January 25, 2009
President Barack Obama
1600 Pennsylvania Ave NW
Washington DC 20500
Dear President Obama:
First, allow me to congratulate you on your election and on a beautiful inauguration. This is an historic time and I am hopeful for the future. For the first time in my adult life, the United States has chosen a leader who can help the country recognize and confront the serious challenges it faces. Although I have been a supporter of yours ever since your October 2006 appearance on On Point with Tom Ashbrook
, my residency here in Iceland ruled out my being on the ground as a campaign volunteer. I am pleased that I could at least contribute financially to your election campaign. It is not an exaggeration to say that once more I feel proud to be an American, and this goes double for an American living abroad. In many ways, we serve as front-line ambassadors of the United States out in the world. We feel on a daily basis and through our personal interactions the attitudes of those around us towards America, and the change of attitude here in Iceland is palpable.
I write to you about an issue of great importance to me and to many of the 7 million American citizens who live and work outside of the United States. As you might know, the United States is one of a very few nations that taxes its citizens on their worldwide income, and is the only industrialized nation to do so. When my Icelandic colleagues move overseas for an education or to live and work (as is quite common here), they pay no income tax to Iceland during their residency abroad, paying that tax only to the country of their residence. The same goes for the citizens of all OECD countries apart from the United States.
America’s collection of taxes on the worldwide income of its citizens, as it has done since the Revenue Act of 1913, might be perpetuated as an attempt to catch “high rollers” but in reality, it has now become a middle-class problem. The Foreign-Earned Income Exclusion (that stood at $85,700 for the 2007 tax year) was originally designed in the 1970s to shelter the majority of Americans abroad from dual taxation, but was only in 2005 indexed to inflation. One author comments: “The FEIE mirrors the flaw [of] the Alternative Minimum Tax: designed to protect all but the very wealthiest tier of expatriates, it now fails to protect the middle class taxpayers and lets them fend with the tax system as if they were all one of those wealthiest few.” (Reference 1)
Even those Americans abroad who know they fall below the FEIE exclusion are obligated to file taxes with the IRS each year. The filing process represents a significant burden in both time and money. Each year, following a weekend spent filing taxes for the Icelandic authorities, I spend the better part of a second weekend preparing my tax information for a tax preparer back in the US. After converting all paychecks, Icelandic income taxes, pension payments, bank interest, and capital gains from local currency into dollars, I mail him spreadsheets full of data. We then go back and forth through several iterations to clarify all of the items. At the end of the process, he mails me a stack of IRS forms and supporting documents running to 35 pages, and a bill for $200. I sign and mail the filing to the IRS, and thank him for not charging me more.
I expend this effort and money each year for the most straightforward of cases: I am unmarried with no kids, one job, and a couple of bank accounts. In the four years I have been filing from Iceland, I have never owed a penny. From my perspective as a middle-income earner, the process is wasteful and unnecessary, not just for me but also for the IRS official on the other end of the manila envelope. The authors of a recent Vanderbilt law paper agree. They state: “U.S. citizens overseas often face a difficult task in meeting their U.S. filing obligation and computing any tax [owed]. The IRS faces a difficult and relatively unrewarding task in seeking to remedy the significant non-compliance that likely occurs.” (Ref 2) Furthermore, the level of IRS service available to us is minimal: “The IRS provides very little in the way of on-site service for U.S. citizens overseas. Currently, the IRS has overseas offices only in London, Paris, and Frankfurt.” (Ref 3)
There are other problems with the taxation of Americans abroad. In its attempt to shoehorn foreign realities into the straightjacket of a Form 1040, the process further penalizes us relative to our families and friends back in the States:
- Pension provisions: In my case, even though Icelandic law binds me to contribute between 4 and 8 percent of my pre-tax income to a personal retirement account, I cannot deduct this amount from my income as can those who contribute to a 401(k) back home.
- Other taxation regimes: There is no allowance for different taxation regimes in this broken system. Here in Iceland we pay 24.5% value-added tax (VAT) on almost everything we buy, representing a significantly higher consumption tax burden than the sales tax of any American state, yet there is no offsetting of these heavy taxes via the IRS forms, resulting in double taxation.
- Asymmetry: Nor is the system symmetrical in that the IRS will not cut me a refund check for any income taxes I pay to Iceland in excess of what I would have paid to the US: “The US taxpayer residing abroad will in no circumstance be able to collect from the US government any foreign tax paid in excess of the amount that would have been paid at home.” (Ref 4) In effect, I have all of the tax obligation of another American, but none of the upside of refunds on excess taxes paid.
- Purchasing power: Finally, the US tax system makes no allowance for differences in purchasing power. With the falling dollar of recent years, an entry-level office job in Iceland in 2007 could easily have converted to a $70,000 gross income, a number very close to the FEIE threshold.
How can we reform this system? I propose to follow the model of our Western-world friends and completely phase out the taxation of Americans living overseas over the next four years. This change would carry great long-term benefits for the United States: eliminating these taxes would encourage more Americans to work for a period overseas, something that is common practice elsewhere in the West, and something that would benefit the image of America abroad. It would also remove what is today a substantial roadblock to American companies posting their own American employees for a tour of duty in their overseas subsidiaries – activity that has fallen especially sharply in recent years in low-income-tax jurisdictions like Hong Kong. In addition, more Americans working for a time abroad would enhance those same Americans’ ability to contribute new ideas and the wisdom of their experience once they returned home.
Now that change is in the air and now that we seem to be taking stock of long-held assumptions, now would be an excellent time to phase out the taxation of the portion of Americans’ income that is earned abroad. The Blum and Singer paper referenced here below offers one proposal for doing just this. I hope that you will consider making this a priority as you look to enhance America’s participation and competitiveness abroad.
Senator Edward M Kennedy
Senator John Kerry
Representative Michael Capuano
Also published as an open letter on: http://icelandreport.blogspot.com/References:
1. Parmly, American University Washington College of Law, provides an excellent background on the realities of taxation on Americans abroad: http://www.aca.ch/joomla/index.php?option=com_content&task=view&id=212&Itemid=46
2. Blum and Singer, May 2008, Vanderbilt Journal of Transnational Law, provide one proposal for reform: http://law.vanderbilt.edu/publications/journal-of-transnational-law/download.aspx?id=3142