Back in the good old days when state lawmakers had little better to do than dream up new ways to raise taxes, digital tax proposals were quickly becoming a trend. But taxpayers across the country won a victory this week, as the most notable of these early efforts to tax digital services, Maryland’s Senate Bill 2, was just vetoed by Maryland Governor Larry Hogan. Governors from other states considering similar proposals, such as New York’s Andrew Cuomo, should follow the lead of Maryland’s governor, not its legislature.
Momentum for taxes specifically targeting digital firms built on the argument that digital firms are undertaxed with the current tax code. There’s little evidence to support these claims, however. One analysis of businesses in the European Union, where digital tax proposals first arose, found that digital businesses paid an average effective tax rate that was only 0.3 percent lower than traditional businesses.
Digital companies are seen as growing and profitable — or, in the eyes of tax bureaucrats, a potential revenue gold mine. But in their haste to grab at a revenue source, these tax bureaucrats set aside principles of good tax policy. Rather than being a means of rectifying a bias in the tax code, digital taxes create one.
Maryland’s S.B. 2 would impose a tax on revenue derived from digital advertising. Digital advertising taxes are a particularly ill-advised subset of digital taxes, as they are likely unconstitutional on top of being bad policy.
In 2016, President Obama signed the Permanent Internet Tax Freedom Act (PITFA) into law. Along with barring states from enacting taxes on internet access, PITFA prevents states from enacting taxes that discriminate against e-commerce. Because Maryland does not tax traditional advertising services, S.B. 2 represents a fairly clear violation of PITFA.
Other elements of the legislation wisely vetoed by Hogan mean that S.B. 2 likely would collapse under legal challenge even if it had progressed beyond the governor’s desk — S.B. 2 appears to violate not just federal law, but also the Constitution.
S.B. 2 is structured to include revenue thresholds that are high enough that a business only operating in the state of Maryland would be unlikely to reach them. That means that businesses affected by the tax would be predominantly national — or multinational — brands. But while it’s good to protect small businesses from being wrapped up in this tax scheme, it also means that the legislation is more likely to be considered an unconstitutional burden on interstate commerce.
The law may even run afoul of the First Amendment. The Supreme Court has repeatedly shown itself to be of the opinion that taxes that target the news media are violations of the First Amendment — and many newspapers today earn a substantial proportion of their revenue from advertising on their websites. Maryland’s Supreme Court has even ruled that advertising taxes specifically violate the First Amendment.
Given all these legal issues, if Governor Hogan’s veto is upheld it will save the hassle of getting courts to strike down S.B. 2 themselves. That’s why Maryland legislators would be wise to let the veto stand. But even if S.B. 2 was legally ironclad, it would still be poor policy to target electronic commerce simply because it is an available revenue source.
Governors facing similar proposals in their own state legislatures should take a cue from Hogan. The internet has delivered innumerable benefits to Americans over the years — and the pandemic has only reinforced how central it is to our society. Hindering its growth through targeted taxes is an idea that deserves a veto if there ever was one.
Andrew Wilford is a policy analyst with the National Taxpayers Union Foundation, a nonprofit dedicated to tax policy research and education at all levels of government.