Maryland’s First-In-Nation Digital Ad Tax Could Catch On — If It’s Legal

Revenue earned in Maryland from digital advertising will be taxed this year unless a court strikes … [+]

Google GOOG +2.9%, Facebook and Microsoft could start paying hefty advertising fees in Maryland — and possibly elsewhere — if the state’s new digital ad tax holds up in court.

Lawmakers in other states including Connecticut, Indiana, Montana, Nebraska and New York are reportedly eyeing similar bills but are waiting first to see if Maryland’s law withstands its legal challenge.

Maryland’s state legislature made history last month when it overrode a veto from the governor to pass the nation’s first tax on digital advertising revenues. Not surprisingly, it took less than a week for the U.S. Chamber of Commerce and a collection of trade groups representing tech giants in the online advertising space to file suit in federal court.

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The lawsuit alleges the tax is discriminatory and violates the Internet Tax Freedom Act, which, among other things, bans states and localities from taxing internet access. Some experts agree.

David Brunori, a public policy professor at the George Washington University, noted that the Internet Tax Freedom Act (IFTA) also prohibits states from imposing taxes on digital goods when they do not tax the non-digital equivalent. (Maryland doesn’t currently tax non-digital advertising.) Brunori also notes there’s “a strong argument that the tax violates the Commerce Clause of the U.S. Constitution” for discriminating against out-of-state businesses.

“As importantly, the tax is bad policy,” he adds. “It is a gross receipts tax. It will be passed on to customers — mostly small businesses in Maryland — in the form of higher prices. It is a very cynical way to raise revenue.”

Maryland estimates the digital tax could raise as much as $250 million in its first full year by taxing annual gross revenues derived from types of digital advertising services in the state. The tax rate is progressive, beginning at 2.5% for companies with global annual gross revenues of $100 million to $1 billion and goes up to a rate of 10% for companies with global annual gross revenues exceeding $15 billion.

The revenue would go toward education funding in the state.

According to an analysis by S&G Global Market Intelligence, companies such as Facebook, Google, Amazon and Microsoft MSFT +2.1% would all be taxed at the top 10% rate. Pinterest, Twitter and Snap would be taxed at a 7.5% rate.

The new tax would also apply to streaming and downloaded digital products. That aspect isn’t getting as much attention because the legality to do so is already well established. According to MultiState Associates, 30 other jurisdictions already tax digital products delivered electronically.

Darien Shanske, a professor at the University of California, Davis School of Law, told Tax Notes that he thinks Maryland’s case for constitutionality is solid in part because IFTA is a “drafting disaster.”

“This is clearly a type of transaction that a state should be able to tax — makes sound tax policy to be able to tax, especially in light of changes in the economy and state need for revenue in the current overlapping crises and so the burden should really be on those arguing for the [ITFA],” Shanske said.

If the tax withstands the legal challenge, it isn’t likely to have a large impact on companies’ bottom lines in and of itself. Maryland is a small state, representing less than 2% of the U.S. population. However by all accounts, it would have a ripple effect. And that would certainly impact business revenues.

Brunori, who is also a senior director at the tax firm RSM US, noted that businesses are also likely to make adjustments to minimize the tax.

“The bigger issue is that about a half-dozen states are considering this type of tax,” he said. “If Maryland prevails legally you will see a lot more states jump in.”

I am a fiscal policy expert, national journalist and public speaker who has spent more than 15 years writing about the many ways state and local governments collect and

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