EU Tax-Hikers, Meet the US Constitution

Search any news coverage over the past week with the terms “European Union” and “digital tax,” and some form of the word “fail” will likely accompany the results. The reason: EU finance ministers could not reach agreement by a December 4 deadline on whether and how to implement a proposal, formally unveiled in March, to impose a 3 percent “turnover tax” on tech firms operating within the Eurozone.  As NTU has noted in previous analysescommunications to the Treasury, and op-eds, this ploy violated numerous tenets of sound tax policy and tax administration. Effectively establishing a base of gross receipts instead of net profit, targeting worldwide revenues, and tinkering with established definitions of physical presence are just a few of the proposal’s flaws.

So with this failure of the original digital services tax framework to gain a solid foothold, should taxpayers have cause to celebrate? Not so fast. If anything, the dangers to citizens on both sides of the Atlantic who support rule of law and limited government are multiplying:

  • Just prior to last week’s breakdown in negotiations among EU tax officials, Germany and France’s authorities teamed up to offer a scaled-down compromise: a 3 percent tax levied only upon European-based online advertising sales instead of all digital revenues. This would increase burdens on affected companies by 2.5 billion euros annually instead of the more aggressive 5 billion euros envisioned under the original digital services tax. The tax plan, which would be negotiated next year among all 28 EU member states, would take effect in 2021 and purportedly would expire in 2025.
  • Meanwhile, other members of the Eurozone are proceeding with their own schemes. In late 2017 Italy enacted a tax on Internet-based transactions involving Italian residents or permanent establishments that meet a sufficient volume threshold (a consciously designed feature to target larger companies). The tax can take effect at any point in 2019. Spain’s officials have drafted legislation that would implement most of the original, broader EU digital services tax, while France may follow suit if its joint proposal with Germany falls flat. 
  • Amid all the turmoil over Brexit, the UK continues to pursue a 2 percent digital services tax plan of its own, mimicking many features of the EU plan released in the spring of this year. One of its most conspicuous aspects is its intent to hit US firms hardest.

Yet, another salient point from an American perspective is becoming clearer as would-be tax-hikers from abroad seek ever-narrower proposals that can win approval from their comrades. The more that Europeans seek to limit the collateral damage of such taxes on their own businesses and consumers, the more they trample on the principles of the U.S. Constitution (and on other nations’ legal traditions). Article I, Sections 9 and 10 of the U.S. Constitution specifically forbid the federal legislative branch or states, respectively, from enacting bills of attainder: acts that single out one individual or group for a specific punishment, usually involving deprivation of property or the right to earnings. 

One reason the Framers of the Constitution prohibited such acts was, at the time, the historical experience of England. By the 16thand 17thcenturies despotically-minded monarchs persuaded Parliament to enact bills of attainder against political enemies. In the United States, however, the Supreme Court has through a handful of cases established a doctrine that “legislative acts, no matter what their form, that apply either to named individuals or to easily ascertainable members of a group in such a way as to inflict punishment on them without a judicial trial are bills of attainder prohibited by the Constitution.” The Court has formulated a multi-part test to assist in evaluating such acts, focusing on whether they are specific enough, whether they constitute an actual punishment, and whether they have the functional effect of judicial punishment outside of a judicial forum.

Those subject to discriminatory taxes might readily agree that they are being targeted by bills of attainder, but based on the precepts outlined above, it is easy to understand why almost all of those claims cannot be supported in court. Elected officials often take pains to write tax laws that don’t actually name a person or an organization, but rather are tailored to apply to “any taxpayer” who fits a certain number of narrow criteria established in law. Furthermore, those same officials can almost always claim a “public purpose” or intent other than punishment for most kinds of taxes, even for “sin taxes” (e.g., encouraging healthier habits) or windfall profit taxes (e.g., encouraging more diversified energy development). 

Yet, at some point nuances about the letter of the law begin groaning under circumstances about the spirit of the law. And in the case of the EU’s tax ambitions, the groaning has risen in volume. 

Democratic and Republican officials in Congress and the White House have criticized the “circular logic” and “politicized rulings” of EU tax authorities against US companies for several years. The latest Franco-German tax on digital ad revenues takes these problems to new heights. As a practical matter, the only two multinational companies that would be significantly affected by the proposal are Google and Facebook. Other US or European tech firms that might have been hit by the original EU digital services levy would likely be untouched. In fact, Germany appears to have warmed to the revised plan precisely because it will avoid financially undermining the country’s own automakers. 

As the noose of specificity draws tighter with the Franco-German plan, the convenient fallback argument that the tax serves some public purpose other than punishment for “being big” becomes weaker. French Finance Minister Bruno Le Maire revealed such an agenda when he said last week that “the digital tech giants concentrate too much capital, too much data, and to be honest, too much power.” How ironic that a major reason why our Constitution prohibits bills of attainder is that they vest “too much power” in one branch of government to create mischief and misery upon individuals or groups without due process. Soon, the European Parliament – one branch of the EU’s government – may be effectively passing judgment on a few American firms in a manner with some disturbing parallels. 

We are not alone in this concern. Bills of attainder fell into disuse in the United Kingdom some 200 years ago, while courts in Australia and Canada have more recently drawn judicial lines in the sand against such acts. 

There are many reasons why the digital tax iterations of the EU, its member countries, and other nations are problematic. Their conflict with firmly embedded traditions such as separation of powers and limits on arbitrary acts by sovereigns is but one of them, especially given the practical economic effects of such taxes and the obstacles they present to efficient administration. 

Still, this conflict should be particularly relevant for US and UK officials as they weigh the consequences of digital tax proposals going forward. Hopefully they can impress as much upon their colleagues at the Organization for Economic Cooperation and Development, which has created a task force to recommend a tax framework for the digital economy by 2020. As Deputy Assistant Treasury Secretary Chip Harter aptly put it earlier this month, “If the OECD were to fail in this effort, we’d almost certainly see an acceleration in the breakdown of consensus and a proliferation of unilateral measures adopted by countries around the world.” The US tax reform experience, as well as our constitutional history, can provide useful guidance in avoiding such a breakdown.