There is one thing no German, Chinese or any other government from a developed nation ever would do: taxing its citizens when they live abroad. I bet every competing nation of the US is quite happy that the US is shooting itself in the foot by subjecting its citizens (and green card holders) living abroad to double taxation, local (e.g., foreign) and the US.
Citizenship taxation unique in the world
To understand the issue, you have to know that the US is the only country in the industrialized world that collects taxes from its citizens living abroad. If you live as an American in Hong Kong, you pay first income taxes in Hong Kong, then in the US. What this means is that you always have to prepare two tax returns, whether you owe taxes to the US or not (there are some exclusions and double tax treaties). Every other country has a territorial tax system – you pay income taxes where you live, where you consume services. Imagine for a moment every country had the US system, and you lived with your French spouse in Germany. That would mean three tax returns, a complexity impossible to master.
Pity the poor American abroad
Let’s leave aside the costs for American individuals to file two returns and carry the costs of paying tax accountants versed in the US and the local laws. Let’s also put aside the consequence that any US person abroad always has to pay the higher of two tax rates for each income class. For example, an American in Germany will pay close to 50% income tax to the German government (but does not owe any more income taxes to the US as tax rates are lower); unlike German taxpayers in Germany, however, cannot take advantage of local tax breaks like buying and sell gold tax-free, as the US is subjecting gold sales to a long-term capital tax rate of 28%.
As an added insult for the poor American abroad, her foreign bank may kick her out thanks to new IRS reporting regulations to foreign financial institutions (e.g., FATCA). Regulations so onerous that many banks now rather deny securities and bank accounts to US customers, labeled “toxic citizens” by the WSJ a few years ago.
Why you should care
While so far you might not care about the pledge of your fellow citizens abroad. Here is a reason why you should be against taxing Americans living abroad. The US system reduces the hiring and experience gathering of Americans abroad, and as a consequence is most likely bad for exports.
Imagine two global companies, one German, and one US. Let’s also assume that each likes to have at least some expats running their foreign businesses, e.g., in Singapore, an Asian hub. Now, our respective German and US executives arrive at the same time. Let’s assume have the same style corporate apartment, send their kids to the same school, and have the same compensation. The executives are now are subject to Singapore income tax of about 22%. That’s where the story ends for the Germans and their Corporate Headquarters.
But that is where the expensive “fun” starts for our US Company. Since its employees need to pay up to 37% (marginal) tax rate on Singapore income (i.e., ~22% to Singapore, up to 15% to the US), they will demand from their parent company to make up the difference in order to roughly have the same after-tax income as local peers. The US firm will comply to be competitive in the labor market. But wait – this tax reimbursement within itself constitutes salary and is a taxable event; and the same goes for any housing allowance and other items, to be taxed in the US. If you take it all together, a US expat costs 2 to 3 times a local (or non-American) executive.
Boom times vs. recession
In good times, this does not matter. Whether a US company pays $250K or $500K for its US executives abroad, nobody cares. In a recession, however, or whenever there is a cost-cutting program going on at home, guess what happens? Yes, you got it…bringing the expensive expat home to make cost-cutting targets. I saw it at two different global companies in the recessions of 2002 and 2008. The US Company brings home its expats and with them their collective experience gained abroad to sell US products or services. Not so the German (or any other non-US) company. It has no incentive to recall its people. Their executives stay in the foreign location, continue to gain experience and sell products as there is no extra costs involved.
If Congress wants to help the US be successful abroad, raise exports, and thereby create jobs at home, the US needs to move to a territorial income tax system, i.e., stop subjecting its citizens to US income tax when living abroad. It’s time to be in sync with the world. Stop taxing Americans living abroad for the good of the country.
Disclaimer: All tax rates and examples used in the article are for illustrative purpose only. If you plan to move to a foreign country or are already one of the estimated 6 million US citizens living abroad, I highly recommend you seek professional help when it comes to filing your tax returns.
© 2019 Michael Froehls – All Rights Reserved
Photo Credit: © Michael Froehls