In just a couple of weeks, early voting in California will begin for the November elections, including on the ballot measure for a first-of-its-kind wealth tax. But, while supporters of the tax may think that the worst-case scenario would be defeat at the ballot box, Maryland’s recent experience with its digital advertising tax provides a vivid reminder that poorly-designed taxes can actually suffer a far more consequential fate.
Maryland’s Whoopsie
Back in 2021, Maryland pushed ahead with a tax on digital advertising despite ample warning from legal experts that the tax was likely to be struck down in the courts. From the federal Internet Tax Freedom Act to the Commerce Clause to the Due Process Clause to even the First Amendment, the tax seemed to accumulate legal defects like Sonic the Hedgehog swerving to collect gold coins.
Rather than turning the ship of state to avoid the approaching iceberg, the tax’s proponents deflected by insisting that the revenue was necessary to sustain recent increases to education funding. And, while receipts from the tax came in substantially under the $250 million per year that advocates hoped for, Maryland nevertheless accumulated around $535 million from the tax during the five years it was in effect.
Five years, as it happens, is about how long it took for the numerous legal challenges to receive a ruling from a judge on the merits. And that ruling was emphatic—Maryland managed to lose cases on the basis of all four of the legal issues I mentioned earlier, each of which would have been sufficient to invalidate the tax on its own.
Now, Maryland has to pay back that $535 million, with interest. The state will probably appeal, but reversing judgments in favor of the taxpayers on four separate legal and constitutional counts is a tall order. Assuming the appeals fail, Maryland will be left with not only the original revenue gap the digital ad tax was intended to address, but with $535 million+ added on top of it.
The California Parallel
The facts in California are startlingly similar. The proposed wealth tax is unprecedented in the United States, was put forward to cover a perceived funding shortfall, and faces a daunting array of legal problems. In fact, the California tax somehow faces even more legal vulnerabilities than the Maryland one.
Going through, in detail, the entire list of angles that the California tax could be challenged from is a task better suited to a book than an email update. To name a few, the tax likely violates the state constitution’s restrictions on taxation of property, Due Process Clause restrictions on retroactive taxation, Commerce Clause requirements that taxes be fairly apportioned, and the right to travel. Other significant challenges could also be levied on the basis of the Takings Clause, Excessive Fines Clause, and other provisions.
If the wealth tax fails to get voter approval in November, the state will have suffered a substantial wealth out-migration, likely having lost over a trillion dollars, for nothing at all. Even the fact that such an extreme proposal could make its way onto the ballot is likely to spur high-earner outmigration at an even faster rate than the state already suffers over the next few years.
Should the tax pass and be ruled invalid down the line, California will be left in a position that mirrors Maryland’s—having suffered all the economic consequences, with the same budget gap, only exacerbated by the need to refund its ill-gotten gains.
But, in California’s case, the amount that would need to be refunded would be in the tens of billions of dollars, not the hundreds of millions.
It’s yet another reminder of how reckless it is to get creative with tax policy in a budget crunch. Losing in court ends up being far worse than losing a whip count or at the ballot box.