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Three Cheers for Tax Avoidance

Corporate profits are looking juicier and juicier. Now the feds want a bite.

By From the July-August 2013 issue

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IN A HEARING before the Senate’s Permanent Subcommittee on Investigations, Senator Carl Levin, the subcommittee’s chairman, is feeling ashamed. Not of himself, but on behalf of Apple Inc., whose booking of profits in low-tax jurisdictions outside the United States is the subject of debate. “Don’t kid ourselves as to the implications of what this means for America’s revenue,” Levin says. “No company should be able to determine how much it’s gonna pay in taxes, how many profits they’re gonna keep offshore, how they’re gonna bring ‘em back home, using all kinds of gimmicks to avoid paying the taxes that should be paid to this country.”

Joining Levin in his criticism was Senator John McCain, who, at the same hearing, asked Apple’s CEO, Tim Cook, whether he was aware that “there is a perception of an unfair advantage here.” Later, Congressman Keith Ellison took to MSNBC where he made it sound like Apple doesn’t pay taxes at all. “It seems to me they ought to want to help to pay the expenses of this country so that everybody can have a fair shot,” he said. “I think it’s really disappointing that they don’t.”

While Levin grudgingly and sotto voce noted that Apple’s behavior is legal, he nevertheless disapproves of Apple’s working to maximize value for its shareholders. And despite recent reports of lower-than-expected earnings, the Cupertino, California-based company’s strategy seems to be working. Revenues for the second quarter of 2013 climbed to $43.6 billion, and the price of a company share is well above $400; meanwhile, the price of its flagship iPhone 5 is widely expected to drop this summer.

The committee wasn’t unanimous in its opinions. Senator Rand Paul, who has called for a corporate tax holiday to repatriate profits currently held overseas, told members of the committee that if they looked in the mirror they would see who was really responsible for Apple’s conduct: they themselves, the authors of America’s “bizarre and Byzantine” corporate tax system. He also called upon his fellow senators to apologize to Apple for “bullying one of America’s greatest success stories.”

In 2012, Apple was America’s third largest corporate taxpayer. And while its 14 percent effective tax rate is well below the average for S&P 500 companies, it also happens to be the revenue-maximizing rate for federal tax receipts, as calculated by the Tax Foundation. In other words, everything else being equal, a 14 percent corporate tax rate reaps the most total dollars for the federal government. In this light, Levin’s policy prescriptions—higher tax rates across the board for corporations—begin to look not only punitive but downright destructive.

Corporations don’t actually pay taxes. People—customers, owners, employees—do. Businesses require a certain return on investments to justify their existence (precisely what rate depends upon a host of factors, including how risky a business we’re talking about), and owners tend to recover tax costs by raising prices.

To the extent that the taxes can’t be fully passed on to the customer (and this is usually the case because of competition, including from rivals operating in low-tax jurisdictions), they then come partly out of retained earnings or dividends paid to shareholders, which hurts investors. And then there are corporate employees, whose salaries and bonuses are lowered by high tax burdens. As a 2010 Congressional Budget Office research paper concludes, “When capital is mobile, a corporate income tax is borne more heavily by domestic labor.” When Democratic vampires rush to feed on successful businesses, it’s usually the little guy’s blood they end up sucking.

LEVIN AND CO. believe that any profit earned anywhere belongs mostly to government, a view that they share with many of their European coevals. Margaret Hodge, a British Labour Member of Parliament, recently told a Google executive that “I get really irritated. You’re a company that says ‘Do no evil’ but I think you do do evil in that you use smokes [sic] and mirrors to avoid paying tax.” What she means to say is that if you abide by the tax code, you’re evil, unless you try to find ways to maximize your tax payments. Corporate executives had better get their priorities straight.

This attitude towards tax obligation is widespread among media and academic elites. Recently BBC Radio produced a documentary entitled Tax Avoidance: The Hidden Cost. A summary of the program reads, with apparently no sense of irony: “[T]ax-avoidance-powered competition is a disturbing danger. Because as a tax-avoiding company extends its operations, so a country’s revenues from corporate tax come under threat.” The implication here is that companies that spend money to expand, hiring more people and offering more goods and services that consumers want, rather than maximize their tax bills, are making the world worse.

The program begins with host Michael Robinson interviewing David Harding, the manager of a hedge fund that paid nearly $100 million in corporate taxes to the British government last year. While Harding—the latest in a long line of rich useful idiots that includes Warren Buffett and George Soros—admits that signing checks to the taxman can “evince a wince of pain,” he also confesses that “the overall knowledge that we’ve paid lots of tax is part of my strategy for feeling good about myself…good-ish.” “Good,” Robinson adds helpfully, “as a hedge fund manager could ever feel.”

For Harding, paying corporate taxes is akin to earning indulgences that shorten one’s spell in purgatory and put one on the road to progressive heaven—or at least all the right cocktail parties. It is hard to imagine that a man as capable as Harding does not recognize that many of the tasks that the British government—armed with billions of pounds in taxes—is charged with performing could not be better and more cheaply handled by privately funded charities. But logic is no substitute for feeling “good-ish” on BBC radio.

More excusable, but probably more pernicious, is the ignorance of one American professor, who, sounding like no one so much as an EU tax official, discusses Microsoft’s low tax rate on non-U.S. income: “Income that formerly belonged to the UK, formerly belonged to France, formerly belonged to Germany, that income has been stripped out, turned into stateless income, which in turn has sailed the seven seas until it found its happy home in a tropical paradise like the Cayman Islands or Bermuda.”

Now that sounds like a winner: Not only does he hit home the idea that income belongs to countries instead of earners, but he also manages to throw in the class warfare imagery of a rich person sunning on a ritzy beach.

Microsoft responded that they “abide by US and international tax laws”—and isn’t that really the point? If politicians hate the results of national and international tax laws so much, they—and only they—have the power to change them.

MEANWHILE, back in the real world, Valeant Pharmaceuticals is on an acquisition binge. Its latest purchase, in a whopping $8.7 billion deal announced on Memorial Day, is Bausch + Lomb, known around the world for its contact lenses and related products. Valeant claims that this purchase will actually save the company money: $800 million annually. How is this possible? In addition to efficiencies gained through working with Valeant’s other health care-related divisions, enormous savings will come in the form of reduced taxes.

Bausch + Lomb is currently headquartered in Rochester, New York, and subject to the American corporate tax system, one of the few that aims to tax all income, no matter where it is made in the world, rather than just income earned within our borders. Valeant is a Canadian company, meaning it is not subject to similar worldwide taxation. In a 2012 interview, Valeant’s CEO explained how the company was able, and will likely remain able, to maintain a tax rate in the low single digits—around 4 percent in recent years. It is essentially the same structure that Apple, Google, and many other companies that are based on intellectual property (IP) rather than hard assets (e.g., oil or minerals) use to minimize their tax bills. As Howard Schiller, Valeant’s executive vice president and CFO, explains:

There is nothing black box about it. Like most technology companies, we have our IP outside of the U.S. and we have it right now in Switzerland, Luxembourg, Barbados, and we have some, I believe, in Ireland… And we’ll continue to move IP around to where it makes the most sense. 

Only a week before Valeant’s purchase of Bausch + Lomb, a New Jersey pharmaceutical firm, Actavis, announced an $8.5 billion acquisition (including the assumption of $3.4 billion of debt) of Warner Chilcott plc, an Irish specialty pharma company. The market capitalization of Actavis is nearly triple that of Warner Chilcott. Yet after the deal closes, Actavis will not be Warner Chilcott’s parent company. Instead a new company will be incorporated in Ireland, Warner Chilcott’s current home. 

Why? Because Ireland’s corporate tax rate, at 12.5 percent, is one of the lowest in the world, whereas America’s, at 35 percent, is now virtually the highest. The price of Warner Chilcott stock, as traded in the United States, averaged about $13.75 in the month before the purchase was announced. It now trades at just under $20 per share. With about 250 million shares outstanding, the purchase enriched the owners of WCRX shares to the tune of over $1.5 billion. 

How much less would that profit have been, which is to say, how much less would Actavis been willing to pay, if the potential tax savings from relocating the company’s country of incorporation to Ireland had not been a factor? Twenty percent less? Fifty percent? Perhaps there would have been no deal at all.

The same goes for Valeant’s purchase of Bausch + Lomb, and many purchases by myriad technology companies, including Google and Yahoo!, whose ability to use the tax code to legally minimize tax bills raises the value not only of acquisitions but of resulting merged companies, benefiting tens of millions of investors across the globe who own stocks directly or indirectly via pension plans and IRAs.

According to Steven Rattner (formerly the Obama administration’s auto czar, if you can believe such a position ever existed in the United States), “by escaping American shores, Actavis expects to reduce its effective tax rate from about 28 percent to 17 percent, a potential savings of tens of millions of dollars per year for the company and a still larger hit to the United States Treasury.” (Just how a dollar in tax not paid means a loss of more than a dollar to the Treasury is unclear.) Rattner, with his liberal talking points sharpened to perfection, has a problem with companies operating within the bounds of national and international tax law to minimize their tax bills—legally. This, he says, “is just not fair at a time of soaring corporate profits and stagnant family incomes.” 

Like Sen. Levin, Rattner believes that corporate earnings belong first to the government, and second—and even then only at the kindness and discretion of politicians and bureaucrats—to shareholders.

ONE OFTEN-PROPOSED solution (assuming that low tax bills deserve to be considered a problem), is tax “harmonization,” a much-loved phrase in European Union bureaucratic circles. “Tax harmonization” involves trying to force various nations to adopt uniform tax rates. It is a polite way of saying “eliminating tax competition.” Fortunately, the present structure of the EU allows a single opposed nation to prevent the imposition of a new Eurozone-wide tax law, and England remains a staunch opponent of such a plan. Lesser-developed EU countries such as the Czech Republic and Hungary are also longtime foes of harmonization.

Imagine the outcry in Texas, Nevada, and other pro-business states if state-level corporate income tax rates were “harmonized” across the U.S. There is a reason that Texas is growing so rapidly, while the economic basket case of California—which has tried to address its massive budget deficits almost entirely by way of tax hikes—is losing employers and population: Lower taxes, accompanied by fewer regulations, spurs growth. Calling an anti-competitive tax policy “harmonization” is a classic fudge, a nice five-syllable word that suggests beautiful music rather than discordant progressive economic theories. But it shouldn’t fool anyone.

What rational citizenry would want to submit to the labyrinthine and anti-competitive diktats of European bureaucrats, many of whom collect their salaries tax-free? Especially when Ireland will happily take all corporate comers at a 12.5 percent tax rate?

When academic leftists say that they want the United States to be “more like Europe,” they almost invariably mean more like Gay Paris and less like Dirty Dublin. The great French economist Frédéric Bastiat implored readers to consider both “that which is seen and that which is not seen.” In the world of international tax policy, that which is seen is the anger of petulant politicians desperate to increase the flow of money running through their sticky fingers, and their conjured images of starving babies and dying grandmas (or is it dying children and hungry seniors? Who can keep track of the horrors that will befall us?) if we don’t take a hard line with Apple and other successful corporations. What is unseen is that tax not collected is money left in the private sector, in which far more capable hands create jobs and income and retirement savings for millions of people. 

Even less visible, but just as important, is the increased value of companies and therefore the increased wealth of their shareholders—including almost every person who has a retirement account or corporate or government pension. With more and more Americans expressing grave—and gravely reasonable—doubts about whether Social Security will exist decades from now, increasing private American wealth should be of the highest priority. One of the best ways to do that is to lower corporate tax rates.

Contrary to the protestations of politicians and their media lackeys for whom government is never adequately funded, the ability of multinational corporations to minimize their tax bills should be cheered by investors, employees, and customers, which is to say by every person other than those like Sen. Levin, whose desire for “fairness” trumps his interest in the American people’s freedom and financial security.

IN RESPONSE to Senator McCain questioning Apple’s “fairness,” Tim Cook, Apple’s CEO, said, “Honestly speaking, I don’t see it as unfair. I am not an unfair person. That is not who we are as a company or who I am as an individual.” But this answer implicitly accepts McCain’s erroneous contention that a corporation has a responsibility to do what politicians think is “fair.” It would be far better if Mr. Cook, and others in his position,  were to respond by saying that business leaders’ jobs are to serve employees and owners and customers, and that a politician’s view of “fairness” has no place in corporate decision-making except to the extent that the politician intends to use the power of government to harm a business that doesn’t cave to his demands.

But the chance of a CEO saying that is pretty low. Cook and his fellows know that pols of the Levin and McCain variety are more interested in picking winners and losers than in facilitating free and healthy competition. Besides, the federal government and industry are separated not by a brick wall but by a revolving door. Witness the multiple Obama aides who have recently become high-dollar lobbyists and speech-givers, or the radical (possibly criminal) former head of the EPA, Lisa Jackson, who has gone to work for Apple as an “environmental advisor.” The business of America is no longer business—the business of business is no longer even business, at least not as traditionally understood. 

Instead, the business of far too many people in business is using government to obtain unfair advantages, often by hiring people who not only understand “the system” but whose very presence may deter their friends who remain in government from persecuting their new employers. 

Business types are too busy playing along, not realizing that they are petting an uncontrollable leviathan, hissing greedily at the sight of other people’s money, with absolutely no sense of rationality, morality, or loyalty. Government will “play nice” with Apple and other corporations until politicians think they can get more money into federal coffers and power into their own hands by playing rough.

Unless and until corporations stiffen their spines enough to resist the likes of Sen. Levin—something that is likely to happen only if the American public’s vertebral columns suddenly begin to harden as well—the prospects for sensible corporate tax reform, or even an informed national discussion of the subject, are remarkably bleak. Even President Obama admits that America’s high corporate tax rate harms our nation. But Democrats’ true goal is redistribution, so desperately needed reform is shamefully unlikely. 

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About the Author
Ross Kaminsky is a self-employed trader and investor and is a senior fellow of the Heartland Institute. He is the host of The Ross Kaminsky Show on Denver's NewsRadio 850 KOA on Saturday mornings from 6 AM to 9 AM. You can reach Ross by e-mail at rossputin(at)rossputin(dot)com.