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My weekly work, readings & writings

Dear all,

The topic of corporate taxation in the digital economy has been raging since at least 2010. The discussion is usually fueled by European governments. Sometime that is a leftist government genuinely concerned with low taxation rates in the corporate world. Or it may be a pro-business government pursuing lower corporate tax rates—but since those are unpopular, elected officials try to find a corporate enemy to prove that they’re nonetheless tough on multinational businesses. In the latter case, large US tech companies look like the ideal scapegoat.

The pro-business version of “Tech companies should pay more” is what once happened with David Cameron, such as when he went after Starbucks and Amazon, or with the epic hearing of a Google executive in the House of Commons. Now the same pro-business / anti-tech stance is happening again, this time in France, where the pro-business Macron administration just spent the summer vowing to crack down on US tech companies. I dare say I know the issue quite well after co-authoring (with Pierre Collin, a tax judge for the French Conseil d’Etat) a 2013 report commissioned by the French government. So let me contribute with a few key points.

First, why do large US tech companies pay so few corporate taxes in Europe? There are two legal reasons—one in the EU, the other in the US:

  • Corporate taxation does not belong to the perimeter of EU harmonized standards, hence the possibility of regulatory arbitrage within the EU. Multinational corporations usually choose countries such as Ireland, the Netherlands or Austria to funnel their profits and minimize their tax burden—a practice known as ‘treaty-shopping’.
  • An obscure rule known as ‘check-the-box’, enacted in the 1990s by the US Congress, enables US-based corporations to avoid domestic taxation on their non-US profits by hoarding them in tax havens and never repatriating them to the US.

The combination of #1 and #2 made possible the scheme now known as ‘Double Irish With a Dutch Sandwich’, which was first documented in 2010 by Bloomberg’s Jesse Drucker—and which has been widely used by every US corporation, not only tech companies.

Second, can the EU act on its own? That’s what European governments think. But the EU is essentially powerless on that front as a unanimous decision is required to dramatically limit the possibility of treaty-shopping; and despite the occasional common front against US tech companies, EU member states have very different views when it comes to corporate taxation.

The EU’s powerlessness explains why most of the action effectively takes place at the OECD, which is in charge of drafting the model tax convention used by all advanced economies to negotiate bilateral tax treaties. To be fair, the OECD and the G20 have been working very hard these last years, with the Base Erosion and Profit Shifting initiative being a major step forward in countering aggressive tax planning by large corporations. But the US is a prominent member of the OECD, and with a Congress dominated by Republicans since 2010, not much can be done when it comes to having US corporations paying more taxes in Europe. Remember that it’s not enough to harmonize corporate taxation between EU member states: the US ‘check-the-box’ rule has to go as well—and that demands a lot of diplomacy…and ultimately a vote in Congress.

Third, can it be solved in theory? When it comes to designing rules, we simply have to realize how young the tax system really is and how much it fits the dying age of the automobile and mass production. Progressive income taxes were first set up in the 1910s to account for the rise of wages as the primary source of household income. The value added tax was invented in the 1950s (by Maurice Lauré, a French inspecteur des finances) to adapt consumption taxes to lengthier and more complex industrial value chains: it soon spread in the entire developed world (with the US as the sole exception).

As for corporate taxation, the current system was designed in the 1920s by a group of economists gathered by the League of Nations to avoid double taxation of profits made by multinational corporations. So it’s no wonder why it all lines up with how production and consumption used to work in the 20th century, and why it is totally unfit to account for how value is created in the new age of ubiquitous computing and networks. If you will, it all comes down to the definition of what is known in the tax world as a permanent establishment. You can read this article I wrote in 2013 to see how we could upgrade that definition to better fit value creation in the digital age.

Finally, what’s the path to redesigning the international tax system? Obviously it’s a long one, but we’re making progress by realizing that there’s a problem and understanding what could be done. Now it’s time to take action, and I think that US tech companies themselves should take the initiative. Consider the situation of Airbnb, one tech company currently under pressure in France. The tax argument is not only used by the French government—it was initially put forward by incumbents in the hotel industry trying to demonstrate how evil Airbnb is, and thus Airbnb is effectively weakened in terms of PR by their not paying much in France. At some point, we could go through the following sequence: US tech companies are fed up with legal issues in Europe; they bargain with European governments to obtain more lenient industrial regulations in exchange for their paying more taxes locally; finally, they lobby the US government to change the rules on the other side of the Atlantic.

I’ll be speaking on that topic at the Erasmus University in Rotterdam on October 11. In the meantime, we’re reaching the end of summer, but you may still find time for reading:

Warm regards (from Normandy, France),

Nicolas

This is a newsletter on entrepreneurship, finance, strategy, policy... and liberalism. Each week, I'll send insights and ideas related to current events as well as my latest work, including the writing of my new book (code-named ‘HEDGE’) about liberalism and the Entrepreneurial Age. If you were forwarded this newsletter and you like it, you can subscribe here.