b. Migration of U.S. citizens and permanent residents

Part IV.C. above, discusses how the Administration proposal might effect the lifetime tax liabilities of an individual contemplating expatriation. By deeming recognition of capital gain on certain assets prior to relinquishing citizenship, the Administration proposal would increase the tax payments made to the United States in some circumstances.210 In other circumstances the Administration proposal may reduce total tax liabilities from expatriation. Where the proposal increases lifetime tax liabilities, the effect would be to increase the cost of expatriating, thereby causing more current citizens and permanent residents to retain their current status than otherwise might. Where the proposal reduces lifetime tax liabilities, the effect would be to decrease the cost of expatriating, thereby causing more current citizens and permanent residents to relinquish their current status than otherwise might.

c. Migration of non-U.S. citizens

For citizens of other countries who are not permanent residents of the United States and who might contemplate residing temporarily in the United States or becoming a permanent resident of the United States, the effect of the Administration proposal is clear, but the effect of S. 700 and H.R. 1535 is ambiguous. Noncitizens contemplating citizenship or residence in the United States may well foresee a possibility, perhaps remote, that their decision to become a U.S. citizen or resident will not be permanent. However, once one is a citizen or resident one would be subject to the deemed recognition rules of the Administration (and S. 700 and H.R. 1535) proposal. This would increase the expected, or potential, tax cost of assuming U.S. citizenship or residency. S. 700 and H.R. 1535, however, would permit a non-citizen to step up the basis of currently held assets upon assuming citizenship (or permanent residence). This may reduce the tax cost of assuming U.S. citizenship or residence. Present law does not provide such a step-up of basis and any gains recognized by a U.S. citizen or resident are computed relative to the individual's actual basis in the asset, even if most of the gain accrued prior to assuming U.S. citizenship or residency. For individuals with substantial accrued capital gains, S. 700 and H.R. 1535 could reduce the potential tax cost of becoming a U.S. citizen or resident. If the cost of becoming a U.S. citizen or resident is increased, immigration to the United States may be reduced. If the cost of becoming a U.S. citizen or resident is reduced, immigration to the United States may increase.

The importance of the step-up feature provided in S. 700 and H.R. 1535 may be small. In practice, a potential immigrant may be able to step up the basis of his assets by briefly residing in certain tax haven countries prior to immigrating to the United States. This suggests that the Administration proposal, S. 700, and H.R. 1535

210 Under present-law section 877, an expatriate may be liable for certain taxes for up to 10 years subsequent to relinquishment of citizenship. If the taxpayer were to sell his or her assets during that 10-year period and if those assets had experienced appreciation between the date at which the taxpayer relinquished U.S. citizenship and the date of sale of the assets, present law could actually require a greater tax payment, even in present value terms, than would the Administration proposal. See Part IV.C. for some discussion of tax liabilities under present law and the Administration proposal.

probably would work to reduce immigration to the United States.211

d. Potential effects of changes in immigration on the U.S. economy

In a large economy the immigration or emigration of one individual is unlikely to have any significant effect, even if that individual is a person of great wealth or skill. The migration of any one individual is unlikely to alter the supply and demand conditions of either the labor market or the capital market. The same would be true in both the country to which the individual migrates and from which the individual emigrates.212 The losses or gains are small in comparison to the economy.

If a significant number of individuals migrate, the losses or gains to the economy may no longer be small. Consider the case of emigration from the economy, the economy that experiences emigration may lose more than marginal contributions to the output of society that were made by the emigres. While the loss of labor may actually drive up the wages earned by those who remain, society's total output will fall. Society may lose even more output than that measured by the wages lost from departing emigrants if the output of those who depart produces rewards to society greater than the rewards the individual captures for himself in his earned income. For example, a scientist who develops a vaccine against a communicable disease generally creates benefits for society in excess of the income he is able to earn from the sale of the vaccine. Economists refer to such additional social benefits as "positive externalities" or "external benefits." The society may lose more than the scientist's wages should he emigrate if society had subsidized the scientist's training. Society would lose its "investment" in human capital.213 Conversely, the country to which individuals immigrate may gain not only the additional output such individuals can produce but also any external benefits they might create and the recipient country may also receive an influx of human capital at no cost.

The Administration proposal is targeted at certain individuals with above median financial wealth. Some such individuals are likely to be talented individuals possessing greater than average skills or human capital. If the Administration proposal discourages the emigration from the United States of such individuals, the discussion above suggests that the economy may benefit. However, as noted above, the Administration proposal also is likely to discourage the immigration to the United States of similarly talented or educated individuals. For example, multinational corporations post foreign nationals to the United States to manage their U.S. divi

211 Immigration to the United States is limited and demand generally exceeds permitted limits. Therefore, the proposals would not lead to reduction in immigration, but rather a change in the composition of those individuals who seek to immigrate to the United States.

212 For a discussion of this point see Herbert B. Grubel and Anthony D. Scott, "International Flow of Human Capital,” American Economic Review, 56, 1966, pp. 268-274.

213 For further discussion of the gains and losses from the migration see Jagdish Bhagwati and Koichi Hamada, "The Brain Drain, International Integration of Markets for Professionals and Unemployment: A Theoretical Analysis," in Jagdish N. Bhagwati (ed.), The Brain Drain, vol. II, Theory and Empirical Analysis, (New York: North-Holland Publishing Co.), 1976, pp. 113-114. For a more recent discussion of these issues see, Vito Tanzi, Taxation in an Integrating World, (Washington, D.C.: The Brookings Institution), 1995.

sions. These executives often obtain green cards. The Administration proposal could discourage such talented executives from seeking postings in the United States.

e. Responsiveness of migration to taxation

The United States has long been perceived as the net beneficiary of the immigration of talented, educated foreign nationals. The United Nations Conference on Trade and Development ("UNCTAD") has estimated that the net income earned by United States from skilled immigrants annually was as large as $3.7 billion in 1970.214 That figure would be equivalent to $14.1 billion in 1994 dollars. While the calculations that lead to such estimate are subject to dispute, others have calculated that 11,236 persons deemed to be "professional, technical, and kindred personnel" immigrated to the United States from developing countries in 1970 alone. In 1971, 18,850 scientists, engineers, and physicians were estimated to have immigrated to the United States from all other countries, developed and less developed. A comparable number was estimated to have immigrated to the United States in 1972.215

While these numbers suggest the magnitude of income flows that are associated with immigration decisions, they provide no insight regarding the motivation of such migration. There have been attempts to empirically investigate the determinants of migration. One survey of such attempts concludes that "both questionnaire and statistical evidence lend support to the view that wage rates matter." 216 The Administration proposal would diminish the expected after-tax income of an immigrant. These findings would suggest that there should be a negative effect on the immigration to the United States of skilled individuals. However, as explained above, the effect on the expected after-tax income of immigrants is ambiguous because of the step up in basis and by the fact that the future tax increase is conditioned upon subsequent emigration.2 The aggregate effect is likely to be small.

217

Some analysts have attempted to assess the factors that motivate internal migration within the United States. The evidence has been mixed. Some studies have found individuals strongly responsive to fiscal packages.218 A recent study examined the migration behavior

214 Jagdish Bhagwati, "Editor's Note," in Jagdish Bhagwati (ed.), The Brain Drain, vol. II, Theory and Empirical Analysis, (New York: North-Holland Publishing Co.), 1976, vol. II, p. 209. 215 Bhagwati, "Editor's Note," The Brain Drain, p. 209 and 215.

216 Paul Krugman and Jagdish Bhagwati, "The Decision to Migrate: A Survey," in Jagdish N. Bhagwati (ed.), The Brain Drain, vol. II, Theory and Empirical Analysis, (New York: North-Holland Publishing Co.), 1976, p. 32. Other studies also point to the importance of greater income or wage potential in the United States as an important factor drawing immigrants to the United States. Robert E. B. Lucas, "The Supply-of-Immigrants Function and Taxation of Immigrants Incomes," in Jagdish N. Bhagwati (ed.), The Brain Drain, vol. II, Theory and Empirical Analysis, (New York: North-Holland Publishing Co.), 1976, and George Psacharopoulous, "Estimating Some Key Parameters in the Brian Taxation Model," in Jagdish N. Bhagwati (ed.), The Brain Drain, vol. II, Theory and Empirical Analysis, (New York: North-Holland Publishing Co.), 1976. 217 The existence of a tax, even if never collected, could affect migration if the tax is perceived as signalling the possibility of higher taxes in the future for these who immigrate to the United States or an anti-immigrant attitude. Some of the survey studies have attempted to assess "attitudinal" factors that effect migration. One study identified "satisfaction with the U.S. way of life" as one of the most important factors determining migration. Krugman and Bhagwati, "The Decision to Migrate," p. 48.

218 For example, see Andrew Reschovsky, "Residential Choice and the Local public Sector: An Alternative Test of the "Tiebout Hypothesis'," Journal of Urban Economics, vol 6, pp 501-520. Reschovsky's study is in the context of individuals choosing among different suburban locations.

Continued

of retired persons to determine to what extent the different fiscal packages available within the United States might affect location decisions.219 By restricting the study to retired persons, an individual's location decision was not dependent upon employment opportunities or a long-term employment relationship. The study found that generally the effects of fiscal variables were small. In particular, the study found that the existence and magnitude of a State estate or inheritance tax did matter statistically, but that the magnitude was so small as to be of little economic consequence. While income taxes also might matter, the study found that generally State and local tax structure was not of large importance to the locational choice of the elderly.

Some view the Administration proposal as a proxy tax for the estate tax revenue that the United States loses if a wealthy individual expatriates. If, as Dresher study suggests, the estate tax has little effect on the location decision, the Administration proposal may have little effect on the migration to or from the United States. On the other hand, the magnitude of individual State estate taxes is small in comparison to the Federal estate tax. The results of this research may not be relevant for assessing the decision of a citizen to continue to reside in the United States or to relinquish his citizenship and take up residence in a country with no estate tax.

f. Cross-border flows of financial and real capital

The Administration proposal relates to the taxation of individuals based upon where they have chosen to reside and the nationality they have chosen to retain. It is not about where individuals choose to invest. Moreover, it is most commonly observed that while capital is mobile, investors generally are not. The bulk of cross border investment is attributable to multinational enterprises and financial institutions, not to migrating individuals. These observations would suggest that the Administration proposal is not likely to affect the flow of financial capital into or out of the United States.

On the other hand, there might be concern that expatriating individuals will take their financial capital with them and invest it in their new country of residence. As the individuals targeted by the Administration proposal are individuals possessing more than median wealth holdings in the United States, withdrawals of financial capital could be more than negligible amounts. Moreover, there is evidence that capital is not completely mobile internationally. Investment is generally greater in countries with high saving rates than in countries with low saving rates.220 If high saving rate individuals expatriate and save abroad, investment in the United States could be diminished.

He finds, for example, that measures of high quality public schools strongly attracted households to certain locations.

219 Katherine Ann Dresher, "Local Public Finance and the Residential Location Decisions of the Elderly," unpublished doctoral dissertation, University of Wisconsin, Madison, 1994.

220 Martin Felstein and Charles Horioka, "Domestic Saving and International Capital Flow," Economic Journal, vol. 90, (June 1980), pp. 314-29, and Martin Feldstein and Phillippe Bacchetta, "National Saving and International Investment," in B. Douglas Bernheim and John B. Shoven (eds.), National Saving and Economic Performance, (Chicago: University of Chicago Press), 1991, pp.201-220.

There is evidence that the location of investment is sensitive to the burden of taxation on the returns to investment.221 However, most of this evidence relates to foreign direct investment by multinationals or individuals who need not reside in the country in which the investment is made. Such investment flows into and out of the United States generally would be unaffected by the Administration proposal.

As long as relief from double taxation is provided, the principle of capital export neutrality is generally upheld and capital would flow to its highest and best use throughout the world.222 With relief from double taxation, the Administration proposal is unlikely to distort the flow of capital to or from the United States. Migration of individuals to tax havens would not alter this result. Most tax havens are small countries not suitable for substantial economic development. As such, real resources will flow to the same investments in the same countries as if the tax haven did not exist. The effect of the tax haven is not to alter international investment, but generally only the amount of taxes paid on the earnings from such investments.223

221 See James R. Hines, Jr., "The Flight Paths of Migratory Corporations," Journal of Accounting, Auditing, and Finance, vol. 6 (Fall 1991), pp. 447-479, and Joel Slemrod, "Tax Haven, Tax Bargains and Tax Addresses: The Effect of Taxation on the Spatial Allocation of Capital," in Horst Siebert (ed.), Reforming Capital Income Taxation, (Tübingen: J.C.B. Mohr), 1990, pp. 23

42.

222 For a discussion of the principle of capital export neutrality see, Joint Committee on Taxation, Factors Affecting the International Competitiveness of the United States (JCS-6-91), May 30, 1991. 223 Tanzi, Taxation in an Integrating World, pp. 78-86.