No one likes to pay tax and few like to think about tax. Perhaps this is why there has been so little radical tax reform for over a generation, despite profound changes to how our economy works.
As a result, the tax system has become one of the main drivers of the “winner takes all” digital economy, with dominant firms still paying little if any tax. Since demands on government spending have escalated, this has meant a bigger tax burden on everyone else.
Europe has belatedly started introducing modest digital services taxes, though these are caught up in arguments with the US (since they mainly hit American firms). These target overall sales, but there are strong arguments for a more sophisticated approach.
The challenge of tax design is to tax fairly without inhibiting productive and creative activity
The challenge of tax design is to tax fairly without inhibiting productive and creative activity. Here economic theory is helpful. Firstly, it tells us that industries with close to zero marginal costs and network effects will tend to become very concentrated (as has happened with Google for search), and secondly that it is possible to levy quite high taxes on marginal revenues without disincentivising investment (the UK’s “Eady levy” on film distribution is a case in point here).
This is the argument for what I call “Proportional Marginal Revenue” taxes which do what they say on the tin—tax marginal revenues, whether for Hollywood films and Netflix series or digital platforms like Meta. The logic of such taxes is that once a film, piece of software or operating system has covered its costs, new revenue from a new customer is essentially a windfall: marginal revenue, with almost no marginal cost, that then becomes surplus for the owners.
Proportional Marginal Revenue taxes can begin quite low, for example at 25 per cent, and should only kick in over specified levels of demand or market share, so as not to hit startups or stifle innovation. Designed well, they could raise a lot of money without distorting effects on behaviour.
Moreover, they are simpler to implement than structural separations and demergers—helping us all to benefit from network effects while also encouraging competition (since they would stem the flows of cash enabling so many dominant incumbents to buy potential competitors).
Ideally, they should be implemented at an international level. But their virtue is that they don’t have to be since they target revenues, which by their nature happen in particular places.
Today, we have an economy structured around intangibles, but a tax system largely trapped in the tangible worlds of consumption, income and property. Without a healthy tax base no society can thrive. My modest proposal would rebalance a system that is skewed in favour of the rich at the expense of the poor and hardworking.
This article first appeared in Minister for the future, a special report produced in association with Nesta.
