Of Course Apple Avoids Billions in Taxes—and It Should

By Derek Thompson

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Reuters

There are a few ways to respond to the congressional report that Apple has discovered ingenious ways to avoid paying taxes on income earned overseas.

  • There is the outraged response: "Apple's scheming to avoid paying taxes is unethical and unpatriotic."
  • There is the proactive response: "The U.S. corporate tax system is broken, and we should fix it."
  • And there is the indifferent response: "Wow, a multinational company is legally saving money. What color is the blue sky, again?"

A year ago, I would have told you I fall between outraged and proactive. I'm trending rapidly toward indifferent.

'A Bad Boy'
Apple is a multinational company, with 61 percent of its revenue from foreign operations. To (legally) minimize its tax bill, Apple has set up empty subsidiaries in lower-tax countries like Ireland, effectively making them a quasi-stateless corporation with an effective corporate tax rate of about 20 percent.

This might sound devious and and a little bit evil. But we aren't accusing Apple of behaving like a criminal. We are accusing them of behaving like corporation, since it is in the nature of corporations to find ways to save money. Rather than a story about patriotic duty, or funding the social net, or corporate ethics, this is really a story about unrealistic expectations. We wish we could tax American companies on their earnings from all around the world. And we can't. We just can't.

Apple is an American company, in most people's eyes. But it is a global company, insofar as most of its employees and most of its revenue come from outside the country. Since most developed foreign economies have lower statutory rates -- and because there are ways to play national tax laws off each other to further cut taxes -- multinational companies like GE and Google have mastered the global tax labyrinth to save money. Congress operates under the illusion that it can impose U.S. taxes on foreign earnings, but trying to fit a global mesh of far-flung money under Washington's narrow tax purview will always end like all efforts to push toothpaste back into a tube: Messily, somewhat embarrassingly, and thoroughly unsuccessfully.

"The most important takeaway for me from this report how ridiculous the US corporate tax system is," said Gary Hufbauer, an international tax policy expert at the Peterson Institute for International Economics. "We have this illusion of taxing earnings abroad. We think we should be taxing Apple and GM on any income earned anywhere in the world. But we can't, and very few countries even try."

"I would hope this turns out to be a great teaching lesson on how dysfunctional the architecture of our tax system is," he continued. "But it's more likely that we'll learn an easier lesson: That Apple is being a bad boy."

'The Worst of All Possible Worlds'
Tax experts I spoke with called the US corporate tax code "the worst of all possible worlds": a high tax rate, loopholes upon loopholes, billions of dollars falling through the cracks, and trillions stowed away overseas to avoid repatriation.

"When Apple needs money, it's cheaper for the company to borrow from the bond market" than to bring back earnings from overseas, said Howard Gleckman at the Tax Policy Center. "That's just crazy."

But even the simplest solutions to the craziness wouldn't end it. One sensible thing to say, if you're a tax wonk, is that we should "move to a territorial system with a lower statutory rate," which is wonkese for "just tax profits in the U.S., but not so much." It's a fine idea. It might even lead to more revenue, counter-intuitively, since more companies might hire and build here under the lower rate. But it wouldn't stop Apple from employing Apple-y tax schemes, because those tax schemes would save money over basically *any* U.S. statutory rate.

"There is not a simple solution," Gleckman said. "Even with a territorial system, there is no evidence that it would create more jobs here. If you're paying tax in the U.S. on US earnings only at 25 percent, we're still competing with an Irish system at 12 percent. So, [all things equal] if you have a choice of building a factory here or Ireland, you're going to go to Ireland."

The current system of international corporate income taxes is not working. But it might not "work," under certain definitions of the word, no matter what we do. Even as most people publicly agree that the system is "broken," Apple (and GE and Google, etc) aren't terribly enthused about most of the proposed reforms, because their tax departments have already figured out how to exploit the "broken" system to save money.

The Real Problem With Ingenious Tax Schemes
So what's the argument against ignoring this whole thing and directing our finite attention to stuff where reform could really make a difference?

Gleckman responded with a short story: Think of it this way, he said. Apple has got all this money stashed overseas. It wants to make investments in the U.S. But bringing the money back is too expensive because of our tax code. So it sells bonds instead. And then it uses the money from that bond sale to pay tax lawyers to keep its tax burden low. "That's a huge waste of resources."

Even as I've grown cynical about attacking Apple for behaving like a corporation, this argument hits home. In perhaps the most ingenious tax juke reported by the Permanent Subcommittee on Investigations', Apple realizes that the US taxes companies based on where they incorporate, while Ireland taxes companies based on where the subsidiary managers work, so Tim Cook sets up an empty subsidiary in Ireland and manages it in the U.S. to avoid taxes in both countries. Admit it. That's ingenious.

And the fact that it's ingenious is sort of the problem. It would, after all, be nice if America's greatest companies spent more time and resources designing ingenious things than designing ingenious tax schemes.


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