November 30, 2008 - Phil Hodgen

Why the new expatriation tax is dumb

The TaxProf blog has a recent post about expatriation. The TaxProf refers to a recent academic paper on the topic, which you can download here.

It’s always interesting to see the academic perspective on something that I do, y’know, for money.

Expatriation is mostly estate tax driven

Giving up U.S. citizenship–when it is tax driven–is mostly about estate taxation. Given a choice between passing 100% or 55% of your assets to your kids, most people choose 100%.

Income tax isn’t such a problem, because in many cases the U.S. income tax rate is lower than the person’s home country. Income tax burdens on U.S. citizens living abroad are usually burdens of paperwork and accounting fees, not tax.

Exit tax? Dumb move

I see the new exit tax as one of the dumber tax moves that Congress has done. Yes, dumber even than this. Why dumber? The bike commuter tax benefit is stupid because the costs of running a program exceed the value of the program itself. I think the bike commuter boondoggle is there just as a sop to the green police. But I digress.

The expatriation tax is a dumb move because:

  • It generates almost no tax revenue;
  • It promotes political disconnectedness–isolationism, if you like;
  • It creates tax problems that are unenforceable by the U.S.

Expected tax revenue will be puny

The revenue projections are puny. The Joint Committee on Taxation estimates that the tax collections will be $411 million for 2008 through 2018.

That’s Four! Hundred! Eleven! Million! folks. Like that’s going to make any difference at all to the Federal government.

The revenue projections assume a static universe. Ask yourself. Will people adjust their behavior to minimize potential taxes? You know the answer to that. (This point continues to elude elected officials). Thus I would expect the total revenues generated by Section 877A to be even less than estimates.

It’s an incentive to drop U.S. citizenship

The new exit tax creates an incentive for people to drop U.S. citizenship. No, you say. It makes people keep their citizenship because the tax cost is so high to give it up.

Wrongo, buddy. In the short term, maybe. In the long term, no. I believe there is an important cohort of citizens that have an incentive to drop citizenship at the first available opportunity.

Let’s say you are a citizen of the Kingdom of Saudi Arabia. Your son is born in the United States and automatically acquires U.S. citizenship in addition to KSA citizenship.

When you die, your son will inherit money and property from you. Now your son must worry about U.S. estate taxation on assets that have perhaps never touched the United States.

And that’s not the only thing your son needs to worry about. As a U.S. citizen, he needs to report his worldwide income and pay U.S. income tax every year — even if he is under the age of 18. If he receives gifts from you, he must report them on Form 3520.

If your son has no plans to live in the United States, why should he suffer these tax problems?

What I expect to see is that in the longer term, as minors reach age 18 they will voluntarily give up their U.S. citizenship. This can be done under the new exit tax rules without any tax being imposed.

Thomas P. M. Barnett probably doesn’t think about U.S. tax policy but my guess is that if he did he would say this is a bad result. Connectedness across borders brings peace and prosperity. Nothing quite says “I’m connected to the United States” as having the U.S. passport.

The exit tax promotes disconnection.

The exit tax creates unenforceable valuation issues

Think of a random person living outside the United States, whose assets are outside the United States. Let’s say the person’s assets are hard to value–real estate, privately-held businesses.

The person has a U.S. passport. She’s thinking of giving up citizenship.

If that person jumps through the exit tax hoops, what we have is a valuation fight between the United States of America and the random person. How is the Internal Revenue Service going to challenge the valuation of real estate in up-country Kenya?

That’s the least of the problem.

The basic concept of international sovereignty makes enforcement of the exit tax rules difficult at best. Let’s just leave it there for now.

The best enforcement mechanism available to the U.S. is the threat that a person who gives up citizenship will be barred from re-entry to the United States for the rest of his or her life. This is not a credible threat (it’s been rattled around for a decade without enforcement) and in any event many expatriates would respond with “So what?” They don’t care. So this is yet another small piece of political plate tectonics, which is bad for the U.S.