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The Impact of Taxation on the Digital Economy

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The Impact of Taxation on the Digital Economy GSR15 Discussion Paper THE IMPACT OF TAXATION ON THE DIGITAL ECONOMY The views expressed in this paper are those of the author and do not necessarily reflect the opinions of ITU or its Membership. This discussion paper was prepared by Prof. Raul Katz under the direction of the International Telecommunication Union (ITU) Telecommunication Development Bureau (BDT) Regulatory and Market Environment Division. It was presented at the ITU’s 15th Global Symposium for Regulators, held at Libreville, Gabon, from 9 to 11 June 2015 2 Executive Summary The purpose of this study is to review and discuss policy issues related to the taxation of firms operating within the digital sector, as well as levies imposed on consumers purchasing digital goods and services. As indicated in the title, its scope is wider than just telecommunication services, although it also addresses taxation of telecommunication operators. A diversity of taxes is imposed on firms operating within the digital eco-system. To begin with, corporate taxes and value-added taxes are typically applied to all firms in the digital sector. In addition, import duties are generally imposed on all types of digital equipment, whether they are consumer-oriented (such as smartphones) or needed by infrastructure operators (such as switches and servers). Finally, a number of sector-specific taxes can be collected within the digital eco-system, either applied to the selling of digital goods (like video-streamed movies) or the ownership of wireless devices. Telecommunication operators typically pay corporate taxes on profits, but are also expected to contribute at several levels (for example, import duties and sales taxes on equipment purchased from overseas suppliers, property taxes on buildings and land owned where equipment is installed). Beyond taxes imposed on telecommunication operators, Internet service providers (ISPs) can also be subject to sector specific levies (for example, conventional corporate taxes, sales taxes on initial equipment purchase, and property taxes for physical assets). In most cases, the burden of taxation is primarily borne by the operator, although in some cases taxes will be passed through to consumers, thereby increasing the cost of acquiring broadband service. On the consumption side, wireless users in most countries pay taxes at the time of service acquisition (generally linked to handset activation) and on an ongoing basis (linked to service delivery). On the service side, most countries impose some form of value-added tax (VAT), a general sales tax or a similar consumption tax calculated as a per cent of the total monthly bill. Some countries also charge an additional special communications tax as a per cent of the service bill. Finally, some countries also charge a fixed tax that could be either driven by general communications or wireless usage. Beyond service taxes, levies can also be imposed on handset acquisition. Broadband consumption taxes, generally referred to as Internet Access Taxes, are not uniformly applied across countries. In some cases, since broadband is considered to be a critical need, regulators have chosen to exempt broadband service from any consumption tax. In other cases, governments consider the ever-growing Internet access an attractive source of revenue and therefore, subject to taxation. Beyond telecommunication and broadband provisioning, taxation of other players in the digital value chain, such as digital advertisers, content over-the-top distributors, and electronic commerce platforms, presents numerous conceptual problems, which result in a much more diverse set of approaches. There is still no consensus among policy makers as to what category should digital goods fall into, or whether a digital good should be taxed at all. The ongoing debate around taxation policy in the digital economy entails multiple issues: • What is the appropriate level of taxation on capital equipment purchased by telecommunication operators? • How should Internet sales be taxed? • How should consumption of digital goods be taxed? • Should the consumer purchasing wireless devices and personal computers be taxed? • Should the providers of digital platforms, such as Google and Facebook, be taxed at the country where revenues are generated, or should they benefit from international rules that allow them to take corporate tax exemptions in certain locations? iii • Should Internet service providers pay taxes the same way as telecommunication carriers? The list of issues could be extended, but the cases mentioned above serve to raise the point that taxation in the digital economy is one of the most important policy issues in today’s environment. Valid policy arguments and trade-offs could be raised on every one of them. At the highest level, two opposing trends can be detected in terms of digital taxation policy: one aims to maximize collections based on exponentially growing digital flows; the second one recognizes that lowering taxation benefits consumers and businesses, and consequently, economic growth. According to the first trend, governments recognize that digitization is critical in their generation of revenues and are putting in place more mechanisms to maximize collection in these domains of economic activity. On the other hand, some countries consider that lowering taxes on the digital sector of the economy triggers spillovers that are larger than the foregone taxes. This effect in the case of broadband taxes is depicted in the following Figure A. Figure A: Virtuous circle of tax reduction on broadband devices, equipment and services Source: Katz, R. and Berry, T. (2014) Driving Demand of Broadband Networks and Services. London: Springer As Figure A indicates, a reduction of taxes on devices and service has a positive impact on broadband penetration as a result of demand elasticities. The increase in broadband penetration improves the number of households connected (in fixed broadband) and the number of mobile broadband subscribers per infrastructure deployed. This increase in penetration enhances the return on the network capital invested. A higher return on capital allows the broadband service provider to lower prices, which in turn has a positive impact on penetration. At the same time, an increase in broadband penetration has direct and indirect effects. On the direct side, it means an improvement in the revenues of broadband operators. On the indirect side, it enhances the contribution of broadband to economic growth and employment. Both effects increase the taxable base, which in turn grows the collected taxes beyond the amount foregone by reducing taxes on broadband devices and services. This effect yields higher welfare benefits. In principle, taxation should attempt to be neutral and equitable across all sectors of the economy. A distortion occurs when a change in the price of a good resulting from taxation triggers different changes iv in supply and demand from what would occur in the absence of taxes. Taxes can create distortions if they affect the choices made by market agents, which in the digital space could be the following: • consumers, particularly those that are price sensitive, face an affordability barrier in the adoption of technology if taxes increase the total cost of ownership; • telecommunications/ICT service providers reduce their rate of investment in infrastructure if taxes reduce the total available capital to be spent; • global digital technology providers adapt their deployment footprint according to a minimization of tax burden; and • different tax regimes within the digital eco-system create asymmetries across industrial sectors. This study identifies the distortive effect of taxes in the digital eco-system on three levels: 1. Potential disparity in tax burdens imposed on telecommunication operators when compared to other operators of the digital eco-system (for example, digital advertisers, social networks). 2. Taxation asymmetry among global players in the digital sector. 3. In country taxation asymmetry between the telecommunication sector and other providers of other goods and services. Governments should examine these asymmetries to determine whether they are a source of distortion. Furthermore, considering the significant indirect impact of digital platforms (such as new business creation, and transaction efficiencies), governments should examine the issue of taxation of digital players in a careful manner. In developing fiscal policies, governments need to consider the trade-offs between revenue generation and the potential negative impact on the development of the digital sector. Recognizing that answers to these questions should be developed based on country-specific policy trade-offs between revenue generation and the potential negative impact on the development of the digital sector as well as the telecommunication/ICT market environment, the evidence provided in this report should help understand the implications of these decisions. The evidence regarding the economic impact of digital industries, ranging from fixed broadband to computing, the Internet, and mobile broadband, continues to grow. From that perspective, the argument to reduce potential distortions emerging from over-taxation of the sector is gaining ground. As others have argued, the reduction in digital sector taxes needs to be weighed in terms of the potential reduction in revenues. Having said that, the need to establish a balanced view of tax policy across sectors in order to eliminate distortions is a tall order. v Table
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