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Monday, November 11, 2013

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.


Tim said...

Thanks Victoria for doing this post. I thought I was going to have a hard time getting anyone to read this paper.

A couple of comments:

On several occasions Kirsch in my opinion digs himself deeper holes by bringing up issues rarely brought up in academia such as Eritrea's diaspora tax. He also acknowledges that FATCA success is by no means certain. Additional when he gets into a discussion of State Dept evacuation fees he starts running around in circles.

I do agree with you that he lets the cat out of bag so to speak by acknowledging his support for taxation as an emigration control mechanism. I am not sure in real life how sensical his ideas are. First under the existing non resident alien withholding tax system NRA's that collect US source income outside the US for "labor" related work are by some standards treated quite harshly in facing a 30% withholding tax if they don't reside in a country without a tax treaty with the US. The withholding tax is applied regardless of income level. Additionally non resident alien Social Security beneficiares also face 30% withholding if they reside in a non treaty country.

P. Moore said...

Reading your post, which in effect does some analysis of Kirsch's paper leads me to one significant conclusion (one that keeps coming up more and more these days), that being, the more the US pushes CBT and FATCA and FBARs, the more they degrade the relative value of US citizenship. The view that US citizenship has value if you are a US resident, but not very much as a non-resident is growing by the day and I suspect if they ever get to implement FATCA to any reasonable degree, that view will explode.

Unknown said...

Kirsch says that some might leave the US for tax havens. Some say that Switzerland is a tax haven. I left unemployment behind in the US, doubled my income in Switzerland and pay less in taxes. Yet I still struggle financially. Why? A family with 2 children that earns $60'000/year is living in poverty, thanks to exchange rates and living expenses. This is not far below the FEIE. If the tax rate in Switzerland was higher, then the poverty would also be greater. Each nation is different, each nation has a different system and thus it is pretty much impossible for the US to determine how things should be in other jurisdictions, especially when it attempts to compare such with its own.

Anonymous said...

Thanks for this reply to Kirsch (who is or was a tax policy wonk at the Treasury Dept., I see).

I agree that what is really going on here on a deep level, whether it is as yet consciously intended or not, is the building of a Paper Berlin Wall to keep USC's and their monies/assets/talents within the Heimat, er, Homeland.

I feel bad for the retiree expats, many of them had to go to Mexico or elsewhere because they simply could not afford to retire in the USA with its SKY high medical costs, and other issues. Forcing them to return is condemning them to poverty in some cases.

Anonymous said...

" 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."

Significant parts of the globe use Skype, internet, etc. to communicate with family living elsewhere, and keep up with news from their country of origin. Maintaining family ties and keeping abreast of current affairs is not a defensible basis for extraterritorial taxation. The US does not provide the internet or Skype access as a service to expats, nor does it provide the news media as as service to expats. Those 'potential ties' to the US are not an economic transaction, and not a taxable event. It is a stretch to say that the rest of the globe lets its expats keep in touch with Grandma, and read the headlines from 'back home' for free, but the US is so desperate to rationalize its tax system that this is a 'valid' argument? And the membership concept does not hold in the face of US attempts to force us to hold and maintain that membership - even forcing it on to those who merely inherit via parentage, and refuses to allow us to say: no, this is a club we have no interest in being a member of. We can't afford the cost, anxiety, depression, and injustice that this enforced membership brings to ourselves and our family. We are being held against our will, and no amount of philosophical pretzel logic can make this either just or rational.

No-one else in the world has to pay this membership fee. Why the US? Other than might makes right.

Victoria FERAUGE said...

@Tim, My pleasure. I'm feeling better these days - got my mojo back. I sent a note to Kirsch by the way saying that I had read the paper and giving him the link to this blog post. We'll see if he answers.

@P. Moore, Absolutely. The relative value of US citizenship compared to other citizenships is clearly falling. It's being "right-sized" with a vengeance.

@Dani, The US *is* a tax haven, right? But not one that works for America's lower and middle-classes. I've watched the standard of living fall in the US since I was a kid. Today, someone with a curious nature and a mobile job or some skills can probably do better in another country with more opportunity. I honestly think that my IT career here in France was much better and I rose higher than I would have if I had stayed in Seattle.

@anonymous, I like that image - a paper Berlin wall. If I'd been the one writing that paper I would not have mentioned the international retirement migrants in this context. That's one interest group in the US I think the government does not want to mess with.

@anonymous, I agree that this is a pretty thin hook on which to hang the CBT hat.

That said, I know there are people who would pay such a membership fee. I might even do it. So, what's the price? This is a challenge to all the homelanders (I think I'll do a post) - how much should someone pay to keep their US citizenship every year>

bubblebustin said...

Thank you for writing this, but I think you are being too kind to Mr Kirsch. His 'clear arguments' support a regime that can only lead to the end of American global migration if allowed to continue. In the end, it will be the citizen who decides what's right and what's wrong, which they will do in in every US consulate in the world. Americans are already renouncing at several times the rate of Canadians. What does this tell you about the 'land of the flee'?

As far as homelanders are concerned, most are a lost cause. Unfortunately, the circular reasoning that afflicts many makes the assumption that expats must be rich in order to afford to do all of that filing, and worse, must be guilty of something because the IRS requires so much reporting. The fact that we would renounce as a result just proves our lack of loyalty! Can we ever win when dealing with this kind of mentality?

Dani, yes, the US is pricing its citizenship out of the market. Something for the homelanders and Kirsch: when the cost of something far exceeds its benefits, that ‘something’ loses value. They should know that it’s the USG itself that needs to take full responsibility for the devaluing of US citizenship, and to stop blaming the victims of these masochistic policies: their own citizens.

Anonymous said...

I find one critical weakness in Kirsch's argument is that he does not address what would happen if other jurisdictions also applied citizenship-based taxation. If you had a dual Brazilian-US citizen working in France, for example, how would the taxing rights be resolved? The pessimist says, do as is done now, with the result that the hapless taxpayer must pay the highest tax any of the three jurisdictions imposed on the income or capital gain. A rational person would speculate that the countries would eventually have to give the country of residence the primary right to tax, and if more than one other jurisdiction were using CBT, the "savings" clauses of Treaties just wouldn't work.

Anonymous said...


You were far too kind to Kirsch.

His piece is nothing more than an apology for the increasing level of totalitarian control over US citizens and the quasi enslavement of Americans living beyond the borders of the Homeland (Fatherland).

Anonymous said...

My criticism is much broader than the one point I raised and I do not mean to be kind to Kirsch! As for enslavement, it is already there, in the expatriation legislation (877A and particularly 2801, which requires the children to pay for the "sins" of their parents)(not to mention a potential Schumer/Casey permanent "ban" from the Homeland). Many thanks for all you do to raise awareness on the plight of US ex-pats.

Anonymous said...

First, thank you Victoria for your review of Kirsch's work. I have read his paper several times and would like to comment on a basic assumption which, if it does not hold, would make the paper's argument for CBT invalid.

Similar to the Rational Economic Man assumption used by many economists, a basic assumption by Kirsch is people strive to be "tax efficient", meaning that US citizens will move to a country with the most favorable tax rates absent CBT. Although international corporations may set up constructs in low tax countries to minimize taxation, there is no or little evidence that individuals/ US citizens change countries to reduce taxation.

1) As researched by Dr. Amanda von Koppenfels, most American emigrants were originally accidental immigrants who then settled down. Her research, from what I can determine, does not support Kirsch's assumption that people move from the US to other countries to be "tax efficient".

2) People are constrained from moving to other countries due to language, cultural, legal and employment issues and barriers to name a few. Although a Flemish speaking Belgian, as a EU citizen, could legally move to Germany tomorrow to save taxes, unless he speaks German well, he will likely find himself unemployed or underemployed, and competing with "sans papiers" from third-world countries for menial jobs. He may even have to resort to illegal activities to stay afloat.

3) American citizens have few legal options for picking up and moving to other countries for employment except Canada and Mexico under NAFTA TN permits and the Netherlands under the US-Dutch Friendship Treaty. To the best of my knowledge, few Americans take advantage of their right to re-settle to the Netherlands, which I would argue is due to language issues, and of course both the Netherlands and Canada have higher taxation. Mexico may have lower tax rates but, as I understand it, most Americans living there are snowbirds and continue to maintain a home in the US and pay their income taxes in the US.

4) Nicholas Hayek was the founder of Swatch and a billionaire. After arriving in Switzerland from Lebanon, where he had met his wife while she was working as an au pair, he lived his entire life in a village in Canton Aargau with its average tax rates. He stated to the media on at least one occasion that he lived there because he was loyal to the village that had naturalized him and besides his wife was from there. He could have saved substantial personal income and wealth taxes by moving to a low-tax canton but chose not to do so. He was comfortable there.

Kirsch's assumption that US citizens will change countries to reduce their tax burden is erroneous. Without this theoretical underpinning, his argument for CBT, which is to keep US citizens from changing countries to reduce their taxation, is also invalid.

USA YesOrNo said...

What an incredibly well written article and arguments brought forward in the comments! After learning about possible future implications due to the crazy CBT system the USA adopts, my wife and I are struggling with the decision as to whether or not we should in fact take up the opportunity potentially given to us as selectees in the current DV (Diversity Visa) lottery! Yes, apart from a few other concerns (health care system, working conditions/benefits), we would feel much more compelled to go ahead and move to the USA if there was no such unwarranted reporting and taxation requirement on US expats! We consider ourselves international expats, being dual EU/AU citizens, and we feel we could become valuable members of the US society, too but we do not want to be 'locked in' to a tax slavery that would penalize us for wanting to stay mobile in the future.

Tim said...


I don't know if this post is closed but I am came across a very interesting lawsuit by two Canadians living abroad who challenging Canadian elections law which does not give the right to vote to non resident Canadian citizens(Canada is perhaps one of the most restrictive countries in the world on non resident voting in addition to being very much opposed to other countries setting up polling places in their Canadian consular offices). Interstingly the CDN govt gives a very strong rebuttal arguing why CDN law IS correct and constitutional to refuse non resident voting. It goes in quite a bit of detail as to why in the government's mind non resident CDN citizens and not true participants in Canadian society. It is quite a harsh rebuttal to the type of arguments Kirsch makes.

I am under strict secrecy but I might be personally meeting Kirsch someday.

Victoria FERAUGE said...

@Tim, I am very interested in that case. Can you pass along some links where I can get more information?

Fahad said...
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