Why NZ should not try underarm bowling

Dr Eric Crampton
The National Business Review
26 July, 2019

A truism in politics has been codified in what’s been called Miles’s Law: “Where you stand depends on where you sit.” In other words, principles can depend a bit on one’s interests.

Legend had it that one of the professors who taught courses in antitrust where I went to graduate school liked to quip: “I support antitrust because antitrust supports me.” Consulting in antitrust cases was rather lucrative.

New Zealand’s general position in favour of rules-based international orders is principled. But it also reflects our interest as a small and trading nation. The rules do not always work out in New Zealand’s favour. Bigger countries will often pull stunts that abide by the letter of trade agreements rather than their spirit – like US President Donald Trump’s strategic tariffs on New Zealand aluminium and steel, or Australia’s long underarm bowl on apple imports.

But things would be worse in the absence of those rules. The rules, such as they are, do make it harder for other countries to set policy in ways that discriminate against New Zealand firms. And those rules are under substantial threat. So why is New Zealand undermining them further in its push for a digital services tax?

Over the past month, the government has been accepting submissions on its discussion document Options for taxing the digital economy. The paper notes that agreement through the OECD on international tax rules for multinational companies in certain classes of activity have proven a bit difficult, and that implementing any multilateral agreement could be a few years away. The paper consequently proposes a 3% digital services tax (DST) to be levied on the gross New Zealand revenues of large companies whose revenues depend “on the size and active contribution of their user base.” The paper gives YouTube and Uber as examples. TradeMe would also fit but does not meet the revenue threshold.

Multilateral fix

The proposal stands as a giant thumb in the eye of New Zealand’s traditional position in favour of rules-based international orders. If there are holes in international tax arrangements, the way to fix them is through multilateral agreement and the OECD – where New Zealand could take a leadership role rather than pursue its own domestic solution.

Most obviously, the proposal is designed with protectionist intent. It is not hard to design rules that have the appearance of neutrality between foreign and domestic firms but whose effects are designed to be protectionist.

While a rule imposing an excise tax on the gross revenues of firms earning more than €750 million in global revenues may be neutral between foreign and domestic firms, the threshold was picked for a reason – the same reason that that threshold has also been contemplated by other countries considering similar taxes. Combined with the domain restrictions on the types of activities subject to the tax, the revenue threshold effectively excludes all but the largest international players, who are mostly based in the US.

If New Zealand passes general-in-appearance but protectionist-in-effect tax rules based on gross revenues, on what leg could New Zealand stand when other countries do the same to us? What objection could New Zealand possibly raise if some other country proposed taxing Fonterra on the proportion of its gross revenues derived from sales in that country? If some country across the Tasman claimed not to have an illegal ban on New Zealand apple imports but rather a neutral rule that accidentally happened to exclude New Zealand imports, could we with a straight face complain that those rules make a mockery of neutrality principles? It would be harder to do so if New Zealand, in tax policy, adopted rules every bit as designed to pay lip service to neutrality while really working to ensure the primary effect is to tax foreign firms.

Principled approach

And while the discussion paper rightly notes a DST here could be designed to be compliant with our international obligation, this would be a drafting effort to meet the letter rather than the spirit of the rules. We should not be advocates of underarm bowling, even if such tactics meet the letter of the rule.

But principles aside for the moment, consider New Zealand’s interests. The rules-based international order is under threat from an American administration with sharply protectionist leanings. Whether deliberately, or through an incomparably incompetent executive, the US is undermining the decades-long consensus in favour of rules-based international order. If Fox News were to highlight – and correctly – that New Zealand were adopting protectionist taxes on US companies, trade retaliation could be rather swift.

Just last week, the US initiated a section 301 investigation of France’s digital services tax, parts of which form the basis for New Zealand’s proposed tax. Section 301 of the 1974 Trade Act allows the US to launch retaliatory tariffs against countries it believes have breached international trading rules, albeit after a rather lengthy process.

New Zealand’s going ahead with a DST would be one of the dumber ways of violating Miles’s Law. It would be madness to give a protectionist and thin-skinned president a legitimate excuse to tax the gross revenues of New Zealand firms with sales in the US. It works strongly against New Zealand’s interests. And it is out of step with our principled support for rules-based international orders at a time when New Zealand’s continued leadership in that area is rather important.

Dr Crampton is chief economist with the New Zealand Initiative.

Stay in the loop: Subscribe to updates