26 June 2019

The EU’s tech tax plan is flimsy, ill-judged and legally dubious

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The UK will soon have a new Prime Minister, and quite possibly a new Chancellor, whose hands will be full dealing with Brexit and the other real priorities facing the country.

But they could at least lighten the Treasury’s load by abandoning plans for a Digital Services Tax (DST). Tech taxes are a terrible idea, anyway, based on dodgy data and shaky economics.

To be fair, it’s not just the UK that’s planning to hit the tech sector. EPICENTER, an independent network of think tanks from across Europe, has today published a report which assesses proposals by the European Commission for an EU-wide tax on digital turnover, as well as unilateral initiatives in France, Italy and Spain.

Like the UK’s DST, due to be implemented in April 2020, these proposals involve charging an additional tax, typically 2-3 per cent, on the revenues of firms with a large digital presence, where these revenues can be linked to the participation of local consumers. The main targets will be social media platforms, search engines and online marketplaces.

These proposals are all based on the presumption that the tech sector does not pay its ‘fair share’ of tax. The justification for this claim is flimsy. Indeed, many advocates of a tech tax have resorted to what could be best be described as ‘policy-based evidence-making’.

In particular, the European Commission has claimed that multinational digital companies pay an average effective tax rate of only 9.5 per cent, compared to 23.2 per cent for more traditional businesses. This claim is, ironically, ‘fake news’.

The Commission’s figures are based on stylised business models, rather than the taxes that digital companies actually pay, which are often much higher. What’s more, even in the Commission study, the main differences are due to tax breaks that governments themselves have promoted, such as the relatively favourable treatment of R&D and intangible assets.

Officials have also had to come up with a pretty dubious economic justification for targeting the tech sector. The DST is based on the argument that digital businesses should pay tax in the UK that reflects the value they derive from UK users. However, goods and services with user-created value are nothing new, and certainly not restricted to the digital sector.

Many traditional businesses, such as airlines, benefit from value contributed by foreign nationals, or have a substantial online element. There is a clear risk that decisions about what is and what is not within the scope of a digital tax become increasingly arbitrary and distortionary.

There are also many practical problems in deciding where and how much value is being created. The DST will require agreement on which activities, and which users, come within the scope of the new tax and which do not. This is hard enough for physical businesses, let alone the online world.

There has also been next to no consideration of the broader economic impact of the DST. Taxes are ultimately paid by people, not companies, which are no more than legal entities and cannot bear the economic cost of taxes themselves. Turnover taxes have particularly large deadweight costs, are more likely to be passed on to consumers, and are a major deterrent to investment.

To cap it all, it’s not even certain that digital taxes are legal. The EU proposals in particular seem to be designed to target large US-based firms. Indeed, even French officials describe their initiative as a ‘GAFA’ tax, aimed at Google, Apple, Facebook and Amazon. This appears to be a de facto tariff in breach of WTO rules. The DST certainly wouldn’t make a US-UK trade deal any easier.

In short, politicians should try to correct misunderstandings about taxation, instead of reinforcing and exploiting them for short-term electoral gain. Additional taxes on the turnover of companies with a large digital presence would be disproportionate and discriminatory, and further complicate the tax system for no obvious benefit. Fortunately, it’s not too late to press delete.

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Julian Jessop is an independent economist