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V'— MSU Is An Affirmative Action/Equal Opportunity Institution encircmNs-ot U.S. FEDERAL TAXATION OF EXPATRIATES: AN EMPIRICAL INVESTIGATION OF THE EQUITY OF THE FOREIGN EARNED INCOME AND HOUSING EXCLUSIONS BY Sarah Emmons Nutter A DISSERTATION Submitted to {Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting 1993 ABSTRACT U.S. FEDERAL TAXATION OF EXPATRIATES: AN EMPIRICAL INVESTIGATION OF THE EQUITY OF THE FOREIGN EARNED INCOME AND HOUSING EXCLUSIONS BY Sarah Emmons Nutter Although both the U.S. Congress and the private sector use equity arguments to justify the foreign earned income and housing exclusions (IRC §911), no study has investigated the extent to which these provisions enhance equity. The purpose of this study is three-fold: to document descriptive characteristics of expatriate taxpayers, to empirically examine the equity effects of the IRC §911 provisions, and to investigate the impact of the Tax Reform Act of 1986 on taxpayer's elections of the IRC §911 provisions. The coefficients of variation and residual variation are used to examine the horizontal equity effects of the IRC §911 provisions. The Suits index and the tax liability and residual progression coefficients are used to examine the vertical equity (progressivity) effects of the IRC §911 provisions. Adjusted expanded income is used as a measure of income and two alternative measures of taxes are used: tax liability and effective tax rates computed on both a U.S. and worldwide basis. The equity measures are computed for two tax regimes: one with the IRC §911 provisions and the other without the IRC §911 provisions using a unique database, the 1987 Statistics of Income foreign sample of taxpayers filing for the IRC §911 provisions. Foreign tax rates and foreign exchange rates are used to recompute the tax liability of the expatriates under a tax regime without the IRC §911 provisions in place. Data from 86 countries are used to assess the use of the IRC §911 provisions across time. The countries included have data available in both the 1987 and 1983 Statistics of Income foreign sample, State Department estimates of expatriates, and an estimated foreign tax rate available. The results are inconsistent with the hypothesis that horizontal equity increases with the inclusion of the IRC §911 provisions. The results of the tests examining the progressivity of the tax regimes are mixed. Using the Suits Index, the tax regime with the IRC §911 provisions is more progressive than the tax regime without the IRC §911 provisions in place. The results using the tax liability and residual progression coefficients indicate the opposite. However, both tax regimes are very progressive. The results indicate that the use of the IRC §911 provisions declined between 1983 and 1987. This dissertation is dedicated to my husband, David my three sons, Neill, John, and Ian my parents, my family and good friends. I couldn't have done this without their love and support and God's blessings. iv ACKNOWLEDGEMENTS I am very grateful to my commitee members at Michigan State University for their professional expertise and personal encouragement throughout the course of my Ph.D. program and especially in the midst of the dissertation process: Chairman Edmund Outslay and Richard weber from the .Accounting Department, and Paul L. Menchik from the Economics Department. I appreciate the support of many members of the Statistics of Income Division and the timely use of library facilities provided by Ernst and Young. I am also very thankful for the support and encouragement of my good friend, Susan C. Kattelus, who always was there to encourage me through the low points. TABLE OF CONTENTS LIST OF TABLES LIST OF FIGURES INTRODUCTION AND OVERVIEW TAX TREATMENT OF U.S. CITIZENS LIVING ABROAD 2.1 Historical Tax Treatment of U.S. Citizens Living Abroad 2.2 Current Tax Law Provisions THEORETICAL FRAMEWORK AND PREVIOUS RESEARCH 3.1. Overview of theory 3.2 Horizontal Equity 3.3 Vertical Equity 3.4. Combined Vertical and Horizontal Equity HYPOTHESIS DEVELOPMENT 4.1 Equity Effects of Eliminating the IRC §911 provisions 4.2 Impact of the Tax Reform.Act of 1986 RESEARCH DESIGN AND METHODOLOGY 5.1 Sample Selection and Data 5.1.1 Sample 5.1.2 Additional Data Sources 5.2 Measurement Issues 5.2.1 Measure of Taxes for a Tax Regime without IRC §911 5.2.2 Measurement of Income 5.2.3 Measurement of Taxes 5.3 Statistical procedures and tests of hypotheses 5.3.1 Horizontal Equity Effects of Eliminating IRC §911 5.3.2 Vertical Equity Effects of Eliminating IRC §911 5.3.3 Combined Equity Effects of Eliminating IRC §911 5.3.4 Impact of the Tax Reform Act of 1986 vi viii ix 13 13 14 18 25 27 27 28 31 31 31 37 37 37 41 47 49 49 50 51 51 ANALYSIS OF RESULTS 6.1 Descriptive Statistics 6.2 Tests of Hypotheses 6.2.1 Horizontal Equity Effects of Eliminating IRC §911 6.2.2 Vertical Equity Effects of Eliminating IRC §911 6.2.3 Combined equity effects of eliminating IRC §911 6.2.4 Impact of TRA of 1986 on the use of IRC §911 CONCLUSIONS AND IMPLICATIONS APPENDIX A HISTORICAL TAX TREATMENT OF EXPATRIATES APPENDIX B TAX FORMS APPENDIX C HORIZONTAL EQUITY REGRESSION RESULTS BIBLIOGRAPHY vii 53 53 72 72 84 95 97 99 105 117 124 132 LIST OF TABLES Table Caption 5.1 1987 8.0.1. Foreign Sample 5.2 Country Screens for Hypothesis Three 5.3 Economic Income Measures 6.1 1987 U.S. Individual and Expatriate Returns 6.2 Expatriate Returns 6.3 Expatriate Returns by Occupation 6.4 Expatriate Returns by Country of Residence 6.5 Descriptive Statistics by Deciles 6.6 Coefficient of Variation - Tax Liability 6.7 Coefficient of variation - Effective Tax Rates 6.8 CRVs - Tax Liability 6.9 CRVs - Effective Tax Rates 6.10 CRVs - Exemption Model - Tax Liability 6.11 CRVs - Exemption Medel - Effective Tax Rates 6.12 Tax Liability Progression Coefficients 6.13 Residual Progression Coefficients 6.14 Summary of Progressivity Measures 6.15 Combined Equity Tests 6.16 Impact of TRA of 1986 viii Page 33 36 42 55 58 63 65 68 75 76 79 80 82 83 90 92 94 96 98 LIST OF FIGURES Figure Caption Page 1 Suite Index 22 2 Tax Liability without IRC §911 Provisions 40 3 Adjusted Expanded Income and U.S. Taxes 85 4 Adjusted Expanded Income and WOrldwide Taxes 86 5 Suits Index - U.S. Tax Liability 87 6 Suits Index - WOrldwide Tax Liability 88 ix Chapter One INTRODUCTION AND OVERVIEW The ability of U.S. firms to compete internationally is a current concern of both the private and public sectors. Congressional hearings on the factors affecting international competitiveness of the United States were held in June and July of 1991 before the House ways and Means Committee.1 More recently, Robert Mattson from the I.B.M. corporation urged the government to "do no harm to competitiveness."2 IHe argued that decisions to invest in the United States and abroad should be tax neutral and that tax legislators should work to improve the competitiveness of U.S. firms. One factor that affects the competitiveness of the United States in world markets is the taxation of U.S. expatriates3 living and working abroad. Residents of the United States, as in many other countries, are taxed on their worldwide income and allowed a credit for foreign income taxes paid on foreign source income. However, unlike many other countries, the United 1For an analysis of the factors affecting international competitiveness see Joint Committee on Taxation [1991]. 2The remarks were made on May 18, 1992, at the Spring Symposium of the National Tax Association. 3Expatriates are defined, within the context of this study; as U.S. citizens (resident aliens) who leave the United States to reside in a foreign country but retain their U.S. citizenship (status). 2 States taxes the worldwide income of its citizens and residents, including U.S. expatriates living in a foreign countryu‘ The primary exception to this general rule is an income exclusion for a certain level of foreign earned income and excess housing costs.’ An exclusion for foreign earned income was initially included in federal income tax law in 1926. The stated goals of the provision were to equate the tax burden of U.S. citizens abroad with that of their domestic counterparts and to provide an incentive for U.S. participation in foreign trade [Sobel, 1985, 120]. Equity and incentive considerations continue to dominate current discussions of the foreign earned income and housing exclusions. Controversy has surrounded the foreign earned income exclusion since its enactment. At the Congressional level, several attempts have been made to diminish or eliminate the exclusion with varying levels of success. For example, in 1976 Congress was concerned that expatriates were being treated more favorably than similarly situated domestic taxpayers. As a result, the exclusion level was reduced and ‘U.S. expatriates are required to file a tax return and pay taxes on their worldwide income. Most other industrialized countries exempt their citizens' foreign source income when they are residents of a foreign country [Maiers, 1981, 692]. 5Section 911 of the Internal Revenue Code (here after referred to as IRC §911) contains the tax law governing the foreign earned income exclusion, housing exclusion, and housing deduction. The term "§911 provisions" encompasses all three of these components. 3 any excess foreign source income was taxed at the marginal rate that would have applied had the exclusion not been in effect.6 In 1988, Senator Proxmire, citing a failure of the exclusion as an incentive, introduced legislation to repeal the exclusion. The private sector has also been concerned with the tax treatment of U.S. expatriates. In July, 1990, at the First World Congress of U.S. Citizens Abroad,’ the organization's tax committee presented Congressional members with a position paper indicating their concerns with the tax treatment of U.S. citizens abroad. The committee stated that U.S. citizens are returning home because of the "high overseas income tax bite", which includes both foreign and U.S. taxes. In the position paper, the tax committee argued that today American business faces stronger competition from expansive aggressive nations which support their offshore activities--exports, construction projects, direct investment, banking--in many ways, and in particular by encouraging their nationals to work abroad through continued exemption from taxation of foreign source earned income. Although Congress and various private interests have cited equity and incentive arguments in their discussions of 6Reported in.H.R. No. 658, 94th Cong., lst Sess., (1976), reprinted in 1976-3 (Vol. 2) C.B. 695,892. 7Details of this conference were reported in the Daily Tax Reporter [July 9, 1990] and by Jones in Tax Notes [July 23, 1990, 503-4]. ' Reported in the Taxation of Overseas Americans Policy Statement [p. 2]. 4 the foreign earned income exclusion, research in this area has been very limited. A few studies’ have investigated the incentive effects of the foreign earned income exclusion. To date, no study has investigated the equity effects of the foreign earned income and housing exclusions. The purpose of this research is three-fold: to empirically document descriptive characteristics of expatriate taxpayers, to examine the equity effects of the IRC §911 provisions, and to investigate the impact of the TRA of 1986 on the use of the IRC §911 provisions using a unique data set of expatriate tax returns. Because no prior study has examined these issues, the results of this research provide initial evidence of the equity and incentive effects of the foreign earned income and housing exclusions. The findings are expected to contribute to the tax policy discussion of the taxation of U.S. expatriates by providing empirical data on the equity and incentive effects of the IRC §911 provisions. 9The most rigorous of these was done by Mutti [1978] for the Office of Tax.Analysis. Using multiple regression, Mutti used an economic model to investigate whether expatriates contributed to the overall level of U.S. exports. Other studies [such as Chase Econometrics Associates (1981)] relied on surveys of expatriates and‘U.S. multinational companies to examine the incentive effects of the foreign earned income exclusion. Chapter Two TAX TREATMENT OF U.S. CITIZENS LIVING ABROAD This chapter describes the historical and current tax treatment of U.S. expatriates. This overview frames the environment within which the equity and incentive effects of the IRC §911 provisions are examined. A brief synopsis of the history of the U.S. tax treatment of expatriates is presented. Appendix A contains a more complete discussion of the history of the U.S. tax treatment of expatriates living and working abroad. The current tax treatment of U.S. expatriates is then described. 2.1 Historical Tax Treatment of U.S. Citizens Living Abroad In 1926, Congress enacted legislation allowing U.S. citizens living and working abroad for at least six months during the taxable year (bona fide nonresidents) to exclude all foreign earned income.1 The exclusion was controversial even at this juncture. The initial proposal by the House ways and Means Committee (here after referred to as the House) was not well received in the Senate Finance Committee (here after referred to as the Senate). Although they 1Earned income included wages and salaries, professional fees, and any other amounts received for personal services. For those engaged.in.a trade or business, a reasonable amount, not in excess of 20 percent of the net profits was considered earned income [Revenue Act of 1926, Ch. 27, §209(a)(1), 44 Stat. 9,20]. 6 ultimately agreed, the Senate initially did not feel that any exclusion was necessary given that citizens employed abroad already were allowed a tax credit2 for any taxes paid to the foreign country on the earned income. The necessity of the exclusion, given that the foreign tax credit exists, continues to be a key controversy in discussions of the exclusion. Throughout its long history, Congress has alternatively advocated repealing or strengthening the foreign earned income exclusion. Although it remained in place in 1942 and 1953, the House was concerned about perceived abuses of the foreign earned income exclusion and recommended repeal. In 1951, the Senate strengthened the exclusion, noting that changes were needed to encourage citizens to go abroad and to place them on an equal footing with their foreign counterparts who were not taxed by their home countries. In 1976, the House felt that the exclusion provided an unfair tax advantage to expatriates when compared with their domestic counterparts and proposed repeal of the exclusion. The Senate advocated retaining the exclusion to protect the competitive position of U.S. firms operating abroad. The foreign earned income exclusion was retained, but the foreign tax credit could no longer be claimed for foreign taxes paid on the excluded income. 2The foreign tax credit [IRC §901] was incorporated into federal tax law in 1918. 7 The availability of the foreign earned income exclusion was severely restricted in 1978.3 For most expatriates it was replaced with a series of complex deductions designed to take into account the special costs of living overseas. The goal of these provisions was to place expatriates in an equitable position when compared to their domestic counterparts. In 1981, citing the need to simplify these tax provisions, Congress reinstated the foreign earned income exclusion and incorporated a new housing exclusion in an attempt to take into account the additional costs of obtaining housing abroad. Congress has modified the fonm of the foreign earned income exclusion many times. The length of the qualifying period has varied. A limitation on the amount of foreign earned income that may be excluded has been included and altered many times. The test of nonresidency has become a test of residency, and a new test based on physical presence has been incorporated into the tax law. At various times the foreign earned income exclusion was available based on the type of occupation and the geographical location of the taxpayer. Current federal tax law includes both a foreign earned 3The 1978 Act limited the foreign.earned income exclusion to individuals either' working“ and residing in camps in hardship areas or working for qualified domestic charities in lesser developed countries. 8 income exclusion and a housing exclusion. Qualified U.S. citizens and resident aliens meeting either the physical presence or bonafide residence tests may take either or both of these exclusions. A.more complete history of IRC §911 is provided in Appendix A. The current tax treatment of expatriates living abroad is described in the following section. 2.2 Current Tax Law Provisions Qualified U.S. citizens or resident aliens living and working abroad may elect to exclude a certain amount of foreign earned income and an excess foreign housing cost amount‘ under IRC §9115. The election is made separately for each of the exclusions. To qualify for the exclusions, an individual must have a foreign tax home6 and satisfy either the bona fide ‘In general, self-employed. individuals may' elect to deduct rather than exclude the excess housing cost amount. They may still elect the exclusion for foreign earned income. ’Amounts paid by the United States or an agency thereof to an employee of the United States or an agency thereof are not included in foreign earned income [IRC §911(b) (1) (B)]. Thus, U.S. government employees (both civilian and military) generally do not qualify for the foreign earned income and housing exclusions. 6The definition of tax home [IRC §911(d)(3)] indicates that the meaning corresponds to the definition of home for purposes of IRC §162(a)(2), which relates to traveling expenses while away from home. The federal income tax regulations [§1.911-2(b)] describe an individual's tax home "to be located at his regular or principal (if more than one regular) place of business or, if the individual has no regular or principal place of business because of the nature 9 residence [IRC §911(d)(1)(A)] or physical presence test [IRC §911(d)(1)(B)]. Only U.S. citizens may use the bona fide residence test. The bona fide residence test is generally satisfied if the individual has established and maintained residence7imla.foreign country for an uninterrupted period that includes an entire taxable year. An individual will not be considered a resident under IRC §911 if (s)he submits a statement to the taxing authorities of the foreign country indicating (s)he is not a resident and the foreign country does not subject him or her to foreign income taxation [IRC §911(d)(5)]. Under the physical presence test, an individual must be present in a foreign country during at least 330 full days during any period of 12 consecutive months. In general, earned income is compensation received for personal services [IRC §911(d)(2)(A)]. Thus, wages, salaries, and professional fees qualify as earned income for purposes of the exclusion. Taxpayers engaged in a trade or business that uses both capital and services to produce income may treat as earned income any reasonable amount that does not exceed 30 percent of the taxpayer's share of the of the business, then at his regular place of abode in a real and substantial sense." “Residence" is not analogous to "domicile." A U.S. citizen may be a resident of West Germany and still maintain a.permanent home or domicile in the United.States. The intent of the taxpayer is critical in determining residence; the taxpayer must intend to work in the foreign country for an indefinite or extended period of time. 10 net profits of the trade or business [IRC §911(d)(2)(B)]. Earned income also includes employer-provided allowances or reimbursements such as cost of living allowances, overseas compensation differentials, quarters, education allowances, and the full rental value of property or facilities8 provided by the employer. The earned income must be foreign earned income. In general, it will be foreign earned income if the personal services are performed in a foreign country [IRC §862(a)(3)]. The actual location of the employer and employee at the time compensation is received does not affect this determination. The maximum.amount of foreign earned income that may be excluded is $70,000, pro rated on a daily basis for the qualifying period [IRC §911(b)(2)(A)]. If both the foreign earned income and housing exclusion are elected, the foreign housing exclusion is calculated first. The foreign earned income exclusion is then limited to the excess of foreign earned income over the housing exclusion. Qualified housing expenses are the reasonable housing costs paid or incurred during the tax year. In general, they include expenses such as utilities, insurance, and rent [IRC §911(c)(2)(A)]. The excess housing cost amount is equal to the individual's qualified housing expenses for the 'For example the fair market rental value of employer- provided housing and automobile use qualify as earned income. However, to the extent the amounts are excluded from income as meals and. lodging furnished for the convenience of the employer, they are unearned income. 11 tax year over a base level amount’ pro rated on a daily basis [IRC §911(c)(1)]. To the extent these are employer- provided amounts,lo the excess housing cost amount is allowed as a foreign housing exclusion. If the housing costs are not employer-provided amounts“, they are allowed as a foreign housing deduction in computing adjusted gross income. The foreign housing deduction is limited to the excess of foreign earned income over the sum of foreign earned income and housing exclusions [IRC §911(d)(7)]. Any excess housing amount that is not deductible may be carried over to the following tax year [IRC §911(c)(3)(C)]. Expatriate taxpayers have a number of alternative tax treatments available for their foreign source income. In addition to the foreign earned income and housing exclusions, these taxpayers may also claim.a foreign tax credit for foreign income taxes paid or accrued on two types of foreign source income: (1) foreign earned income for 9This base level is equal to 16 percent of the salary of a U.S. government service employee at a grade 14-step one level (GS-14 step one). For 1987, the base level was $7,109 or $19.48 per day. 10The employer-provided amount is foreign earned income paid to or on behalf of the employee. For example, salaries or other compensation, amounts paid to a third party for housing, and the fair rental value of employer provided housing would all be employer-provided amounts. uGenerally, an amount is considered to be an employer- provided amount unless it is attributable to self-employment [IRS Publication 54, p. 6]. 12 which the foreign earned income exclusion is not claimed, and (2) foreign source income that does not qualify for the exclusions. The foreign tax credit is limited to the amount of U.S. federal income tax that would have been paid if the income had been U.S. source. Thus, if the U.S. tax rate is lower than the foreign tax rate, an excess credit will result. This excess credit may be carried back two years and forward five years. Alternatively, taxpayers may choose to deduct12 foreign income taxes paid on income for which the exclusion is not elected rather than claim the foreign tax credit. 12The foreign income taxes may be taken as a itemized deduction on Schedule A of Form 1040 or as a deduction on Schedule C of Form 1040. Chapter Three THEORETICAL FRAMEWORK AND PREVIOUS RESEARCH Public finance theory provides a framework for examining the equity effects of the IRC §911 provisions. Although no studies have investigated the equity effects of the IRC §911 provisions, prior research using public finance theory to investigate equity issues provides a basis for the methodology used in this research. An overview of relevant public finance theory is followed by a discussion of the equity measures used in prior research. 3.1. Overview of theory For more than two hundred years, the equity of tax regimesl has been a primary concern of public finance theorists. Early theorists, such as Adam Smith, identified criteria for ngood taxation." One of the criteria identified as most important was equality (equity). In 1776, Adam Smith presented a rule of tax equity as his first maxim.of taxation: "the subjects of the state ought to contribute towards the supply of government, as nearly as 1For purposes of this study, a tax regime is defined as a given set of federal income tax rules. The term "current tax regime" encompasses all of the current existing federal income tax law relating to individuals. The IRC §911 provisions are part of the current tax regime. 13 14 possible, in proportion to their respective abilities"2 [Musgrave, 1985, 16]. Equity considerations continue to be important criteria in the evaluation of taxes. Boadway and Wildasin [1984, 225] note that in the theory of public finance, equity is one of the two principal criteria by which taxes are judged.3 Overall, the equity criterion is concerned with assuring that each taxpayer contributes his or her "fair share" to the cost of government [Musgrave and Musgrave, 1976, 216]. Two notions of equity are generally employed to assess tax policy: vertical equity and horizontal equity. Normative public finance theory indicates that both horizontal and vertical equity are necessary components of an optimal tax system.[Musgrave, 1990]. 3.2 Horizontal Equity The concept of horizontal equity requires that individuals who are the same in all relevant respects should be treated equally for tax purposes [Atkinson and Stiglitz, 2At this time, income was felt to be the relevant measure of ability and proportional taxation was deemed to be the fair way to distribute the tax burden. 3The other principal criterion, efficiency, is concerned with minimizing the deadweight loss imposed by a particular tax. Policy makers have also been concerned with other criteria such as administrative costs and simplicity. 15 1980, 3531.‘ This implies that taxpayers with equal abilities to pay taxes should bear equal shares of the tax burden. Given this definition of horizontal equity, inequity arises when the taxes of "taxpayers with equal abilities to pay" or similarly situated taxpayers are not the same. Thus, a dispersion measure that captures the variance of taxes within groups of similarly situated taxpayers would provide a measure of horizontal equity. A smaller dispersion would imply greater horizontal equity. A stumbling block in measuring horizontal equity involves identifying "similarly situated“ taxpayers with equal abilities to pay. In an ideal world, this identification would be made based on individual welfare or utility levels. Individuals with equal welfare before the tax is imposed should have equal welfare after the tax is imposed. In the empirical setting, an assumption has been made that individuals with the same income have the same level of welfare.’5 Thus, from.an operational standpoint, ‘Some theorists have suggested a definition of horizontal equity that requires that a tax should not alter the rank- ordering of individuals [for example see Feldstein, 1976; Atkinson, 1980; Berliant and Strauss, 1985; and Plotnick, 1985]. Use of this "no-rank-reversals" criterion avoids the potential empirical difficulties that result from grouping taxpayers but becomes difficult to apply in an empirical setting. Empirical studies usually group taxpayers by some measure of income and use some measure of dispersion to examine the level of horizontal equity [for example see Anderson, 1985, 1988; Pierce, 1989; and Ricketts, 1990]. ‘This assumption.can.be traced back to.Adam.Smith and his first maxim of taxation [Musgrave, 1985]. 16 horizontal equity has been defined to require that taxpayers with equivalent incomes pay equivalent amounts of tax [Enis and Craig, 1990]. The coefficient of variation is a measure of dispersion that has gained wide acceptance as a measure of horizontal equity [Anderson 1985, 1988; Grasso and Frischmann, 1992; Pierce, 1989; Ricketts, 1990]. Anderson [1985] indicates that the coefficient of variation has been accepted as a measure of horizontal equity because it is scale-free; allowing comparisons within and between groups of taxpayers with differing income and taxes. After grouping taxpayers by income, the coefficient of variation for each group is defined as: (1) CVj = (SDj / Ti) x 100 where, CVia the coefficient of variation for income group j, SDi= the standard deviation of the taxes for income group j, and *3 II the mean of the taxes for income group j. The coefficient of variation provides a measure of the dispersion within each group: the smaller the dispersion, the greater the horizontal equity. Grasso and Frischmann [1992] recently proposed the coefficient of residual variation (CRV) as another measure of horizontal equity. They use a regression-based approach 17 and model taxes as a function of income. Grasso and Frischmann [1992, 124] argue that using the CRV measure reduces the distortion in the measurement of horizontal equity that is caused by progressivity in the tax regime. The progressivity of the tax regime is measured by the regression coefficient. If the function is properly specified, any unexplained variation is included in the error term and is due solely to the horizontal inequity of the tax regime.“ “Any functional misspecification is also included in the error term. 18 The CRV is an estimate of the standard deviation of the error term of the regression expressed as a percentage of the mean value of the dependent variable and is defined as: 2 (x-fiiz/(n-Z) (2) CRV= , "1 #100 {In/n i-l where, n = number of observations, yi-: observed value of the dependent variable, i - predicted value of the dependent variable. 3.3 Vertical Equity Vertical equity is concerned with how the tax system treats unequals and with the distribution of the tax burden across individuals who are not equal. Stiglitz [1986, 337] defines vertical equity more precisely by stating that individuals that are in a position to pay higher taxes than others should do so; those with a greater ability to pay taxes should bear a larger share of the tax burden. As with 19 horizontal equity, an income measure is commonly used as a surrogate for ability to pay. Vertical equity has traditionally been used to justify progressive taxation.7 .A progressive income tax is one in which the rate of tax increases as income increases. Operational measures of vertical equity assess this progressivity. Several measures“ are available to examine the progressivity of the tax system. One of the most commonly used measures is the Suits index9 [Suits, 1977] . Figure 1 graphically illustrates the Suits index and its associated Lorenz curves.10 The cumulative percent of the tax burden is plotted against the cumulative percent of income. The plotted line (Lorenz curve) represents the 7Early in the nineteenth century, Bentham.first used the criterion of vertical equity as a basis for proposing progressive taxation [Musgrave, 1990, 115]. For a different definition of vertical equity see Plotnick [1985]. “Ricketts [1990] provides a brief overview of various measures. 9The Suits index has been used to assess the ,progressivity of tax laws as divergent as the combined social security and income tax system [Ricketts, 1990] and the childcare credit [Dunbar and Nordhauser, 1991]. l0The Suits index is based on a variation of the Lorenz curve and its related Geni coefficient. Figure 1 can also be used to illustrate the geni coefficient. The y-axis now becomes the cumulative percentage of income and the x-axis becomes the cumulative percentage of individuals within the tax system. The plotted line represents the distribution of income across all individuals. The Geni coefficient, defined as the area between the diagonal line and plotted line provides a measure of the inequality of the income distribution. The Geni coefficient varies between zero and one. 20 distribution of taxes across all income levels. The three Lorenz curves in Figure 1 illustrate the possible distributions of taxes across the income distribution. A proportional tax is represented by diagonal line AB; the tax rate remains constant over all income levels. A progressive tax is represented by curve ADB; the tax rate increases with income. A regressive tax is represented by curve ACB; the tax rate decreases with income. The Suits Index provides a summary measure of the distribution of taxes across the income distribution. Defining the triangle ABE as K and the area under the Lorenz curve as L, the Suits index is defined as: (3) S = (K-L)/K = 1 - L/K. The value of the Suits index can range from -1 (extreme regressivity where all of the tax burden is paid by the lowest income class) to +1 (extreme progressivity where all of the tax burden is paid by the highest income class). An index of zero indicates a proportional tax.“ “Note that by definition, L is always less than or equal to 2*K. 21 Because the triangle AEB has a base and altitude of 100, Parameter K in the above formula is always 5,000. Parameter L12 is defined as: n (4) L =2 1/2[('I'i + TH) (Yi - Yi_1)] i=1 where, 'n,= the accumulated percentage of the tax burden borne by income groups 1 through i, Yi= the accumulated percentage of income earned by income groups 1 through i, and n = the total number of income groups. The Suits index provides an overall measure of the progressivity of the tax system. 12For example, for a progressive tax, L provides a measure of area ADBE. L is a geometric midpoint estimation of the integral of the area beneath the Lorenz curve ADB. 22 Figure 1 Suits Index 100 3 Cumulative C Percent of Tax Burden (1) D 0 A 0 100 E Cumulative Percent of Income (Y) K = Area of triangle AEB. L = Area between Lorenz curve and horizontal axis AE. L is represented by area ADBE with a progressive tax. Source: Adapted from Suits [1977]. 23 A second measure of progressivity, tax liability progression [Ott and Dittrich, 1981, 33] is estimated from the log transformation of the equation: (5) T = aY"u° where, T a tax liability Y = income u = error term e = natural e b = elasticity of tax liability with respect to income b = 1 for a proportional tax > 1 for a progressive tax < 1 for a regressive tax. The regression coefficient b provides a measure of the progressivity of each tax regime. 24 A third measure of the relative degree of progressiveness, residual progression [Ott and Dittrich, 1981, 34], is estimated from a log transformation of the equation: (6) v = YBu‘ where, V - after-tax income Y = before-tax income u = error term 6 = natural e B = elasticity of after-tax income with respect to before- tax income B = 1 for a proportional tax < 1 for a progressive tax > 1 for a regressive tax. The residual progression coefficient provides a measure of the ratio of the percentage change in after-tax income to the percentage change in before tax income. 25 3.4. Combined Vertical and Horizontal Equity A proposed but untested combined measure is available to simultaneously assess vertical and horizontal equity [Menchik, unpublished]. This measure initially expresses after-tax income as a function of before-tax income: (6) Y.t = e' prc e“ where, Y; = after tax income, Ypt = pretax income, e = natural e, a = intercept tenm, b a elasticity of after-tax income with respect to before-tax income, and u = error term. 26 Taking logs and variances of both sides, this reduces to”: (7) afofli=bzazmyp+ai+200wlogY”, u) where, of = measure of horizontal equity b2 measure of vertical equity 1 for a proportional tax < 1 for a progressive tax > 1 for a regressive tax The coefficient b indicates the variance of the pre-tax distribution relative to the post-tax distribution. If the post-tax distribution has less dispersion than the pre-tax distribution, b will be less than one. If the post-tax distribution is more dispersed than the pre-tax distribution, b will be greater than one. A value of one for coefficient b indicates a proportional system. The variance of the error term provides a measure of horizontal equity. The larger the variance the less horizontal equity; the smaller the variance the more horizontal equity. 1"‘In this study, it is assumed that before-tax income (Y“) and the error term (u) are independent and the covariance between before-tax income (Ya) and the error term (u) is zero. Chapter Four HYPOTHESIS DEVELOPMENT Historically, the IRC §911 provisions have played a major role in the overall taxation of U.S. expatriates living and working abroad. Although the IRC §911 provisions, in some form, have been part of the federal tax law more than sixty years, little is known about their impact on expatriate taxpayers. Even though the initial exclusion was written into the federal tax law on equity grounds, little is known about the equity effects of these provisions. The first two research hypotheses address the equity issues related to the IRC §911 provisions.‘ .As a secondary issue, a third research hypothesis addresses whether the Tax Reform Act of 1986, with its significant reduction in marginal tax rates, has reduced the use of the IRC §911 provisions. 4.1 Equity Effects of Eliminating the IRC §911 provisions As noted in the introduction and history of the IRC §911 provisions, various attempts have been made in Congress to diminish or eliminate the IRC §911 provisions. At the lIRC §911 of the Internal Revenue Code contains the tax law governing the foreign earned income exclusion, housing exclusion, and.housing deduction” The term."§911 provisions" encompasses all three of these components. 27 28 same time, citing incentive and equity concerns, businesses operating overseas and individuals working overseas have advocated maintaining and strengthening the IRC §911 provisions. Even with all of the discussion concerning the exclusions, little is known about the impact of eliminating them.2 Given the initial equity motivation of Congress in including the exclusion in federal tax law, it is expected that the current tax regime3 will be more equitable to expatriates than a regime without the exclusion. Thus, it is hypothesized that (stated in alternative form): IHfi The current tax regime will display more horizontal equity for expatriates than a tax regime without the IRC §911 provisions. In addition, it is expected that the IRC §911 provisions will also affect progressivity. Therefore, the second hypothesis (stated in alternative form) is: lag The current tax regime will display a different level of progressivity for expatriates than a tax regime without the IRC §911 provisions. 4.2 Impact of the Tax Reform.Act of 1986 U.S. citizens working abroad may elect to exclude a certain level of foreign earned income and excess housing 2The U.S. Treasury estimated that in tax year 1983 the revenue cost of the IRC §911 provisions was one billion dollars [Department of the Treasury, 1988, 22]. 3The term "current tax regime" encompasses all of the current existing federal income tax law relating to individuals. The IRC §911 provisions are part of the current tax regime. 29 costs. In addition, they may claim a foreign tax credit for foreign taxes due or paid on foreign source income. However, federal tax law provides that no deductions, exclusions, or credits are allowed to the extent they are allocable to excluded income [IRC §911(d)(6)]. Thus, in making the election, the individual taxpayer must determine if the foreign earned income exclusion will reduce his combined U.S. and foreign tax liability more than the foreign tax credit or deduction. This determination is generally a function of the differential in the effective tax rates between the two countries. In general, a U.S. taxpayer in a low-tax foreign jurisdiction would reduce his overall tax burden more by electing the exclusion because the calculated amount of the foreign tax credit would not offset his U.S. tax liability on the otherwise excluded income. In contrast, a U.S. taxpayer in a high-tax foreign country would reduce his overall tax burden more by electing the foreign tax credit because the credit would fully offset his U.S. tax liability on the otherwise excluded income and perhaps result in an excess credit that could be carried over to another year.‘ Thus, one would expect that the reduction of the marginal tax rates in the Tax Reform Act of 1986 would reduce the use of the foreign earned income exclusion. Holding all else constant, a decline in U.S. tax rates would “This is illustrated in Price waterhouse [1988, 70-72]. 30 tend to increase use of the foreign tax credit and decrease use of the foreign earned income exclusion. However, SOI data indicate exactly the opposite. 801 data for 1983 and 1987 [Internal Revenue Service, 1987, 1992] indicate that the number of returns claiming the foreign earned income exclusion increased from 159,194 to 171,191. The number of returns reported by 801 does not control for any change in the number of U.S. expatriates residing overseas. Controlling for the number of expatriates abroad, one would expect that the reduction in marginal tax rates in the Tax Reform Act of 1986 would reduce the use of the foreign earned income exclusion. The third hypothesis (stated in alternative form) is: H5: Controlling for the number of expatriates overseas, use of the IRC §911 provisions will decrease from 1983 to 1987. Chapter Five RESEARCH DESIGN AND METHODOLOGY The data needed and the methodology used to test whether the IRC §911 provisions result in increased equity for expatriate taxpayers and whether the decrease in marginal tax rates in the Tax Reform Act of 1986 impacted the use of the IRC §911 provisions are discussed in the following sections. 5.1 Sample Selection and Data 5.1.1 Sample A unique set of databases is available to address the hypotheses. The first is data generated by the Statistics of Income Division for a Treasury Department project, Americans Living Abroad (here after, 1987 SOI individual foreign sample).1 This sample, collected every four years, provides detailed information from individual federal tax returns. Collection of the 1987 data has recently been completed. The data set for the 1987 tax year is a weighted stratified sample containing information from 15,724 1These data are collected every four years for a Congressionally mandated study to assess the operation of the foreign earned income exclusion. The last study was published in 1989 and based on data from the 1983 tax year [Department of the Treasury, 1989]. 31 32 individual federal tax returns” with a Form 2555 (Foreign Earned Income) and/or a Form 1116 (Foreign Tax Credit) attached to the 1040 individual return. The sample was selected from all individual federal income tax returns filed in 1987. Examples of the relevant IRS forms for 1987 are included in Appendix B. Table 5.1 provides a breakdown of the types of returns included in this data set. Of the total sample of 15,724 returns, 902 returns are for tax years prior to 1987. A majority of the 9,472 returns that have only a Form.1116 (indicating use of the foreign tax credit) attached to their Form.1040 have U.S. addresses on their return. Of the 5,350 returns with a Form 2555 attached to their Form 1040, 3,931 returns are from taxpayers who qualified under the IRC §911 provisions for the entire tax year. Of these 3,931 returns, 1,850 are from taxpayers with only a Form 2555 (without a Fonm 1116) attached to the their Form 1040. The remaining 2,081 returns are from taxpayers filing both a Form.1116 and a Fonm 2555 with their tax returns. In addition, tabular information from the 1983 Americans Living Abroad project is available for use. Due to the disclosure concerns, these data are available only at the IRS national office in washington, D.C. ”When weighted this represents a population of 706,066 returns. 1987 8.0.1. Foreign Sample Total Sample less returns pro—1987 tax returns less returns with only a 11 16' attached (without a 2565”) Returns with a 2555 attached less returns with a short year Full year returns with a 2666 Full year returns with only a 2555 Full year returns with both 2655 and 1 1 16 33 Table 5.1 1 5,724 All Filing Statuses Unwsighted Weighted Returns Returns 706,066 30,996 524,424 1 60,646 4729 103,367 M Unweighted Returns Married Filing Jointly Weighted Returns lForm.1116 is used by individuals to claim the foreign tax credit. ”Form 2555 is used by individuals to claim the foreign earned income exclusion, deduction. housing exclusion, and housing 34 W The 1987 801 individual foreign sample is used to test the first two hypotheses that assess the relative equity of two tax regimes: one that incorporates the IRC §911 provisions (current system) and the other without the IRC §911 provisions. Those taxpayers affected by the elimination of the IRC §911 provisions are included in the sample (in a manner similar to Anderson [1985, 1988]). In addition, to eliminate any variance induced by differing rate schedules, only married couples filing joint returns are used in the equity analysis. Finally, 54 returns for which foreign tax rates are not available3 are eliminated from the analysis. Thus, all full year joint returns from the 1987 301 individual foreign sample with a Form 2555 (which indicates they are filing for the IRC §911 provisions) with positive adjusted expanded income for which foreign tax rates are available (2,882 returns) are used in the equity analysis. mm Data from both the 1987 SOI individual foreign sample and tabular information from the 1983 Americans Living Abroad project are used to test the third hypothesis assessing the use of the IRC §911 provisions across time. The sample selection process is detailed in Table 5.2. 3Most of the returns eliminated were lone returns from various countries around the world. 35 Country data must be available for each tax return included in the sample. For each return included in the sample, the country is represented in both the 1987 and 1983 SOI samples, and has State Department population estimates for both years“ and an estimated foreign tax rate available. The final sample includes data from returns of taxpayers in 86 countries that satisfied these requirements. “State Department estimates of U.S. citizens residing abroad are not available for 1987: Data from.1986 are used in the analysis. The 1987 estimate of U.S. citizens residing abroad was 1,963,784. For 1986, the estimate was 1,929,917 while in 1988 the estimate was 2,056,799. The estimates reflect a 1.7% change from.1986 to 1987 and.a 4.7% change from 1987 to 1988. The 1986 estimate was used as a surrogate for the missing 1987 estimate because of its smaller percentage difference from 1987. Although the differential impact across countries is unknown, use of the lower 1986 numbers rather than the 1988 numbers should provide a more conservative test of the hypothesis. Because the denominator of the fraction determining the percentage of taxpayers filing for the IRC §911 provisions would be larger in 1988 than in 1986, the overall percentage of taxpayers would be smaller using the 1988 estimates rather than the 1986 estimates. 36 Table 5.2 Country Screens for Hypothesis Three NUmber of Countries Total number of SOI country codes in 1987 SOI Individual Foreign sample 138 less multi—country or unallocated country codes1 (19) less countries for which State ' Department foreign population estimates are not available” (11) less countries for which an estimate of foreign tax rates is not available (22) Number of Countries in sample 86 lOn Form 2555, the expatriate writes in the country of his or her tax home. This is then recorded using a three digit country code. If the taxpayer neglects to fill in the tax home on the tax return, the country is coded as unallocated. Although all major countries around the world have an individual country code, some small countries are grouped with others in their particular region of the world and assigned one country code. ”The State Department estimates are developed at the various embassies and consulates around the world. Estimates are not available for countries where there is no U.S. presence. 37 5.1.2 We Measures of foreign tax rates and foreign exchange rates for 1987 are needed in this research. The 1987 individual foreign tax rates used are from the Coopers and Lybrand International Tax Network [Reavey, 1987, 1988]. These international tax summaries provide information about both individual and corporate tax laws at the federal, state, and city levels. Embassies were contacted to obtain foreign tax rates for those countries in the sample that are not included in the Coopers and Lybrand publication. The 1987 foreign exchange rates are obtained from the International MOnetary Fund [1992]. Foreign exchange rates unavailable from the International Menetary Fund were obtained from the U.S. Treasury Department. 5.2 measurement Issues To test the equity hypotheses, a measure of taxes under a tax regime without the IRC §911 provisions must be calculated. A.measure of income and taxes must also be identified to compute both the horizontal and vertical equity measures used in this study. 5.2.1 meeeere ef Texee fer e Tex Regime wieheee IRC §211 To test whether the inclusion of IRC §911 provisions in federal income tax law results in increased equity for 38 expatriate taxpayers, a benchmark is needed for comparison.“ The appropriate benchmark in this case is a tax regime that does not include the IRC §911 provisions. Comparing the taxes from a tax regime without the IRC §911 provisions to the taxes from a tax regime with the IRC §911 provisions allows one to determine if the incorporation of the IRC §911 provisions has resulted in increased horizontal equity. The current tax regime corresponds to the tax regime incorporating the IRC §911 provisions. For each expatriate return, a measure of each expatriate's federal income tax liability is directly available from the 1987 SOI individual foreign sample. A.measure of federal income tax liability for each expatriate does not exist for a tax regime without the IRC §911 provisions. Therefore as a first step, for each individual tax return in the sample, the federal income tax liability is recomputed to conform to a tax regime without the IRC §911 provisions. In general, this involved eliminating all of the effects of the IRC §911 provisions,“ computing an estimated foreign tax credit,7 and “The methodology used to assess equity is similar to that used by Anderson [1985, 1988] and Enis and Craig [1990]. “This included eliminating the effects of the foreign earned income exclusion, housing exclusion, and housing deduction. 7To compute an estimated foreign tax credit, the 1987 individual foreign tax rates are needed. The Coopers and Lybrand International Network [Reavey, 1987, 1988] provide information concerning the individual tax rates in foreign countries for tax year 1987. 39 recalculating the federal income tax liability for each return. Figure 2 outlines the steps used to recompute each expatriate's federal income tax liability.“ “Two alternative assumptions are made in determining the new taxable income: 1) assume the maximum change in itemized deductions for itemizers and 2) assume no change in itemized or standard deductions. The tests of hypotheses are consistent using either assumption” The reported results are based on the first assumption. II. III. IV. VI. 40 Figure 2 Tax Liability without IRC §911 Provisions Add back the IRC §911 exclusions and deduction. Recalculate taxable income. Recompute income tax before credits (Form.1040, line 39) using the 1987 tax rate schedule. Recompute the general limitation foreign tax credit. A. If no Form.1116 is present then estimate foreign taxes paid using foreign tax rates for 1987 from Coopers and Lybrand International Network [Reavey, 1987,1988]. B. If Fonm 1116 is present then compute total foreign taxes paid. C. Recompute credit. Recalculate other types of foreign tax credits if necessary. Compute new tax liability. 41 5.2.2 W Income is used as a basis for classifying individuals into similarly situated groups. Ideally, many theorists suggest that a comprehensive income measure that includes all accretions of wealth such as the Haig-Simons definition of income9 [Simons, 1938; Haig, 1959; Atkinson and Stiglitz, 1980] provides the best measure of income. Income measures available directly from tax returns, such as taxable income or adjusted gross income, do not take into account all intraperiod changes in wealth. For example, unrealized capital gains and tax-exempt interest are not included in either measure. To overcome these difficulties, several expanded income measures have been developed that use tax return data and other information to obtain a more comprehensive measure of economic income. These include: expanded income, family economic income, modified expanded income, and the 1979 Income Concept. Table 5.3 details the components of each of these measures and each is discussed in turn. This provides a backdrop for the adjusted expanded income concept used in this research which is then presented. Each of the measures uses adjusted gross income from Form 1040 as the starting point of the calculation. 9The Haig-Simons comprehensive income measure includes all income regardless of its use or source. It is defined as the sum of current consumption plus net accretions to wealth. 42 Table 5.3 Economic Income Measures .000:0..x0 000503 006.080 0:0 0.00 >c08..0 0.00.. 000 8: 0000 0800:. 00 88:00 asap 0:... 000000000 0005 .0 «008 .0. 00.00 00.00008 .ws. 0:0 mu. 0...: 80000000 0:.000: 00.0.00 05 0:0 0.00 808:0 .00:.>00 .0 030.05.; 2.00 :0 3.800 80.000000 amw 006380.200 0:0 :0... 0:080:00. £003. 60.000000 0000.005 5.00.. 00>o.080.=00 03.000000 5.. .000:00x0 000500.. 008.080 00938.0. 00020:. 0800:. 0.. 080800005 .39 .00.. x8 .0. 0500 .00.:00 00029.0 0: 0.0 0.0... .009 .0 U< 8.0.0.. .0... 05 3 0:0 2.8.8.00? 80.00.00.000 8.720.050 00 00000.0 :. 5.00.00.000 3 000.8...» 009 0:0 3.00.000 000800.00 .0. 80:50:00 :0 0:0 .n. a o 00.00050 0:0 0020.05.00 .0Omm 0:0 0.080. ".0 80.00.00.000 0.80:000 0058 8.800500 x0: :0.«0.00.000 0009.0 00020:... 80.850800 0.. 808.52 0200805.. . Sum 8.0“. :0 000.000. 080.. 0000.05." 0800:. 808.008. .0 80080 05 8 00 05.80000 $0.08. 8080008. 00 005.00 0. 000.08. 808.008. «02N 20280000. .0800:. 000.0 00000.0( 80¢ 00.000300 .0 002000 :0 00000.05 .-. .o . + . 0...? E + + + + .0800:_ 8 80803.0( + 00.03.90 0800:. 00800 5.0.0“. 0000.. 0000.00 + 00.0.0.6”. 0020.05.00 0>.000n. .080: :0 00000.. + + + .0500 3800 00029... 0080: 00:20.0... .80 808.55. 0.0>o..o. 0:0 1. 00.03.80 0:000:50! (a. 000.05... 0.00.8802 8080.30... 002...... 0:0 30800 .0000 039.382 00x8 0800:. .000. 0:0 00000 .0 00:20. 0300.0» + + + + 0800:. «00.08. «080x903: N«00.0.... 80:009.... «02 + + + + .1. 0800:. 000.6 00.0:_0< .0830: 00... 80.. 0.08.0.5 ..m<. 5.2. .5... 0800:. 800000 0800:. 0800:. 000:00xm 0800:. 0008090 000:0..xm 0800:. 083.3. 03. 00000.2 2.80. 00008.... 05000! 82.00800 43 Table 5.3 (Cont'd.) Economic Income Measures .0. 000 .0 .< 00.000000 0:0 00.00.000.00 .00mm 0.080. 00 000.08. 000 0:0 00>.000. 000.08. .00 0808.00.00 00.8.8.2 ..0< 0. 00.00 80.000 00 00: 000 00.0.5000 .0000 000 0.0000 000.0080 00 0000.6. =w<. 0800:. 00002.0 00000.0( .0003 0000.000. 00.. 000 00.0000 00 000.800 0:00.>.0 000 00.03on 0.0000 00:00.20 00 002.. 5 0000000 08000. mums + + + + ++ + +++++ 5.2. .5... 0800:. 08000. 0000005 0000080 0800:. 000.002 2.80.. 00.2.3.0 2080800....0< 00.8.00. .0500 .088 00: .00: ..0800:. 0.800000 08.00.00 0.00.0.0 .000 00.000: 00.00.009.830 00 80. 000 .00.. 00.3. .003. 0.... .5: ..000.0000 0.0080 000.. 0002 00.0000 00 000.0.0m 0003 0000.000. 00.. 00 000.800 .0000 0:0 00.0000: 00000.. 000 00.00000 >.00...8 60.800 0.00.0 000 000.0000 00 000.000.0000 .0>o.080 00x08: 0000.000. 00.. 0:0 00.00... 00 000.000.0000 .0>0.080 00x08: 00.00000 0.00.0.5 000 .008000 0000 00.0000: 0.00.000> 0.80.0802 00.80000800 8088.088: 0.80.0802 00.880088 0.008802. 0.8.8802 0.0.000: 00 0800:. 000.0020... 0.0...— 00 08000. 00000082000808: "000.000 .0000 80.0 008880 80000800 44 BMW Expanded income was developed in response to a Congressional request for data on high-income taxpayers using a measure closely approximating economic income that could be derived using only tax return data [Internal Revenue Service, 1990, 71]. Expanded income is defined as adjusted gross income plus items of tax preference income excluded from adjusted gross income less investment expenses to the extent that they do not exceed investment income. The actual calculation of expanded income has varied from year to year. Tax preference items added back to adjusted gross income for tax year 1987 were tax-exempt state and local government bond interest and income preferences subject to the minimum tax (reported on Form 6251, Alternative Minimum Tax Computation). Investment interest expense was defined as the entire interest deduction other than interest paid on home mortgages. Investment income was defined as total interest and dividend income. W The family economic income measure, developed and used by the Treasury Department since 1984, uses the family unit rather than the tax return unit as the basis for defining income [Nelson, 1987, 77]. An imputation process is used to combine dependents with their own tax return with the tax returns of those who support them. In addition, as noted in Table 5.3, adjustments are made in an attempt to measure 45 only current year income and to adjust for inflation. The family economic income measure also includes an estimate for non-filer income. The family economic income measure includes estimates for many items of income not included on tax returns. Thus, it provides the most comprehensive measure of income by incorporating more non-tax information but also is mmch more difficult to estimate and is less objective. In Treasury Department estimates, adjusted gross income accounts for approximately two-thirds of family expanded income [Nelson, 1987, 82]. medified expended igeeme The modified expanded income measure was developed by the Joint Committee on Taxation [Nelson, 1987]. This income measure uses the tax unit (tax return) as the basis of analysis rather than the family unit but excludes tax returns for taxpayers under 16 years of age.10 Like the family economic income measure, the modified expanded income measure includes an income estimate for non-filers. Overall, while the modified expanded income measure is less comprehensive than the family economic income measure, it requires fewer estimates of income and is subject to less estimation error. 10The Joint Committee on Taxation assumes that these taxpayers are not self-supporting and deletes them from the analysis. 46 l m n The 1979 Income Concept is used within the Statistics of Income Division to analyze changes in income and taxes over a period of years [Internal Revenue Service, 1991, 6]. Because the components of adjusted gross income vary from year to year, a "retrospective" income concept was developed that includes the same income items in each year's calculation. The years 1979 through 1986 were used as base years in identifying the income iteme. The 1979 Income Concept includes only items available on federal individual income tax returns and uses the taxpaying unit as the basis for analysis. The 1979 Income Concept is the most objective measure of income, but it is less comprehensive than the modified expanded income or the family economic income measure. ' in m The economic income measure developed and used in this research is similar to the above measures in many respects. It provides a more comprehensive income measure than adjusted gross income. Adjusted gross income is used as the initial starting point in the computation of the measure. As noted in Table 5.3, nontaxable income items reported on the tax return are included in the measure. The foreign earned income and housing exclusions and the housing deduction are also added back to provide a more comprehensive measure of income. Due to estimation 47 difficulties, the non-tax return estimated items included in other measures are not included in this measure. 5.2.3 W Two alternative measures of taxes are used in this research: tax liability and effective tax rates. Taxes are computed on both a U.S. and worldwide basis. The measure of U.S. tax liability is defined as total tax after credits (1040, line 47) plus the alternative minimum tax (1040, line 49) plus investment tax credit recapture (1040, line 50).‘1 U.S. income taxes are based on worldwide income. The measure of U.S. tax liability computed above does not take into account any foreign taxes paid by the expatriates. To better reflect the total worldwide tax burden of U.S. expatriates, the equity of the IRC §911 provisions are also examined using a worldwide measure of taxes. The worldwide tax liability is defined as U.S. tax liability plus the amount of estimated foreign taxes paid and accrued.” 11This measure is similar to those used by Anderson [1985, 1988] and Ricketts [1990]. ”The Statistics of Income ZDivision. of the Internal Revenue Service also computes a worldwide measure of income taxes to provide a more accurate measure of the tax burden imposed on worldwide income. Worldwide tax liability is defined as the U.S. tax liability plus the amount of foreign tax credits reported on Form 1040 [Internal Revenue Service, 1990, 73] . Rather than using the reported foreign tax credits, the worldwide tax liability measure used in this study incorporates the amount of estimated foreign taxes paid and accrued that are reported on Form 1116. Because this measure uses actual taxes paid or accrued it should.provide a better estimate of worldwide tax liability. Calculation of this measure is possible because of the detailed data collected in the 1987 301 Individual Foreign sample which is 48 Effective tax rates are used as an alternative measure of taxes to assess the sensitivity of the results to the choice of tax measure. The effective tax rate is calculated by dividing the tax liability by the adjusted expanded income measure. For equity measures which group taxpayers by income level, Ricketts [1990, 42] notes that effective tax rates should enhance comparability by minimizing the dispersion that might occur in expanded income groups with a broad range of income. not available in the overall Individual Tax Model developed by the Statistics of Income. 49 5.3 Statistical procedures and tests of hypotheses 5.3.1 W The coefficient of variation is used to measure the horizontal equity within adjusted expanded income deciles for each tax regime. For purposes of this study, the coefficient of variation for each income group is determined using equation (1). For each adjusted expanded income group, the coefficient of variation from the tax regime without the IRC §911 provisions is compared to the coefficient of variation from the tax regime with the IRC §911 provisions (the current tax regime). The percentage decrease (increase) in the coefficient of variation is calculated as: (6) Percent change = [(CVfimm- CVfim)/Cvfimm] x 100 .A percentage decrease represents an increase in horizontal equity. A.percentage increase represents a decrease in horizontal equity. A.paired-comparisons t-test of the means of the coefficients of variation for each regime is used to test the overall difference in horizontal equity between the two regimes. For each tax regime, the coefficients of residual variation (CRVs) are calculated for each adjusted expanded income decile and on an overall basis for the total sample using equation (2). Following Grasso and Frischmann [1992] 50 two alternative variations of the regression equation are estimated: average effective tax rates are regressed on a logarithmic transformation of adjusted expanded income and tax liabilities are regressed on adjusted expanded income. In addition, the analysis is repeated including the total number of exemptions as an additional explanatory variable. Both measures of taxes (U.S. and worldwide) are alternatively used in the analysis.13 5.3.2 yertital Equity Effegts of Eliminating IRQ §211 The Suits index, the tax liability progression measure, and the residual progression coefficient are used to assess the relative progressivity (vertical equity) of the two tax regimes: the current tax regime that incorporates the IRC §911 provisions and the tax regime without the IRC §911 provisions. The Suits index (estimated from equation 3) is calculated for each tax regime. As for the horizontal equity measure, taxpayers are grouped into deciles by adjusted expanded income and the computations use both U.S. and worldwide measures of tax liabilities. For each tax regime, the tax liability progression coefficient is estimated from a regression of the log 13This requires running 16 regression.:models: 2 tax regimes X 2 tax measures (U.S. and worldwide) X 2 tax variations (liability and effective tax rate) X 2 types of model (income only and income plus exemptions). Each regression.model is then run on an overall basis and for each income decile. 51 transformation of equation (5). The regression coefficient provides a measure of the progressivity of each tax regime. Changes in liability progression are assessed by comparing the coefficients obtained by estimating the equation for each tax regime. The residual progression coefficients are calculated for each tax regime using equation (6). 5.3.3 Combined Equity Effggts of Eliminating IR: 5211 Menchik's combined model of vertical and horizontal equity [Menchik, unpublished] is also used to assess the relative equity of the two tax regimes: one with the IRC §911 provisions (current tax regime) and one without the IRC §911 provisions. The equity measures are estimated for each tax regime from a regression using equation (7). After-tax income is equal to adjusted expanded income less tax liability. Adjusted expanded income is used to measure before-tax income. This regression model is used to assess the horizontal and vertical equity of the tax regimes with and without the IRC §911 provisions. 5.3.4 h R f f To test the hypothesis that the use of the foreign earned income exclusions decreased following the Tax Reform Act of 1986, data must be available from both the pre-TRA and post-TRA periods. Data indicating the number of individuals claiming the IRC §911 provisions on their tax returns from the 1983 and 1987 S01 individual foreign 52 samples“ are used in conjunction with State Department estimates of the non-military/non-governmental overseas population to test this hypothesis. The number of individuals within each foreign country electing the IRC §911 provisions in each tax year is divided by the estimated non-military/non-governmental overseas population estimates for the country. This calculation standardizes and controls for any changes in the overseas populations in the various foreign countries and provides an estimate of the percentage of individuals using the IRC §911 provisions within each country. The analysis includes comparisons on an overall basis and grouping by high and low tax foreign countries. 1“The application of the foreign earned income provision changed very little between 1983 and 1987. In 1983 an individual could exclude up to $80,000 of foreign earned income, while in 1987 the exclusion was limited to $70,000. Because this hypothesis examines the number of individuals claiming the exclusion and not the magnitude of the exclusion, this minor change should not influence the test results. To determine if the change in the level of the exclusion.may have had a differential impact on taxpayers across income levels, a.paired comparison t-test was used.to»determine if there were any significant differences across income levels in. the percentage of taxpayers claiming the IRC §911 provisions between 1983 and 1987. After grouping returns by adjusted gross income, a paired-comparisons t-test was used to compare the percentage of taxpayers using the IRC §911 provisions in 1983 and 1987. The t-test was insignificant (t-.00004, p=1) indicating there was no significant difference between 1987 and 1983 in the percentage of taxpayers using the IRC §911 provisions across the income levels. Chapter Six ANALYSIS OF RESULTS The results of the descriptive analysis and the tests conducted to examine the hypotheses are reported in this chapter. The descriptive analysis of the data is followed by the results of the analysis examining the equity effects of eliminating the IRC §911 provisions and the impact of the Tax Reform Act of 1986 on the use of the IRC §911 provisions. 6.1 Descriptive Statistics An initial comparison of 1987 individual returns with those taxpayers (expatriates) filing Form 2555 is provided in Table 6.1. A simple comparison of the mean adjusted gross incomes or taxable incomes of the expatriates and all individual returns suggests that the two groups are quite similar. The mean adjusted gross income for expatriates and all individuals filing returns is $25,384 and $25,924, respectively. The mean taxable income for expatriates and all individual returns is $19,515 and $20,544, respectively. However, a comparison of some of the components of income reveals striking differences between expatriates and all individuals filing returns. The mean salaries and wages for expatriates is more than double that of all individual return filers ($61,087 vs. $23,873). The average amount of 53 54 reported business net income is double that reported by all individual return filers ($16,289 vs. $8,111). In contrast, the mean total tax liability of expatriates is approximately sixty-five percent of the mean for all individual return filers. 55 Table 6.1 1987 U.S. Individual and Expatriate Returns 1 All Full Year EYE with FYE with Individual Expatriate only foreign Returnsl (EYE) exclusions tax credit Returns2 and exclusions Adjusted 25,924 25,384 9,826 93,783 Gross Income3 Taxable 20,544 19,515 6,066 78,645 Income‘ Salaries and $23,783 $61,087 $40,245 $149,866 I We es’ I Taxable 2,487 3,221 2,386 6,127 Interest‘ Business Net 8,111 16,289 13,148 29,126 Income and Loss’ Capital 8,893 11,199 9,577 16,922 Gain/Loss8 I Total Tax 4,342 2,794 1,467 8,622 Liability? % Itemizing 34% 22% 16% 45% Deductions == = 1Derived from data in Internal Revenue Service (1990). 2Individuals filing Form 2555. 31987 ‘1937 51987 61987 71937 ‘1987 91987 Form Form Form Form Form Form Form 1040, line 1040, 1040, 1040, 1040, 1040, 1040, line line line line line line 30. 36. 7. 8. 13. 14. 53. 56 The expatriate returns can be partitioned into two groups: expatriate returns claiming only the foreign earned income and housing exclusions and expatriate returns with both the exclusions and the foreign tax credit. As shown in Table 6.1, expatriates claiming both the foreign tax credit and the exclusions have much higher incomes and tax liability than those expatriates claiming only the exclusions. This is not surprising given that the foreign earned income exclusion is limited to $70,000. Foreign income taxes paid on foreign earned income in excess of the limitation are eligible for the foreign tax credit. Thus, high income expatriate taxpayers are likely to claim both the exclusions and the foreign tax credit. Table 6.2 provides a breakdown of full year expatriate (EYE) returns by type of return: all expatriate taxpayers filing for the foreign earned income and housing exclusions, full year expatriate taxpayers claiming only the foreign earned income and housing exclusions, and expatriate taxpayers claiming both the foreign earned income and housing exclusions and the foreign earned income credit. As shown in Panel A of Table 6.2, an estimated 103,367 expatriates claimed the foreign earned income or housing exclusions for the full year. The average combined foreign earned income and housing exclusions (2555 exclusions) was $42,370, and the total amount excluded was in excess of four billion dollars. Full year expatriates excluded over $335 57 million dollars in housing costs and four billion in foreign earned income. Only an estimated 919 expatriates claimed the housing deduction. The mean housing deduction was $11,375 with a total housing deduction of more than ten mdllion dollars. The total tax liability of all expatriates was less than $300 million with a mean liability of $2,794. Panel A: Table 6.2 58 Expatriate Returns 1987 Full Year Returns with a Foreign Earned Income or Housing Exclusion (N = 3,931) ITEM (Faun. lino) WEIGHTED MEAN STANDARD TOTAL N DEVIATION ADJUSTED GROSS INCOME (1040,33) 103,387 025,384 0104.446 02.823.881.663 2556 EXCLUSIONS (1040.21A) 103.387 42.370 32.31 3 4,378,874,072 HOUSING EXCLUSION (2565.25) 18.463 20.384 23,134 335,380,388 FOREIGN EARNED INCOME EXCLUSION (2666.34) 103.348 38.134 28.086 4.044.420.337 HOUSNG DEDUCTION (1040.ADJ) 818 1 1.376 16.038 10,461.832 TOTAL TAX LIABILITY (1040.53) 103.387 2.784 17.178 288,787,712 TOTAL WAGES (2565.10) 88.” 41.861 42,282 4.032.031 . 1 08 BUSINESS INCOME (2666.11A) 7.434 21.710 40,760 181,380,718 PARTNERSHIP INCOME (2665.1 18) 1.023 44.885 88.723 46.836.878 NONCASH INCOME - HOME(2565.12A) 7.408 10.186 14,183 76,433,718 NONCASH INCOME - MEAL (2666.128) 2.088 3.833 2.351 8.038.453 II NONCASH INCOME - CAR (2666.128) 4.817 2.783 2,608 12,755,674 II NONCASH INCOME - OTHER (2566.120) 3.488 2.018 7,372 7.004.736 fl ALLOWANCE - COLA (2665.13A) 13.430 18.788 14. 202 226,473.606 ALLOWANCE - FAMILY (2665.138) 1.084 3.188 6,723 3.488.638 ALLOWANCE - EDUCATION (2656.138) 7.040 8.288 7,487 68,210,838 ALLOWANCE - HOME LEAVE (2565.1 SD) 13.207 5.w2 4,522 73,878,880 ALLOWANCE - OUARTERS (2556.13E) 13.674 20.842 23. 751 284,255,030 ALLOWANCE - OTHER (2566.13F) 18.788 20.458 36.675 404.432.458 ALLOWANCES - TOTAL (2666.13G) 26.873 40.881 48,808 1,048,818,127 OTHER FOREIGN EARNED INCOME (2566,14) 12,766 1 2,818 30,418 180,848,727 GROSS FOREIGN EARNED INCOME (2565,16) 103,348 63,735 81,287 5,563,381,486 59 Table 6.2 (Cont'd.) Panel B: 1987 Full Year Returns with only a Foreign Earned Income or Housing exclusion (N = 1,850) ITEM (Fem. lino) WEIGHTED MEAN STANDARD TOTAL N DEVIATION ADJUSTED GROSS INCOME (1040.30) 84.212 08.828 873,121 6821482818 2666 EXCLUSION (1040.21A) 84.212 34.108 25.255 2.872.131.248 I HOUSING EXCLUSION (2565.25) 8.882 12,008 1 1.183 ”300.750 FOREIGN EARNED INCOME EXCLUSION (2666,34) 84.212 33.168 23.248 2.782.111.488 HOUSING DEDUCTION (1040.ADJ) 520 8.768 10.725 4.661.887 “TOTAL TAX LIABILITY (1040.53) 84.212 1.488 10.050 123.808.408 TOTAL WAGES (2666.10) 78.254 32.683 25.881 2.548.218.882 BUSINESS INCOME (2566.1 1A) 8.081 17.080 24.887 103.401.162 PARTNERSHIP INCOME (2566.118) 886 24.648 56,482 21 .226,323 NONCASH INCOME - HOME (2566.12A) 5.788 7.588 7.448 43.773.550 NONCASH INCOME - MEAL (2666.128) 1.388 3.481 2.382 4.848.883 NONCASH INCOME - CAR (2556.128) 2.680 2.861 2.230 8.838.258 NONCASH INCOME - OTHER (2665.12D) 1.316 1,628 1.778 2,010,828 ALLOWANCE - COLA (2566.13A) 8.226 1 1.103 8.488 88.1 14.824 ALLOWANCE - FAMILY (2665.138) 848 2.017 3.823 1,708,678 ALLOWANCE - EDUCATION (2555.130) 2.831 5.586 5.328 14.843.040 ALLOWANCE - HOME LEAVE (2566.130) 6.848 4.881 4.778 28.638.867 ALLOWANCE - OUARTERS (2556.13E) 6.803 11.884 11.884 88,858,878 ALLOWANCE - OTHER (2565.13F) 8.878 7.308 10.183 70.728.882 ALLOWANCES - TOTAL (2656.138) 14.348 17.877 18,528 253,688,880 iOTHER FOREIGN EARNED INCOME (2665.14) 7.403 8.814 17.887 85.254.226 [GROSS FOREIGN EARNED INCOME (2555.16) 84.212 38.208 31.234 3.048.183.171 60 Table 6.2 (Cont'd.) Panel C: 1987 Full Year Returns with both a Foreign Earned Income Exclusion and a Foreign Tax Credit (N = 2,081) t‘EM (Form. lIne) WEIGHTED MEAN STANDARD TOTAL Jl N DEVIATION ADJUSTED GROSS INCOME (1040.30) 18.156 083.783 172.108 01.788.388.836 II 2565 EXCLUSIONS (1040.21AI 18.166 78.703 34.788 1.607.642.824 HOUSING EXCLUSION (2666.26) 8.781 28.083 27.088 266,378,837 ll FOREIGN EARNED INCOME EXCLUSION (2666.34) 18.136 86.446 20,888 1,262,308,862 II HOUSNG DEDUCTION (1040,ADJ) 388 14.783 18.733 6.800.086 ll TOTAL TAX LIABILITY (1040.63) 18.166 8.822 33.286 185.181.303 TOTAL WAGES (2665.10) 18.661 78.888 88.278 1,483,814.247 II BUSINESS INCOME (2666.11A) 1.373 42.237 78.074 67.888.683 PARTNERSHIP INCOME (2666.1 18) 168 166.828 131,421 24,710,868 NONCASH INCOME - HOME (2666.12AI 1.837 18.341 24.680 31,880,188 NONCASH INCOME - MEAL (2666.128) 708 4.602 2.138 3.180.480 NONCASH INCOME - CAR (2666.12CI 2.038 2,803 2.818 6.818.317 NONCASH INCOME - OTHER (2666,12D) 2.163 2.318 8,240 4,883,806 ALLOWANCE - COLA (2666.13AI 7.206 21.702 18.171 168.368.681 ALLOWANCE - FAMILY (2666.138) 248 7.136 8.611 1,768,883 ALLOWANCE - EDUCATION (2666.138) 4.408 8,883 8,070 43,687,888 ALLOWANCE - HOME LEAVE (2666.130) 7.380 8,174 4.221 46,443,023 ALLOWANCE - OUART'ERS (2666.136) 7.870 28,083 27,788 216,388,061 ALLOWANCE - OTHER (2566,13FI 10.082 33.087 45.338 333.706.674 II ALLOWANCES - TOTAL (2665.138) 11,328 70.280 68,888 788,230,147 ll OTHER FOREIGN EARNED INCOME (2666.14) 6.362 17.881 41.360 86,882,602 ll GROSS FOREIGN EARNED INCOME (2666.16) 1 8.136 130,888 83,167 2,604,188,284 II 61 Data from Fonm 2555 provide information about the components of the foreign earned income of expatriates. As shown in Panel A of Table 6.2, salaries and wages, in excess of four billion dollars, are the primary source of foreign earned income. Approximately 73 percent of all foreign earned income is derived from salaries and wages. Combined business and partnership income is less than four percent of total foreign earned income. Less than two percent of foreign earned income is non-cash income. Total allowances account for approximately 19 percent of foreign earned income. 0f the total allowances, approximately half are for cost of living and quarters (housing).l Panels B and C of Table 6.2 provide information from tax returns for expatriates filing only for the exclusions and for both the exclusions and the foreign tax credit, respectively. An estimated 84,212 expatriates, over 80 percent of the estimated 103,367 expatriate filers with a Form 2555 attached to their 1040 return, filed 1040 returns with only a Form 2555 attached. Expatriate returns with only a Form 2555 (foreign earned income) attached accounted 1It appears that many of the amounts reported as "allowances-other" on line 13f of Form 2555 are tax equalization payments. In a physical check of 94 paper tax returns within the sample, 55 (58%) reported tax equalization payments on line 13f of Form 2555 and 11 (12%) reported the tax equalization payments on line 14 of Form 2555. Tax equalization payments were not reported.on lines 13f or 14 for twenty-eight (30%) returns reporting income on those lines. These twenty-eight taxpayers did not report any tax equalization payments. 62 for more than $2.8 billion (or 66 percent) of the estimated $4.38 billion combined foreign earned income and housing exclusions (2555 exclusions) claimed. Expatriates filing both a Form 2555 and Form 1116 accounted for the remaining 34 percent of the total combined exclusions (2555 exclusions) claimed by all expatriate filers. Although expatriates filing both a Form 2555 and Form 1116 account for 45 percent of the total foreign earned income reported by all expatriate taxpayers, they account for 75 percent of the total allowances. A breakdown of full year expatriate returns by occupation is provided in Table 6.3.2 More than half of the expatriates are employed in business professions (business management, construction, support services, finance and insurance, sales and public relations, accounting and law, and agriculture and forestry). Expatriates employed in education, religion, and research account for approximately 28 percent of all returns filed. IAlthough this table provides some sense of the occupations of expatriates it should be interpreted with caution. Anecdotal evidence indicates that the occupations were not consistently coded" Almost 14 percent of the sample has been classified into "other occupations". 63 Table 6.3 Expatriate Returns by Occupation Occupation Number of Percentage of Returns Returns EDUCATION AND RELIGION 22,634 21.9 OTHER OCCUPATIONS 14,320 13.9 E BUSINESS MANAGEMENT 14,159 13.7 CONSTRUCTION/ENGINEER 13,761 13.3 PETROLEUM EXTRACTION MENING n SUPPORT SERVICES 8,418 8.1 u RESEARCH 6 , 852 6 . 6 FINANCE AND INSURANCE 6,572 6.4 SALES AND PUBLIC 5,571 5.4 RELATIONS “Inuumn 4,297 4.1 n ART AND ENTERTAINMENT 3,400 3.3 ACCOUNTING AND LAW 2,891 2.8 AGRICULTURE/FORESTRY 442 0.4 FISHER! UNLISTED 90 0 . 1 IL TOTAL RETURNS 103,367 100.0 64 The twenty-five countries with the highest numbers of full year expatriate taxpayers are reported in Table 6.4. MOre than 80 percent of the sample resides in these twenty- five countries. Expatriate taxpayers filing Form 2555 for tax year 1987 are residents (or present under the physical presence test) in approximately 123 foreign countries. Half of the expatriates live in six countries: West Germany, Canada, the United Kingdom, Saudi Arabia, Japan, and Israel. 65 Tarflxa 6.4 Expatriate Returns by Country of Residence i Country Weighted Percent of t L _ __ _ Returns _Ret_urns fumjetums Percent .west Germany 13,349 12. 9 13, 349 12.9 n I Canada 10,332 10.0 23,681 22.9 gunited Kingdom 9,736 9.4 33,416 32.3 ESaudi Arabia 7,624 7.4 41,041 39.7 ‘Ja-an 6,501 6.3 47,542 46.0 Israel 4,004 3.9 51,546 49.9 “ iFrance 3,381 3.3 54,927 53.1 iSwitzerland 3,122 3.0 58,049 56.2 :Italy 2,256 2.2 60,305 58.3 “ (Brazil 2,245 2.2 62,550 60.5 j Australia 2, 136 2 .l 64, 686 62 .6 iHon- Kono 2,128 2.1 66,814 64.6 i Mexico 1,892 1.8 68,706 66.5 EPhilippines 1,829 1.8 70,535 68.2 I (Indonesia 1,593 1.5 72,128 69.8 “ ;Netherlands 1,407 1.4 73,534 71.1 iSouth Korea 1,398 1.4 74,933 72.5 (Taiwan 1,341 1.3 76,274 73.8 ESpain 1,287 1.2 77,560 75.0 Belgium 1,264 1.2 78,824 76.3 venezuela 1,219 1.2 80,044 77.4 Sin apore 1,166 1.1 81,210 78.6 Greece 1,061 1.0 82,271 79.6 South Africa 1,030 1.0 83,301 80.6 Kuwait 885 0.9 84,186 81.4 L 66 For each of the horizontal equity measures, the sample is partitioned into deciles using adjusted expanded income. Selected information for the total sample and each of the deciles is reported in Table 6.5. Recall that the sample contains all married individuals filing joint returns with a Form.2555 for the full year and a positive adjusted expanded income or 2,882 tax returns. As noted in Panel A of Table 6.5, the overall mean adjusted expanded income is $85,625. The average U.S. tax liability with the IRC §911 provisions in place is $3,385 while the worldwide tax liability is $23,934. Without the IRC §911 provisions, the U.S. tax liability increases to $8,236 and the worldwide tax liability increases to $28,785. With IRC §911 provisions in place the average effective tax rates are 2.25 percent (U.S.) and 23.08 percent (worldwide). For the tax regime without the IRC §911 provisions, the average effective tax rates increase to 6.75 percent (U.S.) and 27.58 percent (worldwide).3 Overall, under current law, with the IRC §911 provisions in place, these expatriates paid U.S. taxes of more than $205 million and worldwide taxes of more than $1.4 billion on adjusted expanded income of approximately $5 billion. 3For two returns in the sample, the average effective U.S. tax rates are in excess of 100 percent due to large alternative minimum tax liabilities. For twenty-eight returns in the sample, the worldwide average effective rates are in excess of 100 percent because the reported foreign taxes paid or accrued exceeds the reported foreign source income. 67 Information for each of the deciles is reported in Panel B of Table 6.5. The mean adjusted expanded income ranges from $13,624 in decile one to $302,165 in decile ten. The average amount of the 2555 exclusions (the combined foreign earned income exclusion and housing exclusion) ranges from $10,400 for decile one to $101,031 in decile ten. Each of the deciles contains approximately 6,000 weighted returns. 68 Table 6 . 5 Descriptive Statistics by Deciles Panel A: Full Year Married Filing Joint Returns with a Form 2555 and Positive Adjusted Expanded Income Mom Standard Mlnlmun Madman 81m C.V. ll OVERALL (wdohtcd Tatum - 80.882) DevIDTIon ADJUSTED EXPANDED INCOME 666.626 6120.666 6660 611,610,000 16.166.614.666 1141 II AGI (1040.301 36.222 104,763 0 1 1,660,000 2.1 37,343,440 267 II 2666 Excwaou 11040.21» 48.481 34.834 226 348.100 3,002,606,644 71 am 611 DEDUCTION I1040,ADJ) 136 2.108 0 81,780 8,228,804 1,664 U.S. TAX WTTH 611 3.386 20.266 0 1 .388,000 206,400.61 1 800 U.S. TAX WITHOUT 611 6,236 26.376 0 1 ,408,000 488,782,888 306 WORLDWIDE TAX WITH 811 23,634 67.631 0 7,083,000 1,462,387,838 :40 WORLDWIDE TAx WITHOUT 81 1 28.786 66,016 0 7,071,000 1,748,768.71 6 206 AVERAGE U.S. TAx wrm 611 2.26 16.30 0 1,230.88 726 AVERAGE U.S. TAx WITHOUT 61 1 6.76 17.76 0 1,230.66 283 AVERAGE woawme TAX WITH 811 23.06 28.82 0 1,421.63 1 17 IAVERAGE wonmme TAx WITHOUT 61 1 27.66 26.23 0 1,421.63 61 u Panel B: Full Year Married Filing Joint Returns with a Form 2555 and Positive Adgusted Expanded Income by Deciles Mean Standard MInImun Modmum 81.611 C.V. II DeviatIon Dec“. 1 Wed rm I 6.883) n ADJUSTED EXPANDED INCOME 813.824 84.180 8880 818,380 881 .243,621 .31 fl AGI (1040.30) 3.1 04 7,21 1 0 1 6,840 18.61 0.803 23’2I 2666 EXCLUSION (1 040.21 A) 1 0.400 7.1 47 226 88,780 82.01 8,864 88 SEC 81 1 DEDUCTION I1 040,ADJI 2 1 86 0 1 2,630 1 3,027 7,672 #8. TAX WITH 811 1 81 2.212 0 78.820 880,606 1 .373 U.S. TAX WITHOUT 81 1 268 2,221 0 78.820 1 .623.727 8“ WORLDWIDE TAX WTTH 81 1 3,221 6,467 0 1 62,780 18,207,674 1 fl ‘WORLDWIDE TAX WITHOUT 81 1 3,31 6 6,41 8 0 162,780 1 8,770,786 1 83 AVERAGE U.S. TAX WITH 811 2.68 60.67 0 1,230.88 1.874 AVERAGE U.S. TAX WITHOUT 811 3.13 60.67 0 1 .230.” 1,813 AVERAGE WONDWIDE TAX WITH 81 1 26.68 83.88 0 1,421.63 248 AVERAGE WORLDWIDE TAX WITHOUT 81 1 28.14 83.48 0 1,421 .63 243 Deal). 2 (weighted Tatum - 8,072) ADJUSTED EXPANDED INCOME 23,313 I 2.180 1 8,71 8 28.840 1 41 ,688,884 8 AGI (1 040.30) 8,742 8,782 0 28,320 40,838,877 1 30 2666 EXCLUSION (1 040.21 A) 1 8,61 3 8.384 600 61 ,8” 1 00,277,788 67 SEC 81 1 DEDUCTION I1040,ADJ) 0 0 0 0 0 U.S. TAX WITH 811 281 622 0 2,700 1,704,726 188 U.S. TAX WITHOUT 81 1 m2 801 0 3,300 3,864,166 133 WORLDWIDE TAX WITH 81 1 4.81 2 6,888 0 60,180 28,828,1 73 1 20 ‘ WOIlDWIDE TAX WITHOUT 81 1 6.233 6,734 888 60,330 31 ,777,803 1 10 AVERAGE U.S. TAX WTTH 811 1 .22 2.23 0 10.06 183 AVERAGE U.S. TAX WITHOUT 811 2.67 3.36 0 1 2.43 130 AVERAGE WORLDWIDE TAX WITH 811 20.78 23.13 0 188.80 11 1 AVERAGE WORLDWIDE TAX WITHOUT 811 22.1 2 22.37 4.40 180.17 101 69 Table 6.5 (Cont'd.) Descriptive Statistics by Deciles Panel 8: Full Year Married Filing Joint Returns with Form 2555 and Positive Adjusted Expanded Income by Deciles 066)). 3 W Tm - 8,082) Mean 8m MInImun Madman Sun Devi-11011 ADJUSTED EXPANDED INCOME 130,774 62,316 126,640 134.600 1167.1 72.718 AGI (1040,30I 6.466 6,670 0 33,660 67,770,763 2666 EXCLUSION (1040.21 A) 20,770 10,647 380 70,1 70 126,326,016 sec 61 1 DEDUCTION (1040.ADJ) o o o o o U.6. TAX WITH 61 1 476 614 o 3.840 2,664,676 U.6. TAX WITHOUT 61 1 630 1.1 26 o 4,730 6,666,031 WORLDWIDE TAX WITH 61 1 6,262 3,666 0 23,660 32,166,706 WOIIDWIDE TAX WITHOUT 61 1 6,746 3,676 460 23.660 34,660,766 AVERAGE U.6. TAX erH 61 1 1.64 2.66 10.88 AVERAGE U.6. TAX WITHOUT 61 1 3.00 3.61 0 13.88 AVERAGE WOI'IDWIDE TAX WITH 61 1 17.16 12.26 88.84 AVERAGE \NOIIDWIDE TAX erHOUT 611 16.61 1 1.22 1.63 66.64 DOGIIO 4 (10¢on return I 8.088) ADJUSTED EXPANDED INCOME 36,606 2,886 34.640 44.340 236,062,666 AGI (1040.301 10,326 1 1,666 (16,760] 34,820 62,662,674 2666 EXCLUSION (1040,21AI 26.366 12.666 2,330 67,660 1 72,076,467 sec 61 1 DEDUCTION (1040.ADJ) o o o o 0 U.6. TAX erH 61 1 670 1 .063 o 3.880 4,066,037 U.6. TAX WTTHOUT 611 1,664 1,667 o 7.370 1 2,103,038 wonDWIDE TAX WITH 61 1 6,672 4,867 0 26.660 36,636,766 WOIlDWIDE TAX WITHOUT 61 1 7,167 3,667 3.070 26,660 43,673,767 AVERAGE U.6. TAX WTTH 61 1 1.76 2.62 0 10.20 AVERAGE U.6. TAX WITHOUT 61 1 6.06 4.60 0 18.82 AVERAGE WORLDWIDE TAX WITH 611 16.06 12.06 0 66.17 AVERAGE womnwme TAX WITHOUT 61 1 18.38 6.66 6.63 66.17 Dean. 6 mama Tm - 8.060) ADJUSTED EXPANDED INCOME 60,076 3,266 44,660 66,630 303,006,066 AGI (1040.301 8.728 16.832 0 47,600 66,666,167 2666 EXCLUSION (1040,21A) 40,227 1 6,666 800 63,610 243,364,660 6EC 61 1 DEDUCTION (1040,ADJ) o o 0 o 0 U.6. TAX WITH 61 1 761 1,476 o 8.800 4,642,616 167 U.6. TAX WITHOUT 61 1 2,366 3,064 0 mm 14,446,663 1 27 WOMDWIDE TAX WITH 61 1 1 1 .188 7.827 36,360 67,661,767 66 WORLDWIDE TAX WITHOUT 61 1 12,623 6,220 6,720 38,380 77,666,221 46 AVERAGE U.6. TAX WITH 611 1.60 2.88 0 14.62 200 AVERAGE U.6. TAX WTTHOUT 81 1 4.66 6.66 0 16.66 126 ll AVERAGE WOIIDWIOE TAX WITH 611 22.60 16.41 0 77.24 66 || AVERAGE WORLDWIDE TAX WTTHOUT 61 1 26.66 12.62 1 1.83 77.24 46 70 Table 6.5 (Cont'd.) Descriptive Statistics by Deciles Panel B: Full Year married Filing Joint Returns with a Form 2555 and Positive Adjusted Expanded Income by Deciles j M681 Stand“ MInImun Maxlmun Sun C.V. 0617168671 _ D6DII6 8 M11168 rm 6 8.m1) ADJUSTED EXPANDED INCOME 884.178 45.378 466.8” 873,030 8380368538 88 AGI (1040.30) 10.248 16,618 0 88,740 82,418,270 161 2656 EXCLUSION (1 040.21 A) 63.781 1 8,264 1 ,1 80 81 .100 327,500,684 30 SEC 811 DEDUCTION “040,ADJI 0 O 0 0 0 U.S. TAX WITH 81 1 826 2,284 0 1 2,880 6,025,424 274 U.S. TAX WITHOUT 81 1 3.888 6.188 0 1 8,780 24,288,827 130 MWDE TAX WITH 81 1 1 5,347 1 1 .300 0 84.8” 83,487,442 74 INOKDWIDE TAX WITHOUT 811 18.610 8,400 8,810 84.8” 11 2.768.846 4:] AVERAGE U.S. TAX WITH 811 1.25 3.38 0 1 7.88 2“ AVERAGE U.S. TAX WITHOUT 81 1 8.13 7.81 O 22.72 1 27 I AVERAGE WOIlDWIDE TAX WITH 811 23.88 1 7.28 0 1 10.78 72J AVERAGE \NOIID‘MDE TAX WITHOUT 81 1 28.74 12.82 1 1 .86 1 10.78 44 D6GII6 7 MM“ "cums I 8,048) ADJUSTED EXPANDED INCOME - 82.188 6.273 73,140 82.240 488,863,282 8 AGI (1 040,30) 1 7.200 1 7.408 0 81 .760 1 03,887,023 1 01 2666 EXCLUSION (1 040.21 A) 84.486 1 8.386 1 .330 1 02,200 388,887,377 28 SEC 811 DEDUCTION (1 040,ADJI 107 884 0 14.3” 844.833 828 U.S. TAX WITH 81 1 1 .342 3,218 0 18,270 8.1 14,860 240 U.S. TAX WTTHOUT 81 1 7.733 7,842 0 22,260 48,767,338 88 WOW TAX WITH 811 1 8,630 13.1 78 0 64,830 88,846,038 80 \NOHJWVIDE TAX WITHOUT 81 1 22,821 8,187 3.840 66,020 138,687,724 38 AVERAGE U.S. TAX WTTH 81 1 1 .5 3.87 0.00 21 .88 240 AVERAGE U.S. TAX WTTHOUT 81 1 8.37 8.1 8 0.00 24.48 88 AVERAGE WORLDWIDE TAX WITH 81 1 20.08 16.82 0.00 “.61 78 AVERAGE WOI'IDW'IDE TAX WITHOUT 81 1 27.78 8.28 6.28 86.61 33 D6686 8 deohtd r6tun16 - 8.134) ADJUSTED EXPANDED INCOME 1 06,003 7,824 82,280 1 18,700 844,077,1 08 7 lAGI (1040.30) 30,483 18,344 0 1 13,800 1 88,878,280 83 2666 EXCLUSION (1 040.21 A) 73.761 18.1 47 420 1 28,000 462,378,213 28 SEC 811 DEDUCTION (1 040,ADJI 1 81 1 .231 18,240 888,068 784 U.S. TAX WITH 811 2.467 4,188 0 26,260 16,070,271 170 U.S. TAX WITHOUT 81 1 1 1 .873 10,367 0 36,470 72,828,408 87 lVVORLDVVIDE TAX WTTH 81 1 22.888 1 8.166 1 60.700 1 40.271 .860 78 WORLDWIDE TAX WITHOUT 811 32,286 11 .730 8.660 160,700 188,028,884 38 AVERAGE U.S. TAX WTTH 811 2.33 4.00 0 22.74 1 72 AVERAGE U.S. TAX \MTI-DUT 811 11 .30 8.74 0 32.78 88 AVERAGE \NOI‘DWIDE TAX WITH 81 1 21 .72 1 8.87 0 1 27.22 78 IAVERAGE mm TAX WITHOUT 81 1 30.“ 10.47 8.62 1 27.22 34 = = I 71 Table 6.5 (Cont'd.) Descriptive Statistics by Deciles Panel 3: Positive Adjusted Expanded Income by Deciles Full Year Married Filing Joint Returns with Form 2555 and Minimum Mexlmum Sun noon. 0 (wdohtd mum. - 0,0731 ADJUSTED EXPANDED INCOME 1143.505 115,070 1110.700 0174.000 1071,440,007 AGI I1040,3oI 57.017 24.024 0 101,000 340,007,700 2555 EXCLUSION (1040,2110 04.304 21.571 050 150.000 51 2,311.1 00 05c 01 1 DEDUCTION I1O40.AD.II 341 2,050 0 35,520 2,073,724 U.0. TAx WITH 011 4,1 72 5.404 0 30,720 25,332,450 0.0. TAX WITHOUT 01 1 15,000 14,553 0 52,500 05,1 44,050 WOHIOWIOE TAX WITH 01 1 40.007 31.775 0 255,500 240,057,040 WORLDWIDE TAx WITHOUT 01 1 52,104 24,374 17,500 255,500 31 0,770,040 PM 0.0. TAx WITH 01 1 200 3.73 0 22.20 AVERAGE U.0. TAx WITHOUT 011 11.02 10.10 0 30.20 IAVEHAOE WORLDWIDE TAx WITH 01 1 20.04 21.47 0 107.00 AVERAGE WORLDWIDE TAx WITHOUT 01 1 30.17 15.00 13.20 107.00 00an 10 107090140 retune - 0,1011 ADJUSTED EXPANDED INCOME 302.105 270,302 174,300 11,010,000 1,043,305,170 AGI I1 040.30) 105.030 275.073 25.030 1 1 .000,000 1.105,200,1 1 5 lg“ EXCLUSION 11040.21» 101.031 37.507 350 340,100 010,354,075 [050 01 1 DEDUCTION (1 040,ADJI 730 5,700 0 01.000 4,510,305 0.0. TAx WITH 01 1 22,570 00,030 0 1 ,300,ooo 137,000,340 tic. TAx WITHOUT 011 30.011 00,004 0 1 ,400,000 223,351,024 flWOHLOWIOE TAX WITH 011 11 2,043 145,742 4,470 7,003,000 007,101 .403 [WOW TAx WITHOUT 011 1 20.004 144.710 23.440 7,071,000 772,053,002 1 14 IAVERAGE U.S. TAX WITH 01 1 5.75 0.33 0 70.77 1 10 “AVERAGE 0.0. TAx WTTHOUT 011 1 1.10 0.05 0 70.30 00 IAVERAGE WORLDWIDE TAx WITH 011 30.00 24.21 1.07 307.07 07 41.43 2002 034 307.00 IAWRAGE mm TAX WITIKDUT 811i| 72 6.2 Tests of Hypotheses 6.2.1 Horizontal Equity Effects 9: Eliminating Igt §211 The coefficients of variation using tax liabilities as the measure of taxes are reported in Table 6.6. Overall. a comparison of the mean coefficients of variation of the U.S. tax liability with and without the IRC §911 provisions is inconsistent with the hypothesis that the IRC §911 provisions increase horizontal equity. The inclusion of the IRC §911 provisions resulted in a mean 68 percent reduction in horizontal equity using the U.S. measure of taxes. The mean variation is smaller (implying a higher level of horizontal equity) for a tax regime without the IRC §911 provisions (mean - 194.9) than for a tax regime with the IRC §911 provisions (mean = 317). A paired comparisons means test of the coefficients of variation indicates that this difference is significant (t - -2.78, p = .0214). Comparisons of the two tax regimes using worldwide tax liabilities as the measure of taxes indicate that horizontal equity also decreases in a tax regime with IRC §911 provisions available. Overall, a comparison of the mean coefficients of variation indicates that the tax regime with IRC §911 exclusions is significantly less horizontally equitable than a tax regime without the IRC §911 provisions using a paired-comparisons means test (t = -S.59, p = .0003). These results are inconsistent with the first hypothesis that the IRC §911 provisions improve 73 horizontal equity for the expatriate taxpayers. Instead. these results are consistent with the notion that horizontal equity actually decreases with the inclusion of the IRC §911 provisions. The coefficients of variation, using the effective tax rates as an alternative measure of taxes, are reported in Table 6.7. Consistent with Ricketts [1990. 42], the effective tax rate measure does seem to minimize the dispersion in those deciles with the broadest range of income. As shown in Table 6.5 Panel B, deciles 9 and 10 contain the broadest range of adjusted expanded income. The adjusted expanded income range exceeds $50,000 in decile 9 and is in excess of $10 million in decile 10. The coefficients of variation for these deciles are uniformly smaller using the effective tax rate measure rather than the tax liability measure of taxes. The overall results using effective tax rates are consistent with the analysis using tax liabilities as the measure of taxes. Again. a comparison of the mean coefficients of variation of the U.S. tax liabiity is inconsistent with the hypothesis that the IRC §911 provisions increase horizontal equity. The inclusion of the IRC §911 provisions results in a mean 65 percent reduction in horizontal equity when only U.S. taxes are considered. The mean variation is smaller for a tax regime without the IRC §911 provisions (U.S. mean a 257.4. worldwide mean - 71) 74 than for a tax regime with the §911 provisions (U.S. mean = 360.5, worldwide mean = 95.2). A paired-comparisons t-test of the coefficients of variation indicates that these differences are significant (U.S. t = -3.28. p = .0095 and worldwide t = -5.82, p = .0003).‘ ‘Results from an analysis of the coefficients of variation for the sample of returns with either positive or negative adjusted expanded income (n = 2,893) are consistent with the analysis using only positive adjusted expanded income returns. For both the U.S. and worldwide measures of taxes, the tax regime without the IRC §911 provisions is more horizontally equitable than a tax regime with the IRC §911 provisions. A.t-test of the mean differences is significant for both tax measures (U.S. t=-2.83, p=.0198 and worldwide t=- 5.63. p=.0003). In addition, in calculating the change in itemized deductions for the tax regime without the IRC §911 provisions. it is assmmed that the maximum change occurs. An alternative calculation of the new tax liability is performed assuming no change in itemized deductions. The analysis using this alternative measure of taxes under a tax regime without the IRC §911 provisions does not alter the results of the analysis. The differences between the mean coefficients of variation are still significant and consistent (U.S. t--2.73, p=.0233 and worldwide t=-5.48. p=.0004). 75 Table 6.6 - Tax Liability ion lat t of var icien Coeff .0530. x3 08.0 2325x230 8:305“: 0:00.. :05 .603 u e 0:55. $98 5 ana... 5850; a 8 080m 80.3 @383 EN. 5 :38 30.3 $8 5%. 2.8. 3.8- e: 3.2 0.8 3.5 3: :82 m cm F- 8.3- 0: 8. m2 08 S o. 8.8- 3.9.- 3 8 on .2 Z a 3.8 7 3.8- mm B 2 o: H 0 ~32- «ed:- 8 8 8 9% o A j. 3.8. Rd:- 3 on, E «R m e 2.3- 3.3. 9. R. 8 B, A m 8.8. 8.8- m... 2: 8 NS - e 8.2. 3.51 No a. 2. F: a n 8....- mmdm. o: 8. cup o3 m N 14 mod- 83- 2: wow 8. at: 5 F __ 83252, .02: 83.252, .m.: 83252, .3. 885 :2 oz. .35.; :2 oz. 53 uwucsomnhm 208 85:85.1 £35.: .8» 58832 76 Table 6.7 Effective Tax Rates Coefficient of Variation .0530. x3 .0006 280506500 8:80.00. 0:000 :08. ..~2.~ .- 5 0:32 ~38 .5 0.2.5» 53.35; a S 083 fl Iflfllfl 2:8 333 ~82- So.m8 2.3.3 son .30- 3.8- 3.8- c. K 3.B~ ~40.» 908 0.2 :8: 8.3- -.-- S 8 E o.- : ~m o. 8.2- -.o¢- 3 ~m 2 2: : a 3.2:- oodow 3 8 2 ~: s m 8.02- 8.3.- mm mm 2. 3~ o H 3.8- S. P P :- 3 R: - 8~ a o 2.8- 8.8- 3 m~ P 2 oo~ s m. 3.8- .20- ~m mo. 8 5: ~ 3 8.o~- 3.3. 8 n F P - a: o n cad- Ed? 8: on: F: «2 Q ~ 3.~- -.-- 3~ m 8 P 3~ :2 F. F £32.25 .05 8.3253 .0: 8332s .0: 8:20 :2 oz. :55? :2 0:. 53 car 2.08 35:00.00 «05“. x8. 020005 030333 77 Appendix C contains the Grasso and Frischmann [1992] regression results. For each tax regime. the regression results using several regression models are displayed for each decile and overall. Four measures of taxes are alternatively used: U.S. tax. worldwide tax. effective U.S. tax rate. and effective worldwide tax rate. For each measure of taxes, the simple model of taxes as a function of income is followed by a regression model that incorporates the total number of exemptions into the analysis. Following Grasso and Frischmann [1992]. when average tax rates are used, the natural log of adjusted expanded income is used as the independent variable in the analysis. Except for decile 10 of the models using U.S. and worldwide tax liabilities as the dependent variable. the adjusted R-squares in each decile are uniformly low for all models. This suggests that the progressivity in each income decile is small relative to the variation that is due to horizontal inequity. When this is true, the regression approach is not likely to offer substantial improvement over the coefficient of variation approach. As one would expect. including total exemptions as an additional independent variable generally increases the explanatory power of the model. The adjusted R-squares of the models incorporating total exemptions are generally higher than those not including total exemptions. Tables 6.8 and 6.9 report the coefficients of residual 78 variation derived from the regressions in Appendix C for tax liability and effective tax rates. respectively. The results are consistent with those obtained from the coefficient of variation analysis. Grasso and Frischmann [1992, 126] note that at worst, the regression approach has the same level of error as the coefficient of variation approach, but that if the regressions are significant, some of the effects of progressivity are eliminated from the analysis. In this research. although the regressions are almost all significant (see Appendix C for regression results). the results of the analysis using either the coefficient of variation or coefficient of residual variation approach are nearly identical. A paired— comparisons t-test of the mean coefficients of residual variation is significant for both the U.S. and worldwide measures of taxes for both tax liabilities (U.S. t = -2.792. p - .0210 and worldwide t = -5.589. p = .0003) and effective tax rates (U.S. t = -3.355, p = .0085 and worldwide t = -s.44, p = .0004). 79 Table 6.8 ility Tax Li CRVs .3305 x3 806 2393853 gov-052 0:03 zoom .fimmd a 5 9:33 «3.8 3 29:3 03:20; a co tor-om _Inljlllj 23.2 :23. .8 .3 5.8- 88. Q8 8.8. «.8 3.8 :8: 3.8. 88- 8 N3 K 3. o. 8. :- 86? 3 mm 2. on. m 8.8.- 8.8. 8 S on o: m 8.5. Réfi- 8 8 2 cg A 8.8- 23 P 7 3 R, an EN m 5.3. m P. 8- we «2 8 8, m 9.8- 2.8- 8 B «a a: v 3.2- 8.9- 8 cu. 2- :. m .4 86 .. Ed? 8. a? - Z 8. u and- 8.3- 8. 88 a: 3.2 F 83232, .3. 8.3.32, .3. 8.32.25 8.: 8:20 :2 oz. 52:; :8 on. 53 ABBL 88:88.... 532.. xfi 80 Table 6.9 Effective Tax Rates CRVs . mat—.505 X8 086 2088.553 «Eur-0&2 ozone comm ..Nmm.u n 5 «532 «8.8 3 0.9.28. 03:90; a co venom moo-mm Nem.~m¢ Fomdm wood 5 Son. .Bm 36m- 3.3. 0.05 «.03 045 v. Sm coo—2 madm- Bd F- on mm mm nor 9. omfih- mad? 3 mm on map a mudm P- 8.09. vm on R a: a mafia 7 36¢ .2. mm 3 on mmu n 8.8. S. p F T 3 our Nu 8N o cadm- 260. me map 5 SN m 3.3. 8.00. mm mm on amp v omd P- moan? ow s: K hop m oed T 3.0? 9.: 09 0: map N om.- om.-. 0mm 5:: 5% «map P 3.323? .m.: 023325 .mj 8.3282, .0: 8:20 9 5m oz. 505.3 F 3. oz. 5:5 2.000 38:020.". 83¢ xa... 95035 L 81 The coefficients of residual variation from the regressions incorporating total exemptions into the models are reported in Tables 6.10 and 6.11. Consistent with Grasso and Frischmann [1992], the addition of total exemptions to the regression model does result in slightly lower coefficients of residual variation in some of the deciles. Overall, the results are consistent with the previous analysis. Using either measure of taxes (tax liability or effective tax rates), the inclusion of the IRC §911 provision results in decreased horizontal equity. The paired-comparisons t-test of the coefficients of residual variation is significant for all models (U.S. tax liability t a -2.78, p = .0214; worldwide tax liability t = -5.54, p = .0004; U.S. effective tax rate t = -3.34, p = .0087; worldwide effective tax rate t = -5.49, p = .0004). 82 Table 6 . 10 CRVs - Exemption Model - Tax Liability .2399. .8. oood 2388.858 888:2 208 56 ..~8.~ u 5 25.2 «8.8 8 one.» 8.8%; a S :88 88.8 «883 98.8 88.8” $8 .8 8.8. 2.8- 8.8 «.8. Q8 3&8 :85. 8.8. 8.8- 8 a... :- 8. o. o...- n...:.. 3 8 2. 8. a 8.3.- 8.8- 8 8 a. 2.. m 8.8 .- S. .3 .- 8 8 a. 88 h 8.5 «3 . .- 3 R. n. .3 m «.3. 8.8- 3 «N. 8 8. m _ R8- 38- 8 8 8 .8. 3 — 8.8.- 8.3? .8 8.. N. 8. m _ 8.8- 2.3. 3. 8. 2. .m. N —V8.m- 8.8. .8. m8 8. 38. . _ 83232, 8.: 83232. .mj 83232. .mj 8:98 .8. o... Song; .8. o... 5.; «.08 88:88 £35 xe- 83 Table 6.11 CRVs - Exemption Mbdel - Effective Tax Rates $505 x8 08.0 332.35% «.5859. 0:08 comm .Awmm.N n 5 ”532 «8.8 .0 29:3 32033 a co venom who-mm Fm flame mum-cm mm .6 .m 500 .3m .25. no.3- «do Emew 6mm «.95 :35. #mfin. and .- Om mm 5 no. 0. .52- #mdm- 3 No on aw. m oar-u .- No. 5.. in on t N: m coda .- 3&3- mm mm :- 02 h .53- co. . p .- 9. mm. Nu 5N o 2.6m- madm- o¢ «N. no cow m Edm- emfio. um mm om mm. ¢ 5d.- .56? 8 o: 2. mm. m 5.0..- «5...? co. cw. o: a: N Om.~. w~.-- omw 3m. .3 mac. . 023252. .m.: 0232.25 .m.: 023232. .m.: 3:20 :3 oz. 50.23 :2 0m. 5.3 2.000 38:88». «89.. xa... 2500.5 84 6.2.2 W The U.S. tax liability for each adjusted expanded income decile is illustrated in Figure 3 for the tax regimes with and without the IRC §911 provisions. The worldwide tax liability for each of the adjusted expanded income deciles is illustrated in Figure 4. In each decile both the U.S. and worldwide measures of tax liability are greater under a tax regime that does not include the IRC §911 provisions. The Suits index for the two tax regimes when only U.S. taxes are considered is illustrated in Figure 5. The Suits index for the tax regime that includes the IRC §911 provisions is .993501, while the index for the tax regime that does not include the IRC §911 provisions is .991957. The Suits index using worldwide tax liability for each regime is illustrated in Figure 6. The indices are similar to those using the U.S. measure of taxes. The calculated Suits index for the tax regime that includes the IRC §911 provisions is .99301, while the Suits index for the tax regime that does not include the IRC §911 provisions is .991957. Using either measure of taxes, the Suits index indicates that both regimes are extremely progressive for expatriate taxpayers. 85 Figure 3 Adjusted Expanded Income and U.S. Taxes 7/////////// . 10 9 V/fl////¢/ O O r////I//M .0. 8 /. . . 7 6 5 Adjusted Expanded Income Deciles E U.S. Tax with IRC §911 Provisions U.S. Tax without IRC §911 Provisions Based on a weighted sample of 60,682 returns (n=2,882). 4 P p m .o. o 22...: 2.55... 5. .3. 00 150 e 86 Figure 4 Adjusted Expanded Income and Worldwide Taxes 7//////////////a DDDDDD 'OIV/l 3 O .9. .27/1 2 v n 800 300+ _ m 4 22...: ......._.5 .3... 923253 700— 600~ 500» mm. 10 8 7 Adjusted Expanded Income Deciles Q Worldwide Tax with IRC §911 Provisions 6 Based on a weighted sample of 60,682 returns (n=2,882). 5 4 1 Worldwide Tax without IRC §911 Provisions 87 Figure 5 Suits Index - U.S 100 . Tax Liability 60— 40l- Cumulative Percent of U.S. Taxes 20— O 20 40 60 80 Cumulative Percent of Adjusted Expanded Income + U.S. Tax with IRC §911 Provisions Based on a weighted sample of 60,682 returns + U.S. Tax without IRC §911 Provisions 100 88 Figure 6 Suits Index - Worldwide Tax Liability 100 80 40 20 Cumulative Percent of Worldwide Taxes 0 20 40 60 80 100 Cumulative Percent of Adjusted Expanded Income + Worldwide Tax with IRC §911 Provisions + Worldwide Tax without IRC §911 Provisions Based on a weighted sample of 60,682 returns 89 The tax liability progression coefficients’ [Ott and Dittrich, 1981] in Table 6.12 indicate that when either U.S. or worldwide tax liabilities are considered, the regime with IRC §911 provisions is slightly less progressive than the regime without the IRC §911 provisions (t—statistics are shown in parentheses)“. ’This measure uses the natural log of taxes. For those tax returns in the sample with a tax of zero, taxes were set to fifty-cents to include the returns in the analysis. 6The confidence intervals (at the 95% level) for the elasticities (U.S. and worldwide) of the tax regime with the IRC §911 provisions overlap the confidence intervals for the elasticities of the tax regime without the IRC §911 provisions. 90 Table 6.12 Tax Liability Progression Coefficients Regime with IRC §911 Regime without IRC §911 provisions Elasticity Adjusted Elasticity Adjusted R-sguared R-squared U.S. Tax 2.510 .2736 2.573 .2633 Liability (149.31) (145.446) WOrldwide 1.373 .1518 1.430 .7343 Tax (102.95) (404.46) Liability The t-statistics are reported in parentheses. 91 The residual progressivity coefficients (Ott and Dittrich, 1981) are reported in Table 6.13. The residual coefficients indicate that the tax regime with the IRC §911 provisions is less progressive (closer to proportional) than the tax regime without the IRC §911 provisionsfl 7The confidence intervals (at the 95% level) for the elasticities (U.S. and worldwide) of the tax regime with the IRC §911 provisions overlap the confidence intervals for the elasticities of the tax regime without the IRC §911 provisions. 92 Table 6.13 Residual Progression Coefficients Regime'with IRC §911 Regime‘without IRC §911 provisions Elasticity Adjusted Elasticity Adjusted R-squared R-squared U.S. Tax .9846 .9979 .9550 .9902 Liability (5329.70) (2439.92) WOrldwide .9284 .8948 .8952 .9080 Tax (707.20) (761.87) Liability 93 As shown in Table 6.14, the progressivity results are mixed. The Suits Index results indicate that the tax regime with the IRC §911 provisions is more progressive than the tax regime without the IRC §911 provisions. In contrast, the tax liability progression coefficients and the residual progressivity coefficients indicate that the tax regime without the §911 provisions is more progressive than the tax regime with the §911 provisions. Table 6.14 94 Summary of Progressivity Measures U.S. WOrldwide with without with without §911 §911 §911 §911 Suits Index * * Tax * * Liability I Progression Coefficients Residual * * Progression Coefficients The '*' indicates the tax regime that is more progressive. 95 6-2-3 C9mbined.egniLx_effecte_9f_elininatins_IE§.§211 The tests of the combined equity effects of eliminating the IRC §911 provisions are reported in Table 6.15. When U.S. tax liability is used as the measure of taxes, the results indicate that the regime with the IRC §911 provisions is more equitable than the regime without the IRC §911 provisions. The variance of the error team is smaller for the regime with the IRC §911 provisions (.00156) than for the regime without the IRC §911 provisions (.00698). The tax regime without the IRC §911 provisions is more progressive (.9120) than the tax regime with the IRC §911 provisions (.9694). In contrast, using worldwide tax liability as the measure of taxes, the tax regime without the IRC §911 provisions is more equitable than a tax regime with the IRC §911 provisions. The variance of the error term is smaller for a tax regime without the IRC §911 provisions (.06219 vs. .07763). The tax regime without the IRC §911 provisions is more progressive than a tax regime with the provisions. 96 Table 6.15 Combined Equity Tests F— Regime with IRC §911 provisions Regime without IRC §911 provisions U . S . Worldwide U . S . Worldwide Horizontal .00156 .07763 .00698 .06219 Equity Vertical .9694 .8620 .9120 .8014 Equity Adjusted .9979 .8948 .9902 .9080 R-squared 97 6.2.4 Impact; 9: lg 9f 1286 9n the LIE: Qfi IRC §211 The results of the tests for hypothesis three are shown in Table 6.16. Approximately 14 percent of U.S. citizens residing abroad used the IRC §911 provisions in 1987, while 16 percent used the same provisions in 1983. Consistent with the hypothesis, a smaller percentage of U.S. citizens residing abroad used the IRC §911 provisions in 1987 compared to 1983. A paired comparison t-test of differences between the 1983 and 1987 percentages is consistent with the hypothesis that the use of the IRC §911 provisions declined following the Tax Reform Act of 1986 (t = -1.914, p - .0591). When countries were stratified by foreign tax rate into high and low tax countries the results are consistent in sign but insignificant. 98 Table 6.16 Impact of TRA of 1986 Variable Mean Standard Minimum. Maximum Deviation ____ ___ ___ ___ ___ ___ ___ ____ Percent 16.29 13.883 1.24 64.95 claiming exclusion in 1983 Percent 14.037 10.535 .56 40.97 claiming exclusion in 1987 Percentage -2.255 10.929 -49.30 26.29 Difference Chapter Seven CONCLUSIONS AND IMPLICATIONS Summer! Although both the U.S. Congress and the private sector have used equity as a justification for the IRC §911 provisions, no study has investigated the equity of these provisions. The purpose of this study is three-fold: to empirically document descriptive characteristics of expatriate taxpayers, to examine the equity effects of the IRC §911 provisions, and to investigate the impact of the TRA of 1986 on the use of the IRC §911 provisions. The public finance literature provides a framework for examining the equity effects of the IRC §911 provisions. The coefficient of variation and the coefficient of residual variation are used to examine the horizontal equity effects of the IRC §911 provisions. The Suits index, the tax liability progression coefficient, and the residual progression coefficient are used to examine the vertical equity (progressivity) effects of the IRC §911 provisions. A proposed but untested combined measure is used to simultaneously investigate horizontal and vertical equity. Adjusted expanded income is used as a measure of income and two alternative measures of taxes are used: tax liability and effective tax rates. Taxes are computed on both a U.S. and worldwide basis. 99 100 The equity measures are computed for two tax regimes: one with the IRC §911 provisions and the other without the IRC §911 provisions using a unique database, the 1987 Statistics of Income foreign sample of taxpayers filing for the IRC §911 provisions. Foreign tax rates from the Coopers and Lybrand International Tax Network and foreign exchange rates from the International Mbnetary Fund were used to recompute the tax liability of the expatriates under a tax regime without the IRC §911 provisions in place. Data from 86 countries are used to assess the use of the IRC §911 provisions across time. The countries included have data available in both the 1987 and 1983 Statistics of Income foreign sample, State Department estimates of expatriates and an estimated foreign tax rate available. The descriptive analysis reveals that although expatriates and all individual taxpayers on average may seem very similar when comparisons are made based on adjusted gross income or taxable income, comparisons using components of income reveal striking differences. On average, expatriates report more than twice the amount of salaries and wages and business income but report U.S. tax liabilities only two-thirds as large as all individual taxpayers. Full year expatriates report average combined foreign earned income and housing exclusions of $42,370 and total combined foreign earned income and housing exclusions of 101 over $4.3 billion.1 Salaries and wages are the primary source of foreign earned income, accounting for approximately 73 percent of all foreign earned income. Mere than half of the expatriates are employed in business professions and approximately 28 percent are employed in the fields of education, religion, and research. The remainder are employed in the arts and entertainment field or other occupations. Approximately half of the expatriates are in six countries: West Germany, Canada, the United Kingdom, Saudi Arabia, Japan, and Israel. The results are significant and inconsistent with the hypothesis that horizontal equity is improved with the inclusion of the IRC §911 provisions. Both the coefficients of variation and residual variation indicate that the tax regime without the IRC §911 provisions is more equitable than the tax regime with the provisions. The results are consistent using either measure of taxes (tax liabilities or effective tax rates) when taxes are computed on a U.S. or worldwide basis. The results of the tests examining the progressivity of the tax regimes are mixed. Using the Suits Index, the tax regime with the IRC §911 provisions is more progressive than the tax regime without the IRC §911 provisions in place. The results using the tax liability and residual progression 1In addition, expatriates claimed over $10 million in housing deductions. 102 coefficients indicate that the tax regime without the IRC §911 provisions is more progressive. However, both tax regimes are very progressive. Finally, the results are consistent with the hypothesis that the use of the IRC §911 provisions declined between 1983 and 1987. L' -! !' Although the results of this study provide initial evidence of the role of the IRC §911 provisions in the tax treatment of U.S. expatriates, the analysis is limited to those taxpayers who claimed the IRC §911 provisions. Expatriates who did not claim the IRC §911 provisions but instead chose to use the foreign tax credit provisions or deduct their foreign taxes as an itemized deduction or a business expense are outside the scope of this analysis. In addition, to limit the impact of the differential treatment based on filing status, only tax returns with filing status "married filing jointly" are included in the equity analysis. To the extent that individuals in the other filing statuses are different, these results may not be generalizable to other types of filers. v n ' i n Although both the U.S. Congress and the private sector have used equity as a justification for maintaining the IRC §911 provisions, no prior research has empirically investigated the equity of the IRC §911 provisions or the impact of the TRA of 1986 on the use of the provisions. 103 Using a unique database, the descriptive characteristics of expatriate taxpayers are documented and the equity effects of the IRC §911 provisions and the impact of the TRA of 1986 on the use of the IRC §911 provisions is examined. The ability of the United States to effectively compete in world markets is affected by the taxation of U.S. citizens living overseas. This ability is influenced both by the cost of maintaining employees overseas and the willingness of U.S. workers to accept overseas employment. Overall, this research effort provides initial evidence concerning the role of the IRC §911 provisions in the taxation of U.S. expatriates. This information should aid Congress as it develops tax policies to improve U.S. competitiveness in the global markets. This research effort provides a basis for further investigation of the role of the IRC §911 provisions in the taxation of U.S. expatriates. Future research will explore this role within the larger context of the employer-employee relationship for those expatriates who are overseas employees of U.S. firms.’2 Taxation affects the cost of employing U.S. citizens overseas. In many cases, the policy of businesses has been to make the employees "whole" by reimbursing them.for any additional living expenses and 2Scholes and Welfson [1992, 192] note that in determining the desirability of compensation alternatives, the tax consequences to both the employee and employer should be considered. 104 additional taxes that they incur while overseas.3 'These policies tend to increase the cost of employing individuals overseas. To the extent the additional taxes are borne by the firms, the incidence‘ for the taxes is shifted from the individual employee to the firm. Future research should explore these issues. 3H.R. No. 201, 97th Cong., lst Sess., reprinted in 1981-2 C.B. 352-412. ‘An examination of the incidence of taxes, within the public finance literature, involves determining who bears the burden of taxation. 105 APPENDIX A HISTORICAL TAX TREATMENT OF EXPATRIATES 1225 In 1926, Congress enacted legislation allowing U.S. citizens living and working abroad for at least six months during the taxable year (bona fide nonresidents) to exclude all foreign earned income:l The exclusion was controversial even at this juncture. The initial proposal [H.R. Report No. 1, 69th Cong., lst Sess. 7 (1926)] by the House ways and Means Committee (here after referred to as the House) was not well received by the Senate Finance Committee (here after referred to as the Senate). Although they ultimately agreed [H.R. Conf. Rep. No. 356, 69th Cong., lst Sess. 2 (1926)], the Senate [8. Rep. No. 52, 69th Cong., lst Sess. 20-21 (1926)] initially did not feel that any exclusion was necessary given that citizens employed abroad already were allowed a tax credit2 for any taxes paid to the foreign country on the earned income. The necessity of the exclusion, given that the foreign tax credit exists, continues to be a key controversy in discussions of the 1Earned income included wages and salaries, professional fees and any other amounts received for personal services. For those engaged in a trade or business, a reasonable amount, not in excess of twenty percent of the net profits would be considered earned income. (Revenue Act of 1926, Ch. 27, §209(a)(1), 44 Stat. 9,20) 2The foreign tax credit had been incorporated into the federal tax law in 1918. 106 exclusion. 1212 In 1932, the Senate unsuccessfully used the foreign tax credit argument to propose eliminating the exclusion. In addition, they voiced a Concern that employees of the U.S. government, who were often exempt from foreign taxation, were unfairly benefiting from the exclusion [8. Rep. No. 665, 72nd Cong., lst Sess. (1932), reprinted in 1939-1 (Vol. 2) C.B. 496, 518]. Even though the exclusion was retained, it was amended so that is was not available to employees of the United States or an agency thereof [H.R. Conf. Rep. No. 1492, 72nd Cong., 1st Sess. (1932), reprinted in 1939-1 (Vol. 2) C.B. 539-543]. 1212 In a reversal of its prior position, in 1942, the House advocated the repeal of the exclusion due to abuse by individuals going abroad for more than six months merely for tax evasion purposes [H.R. No. 2333, 77th Cong., 2d Sess. (1942), reprinted in 1942-2 C.B. 372-504]. However, believing it would cause a hardship to legitimate residents of foreign countries, the Senate recommended and the House agreed to a modification of the residence test and a lengthening of the qualification period. To qualify, a U.S. citizen now had to be a bona fide resident of a foreign country (rather than nonresident of the U.S.) for an entire tax year [3. Rep. No. 1631, 77th Cong., 2d Sess. (1942), 107 reprinted in 1942-2 C.B. 504, 549, and H.R. Conf. Rep. No. 2586, 77th Cong., 2d Sess. (1942), reprinted in 1942-2 C.B. 701-733]. 125.].- The qualifying test was altered again under the Revenue .Act of 1951..3 .A new physical presence test was included as a companion to the bona fide residence test. To qualify for the exclusion under the physical presence test, an individual had to be physically present in a foreign country for 510 days during any period of 18 consecutive months. This modification of the qualifying test allowed individuals who could not satisfy the stricter bona fide residence test to qualify for the exclusion. The bona fide residence test was also relaxed, allowing individuals to qualify if they were bona fide residents for an uninterrupted period that included an entire taxable year (S. Rep. No. 781, 82d Cong., lst Sess., reprinted in 1951-2 C.B. 458-544.; S. Rep. No. 781, Part 2, 82d Cong., lst Sess., reprinted in 1951-2 C.B. 545-622, and H.R. Conf. Rep. No. 1213, 82d Cong., lst Sess., reprinted in 1951-2 C.B. 622-654]. 1251 The Technical Changes Act of 1953 was enacted to remove perceived inequities in the tax law [H.R. No. 894, 83d 3In making these changes the Senate Report [3. Rep. No. 781, 82d Cong., 1st Sess., reprinted in 1951-2 C.B. 458, 495] notes that the provision was intended to encourage citizens to go abroad and place them on equal footing with their foreign counterparts who are not taxed by their home countries. 108 Cong., lst Sess. (1953) reprinted in 1953-2 C.B. 508, 508]. The House [H.R. No. 894, 83d Cong., lst Sess. (1953) reprinted in 1953-2 C.B. 508, 511] proposed repeal of the exclusion on equity grounds, indicating that the provision was being abused. Individuals were preforming services abroad that were customarily performed at home only to avoid taxation, and in many cases these same individuals were also not paying taxes in the foreign countrym‘ The Senate, believing that repeal was not necessary to correct the abuse, proposed a $20,000 cap on the amount of excludable income for individuals using the physical presence test to qualify for the exclusion [S.Rep. No. 685, 83d Cong., lst Sess. (1953) reprinted in 1953-2 C.B. 526, 529]. The unlimited exclusion remained in effect for those qualifying under the bona fide residence test. 2258 In 1958, Congress for the first time required that income subject to the exclusion must be treated as gross income for purposes of determining whether a tax return should be filed [P.L. 85-866, 85th Cong., Sept. 2, 1958, ‘The perceived abuses were primarily within the film industry. Using the physical presence test, film stars made movies at various foreign locations and qualified for the unlimited foreign earned income exclusion. In many cases, they also avoided foreign income taxation if they did not meet the residence tests of the foreign country. In addition, technical support, supporting roles, and extra roles were being provided by foreigners in the foreign countries at the expense of their U.S. counterparts in the United States [Sobel, 1985, p. 123-124]. 109 H.R. 8381, reprinted in 1958-3 C.B. 254-333]. Taxpayers had previously not been required to report the excludable amount on their returns. As a result, the Internal Revenue Service (IRS) found it difficult to administer the exclusion. The Senate and House [H.R. No. 775, 85th Cong., lst Sess. (1957), reprinted in 1958-3 C.B. 811-921 and S. Rep. No. 1983, 85th Cong., 2d Sess. (1958), reprinted in 1958-3 C.B. 922-1187] both felt that considerable misunderstanding of the proper application of the provision existed and were concerned about the revenue loss that resulted from the misapplicationi. .A new initiative within the IRS today demonstrates the continuing concern with many of these same issues. Because of a concern that U.S. citizens living abroad misunderstand their federal income tax obligations, the IRS is currently studying ways to improve the compliance of overseas taxpayers. iii; A limitation on the exclusion for taxpayers qualifying under the bona fide residence test was first included in the Revenue Act of 1962 [P.L. 87-834, 87th Cong., October 16, 1962, H.R. 10650]. The exclusion was limited to $20,000 for 5Congress had evidence that taxpayers were claiming the exclusion for unearned income, U.S. source income, and without satisfying the physical presence or bona fide residence tests [H.R. No. 775, 85th Cong., lst Sess. (1957), reprinted in 1958-3 C.B. 811-921 and S. Rep. No. 1983, 85th Cong., 2d Sess. (1958), reprinted in 1958-3 C.B. 922-1187]. 110 the first three years of bona fide residence and $35,0006 thereafter. Congress also allowed a phase-in on the valuation and inclusion of noncash compensation (such as use of a house and car) in earned income for individuals qualifying under the bona fide residence test. Under previous law these items were often not valued due to the unlimited exclusion [3. Rep. No. 1881, 87th Cong., 2d Sess. (1962), reprinted in 1962-3 C.B. 707, 781]. To prevent individuals from taking inconsistent residence positions and avoiding income taxes in both countries, the exclusion was denied if the individual had foreign earned income, filed a statement with the foreign authorities claiming nonresidence, and was not held subject to income tax as a resident of the foreign country [8. Rep. No. 1881, 87th Cong., 2d Sess. (1962), reprinted in 1962-3 C.B. 707, 781]. 1215 Congress included sweeping changes in the taxation of expatriates in Tax Reform Act of 1976. The House felt that the exclusion provided an unfair tax advantage to U.S. citizens living and working abroad when compared to their domestic counterparts [H.R. No. 658, 94th Cong., 1st Sess., (1976), reprinted in 1976-3 (Vol. 2) C.B. 695, 892]. The House proposed repealing the exclusion for all but overseas 6The limitation was subsequently reduced to $25,000 in the Revenue Act of 1964 [P.L. 88-272, 88th Cong., February 26, 1964, H.R. 8363, reprinted in 1964-1 (Part 2) C.B. 6-113. 111 employees of U.S. charities.7 Recognizing that individuals in foreign countries may incur costs for services that would normally be provided by the U.S. government or governmental agency, the House proposed a deduction for education expenses for dependent children and an exemption from.earned income for the value of any municipal-type services (roads, sewers, water service) provided for the employee by the employer [H.R. No. 658, 94th Cong., lst Sess., (1976), reprinted in 1976-3 (Vol. 2) C.B. 695, 893]. Although these provisions were not incorporated into the final version of the Tax Reform Act of 1976, the notion of allowing deductions for the special costs of living overseas was revived in the discussion surrounding the Foreign Earned Income Act of 1978. The Senate proposed retaining the exclusion so as not to jeopardize the competitive position of U.S. firms abroad but did propose several changes in the taxation of U.S. citizens abroad. They recommended that: (1) anyone entitled to the earned income exclusion not also be allowed a foreign tax credit for foreign taxes paid on the excluded income;8 7The foreign country often encouraged the presence of these workers by not subjecting them to income tax. A.U.S. tax could not be offset by any foreign tax credit in these cases. Thus, the House felt it would make it more expensive for U.S. charities to operate overseas [H.R. No. 658, 94th Cong., 1st Sess., (1976), reprinted in 1976-3 (Vol. 2) C.B. 695, 893]. ‘Prior to this, individuals earning more than the excludable amount ($20,000 or $25,000) were able to offset their U.S. tax liability (based only on income in excess of 112 (2) additional earned income beyond that eligible for the exclusion be taxed at the marginal rate that would apply if the income were not excluded; and (3) if tax avoidance was one for the reasons for receiving earned income outside of the country in which it was earned it would be ineligible for the exclusion [8. Rep. 938, 94th Cong., 2d Sess., (1976), reprinted in 1976-3 (Vol. 3) C.B. 57, 249]. The Senate also proposed a housing exclusion for housing that is furnished or reimbursed by the employer. The exclusion was to be limited to the amount by which the State Department allowance in that particular area exceeded the cost of comparable housing in washington, D.C. [8. Rep. 938, 94th Cong., 2d Sess., (1976), reprinted in 1976-3 (Vol. 3) C.B. 57, 250]. Although this exclusion was not enacted, it was a precursor to the present housing exclusion. The final version of the Tax Reform Act of 1976 adopted most of the Senate provisions with the exception of the housing exclusion. The foreign earned income exclusion was limited to $15,000 ($20,000 for all employees of U.S. charitable organizations). In addition, for the first time individuals could elect not to be subject to the exclusion provisions [P.L. 94-455, 94th Cong., October 4, 1976, the exclusion) with a foreign tax credit based on taxes paid on all foreign income (including the excluded portion). Congress estimated that "$40,000 or more of earned income could be exempted from U.S. taxation if the U.S. employee pays any significant income tax to the foreign government." [3. Rep. 938, 94th Cong., 2d Sess., (1976), reprinted in 1976-3 (Vol. 3) C.B. 57, 248] 113 reprinted in 1976-3 (Vol. 1) C.B. 1-410]. In reality, these provisions were never effective. They were initially to be in force for tax years beginning after December 31, 1975. The effective date of these changes was twice delayed: first, to tax years beginning after December 31, 1976 [P.L. 95-30, 95th Cong., May 6, 1977, H.R. 3777] and then, to tax years beginning after December 31, 1977 [P.L. 95-615, 95th Cong., November 8, 1978, H.R. 9251]. Controversy surrounded the provisions. Maiers [1981, 700] notes there was an "extraordinary volume of mail, telegrams, and meetings in which United States citizens employed overseas angrily protested to their embassies and to Congress against the timing9 and substance of the changes." 1218 Immediately after the 1976 provisions took effect, the Foreign Earned Income Act of 1978 [P.L. 95-615, 95th Cong., H.R. 9251, reprinted in 1978-2 C.B. 415-422] was passed. Sobel [1985, p. 131] notes that the goal of this Act was to place the overseas taxpayer in an equitable position when compared to his (her) domestic counterpart. The provisions included striking changes in the tax treatment of the overseas taxpayers. First, Congress limited the foreign earned income exclusion to individuals working and residing 9The Tax Reform Act was enacted on October 4, 1976 and the provisions applied retroactively to the beginning of 1976. 114 in camps in hardship areas or working for qualified domestic charities in lesser developed countries. Second, for all other U.S. citizens living and working abroad, Congress devised a system of deductions meant to take into account the actual additional expenses of living abroad. Five possible deduction were available for: 1) reasonable excess cost of living expenses, 2) reasonable excess housing expenses, 3) reasonable schooling expenses, 4) reasonable annual home-leave transportation expenses, and 5) a deduction for individuals living in a "hardship area". The calculations involved in determining these various deductions were quite complex and "no one liked it" (Sobel, 1985, 138]. Both the public sector (Congress and the I.R.S.) and the private sector (businesses and expatriates) believed the provisions were too complicated. As a result of the widespread dissatisfaction with the 1978 provisions, they were repealed in their entirety with the passage of the Economic Recovery Act of 1981 [P.L. 97-34, 97th Cong., H.R. 4242, August 13, 1981, reprinted in 1981-2 C.B. 256-352]. 115 1281 The Economic Recovery Act of 198110 reinstated the foreign earned income exclusion for all taxpayers meeting either the bona fide residence or physical presence test. The physical presence test was relaxed so that taxpayers present in foreign tax home for 330 full days in a twelve- month period now could qualify for the exclusion. The limit on the exclusion was raised to $75,000 increasing to 95,000 in 1990. Congress retained the notion of providing some relief for excess housing costs with the inclusion of a new housing exclusion.ll The goal of the housing exclusion was to make an allowance for the special expenses that expatriate taxpayers incur above those of the domestic taxpayers. 1224 292 1225 Very little has changed since 1981 in the taxation of U.S. citizens abroad. The 1984 Deficit Reduction Act [P.L. 98-369, July 18, 1984, 98th Cong., reprinted in 1984-3 C.B. Vol 1. 13] froze the maximum amount of the foreign earned income exclusion at $80,000 for tax years 1983 to 1988 and then allowed a gradual increase to $95,000 in 1990. The Tax loSimplification was the primary goal of Congress in enacting this legislation. In addition, they hoped to provide an incentive for U.S. citizens to work abroad [H.R. No. 201, 97th Cong., 1st Sess., reprinted in 1981-2 C.B. 352-412]. 11The calculation of the housing exclusion is discussed in the following section as part of the current tax law provisions. 116 Reform Act of 1986 capped the foreign earned income exclusion at $70,000 for all tax years beginning after December 31, 1986. Congress enacted the 1986 reduction in the foreign earned income exclusion because of the general decline in the marginal federal tax rates instituted in the Tax Reform Act of 1986 [H.R. No. 426, 99th Cong., lst Sess., reprinted in 1986-3 C.B. Vol. 2, 1-1068]. 117 APPENDIX B TAX FORMS 5 1040 tilndzlglll'nrmrxflm 11987) m 09.!“ 15450014 I)“ mm van-ism...- washed. ._ .. l ' pic-mar W~ r1. nun-mum PM ’ DoywwamSltopmthisMid? mm )0 Muham- aossyour spouse want 81 leptothis iuridl l _ Smo- Fill-[Shins z _ . Ct ' 3 .— “JW s my. N-n-T-Ioi ““ * men-autos: mmmmfl'sfim. 5 ‘>19 )6“... “ - _ _ .. » sul— uo-ia-u - air-‘- . [:1 (Sss ‘- [:1 Vourssfl “E 50ml. Isl I | - e W m” (hi.5--.~s “Wu-'- nit-hid [j aria-.7.) (Uhmudfld ‘3 am... (Inn-no a“: “g,- F Md“- lists“! --—- m Isms! p Huntsman Us! gown-111.: “I“ D D Dis-7- lsdslll D a at: ’ ‘u. ‘ a-an-n .'D U“! l . - . . .Aw1‘\ ‘ ‘ > . . . 7 wmuwmmnmamrmnw-z) . . 7 _ In“ ' .. “ ' 5:32: , . . . U _ M 9 - unborn -| I 1 Con! to * ' -- . . , . . 10 Forms)“ Vl-ZG. mw- ' u . 1 I..." II‘lI-nh“ u "pudenda-sin 11 Nlmm. . 12 sill-2.30s 23 Bm-maflmfiufltflMC) 13 41 '9'0'6“ u awwnmmmmm 0) . “ is monument-)(mrmann . . . . I! tumwflmamm “misuse-ins I“ hummus-9.11).. ’— 11 “mm-mmmwgammn ll meauuumwn. I! ll) Pisa- mwmmuunlz) . . emu-se- .. _. ‘__ ,, Um mm. 21 ".12 21 22 -- ~smio.1.‘..-,_:; D g — no“ . n “Inst-ssh u. Vow -- - j -: n 24. Mass s' -- - u. m 25 ‘ , ‘ 23 2s , “ ., 2...... 2‘ (See 17 Penman-unmet”. Linn.) 2. Alimonym(ncim's|-tnsms : 2L ) 2s mmza >129 "mm-Inhalat- nsmnndsa'nummms- -wmc~a" mflnnnud > . k. 118 APPENDIX B (Cont'd.) rmioioussn Pug-2 31 Amoumrromuns30udmusdmmorns). . . . . . . . . . . . . . . . VII 32s Cristina; DYmeSOrovsr Delirid: DSssI-ssrssésorovsr UM Coisss- WWMMMMCWMWWWM. . . . . . D m ii NMWNC‘IIMIIIWMWWLM chsckhsis. . D as D c "mmmmrdmgsmsrstumsndmmmm oryousrssdusi-sutmsiisnasspscsLSsnddisckhsrs. . . . . . . . D u: D 33s WWSssosuslStosssuyoushouiditsm.uyoudori'tm.mmfl youdoitsmas.smchScrisdulsAJmsrthssmoumtromSchsduisA.lirisZG.AIDinsIris33b. 33- .— s IWWRsstsuusnmmt.uncountsssosplsfomisMIim. "you irCuUsrioossn'i Siriusorflssdorhoussmflmszuo criscssdsriy spuysndyourriiin. Msrrisdfiling‘iom tiyorQuslimmdov-(sr). ”(883.760 tic-onions smrrornoscslis. Msrrisdriiirigsspsrstsiy.sntsr81.880 2?",2?" 34 Subtract Inns 33ssr33b. whichsvsrsooiiss. from inns 31 Entsrtrisrssuluisrs. . . . don't 3! Mummy$1.9mwmstouimbsrormmusimsdonuns6ssrsssdisnsn"16. . 3 fwwmm‘: 30 rmmmmasmmu. Eriisrtrisrssuiubuuiaris-tmrissrs) . mom—nun: muonouqsummnsnmmsimommm.mm DD :x‘mfi'bm sndsssoqslstosssirywnsvsiomsiormulsmmmu. I . 31 Entsrtsx.ChsciiMroriiDst1sus. DTssttsSchsduiss. Elms-0.4: Drums 37 3s Additionsiulss(sssnscs16).ChsddfrornUForms970orBrennan . . . ; 39 Addlinss37snd38.fintsrtrisw. . . . . . . .D 9 co CrMMcMWWmm(Ime2“1)m ‘ Crllfll u Crmmmmummwmmw 1 (s. (ma-ma) , . r 41 1 gm, 42 mmiomii. moi-m . . 1 43 Samurmszmmas. Eritsrtrisissuubiitrioiisssmsiim). i u rwmmrmrmuu) . . . 44 I ‘3 Gsnsrsibusirisssasdn. Chairman-ins. Dior-Jul . Dru-5m. Dru-om Dru-mas Dru-ass . r 4 i «mmusmssjmrmw... ’ 47 summiamma Entsrmsrssulmnndtlsssmsrissrs). . . . . . . . .b 91 r 0" 48 Ssii-srnpioyrrismmarbcn SchsdubSE) . TL has 49 Altsrristrvs minimum is: (amen Form 6251) 50 Tax from rscsotiirsor irivssiirisrit crsdii (m Form 4255). . . ‘.'“I “"1“: 51 Soc-sisscmmonnomcomsnoimtosmmumcnfmdfln . Pam) 52 TumsniRAorsousiifisdrsnrsrnsritpisnamchFormsm). . . . . . . . 53 mumnmmsz. Thisismwu . r . . . . . . . . . .D ‘ 54 Fsdsrsiiricorrismmririsid(includinfluMonFms)1099H_H PM“! 55 1987msdhnummmwrrornlum Lil ‘ IF SO Esrrisdiricorriscrsdiusssosusla) . . w.z.w.2c. 57 mmmrmwrmm). 11 | :33?" as Excssssocisisscuritymsndflflnmmmusssqsl!) LJI 3 ' ss cmmrmmmmwmmrmmum 1.31 50 Rsuisisd invsstmsm compsriy crsd'il (other! Form 2439) 61 AddkissfitrirouuiGOJhssssrsme D n L 62 lfiirisfilislsrgsrmsriiins53.sritsrsmouritOVl"MD . . . . . . . . .D [shunt s3 imamsziousmmmrorou. . . . . . . . . . .> M“ 64 mamamuwuiomimmu D L11 J YosOss 65 ”mesaisummnm61.mmoumvoummasuammuu smouritosysoisio' '."IntsmsiflsvsnusSsrvrcs wmwwmw.dsmsrisris numosr. sod 1987Forrri 1040“ om! . . . . . . CW3 I ummumwmmmmmmmmmm “mmhmsssisrm-msns "C!” m. irisysrstrus. corrscr. mm. mumrmmmismmu-mdmmmmm 5". l’ Yum Osts Yum Hers _ ’ sm‘swm pm mun. m Mum Osis Wisconsin-i _ Osts Wins-um” p“ m‘ ’ cuss“ . . “has I] e . 'm'.“(' a.“ "‘.” Mammy ’ ' * massa- m, 119 APPENDIX B (Cont'd.) ".1116 Computation of Foreign Tax Credit individual. 0“ No. ISIS-012! M.NNMWNMW figs? Within-1y DAMN?“ 1040. 10400“. 10“. UMY. Mia's-Sums puma-om m 21 a... Monsanto-om Usssumrsfomi 1115mm iypsori‘ncoms. Chock onlysiisbox. Thnfonmsbsimmplorsdforcrsdr‘rfornnsm: DPsssrvsirieoms DSiiiooinginconis 09°32‘63“! ‘ ”WW [3 High withhoidin'tsxmtorsst D Dividsi‘idsfromsri IC-DISCorforirisr DISC G IF u I'll“ I I DFinsricisissmcssincorno. DWMsbwm Dmmmsmsmmm corporation(FSC)orforrnerSC incornsiromsourossiiitiiinUSJrisssssiuuz Resident oi (norm of country) D Mots: Ifyoupsidtamroorisforscncoanrry.usscorumn41 country. interns FroriiSiiiircssOiitsidstiisUriIIstbtss coun .usouopsrsrscdumnsndli‘nslorsscn m Imus Wflhmm‘mmmflus. 1 Grouiricornsfrornsourcsswitriincounuysiiown ooooooooooooooooooooooooooooooooooooooooooooooooooooooo PsrtlsndlinsAmPsrrll. Ifyoupsrdtusstomtlisnsnsw Posssssiss Total A mess-07.0.3. I c (MUCOB.A.B.IMC) 2 Aooiicsoisdsductiomsnd losssusssinstmctions): sExosrisssdirsctiysIIoosbistotiisincomsoniinsl (MM) . . . . . . . b Pronusiisrsotsiiotiisrdsductionsnotdirsctiy siiocsois: (I) ltsrrirasddsdoctionusttscri schsduis) . (ii) ornorosoucimmucn schsduis) . (IN) Addliriss 2N6) and 2b(ii) . . . . (IV) Tobihrsi'isouruirioonis(sssiristructions) . (v) Gross "icons from oil sourcss (so. instructions)........,, (vi) Oividsiins 2b(iv)oyiinszo(v) . (VII) Muitiply lino 2b(iii’) by lino 2N“) . c Lossssirorniorsiuisourcss . . d AddiinssZs.2 Vii snd2c. . \ 3 Subtroctiindefromiinol. EntcrtIioiuifitI’iflslI'idinPlfllllJimsl . F Lends mun- Toss: Psid or Mound gAttscii rscsig or egg! oi um.) ' I 2. Forsvi Islam.“ (ya-‘.‘“): Infill.” inut Dobro TumstI-lu-i: Bra-o:- (F0 on. MEI .m. (“N- 4%"; (C) m. TuuWIMUI: )m (I fwfm (: #ssssPsidcr T-Psidor Ann-s (s) m (m Mil m C“. (0 (O). (0. (D. 000 0‘» Tau “m um um on) Country ‘ A i. mmmummmium mm. m Form 11 16 (m?) 120 APPENDIX B (Cont'd.) Fliiiiufllm “m2 mmarm TosCrsdit Chockiiyouorocioimio'ocroditiortoxosooidtothowrginisiondsiiridorsoction932(b) . pl] 1 EntsronioiuitiiomPsrtiiiuio3Uhisisttioiotsiioroi|nioosspsid oroccrusd.) . . l 2 Coiryoociiorcorryovor(ottociidotsiiodcomouiotion). . . . . . 2 3 Addiinssiondz. . . . . . . . . . . . . . . . . . 3 4 mmwmmmmmwumunmmmmy ..... ... 4 5 swamimumamunmwmoimmmmmx 6o EntoronnuntiromPortiJinoMsooinsouctions) . ofinisrpiorstoshorooioiiocotsdiorsiuiiossss(sooinstiuctions) c RoducotiioomoiiritoniinoSsoytiioiossoniinon.(1'iiisisyoiir unbioincomo(oriou)iromsourcosoutsidstnoUnitsttsb.)ii thisisoioss. youiiovonoioroiuiioxcrsditiortnotyosoiincornoyou chociisdonoopl. Siiioiinss7throu¢iil3 . 7 Rscsotinoiorioryosiovsroiiioroiuiiosoouottociicomoultili). 7 3 Subtroctiim7iraniins6c.misisyounstils'uisoucotolooioinclno. . 9 WWomountiromFomlmo.lirio34.oriromForm l 9 10. Dividoiinosoyiino9.(iiiins8ismorotiioniino9. ontsrtiioii'urs 1.") 104mm. iino33. mmmfintsrontiiisiindyourtonoio 11 IWEntoromounti‘romForm 1040. iino43. orForm 104M. iino40. (std-litmus: inconiointiiointiiodsductionioryouroiismotion . EntoromountiromForm 1041. lino 22c.orForm 990-1’. Iinol. 12 Miiitioiyiinolliiyiino10(Moiomumonioilitoicrsdii.) 13 EntorthoomountiromiinoSoriino12.wiiiciisirorissriislsr.(iitiiisistiiooniyfonn llleouoro computing. siiioiinos 1 throuciiain Psrthondoniortii‘isomountoriiino9. Portiv. mmmmiotoiinosinhrtlvfl) . . . . . . . .D u 12 13 mumrmmmuusawi Croditiortoiiosonoossivoincomo . Crsditioriosssoniiigiiwitiiiioidinfloxiritorsot. Crsdiiiortoxssoniinoncioisomcssincomo. Crsdiiiortosssonsiiiooin'incomo. Croditiortoiissondividsridsiiomonic-DISCoriornieriSC CroditiortsossoridistrmiromoFSCoriormorFSC Crodit iorioiiss on m irom oscii noncontroiisd action 902 coronation . . . woo-oun- L pi Lonnie}- . Croditiortoossonpnoroiiimitotionincomo(olotiisruicomoirom WWWUWS) .. 9 Addiinosltiiroudia . lo deuctionoicrsditiorintoriiotionsiooyootioosrotiomuss Iisdiiction'oiCroditioriiitsrnotioiioi BMW" ininstructionsforPonlII). n swooctiinsmiromiino9.misisyouiors'.iioii crsdit+£ntsriisroondonform1040.iins44: F 1 RI‘ 41'Form104 lino ' Form 11 121 APPENDIX B (Cont ' d . ) ‘.'-E ‘i: 5;: 'o“. n... 2555 Foroign Earnod incomo ? ¢ ! ‘ - 7 l “7 8 W at Y ' _. M m '06:” o Soo soooroto instructions. 5 Attocn to Form 1040. ...,..-,-. ;.,:-._.. ... 3‘ For Uso by Unitod Stotos Citizons and Rosidont Aiions Only A Nomo 3723100"! Your new socuniy «union =orou¢n sacross . r: ...:an COuf'il'y) vcu oc:.:ioi or Vor'o 0' However o E‘“Di0yof s b S ’ OCO'QSS Fofe.gr . E‘OIOVOI .sicnocx ’ I A toreign entity - A U S cor-"oony any inst oooiy) : A ioreogn oiimoto ot a U S company I Soii : Otter «soocwn D Enter earlier years (oitcr 1981Hnot10u moo Form 2555 to cxa-n' eitt‘er oi trio cucuusions D n mu cnoso to cioim on exclusion -n on corner yoor (otter 1981). "3v. y0u rovoiioo your chores? I ' es _ ‘i . _ o H Yes. guys the moi ewuion and the to: year tor «men the revocation was effective o Test undor which you quality to crown the I Bono tido rosioonco tost (Port I) Are you o ”0090““, “0- 0' 0900“" I OHSICII grosonco tost (Port "2 z y S citizen’ I ' es " ‘.c Did ini mointoin o soooroto ioreogn residence tor your iomuy oocouso of ammo living conditions at mm to: homo? : 'es : ‘iO ii Vos. am City and cauntry oi the scooroto ioroign residence Aiso snow the numoor oi doys during mm to: year :“at yoi. -a."ta..*ec 3 second nausonom at toot ooorsss ............................................................................................. ........................................................................................................................... ............................................ ............................................................................................................................ Comoioto sitiior Port i or Port ii. lion itom doos not oooiy. writs “NA." ii you do not orovido trio iniormotion osiiod ior. ony osciusion or doduction you cioim moy tio disoiiowod. m Yosooyors Quoiiiying Undor Iono Fido Rosidoncs toot. (Soo instructions.) 1 Oats 00"! "00 “3'00"“ 3983" ................................... "00° ....................................... . 2 mm Oi ‘lVlng quarters in tore-gr- COuntry D : Purcnosoo nouso : Renter: nause or aoartr'e'" : :E"'e-: ': :"' : Quortors iurmsnod by summer 3 Did any at y0ur iomny we win yOu ooiood during any can oi the to: yoor? Z .95 : *..; it Yes. «no one tor and! oorioa’ b 4o Hovo ydu sunrnittod o itotomont to tho outrioritios oi tho torsion cauntry wnoro yOu atoim oono 'icc residence '.'-a: you oro net o rosioont oi toot cauntry’ (Soo Instructions.) o Aro yOu roduirod to on acorns to: to the country whom you cioim oono iido rosidonco’ (Soo Instructzons ) ii "Yos" to 4o ond ""No to 4s. you do not ouoiiiy os o sons iido rosidont. Do not comoioto tiio rost oi Port i. 5 Comoioto trio ionowm; tor ooys orosont in tho Unitod Stotos or Its oossossions during trio is: yoor (00 net inciuco ems r'c:"‘c r- 3:- Numooroi meow-solace in u , . Nun-nor at “(3’9 ""9: ' - -. 0": 3'5"" 3.5.5" son-n u S . on ouunossioitocn 3": "5'” “"5" an r- u 5 :' :.i.-ui rs:- an ousinsss :omoutoi-om ' " in across ::-: .‘3’ :- So Stoto ony contractuoi terms or otnor conditions roosting to the iongtri oi yOur omoioyment oorood .......................... ....................................................................................................................... b Sim the two at as. under «men you enter-0 the torus" country .......................................................... c Did yOur yiso term: in. igngm oi yOuf stay 0r omoioymont In a toroign country ’ I ' es I ‘ic ii "Yos. ' ottocn stoionotion it Did yOu mointoin o nomo «n in united States «nus twin; abroad? I ' as I ‘.c I, y”. ' snow GOO'QSS 0’ '00! ”ONO. another '1 N03 'Of‘tfd 850 the film” .00 'eiltIOnSHiDS O? '."! OCCUOIMS . . . . .............................................................................................................. Fl'ool-lsluuctnnmmiooosooioisooorotoinstructions. :~~ 2555 122 APPENDIX B (Cont'd.) ‘1"- 2555 . 3.7) °i¢e 2 m Tosooyers Quoiiiying Under Physicoi Presence Test. (See instructions.) 7 The ohysicoi oresence test .s dosed on the iZ-month oeriod "0i“ ......................... TP'OUB" ................... . . . . 3 Enter yOur orinoooi cauntry oi emoidyment durini your II! it" ' .......................................................... 9 Enter oil flow sorood during in iZ-moi‘ith oeriOd shown on who 7 exceot trovei between foreign countries tnot and ”O! More "3.1- on or diet hte'not'onai waters or r- or 749' 2’9 United States ior 24 "-Ou's or more it the ost entry s on on w .- s we g- caur‘i'i enter me number or "uii days to tne end at tne ‘.2 morith deride ii ,ou "lye no new to reoort during the 90006. «i te - '.'-e sc-edu.e :e ow '.'-at you were ahvsicaziy oreseht .n a iore-gii country or countries dur~n¢ the entire 12mm oeriod (Do hdt nc .:e c Dart m tne ncoh‘e '.i‘at in. .st -ere out reoort-t on Form 1040 ) ‘.‘-o i:- ::.-o-. -'. i- a. i :re or' we :re o“. 3'91." - :oii ' o S ‘ ’ ' 225“"- :' :.s “991 . . ' . Eli! ‘i.-30' 3' '13”. 00"” ' . ‘. 3' 3.! ‘ess 5932' —-- . .-— - ...l 4 N All Tosooyers Note: On mes .‘0 Waugh 14 enter an income. :hCIuding noncosh income. that yOu corned ond ocruoily or construcnveiy recei curry you .‘987 to: year tar semces yOu oer-formed in o foreign country If any of the foreign eorned income received this to: year as 93"” m d ONO? MI 790'. 0’ W!" O! Olin” In 0 MM fl! ”0’ (SUCfl l! I 000”). see the IMWCUOflS 00 "Of '"C’UOO "‘60"! "0"" part I we 5 or Parr u :me 9 Report amounts -n u S donors. using the exchange rotos in effect when you actually or constructively wowed the income it you ore o coon oosis tosooyer. reoort on Form 1040 oii income you received during 1997 no mottor when you performed the service. Amount 1937 Foreign Eorned income _ (in us. deiiorsi 10 fora: noses. soiones donuses. comMissidns. etc XL 11 A-iowome shore or income ‘0! oersonoi services oeriormed (see Instructions for Port "I. who 1 1) o in a business iihc’ucmg firming) dr ardiession 111 o in a donnershio igwe ~ame address and noture oi income) ,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,, .................................................................................................. mf— _ 12 Noccasn rcame mane! vaiuc oi orooerty or iacmties furnished oy emoidyer—attoCh statement showing g: .31; ~dw determined) ; a . o Hon-oi dds-n3) - 12o ii Meois 12L c Cor 12: d Other orooenv or tacmixes (sown) ............................................................... 13 AIIOwonces. reimoursemehts. 0r exoonsos new on ydur oenoii ior seryices y0u oer-termed. _ o Cost of living and Overseas diherehtioi _Lh_‘_____;, 7n" 11 Funny J”; _gz’éuxuta c Education . .18 iv it Home ieovo L’ 1’, .,.,. Zi’frt’ué'fl e Quarters - J},— -5 i For any other ouroose (soecify) ............................................. $5.13. I]! ,‘f 3?)" 3 Add the omounts on iihes 13o through 13i ond enter the totoi L31— 14 Other foreign earned income (soeciiy) ............................................................. - OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO L . 15 Add the amounts on unes 10 thrdugh 12d. line 13¢. ond line 14 ond enter the totoi 15 16 Totoi amount or moms and moon; inciuded on me 15 thot is excludooio. (See instructions.) 1‘ 17 Subtract ans :5 train «he 15 and enter the result This is your ioreigh eorned income 5 17 ComoiotePortiv noninmchoeauulmtnomescuennllemuiemm. mm. more Psrtv 123 APPENDIX B (Cont'd.) Ear-255MB!” ’iii 3 For faxooyers Claiming Housing Exclusion AND/DI Deduction 1! Qualified hdusing eiioenses for the tax year (See instructions l 13 4 19 Number oi days n 70;)! Ollfili‘nfi‘ ogriod that fall within ybui 1987 ility!!! (569 // a, ; instr..ctions i 11 #2" . 20 M ’ 3i, 319. «by the numoer or days on who 19 Enter the '09"! but do not enter m6reM37 109 00 L 21 Suatract ... e ,o-ount on who 20 tie- :r-e amount on who 18 (If zero or iess. do not comoiote the rest of Part 'V or any 3? 934 ‘.ll‘. Ir‘ J] - . 22 ‘.'-set en'bioie'orowcec ambur-ts (See instructions ) .22. ~ - __‘9’74/ 23 Enter the ache." ram we 1 7 2] ,‘ "22!» 24 Di. ce t-e smart or ire 22 av the amount on line 23 and enter the result as a deCimoI (to two oiaces) LmtedtoLQC) 24 x, 25 Housing exclusion. Muiiioly the amount on tine 21 by the decimal amount on has 24. but do not enter more Win the amount on 'm 22 Aug enter this .mggn; on no. 353m in o 25 Note: it the amoim: on hne 21 is more than the amount on me 25. comoiote Me 26. Otherwise. slim to Part V if you choose to 5'8"” the ‘dre-gn earned income etcmsidh 26 subtract the amount on who 25 irom the amount on line 21 Enter the rosuit here and on me 40. Part Vii ~Camoiete Part v oerore Pan W .i yOu choose to moan tne ioreigh earned income esciusion l D 23 For Tattooyers Claiming Foreign Earned income Exclusion 27 Maximum ioreign earned income exclusion 2| Numoor of days in your dueliiying period that is" within your 1987 to: year (See . Instructions ior nne 19 ) 29 Guide the number or days on um 23 by the number oi days in your tax year (usuaiiy 365) and enter the result as a deCimoi (to two discos) 30 Multioiy the amount on me 27 by the decimal amount on me 29 31 Enter the amount irom line 17 31 __ . 32 Enter the or' ‘ .m from me 25 .314 33 Subtract the amount on me 32 irom the amount on line 31 Enter the result 34 Foreign earned income exclusion. Enter here and on line 36. Part VI the amount irom me 30 or me 33. «niChever -s iess 34 For Tasooyers Claiming Housing Exclusion. Foreign Earned income Exclusion. or loin 35 “0031““ exclusion irom sine 25 _31 ,. 36 Foreign earned income exciusion irom um 34 _1I____.‘ " 37 Add the amounts on lines 35 and 36 and enter the total 34 Deductions snowed in riguring your odiustsd gross income (Form 1040. line 30) that are aiiocabie to the encauded income (See instructions and attach computation ) 39 Subtract me 38 from line 37 Enter the result here and in oorentheses on Form 1040 line 21 Next to the amount write Exciusionis) irom Form 25553 On Form 1040 subtroct the amount irom your income to , arrive at totoi ncome on F drm 1040 line 22 D 31 For Tosooyers Claiming Housing Deduction Hots: Complete this out only if: (1 ) you entered on amount on line 26. and (2) the amount on nos 1 7 is more than the amount on nne 3L 40 Enter the amount irom line 26 41 Enterthoomouhtiromtino 17 41 42 Enter the amount irom line 37 43 43 Subtract the amount on line 42 from the amount on line 41 and enter the result 44 Entortho amount irom lino 40 or non 43. lhlcm is L”: Note: if the amount on me 43 is more than the amount on line 44 and you could not deduct air or your 1966 housing deduction because of the 1986 limitation. complete the worrishoot on dogs 4 or theI instructions to figure how much or your 1986 housing deductior may be carried over to 1987 Othorimso. enter a zero {-0-} on line 45. 45 Housing deduction carryover irom 1986 (irom woriishoot on page 4 at the instructions) ‘5 . 46 Add the amounts on iines 44 and 45 Enter here and on Form 1040 to the left oi line 29. Next to the amount ' on Form 1040 write Deduction irom Form 2555 " Add it to the totoi odiustments reoorted on that line o ed . 124 .APPEEHIEX C HORIZONTAL EQUITY REGRESSION RESULTS Mbdel: tuufig = bo-ilm(Incomm) + at I Parameter Estimates n Decile F Sign .Adjusted Intercept. Income Exemptions (F) R-square with IRC §911 1 24.10 .0001 .0039 596.7112 -.0324 2 .979 .3224 .0000 210.1206 .0030' 3 27.16 .0001 .0043 -245.3627 .0234 4 86.91 .0001 .0140 2535.7976 -.0479 5 6.88 .0087 .0010 -17.9443' .0154 6 162.73 .0001 .0262 -3558.478 .0683 7 25.44 .0001 .0041 4629.3870 -.0400 8 45.94 .0001 .0077 -2514.251 .0475 9 82.14 .0001 .0142 -1859.983 .0420 10 5683.64 .0001 .5009 -23335 .1522 IOverall 55381.40 .0001 .4833 -6525.612 .1172 without IRC , __5911 1 4.97 .0259 .0007 451.1237 -.0148 3 2 76.57 .0001 .0123 ~349.3976 .0408 I 3 143.35 .0001 .0229 -1339.844 .0738 4 271.61 .0001 .0427 -3963.238 .1531 I 5 475.55 .0001 .0732 -10238 .2521 6 247.30 .0001 .0393 -83D4.446 .1916 n 7 100.55 .0001 .0165 -7636.951 .1870 n 8 59 .45 .0001 .0100 -2070.392' .1328 9 3.52 .0606 .0004 12316 .0232' n 10 4865.32 .0001 .4621 -14435 .1692 n Overall 1667.42 .0001 .0274 -29.1544 3.2739 " # insignificant at the .05 level. 125 APPENDIX C (Cont'd.) [Modeh tazq£2 3 b, + b,(Income) +b‘ (exemptions) + e, L Parameter Estimates Deci 1e F Sig . Adjusted Intercept Income Exemptions (F) R- square with IRC §9 11 1 16.56 .0001 .0052 400.6571 -.0347 67.9277 2 152.42 .0001 .0475 635.2787 -.0029' -79.6260 3 322.98 .0001 .0958 661.2770 .0145 -186.7631 4 43.60 .0001 .0139 2566.6818 -.0481 -7.4390'I 5 3.45 .0318 .0008 -27.6662' .0154 2.1785' 6 81.38 .0001 .0260 -3540.172 .0683 -5.4180' 7 98.77 .0001 .0318 4504.2256 -.0198 -460.6374 8 38.77 .0001 .0129 -1924.295 .0498 -256.4513 9 57.69 .0001 .0198 -596.6102' .0413 -339.2688 10 2849.03 .0001 .5015 -18618 .1520 -1307.3778 Overall 27727.54 .0001 .4837 -5516.174 .1173 -300.8700 without IRC §9 11 1 5.34 .0048 .0015 294.0020 -.0167 54.4386 2 258.19 .0001 .0781 416.6275 .0302 -143.4655 3 468.64 .0001 .1334 36.9947' .0603 -283.6217 4 163.10 .0001 .0508 -3240.112 .1490 -174.1796 5 246.15 .0001 .0754 -10812 .2550 128.5413 6 124.80 .0001 .0395 -8582.934 .1917 82.4256' 7 56.43 .0001 .0183 -7557.546 .1742 292.2402 8 56.20 .0001 .0188 -3942.756 .1255 813.9087 9 2.49 .0834 .0005 13028 .0228' -191.1276' 10 2439.69 .0001 .4628 -8644.272 .1690 -1604.9159 Overall 31883.11 .0001 .5186 -4166.552 .1550 -154.6093 # insignificant at the .05 level. 126 APPENDIX C (Cont'd.) a b.4-th(1ncome) + e; L Parameter Estimates Sig. Adjusted Intercept Income (F) Rssguare ‘1 46.63 .0001 .0076 1654.6424 .1140 ‘2 272.97 .0001 .0429 -81ll.617 .5587 ‘3 132.90 .0001 .0212 -2290.318 .2464 '4 102.71 .0001 .0165 -3205.408 .2333 5 24.06 .0001 .0038 18573 -.l477 6 122.34 .0001 .0198 -3664.417 .2960 7 111.48 .0001 .0182 -11292 .3384 8 122.94 .0001 .0207 -12083 .3330 9 429.53 .0001 .0709 -36843 .5402 10 13971.75 .0001 .7116 -19986 .4388 Overall 178290.8 .0001 .7507 -l1232 .4122 without IRC 5911 1 63.21 .0001 .0103 1509.0549 .1317 2 332.05 .0001 .0517 -8671.135 .5964 '3 232.44 .0001 .0367 -3384.799 .2967 4 577.63 .0001 .0869 -9704.444 .4344 5 13.14 .0001 .0020 8352.3138 .0891 6 470.15 .0001 .0723 -8410.385 .4193 7 912.09 .0001 .1328 -23558 .5654 8 493.72 .0001 .0788 -11639 .4184 9 711.89 .0001 .1123 -22667 .5215 10 19780.04 .0001 .7774 -11087 .4558 “Overall 301084.5 .0001 .8357 '9392 .4464 u ==a==é=== # insignificant at the .05 level. 127 APPENDIX C (Cont'd.) Model: tuwomg a 1:10 + b1(Income) + bfiexemptions) + e, q Parameter Estimates I Decile F Sig. Adjusted Intercept Income Exemptions (F) R-square with IRC §911 '1 24.78 .0001 .0079 1937.0281 .1173 -97.8392' 2 145.88 .0001 .0456 -9281.662 .5749 219.1325 fl I3 109.41 .0001 .0344 -3948.901 .2627 341.6595 H 4 51.36 .0001 .0163 -3246.697 .2335 9.9452' N Is 143.13 .0001 .0452 24566 -.1774 -1.342.9540|| '6 69.69 .0001 .0223 -1998.781' .2951 -492.9876 '7 99.27 .0001 .0320 -11652 .3963 -1326.0084 8 115.52 .0001 .0382 -7464.840 .3510 -2007.6335 I9 223.62 .0001 .0734 -31791 .5372 -1356.8335 10 6984.65 .0001 .7116 -20231 .4388 67.6571' Overall 89180.35 .0001 .7508 -9874 .4122 -404.5602 without IRC §911 1 33.54 .0001 .0108 1830.3731 .1354 -111.3283 " 2 171.08 .0001 .0531 ~9500.313 .6079 155.2930 "3 143.09 .0001 .0447 -5473.183 .3084 244.8009 4 294.85 .0001 .0884 -9053.490 .4307 -156.7953{ 5 169.33 .0001 .0531 13782 .0621 -1216.5911 6 246.70 .0001 .0755 -7041.542 .4185 -405.1440 7 482.79 .0001 .1393 -23714 .5904 -573.1309 '8 278.43 .0001 .0879 -9483.302 .4268 -937.2734 9 369.03 .0001 .1158 -18166 .5188 -1208.6924 10 9888.49 .0001 .7774 -10257 .4558 -229.881' “ Overall 150572.1 .0001 .8357 I-8525 .4464 -258.2995 “ # insignificant at the .05 level. 128 APPENDIX C (Cont'd.) aggggggis bb-rlm(LnIncome) + e1 % Parameter Estimates Decile F Sig . Adjusted Intercept LnIncome Exemptions (F) R-square with IRC 5911 1 51.20 .0001 .0084 93.9197 -9.6906 :2 21.06 .0001 .0033 15.1475 -1.3860 3 1.39 .2384 .0001 -3.8114' .5183' '4 145.42 .0001 .0233 68.1099 -6.2799 5 .00 .9559 -.0002 1.8564' -.0328' 6 100.87 .0001 .0163 -55.8023 5.1556 .7 36.28 .0001 .0059 56.1768 -4.8183 38 8.16 .0043 .0012 -20.9723 2.0168 is 5.32 .0211 .0008 -9.6128' 1.0535 .10 838.79 .0001 .1289 -62.3408 5.4503 ;0verall 102.05 .0001 .0017 -6.0021 .7508 : without IRC 5911 E1 44.29 .0001 .0074 88.1357 -9.0714 :2 2.47 .1161 .0002 -4.6178' 0.7151' '3 39.21 .0001 .0062 -35.6291 3.7329 4 107.37 .0001 .0172 -94.098 9.3859 5 293.67 .0001 .0464 -205.272 19.4058 6 101.63 .0001 .0164 -126.7441 12.0076 7 36.59 .0001 .0059 -116.9305 11.1618 8 .65 .4208 -.0001 -4.5757' 1.3734' 9 53.13 .0001 .0094 118.343 -9.0436 10 49.62 .0001 .0085 -16.5167 2.2110 1667.42 .0001 .0274 -29.1544= 3.2739 “ # insignificant at the .05 level. 129 APPENDIX C (cont'd) Decile P Sig . Adjusted Intercept LnIncome (F) R-square with | IRC 5911 .1 37.35 .0001 .0121 95.0098 -10.6895 2 4956 I ‘2 185.83 .0001 .0574 22.4916 -2.0161 - 3625 3 320.62 .0001 .0952 7.7098' -.3992' -.6032 ’4 72.70 .0001 .0234 68.1554 -6.2831 - 0035' I5 .01 .9918 .0003 1.9143' -.0369' -.0039' 6 50.47 .0001 .0162 -55.8115 5.1559 .0017' 7 100.19 .0001 .0323 35.1228 -2.7953 -.0554 8 25.01 .0001 .0083 -23.2178 2.2909 - 2851 9 18.80 .0001 .0063 -8.0276' .9862 - 2307 10 473.18 .0001 .1429 -58.9654 5.3586 -.6235 Overall 51.74 .0001 .0017 -5.8004 .7519 - 0633' I without IRC §911 1 32.92 .0001 .0106 89.1806 -9.9748 2.3919 n 2 233.78 .0001 .0712 8.5496 -.3703' - 6244 n 3 418.82 .0001 .1209 -18.3965 2.3667 -.9022 I 4 74.48 .0001 .0237 -89.0647 9.0277 - 3852 n 5 155.75 .0001 .0490 -209.2113 19.6880 26384 II 6 51.50 .0001 .0165 -127.252 12.025 0976' l 7 23.47 .0001 .0075 -104.5831 9.9753 3250 8 23.88 .0001 .0079 1.1802' .6705' 7307 9 27.31 .0001 .0093 119.2691 -9.0828 - 1348' 10 54.75 .0001 .0186 -12.0246 2.0889 -.8298 “Overall 834.17 .0001 .0274 -28.9800 3.3749 - 0548' n # insignificant at the .05 level. 130 APPENDIX C (Cont'd.) . _ :_ s 13.4» denIncome) + e. Parameter Estimates Decile P Sig. Adjusted Intercept LnIncome Exemptions (F) 13.-square with IRC 5911 1 38.75 .0001 .0063 126.7090 -10.7325 2 126.33 .0001 .0204 -330.4313 34.9366 3 15.70 .0001 .0026 -68.4449 8.2847 1 4 21.20 .0001 .0033 -94.1809 10.3374 5 157.45 .0001 .0254 430.3934 37.7027 6 10.62 .0001 .0016 -71.6330 8.6275 7 9.95 .0016 .0015 ~92.2215 9.9235 8 14.52 .0001 .0023 -108.2241 11.2429 9 95.31 .0001 .0165 -273.8124 25.4341 10 70.82 .0001 .0122 -43.8934 6.3998 Overall 796.82 .0001 .0133 -15.2414 3.4920 without IRC §911 34.21 .0001 .0055 120.9250 -10.0593 152.45 .0001 .0243 -350.1967 37.0377 36.37 .0001 .0058 -100.2626 11.5054 215.98 .0001 .0342 -256.3886 26.0032 54.15 .0001 .0088 223.2648 -18.2641 64.64 .0001 .0105 -142.5747 15.4795 199.64 .0001 .0323 -265.3288 25.9036 33.65 .0001 .0056 -9l.8275 10.5994 62.23 .0001 .0108 -145.8566 15.3370 23.15 .0001 .0039 1.9307' 3.1604 Overall 2782.87 =|00$ .0449 I==-___:18.3936 6.0151 # insignificant at the .05 level. 131 APPENDIX C (Cont'd.) Mbdel: avgtaxwom :- b, + b,(LnIncome) +=b2(exemptions) + e. Parameter Estimates EFT Decile F Sig. Adjusted Intercept LnIncome Exemptions (F) R-square | with i IRC i §911 1 20.65 .0001 .0066 127.1678 ~11.1528 1.0503' “2 74.00 .0001 .0235 -350.3515 36.5786 .9446 “3 45.27 .0001 .0144 -88.0045 9.8423 1.0240 4 11.03 .0001 .0033 -92.3579 10.2076 -.1395' 5 216.13 .0001 .0668 470.9409 -40.6086 -2.7158 6 13.86 .0001 .0042 -67.6468 8.4925 -.7660 7 43.77 .0001 .0142 -149.6334 15.4402 -1.5111I 8 60.71 .0001 .0203 -123.1294 13.0629 -1.8923 I 9 54.12 .0001 .0186 -268.1187 25.1926 -.8287 '10 35.41 .0001 .0120 -43.8922 6.3998 -.0002' Overall 403.04 .0001 .0134 -14.3916 3.4965 -.2668 without IRC n §911 1 18.15 .0001 .0057 121.3386 -10.4382 .9467' ll 2 82.31 .0001 .0261 -364.5936 38.2245 .6827 3 40.67 .0001 .0129 -114.1109 12.6081 .7250 4 118.10 .0001 .0372 -249.5779 25.5184 -.5213 5 189.36 .0001 .0590 259.8153 -20.8835 -2.4481 6 44.76 .0001 .0147 -139.0873 15.3614 -.6701 7 120.29 .0001 .0385 -289.3395 28.2108 -.6320 I 8 46.59 .0001 .0156 -98.7315 11.4425 -.8765 9 40.16 .0001 .0137 -140.8220 15.1235 -.7328 10 11.99 .0001 .0039 3.0487 3.1300 -.2065' Overall 1396.69 .0001 .0450 -37.5712 6.2195 -.2582 # insignificant at the .05 level. 132 BIBLIOGRAPHY Anderson, K. 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