Tax Me Once, Shame on You . . .
Wednesday, June 28, 2006; 12:00 AM
Globalization is sending tax rates tumbling across the world, as jobs and capital migrate across borders in search of lower and more equitable taxation regimes. That makes it all the more imperative not only to roll back the recent tax increases on U.S. expatriates, but to eliminate double-taxation of overseas Americans altogether. Thankfully, there's a new bill in front of the U.S. Congress to do just that.
The U.S. is one of only a handful of countries that insists on applying an onerous system of "world-wide taxation." Since U.S. citizens living overseas are already, in most cases, paying local taxes in the countries where they work, that means they end up being taxed twice -- thus violating one of the most important principles of good tax policy. Most other countries, by contrast, have the good sense only to apply "territorial taxation," confining their taxation systems to income earned inside their national borders.
America's policy makers have tried to mitigate the adverse impact of world-wide taxation by exempting Americans living overseas from paying U.S. taxation on up to $82,400 annually. This is the "foreign-earned income exclusion" in Section 911 of the U.S. tax code. Thanks to a last-minute amendment inserted into a recent comprehensive tax bill, the foreign income exclusion will be slightly raised, but other benefits, such as housing exclusions, will be cut -- resulting in a huge spike in tax payments for many American expatriates.
While the foreign-income exclusion is better than nothing, it still leaves any overseas Americans earning more than this at a substantial competitive disadvantage, along with the U.S.-based multinationals that employ them. Such companies commonly foot the bill for ensuring that their American expatriate employees pay no more taxation than they would at home. In low-tax jurisdictions, for instance, American firms might have to pay 30% more to employ an American citizen than a national from another country with a less onerous taxation system.
Now relief is sight under the "Working American Competitiveness Act" recently introduced into the U.S. Senate by Jim DeMint (R-S.C.). This bill would end the double taxation of Americans who live and work abroad, and has a decent chance of getting enacted in the next two years thanks to the Center for Freedom and Prosperity's Coalition for Tax Competition. The likely outcome if it is approved? Increased job opportunities for American workers -- particularly in the executive-level jobs and marketing, management and financial-services posts most affected by the current system. With the operating costs of U.S. companies lowered, American exports would become more competitive. And the U.S. taxation system would be simplified too -- since Section 911 is so complex that those using it almost always have to seek expensive professional assistance.
The revenue implications would be surprisingly modest. According to the IRS, only 306,000 Americans filed tax returns in 2003 showing foreign-earned income, and fewer than 126,000 of those returns resulted in a tax payment to the IRS. In other words, the IRS collects a paltry amount of money -- perhaps $2 billion annually -- from a policy that creates a very large competitiveness challenge.
Even that revenue estimate is exaggerated, though, since it ignores the economic stimulus that ending double taxation would be sure to bring.
As has been again demonstrated by the success of the Bush tax cuts, lowering marginal tax rates on productive activity is a recipe for faster growth, which yields substantial revenue feedback. Liberated from the shackles of world-wide taxation, American companies would create more jobs and boost their exports -- and most likely end up paying more in taxes as a result of their improved economic performance. So ending a pernicious tax practice, which deserves to be abolished simply because it's wrong, could well end up being a money spinner as well.
Daniel J. Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation.