Maryland Democrats' Digital Advertising Taxes Likely Illegal
Leave it to Maryland Democrats to spend their political capital on passing a tax bill whose revenues they are unlikely to be able to collect legally.
Maryland Democratic legislators are expected to try to resuscitate two tax bills passed in 2020 but vetoed by Governor Hogan last May. The vetoed tax measures were intended to fund H.B. 1300, the Kirwan education spending package. Kirwan’s anticipated price tag is expected to reach more than $4 billion annually, hence the scramble for new revenues. The bills are H.B. 732, which proposed a first of its kind Digital Advertising Tax, and H.B. 932, which would have expanded Maryland's sales tax to sales of digital products, such as Netflix (both downloads and streaming).
The bills were passed even though legal experts and tax opponents pointed out that Federal courts will likely block implementation, due to a conflict with the federal Internet Tax Freedom Act.[i] This Federal law, signed into law by President Barack Obama in 2016, prohibits states and localities from assessing taxes on internet access and prohibits "discriminatory taxes on electronic commerce."
Furthermore, the state law would face challenges that the tax violates the Commerce Clause of the U.S. Constitution, which prohibits state laws that interfere with interstate commerce. This is because, as the tax is structured to be assessed on global revenues, large multinational businesses are likely to have a significantly higher tax burden in Maryland than Maryland-only providers.
The bill may also violate the First Amendment. In Grosjean v. American Press Co. and Minneapolis Star Tribune Co. v. Commissioner, the U.S. Supreme Court considered the impact of taxes on the news media, ruling that industry-specific taxes violate the First Amendment's speech protections.[ii]
In a similar case, the Maryland Court of Appeals ruled that advertising taxes were unconstitutional violations of the First Amendment. In 1958 the Maryland Court of Appeals ruled that a 4% sales tax on television, newspaper, and radio advertising that was proposed by Baltimore City was an unconstitutional violation of the First Amendment.[iii]
The digital products tax (HB 932) would have applied Maryland's existing 6% sales and use tax to digital products, including digital code, streaming, music, ring tones, e-books and audiobooks, movies, online newspapers, and cable, satellite, and pay-per-view television programming.
The Federal Internet Tax Freedom Act prohibition of discriminatory taxes on electronic commerce could also block the Netflix or digital products tax. The definition of "discriminatory tax" includes any tax imposed by a State or political subdivision thereof on electronic commerce that "is not generally imposed and legally collectible by such State or such political subdivision on transactions involving similar property, goods, services, or information accomplished through other means."
This provision means that a tax must treat digital services in an equivalent manner to non-online services.
According to the Department of Legislative Services: "Under one set of assumptions, special fund revenues could increase by as much as $250.0 million in the first full year that the tax is imposed and collected. However, the potential for legal challenges and compliance issues may significantly impact the amount of revenues the State collects from the tax, particularly in the short term."[iv]
Leave it to Maryland Democrats to spend their political capital on passing a tax bill whose revenues they are unlikely to be able to collect legally. Any revenue forecasted for the tax would be unlikely to be collected due to the numerous legal hurdles ahead.
[i] Pub. L. 114-125, Trade Facilitation and Trade Enforcement Act of 2015
[ii]Grosjean v. American Press Co., 297 U.S. 233 (1936); Minneapolis Star Tribune Company v. Commissioner, 460 U.S. 575 (1983)
[iii] Baltimore v. A.S. Abell Co., 218 Md. 273, 145 A.2d 111 (Md. 1958)