Maryland Legislators Want to Tax Online Advertising

Tax Policy – Maryland Legislators Want to Tax Online Advertising

Whenever anyone surfs the internet, they inevitably encounter online ads. They are everywhere, and they are big business. According to Forbes, the market was worth over $100 billion in the U.S. in 2018. With so much of our daily communication moving online, it has always been just a question of time before implications for the tax code would emerge.

Over the last few years, several countries, the EU, and the OECD have looked at ways to tax the profit streams from this market. Unfortunately, many of the proposals pursued by these countries fail every test of sound tax policy. Fortunately, only a few countries have implemented a tax so far.

The nonneutral and discriminatory nature of the tax has led the U.S. federal government to oppose these taxes. However, Maryland legislators do not share this skepticism, and have introduced a bill to impose a tax on revenues derived from digital advertising.

The sponsors of the bill, Bill Ferguson (D) and Thomas V. “Mike” Miller Jr. (D), expect the tax to raise more than $100 million per year, which will be appropriated to Maryland’s education program. In 2019, the state’s Kirwan Commission published a set of recommendations that would increase education spending by $4 billion per year. State lawmakers are looking for new revenue, as both Governor Larry Hogan (R) and leading Democrats have promised not to hike income, property, or sales taxes in 2020.

A tax on digital advertising must rely on the assumption that value is created in a state regardless of a digital advertising provider’s presence in that state other than large user bases. In other words, the taxable event or tax base is an assumed value creation in the meeting between the Maryland user and the online advertisement without regard for the costs of developing and maintaining the software, which allows these online interactions. The tax would apply to revenues derived from digital advertising in the state based on a user’s IP address or reasonable suspicion of location. It will be up to the companies to report their revenue. However, determining location and revenue generation of a user could be very tricky. Think about the problems arising from the use of VPNs (where a user connects to the internet via an out-of-state server), online bots, or the use of ad-blockers.

The rate ranges from 2.5 to 10 percent of gross revenues based on the company’s global annual gross revenues. Companies with revenues below $100 million are exempt from the tax. Given these high revenue thresholds, the tax seems designed to tax the tech giants. This might be good politics, but it is not sound tax policy. While there can be good reasons to exempt smaller businesses from undue burdens related to the tax, exempting all businesses with revenues below $100 million narrows the base and drives up the rate.

Not only is the tax nonneutral due to arbitrary revenue thresholds, it also discriminates between online and offline businesses and singles out global advertising services for a higher tax rate than other businesses in the state. The current corporate income tax rate in Maryland is 8.25 percent, which is significantly lower than the gross revenue tax of 10 percent. Corporate income taxes are levied on the income of a company, whereas a tax on gross revenues is levied on revenues before deducting costs. This results in a rate that could exceed 100 percent of profits.

Below is a sample calculation of the difference.

Tax policy designed to target a single sector or activity is likely to be unfair and have complex consequences as there is a difference between legal tax incidence and effective tax incidence. While the large tech companies are legally obliged to pay the tax, the effective incidence might very well result in local companies in Maryland experiencing increasing marketing cost. The digital economy is not something that can easily be separated out from the rest of the global economy.

Furthermore, traditional advertising is not taxed in Maryland, which means the tax could effectively encourage companies to move marketing dollars away from online platforms. This particular discriminatory element of the tax is likely in violation of the federal Internet Tax Freedom Act, which protects online businesses from punitive or discriminatory taxation.

Maryland lawmakers have called for a modernization of the tax code, and while the proposal for a digital advertising tax fails the tests of sound tax policy, there is reason for updating the tax code to reflect modern consumption patterns. For instance, streaming services like Netflix, Apple Music, and Hulu should be included in the sales tax base. As a rule of thumb, taxation of digital transactions using existing consumption taxes are superior to special taxes on digital services.

Source: Tax Policy – Maryland Legislators Want to Tax Online Advertising