In recent years, the United States has increased enforcement of non-resident tax liability, generating debate surrounding the U.S. moving towards a territorial model of taxation. An increasing number of Americans living abroad are renouncing their citizenship. According to the U.S. Treasury, 1,781 Americans gave up citizenship in 2011. Contrast that with 742 in 2009 and 278 in 2006 (McKinnon 2012). Corporations also bear the burden. In 2008, 12 percent of all federal revenues came from corporate income taxes, of which about half was paid by multinational corporations reporting foreign income (CBO). Thus, many corporations are following suit, using tax avoidance schemes to reduce the scope of their U.S. tax burden or simply moving to other tax jurisdictions.
The United States is one of only two countries in the world that taxes its citizens on their worldwide income, without regard to physical residence. Throughout the rest of the world, taxes are imposed on individuals based on their residency, not citizenship (McKinnon 2012). Such a statement brings the question as to why the United States is such an outlier in this respect? This paper will serve as a discussion of the origins of the United States’ system of worldwide taxation, the tax system’s current state and implications on U.S. corporations, and recent proposals to amend the system.
The United States’ system of worldwide taxation garners its origins from national conflict. The first national individual income tax, enacted in with the Revenue Act of 1861, coincided with the outbreak of the Civil War and sought to help the funding of war expenses (Terrell). The Act imposed a 3% tax on income over $800. However, a 5% tax was imposed on income earned by any citizen living abroad (McKinnon 2012).
The intention of such a stipulation was to prevent U.S. citizens from evading military and civic obligations by fleeing the country. The Act was further enhanced in 1864 to include income from all sources, wherever derived. The motivation for such a revolutionary tax grew from the idea of taking pride in being a U.S. citizen, and accepting the opportunities with the obligations (McKinnon 2012).
Ten years later, following the conclusion of the war, the tax was repealed. In 1894 Congress enacted a flat rate Federal income tax. The tax was ruled unconstitutional the following year by the Supreme Court due to its nature as a direct tax not apportioned to the population of each state (Terrell)
The 16th amendment, passed by Congress on July 2, 1909, and ratified February 3, 1913, removed this issue. The amendment allows the Federal government to tax income without regard to the population of each State (Terrell).
However, the notion of citizenship-based taxation remains part of U.S. law today. In contrast, majority of early international agreements taxed either residence or source of income, but not both (McKinnon 2012).
Under a worldwide approach to taxation, the home country considers all of the income...