“Cowboy Cocktails”: The Determinants of Tax Havens among American States

• In Event: Poster Session: State Politics and Policy & Law and Courts
  In Poster Session: Poster Session: State Politics & Policy

Abstract

The state of Wyoming became the first state in the US to legalize the formation of limited liability companies (LLCs ) in 1977 when it passed the Original LLC Act, thereby putting Wyoming on the road to creating the Cowboy Cocktail, now arguably the most effective vehicle for hiding personal and corporate wealth in the US (Cottam et al. 2011). In the past 50 years, Wyoming has used its sovereignty as a state to create laws making it comparatively easy to form an LLC, make assets the property of the LLC, and then make a trust the owner of that LLC. By combining relative ease of formation with multiple layers of secrecy, the Cowboy Cocktail has made Wyoming the most attractive tax avoidance destination in the US, bringing individual and corporate customers from around the world (Fitzgibbon and Cenziper 2021). Other states, like South Dakota, Delaware, and Alaska, have followed suit, putting pressure on other states like New Jersey, Florida, and Nevada to create new financial vehicles of their own. In fact, many states in the US appear to be competing for a share of the tax avoidance business. This competition creates the central puzzle of this article, as the benefits to the state governments that engage in this competition seem to be remarkably limited, with few likely improvements to employment and no increase in state revenue. So, the question is: why do US states engage in this behavior when the benefits to its citizens seem negligible?

In order to understand why states would want to become tax havens and what benefits accrue to those that do, we build from a rich literature from the disciplines of comparative politics and international political economy regarding tax havens. Previous work by Dharmapala (2008), Sharman (2011, 2014) and Dainoff (2021) demonstrated that countries or territories like Liechtenstein or the Cayman Islands became tax havens as an economic development strategy in the absence of other workable alternatives and persisted because the financial gains outweighed the costs imposed by international anti-tax haven campaigns. Yet, little research has explored the presence of tax havens in the American context, and one of the primary questions we will attempt to answer is whether individual US states have similar motivations.

Thus, we also build from the state politics literature that examines the political motivations of taxation policy. Previous scholarship shows that political determinants like election cycles (Nelson 2000), partisanship (Reed 2006; Warren 2009; Grumbach 2018), and economic competition (Brunori 2005) are all good predictors of taxation policy in the states. In this vein, many scholars explore how a “race to the bottom” motivates legislatures on welfare (Volden 2002), environmental policy (Potoski 2002), and tax incentives (Leiser 2015). Here, we argue that states are similarly motivated by this “race” through policy diffusion, particularly competition among comparable states. Ultimately, our contribution is two-fold. First, we explore how to measure tax havens in the American context, borrowing from scholarship in comparative politics, with a focus on states specifically. Second, we examine the determinants of states becoming tax havens, with a focus on policy diffusion and competition.

In terms of research design, we propose adapting Ates et al.’s (2021) measurement of tax havens in the comparative context. They propose twenty specific indicators, along five dimensions: corporate income tax policy, loopholes, transparency, anti-avoidance, and double-tax treaties. Some dimensions (e.g., double-tax treaties) and indicators (e.g., patent boxes) do not apply in the American setting. Yet, many are still relevant in the American context, and we propose including the following measures from their work, as well as the addition of those focused on individual and family tax policy. These indicators include the lowest available corporate income tax, state income tax, state taxes on capital gains, deduction for net operating losses, sectoral state tax exemptions, corporate and estate tax transparency, policy on dynastic trusts, and incomplete gift non-grantor trusts. We propose experimenting with a variety of indices, including an additive index, factor analysis, and ultimately a Bayesian IRT. Second, we model what predicts these tax haven policies in the American state. We will rely on data from the Tax Justice Institute and the National Board of Economic Research, as well as traditional indicators from state politics and policy, including partisanship, professionalization, and economies. Ultimately, this project helps scholars understand how to measure tax havens in the American context, as well as identify the determinants of such policies.

Authors

• Markie McBrayer, University of Idaho

• Charles A Dainoff, University of Idaho