Tom Spencer // 25 March 2021

Amidst a global populist attack on “Big Tech”, the European Union has not just failed to resist, but has embraced unwarranted attacks on some of the world’s most innovative companies. These attacks only serve to worsen the competitiveness of the Single Market, and push investment that would help Europeans outside of the bloc. This problem is only going to worsen with the implementation of a new digital levy that is currently going through consultation.

Already we have seen huge levels of disinvestment in Europe due to its populist tech policy. For example, venture capital investment in European start-ups has halved since GDPR came into force, and huge numbers of mergers have fallen through due to compliance concerns. The Commission must be extremely careful not to repeat the failures of GDPR when regulating tech companies. Proposals for a specific digital tax show a complete disregard for that risk, and will only worsen outcomes for Europeans.

There are currently three policies undergoing consultation:

• A top-up corporate income tax on all companies with digital activities in the EU
• A tax on revenues from certain digital activities in the EU
• A tax on business-to-business (B2B) digital transactions in the EU

Each of these taxes come with significant distortionary effects, because they all assume it is easy to define what a firm with digital activities is. We can see from the VAT base that providing guidelines on how taxes are collected imposes significant compliance costs on firms and leads to inefficient outcomes, therefore reducing investment and thus economic growth. The same would happen with all three proposed digital taxes.

More specifically, each individual tax also comes with its own problems. Firstly, a top-up tax will not be applied equally to each nation state, and would cause distortions within the internal market. The power to set corporation taxes within the EU is largely left to the nations themselves. This means a 2% top-up tax would affect Ireland (with a corporation tax of 12.5%) very differently to an equivalent top-up in France (with its 33.3% corporate tax rate).

Secondly, taxes on turnover (revenue) are very harmful to an economy. In a 2019 EPICENTER publication, researchers pointed out that these taxes directly harm productive economic activity, producing high deadweight losses. This has the effect of directly deterring investment and expansion to an even greater extent than taxes on profits do, because it penalises market expansion even if it is not particularly profitable.

The third proposal is no better than the rest. By proposing to tax B2B transactions, you are taxing a business input. This makes it much harder to invest in one’s own business. Suppose, Company A pays Company B to design its website, then Company A should not have to pay tax on investment. By aiming to tax these services, the net effect will be a delay to any digital transformation that companies may wish to undertake, lessening firms’ ability to innovate.

Each one of the proposals the Commission would manifest itself in fundamentally worse outcomes for consumers and businesses. Instead, the EU should consider fixing VAT as a better way of taxing tech firms. VAT is a relatively efficient and effective tax. As it is charged at each stage of production, it is hard to evade, and easy to comply with. It is also not obviously regressive, and many even find it to be slightly progressive. However, when VAT is allowed to have an insufficiently broad base these benefits disappear.  Currently the digital economy is already taxed effectively in the EU through VAT. From 1 July 2021, new rules will be implemented on how VAT is charged for E-Commerce. This is expected to bring another €7 Billion per year, in addition to the €4.5 Billion of receipts from digital services under the current system received in 2018.

If the Commission wants to ensure that “big tech” is taxed adequately, then they must open their eyes. Technology firms pay a huge amount of taxes already.  Rather than risk closing off European markets to some of the most innovative companies in the world through these taxes, the EU should focus on getting a good policy negotiated at the OECD level to ensure that this does not just result in further disinvestment. This process has already begun as many parties have pointed out in the responses to the consultation; the EU must not lessen the effect of any multilateral agreement by its ideological desire to have a uniquely European system of digital taxation. If the EU does not take more care than is shown in this consultation when digital taxation is implemented, then the same disinvestment we saw post-GDPR will occur.