AuthorKudrle, Robert T.
  1. INTRODUCTION 799 A. General Concerns About International Taxation 800 B. U. S. Citizenship Taxation: A Brief Sketch 801 C. The Arguments Made Here 804 II. A BRIEF DEFENSE OF CITIZENSHIP TAXATION 805 A. The Benefit Principle 805 B. Horizontal and Vertical Equity 808 C. Efficiency 809 D. Mobility to Escape Taxation 810 E. Administrability 813 III. SALIENT PROBLEMS WITH THE CURRENT SYSTEM 814 IV. A PROPOSAL FOR POLICY CHANGE 818 A. FATCA as a Watershed 818 B. The Soft Exit 819 C. The Hard Exit 822 V. ENFORCEMENT 826 A. Poorly coordinated administration 826 B. The Need for Increased Resources 828 C. Greater Unilateral Action to Achieve Foreign Government Cooperation 829 VI. LOOKING AHEAD 832 VII. SUMMING UP 834 I. INTRODUCTION

    An oft-told tale traces U.S. citizenship taxation to the flight from Civil War service by upper-income Americans. (7) In his rejection of such taxation, Reuven Avi-Yonah characterizes the original tax as "a symbolic gesture" and

    [t]he application of the income tax to nonresident citizens stemmed from a great national crisis in which resident citizens were expected not just to pay tax but also to risk their lives for their country. At the same time, nonresident citizens were likely to be few in number, rich (or else they would not be subject to tax), and suspected of living overseas to avoid both the draft and the tax. (8) Avi-Yonah argues (inter alia) that the U.S. does not currently face a national emergency and that the tax was from the beginning, and will likely remain, unenforceable because the collection of taxes from non-residents without U.S. property to attach has proven so difficult. This Article takes a contrary view. Modern technology and international agreements have greatly improved the ability to identify those citizens abroad with U.S. tax obligations. (9) Enforcement has yet to be well developed but could be made far more effective. Moreover, doing so has taken on increased urgency. The recent and probable future development of the American economy suggests ever-increasing market inequality of both income and wealth. (10) While this situation certainly does not constitute an emergency of the magnitude of the Civil War, it poses an unprecedented policy challenge. Facing that challenge will almost certainly require a higher level of redistributive taxation. This, in turn, necessitates a robust defense against expatriation to avoid legislated tax burdens; citizenship taxation should play a role in that defense. On the other hand, millions of low- and middle-income Americans living abroad would benefit from less intrusion by U.S. law and the ability to function more fully under the tax laws of the state in which they reside. Law and policy should serve their interests too.

    1. General Concerns About International Taxation

      All international taxation faces three broad challenges. First, national policymakers serving the public interest should aim to maximize national economic welfare (11) unless other national goals, particularly autonomy or security, require deviation. (12) Second, international comity suggests a high level of policy reciprocity to maintain good international relations, to avoid double taxation, (13) and to bolster efficient and effective enforcement. These concerns underlie the development of international conventions over the past century. (14) Finally, all tax policy should comport with traditional public finance criteria of fairness, efficiency and administrability. (15)

      This Article argues that past U.S. policy of international personal taxation has fallen dramatically short of maximizing national economic welfare. It has allowed hundreds of billions of dollars to be hidden abroad, and it poorly protects against tax-motivated expatriation. While collecting taxes levied on those outside the national territory poses special problems, they could be substantially reduced through determined pursuit--something that has so far been sorely lacking.

    2. U.S. Citizenship Taxation: A Brief Sketch

      Until late in the 20th century, the U.S. government made only intermittent and largely ineffective attempts to collect taxes on overseas earnings of Americans living either at home or abroad. While taxing residents on their foreign earnings challenged all governments, the problem of taxing non-residents was almost uniquely American due to its global system. Some states that practice residence taxation have attempted to levy taxes at departure from national residence or for some period thereafter, but most late-twentieth century results were discouraging. (16) Attempts to tax persons following their departure have largely failed because mandated payment can be easily ignored when the person owing, and that person's property, are outside the reach of direct national enforcement. This has been the American experience despite legal requirements that all citizens file financial forms every year; a very high percentage of overseas Americans have until recently ignored the requirement with impunity.

      The 2010 Foreign Accounts Tax Compliance Act (FATCA) increased discussion of citizenship taxation in the legal literature. (17) This provision of the HIRE (18) (stimulus) legislation obliged foreign financial institutions to report information on all U.S-connected accounts to the IRS on an annual basis under threat of a 30% withholding penalty on all of the institution's U.S. earnings. FATCA did not aim primarily at U.S. citizens living abroad but rather at foreign property earnings of resident Americans with undeclared assets.

      The FATCA threat was credible, and cooperation came swiftly because nearly all affected firms necessarily held U.S. assets. (19) The legislation generated immediate cries of coercive unilateralism, but it was soon followed by many inter-governmental agreements with the U.S., an approach that overcame the frequent illegality of direct institutional reporting to the Americans. Some of these agreements included a U.S. pledge to move towards reciprocity as soon as feasible. (20) Fulfilling this pledge was hindered by the fact that American business formation and much financial regulation take place at the state level, and many special interests opposed moves towards reciprocity on various grounds. (21) Federal legislation to provide for the collection and sharing of beneficial ownership information on LLCs and corporations in the U.S. finally passed in late 2020. (22)

      Other states resisted FATCA as a unilateral imposition but not as a model for cooperative policy. Far from it. National fiscal authorities around the world seeking to uncover hidden foreign accounts had become convinced of the futility of anything short of automatic informationexchange. (23) Over the decade following FATCA's passage, anon--U.S. version of automatic international sharing of financial information was almost universally agreed upon under the auspices of the OECD. (24) Although, unlike FATCA, government commitments involving the OECD's Common Reporting Standard (CRS) include no specific penalties for non-compliance, states are at liberty to retaliate against a failure to provide what was agreed upon. The results have been impressive; the OECD claimed in mid-2020 that nearly 100 cooperating countries have found [euro]10 trillion kept by their residents in 84 million offshore accounts. (25)

      FATCA and the subsequent efforts elsewhere aimed mainly at the use of secret foreign holdings by residents. But U.S. citizenship taxation highlighted America's unique policy challenge. Because the U.S. taxes all citizens and long-term permanent residents, overseas Americans never escape the legal purview of the IRS. Those continuously living in the U.S. and whose only foreign income, if any, comes from the ownership of real or financial property abroad are the largest group that FATCA affects; this article concerns those persons only insofar as they might decide to live abroad in the future. Nevertheless, FATCA exposed the weakness of U.S. collection efforts with Americans and expatriates (26) living abroad.

    3. The Arguments Made Here

      Current U.S. citizenship taxation for those abroad does not simply levy the same rates at the same income levels as those for resident Americans. Instead, it provides a very generous earned income exclusion for overseas Americans and allows crediting for most or all of the remaining income tax liability. For those who wish to renounce their citizenship, it levies a capital gains tax on "deemed" asset gains above high income and wealth thresholds. In addition, U.S. inheritors of ex-citizens are taxed at the highest estate tax rate. All of this needs to be revised in the service of equity.

      This paper makes several arguments:

      First, citizenship taxation should be retained. It serves the U.S. national interest, and its successful pursuit by the U.S. will redound to the benefit of other states as well. Second, FATCA has exposed the awkwardness of citizenship taxation as it actually applies to most U.S. citizens and long-term permanent residents abroad. Third, both fairness and administrability would be served by carving out a sphere of residence taxation for many overseas Americans who live in countries with tax systems similar to that of the U.S. while also eliminating subsidies to foreign residence. Fourth, those who choose to relinquish U.S. citizenship should pay once-for-all compensation rather than facing the two-part exit taxation scheme of current policy. Fifth, the resources devoted to monitoring the tax compliance of high -income and wealthy Americans should be greatly increased. Sixth, the U.S. should spearhead further international cooperation to prevent tax escape by the wealthy. II. A BRIEF DEFENSE OF CITIZENSHIP TAXATION

      Many writers have considered citizenship taxation using elements of traditional public finance criteria. (27) These evaluations come to quite different conclusions largely because the yardsticks for evaluation were originally developed...

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