Maryland’s Digital Advertising Tax Is Not Wayfair 2.0

On Friday, Maryland’s Senate Budget and Taxation Committee will hold another discussion on Senate Bill 2, its proposed digital advertising tax. Though the National Taxpayers Union Foundation has warned that Maryland’s proposed bill is unconstitutional, state legislators have largely brushed off these concerns by pointing out that South Dakota’s economic nexus law was unconstitutional until the Supreme Court decided otherwise in South Dakota v. Wayfair. Senate President Ferguson, one of the bill’s sponsors, recently compared the two when discussing the path the bill would need to take to become law. He went so far as to say that Maryland’s approach is “very similar to the path South Dakota took in discussions with Wayfair.” 

But that’s an inapt comparison, and it is setting the state up for years of costly and ultimately fruitless litigation. Here are the top four reasons that the legal climate for Maryland’s digital advertising tax bears little resemblance to South Dakota v. Wayfair:

  1. Constitutional and statutory barriers

The restriction preventing South Dakota from imposing tax obligations on out-of-state businesses in 2016 was Supreme Court precedent, most notably its interpretation of the Commerce Clause in the Quill and National Bellas Hess cases. There was no underlying federal statute that directly applied to remote sales tax collection, so the Supreme Court’s interpretation was effectively the final word on the subject.

By contrast, there are several barriers preventing Maryland from imposing targeted digital advertising taxes. There are violations of the Constitution — namely that it likely wouldn’t pass scrutiny under the First Amendment’s free speech and press protections, Commerce Clause jurisprudence prohibiting laws that unduly burden interstate commerce, and possibly the Equal Protection Clause of the 14th Amendment.

But even if courts failed to find the law unconstitutional under any of these three provisions, the law is a clear violation of a federal statute, the Permanent Internet Tax Freedom Act (PITFA). PITFA clearly prohibits discriminatory tax treatment for internet-based activities. In other words, if South Dakota’s law faced a high hurdle, Maryland’s faces a veritable skyscraper.

  1. Procedure

Wayfair was a rare case of strategic litigation initiated by a state government to challenge a constitutional standard. Legal analysts for years questioned the durability of the Supreme Court’s precedent-setting decision in Quill, making a case like Wayfair a likely next step in challenging restrictions on state power. There are several signs that South Dakota’s path was unique, offering it a chance at quick review and approval at the Supreme Court.

Justice Anthony Kennedy had signalled strongly that the Court was willing, if not eager, to reconsider Quill and Bellas Hess. In his concurrence in Direct Marketing Association v. Brohl, Kennedy stated that “it is unwise to delay any longer a reconsideration of the Court’s holding in Quill” and that “the legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess.” Wayfair was a long time coming, and came at the invitation of the Court.

South Dakota charted a short path to the Supreme Court. It passed its economic nexus law explicitly for the goal of challenging legal precedent, brought suits against the businesses which became the defendants, then immediately suspended collection until constitutionality had been resolved.

South Dakota effectively invited a loss at the state court in order to set up a Supreme Court challenge. The South Dakota Supreme Court’s opinion says: “The State has consistently agreed throughout this litigation that, unless and until the U.S. Supreme Court reconsiders its decision in Quill, this Court must affirm the circuit court’s holding that the Act is invalid as applied to Defendants.”

Maryland’s law, however, has no such path to potential vindication, with neither Congress nor the Supreme Court suggesting any openness to revisiting existing free speech, Commerce Clause, or equal protection standards that SB 2 violates.

  1. Impact on state budget

Under the prevailing standard at the time, South Dakota could not collect sales tax from out-of-state businesses, which meant that it never counted on any such revenues to balance its budget and fund state priorities. As a result, the only cost to the state in advancing the Wayfair case was its legal expenses. In the event of a victory, they’d gain new tax authority. In the event of a loss, they’d owe no refunds.

Not so in Maryland. SB 2’s digital advertising tax is being pitched as a means of funding education costs. So not only will the state most likely have to refund tax collection if (or when) it loses in court, like it did following the Maryland v. Wynne case where it had to refund $200 million to 55,000 taxpayers, but it would also have to find new tax revenue elsewhere to make its budget math work. It may prove very difficult for Maryland to fund its education priorities with an uncertain revenue stream that could be in legal limbo for years.

  1. The law at issue

That it was South Dakota, and not some other state, that took an economic nexus law to the Supreme Court was not an accident. The Mt. Rushmore State’s tax system stood the best chance of any to survive Supreme Court scrutiny. It included a safe harbor for small businesses and a ban on retroactive enforcement. The state was also a member of the Streamlined Sales and Use Tax Agreement and had a relatively simple tax system, with state-level administration and a simpler tax structure.

By contrast, Maryland’s law is not well-crafted to survive Court scrutiny. The state does not tax traditional advertising, putting it in danger of failing challenge under PITFA. The tax is also structured so as to fall heaviest on global firms with most of their revenues outside the state of Maryland; a design which may be politically popular, but which makes the tax more likely to be considered an unconstitutional burden on interstate commerce. 

Legislators may think they can ignore SB 2’s serious constitutional issues by pointing to Wayfair, but they would be mistaken. Just because one state won a recent victory on a tax issue at the Supreme Court doesn’t mean that Maryland will. The law is likely to meet defeat in the courtroom unless Maryland’s representatives seriously reconsider their course of action.