New year, new tax code — and a much improved one at that.
According to U.S. Treasury Secretary Steven T. Mnuchin, the tax reform bill signed into law by President Donald Trump in December will increase the take-home pay for 90% of workers. Tax season will also be simplified for many Americans next year, as the number of filers who must itemize in order to lower their tax bill will fall from approximately 30% of households to less than 10%
The move to immediate expensing will also stoke productivity-increasing business investment, and small businesses will have greater job-creating capacity. However, we view the 14-percentage-point corporate rate reduction — from 35% to 21% — as the crown jewel of tax reform’s success. Prior to this bill, America’s corporate tax rate was the highest corporate rate among advanced nations. Now, the U.S. no longer has that dubious distinction.
In addition to the much-needed reduction in the corporate tax rate, the bill also ends the double taxation of U.S. company profits earned and already taxed overseas. This move to a territorial tax system for corporations ends a system of double taxation that is rare in the modern world (according to the Tax Foundation, there are only five other countries that tax corporations on global income). However, one of the biggest missed opportunities in the new law is that it fails to stop double taxing expats living abroad.
One of the biggest missed opportunities in the new law is that it fails to stop double taxing expats.
On top of paying taxes in their country of residence, U.S. citizens who live overseas must also file U.S. taxes. This system of citizen-based taxation (CBT) is practically unique to the U.S., with only one other nation, Eritrea, sharing the same approach. In fact, it is a 150-year-old relic that started with an effort to tax Civil War draft dodgers who had fled to Canada. Just as the double taxation of international profits hurt U.S. companies and put them at a disadvantage in the global economy, citizen-based taxation negatively affects American individuals and families living in other countries.
Under the current system, Uncle Sam taxes Americans and U.S. green card holders on global income, no matter where they reside and earn a living. Jaqueline Bugnion, the former director of American Citizens Abroad, explained in an article for Tax Notes how citizen-based taxation goes against the fundamental tenet of tax policy that a government’s taxing authority should be based on services provided:
“An American residing in a foreign country pays taxes in the country of residence and receives in return government services from that country — roads, education, medical plans, social security programs, police forces, etc.” writes Bugnion. “Under CBT, the American abroad must also file U.S. taxes and pay the marginal income tax to the IRS if U.S. income taxes exceed those paid in the country of residence.”
Obamacare made the problem worse. Among the many tax increases included in Obamacare was a 3.8% surtax on investment income. Foreign credits can’t be applied against this tax, resulting in further double taxation of investment income for wealthier Americans abroad. This system also makes it difficult for Americans abroad to save and invest, as foreign currency fluctuations result in phantom capital gains and U.S. citizens living in some countries must pay into two social security systems.
This system makes it difficult for Americans abroad to save and invest.
For some Americans living and working overseas, the unreasonable tax and regulatory burden imposed by the U.S. government has potentially grown more than they can bear. The past year has seen Americans continue to renounce their U.S. citizenship at record rates.
There was hope that tax reform would fix this mistreatment by implementing a residence-based system. Under residence-based taxation, the U.S. government would tax Americans living overseas in the same manner in which it currently taxes foreigners with U.S.-sourced income or U.S.-based assets. A residence-based system of taxation would be simpler than the current system, fairer, and would end the aforementioned predicaments.
Members of Congress, including House Ways and Means Committee Chairman Kevin Brady, acknowledged the need and desire to address this problem during tax reform negotiations last year. High-ranking members of the Trump administration have also come out in support of moving to residence-based taxation for Americans overseas.
“It is something that I have advocated for as a member of Congress,” Mick Mulvaney, the White House budget director, said last fall. “It is good for American businesses to encourage Americans to work overseas.”
“It is good for American businesses to encourage Americans to work overseas.”
Unfortunately the constraints of 2017’s budget reconciliation process, which required the package to be deficit neutral, precluded this much-needed reform from being part of the final package.
The good news is that it won’t be another 30 years before the next major tax bill is passed. There is always another tax bill. Prior to passage of the 2017 tax reform act, there were the tax bills of ‘81, ‘82, ’86, ‘90, ‘97, ’01, ’03 and Obamacare — yes, that was a tax bill — in 2009.
The point is that Congress makes substantial changes to the tax code fairly often. Proponents of fixing the tax code’s mistreatment of expats must ensure this needed reform doesn’t miss the boat when the next tax bill comes up for a vote.
U.S. citizens who live and work abroad are some of the country’s most important unofficial ambassadors. They play an important part in shaping how their international coworkers, friends and family members view the U.S. and American values. President Trump, Speaker Paul Ryan, Senate Leader Mitch McConnell and other members of Congress would do well to use the next tax bill as an opportunity end the double taxation of U.S. citizens abroad.
Grover Norquist is president of Americans for Tax Reform.
Patrick Gleason is Americans for Tax Reform’s director of state affairs.