Maryland law recently overruled a gubernatorial veto and passed a new tax on digital advertising – the first of its kind in the state. It was inevitable that someone would break the ice. Last August, I investigated the impact of a federal tax on interstate digital commerce on states and municipalities. Globally, the COVID-19 pandemic has accelerated business migration to internet platforms, making this the new frontier for tax policy.
Maryland lawmakers deserve credit for planting their semi-checkered state flag first to help make their claim, but they're still far from the finish line. Anti-tax wonks indicate a variety of potential legal flaws that could bind the Maryland tax for some time. They complain that it is inappropriately vague and imprecise and invites double taxation. The social media Goliaths are already protesting the unconstitutionality under the trade clause, which gives Congress the highest authority to regulate international transactions. To save its tax, Maryland may find it necessary to make reasonable changes that stand up to judicial scrutiny. But instead of doing it on its own, the state could use help from its peers who are keeping an eye on their own digital advertising taxes.
States were rightly called laboratories of democracy. However, when it comes to national and international business activities that go beyond state borders through complex multi-party transactions, let's be honest: heterogeneity and administrative complexity are not desirable results. Fifty separate laboratories tinkering with different tax formulas will drive companies crazy.
The elephant in the room now is whether a patchwork of disparate state tax laws and competing enforcement measures makes good business sense even if they are on trial. Imagine a future where every state allows inexperienced lawmakers who turn to local lobbyists to create a mess of rival, untested, idiosyncratic digital tax rules. This is a dream for litigation attorneys and CPA firms, but a nightmare for advertisers' compliance departments. Such a lack of uniformity invites Congress to ultimately trump state rights with a national tax, ostensibly to reduce complexity and friction.
With the global race to tax multinational activities, a long-term future for uncoordinated, piecemeal, competing and overlapping sub-national taxes on digital advertising is difficult to see. Treasury Secretary Janet Yellen has now spoken out in favor of a global minimum tax structure for companies that could eventually include digital commerce as one of its groundbreaking elements.
This is a job for the professionals performing operations in the Hall of the States on Capitol Hill and they should act quickly. The national associations of governors, treasurers, state tax administrators, and state lawmakers need to organize quickly to develop a model tax law that will provide the template for coordinated tax revenue and administration in the digital advertising space. Failure to act in a timely manner can lead to an avalanche of lost court battles and preventive interventions by Congress.
Just as the 1988 Supreme Court ruling in South Carolina v Baker dealt a crippling blow to the historic premises of municipal bonds for federal income tax exemption, a group-based approach to taxing digital ads could forever hold the states back on pace with future business innovation . Nature hates a void, and the longer these groups wait, the more likely it becomes that Capitol Hill or the G7 nations will pass an overarching tax law or international treaty that transcends the labyrinthine rules of 50 states ruled instead by chaos theory are carefully managed by mutual interests.
Here are five guiding principles for state model law to promote maximum consistency of tiered digital advertising taxes and to bolster the case for state and non-state agencies:
• • A common tax base: As the Japanese saying goes, "the nail that stands out is knocked down", and that is aptly true of eccentric tax characteristics in a state. A uniform tax system should apply the levy uniformly in all participating states to the same and similar companies at the same level. This framework minimizes the administrative burden for companies and eliminates the objection of "different treatment". For starters, most lawmakers will likely try to avoid taxing small local businesses instead of focusing their taxes on the big tech companies. But that's only the first step. Digital advertising has many facets, including the creation, promotion, display, funding, dissemination and analysis of content. It is therefore necessary to indicate those who are to be included in and excluded from a sub-sector tax. To minimize the secondary presumption by the courts, the principles and research in support of these distinctions should be contained in preambles and legislative statements. There will be comfort in the flock and strength in the pack.
• • Efficiency: Digital advertising industry taxes should be easy to manage and have the lowest attainable standardized costs of computation, collection and enforcement. A gross income tax is the easiest, but states will struggle to create the relevant taxable context for myriad transactions that cross state lines.
• • Clarity: Legislation should be clear to all parties as to “incidence” – where and to whom the tax applies – and administration. The anti-tax wonks' complaints and industry arguments against Maryland laws are the obvious hot buttons to avoid.
• • A fair price: A revered tax rule is attributed to the French finance minister Jean-Baptiste Colbert under Louis XIV: "The art of taxation consists in plucking the goose in such a way that the greatest amount of feathers is obtained with the least hiss." Predictably, the Internet Goliaths have learned to hiss at all taxes. There is no reason for digital advertising to get a lower tax rate than other highly profitable businesses. This is especially true for the global giants who otherwise enjoy massive write-offs and offshore havens to shield their taxable income. If advertising departments like agencies are to be taxed on their profits in addition to business taxes, a lower separate tax rate (or an equalization credit similar to a VAT equalization) may be justified – and both legally and legally justifiable politically.
• • Constitutionality: During the drafting, every precaution should be taken to minimize the litigation risk that the model legislation invites the giants of the digital advertising industry to advocate for the congress for relief under the trade clause. Maryland plaintiffs opposing this state's initiative are already making this claim, and the ugliest scenario for states would be if Capitol Hill passed preventive laws. Congress has a clear right – but no obligation – to regulate trade, while its failure to give credibility to states' right to tax economic activities on their territory. Some of the precedents in South Dakota versus Wayfair, the 2018 Supreme Court ruling that paved the way for states to collect taxes on online sales, may help shed light on draft legislation that is most likely to succeed in federal courts .
Good advice to states is that their political associations be wise to consult with trial lawyers and expert economists, whose advice can be embedded in a sample calculation so that expert testimony can be reliably presented to you in the inevitable struggles of Congress and the multilevel courts lie. States looking at this new tax frontier with an envious look at Maryland's foray would do well to reveal some of today's modern day Jean-Baptiste Colberts.
Governing's columns of opinion reflect the views of their authors, and not necessarily those of the editors or management of Governing.
Girard Miller
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