Menu
Tax Notes logo

The Economics of Ladies’ Night Sheds Light on Red-Hot Digital Tax Dispute

Posted on Feb. 4, 2020

 “If you hear any noise, it ain't the boys

It's Ladies' Night, uh-huh.”

— "Ladies’ Night,” Kool and the Gang (1979)

In the Ron Howard film A Beautiful Mind, Russell Crowe plays troubled math genius John Nash. In one famous scene, Nash and his male friends are in a bar when in walks a group of women, one of whom is more eye-catching than her companions. In a thunderbolt of insight, Nash realizes that if all members of his crew compete for the most attractive woman, it's likely none will succeed in their quest for female companionship. On the other hand, if they cooperate and spread their charms more evenly among the ladies, success is more likely. Cooperation beats competition. Adam Smith is dethroned. Nash wins the Nobel Memorial Prize in economics in 1994. A Beautiful Mind wins best picture for 2001. 

It turns out the facilitation of female-male interaction in a location conducive to inebriation provides insight into another phenomenon on the frontier of economic science. Your hard-working economist hasn't made “the scene” since the Reagan administration, but the internet tells him that the seemingly outdated phenomenon of ladies’ nights is still in vogue in many establishments serving alcoholic beverages throughout America. Perhaps you knew that. But what you probably didn't know is that this business practice is an example of what is now understood as a “two-sided business model” that figures so prominently in this increasingly digitalized economy.

If it’s ladies’ night, a bar will provide free or low-cost admission and beverages to women. Men pay full freight. Instead of setting one nondiscriminatory price, the establishment can maximize profits by skillfully setting two prices (one of which can be zero). For example, the profit-maximizing price for drinks might be $10 for men and $0 for women. This might bring in a crowd of 50 men and 50 women ($500 of revenue). That would be superior from a financial point of view to, for example, the business charging $5 to all patrons when only 70 men and no women show ($350 of revenue).

At ladies’ night, men in effect subsidize women through the platform provided by the establishment. Note that the female clientele is the key to increasing profit, but the ladies make no payments. On the business's books, the profits attributable to female participation are “hidden” because all that is seen are the losses from the cost of free drinks.

Now let’s move from the local pub to activities of some of the world’s largest multinationals. Like a pub with ladies’ night, Google, Facebook, Amazon, and dozens of other fast-growing businesses are two-sided business. On one side, users are provided a service for which they are charged nothing. That’s because their presence increases the ability of the service provider to sell other services to other customers.

For example, an online search engine may sell advertising targeted at French users of the digital service to a German auto manufacturer. If we don’t take into account that the service provider is a two-sided business, all we can see from a financial point of view is that revenue is generated by sales to Germany. After the huge upfront cost of developing the search engine, the cost of providing services to French users is close to zero. And the French users pay nothing for the service. On the financial accounts, French users are invisible.

But as pointed out so cleverly by professor Wei Cui of the Peter A. Allard School of Law at the University of British Columbia, French users are integral and unique to the service provider generating profit from advertising in France. Just as governments impose royalties for extraction of natural resources inside their borders, it's fitting for France to impose tax on profit from advertising paid for by a German manufacturer. Like profits from mining, profits arising from French use of a search engine are what can be called “location-specific economic rent.” The taxation of such economic rent is, from an economic perspective, the cat’s meow. That is, such a tax is economically efficient because it doesn't distort market behavior. But unlike profits attributable to mining, profits attributable to our French users are hidden. At least they were hidden until Cui brought them into focus.

This insight could have big implications for the hot (but temporarily halted) tax-tariff dispute between the United States and France. France wants to impose tax on some revenue generated by large U.S. companies providing digital services in France. The Trump administration calls this tax discriminatory and unprincipled. In retaliation, the United States is threatening to impose tariffs on imported French cheese, wine, and other goods. The U.S. trade representative says the tax is “inconsistent with international tax principles.”

That may well be true. But the international tax principles the U.S. trade representative is talking about were developed a century ago for multinational businesses producing physical goods. Cui has provided a new rationale for multinational digital business taxation. The economic case is compelling.

Unfortunately — that is, unfortunately from an academic perspective — nobody should expect wide acceptance of Cui’s ideas anytime soon. Powerful U.S. businesses and politicians of both parties hate digital services taxes. As time marches on, the business practice of offering ladies’ night may fade into obscurity, but the digitalization of the world economy will only grow. And with it so will the need to find truly principled solutions to the tangled mess that the global tax ecosystem is becoming.

Copy RID