THE BLOG
11/09/2012 09:46 am ET Updated Jan 09, 2013

Simple Math: How Corporations Are Getting a Free Lunch From Uncle Sam at Our Expense

Now that the contentious race for the White House is finally over, the American government can get back to governing and the private sector can get back to business. That is all good except for the fact that we still have a steep fiscal cliff looming ahead of us as well as a massive disagreement on taxes that is not going to be easy to resolve.

At the heart of the tax dispute lies the issue of fairness: should so-called job creators pay lower tax rates than low and middle income Americans? The answer to this is not simple and will not be found in ideology. The real test has to be conducted on the basis of dollars and cents, since that is really what impacts our economy; and since corporations are notoriously creative in taking advantage of tax loopholes, they are a good proxy to determine if our current system is helping or hurting us.

To figure this out, I looked at one of our most revered corporations, Apple Inc. While this hypothetical cost-benefit analysis is very broad and while Apple is simply an illustrative example, it does offer insight into what is wrong with our tax code (all actual numbers are from Apple's 10-K and website; the assumptions and calculations are mine).

Let's start with how much Apple does not pay in taxes on just one part of its income stream.

Cost
For the latest fiscal year, Apple paid only a 1.9% tax rate on its earnings outside the US, or $713 million on income of $36.8 billion. Given the US corporate tax rate of 35%, what this means is that the company was allowed to withhold almost $12.2 billion from the US Treasury in 2012. As an aside, Apple does account for possible taxes in the future but is unlikely to ever pay them.

Benefit
Now let's look at what Apple might do with this surplus cash and how that will benefit our economy. To be fair to the company, I will assume that it will use as much cash as it reasonably can for the development of new products, new hiring, and sales.

For the past couple of years, Apple's Research & Development expense has remained at a steady 2% of net sales. Let's increase that to 3% for next year - a 1% bump. Also, since the company's net sales grew by 66% in 2011 and 45% in 2012, let's assume that 2013 net sales will show growth of 50%, rising to $235 billion. A 1% increase in R&D expense then translates into an incremental $2.4 billion.

On the headcount side, the company currently employs 76,100 people in the US, including temporary workers. In addition, Apple claims that it is responsible for generating another 210,000 jobs in related industries. Using the historical correlation between sales and headcount, the company's internal labor force should grow by about 25% in 2013, which should also spur employment in related industries. Let's increase that by yet another 10% (because of the surplus cash), which means 7,600 more Apple employees and 21,000 other workers than in the normal course of business. To quantify this in dollars, let's assume that the average salary for a worker is $35,000 (since most of them work in retail stores or in ancillary roles), which leads to a total economic contribution of $1 billion.

For sales and marketing, let's just throw in an incremental $1.2 billion (0.5% of net sales) although that is generous for this scenario and given that the company's Selling, General, and Administrative expenses have declined as a percentage of net sales for the past two years.

Finally, let's compute the additional profits Apple might make by rolling out new products and by hiring 7,600 more employees - and what that means in tax revenues for Uncle Sam... Using the pre-tax profit per employee from 2012 of $730,000, we get to $5.6 billion in new profits and $1.4 billion in new taxes because of the 25% effective tax rate the company pays in the US.

Bottom Line: Cost > Benefit

Based on the above analysis, Apple might contribute around $6 billion back to our economy while saving $12.2 billion in taxes. That still leaves the US with a $6+ billion shortfall!

Granted some of that cash might be used for making acquisitions but more likely it will just sit on the books or be used for things like share buybacks and dividends, both of which are taxed preferentially at 20% and do not necessarily benefit our economy dollar for dollar. The other thing to keep in mind is that the assumptions I used are highly bullish for today's slow economic climate; in the real world the shortfall could be much larger.

What all this says, obviously, is that while most American taxpayers have no option but to pay 35% or more in taxes every year, businesses like Apple are able to hold onto much more of their cash and that those savings are not guaranteed to be invested back into our economy. That money is falling through the cracks of our system, and ultimately being subsidized by those who are paying their fair share of taxes and keeping the engine of our nation running. That is not capitalism but discrimination, and to use the favorite catchphrase of the Republicans, "redistribution of wealth".

The business world loves to claim that there is no such thing as a free lunch, and yet our corporations seem to be enjoying exactly that, at our expense. I vote we shut down these expense accounts and restore fairness to the tax code. We just re-elected a President who has vowed to eliminate inequality in our country. I think this would be a great place to start.

SANJAY SANGHOEE has worked at leading investment banks Lazard Freres and Dresdner Kleinwort Wasserstein as well as at a multi-billion dollar hedge fund. He has an MBA from Columbia Business School and is the author of a financial thriller, entitled "Merger", which Chicago Tribune called "Timely, Gripping, and Original". Please visit www.sanghoee.com for details.