President-elect Donald Trump pledged last month to eliminate “the Double Taxation of overseas Americans.” Never mind the clumsy wording — taxes on US citizens working abroad aren’t excessive so much as excessively complicated — this is one campaign promise that may actually be fulfilled, given the Republican control of both houses of Congress. That would be a good thing not only for those Americans but also for America.
There is in fact a long-standing debate over getting rid of what is commonly called “citizenship-based taxation” and replacing it with “residence-based taxation,” which is standard practice around the world. America’s system is different. If you are a US citizen but do not live, work or earn income in the US, you are still liable for US taxes. There are as many as 9 million Americans living abroad, a substantial population.
To be sure, the system is set up so that most people do not suffer financially. If an American is working in Paris and paying taxes to the French government, for example, a complex system of tax credits limits their liability to the US government. But extra tax may be due if that US citizen faces a low foreign tax burden; high earners or those with investment or retirement income may end up owing the US Treasury.
In any case, this is not mainly about revenue. The bigger problem is simply that dealing with two (or more) national tax systems is an extreme burden in terms of paperwork and legal fees — and the complications, it must be said, come from the American side. This is officially ranked as one of the most serious procedural problems with the US tax system, and if you have American friends living abroad, you have undoubtedly heard about it. I know a few who have actually repudiated their citizenship because of it.
If this system were reformed, Americans would find it easier to work, start companies and manage investments abroad.
One major result would be an expansion of US soft power: Americans, and American businesses, would be far more globally visible. China is often seen as more involved in most parts of the developing world, especially Africa. Simply by changing a small part of its taxation system, the US could help counter this general trend — while also benefitting millions of actual Americans.
There is another possible gain, one which may have more appeal to the incoming administration than to economists like me. Trump and his advisers have long worried about the US trade deficit, and there has been talk of taxing foreign direct investment to weaken the dollar and boost US exports. Rather than discourage foreign investment in the US, why not do something more positive — and encourage US investment abroad?
If Americans leave and start new businesses around the world, using previously domestic capital, that too will bring downward pressure on the dollar. Thus could Trumpian ends be achieved by more constructive means. As a bonus, such a plan would not alienate foreign countries, as they tend to view a tax on FDI as a tax on their citizens.
This tax reform also might benefit US exports more directly. Say a US company wants to send an employee abroad to do market research and explore distribution channels for future sales. The US tax system should not turn this into a difficult ordeal.
Encouraging more Americans to work abroad also is a form of foreign aid, as many of them will grow or start businesses, creating jobs and tax revenue for the foreign country. And it is a form of foreign aid that benefits US citizens rather than costing them money. In fact, given the prowess of US business, it may be one of America’s most effective forms of foreign aid.
Another problem with the status quo is that it penalizes those born in the US who move away from the country at an early age. Former UK Prime Minister Boris Johnson, who was born in America but left at the age of 5, faced considerable tax complications decades later when he was mayor of London and sold his British home. While the number of such cases is probably not large, they illustrate how nonsensical the US tax system can be.
As for the details of how exactly to make the change: One option would have Americans pay regular taxes on interest, dividends and capital gains originating in the US, but not owe US tax on the rest of their income. Such a system might also discourage very wealthy Americans with a lot of passive US income from setting up residence in low-tax jurisdictions.
There are other models, of course, and people will debate the various benefits and drawbacks. But the main goal is clear: to end America’s absurd, bureaucratic, hard-to-manage, time-wasting system of taxing its citizens who live abroad.
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