Bloomberg Tax
March 30, 2020, 7:01 AM

INSIGHT: Does It Make Sense to Impose Higher Taxes on Automated Digital Services?

Jefferson VanderWolk
Jefferson VanderWolk
Squire Patton Boggs LLP

Now that many people are working from home on a full-time basis, they are realizing, as never before, the value of the Internet and the many applications that facilitate online communication, group meetings, and transactions. Due to the hundreds of billions of dollars invested by the private sector in R&D and infrastructure, we are able to speak with friends and family on daily video calls; businesses can continue to operate and provide services; and those of us with desk jobs can continue to work and stay productive without significant problems in most cases. And we can do this without having to reach into our pockets to pay any more than we were paying before the coronavirus pandemic began.

It is frightening to contemplate the consequences of a prolonged interruption of the automated digital services that we are all relying on so heavily. Going forward, we can see clearly that, in the words of the Organization for Economic Cooperation and Development (OECD), “governments and stakeholders must shape a common digital future that makes the most of the immense opportunities that digital transformation holds to improve people’s lives and boost economic growth for countries at all levels of development” (OECD, “Going Digital in a Multilateral World,” May 2018, p. 88).

Internet-based business services will be a key factor in the economic growth that will be needed to pull the global economy out of recession after the pandemic recedes. Not surprisingly, the U.S. economy is likely to be an important part of that recovery. Economic growth in the U.S. has in recent decades functioned as an engine for global economic growth due to the unparalleled size and strength of the U.S. economy. Increasingly, highly digitalized businesses are in turn driving economic growth both in the U.S. and elsewhere in the world.

There is currently a debate among tax policymakers and commentators about increasing taxes on automated digital services businesses. Some, such as the European Commission, say that successful companies such as the so-called GAFAs (Google, Amazon, Facebook, Apple) pay lower effective rates of tax than less digitalized businesses. Others, however, including the experts who did the research on which the European Commission relies, argue that in fact there is no such tax rate disparity. Thus, as with many controversial topics, the opposing camps cannot even agree on the facts, much less the conclusions to be drawn from them.

It is not necessary to resolve the dispute about effective tax rates to see that imposing higher taxes on automated digital services makes no sense at a time when those services are key to global economic recovery. It is a truism that if you want less of something, you tax it more heavily—think of taxes on tobacco products, for example. It is inconceivable that the world will want less widespread use of automated digital services in the future.

This is not to say that these services should not be taxed at all or should be taxed more favorably than other businesses. In this regard the debate about effective tax rates is meaningful. However, given that automated digital services are generally taxed under the same rules as other businesses, and that there is evidence supporting the view that the effective rates of tax are not dissimilar, it seems wrong to jump to the conclusion that higher taxes are needed on automated digital services. Moreover, it does not appear that companies currently experiencing an unprecedented level of demand for their services, such as Facebook, Zoom, and others, are seeking to derive windfall profits by raising their prices.

Nevertheless, numerous countries are proceeding with digital services taxes that were introduced before the pandemic began. In an effort to prevent a chaotic situation in which inconsistent taxes of this kind are applied by a large number of countries, the OECD is currently leading a program of work on so-called Pillar 1 and Pillar 2 proposals being considered by the 137-member Inclusive Framework on Base Erosion and Profit Shifting (IF) in relation to the tax challenges of digitalization.

Pillar 1 would reallocate taxing rights in favor of market jurisdictions in relation to businesses in two categories: automated digital services, including cloud computing, and consumer-facing businesses. In December 2019, U.S. Treasury Secretary Steven Mnuchin proposed that this reallocation be a safe harbor rather than mandatory, as it involves a departure from long-established norms of international taxation. The IF has agreed to consider the safe harbor proposal in due course, after the details of Pillar 1 have been worked out. In the meantime, it is rumored that the U.S. may be willing to accept a compromise in which the safe harbor option is available to consumer-facing businesses but not automated digital services companies—in effect, raising taxes on those companies, which are predominantly based in the U.S.

Presumably the coronavirus pandemic and its economic fallout will divert policymakers’ attention away from the IF’s work on Pillars 1 and 2 for a few months at least. The OECD, however, has signaled its intention to pursue its program of work without delay. Common sense would seem to dictate that the G20 leaders should instruct the OECD/IF to stand down and wait until global tax policy measures can be evaluated in light of the changed circumstances once the pandemic has been brought under control.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Jeff VanderWolk is a partner at Squire Patton Boggs (US) LLP in Washington.

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