Towards a deal to limit trade frictions on corporate taxation

The COVID-19 lockdowns provide a potent demonstration of the digital economy to our lives. Simon J. Evenett, professor of international trade and economic development, University of St Gallen, looks at the tension points when it comes to levying taxes on digital service providers

Mention of digital services taxes touches a raw nerve among G7 members. For some, taxing the revenues of digital service providers constitutes a discriminatory and unreasonable burden on international commerce. For others, it is a matter of fairness – ensuring that all firms selling in a country contribute to the common weal. What adds fuel to this particular fire is that the largest, more commercially successful digital service providers are headquartered in the United States and often have little physical presence in the foreign markets they seek to serve.

Attempts to levy taxes on digital service providers have triggered trade tensions that, on the current trajectory, will likely get a lot worse. On 10 July 2020, the United States Trade Representative levied 25% additional import tariffs on a range of French products. Fortunately, the imposition of those tariffs has been suspended until 6 January 2021, allowing for a settlement to be negotiated. But what could be the basis of a deal?

Taxing digital service providers is not just a matter of bilateral dispute. Other G7 members, including Italy, the United Kingdom and the European Union (which implicates two other G7 members), have mooted or implemented digital services taxes. This has not gone unnoticed in Washington DC, which launched on 15 June 2020 a formal investigation into those moves and actions by eight other governments, similar to the inquiry that resulted in tariffs being levied on French goods.

Before a possible way forward can be considered, note should be taken of the fact that in the past this subject could not be settled at the technocratic level. Indeed, the United States called for a pause in work at the Organisation for Economic Co-operation and Development on this subject in June 2020. To avoid a new round of trade tensions being unleashed, direction is needed from heads of state and government.

The current framing of the discussion is not propitious to securing a deal. Asking one country – whose leadership is not minded to negotiate international deals at the best of time – to accept losses for its firms without getting anything in return will not work. So what else can G7 members put on the table?

Another development points to a related policy that implicates the entire G7: rules on the cross-border transfer of data. Framed often as digital privacy, in fact such rules implicate the business models of many companies engaged in cross-border business. The July 2016 decision by the European Court of Justice to strike down the current EU-US Privacy Shield creates uncertainty for firms on both sides of the Atlantic.

The silver lining from this recent court judgement is that data transfer rules could be added to any G7 deliberations. For sure, digital services taxes and data transfer rules are distinct topics. But trade-offs across policy domains are at the heart of much successful commercial diplomacy, as are trade-offs across sectors (although that is not relevant in this case).

G7 governments would be well advised to set up a senior officials group to explore ways to increase the predictability of cross-border data transfer rules as well as the taxation of digital services. These officials should be mandated to devise a work programme within six months and submit reports to the next two G7 summits.

Another reason why these matters must rise to the leaders’ level is that many powerful bureaucratic fiefdoms are involved that can veto progress. A striking feature of the European Union’s experience in this regard has been the powerful role played by the privacy regulators of its members, acting individually and (sometimes very effectively) together. The regulation of the digital economy is such a complex matter that siloed regulators do not have the mandate, or often the inclination, to develop a comprehensive approach. Such regulators should contribute to the process but any G7 initiative is destined to fail if it is outsourced to them.

One canard should be set aside. Successful completion of this initiative would not only benefit the large American digital service providers. It would also benefit the many small and medium-sized businesses that want to supply customers abroad and that find the current rules on data transfer and storage confusing and costly to adhere to.

The lockdowns imposed in response to the COVID-19 pandemic provide a potent demonstration of the contribution of the digital economy to our lives. The expansion of digital commerce over the past months will become a permanent feature of our lives, assert numerous experts. The successful completion of this work programme would set the key ground rules for the digital economy among G7 members and would inevitably become the point of reference for future deliberations at the World Trade Organization.