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Julian Jessop is Chief Economist at the Institute of Economic Affairs.

The current furore over Cambridge Analytica’s alleged misuse of personal data from Facebook is, of course, only the latest of a series of controversies involving the tech sector. The EU’s proposed digital tax (greeted with ‘three cheers’ by the Financial Times) has therefore tapped into hostility towards internet companies which has been building for some time. However, heated calls for ‘something to be done’ rarely lead to sensible policy choices.

An IEA paper published in January discussed some of the accusations leveled at internet companies over the last few years, including tax dodging, facilitating the spread of ‘fake news’ and extremist material, tampering with elections, failing to protect children and other vulnerable groups, and exploiting their market dominance to the detriment of consumers, advertisers and more traditional media alike. This is an impressive rap sheet.

Nonetheless, the growing demands for governments to wade in could have unintended and unwelcome consequences. Surveys, such as the 2018 Digital Attitudes Report, do show how people are worried about the impact of the internet on society as a whole. But they also confirm that the internet has had a positive impact on our lives as individuals. After all, tech companies provide valuable services to billions of people at zero financial cost. These benefits would be threatened by clumsy state intervention that raises costs and stifles competition and innovation.

Fortunately, there is an alternative, which is to allow commercial pressures to force internet companies to clean up their act. This isn’t wishful thinking. For example, the market has already been coming up with solutions to the problem of ‘fake news’, such as independent fact-checking services and the ‘flagging’ of disputed reports. Advertisers have also boycotted online platforms that fail to prevent the promotion of their products next to inappropriate material. The tech companies themselves have a compelling economic interest in responding to these pressures – as the recent slide in Facebook’s share price has shown.

There are, however, some ways in which these forces can be strengthened. Markets work best when the key players are well informed. In contrast, users of online platforms are often unaware of the extent to which their personal data is used commercially. There is not necessarily anything wrong with this. Most people are comfortable with the idea that supermarkets can use data on shopping habits in return for the discounts offered by loyalty cards. But more transparency would be welcome, particularly in relation to the sharing of data with third parties.

This market-based approach could be taken further. For example, tech firms could be required to make it easier for users to move their personal data from one platform to another, in the same way that consumers can transfer phone numbers between providers. This is the concept of ‘social graph portability’ and is similar to the measures now in place that make it simpler for people to switch between energy suppliers or banks.

Unfortunately, the instinct of many politicians and commentators is to reach for state regulation as a first resort. This seems doomed to fail. Government is always likely to be playing catch up, given the speed at which technology develops. And there are broader concerns. For example, some left-wing commentators have (inevitably) suggested bringing social media platforms under public ownership. But what would this do for competition and innovation? Can governments always be trusted to look after our data better than private companies? (The many disastrous IT projects in the public sector would suggest not.) Do we really want the state to decide what is and what is not ‘fake news’?

Indeed, the EU’s digital tax is a good example of a well-intentioned measure that makes little sense. Under the proposed new rules, EU member states would be able to levy a tax, initially set at three per cent, on the revenues of digital companies generated in their territories.

The main justification for this new tax is that, according to the Commission, these companies currently face an effective EU tax rate of only 9.5 per cent, compared to 23.2 per cent for those using more traditional business models. The Commission does not properly explain this. But it does make clear where its sympathies lie by citing evidence that a majority of citizens want the EU to take more action against ‘tax avoidance’.

It might be true that some multinationals find it easier to artificially book profits in jurisdictions where taxes are relatively low, perhaps via dubious practices such as making large royalty payments to offshore holding companies. Most people would agree that this sort of behavior is unacceptable. Nonetheless, a blanket tax rise for all digital firms would be a pretty crude way to address this problem, which is certainly not limited to the tech sector.

In reality, the main reasons why tech companies often pay less EU tax are simply a reflection of the economics of what they do. Justifying the proposed EU digital tax, Pierre Moscovici, the EU’s economics and finance commissioner said that ‘our pre-internet rules do not allow our member states to tax digital companies operating in Europe when they have little or no physical presence here’.

But if these companies are based overseas, it might actually be fairer for them to pay less tax than local firms. This is because they are not making the same demands on taxpayer-funded public services or infrastructure. Tech companies usually pay less in sales taxes too, because they do not charge end users. That is a huge benefit to consumers.

Revenue taxes are also more likely to be passed on to consumers. The EU simply asserts that there is ‘no reason why this should happen’, therefore wishing this problem away. What’s more, taxes on revenues can lead to very high tax rates on profits. A company facing an additional three per cent tax on revenues but making margins of, say, six per ent would effectively be paying corporation tax at a rate of more than 50% – unless of course they do raise prices to compensate.

The EU has tried to minimise all these problems by proposing a low initial rate that makes the digital tax more of a political gesture than a serious revenue-raising measure. That’s not a great basis on which to set policy.

Overall, the internet isn’t perfect, and nor are the companies operating in it. But self-regulation and the disciplines of market pressures are likely to be far more effective in keeping them in line than further government intervention.

33 comments for: Julian Jessop: It’s the markets, not government, that can tame the tech giants

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