In the 1930s, well-heeled taxpayers developed Bahamas-based strategies to blunt the rising tax rates of Franklin D. Roosevelt’s New Deal.
Notably, the initial legislative effort to curb these practices didn’t devolve into a blame game: American policymakers didn’t seek to strong-arm the Bahamian government into changing its laws or commercial practices. Rather, the United States accepted responsibility for the tax behavior of its own citizens.
Tax Avoidance in 1937
In 1937 Treasury Secretary Henry Morgenthau Jr. sent the White House a memo on tax avoidance practices. Morgenthau had asked his tax experts to compile a list of the most important (or at least egregious) avoidance strategies then in use.
The resulting memo — delivered to the White House in two forms, one naming particular taxpayers and the other scrubbed of identifying details — became the basis for a bombshell message to Congress.
Lawmakers followed up with a series of high-profile hearings over the summer of 1937. While Roosevelt had been persuaded by his more cautious advisers to avoid naming names, witnesses testifying on Capitol Hill were happy to identify the taxpayers involved in particular schemes. And journalists, of course, were happy to amplify all the lurid details.
And there were many lurid details. Treasury officials described egregious examples of tax avoidance, including a range of incorporated yachts, hobby farms, and racehorses. One particular scheme, involving foreign insurance companies established to create spurious interest deductions, actually involved shell companies organized in the Bahamas.
But this Bahamas gambit, which Treasury believed to involve only a half-dozen or so taxpayers, was just a sideshow in the larger circus that the department was staging for lawmakers. And it wasn’t even the most important avoidance strategy involving the Bahamas. A much more prevalent and flexible scheme — and one that drew sustained attention from both Treasury and Congress — was the creation of foreign personal holding companies, many of which were organized in the Bahamas.
Surging Interest
While testifying before the special Joint Committee on Tax Evasion and Avoidance, Treasury officials described an epidemic of tax dodging. In particular, they emphasized the surging popularity of foreign personal holding companies, which taxpayers were creating at a furious pace — one estimate pegged the number of such companies established by U.S. citizens at 585, including 94 in the Bahamas, 202 in Newfoundland, 46 in Panama, and 243 in Prince Edward Island.
Although it wasn’t the most popular jurisdiction, the Bahamas got most of the attention from Treasury experts when they testified at the tax avoidance hearings. In part, this emphasis was attributable to the pace of holding company creation in the islands.