Authors: Caleb Ang & Varun Chandran
Research Head: Sasthaa Gingee Babu (Uday)
Tax havens are countries that offer foreign businesses or wealthy individuals negligible or no tax at all for their bank deposits. In the US, there are 2 states in particular that are known infamously for hundreds of shell companies registered at a single address; Delaware and South Dakota. The US is one of the most popular tax havens in the world due to the stability of its economy, anonymity of information, and ease of opening a shell company. “ I need less information to open a shell company in the US than I would need to get a driver’s license or a library card” (Shah, 2016)
The US tax system is divided into 2 levels, federal and state. Hence everyone in the US has to pay 2 sets of taxes. There are federally mandated taxes such as income and company taxes, which rise based on brackets. At a state level, states may add additional taxes such as income, company, capital-gains, property, estate, sales, alcohol etc. Further income tax paid to the state can be used to offset federal taxes to a maximum of $10,000. Income taxes in states can vary from 0% in South Dakota to 13.3% in California. In combination with state laws on business registration and data privacy, South Dakota and Delaware have been leading by the number of trusts and companies headquartered there. Another interesting facet to the is California, which has the highest effective tax rates in the US, yet is a hotbed for Technology companies.
In terms of the impacts of being a tax haven on the state, it is minimal. Only trust companies reap profit from bank deposits through fees. The minimum annual fee is $3,750 and the maximum annual fee is $20,000 for private trust companies, while the minimum annual fee is $4,500 and the maximum annual fee is $30,000 for public trust companies.In South Dakota, more than $367 billion in trust assets were managed in South Dakota last year through at least 62 publicly chartered trusts (Howard Gleckman, 2021). Delaware is home to 1,000,000 businesses and more than 67.8% of Fortune 500 companies. However, none of this hot money generates tax revenue and creates few, if any, jobs for these tax havens. In 2016, state tax collections per capita were $2,019 in South Dakota and $3,700 in Delaware. In contrast, California has state tax rates and tax brackets, 7.25% tax rates. State tax collections per capita in California were $3,955 in 2016. Despite California tax rates being one of the highest, many technology companies are still based in California such as Apple and Google.
Individuals stand to gain from placing their assets in these states as both South Dakota and Delaware’s code does not impose a tax on statutory corporate offices in the state despite not doing business within the state. South Dakotan’s trust has superior asset protection, shields assets from divorce, creditors, taxes, and anyone else. It prevents information on assets from leaking out, providing anonymity, shielding wealth from the government as there is no income tax, inheritance tax, and capital gains tax. No residency is required. Delaware boasts elimination or minimisation of tax on trust assets, confidentiality and investment flexibility, no time limit on dynasty trusts. Wealthy individuals who place assets in tax havens in the US can expect high security and anonymity whilst avoiding the taxation of their assets.
The politics of tax policy is severely partisan. Republicans favour lower corporate taxes as a magical tool to boost the economy, whilst Democrats (excluding Manchin) favour higher, more distributive tax rates, which can help reduce the widening inequality gap. Biden, who is generally seen to be in the centre for Tax policy (as he was the senator for Delaware which is a tax haven state), recently proposed that the Federal corporate tax rate be increased from 21 to 28%, but this remains a pipe dream as it will not pass the senate.
At a state level, the lines can be muddied slightly as Oregon and Washington, which are blue states, have been reluctant to pass tax hikes. Oregon has no sales taxes, but the second highest income tax rate for those earning above $100,00 p.a. Measures to create a sales tax have been defeated. Meanwhile, Washington has no income tax, despite Seattle being a hub for Tech firms, and measures to pass income tax increases have floundered as well, suggesting that at a state level, even Democrat representatives are reluctant to pass tax hikes.
Analysis of other factors
To start with South Dakota, the first key reason Banks are headquartered there was due to a law passed in 1981, which removed the cap on the amount of interest banks were able to charge customers. Because of this, Citibank (and later other banks) were able to evade the restrictions other states placed on interest rates, and still charge high rates to customers in other states. Some argue that this contributed significantly to the US having the largest per capita credit card debts,
Secondly, in both South Dakota and Delaware, there are very strong privacy laws and lax regulations about declaring company ownership. South Dakota provides privacy protections for assets held in trusts, including the sealing of trust-related court documents, hiding them from external scrutiny. Next, Delaware law does not require the public disclosure of the names of Limited Liability Companies’ owners or members.
Avoidance vs Evasion
Tax avoidance is the use of legal methods to avoid taxing, such as through tax havens. Tax evasion is the use of illegal methods of concealing information from the IRS to evade taxes. However, to what point is tax avoidance moral? Tax havens only benefit wealthy individuals and large companies at the expense of global impacts and lower income. Moreover, shells are the No. 1 vehicle for laundering illicit money and criminal proceeds (Lanny A. Breuer, 2012). Should all this bank transfers be done anonymously, how are governments to know which transfers are laundering and which are towards fund for crime such as terrorism, an extremely pertinent problem today?
Global minimum tax
It has been noted that federated states like the US would face the greatest difficulty in implementing a minimum 15% corporate tax rate, due to the need to homogenise rules across many states. Further, it is unlikely that the senate will back such laws. Moreover, if a minimum tax rate was introduced, it would not stop states from competing with each other by for instance giving tax breaks, or “green funds” or other such kickbacks to corporations to attract them. It also does nothing for the extreme privacy laws.
Tax havens cause a decrease in tax revenue, resulting in a cut of the government’s budget. Lack of funds to finance the needs of the state, in terms of education, healthcare and R&D, distort the function of a national economy, and subsequently, spillover effects on the global economy. A fall in tax revenue would result in governments needing to tax citizens more, thus greater inequality between rich and poor, hence the poor gets poorer. Due to the anonymity of fund transfer, increase risk of using the fund for crime with negative social consequences. Developing countries will lose about € 160 billion in tax havens annually due to tax havens. An Australian mining company has saved so much money on taxes in Malawi, that would be enough to pay 39,000 teachers or 8,500 doctors a year (Gizela Lénártová, 2020).
In conclusion, it seems unlikely that there will be any changes to the state level tax systems in the US. States are fiercely protective of their independence and any meddling by the federal government is unlikely to be received well. Further, it is unlikely that the 15% minimum tax will make significant change due to the difficulty in implementing it in America. The future of tax avoidance, thus, still looks rosy.
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