Apple and the Taxman: Why Treasury Always Loses

Watching the Senate hearing yesterday with Apple chief executive Tim Cook, I came to the conclusion that there are some things the government should not be trying to do even if the reasons for doing so are obviously good ones. And one of those things is taxing corporations.

I say this reluctantly because the share of the government’s total tax take paid by corporations has been falling steadily for years, and continues to fall even as corporate profits have reached record highs. This fine backgrounder by my Renewing America colleague Jonathan Masters points out that corporate tax payments as a percentage of GDP have fallen from more than 5 percent in the 1950s to less than 2 percent today. While corporate taxes are still the third largest source of federal revenue, they accounted for less than 8 percent of Treasury revenue in 2011, compared with 47 percent for the individual income tax and 36 percent for the payroll tax. In the 1950s, taxes on corporate profits accounted for about one-third of federal revenue.

From an equity perspective, corporate profits should clearly be taxed more heavily. But the Senate investigation into Apple, which showed that the company avoided U.S. tax on at least $74 billion in profits over three years, and the brazen defense of Apple’s tax record from  Mr. Cook, showed why this simply won’t happen. In a global economy where it’s relatively easy for companies to move physical operations to low-tax countries, and even easier to shift paper profits to those jurisdictions, there is no way that governments can extract anything close to the tax revenue they believe they are owed.

One of the Senate investigators called it a game of “Whac-a-Mole” – once the committee uncovered one tax dodging strategy by Apple there were many more that popped up. The reality of modern multinational corporations in a global economy is that governments will always be, at best, several steps behind the clever tax lawyers. This is not just true in the United States. Europe has faced precisely the same problem; the UK had its own uproar earlier this year when it discovered that Starbucks had scarcely paid any corporate tax because it was effectively booking all its profits through subsidiaries in Switzerland and the Netherlands.

So what can be done to make companies pay a fairer share? One possibility is to negotiate an international arrangement to crack down on “tax haven” countries. The Clinton administration tried this in the late 1990s, led by one of the country’s distinguished public servants, Stuart Eizenstat, who was then deputy Treasury secretary.  Despite his determined efforts through the OECD and the support of many European countries, the initiative came away empty-handed. Too many countries simply refused to bargain away their sovereign power to cut taxes to attract investment, even if that “investment” is sometimes little more than a postal drop box.

A second possibility, and one that will be on the table if Congress takes up tax reform this year, is to cut the high U.S. statutory tax rate (currently the highest in the OECD at 35 percent) back to a more competitive level, say in the mid-20s. This is what Mr. Cook recommended at the hearing. But as the Senate investigation showed, in many cases Apple was paying less than two percent in taxes on its overseas profits. Even at a 25 percent top tax rate, companies would have little additional incentive to expand their operations in the United States. Mr. Cook suggests a still lower “single digit” rate for repatriation of overseas profits, which might encourage companies a bit, but would net minimal revenue for the Treasury.

A third option, being pushed by the “Lift America Coalition” of U.S companies from Coca-Cola to Xerox, is for the United States to move to a “territorial” tax system in which profits are taxed only in the country where they are earned. This is what most European countries do. The problem with that, however, is that it would increase even more the incentive for companies to shift profits offshore, and in reality there is little the IRS can do through regulations to prevent this. Not only would this erode corporate tax payments still further, companies that can shift profits easily -- such as technology and intellecual property-based businesses -- would be the big winners, while those that actually make things in the United States would see little benefit.

The frustrating reality is that there is only one sensible solution actually within the power of the U.S. government to enact and enforce – abolish the corporate tax entirely. This is not as radical as it sounds. The tax on corporate profits has always been a double tax, since profits are taxed a second time when they are distributed to shareholders as dividends or capital gains. A revenue-neutral tax reform could make up most of the losses from corporate taxes with higher tax rates on dividends and capital gains. The Joint Committee on Taxation has estimated that taxing capital gains and dividends at the same rate as ordinary income (a top rate of 39.6 percent rather than the current 15 percent) would raise an additional $160 billion, which is only a bit less than the $181 billion corporations paid directly in taxes in 2011.

Of course the idea of raising dividend and capital gains taxes is anathema to many and would be bitterly resisted. But the alternative is worse – to watch companies like Apple pay an ever dwindling percentage of their profits in tax to the U.S. government, while Congress and the administration stand by powerless to do anything about it.