Adam N. Michel
Earlier this summer, France briefly floated the idea of quintupling its digital services tax (DST), a tariff-like levy on services primarily provided by American tech firms. The proposal was pulled back almost immediately, but it highlighted something striking: A key piece of the international tax debate was completely absent from the Group of Seven’s recent side-by-side agreement.
DSTs were originally a pressure tactic. They provided a means for European governments to force the United States into accepting the Organisation for Economic Co-operation and Development’s (OECD) Pillar One proposal for a sweeping reallocation of multinational profits that would have transferred overseas the most dynamic part of the US tax base. Now that Pillar One has permanently stalled, DSTs will return absent a new agreement.
Unlike the Pillar One proposal, DSTs mostly hurt the domestic constituencies of the countries imposing them. Yet, despite their discriminatory and distortionary targeting of American businesses, DSTs are not a threat worth overreacting to.
Doomed to Fail: The OECD Pillar One Tax
The OECD’s Pillar One project to create a multilateral tax treaty (part of the “Inclusive Framework”) was marketed as a replacement for unilateral DSTs. What eventually became “Part A” of Pillar One would have redistributed hundreds of billions of dollars of multinational corporate profits to countries based on the location of their customers, regardless of a company’s physical location, domestic activity, or value creation. This would have upended half a century of consensus-building for the opposite principles.
Despite lofty rhetoric about modernizing the international tax system for a digital 21st century, the Pillar One project was borne out of domestic populist politics in Europe. In 2019, France and a handful of other countries enacted or proposed DSTs that taxed the revenues (instead of profits) of prominent US technology firms. Successful American businesses were an easy political target for punitive new tax collections. Using the DSTs as leverage, the European Union encouraged the OECD to wrap the DST dispute into its broader reform agenda. The project stalled in 2024 without sufficient buy-in from the United States or developing countries.
DSTs Reemerge
The OECD process gave legitimacy to DSTs, and when the alternative solution stalled, countries once again returned to the politically irresistible revenue source. France remains the most prominent example, with a 3 percent tax on digital advertising and platform revenue tied to French users. Lawmakers there have considered raising the rate to as high as 15 percent. Canada postponed implementation of its 3 percent DST several times as part of ongoing trade negotiations with the Trump administration.
The map below shows that implemented or proposed DSTs are present in most major European countries. They are also in effect in India, Nepal, Vietnam, and Colombia, among others. Despite the stalled Pillar One process, the threat of a broad US response via tariffs or the proposed Section 899 has likely deterred some governments from advancing their DSTs. Eventually, the dam will break.
Don’t Overreact to DSTs
DSTs create costly economic distortions by taxing revenue instead of net profits, and they unfairly target certain sectors and firm sizes that proxy for US-based technology firms. The OECD alternative, however, would do far more harm. As the economic burden of DSTs primarily falls on countries adopting the tax, US policymakers have little reason to pursue any economically costly response.
While the tax is assessed and remitted by large digital platforms, the economic incidence (i.e., who bears the true cost of the tax) is less straightforward. One view is that DSTs function as taxes on economic rents and therefore fall mostly on the owners of large multinational firms. Others have argued that DSTs behave more like “a de facto tariff” by singling out foreign digital services, which ultimately means higher prices for domestic consumers and suppliers.
Both theories are likely partially true, depending on market structure. Thus, the cost of the tax will be shared between domestic consumers and owners of the firms. However, the evidence increasingly suggests that domestic consumers bear the majority of the tax.
Digital companies have been remarkably transparent in how they handle these levies. Google lists jurisdiction-specific surcharges that closely correspond to DST rates. Amazon has increased seller fees in countries with a DST, and Apple has passed the taxes through to app prices and in-app purchases. Facebook has held off, seemingly as a measure of political goodwill to fend off other political attacks.
Academic research confirms these patterns. A recent investigation into Amazon’s response revealed that the company “passes the DST almost entirely onto sellers via increased fees” and that most sellers subsequently passed those higher fees directly to consumers. The investigation concluded that “DSTs largely fail to achieve their objective of taxing large digital firms.”
As an economic matter, governments shouldn’t create or increase DSTs. However, if France, Canada, or any other jurisdiction wants to raise taxes on its own citizens, that is a political choice. It does not make DSTs good policy, but neither does it justify retaliatory tariffs or forcing through new global tax systems that impose even greater compliance burdens on a much larger number of firms.
Seen in this light, the collapse of the OECD’s Pillar One is a good outcome for the United States, even if DSTs continue to proliferate. DSTs are bad, but many of the alternatives are worse. The right path forward is not to revive Pillar One but to let DSTs face the scrutiny of domestic politics. Countries that adopt them will eventually learn the costs, and the international system will remain more flexible and competitive as a result.