Digital services taxes are being considered as a possible source of EU budget revenue, but the testimony argues they would raise little money, create economic distortions, increase compliance burdens, and risk trade conflict. A VAT-based approach is presented as a stronger alternative for taxing digital consumption and supporting EU own resources.
How Digital Services Taxes Emerged
Under current international tax rules, multinational companies generally pay corporate income tax where production occurs, not where consumers or digital users are located. Supporters of digital taxation argue that digital firms can earn income from users abroad without having a taxable physical presence in those countries.
The OECD began discussions on taxing digital activities in 2013. In 2019, negotiations involving more than 140 countries began, leading to the 2021 Pillar One proposal. Pillar One aims to reallocate some taxing rights so that certain profits are taxed where consumers are located.
Despite those negotiations, several countries introduced unilateral digital services taxes, or DSTs. The first major proposal came from the European Commission in March 2018, alongside rules for taxing companies with a significant digital presence.
The proposed EU-wide DST would have:
- Taxed revenues from digital advertising, online marketplaces, and user data sales in the EU
- Applied a 3 percent rate
- Covered companies with more than €750 million in global revenue and more than €50 million in EU revenue
- Raised an estimated €1.3 billion to €5 billion annually
That estimated revenue would equal about 0.07 percent of total EU tax revenues and about 2.6 percent of the EU budget. The proposal failed to gain unanimous support.
National Digital Services Taxes in Europe
Roughly half of European OECD countries have announced, proposed, or implemented a DST.
Ten countries have implemented one:
- Austria
- Denmark
- France
- Hungary
- Italy
- Poland
- Portugal
- Spain
- Turkey
- United Kingdom
The design varies widely. Austria and Hungary focus only on online advertising revenue. Denmark applies its DST only to streaming services. France uses a broader base, covering digital platforms, targeted advertising, and sales of user data collected for advertising.
Rates also differ. Poland’s rate is 1.5 percent, while Hungary and Turkey have had rates as high as 7.5 percent. Hungary has reduced its rate to zero, and Turkey lowered its rate to 5 percent from 1 January 2026.
Six other countries have announced or explored a DST without passing one into law:
- Belgium
- Czech Republic
- Latvia
- Norway
- Slovakia
- Slovenia
Germany recently examined a DST, while Poland considered a broader version, but neither proposal is expected to advance.
This fragmented approach has created added complexity across the Single Market. Pillar One was intended to replace unilateral measures such as DSTs, but negotiations have stalled and countries continue to act independently. Separately, the UN has introduced Article 12B of the UN Model Tax Convention for taxing income from automated digital services, and in November 2024 launched negotiations for a new tax cooperation treaty, with talks targeted to conclude by 2027.
Revenue Is Limited
DSTs generate relatively little revenue. In countries that report DST revenue separately, annual receipts range from about €137 million in Austria to around €1 billion in the UK.
As a share of total government revenue, DSTs are usually below 0.1 percent. Turkey is the highest case cited, at about 0.24 percent.
At EU level, the European Commission’s estimate of up to €5 billion annually would still represent only about 0.07 percent of total EU tax revenues and about 2.6 percent of the EU budget. The argument presented is that DSTs are too small to meaningfully fund the EU budget.
Who Pays the Tax
DSTs are often presented as taxes on large digital companies, but they are levied on gross revenues rather than profits. The testimony compares them to excise taxes and argues that, like excise taxes, they are largely passed on to users and consumers.
Google, Amazon, and Apple are cited as companies that introduced surcharges in response to DSTs, passing costs through higher advertising fees, marketplace charges, and consumer prices.
The testimony argues that this has two consequences:
- DSTs can be regressive, because higher prices affect lower-income consumers more heavily.
- DSTs can burden European businesses, especially small firms that rely on digital platforms.
As a result, the tax may not fall mainly on foreign technology companies, but on European users, consumers, and businesses.
Design Problems and Economic Distortions
A central problem is that DSTs tax revenue, not profit. This means companies may owe tax even when they are not profitable, and low-margin businesses can face very high effective tax rates.
For example, a company with €100 in revenue and €15 in profit would pay €3 under a 3 percent DST. That equals a 20 percent tax on profit. If the company has a lower profit margin, the effective tax rate can rise sharply, potentially reaching 60 percent or more.
This structure can:
- Penalize low-margin firms
- Discourage investment and growth
- Distort business decisions
- Tax the same activity multiple times along the supply chain
- Apply to business inputs such as advertising and cloud services
- Penalize specialization that can make the economy more productive
DSTs can also be discriminatory because they target firms above certain revenue thresholds and treat digital businesses differently from traditional businesses.
The testimony also highlights administrative costs. Governments must design and enforce complex rules, while companies must track user locations and comply with multiple national systems. Because DSTs differ by country, businesses face higher compliance costs across the Single Market.
The testimony compares DSTs to turnover taxes, which Europe replaced with VAT in the 1960s to improve the functioning of the Single Market. Reintroducing similar features is described as a step backward in tax policy.
Trade Risks
DSTs are widely viewed as targeting US-based technology companies, creating tensions with the United States. The US has launched Section 301 investigations and threatened retaliatory tariffs in response to digital taxes.
An EU-wide DST could create stronger trade tensions than the current patchwork of national DSTs. The testimony warns that unilateral tax measures can produce tit-for-tat responses and harm all sides.
VAT as an Alternative
The testimony argues that VAT is a better tool for taxing digital services and supporting EU budget resources.
VAT already taxes digital services at the point of consumption and requires non-EU firms to register and pay where consumers are located. Revenue from this approach increased from €3 billion in 2015 to more than €33 billion in 2024, about seven times the estimated yield of an EU-wide DST.
The argument is that the EU should strengthen VAT rather than create a new DST-based own resource.
VAT-based resources currently account for about 9.5 percent of total EU revenue, down from 60 percent in 1988. This decline reflects reforms that reduced both the VAT base and the applicable rate.
Broadening the VAT base by eliminating reduced rates and exemptions could generate up to €773 billion in additional national revenue. Since Member States’ VAT revenue determines the base for EU own resources, this could translate into about €2.3 billion for the EU budget, slightly above the lower-end €1.3 billion estimate for an EU-wide DST.
If the VAT base cap is non-binding, and the new own resources framework raises the current cap, increasing the call rate from 0.3 percent to the previous 1 percent level could generate an additional €7.7 billion in stable funding.
Policy Takeaway
Digital services taxes respond to a real concern about adapting taxation to the digital economy, but the testimony argues they are not an effective solution for the EU budget.
The main criticisms are that DSTs:
- Raise limited revenue
- Are often passed on to consumers and businesses
- Create high effective tax rates for low-margin firms
- Increase complexity and compliance costs
- Fragment the Single Market
- Risk harming innovation and competitiveness
- Could trigger international trade retaliation
VAT is presented as the more efficient, neutral, and stable option. Instead of expanding national DSTs or introducing an EU-wide version, the testimony argues that policymakers should focus on strengthening VAT collection, broadening the VAT base, and modernizing VAT for the digital economy.
Source article: taxfoundation.org
