Digital Sales Tax v. Tariffs on French Wine

Even before Donald Trump departed for the G7 in Biarritz France, he threatened another trade war this time with the host country over the digital sales tax:

U.S. President Donald Trump on Friday reiterated criticism of a French proposal to levy a tax aimed at big U.S. technology companies and threatened again to retaliate by taxing French wine. Speaking to reporters at the White House before leaving for a Group of Seven summit in France, Trump said he is not a “big fan” of tech companies but “those are great American companies and frankly I don’t want France going out and taxing our companies.” “And if they do that ... we’ll be taxing their wine like they’ve never seen before,” he said.

A tariff on French wine might help New York’s Finger Lake area as well as California wine makers so maybe Trump is hoping to win over California and New York in the 2020 election. Or maybe Trump does not know that some states impose digital sales taxes:

The sales tax laws have been updated to include digital goods and services in different ways across the different US states, and the application of these laws has been troublesome for most state and local governments. Quick Stats: There are 27 states that tax digital products. There are 23 states that do not tax digital products. 5 states do not have a retail sales tax at all; these include, Alaska, Delaware, Montana, New Hampshire and Oregon. For the states that tax digital products, the tax rate varies from 1% to 7%, depending upon the state and the type of digital good.

The push for a digital sales tax (DST) in Europe is discussed by the Congressional Research Service:

Several countries, primarily in Europe, and the European Commission have proposed or adopted taxes on revenue earned by multinational corporations (MNCs) in certain “digital economy” sectors from activities linked to the user-based activity of their residents. These proposals have generally been labeled as “digital services taxes” (DSTs). For example, beginning in 2019, Spain is imposing a DST of 3% on online advertising, online marketplaces, and data transfer service (i.e., revenue from sales of user activities) within Spain ... Proponents of DSTs argue that digital firms are “undertaxed.” This sentiment is driven in part by some high-profile tech companies that reduced the taxes they paid by assigning ownership of their income-producing intangible assets (e.g., patents, marketing, and trade secrets) to affiliate corporations in low-tax jurisdictions. Proponents of DSTs also argue that the countries imposing tax should be entitled to a share of profits earned by digital MNCs because of the “value” to these business models made by participation of their residents through their content, reviews, purchases, and other contributions. Critics of DSTs argue that the taxes target income or profits that would not otherwise be subject to taxation under generally accepted income tax principles. U.S. critics, in particular, see DSTs as an attempt to target U.S. tech companies, especially as minimum thresholds are high enough that only the largest digital MNCs (such as Google, Facebook, and Amazon) will be subject to these specific taxes. DSTs are structured as a selective tax on revenue (akin to an excise tax) and not as a tax on corporate profits.

Let’s take the Spanish affiliate of Google as an example. It currently retains very little corporate profits as most of Google’s profit ends up in tax free Bermuda via the old Double Irish Dutch Sandwich trick. Google’s consolidated profit margin is near 30% and I guess one could argue that the Spanish affiliate is entitled to 8% of this 30% although many transfer pricing practitioners might argue a local distribution affiliate deserve much lower profit margins. It all comes to do what are Google’s intangible assets and who owns them. Of course the IRS might argue that the U.S. parent owns the valuable intangible assets except for the fact that they made a deal with Google many years ago. Now it would be very odd to argue that Amazon-Spain deserves an 8% operating margin since Amazon’s consolidated margin is half of that. And of course Uber’s profit margin is negative as noted here:

Tax authorities in the United State and several other countries are investigating Uber, even though it's a loss company and therefore owes no income taxes.

The Congressional Research Service addresses these concerns:

Proponents of DSTs argue that profits earned by MNCs in the digital economy are not adequately taxed on a worldwide basis, as many of these firms have reduced their effective tax rates through international tax planning strategies…Critics of basing DSTs on this position could make several arguments. First, revenues lost from profit shifting are lost revenues to the country with the right to tax the corporation that owns the asset, not the country that is home to the corporation’s customers. Although many developed economies are concerned with ensuring that profits are taxed from their proper source under international tax laws, a country that imposes a DST on foreign MNCs’ income (in which they have no right to tax) is not consistent with the rationale of recouping revenue lost from the profit shifting practices of that country’s firms. Second, tax strategies enabling MNCs to pay little to no tax have been used by a broad array of firms that rely on intangible assets for the majority of their profits, and these firms are not limited to industries in the “digital economy.” ... Third, tax policies in a number of countries have recently changed or are scheduled to change in ways that will reduce incentives for profit shifting. These changes will most likely affect firms with the most aggressive profit-shifting strategies, including some digital economy firms ... Fourth, DST proposals are unlikely to affect profit-shifting behavior. As explained above, a tax on corporate profits, in a very general sense, taxes corporate income minus the costs of production. In contrast, DSTs are imposed on gross revenue derived from certain business activities (or “turnover”) and do not take into account costs or net profits earned by the taxable firm. Thus, economic incentives for MNCs to shift profits remain unchanged by DSTs as they do not affect profit-maximizing decisions at the margins.

All of this reminds me a lot of our discussions over the Destination Based Cash Flow Tax, which I criticized. Maybe DST is not the best way to deal with transfer pricing manipulation but Trump’s proposal to tax French wine strikes me as a very bad idea.