Long arm of the tax man reaches expats

It looks like American expatriates working in Europe are facing a double squeeze, from rising U.S. taxes on their income even as tax rates in the countries where they work ease downward. According to the International Herald-Tribune:

You could say American expatriates were ambushed in May 2006, when the U.S. Congress passed a new tax law - retroactive to the previous January - that raised the tax bracket on anything U.S. expats earned overseas beyond a fixed amount, and put a cap on expat housing allowances...

Anything beyond $85,700 is subject to U.S. tax, unless the expat is paying taxes at an equal or higher rate elsewhere. If paying higher taxes abroad, he can use a foreign tax credit to offset his U.S. tax liability. If there are low or no taxes overseas, then according to the 2006 law, the first dollar of compensation above $85,700 is taxed at the rate it would be taxed at as if the person were living in the United States. Previously it had been taxed as if it were the first dollar earned, at the lowest rate.

But while 20 years ago U.S. citizens who worked in high-tax places like France or Austria were able to use their tax credits to offset all U.S. taxes, these days many countries' tax systems are becoming more competitive, and their top rates have fallen.

In France, where the top rate used to be more than 50 percent, it is now 40 percent. In Germany, the maximum tax rate has been falling 1 to 2 percentage points a year and now stands at 42 percent. Slovakia's maximum personal income tax rate is a mere 19 percent.

What is more, some countries give taxpayers a lot more deductions than the United States. While the French top tax rate of 40 percent is still higher than the U.S. top rate of 35 percent, the French permit taxpayers to deduct large social security payments that cover medical insurance and other obligatory social payments from gross income. The United States does not. The French also allow deductions for child support and support of aged parents, and credits for housekeeping help if done within the legal framework. In the United States, there are no tax benefits for these expenditures.

The bottom line is that in some cases, despite higher nominal tax rates, the tax liability overseas may actually be lower than the U.S. tax liability.

The United States is one of the few countries around the world to treat its citizens as property of the state whose income can be claimed by the tax man no matter where they live. Most countries tax only people who reside within their borders under the theory that folks living thousands of miles away aren't putting any demand on the government they left behind. The long reach of the American tax man was annoying, but tolerable (by those who didn't actively evade the I.R.S.'s sticky fingers) so long as the U.S. was a comparatively low-tax nation and the countries in which the expats resided were high-tax -- after all, it's not like most expats were losing out on a deal.

But now they are missing out on a deal. The inclusion in the European Union of the newly free nations of Eastern Europe, most of which are opting for limited governments funded by low, flat tax rates, is exerting downward pressure on tax rates even in the traditionally over-governed Western European countries. If France and Germany don't lower their tax rates, they lose businesses and talent across borders to more competitive environments. And so lower them they do.

Americans working in Europe get to watch these developments, but because they're still taxed by distant Washington, D.C., they don't enjoy the benefits. Especially under the new rules, lower European taxes get turned into a higher bill from the I.R.S.

Now, throw in the fact that most of those expats are paid in free-falling U.S. dollars, and you add insult to injury.

Companies seeking to entice Americans to work overseas are likely to face increasing obstacles to making such assignments financially attractive. Compensation packages are probably going to have to become creative to make it worth Americans' time to work overseas. I expect that at least some long-time expats who plan to maintain that status will opt to drop their U.S. citizenship in order to escape avaricious U.S. officials. Even then, though, the I.R.S. claims the power to pick the pockets of former citizens for ten years.

In the end, there has to be some escape from a government that seems dead-set on turning U.S. citizenship into an expensive burden.