Late last year, as the Chinese government prepared to enact tough new tax rules, the billionaire Sun Hongbin quietly transferred $4.5bn worth of shares in his Chinese real estate firm to a company on a street corner in Sioux Falls, South Dakota, one of the least populated and least known states in the US. Sioux Falls is a pleasant city of 180,000 people, situated where the Big Sioux River tumbles off a red granite cliff. It has some decent bars downtown, and a charming array of sculptures dotting the streets, but there doesn’t seem to be much to attract a Chinese multi-billionaire. It’s a town that even few Americans have been to.
Super-rich people choose between jurisdictions in the same way that middle-class people choose between ISAs: they want the best security, the best income and the lowest costs. That is why so many super-rich people are choosing South Dakota, which has created the most potent force-field money can buy – a South Dakotan trust.
If an ordinary person puts money in the bank, the government taxes what little interest it earns. Even if that money is protected from taxes by an ISA, you can still lose it through divorce or legal proceedings.
A South Dakotan trust changes all that: it protects assets from claims from ex-spouses, disgruntled business partners, creditors, litigious clients and pretty much anyone else. It won’t protect you from criminal prosecution, but it does prevent information on your assets from leaking out in a way that might spark interest from the police. And it shields your wealth from the government, since South Dakota has no income tax, no inheritance tax and no capital gains tax.
A decade ago, South Dakotan trust companies held $57.3bn in assets. By the end of 2020, that total will have risen to $355.2bn. Those hundreds of billions of dollars are being regulated by a state with a population smaller than Norfolk, a part-time legislature heavily lobbied by trust lawyers, and an administration committed to welcoming as much of the world’s money as it can. US politicians like to boast that their country is the best place in the world to get rich, but South Dakota has become something else: the best place in the world to stayrich.
At the heart of South Dakota’s business success is a crucial but overlooked fact: globalisation is incomplete. In our modern financial system, money travels where its owners like, but laws are still made at a local level. So money inevitably flows to the places where governments offer the lowest taxes and the highest security. Anyone who can afford the legal fees to profit from this mismatch is able to keep wealth that the rest of us would lose, which helps to explain why – all over the world – the rich have become so much richer and the rest of us have not.
In recent years, countries outside the US have been cracking down on offshore wealth. But according to an official in a traditional tax haven, who has watched as wealth has fled that country’s coffers for the US, the protections offered by states such as South Dakota are undermining global attempts to control tax dodging, kleptocracy and money-laundering.
“One of the core issues in fighting a guerrilla war is that if the guerrillas have a safe harbour, you can’t win,” the official told me. “Well, the US is giving financial criminals a safe harbour, and a really effective safe harbour – far more effective than anything they ever had in Jersey or the Bahamas or wherever.”
That calculation changed in 2010, in the aftermath of the great financial crisis. Many American voters blamed bankers for costing so many people their jobs and homes. When a whistleblower exposed how his Swiss employer, the banking giant UBS, had hidden billions of dollars for its wealthy clients, the conclusion was explosive: banks were not just exploiting poor people, they were helping rich people dodge taxes, too.
Congress responded with the Financial Assets Tax Compliance Act (Fatca), forcing foreign financial institutions to tell the US government about any American-owned assets on their books. Department of Justice investigations were savage: UBS paid a $780m fine, and its rival Credit Suisse paid $2.6bn, while Wegelin, Switzerland’s oldest bank, collapsed altogether under the strain. The amount of US-owned money in the country plunged, with Credit Suisse losing 85% of its American customers.
The rest of the world, inspired by this example, created a global agreement called the Common Reporting Standard (CRS). Under CRS, countries agreed to exchange information on the assets of each other’s citizens kept in each other’s banks. The tax-evading appeal of places like Jersey, the Bahamas and Liechtenstein evaporated almost immediately, since you could no longer hide your wealth there.
How was a rich person to protect his wealth from the government in this scary new transparent world? Fortunately, there was a loophole. CRS had been created by lots of countries together, and they all committed to telling each other their financial secrets. But the US was not part of CRS, and its own system – Fatca – only gathers information from foreign countries; it does not send information back to them. This loophole was unintentional, but vast: keep your money in Switzerland, and the world knows about it; put it in the US and, if you were clever about it, no one need ever find out. The US was on its way to becoming a truly world-class tax haven.
The Tax Justice Network (TJN) still ranks Switzerland as the most pernicious tax haven in the world in its Financial Secrecy Index, but the US is now in second place and climbing fast, having overtaken the Cayman Islands, Hong Kong and Luxembourg since Fatca was introduced. “While the United States has pioneered powerful ways to defend itself against foreign tax havens, it has not seriously addressed its own role in attracting illicit financial flows and supporting tax evasion,” said the TJN in the report accompanying the 2018 index. In just three years, the amount of money held via secretive structures in the US had increased by 14%, the TJN said. That is the money pouring into Sioux Falls, and into the South Dakota Trust Company.
“The easy takeaway is that people are trying to hide. But wanting to be private, to be confidential, there’s nothing illegal about that,” said Matthew Tobin, the managing director of the South Dakota Trust Company (SDTC), where Sun Hongbin parked his $4.5bn fortune. We were sitting in SDTC’s conference room, which was decorated with a large map of Switzerland, as if it were a hunting trophy.
Tobin added that many foreign clients had wealth in another jurisdiction, and worried that information about it could be reported to their home country, thanks to CRS. “That could put them at risk. They could be at risk of losing their wealth, it could be taken from them. There’s kidnapping, ransom, hostages. There is risk in a lot of parts of the world,” he explained. “People are saying: ‘OK, if the laws are the same, but I can have the stability of the US economy, the US government, and maintain my privacy, I might as well go to the US.’” According to the figures on its website, SDTC now manages trusts holding $65bn and acts as an agent for trusts containing a further $82bn, all of them tax-free, all of them therefore growing more quickly than assets held elsewhere.
When I spoke to the official from one of the traditional tax havens, who asked not to be identified, for fear of wrecking what was left of the jurisdiction’s financial services industry, he was furious about what the US was doing. “One of the bitter aspects of this, and it’s something we haven’t said in public, is the sheer racism of the global anti-money laundering management effort,” he said. “You will notice that the states that are benefiting from this in America are the whitest states in the country. They’ve ended up beating the shit out of a load of black and Hispanic places, and stuffing all the money in South Dakota. How does that help?”
I put those comments to a South Dakotan trust lawyer who agreed to speak to me as long as I didn’t identify them. The lawyer was sympathetic to the offshore official’s argument, but said this is how the world is now, and everyone is just going to have to get used to it. It is, after all, not just South Dakota and its trust companies that are sucking in the world’s money. Banks in Florida and Texas are welcoming cash from Venezuela and Mexico, realtors in Los Angeles are selling property to Chinese potentates, and New York lawyers are arranging these transactions for anyone that wants them to. Perhaps under previous administrations, there might have been some appetite for aligning the US with global norms, but under Trump, it’s never going to happen.
“You can look at South Dakota and its trust industry, but if you really want to look at CRS, look at the amount of foreign money that is flowing into US banks, not just into trusts,” the lawyer said. “The US has decided at very high levels that it is benefiting significantly from not being a member of CRS. That issue is much larger than trusts, and I don’t see that changing, I really don’t.”
We have no idea yet what this means in the long term, because the revolution in trust law that began in South Dakota and spread throughout the US is only a generation old. But the implications are ominous.
Here is an example from one academic paper on South Dakotan trusts: after 200 years, $1m placed in trust and growing tax-free at an annual rate of 6% will have become $136bn. After 300 years, it will have grown to $50.4tn. That is more than twice the current size of the US economy, and this trust will last for ever, assuming that society doesn’t collapse altogether under the weight of this ever-swelling leach.
If the richest members of society are able to pass on their wealth tax-free to their heirs, in perpetuity, then they will keep getting richer than those of us who can’t. In fact, the tax rate for everyone else will probably have to rise, to make up for the shortfall caused by the wealthiest members of societies opting out, which will just make the problem worse. Eric Kades, the law professor at William & Mary Law School, thinks that South Dakota’s decision to abolish the rule against perpetuities for the short term benefit of its economy will prove to have been a long-term catastrophe. “In 50 or 100 years, it will turn out to have been an absolute disaster,” said Kades. “Now we’re going to have a bunch of wealthy families, and no one will be able to piss away that wealth, it will stay in the family for ever. This just locks in advantage.”
So far, most of the discussion of this development in wealth management has been confined to specialist publications, where academic authors have found themselves making arguments you do not usually find in discussions of legal constructs as abstruse as trusts. South Dakota, they argue, has struck at the very foundation of liberal democracy. “It does seem unfair for some people to have access to ‘property plus’, usable wealth with extra protection built in beyond that which regular property owners have,” noted the Harvard Law Review back in 2003, in an understated summation of the academic consensus that South Dakota has unleashed something disastrous.
And if some people have access to privileged property, where does that leave the equality before the law that is central to how society is supposed to function? Another academic, writing in the trade publication Tax Notes two decades ago, put that unfairness in context: “Perpetual trusts can (and will) facilitate enormous wealth and power for dynastic families. In the process, we leave to future generations some serious issues about the nature of our country’s democracy.”
With Washington unconcerned by what is happening, and the rest of the world incapable of doing anything about it, is there any prospect of anyone in South Dakota moving to repair the damage? The short answer is that it is too late. Two-dozen other states now have perpetual trusts too, so the money would just move elsewhere if South Dakota tried to tighten its rules. The longer answer is that South Dakotan politics appears to have been so comprehensively captured by the trust industry that there is no prospect of anything happening anyway.
The state legislature is elected every even-numbered year, and meets for two months each spring. It last updated the law governing trusts in 2018, and brought in Terry Prendergast, a trust lawyer, to explain the significance of the changes. “People should be allowed to do with their property what they desire to do,” Prendergast explained. “Our entire regulatory scheme reflects that positive attitude and attracts people from around the world to look at South Dakota as a shining example of what trust law can become.”
There were a few questions from the representatives, but they were quickly shut down by Mike Stevens, a Republican lawyer, and chairman of the state’s judiciary committee. “No more questions. I didn’t understand perpetuities in law school, and I don’t want to understand it now,” he said, laughing.
Susan Wismer, one of just 10 Democrats among the House’s 70 members, attempted to prolong the discussion by raising concerns about how South Dakota was facilitating tax avoidance, driving inequality and damaging democracy. Her view was dismissed as “completely jaded and biased” by a trust lawyer sitting for the Republicans. It was a brief exchange, but it went to the heart of how tax havens work. There is no political traction in South Dakota for efforts to change its approach, since the state does so well out of it. The victims of its policies, who are all in places like California, New York, China or Russia, where the tax take is evaporating, have no vote.
Wismer is the only person I met in South Dakota who seemed to understand this. “Ever since I’ve been in the legislature, the trust taskforce has come to us with an updating bill, every year or every other year, and we just let it pass because none of us know what it is. They’re monster bills. As Democrats, we’re such a small caucus, we’re the ones who ought to be the natural opponents of this, but we don’t have the technical expertise and don’t really even understand what we’re doing,” she confessed, while we ate pancakes and drank coffee in a truck stop outside Sioux Falls. “We don’t have a clue what the consequences are to just regular people from what we’re doing.”
That means legislators are nodding through bills that they do not understand, at the behest of an industry that is sucking in ever-greater volumes of money from all over the world. If this was happening on a Caribbean island, or a European micro-principality, it would not be surprising, but this is the US. Aren’t ordinary South Dakotans concerned about what their state is enabling?
“The voters don’t have a clue what this means. They’ve never seen a feudal society, they don’t have a clue what they’re enabling,” Wismer said. “I don’t think there are 100 people in this state who understand the ramifications of what we’ve done.”