As soon as Maryland legislators proposed an advertising tax that targeted out-of-state digital businesses, they were warned that their tax scheme was almost certainly unconstitutional. They went ahead with the tax anyway, even overriding Governor Larry Hogan’s veto to do so. And now, just months after going into effect, a Maryland judge has done what legislators were warned would happen.
Even before the legal issues, there are plenty of reasons why Maryland’s digital advertising tax should never have made it through the legislative process. Maryland’s digital advertising is structured as a gross receipts tax, meaning that it would apply to all digital advertising revenue from Maryland sources, not just profits.
This means that at the top bracket, businesses selling advertising services in Maryland would need a profit margin of at least 10 percent just to break even. Gross receipts taxes are a suboptimal means of raising revenue, as they arbitrarily punish low-margin businesses over high-margin businesses, but most have rates of fractions of a percent — not up to 10 percent.
On top of that, the tax was intentionally structured to fall primarily on out-of-state businesses. The brackets that a business pays are determined not by their Maryland-sourced digital advertising revenue, but by their worldwide revenue from digital advertising, with the first bracket starting at $100 million. In other words, it would be nearly impossible for a business operating entirely inside Maryland to be affected by the tax. The tax would fall almost entirely on businesses located out-of-state.
This is one reason why Anne Arundel County Circuit Court Judge Alison Asti found the Maryland tax to be unconstitutional. By targeting out-of-state businesses, Maryland was in effect exporting tax burdens to businesses in other states. This is a textbook violation of the Commerce Clause of the Constitution, which prohibits states from imposing undue burdens on interstate commerce.
Another reason Judge Asti decided as she did was the federal Permanent Internet Tax Freedom Act (PITFA), which prohibits states from imposing taxes on digital goods and services that do not apply to their traditional counterparts. Maryland does not tax traditional advertising services (rightly, as advertising is generally an intermediate, business-to-business activity), so a tax that applies exclusively to digital advertising services is a clear violation of PITFA.
Lastly, Judge Asti determined that Maryland’s tax violates the First Amendment. Courts both within Maryland and at the federal level have consistently ruled that taxes that target the news media violate the First Amendment. In this case, digital advertising is a key source of revenue for online media outlets, a revenue source that would be threatened by the tax. Judge Asti therefore determined that the tax violates the First Amendment.
States considering their own digital advertising taxes had been watching the fate of Maryland’s legal battles to determine whether to move forward on similar discriminatory taxes. Hopefully, states will take this as a sharp rebuke against following in Maryland’s wake.
State legislators should view the digitization of the economy not as an opportunity to grab at new sources of revenue, but merely as new expressions of traditional goods and services. States should not require judicial oversight to treat digital goods and services the same as they would treat their traditional counterparts. But as long as they are considering it, taxpayers can celebrate states taking one on the chin for stepping well outside the bounds of fair tax policy.