Up to 6 million Americans live outside the United States. They're a diverse bunch -- self-employed entrepreneurs and corporate wage-earners, artists and academics, students and stay-at-home parents.
Unfortunately, these Americans -- unlike the citizens of every other developed country -- are forced to pay taxes not just to their countries of residence, but also to the IRS. This quirk in the U.S. tax code isn't merely expensive and unfair for Americans living abroad. It also hurts the U.S. economy and stifles job growth here at home.
Fortunately, there's a way to end this counterproductive "citizenship-based taxation" -- and unlock more economic growth -- without increasing the deficit.
Almost every other nation uses some form of residency-based taxation. That means that their citizens only pay income taxes to the country where they're living. For example, a Japanese citizen living and working in Chicago only pays income taxes on his U.S.-earned income to the United States.
But an American working in Tokyo pays Japanese taxes and must also file a return with the IRS -- paying additional taxes on the same income. Expatriates can use provisions like the Foreign Tax Credit or the Foreign Earned Income Exclusion to reduce their U.S. tax bill. But they still often end up double-taxed.
As a result, the entire U.S. economy suffers. Citizenship-based taxation disincentivizes American entrepreneurs from starting new businesses abroad or expanding their domestic business operations overseas.
These enterprises don't exist in a foreign vacuum. A tech firm owned by a U.S. citizen in Germany usually purchases American-made software and exports its final products back to the United States. When these companies struggle, Americans at home lose out.
Citizenship-based taxation also makes it prohibitively expensive for many of these businesses to hire U.S. citizens. According to some estimates, it costs 40% more for U.S. companies overseas to employ Americans rather than foreigners.
Lawmakers from both parties have tried to fix this badly misguided policy on several occasions. In 2018, Rep. George Holding (R-NC) introduced the Tax Fairness for Americans Abroad Act, but it didn't pass. Since then, several Democratic lawmakers have introduced bills to address expat tax issues. But they didn't pass either.
Now another opportunity is coming up. In 2017, Congress passed the Tax Cuts and Jobs Act, a package that streamlined taxes on foreign income earned by U.S. corporations -- but didn't change taxation on foreign income earned by individuals, even though many legislators recognized the importance of such reforms.
In 2025, Congress must decide whether to extend the 2017 provisions or allow them to expire.
Both parties want to make some changes to the Tax Cuts and Jobs Act -- and that process offers the perfect opportunity to finally end citizenship-based taxation that's so counterproductive, it has been rejected by every single country except Eritrea, North Korea, and the United States.
Such a move needn't be complicated or expensive. The revision would simply have to specify that U.S. citizens abroad have the option of switching to residency-based taxation if they wish. Those who prefer to stay in the current system and use a foreign-income tax credit or exclusion could still do so.
A 2022 study by my organization, Americans Citizens Abroad -- which advocates for expats -- showed that switching to a residency-based tax system can be done in a revenue-neutral way. Any new bill should include strong oversight provisions and some other common-sense measures.
For example, the new system could exclude American residents of tax-haven countries from being able to use residency-based taxation. It would also continue to tax U.S. expats on income from U.S. sources and might charge a one-time fee to Americans who decide to transition to residency-based taxation. Long-time residents overseas could be excused from any transition fee. Measures like these would ensure that the transition doesn't cost the U.S. Treasury anything.
Americans living abroad are a net positive for the United States. For the sake of our economy and global competitiveness it's time to treat our expats the way every single other advanced country treats theirs.
