End the American Expat Tax
The sun never sets on the American tax system.
Only two nations in the world tax their citizens who live abroad. One of them is a small and vicious African dictatorship. The other is the world's most powerful democracy.
Does the U.S. really want to share this distinction with Eritrea?
It's true that most expatriate Americans end up with no U.S. taxes to pay on their worldwide income, because they can exclude some income and offset host country taxes against what remains. Yet all must file and many do pay, because anomalies are rife. Apart from this, the principle is simply wrong.
It's also outdated. The taxation of Americans abroad was designed to deter draft dodgers who fled the country to avoid fighting the Civil War more than 150 years ago. From the beginning, in other words, bad intentions were assumed. Yet hardly any of the estimated 7.6 million U.S. expatriates today are trying to evade taxes -- indeed, most pay more than they would at home.
It's for the sake of fairness that other countries base the taxation of their citizens on residence. After all, why demand taxes of people who don't benefit from the proceeds -- who cannot use their countries' roads or schools or health care while living abroad?
What's more, because national tax structures tend to evolve into their own eccentrically balanced ecosystems, expatriates can easily be entangled in a complex web of taxation.
Take the differences in the way countries handle the taxation of primary homes. The U.S. demands payment of capital gains tax on the sale of a home; it also gives a $250,000-$500,000 deduction and a break on mortgage interest payments while the taxpayer owns the home. In the U.K., there's no capital gains tax when selling, but there's a large purchase tax on the price of a new home -- and no break on mortgage interest. As London Mayor Boris Johnson discovered, a U.S. citizen who moves within London's property bubble will pay both taxes and get none of the breaks.
Among other unfair anomalies is the treatment of foreign pension contributions, which the IRS doesn't recognize in most countries. As a result, many Americans abroad pay tax on their pension contributions -- something they wouldn't do at home.
The tax issue has come to a head since Congress, in 2010, introduced new reporting rules for all foreign financial institutions that hold the assets of U.S. citizens. The goal is to catch wealthy Americans in the U.S. who offshore their investments to evade tax, but expatriates get caught in the crosshairs. They have to report on their local bank accounts or face penalties. And because foreign banks don't want the U.S. reporting liabilities, some expatriates have trouble opening accounts at all.
Expatriate taxation raises as little as 0.2 percent of federal tax revenue yet greatly complicates tax filing for Americans abroad. Congress should change the law -- perhaps as part of its nascent effort toward broader tax reform. In the meantime, the existing laws and regulations should be adjusted to end some of the most egregious injustices.
To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at email@example.com.