Why does the US require non-resident citizens to file taxes even for non-US income?

Question

The US requires US citizens to file a return for federal and state income taxes. Interestingly, per the 2017 IRS guide, page 5, it does not matter whether the US citizen resides in the US, or whether the income derives from US sources.

Thus, a US citizen residing outside the US and drawing income entirely from non-US sources would still be required to file for US taxes. In principle, this would even apply to US citizens that were born abroad and never set foot in the US.

This seems to be very uncommon in the rest of the world. For instance, on Expats.SE, it is claimed that only the US and Eritrea tax non-resident citizens on foreign income, and when I as a German national lived and worked in Switzerland, Germany didn't care about my Swiss income. (The Swiss did care about my German income, though.)

I assume that following up on foreign income on non-resident citizens is a big hassle for the IRS. Plus, people qualify for the Foreign Tax Credit and Foreign Earned Income Exclusion, so whatever the IRS does collect in such cases is further reduced. It seems to me like the taxes collected in this manner will likely be trivial compared to any serious enforcement costs. (I would welcome any statistics proving me wrong, or backing this up.)

What is different in the US from the rest of the world to cause this? Has there ever been a political discussion, say in Congress, in which someone explicitly articulated a reason why this practice should continue? I could imagine a couple such reasons, e.g., that US citizens will be eligible for consular protection no matter where they live, and so they should darn well pay for it - but that would apply to citizens of other countries, as well, so it doesn't really tell why the US took a different view of this matter than everyone else.

Answer 1

The United States is the richest country in the Organisation for Economic Co-operation and Development (OECD) by financial assets per capita and first in the world by wealth per adult among the countries evaluated. The US has the most billionaires of any country, more than the entire continent of Europe, much less Africa or South America.

The reason to focus on wealth over income is that it is the wealthy who can migrate. Someone who has a high salary can't simply change their residency. Such people have to change their employment as well. But someone whose income is entirely derived from wealth can easily change their residence.

The US relies on its higher income residents for an exceptionally large amount of its revenue. Almost half of the population pays no federal income taxes at all. The top .1% pay about a fifth of the overall taxes.

What would happen if the US switched to taxing only the income earned in the US for non-residents? A number of ultra-rich people would adjust their residency such that it was no longer in the US. To take full advantage of this, they might also move the corporate headquarters so that what is currently US income and taxed regardless would become non-US income and not subject to US taxes.

As things are, if an ultra-rich person wanted to avoid US taxes, that person would have to give up US citizenship. That would lose various privileges, e.g. the ability to donate to US politicians. But under the more common international model, they would only have to give up residency.

The US is heavily reliant on its richest citizens to support the tax burden. If it reduced that, then it would have to do one or more of increase middle class taxes, reduce spending, or increase borrowing. Note that it dropped provisions changing expatriate taxes out of the recent tax bill to avoid those choices. It may change in the future, as there has been a global shift away from global taxation (tax all income by citizenship) to territorial taxation (tax only income earned locally).

This is less of a concern for most countries, as they rely less on taxes on the rich and more on taxes on the middle class. E.g. Canada gets 54% of its income taxes from the top 10% of earners, compared to 70% in the US. And that's not counting the difference from the Canadian Value-Added Tax (VAT). Comparing to other countries finds that the US had the tax system that concentrated the most taxes on its top 10% in income.

Unfortunately, most of the literature in the US is devoted to income taxes, so we don't have a good measure of all taxes. This is problematic because most countries have a national VAT, which skews taxes paid towards the middle class. The US doesn't. So looking just at just income taxes undercounts the US' relative dependence on income taxes paid by the rich.

Answer 2

As a US citizen abroad you are entitled to tax funded benefits. Here are examples of such benefits. Citizens of other countries are entitled to tax funded benefits provided by their countries, so they would be in their full right to require their citizens to file tax returns as well. The difference between the US and other countries is that the US legislators voted for this law, but their equivalents in other countries have not.

Answer 3

Reasons to tax non-resident citizens:

1. Many countries grant expats the right to vote. So you might argue "no representation without taxation!"
2. Citizens are entitled to consular assistance when abroad.
3. It prevents tax avoidance, in the form of high wealth citizens relocating to foreign tax havens.
4. It prevents unfair tax competition. If only residents are taxed then foreign governments can seek to lure high wealth individuals by offering tax breaks.
5. The potential for tax avoidance and tax competition limits the policy making freedom of governments when it comes to setting tax rates for high earners, and may create a race to the bottom that erodes the tax base in all nations, to the common detriment.

In Europe, whenever any party proposes to increase taxes on high earners opponents invariably argue that the policy would be counter-productive, because high wealth individuals would simply relocate abroad, which may lead to the policy producing little additional revenue for the government, or even a net loss.

When the French government recently attempted to introduce a 75% income tax rate (for earnings over €1 million per annum) there were high profile cases of wealthy individuals threatening to flee the country, including the actor Gérard Depardieu (who followed through).

In the UK, a common argument of Conservatives is that any increase in taxes on high earners will make the country "uncompetitive" (in the sense that the rich will flee to foreign tax havens).

Why don't more countries do it?

A. Administrative convenience: Taxing non-residents is complex to administer and difficult to enforce.

B. Ideological opposition: The right (and some elements of the centre-left) regard tax competition as a feature rather than a bug. A territorial taxation system enables tax avoidance by the rich, limits the policy-making freedom of governments, and helps reduce the size of the state. So what's not to like?

"Competitiveness" can be used as a convenient excuse for opposing popular tax rises on high earners, while presenting the right as sensible pragmatists and the left as unrealistic ideologues.

C. European integration: In Europe, all EU citizens have the right to work and reside anywhere in the union. This means that there would be an awful lot of non-resident citizens for national tax authorities to keep track of. It also means that it is relatively easy for an EU citizen to settle in another member state and, after a period of time, become naturalised and renounce their native citizenship.

Any policy of taxing non-residents would therefore probably have to be imposed at the EU level in order to be truly effective. At the moment there is little appetite among member states for the EU to be given more powers over taxation.

D. Scaleability: For similar reasons I suspect one reason this policy seems to work for the U.S. has to do with scale. If every U.S. state had its own "citizens" and tried to tax them regardless of where they lived in the union (or the world) I expect that would be impracticable. The policy no doubt benefits from being implemented at the federal level of a very large nation.