The Problem with Taxing Foreign-Earned Income

Published: June 27, 2012

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Free Advice to My Schoolmate Barack Obama: Want to Grow Exports and Create More Jobs? Don’t Tax Americans Abroad
Dr. Saud Al-Ammar

[Reprinted with permission of SUSTG.org]

SUSTG Analysis

Eritrea is one of only two countries in the world that applies citizenship-based taxation in addition to residence-based taxation. The other? The United States of America.

In fact, the US is the ONLY industrialized country in the world to impose citizenship-based taxation. The immediate result for American expatriates is a blizzard of confusing and complex filing and reporting requirements that have kept innumerable accounting firms in the black and thousands of Americans up all night at tax time. Their constant (and unwelcome) traveling companions include IRS Form 2555, US Code section 911, cost of living adjustment tables, physical presence tests, housing expense formulas and, coming soon, Form 8938 (Foreign Account Tax Compliance Act).

However, as Dr. Saud Al-Ammari notes in his pointed analysis, “Free Advice to My Schoolmate Barack Obama: Want to Grow Exports and Create More Jobs? Don’t Tax Americans Abroad,” the larger issue is what this tax policy means for American exports and American jobs. Dr. Al-Ammari writes:

“From the standpoint of a business, it must offer significantly higher gross pay to an American over a non-American to account for the difference in net pay between them. No profit maximizing entity, however, is going to offer an American a higher salary over an equally qualified non-American just for holding an American passport. The fact is that over a 20-year period, the number of Americans employed by foreign subsidiaries of U.S. firms fell by 50 percent even as these firms continued to expand their overseas hiring. More alarming still are reports that U.S. Government requirements for reporting income of American workers are so onerous on businesses that some have foregone hiring Americans altogether.”

The US Chamber of Commerce and other business groups couldn’t agree more with Dr. Al-Ammari. The Middle East Council of American Chambers of Commerce (MECACC), an affiliate of the US Chamber of Commerce represents the over 700 US companies in the GCC states where some 50,000 American civilians live and work — one of the largest US expatriate communities relative to the host nations’ size.

According to MECACC, US companies’ sales of goods and services in the GCC have totaled more than $20 billion annually, creating or sustaining more than half a million jobs in the United States. According to the U.S. Department of Commerce one in every eleven manufacturing and agricultural production jobs in 2010 was created by exports.

Yet the matter of taxation of Americans abroad — or double-taxation in many cases as host countries tax expatriates as well — remains a political football and a constant legislative struggle for American business advocates. Even when the Obama administration is actively pursuing its National Export Initiative, the allure of additional tax revenue makes abolishing the exclusion entirely an annual darling of US lawmakers.

MECACC and others have been fighting this legislative battle since the 1970s and they make their case to Congress at least once every year during their Capital Hill “Door Knock” campaigns. [For a full report on their May 2012 “Door Knock,” click here.] Among the recommendations arising from this “Door Knock” is strong support for the efforts being made by Congressman Dave Camp (R–MI) and other leaders on the U.S. House Ways and Means Committee to:

“Transform America’s tax system from a worldwide system based on citizenship to a territorial based system… Such a system is desirable for corporate taxation; the taxation of individuals under a territorial based system would level the playing field for Americans abroad. Leveling the tax playing field will make it less costly for companies operating abroad to hire American workers and stop the outsourcing of those jobs to foreign nationals.”

While MECACC and others continue their work, the extraordinary aspect of Dr. Al-Ammari’s analysis below is that he is not American; he is Saudi. His analysis stems from years of experience of seeing companies inclined to hire Americans but unable to do so because the comparative cost is so prohibitive.

An objective observer, Dr. Al-Ammari encourages President Obama and Congress to, “reform the anachronistic income tax policy of the United States that is harming the ability of America to compete in the global economy.”

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Free Advice to My Schoolmate Barack Obama: Want to Grow Exports and Create More Jobs? Don’t Tax Americans Abroad
Dr. Saud Al-Ammar

As a member of the Harvard Law School community, I was pleased to meet fellow alumni at a recent gathering of American businessmen in my home country of Saudi Arabia. Nicole Lamb-Hale is an appointee of President Barack Obama and was his classmate at Harvard Law School. She now serves as United States Assistant Secretary of Commerce for Manufacturing and Services. She was in Saudi Arabia on an official visit to discuss ways that the US Government can help American industries succeed by strengthening their competitive position in foreign markets while creating and sustaining American jobs.

During a meeting of the American Business Association for the Eastern Province with the Assistant Secretary, the president of the organization, David Cantrell, raised the issue of the burden that US income taxes place on Americans working and living abroad. Mr. Cantrell was keen to point out that the tax also hurts the global competitiveness of American businesses. He explained that a tax on foreign income creates a disincentive for Americans to work overseas and went on to say that the tax and its associated reporting requirements also present serious obstacles to global firms, which might otherwise hire Americans.

To appreciate the significance of Americans working abroad to the American economy, it is important to recognize the effect these workers have on exports and employment in the United States. They perform vital functions for the growth of the US economy, including opening and expanding foreign markets and serving as ambassadors for American products and services in the global marketplace.

Furthermore, Americans with the technical and management skills sought by global businesses are often in a position to direct spending at those businesses. In fact, Americans on the front line of the global economy are uniquely positioned to advocate for the purchase and use American goods and services.

So how does taxing foreign-earned income create disincentives? It has to do with the unfavorable position in which the tax and related reporting requirements put both the American worker and the hiring firm in relation to a non-American worker being considered for the same job.

An American looking to work overseas must consider how both the foreign jurisdiction and the US Government will tax earnings. Americans are subject to double taxation when they must pay income taxes to the country in which they are residing in addition to US income taxes. And while some jurisdictions do have tax treaties with the United States that limit this burden, most do not.

A non-American worker, on the other hand, has no such concerns, as the United States is one of only two countries to tax world-wide income based on citizenship in addition to residence. This puts Americans at a competitive disadvantage. For the same amount of gross pay, the take-home pay for an American expatriate is significantly less than for a non-American expatriate. The result is that an American is less likely than a non-American to accept the same overseas job offer.

From the standpoint of a business, it must offer significantly higher gross pay to an American over a non-American to account for the difference in net pay between them. No profit maximizing entity, however, is going to offer an American a higher salary over an equally qualified non-American just for holding an American passport. The fact is that over a 20-year period, the number of Americans employed by foreign subsidiaries of US firms fell by 50 percent even as these firms continued to expand their overseas hiring. More alarming still are the reports that US Government requirements for reporting the income of American workers are so onerous on businesses that some have foregone hiring Americans altogether. And recently added reporting requirements (such as IRS Form 8938) have been implemented pursuant to the Foreign Account Tax Compliance Act, and will only make the situation worse.

The unintended consequences of taxing expatriate Americans by the US Government is that fewer of them seek employment overseas, and even fewer are hired by global firms. With fewer proponents of American goods and services who can influence buying decisions, there are fewer exports made by domestic companies, and in turn, fewer jobs in America. Ultimately, the US Treasury collects less overall revenue and America has a less competitive economy.

So why does this tax exist? In truth, the tax is a remnant of an out-dated 1924 Supreme Court decision in the case of Cook v. Trait. There, the Court held that the Federal Government had the right to tax the foreign-earned income of Americans and justified its decision largely on the “presumption that government by its very nature benefits the citizen and his property wherever found.” Today, proponents of the tax offer the same tired argument: If Americans living and working overseas enjoy the benefits of citizenship, they why should they get a tax break just because they choose to live overseas?

This argument, however, is misinformed. Americans residing abroad do not receive many of the benefits of citizenship. They do not use US infrastructure, cannot claim Medicare, do not enjoy the protection of the US Government to their person or overseas property, must pay for all consular services, and are charged at full commercial rates if they should ever need to be evacuated from a foreign country.

The larger point, however, is not whether the US Federal Government has the right to tax foreign-earned income, but whether doing so makes sense in a global economy. There is a reason why other modern industrial economies do not burden their citizens with taxes on their overseas income, and that reason is economic growth. A nation that adopts tax policies that remove the cost to businesses of hiring its citizens receives real payback in the form of increased exports and employment back home. The evidence is clear that reducing income taxes on citizens abroad increases exports, domestic employment and overall tax revenues while making a nation more competitive globally.

For years, American politicians have railed about how taxes impede businesses and hinder growth. In a global economy where new jobs are driven by exports more than ever, it would be wise for these politicians to heed their own words. President Obama, please take some free advice from your fellow lawyer and schoolmate. Give the American economy a much needed boost and reform the anachronistic income tax policy of the United States that is harming the ability of America to compete in a global economy.

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Dr. Saud Al-Ammari is Managing Partner, Saudi Arabia & Gulf Region, Blake, Cassels & Graydon LLP, Al Khobar, Kingdom of Saudi Arabia. He has experience in a wide variety of corporate and commercial matters inside and outside the Kingdom. He served for ten years as special counsel and later general attorney for Saudi Aramco. Dr. Saud participated as legal counsel and a member of the team negotiating the Kingom’s accession to the World Trade Organization and served as chairman of OPEC’s legal defense team.

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