The digital economy has many features inimical to competition. Those features mean the market’s invisible hand, if unguided by regulation, can cause economic harms of which the greatest is the extraction of economic rent — profits above the level needed to encourage the provision of the product or service in question.
Economics teaches many ways to correct market failures. Many involve regulation — which Free Lunch will consider later this week — but the most obvious way to address the central problem of economic rent is to tax it.
Internet companies are, however, very good at reducing their tax burden. That is not specific to the digital economy — it is, rather, an effect of globalised economic activity combined with national tax systems designed for an era dominated by manufacturing production or non-traded services. Multinationals in general have perfected the art of locating — in terms of law and accounting — their tax bases in low-tax jurisdictions. But internet companies are at the cutting edge of this because so much of their moneymaking derives from intangible activity. And so it is no accident that the giants of the digital economy feature so prominently in the revelations in recent years of corporate gaming of tax systems. They are even quite good at making politicians design the system for them: the entirely unnecessary tax holiday on repatriated profits recently granted to US multinationals by their government is a case in point.
There are three points to note, however, about how the failure to tax internet companies is even more aggravating than the loopholes enjoyed by multinationals generally. First, for the reasons I set out earlier this week, there are reasons to think that the digital economy creates more economic rent than traditional economic activity. It is bad enough not to tax normal profits properly; it is preposterous when profits are largely rent extraction.
Second, this is not just a matter of taxes on corporate profits. A big part of what internet companies can do is to intermediate conventional, material economic activity through intangible, online services of selection and matching — think eBay, Uber and Airbnb. But that also allows them to shift tax liabilities (such as value added and sales taxes or specific excise taxes) from the material, place-bound activity to the online intangible activity. Uber and eBay customers who have seen bills from the Netherlands or Luxembourg on their credit card statements understand this very well.
And third, the greater ability of providers of intangible services to reduce their tax liability, relative to local, material economic activity, is in effect a subsidy of the latter, more rent-extractive activities. That is perverse.
So even without regulating internet companies better, there is an incontrovertible case for taxing them better — and that means taxing them as heavily as other types of activity. Now doing so is largely in the gift of national governments. The best proof is that more and more countries are doing it — if not before time.
As the Financial Times reports this week, India is moving towards treating online companies as resident for tax purposes if they engage digitally with a certain number of users, regardless of physical presence. At the opposite end of the income spectrum, France is contemplating an “equalisation tax” on internet companies’ revenues in the country, designed to mimic the corporate income tax that would have been owed had their activity been considered physically resident. The VAT problem mentioned above is beginning to be fixed. The EU as a whole is moving towards a system more fit for the purpose of including digital economic activity in corporate tax liability. What all these efforts have in common is that they involve updating the notion of taxable presence, and of the location of value-creating economic activity, to fit 21st century reality. Achieving this is largely a question of political will.
This is all welcome news. It is also little and late. But it proves two things. One is that it is perfectly possible to do a proper job of taxing the digital economy. The other is that this can be done in the context of fixing the taxation of multinational corporate activity generally. There is no excuse for politicians not to move ahead, and soon.
- Can the US achieve faster growth? Sam Fleming’s Big Read on the US economy sets out the challenges.
- More on the anti-competitive features of the digital economy in a New York Times magazine piece on the internet search engineers who tried to take on Google.
- The former governor of Cyprus’s central bank revisits the bank bail-in of 2013.
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