The EU should drop the Digital Services Tax

European consumers risk paying more ...

With the rise of the digital economy, a trend towards increased regulation of digital services has come to the fore. Digital services tax (DST), under which multinational enterprises are taxed in countries where they provide services through a digital marketplace, has become one of the most popular means to tame the big players.

In 2018, the European Commission initiated the introduction of a 3 per cent DST on the revenues generated in the EU digital market, including online sales and advertising. However, with the opposition of countries such as Sweden or Ireland, no agreement at the Council level has ever been reached. Despite the lack of compromise, member states went on to introduce DSTs on national levels. As a result, Austria, Belgium, Czech Republic, France, Hungary, Italy, Poland, Slovenia, Spain have proposed, announced or are already implementing some sort of digital tax. 

According to a KPMG report, the said tax is generating 2 to 3 percent of the countries' government revenues from a narrow group of large Internet companies. Although rates slightly differ between the member states - 7.5 percent in Hungary and 3 percent in France - the target is generally the same: large multinational companies.

Under current international tax rules, a country where multinational service companies are subject to corporate income tax is generally determined by the place where  production occurs rather than where consumers or users are. However, the proponents of DST argue that digital businesses get income by selling to users abroad through the digital economy but do so without physical presence there and conversely they are not subject to corporate income tax there.

The Organisation for Economic Co-operation and Development (OECD) has called on more than 130 countries to amend the international taxation system. This current proposal would require multinational businesses to pay some of their income taxes where their consumers or users are. According to the OECD, the dilemma could be unlocked this year, and great hopes are put into the Biden administration to help make that happen.

DSTs distort the market

While Austria and Hungary are taxing just advertising, in France, Turkey, and Italy, the tax scope is much broader. It includes revenues from providing a digital interface, targeted advertising, and data transmission about users for advertising purposes. Ultimately these taxes and the additional costs companies will have to be borne by consumers. Higher costs for advertising are likely to result in higher prices for these companies' products and services. According to a 2019 study on the economic impact of the French Digital Service Tax “approximately 55 percent of the total tax burden will be borne by consumers, 40 percent by businesses that use digital platforms, and only 5 percent by the large internet companies targeted.”

Turkey and Austria provide a valuable insight into how these taxes work.

According to the report mentioned above, in Turkey, in September 2020, an additional 7.5 percent fee was added to the costs of in-app subscriptions and other types of payment made on the digital platforms. In Austria, 5 percent of DST has been added to developers and advertisers' invoices when promoted as part of the Austrian DST. 

These additional costs are paid by consumers and small developers and do nothing to address the evolving nature of the digital market. In economic terms, DSTs increase the deadweight loss.

At first glance, it seems unfair that big multinationals don’t pay taxes while traditional businesses are overwhelmed by taxation and regulation. The EU Commission found that within the EU, digital companies had to pay 9.5 percent in tax on average while traditional business models were subject to a 23 percent  average effective tax rate. However, if the goal is to enhance economic well-being, a better solution would be to drive down taxes for both types of businesses. 

Digital platforms are creating innovation and wealth within the economy. The "app economy" has created millions of jobs in the last few years, with 800,000 jobs in Europe and the United States in 2017 alone.

On the opposite of the current political belief, the digital service tax won't affect big multinationals, but small developers will have to increase their price. European innovation will suffer too. If the prices of scaling up go up, small developers and innovators won’t be able to effectively compete with the US companies.

Digital platforms and services have helped millions of people working from home during the recent COVID-19 pandemic and generally have revolutionised the global economy. It is exactly because digital platforms are different from the supply chain that had been prevalent for hundreds of years, that there is a temptation to overregulate them, otherwise to put brakes on them in order to limit risks stemming from the lack of knowledge. 

Every tax, including a revenue tax, is more preoccupied with collecting profits rather than enhancing innovation. When talking about DSTs, it is key to understand what goal we are pursuing. If we want the European Union to become an innovation hub, then the DST definitely isn’t the way forward but if we want to punish big tech companies valued by European consumers for their success, then it is exactly what we need. 

And yet, even if we were to go down that road and continue to stand by the DST, we should do so by encouraging tax competition within the EU instead of imposing even more tax centralisation. Competition would allow EU member states to compete between themselves as regulatory regimes. In a similar fashion, that would provide digital services and platforms with more choice.

Digital economy boosts economic well-being. Some apps, such as Shazam, which recognizes the song played in that moment, or Slack, a service that provides instant messages for companies and teams, have been created by young entrepreneurs. Since then, they have exponentially expanded, becoming part of our daily life. 

In order to increase competitions in the digital market the EU should look to push more to smartly regulate the digital platform not to tax them. Such regulation would include clear rules of conduct defining blacklisted practices (e.g.i.e. self-preferencing) in order to self regulate certain aspects of a digital platform conduct, including transparency towards users, reporting obligations and prohibitions. 

Such an approach would safeguard the competition so that SMEs are able to compete with big players and create the dynamic market that benefits all consumers.

If, on the other side, European countries continue to push to introduce and increase DSTs without any agreement at the global level, European consumers risk paying more than their North American or South Asian counterparts and lose innovation and choice. DSTs are ineffective, and the EU should walk away from it once and for all.