Tax Thee, Not Me: Why Taxing Digital Giants Is a Lawmaker’s Dream

Being an elected official is no easy feat. On the one hand, you get to pass legislation to spend money, but unfortunately you need to pass laws to raise taxes, too. That is something no legislator who is running in the next election relishes. So, an ideal answer is to tax entities in some other jurisdiction. They may complain, but they can’t vote. Plus, if you tell your voters that this free windfall will be spent on apple-pie-like priorities such as K-12 education (and not on public sector retirement funds) you can cruise to reelection. Win-win.

Therefore, it should be no surprise that not only are European countries taking this easy path, but so too are U.S. states—in this case taxing large, out-of-jurisdiction Internet companies. The latest example is the Maryland legislature’s recent decision to tax digital advertising revenue in the state, which of course mostly amounts to taxing large Internet platforms.

There are several problems these provisions. First, tax law is based on the notion that corporations pay taxes on their profits, not on their sales, and moreover that taxes relate to geographic nexus. (You get to tax firms in your state, but not those outside it.) Most large Internet firms are based in California and pay taxes to the state of California on their profits, just as companies headquartered in Maryland, like Lockheed Martin and Marriot, pay most of their corporate taxes in Maryland, not California.

Lawmakers use all sorts of justifications for breaking form to impose discriminatory extra-jurisdictional policies, with the most popular being that digital commerce is new and important and therefore should be taxed. Washington State Representative Shelley Kloba (D) states: “Our tax system reflects our economy the way it was back when we achieved statehood. Our economy doesn’t look like that anymore. The collection, processing and sale or commercialization of data is really big business.”

This would be akin to a state legislature in 1921 saying “our economy doesn’t look like that anymore. The production, sale and commercialization of steel is really big business.” When steel was the most important factor driving economic growth, states didn’t impose steel taxes. Likewise, today the collection, processing, and sale or commercialization of electricity, water, and paper is critical, but we don’t have discriminatory taxes on the sales of products that had electricity as an input.

The simple fact is that taxing digital advertising is discriminatory. Why not tax highway billboards, TV ads, or newspaper ads? The obvious answer is that lawmakers want to grab revenue from out-of-state firms in an ill-advised, distortionary attempt to shore up state tax coffers at the expense of local businesses that advertise on the Internet, which will now surely face higher costs to reach their local customers.