2. Those on the Front Lines: No one is more aware of the significance of this question than the 4 million U.S. citizens who today are living and working abroad. They have to compete with individuals of other nationalities for jobs abroad as employees, and as entrepreneurs have to compete with other companies in their same product and service fields. Being able to compete on a level playing field can make the difference between success and failure.
 

3. How Overseas Americans See the Competitive Environment Today: One of the greatest surprises awaiting an American going overseas to work today is the double discovery that not only is the international marketplace not a level playing field, but also that the principal factors distorting competitive neutrality are decisions that have been taken unilaterally by the U.S. Government.
 

4. What is the Principal Complaint? A number of decisions that have been taken by the U.S: Government alone, and even more so in aggregate, cause competitive disadvantages for overseas Americans. Perhaps the most egregious of these is the policy of the United States to subject the foreign income of overseas Americans, who are already paying taxes on this same income to a foreign country, to domestic U.S. income taxation as well. It is the double taxation problem.
 

5. Isn't That Standard Practice Overseas? No. The United States is alone in choosing to use the extraterritorial extension of its own tax code to distort the competitive neutrality of world markets to the disadvantage of its own citizens.
 

6. Why Does This Matter? Many overseas Americans believe that there is a direct relationship between U.S. policy towards its expatriates, particularly U.S. tax policy, and the evolution of a chronic and growing U.S. trade deficit.
 

7. What is the Historical Basis for Current U.S. Tax Policy? The U.S. Government had a rather hard time introducing a direct tax on income because this was deemed a violation of the U.S. Constitution. The Sixteenth Amendment corrected this infirmity. The new language was:
 

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration." (16^th Amendment, ratified February 3, 1913.)
 

The question then arose as to whether it was a violation of the Constitution to try to extend the reach of U.S. law to citizens living and working abroad. This question was resolved by the U.S. Supreme Court in Cook vs Tait in 1924 when the Court declared that:
 

"..the native citizen who is taxed may have domicile, and the property from which his income is derived may have situs, in a foreign country and the tax be legal - the government having power to impose the tax." (Cook v. Tait, 265 U.S. 47(1924)).⁽¹⁾
 

8. How Did Congress React to This Decision? Congress, in the 1920s, was sensitive to the stability of the world's economic situation and expressed concern that trying to apply domestic U.S. income tax to citizens living abroad would create a competitive problem for U.S. trade. As a result, the Revenue Act of 1926 specifically excluded overseas income from U.S. taxation if an American citizen was absent from the United States more than six months in any calendar year.
 

9. When Did This Policy Change? During the Kennedy administration, in the early 1960s, the United States was enjoying great success at home and abroad. Trade played a relatively modest role in the U.S. economy, exports accounting for about 5% of GDP. Professor Stanley Surrey of Harvard, the new International Tax Counsel at the Treasury Department, headed up a reform of U.S. tax policy introducing a new concept of ubiquitous tax obligation based upon citizenship rather than residence. Henceforth, U.S. citizens living and working abroad would be required to file returns and pay U.S. taxes on the income that they earned in foreign countries. It was recognized that these individuals would already be paying taxes to the country of overseas residence, so there was an attempt to alleviate some of the potential inequity of double taxation by granting a credit for some of the taxes paid abroad. This credit was limited, however, to those taxes abroad that were equivalent to the types of taxes that were recognized under U.S. practice. For Americans living in countries which used forms of taxation of income that were not in conformity with U.S. practice there would be no such automatic tax credit indulgence.
 

10. Did Any Other Country Emulate This U.S. Innovation? No.
 

11. What Did Other Countries Do Instead? The other major trading nations of the world thought it was a particularly unwise thing to do to violate the tax neutrality of a given marketplace, especially when this would harm your own citizens. Those countries that were members of the Organization of Economic Cooperation and Development (OECD) created a committee to study how taxation should apply to citizens living away from home and with the exception of the United States agreed unanimously that citizenship based taxation was a bad idea. Having agreed with the former wisdom of the U.S. Congress in the 1920s that "thou shalt not harm the competitive ability of thy own citizens", the OECD adopted a model bi-lateral tax treaty among members which recognized residence-based taxation as the standard practice. Subsequently the OECD members negotiated bi-lateral tax treaties among themselves expressly to avoid double taxation of their own citizens.
 

12. Does the United States Also Have Such Treaties? Yes, the United States played a major role in helping draft the model bi-lateral treaties for the avoidance of double taxation. And the United States has negotiated and signed a significant number of such treaties.
 

13. But How Can This Be, Isn't There a Contradiction with U.S. Tax Law? When the United States negotiates such treaties it pays careful attention to the concerns of other countries and helps the other countries ensure that their citizens will not be subjected to double taxation of the same income when these individuals are living and working in the United States. Then, when it comes to the question of the double taxation of Americans living and working abroad, the United States unilaterally interprets such treaties as not applying to U.S. citizens living and working abroad. Thus foreigners are protected while competing in the United States, but the U.S. Government reserves the right to practice double taxation of its own citizens under the terms of such treaties which, ironically, are entitled treaties for the avoidance of double taxation.
 

14. Is There Any Evidence That This is Harmful to the United States? The effect started to be manifested on two levels. From the perspective of individual Americans, the new law, enacted in 1962, meant that they now had a double tax obligation, double taxation of at least part of their income abroad, and, in the no longer neutral tax environment in foreign markets, their ability to compete on a level playing field disappeared. From the perspective of the United States, U.S. trade performance slowly started to deteriorate.
 

15. How Has the Trade Performance Evolved Since 1962? Table 1 at the end of this paper shows the evolution of U.S. gross domestic product (GDP), and trade in goods and services since 1962. When the new double taxation decision was made, exports and imports together represented less than 10% of GDP and the trade balance was less than 1% of GDP. As world trade grew in the following years, both U.S. imports and exports began to grow, but only slowly at first. By the late 1970s, however, U.S. trade performance began to deteriorate and a trade deficit began to become a more permanent phenomenon.
 
 

16. How Does Double Taxation Harm the United States? Common wisdom has it that "the power to tax is the power to destroy". The destruction in this case is not always obvious, often acting like a slowly accumulating poison. In essence, U.S. citizens, taxed double on the same income, are simply more expensive commodities than citizens of other countries that do not have the same double taxation burden. That extra expense means that their employers have a financial incentive to replace them whenever possible by individuals of other nationalities who are not double taxed, hence less expensive. The difference in cost is not a difference in the initial gross salary, but in supplementary measures that have to be taken to ensure that American employees have a comparable after-tax take home pay so that they can live on par with their colleagues. When you cut through the rhetoric on this complicated issue, you finally get to the heart of the matter. That is simply that this U.S. double taxation of the same foreign income is an export tax on U.S. citizen labor, one of the most foolish things that any country has ever instituted. In light of this extra burden, many large American companies have reduced the number of U.S. citizens on their overseas payrolls to a very small percentage. This, of course, eventually results in a smaller pool of American citizen executives with overseas market experience, and eventually encourages these same companies to employ foreigners for international executive positions even in the United States.
 

17. How Does This Effect Export Performance? There are many stories about how the replacement of a U.S. citizen by a citizen of another country in a design or procurement-related job abroad has led to U.S. raw materials, parts and services being replaced by their equivalents from other countries. While the Treasury Department often dismisses these stories as mere anecdotes, their aggregation results in a significant negative impact on U.S. trade performance. Another harmful effect is that double taxation discourages entrepreneurs from embarking on new investments abroad, especially in developing markets, where there could be good prospect for exports of American products and services. Having their own government making their lives economically difficult abroad has discouraged many entrepreneurs from remaining in difficult foreign markets and from continuing their efforts to build foreign markets for U.S. products and services. It has also discouraged many from even making the eventual effort to move overseas to try to compete because they know that their costs are going to be so much greater than those of their competitors whose home country governments do not impose the same double taxation and other associated harassments.
 

18. How Does this Double Taxation Handicap Really Work? The double taxation of the same income creates an extra financial burden on overseas Americans unless foreign tax credits completely offset the amount of tax due to the United States. As this full coverage of double taxation by offsetting foreign tax credits is rarely the case, a decision has to be made as to who should bear this extra tax burden, the overseas American or the employer?
 

A. If the Employer Pays: When a U.S. citizen works abroad for a U.S. corporation, the employer often faces an embarrassing personnel policy challenge. Take the case of two employees of two nationalities, working in the same place, in the same type of job, for the same basic salary. If the U.S. citizen has taxes to pay to the United States through the double tax burden that is not faced by a foreign colleague, that means that these two employees will not have the same take-home pay and will not be able to enjoy the same standard of living abroad. Often, to avoid this inequity of economic reality, the employer agrees to pay the extra tax burden on behalf of the U.S. citizen employee. The U.S. tax then becomes an extra cost of business for a U.S. employer abroad, and in effect the double taxation is really a U.S. export tax on U.S. labor working abroad. But it gets worse. Because the corporation pays the first tax burden in year 2, the tax payment made by the corporation on behalf of the U.S. employee abroad has to be reported by this employee as additional income earned abroad! Thus the double tax burden grows in year 3 and each subsequent year until this burden becomes quite large. It is not surprising, therefore, that many U.S. corporations eventually send most of their U.S. citizen employees home and prefer to have foreign citizens on their payrolls abroad because of the lower cost burden. U.S. taxation has become, in such a case, a competitive handicap for the employer.
 

B. If the Employee Pays: Some U.S. companies and many foreign companies refuse to pay the extra U.S. tax burdens faced by U.S. citizens living abroad. In this case, the U.S. citizen has lower take-home pay than colleagues of other nationalities. Were the tax imposed only on the basic salary abroad this would be a burden by itself, but consider how much more difficult it becomes if the employer accepts to pay for private education in a foreign language for the children of its expatriate employees of all nationalities. The U.S. citizen will have to pay U.S. taxes on the value of this educational benefit too and will be further in the hole the more generous the employer is.
 

19. It Gets Worse: The tax law today treats all income earned abroad in a foreign currency as income earned in U.S. dollars at the exchange rate in effect on the date of receipt of each salary check or other remuneration. As the value of the foreign currency in U.S. dollar terms can fluctuate quite widely during the course of a year, there is no way to predict what the U.S. tax burden will be.
 

20. And Worse: But that is not all. One you start chasing after exchange rate movements to define income, why not also look for transient capital gains (in US dollar terms) that might be generated by these movements during the course of a year? So, as of yet another rule change, every overseas American today is supposed to keep track of every deposit in a foreign currency and every payment in a foreign currency and use the exchange rate that applied to each such transaction to calculate whether the foreign currency that they earned may have subsequently varied in U.S. dollar terms as of the date it is spent in such a way that a U.S. dollar capital gain may appear to have arisen. It doesn't matter that the foreign currency was earned and spent entirely in that foreign currency and never transited via a U.S. dollar account. This attempt to tax phantom capital gains is so difficult to apply that even major accounting companies haven't figured out a practical way to do it.
 

21. And Worse: Other complicated rules have been issued pertaining to the accounting for any bank accounts and investments that might be made overseas outside of the country of foreign residence. Still more restrictions apply to the deductibility or credit allowed for foreign taxes paid on such earnings. There are different rules to apply to "unearned" income such as foreign source pensions, etc, etc, etc.
 

22. And Worse: As Congress never seems to tire of making changes in the tax laws applied to overseas Americans, it is nearly impossible for anyone to master these changes and also at the same time follow the continuing evolution of the tax regulations in the overseas country of residence as well.
 

23. U.S. Tax Filing Abroad is Complicated and Expensive: For most Americans abroad, the U.S. Internal Revenue Service has stopped sending tax forms to the overseas taxpayer's address. To save money, the U.S. Government has greatly reduced the number of overseas IRS offices and employees. It is increasingly difficult for an overseas American taxpayer to even find the necessary tax forms let alone try to get help in understanding what is required and how these forms are to be filled out. Because there are fewer and fewer embassies and consulates abroad, taxpayers may have to travel a considerable distance at their own expense to find forms and seek help. Often even after making such a trip the forms that are required are not available and no one at the embassy or consulate is qualified to offer any advice or assistance.
 

24. Expert Advice from Tax Consultants is Expensive: Another dimension of the lack of tax neutrality abroad is that there is considerable extra expense for an overseas American to seek a double amount of assistance for two entirely different tax systems. Professional tax preparers make a lot of money abroad and they, of course, have a vested interest in the maintenance of the status quo, if not in its increasing complexity. Indeed, in one of the most egregious examples of market development initiatives, not so long ago, some ambitious young members of the staff of a leading member of the Congress helped draft some very intricate new rules for overseas American taxpayers. Then when these new rules were enacted, and prior to even leaving the Congressional staff, they wrote letters to major American corporations on behalf of the new tax consulting business they were setting up, offering their services to help interpret and live with these complicated new rules which they had just invented. Small wonder that foreign competitors regard U.S. export strategy with such unadorned admiration.
 

25. Don't Tax Credits Work? Although U.S. tax rules provide for offsetting credits for taxes paid to a foreign government, these credits are usually restricted to taxes that are essentially identical in form to taxes required on the same income by the United States. If, as is often the case, the foreign country of residence imposes novel forms of taxation that are not similar to those used by the United States, credit for taxes paid abroad can be denied by the United States and this same income will be taxed a second time. A classic example in which there is a significant amount of double imposition on the same income is the refusal of the U.S. Government to recognize the very large amounts of value added taxation that is imposed on most purchases of goods and services in many foreign countries. In terms of economic reality, such taxes are used to collect a higher percentage of income than direct income taxes, especially in the major countries of the European Union. This double taxation of the same income is flagrant, but because the tax is experienced on expenditures rather than on income, it does not qualify for credits against a U.S. tax liability on the same income.

26. Can U.S. Tax Laws be Made to Work Better? There has been a bewildering number of changes in the laws and regulations that affect U.S. citizens living overseas during the last thirty-eight years. Sometimes the burden goes up, sometimes in goes back down again. Sure, one could keep playing with this double tax policy in an infinite number of new ways. Put simply, however, a really equitable system would have to involve a foreign tax credit scheme that recognized the local economic reality and was specifically tailored to the tax system used by of each and every country where a U.S. citizen taxpayer lives and works abroad. Such a beginning would require special tax forms for each overseas country, an immense additional amount of record-keeping and reporting, and an enormous burden on the U.S. Treasury Department to understand and supervise such filings and establish and keep up to date a truly equitable tax credit systems for each foreign country. This is not going to happen. Absent this sort of care, however, a considerable amount of double tax burden is inevitable for many overseas Americans.
 

27. How Do Overseas Americans React to These Extra Burdens? There is no simple answer. Some deplore and pay. Some ignore and don't pay, rejecting the absurdities of this system and taking their chances. Some give up and come home. Others would like to remain abroad, but their employers tire of paying a premium to have an American on the payroll and send them home. Finally, some take a look at the competitive handicap that they will face and simply don't bother to move abroad. Some who decide to retire abroad and realize that the U.S. Government considers their foreign source pensions are not "earned income" conclude that the extra expense and harassment of maintaining their U.S. citizenship abroad is just not worth it. They try to give up their U.S. citizenship.
 

28. But Even Giving Up Citizenship is Not Easy: Even this solution is not an easy one for a number of overseas Americans who have a certain threshold amount of annual income or a certain level of savings. If an overseas American's income or wealth is beyond these thresholds, renouncing U.S. citizenship is automatically assumed to be for the specific purpose of avoiding U.S. taxes, no matter what the real intention of the individual might be. Former citizens who are arbitrarily consigned to this category face a number of sanctions including possibly never being able to return to the United States again.
 

29. Special Discouragement of U.S. Entrepreneurs Abroad: Onerous as the current tax laws are for U.S. citizens who work as employees abroad, their problems pale before those faced by American entrepreneurs who choose to set up Subpart F-Controlled Foreign Corporations abroad. The myriad rules they face are complicated and expensive, and are not matched by comparable burdens on any of their competitors of another nationality. To cite just a few of these, they have to keep parallel sets of accounts for the local authorities according to local law, and accounts according to U.S. tax practices for the U.S. authorities. Foreign tax documents have to be translated at their own expense for submission to U.S. authorities. Whether or not the U.S. entrepreneur actually takes a salary from such a business, U.S. rules impose a percentage of income of such a foreign entity as personal income that is taxable by the United States, etc, etc. This extraordinary harassment of U.S. entrepreneurs applies to individuals setting up the tiniest of corporations in the most impoverished countries of the third world. Needless to say, these rules have had a number of different effects. One has been to discourage U.S. citizens from setting up small businesses abroad. Another has been to encourage entrepreneurs to simply ignore the burdens and costs of complying with this extra tax obligation with all of the eventual peril that this might imply.
 

30. With Extra Burdens, Don't Overseas Americans Get Special Benefits? The answer, unfortunately, is no they don't. Americans abroad pay more and receive less than overseas citizens of any other major country. One possibility, that has never been implemented, but which could attenuate the extra burdens of double taxation would be to take a look at what happens to U.S. income taxes paid by residents of U.S. Territories and the Commonwealth of Puerto Rico. U.S. federal income taxes collected from residents in these U.S. territories never leave these locations. They are used to support programs addressed specifically to those living in these local communities. Taxes that are collected from U.S. citizens living overseas, however, still today disappear into general Treasury Department revenues. They are not credited in any special way to overseas Americans and they are not used to finance any specific programs to help improve the competitive situation of U.S. citizens overseas.
 

31. Do Overseas Citizens of Other Countries Receive Special Benefits? Yes. Although the governments of France, Germany and Japan do not tax their citizens abroad, they do feel strongly that they should be assisting their overseas citizens as much as they can. They therefore spend several hundred million dollars per year providing subsidized educational facilities and teachers to provide for home country language schooling for their children. Although the U.S. Government collects hundreds of millions of dollars from overseas Americans, it does not spend a penny to help provide educational benefits for overseas American children. The U.S. Government also taxes the educational benefits that corporations give to their employees abroad. Thus overseas Americans are at a triple disadvantage in the educational field alone. They pay, don't get benefits, and even pay taxes on the benefits they receive from their employers. There are many other special programs that are offered free of charge to overseas citizens of other countries that are not matched by the United States.
 

32. How Can This Disparity of Treatment be Explained? Most major trading nations of the world build their foreign policies and trade strategies by strengthening the status of their overseas citizens. Some have instituted elaborate programs of regular consultation with their foreign citizen communities, bringing their representatives home at government expense for meetings with senior government officials. In some cases countries have even created seats in their national legislatures for representatives elected by their overseas communities.
 

33. Why Doesn't The U.S. Government Share This Strategic View? No one really knows. In a number of different policy areas, the attitude of the United States toward overseas Americans took a major turn for the worse in the 1940s and things have not gotten much better since then. Although the U.S. Congress in 1926 believed that overseas Americans were important components of U.S. trade strategy, this view has not been shared since 1962. Although the double tax burden on bona fide foreign residents was initially instituted by a Democratic administration, double taxation is clearly not a partisan issue. Recent Democratic and Republican administrations have continued and exacerbated a number of policies that keep the overseas playing field far from level. They seem to share the common conviction that overseas Americans are basically irrelevant to U.S. national interest.
 

34. What is the Trade Deficit Situation Today? As Table 1 shows, the U.S. trade deficit has become much more substantial in the 1990s. During the most recent year, 2000, this trade deficit will exceed $ 300 billion, once again a new world record. Trade has continued to grow in importance as a component of the U.S. national economy. In 1998, imports and exports together were the equivalent of 24% of GDP. This suggests that nearly one out of every four jobs is now related to trade in one form or another. The trade deficit has grown to represent more than 2% of GDP, and the chronic nature of this deficit means that a greater and greater amount of the funding of this debt is dependent on the willingness of foreign governments to accumulate U.S. dollar assets. The U.S. economy is increasingly beholden to foreign indulgence.
 

35. What Should be Done? It would be easy, and relatively inexpensive to carry out a simple experiment. Why not go back to the level playing field formerly enjoyed by overseas Americans prior to 1962 and see what would happen? Make the foreign marketplaces of the world tax neutral again. Let everyone competing in the same foreign market have the same treatment, the same burdens, and the same take-home pay. Give this a few years to work and then check the results.
 

36. Has Anyone Proposed This Recently? Yes. One exemplary initiative was HR 4562 which was introduced during the 2^nd Session of the 102^nd Congress in 1992 by then-Congressman Bill Alexander (D-Ark) and Congressman Ben Gilman (R-NY). This would have restored competitive parity overseas, eliminated double taxation of the same foreign source income, and made the overseas playing field truly level once again. It would have brought the United States into conformity with the practices of all of its trading competitors. While HR 4562 was unfortunately not enacted, it was very much the right thing to do. As the U.S. trade deficit has grown considerable larger since 1992, this legislation is even more appropriate today. This proposal should be redrafted and enacted as soon as possible.

1.

¹ For a more complete statement of the Court's reasoning see Annex 1, U.S. Tax Law and Overseas Americans, An Historical Summary.