Digitalisation should be promoted, not taxed

Digitalisation is leading to dramatic shifts in the balance of power in the economy. The five most valuable companies in the world are all US tech companies with digital business models, headed by Apple with a stock market value of around a billion US dollars. Traditional manufacturers are falling behind. Volkswagen, the most valuable German automotive company, has a stock market value of around 100 billion US dollars – a tenth that of Apple.

Companies that generate high profits should technically also pay high taxes. But their critics blame digital economy players for failing to do just that. The EU Commission argues that there is a difference in the tax treatment of companies with conventional business models and players in the digital economy in favour of the latter. Companies with traditional business models have an effective average tax burden of over 20 percent, versus just 8.5% for digital economy players. The Commission believes that this distorts competition. So it has proposed to introduce a new kind of EU-wide digital tax. Companies that offer certain types of digital services would have to pay a 3 percent tax on their turnover.

At first glance the Commission’s argument seems plausible. On closer analysis, however, this thesis of an undesirable difference in tax treatment is suspect. The difference in the tax burden documented by the Commission partly arises from the fact that many EU countries subsidise research and development activities with tax credits. Digital economy players spend more on research than companies in other sectors. Their effective tax burden is lower as a result. If the Commission considers these tax breaks to be damaging, it should propose to abolish them instead of introducing a new tax on digital turnover.

But there are good reasons for such tax relief. The benefits of R&D spending are not only harnessed by those companies performing research, others also stand to profit from it. Since individual companies do not factor the positive impact of their research for the rest of the economy into their calculations, too little research will be done if tax subsidies are cut. Removing the preferential tax treatment that arises through tax subsidies for research would be economically damaging as a result.

But public criticism of digital companies focuses on another aspect of their taxation. Many of them generate a significant share of their turnover in Europe, but pay very little income tax here. In the past Apple, for instance, has posted a large share of its profits generated outside the USA in a firm registered in Ireland, but it is not based there for tax purposes and does not have to pay any income tax as a result. The Commission sees the legal regulations in Ireland that enable such an arrangement as an illicit subsidy and has demanded that Apple pay tax arrears of 13 billion euros. The Commission has also publically criticised the company for paying almost no profit taxes in Europe. This overlooks the fact that the internationally agreed rules on taxing global companies do not provide for the taxation of profits in the location where the goods generating these profits are sold. They are to be taxed where these goods are developed and produced. Since digital firms like Apple and Google have developed their products and services in the USA, it primarily has the right to tax the global profits of such companies. The USA may not always fully exercises this right, but that is its prerogative, not a problem for EU taxation policy.

It would naturally be theoretically possible to change the rules of international profit taxation and allocate more taxation rights to those countries in which products are sold. But there has to be an international consensus on this; it cannot be achieved through one-sided measures like a European digital tax. There is also little evidence to suggest that Europe would benefit from such a reform.

Firstly, VAT is already charged on all revenues generated in Europe, including that of US internet giants. Secondly, as an exporting nation, Europe benefits tremendously from the fact that the profits generated by its exporters are largely taxed in Europe, and not where their products are sold. Thirdly, the problem with the plan to introduce new taxes on digital business models is that traditional manufacturers are increasingly digitalising their businesses. German automotive companies, for example, collect large volumes of data on their customers’ driving behaviour. If Europe introduces a tax on revenues generated by the digital economy, other countries could argue that many products exported by Germany feature components from digital business models – and they could impose tariffs or levy taxes on them.

Europe should spend less time speculating about new taxes and duties on digital business models. It is far more important to promote digitalisation and move forward with the project of a European internal market for the digital economy.