Being an American citizen is an honor in many ways, but it is a huge millstone around the neck for highly successful investors and entrepreneurs because of an oppressive and complex tax system. This is particularly true for those based in and/or competing in global markets.
Indeed, because the tax system (and regulatory system) is so onerous and because it is expected to get far worse in the future, a growing number of Americans are actually giving up citizenship and “voting with their feet.” The politicians view these people as “tax traitors” and are trying to erect higher barriers to hinder economic migration, particularly in the form of confiscatory “exit taxes” that are disturbingly reminiscent of the totalitarian practices of some of the world’s most unsavory regimes. The Wall Street Journal recently reported on this issue:
The number of American citizens and green-card holders severing their ties with the U.S. soared in the latter part of 2009, amid looming U.S. tax increases and a more aggressive posture by the Internal Revenue Service toward Americans living overseas. According to public records, just over 500 people world-wide renounced U.S. citizenship or permanent residency in the fourth quarter of 2009, the most recent period for which data are available. That is more people than have cut ties with the U.S. during all of 2007, and more than double the total expatriations in 2008. …Others are giving up their U.S. nationality to avoid tax increases in the U.S., as the government struggles under huge budget deficits. The top marginal tax rate is set to rise to 39.6% from 35% at the end of this year. A proposal to tax fund manager pay at ordinary income rates, instead of the 15% capital gains rate, is gaining currency in Congress. “Everybody sees the tax rates are going up. At a certain point, it gets beyond people’s pain threshold,” said Anthony Tong, a tax partner at accounting firm PricewaterhouseCoopers in Hong Kong. Unlike most jurisdictions, the U.S. taxes the income of citizens and green-card holders no matter where in the world it is earned.
Perhaps the key sentence in this excerpt is the final one about the United States having a very misguided policy of what is known as “worldwide taxation.” This is the policy of taxing income earned in other nations, even though that income already is subject to all applicable taxes imposed by the governments of those other nations. This policy is a huge competitive disadvantage for American companies trying to compete in world markets (and Obama, not surprisingly, wants to make it more burdensome), but the impact on individual taxpayers is a key factor in the decision by so many U.S. taxpayers to escape the clutches of the IRS. Indeed, it may also be one of the reasons why some highly-talented foreigners – the kind of people who helped make Silicon Valley an engine of prosperity for the entire nation – no longer want American residency.
Ironically, Europe’s welfare states actually have better policy in this area. It is much easier for their residents to move to lower-tax jurisdictions without being followed by their national tax authorities or being ransacked at the border by oppressive exit taxes. Indeed, they usually don’t even need to give up their citizenship. Many French entrepreneurs and investors escape to places such as Switzerland, just as many Swedes and Germans migrate to places like Monaco.
But bad policy is like a toxic virus and it spreads from one place to another. The Financial Times recently urged that all European Union nations agree to impose American-style worldwide taxation rules on their citizens. What should happen, by contrast, is that the United States should copy Europe (in this limited example!) and shift to territorial taxation. This is the approach that would protect America’s sovereignty and also respect the right of other nations to determine the tax treatment of income earned inside their borders. It is also the approach that is embedded in all good tax reform plans, such as the flat tax and national sales tax. Sadly, these arguments don’t seem to matter to the crowd in Washington. If they get to choose between what’s good for America and what gives them more power…well, we all know the answer to that question.