Guest blog post by Helge Sigurd Næss-Schmidt, Partner and Director of Economics at Copenhagen Economics
European finance ministers are expected to discuss digital taxation when they meet later this week. Discussions will focus on the Digital Services Tax (DST), proposed by the European Commission in March, which introduced a new 3 percent tax on revenues resulting from certain digital activities such as revenues from online advertising, online intermediation and selling user data.
We have analysed the EU proposal and we will later this month publish our findings in a new study. We suggest that European finance ministers examine 4 key problems with the proposal both in terms of its economic rational as well as actual impact if implemented:
First, the new tax is justified as a means to mitigate an alleged under-taxation of digital companies, yet this claim is not backed by solid evidence or economic reasoning. The calculation largely reflects that digital companies have higher shares of R&D investments than other companies, a category of spending which receives better tax treatment than other investment spending. But it fails to take into account how digital companies are also relying more on equity financing as opposed to less risky and less R&D intensive firms. This tends to increase the actual effective tax rate as almost all international tax systems favour debt over equity financing. This factor is missing in the IA calculation. Indeed, a study covering recent years shows that digital companies pay the same effective corporate tax rate as other companies. Moreover, the beneficial treatment of R&D expenditure is intentional: the social returns for investments in R&D intensive industries such as ICT and pharma exceed private returns, hence the international practice to support R&D investments by fiscal incentives and other means.
Second, the IA is lacking a serious analysis of the consequences for the development of the digital economy in the EU in the event that the DST or equivalent measures are put in place at the EU or national level within member states. In the first place, the IA assumes that the digitalised companies affected will largely absorb the costs. This is not supported by empirical research on the price effects of comparable tax hikes. Indeed, companies will have no choice but to pass on costs without risking going out of business in a longer term perspective. We have therefore considered the cascading effects on EU SMEs, consumers and jobs – an important reflection missing in the IA. Due to these effects, the DST will harm EU consumer welfare.
Third, the proposal will lead to five negative distortions in the development of the EU digital single market and wider EU economy: Digital platforms will lose market shares to non-digital alternatives. Platforms above thresholds will lose market shares to platforms below. SMEs using online platforms will lose market shares to non-intermediated online sellers. EU exporters will lose market shares to non-EU competitors in global markets. Finally, compliant firms will lose market shares to non-compliant firms, due to enforcement limits.
Fourth, the DST is at odds with the OECD efforts to find a global solution to taxation. The key focus is to ensure that corporate income is taxed where it is being created. That is where firms commit labour and capital to develop, produce and market products and services. By contrast, the DST introduces a new concept where services, on top of due VAT and excise duties, are to be taxed in the countries in which they are deemed to be consumed based on the somewhat spurious concept of user contribution as a new tax base.
In conclusion, our analysis finds that the EU proposal needs a serious re-examination both in terms of justification as well as its ramifications on the development of Europe’s digitising economy and international efforts to achieve sustainable tax reform.