As I watch the IGA spectacle unfold, I have the feeling that other countries don’t understand citizenship-based taxation. They don’t understand that by employing citizenship-based taxation, they are really asking other countries to identify lawful residents of their countries, and help the U.S. collect tax from them. This tax collected as at the expense of the country where those US citizens reside. All penalties paid under the OVDP and OVDI penalty programs erode the tax base of the country where the U.S. citizen abroad resides. Because no other country (except Eritrea) imposes citizenship-based taxation, reciprocity (even if the U.S. could be trusted, which it clearly can’t) would not mean that the US would report on citizens of other countries. At best, the US would report on residents of other countries that have bank accounts in the US. The point is a simple one:
A FATCA IGA does not require the US to erode its own tax base in any significant way.
Why is there this imbalance? The answer is simple. Only the US employs citizenship-based taxation. The US employs citizenship-based taxation as a weapon against not US citizens abroad, but against the countries where they reside.
Therefore, at the end of the day, if the US is going to get “FATCA Co-operation” from the rest of the world, it must stop citizenship-based taxation.
Interestingly this necessity seems to have been recognized in an academic paper – FATCA: Toward a Multilateral Automatic Information Reporting Regime by Joanna Heiberg. I highly recommend this article.
She writes in part:
D. Room for Compromise: Citizenship-Based Taxation
Despite its commitment to a collaborative FATCA regime, the proposed intergovernmental approach ignores a significant underlying inconsistency: basis for taxation. Whereas most countries impose taxes on resident and source income, the United States also taxes nonresident citizens. This inconsistency provides an opportunity to reevaluate the policy of taxation based solely on citizenship159 and, this Note argues, to terminate it.
First, strong non-FATCA based arguments exist in favor of eliminating citizenship-based taxation.160 The United States is the only country in the world to base worldwide taxation solely on citizenship.161 This policy dates back to the Civil War,162 and is protected via a “saving clause” in U.S. income tax treaties.163 Historic U.S. justifications for taxing nonresident citizens, including deterring draft-dodging and flight of wealthy Americans, no longer apply.164 Similarly, arguments in favor of taxing these individuals are weak,165 especially in light of existing alternative bases for taxation.166
Second, FATCA imposes substantial burdens on U.S. Citizens living abroad in the form of complex reporting requirements167 and, in some circumstances, barriers to obtaining a foreign bank account, insurance, or pension.168 Under FATCA, FBAR, and other existing reporting requirements, inadvertent noncompliance may result in steep civil and criminal penalties that are often disproportionately high in comparison to the amount of tax involved.169 Abandoning taxation of nonresident citizens could lead to significant simplification and reduction of administrative costs, which likely exceeds the revenue collected solely on the basis of citizenship.170 Third, elimination of citizenship-based taxation would not impair FATCA’s goals of tracking down tax evaders and raising revenue. FATCA was designed to fight offshore tax evasion by “bad actors” whose primary reason for establishing and and avoid paying U.S. taxes they legally owe.171 In contrast, the estimated five to seven million172 U.S. citizens living abroad generally fall into a category of “benign actors”173 whose primary reasons for establishing and maintaining overseas accounts are unrelated to tax. Nonresident citizens include a wide range of individuals, from those who choose or are assigned to live overseas due to the opportunities of globalization to “accidental citizens” who were merely born in America and left the country at a young age.174 The average nonresident citizen holds foreign assets, including bank accounts, retirement funds, insurance plans, and investments, that are necessary for living and working in his country of residence. Similarly, due to international income exclusions and credits, citizens living abroad have, at most, a deminimis tax liability.175 Despite this inconsistency, FATCA poses serious problems for U.S. citizens living abroad.176
Finally, termination of citizenship-based taxation would facilitate an intergovernmental approach to automatic information reporting.177 Requiring financial institutions to identify both a taxpayer’s residence and citizenship, as is currently the case, doubles the amount of work required for compliance with FATCA. Unlike other FATCA requirements under the intergovernmental approach, identifying a taxpayer’s citizenship would only benefit the United States.178 Conversely, the ability to apply a single standard for identifying taxpayers based on residence would improve efficiency and reduce the burden on financial institutions to the benefit of all FATCA partners. Further, this compromise may induce other countries to participate in the proposed intergovernmental approach. This may be especially true of countries, like Canada, that are home to a significant number of U.S. citizens.179
In sum, taxation of nonresident citizens is inconsistent with global norms, creates administrative inefficiencies, and impairs development of a multilateral FATCA regime. For these reasons, the United States should abandon the policy of citizenship-based taxation.