The Apple Tax Diversion

Senators beat up a U.S. success for following the tax laws they wrote.

MORE IN OPINION »

You almost have to admire Carl Levin's timing. Amid a furor over politicized IRS tax enforcement, the Michigan Democrat on Tuesday tried to change the subject to a hardy Washington perennial—corporate tax loopholes. Too bad his designated business pinata, Apple, AAPL +0.38% demonstrates instead the insanity of the tax code that Mr. Levin has done so much to write.

Mr. Levin unveiled the results of his months-long investigation into Apple's corporate taxes and accused the American business success of employing "alchemy" and "gimmickry" to lower its tax bill. What Mr. Levin did not do was present any evidence of anything illegal or even inappropriate. He did prove that Apple has smart accountants and tax lawyers.

Mr. Levin is outraged that Apple subsidiaries in Ireland pay little or no corporate income tax on profits generated from Apple's international sales. Ireland has a laudably low corporate tax rate of 12.5% to attract jobs and capital, but it turns out that for certain corporations controlled by entities outside Ireland, the deal gets better.

The Apple units are based in Ireland, so U.S. law does not consider them to be U.S. corporations subject to U.S. corporate tax. But since they are managed and controlled by Apple in the U.S., Irish law doesn't consider them Irish companies and thus they are also not subject to the 12.5% Irish corporate tax. This isn't alchemy; it's accountancy.

Enlarge Image

Bloomberg

Sen. Carl Levin (D., Mich.) questions Apple Inc. witnesses during a hearing in Washington on Tuesday.

Mr. Levin claims that as a result one Apple subsidiary reported net income of $30 billion from 2009-2012 but didn't pay any corporate income tax. Apple says that since 2003 its Irish subsidiaries have paid a corporate rate of "2% or less," though it has also created some 4,000 Irish jobs.

None of this required a Senate "investigation" to discover because Apple is constantly inspected by the IRS and other tax authorities. These tax collectors are well aware of Apple's corporate structure, which has remained essentially the same since 1980. An Apple executive said Tuesday that the company's annual U.S. tax return adds up to a stack of paperwork more than two feet high.

We wonder what the Irish think of the spectacle of an American Senator expressing outrage that an American company doesn't pay enough Irish taxes. As Wisconsin Republican Ron Johnson pointed out on Tuesday, Americans are better off when U.S. companies pay less in taxes to foreign governments.

That includes Americans who are invested in Apple through their mutual and pension funds. And it includes Apple's U.S. workers who benefit when the company is able to sell more iPhones and iPads overseas. Roughly 50,000 of Apple's 75,000 employees are in the U.S.

It's also amazing to behold Democrats who routinely claim that high tax rates don't matter to business behavior denouncing a business for engaging in behavior to avoid paying higher tax rates. Which brings us to the real scandal that Mr. Levin has exposed: the folly of America's corporate tax code.

The genuine outrage is that Apple's profits in the U.S. are subject to a combined state and federal statutory tax rate of 39.1% that is the developed world's highest. Corporate taxation is so heavy in the U.S. relative to other countries that even while enjoying its near-zero rate in Ireland, Apple ends up with roughly the same overall effective tax rate, 14%, as South Korea's Samsung, its main global competitor. Yet Samsung still enjoys a tax advantage, because it has more flexibility to allocate those profits to the most promising investments anywhere in the world.

Like other U.S. companies, Apple pays an extreme tax penalty for bringing its foreign profits home to invest in the U.S. This is due both to the punitive U.S. tax rate and the fact that the U.S. is virtually alone in refusing to embrace a territorial tax system that applies corporate income taxes only in the jurisdiction where the money is earned.

So it's no surprise that Apple keeps $102 billion of its roughly $150 billion cash pile overseas. The repatriation tax penalty is so absurd that Apple chose in April toborrow $17 billion to pay a prospective dividend to shareholders rather than pay out of its overseas cash horde.

All of which argues for a corporate tax reform that would at the very least cut the combined U.S. state-federal rate to the mid-20s to be comparable with many of our trading partners. We'd suggest something closer to the Irish model—ideally zero but 12.5% also works—to turbo-charge growth and coincidentally generate lots of new revenue for Mr. Levin's beloved IRS.

Speaking of which, Mr. Levin is one of those Senators who wrote the IRS demanding that it inspect the tax-exempt status of Americans for Tax Reform, the Club for Growth and other groups that are his ideological opponents. "Why does the IRS allow 501(c)(4) organizations to self-declare?" he roared in July 2012. The IRS seems to have followed his orders, so no wonder he is trying to change the subject.

A version of this article appeared May 22, 2013, on page A16 in the U.S. edition of The Wall Street Journal, with the headline: The Apple Tax Diversion.

JOIN THE DISCUSSION

544 Comments, add yours