Cisco Is Getting a Bad Rap on the Corporate Tax Issue

This is Not Cisco's Fault, it's Congress'

Cisco can't seem to shake the image - at least in blogs - that it's some sort of corporate tax cheat. Nothing could be farther from the truth. Last week Network World Editor Jim Duffy had a generally fair blog on this issue, but the insinuation in the blog (see the last sentence in particular) is that Cisco is cheating the US Government out of money by using smart tax planning (i.e. accountants and lawyers). Brad Reese has always been much more direct about this issue. A couple issues are in play here. First, Cisco is doing nothing illegal. If Congress continues to manipulate the tax laws making it more and more complicated then companies need smart people to figure it out. If Cisco releases complicated new products, don't companies need smart network engineers to figure it out? Cisco is performing tax engineering. This is completely legal and it is smart. Cisco is taking actions to maximize value for shareholders by paying less tax. That is what they are supposed to do. They are not acting illegally or skirting taxpayers or the government. The fix for this is to simplify the tax code and lower the rates. A lower tax rate without any exemptions, perks, carve outs, loop holes, breaks, and deals will remove the need to hire lawyers and accountants (well, to tax plan that is). Cisco's reported income is $10 billion? Great, send 10% to the IRS. Done.

Second, this is about overseas profits, not profits earned in the US. In an very uncompetitive way, the US government taxes profits made overseas in addition to profits made in the US. This would be like buying something in New York City on vacation and having your home state charge you sales tax on the purchase. So, to avoid this extra tax, companies keep their profits overseas instead of bringing the cash back to the US to use it for new investments. Jeff tried to point out that the last time an exception was allowed in 2005 most of the repatriated profits went to shareholders, not new corporate investments. Thus, this is a bad idea. HELLO! What do you think the shareholders did with the money? Stuck it under their mattress? No, they used it to invest in other things! Allowing companies to keep more of their profits - even if they decide to return the profits to shareholders - is always a good idea. That's called capital formation and it is extremely good for the health of an economy.

Finally - and this is a complicated issue so stick with me - is the difference between effective tax rates and marginal tax rates. "Effective" = "average". The corporate tax rate in the US is 35%, but taking in certain tax breaks can lower the average tax a company pays on all profits. At the end of the year when Cisco does its tax return for the IRS the percentage of profits it sends to the IRS is the effective tax rate. But, business decisions are made on marginal tax rates, not effective. Marginal taxes are on the next dollar earned. This is best explained by two analogies: burgers and doctors. Burgers - let's say McDonald's came up with a new marginal pricing (taxing) model for hamburgers. Burger #1 costs you $1. Burger #2 costs $2. But, burger #3 costs $6. Your average (effective) cost (tax) across all three burgers is $3. Not too bad. But wait, you decision to buy that last burger is not $3, it's $6! Are you willing to part with $6 to eat a third burger? Well, I'm just not that hungry. But, your effective (average) price is just $3. Who cares, I'm not paying $6 for a burger. See the difference between effective and marginal tax rates? Doctors - they make decent money. Let's say that doctor keeps his office open 40 hours a week and makes $370,000 a year, just below the top marginal tax rate in the US. The doctor is considering working more, opening on Saturday, hiring another nurse, and making more money. All good to grow the economy. But wait. This new income for the doctor will be in the top marginal tax rate. So, by working more and creating a job and serving more customers, the doctor is going to lose 35% of everything he earns to the IRS. He's thinking, "Let's see, I get one less day off, I have to work harder, and I lose 1/3 of the income. Ah, screw it; I'll just go golfing on Saturday. But, doctor, your effective tax rate this year is only 20%. Yes, but deciding to work more will cost me 35%, not 20%. I'm going golfing." See the difference now between effective and marginal tax rates? Cisco is doing the same thing. Cisco is going to make a bunch of profits, it will happen. But to grow (and add jobs in the US), Cisco's new profits will be taxed at the marginal rate (35%), not a lower average rate. Thus, Cisco may decide not to grow and keep those profits overseas. So, when you read blogs about how Cisco is shipping jobs overseas and only paying 8.8% tax, it's because the marginal tax is 35%, not 8.8%. Cisco is making a wise business decision.

I hope by now you see the fix for this is a simpler tax code with lower rates. That will make the US more competitive with India, China, and other locations. This is not Cisco's problem or fault, it's Congress'. If this can be fixed, then Cisco can invest in the US and help grow our economy. Except for the fewer lawyers and accountants they'll need of course.

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