Maryland’s digital ad tax not only bad policy, it’s fraught with legal problems | COMMENTARY

When Maryland’s legislature made the decision last month to override Gov. Larry Hogan’s veto of its digital advertising tax, it was clear that the legislature had pushed the state into legally dubious territory. And sure enough, the state is already facing legal challenges from tech industry trade groups and the U.S. Chamber of Commerce.

The state’s new system will impose a gross receipts tax ranging from 2.5% to 10% on businesses with global revenues exceeding $100 million, so long as they have at least $1 million in advertising revenue within Maryland. By structuring the tax as a gross receipts tax, those rates are even higher than they may sound, as affected businesses will face taxes on total digital advertising revenues within the state of Maryland, not net profits. Businesses with small profit margins would be particularly hard-hit.

There are plenty of policy reasons that Maryland should have stayed away from a digital advertising tax even if the law was legally unimpeachable. Though liberals and conservatives, each with their own grievances against large tech companies, may see a chance to tax these companies as a positive development, it won’t be Big Tech companies who bear the brunt of Maryland’s tax. A 2019 Deloitte/Taj study analyzing a similar French digital advertising tax proposal found that just 5% of the tax would be borne by Big Tech companies; the remaining 95% would be split between smaller businesses and consumers.

But the more immediate problem for Maryland is that the tax is fraught with legal problems. The Chamber of Commerce’s case challenges the law on four separate grounds, and it appears to have a compelling argument on each.

First, the chamber argues that the law violates the Permanent Income Tax Freedom Act (PITFA), signed into law by President Obama in 2016. One element of PITFA prohibits states from imposing taxes that discriminate against internet commerce. Because Maryland does not tax traditional advertising, it will be difficult for Maryland to argue that its law is not unfairly targeting digital commerce in this case.

Second, the chamber’s suit also alleges that Maryland’s law creates an undue burden on interstate commerce, violating the dormant Commerce Clause. Because of the way the law is structured, global businesses are far more likely to face the tax than businesses operating only in Maryland — courts may agree with the chamber that this structure discriminates against interstate commerce. This could also potentially violate the Due Process clause, as Maryland is targeting conduct by largely out-of-state businesses.

Lastly, the suit argues that Maryland’s law violates the Foreign Commerce Clause, which grants Congress the sole authority to regulate commerce with foreign nations. The federal government is currently engaged in a battle to prevent other countries from enacting similar digital taxes to Maryland’s, and the Supreme Court has ruled in the past that state taxes may not undermine the federal government’s positions on commercial matters regarding other nations.

And that array of legal hurdles may not be all that Maryland ends up facing. The state could conceivably face legal challenges on First Amendment grounds as well, as courts have often not looked fondly upon taxes that target communications media. The Maryland Court of Appeals has even ruled in the past that advertising taxes represented violations of the First Amendment.

Digital advertising taxes are a bad idea on policy grounds alone, but the legal jeopardy that Maryland is willingly wading into should have been sufficient to leave the idea on the drawing board. Maryland taxpayers on the hook for these legal challenges should know that the battle now facing their state could have been avoided from the beginning if their legislators had only bothered to listen to experts.

Andrew Wilford (andrew.wilford@ntu.org) is a policy analyst with the National Taxpayers Union Foundation, a nonprofit dedicated to tax policy research and education at all levels of government.