Efforts in the last couple of years to produce a new international tax plan to deal with the growth and effects of the digital economy may soon become a potential windfall for many international governments. As countries struggle across the globe from the COVID-19 health crises and the economic turmoil, these countries find themselves needing to increase government spending to weather the crisis. While any tax plan will be seen by many countries as a potential source of funds during and after the crisis, the plan will most likely come at the expense of U.S. industries, and it will negatively impact consumers by driving up prices and diminishing demand.
As background, the Organization for Economic Cooperation and Development (OECD) has taken a leading role in developing the tax plan. The OECD’s efforts, at least originally, were focused on the “challenges” from the digital economy. These member OECD countries have, in recent years, treated large U.S. tech firms, like Google, Amazon, Facebook and others, as economic threats to their tax base and a potential new source of future tax revenue.
OECD’s “two pillars” plan that is being drawn up, however, should be regarded as a threat to U.S. multinational corporations and, in general, to consumers across the entire globe. What the plan may look like remains a mystery, due to the lack of transparency by the OECD in explaining how the tax mechanisms would work. Hopefully, more information will be forthcoming in the next couple days when the OECD meets again. Either way, the plan is unlikely to be a good one for consumers.
Pillar One: Let us Tax U.S. Technology
In a draft leaked last September, the plan proposes a two-part tax frame. The first part, referred to as Pillar One, addresses what the OECD sees as a threat by large tech firms that supposedly engage in “profit shifting” and the avoidance of international tax payments markets where it creates value to its customers. The plan looks to identify the market share for primarily large U.S. tech corporations as a means to reallocate profits from its multinational operations.
Since there are no specifics on how the tax mechanisms would actually work, it is hard to analyze the plan, which may be a convenient omission by the OECD. Regardless, there are multiple problems with the tax proposal. For one, the Internet is globally available; its services can reach many users, servers, and online application sites across the world; and data can be accessed and housed in the cloud.
How is market share determined? Let us say a German Twitter user travels to Spain and uses his/her smartphone to view an Irish friend’s online comment about a Canadian news report. So, who pays for the “created value?” Should Twitter pay for it because it is a large U.S. company, or the German wireless service that facilitated the electronic interaction, or Spain or Canada for that matter?
The answer to this question is very subjective, particularly when the allocation of revenues is based on market share. If the German citizen connects to Twitter for free, why should the allocation of market share be anything other than zero? After all, Twitter charges the German citizen nothing, so to allocate a portion of Twitter’s profits to Germany based on the electronic interaction is senseless. Because the German citizen paid nothing, the value is priced at zero, and the interaction produced no direct profit for Twitter. To what extent should Canada, Ireland, Germany, or Spain get tax revenue for the online interaction?
Another relevant question is whether social media giants should pay taxes because they make their money on ads? If an advertisement agency in Germany creates its own content and places it on Twitter themselves, hasn’t the German agency created the value in question? Herein lies the problem — the ad agency and Twitter are both already taxed. This means that Pillar One runs the risk of duplicative and pyramid taxes, and the risk is that any business engaged in social media or putting content and ad coupons on their own website could eventually become targets by greedy governments abroad. How are the rights of citizens and consumers better served by taxing information, content, communications, and the news?
European Bias or Tech Envy?
Europe has long suffered from U.S. “tech envy” and for quite some time now antitrust regulators in the European Union (EU) have targeted U.S. tech firms, extracting tens of billions of dollars of fines harvested by European Court of Justice (ECJ) based on weak evidence and the knowledge the U.S. firms have dominant market positions. These government bodies often ignore the economic reality that dominance in tech is often necessary in order to achieve economies of scale and scope, and, for social media firms, necessary for the attainment of network economies. If only a few people subscribed to Facebook, what is the sense of a consumer posting a message that no one reads? Scale matters.
In effect, “big” means increased productivity, lower per unit costs of production, and lower prices for consumers – often free for consumers. For a Google search customer, because the service is free, the size of the firm does not translate into a consumer welfare loss. Consumers are not being overcharged. As such, the concerns of European regulators may be entirely misplaced. The economic literature is absolutely clear on the consensus that big is not necessarily bad.
Still, Europe is fixated with targeting U.S. corporations, particular tech firms. In recent years, these firms have included Microsoft, Apple, Intel, Amazon, Facebook, Google, Nike, Qualcomm, and Universal Studios – subject investigations or allegations of anticompetitive behavior. The ECJ has ordered many of them to pay billions of dollars in fines and restitution. It is not surprising that this fixation has spilled over into revamping the international tax rules and harvesting additional profits from U.S. multinationals.
Pillar Two: Let us Tax Everyone Else Too
As an attempt to make Pillar One more palatable, Pillar Two looks to establish an international minimum tax rate, a concept that is equally problematic. Specifically, Pillar Two seeks to establish a minimum tax rate on profits and raises the aspect of double taxation, even triple taxation.
This pillar does not just target high tech, but any multinational company – including financial firms, shippers, and others. For example, a reinsurer may be subject to duplicative taxes when they are subjected to taxes on profits in one country and potential withholdings on premiums in another country. There are twenty European countries that already require taxation on non-life insurance, they already bear value-added taxes and services taxes that they cannot recover, as well as being subject to additional financial transactions taxes and stamp duties.
As Europe and much of the world has expressed great alarm over the risks of climate change around the globe — pointing to rising sea levels and increases in storms and flooding – the tax plan by international governments seeks to increase taxes on the very companies that risk billions of dollars in capital protect their citizens and property. What is the impact of these taxes on sustainability and mitigation? How are consumers served by putting them at risk? Why load up on taxes on activities that we should be encouraging?
The irony could not be more absurd, but it demonstrates that this proposal has less do with protecting consumers around the globe and more about a greedy money grab by foreign governments. Once in place, the international money grab will only expand.
Consumers are the Big Losers
We have heard nothing from the OECD on how consumers will be impacted, but this should be the major consideration before implementing any plan. It does not take an economist to know that taxing businesses does not spare consumers the costs. When taxes are increased, such as proposed by Pillar Two, they ultimately flow through to consumers in the form of higher prices. Then, compliance burdens become yet another aspect of complexity, which means additional costs for businesses, and yet higher prices for consumers.
When consumers pay more, they lose and are likely to curtail demand – which, by definition, means that consumer welfare decreases. In short, the harvesting of more taxes will have negative impacts on consumers. Consumer are clearly the big losers from the tax plan.
Led by Europe, countries around the world are focused on increasing taxes on multinational businesses. In many cases, the results would disproportionately impact U.S. firms – exposing profits to taxation, as well as risking duplicate and pyramid taxes on businesses and consumers. In short, these taxes effectively act as a tariff on international commerce.
With all this in mind, what is the potential impact on consumers? That is something that the OECD should give serious thought to, and certainly the Administration and Congress should want to understand.
Published in the Economic Standard on October 7, 2020.