Some (large) EU governments are making the case for digital companies to pay “their fair share of tax”. The key underlying assumption is that companies in the digital space are not doing so right now. Governments also assume that there is a substantial source of untaxed profits that is waiting for the embrace of the taxman. The European Commission is now considering “revenue taxes” on those companies that under some definition can be called “digital corporations”. In this paper, we provide a critical assessment of the underlying reasoning of the European Commission and those EU governments that currently are in favour of targeted taxes on digital revenues.
There is indeed a good case to make for fair taxation and that uneven effective tax rates can distort competition and lead to smaller tax revenues. However, those that are calling for higher taxes on one particular group of firms – digital corporations – have yet to present the evidence for why that is motivated by principles of fair taxation. The European Commission’s “hypothetical” estimates for effective corporate tax rates (ECTRs) do not reflect the high effective corporate tax rates of most corporations that operate in the EU and outside EU Member States, including the world’s largest digital enterprises.
In addition, the European Commission’s selective focus on digital companies that are big on “stock markets” mixes up market capitalization with corporate income. Thereby, the focus on the world’s “top 100 companies by market capitalisation” and the world’s “top 5 e-commerce companies” hardly reflects the reality of the digital economy and profit levels among different, often highly diverse, firms. Real world financial data show that the average corporate tax rates of many digital companies actually exceed the European Commission’s “hypothetical” estimates by about 20 to 50 percentage points.
Ideas to slap a targeted tax on digital revenues clash with the EU’s top policy priorities for the digital economy. It is therefore remarkable that such taxes even are considered. A tax on digital revenues would not only stand in opposition to tax efficiency and neutrality; it would also undermine digitalisation, European integration, and the Digital Single Market.
Research assistance by Nicolas Botton is gratefully acknowledged.
Why is the EU Contemplating a Tax on “Digital” Revenues
In its Communication last year on a “Fair and Efficient Tax System in the European Union for the Digital Single Market”, the Commission calls for efforts to “stabilise the tax bases of the individual Member States, and ensure fair competition and the flourishing of companies operating within the Single Market.” It is argued that “international tax rules […] no longer fit the modern context where businesses rely heavily on hard-to-value intangible assets, data and automation, which facilitate online trading across borders with no physical presence.”
Aware of the “lack of international consensus” on how to tax traditional and digital corporations in general, the Communication calls on EU Member States to consider “short-term measures […] to protect the direct and indirect tax bases of Member States.” The “shorter-term solutions” proposed by the Commission are also sketched:
- Equalisation tax on turnover of digitalised companies: A tax on all untaxed or insufficiently taxed income generated from all internet-based business activities, including business-to- business and business-to-consumer, creditable against the corporate income tax or as a separate tax.
- Withholding tax on digital transactions: A standalone gross-basis final withholding tax on certain payments made to non-resident providers of goods and services ordered online.
- Levy on revenues generated from the provision of digital services or advertising activity: A separate levy could be applied to all transactions concluded remotely with in-country customers where a non-resident entity has a significant economic presence.
It is not yet clear whether the Commission aims for taxing all digital revenues or revenues from advertising services only. Similarly, it is unclear if the Commission aims to ring-fence, i.e. explicitly discriminate, non-EU companies or not.
The European Commission’s line of argument
In its Communication, the Commission argues that “policy makers are struggling to find solutions which would ensure fair and effective taxation as the digital transformation of the economy accelerates.” Contrary to a core objective of the Digital Single Market (DSM) strategy (European Commission 2015), the Communication actually argues in favour of treating digital corporations differently from other companies. Furthermore, it is claimed that the current failure to “fairly tax” digital corporations leads to more opportunities for tax avoidance, which negatively impact on social fairness and “puts at risk EU competitiveness, fair taxation and sustainability of Member States’ budgets.”
A revealing part of many claims of this kind, however, is that they are not substantiated by actual data and evidence. It is only assumed rather than proven by real-word data that a special category of firms pays too little tax. In addition, the Commission and some Member State governments that call for more taxation on these firms do not give supporting evidence that a new form of taxation actually would raise tax revenues and that it would not impact negatively on the competition between competing business models.
Fairness and sustainability in taxation
Considering the actual development of overall EU tax receipts, it becomes immediately obvious that calls on more taxation of digital corporations are troubling. In fact, the actual development of overall EU tax receipts suggests that there is not much of a “failure” in Europe in tapping profits and that this threatens the sustainability of public finances. Over the past 20 years, the growth of overall government tax revenues in the EU (119 percent) was significantly higher than overall EU GDP growth (103 percent). Tax revenue data demonstrate that a significantly higher amount of both household and corporate income has been collected by EU governments since 1995 (see Figure 1).
Moreover, it is apparent that, since 1995, revenues from taxes on corporate income show by far the highest growth rate compared to other forms of taxation, i.e. (sales) taxes on value added (VAT) and taxes on individual and household income. Increasing by 147 percent from 1995 to 2016, the growth of overall EU government revenues from taxes on corporate profits exceeded the growth of general tax receipts by not less than 28 percentage points. Accordingly, between 1995 and 2016 the share of overall tax revenues in the EU relative to EU GDP increased by 2 percentage points to now 26.8 percent (see Figure 6 in the Appendix).
While aggregate data on revenues from corporate income taxes do not deny the claim that some companies may pay too little in tax, let alone that some companies may be illegitimately evading taxes, it is notable that the overall share of taxes from corporate profits relative to GDP remained constant over the past 20 years. Consequently, views about “tax base erosion in the EU” as a whole are exaggerated, and the same verdict is true for the statement that the rise of the digital economy has exacerbated corporate tax base erosion. EU countries’ tax data rather indicate that the digitisation of the economy has, overall, not impacted tax revenues and base erosion. In addition, it should also be noted that even if EU Member States were able to collect the total taxes paid by the world’s largest digital corporations, the amount collected would not make an impact on the sustainability of public finances in the EU (see Figure 7 in the Appendix).
Source: Eurostat, OECD. Note: for total receipts from taxes and compulsory social contributions, 1995-2016 growth numbers are depicted for EU28 ex Croatia. For total tax receipts, 1995-2016 growth number are depicted for EU28 ex Croatia. For total tax receipts from VAT, 1995-2016 growth numbers reflect the EU28 ex Bulgaria, Romania, Croatia. For total tax receipts from individual and household income, Eurostat numbers are only available for the EU28 ex Germany, Estonia, Spain, Croatia, Hungary, and depicted accordingly. For total tax receipts from corporate profits, Eurostat and OECD data are not available for Spain, Croatia, Hungary, Poland, while OECD data on tax revenues in national currency (EUR) have been added for Germany and Estonia.
Digital firms are not just big
It is also revealing that much of the thinking in Europe about taxing digital companies more is only occupied by big and listed Internet companies. Obviously, there is rich variety in how various firms perform in profit and taxation, and that is true also for companies that run digital business models. The selective focus on digital companies that are big on “stock markets” mixes up market capitalization with corporate income. A focus on the world’s “top 100 companies by market capitalisation” and the world’s “top 5 e-commerce companies” hardly reflects the reality of the digital economy and profit levels among different firms. Hence, when the governments and the Commission present low effective tax rates of digital corporations as the heart of the problem, they are conflating the digital economy with the alleged tax rates of a few firms.
For instance, the above-mentioned Commission Communication selectively uses highly aggregated average data for corporate revenues (top 5 e-commerce retailers) and average corporate tax rates to highlight that companies with “traditional”, less or non-digital, business models face significantly higher tax rates than companies with “digital” business models. According to the references provided by the Commission, the numbers are taken from a ZEW (2016) study that had been commissioned by the European Commission’s DG TAXUD and PWC (2017), which refers to the work done by ZEW. It should be noted, however, that the numbers presented by the Commission for the effective corporate tax rates (ECTR) of digital companies are neither explicitly reported in ZEW (2016) nor depicted in PWC (2017). While the numbers presented may have been calculated on the basis of the ZEW study, it remains unclear how they arrived to their specific estimates on the ECTR. Most notably, real observed data do not correspond with these estimates and, importantly, the ZEW study (2016, p. 9) says that the numbers they have calculated are mere estimates based on a “hypothetical investment project” and a number of theoretical assumptions about pre-tax rates of the return of a hypothetical investment, real interest rates, and different depreciation rates for a limited number of asset classes.
It is also troubling that the evidence presented by the Commission has been estimated on the basis of formal country-specific tax codes. But such estimates on tax do not reflect the real effective corporate tax rates of individual corporations that operate in the EU and outside EU Member States. The fact that the data presented in the Communication are based on individual countries “most favourable tax regulations, that is, including special tax regimes for research, development and innovation” PWC (2017, p. 4), indicates that the Commission did not take into consideration that many internationally-operating companies have to bear the financial burden of double taxation.
 The EU’s commercial landscape is characterised by an overall share of highly diverse SMEs which account for of 99.8 percent of all EU enterprises and 66.6 percent of overall EU employment (European Commission 2017b). Despite an overwhelming amount of empirical evidence, the Communication does not say anything about the importance of new digital technologies and digital business models for the empowerment of traditional and new SMEs, as, for example, outlined by the EU’s DG GROW (European Commission 2016) and the EU’s Digital Progress Report (European Commission 2017c). The latter indicates that there are “a lot of technological opportunities still to be exploited by SMEs with big data, cross-border eCommerce, cloud services and automation.” (p. 6) Importantly, a tax on digital companies and/or digital revenues would be passed on to the consumers of such services and, according to basic economics, suppress the demand of these services and their dissemination respectively.
 From 2005 to 2016, the overall growth of EU governments’ revenues from taxes on corporate profits slowed down, increasing at a lower rate compared to other forms of taxation. At EU Member State level, lower growth rates in revenues from taxes on corporate income largely resulted from the adverse impact of the economic recessions following the 2007 asset market and sovereign debt crises.