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Digital Taxes Are Here to Stay, Regardless of Maryland Outcome

March 30, 2021, 8:00 AM

Maryland faces a difficult court battle over the legality of its digital advertising tax, the future of which hangs in the balance. But whatever the outcome in Maryland, other states have already been eyeing their own digital tax options, and the need to rebound from pandemic-related budget deficits has only accelerated the timeline.

States will be looking at Maryland as the fiscal canary and will undoubtedly adjust their proposals to avoid similar pitfalls. The question for businesses moving forward isn’t whether digital taxes will become a reality, but rather when and how.

While there aren’t concrete answers to either of those questions, past actions, including the rollout and implementation of Wayfair-related tax rules and European digital tax models, can shine a light on some possible moves ahead. However, before businesses can consider the path forward, it’s important to understand how we got here.

Maryland, Round Two

Maryland wasn’t the only state to have a digital tax bill on its legislative docket over the last couple of years.

New York, Nebraska, Kansas, and the District of Columbia all proposed some form of digital taxes in 2020. This year, Connecticut, Indiana, Oregon, and Washington already have unveiled similar proposals, some of which target revenue from social media advertising.

Maryland has been the only state to pass legislation, which has since been met by a federal lawsuit involving an influential collection of business and industry groups including the U.S. Chamber of Commerce, the Internet Association, the Computer and Communications Industry Association, and NetChoice. The coalition claims that the Maryland law is unconstitutional and does not conform with federal laws that prohibit state lawmakers from targeting online services for taxes.

Although many say the outcome of Maryland’s case will be a bellwether for other states, digital tax bills will continue to be proposed even if the Maryland law fails. In fact, states will likely rethink their nascent plans to avoid the same pitfalls.

Looking Toward a More Workable Model

Maryland’s digital ad tax model is fundamentally complex, confusing, and challenging to navigate. Consider the foundation of the law, that a tax is levied on ad sellers like Facebook, Google, or Amazon whenever a user in Maryland views one of their digital ads. While that seems straightforward, in the age of smartphones and connected devices everywhere, knowing exactly where the user viewed that ad could be difficult.

For example, someone traveling on public transportation from work in D.C. could click on a page and view an ad as they’re crossing the border into Maryland where they live. Or a user could navigate back and forth between pages or apps that display ads as they’re crossing from Maryland into its northern neighbor of Pennsylvania. The nexus becomes unclear, and compliance becomes next to impossible.

These challenges are similar to the problem the sales tax world faces as points of sale move closer to the consumer and out of brick and mortar stores, except pinpointing digital ad views is vastly more complex. It also mirrors the challenges around complying with post-Wayfair rules. It’s been nearly three years since that ruling, and some states are still grappling with a lack of uniformity of taxation, economic thresholds, and how to treat marketplace facilitators.

Digital taxes will be added to the cost of doing business moving forward, but that doesn’t have to be painful for organizations. There are a few steps states can take that would better balance the taxation burden, while still rightfully levying a reasonable tax on a booming industry.

  • Don’t Rush—States need to raise money to address budget shortfalls, and a good way to do that is to widen the tax base. In an ordinary funding gap situation, this would make sense, but several legal and economic factors should be causing states to slow down and think about the best way to draft and implement taxes in a space where they’ve never existed. Only as states move closer to post-pandemic recovery and eventually see regional growth will they be able to ascertain the best method to intervene without precipitating either fiscal or market failure, while increasing the transaction costs. By rushing to draft new digital tax laws, states could enact rules that discriminate against digital media, run afoul of the Permanent Internet Tax Freedom Act, and pose other constitutional problems. In addition, such laws can decelerate recovery in some sectors and create negative externalities and other market inefficiencies. It would be best to avoid those types of fiscal train wrecks.
  • Make digital taxation uniquely American—States should not be modeling their laws off those enacted in European countries like Austria and France. European Union countries share a collective tax base and common regulations within a single market. These are distinct governmental structures. U.S. states do not have that integrated luxury. Instead, states have to think about how a new tax will not only affect its residents, but also those in surrounding states that might have entirely different and competing regulations.
  • Learn lessons from Wayfair—While states are still trying to untangle the intricacies of Wayfair, the early stumbling blocks can provide guidance. Those who moved too quickly faced legal opposition and delayed any money they may have raised from the new taxes by not considering the fundamental ramifications of their particular model. State lawmakers are still trying to understand all the moving components that comprise Wayfair, including safe harbors, marketplace facilitator laws, and how individual jurisdictions within a state should draft local regulations.

We live in a digital age where physical boundaries have become fluid and, in some instances, somewhat irrelevant. As constantly connected consumers—whether that means ordering dinner on our way home from work, browsing for a new TV while in line at the grocery store, or looking up the lyrics to a song while riding into the city—our lives exist outside state and local boundaries.

States should be creating new taxes that address new consumer and technology worlds, but there needs to be a balance, especially in these tenuous times when the next few years could determine the economic futures of many of these states considering digital tax laws.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

George Salis is principal economist and tax policy advisor for Vertex, Inc. He is also an economist, lawyer, and tax professional with 25-plus years of experience in international taxation and trade compliance, tax planning and controversy, fiscal regulation, and tax economics consulting.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.

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