At the beginning of this year, after a long and drawn out legislative process involving a governor’s veto, Maryland became the first state to implement a tax on digital advertising. Yet even as the state remains mired in legal proceedings over its likely unconstitutionality, momentum is starting to build for more states to follow Maryland’s lead.
Digital taxes are taxes that are targeted specifically at digital goods and services, often subjecting them to taxes that their traditional counterparts do not face, or else face at lower rates. In Maryland’s case, the tax at issue is a four-tiered gross receipts tax on all revenue earned from digital advertising in the state, even though traditional advertising revenue is not taxable. The tax rate rises as high as ten percent, meaning that affected businesses deriving advertising revenue in Maryland with a profit margin below ten percent are better off packing up and leaving.
But aside from being ill-advised economically, Maryland’s tax is also harmful to interstate commerce. As the tax only starts to kick in on businesses making more than $100 million in global revenues, it is almost definitionally set to apply to businesses whose operations are predominantly out-of-state. In other words, Maryland is attempting to import tax revenues from out-of-state businesses at the expense of other states and businesses.
At its core, this is little different than Maryland imposing tariffs on other states’ businesses in order to glean some extra revenue. Though the Dormant Commerce Clause, which prohibits states from excessively burdening interstate commerce, has not been as strictly enforced as it could be of late, there can hardly be a more cut-and-dry case for why it exists than Maryland’s cynical effort to fatten its coffers.
Legal issues such as this are largely the reason that other states have declined to follow Maryland’s example. Though digital tax legislation has been introduced in several states, no bills have made it to a governor’s desk. One bill, in New York, was so shoddily wordsmithed that it would have applied to most businesses, not just “digital” ones.
That may soon change, however, as a more serious push for digital taxes takes shape. New Mexico is reportedly soon to publish new draft rules “clarifying” that the state’s version of their sales tax, the gross receipts tax, applies to digital advertising.
That’s less objectionable than what Maryland is doing for a few reasons. First, the tax already applies to traditional advertising, so the tax would not be discriminatory against digital services like Maryland’s is. Second, the tax applies to all businesses in New Mexico, not just above a high threshold intended to export the tax burden out-of-state. Third, the rate applied is not a punitive special rate but would be the same rate imposed on all other taxed goods and services.
But on the other hand, New Mexico is learning the wrong lesson from Maryland’s efforts. Though taxing traditional advertising as well as digital advertising avoids some legal issues, most states do not tax advertising at all, and for good reason. Advertising is generally a business-to-business (B2B) transaction, and most B2B transactions should not be taxable to avoid tax pyramiding. The good-policy solution for New Mexico is not to add digital advertising to its tax base, but to remove traditional advertising.
What’s more, New Mexico’s action creates renewed momentum for less discerning digital tax legislation to progress through states. The Multistate Tax Commission (MTC) is currently in the process of putting together a white paper that will likely play a large role in future digital tax legislation. Should the MTC fail to make clear that states must take care not to discriminate against digital goods and services with their tax policies, many will likely be tempted by the promise of added revenue.
Discriminatory tax obligations imposed on digital goods in the name of squeezing revenue out of a productive industry is a surefire way to prevent the benefits of innovation from flowing to regular Americans. As states prepare for a new digital tax push, they must be careful not to violate first principles of good tax policy.