Jurisdictional competition for trust funds: an empirical analysis of perpetuities and taxes.

• Author: Sitkoff, Robert H.

ARTICLE CONTENTS INTRODUCTION I. JURISDICTIONAL COMPETITION FOR TRUST FUNDS A. The Rule Against Perpetuities B. Federal Wealth Transfer Taxes C. The Race To Abolish the RAP D. Additional Margins of Competition 1. Self-Settled Asset Protection Trusts 2. Fiduciary Income Taxes II. DESCRIPTION OF THE DATA SET A. Data Sources B. Brief Treatment of Data Limitations III. EMPIRICAL ANALYSIS A. Initial Data Analysis B. The Estimation Strategy C. Econometric Results 1. Trust Assets 2. Average Account Size 3. Total Number of Accounts D. Summary of Results 1. Perpetuities and Fiduciary Income Taxes 2. Self-Settled Asset Protection Trusts 3. Uniform Statutory Rule Against Perpetuities IV. IMPLICATIONS FOR POLICY DEBATES A. The Fall of the Rule Against Perpetuities B. The Rise of the Self-Settled Asset Protection Trust? C. An Interest Group Theory of Jurisdictional Competition D. Federal Wealth Transfer Taxes CONCLUSION TABLES 1. Reported State Trust Assets (in billions) 2. Log Reported State Trust Assets 3. State Average Account Size (in thousands) 4. Reported Number of State Accounts (in thousands) 5. Dating of Trust Law Changes APPENDIX A: EXTENDED TREATMENT OF DATA LIMITATIONS APPENDIX B: TRUST ASSETS PER PERSON APPENDIX TABLE 1. Reported State Trust Assets Per Person (in thousands) INTRODUCTION

By the end of 2004, twenty states had validated perpetual trusts by abolishing the centuries-old Rule Against Perpetuities (1) as applied to interests in trust. The driving force behind the erosion of the Rule was not a careful reconsideration of the ancient common law policy against perpetuities, but rather a 1986 reform to the federal tax code. Under the 1986 Code (as amended through 2005), a transferor can pass $1 million during life, or $1.5 million at death, free from federal wealth transfer taxes. (2) By passing this $1 million or $1.5 million in trust, a transferor can ensure that successive generations benefit from the trust fund, free from federal wealth transfer taxes, for as long as state perpetuities law will allow the trust to endure. In a state that has abolished the Rule, successive generations can benefit from the trust fund, free from subsequent federal wealth transfer taxation, forever.

This Article presents the results of the first empirical study of the jurisdictional competition for trust funds. Based on state-level panel data assembled from annual reports to federal banking authorities by institutional trustees, we find that the interstate competition for trust funds is both real and intense. Our analysis indicates that, on average, through 2003 a state's abolition of the Rule Against Perpetuities increased its reported trust assets by about $6 billion and its average trust account size by roughly $200,000. To put these figures in perspective, in 2003 the average state had roughly $19 billion in reported trust assets and an average account size of about $1 million. In the timeframe of our data, seventeen states abolished the Rule, implying that through 2003 roughly $100 billion in trust assets have moved as a result of the Rule's abolition. (3) This figure represents about 10% of the total trust assets reported to federal banking authorities in 2003.

Prior to our study, the evidence of jurisdictional competition in trust law has been entirely anecdotal. Lawyers and bankers in New York and other states that have not abolished the Rule regularly complain about the loss of billions of dollars in trust business to South Dakota, Delaware, and other trust-friendly jurisdictions. (4) The practitioner journals on estate planning are rife with assessments of the different state laws and advertisements by banks and trust companies touting the virtues of one state or another. (5) Anecdotes of competition have even been reported by popular media outlets such as the Wall Street Journal, New York Times, and Forbes Magazine. (6)

In spite of this anecdotal evidence, before our study there were at least two reasons to doubt the magnitude of the jurisdictional competition for trust funds. First, no state collects a filing or other fee on the creation of a private trust under its law, and several of the leading jurisdictions that have abolished the Rule do not levy income taxes on trust funds attracted from out of state. (7) Hence, in these states there is no direct state revenue payoff from attracting trust funds.

Second, the main tax benefits of a trust not subject to the Rule Against Perpetuities accrue not to the donor, but to beneficiaries whose interest in the trust will not vest within twenty-one years of the death of a life in being at the time the trust became irrevocable. Hence, as compared with an ordinary instate trust, the added benefits of settling an out-of-state perpetual trust flow to beneficiaries who are remote descendants unknown to the donor. (8)

Accordingly, the absence of empirical study of the jurisdictional competition for trust funds represents a gaping hole in the literature. This lacuna stems from the difficulties that inhere in such a project. First, because inter vivos trusts are private arrangements for which there are no public filings, it is commonly assumed that the data is unavailable. For example, Jesse Dukeminier and James Krier, authors of a widely used casebook on property law, believe that "[i]t is difficult to get hard data on the popularity of perpetual trusts among consumers." (9) Likewise, Eric Rakowski has written that "[t]here is no way to count [perpetual trusts] with certainty." (10) In a similar vein, the English Law Commission, which in the 1990s was tasked to make recommendations on perpetuities reform in England, "considered the possibility of commissioning a full study of the economic implications of abolishing the rule," but declined to do so "because it proved impossible to obtain sufficient data." (11)

Second, the domestic perpetual trust phenomenon exists at the intersection of several varied and complex bodies of law, including the Rule Against Perpetuities, federal wealth transfer taxes, and state fiduciary income taxes. Designing an empirical study of the perpetual trust phenomenon thus requires sensitivity to each of those fields. Moreover, to avoid omitting other potentially relevant variables, empirical study of the perpetual trust phenomenon also requires accounting for other possible margins of jurisdictional competition for trust funds. Perhaps the most significant is the rise of the self-settled asset protection trust. Contrary to traditional law, in a jurisdiction that has validated self-settled asset protection trusts, the settlor can shield assets from creditors by placing those assets in a trust for his or her own benefit.

Our findings provide strong evidence of a national market for trust funds that is responsive to the interplay between state trust law and federal tax law. Contrary to the standard theoretical and practical accounts of jurisdictional competition, which view increased state tax revenue as the incentive for states to compete, (12) we find that the only states that experienced an increase in trust business after abolishing the Rule were those that did not levy an income tax on trust funds attracted from out of state. Although in tension with the dominant model of jurisdictional competition, this finding is strongly intuitive. The demand for perpetual trusts was sparked by their utility in avoiding federal wealth transfer taxes. (13) Donors who are sensitive to federal transfer taxes are likely also to be sensitive to state income taxes.

Our findings have broad implications for both policy and theory. Regarding policy, we find strong evidence that transferors have been escaping the Rule's application at an increasingly rapid pace since the mid-1990s. Although neither the federal wealth transfer taxes nor the interstate competition for trust funds relates to the policies underpinning the Rule, together they have mortally wounded the Rule by reducing it to a mere transaction cost. Accordingly, to the extent that the policies underpinning the Rule continue to have contemporary relevance, it is necessary to look elsewhere to service those policies.

Our results are also relevant to the ongoing policy debate in Congress and elsewhere over the future of federal wealth transfer taxation. (14) A principal tax policy underlying the 1986 code, the relevant features of which remain in effect today, is to prevent the "enjoyment of property followed by its movement down the generations without being subjected to estate or gift tax." (15) If Congress wants to put this policy into practice, it will need to close the loophole opened by the states that have abolished the Rule Against Perpetuities. Successful implementation of federal tax policy necessarily requires attention to its interaction with state property law. It is thus worth noting that, in a recent report, the staff of the Joint Committee on Taxation proposed closing the perpetuities loophole--but its analysis is based in part on an empirical assumption that we show to be erroneous. (16)

On a theoretical level, our findings are relevant to the ongoing scholarly debate over the nature of jurisdictional competition. Our findings not only contradict the simple, state-revenue-based model but also cast doubt on recent high-profile work that, by showing a lack of tax revenue from attracting new business, questions the existence of the phenomenon. (17) Instead, our findings lend support to an interest group model, one that is informed by public choice theory. (18) Even if attracting business does not directly increase the state's tax revenue, local interest groups nonetheless may benefit from, and hence lobby for, laws that will attract business to the state.

The rest of the Article is organized as follows. Part I frames the empirical analysis by examining the relevant legal issues: the race to abolish the Rule Against Perpetuities, the pertinent features of the federal wealth transfer...