Turnover tax on global technology giants is sheer folly

Ten European Union countries’ finance ministers have signed a letter calling for a tax on the revenues of multinational tech companies that have been hiding away their European profits. But European leaders should proceed with caution, because a turnover levy may not be the best solution to this multi-billion-dollar problem.

The name proposed for the new levy — an equalisation tax — suggests the idea is to take cross-border tax optimisation out of tech companies’ business planning. The size of the new levy would “reflect some of what these companies should be paying in terms of corporate tax” and would bypass the companies’ multilayered tax arrangements in Europe’s low-tax jurisdictions such as Ireland and Luxembourg, as well as in Caribbean tax havens.

France, whose government in July lost a major tax case against Google, is the principal driver behind the proposal, joined by all the top EU economies, save for the one currently Brexiting: Germany, Italy and Spain, in addition to Austria, Bulgaria, Greece, Portugal, Romania and Slovenia. But the signatures of another 17 financial ministers — who are also familiar with the proposal after discussing it at a meeting in Tallinn, Estonia last week — are notably absent from the letter. Beyond the obvious opposition from the low-tax countries, which would stand to lose major US investors, some European governments are worried the tax would undermine tech progress and hurt consumers.

There may be something to that; to find out, it’s worth following the Indian experiment.

Since June, 2016, India has been taxing digital business-to-business services provided by foreign companies — such as advertising or the provision of cloud services — at 6%. The Organisation for Economic Cooperation and Development (OECD), the developed-nation club that the world’s biggest economies have tasked with developing an anti-tax-avoidance framework, has suggested that countries may use an equalisation tax as a stopgap measure until international rules are established, and India was the first country to try it.

Opponents claimed that Google and Facebook, because of their market dominance, would respond by increasing costs for ad buyers in India, which could lead to a downturn in the sector. They were right on the increase but wrong on its impact. The growth of the digital ad market continues, though it’s slowing down somewhat to a predicted 25% to 30% this year from 47% in 2016. At the same time, not much was collected — just 1.5 billion rupees (US$22.8 million) in the first six months of the levy’s existence. What’s worth watching now is whether e-commerce growth slows down more markedly than that of the ad market. If it does, it might mean the tax was a bad idea.

In Europe, the digital market is more mature: It grew 12.2% last year. It is dominated by large foreign players. According to a 2016 report from the EU’s European Audiovisual Observatory, 17 global companies, of which not a single one is European, accounted for 66.9% of the total online ad spend, with Google and Facebook taking a combined share of 42.2%. What would happen in such a market if an “equalisation tax” were applied?

Google’s parent company, Alphabet, applied a “foreign rate differential” of 11% of taxable income, which should work out to about the same revenue tax rate as in India. European governments could collect quite a lot of money that way: €800 million (US$957 million) last year in Germany, France, Italy and Spain alone, according to eMarketer.

But, relative to these countries’ budgets, it’s almost as insignificant a take as in India, and it’s not clear what the tax would achieve. Given their market dominance, the US tech firms would have no problem passing on much of the cost to the buyers, many of them European retailers and producers. Market growth would suffer, and so would these local companies’ sales. The extra government revenues might not be worth it.

There’s no doubt that a special tax on the likes of Google and Facebook would be politically popular. But a turnover tax is essentially pass-through. Instead of a fairer tax environment, in which Google pays as much tax as a local business that buys advertising from it, the European governments will end up with the local businesses paying more and the Googles and Facebooks still hiding as much profit from taxation as before. That can’t be what French Finance Minister Bruno Le Maire and his German counterpart Wolfgang Schaeuble, the two most powerful signatories of the Letter of the Ten, really want.

There’s little doubt the US tech firms should pay more taxes or that they should pay them where they make their profits. It’s easy to understand the frustration of the European governments that have no easy way to make sure of that. But they don’t really need a quick fix that might make things worse. They need to agree on how to define the tech giants’ corporate tax base so a fair tax could be charged wherever they operate. It’s not easy, but it’s the more reasonable way forward, even if it grants the US tech firms a few more windfall years.