Tax Professors Come to the Defense of Challenged Maryland Digital Tax

Maryland legislators in February 2021 overrode Governor Larry Hogan’s (R) veto and made their state the first in the nation to adopt a digital advertising tax. The legislators were inspired by an op-ed by Professor Paul Romer, who testified in favor of the law and detests targeted digital advertising. In this op-ed, Romer argued for state governments to pass laws to deal with this “threat” and “encourage” (forcefully) the business model he prefers (paywalls, subscriptions, and traditional advertising).

The tax Maryland passed applies to revenue “derived from” digital advertising in the state, with a scale of punitive rates starting at 2.5 percent up to 10 percent on revenue (not profits) for businesses with $100 million or more in global revenue. Any entity (except broadcast and news media, which are carved out entirely) with $1 million in revenue from digital advertising services in Maryland must file a tax return, with the tax taking full effect on January 1, 2022. 

The law gives no clear guidance on how companies are supposed to measure digital advertising in Maryland, but does specify a penalty of 5 years’ imprisonment and a $5,000 fine for failing to file a return. While other states have considered similar proposals, none have yet followed Maryland’s lead.

One reason for Maryland being alone (aside from France and Hungary) is litigation: two lawsuits have been filed challenging the tax’s constitutionality, one in federal court and one in state court. The lawsuits point out a number of legal flaws: the tax is structured so as to target non-Maryland providers over in-state businesses in violation of the U.S. Constitution’s Commerce Clause, it targets out-of-state companies for regulation in violation of the U.S. Constitution’s Due Process Clause, and the tax is imposed on digital advertising but not non-digital advertising in violation of the anti-discriminatory provision of the Internet Tax Freedom Act (ITFA). 

There are also concerns about the tax’s vagueness (much is left unclear, making compliance very difficult), the First Amendment (taxing one category of speech), and newly issued regulations from the Comptroller that are ambiguous, suspect, and unworkable. On the other side, Maryland’s government is arguing that the lawsuits should be delayed until they start collecting the tax, which would ensure the legal process won’t conclude until long after any economic damage has already happened.

With Maryland’s tax now under attack from all sides, two law professors weighed in this week with a court filing to shore up its defenses. UC Davis Law Professor Darien Shanske and University of Utah Tax Professor Young Ran (Christine) Kim have submitted a “Tax Law Professors” brief that argues that digital advertising is unique and therefore should not be protected by ITFA or compared to non-digital advertising for evaluating whether it is discriminatorily taxed. Specifically:

  • Shanske & Kim argue that digital advertising activity is “previously untaxed” (pp. 2, 8) and this tax is really “a consumption tax on the portion of the transaction…that occurs between the platform and Maryland users” (pp. 1, 8). It’s not true to say that digital advertising is “untaxed” – these retailers pay billions in corporate income tax as well as sales taxes, property taxes, employment taxes, and so forth. More importantly, if this is really a tax on the platform-consumer transaction and not a punitive levy on the company for providing the service, shouldn’t the tax be zero? The consumer of digital advertising pays the platform nothing, and 10 percent of zero is zero.

  • Shanske & Kim reject the view that the tax “punishes out-of-state conduct,” saying it only applies to those “generat[ing] substantial revenues at high profit margins for digital advertising platforms” and “examining a taxpayer’s revenues outside a jurisdiction…is a common and reasonable practice” (p. 2). They do not acknowledge that in practice this tax will only apply to non-Maryland businesses and that Maryland-based businesses who might have fallen under it were explicitly carved out. And far from being common, they would be unable to point to an example of any other state tax that uses a global tax revenue threshold for triggering liability. That’s not about apportionment, that’s about ensuring that only big non-Maryland companies end up owing the tax.

  • Shanske & Kim cite a U.S. Supreme Court case from 1997 to claim that the Court evaluates tax discrimination only by looking at whether companies are similar, not whether products are similar (p. 4). This is not quite correct as it conflates the Commerce Clause inquiry with the ITFA inquiry. For the Commerce Clause, a court will ask whether the law is designed to produce disparate tax burdens between in-state and out-of-state companies. For ITFA, the statute itself commands looking at “transactions involving similar property, goods, services, or information….” Even for the Commerce Clause, what matters is not whether the companies are similar but whether they could be said to be competing. If the out-of-state company is taxed and the in-state competitor is untaxed, as is the case here, then that is discriminatory.

  • Shanske & Kim cite a handful of cases where challenges to taxation of a digital company were upheld, such as with application of hotel taxes to online travel companies (pp. 4-5). They do not acknowledge that the vast majority of those cases have gone the other way, and that applying an existing tax to digital equivalents is very different from a brand new punitive tax only on digital activity.

  • Shanske & Kim strangely argue (pp. 6-12) that digital advertising is unique in that it is concentrated among only a few providers (so are newspaper and billboard ads), only it can target users (this would be news to the direct mail industry), only it can verify if a user has acted on the ad (have they never encountered coupons or email solicitations before?), and only it can control placement of ads (a strange claim given that advertisers can and do decide where their digital ads appear).

  • Shanske & Kim argue that ITFA was intended only to protect a developing industry, “an issue not implicated by Maryland’s tax” (p. 13). Whatever the truth of this (and their main evidence is statements by ITFA opponents in 2007 and 2016), the ITFA statute has both a ban on taxation of Internet access and a ban on discriminatory taxes on the digital world. The law’s framers were concerned about more than one thing.

  • Finally, Shanske & Kim argue that the court should restrain itself from striking down Maryland’s tax unless Congress specifically tells them to (pp. 14-15), but this would first require the court to somehow conclude that ITFA is vague or not clear in seeking to preempt state taxes. It’s quite clear, especially as federal statutes go.

ITFA is an essential protection for taxpayers against an ever-present temptation by state policymakers to export tax burdens and import tax revenues from other states. The simple requirement it entails — if you are going to tax a digital good or service, you must also tax the non-digital equivalent good or service — is not met by Maryland here, which chose to impose a brand new, punitive tax on digital activity. The U.S. Constitution’s Commerce and Due Process Clauses also guard against states taxing out-of-state activity while exempting in-state activity. It cannot be denied that this will be the effect of Maryland’s digital advertising tax.

Hopefully the court will see past the claims in this brief and reach the right conclusion.