The Era of Digital Goods: Transcript

Cara Griffith: Welcome everyone. I'm Cara Griffith, the president and CEO of Tax Analysts. I'm so pleased that you've joined us for this timely discussion on taxing digital advertisements and other products and the development of state laws to address modern technology.

Today is the ninth in Tax Analysts’ series of public discussions that we call “Taxing Issues.” We launched this series in 2020 as part of our 50th anniversary celebration. And through the series, we are bringing together the tax community with leading policymakers and experts for bipartisan discussions on the future of tax policy. While I'm hoping that we can hold in-person events in the not-too-distant future, we will for now continue to hold these discussions in a virtual format. And we welcome your feedback on how we can make them more interactive. We also welcome your suggestions on future webinar topics. You can send your feedback or suggestions to events@taxanalysts.org.

And now on to the topic at hand. At the state level, Maryland has been on the cutting edge when it comes to developing taxes for the digital era. Maryland enacted laws to tax digital advertising services and digital products, as well as digital code, earlier this year when the Democrat-controlled General Assembly overrode [Republican] Gov. Larry Hogan’s veto of two bills.

The first bill, H.B. 732, imposed a tax on the revenues received from digital advertising. Taxes imposed on persons that have global annual gross revenues of $100 million or more and digital advertising revenues sourced to Maryland of $1 million or more. The rate of tax is said to be determined on a sliding scale based on global annual gross revenues. Numerous business groups have opposed the digital ad tax. They say that it probably violates the Internet Tax Freedom Act (ITFA) because the tax would apply to digital advertising but not to non-digital advertising.

The second Maryland bill, H.B. 932, amends the term “retail sale” for purposes of the sales and use tax to include certain digital products. Along with taxing digital products themselves, the bill expands the sales and use tax to include sales of subscriptions to digital products, streaming of digital products, access to digital products, or the purchase of a digital code to receive or access digital products.

While the digital products tax is less novel, the digital ad tax is truly novel. Maryland is the first state to tax the revenues derived from digital advertising. But several other states are considering similar proposals. Revenue from the digital ad tax has been earmarked for education. State lawmakers have been looking for ways to fund the state's $855 million education system overhaul without raising income, property, or sales taxes. Revenue from the new digital ad tax will go a long way towards reaching that goal.

But the road that both bills took from conception to enactment was far from smooth, and we expect to see a few more bumps along the road. Maryland’s attorney general, Brian Frosh [D], didn't inspire a lot of confidence that the digital ad tax would survive legal scrutiny when he said that there is some risk that a reviewing court would find the tax unconstitutional. Nevertheless, Frosh said that he believes the tax is not clearly unconstitutional. To buy itself some time, the Maryland General Assembly passed an emergency bill last month that would push back the implementation date of the digital ad tax and make some corrections to the expansion of the sales and use tax to digital products. Importantly, this new bill prohibits companies from directly passing on the cost of the digital advertising tax to customers through a separate charge. In addition, the bill further defines digital code and what items are not subject to tax even if they're delivered digitally. The legislation now awaits the governor's signature.

Maryland is certainly serving as a laboratory for democracy here. And a lot of other states are watching closely. To help us sort all of this out, we have an outstanding keynote speaker and panel. We will begin today with remarks by Del. Eric Luedtke [D], the majority leader and chair of the Revenues Subcommittee in Maryland's House of Delegates. He represents Maryland's District 14, and he was instrumental in the development of the digital tax bills. After Majority Leader Luedtke speaks, we'll have a panel discussion with three additional outstanding speakers. But without further ado, Majority Leader Luedtke, thank you so much for joining today. And we look forward to hearing your remarks.

Eric Luedtke: Thank you so much for that very kind introduction and for inviting me. And thank you to Tax Notes for the work you do to educate people about tax policy. It's not something that all of my colleagues are super excited about, but as chairman of the Revenue Subcommittee, I find it really important and really interesting. As you say, I think this is a period where states are fundamentally reconsidering the structure of their sales taxes, and we're seeing significant shifts in the applicability of sales taxes. Perhaps it's been no more significant than at any period in the history of the sales tax, going back to the implementation of retail sales taxes by states during the Great Depression. And as you say, these issues have to do with the transitions going on in our economy.

And there are a number of those transitions that I'm sure our listeners here are familiar with. One, of course, is the gradual transition we've been experiencing for the last few decades from a goods-based economy to a services-based economy. And those conversations are still ongoing, but they're now caught up in conversations about the much more rapid shift to a digital economy. And I think what states are struggling with is that the sales tax has become such an important part of our revenue, and that if we do not modernize our sales taxes, we will either have to shift our sources of revenue to other types of taxes, which would require increases in things like the income tax or the property tax, or we would have to cut government. And that is particularly challenging, frankly, at a time where state governments are being tested as never before. We’re seeing record applications for entitlements, for unemployment insurance, [and] record spending on emergency healthcare related to the pandemic.

So yes, in Maryland a lot of our focus has been on funding our schools. But the larger question is how states can continue to fund the basic services that keep our society and economy running if we don't implement changes to the sales tax. In Maryland, we have been fairly aggressive in making changes to our tax code. The digital goods and products tax was actually significantly less controversial. And many business groups didn't express strong opposition to it — until, I should say, the interpretation, the guidance around some of the details of the digital products and codes tax came out earlier this year. And we did have to do some follow-up legislation, as you mentioned, addressing things like the taxability of semi-customized software, the taxability of trainings that professional associations and business associations offer — a lot of smaller details like that, that are important to get right, and to clarify the intent of the legislature.

And then, of course, there's the digital advertising tax, which, as you say, I think is an innovative proposal. I think the question of its legality or constitutionality is certainly going to be decided by the courts. There have already been cases filed challenging the law. And that's one of the reasons that we delayed implementation, to give time for the judicial branch to do its job and provide due diligence as to the legality of this type of taxation. But you know, from my perspective, the fundamental question is: Should companies that have this advertising-based business model essentially not have to pay any state tax in Maryland, despite the fact that they derive enormous benefits from our residents and our economy? I'm of the belief — and I think it's a basic belief that a lot of the members of our legislature hold, and I think it's true of other legislatures and other states — that everybody should pay their fair share.

And that's, I think, the basic political argument behind the bill. Now, of course, it is much more complicated than that in its implementation. And I think the courts will suss that out. The changes we made to the digital advertising gross receipts tax this year are essentially intended to be clarifying changes. The provision that says that businesses cannot pass through as a line item the cost of the tax was a direct response to concerns expressed that the gross receipts tax would be billed to consumers — basically as if it were a sales tax instead of a gross receipts tax, which is what it's intended to be. And the clarifications around the applicability to media organizations were also intended to be simply a clarification. But ultimately, as with many other policy issues and many new ideas in our governance and in tax policy, the courts are going to have their say. And that's where we're at in the process right now.

So thank you for inviting me. I'm happy, if we have time, to answer any questions you have, Cara.

Griffith: Thank you so much. I do actually have a couple of questions. You mentioned at the outset that this is an innovative proposal, and it truly is. Did you have a model, or was there an inspiration for this tax that you kind of based it all on?

Luedtke: Some European countries have been considering similar taxation schemes, and the original sponsor of the bill is actually our Senate president, Senate President [Bill] Ferguson [D]. And I know he did look at some of those models. But primarily he was working with economists, who were proposing this as an idea for expansion of the sales tax.

Griffith: Do you think it's the best way? You've mentioned the idea of corporations paying their fair share. And so we look at these large social media companies like Facebook and Google. Is this the best way to tax them, or is there some other way that might work better and accomplish the goal of having everyone paying their fair share?

Luedtke: It's a tough question, and it's rooted in larger issues having to do with sales tax and nexus and income tax and property tax — sort of the whole range of taxation. Companies like Google and Facebook do not really have a physical presence in the state of Maryland, but they have an enormous presence in reality. Our concept of a physical nexus as being important to taxation is a concept that's rooted in a pre-digital age. So is this the best way to go about it? There may be other alternatives out there. Should the courts strike down this version of it, I suspect that Maryland and other states will be looking at alternative ways to make sure that we have a broader base for sales taxes and we're not overly taxing certain segments of society because we simply can't find a way to tax other segments.

Griffith: Well, thank you so much for joining us today. Really appreciate it. I know that we're going to now have a fun discussion, debating a lot of the issues presented by this. There's a lot here, but thank you so much for joining us. We really appreciate your time today.

Luedtke: I appreciate it, and I'll be listening. And I'm looking forward to listening as well.

Griffith: So with that, let's turn to our panel. I think we have a lot of issues to discuss, and this is going to be a lot of fun. So our panel: We have three terrific speakers today. First we have Nancy Prosser, who is general counsel at the Multistate Tax Commission where she provides legal support to the commission and participating states. We have Doug Lindholm, who is the president and executive director of the Council On State Taxation, a membership organization of nearly 550 multistate corporations. Finally, we have professor Richard Pomp, who is a professor of law at the University of Connecticut School of Law. Professor Pomp is a qualified expert witness. He serves as a counsel and consultant, and he is also on the advisory board for State Tax Notes.

At the outset I noted that we welcome your questions, and we absolutely do. Thank you to those who emailed questions in advance. If you'd like to submit questions during today's event, please do so using the chat feature. The panelists will discuss the issues at hand, and then we'll get to as many of your questions as time permits. I'd also like to mention that you can download any of the slides for today's presentation. And with that, I'm going to turn it over to Nancy to provide some background and some opening remarks for us.

Nancy Prosser: Thank you, Cara. Good afternoon, everybody. It's great to be part of this program today. Thank you for the invitation. I want to say a few things about the Multistate Tax Commission, the organization I work for, and then give some thoughts about how I see this whole topic of taxation of digital products. I'm not sure what slides you're seeing at this point. One thing I did want to start with is a brief disclaimer that a lot of the remarks today will be my own. I will try to be clear when I'm speaking on behalf of the commission. Next slide, please.

Just quickly, I know that we have some people that are participating from across the world in other countries today, so quickly about the Multistate Tax Commission. We are an interstate governmental agency, a dot.gov organization based in Washington, D.C. One of the important things to remember about the MTC is we focus on income franchise sales and use taxes in our work. And we do our work in the public sphere. We very much encourage public participation in our different activities. We work under the Multistate Tax Compact, and our members are the heads of the departments of revenue throughout the country. And so, right now all states, except basically one, participate in some respect with our organization. Next slide, please.

Our mission is threefold: to promote uniformity; to assist taxpayers with compliance; and then importantly, to advocate for state sovereignty over tax systems. Next slide, please.

I guess I also wanted to mention some of our program areas. We have a robust Uniformity Committee, which works on model statutes and regulations. I am part of a great team of six attorneys that provide legal support to the states. And part of what I bring to this discussion is also almost 16 years of working for the Texas comptroller of public accounts before I came to the MTC. So I've worked around these issues for a number of years. And in thinking about preparing for today's program, I realized that — and as Cara kind of touched on — there's a sense that with this topic that the states are rather new to it, that they haven't been dealing with this for very long. But my experience says that actually some states have a lot of experience with this topic. And yes, there are some that are kind of dipping their toes in for the first time.

But it led me to kind of come up with what I call “brief and random history of events relating to taxation of digital goods and services.” And these are just things that jump out at me as I've worked in this arena and with this topic over the years. Starting with: When did this even come on the scene for states to have to deal with this? And so, by doing some research on the internet, it said 1989 was the first time we had an internet service provider on a commercial scale.

And then from that, the next event that really stuck out to me was 1989 — or not — excuse me, 1998 — when something called the Internet Tax Freedom Act was originally passed. And I know we're going to be talking about that a fair amount as we have this discussion today. But to keep in mind — for those of you who may not know as much about that particular federal act — when it was originally passed, the whole idea was it would be a temporary measure, to put in place kind of a pause, if you will, so that this fledgling new technology called the internet would have a chance to get under its wings and be established before the states may do something through taxation that would cause a problem. And I'll note that there were states like Texas, which were already imposing tax on internet access. So there were some that were along the way grandfathered until ITFA became permanent and the preemption [was] in place.

The other thing that I noted just from my own experience in Texas, and this question of have states been dealing with this issue, is in 2001, when in Texas the definition of taxable item was amended to add this statement that essentially says the electronic version of a digital or of a tangible item would be taxed the same. Ergo, the book you buy in the bookstore, or one you download from the internet, the taxability was going to be treated the same. So again, 20 years ago, Texas put this into its laws.

I also was mindful that we have, of course, the 24 or so streamline states that work on uniformity with respect to sales and use tax issues. They’ve dealt with this a little bit. In 2008 [they] adopted something into their agreement.

And then another major milestone for me is that 2009 to 2010 period, when Washington state, after a couple of years of spending a lot of time working in conjunction with industry and legislature and the Department of Revenue, came up with a pretty comprehensive scheme towards and structure for taxing digital goods and services. Congress has come back into play again. In 2010 we first saw the bill, the Digital Goods and Services Tax Fairness Act, [which] hasn't been passed into law. We haven't seen it in this recent Congress, but I'm sure we'll see it again, which puts in place more of a sourcing regime for these items.

And then, since these are all more on the sales tax side of things, I wanted to note again work of the commission on the income tax side. In 2017 it amended its regulations regarding apportionment and allocation and included amongst those revisions a provision that dealt specifically with sourcing of advertising. And I'll also note even this week in [Tax Notes State], there were two articles. COST — our friends there had a really interesting article where they noted this particular provision with a very positive mention in terms of the uniformity that it helped to bring to the arena. So I just wanted to note that it's not just been in the recent past that states have dealt with this for the MTC, but we do have some experience. Next slide, please.

I just also wanted to note that our Uniformity Committee, which has been helmed by Helen Hecht, is just starting a new project on the sales and use tax side, which will focus on trying to take all of the things that we have learned in the past, and how can we look at putting together best practices for how we tax sales of digital products in the world that we find ourselves. And you can find information about that project through our website. And again, we encourage public participation, and we know this is going to be of great interest to a lot of folks. Next slide, please.

So my last slide in opening remarks on this topic — just my take on things, given all the years that I've now worked around this issue and looked at what's going on in the world — kind of came up with four key things, takeaways for myself. One is I'm not surprised that legislatures are looking at this topic. It makes sense for them to look at their tax codes and try to bring them into — as we've heard the legislator before us talking — say, match the economy where we're in with their tax codes.

But, as I've already noted, too — second point: There are some states that have had some real success with this, who have a lot of experience with this. I mean, Washington State did a really nice presentation for the Uniformity Committee, and we're going to get that on our website for you to take a look at if you want to, about their experiences. And success for me means we get legislation on the books that people can understand, that the departments of revenue can administer, and taxpayers can comply with, that does bring in revenue but also takes into consideration — that doesn't burden, create great risks and tremendous costs for the taxpayers who are affected.

Third — this is an MTC position but also a Nancy Prosser position from my years of experience — I don't think Congress is the right way and the right place to answer these questions. Because part of what we see is, once that happens, there's nobody to provide guidance on that front, leaving a gap. And usually these laws sit on the shelf, and it's hard to get any kind of revision to them.

So lastly, my point is what would SCOTUS [the Supreme Court of the United States] do? And that is, we've got lots of cases. We've got things that are percolating through. But is there a chance that we'll see the Supreme Court weigh in on this in some way that gives us more guidance about commerce clause issues and the anti-commandeering doctrine? And where will that lead us? So with that, I will pause and turn it back to Cara.

Griffith: Thank you so much. That was very useful background. I appreciated that. Doug, let's turn it over to you.

Douglas L. Lindholm: Thank you, Cara. It's great to be here on this webinar. Just a couple opening, prefatory remarks. From a policy standpoint, we have no objection to states expanding their sales tax base, as long as they expand them to consumer goods, digital consumer goods. Where states run a little bit afoul of policy is if the digital goods they try to tax are business-to-business — that is, business inputs.

But I want to drill down a little bit on the 64,000-pound gorilla in the room. And that's the digital ad tax. I know that's the one that is concerning you, and that is not an expansion of the sales tax base. That is a separate gross receipts tax imposed on companies. And fair disclosure: I'm the executive director of COST. COST has about 550 multinational companies. And many of the companies that are targeted under the ad tax are our COST members.

But let me say, we're not anti-tax-law. We realize that taxes are the price that you pay for a civilized society. But we're very concerned about taxing companies the right way. That is, taxes cannot be discriminatory; they must be imposed in an equitable manner, and in the way that is least harmful to economic growth and competitiveness. I'm not going to spend a lot of time in my prepared remarks on the constitutional problems with the ad tax or the violations of the Internet Tax Freedom Act. I think we'll get to that in questions. And I suspect professor Pomp will touch on those as well.

But I would like to touch on the origins of the ad tax or what they call digital services taxes — or you'll hear me refer to them as DSTs — in Europe. Majority Leader Luedtke referenced the fact that a lot of European countries are doing this, and in particular, France. France was the first one out of the gate to target primarily U.S. companies with a unilateral tax. And I think 90 percent of the tax in France impacts U.S. companies. So this begs the question: Why did France do this?

Well, international tax rules are ill-equipped to deal with the digital economy. First of all they have a permanent establishment rule that says, unless a company has a significant physical presence in that country, the country can't tax them, can't reach them, no nexus. Secondly, international tax rules rely heavily on rules that allocate taxing rights to the location of the income-producing activity and not to the location of the market state or the market jurisdiction. So in France, there was really no way that they could get to either the company or the income from that company that they saw as being derived from the subscriber base in France.

So they took a unilateral approach and targeted U.S. companies. The U.S. trade rep immediately objected. And we got into this negotiation with France, and they agreed to make it temporary. Now, while this is going on, the OECD, the Organisation for Economic Cooperation and Development, just is sort of like the MTC on a national scale — and that's a compliment, Nancy — has been working for the last decade on base erosion and profit shifting. That is, finding a multilateral way to make sure that big companies are taxed fairly. One of the offshoots of this BEPS project is what we call pillar 1.

Pillar 1 acknowledges the weaknesses that I just discussed and tries to fix them. What they propose is to (1) get rid of the permanent establishment rule and replace it with an economic presence rule or a significant economic presence rule, and (2) specifically allocate some of the taxing rights to the jurisdictions that aren't getting them. Now, that is the market jurisdictions, like the subscriber bases. There's a precondition, however, in pillar 1 that says if we're going to adopt this multilateral approach, then there has to be acknowledgement that all of these DSTs are temporary and will be withdrawn before pillar 1 is agreed on. Nearly every country — there's about 25 or 26 — that has looked at this has said, “Yes, these are temporary; if we get to a pillar 1 agreement, then we will withdraw them because there's no more need.

Now let's compare that to the state rules. Are the same flaws present in state corporate income taxes as in the international tax arena? Absolutely not. And let me tell you why. First of all, ever since Wayfair, every state (except Delaware, I think) has imposed an economic presence rule to exercise taxing authority over companies. So Maryland can indeed get to those companies through their corporate income tax. Secondly, most states have moved over the years to either a single sales factor or a heavily weighted sales factor. I think in Maryland a single sales factor goes into effect next year. That again is a move toward the market, where the sales take place.

Finally — and I referenced Nancy's — the MTC’s — section 17 regs that move states to market sourcing — more and more states — I think we're up to around 33 — impose market sourcing, which sources the sale of advertising services specifically to the location of the customer. So Maryland can indeed get to this income from these big companies.

Now I want to give a shout out to two of my colleagues here: Karl Frieden and Stephanie Do. Nancy referenced the article that they wrote. It is called “State Adoption of European DSTs: Misguided and Unnecessary,” published in Tax Notes State just two days ago [May 10, 2021, p. 577]. I highly recommend it. It goes far into more detail than the than the four or five minutes I have here.

In effect, what's going on since the state corporate income tax rules have adopted and evolved to address the digital business model, there is no need to go after it to ring-fence a specific company and go after them in an aggressive way and in a way that, most economists will tell you, gross receipts taxes are very, very poor way to reach companies.

One final point I'd like to make — and I'd like legislators who were listening and state legislators to take a look at the big picture — adoption of state digital services taxes or digital advertising taxes really puts our national government in a bind on the global arena. We oppose those, and this is bipartisan opposition. Both the Trump administration and the Biden administration oppose the unilateral national adoption of digital advertising taxes. And I'll tell you, that's very rare that you get a consistency like that.

Now imagine Secretary [Janet] Yellen, our Treasury secretary, in a meeting with the G-20, trying to convince them that these digital advertising taxes are bad and should be repealed. A very easy response: “Well, you can't; you have no leg to stand on. Your states themselves are imposing the very same tax that we want.” So don't just recognize that we, the U.S., have a huge economic advantage with our tech companies. And by all means, states should tax them using the full array of their tax structures now: corporate income taxes, sales taxes (by the way, businesses pay 40 percent of sales taxes, which are on business inputs), property taxes, a whole host of other taxes — employment taxes, payroll taxes, etc. But don't go out of our way to discriminate against a specific sector of companies just because they're doing well, when you can already reach them through your existing tax structure. And unfortunately, a new untested tax like this is going to be very painful from a litigation and a planning standpoint. So I will stop there and turn it over to my colleagues.

Griffith: Thank you, Doug. You make a good case against this. So let's hear a little bit more maybe on the legality and the constitutionality, from professor Pomp.

Richard D. Pomp: Yes. First, this pirate’s patch [referring to his eye patch] is not a political statement on how the Facebooks of the world are pirating our data. I had surgery this morning, and this patch was free. The painkillers were free, so I took a couple of free souvenirs with me, and am very happy to be here — at least until the souvenirs wear off. And thank you, Cara, for another wonderful panel in what has been a series of just terrific panels. So my compliments.

Doug — with his usual eloquence, of course — leaves out one or two pretty major points. I have heard Mr. Luedtke earlier — let's see, maybe it was last month — talk about that Maryland is not getting its fair share of some of these large players like Facebook. And he has a wonderful point. Facebook posted U.S. net income of about $20 billion in 2020. I don't know what share of that Maryland is getting. Probably not its fair share. I agree with Mr. Luedtke on that. Why? And this is the point Doug, in his excitement, of course, just seemed to overlook: Maryland is a separate-entity state with no throwback rule. So a little point that ought to be put on the table.

I can only think of the incongruities of our being here lamenting the lack of fairness that requires a (misguided, in my opinion) tax on digital advertising without closing these blatant gaps in Maryland law. You might as well put a sign on I-95, the major north-south highway coming into Maryland — “Maryland: Home of Voluntary Compliance,” because that's what it means when you're a separate-entity state with no addback, no throwback, or — they have a modest addback for intercorporate transfers. You just don't control your own tax base.

It is somewhat ironic that at the same day, there was a hearing on this bill, there was a hearing on a bill to introduce combined reporting and a throwback rule. And who testified against it? Well, Doug unleashed his dogs because they're very good. They're smart. They’re eloquent. And they testified against the bill — probably the single-most important thing Maryland can do to take control over its tax base.

Their argument is based on something that happened back in 2007, 2008 — you remember, recession years in this country. Maryland was thinking of combined reporting then, and they did something that made sense. It said to the companies: File pro forma returns as if we had combined reporting. But, of course, they left out a lot of the details on what the rules on combined reporting were going to be: How are you going to handle losses, credits, instant unity — all of that — net operating losses, and various apportionment formulas — different apportionment formulas for members that were going to be combined. And so it wasn't the most rigorous pro forma set of returns that one has seen. And it was a bit asking the fox to design a lock on the hen house. You can't help but think that folks who did not want combined reporting calculated their pro forma returns to suggest it would not be a good thing for Maryland. It showed losses. Well, maybe not surprising given that it was 2007 and 2008.

That is what gets thrown up every time Maryland discusses combined reporting. It's about time we reject that mantra and move beyond that. There are ways to control losses that might result from combined reporting. Of course, no one asked the question: How much would Maryland save in administrative resources that go into guarding a separate-entity regime from taxpayer abuse? So if you're worried — as any state should be — but if Maryland is worried about some of these big companies like Facebook [and] Google not paying their fair share, they certainly have it within their power to correct.

As Doug correctly noted — and that is a great article, by Karl and Stephanie — we are no longer saddled with that physical presence rule. We have economic nexus. Our sourcing rules have moved toward a market-based approach. And that means you can get a lot of money that you previously weren't getting. But if your base is defective because it's on a separate-entity basis, you're not going to pick up that money.

I will turn, maybe, as we move into the questions, Cara, to the digital advertising tax. But for now, I would have asked Mr. Luedtke: While this bill was being drafted, all of the defects were brought to the attention of his committee, and more generally the General Assembly and the attorney general. Not one change in the bill was made in response to these complaints. And you have to ask yourself: Why not? I mean, some of them were remediable, so why was nothing done? And I have to wonder whether this bill — this law now — isn't a stalking horse for combined reporting. I mean, maybe that wasn't the intent, but it could well be the result.

The revenue is earmarked for education — a laudable goal, to be sure. And there's a lot of the beneficiaries of that earmarking that I'm sure already have the money spent, because that's the way it usually works. They're going to be chagrined when they realize that the money is not going to be forthcoming, in which case they really now become allies for getting something in place that will generate that money. And that's something will be combined reporting. And rather than Maryland take great pride in being the first state to have a defective tax on digital advertising, maybe it could join the nearly 30 states that have combined reporting. And if they really want the distinction of being the first, they could adopt worldwide combined reporting, which, by some estimates, will raise over $300 million more than this law was estimated to raise but probably won't see a penny. And that may turn out to be the silver lining. So Cara, back to you with wherever you want to take us.

Griffith: Wonderful. Thank you. So Doug, I have to give you an opportunity to respond here to the idea that — and I asked Delegate Luedtke on — if there is a better way to tax the Googles and the Facebooks and the social media companies. And professor Pomp suggested that perhaps combined reporting is right. So I want to give you an opportunity to respond and give your side of the coin on that.

Lindholm: Thank you, Cara. Professor Pomp — I'm not sure why he is chewing on this like a terrier on a bone — but the difficulty with combined reporting — and Maryland, more than a lot of states, took a very, very intense study of what combined reporting would mean for the state. They forced companies to do a pro forma. Companies did that. They called thousands of companies as a follow-up. Professor Pomp said they left out some of the details. Well, all it does is highlight the difficulty of defining what a unitary group is and what should be in that base. And the difficulty here is that the result of that pro forma testing found that combined reporting would actually make the state corporate income tax more volatile than it is now. There would be greater losses when a recession, greater income in an uptake. Do you really want a more volatile tax? And the legislature, in their wisdom, said no.

I still think that combined reporting, because it is a judicial doctrine, is hopelessly vague. Who knows what functional regression, economies of scale, centralized management, actually mean in the real world? And again, it's very, very difficult to administer it [and] very difficult for taxpayers, especially if it encourages both taxpayers and the states to cherry-pick on who is in the unitary group. So I don't think that is an answer at all.

He also referenced worldwide combined reporting, which was an idea that was thrown out by California way back in the 80s that created threats of retaliatory taxation from some of our biggest trading partners, the U.K. and Japan. And ultimately, a committee established by Treasury Secretary [Donald] Regan shot that down as not something that you should do.

I love professor Pomp, but sometimes he sits up in his ivory tower and has never had a chance to file a unitary return or go through a unitary tax audit. I don't think that unitary is or would be an effective stalking horse to replace this ad tax at all. I'm sorry that we seem to be getting off topic here.

Pomp: All I can say is, it must be 30 states are just wrong then in the country. And when did California start to do combined? Probably the mid-‘30s to deal with the movie industry. That's nearly 100 years of experience.

Lindholm: I don't think the states that have adopted combined reporting have seen the revenue jump that you're talking about — $300 million?

Pomp: That’s on worldwide. That is the estimate for Maryland on worldwide.

Lindholm: That's the ITEP [Institute on Taxation and Economic Policy] report that is based on a wildly, wildly exaggerated estimate of global profit shifting and how much it might impact the staff.

Pomp: The numbers you don’t like are always wildly wrong.

Lindholm: Well again, the hundreds of millions of dollars have not come forth in the other states that the ITEP projected as well.

Pomp: Alright. Cara, on to the bill and the law now in front of us.

Griffith: Nancy, I'm going to turn to you on somewhat of a similar question, but is the digital ad tech sound tax policy, or is there — it does come back to a similar question — is there a better way if this is not sound tax policy? What's your take on it from a multistate perspective?

Prosser: Again, I guess I look at this as I'm sitting here as the tax administrator. We're the people that are given these laws to try and figure out how to help people comply. I don't see my role here is saying it's good tax policy, it's bad tax policy. That's for the legislatures to determine. In keeping with the mission on the MTC, we support the right of every state to have whatever tax structure they think is appropriate. So it's not for me to say it's good policy, it's bad policy.

I will say, though, that — getting back to earlier talking points — to me, a successful piece of legislation is one that is understandable and administrable for taxpayers to comply, and balances the revenue raised with any of the burdens and costs to the taxpayers — that this is a new approach to state taxation. And if the goal is to modernize your tax system and do it in a way that reflects good tax policy in a sense, or policy that is proven, I should say then, as I noted in my introductory comments, there are states that have experience with this, that have been able to do it. And instead of doing something new and generating a lot of expected litigation that may take a while to work its way through the system, I'm excited about this project the MTC is undertaking to look at it on the sales tax side, where can we take the successes we know exist and build on that, and build on what MTC and other states have done even on the income tax side. So that would be my response to that.

Griffith: I think it's going to be one of those taxes where the guidance that comes out is going to be incredibly important for taxpayer compliance purposes, as well as for administrability. It looks to me like the Maryland law determines the taxpayer's tax rate based on income that includes what the taxpayer earned outside of Maryland. I'm curious from all three of you: Is that legal, to determine a taxpayer's tax rate based on their income earned outside of the state? So professor, start with you?

Pomp: Indeed, it's based on their revenue, worldwide revenue. The more revenue you have outside of Maryland, the higher your tax rate is going to be, even though that rate will be levied on only Maryland advertising. Yet to be determined how that decision will be made. And that's just so contrary to what we know from the corporate income tax — the more outside-the-state activities you have, the lower your tax in the state — and it violates the Constitution. It violates a number of provisions. We could dig down deeper if you want, but just to get it on on the table: No, that is one of the many defects in the bill.

Just to comment on things that have not received the same attention. That point, I think, has received attention. What has been less obvious is this tremendous notch effect that is in the law. When you put your slides up, if a taxpayer has worldwide gross revenues of $1 billion, the rate I believe is — what? — 2½ percent. But if they have $1 billion plus $1, a billion and one, that rate goes up to 5 percent — it doubles. And that is what economists have called a notch effect — that normally we don't have progressive rates greater than 100 percent. And that's just a very odd way they drafted the rate structure. I don't know exactly why. It's certainly not inevitable it'd be done that way. It's interesting that they're so embarrassed by this that they won't let the taxpayers separately state the tax on an invoice or show it or itemize it. Maybe that's unconstitutional. Some of my colleagues who teach more First Amendment jurisprudence than I do suggest that it's commercial speech, and that is protected under the First Amendment. So that may be an issue. But they've turned it into this stealth tax, which it really starts off being anyway, and then they've aggravated that feature of it by saying you can't even itemize it if you want.

It's not that you can't increase your prices by the tax. You can. No statute can repeal the supply-and-demand curves as determined the economic incidence of a tax. That's what determines whether tax can be passed on or not. All this does is hide the cost of government from voters. And so much for openness and transparency in the financing of state government.

It's interesting to compare that with the sales tax, which you notice, Mr. Luedtke kept transposing sales tax [and] gross receipts tax; these are very different animals. In the sales tax, separately stating the tax is routine. In fact, retailers lobbied for that back during the Depression, when many states adopted a sales tax because they wanted to show consumers, “Hey, don't blame us for that additional 2 percent,” which was a common rate in the old days. “Don't blame us for that additional 2 percent. That's what the government is making us do.” And there was probably also a signaling, saying to everyone else, retailing, “Keep your base price the same, and just separately itemize this at the end.”

But if this were really a sales tax, which it is not, it has none of the attributes of a sales tax, except for the fairly high rates more common of a sales tax and a gross receipts tax. But a sales tax has, at least makes efforts to make sure the tax doesn't fall on business inputs. It has a purchaser resale exemption. It has an ingredient component exemption. It may have a manufacturing exemption, the goal of which, as Doug did mention — and I'll throw out an olive branch to him; I agree with him on this — that a sales tax should fall on ultimate consumption by the end user. This is a gross receipts tax. It's a turnover tax. It's a kind of tax that's been condemned and vilified and mocked by economists for at least a couple of hundred years. It is what led to the value added tax in Europe, which overcomes many of the defects in a turnover tax. This is really nothing to be proud of, to say we've adopted a turnover tax.

And then we have the Internet Tax Freedom Act. But I can stop at this point, Cara, and let people just respond to what I have said. And then we can circle back on the Internet Tax Freedom [Act].

Lindholm: If I could make two points, all in agreement with professor Pomp. First, anytime you've got a tax based on conduct by the taxpayer that takes place out of state, it violates at least the fourth prong and external consistency of the enforcement problem, complete auto. I really have a problem with that. The issue we haven't really talked about — Cara, you referenced guidance forthcoming from the comptroller — the tax is currently in effect right now. Taxpayers have already had to figure out what their first-quarter estimated payments were and send them in — with absolutely no guidance [on] how to determine what the tax base is. If there's ever a poster child for due process violation, this is it. When does that guidance forthcoming? How will it happen? What will happen to taxpayers that have already underpaid estimated? I mean, [this is?] very, very, very difficult.

And the Internet Tax Freedom Act — I’d love to hear professor Pomp’s and Nancy's take on this as well. That to me seems to be the biggest impediment. I want to reference the AG’s [attorney general’s] letter that said that this is not clearly unconstitutional. I thought there was a very interesting explanation for that. And his explanation was: Because you can pay for digital advertising not through the internet, that a court may suggest that the transaction is therefore not discriminatory. I guess that you can write a check for digital advertising, or you can go to the cash window at Facebook and pay cashbit. To me, it's a bit of a stretch. And I think that the AG was wise to couch his words as “not clearly unconstitutional.” But I think they have some real problems in the courts. And professor, Nancy, I'd love to hear your thoughts on that as well.

Prosser: Well, one thing, Doug, is I thought the tax effective date had been moved back and that the first payments are not due until — according to the bulletin — until April of 2022, so. . . .

Lindholm: Yeah. [Inaudible overtalk]

Prosser: Yeah, I think that was one of the legislative changes. So there is more time there, and I agree that was a good move by the legislature to give everybody, including the department of revenue, and give that department its chance to get out the guidance that I'm sure they're actively working on and the taxpayers deserve. And so let’s let the department do their job. In terms of these barriers — claims of unconstitutionality — we know the lawsuits have been filed. We've seen their side of the story.

I will just say again, working with the departments of revenue with the MTC, I want to give the state a chance to defend its law, and give the attorneys who've been assigned the cases to work through them and figure out what they believe about the cases and these constitutional issues, and do the discovery and the research to respond to the claims that have been made. So I'm going to support the department, support those attorneys, and let them do their jobs. And let's see what they have to say in response to the cases that have been made.

Pomp: I'll tell you what they're going to say, because it's certainly no mystery. They're going to say that offline advertising is not the same as digital advertising. Any claim of discrimination requires comparing two transactions or activities. And it presents a level-of-generality problem, which is ubiquitous in the law. There are many levels at which you can describe a transaction. I mean, just take those of us here. We could be described most specifically according to the sequencing of our DNA. And that would be very specific. We could be described most generally as being part of the Homo sapiens group. What level you think is relevant is not always a matter of a priori logic.

If you want stability in the law, you don't want every year someone coming in and saying, “Well, our form of advertising is different from what has already been decided to be acceptable, but we do it in a different way.” We know how technology is evolving. We know there's going to be lots of differences going forward. You really want the most basic level of generality, and that is advertising versus advertising. And if you cut too fine a point on that, you're introducing an instability into the law. You're never going to be done with the litigation. So you can bet that — this a pretty safe bet — that the argument over the Internet Tax Freedom Act will reduce to “offline advertising is just a different beast from online advertising.” Well, we know that. That doesn't tell us very much.

Prosser: You're right, professor. To me, one of the big issues here with the Internet Tax Freedom Act is we don't have a lot of experience litigation-wise. How do you set up those comparison classes? I mean, what are you going to compare? That's one of the fundamental problems I have with [the] Internet Tax Freedom Act. I know this is one of the questions. Is this an opportunity to take a closer look at that particular federal act?

I still have fundamental problems with the idea that Congress can just say, “Hey, we don't like the states imposing a tax on this particular type of activity, so we're just gonna tell you you can't do it.” Again, drawing on my experiences in Texas, when the internet came into being, Texas already had in place a tax on telecommunication services. Its definition covered without question the sale of internet access service.

And, at the time that the permanent ban has now gone into effect as of last year, Texas is losing something like a half a billion dollars a year in revenue. And this is through a tax on a service that, through my experience . . . . Texas, the way it had structured it, it was one of those good taxes in that it was understandable. It didn't generate a lot of disputes or any real litigation. So it met my best practices of tax approaches in tax legislation.

And yet now look at all the challenges that we're going to continue to have as we move through this growing digital economy. Now we've got this federal act that is sitting there, and will Congress ever look at this again? So I really have problems. And this is where, I hope maybe — whether it's this piece of legislation and litigation, or maybe there'll be other cases that come down the pike — but I think it's a real question whether or not Congress should just be able to say, “We don't like you states having a tax on this particular item. And so you can't do it.” So, we could solve this problem if it just went away.

Griffith: So do you think this will be an opportunity to challenge the constitutionality of the Internet Tax Freedom Act? I mean, could we get that far with litigation on the Maryland digital ad tax?

Prosser: Well, I think it's possible. I mean, there again, there are arguments out there that folks have made to look at what was really intended by the commerce clause and whether or not to [inaudible] the Murphy case. I'll be interested to see, with the challenges that we've seen to the American Rescue Plan Act [P.L. 117-2], the states that have filed suit to challenge the provision that says states can't put in place any kind of tax cuts. Does that present an opportunity, if those cases get up to the Supreme Court, to give us some more guidance on that particular issue? Because — and this is one of those things — it would be helpful to know if indeed Congress, through the commerce clause, has this very broad ability to just say again, “We don't like states imposing a tax on X thing,” or “We want to protect this industry; therefore, sorry, states. You're out of luck.”

Griffith: It will be. There's going to be a lot to watch, for sure. I will note that Jim Dawson put in a comment that the Maryland legislation that extends the application date of the tax has not yet been signed by the governor. So the law as it is on the books is currently in effect and became effective 30 days after February 2nd. Though it is his understanding that the comptroller is not accepting estimated payments at this time. So just a side note. Thanks to Jim for that.

Well, I can't thank you guys enough. This was as much fun as I had hoped. It was a very interesting and engaging discussion. And I thank you all for your time, and we could go for another hour. So maybe we'll have to have an update sometime soon. But I thank you. And I thank everybody for listening, and I hope everyone has a great rest of their day.

Multiple Speakers: Thank you, Cara.