2017 Was Bad for Facebook. 2018 Will Be Worse.- Bloomberg

2017 Was Bad for Facebook. 2018 Will Be Worse.

The tech giant's carefree years of unregulated, untaxed growth are coming to an end.

By Leonid Bershidsky

December 14, 2017, 6:00 PM GMT+11

Facebook is projected to boost sales by 46 percent and double net income, but make no mistake: It had a terrible year. Despite its financial performance, the social media giant is facing a reckoning in 2018 as regulators close in on several fronts.

The main issue cuts to the core of the company itself: Rather than "building global community," as founder Mark Zuckerberg sees Facebook's mission, it is "ripping apart the social fabric." Those are the words of Chamath Palihapitiya, the company's former vice president of user growth. He doesn't allow his kids to use Facebook because he doesn't want them to become slaves to "short-term, dopamine-driven feedback loops."

Palihapitya's criticism echoes that of Facebook's first president, Sean Parker: "It literally changes your relationship with society, with each other ... God only knows what it's doing to our children's brains."

Facebook has reacted nervously to Palihapitya's accusations, saying he hadn't worked at the company for a long time (he left in 2011) and wasn't aware of Facebook's recent initiatives. But I can't see any practical manifestations of these efforts as a user who has drastically cut back on social networking this year for the very reasons cited by Parker and Palihapitya.

To outsiders and regulators, Facebook looks like a dangerous provider of instant gratification in a space suddenly vital to the health of society. It's also making abuse and aggression too easy -- something the U.K. Committee on Standards in Public Life pointed out in a report published on Wednesday. Sounding one of the loudest alarm bells on social media yet, the panel urged the prime minister to back legislation to “shift the balance of liability for illegal content to the social media companies."

While Facebook remains the biggest platform, Google and Twitter are facing similar pressure from governments in the U.S. and in Europe. Germany enacted a law requiring the social networks to remove hate speech promptly or face fines. In the U.S., the activities of a Russian troll farm during the 2016 election campaign prompted scrutiny of Facebook's ad selling practices and a (rather ham-handed) legislative attempt to force some transparency.

Taxation is another area that regulators, especially in Europe, are targeting. Facebook, like Google, books almost all its non-U.S. revenue in Ireland with its low corporate tax rate -- and pays most of it to a tax haven for the use of intellectual property rights. The practice resulted in a 10.1 percent effective tax rate for Facebook in the third quarter of 2017.

This year, the top European economies, led by France, Germany, Italy and Spain, called for a turnover tax on the U.S. tech companies to compensate for their tax avoidance. This angry move failed to get enough traction on the European Union level thanks to Ireland and other nations that fear the economic fallout. But individual nations are taking action -- Italy's ruling party backed a plan to withhold 6 percent of any digital advertising purchase in the country.

On Tuesday, Facebook announced that it will start booking revenue from large ad sales in the countries they occur, not Ireland. But when Facebook and Google tested this approach in the U.K., it didn't result in a significantly higher tax bill, according to Irish economist Seamus Coffey. Last year, Facebook U.K. paid 2.6 million pounds ($3.5 million) in taxes while booking 842 million pounds in revenue. Regardless of where the company books sales, it still has to pay for the intellectual property rights held far from European shores, likely in the Cayman Islands. Coffey doubts that the new scheme will significantly change Facebook's overall tax bill. Instead, it will create insultingly small revenue streams to more countries.

Facebook’s also trying to pre-empt concerns about problematic advertising and offensive content by hiring 1,000 reviewers. But even if Facebook hired in 100,000 people, they'd have trouble policing the sea of effectively anonymous content produced by 2 billion users, an unknown number of which are bots and paid trolls. The obvious solution is to enforce Facebook's user policy (which says people can only post under their real names) and hold them responsible for what they publish. But that would cause Facebook's user base to shrink, which would alarm investors.

A third line of attack is likely to become important soon, perhaps as soon as next year. Former Facebook executive (yes, another dissident insider) Antonio Garcia-Martinez argued earlier this year that Facebook's ad targeting based on data collected from users is essentially unethical (and also that Facebook oversells its targeting ability). This resonates with politicians -- who worry about the social networks' voter manipulation potential -- and privacy advocates. Even if new legislative curbs on data gathering and ad targeting don't arrive soon, standards may start shifting thanks to the efforts of people such as Brendan Eich, the creator of Javascript and the Firefox browser. Eich's latest start-up produces a browser that effectively blocks all ads -- and that will next year offer an entirely new advertising model built on revenue sharing with consenting users.

The social networks' carefree years of unregulated, untaxed growth are coming to an end. Facebook will probably remain a major force in the attention market, especially given its foothold in the messenger app market and the popularity of Instagram with young people. It may keep rowing against the tide and offering meaningless concessions, but that's not an endless path. Eventually -- likely soon -- it'll have to submit to rules and popular attitude changes that will cut its ambition down to size and perhaps force it to rethink its business model.