The Next Trade War Will Be Digital
At a celebration of the three-centuries’ long relationship between the United States and France last spring in Baltimore, Maryland Lt. Gov. Boyd Rutherford (R) proclaimed, “The history of Maryland is intertwined with France.” While the lieutenant governor was most likely referring to French immigration to Maryland beginning in the mid-1700s that has created a vibrant “French Town” in Baltimore, the nation and the state seem to still have a lot in common: to the chagrin of other governments, both are pursuing a digital services tax (DST).
A DST is a tax on revenue earned by companies that provide digital services to the residents of a nation (or, in Maryland’s case, a state), whether or not those companies have any kind of physical presence in the territory that is levying the tax. Sometimes called a Google or Facebook tax, DSTs provide governments a way to generate additional revenue without directly raising taxes on constituents (either individual taxpayers or businesses that are incorporated in a state).
As the Congressional Research Service—the nonpartisan research arm of the U.S. Congress—has explained, DST proponents argue that the countries or states imposing them are “entitled to a share of profits earned by digital” companies “because of the ‘value’ to these business models made by participation of their residents through their content, reviews, purchases, and other contributions.” Critics say DSTs “target income or profits that would not otherwise be subject to taxation under generally accepted income tax principles.”
If implemented, the levies could be quite lucrative for the countries imposing them. According to the Information Technology and Innovation Foundation, which opposes these taxes, DSTs could generate two to three percent of a country’s domestic revenue simply by targeting “a narrow group of large Internet companies.”
Digital services taxes have proliferated over the last handful of years. As the right-leaning nonprofit Tax Foundation has explained, between 2014 and 2016, Hungary, India, Israel, and South Korea were among the first nations to implement digital services taxes. In the following two years, several additional countries, including the United Kingdom, Spain, and Singapore, along with the European Union, all proposed or implemented DSTs. Italy, Austria, and the Czech Republic plan to implement these levies this year.
In a spectacular show of bipartisanship last April – at least given the current partisan rancor in Washington –, Senate Finance Committee Chairman Chuck Grassley (R-Iowa), House Ways and Means Committee Chairman Richard Neal (D-Mass.), Senate Finance Committee Ranking Member Ron Wyden (D-Ore.), and House Ways and Means Committee Ranking Member Kevin Brady (R-Texas) issued a joint statement urging that nations think carefully about DST’s impact and work together on the matter. What drove the unanimity? As the four warned, these levies “would disproportionately affect U.S. technology companies.”
Digital services taxes clearly are controversial, but it is France’s DST that seems to have rankled U.S. policymakers and the Trump administration the most.
Less than a week after the French parliament gave its final approval to a digital services tax that imposes a three percent levy on gross revenues of companies that provide €750 million ($835 million) in services globally and €25 million ($27.8 million) in France, the Office of the U.S. Trade Representative launched an investigation, which last December concluded, “the French DST is intended to, and by its structure and operation does, discriminate against U.S. digital companies.”
President Donald Trump has been very vocal about his opposition to France’s DST, threatening to impose tariffs on $2.4 billion worth of French products, including cheese, handbags, yogurt, and champagne, in retaliation if the French government implements its DST.
For now, it appears there is a truce, even if only temporarily. On Monday, President Trump and French President Emmanuel Macron reportedly agreed to a deal in which neither country would impose new tariffs until at least the end of 2020 while negotiators discuss France’s DST. On Twitter, President Macron said he had a “great discussion” with President Trump and pledged to “work together on a good agreement to avoid tariff escalation.”
Additionally, as The New York Times reports, international negotiators at the Organization for Economic Cooperation and Development (OECD) are working to develop a broader DST framework for implementation and integration of digital taxes around the world. A source close to President Macron said the French hope the OECD will framework will resolve the flare-up between the United States and France.
The discussions with France bore other fruit as well. According to Politico Pro, Canadian Prime Minister Justin Trudeau has distanced his government from a campaign proposal to install a French-style digital tax. In an interview with Politico, Canadian Heritage Minister Steven Guilbeault said, “I have a lot of respect for what France is doing, they’ve decided to take an approach to it — ours will be different … We understand that although this is a direction we want to take, it’s a more complex issue — we’ve seen what’s happening in France and the U.S. on this front."
Despite the movement toward the United States’ position, the University of Calgary’s Anup Srivasta recently told ZDNet the issue “has the potential to blow up into a major trade war.” Indeed, at Davos this week, U.S. Treasury Secretary Steve Mnuchin reportedly warned that the United States could impose tariffs on Italy and Britain if they go ahead with a digital tax.
The international détente also might not slow the growth of DSTs, especially closer to home. According to Politico, Maryland’s Democratic legislative leaders have proposed a digital services tax that is similar to France’s. It would “hit companies like Facebook and Google with as much as a 10 percent tax on revenue collected from advertising targeting IP addresses linked to the state.”
But are these state-based proposals likely to withstand legal scrutiny?
That’s doubtful, at least according to individuals who weighed in on Maryland’s legislation after it was introduced on January 8.
On Twitter, University of Virginia tax professor Ruth Mason said Maryland’s DST would violate the U.S. Constitution’s commerce clause, which gives the U.S. Congress, and only Congress, the power to regulate commerce with foreign nations and between the U.S. states.
Mason also said Maryland’s proposal might run afoul to the Internet Tax Freedom Act, in which Congress explicitly said it would be discriminatory to tax a digital service or good while not taxing at the same amount a similar good or service purchased or delivered through more traditional means. Mason noted “it’s rare to have such a clear statement from Congress on what they want.” Rob Callahan, senior vice president for state government affairs at The Internet Association, said the Maryland “bill appears to stand on questionable legal footing and unfairly discriminate against a single segment of the advertising sector.”
Then, of course, there are the politics. Mason said allowing states to have digital taxes would undermine the federal government’s effort to oppose France’s digital services tax. The Trump administration can be expected to weigh in against the Maryland proposal, especially since it originates in a legislature run by a majority of members of the opposing party.
But Maryland is not the only state in the union that apparently is open to the idea of a DST. The National Taxpayers Union’s Nicole Kaeding told Politico Nebraska—a traditionally Republican state—also is considering a digital services tax.
Will any of these considerations matter to states? While ultimately a legal ruling against state-based digital services taxes could be the deciding factor, political considerations are likely to fuel shorter-term pushes to enact DSTs. Remember, that at least 45 states must, by law—and in some cases under state constitution requirements—balance their budgets every year. Policymakers always are looking for novel ways to raise revenue, particularly if it means they would not actually have to levy new taxes on middle-class voters in their state heading into an election cycle.
Indeed, the two sponsors of Maryland’s legislation, Bill Ferguson (D) and Thomas V. “Mike” Miller Jr. (D), have said their proposal would generate $100 million in new revenue each year and that they would devote that money to improving education in the state. That mission – and revenue collected from outside the state’s borders – will be hard for digital services providers to counter.