Jurisdictionally speaking, the Internal Revenue Code attempts to cast a broad net. The United States taxes its citizens' income on a worldwide basis, regardless of residency. As every American expat knows all too well, this means overseas earnings must be reported to the IRS as taxable income. It matters not whether you're a permanent resident of another country who hasn't set foot in the U.S. for decades.
The usual justification for this policy is that all Americans derive benefits from their citizenship and should help pay the country's bills. The policy also can be viewed as an antiabuse measure. It deters cross-border tax evasion that might otherwise occur if U.S. taxpayers disguised their domestic activities as foreign employment.
That said, the policy irks many observers. Critics point out that U.S. citizens living abroad don’t benefit from many of the public services their tax dollars support. Paying for things like national parks, aircraft carriers, and farm subsidies has limited utility to an American hedge fund manager living in Dubai. [We note that foreign earned income is subject to a statutory exclusion under code section 911 -- currently about $99,000 per year -- which largely eases these objections. It could just as easily be argued that such a generous exclusion in effect subsidizes the U.S. expat community.]
While the merits of the policy can be endlessly debated, everyone agrees that our citizenship-based tax model is a rarity in international terms. Almost no other countries impose income tax on this basis, with one glaring exception: China.
When the political leaders of the People’s Republic of China decided to modernize the country's federal tax system in the early 1990s, they carefully examined the rules in place in other counties. They eventually concluded their empire-building ambitions would best be served by adopting the key design features of the IRC -- including citizenship-based taxation of personal income.
Yet for the past 20 years, China's State Administration of Taxation (SAT) has declined to enforce this rule. As a result, Chinese expats have grown accustomed to not paying Chinese income taxes on their foreign salaries. The government’s failure to apply the law has been attributed to limited organizational resources inside the SAT and the nonavailability of pertinent income data from private employers. It's also been suggested that by going soft on expats, the government indirectly promotes the expansion and global influence of Chinese firms.
Whatever the case, Beijing is no longer looking the other way. Beginning in 2015, the government expects all Chinese citizens residing abroad to include their foreign salary and wages in taxable income. Why the change? The best answer appears to be that the Chinese government needs the money to meet its spending needs.
Viewed in isolation, this development could easily be overlooked. But when considered alongside other recent steps, it seems clear that China's central government is newly emboldened when it comes to revenue collection. As this trend continues, it wouldn’t be surprising to see China's tax framework become more like America's with each passing year.
We can criticize the code all we want, and for good reason, but it remains the envy of governments all over the world -- including the only other global superpower.