Thursday, February 02, 2012

Saying NO to Maryland's New Tech Tax

Remember Maryland's ill-fated computer services tax? State officials wanted to cover the state's budget deficit by tapping a new revenue source. The tax was unpopular and never took effect.

But the idea of taxing innovation and economic efficiency has now been brought back to life in the Maryland legislature. The newest tech tax targets? Online remote sales and digital downloads.

Back in 2007, the Maryland legislature stuck computer services with a 6% sales tax rate. The tax was quickly rammed through the legislature in a special session, without public debate, and signed into law by Governor Martin O'Malley. This triggered an immediate backlash from businesses and everyday citizens. Public officials who supported the computer services tax backpedaled and soon caved. It was repealed just a handful of months later.

Unfortunately, the Governor and some in the Maryland legislature seem to have forgotten the lesson. This month bills containing Governor O'Malley's proposed budget were introduced in the Maryland Senate and House (SB 152 and HB 87). If enacted, the proposed budget would extend the 6% sales tax rate to downloaded "digital products" of several stripes, such as music, videos, books, ringtones, and more. It would also impose sales tax collection obligations on remote (that is, out-of-state) online retailers that have website ad commission sales arrangements with Maryland residents. This means that online retailers with no physical presence in Maryland would charge the 6% sales tax rate on purchased goods and remit the money collected to Maryland tax officials.The lesson of the computer services tax is that policymakers shouldn't harm businesses and consumers with tax burdens on hi-tech services that are crucial to optimizing beneficial solutions and cost efficiencies. By enabling businesses and consumers to order goods from remote retailers through the Web or to download products directly through the Internet, broadband networks offer the benefits of convenience and increased speed. Such technology also reduces delivery and transaction costs. This makes digital e-commerce platforms economic force multipliers.

These tech tax provisions in the proposed budget will, of course, place direct and indirect burdens on all those using Internet-related technologies. But there are some particularly problematic aspects to the current budget proposal's targeting of e-commerce.

For starters, language included in the current budget proposal is overbroad. Definitions and provisions relating to "digital products" appear to subject to taxation, not just digital products downloaded in business-to-consumer transactions but also digital products downloaded in business-to-business transactions. This would create multiple taxation problems that tax laws typically protect against. Here, the result of compounding taxable events would be increased costs to businesses for inputs. And those costs surely will be passed on to consumers in the form of higher prices for outputs.

As a matter of tax policy, the budget proposal's treatment of remote online sales is counterproductive. It would likely generate little revenue, and it could cause Maryland residents to lose business.

The budget proposal would impose sales tax collection obligations on remote online retailers that have website ad commission sales arrangements with Maryland residents.

More specifically, it would attach tax collection obligations to remote online retailers that have web advertising affiliate agreements with in-state residents. Under such agreements, online affiliates typically place ad banners on their websites for goods sold by retailers like Amazon and The affiliates receive a small commission when buyers click on the ads and purchase such goods.

But if this provision regarding online remote sales is adopted by the Maryland legislature and signed by the Governor, it would likely backfire. Significant numbers of Maryland residents with ad banners for remote retailers on their websites would find their ad affiliate agreements cancelled. As a study released by the Maryland Comptroller in November states, "[r]eportedly over 200 companies including and have terminated their affiliates in one or more states that have enacted affiliate-nexus laws." And so the state would lose its trigger for imposing sales tax collection obligations on online remote sellers. (For more detail, see my FSF Perspectives paper from November, "Taxing Ad Affiliate Internet Sales Would Be Maryland's Mistake.")

For that matter, imposing tax collection obligations on out-of-state retailers likely violates the U.S. Constitution’s interstate Commerce Clause. Current U.S. Supreme Court jurisprudence recognizes Congress as the authority to address interstate e-commerce taxation matters.

Even if these glaring defects of the Governor's proposed budget were to be corrected, there are still good prudential reasons for Maryland to think twice before imposing sales taxes on digital downloads and on purchases from remote online retailers. Consider, for instance, the adverse effects of such taxes on Maryland's business climate. The just-released Tax Foundation's 2012 State Business Tax Climate Index once again places Maryland near the bottom compared to other states with respect to its business climate. Maryland (#42) must avoid doing further damage to its competitiveness vis-à-vis its neighboring states, such as Virginia (#26), Delaware (#12), and Pennsylvania (#19). According to the Comptroller's study, none of those three neighboring states currently impose taxes on digital goods. And both Virginia and Delaware already have lower general sales tax rates than Maryland.

Characteristics of digital age technologies only heighten the need for Maryland to make itself a competitive place for businesses to start-up or relocate to. Such technologies are highly portable. Therefore, it is not difficult of purveyors of digital goods to relocate to states without growth-inhibiting taxes and regulations.

The Governor and the Maryland legislature shouldn't repeat the sorry history of the computer services tax. Making up for budget deficits by taxing innovation and economic efficiency doesn't make sense. Putting a priority on fiscal responsibility and cutting wasteful spending does.