In the beginning of 2022, after a delay and an overridden governor’s veto, Maryland’s first-in-the-nation tax targeting digital advertising went into effect. Due to the law’s myriad legal and constitutional failings, it didn’t even take a year before the law was struck down in a lower Maryland court. But now, Maryland’s lawyers have managed to delay the inevitable by getting the Maryland Supreme Court to reverse the lower court’s decision on purely procedural grounds.
The Maryland law in question imposed a graduated gross receipts tax on receipts from digital advertising from businesses that exceeded $100 million in total global revenues. The gross receipts tax rate could rise as high as 10 percent in the highest bracket. Because the tax is structured as a gross receipts tax, this means that businesses deriving digital advertising revenues would have to exceed a profit margin of 10 percent just to break even at this highest bracket.
Taxing gross receipts is always a bad way to tax businesses or sales, as it makes no allowance for different businesses’ profit margins. But Maryland wasn’t content to make just one tax policy faux pas, as taxing advertising is also a bad way to raise revenue.
Tax policy should always strive to tax only the final transaction, not intermediate business-to-business (B2B) transactions. That’s because taxing B2B transactions generally leads to tax pyramiding, or the levying of taxes upon taxes assessed earlier in the supply chain. In other words, taxes on B2B sales earlier in the supply chain get baked into the price the final customer pays — resulting in that customer paying more in taxes. Advertising is one such intermediate transaction.
Subsequent amendments tried to solve this problem by forbidding businesses subjected to the tax from passing the costs onto customers — a prohibition that attempts to override fundamental laws of supply and demand in the bluntest and most useless way possible.
But aside from the terrible policymaking reasoning that went into the formation of this tax, it faced some serious legal and constitutional shortcomings. First and foremost, the law appears to be a rather blatant violation of the Internet Tax Freedom Act (ITFA).
ITFA prohibits states from passing laws that discriminate against digital commerce, such as by subjecting the digital equivalents of traditional goods and services to higher tax rates. It’s hard to imagine a more cut-and-dry example of this than Maryland’s digital advertising tax — Maryland does not tax traditional forms of advertising, such as billboards, at all. Of course, it would not be better tax policy for Maryland to tax traditional advertising as well, but it would at least not arbitrarily discriminate against digital commerce.
But while this violates federal law, another aspect of Maryland’s tax violates the Constitution. Maryland very deliberately structured the tax to fall upon out-of-state businesses — the emphasis on global, rather than Maryland-based, digital advertising revenues ensures that local businesses will not face the tax. That sort of “tax exporting” violates the Commerce Clause.
In overturning a lower court’s decision striking down the tax, Maryland’s Supreme Court considered none of the merits of these arguments. Instead, the decision hinged entirely upon whether or not plaintiffs exhausted “administrative remedies” before taking the case to court. Leave it to the lawyers to reinstate a legally and constitutionally dubious law just because those affected by it didn’t spend enough time arguing with state bureaucrats.
Though in practice this decision is likely to accomplish little but a delay to the law eventually being struck down again, it may embolden other states considering similar taxes. That would be an entirely incorrect takeaway from a decision that had nothing to do with the merits of the case.
States considering digital advertising taxes should not need judges to tell them that discriminating against digital commerce is the wrong way forward. Digital commerce should be a reason for tax policy to evolve, not an excuse for taxes to expand.
