Rationality wins, for a change

The Ninth Circuit opinion in Altera v. Commissioner has now come out, reversing a Tax Court decision in a transfer pricing / cost-sharing case that I previously discussed here. It’s a win for the government, and a win for good sense both in regulatory review generally and with respect to the particular issues posed here.

The majority opinion appears to have wholly adopted the viewpoints expressed in amicus briefs that multiple law professors signed, one lead-penned by Clint Wallace (I was among the signatories) and the other by Susan Morse. Whether or not the court thought about it this way, the fact that so many law profs were on one side, without any financial stake, remuneration, etc. (and I believe none were on the other side, at least on this basis) may conceivably have served as a useful signal. There have been quite a few recent international or state tax cases in which law profs were on both sides, and there the proper takeaway was indeed that, in those cases, the merits were far more substantially in dispute among experts than here.

In Altera, the Tax Court unfortunately lost its way, and adopted the views both that stock options cost the issuer zero (in which case I’d like some, please) and that particular details of exchanges between unrelated parties in wholly different contexts should be used mechanically as evidence of “arm’s length,” without an adequate analysis of actual comparability or of how incentives and circumstances might differ as between the settings. The Ninth Circuit’s Altera opinion does a nice job in explaining why the so-called comparable transactions, in which costs of incentive compensation were apparently ignored in particular deals between unrelated parties, weren’t actually comparable in any serious or realistic sense.

The majority opinion also offers a useful and instructive primer on both the history of, and the legislative rationales for, the U.S. transfer pricing rules, in particular as they apply to intangibles. And it sensibly explains why the trap that taxpayers tried to set for the government in the regulatory “notice and comment” stage, by submitting an avalanche of not very relevant material that they correctly guessed the Treasury preamble wouldn’t spend countless pages rebutting point by point, shouldn’t be treated as showing a process failure on the Treasury’s part.

The just-released decision is in effect a do-over. It came out the same way a couple of years ago, but Judge Stephen Reinhardt’s death, after he had signed the majority opinion but before it was reissued, persuaded the Ninth Circuit that the case should be reheard. Given the merits. I’m not at all surprised that Judge Graber, who replaced Reinhardt on the panel, ended up voting the same way.

2019 Law and Society Association Annual Meeting

This past Thursday through Saturday (May 30-June 1), I was attending, as I do most years, the Law and Society Association’s Annual Meeting, which was held this year in Washington D.C. (Next year, Denver.)

I went to a couple of LSA annual meetings about twenty years ago, then stopped going because there was almost no one there who had any interest whatsoever in tax or budget topics. But then Neil Buchanan created an institution in which lots of tax people would attend the LSA and have their own panels – kind of a separate conference within the LSA conference. And when Neil eventually got tired of doing all the grunt work year after year after year, Jennifer Bird-Pollan and Mirit Eyal Cohen volunteered to help out so that he / they / we could keep the thing going.
This was a typical year, with a tax panel in every single conference time slot (including a lunchtime slot), and I think about 60 tax people attending – mainly from the U.S. and Canada, but also from farther afield, such as the EU and New Zealand. It’s a nice group, with diverse interests and a supportive / collegial vibe that makes attending the LSA a pleasure. The seniority range is from very junior to very senior plus everything in between.

In this type of setting, one won’t have read the papers that are being presented, absent significant extra effort. But you do get to hear the twenty minute talks, and if one paper doesn’t happen to interest you enormously (as is inevitable when there are so many), there’s always the next one. Its being a “law and society” conference tends to reduce – but not eliminate – hardcore public economics content in favor of diverse methodologies and interests, but you get a range of standard tax policy papers, tax history, sociology, focus on retirement or inequality issues, etc.

This year, because it’s a hot topic, there were several papers touching on the digital service taxes that are currently emerging in the EU and elsewhere (does the UK still count as “EU” for this purpose?). This was good news for me, as DSTs are a current interest that I’m writing about. Indeed, during spare moments I was able to think about the structure of my paper-to-be. Current working title, which is perhaps too long and wordy: “Digital Service Taxes and the Broader Shift From Determining the Source of Income to Devising (Sub?-) Optimal Tariffs.”

My own talk concerned a paper on P.G. Wodehouse that I may or may not write, either as a freestanding piece or as an early chapter in Volume 2 of a possible book sequence on literature and high-end inequality. I have already written Volume 1, which is currently on offer to publishers and has the working title Dangerous Grandiosity: Literary Perspectives on High-End Inequality Through the First Gilded Age

My talk discussed the completed book, along with what I might (or might not) write about P.G. Wodehouse. Its title is “Reading Wodehouse Seriously (?!),” with the ?! serving to acknowledge the point, why on Earth would one want to be such a spoilsport as to do that? The slides are available here.
At least one audience member had thought in advance – quite reasonably and logically, I’d say – that I meant to discuss P.G. Wodehouse v. Commissioner, a well-known U.S. international tax case. But that was not the case, and the main Wodehouse text that I discuss discussing is his immortal Right Ho, Jeeves.

This is the novel that begins something like this:

Jeeves, I said, may I speak frankly?

Certainly, sir.

What I have to say may wound you.

Not at all, sir.

Well then, Jeeves –

But then our narrator, who is of course the immortal Bertie Wooster (rentier supreme in an era when rentiers have long since ceased to view themselves or be viewed like a Darcy), realizes that he has failed to give the reader the necessary background information preceding this exchange. So we don’t get the next words in this dialogue for maybe 30 pages or so.

The joke, immediately clear to any reader who knows about the Jeeves-Wooster relationship, is that Jeeves the servant cannot possibly be “wounded” emotionally by anything that the “mentally negligible” (his own phrase) Bertie might have to say about him.

There are actually rich possibilities in a close reading of Right Ho, Jeeves and associated works (such as its successor, Code of the Woosters), even though one doesn’t wish to be stodgy or to kill all the fun. My slides briefly allude to some of the possibilities.

Conference aside, it was nice to be back in Washington (my home base for six years in the 1980s), and I also briefly got to meet these individuals.


The IRS memo on Trump’s taxes

I haven’t had much to say here about the “dispute” concerning the House Democrats’ request and subpoena for Trump’s taxes, because I try to focus on things that are interesting, and here there is no bona fide legal dispute (hence the scare quotes). But the recent revelation that the IRS wrote a draft memo reaching this obvious conclusion merits a brief comment here.

The case that the IRS has to hand over the tax returns is 100% ironclad, since the statute says “shall” and the request is clearly within legitimate Congressional oversight functions.

Mnuchin is being lawless in refusing to comply. It’s true that one generally has the right to contest claims with which one disagrees legally, and then let the courts decide. But here the grounds for objection are frivolous. I thought it was settled back in Magna Carta days, or certainly before the American Revolution, that the Parliament had oversight powers with regard to the executive branch, and the U.S. Constitution clearly reflects a stronger balance of powers commitment than they had in those days across the Pond.

Mnuchin’s position is apparently that Congress has no oversight powers. This is not within the range of debate about what the U.S. Constitution might mean, whatever one’s interpretive theory. And no one at even the very highest levels of the Administration actually believes it, at least in the sense of agreeing that a Democratic president would be similarly exempt from Congressional oversight.

It’s true that Mnuchin is being ordered from above not to comply. But when you receive a lawless order, your choices are to decline to follow it, or else to resign.

The IRS memo has no authoritative legal force as such, but it shows two things. The first is that the IRS lawyers realized how clearcut and indisputable the legal issue is. (The mention of executive privilege presumably reflects a view that such issues would be outside IRS legal expertise, but of course it’s completely absurd to argue that a president could have executive privilege regarding the tax returns he filed as a private citizen, and also no such claim has been made.)

Second, the fact that the IRS memo apparently played no role in the Administration’s, or Mnuchin’s, consideration of what to do unsurprisingly confirms their lawlessness. In an Administration that viewed legality as at least relevant, the memo would have been considered, and if its analysis was rejected that would have been based on non-risible legal arguments to the contrary. That does not appear to be what happened here.

Sticking the ending is tough

Last night I watched the Game of Thrones finale, what with others in the household watching it & its having become such a huge cultural event, etc.

I had seen most or all of Season 1, but then quit although I recognized the quality as I simply wasn’t in the market for another long-haul medieval dragons & kings fantasy. But I’ve seen bits here and there, and was familiar with the general story arc et al because it had become so culturally prominent.
My gawd but the ending was awful. Slow, portentious, pretentious, mawkish. They could have done the whole thing in 10 minutes, or alternatively they should have taken 6 weeks. And all the convenient happy ending bits, but also the oh-I’m-so-noble sorrow bits, were bad cliche.

Also the burning city was a bit too picturesque. Nicely curated little fires burning at regular intervals near arranged rubble. The set designer needed to go a bit more chaotic and rando.

But I recognize, from all I’ve heard about G of T online and in person from its fans, while this is the fault of the show runners it doesn’t say anything against the high quality of the first 6 seasons.
All that said, sticking the ending is tough. The Seinfeld finale was awful – strained, unfunny, completely misconceived – although it didn’t really matter since story arcs weren’t key to the show, so it was really just a by then rare bad episode. (Early Seinfeld episodes are interesting in that one can see they hadn’t quite figured it out yet.)
The famous, controversial Sopranos ending I thought was great, along with the entire series.
Breaking Bad I thought blew it a bit in the ending. Like Game of Thrones, they made things too nice and even rah-rah at the end, at the expense of everything that had come before. But at least it was a dramatic and fast-paced episode.
Luckily a bad ending to a miniseries doesn’t do as much harm to what came before as, say, failing to land a plane.

Considering exercise of the House’s inherent arrest power

My USC tax colleague and friend Ed Kleinbard, along with USC con law professor Sam Erman, argue here – I think entirely persuasively as a matter of law – that the House of Representatives has well-settled inherent power to arrest the likes of Steven Mnuchin and Robert Barr for their lawless defiance of subpoenas, and to forcibly detain them (say, in Capital Hill hotel rooms under guard) until they comply. (The arrestees would be free to try going to court themselves, but they would lose if precedent still means anything.)

I have to admit, I consider it a tough question how this would end up playing out in the public arena, given that these individuals do not seem terribly committed to the rule of law, have armed bodyguards, and would not necessarily agree to go peaceably.

Back in the day

As I approach another birthday (let’s not say what #, although the info is publicly available), I enjoyed seeing this photo from a vacation many years ago. I wonder where (if?) she is today.

2019 Tribeca Film Festival

Sometimes I wonder if New York is worth it – expensive, crowded, crumbling infrastructure (although our whole country is like that), and I’ve grown to hate the winters.

But it does have some things going for it, like endless restaurant variety, along with cultural events that are scarcer in most other places. An example was getting to see Hannah Gadsby (and soon I’ll be seeing her again) before she had broken through on Netflix. One of my faves, however, is the Tribeca Film Festival, held each year around lower Manhattan in late April and the beginning of May (just at the right time for one to wish the weather was better, although that’s almost always true here).

You can get an 8-ticket package and go with partner to 4 movies that you choose before they’re otherwise on sale, but this year we doubled down and got a 16-ticket package, with the end result of seeing 8 films in 9 days.

Best news: none of them were superhero movies or anything like it. Indeed, it was a common joke on the lines where you wait for admission to your event: “Are you here for The Avengers?”

If you play your cards right you can try for a varied slate by genre, site, time of day, etc., reducing the monotony of having to get somewhere (half an hour early) each day, and turning it into more of a staycation. You also generally get to see and hear a short Q&A with the director, stars, etc., after each show, which adds human context.

This year’s slate for us was as follows:

1) Lost Bayou – small film about a troubled young woman who has to go see her faith-healer dad on a houseboat in the Louisiana swamp. Beautifully photographed, a bit slow, unlikely to go far commercially, but it felt worth seeing.

2) Good Posture – excellent indie growing-up film with Angelika-style potential, young woman in a beautifully shot Brooklyn meets (fictional) famous writer, great cameos by Zadie Smith, Martin Amis, and Jonathan Ames.

3) Plus One – rom com that also has breakout potential, very enjoyable to watch, and with a charming performance by the female lead, but a bit cliched despite efforts to address the genre’s familiarity, and seemingly aimed more at commercial success than, say, artistic exploration.

4) Inna de Yard – documentary about founding musicians from the Jamaican reggae scene who are still performing today.  Great music and a nice cultural document.

5) Woodstock – new documentary about the famous 1969 concert, based on previously unused archival footage and interviews. Rather than being a concert movie like the original 1970 release about this epochal event, it focuses on how the organizers put the concert together, why people went there and what they felt they got out of it, and how everyone got through the challenging circumstances of a prolonged mass concert experience with inadequate facilities, drenching rain, etcetera.

6) The Quiet One – documentary about former Rolling Stones bassist Bill Wyman, featuring a dip into his massive archives that go back to before the group’s beginning. Interesting and had some nice footage, but mainly stayed on the opaque surface and also steered clear of controversy.

7) Buffaloed – Zoey Deutch stars in a somewhat Wolf of Wall Street-ish comedy-drama about a young woman in Buffalo who is desperate to rise from poverty. Enjoyable and lively, although at times straining dramatic credibility.

8) See You Yesterday – This was one of my three favorites (along with Good Posture and Woodstock). Like Get Out, it takes a familiar genre, here sci-fi, and imbues it with observation and commentary on where the United States is today racially. A young black woman and man who are completing their junior years at Bronx Science have a science project that they hope will get them scholarships to the likes of MIT and Stanford. To wit, they’ve invented a time machine, although they can only go back a day (raised gradually to a week) due to its energy and system demands. The sci fi premise would not by itself make the film worthwhile, but it enables the sociological exploration that is the film’s real topic. While, at first, the two of them just want to time-travel to show themselves that they can, police violence leads to a tragedy that makes them want to go back and fix things. But that proves not so easy. Great performances, great ending, very moving, and it does not make one happy(nor should it) about the society we live in.

NYU Tax Policy Colloquium soon to be back for its 25th season

As noted in passing in my last two blog posts (concerning digital service taxation and Wei Cui’s paper discussing it), this week marked the end of the “spring” 2019 NYU Tax Policy Colloquium, number 24 in our annual series.

We will be back quite soon, however. My co-convener Lily Batchelder and I have decided to switch the colloquium to the fall semester, at least on a trial basis and probably (as we hope) permanently.

Season #25 of the NYU Tax Policy Colloquium will therefore be running on Tuesdays from September 3 through December 3 of this year. As usual, the public sessions (after we meet privately with our students in the morning) will go from 4 to 5:50 pm, in Vanderbilt Hall, room 208, and to be followed by a small group dinner nearby.

We’re in the process of developing our speaker schedule, and I will post it here once it’s reasonably set.

Digital services taxes, part 2: inter-nation equity and global coordination / political economy issues

Wei Cui’s The Digital Services Tax: A Conceptual Defense, which we discussed earlier this week in the final session of this semester’s NYU Tax Policy Colloquium, deserves props for lucidly and significantly advancing the debate on digital services taxes (along with an associated debate on corporate income taxes). My prior blog post emphasized the efficiency issues discussed in the paper, but Cui also more briefly discusses equity issues, and this post will address them.

“Equity” here means inter-nation equity, a concept which is distressingly difficult either to use or, when global coordination / who-should-get-the-revenue issues arise, to avoid. The core challenges in using it relate to (1) the fact that nations are collective entities, composed of individuals but not themselves sensate, and (2) the difficulty of determining consistently how people in one country should weight the interests of people in other countries.

As to (1): Any approach to tax or other policy that is based on the welfare of individuals can readily be deployed to evaluate distributional issues as between the members of all those whom one classifies as members of the relevant group – for example, the rich and the poor within a given society. But a nation is a legal or sociological entity, which can’t itself experience welfare, any more than a corporation can. So it is hard to get one’s hands around the concept of, say, America’s versus France’s welfare. To be sure, one has American and French individuals – although the membership list for each group may be both contested and fluid. But we can be sure, for example, that some American individuals are better-off than some French individuals, and vice versa.

One needn’t employ a fully welfare-based standard in order to face problems of this kind. In standard distributional analysis of a group of people, I can understand the claim that, if X has gotten very rich due to her effort in applying her talents, she deserves to keep everything based on entitlement, not just incentive effects. I disagree with this line of argument, but I understand it.

Now suppose we say that investment from Americans into France will be taxed in a certain way, leaving only the question of which country will get the revenues. To say that France “deserves” the revenues, perhaps on some sort of benefit theory, and notwithstanding the possibility that France would choose not to tax the activity at all if the alternative were that no one (rather than the U.S.) would get the revenues, is hard to make coherent enough even to be refuted in a specific way. I sometimes feel that one might as well be discussing with the Walrus and the Carpenter “why the sea is boiling hot, and whether pigs have wings.”

But then again, suppose we hear that Finland or Taiwan wants to claim the revenue from Americans investing in France. Or suppose I want to claim the revenues personally. (As Al Franken used to say, decades before his disgrace, “Why not me?”) From an efficiency standpoint that focuses just on taxpayers’ incentives, it makes no difference who gets the revenue. So where do we go to conclude that, perhaps, if anyone is to claim revenue from these cross-border investments, it should probably go (absent further complicating facts) either to the U.S. or France.

Obviously, there might be rationales here of political economy, making global coordination more feasible, requiring national and other actors to treat each other “reasonably,” having rules of the road like driving on either the left or the right, etcetera. But the language of inter-nation equity naturally creeps in here, whether or not one ultimately thinks it is about equity.

This brings us to (2) the difficulty of determining consistently how people in one country should weight the interests of people in other countries. I’ve written about this before, but, in a nutshell, global beneficence – valuing everyone’s interests equally – is hard to beat as a moral standard. But we accept that countries may greatly prioritize the interests of their own community members (a concept which of course is in itself highly fraught). This is at least analogous to the fact that individuals who might consider themselves utilitarians may nonetheless not beat them themselves up to much over using their own material resources chiefly on behalf of themselves and other members of their households or families, rather than asking themselves who in the entire world is most in need.

From this standpoint, at a first approximation tax revenues that go to another country, rather than to one’s own country, have zero value to oneself. So why not be Finland or Taiwan with respect to U.S. to France cross-border investment? But again one may reach for the idea that all may gain if all behave reasonably and cooperatively. And this in turn takes us to the case for generally behaving cooperatively in prisoner’s dilemmas (at least, if one thinks others are sufficiently doing so) even insofar as one doesn’t expect this to pay off directly for oneself via multi-stage strategic play.

I’m known in some circles for arguing that the U.S. (and other countries) should make international tax policy choices as if foreign taxes were just a cost like any other. My argument was partly just about logical consistency – those who claimed otherwise could not, or at least had not been able to, explain coherently why a global welfare standard should apply here in particular but not elsewhere. But it was more fundamentally about disagreeing that, in recent and present circumstances, any one country’s offering foreign tax credits (while other countries were shifting their international tax systems in a more territorial direction) made sense either unilaterally, or strategically, or as conditional-Kantian cooperation (in John Roemer’s sense). I probably would not have regarded this line of argument as indicating, say in 1976 if I were flown back there with my present state of beliefs, that the U.S. should go first in reducing foreign tax creditability.

With all that as background, let’s turn now to the inter-nation equity issues in Wei Cui’s paper, Suppose we posit the following. There are a bunch of people out there who have become billionaires by launching successful start-up companies that exploded via the creation of digital platforms that are being used globally. As it happens, many or perhaps even most of these people are Americans – e.g., the Facebook, Google, Amazon, Apple, et al founders. Suppose further that they are generating rents, which in turn can be divided, if one likes, into the location-specific rents (involving zero marginal cost and non-rival use) that are available to be earned in each particular country.

Now suppose that one is thinking about entity-level corporate income taxation, and that one starts out by regarding it as purely a proxy for income taxation of individuals – which could be wholly avoided or at least deferred, by one’s operating through corporations, unless the income was contemporaneously taxed at the entity level (or otherwise adjusted for at the individual level). This clearly is AN important reason for corporate income taxation, treating the rest of the fiscal system as fixed, although not necessarily the only purpose that it could be designed to serve.

From this perspective, the mega-profits earned by those mega-companies – or to be earned in an accounting sense, but already reflected in stock price valuations – belong to the individuals who own the companies. Insofar as these people are U.S. residents (Zuckerberg, Page, Bezos, et al), the U.S. has reason to, and should want to, tax them on the location-specific rents that they are earning around the world. Or more precisely, it has reason to count those rents’ effect on these individuals’ annual economic income and net worth. In addition, to the extent not already following automatically from the above, it has reason to tax U.S. individuals’ foreign source income on the same terms as their domestic source income, so that such individuals can’t avoid source-based U.S. income taxation by investing abroad. (The reason this doesn’t follow so automatically for entity-level corporate income taxation of resident companies relates to the differences between corporate and individual residence as operating concepts.)

From a U.S. standpoint, therefore, if one were to assume that only one country should be able to tax the location-specific rents that U.S. individuals earn abroad (whether through corporations or not), it would be us. This is even leaving aside the “Finland or Taiwan” reasonableness point from above that we’d also want to be the one taxing all the other rents that arise anywhere in the world.

On the other hand, suppose people from other countries are earning location-specific rents from investing in the United States. Even under the reasonableness constraint, we’d want to tax those, too. And by the same token, all the other countries out there in which U.S. individuals, often through U.S. corporations, are earning location-specific rents may quite reasonably want to be the ones to tax at least the rents earned in their own jurisdictions. Not to mention that they have also observed our not especially taxing those rents, given the porousness of U.S. (and other countries’) corporate income taxation as applied to multinationals.

Cui’s paper on digital services taxes argues that it is at least prima facie reasonable and fair, subject to further development of the relevant inter-nation equity issues, for a given country to want to tax a piece of the location-specific rents that multinationals deploying highly profitable digital platforms are earning with regard to activity that takes place inside such country and/or involves individuals who are among its residents.

I agree with this proposition. At a minimum, we’re not in the realm of Finland, Taiwan, or me trying to grab the rents from, say, U.S.-into-UK activity, and we’ve all generally agreed that self-interested behavior is permissible within those broad bounds. How to handle the coordination issues that may arise, and how well they are likely to be handled, is of course another, and far more difficult, question.

NYU Tax Policy Colloquium, week 14: Part 1 regarding Wei Cui’s The Digital Service Tax: A Conceptual Defense

Yesterday we completed the NYU Tax Policy Colloquium’s (and my) 24th year of operations with a paper on a hot topic, Wei Cui’s The Digital Services Tax: A Conceptual Defense. The paper makes creative and important contributions regarding how best to think about a new fiscal instrument that has been attracting a lot of attention, most of it hostile. Digital services taxes (DSTs) are a rich topic that I will probably be thinking about some more in the near future. E.g., I’m scheduled to give an international tax policy talk in Singapore next January, and my lecture topic will likely have something to do with DSTs, whether as themselves the prime topic or as an important subordinate / illustrative piece thereof.

There are some actual DSTs out there, in varying stages of being adopted or proposed. There are also related instruments that appear not to be quite the same – for example, Singapore recently enacted what appears at an initial glance to be an extension of their VAT/GST to digital services, requiring certain foreign suppliers to register and participate. That’s not quite the same thing, and indeed might be relatively uncontroversial as a tax policy matter.

In this post, I’ll lay out some preliminary structure that might aid one in understanding Cui’s arguments and the DST debate more generally. For reasons of overall length, I’ll continue the discussion in a follow-up, Part 2 post.

1) What is a DST for the paper’s purposes?

a) Conceptual overview – In principle, whether or not perfectly in practice, a DST within the paper’s conceptual defense is a gross receipts tax on the use of a digital platform to earn location-specific rents in a given country, via an (at least) two-sided business model, and featuring both non-rival deployment within the country and zero marginal cost. The paper recognizes that some of these features will never be completely true, but, as noted below, if they are sufficiently true they might be highly policy-relevant.

b) Whom might one have in mind as companies potentially subject to such a tax? – Before unpacking this a bit more, let’s give a sense of the territory, by noting some well-known companies that might be subject to a DST – although, in fact, many of them are deliberately exempted by existing versions.

Consider Facebook, Google, Amazon Marketplace, AirBnB, Uber and Lyft, Microsoft and Android, Apple, Netflix, PayPal, Spotify, LinkedIn, EBay, Expedia, YouTube, and Seamless and GrubHub if they went international. All are potentially within scope at least as to some of their operations, if one conceptualizes the DST as Cui does.

To be clear, here, many of the above companies have been deliberately left outside the scope of existing DST proposals. In some cases, the DST proponents have had express rationales for the exclusions that reflect their viewing the instrument’s purposes differently than the paper does. For example, they may focus on whether content or valuable data is being provided by local customers, or instead is being supplied from outside the jurisdiction (a la Netflix and YouTube). This reflects rationalizing the DST differently than the paper does.

It will be illuminating below to compare a couple of these companies with one that presumably would NOT be subject to any DST, yet that shares some (though not all) of the key economic features noted above. The company I have in mind for this purpose is Starbucks, although I’ll also briefly mention American Express and Visa.

2) Illustrating and rationalizing each of the above DST’s main features

a) Gross receipts tax – Suppose the taxing jurisdiction is the UK, and that the taxpayer is either Facebook or AirBnB. The tax as envisioned by Cui would fall on the company’s gross revenues from exploiting the UK market. For Facebook, this would be advertising revenues that Facebook earns from third party advertisers (wherever located) that are targeted to UK consumers. For AirBnb, the tax would fall on fees paid to it by guests (wherever located) who used it to book UK accommodations. (In other words, this would be the excess of what they paid AirBnB over what it then remitted to the host.)

b) Digital platform – According to a standard online definition of digital platforms, they are “online businesses that facilitate commercial interactions between at least two different groups, with one typically being suppliers and the other consumers.” This obviously fits most of the companies that I listed above as potentially subject to the DST, although for some it either applies only to some of the company’s operations, or is debatable. For example, Netflix presumably isn’t intermediating between two groups as to its own content, but (along with Spotify) could be seen as doing so for commercially released stuff that it allows one to stream. Apple isn’t intermediating when it sells iPhones, but is doing so as between app developers and iPhone owners. PayPal and Venmo are playing a similar market role to American Express and Visa, but the latter aren’t using a digital platform in the same way as the former. Starbucks has physical stores and really isn’t using a digital platform at all (unless I am missing something), although it’s true that the stores may attract some customers via free wireless.

Who cares, for tax design purposes, whether or not one uses a digital platform? It doesn’t or at least shouldn’t, directly matter at all. It’s just one way of doing business, and there are others. But the use of a digital platform may be highly correlated with various features that do matter.

Just to name one for now, although more will emerge below, digital platforms can make it easy for a company to reach a given country’s consumers (or suppliers, as in the AirBnB case) without having the sort of physical presence that can give rise to a “permanent establishment” (PE) for tax purposes. Both tax treaties, and numerous countries’ domestic income tax laws, treat the existence of a PE (or of something similar, such as a “U.S. trade or business” under U.S. income tax law) as a precondition to taxing non-resident companies on the profits that they earn from interacting with one’s resident consumers and/or suppliers.

Suppose one thinks that a PE really oughtn’t to be necessary in order for a given country reasonably to tax non-resident companies on the profits that they earn from interacting with one’s residents. It’s rather an obsolete concept, from the days when interaction without physical presence was costly and cumbersome, and when nonresident businesses might find it difficult to understand, or costly to comply with, a given country’s tax regime unless their people were there. Then companies with digital platforms would be at least among those that one wanted to tax and that found it easy to avoid a PE. But seemingly the most direct response would be to eliminate the PE requirement, not focus directly on the presence or absence of a digital platform.

To illustrate, suppose that Starbucks used franchising to place stores in a given country such as the UK, rather than operating its own store. Now, I presume that the main reason they don’t do this is that it simply isn’t the business model they prefer to maximize profits from their brand. As explained by Ronald Coase’s theory of the firm, they have apparently concluded that direct control over employees is the best way to get the behavior and incentives that they want. But if they DID use franchising and independent agents, and if this worked as well from a business standpoint as what they actually do, then they might be able to avoid having PEs outside the United States. Yet they would not be a penny less globally profitable than they actually are (again, under the assumption that doing business this way worked just fine).

In that scenario, the UK would of course be taxing Starbucks’ UK franchisees on the profits that they earned from the UK stores. But let me offer a guess: these profits wouldn’t be very impressive. Indeed, at a first approximation they’d resemble those currently earned by Starbucks’ UK employees (adjusting for the allowance of normal returns to any capital that they supplied or entrepreneurial risk that they bore). Or perhaps a better comparison is to the folks running rival coffee establishments that couldn’t take advantage of the Starbucks brand. After all. why would Starbucks give away to them any more than it had to, given their wage rates and opportunity costs that had nothing to do with the value of the Starbucks brand?

Among other things, this point arguably puts a rather low ceiling on the amount of profit that would end up in Starbucks UK operations for corporate income tax purposes, under its existing commercial structure, if arm’s length transfer pricing principles were neutrally and “accurately” deployed with respect to its UK PEs. Starbucks may be earning huge global profits, but not by reason of what’s happening in the UK in particular. But this doesn’t tell us whether either “we” from the standpoint of global welfare, or the UK from the standpoint of its residents’ self-interest, ought to support the UK’s getting its hands on what one reasonably deemed to be the UK piece of Starbucks’ global hyper-success.

c) Location-specific rents – Suppose one takes here for granted the point, admittedly requiring further analysis, that a host of highly successful global companies, such as all those that I named above with digital platforms, but also the likes of Starbucks, are earning extra-normal returns that we can properly call rents, within standard economic parlance. And let’s ignore for now the issue of whether, while looking like rents ex post, they are better thought of as quasi-rents that, from an ex ante perspective, merely reflected an ordinary, competitive, risk-adjusted return to intermingled labor effort and capital investment.

From at least the ex post perspective, taxing rents is efficient and in theory will not lead to efficiency costs. For example, if I can costlessly pocket $1 billion (e.g., by reason of getting extra-normal returns on investments for which I only required the normal return), then taxing even 99% of it away won’t deter me from still pocketing it all so that I can keep the residue.

If either Facebook or Starbucks is properly viewed asd earning rents around the world, then those it is earning in any particular place might be called rents specific to that location. For example, we might say that Facebook has UK rents from selling advertising that is targeted at UK users (as identified by their IP addresses or whatever). And Starbucks has UK rents from the profits it derives, given the value of its trademark etc., from operating stores in the UK. (Or, one might instead or also say, from selling to UK individuals anywhere in the world, if this fact automatically emerged in the course of a normal customer transaction.)

d) Non-rival deployment – Crucial to the idea of calling Facebook’s or Starbucks’ UK rents location-specific is the view that its IP can be simultaneously deployed everywhere. A given car, or for that matter a given espresso shot using particular Starbucks beans, can only be sold in one place. But Facebook’s platform can be offered and used around the world in non-rival fashion. The same holds for Starbucks’ brand value and basic organizational scheme. Thus, taking as given that the two companies are earning rents, they needn’t ask themselves where they should try to earn these rents. The answer is everywhere. There is no opportunity cost to entering the UK market – in the pure case, their doing so has no impact on their also doing so everyplace else. So if the global rents that they can earn include some that we have defined as location-specific to the UK, then of course they will choose to do so, (at least within the model’s contours) even if these rents are highly taxed.

e) Zero marginal cost – A further and related key assumption, in terms of making an appealing theoretical case for something like a DST, is that the firm has zero marginal costs of operating in a given jurisdiction. If Facebook already has a digital platform at the ready, then one could imagine its costing the company zero to allow UK users to access the platform, and outside advertisers to pay for targeted access to these users. In practice, this of course is not likely to be literally true. For example, Facebook may need to be able to handle more traffic by reason of its being in the UK, and may need to address U.K. regulatory issues, along with users who speak in English dialect (rather than, say, American or Australian).

Zero marginal cost matters because, where found, it takes away the sting from DSTs’ being a gross receipts tax. Gross revenue equals net revenue if there are no marginal costs. So one avoids the problems with gross turnover taxes that made their decades-ago replacement by VATs a huge step forward for various European and other countries. And even if there are some marginal costs, so that the gross revenue facing DST exceeds true net revenue, corporate income tax accounting efforts to measure the latter, especially for a given location within a company’s global operations, may conceivably lead to answers that are actually further from the mark. So there may be a case for gross revenue taxes on digital platforms if we believe that net revenues from its deployment in a given country are both small enough in truth, and tax-manipulable enough in practice.

What about Starbucks? Well, a tax on gross revenues from its UK operations would be normatively unappealing, given that it clearly does have substantial marginal operating costs, such as from paying rent, wages, and for supplies. So its not using a digital platform has a lot to do with why placing it under a pure DST-style regime would not make sense. Yet there is an element of its operations that overlaps with the DST rationale. After all, analogously to Facebook, it might be viewed as earning location-specific rents in the UK from non-rival deployment there of its global brand value.

Suppose that the UK corporate income tax was inevitably going to under-tax both Facebook and Starbucks, relative to a UK-only firm that had no rents. I am here using “under-tax” to refer both to the unique profit-shifting opportunities that multinational firms often have – although the concept of “profit-shifting” implies a judgment as to “true” UK-source income – and to the rationale for imposing higher taxes on rents than on normal returns. Also, I am ignoring here the considerable flexibility that an instrument which we chose to label as the “corporate income tax” might in practice actually have – at least, if not overly constrained by income tax treaties.

Then applying a DST to Facebook, but nothing new to Starbucks, might combine the virtue of raising revenue efficiently from the former, and better aligning its taxation to that of the UK-only firm, with the vice of newly tax-disfavoring it relative to the latter. This is a tradeoff that DSTs will almost inevitably offer, even where the theoretical conditions for favoring them are pretty well met, if the underlying concept couldn’t somehow be suitably generalized and adapted to settings outside that of digital platforms.

f) Two-sided business model – There is an extensive literature (not currently all that familiar to me) concerning two-sided business models, and referenced by Cui’s paper. A key issue here is that the intermediary, such as a digital platform, doesn’t have to charge an independent arm’s length price to each side of the arrangement. It can subsidize one side and recover by charging the other side, because (a) it only cares about its net from the two together, and (b) things are suitably adjusted as between the other two parties in their indirect dealings with each other.

The Facebook example is: We get to use the platform for free because Facebook is delivering us to advertisers (or others through whom it monetizes the data it has acquired about us).

This of course isn’t a newfangled product of modern digital platform technology. TV and radio stations that broadcast for free to non-subscribers but that are funded by commercials are doing a version of the same thing.

The AirBnB example is: the company offers value to hosts who sign up, but doesn’t directly charge them anything, because it can collect fees on the consumer side (i.e., the gross amounts guests remit to it, minus what it then pays forward to the host).

While I’m planning to read up more on the literature concerning two-sided business models, my impression is this feature doesn’t play a first-order role in the DST debate. Rather, it matters here mainly via its effect on the application of conventional corporate income taxes to platform companies.

In the Facebook example, the UK can’t glom onto the fees paid by users to Facebook, as a ground either for taxing those fees or using them to establish a broader PE from which it can stake its claim to other revenues or profits that are attributable to Facebook’s having UK users.

In the AirBnb example, the fact that the company gets nothing directly from UK hosts, as distinct from the hypothetical case (with identical net cash flows) in which guests paid hosts directly and the hosts then remitted a piece to the company – or, for that matter, from that where hosts paid it sign-up and subscription fees – similarly at least complicates things for the UK tax authorities, if they would have liked to get revenues from the company, say through the corporate income tax.

Two-sided business platforms therefore strike me as potentially important to the motivation for imposing DSTs, but less so as to how one might think about DSTs in fundamental economic terms.

Okay, that’s plenty long enough, if not too long, for a single blog post. It offers grist for both sides with respect to DSTs’ good and bad efficiency properties. I’ll shortly (or when I can) post a follow-up that looks to the equity issues – meaning here inter-nation equity, not say vertical distribution – aka, who gets the money and how should we think about that issue.