Tax Haven's Tax Haven Pays a Price for Success

The Wall Street Journal

By DEBORAH BALL

ZUG, Switzerland—Developed nations from Japan to America are desperate for growth, but this tiny lake-filled Swiss canton is wrestling with a different problem: too much of it.

Zug's history of rock-bottom tax rates, for individuals and corporations alike, has brought it an A-list of multinational businesses. Luxury shops abound, government coffers are flush, and there are so many jobs that employers sometimes have a hard time finding people to fill them.

But when Stefan Hurschler, a man who works with the disabled, and his schoolteacher wife decided to expand their family and wanted a bigger house, they found nothing in Zug they could afford. They moved to Zurich, and Mr. Hurschler now commutes back to the town he grew up in.

"There are older people who still live [in Zug] because they bought their homes in the 1960s," said his wife, Lilian. "Or there are the very rich. But there isn't much of a middle class."

If Switzerland is the world's most famous tax haven, Zug amounts to a haven within a haven. It has the highest concentration of U.S.-dollar millionaires in Switzerland, a country where nearly 10% of households meet that standard, according to Boston Consulting Group. The highest personal income tax anyone in Zug has to pay is 22.9%, and companies pay an average of just 15.4%—rates lower than Switzerland's average and far below top rates in the U.S.

Thanks in large part to such policies, Zug now boasts the headquarters of big companies ranging from construction firm Foster Wheeler Ltd. to commodities trader Glencore International PLC, and branches of many more. When Transocean Ltd., a drilling contractor known for its tax planning, decided two years ago to move its headquarters from the Cayman Islands and Houston, it picked Zug.

But lately, the place has become something of a victim of its own success. It is grappling with the consequences of the wealth it has attracted, now crowding out the non-rich and squeezing companies looking for space and talent.

"if you make 300,000 or 400,000 francs, you struggle" in Zug, said Kilian Borter, a public-relations executive, referring to incomes that equal $380,000 to $490,000. Living in Zug "maybe starts to make sense starting at about a half a million" francs a year in income, he said.

The pressures arise at a time when debates over taxes and economic growth have intensified. That is particularly so in the U.S., where business leaders complain that a 35% top federal corporate income-tax rate impedes business expansion, and in the U.K., which last year raised its top individual rate to 50%. In both countries, low-tax advocates say these rates drive jobs and wealth to places like Switzerland. The average corporate tax rate in the developed world has dropped to 25% from 32% since 2000, according to KPMG International.

Tax policy is high on the agenda for next year's U.S. elections, a debate fanned when multibillionaire Warren Buffett recently called for higher taxes on the superrich. Fifteen of France's wealthiest people have urged their government to levy a one-off tax on the rich to plug budget holes. And in Italy, which needs to reduce its budget deficit, the government of Silvio Berlusconi, one of Europe's richest people, has proposed an extra 10% tax for two years on earnings above €150,000 (about $215,000).

Zug long was a poor farming region, but in 1947 its leaders began to trim tax rates in an effort to attract companies and the well-heeled. In Switzerland,, two-thirds of total taxes, including individual and corporate income taxes, are levied by the cantons, not the central government. The cantons also wield other powers that enable them compete for business, such as the authority to make residency and building permits easy to get.

Zug's tax policies didn't bear much fruit until the 1960s, but then its fortunes began to soar as businesses moved in, many establishing regional headquarters. Over the past decade, the number of companies with operations of some sort in the canton jumped to 30,000 from 19,000.

The number of jobs in Zug rose 20% in six years, driven by the economic boom and foreign companies' efforts to minimize their taxes. At a time when the unemployment rate in the European Union (to which Switzerland doesn't belong) is 9.4%, Zug's is 1.9%.

The boom leaves Zug an odd mix of rural tranquility and high finance. Nearly 90% of the canton's 92 square miles consist of forest, farmland and lakes. Much of the rest is packed with commodity traders, private-equity firms and divisions of big multinationals, occupying mostly low-rise, modern buildings.

Despite its Lilliputian proportions, Zug is home to a dealer in Maseratis and Ferraris. The dealership has among the highest demand in Switzerland for customized luxury sports cars with tweaks such as monogrammed leather interiors or special lacquer finishes that can add tens of thousands to the price.

Zug has the widest wealth disparity in Switzerland, according to Ganga Jey Aratnam, who studies wealth in the country at the University of Basel, and who adds that Switzerland itself has the world's largest such wealth disparity outside of Zimbabwe and Namibia.

With expatriates making up nearly a quarter of Zug's residents, luxury SUVs line up in front of the international schools for the morning school run. Posh villas dot the acreage overlooking Lake Zug.

The tight market for housing—a residential vacancy rate of just 0.3%—has become a concern for multinationals looking to relocate to Zug. "I have clients who say, 'In Chicago, we could see 30 houses,'" said Robert Baldwin, director of Packimpex Ltd., a relocation company. "I tell them that in Zug, you'll be lucky if I can show you two or three." At one point, he had just one house to show to an arriving family.

Companies seeking commercial space learn they may have to wait for it to be built. "Sometimes you're taking them to look at cranes and meadows," said Florian Kuprecht, the Zurich-based director of real-estate firm CB Richard Ellis Group Inc. He told of a client that wanted to bring in 100 staff members but is instead starting with 25 for lack of space.

Zug's tight job market is also a headache, executives say. "We struggle to find qualified professionals such as accountants and administrative staff," said Urs Wietlisbach, executive vice chairman of Partners Group AG, a private-equity firm in Zug. "We constantly have open positions in those areas."

In response to these pressures, Zug is searching for ways both to cool its red-hot growth and to help middle-class people cope.

Describing Zug's development as "astonishing," Matthias Michel, the head of the canton government, said, "We are too small for the success we have had."

To help those squeezed by pricey residential property, the canton is expanding affordable housing. Its version is a step up from such housing stock elsewhere, often boasting balconies, a parking spot and grassy play areas for kids. For home buyers, the canton provides families earning less than about $100,000 annually 500 francs ($630) a month toward mortgage payments.

While the canton remains firmly committed to the low-tax policy that has fueled its prosperity, Zug has largely stopped trying to lure more multinationals, according to Mr. Michel, the head of the canton government.

Ms. Hurschler, the teacher who with her husband had to leave Zug to find a home they could afford, says, "It's important for a society to have a mix of poor and rich, of Swiss and foreigners, and not just a single class of rich people. It's not just more, more, more."

In another effort to discourage more growth, the canton is urging its towns to rein in permits for new office construction. "Some of the communities are annoyed" with this policy," the canton leader acknowledged. "They still want to grow a lot."

Towns are seeing fresh demand for space with the recent opening of a six-lane highway connecting to Zurich and Lucerne. In one such smaller town, Rotkreuz, Swiss drug maker Roche Holding AG has erected six buildings over the past five years.

Moreover, there is heated tax competition among Switzerland's cantons. The competition ramped up several years ago after the country's central bank decided to sell some of its gold reserves and hand over a large chunk of the proceeds to the cantons. The windfalls made them more comfortable about slashing their tax rates.

Normally, critics of the low-tax policies that prevail across Switzerland are a voice in the desert, but the failure of a few tax initiatives in recent years shows there are limits to how far Swiss cantons can go to lure the rich.

A Swiss court four years ago struck down a move by Obwalden canton to enact a regressive tax—the more you earn, the lower rate you would pay. The canton chose a flat tax instead. Two years later, voters scotched a plan in the same canton to set aside prime tracts of land for rich people who might fancy building grand villas.

Despite those limits, the Swiss are mostly holding fast to their fiscal beliefs. Last November, in a national referendum, they overwhelmingly rejected a proposal that would have established a minimum 22% tax rate on incomes over 250,000 francs, or about $315,000.

After Zurich residents in 2009 dropped a deal that allowed wealthy foreigners who moved in to pay an ultra-low, nominal tax, efforts to withdraw similar sweet arrangements in other cantons went nowhere. Some of the wealthy foreigners who had lost their tax deal in Zurich simply moved to Zug.

Write to Deborah Ball at deborah.ball@wsj.com