship-based taxation have been.  Without warning the US government simply, without any research or studies,  changed their policy to enforce these little known laws without making the slightest effort to determine why Americans abroad were mostly non-compliant in the first place.  The assumption they made (and Kirsch implies it as well) is that their non-compliance was intentional and an effort to "escape America".  Having committed one terrible act (that of leaving in the first place) it is not a stretch for homelanders to assume that this population is continuing their dark deeds abroad.  In any case, with such limited representation in the homeland, Americans abroad have few avenues for protest and so can safely be ignored.

Since no attempt was ever made to determine the feasibility of the effort and just how much revenue could be gained versus the costs of administrating an extra-territorial system in 190+ countries around the world, there is no evidence whatsoever that the enforcement of citizenship-based taxation and FATCA will benefit the homeland.  Is it possible that the cost will far exceed revenue gained?  Yes, but since these kinds of questions are never raised, and America (lawmakers, bureaucrats and homeland citizens alike) seem to prefer a state of ignorance,  the only conclusion I can come to is that these efforts are mostly designed to punish those who went abroad in the first place and to actively discourage those Americans who might be thinking about it.

Which, in the end, takes this entire discussion for and against CBT out of the realm of "tax evasion" and into the world of "emigrant control."  It is nothing less than an attempt to make Americans of all classes, income levels, and professions less globally mobile.  I find it telling that Kirsch inadvertently lets this slip - the usual framework (and the way of selling FATCA and CBT to the homeland public) is to frame it as catching the rich who are evading their responsibilities.  His mention of the international retirement migrants says it all - American on Social Security or military pensions who wish to live in Mexico, Thailand or any other place where the cost of living (and taxes) is low but the standard of living is high, should be "incentivized" to change their minds and come home to spend that money.  As for the IT workers, nurses, teachers, professors, musicians, writers and journalists, their production should remain in the U.S. where it and they belong and they should be discouraged at all costs from going out into the world and being at home in it.

It is deeply ironic that, having been one of the nations behind globalization, the United States has decided that its own citizens (via the tax system) should be actively discouraged from taking advantage of all that this new era has to offer.  It is my firm conviction that FATCA and broad enforcement of citizenship-based taxation will come back to haunt America.  As it stands, American citizenship is (with only one exception) the only citizenship that comes with this sort of bureaucratic ball and chain, thus making it a citizenship wholly incompatible with international mobility.  

In a globalized world this is a counter-productive "exceptionalism" that will do nothing more than incentivize the curious, the ambitious, the entrepreneurial and the highly qualified to cast off that citizenship in favor of one (and there are many) that is more compatible with their aspirations.  For lower to middle-class Americans this will hit them hardest of all and make shedding their U.S. passports the only way to achieve their ambitions of becoming full participants with an equal chance in a globalized world.