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Why a digital tax is a sensitive issue - note

Hector McNeill1

President Trump and Steven Mnuchin, the Secretary of the US Treasury, are attempting to dissuade European countries, the EU Commission and the UK to not impose a digital tax on large US dot com or tech corporations. This has gone as far as threats of sanctions on UK and European economies through raised tariffs. There is a hyper-sensitivity on the part of the US side on the digital tax question.

Trump identified the holding of massive cash resources abroad by the US tech companies as a prejudice to the US economy. He therefore provided them with tax relief to repatriate this capital. Most of these funds, some of which have flowed back to the USA, accumulated in low or zero tax regimes have avoided payment of taxation in European nation states as well as US taxation. However, the USA is only focusing on its particular government revenue and hoped for investment and demand impact of repatriation.

Just at the moment, however, these tech companies are becoming exposed as a result of Federal Reserve policies. This is making the digital tax issue even more critical. This note reviews some aspects of this issue.

The continued use of quantitative easing and the high turnover in the repo market (over night lending to banks in distress) in the last 6 months has ended up with the main doc com tech companies repurchasing shares and released funds entering assets and share markets. As a result something like 18%-20% of share values in the top 500 corporations in the USA are taken up by just five corporations (Amazon, Apple, Facebook, Google and Microsoft) whose values have risen significantly during the last year and, in particular, last 6 months. A high proportion of the remaining 495 companies around 50% are not performing at all and are drifting up in share values as a direct result of Fed actions.

The trend is for the tech companies to become dominant in the stock market. However, the rapid rise in share values has not been met by rises in efficiency or earnings so the price to earnings or price to sales ratios has fallen drastically showing up the level of false valuations. The normal metrics for assessing the value of investing in shares have been destroyed by quantitative easing.

The levying of taxation on sales in countries where these companies have "deals" that avoid, or radically reduce taxation, will bring the performance of these companies into focus, they will have to argue their case to explain why they should not pay tax and this will bring into focus the true performance and lack of objective fundamentals supporting the high stock prices.

President Trump does not want his sort of scrutiny on the "success" of the US economy nor on these companies which are becoming a predominant force in lobbying and PAC funding in support of electoral candidates. So rather than allowing each company to argue their weak cases or enter into negotiations with other governments over tax, Trump and Mnuchin are attempting to cut short this sort of analysis by threatening sanctions against countries that introduce such tax regimes.

Introducing an international regime for taxation of such companies is, of course, in everyone's interest. However, another dimension to this is the international dispute settlement issue where under international trade deals corporations can sue governments for loss in profits as a result of government acts or changes in legislation. There is therefore a race for European countries, including the UK, to establish an international convention before this particular issue will be dragged into the conditions of trading relationships under trade deals.

By making this topic subject to the legal provisions for dispute settlement within trade deals only undermines the sovereign rights of countries to establish taxation rates in relation to the economic performance and conditions at the national level, so that national and international companies end up on a level playing field. This is an important topic that comes under the topic of constitutional economics and has important implications on the conduct of democracies in relation of the rights of constituents to become involved in issues of public choice governing policies and legislation. This process needs to be expanded and not reduce as a result of governments curtailing this important process because of fear of damages resulting from legal claims by large tech companies with bloated share values and who pay little tax.

With the United Kingdom leaving the EU soon these considerations need to be taken into account by the government and opposition parties on the question of a continued and dedicated collaboration with the EU and OECD on this question and in relation to what should be excluded from any trade deals with the USA.

1 Hector McNeill is the Director of SEEL-Systems Engineering Economics Lab.