The corporate push to pay ever lower amounts in taxes and wages has reached a tipping point and the backlash could ultimately harm the businesses themselves, writes Daniel Gross.
APPLE always seemed like the perfect company. Not so fast. When CEO Tim Cook testified before the US Congress on May 25, he didn’t come to talk about Apple’s latest amazing gadget or the need to grant more visas to computer programmers. Rather, in his maiden voyage to the parliament as Steve Jobs’s successor, Cook had to defend the company’s tax-avoidance efforts. What should have been a triumph for Cook was instead an awkward encounter.
The senate sub-committee documented the ways in which Apple avoided billions of dollars in US taxes by funnelling activities through subsidiaries in Ireland, where it paid about 2% tax and where some Apple subsidiaries appeared to be the business equivalent of duty-free zones — residents of no country and, hence, immune to taxation.
So Cook was left defending the company by waving around its progressive bona fides. “We believe in President Kennedy’s phrase ‘To whom much is given, much is required’.” By turns humble and combative, he noted that Apple paid about $6bn (€4.6bn) in US taxes in 2012. “We expect to pay even more this year,” he added. “We pay all the taxes we owe.”
But both Democrat and Republican senators said Apple has a superior tax-planning department that is a source of profits no less important than the beautiful, simple interface of the iPad.
Corporate America has never been more profitable or had more cash. It dominates labour, bosses around the political system, and manipulates the tax code the way Yo-Yo Ma plays the cello. Corporate profits have soared from $1.1tn in 2008 to $1.95tn in 2012 — up 77%. The amount of cash on companies’ books has risen from $1.39tn in 2008 to $1.79tn in the fourth quarter of 2012 — also a record. The stock market has more than doubled since Mar 2009.
And yet this year, a set of seemingly unconnected events — the unmasking of America’s most admired company as a serial tax avoider, the collapse of a factory in Bangladesh, empty aisles and falling profits at America’s largest retailer, the relentless legal pursuit of hedge-fund titan Steven Cohen — shows that businesspeople can, and often do, take things too far. In other words, it seems that corporate America may be in danger of becoming too brutally efficient for its own good.
The single-minded pursuit might endanger even a strong brand such as Apple, which otherwise epitomises the socially progressive Silicon Valley ethos. But then Apple also epitomises the profit-at-all-costs mentality that drives technology leaders today.
Karen Brenner, of New York University’s Stern School of Business, notes that the law tends to lag business practice, leaving wide loopholes. “When that’s the case, companies are left to their own decision-making processes on what is right, compared with what is legal.” And as the Cook hearing showed, what is technically legal might not pass the smell test.
It’s not just Apple. Today’s corporate culture is one in which the smart, well-connected, and the wealthy seemingly can’t resist taking that extra step to squeeze a few more pennies out of the system. This habit has morphed into pathology. Drive 30% of your revenues through an offshore tax shelter this year, and why not push half of all your business through the next? Pay a 15% tax rate on your vast income in 2011, and the temptation is to lower your rate to 14% next year. Find workers in China willing to assemble garments for $114 a month this year, and switch production next year to Bangladesh, where workers will do the job for $38 a month.
In his book The Fracturing of the American Corporate Elite, sociologist Mark Mizruchi says the corporate brakes on unethical behaviour are gone. Unions are becoming irrelevant, corporate boards are somnolent, and regulators and politicians — when they’re not abetting corporations — are mostly catatonic.
Meanwhile, hordes of lawyers, accountants, and consultants are standing by to help drive profit ever further, ever wider. Not only does our culture celebrate and laud those who make obscene amounts of money, the market demands this type of behaviour.
Today, American companies are keeping a total of $1.9tn in profits offshore where they can’t be taxed, an increase of 70% in the past five years.
Many smart companies — HP, Microsoft, Google — engage in similar tax-avoidance activities. Facing the threat of consumer boycotts in Britain over tax-reduction strategies that left it with no liabilities, Starbucks last December volunteered to pay £10m (€11.6m) in taxes.
If there are loopholes wide enough to drive one cash-filled Brink’s truck through, corporate accounting departments will drive 10 trucks through. So long as it’s legal, what’s the problem?
That’s capitalism. And there’s something very American about this. Latch on to a profitable idea and make it huge, whether it’s a burger chain or a smart tax-avoidance strategy.
But we may have hit a breaking point. Corporate profits as a percentage of gross domestic product are at a record high, while corporate taxes as a percentage of GDP continue to fall.
Mitt Romney personifies how legal-but-dodgy can harm one’s reputation and ability to produce results. The phenomenally wealthy financier owed his nine-figure fortune in large part to a wrinkle in the tax code that gives hedge funds and private-equity firms a preferential 15% rate. Romney’s accountants scoured the tax code for ways to reduce his liabilities further and a retirement fund worth more than $100m.
For the private Romney, these moves were genius. For the public Romney, they were disastrous.
There’s no earthly reason that a guy worth more than $250m needed to put money offshore or engage in legal behaviour that would put his presidential aspirations in jeopardy. But today’s corporate hotshots can’t help themselves. They skirt up to the edge of the law, and occasionally go over it.
Billionaire hedge-fund manager Steve Cohen and his Connecticut-based firm, SAC Capital, have racked up stunning annual returns — 30% or more — for the past several years. Cohen’s relentless push for higher returns has made him phenomenally wealthy (No 40 on the Forbes 400).
But long-running insider-trading investigations of SAC, its affiliates, and current and former employees have taken a toll on the company. In March, SAC paid a record $600m fine to settle federal charges over insider trading.
The too-successful search for low costs and high profits can be bad for brands and individual companies. As wages in China have risen, garment manufacturers have looked to Cambodia, to Laos, to Sri Lanka, and finally to the dark satanic mills of Rana Plaza in Bangladesh, where 1,123 workers earning as little as $38 a month paid with their lives. Retailers like the Children’s Place and JCPenney, who saved a few pennies per garment because their contractors and subcontractors sourced products in Bangladesh, suffered black eyes.
Apple was able to rack up huge profits on its devices because it outsourced manufacturing and assembly to China. But when press reports detailed tough working conditions at one of its main contractors, Foxconn, Apple’s brand was bruised. And the costs incurred in such cases are often greater than the costs they hope to avoid, notes Michael Gordon, chief executive officer of crisis-communications firm Group Gordon. “Companies that would otherwise have a halo on them are getting tagged with these things that are hurting them reputationally for the long term.”
There are also macroeconomic effects. Since the recession, companies have realised that if they freeze, or even cut wages, workers will still show up and toil just as productively.
The equipment manufacturing company Caterpillar, where profits soared from $895m in 2009 to a record $5.68bn in 2012, last year settled a strike with union workers. The deal included a six-year wage freeze.
This isn’t unusual. The chart showing wages as a percentage of GDP against corporate profits over the last several years looks like the gaping maw of a hippopotamus. Wages were 43.5% of GDP in 2012, down from 49% in 2001, and a modern-day low. US median family income has actually fallen since 2009.
But the strategy of beggaring American workers for the sake of short-term profits may have reached its limits at America’s biggest retailer.
“Where are all the customers?” read a plaintive email from a Walmart executive that leaked in early February. “And where is all their money?” Once the epitome of hyperfunctioning America, Walmart is an increasingly plagued by empty aisles, empty shelves, and falling sales.
The problem for Walmart, and for many other retailers, is that wages simply aren’t growing. According to the Bureau of Labor Statistics, average hourly earnings are up just 1.9% in the past 12 months. And that’s partially because America’s largest private-sector employer has been too effective at keeping domestic labour costs down. Walmart employs 1.4 million people in the US. The company says the average wage for its associates is about $13 an hour. Because it is so big it sets the standard for retail wages.
“Today we are really seeing the limits of the ultra-low-wage model that Walmart pioneered. Workers are consumers, and when they aren’t paid enough to buy goods, the economy can’t grow,” said Amy Traub, senior policy analyst at the Manhattan-based think tank Demos. “We end up trapped in a vicious cycle of low growth, and companies that persist in trying to cut labour costs further only make matters worse for themselves.”
Companies have become incredibly successful at shucking historical, profit-reducing obligations — paying decent wages, paying taxes, providing benefits. But in pursuing tax avoidance and cost-cutting strategies to their logical conclusions, companies often lose sight of a basic truth.
Paying taxes, generally sharing the wealth, and living up to social responsibilities aren’t a matter of public relations or “optics”, to use a favoured business term. They’re matters of legitimacy. And the offensive actions cause companies to lose legitimacy and social license.
When Cook and his colleagues testified, senators were respectful of Apple as a corporate force and an innovator but derisive of its claims. Even Cook seemed to acknowledge that his company had taken it too far. “Apple has always believed in the simple, not the complex,” Cook said. “It is in this spirit that we recommend a dramatic simplification of the corporate tax code. We make this recommendation with our eyes wide open, fully recognising that this would likely result in an increase in Apple’s US taxes.”
Apple’s tax bill has shrunk so low, Cook seemed to be saying, that the only place for it to go is up.
The same is likely true for the thousands of companies that view Apple as an example to emulate.
* Daniel Gross is global business editor at Newsweek Daily Beast.
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