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Friday, July 22, 2016

A bet with Tim Worstall on Apple's state aid repayment

Tim Worstall, a contributor at the Forbes Magazine website, wrote a column Thursday wherein he challenges all comers to a bet on the outcome of Apple's state aid case I discussed Sunday. He repeated the challenge to me specifically in the comments section of my post, and I accepted. It's for bragging rights only (I think I'd prefer for the prize to be a beer next time I go to London, oh well).

Worstall's angle is that he believes winning the bet shows he has a better understanding of the issues than I do.That's conceivable, but not necessarily true. In particular, he challenges my emphasis on
Ireland's creation of a corporate entity that is taxable nowhere, and the possibility that the company negotiated a tax rate far below the country's already-low 12.5% corporate income tax rate.
The thing is, we have strong evidence for what the case is about: The Commission decision that started this Article 108(2) detailed investigation. So let's turn to the decision and see what the Commission says it is investigating.

As paragraph (or "recital" in legalese) 6 states, this investigation revolves around transfer pricing (i.e., between different Apple subsidiaries) agreements called "advance pricing arrangements" or APAs. APAs are precisely the result of negotiations. Here is what the New York Times says about Apple Operations International:
Atop Apple’s offshore network is a subsidiary named Apple Operations International, which is incorporated in Ireland — where Apple had negotiated a special corporate tax rate of 2 percent or less in recent years — but keeps its bank accounts and records in the United States and holds board meetings in California.
Worstall is correct that these negotiations do not change the official tax rate of 12.5%; what they change is the effective tax rate. What the APAs do is reduce the amount of earnings of Apple Operations Europe (a wholly-owned subsidiary of Apple Operations International) and Apple Sales International (a wholly-owned subsidiary of Apple Operations Europe) -- I'll get to the details in a moment -- and these artificially derived profit numbers are then taxed at the standard rate of corporate income tax, 12.5%. To get the effective tax rate of under 2%, as cited by the NYT, is to claim that the tax paid (12.5% of the amount of profits as determined under the APAs) is actually less than 1/50th of the true profits these subsidiaries earned.

To take a numerical example, let's say that Apple Operations Europe made $625 million in 2015. However, under its advance pricing arrangement, let's say AOE is only deemed to have $100 million in profits for the year (we'll see how in a minute). AOE then pays 12.5% tax, or $12.5 million, in Irish corporation taxes. But 12.5/625=2%, so its effective tax rate is 2%.

So, when Worstall says this state aid case is not about a negotiated tax rate, he is not replying to what Apple's critics are actually saying.

How does Apple get its profit determined for the two subsidiaries with APAs? There are four separate rulings by the Irish government, two in 1991 (one for each company) and two in 2007 (one for each company). We'll take the 1991 APA for Apple Operations Europe as our example to show the main ideas. According to paragraph 31,
the net profit attributable to the AOE branch would calculated as 65% of operating expenses up to an annual amount of USD [60-70] million and 20% of operating expenses in excess of USD [60-70] million.
 When you think about this for a minute, you realize that this is a very odd formula for calculating "profit." Usually, we'd think about it as sales minus costs. This formula does not mention sales at all! So it's not surprising that it could give a figure far from what we would consider the true profit of Apple Operations Europe. For the record, AOE's 2007 formula does mention sales of intellectual property (paragraph 32), but neither the 1991 or 2007 formula for Apple Sales International uses sales in its calculation (paragraphs 33-34). Ho-kay!

Indeed, in its detailed analysis, the decision says that the formula for AOE was "reverse engineered" to allocate a specific profit number to the subsidiary (paragraph 61).

What about the non-tax resident company structure? Again, Worstall denies it's relevant here. But in fact, both Apple Operations Europe and Apple Sales International (and Apple Operations International, for that matter, though it's not a direct target in the case) are incorporated in Ireland but are not tax-resident there (paragraphs 25 and 27). These are the only Apple subsidiaries in Ireland that are not tax-resident in Ireland (paragraph 19). So this case wouldn't exist without this very unusual corporate structure.

To sum up, I believe that Worstall has misunderstood the reasons for the case given in the decision to open a detailed investigation. As I pointed out two years ago, if the Commission opens an investigation, it almost always finds that state aid was given, and that it is not compatible with the common market. So I am quite confident Apple will lose the case. Unless the Commission unexpectedly changes its mind on the importance of regulating fiscal aid, I am also confident that I will win my bet with Worstall. We'll know soon enough.

Sunday, July 17, 2016

We will soon know if Apple is ordered to pay billions in EU state aid case UPDATED

$19 billion? $8 billion? A few hundred million? Estimates are all over the map regarding the European Commission's imminent decision on whether Apple received illegal, unnotified state aid (subsidies) from Ireland. As I mentioned two years ago, two factors go into the Commission's claim: Ireland's creation of a corporate entity that is taxable nowhere, and the possibility that the company negotiated a tax rate far below the country's already-low 12.5% corporate income tax rate.

As you may remember from earlier posts, if the Commission rules against Apple, the sanction it will impose will be the repayment of the illegal subsidies, with interest. Some estimates of Apple's tax savings are astronomical (the New York Times reported an estimate Apple saved $7.7 billion in 2011 alone), which creates the possibility of an extremely high repayment order. On the other hand, recent cases have seen relatively low repayments, such as the mere 30 million the Commission ordered Starbucks to repay the Netherlands last year. Still, it is perfectly possible that the Commission used smaller cases as a way to establish the legal precedent regarding fiscal aid before dropping the bomb on Apple.

It's worth noting, as reported by Bloomberg, that the largest state aid repayment order ever made was approximately €1.4 billion charged to √Člectricit√© de France, followed by two orders in the €1 billion range. When this decision is announced, we may see a new record by a large margin. Or maybe we won't. Either way, the Commission will be giving us a clear sign regarding how seriously it intends to treat fiscal aid abuses.

Update: For a little perspective on fines, Chillin' Competition (via email) points out that the European Commission has just imposed an anti-trust fine on four truck manufacturers of over 2.9 billion , a new record.

Cross-posted at Angry Bear.

Wednesday, June 29, 2016

New book on investment incentives will help shape policies debates for years to come

This past week I received my chapter author's copy of a new book from Columbia University Press, Rethinking Investment Incentives: Trends and Policy Options. Based initially on the November 2013 conference on investment incentives at Columbia Law School, the contributors were put through their paces to upgrade their conference presentations into proper papers. The result is what Theodore Moran of Georgetown University calls in the Foreword "a who's-who of experts across this broad span of topics." He predicts, and I concur, that the work presented in this book will help drive policy discussions around the globe.

The book is divided into four parts. The first discusses theoretical debates on definitions and the effect of these incentives on (especially) foreign direct investment. The second section provides a global overview of the use of incentive incentives, both in major economies and in developing countries. Part III includes practical tools for ensuring program effectiveness as well as value for money. This includes a chapter on cost-benefit analysis, a methodology of which I am highly skeptical. As I have written before, if you end this analysis at the state (or city!) border, you miss many of the indirect job losses inflicted at competing companies by the addition of new subsidized competition. Indeed, according to economist Tim Bartik, very few subsidy programs have positive *national* effects, even if they have positive local effects that will be the only thing considered in the cost-benefit analysis.

Finally, the fourth part of the book considers ways to reduce the competitive use of investment incentives to attract investment. My chapter falls in this section, considering the control of subnational incentives in Australia, Canada, and the United States. (Spoiler: Most of the record is not pretty; Australia was an exception but the policy expired in 2011.) A variety of supranational regulatory efforts, including most notably that of the European Union, are considered in a chapter by Lise Johnson.

Have I teased you enough yet? This book is a must-have if you are interested in investment incentives and economic development; co-editors Ana Teresa Tavares-Lehmann (University of Porto, Portugal), Perrine Toledano, Lise Johnson, and Lisa Sachs (all of the Columbia Center for Sustainable Investment) are to be congratulated for the fine product.

Tuesday, May 31, 2016

Subsidy Tracker Reaches Major Milestones

Subsidy Tracker, the free subsidy database created in 2010 by Good Jobs First, has reached major milestones in its coverage of state, local, and federal subsidies.

This month's enhancements to the database bring it to a once-unimaginable 500,000 individual incentive awards with a cumulative nominal subsidy value of $250 billion! That's starting to add up to real money!

I explained two years ago how to use the data from Megadeals or Subsidy Tracker to compare a proposed economic development incentive package with past subsidies given in the same industry to get some idea whether the proposal represented a gross overpayment for a given investment. This method relies on finding good matches by industry, location, unemployment rate, and so on. The more deals available to search means your chances for finding good comparables improves proportionately. This can only enhance the ability of citizens' groups, labor organizations, etc., to independently analyze proposed costly incentive packages.

As Philip Mattera, Good Jobs First Research Director, says, the steady expansion of Subsidy Tracker "reflects the improvement in government transparency over the past decade." I can personally remember when the first statewide transparency law was passed in Minnesota in 1995; transparency has improved exponentially since then, although there is much progress that still needs to be made.

One notable recent innovation in Subsidy Tracker is a matching system to determine the ultimate corporate parent of subsidy recipients. According to Mattera, it now includes 2,606 parent companies, a threefold increase since 2014. This is critical information, given that so many companies hide their corporate connections through misleading names.

Although transparency remains an elusive goal, it's worth celebrating successes when they occur. Cheers!

Cross-posted at Angry Bear.

Sunday, May 8, 2016

Kansas City event analyzes the border war

As I noted last time, there is finally a real possibility that the $200+ million job piracy border war between Kansas and Missouri could have a real, legally binding truce. As we wait to find out if this materializes, American Public Square in Kansas City is sponsoring a public forum Wednesday, May 11, at the Plaza Branch of the Kansas City Public Library at 6:00pm.

"Cents and Sensibility" will examine the pluses and minuses of economic development subsidies, turning to research on the effects and effectiveness of these incentives, whether it can be justified to give subsidies to private enterprises, and who benefits from subsidy programs.

I will be taking part in this event, which has an interesting format: no presentations, just questions from the get-go, and a roving reporter who acts as a real-time fact checker. The other panel participants are:

Bill Hall, President, Hall Family Foundation
Michael Farren, Research Fellow, Mercatus Center, George Mason University
Moderator: Dr. Scott Helm, Director of the MPA program at UM-Kansas City's Henry W. Bloch School of Management
Roving Reporter: Steven Steigman, Chief of Broadcast Operations, KCUR 89.3

Be there or be square!

Monday, April 18, 2016

Breakthrough in Kansas-Missouri Border War

Via @goodjobsfirst, we learned Friday that Kansas Governor Sam Brownback had made a major response to Missouri's proposed jobs truce in the Kansas City region.

As regular readers may recall, studies have shown that more than $200 million has been spent moving jobs back and forth across the state border in the Missouri and Kansas counties surrounding Kansas City. This is to create 0 new jobs. Despite this being perhaps the country's second-largest border war after the New York City area, Governors Jay Nixon (D-Missouri) and Brownback (R-Kansas) in December 2012 both told New York Times reporter Louise Story, on camera, that they had no plans to end the incessant job piracy.

Nevertheless, in July 2014, Nixon did an about-face, signing a bill from the majority-Republican legislature to end the availability of state subsidies to be used for such job poaching. Unlike the voluntary no-raiding agreements I have discussed on previous occasions (Council of Great Lakes Governors, NY-NJ-CT, Kansas-Missouri, and even Australia's Interstate Investment Cooperation Agreement), this has the force of law. The four counties making up Kansas City would be completely barred from using state subsidies to give relocation subsidies to companies in four bordering Kansas counties, if Kansas passes comparable rules.

Now, facing an August 2016 deadline in the Missouri law for the truce to take effect, Brownback ordered the Kansas Department of Commerce to disapprove PEAK (Promoting Employment Across Kansas) subsidies for job piracy, and asking for legislation to formalize this policy.

Brownback's proposal differed from the Missouri law by allowing PEAK subsidies (and the corresponding Missouri Works program) to be used for piracy if a company invested at least $10 million in new construction. While this means really large projects would not be affected by the truce, it would kill off the dozens of deals made by what Brownback called "lease jumpers," who simply move from a leased facility in one state to a leased facility in the other to cash in on the subsidy programs.

Good Jobs First today lauded the progress on the truce, noting the five years of both public and behind-the-scenes work by Hallmark and 16 other prominent Kansas City companies to promote sanity. Good Jobs First, of course, has conducted a great deal of research on job piracy, including the 2013 report, The Job-Creation Shell Game. Executive Director Greg LeRoy expressed hope that this potential agreement would be "a wake-up call" for the National Governors Association, which he called "MIA" on the issue of job piracy since 1993.

This is not yet a done deal. However, the proposal to meet legislation with legislation would create an unprecedented advance in stopping job piracy.

Monday, April 4, 2016

It's official - Icelandic bankers have been jailed

If you've been following this blog over the last few years, you know that Iceland took the dramatic step of prosecuting top officers at the country's big 3 banks, all of which were allowed to go bankrupt in the wake of the 2008 financial collapse. Unlike Ireland, it did not turn bank debt into government debt, which increased Ireland's debt by close to 100% of gross national product (GNP) overnight. Though hit hard by the 50% drop of the krona, Iceland has managed a remarkable, though still incomplete, recovery marked by its renewed ability to borrow in foreign currency with less than a 1% risk premium and by achieving unemployment rates that Eurozone countries can only envy.

What you wouldn't know, if you just been looking at the headlines (Google "Iceland jails bankers" and you'll see what I mean), is that Iceland had not actually been jailing bankers. Here's a typical one from the BBC, "Iceland jails former Kaupthing bank bosses" (12 December 2013). In fact, nobody went to jail at that time: They were convicted, but all four Kaupthing officials appealed their sentences. If you search similarly titled stories, you will see that headline "jailings" were either convictions, or an affirmation of these lower court decisions by the Icelandic Supreme Court, neither of which actually led to immediate jailings. Indeed, one of the "Kaupthing Four," as they are now called, was living in Luxembourg (he had headed Kaupthing's Luxembourg branch), and I wondered to myself if could even be compelled to return to Iceland to serve his sentence.

Now I am happy to report that the Kaupthing Four are finally in jail in a minimum-security prison with only one road connecting it to the outside world, including the former CEO of Kaupthing's Luxembourg unit who was outside Iceland when his conviction was upheld. There have been an additional 22 convictions now at various stages in the appeals processes, and special prosecutor for the banking crimes, Olafur Hauksson, indicted five more bank officials for fraud and manipulating stock prices just last month.

As Kaupthing was Iceland's largest bank before the crash, jailing its top officials sends a reassuring sign that the rest of those convicted will eventually follow suit. Iceland thereby establishes a precedent we should continue to urge in the United States, United Kingdom, and elsewhere that bankers are not too big to jail.

A note to readers: Bloomberg reporter Edward Robinson had not replied to a request for some clarifications at the time this story was published. If any of you know when the Kaupthing Four reported to prison, whether there are other bankers already in jail, or other useful news, please send along the information and I'll be happy to credit you. Thanks!

Cross-posted at Angry Bear.