Taxing Digital Advertising Is a Bad Idea...So Is Taxing Traditional Advertising

Taxing Digital Advertising Is a Bad Idea...So Is Taxing Traditional Advertising
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Sometimes, all it takes to open the floodgates for bad tax policies is a small budget hole, and the deficits that many states and localities are facing are far from tiny. Unfortunately, the progress of a recent proposal by the Chairman of the D.C. City Council to tax advertising in response to recession and pandemic-induced budget pressure has illustrated this phenomenon.

D.C. Mayor Muriel Bowser, recognizing the danger of imposing new taxes to plug budget holes in the middle of a recession, has pushed to make up any shortfalls through freezing city employee pay and hiring, and relying on relief and rainy-day funds.

Yet Council Chairman Phil Mendelson has other ideas. On top of pushing to raise the gas tax, Mendelson has proposed a new 3 percent tax on all forms of advertising — a proposal that made it through a preliminary budget vote on Tuesday.

I’ve written in the past about why proposals to tax digital advertising (such as neighboring Maryland passed) are bad, and one of the main reasons I cited is that they are usually discriminatory, asmost states do not tax traditional advertising. But taxing all advertising is no better an approach, as there are good reasons why most states exempt advertising from tax.

The main reason why taxing advertising is problematic is because advertising is a business input. Good sales tax policy seeks to tax only the sale of the final product, not the intermediate transactions along the way to the final sale. Failure to restrict a sales tax to the final sale creates tax pyramiding, or taxing of a tax.

Put another way, consider a simplified scenario in which a business sells bicycles, and buys raw materials in order to produce those bikes. If that business had to pay a sales tax on the purchase of the raw materials, the business would make up the increased cost of acquiring raw materials created by the tax by passing on the tax to the consumer in the form of a higher price to buy the bicycle.

Because the consumer would be liable for sales tax on the purchase of the bicycle, he would face a pyramided tax. The sales tax liability the consumer is responsible for in order to buy the bicycle is that much higher because it includes the sales tax the business paid on the bicycle’s raw materials. The consumer is, in effect, paying sales tax on sales tax.

Advertising is no different. Businesses do not purchase advertising services as a final transaction, as it is a step along the way to getting more consumers to buy their products or services. Taxing those advertising transactions would have the same effect as taxing the bicycle company in the above example — the increased cost of business inputs would raise the price of products sold by businesses using advertising services, resulting in consumers paying sales tax on advertising taxes.

And though they avoid the ire of the federal government's prohibition on taxes that discriminate against digital commerce, taxes on advertising still face other legal challenges. Because many news media outlets derive a great deal of their revenues from advertising, courts have ruled in the past that advertising taxes represent violations of the First Amendment’s protections of freedom of speech and the press.

Digital taxes remain a trendy bad tax policy proposal in the United States and abroad, but Chairman Mendelson’s proposal is a reminder that plenty of more mundane bad ideas do not need the sexiness of the internet to gain traction. D.C. should heed these warning signs and solve its budget problems without resorting to dangerous tax hikes.

Andrew Wilford is a policy analyst with the National Taxpayers Union Foundation, a nonprofit dedicated to tax policy research and education at all levels of government. 

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