Delaware: the home of business

Delaware, despite being a fairly unassuming state, is home to a huge number of Fortune 500 companies. A unique corporate tax system is one of the reasons behind this, writes Tom Bailey

 
Delaware: the home of business
A statue of Caesar Rodney, a signer of the Declaration of Independence, in the heart of Wilmington, Delaware 
Author: Tom Bailey
December 23, 2016

Whether it was Abraham Lincoln’s talk of the US being the world’s “last best hope”, Jackson Turner’s celebration of the American frontier and its role in the creation of democracy, or Ronald Reagan’s portrayal of the country as a shining city atop a hill, there is a tendency to view the US as being exceptional. Every state within the country would no doubt also like to imagine itself as being unique, possessing some kind of distinctive feature for which it is known around the world.

Delaware’s courts are known for their expertise on handling complex business disputes without a jury

Some states are more successful in this than others. That Texas is an exceptional state – be it for good or bad reasons – is beyond doubt. Massachusetts and Virginia both played a defining role in the history of the US, while California has such a strong identity it is often spoken of as if it were an entirely different country. Other states, however, are not so lucky.

The first state Delaware holds the distinction of being the first state in the country to have signed the US Constitution. This, officially, makes it the first state in the country – and Delawareans are proud of that fact. The state slogan is “it’s good being first”, yet this distinction is easily overshadowed by the role other states played in the long saga of the War of Independence and founding of the US. Much more attention and praise is given to the pivotal role played by other, surrounding states during this era: from Pennsylvania, being the birthplace of the constitution, to Virginia, for supplying its most important framers.

The primary reason Delaware holds the title of being the first constitutional signee is due to its size: the small state was eager to sign the document that conferred equal senate representation to all states, regardless of population or area. Size, then, is also something Delaware has tried to leverage to make it stand out from the other states.

Delaware officials have attempted to use its status as a small state to craft a unique image, labelling it the ‘small wonder’ on highway signs. Vice President Joe Biden, who previously served as a senator for the state, affectionately refers to it as “my little state of Delaware”. Yet the state cannot lay claim to being the smallest state in the country – while not the most desirable title, this would at least afford Delaware some additional charm. Rhode Island, however, has snatched that honour from Delaware’s grasp.

Delaware, however, is unique in another way: businesses seem to really like the state. Disproportionate to its size, it is the home of more than one million companies. In total, a staggering 64 percent of Fortune 500 companies based in the US – including heavyweight brands such as Coca-Cola and Apple – are incorporated there. Coke’s official home may be in Atlanta, but it has still chosen to reside in Delaware.

delaware-fig-1According to a joint report by the state’s Division of Corporations and the Delaware Department of State, Delaware “has become almost a brand name for the ‘business’ of serving as the official home for corporations”. It may seem odd how such a small state – seemingly inconsequential, other than for its constitutional eagerness more than 250 years ago – should be such a favoured destination for businesses (see Fig 1). But there could be a logical explanation.

Courts of chancery
Delaware has made a conscious effort to foster a pro-corporate and business-friendly regulatory environment and tax regime. One of the unique features of business law in the state is the continued existence of the Delaware Court of Chancery, which is a huge attraction to corporations looking for a new place to base their operations. Courts of chancery are institutions with history stretching back to the Middle Ages; they first appeared in 14th-century England, and were intended to arbitrate on commercial affairs. Many were incorporated into general courts in the 19th century, but Delaware’s was not. Instead, it continued to stand alone as a separate body. As Delaware’s Division of Corporations noted in its report, one major attraction for businesses incorporating in Delaware is its courts, and “in particular, Delaware’s highly respected corporations court, the Court of Chancery”.

These courts are known for their expertise on handling complex business disputes without a jury. Experts in corporate law decide the case according to Delaware’s own unique laws, which have often been structured to offer an even more accommodating environment for business to operate in.

“Delaware law requires, and the Court of Chancery enforces, that a company’s directors must always be trying to maximise profits for shareholders”, said Lawrence Hamermesh, a professor at Delaware Law School at Widener University, as reported by The Atlantic. Delaware often pushes for even more corporate friendly laws. “In 2009, for instance, concerned that it was losing ‘pre-eminence’ in corporate litigation, Delaware passed a law allowing litigants with more than $1m at stake to try cases in the Court of Chancery in closed arbitration proceedings, meaning that the public would never know what had happened.”

However, even when challenged, the institutions of the state remained steadfast: “The Court of Chancery took a public stance on the matter, arguing that there was no reason the public should have access to all hearings”, according to The Atlantic.

Added to this is the low tax rate enjoyed by those domiciled in the state: there is no state tax, nor is there any income tax. If a business is located
in Delaware – even if it is operating across state lines – it is not subject to tax on in-state purchases. The state also has no property tax, no taxes on inheritance, stock or share transfers, or even value-added tax. Specifically for corporations, however, the state has a small franchise and limited liability company (LLC) tax. As Investopedia noted: “Most states require annual franchise and LLC taxes based on earned income. Delaware, however, offers a flat fee franchise tax of $100 and a flat fee LLC tax of $250. Compared to other states, Delaware offers exponentially lower franchise taxes and LLC taxes.”

State vs national interest
According to some, Delaware’s unique laws and consequent appeal to corporations is undermining other states. As one article in The Atlantic put it, Delaware “profits from this race to the bottom today. The rest of the country, however, isn’t making out quite as well”. Yet at the same time, from Delaware’s perspective, such policies are necessary. Compared to many other states, such as Texas and other oil states, Delaware has little in the way of natural resources. Nor does it have a large and sprawling university complex producing top-level graduates, as California and Massachusetts do, which in turn allows these states to become top centres for health and technology innovation. Furthermore, Delaware, being such a small state, did not benefit from military production investment in the way many Sun Belt states did.

According to some, Delaware’s unique laws and subsequent appeal to corporations is undermining other states

Manufacturing, as in many other northeastern states, has declined in recent years, and Delaware also lacks the ability to attract large numbers of tourists: its climate is not much different to those of other states in the surrounding area, which often have more developed tourism industries, as in the beach towns of New Jersey. While far from being an ugly state, neither does Delaware boast any natural wonders on a par with those that can be found in many other parts of the country: nor does it have any man-made attractions that might draw tourists in the same way Mount Rushmore does to otherwise inoffensive South Dakota.

States often use specific legislation and craft certain laws to make them stand out from the crowd, with the express hope of attracting investment, revenue, visitors and residents. Nevada’s gambling legislation, many could and did argue, gave it an unfair advantage with regards to tourism. Likewise, those states now legalising recreational marijuana could be accused of the same charge: Colorado is cultivating a tourism industry solely based around its liberal attitude to the drug. Other, more conservative Rocky Mountain states could be asking themselves how on earth they could compete.

When New York City appeared to be in terminal decline in the late-20th century, plagued by social decay and violence, its neighbour state New Jersey openly courted businesses to hop across the Hudson River. Inter-state competition is nothing new.

Distinct entities
Part of the cause for concern over Delaware promoting its own interests supposedly at the expense of other states is down to a perceived weakening of the idea of states being distinct polities with their own unique interests. This was shown in the recent furore surrounding the US presidential election, where Donald Trump won enough states to win the overall presidency by electoral college votes, but fell over 2.5 million votes behind Hillary Clinton in the popular contest.

Many have railed against the result on the basis that the overall popular vote should matter more than the electoral college tally. But whatever the correct decision on this is, the fact that such a system – where states poll their own residents and return their results as one unified vote – suggests a specific understanding of how the states within the US should be viewed.

64%

of US-based Fortune 500 companies are incorporated in Delaware

1.18m

companies were registered in Delaware as of 2015

$100

Delaware’s flat fee franchise tax

States, according to this system, have their own distinct interests: a majority of Pennsylvanians voted for Donald Trump, supposedly as a result of Pennsylvania’s specific interests. But those who would favour the national popular vote as the decider of presidential outcomes have a different – and indeed, increasingly popular – view of how states operate. US states, in this view, are not distinct polities with their own discernable interests – rather, they are simply administrative districts of the federal government.

This latter view, of course, would condemn Delaware’s enticing of corporations away from other states as unjust or at the very least unfair. On the other hand, the former view – that states have their own interests and they are expected to exert them – would hold Delaware’s policies as being entirely legitimate. However, it is important to note there are certain areas in which states already cannot compete, such as those where it is specifically banned by the US Constitution. This includes, for instance, the levying of tariffs on other states or efforts to disrupt commerce flowing through one state to another.

Place in history
Any union of states often faces such trouble. The EU is overcome with intrastate rivalry on issues from different tax regimes to attitudes towards trade with China. Northern EU states are, typically, more open to Chinese trade, while southern states, such as Italy and Portugal – which still hope to preserve their struggling textile industries – generally take a harder stance. The EU often tries to standardise regulations across states, but this is usually met with much resentment.

The EU also specifically restricts the ability of states to lend public assistance to private industry – for instance, ‘bailing out’ banks is now proscribed, with banks in financial folly needing to be ‘bailed in’ – much to the chagrin of Italy.

Delaware is a small state with little in the way of natural assets, hubs of innovation or other drivers of economic growth. To this end, it is using its unique history to carve out an economic model that allows it to ensure revenue, jobs and growth. This may be at the expense of other states, but that is not uncommon within the US.

Delaware is making the most of what it has. The US states are, at least for now, distinct entities and all pursue certain economic policies at the expense of others. Delaware is just doing what states in the country have always done, and indeed are assumed to continue to do, according to the design of the United States of America.