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“Separate But Unequal”: Why Do We Tax Ourselves Today So Apple Can Pay Its Taxes Someday?

The richest of the rich are different from you and me because instead of paying taxes, Congress lets them pay interest.

This little-known difference was on full display before the Senate Permanent Investigations subcommittee this week, though you would hardly know that from the news reports of testimony by Apple CEO Tim Cook and his top finance and tax executives.

The reality is that America has two income tax systems, separate and unequal. And as with all such separate and unequal systems, the powerful benefit by sticking everyone else with the costs.

The system is so unequal that corporate tax departments at the biggest multinationals have been transformed from cost centers into what Enron called its tax office: a profit center.

To most Americans, taxes are an expense. The idea that a tax can make you richer may seem hard to believe, but as the Apple executives showed in their testimony, it is standard operating procedure these days.

But instead of reporting this, we got mostly fluffy political stories. The New York Times account was typical, focusing on how Cook so charmed senators he had them “practically eating out of his hand.”

What Apple is really doing is eating your lunch.

Let’s start with how Congress taxes most people. It does not trust them to report their incomes in full or to pay their taxes, and with good reason since numerous studies show that a third or more of self-reported income simply does not get written down on income tax returns.

We all know this as the “underground economy” of people who get paid in cash; clean pools, cut grass or sell another type of grass. (Many drug dealers, however, report their incomes in full knowing that if they get caught dealing and cheating on their taxes their prison terms will be longer.)

People who work, and pensioners, have their taxes taken out of their checks before they get paid — which is why we call the shrunken cash that we pocket “take-home pay.”

Because Congress also does not trust workers and retirees to report their incomes in full, it requires their employers and pension plans to verify how much they make. The Social Security Administration adds up all the W-2 wages-paid forms for people with any paid work. In 2011 there were 151,380,759 people who earned  $6,238,607,249,941.26, which would usually be written up as $6.2 trillion.

Congress also says you can defer tax on money you save in a 401(k) plan if your employer offers one, a maximum of $23,000 for older workers. If you do not have a 401(k) you can save no more than $6,000 this year and pay taxes when you withdraw.

In other words, you get fully or almost fully taxed when you earn.

But Apple operates under very different rules. At the end of March it has more than $102 billion of mostly untaxed profits. If Apple were a worker it would have paid the federal government $36 billion in taxes.

Instead of paying taxes, Apple has taxes that are deferred for as long as it chooses.

In total, I estimate from corporate disclosure documents, American multinational companies have $2 trillion of untaxed profits offshore because they did just what Apple has done.

Had Congress required those companies to pay up last year it would have been the equivalent of all the income taxes paid by everyone in America from January until July 10. Imagine that, all the income taxes taken out of your pay or pension from January into the middle of summer just so Apple and other multinational companies can profit today and pay their taxes someday.

The $700 billion of income taxes that would have come due without deferral would also have reduced the federal budget deficit last year by more than two-thirds. Instead, the federal government borrowed a little more than a trillion last year to pay its bills.

In effect the federal government loaned Apple the $36 billion in deferred taxes at zero interest. Imagine how rich you would be if you could keep all the income taxes withheld from your paycheck this year and then pay the money, interest-free, 30 years from now.

Because taxes deferred are at zero interest, inflation erodes the value of the taxes owed. If Apple waits 30 years and then chooses to pay its taxes the government will get the equivalent of 40 cents on today’s dollar, assuming 3 percent annual inflation.

Meanwhile, Apple will be investing that $36 billion, earning interest. If it earns 3 percent in 30 years, it will have more than $87 billion.

Now jump forward to 2043. Apple pays $36 billion in taxes from its $87 billion cash pile, leaving it with $51 billion after taxes in 2043 dollars.

As advisors to the very wealthy teach their clients, deferring a tax for 30 years is the functional equivalent of not paying any tax.

In the textbook version of events, that huge pile of untaxed profits that Apple keeps offshore cannot be put to work in America. In reality here is what happens:

—Apple has its tax haven subsidiary deposit the money in the United States at a too-big-to-fail-bank, eliminating any risk of loss it would incur with smaller banks.

—Apple has the American bank buy U.S. Treasury bills, notes and bonds so that its untaxed profits, which force the government to borrow, earn interest.

—Apple can also borrow from itself, making short-term loans from its many separate piles of untaxed offshore profits to fund any operational needs in the U.S.

—Rather than tap its $102 billion of offshore cash, Apple sold corporate bonds for periods of up to 30 years at less than 2 percent interest.

As Cook explained to the senators, why pay taxes at 35 percent when you can borrow at 2 percent? Cook is right from a financial perspective. At 2 percent, the interest on the interest, measured to infinity, will never equal the 35 percent taxes avoided.

But here is the best part of the whole deal, which Cook and Peter Oppenheimer, Apple’s chief financial officer, explained to the senators, but the news media neglected to report.

Apple turns some of the profits it earns inside the U.S. into tax-deductible expenses, which it pays to its offshore subsidiaries.

Now, if you move a dollar you earned from your right pocket to your left, nothing significant happens. Your wealth is unaffected and your tax bill is unchanged.

But Apple and other multinationals have an American right pocket, from which they pull cash to put in their Irish, Cayman Islands, Singaporean and other left pockets. When they do that the profit goes poof on their tax return and a tax deduction gets added.

Accountants use black ink to show profit, and red for losses and expenses. This modern accounting scheme is what the alchemists of old sought, hoping to turn lead into gold. But unlike the fictional philosopher’s stone, this alchemy works.

So, to review, you get taxed before you get paid and can set aside only modest sums with the taxes deferred until your old age.

Apple and its corporate peers get to earn profits now, but pay taxes decades into the future and possibly never, while earning interest on the taxes it defers into the future — interest you must finance as a taxpayer through higher taxes, reduced government services or more federal debt.

The one place Apple cannot escape taxes is on the interest it earns on its untaxed hoard of offshore cash, as Apple’s top tax officer, Phillip Bullock emphasized to Senator Carl Levin, the Michigan Democrat who chairs the investigations panel.

Levin’s staff, its reports issued with bipartisan support, also found that Apple did owe some foreign taxes on profits it earned overseas.

It pays the Irish government a corporate tax rate of 2 percent under a deal made in 1980 when it was a pipsqueak company. On some other earnings its tax rate is 0.05 percent – that is a nickel on each $100 of profit.

Rich individuals – very, very, very rich individuals – get to do the same thing: earn now and be taxed much later, if at all, by paying interest on borrowed money instead of paying taxes.

There are different techniques to defer, delay and escape paying income taxes for executives, business founders, managers of hedge and private equity funds and movie stars, all of which will be explained in future National Memo columns.

One of these techniques explains in good part why companies have been slashing health and retirement benefits for workers – because it masks the real costs of letting executives earn now and pay taxes either later or never.

Another explains why Mitt Romney was never going to release his income tax returns for the years he ran Bain Capital Management, the private equity fund that made him rich.

But the bottom line is the same – America has two tax systems, separate and unequal. There is a word to describe such systems: un-American.

There is also a question to ask: Why do we tax ourselves today so Apple can pay its taxes someday?

 

By: David Cay Johnston, The National Memo, May 23, 2013

May 24, 2013 Posted by | Congress, Taxes | , , , , , , , | Leave a comment

   

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