Digital Ad Tax Isn’t How Washington Should Modernize State Code

In an ill-fated effort to “modernize” its tax code, Washington state expanded its sales tax to include digital advertising, among other services. Modernizing sales tax is a noble goal, but not at the expense of hurting state businesses and violating fundamental principles of sound sales tax policy.

It’s too late in the day for the tax to be vetoed, since it took effect Oct. 1, but the state should still reverse course and repeal this folly.

Gov. Bob Ferguson (D) shouldn’t have signed the bill on May 20. Regardless of the legislature’s intent, its timing couldn’t have been worse. Just two months after the bill became law, the Maryland Tax Court hosted a week-long trial in July overseeing the challenge of the state’s tax on digital advertising.

That trial focused on whether Maryland’s tax violates the Internet Tax Freedom Act, or ITFA. (It does.) In August, a federal appeals court ruled that Maryland’s tax is an unconstitutional restriction on free speech. Washington has hitched its wagon to the wrong horse.

The ITFA preempts conflicting state laws and prohibits discriminatory taxes on interstate commerce. Like Maryland, Washington taxes all forms of digital advertising while exempting almost all non-digital advertising conducted offline—a clear ITFA violation. A subsidiary of Comcast Corp. sued in September, asserting that Washington’s law unconstitutionally violates ITFA.

Even if ITFA didn’t exist, the expansion of Washington’s sales tax is still ill-conceived. No other state levies a sales tax on advertising, and only two other states (besides Maryland) tax the purchase of advertising: Hawaii and New Mexico.

Those states’ taxes on advertising are pursuant to a broad-based gross receipts tax that sometimes acts like a sales tax—and both states’ laws pale in comparison to Washington in terms of the size and scope of their states’ gross domestic product and industrial base.

Florida, which is more on par with Washington, tried a sales tax on advertising nearly four decades ago, but abandoned the effort after six months. Washington is illustrating the adage that those who can’t learn from history are doomed to repeat it.

So what are the problems with a sales tax on advertising? Consider the sales tax sourcing rules. A business may be subject to the tax if it sells or purchases advertising in the state of Washington. It means Washington businesses could be subject to a maximum 10% sales tax on the entire amount of advertising sold or purchased in Washington. That provides a large incentive for businesses to buy or sell their advertising in another state without a similar tax.

It would be easy enough for a Washington business to go move to a state that doesn’t impose any sales taxes, or one that at least doesn’t impose a sales tax on advertising. California and Oregon, which have no advertising taxes, could be the unintended beneficiaries of Washington businesses.

Washington, of course, attempts to protect against that risk by applying its use tax. But it’s one thing to implement a use tax on tangible property, whose movement can be tracked through shipping documents and other paper trails. It is quite another thing when dealing with advertising—specifically digital advertising.

For example, how would a use tax be applied to digital advertising, which pops up momentarily on a website, on a streaming platform, or on social media platforms such as Instagram, and TikTok? Because advertising can be purchased or sold free of sales tax outside of Washington, the state will have to aggressively impose its use tax if it wishes to actually collect any tax and protect its local businesses.

Florida couldn’t figure out how much of an ad purchased in Georgia but shown over Florida airwaves for 30 seconds should be subject to its use tax. Those were simpler times, and yet the difficulty of levying a use tax helped lead to a repeal. Washington’s statute has no solution to this conundrum, either.

A final problem is that this new tax violates the fundamental principle that a sales tax shouldn’t be applied to business inputs—those that are purchased as part of the chain of production and distribution on the way to producing income and sales to the end user. Without that exemption, the tax will cascade through the production and distribution network, resulting in multiple—and invisible—sources of taxation.

If business inputs were taxed, the sales tax on the purchase of shoes by a store, for example, would enter into the price of the shoes when sold to a customer. That tax would then be taxed again, when the shoes are taxed on the sale to the customer.

If the store were now required to pay tax on the purchase of its advertising, which brings customers to its store or website, another level of tax would get collected. That tax also would enter into the price of the shoes and be taxed again at the time of sale.

Consumers are aware of the tax on their purchase because it’s visible on their receipts. But the first tax on the purchase of inventory, and the second tax on the purchase of the advertising, would be buried in the price of the shoes. Those stealth taxes hide the true cost of government from voters, which makes them anti-democratic.

Washington’s state sales tax does have provisions to guard against this cascading. An exemption exists for inventory purchased for resale like the shoes; for items that become an ingredient or component of other items, such as the lumber that ends up as furniture; and for items that are used in manufacturing. But none of these would necessarily apply to the purchase of advertising.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Richard D. Pomp is a professor at University of Connecticut Law School and member of the American College of Tax Counsel.

Nikki Dobay contributed research assistance to this article.

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