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Is The Justification For The United States’ System of Worldwide Taxation A Hoax? – Part I



The U.S. is one of the only countries left in the world that still taxes its citizens and residents on their worldwide income, regardless of where it is earned. In contrast, other countries practice a territorial tax system. Under a territorial tax system, taxation is limited to taxation of income from sources within a country’s boundaries, no matter who derives it – a citizen, resident, or anyone else. Territorial tax systems accommodate other tax systems in the simplest way possible – by not extending their own.

No other topic generates more debate than the U.S. policy of taxing its citizens and residents on their worldwide income. Have you ever stopped to think about what the justification is for the U.S.’s system of worldwide taxation? Does it make sense?

This article will reveal exactly what that justification is and evaluate whether it makes sense from the perspective of a U.S. citizen who lives abroad.

What gives the United States the right to tax its citizens on a worldwide basis in the first place? It has long been established that the U.S. Constitution permits the federal government’s worldwide taxation of nonresident U.S. citizens. A little-known U.S. Supreme Court case by the name of Cook v. Tait, 265 U.S. 47 (1924) is responsible for that. In upholding the federal income tax assessed by the federal government on a non-resident citizen’s Mexican-source income, the U.S. Supreme Court interpreted the U.S. Constitution to allow worldwide taxation of nonresident U.S. citizens.

What rationale lies at the heart of the Court’s justification for worldwide taxation? Nothing less than the “public benefits” stemming from U.S. citizenship.[i] Specifically, the Court reasoned that a citizen who lives abroad and whose property is located outside the U.S. receives benefits from the federal government.[ii]

Precisely what “benefits” was the Court referring to? According to T. H. Marshall, author of “Citizenship and Social Class,” the Court viewed benefits as consisting of three distinct rights: “civil, political, and social rights.”[iii]

By civil rights, Marshall was referring to “the rights necessary for individual freedom – liberty of the person, freedom of speech, thought and faith, the right to own property and to conclude valid contracts, and the right to justice.”[iv]

By political rights, Marshall was referring to “the right to participate in the exercise of political power, as a member of a body invested with political authority or as an elector of the members of such a body.”[v]

And by social rights, Marshall was referring to those that were the most significant, namely “the educational system and the social services” available to members of a society.[vi]

Against this framework, how did Mr. Cook stand? He fell woefully short of enjoying most, if any, of these rights. With respect to political rights, Mr. Cook lacked the most fundamental one: the right to vote. Why? Because back in 1924 when Cook was decided, a U.S. citizen living abroad did not have the right to vote.[vii] That’s because such a person “did not live in any state and thus had nowhere to cast a ballot.”[viii]

However, that has long since changed. Since 1986,[ix] a nonresident U.S. citizen, like Mr. Cook, has the right to cast an absentee ballot in a federal election in the state where he “was domiciled before leaving the United States.”[x] That does not mean that every nonresident U.S. citizen can automatically vote. On the contrary, a nonresident U.S. citizen who has not established residence in a particular state will not be able to vote in a U.S. election.[xi] Very simply, he is a nomad when it comes to having a “home” from which he can cast a ballot.

In terms of civil rights, Mr. Cook, not unlike any contemporary U.S. citizen living abroad, could “have called on the U.S. for formal diplomatic protection, including representation in international negotiations or arbitration.”[xii] Mr. Cook could have also requested “less formal assistance” from the American Consulate in Mexico or, at the extreme, “military protection, including evacuation” by the U.S. military.[xiii]

The problem of course, is that there is no telling whether the U.S. would have granted these requests. In other words, Mr. Cook “merely had the right to ask.”[xiv] Beyond that, because Mr. Cook was a Mexican resident, his civil rights were guaranteed not by U.S. law, but by Mexican law.[xv] This is true today of any U.S. citizen living abroad: it’s the foreign government’s responsibility.[xvi]

Perhaps the only remnant of U.S. civil rights that Mr. Cook retained was the ability to return to the U.S. at anytime. In terms of this right, Mr. Cook had a “leg up” on a permanent resident. Very simply, permanent residents can be stripped of the right to permanent and continuous presence in the U.S. if they commit any one of a number of certain types of crimes, aptly referred to as “aggravated felonies.”

Consider a permanent resident who is arrested and charged with aggravated assault, a crime that has been designated as an “aggravated felony.” If convicted, the person would be deported. While a U.S. citizen who commits a crime faces punishment, he or she does not face the same draconian result as a permanent resident – outright “expulsion” through deportation.[xvii]

Therefore, a permanent resident does not have the same ironclad guarantee of permanent and continuous presence in the U.S. as a nonresident U.S. citizen does.

And let’s not forget something even more fundamental when it comes to distinguishing between nonresident U.S. citizens and permanent residents: freedom to travel and to move from place to place. While U.S. citizens, resident and nonresident, have the absolute right to live outside of the U.S. for however long they wish, the same is not true of permanent residents.

Unlike a U.S. citizen, a permanent resident cannot live outside the U.S. for a continuous period in excess of 180 days. Such a person must “return to the U.S. after spending 180 days abroad.”[xviii] As a U.S. citizen, Mr. Cook “faced no such requirement.”[xix] In other words, Mr. Cook could have spent 181 days or 181 years in Mexico. If he then decided to return to the U.S., he would not have encountered any barriers to re-entry. On a primitive level, while a permanent resident’s ability to remain outside of the U.S. might be restricted, one cannot overlook the fact that he still has the right to live in the U.S. just like a U.S. citizen does.

With respect to social rights, there are few U.S. social benefits that the “contemporary Mr. Cook” would be entitled to while living in Mexico. For starters, unemployment insurance and Medicaid are state-run programs to which Mr. Cook would not be entitled to today since he has no state of residence.[xx]

On the other hand, if the contemporary Mr. Cook was self-employed or worked for a U.S. employer, he would be eligible for U.S. social security benefits, since there is no totalization agreement between the U.S. and Mexico.[xxi]

If, however, Mr. Cook had lived in one of the twenty-four nations with which the U.S. had a totalization agreement, then he would not be eligible for U.S. benefits. Why? Under a totalization agreement, U.S. citizens living abroad are exempted from paying U.S. social security taxes.[xxii] And because they are exempted from making payments, they get absolutely nothing in return.[xxiii]

However, that does not mean that Mr. Cook would be deprived of social insurance benefits altogether. On the contrary, to the extent that he paid into the social security system of the country in which he resided, he would be eligible for retirement benefits from that country later in life. Such would be the case if Mr. Cook lived in Canada, Japan, Australia, South Korea, or Chile, a few of the countries in which the U.S. has a totalization agreement.[xxiv]

In order to see how paltry a nonresident U.S. citizen’s rights actually are, it is helpful to compare the U.S. legal rights of such a citizen with the U.S. legal rights of a resident alien. If you thought that a nonresident U.S. citizen enjoyed more rights than a resident alien, you’d be sorely disappointed.

A nonresident U.S. citizen possesses more rights than a resident alien in just one respect: the right to vote. Very simply, resident aliens are not permitted to vote in U.S. elections.[xxv]

Outside of the right to vote, the resident alien possesses substantially more rights than the nonresident U.S. citizen. How so, you ask? By the mere fact that he lives on U.S. soil.

Let’s take civil rights for example. While a nonresident citizen “has the right to ask the U.S. government for assistance” during a time of crisis, there is no guarantee that the government will “answer the call.”[xxvi] In stark contrast, a resident alien receives a plethora of civil rights, from “the protection of his person and property” by the U.S. government to “the guarantees embodied in the Bill of Rights.”[xxvii]

The civil rights of a nonresident U.S. citizen, on the other hand, are provided by the nation in which he resides, and not from the U.S.[xxviii]

With respect to social rights, a nonresident U.S. citizen derives few, if any, from the U.S. government.[xxix] Because social security benefits tend to be one of the most cherished social rights of U.S. citizenship, let’s look at how a nonresident U.S. citizen’s claim for social security benefits would be viewed by the Social Security Administration.

Such a claim would be denied, unless the nonresident U.S. citizen satisfies the following conditions:

(1) There is no totalization agreement between the U.S. and the nation in which he lives;[xxx]

AND

(2) He works for a U.S. or other employer covered by the U.S. social security system (as a general rule, U.S. citizens or residents employed outside the U.S. by “an American employer” pay FICA taxes on their salaries);[xxxi]

OR

(3) If he is self-employed, he pays federal self-employment tax on his foreign-source earned income.[xxxii]

On the other hand, a resident alien is entitled to a plethora of social services provided by the federal government and the states, from “public education for his children” to “welfare benefits such as unemployment compensation and income assistance.”[xxxiii]

In summary, the citizenship-based benefits enjoyed by Mr. Cook and other U.S. citizens residing abroad are minimal. These trifling benefits fall woefully short of justifying worldwide taxation of a U.S. citizen’s assets and income under a benefits theory.

While Cook might provide Constitutional validation for the U.S. to tax its citizens and residents on a global basis, the benefits rationale that it relies upon as justification for that authority is unconvincing.

What do you think?

 

Next:  Is The Justification For The United States’ System of Worldwide Taxation A Hoax? – Part II

Original Post By:  Michael DeBlis

Endnotes:

[i] Citizenship and Worldwide Taxation: Citizenship as an Administrable Proxy for Domicile, Edward Zelinsky, Iowa Law Review, 2011.

[ii] Cook v. Tait, 265 U.S. at 56 (“government by its very nature benefits the citizen and his property wherever found”).

[iii] T.H. Marshall & Tom Bottomore, Citizenship And Social Class 8 (1992).

[iv] Id.

[v] Id.

[vi] Id.

[vii] Id, supra, Note (i), at p. 1308.

[viii] Id.

[ix] In 1986, the President signed the Uniformed and Overseas Citizens Absentee Voting Act, Pub. L. No. 99-410, 100 Stat. 924 (codified as amended at 42 U.S.C. Sections 1973ff to -6 (2006)).

[x] Id. Section 1973ff-6(5)(C).

[xi] Id., supra, Note (i), at p. 1308.

[xii] Id.

[xiii] Id.

[xiv] Id.

[xv] Id., supra, Note (i), pp. 1308-09.

[xvi] Id. at 1309.

[xvii] Id.

[xviii] Id. at 1309, citing 8 U.S.C. Section 1101(a)(13)(C) (listing conditions under which a permanent resident alien shall be “regarded as seeking an admission into the United States for purposes of the immigration laws,” including “absen[ce] from the United States for a continuous period in excess of 180 days”).

[xix] Id.

[xx] Id.

[xxi] Id. (citing U.S. International Social Security Agreements).

[xxii] Id.

[xxiii] Id.

[xxiv] U.S. International Social Security Agreements.

[xxv] Id., supra, Note (i), p. 1315.

[xxvi] Id. at 1315-16.

[xxvii] Id. at 1316.

[xxviii] Id.

[xxix] Id.

[xxx] Id.

[xxxi] Id.

[xxxii] Id.

[xxxiii] Id.

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As a former public defender, Michael has defended the poor, the forgotten, and the damned against a gov. that has seemingly unlimited resources to investigate and prosecute crimes. He has spent the last six years cutting his teeth on some of the most serious felony cases, obtaining favorable results for his clients. He knows what it’s like to go toe to toe with the government. In an adversarial environment that is akin to trench warfare, Michael has developed a reputation as a fearless litigator.

Michael graduated from the Thomas M. Cooley Law School. He then earned his LLM in International Tax. Michael’s unique background in tax law puts him into an elite category of criminal defense attorneys who specialize in criminal tax defense. His extensive trial experience and solid grounding in all major areas of taxation make him uniquely qualified to handle any white-collar case.

   

5 thoughts on “Is The Justification For The United States’ System of Worldwide Taxation A Hoax? – Part I

  1. Avatar Kathleen P. says:

    As an ‘accidental’, who has been battling FATCA, and USA’s unique to the world ‘US person’ taxation regime for over two years now, immediately I noticed that the article does not quite clarify how USA’s taxation differs from the taxation systems of virtually ALL other countries (with one minor exception, Eritrea, with a much milder from of extra-territorial taxation).

    Many countries tax WORLD-WIDE income of their citizens and residents. the BIG DIFFERENCE is that they do not tax income of non-residents earned OUTSIDE the country. Thus, this statement in the article is incorrect at best, and misleading at worst: ” Under a territorial tax system, taxation is limited to taxation of income from sources within a country’s boundaries, no matter who derives it – a citizen, resident, or anyone else. ”

    Under a territorial tax system, SOME countries, for example Canada, do indeed tax income earned OUTSIDE Canada by their residents (citizens and legal residents), but the point is that the people being taxed RESIDE in Canada. In other words, many countries with a territorial taxation system, tax worldwide income, BUT they tax worldwide income of people who actually reside within their borders. USA is the only country in the world (with that one minor exception) who tax income of people who NEITHER LIVE, NOR EARN within its borders.

    • Avatar Mike says:

      Kathleen:

      You are correct. There are two forms of worldwide taxation: citizenship-based and residence-based. I did not get into the specifics of the second form of worldwide taxation (i.e., whereby nations tax individuals on their global incomes and holdings only if such individuals reside in these nations) as the theme of the article was the lackluster justification for U.S. worldwide taxation.

      However, if you were confused, then I assume that many others were as well.

      To clear up the confusion, my discussion of “territorial taxation” had nothing to do with the “other” form of worldwide taxation (i.e., residence-based worldwide taxation).

      Let me go back to the beginning. There are two bases on which nations may exercise jurisdiction to tax: (1) source and (2) political allegiance. Under the first category, a nation taxes income or assets located (“sourced”) within its borders regardless of where the owner of such income or assets lives. This is what I meant by a “territorial tax system.”

      Jurisdiction based on “political allegiance” is premised not on the source of income or assets but upon the political allegiance of the taxpayer who owns such income or assets. Taking a unique position, the U.S. defines “political allegiance” as an individual’s citizenship, regardless of his residence. Very succinctly, Treas. Reg. 1.1-1(b) states that all U.S. citizens, regardless of whether they live in the U.S. or not, must pay U.S. tax on their worldwide income.

      Nations other than the U.S. define “political allegiance” for tax purposes on the basis of residence (i.e., residence-based taxation). in so doing, they tax their residents on a worldwide basis without regard to the source of such residents’ incomes or assets and without regard to such residents’ citizenships. This is Canada’s system.

      Canada imposes worldwide taxation on all of its residents without regard to Canadian citizenship. The chief difference between the U.S. system of citizenship-based taxation and the Canadian system of residence-based taxation is that a non-resident Canadian citizen pays Canadian income tax only on his Canadian-source income, whereas a non-resident U.S. citizen is liable for U.S. taxes on his worldwide income.

      Sorry for the confusion. Hope this clears things up.

  2. Avatar JDL says:

    @Michael

    Great article. I completely agree with your conclusion. Please have a look at this post about the unconstitutionality of citizenship based taxation over at Isaac Brock Society. I think you will find it interesting.

    http://isaacbrocksociety.ca/2014/12/22/from-shadow-raider-on-december-17-2014-constitutionality-of-citizenship-based-taxation/

  3. Avatar Mike says:

    JDL:

    Thank you very much for providing me with this link. It looks very interesting. Can’t wait to read it.

  4. Avatar Lynne says:

    Yes, Michael, the justification for CBT is a hoax. Read this article I wrote for Tax Connections and tell me what benefits a Canadian cop or an elderly Canadian grandmother possibly gets from the United States.

    http://taxconnections.com/taxblog/why-does-u-s-congress-and-irs-want-a-canadian-cop/#.U7x6c0DfV8E

    Yet, without a CLN (which U.S. Consulates did not even mention decades ago!), the U.S. considers them and millions of other honest people around the world to be criminal tax cheats.

    As Nina Olsen said: “Why are we doing this to folks? Why are we tormenting them in this way?”

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