Apple on the Hill: What Can Be Learned From Yesterday's Hearing

"... we are deeply committed to our country's welfare." -- Apple CEO Tim Cook at a hearing yesterday focused on the company's extensive tax avoidance.

OK... I've got no reason to question that assertion. I suspect Mr. Cook and other execs over there are thoroughly patriotic. But they are also unquestionably "deeply committed" to their bottom line and their shareholders, as they should be. And herein lies the problem: it's at the intersection of our broken business tax code and the competing interests of our nation's welfare and corporate profitability.

There are lots of reasons why we want innovative businesses like Apple -- the senators fell over each other to tell Cook how much they love their iPads -- to be profitable. It invokes the virtuous cycle of innovation, consumer satisfaction and demand, growth, innovation, etc. But part of that cycle should also spin off revenue to support the nation's welfare, not least of which are its public goods that educate the future workforce and support the public infrastructure that's complementary to corporate success. Even global companies like Apple, with two thirds of their revenues from abroad, need quality roads and ports and airports and water and (especially) communications systems.

The current tax code -- specifically the treatment of overseas earnings -- breaks that last part of the cycle. Innovative, global firms are perfectly able to achieve great success re sales, profits, and share prices. That's why it's always so discordant to me to hear them complaining all the time about taxes and regulations. But because they can indefinitely shield their foreign profits from U.S. taxes, meanwhile engaging in endless (legal) schemes to avoid taxes in countries where they book those earnings, the link between the profitability of American companies and the well-being of America is broken.

Moreover, the fact that multinationals have such a pronounced tax advantage over solely domestic firms creates a deeply perverse incentive to produce abroad versus here.

I grew up in an era where you could make a case that what was good for GM was good for America. As they did better, their products made us better off, and they in turn helped to pay for the public goods that are essential to improving living standards in an advanced economy. But can you make that case today? Yes, many enjoy Apple products -- I'm a PC guy, so perhaps I should recuse myself from this whole debate -- but the feedback loop just described is broken.

In that regard, when Cook says "we don't depend on tax gimmicks" he's being far less credible than in the opening quote above. In between gushing over cool apps:

... lawmakers accused Apple of setting up an elaborate system overseas to stash cash and avoid tax payments on at least $74 billion in profits between 2009 and 2012, facts that were uncovered in a Senate investigation on Monday.

The problem isn't Cook or Apple. They're following the incentives we've set up for them and they alone cannot resolve the split those incentives engender between country, profits, and shareholders. Therefore, instead of wasting time with these types of ambiguous investigations, what Congress should be asking is how can we shut down the vicious cycle and restart the virtuous one?

As economist Eileen Appelbaum points out here, moving to a territorial system, where foreign profits go largely untaxed at home, would only deepen the already too-strong incentives to produce abroad. A better idea is to close the deferral loophole and use some of the extra revenue to lower the rate. Eileen links to another interesting idea that's getting more attention: moving international firms to an apportionment model. Under that framework, a firm's liability in a given country would be determined by their share of sales, employees, or property (or some combination of those shares) in that country. This immediately shuts down offshore Cayman accounts since none of those factors exist on those lovely beaches.

Those are the directions to go with corporate tax reform. The guiding principle here should not be to haul executives in front of the Senate so that they can profess their love of country. It's to craft a code that puts their money where their mouth is.

This post originally appeared at Jared Bernstein's On The Economy blog.