Digital Service Tax can help to create real jobs

Digital Service Taxes: people either seem to love ‘em or hate ‘em.

Proponents want DSTs to right the wrong that some companies pay very little corporate income tax in markets where they sell a lot but do not have ‘a physical presence’. Countries that host these companies see nothing in terms of ‘compensation’ for the benefits they provide them. So, the current (proposals for) DSTs aim to do one thing: create revenue in the market jurisdictions.

Opponents do not like the DST for that exact same reason: markets are just making a grab for tax revenue. As DSTs tax on gross basis, companies will have to pay twice; on their turnover and on their profit. This will – possibly even more so than double taxation on a net basis – have a host of deadweight loss effects in terms of loss of innovation, loss of jobs, loss of wealth etc.. For, introducing such an extra tax burden will influence behaviour.

Good tax policy produces a tax system that is efficient, equitable and administrable. The current system probably has been a little too efficient, in the sense that companies were able to organise much of their tax burden – and thus the accompanying distortions – away. This feature makes for a very poor score on the equity scale.

However, you can’t fix this problem just by saying: “Here’s some extra revenue!”. For the international tax system to be sustainable, the whole system needs to be fair by design, all parts need to fit together, and all elements need to be based on general principles. Otherwise, you might fix the equity problem on the short-term, but not without wreaking structural havoc on the efficiency part (and as far as the OECD proposals go, also on the administrability part).

You can overcome this improving the design of DSTs so they become an integral part of the international profit tax system. That way you can also really use DSTs to make the whole system work better. How? By fashioning a docking station for DSTs to properly connect to the profit tax system. And you can do that with only a minor adjustment: the country that collects the DST should introduce a CIT tax credit. So, the DST paid in year x can be off-set against the corporate income tax due over that same year. This is helpful in two ways:

  1.  It ensures that companies can choose to avoid the extra tax burden of the DST, thus eliminating the deadweight loss. The only thing they need to do is make sure there is enough taxable profit in the country that levies the DST – and that requires putting real investments there, real people, real jobs.
  2. Pushing profits (back) towards where the market is, automatically means that corporate income tax revenue is more evenly distributed over the world.

So, no transfer pricing antics are needed. The arm’s length principle can stay intact. And market jurisdiction (including developing countries) can take their place in the driver’s seat. All that countries need is a national tax credit. And Pillar 1? We can all quickly forget about that plan. Who needs all that complexity in order to bend economic reality to some imagined shape, if you can just use market forces to incentivise companies to willingly change their global value chains back to a more decentralised model? Isn’t that much more efficient, equitable, administrable and fair?