Economist Jeffrey Sachs has rarely met a boondoggle he didn’t like. So it shouldn’t be surprising that he has now argued for a “tech tax"—essentially, “finding ways to tax capital income and IP [intellectual property] income". The thing is, he is not the only one. The concept of a tech tax is gathering momentum. The European Union (EU) has been grappling with it since March this year. India introduced it in the Finance Act 2018. Australia is considering it and so are a number of other countries. It is a clear sign of the difficulty of dealing with the changing nature of the digital economy.

Cheap services and products built on the back of technological innovation enable productivity growth among the poor. They can aid farmers in price discovery, say, or give a push to financial inclusion and credit access. This is a given. But Dani Rodrik has pointed out that new technologies can also have downsides for developing economies. They show a bias towards skill and education when it comes to job creation. This reduces the labour arbitrage advantage developing economies have. The overall shift in income distribution from labour to IP doesn’t help.

The digital economy’s combination of intangible capital and disaggregated business models also creates an almighty headache for governments when it comes to taxation. Businesses that depend on monetizing user data for revenue, for instance, may realize millions of dollars of value from a tax jurisdiction without having a significant, taxable presence in it. The revenue can be registered to dummy head offices set up in low tax jurisdictions. Meanwhile, the difficulty of pricing intangible capital accurately undercuts measures such as the arm’s length principle meant to keep companies reasonably honest when indulging in transfer pricing for tax avoidance purposes.

The souring public perception of big tech hasn’t helped. The Russian misinformation campaign via social media during the 2016 US presidential election, the difficulty of keeping fake news in check, user data privacy missteps and the disconnected realities that tech evangelists seem to inhabit have often left tech companies looking like irresponsible mercenaries. This reduces the political cost of governments putting the boot in. The temptation can be difficult to resist—and lead to impractical solutions as various forms of the tech tax show.

Take San Francisco, the heart of the global tech industry. In 2011, the city phased out the payroll tax and replaced it with a gross receipts tax—a popular move with tech companies since they often have large workforces before they have revenue. The tactic worked. Tech companies flooded into formerly blighted parts of the city. The unemployment rate fell by almost two-thirds over the next few years. But with the growth came disruption as gentrification pushed poor residents out of their houses and home prices rocketed to well over the national average. Thus, in 2016, members of the city’s administration proposed a payroll tax targeting only tech companies; the revenue would be used to build affordable housing and homeless shelters. They had seized upon the most visible target—no matter that a tax targeting a job-creating sector could be counterproductive or that the city’s long-running housing problem had as much to do with restrictive building regulations that choke supply.

The EU’s tech tax, likewise, is likely to have negative consequences. In March, the European Commission mooted the idea of a 3% levy on digital companies’ revenues from online advertising, selling users’ data and intermediation services connecting online buyers and sellers. While France has strongly backed the idea with lukewarm support from Germany, low tax countries like Ireland and others like the Nordic countries have pushed back. They argue that the US where most of the potentially affected companies are headquartered will see this as a tax grab.

They are correct. Washington has been disgruntled about what it considers the EU’s attempts to hobble US tech companies. Under a bellicose Donald Trump who never saw a retaliatory trade barrier he didn’t like, the US reaction to such a levy is likely to be unpleasant. Against this is an estimated revenue from the levy of €5 billion a year. Distributed among EU member states, it is a piffling amount. The tradeoff hardly seems worth it.

As for India, the ‘significant economic presence’ (SEP) concept introduced in the Finance Act this year—it means that if a company has an SEP in India, it has tax liabilities here whether it is based here or not—makes instinctive sense. The problem is creating thresholds that don’t stifle competition or open New Delhi up to accusations of protectionism. An even bigger problem is finagling such a regulatory change without becoming entangled in existing bilateral tax treaties.

These moves take aim at legitimate problems which will grow in scale as IP comes to play an increasingly important role in traditional sectors such as automobile. But the transnational nature of digital businesses demands a multilateral response rather than a patchwork of rivalrous measures. This is difficult at a time when protectionism is on the rise, but all the more important for it. The Organisation for Economic Co-operation and Development’s work on a new framework for base erosion and profit shifting for example, could do far more to shape an effective response to the digital economy than the EU’s levy. Getting there, however, will require governments to refrain from letting frustration goad them into making counterproductive policy.

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