The Nation's First Digital Ad Tax
Raj Ashar | April 2021
The view above Annapolis, the capital of the State of Maryland and the hearth of the proposed digital ad tax
top the Digital Ad Tax. It's a Bad Time for a Bad Idea.” While at home in Maryland during my university's winter break, this ad was playing seemingly every other commercial break, sponsored by the independent coalition Marylanders for Tax Fairness.
The organization was lobbying against a recently proposed digital ad tax, which was introduced by the Maryland General Assembly and vetoed by Governor Larry Hogan at the time. However, on February 12th, the legislature overrode the governor’s veto, and the bill passed, rendering Maryland the first state to have a digital ad tax.
The digital ad tax is aimed at taxing the ad revenue accrued by tech companies, and has a progressive structure, starting at 2.5% for revenues between $100 million and $1 billion all the way up to 10% for revenues over $15 billion. The new tax aims to capture some of the revenues from the surging digital advertising industry, whose revenues have more than quintupled since 2010. A fiscal policy note from the Maryland General Assembly estimates that the tax will collect $250 million in 2021, its first year in effect.
Maryland’s digital ad tax was inspired by a New York Times op-ed by economist Paul Romer. In the piece, Romer outlines a digital ad tax as a path forward to curb misinformation, claiming that the tax will incentivize more online platforms to turn to an ad-free model dependent on subscriptions for revenue, a model whose profitability would not hinge on tracking individuals.
Romer also believes that such a tax, implemented progressively, would help address antitrust concerns as well. Large companies would bear the brunt of the tax, while competition could be encouraged, as smaller entrants would bear a significantly lighter burden. Additionally, mergers and acquisitions between companies would be disincentivized as such activity would only increase the burden of the tax.
Romer’s argument makes sense; as costs for advertising rise, companies will want to pass the increased costs to consumers, and an optional subscription model seems to be the most likely way to do this without losing a significant customer base.
However, one concern with Romer’s proposal is that consumers will not adapt. Should social media platforms such as Facebook and Twitter offer a “paid option” free of advertisements and consumer data collection, I find it unlikely that a high proportion of individuals would switch to the paid version. On sites like Facebook and Twitter, ads feel relatively unobtrusive; you can easily scroll through them. The primary incentive for many to switch to the paid model is the lack of data collection. However, I wonder whether data collection could already be seen as a sunk cost in the eyes of many. For a user who has had their data and personal information mined by Facebook since 2015, what difference does it make if the mining ends six years later? For new users it could make sense, but for current users, not so much.
Another issue related to a digital ad tax involves equity. By opening up paid models, the wealthy would be able to buy themselves data privacy, while those with fewer resources would be effectively forced to sell their data to access different internet services.
Just a week after the bill’s passing, a lawsuit was mounted against the digital tax by NetChoice, an internet trade organization which includes some of the largest online players, including Amazon, Facebook, and Google. The injunction filed cites several reasons for the tax to be deemed illegal: it violates the Internet Freedom Act (ITFA), the Commerce Clause, and the Due Process Clause.
The ITFA was passed in 1998, and was made permanent law in 2016. The act has a clause which prohibits “[m]ultiple or discriminatory taxes on electronic commerce.” The idea behind this is that states should not be able to impose higher taxes on e-commerce than brick and mortar stores. According to NetChoice’s argument, the tax is “discriminatory” because it only applies to “digital” advertisements; non-digital advertisements get a pass. It is also viewed as a “multiple tax”, which, according to 47 U.S.C. § 151 note § 1105(6)(A), is “any tax that is imposed by one State or political subdivision thereof on the same or essentially the same electronic commerce that is also subject to another tax imposed by another State or political subdivision thereof (whether or not at the same rate or on the same basis), without a credit (for example, a resale exemption certificate) for taxes paid in other jurisdictions.” The Maryland tax could be considered a “multiple tax” as it taxes commerce by imposing “a charge on digital advertising for extraterritorial commerce that is taxed by the States in which that commerce actually takes place, without a credit for those other taxes.”
In an open letter, Brian Frosh, the Attorney General of Maryland, defended the ad tax, noting that there was a path forward for its legality which hinged on the definition of “transaction” in the context of the tax. Frosh holds that if the “transaction” is defined as the display of digital advertisements to consumers, then the tax could easily be seen as discriminatory through the lens of the ITFA, as the transaction would presumably occur over the internet alone.
The other potential definition of “transaction” would encompass the general sale of digital advertising services in Maryland, rather than the specific, digital consumer-advertiser interaction, implying that the tax would apply “regardless of whether the advertiser purchases those advertising services from the taxpayer over the internet or through some other means.” In this case, the tax could be seen as non-discriminatory, as it is “generally imposed and legally collectible… without regard to whether the transaction is conducted over the internet.” If the transaction does not, as defined, always occur over the internet, then the taxation of such a transaction does not single out electronic commerce alone, paving a path forward for the legality of the tax.
A second challenge to the digital ad tax comes with the Commerce Clause from Article I, Section 8 of the Constitution, enumerating that Congress shall have the power “[t]o regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.” The clause also has been interpreted to indicate that states have no authority to interfere with interstate commerce. In the NetChoice injunction, counsel argues that “The Act favors in-state companies, exceedingly few of which will be subject to the charge imposed by the Act, even if they engage in the sale of some digital advertising. Liability imposed by the Act will be borne almost entirely by out-of-state companies based on their out-of-state conduct.” In addition, NetChoice claims that the legislation imposes “progressively greater liability on companies for the revenue they earn outside of Maryland...” The plaintiffs use similar reasoning in claiming that the state tax violates the Due Process Clause of the 14th Amendment, as the tax can be seen as “punishing or regulating extraterritorial conduct or activities.”
A recent case that could provide insight into how legal argumentation regarding the Maryland tax will conclude is that of Wayfair v. South Dakota, which was decided by the Supreme Court in 2018. In this case, South Dakota passed a law forcing outside sellers without a physical retail presence in the state to remit sales taxes as stores within the state would. In other words, online sellers sending products to residents of South Dakota would have to remit a sales tax to South Dakota, even though they may be located in a different state. The Court upheld this legislation, and in so doing overruled several previous rulings on the issue, notably Quill Corporation v. North Dakota and National Bellas Hess v. Illinois, which both ruled against the defendant states and in favor of the idea that states can only tax businesses within their respective jurisdictions.
However, Wayfair bucked the trend. In the majority opinion, Justice Anthony Kennedy opined that the standard of physical presence was outdated, claiming the internet has allowed buyers and sellers to be “closer” than before, even if the seller is not physically located within proximity of the buyer. This case presents hope for Maryland’s defense of its own proposed tax.
In summary, the digital ad tax, while a somewhat promising tool to combat misinformation and excessive power wielded by Big Tech, is far from a legally uncontested, politically undisputed idea. Numerous legitimate legal challenges lie ahead from a few different perspectives. Based on the Wayfair case, the tax seems to have a chance at dodging Due Process and Commerce Clause concerns, yet circumventing the ITFA could prove to be an insurmountable legal roadblock.
If Maryland fails to implement the tax, the effects will ripple to other state legislatures who are currently considering a similar measure. As a result, the tax’s only truly secure hope lies in its potential implementation at the federal level, which would allow it to dodge a variety of private legal challenges in each state.
Moving forward, the US might look to French policy as a normative example of digital ad taxation, as the country has recently implemented a nationwide 3% tax on digital ads. Yet even within the US, our system of federalism enables us to learn from the attempts and failures of other states in implementing new legislation. As Justice Louis Brandeis once put it, such a system allows states to become “laboratories of democracy,” testing, both legally and politically, new and innovative policies that hold powerful private actors accountable. Such state-level innovation and ensuing private legal challenges, including that occurring in Maryland, can reveal to the federal government more efficacious and legally impenetrable ways to implement a digital ad tax.
As the digital frontier expands and the American regulatory regime catches up with new innovations in advertising technology, increasingly innovative legislation will be required in order to raise state revenues and nudge large digital firms to act in line with consumers’ privacy-related interests. Maryland’s digital ad tax, though legally challenged and impeded, is an interesting step in the direction of increased government responsiveness to the new, digital American consumer.