Gimme Shelter!

Congress to Grill Apple CEO About Taxes

Apple has avoided billions in taxes. Congress says it wants to know why. But we know why—and it’s probably not going to change.

05.21.13 2:37 PM ET

Today Apple CEO Tim Cook will testify about Apple's corporate tax practices in front of a congressional committee. Here's what you need to know:

  • Apple pays a lot of taxes to the U.S. government.
  • It also avoids a lot of U.S. taxes by sheltering income in various international subsidiaries.
  • This is probably not going to change.

It's probably not going to change for two reasons. One is that even if the Senate gets up some bill to "close the loopholes," it woud die a quick yet painful death in the House. And the second is that what Apple is doing isn't really "loopholes." Rather, it's relying on a gap between how corporate income is taxed in the United States and how it's taxed in Ireland.

The United States collects corporate income tax on all the taxable income of companies headquartered in the United States. Like most other countries, Ireland's corporate income tax is a "territorial" system: it collects taxes on income that is generated within the borders of Ireland. Ireland has also developed something of a specialty in attracting corporate headquarters to the island with low, low corporate income-tax rates—starting at 12.5 percent and going lower for favored guests like Apple.  

Basically, by headquartering a subsidiary in Ireland, but conducting many of its operations here, Apple managed to avoid paying tax to anyone. Naturally, that makes senators angry. But it appears to be legal. Worse, it appears to be very difficult to fix. Here are the things that the government could try to fix the situation and why they either won't happen or won't work:

The United States could try to pressure Ireland to change its tax policy to a global system like the one America has. It could also try to persuade the ocean to stop being so wet, for all the good this will do. Almost everyone except us is on a territorial system, and for good reason: it's a lot simpler to administer and harder to game. Moreover, Ireland's low corporate income tax is one of its major economic advantages, one it will not be anxious to surrender so that the U.S. can collect somewhat more tax revenue from global corporations.  

Alternatively, the U.S. could switch to a territorial tax system like all the other cool kids. (Oddly, this is almost never on the list of stuff that we should do because every other civilized country has a territorial tax system.) If we did this, we'd be able to tax the bejesus out of everyone doing business here, wherever they happened to be headquartered. This has its own problems, of course—it's relatively easy under such regimes to route your inputs through lower-taxed international subsidaries that then charge you enormous amounts for raw materials and so forth, reducing the amount of taxable profit you have to show the taxman. But this is also something of a problem with our global system. And it's much simpler to administer and collect.  

This has somewhat more chance of passage than moving Ireland to a global system, but if it happens, it will probably only be in the context of a much broader tax reform.  And even then, I'm not sure I rate its chances that high. Anything that sounds like "tax corporations less" makes a lot of powerful interest groups go ballistic, even if the net effect might be more collections from corporations.

The United States could lower the rate on repatriated foreign profits, or corporate income more generally. This is what Tim Cook is going to suggest today, again as part of a broader simplification effort. This strikes me as fairly unhelpful. For one thing, the difference between paying 25 percent, or 28 percent, on your foreign dividends and paying 0 percent is still pretty large; I'm no sure any politically feasible rate would actually cause much money to come home. Personally, I'd applaud if the United States reduced its corporate income tax to 12.5 percent, or better still to 0 percent, and made it up by collecting more from shareholders through the progressive income tax. But I'm not holding my breath for this happy moment.  

A rate low enough to convince substantial numbers of companies to repatriate foreign earnings is probably a rate that doesn't collect much tax. Most of that money will be shipped home to the U.S. and passed out to shareholders at extremely favorable dividend taxation rates. But the good senators are not mad at Apple because they aren't passing out enough money to shareholders. They're mad because there's a big pile of money upon which very little tax has been paid.

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The United States could require companies to pay income tax on foriegn-subsidiary income as it is earned, rather than as it is repatriated to the U.S.   Sounds better than it would actually work, for a host of reasons. We do this for individuals now, but individuals find it much harder to pick up everything and reincorporate their lives in another country. The net effect would be to encourage companies to shift their headquarters out of the United States, costing us both jobs and tax revenue.

The United States could pass some fiddling, complicated patch designed to prevent Apple from doing exactly what it is doing. The most likely to pass, but the least likely to be a good idea. We've "patched" the personal income-tax code this way multiple times: requiring foreign banks to report any U.S. account holders, taxing expatriates on their living allowances in high-cost countries like Japan. The net result has been that foreign banks no longer want to do business with American citizens, and foreign companies don't want to send us abroad. The small amount of extra tax we've collected this way is probably offset by the large amount of lost economic activity from American citizens trying to do perfectly reasonable, legal things, like live in Hong Kong or open a bank account while they're studying in the Netherlands.  

Moreover, in order to avoid inadvertently creating a disaster for American firms with operations abroad, such a "loophole closer" would have to be written very narrowly. Which is to say, it would probably be easy for companies to slightly tweak what they are doing and go on paying very little tax.  

To sum up, the best way to react to the fact that Apple shelters income abroad is to get rid of the corporate income tax and, at the same time, get rid of the special tax rates for dividends and capital gains. That would not only remove the incentive for these sorts of shenanigans, but also give other companies incentives to headquarter here. And as a bonus, it would collect more taxes from individuals, progressively, so that Warren Buffett doesn't pay the same tax rate as the widow with a few utility shares.

The second best way to fix it would be to move to a territorial tax system, which would close the tax-free gaps between everyone else and us.  

But if we do anything at all, we're likely to do it the eighth best way, raising little money while making the byzantine thickets of our tax code even thicker and more tangled. It won't do much for the economy, but it will probably sound great on TV.