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Patriotic Companies Crossing the Delaware
[August 13, 2002]

By S. M. Oliva

Just before leaving town for the August recess, both houses of Congress saw fit to declare war on the "Corporate Axis of Evil"—Bermuda, Barbados, Gibraltar and a number of other offshore tax havens. Speech after speech in the House and Senate decried the "unpatriotic" American companies who reincorporated abroad to reduce their high tax burden within U.S. borders. To hear some Democrats (and even a few Republicans) tell it, incorporating your business in the Cayman Islands was the equivalent of arming Saddam Hussein.

But tax competition isn't just a game played by Caribbean islands. Within the United States tax competition and tax "havens" are alive and well, and some critics are beginning to take notice. A recent cover story in The New Republic spoke of Delaware, the first state to ratify the Constitution, as being "the worst state." The magazine accused the state of being a "bottom-feeding parasite" for having the audacity to have easy incorporation laws, no taxes on most corporate activities, and a specialized court system just to deal with corporate law matters.

The theory is that Delaware is evil because it makes it harder for high-tax states, such as neighboring New Jersey, to steal from domestic corporations via high taxation on multiple forms of commercial activity. Delaware, we're told by the left, owes it to America to adopt high tax policies in the name of "harmonization"—a refrain we're also hearing from international organizations that consider America's relatively low corporate taxation an affront to European socialism.

The Wall Street Journal  last week offered a good example of how Delaware's laws help corporations. Retailers such as Toys "R" Us have set up limited holding companies in Delaware which hold the rights to certain corporate trademarks, such as the use of the Toys "R" Us logo and mascots. Subsidiaries are set up in various states to actually conduct the retail business, and these companies in turn pay a "licensing fee" to the Delaware company for the right to use the corporate trademarks. This money is then sent back to the subsidiaries in the form of loans. By doing this, the company as a whole saves several million in state taxes, since the Delaware company pays no income tax on the "licensing fees" collected, and the interest on the loans to subsidiaries is generally tax-free as well.

The only "loses" here are the states with high sales taxes who can't get in on the "licensing fee" bonanza. The Journal article states that "tax experts contend that the strategy is inflicting billions of dollars in revenue losses on states." Of course that's a misstatement of sorts. The states were never entitled to the revenue in the first place, since they did not actually earn the money. The process I described above is not only legal, but the Supreme Court itself has directly upheld this practice.

Still, the high-tax states won't go down without telling a few more lies. Said one North Carolina official, "It's not fair to the corporations that do properly report their  income or to the millions of working people who pay their taxes without trying to avoid them." In other words, fairness equals submission of oneself to state authority.

What's more striking about that statement is the cognitive disconnect between employment and wealth. After all, who creates jobs? Corporations. If corporations want to create more jobs, what do they need? Profits. And who takes profits earned by corporations? Tax collectors.

Some will argue that the state can create jobs as well. True, the state can put somebody to work and give them a check. But what the state cannot do, generally speaking, is generate wealth. They can only take wealth others have generated, or repossess the means of producing wealth and produce it in a far less efficient manner.

Companies not only generate wealth, they have a moral and ethical obligation to do so. If that means they have to employ novel legal procedures to keep their profits out of the hands of tax collectors, than so be it. I'm not saying that it's ridiculous that we have a bunch of Delaware holding companies existing solely to evade tax laws. I am saying that it's ridiculous that there is a need for such a procedure in the first place.

In the end, it's much easier to lower taxes and generate wealth than it is to maintain high taxes and engage in the futile pursuit of closing all loopholes.


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