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E.U. Tries to Tax & Regulate Away U.S. Tech Edge

Posted: May 20, 2024

The United States is the world’s largest economy, and its citizens enjoy the highest standard of living among major world economies. Essential to that prosperity are economic policies that foster entrepreneurship and market dynamism. Among major trading partners, the U.S. is substantially advantaged to the extent that it maintains these features in its economic policy outlook. 

By contrast, Europe stands as a cautionary tale to the perils of abandoning these essential tenets, and there is no more glaring example than its laggard tech sector, and its pursuit to tax and regulate away its tech gap. 

The U.S. private-sector dominance in the global technology sector is profound. According to the most recent data compiled by the E.U., the U.S. is home to 827 of the world’s 2,500 leading technology firms in the world. Further, American firms dominate the top 50. R&D investment by U.S. firms was more than twice that of China and the EU in 2022. 

A graph of the number of countries/regions

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In 2022, U.S. firms invested an estimated $500 billion in research and development, about 40 percent of the global R&D spend that year. In certain sectors, U.S. dominance is more pronounced. U.S. investment in AI research is by one measure 50 times that of Europe. Therefore, American policymakers ought to be skeptical of policy developments in Europe and elsewhere that appear designed to chip away at the U.S. advantage, not through innovation or R&D, but through the levers of regulation and tax policy.

Among the most conspicuous policies are the proliferation of digital service taxes (DSTs). DSTs are excise taxes levied on firms’ digital activities in a given jurisdiction, and they can take many forms. Typically, DSTs are structured as excise taxes on a firm’s digital footprint – such as revenue – in a jurisdiction in which the firm otherwise has no presence, or nexus, such as an office or employees. In that sense they are both at odds with prevailing tax norms and poorly designed. In general, nations don’t have taxing rights on entities with no physical nexus in their jurisdictions. The design of some of these taxes, specifically those on revenue, which do not allow for the deduction of expenses, are uniquely poor. Taxes on revenues, as opposed to profits, can lead to taxing inputs multiple times, giving rise to high effective tax rates. 

Essentially, many European and other jurisdictions have created novel taxing rights out of thin air, and imposed new levies on uniquely American activity. U.S. tax officials eventually cried “uncle” and agreed to an international tax agreement that would formalize new digital taxing rights and establish a global minimum corporate tax. This global tax agreement includes a key provision known as Pillar One, which would carve out a portion of large multinational firms’ profits related to digital activity, and grant new taxing rights to jurisdictions in which those firms had a digital presence. The tradeoff for agreeing to Pillar One was that “all” DSTs were supposed to be eliminated. It appears increasingly likely that even if the U.S. adopts Pillar One, also unlikely, all DST’s will not be eliminated.

The upshot is that the U.S. leads the word in the innovation economy and that leadership is driven by the private sector. In the absence of developing their own world-class innovation economy, governments in Europe and other countries appear increasingly disposed to using the levers of government to tax and regulate away the U.S. advantage.