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Digital economy presents challenges to which US taxation system is unsuited

about 16 hours ago

Rana Foroohar

President Donald Trump wants to overhaul corporate taxation in the United States, and bring home the large pot of profits being held overseas by US corporations. Photograph: Molly Riley/AFP/Getty Images




The tax reform debate continues to rage in the United States. And it is likely to do so for the next few weeks as the Senate and House of Representatives try to square the circle on new legislation that will benefit mostly rich companies and individuals.

The markets are already jittery with worries that the Republicans won’t be able to pass a tax reform at all (a very real possibility).

But it’s all a distraction from the debate we should be having, which is how to come up with a fair, growth-enhancing method of taxation for an age in which most wealth is going to reside in intellectual property that can be located anywhere.

As the debate stoked by the Paradise Papers and the increased offshoring of cash by multinational corporations has shown, rich people and companies can float over national concerns and existing tax structures with ease (and quite legally). This is the natural, albeit undesirable, effect of economic globalisation running so far ahead of political globalisation.

Large companies have long been able to “optimise” their tax affairs by moving capital where it is most convenient (labour is, of course, less portable). This sort of optimisation is easiest for finance and tech groups, since they traffic in capital and data. As these companies have come to represent a larger share of the economy (in 2016, four of the largest US public companies were Apple, Google parent Alphabet, Microsoft and Amazon), more and more tax revenue has been lost.

Taxing consumption

What we need is a fundamental rethink of how to align taxable profits with real economic activity and value creation. That probably means taxing something that cannot be moved around so easily – such as consumption.

Today, about half of all US corporate profits from overseas are located in tax havens such as Ireland, Luxembourg, the Netherlands, Switzerland and Jersey. This is, of course, a key reason for the omnipresent threat to liberal democracy from extreme politics; many people rightly feel that such entities are not contributing their fair share to the societies from which they profit.

How to fix this? The business argument, particularly in the US, is that we should cut the corporate tax rate to encourage companies not to offshore. But that would require closing loopholes to make up revenue, which is politically unfeasible.

Meanwhile, other countries would undoubtedly cut rates too, in a race to the bottom. US business also argues for a shift to a territorial system. While this would solve the double-tax problem on US companies, it would actually increase the incentive to shift profits and activities offshore, because they would no longer face any US tax if moved abroad.

In fact, both ideas are just a sticking plaster on a system of taxation that is fundamentally unsuited to the 21st-century digital economy – one in which the vast majority of wealth is being captured by companies that have no need of a major physical presence in their various markets, or even a fixed national headquarters.

Equalisation levies

European Union finance ministers from 10 countries, led by France, support a plan to tax tech groups on sales in countries where they do business. Other countries, such as India, have already implemented “equalisation” levies on payments in excess of $1,500 to foreign enterprises without permanent establishment in the country. When, say, Amazon makes a sale there, a certain amount of tax is withheld on the payment.

All this represents a big shift in the old order. The Silicon Valley giants are, of course, complaining bitterly. An OECD conference on the challenges of digital taxation held recently at the University of California Berkeley made for interesting listening.

While independent tax experts and academics argued for a new system in which companies could be found to have taxable “physical entities” in countries where they collect and monetise data from citizens, the tech companies are predictably digging in their heels.

Robert Johnson, a representative for the Silicon Valley Tax Directors Group, insisted: “Raw user data isn’t like oil – value is created by the development and production of goods and services, not consumption.”

Yet in the age of digital commerce, data really is the new oil: consumption of online goods and services is what generates the user data that companies can then monetise. Tech groups do not want to admit that just collecting data creates value – but plenty of research (including some funded by Google itself) shows exactly that.

It is not the cleverness of the algorithm that matters, but what you stuff into it. And national governments rightly believe their citizens should receive improved public services in return for their data – which of course must be funded by taxes.

Crafting a smart and fair system of digital taxation will not be easy. What is the true value of the data that firms collect? What percentage of tax should be taken from a transaction? Who would collect it and how? Answering these questions would be easier if large tech companies and others engaged in digital commerce were more forthcoming about their business models. When the public feels betrayed by the people who run such outfits, it is not good for politics – or business. – Copyright The Financial Times Limited 2017