Taxing cross border digital transmissions may not be acceptable to MSMEs

IBT: There has been a concern by some experts that the moratorium on customs duties for cross border digital transmissions leads to the growth of digital monopolies, thereby impacting trade competitiveness of such companies or startups in developing nations. Furthermore, it also deprives governments of these nations of much needed tax revenues. Please provide us with some background on this moratorium on customs duties and its significance in shaping global trade policies, as you have discussed in your research paper.

Dr Badri Narayanan Gopalakrishnan: In the late 1990s, there was a detailed deliberation in the WTO about digital transmissions, digital trade, e-commerce, etc. In those days, digital trade and transmissions were not that big a deal. It was relatively easy to get the entire WTO membership to come to a consensus in the spirit of promoting free trade, fostering policy certainty & stability across the world, and also to maintain status quo.

The consensus was that no WTO member can impose custom duties on digital or electronic transmissions. After that, there has been some debate, particularly around a decade after the moratorium was first concluded, based on some of the arguments you just mentioned.

When you say that you cannot impose certain custom duties, then it deprives countries of the ability to raise revenues. Secondly, there is the challenge of digital monopolies, and thirdly, a lot of trade in goods is getting converted into digitized trade in services and so on.

Many of these concerns have been raised by some of the developing countries, including India. But there has been a dearth of very in-depth economic research in this area. Keeping this in mind, we did this particular research project.

“When you implement taxes at the transactional level, it also encourages misreporting. One good example is watching Netflix. If there is a tax on digital transmissions and if you use using VPN, you can actually use Netflix India sitting in the US, and then you can avoid all those taxes. There can be a lot of difficulties in terms of practical implementation.”

We had done similar kind of analytics a few years ago, in which we looked at the potential impact of raising taxes on digital transmissions on various economies. Our central finding was that when you are increasing these tariffs and even ignoring costs of compliance and implementation, they can really increase the costs of goods and services and reduce demand, which would in effect defeat the purpose of raising revenue. How can you raise revenue when your base shrinks?

OECD came up with a report last October, where they suggested that there are many other channels to raise revenue – through blanket taxes, which target both imports and domestic demand. And you always have income taxes that you can impose on digital transmissions.

But when you implement taxes at the transactional level, it also encourages misreporting. One good example is watching Netflix. If there is a tax on digital transmissions and if you use using VPN, you can actually use Netflix India sitting in the US, and then you can avoid all those taxes. There can be a lot of difficulties in terms of practical implementation.

One country that has recently tried to begin some kind of compliance procedures is Indonesia, and they’re already facing a lot of difficulties, both in terms of administration and in terms of backlash from the industry.

IBT: So your research paper highlights India’s impressive growth in cross border sales of digitally delivered services. Can you discuss the specific trends and sectors which are contributing to this growth from smaller Indian firms? How are they benefiting from this?

Dr Badri Narayanan Gopalakrishnan: We looked into this issue of the impact of cross border digital transmissions on MSMEs through the lens of their economic value added, employment and labour productivity. We did a very detailed survey from NSSO’s official national statistics and also used the IO table, input output table, to compute digital transmissions.

The channels through which cross border digital transmissions can help these variables in MSMEs are manifold. The first is through greater efficiency, because many of the commonly used apps like Facebook and Google have servers outside India. But there are also very specific apps involved with lot of cross border digital transmissions.

You can clearly see that over time, these MSMEs are becoming more productive because of the use of these digital transmissions, particularly cross border ones. These can particularly be more helpful because if an MSME is going to use a cross border digital transmission, it is really cost saving and efficiency enhancing for them. And that in turn is also leading to competition domestically. And there are domestic customized apps coming up, which can compete with these cross border apps. So MSMEs are able to increase their productivity, value added and employment.

Here there is one important feature which is kind of an answer to the dilemma faced by policymakers. Generally when productivity and activity increases, there are high chances that employment can fall. Here is a situation where we see both labour productivity and employment are increasing. So I think that is noteworthy finding that we have.

During the COVID-19 crisis, we had lot of small restaurants and shops. They were able to thrive or even survive because of digital technologies, many of which involved cross border digital transmissions. So they have helped MSMEs to survive.

IBT: You have also discussed significant growth in India’s share of global estimated digital trade. Could you elaborate on how its performance compares to other OECD member states?

Dr Badri Narayanan Gopalakrishnan: There are three different angles in which I would think about India’s rise as a digital player, which is far ahead of other countries. The first thing is that India has established its role as a global leader in IT services with companies like Infosys, TCS, Wipro, etc. The second aspect is the new age unicorns, startups focused on developing digital products rather than digital consulting services that used to be the forte of IT giants. Here, I mean companies like Swiggy, Zomato, etc.

And the third is what I might call democratization of digital services. How many of these digital services reached rural areas and vulnerable sections of the population, which in turn led to huge increase in the use of digital transactions?

Definitely, India is far ahead of many other countries, particularly in terms of digital transactions. On the other two aspects as well, it is a major player.

In our study we only focus on the cross border digital transmissions that are imports coming into India, because we particularly wanted to see their impact on the domestic MSMEs. However, what we have not looked into the study is the role of India’s digital or IT exports. And there also MSMEs are involved. Many times you have vendors for these large IT companies, as small companies. And if you look at the electronic components and products ecosystem, which is closely related to the digital transmissions ecosystem, you see a lot of MSMEs contributing.

“India has established its role as a global leader in IT services with companies like Infosys, TCS, Wipro, etc. The second aspect is the new age unicorns, startups focused on developing digital products rather than digital consulting services that used to be the forte of IT giants. Here, I mean companies like Swiggy, Zomato, etc.”

So with all these different aspects in terms of exports, domestic production, expansion of unicorns, and consumption, that is digital transactions, India is far ahead of many other countries, including developed OECD countries.

IBT: My next question is regarding your assertion in the study that there is a positive correlation between digitally delivered imports and the gross value added of MSMEs. So what have you specifically found out from your study on this aspect?

Dr Badri Narayanan Gopalakrishnan: Yes, before we get into the detailed economic analysis, we wanted to look at various correlation matrices. We wanted to see to what extent the cross border digital transmissions, basically digital services imports, are correlated with MSMEs’ value added, employment, productivity and so on. So we found a very strong positive correlation in all of them. Correlation analysis is kind of the first step going into the detailed econometric analysis. And of course, just because there is correlation, we cannot say that cross border digital transmissions are the only reason why GVA is increasing, or labor productivity is increasing and so on. But we can definitely say that they are positively correlated.

Now, that led us to the detailed economic analysis, which I can explain later, because we want to capture the simultaneity, like how different variables affect each other. And there we can net out the effects of these cross-border digital transmissions on MSME variables.

IBT: Finally, your research paper also mentions insights from various stakeholders in the ecosystem. So what was the perspectives of this issue that they shared with you on the possible impact of the implementation of tariffs or taxes or digital transmissions?

Dr Badri Narayanan Gopalakrishnan: We were astonished to see that many of these MSMEs – mom and pop stores, petty shops, etc, they were not even aware of this whole debate going on, for obvious reasons. There has not been enough stakeholder discussion done to take a position in this regard. So I think that is very important for us. So we have to consult.

So we had to educate them and tell them about the discussion happening in the WTO. They said that they’re not much bothered or aware of it. But they made one point clear – anything that can increase the cost of production in these MSMEs can be catastrophic for them, because they are running on very low margins. So if the aim of these digital taxes are to raise revenues, that, in my opinion, cannot be at the cost of these MSMEs who are in a very delicate position.

We also see that MSMEs have been declining over time. Their output, employment, productivity, everything has been declining over time with a small increase recently. So digital transmissions have, in a way, been a saving grace for them.

Then when we spoke to some of the government stakeholders. They felt the need for some policy space for domestic digital players, but this cannot happen at the cost of the MSMEs. We need to proactively help domestic digital companies to develop, but that cannot be done through tariffs because implementation costs are very high. How are we going to track and classify something as digital transmission and then tax it and so on? So it’s going to be very difficult.

And we also spoke to some industry associations which also kind of echoed the opinions of the MSMEs. So in general, they are apathetic, but if anything is going to increase their cost, they won’t support it. There are a lot of opportunities for MSMEs to become global using digital transmissions and they would like to avail these technologies without a hit on their margins. So these are some major points that emerged out of our discussion with various stakeholders.

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Dr. Badri Narayanan Gopalakrishnan is Fellow and Former Head, Trade, Commerce and Strategic Economic Dialogue, NITI Aayog, Government of India. He is an economist, data scientist and interdisciplinary researcher with over two decades of experience in academic, government, corporate and startup settings, based in Seattle USA, with travels across the world.

Besides, he is also a former diplomat, management consultant, policy advisor, published author of 10 books and 250+ research papers, articles and Opeds in leading journals, magazines and newspapers, with thousands of citations and media coverage. He has also served as a senior advisor and consultant to many governments like Saudi Arabia, UAE, Cyprus, EU, USA, Canada, UK, Mongolia, etc., and international organizations like World Bank, UN, WHO, FAO etc.

Dr Gopalakrishnan has worked with many leading academic organizations in a full time or affiliate faculty roles – such as Purdue, University of Washington Seattle, Oregon State University, Boston College, while also visiting many other universities like Harvard, MIT, University of British Columbia, LSE, IITs, IIMs etc., as a speaker or research collaborator. 

He has established a new global analytics consulting firm Infisum with offices and clients across the world. Views expressed are personal.