Digital Taxation Is Not The Solution to the Covid-19 Fiscal Crisis

Aurelien Portuese February 19, 2021
February 19, 2021

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The Covid-19 crisis has put a dramatic strain on public finances. Tax revenues are in decline as the recession takes its toll on businesses and families. Meanwhile, public spending is skyrocketing due to inevitable federal and local stimulus relief packages. To bridge the gap, some legislators are contemplating new sources of taxation, and a favorite target is emerging: tech companies. As the apparent winners in the current economic crisis, they look like ideal sources of revenue, and a “digital tax” seems to be the legislators’ favorite mechanism. Look no further than Maryland, which today becomes the first state to adopt a digital tax on online advertising revenues. It may pave the way for other states follow, but Maryland’s digital tax will not prove to be a way out of the crisis. It will only make the crisis linger.

The first problem is that while digital taxes may appear to be targeted toward big tech companies, they really constitute a much broader penalty on innovation. Although big tech companies attract most of the media attention—and the lion’s share of regulators’ scrutiny—the entire tech industry has benefitted from the pandemic. That’s because, from small start-ups to large corporations, digitally innovative companies have been the ones most ready and able to adapt well as the inexorable digital transformation of the economy suddenly accelerated.

To tax digital companies that were innovating before and managed to continue innovating through the crisis is to punish innovative, risk-taking activities, and thus deter further innovation. And worse yet, to tax digital companies in order to refund less innovative firms will only delay the digital revolution’s full-fledged benefits, which will come at the expense of American competitiveness nationally and internationally. That is what the tax-and-transfer mechanism induced by digital taxes such as Maryland’s accomplishes. It is tantamount to taxing innovative companies to transfer “entrepreneurial rents,” as the economist Joseph Schumpeter wrote, to digitally illiterate companies.

As a way out of the crisis, we need more digitally competitive and innovative companies, not less. We need more risk-taking companies investing in technological assets, not risk-averse business owners resting on their laurels. Digital taxation thus is not the solution to the fiscal crunch the pandemic has created. It will instead delay the economy’s exit from the crisis. We do not need digital taxation, we need digital incentivization.

Moreover, to enforce a digital tax at the local level based on budgetary arguments emulates the European Union’s disingenuous justifications for a comparable “digital levy.” Policymakers there had plans to tax tech companies—the pandemic gave them a reason to do so. But the United States has consistently opposed the efforts, retaliating whenever such taxes were enforced. The U.S. position has, through consecutive presidencies, fostered international discussions in the OECD to ensure that tech companies are taxed without suspicions of disguised protectionism under the moniker of “digital sovereignty.” Consequently, Maryland’s digital tax, and any other state’s digital taxes that may follow, would frustrate the ongoing U.S. efforts and run counter to the whole rationale of cooperating internationally on fair corporate taxation. If unilaterally taxing digital companies at the national level is inappropriate, then doing so at the state level is, a fortiori, even less appropriate. We do not need digital taxation; we need digital cooperation.

Finally, Maryland’s digital tax on online advertising revenue is not a narrow tax applicable to a small set of companies—it is a broad tax, making the Internet less competitive. Indeed, since ad-funded business models constitute a large ratio of tech companies, the digital tax on advertising revenue threatens the business models’ competitiveness however essential to the Internet’s history and future. Taxing advertising revenue would disproportionately harm small ad-tech companies as opposed to ad-tech giants. Also, online advertising is a powerful way for entrants to effectively compete with incumbents in different economic sectors. Thus, the digital tax risks fossilizing competition, not reinvigorating it.

Ultimately, taxing advertising revenues jeopardizes ad-funded digital services, so consumers may start paying for services and products they currently use for free. Should budgetary concerns justify such consumer harm in times when households’ purchasing power are strained? We do not need digital taxation; we need digital protection of purchasing power.

Maryland’s digital tax set an unfortunate precedent at an inconvenient time and for insincere reasons. We need to bridge the digital divide and harness digital capabilities. That is the best relief from the crisis we can expect.