Friday, October 26, 2012

How important is Delaware as a tax haven?

The larger OECD countries have increasingly complained that some of the smaller member countries are hurting them because of their tax havens. While I have argued before that these tax havens have some benefits, foremost to provide tax competition to keep the others with reasonable bounds, there is no doubt that they hurt various efforts in collective action. But there are tax havens also within the borders of the complainants, and the prime example is Delaware, a small state that tries to attract corporations and financial companies through low taxes and little regulation.

Scott Dyreng, Bradley Lindsey and Jacob Thornock show that if regulatory concerns have been shown in previous literature to be an important determinant in the Delaware location choice of companies or their subsidiaries, the tax haven status of the state is even more relevant. If a firm adopts a so-called Delaware tax strategy, it can save 15 to 24% in state taxes, which amounts to increasing after tax income on average by 1 to 1.5%. Given profit margins, this is huge. It is then no wonder that Delaware is often mentioned in the same breath as other world-renowned secretive tax havens. Domestically, the paper shows that the tax savings have decreased, because the other states have either tried to close loopholes or have lowered their tax rates. But there is surprisingly little international policy reaction to this, and I wonder why.

And for Europeans, a significant lesson to be learned from Delaware is that if you want to adopt a formula apportionment system, make sure that its formulas and rates do not differ across countries, or you will have some Delaware that exploits some loophole.

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