What is City Talk? Info Info. Latest

The new pollution: Tax challenges arising from digitalisation

Jason Piper
Abuse of social networks technology whether for straight financial gain or other ends is clearly an issue that needs to be regulated, and we can expect policy makers to look to their comfortable tools for that regulation – tax. (Source: Getty)

Industrialisation has been hugely beneficial to humans. It has enabled huge leaps in the improvement of physical health and wellbeing, creating the productive surpluses that fund research, hospitals, free healthcare – but not without cost, and in many cases perversely a specific cost in harm to the physical environment on which we rely for that wellbeing.

Governments and societies have devoted time and energy to developing legal and economic frameworks which attempt to control the harm done, and many of the most obvious and direct impacts are comprehensively regulated. But concerns persist about more indirect issues; transport and production costs, impacts along the value chain. Businesses respond to financial stimuli, but working out how to value those externalities effectively is a huge challenge.

Looking forward though, we’re on the cusp of a greater industrial upheaval, and greater challenges yet in valuing and controlling the forces at play. Traditionally governments have used tax as a mechanism to regulate behaviours, identifying transactions and placing a value on them which in turn attracts a financial penalty, aka the charge to tax.

Regulatory taxes are a very different beast to profits taxes. They are designed as a penalty, to discourage particular behaviours, whereas profits taxes are nothing more than the consequence of success. Value generated for society is returned to the central purse and redistributed out. Opinions of course vary on how much should be returned and on what it should be spent, but there are few who would suggest that modern societies can work without taxes. Regulatory taxes on the other hand attempt to reflect a concern that the financial returns on a given transaction or behaviour do not reflect the returns to society at large.

And that brings us to the most exciting thing to happen to tax nerds this week – the release of the OECD’s Interim Report on Tax Challenges Arising from Digitalisation. Before even talking about tax, the report goes back to first principles and tries to understand what it is that governments are trying to tax. No self-respecting lion tamer would step into the ring without first checking that he’s not actually dealing with an elephant, and policymakers should adopt the same attitude to taxing digital.

However, reading the chapter on models of value creation has been a decidedly uncomfortable experience. Social network services are regularly provided to network members at significantly below marginal cost, and typically free of direct charge. Network providers are then able to create sufficient financial return from exploitation of the network to subsidise the network provision. The challenge in the short term is to establish where and how those financial returns should be valued for the purpose of profits taxes. (An alternative mechanism might be something akin to a consumption based tax; tax nerds will be familiar with DBCFT type models – destination based cash flow tax).

But in the long term, we could be looking at a far bigger challenge, and that’s coping with the externalities of these social networks. They don’t simply affect society, like a conventional business; they are far more a part of society. For many users they have replaced conventional relationships and communication channels. Which means that the feedback relationship between the business and society is far more direct than has ever been the case before, and the issues arising are not of physical health and wellbeing but behaviours and attitudes to others. Abuse of social networks technology whether for straight financial gain or other ends is clearly an issue that needs to be regulated, and we can expect policy makers to look to their comfortable tools for that regulation – tax.

But the problem we’ve got is that so far we don’t even know how to identify and tax the straight financial profits in the value network. Tax as a regulator is only ever a proxy, in much the same way that GDP as a measure of a nation’s success is only ever a proxy. Trying to identify and then value the negative externalities of a value network will be the biggest challenge to face tax policy designers yet. We’re not even trying to run before we can walk; this is trying to ask a blindfolded toddler to sprint across a boulder strewn lava field. But someday soon it’s a challenge that must be faced. The OECD report is an important first step on that road, and perhaps the most important thing it highlights is that this won’t be a quick, or easy journey – and the stakes are as high for society as they have ever been.

Related articles