Don’t Blame Apple For Paying 2% in Taxes

Last week it became public knowledge that Apple paid a corporate income tax rate of 1.9% on income that originated outside the United States. This is in comparison to a 35% corporate tax rate in the U.S., before engaging in relevant deductions and tax credits. The United States currently has one of the highest corporate tax rates in the world, yet we keep asking ourselves why we’re losing jobs to other countries. The United States does an excellent job fostering innovation, intellectual property rights, and entrepreneurship, yet we fail to fully capitalize on corporate America’s success because of an outdated tax policy.

There are a few key elements that have resulted in successful U.S. corporate development relative to other countries. These include an unprecedented access to capital, the best higher education in the world, robust intellectual property rights, and a stable and legitimate legal, political, and bankruptcy system. All of these factors encourage entrepreneurship and contribute to why we have highly innovative areas like Silicon Valley. Since the Industrial Revolution — but particularly after WWII — these factors have contributed to American economic growth and prosperity and to the rise of American-based, multinational superstar companies, such as Apple.

As most people probably know, Apple is based in Cupertino, California, yet outsources most of their manufacturing to low-cost countries such as China. This isn’t really the issue — most multinationals will conduct business this way to maximize shareholder value — rather, my point focuses on Apple’s income from overseas operations, on which they paid less than 2% during the last fiscal year.

First of all, the high U.S. corporate tax rate encourages Apple to shift operations overseas and take jobs with them. This is true for low-cost manufacturing countries such as China, but it’s also the case for more developed countries where manufacturing is not a key competitive advantage. All multinational firms, Apple included, try to minimize their global tax burden, and with the increased globalization of the past two decades, this involves shifting operations away from the United States. Lowering the U.S. corporate tax rate would make domestic hiring a relatively more attractive option than the status quo.

Second, the U.S. levies a tax of up to 35% on all overseas profits that are brought back to the U.S. This is, in effect, a double taxation and a further disincentive to bring overseas profits back to the U.S. to create jobs in the domestic economy. Let’s say that we look solely at Apple’s income in Ireland, where the corporate tax rate is 12.5%. Assuming that these earnings are taxed according to Irish corporate tax rate, for every dollar of earnings there would be 87.5 cents left. Now, let’s say that Apple wants to repatriate these profits to expand their Cupertino campus, hire more engineers or designers, this 87.5 cents would be taxed at an additional 35%. No wonder corporations are leaving money in overseas accounts! The Brookings Institute claims that overseas profits sitting in offshore accounts is approximately $1.5 Trillion for all U.S. corporations.

Critics of a lower tax rate on repatriated overseas profits claim that we tried it already in 2004 when Bush temporarily lowered the repatriation tax rate to 5.25%, and it did not work then, so why should it work now? Their argument is that corporations took advantage of this tax break to bring overseas profits home to the U.S., but then failed to create jobs, instead using the excess capital to buy back shares or issue dividends. But even if these critics are right and firms used profits to help shareholders, that’s a net positive for Americans since dividends and share buybacks would increase the stock prices of American multinational firms. As you can read in my piece on QE3, asset price increases have a “wealth effect” on the American consumer, which encourages them to spend more money, thereby stimulating the economy. Considering that over 50% of Americans own shares of domestic firms, this wealth effect would be quite widespread and benefit a broad intersection of Americans, both directly and indirectly.