By Randolph May and Andrew Long
The so-called Kirwan Commission, established by the Maryland
General Assembly in 2016, recommended a number of rather expensive reforms that
it contends would improve the quality of public education in the state. To fund
the Kirwan Commission proposals, the legislature is considering a tax on
digital advertising services that singles out large online platforms. Such an
approach is more likely to result in legal bills than increased funding for
education. Considering that the proposed legislation is based upon a proposal apparently
designed to force online providers to abandon ad-supported business models –
rather than generate actual revenue – perhaps that is not surprising.
On January 8, 2020, incoming Maryland State Senate President
Bill Ferguson (D-Baltimore) and President Emeritus Thomas V. Mike Miller
(D-Calvert) introduced SB
2, legislation that targets digital advertising services with a tax on
annual gross revenues. Delegate Alonzo T. Washington (D-Prince George's County)
sponsored similar legislation in the House of Delegates, HB 695.
The first bill of its kind in the nation, SB 2 would impose
a tax – ranging from 2.5 percent up to 10 percent – on annual gross revenues
derived from "digital advertising services" provided via a
"digital interface" within the state. It would not apply to
traditional forms of advertising (print, TV, and radio, etc.). In addition,
companies with less than $100 million in annual global gross revenues would be
exempt. The focus thus is on large digital platforms (for example, Google and Facebook).
SB 2 is riddled with impracticable language. For example, the
definitions of both "digital advertising services" and "digital
interface" are broad and vague: the former includes "advertisements
in the form of banner advertising, search engine advertising, interstitial
advertising, and other comparable advertising services," while the latter
applies to "any type of software, including a website, part of a website,
or application, that a user is able to access."
Similarly, as originally drafted, SB 2 would have applied to
any digital advertising service (1) when a user's device is assigned
"an Internet Protocol address that indicates
that [it] is located in the State," or (2) the user "is known or
reasonably suspected to be using the
device in the State" (emphasis added). (To our knowledge, companion bill HB
695 still includes this language.) As the Association of National Advertisers has
explained, however, "consumers' IP addresses don't always reveal their
locations," particularly when they are on mobile devices, and "the 'reasonably suspected' test for
use … would be very difficult, if not impossible, to apply." Recent
amendments to SB 2 have eliminated these problematic attempts to define the
geographic application of the tax. Unfortunately, their replacement – an
apportionment fraction that defines the amount of annual gross revenues to
which this state-specific tax applies – inappropriately uses nationwide digital
advertising revenues for its denominator.
Legislative analysts estimate
that SB 2 could generate as much as $250 million per year in tax revenues. That
assumes, however, that SB 2 survives judicial challenge, which, under a number
of legal theories, is doubtful. For example, the Permanent Internet Tax Freedom
Act prohibits discriminatory taxes on electronic commerce – but SB 2 would
apply only to online advertising, and solely the largest providers. In
addition, the U.S. Supreme Court on more than one occasion
has struck down industry-specific taxes on First Amendment grounds. Similarly,
the Maryland Court of Appeals in 1958 held that a tax on
TV, newspaper, and radio was unconstitutional under the First Amendment. Given
its focus on companies with annual gross revenues over $100 million, SB 2 also
is vulnerable to a challenge under the Commerce Clause: a significant portion
of those revenues likely are derived from activity outside of the state,
therefore the tax could be found to discriminate impermissibly against
interstate commerce.
Even if it withstands judicial scrutiny, SB 2 is a bad idea
that would harm both consumers and businesses in Maryland. Digital advertising
is a significant contributor to the economy, generating $130 billion in annual
revenues. However, SB 2 would jeopardize that success by imposing a second
levy, in addition to the sales tax, on goods and services marketed via digital
advertising. A double tax would increase prices for consumers. As a
consequence, demand – and sales tax revenues – would decline. That is why the
Association of National Advertisers calls SB 2 "one
of the most serious threats to advertising in the United States that we have
encountered in decades."
In addition, SB 2 would encourage companies to redirect
advertising expenditures to other states. That, along with increased costs,
would lead to a reduction in total spending on digital advertising in Maryland,
which would harm local businesses, in particular those that depend on
advertising revenues. Were it to go into effect, SB 2 would subject consumers
to higher costs, reduce sales tax revenues, and generate less funding for
education than anticipated by disincentivizing participation in Maryland's
digital advertising marketplace. Considering the immodest proposal that
inspired it, this last harm, in particular, is to be expected.
Senate President Ferguson told
the Washington Post that the draft legislation builds upon a May
6, 2019, article in the New York Times by economist Paul Romer. In that
opinion piece, Romer advocates for a tax on digital advertising – specifically
targeted advertising – not because of the revenue it would generate, but rather
due to his objection to targeted advertising generally.
But this is misguided. Targeted advertising is the lifeblood
of the Internet as we know it. Consumers willingly provide personal information
(browser history, etc.). In return, they receive "free" content and
services. Exposure to targeted ads – which, incidentally and importantly,
provide information on specific offerings that, by definition, they are likely
to find compelling – is the non-monetary price that they agree voluntarily to pay.
This voluntary exchange enhances consumer welfare, and even more so for
low-income individuals.
Romer makes clear, however, that he would prefer that digital
platforms abandon this win-win business model and switch to ad-free
subscription (pay) services. A tax on targeted advertising is the stick he
would use to force them to do so. In fact, when Romer testified in late January
at a hearing before the Maryland State Senate's Budget and Taxation Committee
hearing on SB 2, he reportedly stated that
he wants targeted advertising to stop and that he would be happy if the tax
resulted in no revenue.
A tax on digital advertising services would reduce consumer
welfare by imposing on ad-supported services additional costs, in the form of
taxes, specifically and primarily designed to modify providers' behavior. According
to its architect, that harm is a feature, not a bug.
Maryland should reject this highly flawed digital
advertising tax and look elsewhere for a source of additional revenue for education
if it wants to fund some or all of the Kirwan Commission recommendations. All
told, SB 2 would require the state to expend substantial sums on legal fees;
likely never go into effect; lead to higher prices if it did; shift advertising
spending to other states; harm both consumers and businesses, in particular
those dependent upon ad revenue; and undermine popular ad-supported business
models. In other words, it would do more considerably harm than good.
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