The ascent of Amazon and Apple into the trillion dollar valuation club is a landmark corporate achievement. Together, these two firms are worth as much as the annual gross domestic products of Spain and Switzerland combined. But, beyond the accolades, what does the rise of these digital titans mean for policymakers?
One key challenge is that a borderless digital economy, in which data is fast becoming the new coin of the realm, is out-of-sync with current regulatory and taxation regimes. These regimes are typically based on corporate residency and define value in monetary terms. In our increasingly digital economy, these approaches are becoming outdated and may be starting to seriously undermine government’s revenue integrity, tax fairness and tax revenues.
Part of the challenge has to do with governments’ ability to collect taxes owed. Between 1985 and 2018, the global average statutory corporate tax rate dropped nearly by half, from 49% to 24%. But even at this much lower rate, the OECD estimates that global multinationals are avoiding paying between $100 and $240 billion annually (USD) in corporate taxes.
Digital firms are increasingly important contributors to this taxation gap. These firms operate in jurisdictions in which they don’t have a physical presence and can easily shift intangible assets like intellectual property between countries. As a result, they pay little or no tax in many of the places in which they are economically active and from which they extract value. At the same time, their business models upend traditional companies such as retailers, taxis and hotels that pay “traditional” taxes in those jurisdictions.
Ireland preferred to maintain their reputation as a tax haven than collect additional tax revenue
Moreover, some countries are exploiting this new reality to their advantage. For instance, for many years Apple paid an effective tax rate of 0.005% to their European home base of Ireland where it booked profits arguably generated in many other countries. But when the EU fined Apple €13 billion ($15 billion) in an attempt to force it to pay Ireland what it argued were unpaid taxes, Ireland opted to fight the ruling. They’d rather maintain their reputation as a tax haven than collect the tax revenue.
Another part of the challenge is that data has tremendous value in the digital world. Firms such as Google and Facebook essentially take payment for their “free” services in the form of data collected from users. Monetary value is then extracted from this data, either by using it to better target ads or to train machine-learning algorithms. But the value transacted in these exchanges is not captured by traditional taxation systems.
This isn’t just a challenge for corporate taxation. As more workers become engaged in virtual gig work on global labour platforms like Airtasker and more economic activity occurs “offshore” in cyberspace, policymakers can expect further pressures on personal income and sales tax revenues. With their populations aging and demand for social services and skills-retraining likely to increase, advanced economies can ill afford to see their tax bases erode just when they will need them most.
Google and Facebook take payment in the form of user data. But the value transacted in these exchanges is not captured by taxation systems
So, what can governments do to update industrial-era tax policies for the digital age? At the Mowat Centre at the University of Toronto, we have written a new report which outlines a number of strategies policymakers should consider. For example, amending the definition of permanent establishment under international tax laws to take account of digital firms without a physical presence could make it much easier to collect tax based on where value creation is truly occurring. Applying existing sales taxes to digital services would be another good way of generating revenues in the digital economy. Taxing the extraction of personal data from users could also help even the taxation playing field.
Governments must also consider how they can turn themselves into more digitally savvy organizations, capable of redefining value and capturing tax revenue from new forms of economic activity. That will require an awareness of global trends, the data analytics capacity needed to track and enforce tax obligations and a willingness to work closely with other governments and firms to develop fair and consistent rules across borders, in areas which have often been solely domestic concerns.
These suggestions and others rely on concerted international cooperation. That’s a challenge, as the incentives for countries like Ireland to attract investment and jobs can outweigh the benefits of a higher international floor for corporate taxes.
The challenges of ensuring tax fairness and revenue integrity in the 21st century digital economy will only grow in scale and complexity as new technologies come online. Blockchain powered cryptocurrencies could, for example, fuel a surge in untaxed underground economic activity in a broad range of sectors.
The sooner that policymakers get on with the task of updating tax policies, the better equipped they will be to provide the core programs and services that workers and citizens need in order to thrive in the future.