Apple has parked $102 billion of assets and profits offshore to take advantage… (Timothy A. Clary, AFP/Getty…)
Apple Inc.'s success at avoiding billions of dollars in U.S. taxes through some (apparently) legal maneuvers has tax pundits pointing their guns at the corporate tax system. The case has revived numerous hoary cures for the supposed evil of corporate taxes.
The cures include abolishing the corporate tax altogether, turning it into a pure "territorial" system that taxes multinational firms only in proportion to the income generated within the United States, declaring a tax "holiday" allowing businesses to repatriate cash parked overseas (where it is taxed at vanishingly small rates, like Apple's) at a one-time-only discount.
Those are all fantasies. The countervailing realities are these: There are numerous good reasons to have a corporate tax, a territorial system would only encourage more Apple-style shenanigans, and a tax holiday would be an unjustified and ineffective giveaway to undeserving firms.
Let's start with the Apple case. As outlined by the Senate Subcommittee on Investigations, Apple avoided U.S. taxes substantially by such devices as vesting a healthy portion of its intellectual property rights in an Ireland-based affiliate, Apple Operations Inc., which claimed to account for 30% of the company's total net profits.
AO managed to avoid paying tax to any country on those profits by exploiting the cracks between Ireland and U.S. tax rules: Ireland bases tax residency on whether a firm's management and control resides in Ireland, and the U.S. bases residency on where a company is formed. AO was formed in Ireland, so Apple claims it isn't subject to U.S. tax; but its management and control are in the U.S., so Apple claims it isn't subject to Ireland tax. Get the joke? According to testimony before the committee, this maneuver and others saved Apple $7.7 billion in U.S. taxes in 2011 alone.
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Apple has parked $102 billion of assets and profits offshore to take advantage of tax loopholes, the committee says; this wealth isn't subject to U.S. tax until it's repatriated to these shores, which could technically be never. A misconception about this stunt needs to be disposed of upfront, however. Although some corporate tax critics say this shows how U.S. tax law prevents a company from repatriating its earnings for the good of the U.S. economy, the money is not truly offshore. It rests in accounts at U.S. banks and investment entities, including Apple's Nevada-based investment fund, Braeburn Holdings, so it actually is deployed widely in the U.S. economy. It's just withheld from the tax authorities.
Moreover, as is pointed out by USC tax expert Edward Kleinbard, a former chief of staff of Congress's Joint Committee on Taxation, Apple effectively is repatriating $16 billion of this hoard tax-free. It is doing so by borrowing that sum to pay for a stock buyback and taking a write-off from U.S. taxes for the interest on the borrowing. In other words, the company will balance the interest income on its overseas billions with an interest write-off in the U.S., and will distribute it to shareholders via the buyback.
Apple is not alone in its chicanery. Estimates of what Kleinbard terms "stateless income" earned by U.S. multinational corporations but untaxed run as high as $1.7 trillion. This has allowed U.S. companies to reduce their effective federal tax rate from the statutory 35% to an average of about 29%, although some big companies have gotten down to single digits or even zero. Apple's effective tax rate in 2011, the Senate committee says, may have been as low as 7%.
Unsurprisingly, about 40% of the profits of U.S. multinationals are reported in such countries as Bermuda, Ireland, Luxembourg and Switzerland, where taxes are minuscule or nonexistent for foreign firms, according to the Congressional Research Service. The phenomenon supposedly bolsters a common rationale you'll hear for abolishing the corporate income tax, which is that it distorts corporate decision-making. Firms spend billions cooking up tax-avoidance strategies, and spend billions more by making otherwise inefficient investments largely for tax reasons. Shed corporate managements of this burden, the argument goes, and they'll be free to deploy their capital sensibly, investing in America and creating jobs in the same atmosphere of cheery amity you'll find (so I'm told) in the world of My Little Pony.
This argument is popular among economists. What it leaves out is that government in the real world requires revenue. Since all taxation imposes economic distortion in one way or another, the question boils down to how to do that in a fair, sensible and efficient way. Having a corporate income tax probably meets those requirements better than not having one.