It’s a seemingly rare case where the safeguards in the system worked as intended. After Maryland’s legislature passed into law a tax on digital advertising, it was quickly found to be unconstitutional for multiple reasons. A tax that was constitutionally and legally dubious on top of being bad policy met its end in the courts, so all is right with the world…right?
Wrong. Nine other states have already introduced proposals for their own digital advertising taxes, clearly not dissuaded by Maryland’s failure. What should have been taken as a stern judicial rebuke instead seems to have had no effect on states eager to grab at revenue from what is perceived to be a lucrative industry.
Maryland first passed its digital advertising tax into law in 2020, overriding Governor Larry Hogan’s (R-MD) veto in early 2021. The law, which went into effect in the beginning of 2022, established a graduated tax on the digital advertising receipts of businesses with over $100 million in revenues, no matter whether that revenue was earned in the state of Maryland or elsewhere.
This proposal created all kinds of overlapping legal and policy issues. To begin with, Maryland has no tax on traditional advertising, meaning that its digital advertising tax would make an arbitrary distinction between how a business advertises for tax purposes. Not only is this bad policy, the federal Internet Tax Freedom Act (ITFA) prohibits states from imposing discriminatory taxes on digital goods and services that their traditional counterparts do not face — a prohibition that Maryland’s law rather clearly violates.
It should be noted also that there’s good reason that most states don’t tax advertising to begin with. Advertising is a business-to-business transaction, whereas good tax policy principles suggest that only a final transaction with the end consumer should be subject to sales tax. Taxing intermediate transactions creates what is known as “tax pyramiding,” or the layering of taxes upon taxes — obscuring tax burdens and forcing taxpayers to pay taxes on the value of taxes paid earlier on in the supply chain.
Even setting ITFA aside, however, Maryland’s tax remained on shaky legal footing. While courts have not enforced the Constitution’s prohibitions against states placing undue burdens upon interstate commerce as strictly as they should, Maryland’s tax is deliberately structured to import tax revenues from businesses with most of their operations outside the state of Maryland. Always a tempting tactic for states, this is explicitly prohibited by the Constitution because of how it harms the broader American economy.
The tax even manages to violate the First Amendment. Courts have consistently found that taxes that specifically target revenue sources of news publications are unconstitutional. A tax on digital advertising does just that.
So why are other states seeking to copy Maryland’s failures? Most hope that they can get by with laws that are slightly less awful than Maryland’s. New Mexico, for example, does already tax traditional advertising — avoiding an ITFA challenge even if taxing any type of advertising remains bad policy. Others may hope that a different tax structure that doesn’t place the tax burden quite so obviously upon out-of-state businesses can avoid Commerce Clause problems.
But the broader point here is that states are asking how they can sneak a digital advertising tax past the courts without bothering to wonder whether or not they should. That’s a big problem for taxpayers, who risk seeing the most innovative sector of the American economy stifled by a bad idea imported from Europe.