Tech Taxes in 2021: Are They Worth it for States?

Taxes on “big tech” have been a major topic of discussion in the tax policy world for a while, but the discussion intensified in this year’s legislative session as a number of states considered new taxes ostensibly aimed at tech companies. In February of this year, we wrote about the three states (MD, NE, NY) that had introduced legislation to tax data or digital advertising and the likelihood of a wave of tech taxes.

Now, however, there’s an even stronger reason to suspect tech taxes may become the next state tax trend: unprecedented revenue shortfalls among states and the knowledge of how states have previously responded to recessions. Following recessions, states have historically raised taxes on targeted industries, particularly the healthcare and telecommunications industries. Though it’s difficult to predict how states will respond when we still don’t know the extent of the revenue crisis, it’s likely the trend of narrow taxation will continue and expand to new policy areas.

Unfortunately, these discussions often fail to contemplate the negative consequences associated with the proposals, or even to acknowledge that the purported targets of the proposed taxes are a small sliver of those who will ultimately bear the legal burden (let alone the economic burden, which would likely fall heavily on consumers).

For the purposes of this post, tech taxes refer generally to taxes on large companies seen as existing primarily in the digital or information technology space, including taxes on data and digital advertising. The scope of these policies, however, often extend far beyond big tech companies and often would result in levies on a wide array of industries, both large and small, and thus would pyramid throughout the economy. 

The most notable example of a state level digital advertising tax is the Maryland effort this year. HB 732 would have created a tax on gross revenue from advertising into Maryland, with rates ranging from 2.5 to 10 percent.  The bill passed the legislature – despite concerns that there was no clear guidance on the practical application of the tax, or how to source advertising receipts – but it was ultimately vetoed by Governor Hogan, who was hesitant to raise taxes in the midst of a recession. It remains to be seen if the Maryland legislature will take it up again in the future.

New York introduced similar legislation at the beginning of July. Proposed rates on digital advertising would also range from 2.5 to 10 percent, but this bill also lacks practical guidance and sourcing rules. The bill has not moved since introduction, and it appears unlikely to progress prior to November elections. New York also has pending legislation to impose a tax on corporations which derive income from individuals’ data. Though this bill is also unlikely to move this session, these ideas illuminate exactly how policymakers are thinking about tax issues. New York and Maryland aren’t the only states to have these conversations this year – policymakers in DC, North Dakota, West Virginia, and a number of other states spent time debating similar issues. 

The reality, however, is that these taxes are nearly impossible for states to get right. States are bound by both the Internet Tax Freedom Act and the US Constitution when it comes to taxing interstate activity. No state yet has proposed a tax structure that would not violate at least one of these federal laws. The Digital Goods and Services Coalition has studied the legal challenges at length. 

An additional concern for states trying to implement these taxes is a lack of precedent. No other state levies taxes on digital advertising or data in this way, and trying to lead the way on complex sourcing rules and costly legal challenges will be difficult at best. Digital advertising and data services are immensely complicated and widespread; monitoring the activity would require significant resources from already strained Departments of Revenue.

Finally, there are the economic concerns: a tax on advertising is a tax on an “input”– something businesses need to purchase to produce their goods and services – on every business in the country. Economists of all stripes rationally argue against including business inputs in the sales tax base (or in an equivalent excise tax base).

Though it’s likely legislators will at least consider tech taxes to help solve their revenue woes, they should also weigh the costs of the financial strain to businesses during an existing recession, litigation, and additional resources that would be required. If these states need revenue, they should consider policies that have solid economic and legal foundations. If the purpose is to demonstrate a different concern with “big tech,” then the better approach might be to articulate those concerns and, if there is in fact a state level policy solution to those concerns, debate that instead.