Falling Behind on Digitalization in Spain

Update (2/20/2020): The proposed digital services tax mentioned below in this post has been agreed to by the Spanish cabinet. The levy will place a 3 percent taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. on earnings from online ads, deals brokered on digital platforms, and sales of user data by tech companies with at least €750 million (US $809 million) in total annual worldwide revenues and Spanish revenues of €3 million (US $3.24 million).

The Spanish government expects now to raise €968 million a year in extra tax revenue from the levy, €232 million less than it initially estimated in January 2019. On the other hand, the Independent Authority of Fiscal Responsibility estimated tax revenue between €546 million and €968 million.

Nevertheless, the measures still require parliament’s approval and will not be enforced until December 2020, when the OECD is expected to reach agreement on a global digital tax. The fear of high retaliatory duties on Spanish products by the administration in Washington is the main reason behind postponing enforcement of the tax.

Update (1/18/2019): The proposed digital services tax mentioned in this post has now been agreed to by the Spanish cabinet and will be debated by the parliament in the coming weeks.

A recent report highlights the fact that among various measures of digitalization, Spain is falling behind not only its European peers but also many other countries in the world. At a time when tech firms and various digital innovations are paving the way for growth and development around the world, it is critical for Spain to evaluate how it can best become a place where digital firms want to locate and grow.

Unfortunately, the Spanish government has recently proposed a policy on digital taxation that would send the wrong signals to tech firms that may be looking to grow their operations in Spain. The policy is a 3 percent tax on digital services, and it is modeled after the European Commission proposal, which has been broadly criticized. Spain’s tax is designed to apply to companies with more than €750 million (US $809 million) in total annual worldwide revenues and Spanish revenues of €3 million (US $3.24 million).

This tax could be costly for the Spanish economy if it leads to innovative firms choosing not to invest in Spain. Europe already has low levels of capital investment from tech firms, and Spain should avoid adopting policies that would make a difficult investment environment even worse.

Good tax policy should be simple, neutral, transparent, and stable. Unfortunately, the Spanish proposal is none of the above. The digital services tax (DST) is complex, distortionary, opaque, and temporary. It would require some digital businesses to pay taxes not only on income, but also separately calculate their tax liability based on revenues under the DST. The policy would be distortionary because it taxes one sector of the economy differently than other sectors and has size thresholds that will cause businesses to change their behavior to avoid the tax. The tax would also be opaque because the burden of the tax would ultimately be borne by businesses and individuals who are different than the ones submitting the tax payments. Finally, the Spanish government plans to eventually replace the DST with a separate definition of significant digital presence.

The tax would also have adverse effects on businesses that have low profitability because the tax would fall on revenues rather than profits. Businesses that are not yet making a profit might still find they owe the tax.

There are obvious challenges to determining how to tax firms that have large digital footprints but no physical presence in countries around the world. However, this is an issue that is not sector-specific. As the OECD has found, it is difficult, if not impossible, to ring-fence the digital economy. This fact calls for tax solutions that are broader than the digital tax or a definition of significant digital presence.

If Spain wants to lead on digital taxation, the government should seek to reevaluate the current international tax rules covering the digital economy rather than simply trying to tax digital firms differently than other firms.

Taxes targeted at specific companies using size thresholds can be highly distortive. Spain should be seeking opportunities to improve its competitiveness rather than pursuing policies that could be damaging for future growth.

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