As part of their newly-published paper on “Options for Reducing the Deficit“, the Congressional Budget Office has suggested, as Option 12 (at page 130), to “Include All Income That U.S. Citizens Earn Abroad in Taxable Income” — in other words, to eliminate the Foreign Earned Income Exclusion and Foreign Housing Deduction. They estimate that this would bring in US$33.3 billion over the next five years, and US$88.5 billion by 2023 — roughly an order of magnitude more than the US$8.7 billion that FATCA is expected to reap in the course of a decade.
This is the third proposal this year to eliminate the FEIE. Eight months ago, the Congressional Progressive Caucus derided the FEIE as the “Foreign Earned Income Loophole” and claimed that eliminating it would raise US$71 billion over ten years (not clear whether they include the FHD in that number). Days before that, when Dennis Ross (R-FL) presented his own hilariously hypocritical plan to kill the FEIE so that corporations could enjoy territorial taxation, the Joint Committee on Taxation estimated that cutting both the FEIE and the FHD would raise US$36.3 billion over five years. CBO states that they are are using the JCT’s new estimates as updated for 2014.
As previously pointed out, the JCT estimates seem to assume that the “cost” of the FEIE is the foregone tax on all of the excluded income by U.S. Persons who file form 2555 — 415,519 excluding an average of $62,147 each, according to 2010 data — when in reality, if the FEIE were eliminated, many of them would simply switch to using the more-complicated Foreign Tax Credit, incurring higher tax preparation costs, but offering no corresponding benefit to the U.S. Treasury. Bizarrely, CBO acknowledges this prospect in their report, but doesn’t adjust their estimates to account for it:
U.S. citizens who live in other countries must file an individual U.S. tax return each year, but several provisions of the tax code reduce their U.S. tax liability. First, those citizens may exclude from taxation some of the income they earn abroad: up to $97,600 for single filers and up to $195,200 for joint filers in calendar year 2013. (Those amounts are adjusted, or indexed, for inflation.) Second, under certain circumstances, U.S. citizens living abroad can also claim an exclusion or deduction for any allowance their employers provide for housing in a foreign country. Those two tax provisions—combined with the personal exemptions and deductions available to taxpayers living in either the United States or other countries—mean that U.S. citizens who reside abroad and earn over $100,000 (or, in the case of married U.S. citizens living abroad, over $200,000) may not incur any U.S. income tax liability, even if they pay no taxes to the country in which they live. Third, if those citizens pay taxes to the country in which they live, they can receive a credit on their U.S. taxes for foreign taxes paid on any income above the U.S. exclusion amount. As a result, most U.S. tax filers who live abroad do not have any U.S. tax liability.
This option would retain the credit for taxes paid to foreign governments but would require U.S. citizens living overseas to include all of the income they earned abroad, including housing allowances, in their adjusted gross income. (Adjusted gross income includes income from all sources not specifically excluded by the tax code, minus certain deductions.) As a result, U.S. citizens living in countries with lower tax rates than those in the United States would tend to owe more—and, in some cases, potentially much more—in U.S. taxes than under current law, while U.S. citizens residing in countries with higher tax rates would generally continue not to owe U.S. taxes on their earned income. The staff of the Joint Committee on Taxation estimates that implementing such a change would increase revenues by $89 billion over the 2014–2023 period.
(Of course, there are far more than 415,519 Americans residing abroad, but contrary to the assumptions behind FATCA and similar laws, no one actually knows if these non-filers are earning much income at all, nor what portion of them live in low-tax countries and what portion live in high-tax countries. If non-filers are on average more like average residents of their countries, and are living in the more typical destinations for Americans abroad such as Canada, Mexico, and Western Europe — and less like the Middle East corporate assignees with Big 4 assistance who are the most likely to be aware of their U.S. filing requirements — then the U.S. is going to find very slim pickings from the pockets of its newly FEIE-less diaspora, especially in comparison to the cost of hunting down all these non-filers and processing their paperwork.)
The Congressional Budget Office goes on to demonstrate that — like far too many Homelanders — they do not understand the difference between moving overseas and renouncing citizenship:
One rationale for eliminating the partial exclusion for foreign earnings is related to a certain concept of equity—that U.S. citizens with comparable income should incur similar tax liabilities, regardless of where they live. Under the option, people could not move to low-tax foreign countries to escape U.S. tax liability while retaining the benefits of U.S. citizenship. (To discourage U.S. citizens from moving abroad to avoid taxes, the Heroes Earnings Assistance and Relief Tax Act of 2008 instituted a significant “expatriation tax” on the net worth of wealthy taxpayers who renounce their U.S. citizenship for any reason.)
As repeatedly noted by Brockers, this “expatriation tax” applies not just to “wealthy taxpayers” but anyone who cannot certify under penalty of perjury on Form 8854 that they filed every single one of the ridiculous paperwork messes the Homeland imposes on Americans abroad in the name of “horizontal equity”. And it is already the case under current law that people cannot “escape U.S. tax liability while retaining the benefits of U.S. citizenship” — if you live in a foreign country and receive unemployment or disability payments from them (funded out of high taxes you paid in prior years), the U.S. considers that “unearned income” and taxes you on it without any FEIE.
On the bright side, unlike every time they previously brought up the FEIE, at least Congress admits:
However, the United States is the only member of the Organisation for Economic Co-operation and Development that taxes the income of its citizens on a worldwide basis; therefore, eliminating the exemption for income earned abroad would move the United States further out of alignment with the rest of the world in terms of the tax treatment of foreign-earned income. Another argument for not making this change is that U.S. citizens who live in other countries do not receive all of the same services from the U.S. government that are available domestically, and they may receive fewer services from the low-tax countries in which they reside.
The fact that they point this out at all is a certain measure of progress compared to last year, and is doubtless in no small part thanks to Shadow Raider’s ongoing efforts to educate Congressional staffers on the uniqueness of the U.S.’ system of citizenship-based taxation.