Hemel: South Dakota’s Tax Avoidance Schemes Represent Federalism At Its Worst

Washington Post op-ed:  South Dakota’s Tax Avoidance Schemes Represent Federalism At Its Worst, by Daniel Hemel (Chicago; Google Scholar): 

States should be free to experiment with policy — but not to create tax dodges.

The Pandora Papers — the trove of more than 11.9 million confidential documents shared with The Washington Post and partner news organizations — shine a light on South Dakota’s role as an offshore financial center.

The Pandora Papers — the trove of more than 11.9 million confidential documents shared with The Washington Post and partner news organizations — shine a light on South Dakota’s role as an offshore financial center.

For the most part, the South Dakota revelations in the Pandora Papers relate to the Mount Rushmore State’s status as a magnet for foreign wealth, including that derived from international drug smuggling and exploitative labor practices. But it’s not just foreigners who are moving money to the “little tax haven on the prairie”: High-net-worth Americans also are shifting billions to South Dakota and a handful of other domestic havens, shortchanging federal and home state tax collectors in the process.

The rise of domestic tax havens marks a troubling new chapter in the history of American federalism. Justice Louis Brandeis hailed states as “laboratories of democracy,” but increasingly U.S. states are becoming laboratories of sophisticated tax avoidance. So far, Congress and the states whose tax bases are being cannibalized by the domestic havens have done little to fight back. Hopefully, the Pandora Papers will catalyze a reaction that’s long past due.

Congress, for example, could close the loopholes in federal tax law that domestic havens exploit. And the states that lose out from cross-border tax wars could bolster their own legal defenses. Of course, lawmakers in the domestic tax havens also could address the problem by halting their efforts to emulate overseas havens such as Luxembourg and Switzerland. ...

Federalism, at its best, can enable states to craft innovative laws that respond to local needs. Surely there are better ways for states to use their sovereign power than to cater to the tax-avoidance interests of wealthy out-of-staters while padding the pockets of a few in-state lawyers and bankers. As Brandeis put it, “It is one of the happy incidents of the federal system that a single courageous State may … try novel social and economic experiments without risk to the rest of the country.” States can live up to that ideal without also trying novel ways to beggar thy neighbors.