EU’s Exploration of an AI Tax Shows an Anti-Innovation Mindset

Artificial intelligence has become an increasingly salient issue for governments. In Europe, the AI question already has turned from how we can embrace it to how we can tax it.

Recent AI advancements come at a time when the EU is claiming to move away from overregulation to focus on competitiveness. If the EU is serious about this mission, its answer to the AI-tax question matters. Broad-based improvements to corporate taxation would better support an innovative Europe than narrow carveouts or punitive tax hikes.

As with any innovation, its fragilities take time to iron out, and taxes will play only one part of governments’ approach to AI. But how policymakers contend with those fragilities through the tax code can make or break new economies.

But you wouldn’t know that if you listened to the European Parliament. Last month, the newly elected chairman of the tax subcommittee claimed “there is no evidence” that taxation discourages innovation.

He’s not the only one making that claim, with groups such as the EU Tax Observatory saying, “We have no economic evidence that lower tax rates spur investment and innovation.” The problem with these claims is that the world has a mountain of evidence showing that tax policy affects investment and innovation.

There are two primary ways innovation is taxed: corporate income taxes and research and development tax credits and deductions. Serious academic research shows that both matter.

A landmark study from the OECD found that the corporate income tax is the most harmful for economic growth. Higher corporate income taxes impact innovation and hamper investment, slowing a country’s overall economy. Likewise, research finds that lower corporate income taxes can boost investment, wages, and gross domestic product.

While corporate income taxes affect growth, better treatment of innovation also can play a pivotal role in accelerating it. A 2019 academic study found tax policies that promote research and development are a government’s strongest tool for advancing innovation. A forthcoming study from the American Economic Association explores profit taxation and innovation in Germany and finds that higher taxes on R&D-heavy industries slow new technologies.

These studies only scratch the surface of what economists have said on the interplay of tax policy and innovation. But unfortunately, ignoring the evidence in policy debates is nothing new in Brussels; it’s how most policies have been made for the better part of a decade.

Underlying the EU’s tax-fairness agenda is the idea that increasing the perceived legitimacy of political institutions in the short term, regardless of the economic consequences, is more important than evidence-based policymaking in the long term.

This legislative attitude has led to ideas such as digital services taxes that are regressive, wealth taxes that historically don’t raise much revenue, and windfall profits taxes that discourage needed energy investment. The implementation of the 15% global minimum tax known as Pillar Two was supposed to stop tax competition, but has only shifted tax competition into a global subsidy race that the EU likely can’t win by penalizing low tax rate competition and favorably treating refundable tax credits instead.

The problem with this change is that not every country can equally afford to offer generous subsidies in the form of refundable tax credits, and without the legislative ability to raise its own revenue, the EU is at a major disadvantage relative to its competitors.

In all these cases, policymakers sold good feelings at the expense of evidence-based policymaking that will make European citizens worse off in the long run.

Pasquale Tridico, the European Parliament’s tax subcommittee chairman, has a hard job ahead of him. Not only is he new to Brussels, but he also is being asked to consider policy responses to one of the fastest-moving technologies in all of humanity. The road ahead will bring as many challenges as opportunities.

If the EU is serious about embracing competitiveness, its parliament needs to focus on evidence-based ways to support growth and innovation. This must include improvements to the corporate tax base to support capital investments without picking special industrial champions. It also must include a clear-eyed view of the consequences of narrow policies.

The evidence is clear on how a pro-growth agenda increases innovation and how a tax-fairness mindset can harm it. Hopefully, policymakers won’t continue to ignore that.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Sean Bray is director of European policy at Tax Foundation Europe.

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