Lesperance: Why Trump Will Not End Citizenship-Based Taxation

Reasonable Doubt
With David Lesperance

A contrarian expert on contingency plans for the wealthy delivers uncomfortable truths.

In a recent speech, Donald Trump became the latest in a long line of US politicians from both major parties who, in seeking the votes of Americans abroad, promised to replace citizenship-based taxation with residence-based taxation. 

Before I go into the details of this topic, as an antidote to criticism, I want to make two points very clear:

• I believe that residence-based taxation is fair and citizenship-based taxation is not, and
• I am not an American, so I do not have a stake in this year’s political fight.

Having cleared that up, I will now evaluate the issue as an observer of the world as it is, not as I wish it to be. In other words, I will try to be the little boy who points out that the Emperor has no clothes. 

Given that only the US maintains a real citizenship-based taxation (CBT) regime (apologies to those few remaining expat Eritreans who may pay a 2% tax to their country for a clearance certificate), I will analyze whether there is any realistic chance that the US will abandon its current CBT basis for a residence based tax (RBT) regime.

There are several perspectives of different groups to consider:

• Group 1: US politicians.
• Group 2: Average Americans who are not golden geese (one percenters) and will live in the US.
• Group 3: Non-golden geese “accidental Americans” who do not live in the US but who reside, work, and will die abroad.
• Group 4: Current or former US golden geese who may already be abroad or could easily move.

US politicians’ perspective

The main goal of a US politician is to get into office and stay there. They may do this because genuine motivation to help society drives them, hunger for power compels them, or they honestly believe they are saving the country from “the other party.”

Whatever the motivation, successful politicians quickly learn that they achieve election and re-election by having the American electorate perceive they are doing everything possible to maximize the net tax (after the IRS budget) that the government collects – from others, of course. 

By creating the image of maximizing tax revenue, politicians make the voters believe that they will pay for the entitlement programs that prior generations of politicians have promised.

One thing to remember is that in the US political world, “long-term” is considered the next election cycle (i.e., every two years). Therefore, real long-term planning falls victim to urgent attempts to get or remain in power.

CBT is very attractive to American politicians for various reasons:

Patriotism and populist appeal

CBT allows politicians to wave the flags of patriotism and to play to the populist underlying prejudices of the vast majority of American voters that the “unpatriotic, undeserving, opportunistic, ungrateful, parasitic rich” who obtained the gift of citizenship in the “greatest country in the history of man” are not paying their “fair share.”

Politicians also want to keep the “what is a fair share?” concept undefined and vague. That is why they will not stick with “legal tax liability” as the definition of “fair share” but rather will talk about additional undefined “moral tax liability.” 

By using imprecise and ambiguous language, they allow the electorate to form their own opinions as to what they feel is fair, patriotic, or moral.

It also allows for the electorate to place their own value on their country’s citizenship and its value to those Americans who live abroad. 

As an illustration, there are a lot of American voters who take it as a given that an American citizen who was born and raised in Thailand will can instantly call upon Seal Team Six to stage a full-blown rescue operation should they get kidnapped in the remote jungle.

The offshore evasion myth

CBT allows American politicians to continue to peddle the “offshore evasion treasure” myth. The say: “You, the voters, don’t have to take entitlement cuts or pay more taxes because there is all this offshore money that will pay for everything.” 

The politicians gloss over 

• That much of that money that is offshore (read: “outside the US”) is not subject to US tax or is after US tax net profits, and 
• Even if you recover that portion, which is US tax evasion money, it is a one-time cash injection, not an ongoing stream of tax revenue.

Since it is virtually impossible to determine the amount that one could reasonably consider the proceeds of tax evasion, politicians fall over themselves with the wildness of their estimates. They might claim $1 trillion one day, $7 trillion the next, escalating to $21 trillion, or even $435 trillion in their rhetoric.

Because of CBT, politicians can vastly increase the number of estimated tax-evading “pirates” out there who are hiding treasure.

Financial leverage over foreign institutions

In the late 1990s, US politicians discovered they had the financial leverage to enforce US tax laws on financial institutions abroad. 

This is a by-product of the US dollar being the dominant world reserve currency and US equity markets having such a large market share. 

No financial institution wants to lose access to US dollar trade or the US markets for its entire client base. Denial of such access would be financial suicide. It was the foreign financial institutes’ recognition of this power that prompted the US to create the Qualified Intermediary Regime (QI). 

So, when authorities found that UBS Group AG and other financial institutions had criminally breached their QI agreements, US politicians used the resulting outrage to pass even tougher legislation – the Foreign Account Tax Compliance Act (“FATCA”). 

The US demonstrated the overwhelming nature of this fiscal power when it forced Vladimir Putin to sign on all Russian financial institutions in the middle of the Crimean crisis. 

Against such devastating financial retribution, one could not reasonably expect other governments, like Canada, to resist US imperialism.

Short-term political focus

Since “long-term” means until the next Presidential or mid-term election, these politicians do not have to worry about whether the US will damage itself on a longer time horizon by using CBT or care whether FATCA is equitable or actually generates significant tax revenue.

Politicians are able to engage in a patriotism auction by each claiming to be doing even more than the last in making sure that the government hunts down golden geese, forces them to pay up, and prevents them from leaving the US tax regime by renouncing the world’s “greatest” citizenship.

As the government pushes all compliance costs onto financial institutions or individual taxpayers, it doesn’t matter that it may collect relatively small revenues. 

In fact, small collections allow politicians to call for even more draconian legislation. It also provides a nice little cover story of those “tax dodging scoundrels” being the reason behind the US’ ongoing budget deficit.

Expanded tax base without political cost

CBT allows the US to tax non-residents who, in any other jurisdiction, would not be subject to that nation’s tax regime. If Russell B. Long, Kingfish Huey Long’s son, were alive today, he would update his famous saying: “Don’t tax you; don’t tax me; tax the fellow behind the offshore tree!” 

In short, through CBT, US politicians can vastly extend the revenue and scapegoating net without upsetting the voters who affect them directly. Since there is no “Senator for the rest of the World” or “Representative for Expats,” CBT has little to no political cost.

Complexity of change

In practical terms, a change from CBT to RBT would require that the government conduct a major rewriting of a significant portion of the US tax code and renogotiate every one of the 66 bilateral tax treaties that the US has on the books.

For all of these reasons, there is a great amount of political capital in maintaining CBT and only loss in going through the tremendous effort to implement RBT.

The average American’s Perspective

During an election cycle, various other issues inundate American voters and consume their attention span.

These are Americans who would also be taxpayers under an RBT system, so a CBT system would have no additional impact on their own US tax liability.

American politicians understand that, for the most part, voters will never take the time or effort to consider the viewpoint of Americans abroad, whom CBT impacts. 

If you doubt this, I suggest you read this typical response to Trump’s proposal. If the average voter thinks about this subject at all, they support CBT because they believe in the offshore treasure story or think only ingrates or traitors would ever consider living outside of the greatest country in the world. 

As for those who would renounce their US citizenship, most of this group would spit venom at them.

If you look at voting behavior, you will find a great deal of support for any effort voters perceive to target tax evasion or make others pay more. Voters consistently feel that they pay too much tax and others are not paying “their fair share.”

Exploiting these underlying prejudices is what passes for political insight in the US on both sides of the aisle.

The non-golden geese “accidental Americans” perspective

This group suffers under a CBT system. US politicians’ efforts to gain and maintain their positions inflict collateral damage on these individuals.

While some willfully ignored their US citizenship and resulting tax liability, misinformation truly misled many on both counts. They are rightly angry about the impact of CBT enforcement legislation like FATCA and the truly draconian cost of becoming compliant.

However, as a practical matter, even when roused, this group lacks sufficient organized numbers to ever capture the attention, or change the minds of, enough average American voters.

For this reason, US politicians have no incentive to do away with CBT, and this group is left to deal with its impact on their lives.

The golden geese perspective

Golden geese tend to be much less bound to the US. They can make and maintain their wealth abroad. There is also a greater chance that increasing numbers will have some experience of life outside of the US, and many may form the opinion that while the US has many virtues, it also has some significant problems. 

Likewise, they may realized that they could live and thrive outside the US.

Finally, this group recognizes the reality that the US tax revenue model is extraordinarily reliant upon them for 46% of the total personal tax revenue. 

As an aging population meets underfunded entitlement programs, they recognize that no matter who occupies the White House or controls the houses of Congress, all levels of the US government will require that golden geese contribute more and more of their income and wealth.

Those who want to at least give themselves the option to leave the US tax system recognize that overcoming CBT is a bigger hurdle for them than for golden geese of other countries leaving the tax regime of their home nation.

As the inevitable increased future tax burden prompts them to recognize their options, we can easily predict that more golden geese will bail out of the US tax system. 

It is also fairly certain that the first reaction of US politicians will be to increase the cost of departure. Of course, they have done this before, and every time, the number of departing golden geese has multiplied as a result (i.e., get out before it becomes even worse!). 

We have no reason to doubt that this action and reaction will continue in the future.

My final thoughts

First, I do not think there is any realistic chance that the US will abandon CBT for a RBT regime. I applaud those Americans abroad who are lobbying for this change, but I just don’t see it happening.

Second, Americans abroad will continue to suffer under CBT until they take action or the government takes action against them. Unfortunately, taking action that will help their situation means coming to terms with bringing themselves into compliance with their existing US tax and filing obligations. 

Once this is done, they can choose to either sever their future liability or pay for the cost of ongoing compliance. Not taking action will inevitably result in the US finding them and applying the full force of tax, interest, and penalties. 

Those who plan to die before the US finds them should realize that they are simply passing this problem to their executors and heirs.

In regard to US golden geese, they will need to decide whether they will continue to absorb the ever-increasing tax liability on them for the benefit of not having to change their current American life situation. 

Some will stay. Some will decide to give themselves the ability to leave but stay for now. Some will leave. While the golden geese are small in number relative to non-golden geese (i.e., the 99%), because the tax revenue system relies on them for over one-third of the total revenue collected, any significant increase in the number of American golden geese who decide to leave will have a major long-term impact on US tax collections. 

Since this impact will not become apparent within a two-year election cycle, American voters will continue to listen to American politicians who dismiss this reality.

In short, CBT is not going anywhere. Americans abroad will suffer the cost and impact of a CBT vs. RBT system. Golden geese will continue to leave. The US will suffer as a result, but because this has a long-term vs. election cycle horizon, American voters and politicians will ignore it.