Billions for Billionaires
But Small Change for South Dakota
by howard gleckman
howard gleckman is a senior fellow in the Urban-Brookings Tax Policy Center at the Urban Institute, where he edits the fiscal policy blog TaxVox. This article is adapted from his recent piece in TaxVox.
Published November 9, 2021
Looking for a friendly place to park a fortune? The Cayman Islands come to mind, as do Guernsey, Panama and Malta. But there’s no need to cross an ocean, put your faith in a bank operating out of a storefront next to Dunkin’ Donuts or thread a tortuous path through U.S. disclosure laws to keep out of the way of the tax man. In recent decades, South Dakota has become one of the world’s great tax havens. By the end of last year, more than $367 billion in assets were managed in the state through at least 62 publicly chartered trusts.
The trust companies earn big fees. The trust owners hide their assets and avoid billions of dollars in taxes. But what’s in it for the state?
None of the trust owners — whether they are foreign leaders accused of corruption or U.S. billionaires — likely will ever set foot there. There is no residency requirement to create a trust in South Dakota. And there are few tax benefits for the state and little evidence that the trusts create jobs. So, at risk of repeating myself, why South Dakota? Read on, but don’t expect a satisfying answer.
Taxes and Jobs, Not
South Dakota has no corporate or individual income tax, though it does have a small tax on financial institutions. The trust companies that manage this massive bundle of assets are subject to examination, supervision and charter fees, but in 2019 these levies added up to a paltry $1.5 million out of total state revenues of $2.2 billion. The trust companies also pay a share of a bank franchise fee that brought the state a modest $14 million in 2020.
Some South Dakota officials suggest the trusts create jobs. But the number of financial services jobs in the state actually dropped slightly in the decade before Covid-19, from about 30,500 in 2009 to 29,000 in 2019. The number of lawyers in the state did increase over the same period, from 1,794 to 1,995. But that 11.2 percent rise lagged the national growth rate of 14.5 percent.
We can fairly easily furrow out the “how” here, if not the “why.” University of Chicago law professor Daniel Hemel has a nice explainer that describes how South Dakota became a tax haven and how the shelters work. In short, back in 1983, the legislature voted to end durational limits on trusts, ending a practice going back to English common law that was intended to prevent families from holding wealth in trust forever.
The math rarely works for states that hollow out their tax base in pursuit of businesses or, in this case, the mega-rich. But the incentives to create dynasty trusts are more perverse than most.
And in states with no income tax — such as South Dakota — these “dynasty trusts” indefinitely avoid both state income tax and federal estate and gift tax. The trusts still must pay federal income tax on any realized capital gains and dividends they receive.But their permanence makes them multi-generational wealth accumulation fortresses. As Hemel writes, “Carefully designed, a South Dakota dynasty trust can operate as a perpetual estate-tax-avoidance machine.”
Normally, though, trusts would owe state income tax. But by creating a trust in a state without such a levy, nonresidents can shift assets from a jurisdiction where they would owe tax to one where they do not. And, Switzerland-like, South Dakota will not share information about the trusts with other state governments.
As goes South Dakota, so goes … Alaska and Nevada. Other states with no income tax have joined the race to the bottom in an effort to encourage residents to create similar perpetual dynasty trusts. Now financial advisers write articles “comparing the best states for trusts.”
The Never-Ending Story
As with other cases of tax competition, the math rarely works for states that hollow out their tax base in pursuit of businesses or, in this case, the mega-rich. But the incentives to create dynasty trusts are more perverse than most.
Usually, states will throw tax subsidies at companies in exchange for a new plant or a shiny headquarters skyscraper and the promise of jobs. These deals often fail to achieve their goals and are not worth the lost tax revenue. But states can at least create metrics to measure success or failure. Not so here: because the dynasty trust states suffer no revenue loss, there is no incentive for accountability.
The only losers are the federal government and its taxpayers. Indeed, the states are little more than willing conduits to federal tax avoidance. All perfectly legal, but that is exactly the problem. While they may have nothing to lose, the rest of us do.