30 October 2018

Does Britain need a special tax on tech?


Philip Hammond has finally unveiled his long-trailed plan to tax tech giants. From April 2020 onwards profitable digital businesses that bring in over £500m worth of global revenue must pay a 2 per cent tax on any revenue made from UK users. The OBR estimates it will raise around £400m per year.

It’s a bold move and will heap pressure on international efforts to figure out how to update a 20th-century tax. But it’s also the wrong approach. There are three key problems with Hammond’s attempt to squeeze a bit more out of Google and Facebook.

First, you have the Brexit issue. The Chancellor rightly recognised the importance of getting a good Brexit deal, but securing a US-UK trade deal would be the icing on the cake. Levying a tax that just so happens to only hit US tech giants (who don’t vote in UK elections) may meet Senator Russell B. Long’s definition of tax reform — “Don’t tax you, don’t tax me, tax that fellow behind the tree!” — but it’ll also make any future trade deals with the US more difficult to agree. The Trump Administration will almost certainly see the new tax as an unfair trade practice and may retaliate.

Second, taxing turnover or revenue instead of profits can unfairly penalise fast-growing firms who are struggling to make money. It took Twitter over a decade to become profitable and fast-growing Snap still isn’t. It’s simply bad policy to increase the tax burden on loss-making firms. It has been suggested that the tax will only apply to profitable firms, but it could create a massive cliff-edge for firms on the verge of breaking even.

Third, it’s papering over the cracks when the system needs real reform. It’s understandable that the public is rather miffed when massively profitable internet giants, who seem to carry out a fair bit of activity within the UK, pay relatively little in tax. But they shouldn’t bash Zuckerberg or Bezos, they should focus on the system.

The global corporate tax regime is based on the principle that taxes ought to be collected where the value was created. It made sense and worked relatively well for a world of factories and tangible assets, but things have changed. How do you determine where the value was created in a world of intellectual property and intangible investment?

There’s a strong case for reconsidering the entire system, but singling out tech fails to resolve the underlying problems. When the European Commission asked leading tax experts about how taxation should adapt they concluded that we shouldn’t set up special tax regime for digital firms but fix the rules for everyone.

The Chancellor has instead decided to adopt what Professor Michael Devereux calls “a Marxist approach to international taxation”  — a reference not to Karl, but to Groucho Marx’s famous line: “those are my principles, and if you don’t like them, well I have others”.

So what should the Chancellor do? He should first recognise that the tax system isn’t just ill-suited to taxing Google and Amazon, it’s not even very good at taxing coffee. He should take a radical step and levy taxes based on where the customers are. Most tax avoidance schemes rely on shifting headquarters and patents to low-tax jurisdictions (at least on paper). But while it’s relatively easy to shift patents around the world, it’s much harder to shift sales.

Overturning a 90 year old status quo may seem unthinkable, but there’s a growing consensus that we need to move to a destination-based tax system. In the US, Paul Ryan’s A Better Way tax reform plan was funded in part by a shift to a destination base. While it didn’t survive a lengthy congressional fight intact (the proposal was eventually nixed by Trump and the Senate), it may have life yet as pressure to address skyrocketing deficits increases.

There is a strong case for fixing the tax system so it doesn’t arbitrarily favour some firms over others. More than 150 budgets ago William Gladstone rightly pointed out that “… it must be borne in mind, that in every case exemption means a relief to A at the charge of B”. But creating a separate parallel tax system for a few firms is no substitute for dragging a 20th-century tax system kicking and screaming into the current millennium.

Sam Dumitriu is Research Director at The Entrepreneurs Network.