Trade wars and digital taxation
The President of the European Commission has stressed the EU’s willingness to pursue multilateral agreements within the OECD and G20 framework, which may result in more sustainable agreements with Washington. In May this year, she expressed an interest in introducing a digital tax to finance the bloc’s €750 billion recovery fund.
The ongoing Covid-19 crisis has increased the financial incentives even more. Stay-at-home measures around the world have played to the strengths of large digital service providers. Countries in the EU face a massive shortfall in tax revenue, and therefore seek additional taxes on one of the sectors the least affected by the pandemic.
According to the OECD taxation standards, corporations pay tax where value is created, which traditionally goes hand in hand with a physical presence. However, GAFA companies (Google, Amazon, Facebook and Apple) and their services do not require physical infrastructure or a permanent local establishment, making it difficult for states to find legitimate grounds and methods for taxation. Since their main services partly consist of intellectual property, they remain relatively agile in their ability to simply shift its costs towards low-tax countries.
France was one of the European frontrunners in trying to introduce a 3% digital ‘GAFA’ tax on revenues generated by said companies and other larger digital service providers in French territory. This was postponed in hopes of reaching a multilateral agreement through the OECD by the end of 2020, which however has not transpired. Unilateral examples of similar attempts of a digital tax include the Austrian tax on digital advertising revenues, with similar taxes introduced in the UK, Spain and Italy.
In July, the main political groups of the European Parliament have banded together in an effort to strengthen the EU’s trade powers, granting it rights of intervention in the realm of services and intellectual property rights. The draft boasts the backing of centrist and centre-left groups, who view these added legislative competencies as a dissuasive instrument for pre-empting transatlantic trade conflicts.
However, there are some issues with the tax. It contradicts a core pillar of taxation theory: the idea that only profits, not revenue, should be taxed, if we are to preserve the ability-to-pay principle.
Further, tax increases may result in a shift of the financial burden to the consumer, as companies, being mere legal structures, cannot bear the economic cost of taxes themselves. Risks include fewer employment opportunities and lower wages, as well as higher pricing for digital service products and an overall lowered contribution to economic growth.
Moreover, expanding legislative reach into the digital realm of IP may set a dangerous precedent. Taxation of companies without physical presence in the EU bears the risk of potential retaliation from other countries on European industries. The introduction of a de facto tariff, therefore in breach of international trade rules, bears further legal complications that the EU would firstly have to address.
Empirically, there is also the risk of potentially overstating the problem. The Commission seems to be operating on the blanket assumption that digital companies are exploiting tax loopholes through shifting assets to lower tax countries. Doing so without nuance within and across sectors may prove discriminatory and needlessly inhibitive of future investment. The UK’s Diverted Profits Tax countered such concerns by charging punitive rates on profits routed via tax havens, namely “contrived arrangements”, and without a particular focus on the tech industry.
In summary, political aims arguably fuel a large part of the renewed effort of introducing a digital tax. In struggling with protectionist measures by the Trump administration, diplomatic motivations underlie the digital taxation reform, in an effort to bulk up legislative competencies in an area where it hurts. Whether or not the EU continues to commit to digital taxation reform, despite foreseeable intimidation from Washington, remains to be seen. From an economic perspective, concerns remain, and it has become clear that the drive towards reform is largely led by political incentives to respond in kind to American trade provocation. From a free-market European perspective, it may prove worthwhile to further pursue multilateral agreements, cooperating with the US, rather than imposing punitive taxation measures.
This article was originally published on the Epicenter blog.