Is the US Tax System worse than Eritrea's for overseas citizens?

By Karl Steinke

It surprises many people that Americans living abroad have a lot in common with Eritreans, and that Eritrea treats its expat citizens better than the United States treats Americans expats.

The general global rule regarding taxation is that people are taxed where they live.  Someone who lives in Germany is taxed in Germany.  Someone who lives in the UK is taxed there.  This is known as residence-based taxation.

Two countries notably deviate from this rule: the United States and Eritrea.

The United States and Eritrea tax their residents just like all other countries but they also tax their citizens regardless of where they live. So these two countries practice residence-based taxation AND citizenship-, or nationality-based taxation.

The result is that citizens of Eritrea and the United States who live abroad are subject to two tax regimes, one of the country they live in and one of their country of citizenship.

The United Nations has condemned Eritrea…

Eritrea has been criticized for collecting this so-called “diaspora tax” since it was first introduced in the 1990s, soon after Eritrea’s independence from Ethiopia. In 2011, the United Nations Security Council even passed a resolution (number 2023) calling on Eritrea to “....stop using extortion, threats of violence, fraud and other illicit means to collect taxes outside of Eritrea from its nationals…..”

Eritrea asks its citizens abroad to pay 2% tax on their worldwide income based on self reporting. But is an Eritrean abroad worse off or better off than an American abroad? Let’s take a fictional example of an American and an Eritrean living and working in Switzerland.

The average annual salary in Switzerland in 2024 is about $90,000.  Since both the American and Eritrean are living and working in Switzerland, they are subject to local Swiss taxation and have to pay income tax out of their income in the country.

Assuming the Eritrean living in Switzerland needs services from the Eritrean consulate, (passport renewal, etc.), he or she could report their income to the local consulate and pay 2% or $1,800 in taxes.

At this income level, the American, who has already paid his Swiss income tax, should be able to get away without any further U.S. tax liability thanks to the Foreign Earned Income Exclusion and Foreign Tax Credit. This is assuming that 100% of the income is from employment income. The reality can often be more complicated.

An Eritrean living in Switzerland may owe less in taxes than an American, but…

At first glance, it seems it is better from a tax point of view to be an American living in Switzerland than an Eritrean. Upon closer inspection, however, it’s not that clear.

Other than having to pay the 2% income tax, the Eritrean is able to lead a normal life. He or she can found a company in Switzerland, be a partner in a company in Switzerland, invest in tax-sheltered retirement savings plans (similar to a 401k or IRA), get a mortgage from a Swiss bank, buy and sell a house, and buy and sell local mutual funds just like any other resident of Switzerland.

The American cannot. At most Swiss financial institutions, the American will find the door closed because the extraordinary reach of U.S. tax and financial law encourages financial institutions outside of the United States to simply say “We do not take U.S. citizens as clients”.  

Americans abroad faced closed doors because of U.S. financial regulations

The American will probably only have one or two banks in the country that will accept them as a customer.  Banking services may be restricted to a simple checking account.  

Their Swiss bank will share this information with the United States government’s “Financial Crimes Enforcement Network”.  (Eritrea has no such information sharing agreement regarding Eritreans living in Switzerland.)

The American is also forced to report the existence of this “foreign” bank account to the same U.S. government agency. On two separate forms. The American will have to report the maximum value of the account in U.S. dollars but the bank only reports the value at the end of the year. If the American makes a clerical error on this reporting, the U.S. government can and has in the past charged fines that can be up to $100,000 or 50% of the account’s maximum value.

The American must also file a US tax return every year, even if the individual owes nothing to the IRS.  Due to the complexity of U.S. tax law, most Americans living in Switzerland opt to have a professional tax preparer file their U.S. taxes. The cost associated with filing a very simple U.S. tax return from Switzerland can already be similar to the $1,800 the Eritrean pays for the diaspora tax.  This American will probably also have to pay a high fee for the preparation of a Swiss tax return. 

Life is complicated enough, US law makes it a lot more so

What if this American is married to a non-American? This makes things even more complicated and expensive. The Swiss government taxes the couple as an entity but how should the Swiss tax liability be translated into U.S. dollars and split between the spouses?  This keeps the accountants busy and can easily make the cost for preparing two tax returns extremely expensive.  

If you think about the time and cost of the above and the non-ability to participate in normal savings and retirement planning activities, I think the Eritrean system is preferable to the US system.

Since the U.N. Security Council has condemned Eritrea for its extraterritorial taxation, the United States should take note of the extraterritorial consequences of its own taxation and financial crimes regimes.  

The United States should end this unfair extraterritorial taxation and align with the global standard of residence-based taxation!