The Philippine experience with the assertion of citizenship jurisdiction

DOMESTIC FINANCE STUDIES NO.64 THE PHILIPPINE EXPERIENCE WITH THE ASSERTION OF CITIZENSHIP JURISDICTION By RICHARD POMP The views presented in this paper are solely those of the author and do not necessarily reflect the official opinions of the World Bank or its affiliates. November 1980 Public and Private Finance Division Development Economics Department Development Policy Staff TABLE OF CONTENTS I. Introduction .p. .. ..... . p•I II. .The Philippine Experience with the Assertion. of Citizenship Jurisdict±on A. Prior to 1970. . ...*..... ... .. p. 6. B. 1970-1972 . . . . . . . . . . . . . . . . . p. 7 C.. 1972. to the Present 1. Descriptiou of the Current Tax. Regime. . . . . . . . . . . . . . p. 8 2. Number of Returns F4ied and: Amount of Revenue Collected .- . . . .. . . . . . . .* . . . p.. 9 3. Taxpayer Compliance. .... ...... p. 13 4. Self-Employed Nönresident Citizens.. .......•p. 17 5. Administration of the Tax . . . . . . . . . . .. .. . . . . p. 19 lII. What Lessous Can Be- Learned From, the. Philippines? . . . .. . . . . . . . p. 22 A. Designing a Tax oi Nonresident Citizens 1. Calculating the Amount of Taxable Income . . . . . . . . . . . p. 23 2., Designing a Rate Schedule. . .. . . . . . p. 27 B- Assistance of the Host DC in Enforcing an LDC Tax . . .... . . . . . p. 29 IV. Conclusion . . . . . . . . . . . . . . . . p. 38 Footnotes . . . . . . .. . . . . . . . . . . . . . p. 39 I. Introduction All countries experience some loss of skilled manpower through 2 emigration. - The large-scale movement of skilled manpower from; the less developed countries to the developed countries, however, has been the, subject of nationaL. and international concern. This loss. of talent, the so-called brain drain, is deeply resented by many less developed countries (LDs) for two reasons. First,. because skilled and talented individuals,. such as doctors, engineers, and scientists, are perceived. as key. ingredients of growth, these less developed countries fear that the brain drain is retarding their econom±c advancement.. Second, many of these countries, especially those which have only recently terminated their -colon±al relationships, view the brain drain as a form of further exploitation by the developed countries (DCs). Instead of exploiting mineral and other natural resources, the developed countries are now accused of exploiting human resources. Indeed, the brain drain has been referred to as "an 'odious bleeding' of Africa, a continuation of the slave trade,5 and an immoral process that is "zgainst the principles and purposes 6 of international cooperation.,' 7 As these comments: suggest, debate over the brain drain from the LDCs, to the DCs is, frequently conducted in a highly charged atmosphere. Rational discussion of the causes and. remedies, and costs and benefits of the brain drain is also impeded by the funda- mental conflicts between the economic, cultural, and political per- spectives of the DCs and the LDCs. So far, the DCs and the LDCs have beer unable by themselves to establish areas. of agreement which. could become the foundation.for fruitful discussion of their differences. Lacking this. foundation, both groups have, tended to dwell. oz their antagonisms and to. dismiss each other's views; of the, brain drain as unfounded, misconceived,. or self-serving.; International attempts at: cooperation have thus been frustrated by the inability of the DCs and the LDCs to agree on the effects of the brain drain. A recent proposal, however, by Professor Jagdish Bhagwati of Columbia University has provided the DCs and the LDCs with a center of focus. Professor Bhagwati formulates the moral principle that, in a world of imperfect mobility of labor, individuals who are able to migrate frm the LDCs to the DCs ought to contribute to improving the welfare of those left behind by sharing their increased income It and other benefits. To implement his proposition, Professor Bhagwati recommends that a tax be levied on the income of skilled persons who emigrate to the DCs. The revenue- raised- by this tax would be channeled back to the LDCs. The DCs have an obligation to cooperate with the LDCs in enforcing this tax, in recognition of the benefits that accrue to the DCs from the brain drain. 3 The Bhagwati proposal was discussed and analyzed at a conference held in Bellagio, Italy in 1975, under a grant from the Rockefeller 12 Foundation. This conference was an interdisciplinary venture, bringing together both. lawyers and economists from various countries. The tax was. also discussed at both. the 1978 and. 1979 meetings of the United Nations Conference on Trade and Development (UNCTAD), which 13 has been studying the brain drain for a number of years. The, Bhagwati, proposal has emerged from these international conferences as a distinctly possible governmental policy. The proposal has received a favorable response for three major reasons. First, the moral underpinnings of the tax appeal to many of the LDCs and the DCs. Second, an LDC-imposed income tax on emigrants, which is- one manner of implementing. the proposal, can be adopted unilaterally by any LDC. The need-for concerted international cooperation is thus 14 reduced. Third, an LDC-imposed income tax is- entirely consistent with existing international custom ana. practice. Im other words, the principle of a country's taxation of its citizens who work abroad is well established and uncontroverted. For example,. the United States, Mexico, and the Philippines all assert tax jurisdiction over the world- wide income of their citizens, even if such citizens are living and working abroad. To the extent that Mexico and the Philippines are successful in enforcing their tax on nonresident citizens, both '15 countries already tax the brain drain. Most LDCs, however, do not follow the approach used by the United States, Mexico, and the Philippines. Instead of using citizenship as the relevant Jurisdictional connection, most LDCs use residence.16 4 That is, most LDCs will assert jurisdiction over the worldwide income of an, individual only if he is a resident of the LDC for tax purposes. Because emigrants do not fall withinusual definitions of tax residents,, emigrants are not being*taxed by most LDCs at 17 present. To implement Professor. Bhagwati's proposal, an LDC would. follow the, pattern established. by the United States,. Mexico, and the Philippines,.and assert jurisdiction on the basis of citizenship. Once the international community fully appreciated. that the Philippines and Mexico provide a precedent for the Bhagwati proposal, the notion of using an income tax to, intervene in the brain drain was greatly enhanced-. International discussion of the Bhagwati proposal has now shifted to the administrative difficulty of implementing an LDC tax on- nonresident citizens. Policing a tax on. nonresidents can create problems even for as sophisticated DC tax administration. A. funda- mental question, therefore, is whether an LDC could effectively 19- administer a tax on nonresident citizens. A resolution of this issue is critical to evaluating the feasibility of the Bhagwati proposal. Indeed, international discussion of an LDC income tax on nonresident citizens has reached an impasse, pending further information on the administrative difficulties that may be encountered by an LDC in the assertion of citizenship jurisdiction. No studies have previously been conducted of the experience of either the Philippines or Mexico in enforcing their tax on nonres-idents. 5 Although information on the United States is available, the'U.S. experience is unlikely to be of much. value in predicting the problems, encountered by an LDC, Many LDCs are less sophisticated than the United States in enforcing their tax systems. Because many LDCs are not yet'efficient in, enforcing their taxes domestically, any attempt to assert jurisdiction over nonresidents may pose difficult admini- strative burdens. In addition, it is common for U.S. citizens working outside the country to alternate periods abroad with periods within the United States, and. their awareness that they will eventually return home is likely to offset any inclinations they have to ignore their U.S. tax obligations. By'contrast,. many nonresidents of the LDCs are emigrants who intend to become citizens of their host DCs. Because generalizations drawn from the U.S. experience have little probative value for an LDC, the need for a study of the experience of either Mexico or the Philippines became obvious. The Philippines was chosen because it is an English-speaking- country and because its tax administration was entirely cooperative and enthusiastic about the study. Research was conducted in Manila during the summer of 1980 at the Bureau. of Inland Revenue, the Ministry of Finance, the Ministry of Labor, and the Central Bank. All pertinent statistical data, although limited, was made available to the author. In-depth interviews were conducted with key policymakers and administrators. IZ. The Philipoine Experience with the Assertion of Citizenship Jurisdiction A. Prior to 1970 Prior to 1970, Filipino tax law did not distinguish between citizens residing abroad and citizens residing within the Philippines. Filipino- citizens. were subject. to the income tax on their net income from all sources, foreign as well as domestic. Net. income was subject to a.set of progressive tax. rates, starting at 3% for net income of up to 2,000 pesos. and reaching 70Z for. net income exceeding. 500,000 20a pesos.. The, tapayer could choose between deducting income taxes paid. to a foreign country from gross income and crediting them against his Filipino tax.2 A, ntimber of problems affecting nonresident citizans emerged. from this pattern of taxation.. The most. severe one arose around 1970, when the exchange- rate of the peso was allowed to float. Prior to 1970,. the exchange rate of the peso to the U.S. dollar. was approximately Z:. When the exchange rate was, allowed to float, however, this rate increased dramatically, and the peso was, in effect, devalued. 22' Consequently, the conversion into pesos of even a modest U.S. salary made a nonresident taxpayer appear quite wealthy by Filipino standards and thus subjected him to a substantial tax burden.23 Consequently, a nonresident perceived the Filipino tax to be inappropriate and harsh. Another complaint by nonresidents was that the' Filipino tax code did not allow deductions for certain expenditures incurred abroad that were allowed by DC tax law. 7 The Philippines, Bureau, of Internal Revenue (BIR) also had its problems with the pre-1970 regime. Without actually conducting an audit abroad, which rarely occurred, the. BIR had difficulty verifying either the income or the deductions of a nonresident. citizen. The tax administration often. had little. choice but to accept whatever return was.filed by a taxpayer abroad. 3. 1970-1972 The Philippines responded to one of the complaints by its nonresident citizens by expanding the deductions available to them. Beginning:in 1970, a.nonresident citizen could deduct from gross income. his housing.costs-either the rent paid for an apartment or, in the case of a. taxpayer owning his own home, the fair rental value of the home. These deductions were intended to offset the higher cost of 24. housing abroad. A nonzesident citizen also became entitled in 1970 to deduct from gross income all the deductions contained in the income tax return filed in the country in which he earned his income. These 25 deductions were in addition to those already allowed by Filipino law. The 1970 changes compounded the BIR's administrative problems. First, in addition to all of its old problems, the Bureau now faced a new problem of verifying deductions claimed under a foreign, and unfamiliar, tax law. The BIR attempted to solve this new problem by requiring nonresident citizens to submit a copy of their foreign tax return at the time that they submitted their Filipino tax return. The BIR's efforts, however, were often frustrated by nonresidents who submitted copies of bogus foreign tax returns that contained nonexistent 26 deductions. Second,. although a nonresident was not allowed to deduct from gross income the same item twice-once, because it was authorized under Filipino tax law and again becauseit was claimed in his foreign tax return-the BIR had difficulty catching these cases of "double dipping." Third, a nonresident's housing costs were nearly- impossible to verify . Because of these administrative problems, the pre-1972 tax regime was unpopular with the:BIR. Taxpayers also remained dis- pleased. because despite: the new, deductions, a. large overall tax burden: £tll resulted fro' a. modest foreign salary.. This. high tax discouraged nonresidents from filing a Filipino tax return. Nonresidents who did file, were tempted to reduce their taxable incomes by claiming bogus deductions. Although statistics for the pre-1972 period are scanty, all tax officials interviewed agreed that tax evasion was widespread in the overseas commnty-, particularly among emigrants.. C.- 1972 to the Present 1. Description of the Current Tax Regime Because of the dissatisfaction with the pre-1972 regime, the tax treatment of income received by a nonresident citizen from sources 27 outside the Philippines was overhauled in 1972. Under the new 27A. scheme, which is still in effect, a nonresident citizen is al- lowed only two deductions: 1) a personal exemption of $2,000 for 9 a single taxpayer or $4,000 for a married taxpayer (or a head. of household), and 2) a deduction (but not a credit) for foreign income 28 taxes. These deductions are denominated in U.S. dollars, just as a nonresident's gross income is. A special set of rates applies to a nonresident citizen's gross income less foreign taxes. and the personal exemption., These rates, which have not changed since 1972, are 1% on: the first $6,000, 2% on amounts between $6,000 and $20,000, and 3% on amounts in excess of $20,000. Because of these rates, the taxation of nonresident citizens 291 is knowm as, the 1-Z-3 systea- The 1-Z-3 system was intended to eliminate the problems that had. plagued the pre-1972 tax regime. By allowing almost no deductions, and thus effectively taxing nonresidents on their gross income, the Philippines wanted to eliminate the BIR's administrative problems. The rates of tax. (1%, 2%, 3%) were kept low to compensate for the lack of deductions. Multiple rates were chosen to introduce a degree of progressivity. The 1-2-3 system was. based on the U.S. dollar to avoid the pre-1972 problems of currency conversion.. 30 2. Number of Returns Filed and Revenue Collected Table I sumarizes the number of returns filed by nonresident citizens and the amount of tax revenue collected under the 1-2-3 system for the years 1972-1979. Data were not available for 1972, 31. the first year of the new system. For comparison, data for 1971, the last year of the old system are also included. .. *... 9A TABLE 1 NUMBER OF RETURNS AND REVENUE COLLECTED FROM NONRESIDENT ALIENS Revenue Collected Calendar Year Number of Returns (Millions of Pesos) 1979 83, 543 19. 5 1978. 71 625- 16.2 1977 57,791 8..1 1976 54,055 8.0 1975 41,755 11.3 1974 27,956 4.8 1973. 32,170 10.6 1972 N /A. N/A 1971 13,000 .342 Source: Compiled from the records of the Bureau of Inland Revenue. The number of returns, filed in 1973 (32,,120) is' large in relation to the number filed- (13,00GI under the last. year (1971) of the old system:. This increase appears to be attributable to a tax amnesty that was declared in 1973. The amnesty encouraged non- -resident citizens to comply with the new 1-2-3 system, even if they had never paid taxes in the past. To encourage compliance, the amnesty guaranteed, that. past acts of' tax evasion. would not be prosecuted. Although the tax amnesty applied only during 1973, many nonresidents apparently believed that another amnesty would be offered in the aear future.- This belief may explain the decline in the number of returns filed in. 1974 (27,956) Table Z shws a lavge increase in returns filed and revenue collected in 1975: 41,755 returns and 11.1 million pesos. This increaser presumably has two causes. First, much as nonresidents had expected, another one-year amnesty was declared in 1975. Second, a progra= of tax clearance certificates was instituted. Under this, nev program, nonresident citizens returning to the Philippines for a. visit were required to obtain a tax clearance certificate before being allowed to leave again for abroad. In order to obtain a certificate, a nonresident had to prove that he.had satisfied his outstanding tax obligation. The tax amnesty allowed a nonresident to discharge any outstanding obligations without the imposition of a fine or penalty. The statistics for 1976 show a decline in revenue collected (8 million pesos) but an increase in the number of filers (54,055). Perhaps these figures reflect a return to a more normal pattern, after an unusually large revenue yield attributable to the 1975 amnesty- and to the institution of the tax clearance program. In 1977, in a reversal of policy, the government suspended the use of tax clearances. This suspension w.as part of the govern- ment's "balikbayan" program, which was directed at encouraging nonresident citizens to visit the Philippines, and to observe the 32 progress and development that had occurred under martial law. Tax revenue collected in 1977 (8.1 million pesos) was not signifi- cantly- greater than. in 1976 (8 million pesos), even though the number of filers (57,791) increased. The- 1978 and 1979- figures. for the number of filers (71,625 and 83,543) and revenue collected (16.2 million pesos and 19.5 million pesos) show a dramatic increase. This increase is presumably explained by the large number of contract workers that the Philippines started to supply to the Middle East. In addition, the definition of a nonresident taxpayer was expanded in 1978, with the result that more Filipinos abroad become taxable under the 1-2-3 system.33 Despite the data available on the number of filers and revenue collected, it is difficult to draw significant conclusions about the operation of the 1-2-3 system. To evaluate properly the success of the Philippines in administering its tax on nonresident citizens, the number of actual filers should be compared with the total pool of potential filers. Unfortunately, data on the number of nonresident 12 citizens abroad are quite sketchy. For example, in the past few years, the Office of Emigrant. Affairs has started to keep detailed records, but is concerned only with emigration and takes no account of the number of Filipinos who have returned home. The records of this office thus overstate the number of potential nonresident tax- payers. Moreover, the number of nonresident citizens who emigrated before the government started keeping detailed records is difficult to estimate. -Some "guesstimates" exist, but they have not been adjusted for deaths or for emigrants who have returned to the Philippines. Also, no estimates are available of the number of emigrants who have become citizens of other countries tnd have therefore removed themselves. from the tax jurisdiction of the Philippines. In order to determine the potential pool of nonresident taxpayers, information would also be needed on the size of families, the number of minors, the number of unemployed adults, the number of housewives, and so forth.; The records kept by the countries of emigration are often.not.detailed enough to be useful in answering these questions. Available estimates of the number of nonresident citizens, however, do not contradict the unanimous opinion of all BIR officials interviewed, including those who had been assigned abroad to various Filipino embassies and consulates., that the Philippines receives returns from only a small percentage of those nonresident citizens subject to the 1-2-3 regime.35 BIR officials also recognized that even if a return is received from a nonresident, no guarantee exists that it contains accurate 13 information. The nonresident may lie about his gross,income, his deductible foreign taxes, or his- marital status. The BIR attempts to verify this information by requiring a.nonresident to submit: a copy of his foreign tax return at the same time that he submits his 36 Filipino return. Apparently,.many emigrants simply ignore this requirement. Other emigrants have continued the pre-1972 practice of submitting copies- of bogus foreign, tax returns that have been 37 specially prepared to mislead the BIR. The BIR has no estimates of the amount of revenue that would be collected under 1-2-3 if 38' there were full compliance by all taxpayers. 3. Taxpayer Compliance onresident citizens tend to fall into two classes: those who are abroad only temporarily (transient nonresidents) and those who are abroad more or less permanently (emigrants.). Officials interviewed agree that overall. compliance by nonresident citizens is markedly low but believe that transient nonresidents have a higher rate of compliance than do emigrants. The two groups of transient nonresidents having the highest compliance rate apparently are contract workers-those Filipinos who go abroad for a definite period of time under a contract.of employ- ment--and seamen. Their high rate of compliance is not surprising, since these workers usually leave their families and financial assets behind and will eventually return to the Philippines. More- over, the identity of these transient nonresidents and the amount 14, of their earned income are knownL because their employment is often controlled and regulated by the Philippine government. Strong pressures therefore exist which. induce, them to comply with the 1-2-3 tax. A high rate of taxpayer compliance is also experienced in areas where the Filipino population, although not composed of contract workers or seame., nonetheless tends. to be transient, rather than permanent. Filipinos. in Hong Kong, for example, are thought to have a good taxpaying record, at least in terms of the number of returns filed as a. percentage of the estimated number of potential 40 taxpayers. The high rate of compliance is explained by two factors.- First, few Filipinos plan to reside in Hong. Kong permanently. Their intent to return home is likely to offset any inclination to ignore their tax obligations. Second, the Filipino: embassy in Hong Kong exercises its legal authority to refuse to renew a Filipino.passport unless the applicant has presented proof, provided by the BIR, that all outstanding tax liabilities have been satisfied. The renewal of a passport is obviously critical for any Filipino who plans to return home. This "passport sanction" which Filipino embassies and consulates in all countries could impose, is evidently effective with Filipinos in .on& Kong The experience in Rong Kong can be contrasted with the experience in the United States, where taxpayer compliance is thought to be quite low. Many of the Filipinos who reside in the United States . . . . .. .. . .* 1.5 are emigrants and intend to become U.S. citizens. Emigrants are more likely to be, recalcitrant taxpayers than are other groups of nonresidents. Some emigrants have little sympathy with the existing Philippine governent and refuse to recognize any obligation to. pay taxes. Those who emigrated because of a lack of professional opportunities at home may also resent the payment of Filipino taxes. In. addition, physical distance from the Philippines breeds a sense of security which encourages emigrants to disregard their tax obligations. Finally,. some emigrants may simply not realize that their Filipino, tax obligation can continue despite their absence. The passport sanction is apparently ineffective with emigrants, in. the United States.. Emigrants, are much less concerned with return- ing, to. the Philippines, at least in the near future, than are transient nonresidents.. An emigrant who intends to become a U.S. citizen can always return to the. Philippines on a U.S. passport.41 Consequently, many emigrants in. the United States evidently. do not. consider the benefits of renewing their Filipino passports as being offset by the costs of paying the 1-2-3 tax. Because emigrants who intend to become citizens of their host DC have the option of waiting and returning to the Philippines on a DC passport, some Filipino consulates and embassies in the United 42 States and other host DCs have stopped enforcing the passport sanction. 'That is, they will renew a passport without requiring proof that a nonresident has satisfied his tax obligations. 16 These consulates and embassies feel that the strict enforcement of the passport sanction woul& be counterproductive, because, rather than pa7 any Filipino-tax, an emigrant will merely postpone a trip to the Philippines.until he obtains a non-Filipino passport. Under these circumstances, the Philippines not only fails to collect its tax, but also forgoes the amount of foreign exchange which would have been generated by the nonresident's. visit. The amount of foreign exchange is thought to outweigh any tax owed. In order to encourage visits home, these consulates and embassies automatically renew Filipina passports, a position they view as consistent with the objectives of the. "balikbayan" program. Another reason sometimes given for not enforcing the passport sanction is the ease with which a nonresident citizen can lie and allege that he has no income and thus no Filipino tax liability. Anonresident can lie and claim that he is a student, unemployed, retired, or the dependent of another person. Rather than trying to verify this information, some embassies and consulates have simply 43 stopped inquiring into an individual's tax status. Although emigrants have higher rates of noncompliance than contract workers and other transient nonresidents, not all emigrants are unwilling taxpayers. Officials interviewed who had been stationed abroad suggested that some emigrants feel a moral obligation to pay Filipino taxes. Doctors, nurses, and other pro- fessionals, for example, were.apparently more inclined to file returns under 1-2-3 than were other groups of emigrants. One r~a 17 official suggested zhat these persons may feel morally obligated because of the educational opportunities afforded.them by the Philippines. Alternatively, these persons may simply be able to bear the financial burden of the Filipino tax more. easily than others. 4., Self-Employed Nonresident. Citizens Although the.1-2-3 system is effectively a tax on gross income, at the time of its inception many policymakers viewed it as a proxy for a tax on net income.. Theoretically,. if deductions are a very szall percentage of gross income for all taxpayers, a tax on gross income is nearly equivalent to a tax on net income. If de- ductions are not, a very small percentage- of gross income, but nonetheless constitute the same percentage of gross income for all taxpayers, then any set of tax rates applicable to net income could be translated into an equivalent, though lower, set of tax rates . 44 applicable to gross income. Im reality, however, deductions are likely to vary among tax- payers. Employees, for example, will usually have lower deductions than self-employed individuals, both in absolute amount and as a percentage of gross income. In 1972, when the 1-2-3 regime was introduced, it was apparently assumed that most nonresidents were employees and that the deductions denied them constituted either a small percentage of their gross incomes, or the same percentage of their gross incomes. To the extent that this assumption was correct, 18 a tax on their gross income at low rates C%,. 2Z, and 3%) could be viewed as a rough proxy- for a, tax on their' net income, and all nonresidents would be treated uniformly. Today, fewer nonresident citizens are employees than was true in 1972. Although no statistics are available, persons familiar with the, overseas Filipino community are able to cite many instances of self-employed emigrants, for example, doctors, engineers, restauranteuzs, importers, and other businessmen. The deductions disallowed under 1-2-3 represent a higher percentage of this group's gross, income than. is true in the. case of employees. Therefore, taxing self-employed nonresidents on gross income, even at low rates, is equivalent to. taxing. their net income at rates substantially higher than those imposed on. employees. Self-employed nonresidents apparently regard the 1-2-3 tax as unfair and inequitable because they are denied a deduction for the normal, costs of doing business, such as wages, rent, depreciation, advertising, materials and supplies, inventory, and so forth.. Moreover, if business costs constitute- a significant percentage of gross income, the impact of the 1-2-3 tax can be substantial. The BIR acknowledges that it receives few, if any tax returns, from 45 self-employed nonresidents. The problem of accommodating self- employed nonresidents under 1-2-3 is currently under study by the BIR.46 19 5.. Administration of the Tax Th. nature of the taxpayer compliance problem encountered by the Philippines sheds insight into understanding the BIR's approach to administering the 1-2-3 system. The BIR deals with two very different groups of taxpayers. In the case of most transient nonresidents, such as contract workers and seamen, taxpayer compliance tends to be high. Transient nonresidents know that attempts at-tax evasion are likely- to be unsuccessful. In many cases, the BIR knows the identities of tonresidents and the amount of their earned income.. The passport sanction is also effective in discouraging tax evasion by this group. In addition, transient nonresidents typically have assets in the Philippines which can be seized by the BIR, liquidated, and the proceeds credited against any outstanding taxes. Consequently, taxes are collected from transient nonresidents without costly intervention by the BIR. The Bureau's primary function, is to ensure that this group under- stands its tax obligations as nonresidents and to assist them in the preparation and filing of their returns. The greatest. cpliance problem is posed by emigrants, and one of the frustrations of the BIR is that it lacks any effective tools for dealing with this group. Tax officials can exhort, cajole, and coax the emigrant community into recognizing its tax obligation, but lack other means of persuading recalcitrant emigrants into paying their taxes. BIR officials assigned to 20 Filipino embassies and consulates abroad have no more authority to investigate or audit a nonresident citizen than would, a private. citizen of that foreign country. Indeed, requests of an emigrant for information about his gross income or deductible foreign taxes are often ignored by the taxpayer with impunity. Because of the lack of any tools for dealing with noncompliant emigrants, the BIR: is forced into a generally passive administrative posture. Emigrants are. informed of their tax obligations at the time of their departure from the Philippines and through speeches and lectures, given abroad by BIR staff. Little. additional effort is expended in what is. perceived to be the fruitless task of inducing. compliance from emigrants. For example, no systematic attempt is made to compile the names or current addresses of nonresident citizens. so that they can be contacted by Philipino revenue attaches or representatives. Almost all tax. returns are accepted as filed, with no audits being performed. Even if an emigrant has failed to. submit documentation supporting the amount of foreign 47 income taxes claimed as a deduction, the BIR will not necessarily contact the taxpayer and request such documentation. As one BIR official explained, "they would only ignore our request anyway so why bother." Tax administrators who were interviewed consistently expressed their frustrations at the passive role the Bureau was forced to adopt in dealing with recalcitrant emigrants. One official described 1-2-3 as a."voluntary tax that emigrants are free to pay or not." 21 Despite these frustrations, no official recommended eliminating the tax. on. nonresidents. They falt that the revenue raised from 1-2-3 greatly outweighed the costs of administration. Because the administration of the tax absorbs little of the BIR's resources, whatever revenue is raised is viewed almost as a windfall. Officials did recognize, however, the inequity in levying a tax that could not be enforced uniformly against all taxpayers. BIR officials were unable to provide any estimate of the costs of administering the 1-2-3 tax. A major difficulty in estimating the cost is that no. one spends a significant; portion of his time working on 1-2-3 BIR officials were confident, however, that the administrative costs were modest,. because those persons who do perform some functions relating. to 1-2-3 tend to be lower paid clerical workers. These workers check returns for completeness of information (name, address, etc.), process payments of tax, file completed returns, and so forth. Few, if any nonclerical functions, such- as the auditing of returns, take place. Occasionally, nonclerical staff of the BIR will lecture about the 1-2-3 system to groups of contract workers or emigrants who are preparing to leave the Philippines. Similarly, BIR officials are'sometimes sent abroad to-lecture to the overseas Filipino community and to assist in the preparation of returns. These activities are minor, however, compared to the- staff 's non-1-2-3 responsibilities. Even personnel of the BIR who are assigned to Philippine embassies or consulates as revenue attaches or revenue representatives do not devote a signifi- cant portion of their time to the administration of the 1-2-3 regime.48 22 III.. What Lessons Can.Be Learned from the Philippines? The experience of the Philippines highlights the difficulties that will be encountered if an LDC adopts Professor Bhagwati's proposal to tax nonresident citizens. Most of the problems faced. 49 by the Philippines were anticipated in the theoretical literature. The Filip.ino experience validates the theoretical analysis and suggests. that similar problems: will be encountered, to some degree, by any LDC asserting citizenship jurisdiction. This section of the paper analyzes the Filipino experience from the perspective of an LDC considering the adoption of citizenship jurisdiction. One of the fundamental.problems that the Philippines had to resolve was the design of a tax suitable for application to non-- residents. This problem is' discussed in Part A of this section which focuses on two interdependent structural issues: (1) the rules and principles for determining, the amount of taxable or net income-that is,. the- amount of income which will be subject to taxation; and (2) the rate at which this income will be taxed. These elements are inherent in the design of any tax and the experience of the Philippines serves as a useful backdrop to the discussion in Part A. Part A also considers the problem of administering a tax on nonresidents. The conclusion drawn, from Part A is that design and administrative considerations point heavily toward an LDC tax on nonresidents that takes the form of a surtax. In other words, the LDC tax would be levied at some percentage of the tax paid by a nonresident to his host DC. In Part B the discussion shifts to the roles that a host DC can play in assisting an LDC in the enforcement of its tax on 23 nonresidents. One of the frustrations of the. Filipino tax administration is its lack: of- affective measures to reach noncompliant taxpayers, particularly emigrants. No LDC is likely to be very effective at coping with widespread tax evasion, especially by emigrants. The cooperation of the host country appears critical to-mitigating this. problem. A. Designing a Tax on Nonresident Citizens 1. Calculating The Amount of Taxable:Income All countries that levy an income tax must design a set of rules and principles for determining the amount of taxable (net) income, but no two countries employ identical rules and. principles. That differences exist is-not surprising because the calculation of taxable income involves a great variety of transactions and types of receipts. Little agreement exists, even in theory, about the normative treatment of many income and expense items., but even if agreement were to-exist, political, social, economic, and adminis- trative constraints could necessitate greatly divergent approaches. The rules and principles for determining an individual's taxable income reflect the complexity and sophistication of a country's business transactions and employment practices. One problem in simply extending,an LDC's domestic rules for calculating taxable income to a nonesident citizen working in a DC is that such rules may be inadequate to cope with the sophisticated business conditions found abroad. Many of the transactions and practices 24~ common in the DCs occur infrequently or have no parallel or counterpart in. the LDCs and their tax consequences may therefore not be specified in the tax laws of the LDCs. For example, the LDC law may not treat pensions, profit-sharing.plans, or deferred compensation arrangements that are available to employees in the DCs. Although one type of problem, arises if the LDC tax law does not adequately treat transactions common in the DC,. a different type of problem aris.es if rules developed in the context of conditions prevailing in the LDC are extended to nonresident citizens. LDC tax lw might not allow a deduction for certain types. of transactions. common in a DC. Similarly, an LDC might place a ceiling on the absolute amount of certain expenses, such as advertising, travel, or entertainment, which can be deducted for tax purposes. Because the ceiling will have been established on the basis of the LDC price levels and business customs, it may be totally unrealistic for a 50 nonresident doing business in a DC. The same problem is raised by provisions of LDC tax law which adjust an individual's tax liability in recognition of the size of his family. This adjustment is often mada by allowing the taxpayer to deduct a fixed amount for each member of his family.. The amount set by the LDC law may, however, be inappropriate for a taxpayer and his family who are abroad. Another problem can arise if the cost of living is much greater in the DC than in the LDC. In this case, the LDC might wish to extend nonresidents special deductions not available to taxpayers resident within the LDC, These deductions could, for example, take into, account a nonresident citizents higher cost of housing,, 51 the- special costs incurred in educating his children, and so forth. The:experience of the Philippines underscores the inappropriate- ness of merely extending an LDC's usual domestic.rules for calculating taxable income to nonresidents. Prior to 1970, a Filipino nonresident citizent calculated his taxable income in. the same manner as a resident. Nonresidents. complained,, however, that Filipino tax law was too restrictive in not allowing a deduction for transactions common in the aCs.52 Setween 197a and 197Z, nonresidents were- entitled to claim all of the deductions allowed in'their DC tax return, in addition to those allowed by Filipino law. Nonresidents were also allowed to deduct their housing costs in order to offset their higher costs of livin abroad. The BIR had difficulty in verifying the deductions claimed by a nonresident, and partially in response to this problem, the Philippines moved in the direction of. a gross income tax i 1972 by denying nonresident citizens almost all of the deductions available to a resident taxpayer. A reasonable alternative, however, to either taxing a non- resident on his gross income, or modifying domestic rules for use by'a taxpayer abroad,53 ts to calculate a nonresidentts taxable income for LDC purposes by the same set of rules used by the DC. Ln other words, the nonresident would report to the LDC the same 54 amount of taxable income which he reported to the DC. A powerful feature of this approach is that the LbC would not have to expend its own resources to determine whether the nonresident 26 correctly calculated his taxable income. The DC tax administration's normal audit and administrative activities,. though directed: at enforcing the DC tax, would automatically be enlisted. on behalf of the. LDC. In addition, any controversy over the amount of a non- resident's, taxable income for purposes of the DC tax would be resolved through the DC's normal appellate procedures. The DC's self-interest i= safeguarding the integrity of its own tax would. greatly reduce the administrative burden on the LDC's tax administration. In order for the LDC to verify the amount of taxable income that was actually reported to, the DC, a nonresident would be re- quired, to submit a copy of thiL DC tax return at the time that he files his. LDC tax return. To. el-fmate the, problem of a nonresident submitting,a photostat copy of a bogus DC tax return, a certified 55 copy of his DC return should be required. Employees of international organizations pose a special problem. Because the eared income of these employees is generally exempt frm DC taxation, many of them do not ordinarily compute their DC taxable income. These employees could, of course, be required to compute their income as. if they were taxable under DC law. Special arrangements would have to be made, however, for ensuring that these computations were accurate because they would not be verified by the DC tax administration. The use of the host country's rules for the calculation of a nonresident's taxable income responds well to the case of emigrants, most of whom work in the DCs. Transient nonresidents, however, may - - -.- ~ ,,,~ ~ -----.---e 27 work.in countries that do not have, an income tax. Many of the OPEC countries, for example, which engage contract workers, do not have an income tax, or else exempt salaries and wages earned by foreigners. Seamen pose a somewhat similar problem, since they are typically not subject to the tax jurisdiction of any foreign country. One solution.would be to require seamen and contract workers to compute, their taxable income under the LDC's normal rules.. The experience of the Philippines suggests.that such rules would work satisfactorily if extended to these groups. In any case, these: groups tend not to- pose severe compliance problems.. 2. Designing a' Rate Schedule Once a nonresident citizen's- taxable income was determined., the next step in calculating.his LDC liability is to apply some tax rate to his taxable income. Applying the normal domestic tax rates to a . ~ 56, nonresident's taxable income, even if such income is calculated, 57 under DC rules, is.likely to generate a significant tax liability. The Filipino approach adopted in 1972--a special schedule of rates (1%, 2%., 3%) for nonresident citizens--illustrates one solution to this problem. Although the Philippines adopted its lov rates on nonresidents as part of its shift to a tax on gross rather than taxable (net) income, an LDC can design a special set of rates applicable to a nonresident's taxable income. Unless these rates were low, however, a special schedule would have to be designed for each host DC in order to adjust for differences in the costs of 28 58 living among DCs. Also, if the exchange rate of the LDC currency were subject to. wide, fluctuations, the rate schedule 'would have to be examined periodically to see if it still generated the desired 59 tax at each level of income. Another approach to the rate problem is to set the LDC rates at a certain percentage of the DC 'tax rates, say 5%. In other words, the LDC rate would be equal to 5Z of whatever DC tax rate were applicable to the. nonresident citizen. If DC taxable income were used by the LDC as its tax base, this approach is the same as levying a 5Z. surtax., that is,. & 5% tax levied on the DC tax. In order to calculate his LDC liability, a nonresident citizen would compute his taxable income under the DC.'s regular rules, apply the DC's regular rate schedule,, and multiply his DC tax. liability by 5%. The surtax is attractive because it automatically relates the 61 additional LDC burden to the DC tax. Presumably, the DC tax base and rate' structure produce a taz burden that is regarded as fair and equitable in terms of conditions in the DC; a modest LDC surtax 62 would therefore ensure that the additional burden was reasonable. Demands for progressivity would be satisfied since an LDC surtax 63 would reflect the- progressliity of the DC tax rates. The amount of the DC tax can be verified by the LDC tax administration from 64 examining a certified copy of the nonresident's DC return. 29 B. Assistance of the Host DC in Enforcing an LDC Tax An LDC-levied surtax will not eliminate the problem posed by noncompliant taxpayers-, To the extent that nonresident citizens view the surtax as equitable and reasonable in its approach and its effects, voluntary compliance is encouraged. Obviously, however, some nonresidents--especially emigrants--may choose tb ignore even a reasonable tax. The experience of the Philippines: suggests. that emigrants may constitute a noncompliant group of taxpayers, against whon an. LDC tax administration lacks-r any effective measures. Under these circumstances, an LDC has little choice but to seek assistance from the host DC. The host DC can provide assistance at each, stage of the administration of the LDC tax-compiling a tax roll, assessing a nonresident's tax liability, and collecting the aount owed. One of the first hurdles that confronts an LDC asserting tax jurisdiction over nouresidents citizens is the compilation of a tax roll, that is,, a listing of the names and address of all individuals who are subject to the tax. One way of building up the tax roll would be through the records kept by various LDC agencies.. These records might supply the names of all LDC citizens who have gone abroad and their country of destination. The current addresses of these individuals., however, will probably be unavailable. Also, if the LDC has only recently started to keep records, it will be impossible to compile a complete list of all nonresidents. 3Q The host DC, however, might be able to help construct a tax roll.. For example, the DC.'s. iigration bureau could compile a list of newly entering: individuals fro the LDC. If the DC had a law that required aliens, to register annually,, as. does the United: States, the current addresses of these individuals would also be. available. If the data in the files of the imigration bureau were up!-to-date and, organized in a usable manner',. it might be possible to obtain information about all individuals who entered the 65 DC from the LDC, regardless of when they Immigrated. Once thesennesident citizens- were identified,, the LDC could. contact them about their LDC tax obligations. The realization by a nonresident that his name and address are. known by the LDC tax administrationmight induce his compliance with the tax, especially if the taxpayer is abroad only temporarily. The experience of the Philippines, however, indicates that emigrants may be uncooperative, eve if' they -are aware that their identities are known by the LDC tax administration. Indeed, the Philippines has. apparently ceased any systematic efforts to identify nonresident emigrants. One advantage, however, in compiling a tax roll is that information about a. nonresident"s .t"cme might be obtained from the host DC's tax administration. The DC tax administration may already have information about the nonresident, or, if it does not, it can make the necessary investigation. The DC tax administration could supply an LDC with a copy of the nonresident's return. A nonresident's knowledge that the host DC is cooperating with his LDC might encourage 31 him- to pay voluntarily his LDC tax. Apparently, the Philippines has never, attempted to obtain information. about the income of its nonresidents from foreign tax administrations. Precedent does- exist for DC cooperation in the furnishing of tax information. The United- States, for example, will supply other countries with tax- information on individuals, though not, on an informal basis. It will, agree to furnish. tax information only under carefully delineated conditions contained in a-tax treaty. These conditions vary from treaty to.treaty.. Information that is readily available, such. as, a. list of foreign taxpayers receiving investment income from whicIr 7.S. taxes have been withheld, may be routinely 66 provided. Information about a,nonresident's income would ordinarily not. be. provided. In limited. circumstances, such nonroutine 67 information car be requested by a foreign government, but the number of individuals about whom information is actually provided is not large. The type of information which, an LDC would normally need if a large number of its nonresident, citizens were unwilling tax- 68 payers far exceeds the current practice of all DCs. Assuming that an LDC obtains enough information from either the DC or. other sources to assess a nonresident's tax liability, it is still faced with the problem of collecting the tax owed. 'Collection is simplified if the nonresident has assets within the LDC which can be liquidated by the tax administration and the proceeds credited against the tax liability. Transient nonresidents will often have assets within the LDC; emigrants, however, have probably removed 32 all of their assets before leaving, An LDC could attempt to collect its. tax. through the DC courts, The British, Canadian, and United States courts., however,, do not recognize foreign tax judgments. 69 An LDC must therefore pursue other, nonjudicial alternatives. The passport sanction used by the Philippines illustrates one such. alternative. More generally, an LDC can, refuse to renew not, only a passport, but also a medical, nursing, or engineering license until a nonresident's tax liability has been satisfied. The experience of. the Philippines, however, demonstrates the limited effectiveness of the passport sanction im the case of emigrants,. many of whom will become citizens of the DC. Once they are DC citizens, they can obtain. a new, DC passport. Similarly, the renewal of a medical or engineering license may be less important to an emigrant who is in a position to obtain an equivalent license from the DC. An LDC. could, of course, ignore a. nonresident's tax liability as long as he was abroad and; try to collect it if he were to return to the LDC. The Philippines adopted this approach for a short time by requiring a tax clearance certificate from nonresident citizens visiting the Philippines before they could leave and return abroad. The use of tax clearances was discontinued, however, in order not to discourage nonresidents from visiting the Philippines under the "balikbayan" program. Because most LDCs try to encourage nonresidents to return home, at least for a visit, tax clearance certificates 70 and the nonrenewal of passports may not be attractive measures. 33 Moreover, these measuras are least. effective with emigrants who are likely to be among the worst tax offenders. The host DC is in a position to assist an LDC in collecting its tax. The DC will have jurisdiction not only over the nonresident, but also over his assets in the DC. These assets can be seized, liquidated, and the proceeds turned over to the LDC. Little precedent, however, exists, for DC cooperation in the collection of foreign taxes. The-United States, for example, will agree to help collect foreign 71 taxes only as part of a tax: treaty. Cooperation is usually limited to situations in which. a. taxpayer wrongfully seeks to obtain treaty benefits72 au& would, therefore not extend to an individual who refused to. pay his LDC tax. Although one recent U.S. treaty does provide 73 for cooperation under more general circumstances,. cases in which 74 foreign taxes are. actually collected under such an agreement are rare. If a DC were willing to break with this limited precedent, it could assume greater responsibility for the collection of an LDC tax. Indeed, rather tharL only assisting an LDC on a case-by-case basis, a DC could actually administer and collect the tax from all nonresidents on behalf of the LDC. The attractiveness of this approach depends on the ease with which a DC could administer and collect the LDC tax. An LDC tax that was levied as a surtax would be. easiest for a DC to collect because a line could be added to the DC tax return where the nonresident could. calculate the amount of his surtax. Although a surtax would be easier for a DC to adminis'ter than would other versions of an LDC tax, ....m..mmm.mmmm. 34 numerous changes would nonetheless be required in DC pr6cedures. The application of a surtax, to a select. group of. taxpayers would be equivalent in many respects to the. adoption of an entirely separate tax. A DC tax administration would be required (1) to modify its tax forms or prepare special forms; (2) to compile a roll of persons subject to the tax;. (3) to design special withholding tables and instructions; (4) to develop or modify current. payment programs for the self-employed and other taxpayers not subject to withholding; (5) to plan or expand taxpayer information efforts, such as descriptive pamphlets and mass. education programs about filing, requirements;. (6) to. write new regulations and rulings interpreting the statute; and (7) to train officials. to answer questions from taxpayers and to deal with disputes on appeal. Most of these administrative tasks are manageable but must be.thought through.in a new context. One final measure that a host DC could adopt is inspired by the Philippine&'passport. sanction-. Specificaly, a DC could condition the granting of its citizenship on proof that the applicant had discharged all of his outstanding ILDC tax obligations. One means of proving.that all LDC tax obligations have been discharged would be.to obtain a tax. clearance certificate from the LDC tax 75 administration.7 Under this approach, a DC would not be involved in the collection process, but would merely ensure itself t4at the emigrant had submitted the required proof. This approach has a number of attractive features. First, it requires no traumatic change in DC practices and would be 35 inexpensive to implement. A DC would simply require another document in addition to those already required as part of its naturalization procedures, Second, unlike the passport sanction, this proposal would not discourage a nonresident from-returning home. Any taxes owed the LDC would be paid at the time of attaining his new DC citizenship; an emigrant would be free to,return to his LDC without suffering any ta= consequences.. Consequently, any LDC program-to encourage visits home by nonresidents, such as the Philippine's "balikbayan" program, would not be disrupted. Of course, an emigrant's, knowledge that a tax. clearance certificate would eventually have to be obtained might increase his willingness to pay his LDC taxes. annually,. especially if the LDC levied a stiff penalty on lata payments. Third,. this, proposal. can be defended by the DC.as being in its own interests; the taxpaying habits of a potential citizen are an indication of moral character--a valid concern. of the DC.- Although this. proposal would. reach only individuals apply- ing for DC citizenship, presumably most LDC emigrants intend to become DC citizens. Because DC citizenship is highly valued by emigrants, the payment of an LDC tax, if reasonable in amount, is unlikely to deter an emigrant from becoming a DC national. Transient nonresidents, wfo pose a less severe compliance problem, could be reached through other measures. Whether a host DC would be willing to adopt any of the measures suggested in this Section is problematic. First, if more than a ~ ~ - ----------- 36 handful of LDC nonresidents refused, to pay the LDG tax, the assistance needed from the DC would be clearly unprecedented. Even if one, DC were inclined to offer broader assistance than it does- now,. it still might not be willing to do so without some assurance that other DCs were similarly inclined. Otherwise, a DC that was competing with other countries for specific types of emigrants, such as doctors, irses, or engineers,, might: fear that its- efforts to assist the LDC would only divert immigration to those DCs which were not willing to cooperate in enforcing the tax. Second, no DC will be- sympathetic toward participating in the enforcement of a tax on an individual who emigrated in. order to escape religious or political oppression or harsh social conditions. A DC will demand some guarantee that this group will be exempted from the tax. An exemption for this group, however, may be difficult to 77 adminsfter fairly and effectively. Even if practical, however, sich an exemption might not satisfy those DCs. which, for political reasons, would refuse to cooperate with certain LDCs under any 78 conditions. Third, a DC will require some assurance that the LDC tax will not impose an inequitable burden on an individual. An LDC tax that was levied as a modest surtax would provide this assurance; other versions of an LDC tax might not. At the least, a DC will require 79 that the LDC tax be reasonable in amount and therefore unlikely to deter an individual from emigrating. 37 Fourth, a proposal to assist an LDC in the collection of its tax might be viewed in the DC as a form of foreign aid or as a gesture of goodwill, but is unlikely to be viewed as furthering an immediate or short-term need of the DC. Accordingly, a DC will probably have difficulty justifying, any proposal that requires costly or time-consuming changes in its existing procedures, or traumatic changes in its law. Certainly, such a proposal will. be resisted by any DC agency or bureau that would bear the responsibility for implementing these changes. For example, a DC tax administration or immigration, bureau can be; expected to resist. costly or time- consuming changes in: their procedures which are. directed at enforcing an LDC tax. Overcoming this, bureaucratic opposition may be difficult unless a: proposal can be justified for reasons beyond those of aiding: an LDC. 38 IV. Conclusion The experience of the, Philippines in. its assertion of. citizenship jurisdiction is; informative, though. discouraging for supporters of Professor Bhagwati's proposal. for an LDC tax on nonresidents. On the. informative side, the Filipino experience does suggest a resolution for the. problem of designing a tax on nonresidents: a surtax. Although not a panacea, a surtax levied at a reasonable, rate, say 5 percent., would at least minimize the problems encountered by the Philippines in. itst various, approaches, to taxing, nonresidents. On the discouraging side,. however, is the problem of tax evasion. While transient nonresidents-may not pose a serious, compliance problem, widespread tax evasion, might be expected from.emigrants.. By itself, an LDC tax administration is unlikely to have any effective response to this. problem. If an LDC's overseas community consists' primarily- of emigrants, the assistance of the host DC seems critical, to the' enforcement of citizenship jurisdiction. Successful implementation of Professor Bhagwati's proposal, therefore, is dependent ultimately on the cooperation of the host DCs. The limited amount of international assistance which exists at present would be clearly inadequate to cope with widespread tax evasion. Supporters of the Bhagwati proposal should now shift their efforts from designing a tax to persuading the DCs to provide the vequired degree of cooperation. 39 Footnotes 1. Part I draws heavily on Pomp & oldman, Tax Measures in Response to the Brain Drain, 20 HARV. INT'L L.J., 1, 2-5, 16-18 (1979). 2. Emigration tends to occur from relatively less. developed countries to relatively more developed countries and is, therefore, a, reflection of different states. of economic development. Because such differences have always existed, scholars suspect that this emigration is. a deeply rooted historical phenomenon. Possibly the oldest mention of this. phenomenom is: the complaint by the Greek writer Athenaeus of "the drain of Greek brains to Alexandria," which referred t efforts, of the Ptolemies to shift the center of learntng. of the classical world from Athens to Alexandria. See -Dedijer, "Early Miration, in THE BRAIN DRAIN 9, 16 (W. Adams ed. (1968) [book hereinafter cited as Adams]. In the case of scientists, a group that has been unusually mobile, one commentator- concludes that, *(flor at least the past 2,200 years, people in power have been doing something about the migration of scientists: they have had policies to promote or prevent it.' Id. at 10. 3. See,, for example, CONGRESSIONAL RESEARCH SERVICE FOR HOUSE COMM. -ON FOREIGN AFFAIRS, 93d CONG., Zd SESS., BRAIN DRAIN: A STUDY OF THE PERSISTENT ISSUE OF INTERNATIONAL SCIENTIFIC MOBILITY (Comm.. Print 1974); The Brain Drain'of Scientists, Engineers, and Physicians from the Developing Countries into the United States: 40 3. (continued) Hearings Before the Research. and Technical Programs Subcom. of the House Comm. on Government Operations, 9Qth CONG., Zd SESSt.(1968); International Migration of Talent and Skills: Hearings Before the Subcomm. on Imigration and Naturalization of the Senate Commn. on Judiciary, 90th CONG., 1st SESS. (1967); J. BEAGWATI, THE REVERSE TRANSFER OF TECHNOLOGY (BRAIN DRAIN):. ACCOUNTING, COMENSATION, TAXATION AND RELATED POLICY PROPOSALS, U.N. DOC. TD/3/C.6/AC.4/Z (1977); THE BRAIN DRAIN (W. Adams ed. 1968); THE BRAIN DRAIN AND TAXATION (J. Bhagwati ed. 1976); COMMITTEE ON THE INTERNATIONAL MIGRATION OF ALENT, TE INTENATIONAL MIGRATION OF HIGH-LEVEL MANPOWER: ITS IMPACT ON THE DEVELOPMENT PROCESS (1970); COUNCIL OF SCIENTIFIC AND INDUSTRIAL, RESEARCEL OF INDIA, CASE STUDY IN REVERSE TRANSFER OF TECHNOLOGY (BRAIN DRAIN): A SURVEY OF PROBLMS AND POLICIES I INDIA, U .N. Doc. TD/B/C.6/AC.4/6 (1977); MARGA INSTITUTE, CASE STUDIES IN REVERSE TRANSFER OF TECHNOLOGY (BRAIN DRAIN): A SURVEY OF PROBLEMS AND POLICIES Il SRI LANKA, U.N. Doc. TD/B/C.6/AC..4/4 (1977); S. NASEEH, CASE STUDIES IN REVERSE TRANSFER OF TECHNOLOGY (BRAIN DRAIM): A SURVEY OF PROBLS AND POLICIES IN PAKISTAN, U.N. Doc. TD/B/C.6/AC.4/3 (1977); REORT OF THE SECRETARY-GENERAL,. OUTFLOW OF TRAIN PERSONNEL FROM DEVELOPING COUNTRIES, U.N. Doc.: A/7294 (1968); A. SAID, BEAIN DRAIN: THE DEVELOPING COUNTRIES-CAUSES, RAMIFICATIONS AND PROSPECTS (1970); F.'SICAT, CASE.STUDIES IN*REVERSE TRANSFER OF TECHNOLOGY (BRAIN DRAIN): A SURVEY OF"PROBLEMS AND POLICIES IN-THE PHILIPPINES, U.N. Doc.. TD/B/C.6/AC.4/5 (1977); 41 3. (continued) TASK FORCE ON INTERNATIONAL EDUCA.TION, INTERNATIONAL EDUCATION: PAST, PRESENT, PROBLEMS AND PROSPECTS, H.R. Doc. No. 527, 89th Cong., 2d Sess. 1966; TAXING THE BRAIN DRAIN CJ. Bhagwati & M. Partington eds. 1976);. UNCTAD, CO-OPERATIVE EXCHANGE OF SKILLS AMONG DEVELOPING COUNTRIES: POLICIES FOR COLLECTIVE SELF-RELIANCE IN SKILLED MANPOWER, U.N. Doc. TD/B/C.6/AC.4/8 (1978); UNESCO, PRELIIAR REPORT ON, TEM EMIGRATION. 0 SCIENTISTS AND TECHNOLOGISTS (1968); Bhagwati, International Migration of the Highly Skilled: Economics, Ethics and Tax Arrangements, THIRD WORLD Q., No. 2 (1978); Coombs, Braim Drain from Developing Countries, in INTERNATIONAL. DEVELOPMENT 61 (H. Singer, N. deKun & A. Oroobadi eds. 1966);: amada, Taxing the Brain Drain: A Global Point of View,. in THE NEW. INTERNATIONAL ECONOMIC ORDER: THE NORTH-SOUTH DEBATE.(J. Bhagwati ed. 1977); Higgins, The Right in International Law of an Individual to' Enter, Stay in and Leave a Countrz, 49 INtL AF. 341 (1973); Pomp & Oldman, Tax Measures in Response to the Brain Drain, 20 HAR7. INT'L L. REV. 1 (1979); Vanderkamp, Migration Flows, Their Determinants and the Effects of Return Migration, 79 J. POLITICAL ECON. 1012 (1971). 4. The migration of skilled manpower- can also occur between, two developed countries,, e.., from the United Kingdom to the United States, or between two less developed countries, e.3., from the Philippines to a country that is.a member of the Organization of Petroleum Exporting Countries (OPEC). A country can experience 4Z. 4. (continued) emigration and imigration simultaneously; some of its citizens may be emigrating to more developed nations at the same time that it is. receiving immigrants from less developed nations. The United. Kingdom, for example, loses doctors.to the United States; this emigration is offset by the imigration of doctors from Pakistan. and India. Adams, Introduction, in Adams, supra note 2, at 1, 2. Israel. also. experiences: both emigration and immigration, but its situation is unusual in that some of its immigrants are from a. more developed country, the. United States. In addition to "external" migration, that is, migration to other countries, a country may experience "internal" migration. For example, persons may migrate within a country from relatively less. developed rural areas to relatively more developed urban areas. This internal migration may be more serious for some countries than external migration. This paper focuses on- the taxation by the Philippines of its nonresident citizens. Throughout most of the paper it is assumed that these nonresident citizens live and work in the DCs. Some nonresidents, however, live and work in other LDCs, and where necessary, the analysis focuses on this situation, Internal migration is outside the scope of this paper. 5. BRAIN DRAIN: A STUDY OF THE PERSISTENT ISSUE OF INTERNATIONAL SCIENTIFIC MOBILITY, supra note 3, at 7, relating remarks attributed to the Representative of Dahomey to the United Nations General Assembly. 43 6, Statement of officials of the United Arab Republic's Ministry of Education, quoted in UNESCO, PRELIMI=ARY REPORT ON EMIGRATION OF SCIENTISTS AND TECHNOLOGISTS 8 (1968), 7. The term "brain drain"' is used in this paper with reluctance; it has negative implications. and seems to prejudge one of the basic issues, i.e., whether the emigration of skilled manpower is, in. fact, harmful to. the less developed countries. Brain drain is, however, much more convenient stylistically than. "reverse transfer of technology," the cumbersome 'expression thought by some international organizations. to be more. neutral in connotation. 8. The terms "developed countries (DCs) and "less developed countries" (LDCs) have no, single established definition, and. no attempt is made ia this. paper to formulate a more precise definition. A country identified as an LDC ou the basis of one set of criteria ma:y be- characterized as a DC on another. The . Organization of Economic Co-Operation and Development (OECD), the United Nations Secretariat,; the UNCTAD Secretariat, the International. Monetary Fund (IMF), and the United States all use different criteria to define LDCs. See Reifman, Developing Countries-- Definitions and Data; Or Third. World, Fourth World, OPEC, and Other Countries, in 2 STUDIES IN TAXATION, PUBLIC FINANCE AND RELATED SUBJECTS-A COPENDIUM 483 (1978). The increasing use of expressions such as "third world," "fourth world," and "fifth world" 44 8. (continued) countries-indicates that the LDCs are no longer thought of as a homogeneous group, In fact, a third world country may be though.t of as a DC by a fourth world country. For a fourth world country to lose manpower to a third world country may be viewed as little different in the short term from its losing manpower to a DC. In the long term, however, migration to a DC is likely to be more permanent. 9. The DC and LDC views of the brain drain are fully elaborated in Pomp & Oldman, supra note 1, at 2-17. 10. Professor Bhagwani's proposal was first sketched in hagwati, The United States in the Nixon Era: The End of Innocence, 101 DAEDALUS 25 (1972), and later refined in Bhagwati, The International Brain and Taxation: Surve7 of the Issues, THE BRAIN DRAIN AND TAXATION (J. Bhagwati ad. 1976); Bhagwati, The Brain Drain Tax Proposal and the Issues, in TAXING THE BRAIN DRAIN (J. Bhagwati & M. Partington eds. 1976); Bhagwati, International Migration of the Highly Skilled: Economics, Ethics and Tax Arrangements, 1 THIRD WORLD Q. No. 2 (1978). Bhagwati's argument is strongest when university education in an LDC, which is usually required for DC immigration, is accessible only to the children of the political and economic elite. Indeed, in some LDCS, higher education may serve to perpetuate an inegalitarian social and economic order. If the universities in an LDC purposely conduct classes in a language 43 10. (continued) not spoken by all social classes, language. becomes a tool of economic and cultural oppression in that it denies certain groups access to higher education. Whatever its causes, however, the lack * of equal. educational opportunity is widespread in the underdeveloped world. According to Bhagwati, those individuals who enjoy the privilege or advantage of higher education and are therefore able to emigrate should share their increased benefits with those lacking the same opportunities for educational and economic advaacement. Bhawati also defends his proposal on the grounds that DC immigration restrictions, in combination with the large salary differentials that exist between the DCs and the LDCs, imply that emigrants enjoy windfall gains in the nature of economic rent. According to Bhagwati, these rents can be taxed to social advantage without entailing any harmful effects by distorting resource-allocational incentives. The moral. principle that Professor Bhagwati formulates is thus independent of whether losses are incurred by the LDC because of the brain drain. To the extent that such losses occur, Bhagwati's position is reinforced. For a discussion of the types of losses that the LDC might incur because of the brain drain, see Pomp & Oldman, supra note 1, at 2-16. 11. For a discussion of the types of benefits that might accrue to-a DC from the brain drain, see id. 4 6 12. The conference was held at the Villa Serbelloni, February 15-19, 1975. The grant from the Rockefeller Foundation was administered by the Institute for World Order. Some of the papers presented at this conference were published in 3 WORLD DEV. (1975); 2 J. DEV. ECON. (1975); TAXING THE BRAIN DRAIN (J. Bhagwati & M. Partington eds. 1976); THE BRAIN DRAIN AND TAXATION (J. Bhagwati ed. 1976). 13. Other proposals discussed at the UNCTAD meetings included a tax incentive to encourage LDC nonresidents, their employers, and other concerned persons and organizations to make voluntary contributions for use in the LDCs; a special income tax on nonresidents levied by the United Nations; and a United Nations assessment on host DCs. See Pomp & Oldman, sura note 1, at 20-25, 40-60. 14. The enforcement of the tax, however, may require the assistance of the host DC. See section III, B., infra. 15. For a brief time,.Pakistan attempted to tax the foreign earnings of its nonresident citizens but found that it could not enforce this broad assertion of jurisdiction. J. BHAGWATI, THE REVERSE TRANSFER OF TECHNOLOGY (BRAIN DRAIN): ACCOUNTING,COMPENSATION, TAXATION AND RELATED POLICY PROPOSALS 40, U.N. Doc. TD/B/C.6/AC.4/2 (1977). ............. 47 16. International custom suggests that some minimum connection or nexus should exist between the country asserting jurisdiction and the taxpayer or the income being taxed. The nature of this nexus varies from country to country, and a country's tax system can be classified as either schedular or global (unitary) according to the nexus employed. The most limited form of tax jurisdiction is that asserted by a country whose system is purely schedular. The only jurisdictional nexus in a purely schedular system is the source of the income; the personal status of the taxpayer is irrelevant. A.country with a schedular system taxes income from domestic sources regardless of the taxpayer's status; income from foreign sources is exempt. Pomp & Oldan, .susa note 1,.at 28. In contrast, a country employing a global system asserts jurisdiction either on the basis of the source of the income or on the basis of the status of the taxpayer. Under most global systems, residence is the necessary personal status, but the United States, Mexico, and the Philippines, use citizenship. Countries that rely on citizenship do, however, tax noncitizens on the basis of residence. In other words, either status--citizenship or residence-is sufficient for the assertion of tax jurisdiction in these countries. C The global approach focuses on an individual's ability to pay, which is measured by his total income, regardless of its source. Both domestic and foreign income are taxed if the necessary personal connection exists. Id. at 29. 48 16, (continued) In a schedular system, the only naexus is the source of the income, and, thus, no tax jurisdiction is asserted over foreign income. A country that uses a schedular system will, therefore, not tax any income earned abroad by a nonresident. If a country uses a global system, jurisdiction to tax income earned abroad depends on the personal status of the individual. If the country asserts jurisdiction on the basis of citizenship, it will tax income earned abroad by its nationals. If a country asserts jurisdiction on the basis of residence, but not citizenship, it will tax the income earned abroad by individuals only if they are considered residents of the taxing country for tax purposes. Id. 17. Countries vary widely in their definition of residence, some defining it on the basis of the period of time the individual has been within or without the country and others on the basis of the intent of the individual in being abroad, the nature of his contacts at home and abroad, and so forth. Regardless of the approach a country adopts in defining resident for tax purposes, a basic question arises: at what point does an individual working abroad cease being a resident of his country of origin? An individual who was sent abroad by his employer for short-term training would clearly remain a resident, but those who have emigrated abroad are not likely to fall within any of the more usual definitions. Unlike the Philippines and Mexico, an LDC 49 17. (continued) using a global system based on residence, is unlikely to assert jurisdiction over individuals who have, been abroad for some time, because the requisite jurisdictional nexus will have ceased to exist. In general, see Pomp & Oldman, supra note 1, at 28-33. 18. Another way of implementing Bhagwati's proposal would be for an LDC to adopt an idiosyncratic definition of residence, one that relied heavily on a person's prior contacts with his LDC, notwithstanding the severance of those contacts upon emigration. Such a definition could specify the maximum period of time (perhaps five years) within which an emigrant would continue to be considered a resident. Although this approach might appear reasonable in some respects, it does deviate from international custom and practice and could pose two problems. First, the LDC's assertion of jurisdiction on the basis of its idiosyncratic definition would conflict with the DC's own claim of residence jurisdiction, see supra :note 16, and the DC would therefore probably refuse to recognize the LDC definition. The DC's cooperation in policing the LDC tax, which might be essential if the tax is to be enforced, see section III, B., infra, will obviously not be forth- coming if the DC views the LDO's assertion of jurisdiction as illegitimate or extreme. To be sure, an LDC's assertion of jurisdiction on the basis of citizenship might also be viewed as creating a conflict with the host DC's jurisdiction. The ihort answer is that countries accept 50 18. (continued) certain conflicts as legitimate and inevitable. The conflict between citizenship jurisdiction and residence jurisdiction is, by custom and practice, considered acceptable. Income tax treaties between nations with citizenship jurisdiction and residence jurisdiction illustrate implicit acceptance of this conflict. The conflict created by a deviant definition of resident, however, would probably be considered illegitimate. See Pomp & Oldman, supra. note 1, at 31. The second of the two problems is that an emigrant PT who has severed his connections with his LDC. of origin will regard the LDC's claim of residence as unjust or unfair even before the five years have elapsed. Under' these circumstances, his voluntary compliance with the tax is improbable. 19. The term "nonresident citizen" is used consistently throughout this article to refer to those LDC nationals who are not considered to be LDC residents for LDC tax purposes. See supra note 17. Such persons may or may not be considered as nonresidents of the DC for DC tax purposes. 20. Philippine Tax Code, §§ 21, 30, 37, 45, before amendment by P.D. 69. 21. The option granted a taxpayer of either deducting or crediting foreign taxes was intended to relieve the burden of double taxation. International double taxation can result whenever a taxpayer or his income has jurisdictional connections with more 51 21. (continued) than one country. International double taxation often arises because .one country taxes an individual on tLe basis of residence or of citizenship and another country taxes the individual on the basis of the source of his income. See suDra note 16. Consider, for example, a nonresident citizen of the Philippines working in the United States. The United States will tax the earned income because it is sourced within the country. The Philippines will tax the same income since the taxpayer is its citizen. Consequently, the same income is taxed by both countries. No principle of international law requires.a country to provide relief from the burden of international double taxation, but most countries that tax foreign income do provide relief in some manner. As a matter of custom, relief from double taxation is ordinarily achieved by the country of source being granted a prior claim to the income. In other words, the U.S. tax on the nonresident's income would have. priority over .the Filipino tax on the same income. A conmon mechanism for giving priority to the country of source is the foreign tax credit. After satisfying his U.S. tax liability, the nonresident would compute his Filipino tax liability, and claim against it a foreign tax credit for the amount of the U.S. tax paid on income earned within the United States. See,Pomp & Oldman, supra note 1, at 36-39. Although prior to 1972, the Philippines allowed a nonresident citizen to choose between a deduction for foreign income taxes and a credit for foreign income taxes, in most cases a credit is more 52 21. (continued) beneficial. For example, a credit would produce a peso-for-peso offset against the Filipino tax liability whereas the benefit of a deduction would be limited to its amount multiplied by the taxpayer-'s marginal Filipino tax bracket. 22. For the rules governing the conversion of foreign currencies into pesos, see Rev. Mem. Cir. No. 3-71. 23. The problem rezained even after the nonresident credited his U.S. taxas against his Filipino taxes. For example, suppose that, for purposes of the U.S. tax, a Filipino nonresident had taxable income of $20,000 derived solely from employment within the United States. Assume that the U.S. tax was $5,000, which represented an effective tax rate of 25%.. Suppose that, for purposes of the Filipino tax, the nonresident also had $20,000 of taxable income. (The Philippines would determine the nonresident's taxable income according to its own rules. See section III, A., infra. The Philippine's determination of taxable income need not correspond with. that of the United States.) If, for eample, the Filipino tax were levied at an effective rate of 45%, the nonresident's Filipino tax liability would be $9,000. The nonresident would claim a credit for the $5,000 tax paid to the United States and would lower his Filipino liability from $9,000 to $4,000. The nonresident would therefore pay tax to the United States at a rate of 25%, and to the Philippines at a rate of 20%. The total tax burden on the nonresident, however, would be $9,000, an effective 53 23. (continued) tax rate of 45%. The nonresident would pay $5,QO more in taxes tban would an individual earning the same salary but subj ect only to the U.S. tax. It was this additional $5,OQ burden, which was not eliminated by the credit for U.S. taxes, that was the subject of amplaints by nonresidents. For a more cmplete discussion of the foreign tax credit, see Pomp & Oldman, supra note 1, at 36-39. 24. Given the shortage of middle-class housing that exists in the Philippines at present, housing costs may no longer be higher abroad. 25. Rev. Me. Cir. 40-71. 26. Until discussions with the author, the BIR was unaware of a procedure available in some DCs under which a taxpayer can obtain from the DC tax administration a certified copy of his tax return. For the procedures in the United States, see Internal Revenue Code, 5 6103(p)(2)(A); Rev. Proc. 66-3, 1966-1 C.B. 601. Requiring a nonresident citizen to submit a certified copy of his foreign tax return would greatly reduce the problem of bogus returns, which still plagues the BIR. See section II, C., infra. The use of a certified return would also increase the effectiveness of the passport sanction. See section II, C., 3, infra. Appropriate safeguards would have to be provided, however, to ensure that the taxpayer submitted a new certified copy of his original tax return were amended. 54 27. P.D. 69 (1972). The 1-2-3 system applies only to oncome received from sources outside the Philippines. Income received by a nonresident citizen from sources within the Philippines is taxable under the usual rules that apply to resident taxpayers. 27A. To qualify as a nonresident, a citizen had to be physically present abroad for an uninterrupted period that included an entire year. Rev. Mem.. Cir. No. 17-73. Visits home did not necessarily interrupt the required period abroad. Rev. Reg. 9-73. This definition of a nonresident was liberalized in 1978. See infra note 33. 28. More specifically, a deduction is allowed for income taxes paid to the foreign country in which the taxpayer resides, and for income taxes paid to the foreign country in which the income was derived. Rev. Reg. No. 9-73. Originally, no deductions were allowed by a nonresident, but shortly after the new regime was introduced, the deductions for foreign income taxes and the personal exemption.were added. P.D. 323 (1973). 29. Because the rates of tax (1%, 2%, 3%) are so low, the Philippines could not follow the usual practice of allowing a taxpayer the .option of either crediting or deducting foreign income taxes. Foreign taxes paid by a.nonresident will typically exceed the amount of his Filipino tax. Granting a credit for these foreign taxes would have eliminated any Filipino liability. 5s 30. A problem remains, however, for nonresidents in countries whose currency is. stronger than the U.S. dollar. 31. The BIR's Office of International Operations, which. administers the 1-2-3 system, was created in 1973. The collection of data prior to the creation of this office was somewhat erratic. Events leading up to the declaration of martial law in 1972 interfered with the orderly processes of the government and made data collection difficult. 32. The Philippines offers various incentives to induce nonresidents to return home. See F. SICAT, CASE STUDIES IN REVERSE TRANSFER OF TECHNOLOGY (BRAIN DRAIN): A SURVEY OF PROBLS AND POLICIES IN THE PHILIPPINES 13-14 (U.N. DOC. TD/B/C.6/AC.4/5 (1977)). See also infra note 70. 33. The new law defines a nonresident citizen as one who is physically abroad with the definite intention to reside abroad and includes. emigrants, persons who leave the Philippines for employment on a more or less permanent basis, and contract workers who are abroad for at least 183 days during the taxable year. Rev. Reg. No. 1-79. 34. The weaknesses in the data available in the DCs are numerous. First, no records are kept on reverse migration-LDC emigrants to the DCs who subsequently return to the LDCs. This reverse migration may be substantial. Second, imigrants are identified by their place of residence, rather than by their country of birth or by their citizenship. For example, a Filipino 56 34. (continued) entering the United States from Canada is identified as a Canadian resident, not as a citizen of the Philippines. Third, the DCs fail to identify individuals wh.o enter as relatives of DC residents and citizens. Fourth, there is a lack of accurate data on illegal immigrants. Fifth, immigration records lack information on the educational level of immigrants. Sixth, the DCs have not adopted uniform definitions for their various categories of immigrants. _Bhagwati, The International Brain Drain and Taxation: Survey of the Issues, supra note 3, at 3, 5-6. 35.. The BIR estimates the number of potential taxpayss subject to the 1-2-3 regime to be 800,000. On the basis of this rough estimate, the BIR received returns in 1979 from less than 11% of the total taxpaying population. Another estimate places the number of Filipino workers abroad at 705,000 but it is not clear how many of these workers qualify as nonresidents for purposes of the 1-2-3 tax. See SICAT, CASE STUDIES IN REVERSE TRANSFER OF TECENOLOGY (BRAIN DRAIN): A SURVEY OF PROBLEMS A.ND POLICIES IN THE PHILIPPINES 20 n.28, U.N. DOC. Tl/B/C.6/AC.4/5 (1977) (citing M. ABELLA, EXORT OF FILIPINO LABOR IN RELATION TO DEVELOPMENT). The Office of Emigrant Affairs estimates that a total of 1,674,722 Filipinos have emigrated, though it is unclear what period of time is covered by this estimate. Office of Emigrant Affairs, A Special Report on Profile of FiliDinos Overseas 1 (1980). This figure is based solely on outflows and is not adjusted for 57 35. (continued) deaths or for persons who have returned to the Philippines. Between 1975 and 1979, 170,528 persons emigrated from the Philippines. Id. at 5. 36. Rev. Reg. No. 9-73. 37. See suDra note 26. 38. A recent law requires certain groups of nonresidents to remit to the Philippines a percentage of their income earned abroad. In 1979, $37-5,000,000 was remitted under this law. Because emigrants are not covered by this law, it is impossible to use the amount of remittances to estimate the total income earned abroad by all nonresident citizens. 39. The BIR does not classify the returns received under 1-2-3 by category of taxpayer. It is difficult, therefore, to validate empirically the views expressed in the text. 40. Because Hong Kong constitutes such a small geographical area, the BIR feels that it has a fairly good estimate of the number of Filipinos residing there. By comparing the number of returns received with its estimate of the taxpaying population, the BIR can measure one aspect of taxpayer compliance. No attempt is made, however, to compare the income actually reported by these filers with an estimate of what should be reported. Such an estimate of taxpayer compliance is obviously more difficult to make than is the former. 58 41, The short-lived tax clearance certificate program, see supra P. 10-11 , was never applied to persons traveling under non-Filipino passports. Once an emigrant obtained a U.S. passport, he could return to the Philippines without any fear of having to pay any taxes owed under 1-2-3. 42. During 1975-1979, a period for which detailed records exist, nearly SOZ of Filipino emigrants listed the United States as their destination. Office of Emigrant Affairs, PROFILE OF FILIPINO OVERSEAS 17 (1980). 43. One BIR official who had been stationed abroad stated, "We would ask them for a copy of their U.S. tax return to see if they had any income subject to 1-2-3 and they would claim they didn't have to file one because they didn't work. Then what?" After learning of the U.S. procedure by which a taxpayer can request from the I.R.S. a certified copy of his tax return, see sira note , BIR officials now recognize that the passport sanction can be more fully implemented, if desired. A nonresident who actually did not file a U.S. tax return will receive from the I.R.S., in response to his request for a certified copy, a letter so indicating. 44. For example, assume that deductions constitute 20% of gross income for all taxpayers. Any rate of tax, r, levied on net income, can be translated into an equivalent rate of tax, .80r, levied on gross income. 59 45, See spra note 39* 46, Nonresident citizens who conduct their businesses in corporate form are taxable only on the income they receive from their corporations as wages, dividends, rent, and so forth. Undistributed corporate profits are not subject to the 1-2-3 tax. If .the Philippines or any LDC asserting citizenship jurisdiction wanted to tax the undistributed profits of a nonresident's closely held corporation, special rules would have to be provided for attributing suchs,profits to the nonresident. 47. A nonresident citizen must submit-a copy of his foreign tax return and proof of having paid his foreign income tax.. Rev. Reg. No. 1-79. 48. The duties of a revenue attache or representative include assisting nonresident citizens in the filing of their returns, disseminating information on the tax aspects. of foreign trade and investment in the Philippines, and the furnishing of technical assistance to foreign corporations and nonresident aliens engaged in business in the Philippines. 49. See, for example, Pomp & Oldman, supra note 1, at 33-44, upon which section III draws heavily. One problem identified in the theoretical literature which was not encountered by the Philippines is the renunciation of citizenship by emigrants in order to avoid an LDC tax. Of course, Filipino emigrants did not have to renunciate their citizenship to avoid the 1-2-3 tax--they simply ignored the tax with impunity. 60 50. Even if the ceiling is expressed as a percentage of income-10% of sales revenue for advertising expenses, for example-- the percentage may be grossly out of line with DC practicea 51. The problems discussed in the text are much less severa for the United States. U.S. tax lav is complex and sophisticated and can cope with business conditions existing elsewhere. U.S. rules on business deductions appear to work satisfactorily when applied to situations found abroad. The United States, however, does grant its taxpayers abroad a number of special reliefs. See, e..., the U.S. Internal Revenue Code, § 911. This tax treatment was recently modified to provide relief explicitly for certain special burdens imposed on individuals abroad, such as their high cost of living. See U.S. Internal Revenue Code H§ 911, 913. In some cases, the effect of these recent changes was to increase the U.S. tax liability of nonresident citizens. Many multinational companies were forced to compensate their U.S. employees for this increased tax burdens. Because the cost of compensation is saidto be very high, pressures exist to curtail the employment of U.S. citizens abroad. Consequently, the recent changes in the U.S. taxation of nonresident citizens have become controversial. In general, see IMPACT ON TRADE OF CANGES IN TAXATION OF U.S. CITIZENS EMPLOYED OVERSEAS (Report to the U.S. Congress by the Comptroller General, 1978). 61 52. The complaint by nonresidents was directed at the failure of the Filipino tax law to grant more generous deductions, Apparently no complaints were voiced about the failure of Filipino tax law to specify the tax consequences of transactions in the. DCs that have no counterpart in the Philippines. Perhaps nonresidents simply interpreted ambiguities or lacunae in the Filipino tax law in their favor, or simply ignored these transactions in computing their taxable income under Filipino law. 53. An LDC may lack the required expertise to revamp its domestic rules to cope with business conditions and practices abroad. Moreover, even if such expertise is unavailable, the effort may not be justified in view of more pressing domestic priorities. 54. The rules for calculating taxable income obviously vary from one DC to another. Because of these differences in DC tax laws, nonresidents who have the same economic income, after adjustment for differences in purchasing power, may have very different amounts of DC taxable income. The adoption of DC taxable income as the base for an LDC would therefore require nonresidents who have identical amounts of economic income to pay different amounts of LDC tax. The question therefore arises whether certain provisions of DC tax law could, or should, be ignored in determining a nonresident's LDC tax liability. The answer depends on the nature and extent of the provisions in each DC's tax law. No doubt, certain alterations in DC taxable income could be made with little 62 54. (continued) effort. For example, a nonresident in the United States could easily add the nontaxable portion of h.is. capital gains to his United States taxable income to obtain a truer measure of his economic income. Other adjustments, however, such as those which would be necessary to offset the use of tax shelters and the availability of sophisticated tax avoidance arrangements, might be too complicated to be practical. By using the DC rules for calculating taxable income, a nonresident would be denied any deductions allowed under LDC tax law which are not allowed under DC tax law. An LDC would have to compare DC tax law with its own tax law to determine whether such deductions exist, and whether they should be extended to nonresidents. 55. See sura note 26. During 1970 to 1972, a Filipino nonresident citizen was entitled to claim all of the deductions allowed by DC tax law, but these were in addition to those allowed, by Filipino tax law. Even if the BIR received a certified copy of a nonresident's DC tax return, which was not the practice, see supra note 26 , it still faced the problem of verifying those deductions allowed by Filipino tax law. The BIR also had the problem of eliminating "double dipping." See suora p. 8. A final problem was the determination of gross income, which was computed under Filipino tax law and not DC law. The approach in the text would have eliminated these problems. 63 56, Some economists argue that the extension of a country's tax system to foreign income maintains tax neutrality in that a decision to invest abroad rather than at home will be unaffected by domestic tax considerations. These economists argue that tax neutrality leads to a more efficient allocation of capital. See, e P. 'MUSGRAVE, UNITED STATES TAXATION OF FOREIGN INVEST1ENT INCOME: ISSUES AND ARGUMENTS 109-10 (1969). It is tempting to extrapolate from this principle and argue that the extension of an LDC's normal tax rules to a nonresident citizen maintains tax neutrality. See, for example, Ramada, Taxing the Brain.Drain: A Global Point of View, in THE NEW INTENATIONAL ECONOMIC ORDER: THE NORTE-SOUTH DEBATE (J. .hagwati ed. 1977). The concept of tax neutrality, however, has been developed in the context of capital investment. That is, tax neutrality is comonly defined "as a situation in which the pattern of taxation does not interfere with or affect the taxpayer's choice between investing at home and investing in foreign countries-." Musgrave, id. at 109. The meaning of neutrality is harder to discern if a taxpayer is living abroad (rather than living at home, and investing abroad), because the LDC's normal rules are designed in the context of domestic conditions, including the LDC's cost of living, salary levels, and distribution of income. 64 57. See section II, A., supra. Ordinarily, at any given income level, the LDC rate will be hiigFier than the DC rate because most LDCs employ steeply progressive rate structures that reflect a commitment to egalitarian principles. The difference in salary levels in the DCs and the LDCs ensures that the LDC tax will exceed the DC tax in nearly all cases. See Hamada, supra note 56 , at 143-47. 58. If an LDC were to grant a nonresident citizen a credit for his DC taxes, the rate schedule would have to be designed so that it would always generate an LDC tax that was slightly higher than the DC tax. This approach would produce some revenue for the LDC without subjecting the nonresident to an excessive overall tax burden. The Philippines does not grant a nonresident a foreign tax credit. Problems of double taxation are minimized by allowing a nonresident to deduct foreign taxes and by the use of low rates (1%, 2%, 3%). 59. The Philippines avoids this problem by basing its 1-2-3 regime on the U.S. dollar. The low rates of tax used by the Philippines, however, would have greatly reduced the problem of currencey fluctuations even without basing the system on the U.S. dollar. 65 60. A special rate schedule would have to be developed for use by nonresident citizens not subject to a foreign tax, for example, seamen, and perhaps contract workers, Employees of international organizations, although exempt from DC taxation, could compute the rate of DC tax that they would have paid if they were not exempt. 61. Tax policy theorists might argue that the surtax approach deviates from the concept of horizontal equity in an income tax. The principle of horizontal equity dictates that persons in similar economic circumstances should pay the same amount.in taxes. Within a country, a taxpayer's choice of where to live is generally viewed as irrelevant to his income tax liability. In other words, two taxpayers who have the same incomes and are similar in all respects except that they live in different geographical areas, should pay the same amounts in' income tax. It is tempting to generalize from. the domestic situation and argue that a taxpayer's choice of residence abroad should be ignored in levying an income tax, and that a country should therefore tax nonresidents in the same manner that it taxes residents. The meaning of horizontal equity is not self-evident, however, if an LDC taxpayer resides abroad in a DC. A nonresident working abroad may.experience a greater increase in his cost of living than any comparable increase that he would experience domestically if he were to move from one area of the LDC to another. The concept of horizontal equity is 66 61, (continued) further complicated by the problem of converting a conresident's DC income into LDC currency. Theoretically, a nonresident's income could be translated into its "equivalent" LDC income, based on the nonresident's purchasing power, and this "equivalent" income could be taxed by the LDC accordingly. Implementing this approach, however, would be difficult. In general, see IMPACT ON TRADE OF CHANGES IN TAXATION OF U.S. CITIZENS EMPLOYED OVERSEAS, supra note 51 ; Gravelle & Kiefer, U.S. Taxation of Citizens Working in Other Countries: An Economic Analysis, in STUDIES IN TAXATION, PUBLIC FINANCE AND RELATED SUBJECTS 72 (1978). 62. A 5% surtax would ensure that the burden of double taxation is minimal and resort to a special relief mechanism, such as a foreign tax credit, see supra notes 21, 23 , is therefore uncessary. 63. If progressivity were not essential, the LDC tax could be a fixed percentage of DC taxable income. 64. See supra note 26 65. But see supra note 34 66. The I.R.S. makes little use of the routine information that it obtains from its treaty partners. Panel discussion, Extraterritorial Effects of United States Tax Law, 12 INT'L LAW 581, 614 (1978) (remarks of Mr. J. Guttentag). 67 67. Each year, the United States receives about 150 requests for information from foreign governments. Id. at 614-15. "Fishing expeditions are not allowed. The foreign government must show specifically why they need. the information, why they think we. have it and that they have exhausted their attempts to get it over here, or in their home country." Id. A tax treaty between the United States and the Philippines awaits ratification by the U.S. Senate. Article 26 of this treaty provides: "The competent authorities shall exchange such information as is necessary . . . for the prevention of fraud. . . . The exchange of information shall be either on a routine basis or on request with reference. to particular cases." 68. See van Room, Problems, Possibilities, and Limitations with ResDect to Measures Against International Tax Avoidance and Evasion, 8 GA. J. INT'L & COMP. L. 763 (1978). 69. Foreign tax judgments are not recognized, apparently on the grounds that a tax is an assertion of a foreign.country's sovereignty which another, independent country should not tolerate within its borders. Another argument sometimes advanced is that taxes are closely connected with public policy and foreign relations; by ruling on the validity of foreign taxes, the judiciary might embarrass its own country or the foreign country. For criticism of this doctrine, see Robertson, Extraterritorial Enforcement of Tax Obligations, 7 ARIZ. L. REV. 219 (1966); Stoel, The Enforcement of Foreign Non-Criminal Penal and Revenue Judgments in England and 68 69, (continued) the United States, 16 INTL & COMP. L.Q. 663 (1967). 70, Some LDCs offer various incentives to entice nonresidents to return home. See Pomp & Oldman, supra note 1, at 8 n,30, 71. The United States has not, as yet, entered into collection assistance agreements or exchange of information agreements which are not part of a more extensive tax treaty. According to H. David Rosenbloom, International Tax Counsel, the "Treasury Department is willing to enter into limited agreements concerning exchange of information . . . (and other subjects, in appropriate cases, as well) in lieu of comprehensive income tax treaties." XI TAX NOTES at 258 (1980). 72. For example, the United States-Japan income tax treaty provides that "each of the Contracting States shall endeavor to collect such taxes imposed by the other Contracting State as will ensure that any exemption or reduced rate of tax granted under this Convention by that other Contracting State shall not be enjoyed by persons not entitled to such benefits." Convention on Double Taxation, Aug. 14, 1962, United States-Japan, art. 27, 16 U.S.T. 697, T.I.A.S. No. 5798. This treaty article reflects the Treasury's current negotiating position. See United States Model Income Tax Treaty of May 17, 1977 (1978] (CCH) Tax Treaties, ¶ 1019. Article 27 of the pending tax treaty with the Philippines contains a similar provision. 69 73. "The two Contracting States undertake to lend assistance and support to each. other in the collection of the taxes to which. the present Convention.relates . . . in the cases where the taxes are definitively due according to the laws of the State making the application." Convention on Double Taxation, July 28, 1967, United 4 States-France, art. 27, 19 U.S.T. 5280, T.I.A.S. No. 6518. 74. IRS officials who were consulted could not remember any case in which the IRS collected a tax on behalf of a foreign govern- ment. They stated repeatedly: "Let them fight their own battles, we're overworked as it is.1" The use of collection assistance piovisions is a relatively undeveloped area. Over- and above taxpayer resistance to such agreements, which is undoubtedly an obstacle to their adoption, a number of policy questions must also be resolved. For example, under what conditions.can one country refuse to assist another in the collection of taxes? How can an individual be protected against arbitrary conduct by the taxing cuntry? The lack of agreement on these and similar issues has hindered intergovernmental cooperation in the collection of taxes. See Johnson, Systems for Tax Enforcement Treaties: The Choice Between Administrative Assessments and Court Judgments, 10 RARV. INIT'L L.J. 263 (1969). The Senate Foreign Relations Committee, which has the responsibility of examining proposed tax treaties, does not appear to be in favor of broader collection agreements; the United jtates is 70 74. (continued) therefore unlikely to enter into a treaty with broad pledges of collection assistance. Panel Discussion, supra note 66! at 615. Some tax administrations hiave refused to engage in inter- governmental tax collection assistance of any kind. A country that felt it would gain very little through such cooperation would not wish to expe- d limited administrative resources in collecting taxes on behalf of a foreign country. 75. Appropriate safeguards would have to be provided to prevent an LDC from harrassing an emigrant by refusing to issue a tax clearance certificate or by inventing nonexistent tax liabilities. 76. In the opinion of the author, this approach would be con- stitutional in the United States if adopted by the Congress. The U.S. Supreme Court has held that "naturalization is a privilege, to be given, qualified or withheld as Congress may determine, and which the alien may claim as a right only upon compliance with the terms which Congress imposes." United States v. MacIntosh, 283 U.S. 605, 615 (1931). The Court has consistently held that the require- ments for becoming a citizen are virtually political questions that are an inherent incident of national sovereignty. Indeed, Congress can condition the naturalization of aliens upon compliance with requirements that would be unconstitutional if applied to U.S. citizens. See TRIBE, AMERICAN CONSTITUTIONAL LAW 277-278, 281 (1978); NOWAK, ROTUNDA, & YOUNG, CONSTITUTIONAL LAW 897-98 (1978). 71 77. Perhaps the exemption could be granted, at a minimum, to refugees protected by the United Nations Convention and Protocol Relating to the Status of Refugees, July 28, 1951, 19 U,S.T. 6223, T.I.A.S. No. 6577, 189 U.N.T.S. 150. 78. A DC could, of course, offer its assistance on a bilateral basis. A DC might find that its assistance in the collection of an LDC tax is a useful bargaining chip in its dealings with an LDC. 79. A ceiling could be imposed either on the amount of the LDC tax paid in any one year, or on the aggregate amount of tax paid over an individual's lifetime. A time limitation on the levying of the LDC tax might also be imposed. See Pomp & Oldman, supra note 1, at 49 n.162. 80. Economists are skeptical that an LDC tax, if levied at a reasonable rate, will have any significant effect on emigration. See Pomo & Oldman, supra note 1, at 26 n.104.