To better understand the current state of tax havens, and perhaps to predict in some way where they are headed in the future, it is helpful to look at the history of their development. While the term tax haven can be rather ambiguous, there are certain key features that underlie them: secrecy, low taxation, and easy access, by which we mean the process of setting up and utilizing the tax haven is relatively simple. (Even if a country or territory offers very appealing tax rate and secrecy, it will be less enticing if the process to incorporate a business or set up a trust is extremely complex and requires many accountants, lawyers, and other financial professionals.) Therefore, while many people point to Switzerland’s post-WWI bank secrecy laws as the first modern tax haven, it is possible to look back even further to the US at the end of the 19th century.
From the founding of the United States and into the early days of the Industrial Revolution, the state of New Jersey had long stood in the economic shadow of its northern neighbor, New York. New Jersey seemingly had much to offer economically: abundant natural resources (thus its sometimes-questioned “Garden State” moniker), a large and eager pool of labor (especially as European immigration began to increase late in the 19th century), and perhaps most importantly, a vital location situated between the urban powerhouses of Philadelphia and New York City. But New Jersey nevertheless reaped very little reward in its early days, especially under the Articles of Confederation.
New York issued its own currency which proved to be far more popular than New Jersey’s, and it used its economic clout to muscle many favorable tax arrangements. At various points New York was inexplicably able to lay claim to both sides of the Hudson River. Jersey businesses would often find themselves paying heavy taxes leaving New Jersey and entering New York, and getting gouged by currency exchanges on either side of the border. This was a major impetus to William Patterson’s “New Jersey Plan” at the Constitutional Convention- also known as “the Great Compromise”- which resulted not only in the bicameral legislature but also granting the Federal Government authority over interstate trade. The advent of shipping goods via canal or railroad, rather than by sea, eventually helped NJ become a profitable artery for transportation, but the state still stood in New York City’s long shadow.
Seeking to entice business across the Hudson, in the 1880s NJ Governor Leon Abbet promoted a rather revolutionary plan- rewriting its incorporation laws to make creating a business in New Jersey far easier than any other US states (or pretty much any place governed by laws derived from English Common Law, which at the time was a fairly large part of the industrial world.) Incorporation in NJ could be done quickly and easily, even by non-residents. In return, NJ collected a franchise tax on the businesses, which helped replenish its coffers drained by Civil War debts and transportation and infrastructure projects. While perhaps not yet a true tax haven, New Jersey’s easy incorporation laws and very lax regulations were successful in attracting business, especially to the rapidly industrializing northern parts of the state like Patterson, which would become a major player in the textile industry- the primary industry in the heyday of the Industrial Revolution. However, in the long run, there was a steep price to be paid as corporate interests ran amok in NJ with little oversight. This would come to a head in the early 20th century as workers and government reformers in NJ would have to fight a grueling battle to reclaim their government, a battle fought in both the statehouse and on the picket lines- where corrupt policemen on corporate payrolls beat, jailed, and shot union workers striking for fair pay, safer working conditions, and an end to exploitive child labor. Though decried as Communists and slandered in the corporate-backed media, NJ workers were at the tip of the spear of the successful 20th century labor movement.
While New Jersey’s history c.1900 provides a cautionary tale about the double-edged sword of offering oneself up as a corporate tax haven (and the state has since ceased to serve in this capacity by most judgment), it should be noted NJ’s southern neighbor Delaware followed in its big brother’s footsteps by enacting liberal incorporation laws in 1898, and Delaware continues to serve in exactly this role, with more than half of publicly-traded US corporations incorporated in the state, and franchise taxes providing a substantial source of the tiny state’s revenue. While Delaware’s corporations are still beholden to federal corporate taxation, they deal with little state scrutiny and enjoy a 0% state corporate tax rate. The Economist has joked that Delaware stands for “Dollars and Euros Laundered and Washed at Reasonable Expense”. While there is no doubt most of these corporations operate within the law, having a tax haven like Delaware so close to home stymies the efforts of regulators in other US states to keep businesses running above board.
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