14 March 2019

How to tame the tech giants

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Wednesday’s Spring Statement was always likely to be a sideshow compared to the Autumn Budget, even if Brexit hadn’t taken centre stage. But the Chancellor still managed to say a few interesting things, including on “tech and the new economy”.

The Chancellor was responding to the independent Furman review on the state of competition in digital markets, which concluded that there isn’t enough. He announced that the Competition and Markets Authority would be asked to investigate digital advertising. He also promised to come back later this year on the Furman review’s other recommendations, including proposals to update competition rules for the digital age, open up markets, and increase consumer choice.

There is actually quite a lot to like here. The Furman review provides some welcome balance to the widespread attacks on the activities of digital companies, emphasising their social and economic benefits. It was good, for a change, to see Uber get a favourable namecheck as a business that is delivering transformative changes which are hugely popular with consumers.

What’s more, this government seems to be leaning towards policies that strengthen market forces rather than replace them. There had been some speculation that the Chancellor would intervene directly to ‘break up’ the tech giants. It is certain that digital companies will find it harder in future to swallow up rivals without scrutiny from the competition watchdogs. But in the event, most of the proposals are based around empowering consumers, rather than bureaucrats.

For example, the government will investigate what can be done to make it easier for users to move their personal data from one platform to another (also known as ‘social graph portability’). The aim is to help consumers to punish bad behaviour by switching providers, including new entrants. This threat may be less effective in the case of a social network where most of your friends might need to switch too, but it could still make a difference.

Nonetheless, I have a couple of concerns. First, government regulation should be seen as a last resort if all other measures have failed. I had a quick look myself at some of the issues here in a brief paper for the Institute of Economic Affairs, ‘Supervising the Tech Giants’, published last January.

Proposals for a stronger ‘code of conduct’ are a good illustration. In reality, most companies have these already, and best practice is quickly replicated. Consumers and investors can put pressure on managers at least as effectively as politicians or civil servants. Indeed, government intervention has its downsides; the more burdensome the regulation, the more likely it will backfire by protecting incumbents from start-ups who may find it far more difficult to comply.

My second concern is that many commentators take it for granted that the tech sector is undertaxed. In the words of the Chancellor, “I have already responded to concerns about unfairness in the tax system with a new Digital Services Tax so that digital platform companies pay their fair share”.

The problem is that these concerns have very flimsy foundations. Unfortunately, rather than attempt to correct these misperceptions, many politicians and commentators have gone out of their way to encourage them.

Indeed, the European Commission’s assessment of its own digital tax proposals includes an outrageous example of “policy-based evidence-making”. It claims that multinational digital companies pay an average effective tax rate of only 9.5 per cent in the EU, compared to 23.2 per cent for more traditional businesses. But these figures are grossly misleading, for two reasons.

First, they are based on stylised business models, rather than data from real firms. Indeed, one recent study found that many traditional companies actually pay much lower taxes than digital corporations, including the US-based giants.

Second, even in the stylised models, the differences simply reflect factors such as more favourable tax treatment of R&D and intangible assets, which happen to benefit tech companies more than most. In other words, if these figures did prove that the tech sector is ‘undertaxed’, it would only be because of government policy.

There are usually a host of misunderstandings when the tax affairs of real firms hit the headlines too. Unfavourable comparisons are often made between the turnover that a company makes in a particular country, and the corporate taxes it pays in that country. This is disingenuous, because corporate taxes are usually paid on profits, not turnover. An online marketplace, for example, might see a lot of business transacted between third parties on its site, but still be working on small margins, or even at a loss.

To pick another example, when a company does not have a physical presence in a country, it is surely reasonable to expect it to pay less tax in that country. This is because it is not making the same demands on local taxpayer-funded public services or infrastructure. A similar argument applies to an online retailer who might be able to reduce their liability for business rates by operating from an out-of-town warehouse rather than a shop on a city-centre high street.

To be fair, the Chancellor’s proposed Digital Services Tax is based on a more sophisticated argument – that companies should pay some tax on the value created by the participation of users in the UK. But it will be very hard to design a tax that hits this target without a lot of collateral damage. The DST therefore requires a disproportionate effort to raise a relatively small amount of money, and should be scrapped.

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Julian Jessop is an independent economist.