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Will Maryland's Tax on Digital Ads Hold Up in Court?

Maryland made history last week, becoming the first state in the country to codify a tax on digital ads. The move would have a significant financial impact on big tech, but the bill will probably face multiple legal challenges.

digital ads on a screen
Overriding a veto from Gov. Larry Hogan late last week, the Maryland Legislature enacted a bill that would allow the state to be the first to collect taxes on digital advertising. While this move might make the history books, experts told Government Technology that legal challenges are likely on the way and that other states will watch the fireworks as they consider their stance on the issue. 

The legislation, which was backed strongly by Senate President Bill Ferguson, takes aim at companies that rake in more than $100 million via digital ads. As such, the law would impact big tech players like Facebook and Google, both of which made billions of dollars in revenue from digital ads last year, according to CNN. 

In a Facebook post, Ferguson said it’s time for big tech to pay up in Maryland, “just like our small businesses.”

“At a time when Maryland’s budget is being impacted in unforeseen and astronomical ways due to COVID-19, Maryland families and businesses can foot the bill, or big tech can start paying their fair share,” Ferguson stated. 

Opposition to the bill included not only Hogan, but many business groups. The fear is that small businesses and consumers will somehow end up paying more themselves, perhaps due to legal maneuvering from big tech. 

Lucy Dadayan, senior research associate for Urban-Brookings Tax Policy Center, said local and state governments “should look into adjusting their tax structures” to adapt to a new age in which e-commerce is a dominant economic force. In her view, Maryland took a step in the right direction. At the same time, she advises states not to rush their tax proposals, as companies will look for loopholes to avoid taxes and pass the burden to others. 

“Enacting digital taxation will not be an easy task,” Dadayan wrote in an email. “Of course there is going to be a lot of challenges in front of legislatures … For example, legislatures and policymakers should carefully craft policies that take into consideration different tax rates and tax policies for cross-border jurisdictions.”

Dadayan believes businesses that participate in the digital economy should be taxed like businesses that participate in the non-digital economy. Otherwise, states could miss out on crucial revenue as the overall economy evolves. 

To illustrate the importance of digital taxation, Dadayan brought up the Supreme Court decision in South Dakota v. Wayfair Inc. that gave states the ability to collect taxes on remote online sales. Tax revenues gathered from such sales “helped dramatically” during the pandemic last year. 

“If the Wayfair decision didn’t happen [more than] two years ago, today we would be in such a terrible situation with the pandemic and associated fiscal challenges,” Dadayan said.

Verenda Smith, deputy director of the Federation of Tax Administrators, wrote in an email that she expects years to pass before a large number of states adopt laws that would impose taxes on digital ads. She cited the example of New York introducing the idea behind marketplace provider collection laws. It took a few years before other states adopted similar legislation. 

“[T]here is little to suggest digital advertising will be different,” Smith said. “Other countries have been engaged in vigorous debate for some years on how best to fairly and even-handedly apply the tax in a digital environment. But most state elected officials want to see how something is working in another state before they give it serious consideration. They want to know how a policy will affect multiple taxpayers, multiple industry types. They want to be aware of political landmines and have an idea of the revenue benefits and losses.”

Dadayan also mentioned the fact that other countries have been looking into taxing digital ads. She said taxing digital ads isn’t as controversial at this point in Europe and that American policymakers should look at best practices in other countries while acknowledging the U.S. Constitution. 

According to the Baltimore Business Journal, the office of Maryland Attorney General Brian Frosh indicated that a court may conclude that “some provisions” of the state’s new law are unconstitutional. However, Frosh’s office added that such provisions aren’t “clearly” unconstitutional in its estimation. 

In an email to Government Technology, Nancy Prosser, general counsel for the Multistate Tax Commission, said she can’t provide an opinion yet on the legality of Maryland’s bill, but it is her understanding that “taxpayers will file suit and at least one of the challenges to the new law will likely be under the Internet Tax Freedom Act [ITFA].” 

ITFA was passed in 1998 during the Clinton administration. The law prohibits “taxes on Internet access” and “multiple or discriminatory taxes on electronic commerce.” Prosser thinks the constitutionality of ITFA might be addressed as debate continues about digital ad taxes. 

“To the extent there is a challenge under ITFA on the grounds that the [Maryland] law imposes tax on digital advertising but not on print or other types of advertising, this could present an opportunity for the states to address whether ITFA itself is constitutional,” Prosser wrote. “So far that has been an academic argument. The Supreme Court’s 2018 decision in Murphy v. National Collegiate Athletic Association that turned on the application of the Court’s anticommandeering rule to a federal law concerning sports gambling in New Jersey could be part of a challenge to ITFA.” 

Jed Pressgrove has been a writer and editor for about 15 years. He received a bachelor’s degree in journalism and a master’s degree in sociology from Mississippi State University.