‘Don’t Tax Me; Don’t Tax Thee; Tax the Fellow Behind the Tree’

The doggerel verse in today’s title, which comes from Senator Russell Long (D-LA), the late chairman of the Senate Finance Committee, came to mind this week when I decided to write about European Union and EU member state tax policies. Making tax policy is hard work because virtually any path chosen will have different impacts on sectors, regions, and individuals no matter how hard one tries to make it as even-handed as possible.

In recent years, however, governments seem to have even stopped trying for tax policy neutrality and instead have embarked on tax policy competitiveness—using it as a bribe to entice companies to locate in their territory and as a weapon to punish companies that are either out of favor or attractive targets for easy money.

We have seen the former in this country in numerous state efforts to attract foreign investors. Oftentimes it works, but sometimes it does not—see the Foxconn case, where it appears Wisconsin got taken to the cleaners.

Recently, the European Union has begun to weaponize its tax policy for both reasons mentioned above—a search for easy money from foreign (almost entirely American)—marks and a way to disadvantage foreign companies in areas where the Europeans are having a hard time competing. The best current example of this is EU efforts, as well as those of individual member states, to impose a digital services tax (DST).

This proposal, which has not yet been agreed to, is intended as an interim step until a separate proposal to tax digital profits is implemented. Under it, a 3 percent tax could be collected by EU member states on taxable revenues collected by digital companies in that member state. Taxable revenues include those gained from digital advertising, operating online marketplaces, and selling user data. Taxable revenues exclude platforms whose sole purpose is to provide digital content, communication services, or payment services to users; financial service providers; and crowdfunding platforms. Companies would be subject to a DST if they both have a total worldwide revenue exceeding 750 million euros and their taxable revenue within the European Union exceeds 50 million euros.

Most of the individual countries and the European Union itself agree that this matter is best dealt with through a common approach, and the Organization for Economic Cooperation and Development (OECD) has been tasked with developing that. The United States has also supported an OECD effort. That appears, however, not to be moving fast enough for some EU countries—at least eight so far—who smell easy money and want to install “temporary” measures pending an agreed-upon OECD approach. This is a terrible idea—bad for U.S. companies for sure but also bad for the European Union.

U.S. tech and digital companies such as Google, Facebook, and Amazon are the primary targets of these efforts—the revenue thresholds for the DST would effectively target only large U.S. companies. Accordingly, the Peterson Institute for International Economics (PIIE) has called the DST a tariff. According to their analysis, the only EU-based company that would qualify for taxation would be Spotify; however, given the exclusion of subscription fees under the DST proposal, even Spotify would not be taxed. It is clear that definitions of “taxable revenue” are specifically designed to include U.S. companies and exclude EU companies. The most recent version of the tax, the digital advertising tax, is even more narrowly focused on U.S. companies, particularly Google and Facebook.

It is also becoming clear that this is not good for European companies either, even though they’re not targeted. At the end of January, CEOs from European tech companies including Booking.com, Spotify, and Zalando, wrote to European governments urging them not to adopt the DST. They suggested the tax would “create a harmful legal precedent of taxing revenues over profits, even when the taxpayer is not yet profitable . . . impose a financial burden on burgeoning European companies and weaken their ability to compete globally . . . [and] . . . result in double taxation, particularly when charged on EU resident companies’ revenues, which are already subject to corporate income tax and VAT in Europe.”

In addition, the Tax Foundation argues that the tax burden of a DST would ultimately fall on European consumers and that turnover taxes have historically been found to be inefficient and barriers to economic growth. They give companies incentivizes to reorganize their business models to stay below the revenue threshold, thus limiting growth and wasting resources on designing strategies to avoid the tax. The foundation suggests that a turnover tax could result in double or triple taxation and that by taxing gross instead of net income, companies will be taxed before they become profitable. Most important, they point out that a DST rests upon the assumption that you can somehow separate the digital economy from the rest of the economy—an assumption that is increasingly unrealistic.

Similarly, the European Policy Information Center points out that taxing revenues would disproportionately harm companies with low-profit margins. A company with a 6 percent profit margin would face a marginal corporate tax rate of 50 percent if taxed at 3 percent on their revenues. This would be particularly harmful to start-ups that often operate on low-profit margins in their early years.

Finally, the ever-popular retaliation argument is relevant here, given the targeting of U.S. companies and the demonstrated tendency of the Trump administration not to take these things lying down.

One argument not always made publicly is that this is, at bottom, simply a case of jealousy. EU companies will be largely unaffected by the tax proposal because the European Union has produced so few of them. Sadly, the European Union has fallen into the same trap as President Trump. If you are in a race, there are only two ways to win—run faster or trip the other guy. Both Trump and the Europeans are concentrating on tripping each other when it would be a lot smarter if they simply tried to run faster.

Special thanks to Jonas Heering for the research behind this column.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Jonas Heering is an intern with the CSIS Scholl Chair.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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