Five things we learned from Tuesday’s big Apple tax hearing

May 21, 2013

On Tuesday, Washington took a break from its usual scandals to bring you the Senate vs. Apple, a face-off between the chief executive of the computing giant and a group of senators who seemed shocked — shocked! — that Apple has been able to minimize its U.S. tax obligations by funneling international earnings through holding companies registered in Ireland.

Apple chief executive Tim Cook swore to tell the truth, the whole truth, etc. etc. (JASON REED - REUTERS)
Apple chief executive Tim Cook swore to tell the truth, the whole truth, etc. etc. (JASON REED - REUTERS)

In truth, despite tough talk from Sen. Carl Levin (D-Mich.), the chairman of the Permanent Subcommittee on Investigations, and ranking member John McCain (R-Ariz.), and the occasional tense exchange, this was not particularly toxic as hearings go. Apple CEO Tim Cook could give lessons to some of his fellow CEOs in how to answer aggressive questioning straightforwardly and non-defensively.

But while the hearing wasn’t packed with dramatic exchanges or actual shocking revelations, it did highlight a number of underlying lessons about the U.S. corporate tax code that anyone who wants a competitive economy should pay attention to. Here are five of them:

It’s amazing how little it takes for a subsidiary to count as being overseas. Most of us think of the holding companies that Corporate America uses to keep its profits overseas as truly being overseas. But the hearing showed the degree to which these entities can exist on paper only. Apple Operations International, for example, the Irish holding company through which Apple channels all its profits outside the Americas, had 32 of its last 33 board meetings in California. And while there is hot debate about under what conditions Apple would "repatriate" its funds into the United States, a dirty little secret is that the money itself is already here. AOI may be registered in Ireland, but its funds are managed by another Apple holding company, Braeburn Capital, in Nevada, and kept in New York banks!

If Apple was restrained in its use of tax tricks, we have real problems. One of Apple's points in its defense was that it has eschewed the use of the really exotic, out-on-a-limb techniques to reduce its tax burden. Said the company:  "Apple does not move its intellectual property into offshore tax havens and use it to sell products back into the US in order to avoid US tax; it does not use revolving loans from foreign subsidiaries to fund its domestic operations; it does not hold money on a Caribbean island; and it does not have a bank account in the Cayman Islands." One of the independent experts who testified Tuesday confirmed as much. "I suspect that what Apple has done is within the bounds of what is acceptable under current international tax law," said J. Richard Harvey, a professor at Villanova University. "In some respects, Apple isn’t as aggressive as others."

If you ask a company what changes should be made to the tax code, the answer is easy to predict. It seems reasonable enough that that senators would ask Cook how he would reform the U.S. corporate income tax, but the answer shouldn't be surprising. Inevitably, when corporate executives are asked that question, they offer an answer that would be highly convenient for their own companies. In Cook's case, he argued for a main corporate income tax rate of around 20 percent, not the current 35 percent, with fewer special deductions. And for overseas money that companies wish to bring back into the United States, Cook proposed an even lower rate of 5 percent to 10 percent. It's no secret that this would be quite beneficial for Apple, allowing it to simplify its corporate structure while paying only a modest tax bill on the international earnings it brings back to the United States to be returned to its shareholders.

The case for no corporate income tax — but higher individual taxes — looks pretty good. Moving to a system where taxes are only leveled on individuals would avoid a lot of the elaborate shenanigans Apple has gone through to keep its earnings in overseas holding companies. To make the revenue number work out, you would have to charge higher rates on individual income and capital gains taxes, but on the plus side the millions (billions?) of man-hours that American companies and their tax lawyers spend trying to avoid the corporate tax. Corporate income taxes raised only about $242 billion last fiscal year (compared with almost $2 trillion for individual income and payroll taxes), which was a relatively small chunk of government revenue for a massive distortions in business strategy and compliance costs. The reasons it won't happen: The politics are terrible (most Americans would rather big corporations pay taxes than individuals), and it would cause problems in international relations, as the United States would become the low-tax haven to the rest of the world, supplanting Ireland.

Sen. Claire McCaskill (D-Mo.) loves her Apple products. She started her questioning by gushing about the company and its products, stating at one point that she has spent thousands of dollars on the gadgets over the years. "I love Apple," she said. "I love Apple." In a day that wasn't great for Apple's public relations, this was its silver lining.

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Dylan Matthews · May 21, 2013