The Fight Over Maryland’s Digital Advertising Tax, Part 2

In the second of a two-episode series, professor Richard D. Pomp of the University of Connecticut School of Law discusses his views on the federal lawsuit challenging Maryland’s digital advertising tax.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: digital advertising taxes, part 2.

We’re continuing our discussion from last week on the federal lawsuit challenging Maryland’s digital advertising tax. The first part of this series, which you can find linked to in the show notes, focuses on the arguments for the digital advertising tax with Young Ran (Christine) Kim, a professor at the University of Utah S.J. Quinney College of Law.

This episode, part 2, will highlight the arguments against this tax with Richard D. Pomp, a professor at the Connecticut School of Law. For those interested in the background and basics of Maryland’s federal lawsuit, check out part 1 of this series.

Again, I’m joined by Tax Notes reporter Lauren Loricchio. Lauren, welcome back to the podcast.

Lauren Loricchio: Thanks for having me.

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David D. Stewart: Now, before we get to this week’s interview, could you give listeners a brief recap of your interview with Professor Kim on the arguments for Maryland’s digital advertising tax?

Lauren Loricchio: Sure. We discussed her thoughts on Maryland’s digital advertising tax in an amicus brief she filed with another tax law professor in support of Maryland in a federal lawsuit challenging the tax. Her main argument is that digital advertising is different from traditional advertising and therefore isn’t discriminatory for purposes of the Internet Tax Freedom Act.

David D. Stewart: All right. Now, you recently talked with someone with a different view on this lawsuit and these taxes. Can you tell us about your guest and what you talked about?

Lauren Loricchio: I spoke with Richard Pomp, a law professor at the University of Connecticut and a well-known expert on state and local taxation. We discussed his views on Maryland’s digital advertising tax and its legal flaws.

David D. Stewart: All right. Let’s go to that interview.

Lauren Loricchio: Thank you for joining us today, Professor Pomp.

Richard D. Pomp: My pleasure, glad to be here.

Lauren Loricchio: First I was hoping to get your views on Maryland’s digital advertising tax and whether you think there are any issues with it.

Richard D. Pomp: Tons of issues. The question is whether it’s even going to survive the Biden administration. Right now it is a thorn in the side of attempts by the president and by Secretary of the Treasury Janet Yellen to get these European countries to back off of their digital services taxes.

I’m only speculating, but I would think calls should be and will be made from Washington to Maryland encouraging them to put this tax on hold so that we can at least say even our own state has backed off from the DST. Otherwise we just really look kind of foolish. I would think that the tax probably will succumb to these pressures.

I think listeners know there’s two cases pending. They will beef up their foreign commerce one-voice arguments, I suspect. If there was ever a poster child for violating the one-voice doctrine, it is Maryland. Normally we don’t think much about that one-voice doctrine, and no taxpayer has successfully struck down a tax under that doctrine. But if there were ever a reason to do so, this is it.

Lauren Loricchio: For listeners who don’t know what the one-voice doctrine is, could you explain what that is?

Richard D. Pomp: Yes. It’s a doctrine under the foreign commerce clause and, without getting too much in the weeds, it essentially says that a state can’t interfere with the need of the government to speak with one voice. You could think of it as kind of a soft preemption type of doctrine.

Of course, when we say government, it’s interesting. Are we talking Congress? Are we talking the White House? We always use the term “government.” There are three branches of government. In this case only two are relevant.

Congress seems to be on the same page as the White House. There seems to be this concerted effort to force these foreign DSTs to either be rescinded or to at least be temporarily suspended. They are viewed as discriminating against the American media companies, and that probably was the effect, to get the Facebooks of the world and Google and others. Maryland had the same objective.

This one-voice doctrine says a state shouldn’t be allowed to interfere with government policy. If the government is unified in their views, and if we have a renegade state that’s an outlier acting inconsistently with those views, then the state tax should fall.

Lauren Loricchio: You kind of touched on the international agreement that was reached on DSTs. Do you think that’ll encourage other states that are thinking about adopting digital advertising taxes like Maryland’s to maybe rethink those ideas and maybe hold off on it?

Richard D. Pomp: I do. You have covered the Connecticut attempt to basically mimic Maryland, which of all things is just absurd. Why would a state kind of hitch their wagon to another state’s tax that’s the subject of two lawsuits? It makes no sense at all.

The Connecticut tax picked up all of the defects in the Maryland tax, but Connecticut backed off. We don’t know exactly why, but we do know that the constitutional problems in the Maryland tax were well known to the leadership in the Connecticut legislature. They knew there were two lawsuits pending. I think they probably got a little gun-shy. This is before there was this international movement to eliminate, or at least hold in abeyance, DSTs.

I don’t see anything happening at the state level at all. I think it would be somewhat foolhardy for a state to choose this at the time to adopt the DST.

Lauren Loricchio: Do you think there’s any way for Maryland to fix the legal flaws with its tax?

Richard D. Pomp: Yes. This tax seems to have been drafted by people who maybe don’t draft tax legislation for a living. We could get into the problems.

To start off, you have this tremendous notch effect in the rate structure. We always avoid notch effects when we draft if at all possible. What do I mean by that?

Well, if your total global revenue is between $100 million and $1 billion, the rate is 2.5%. If your total global revenue is between $1 billion and $5 billion, the rate doubles to 5%. So, if your total global revenue is $1,000,000,001, the rate jumps from 2.5% to 5%, and that produces a notch effect.

Let’s just assume — and this is a big assumption because this assumption is going to assume away a major problem with the Maryland tax — that your global revenue is coterminous with your Maryland advertising revenue. Big assumption, because the way it’s defined, your global tax revenue may have nothing to do with Maryland advertising revenue.

But for the sake of just demonstrating an artifact, let’s assume that your total global revenue is identical to your Maryland advertising. You have, let’s say $1 billion of global revenue, which is the same as your Maryland digital advertising. The tax would be $25 million. That’s 2.5% times $1 billion.

Now suppose the taxpayer receives $1 more in total revenue, so now it has $1,000,000,001. We’ll assume that’s all Maryland advertising revenue. The total tax now would double to $50 million, 5% times $1,000,000,001. That extra $1 of revenue generates an additional tax of $25 million. That is as large a notch effect as I have ever seen.

Compare that to the normal graduated rates in a personal income tax, where you have your zero bracket, where you pay no tax, then you have your first bracket, and the tax on that first bracket remains the same as you move up the income ladder. As your marginal tax rate increases, as you earn more income, it does not change the amount of tax you owe on the preceding brackets of income. You do not have this notch effect.

All this notch effect is going to do is encourage corporations to subdivide, to keep their global revenue less than $100 million, and get out of this tax regime, to the extent they can. That’s one problem that’s not received as much attention as other problems.

The rate schedule actually discriminates against interstate commerce because the amount of tax imposed on digital advertising services in Maryland is a function of global gross revenues. Those global gross revenues may have nothing to do with Maryland or with advertising. Consider, for example, a business that has $1 billion of global revenue, and that would generate a tax rate of 2.5%. If the next dollar of global revenue is received from transactions outside of Maryland, as we just talked about, the rate will double to 5%.

The Maryland tax will double, not because digital advertising has increased in Maryland, but because activities outside of Maryland have increased. Activities that may have nothing to do with advertising and nothing to do with Maryland at all. That is an aspect of this tax that I’ve never seen before. Normally, if your out-of-state activities increase in a state corporate income tax, your tax goes down. It doesn’t go up. We have a very odd feature.

Then we really get to the heart of the constitutional issue: Does the Maryland tax violate the Internet Tax Freedom Act? You cannot discriminate by imposing a tax on electronic commerce that’s not generally imposed on offline activity. You can’t tax the online activity and not the offline activity. That’s paraphrasing in a nutshell what ITFA prohibits. The question now is: Maryland is taxing online advertising and not taxing some forms of offline advertising. Is that discriminatory or not?

Lauren Loricchio: Do you think it is?

Richard D. Pomp: I think it is. I happen to have worked on ITFA as consultant for the Treasury.

Obviously, online advertising is different from offline advertising. I mean, that’s not the point. We can all stipulate to that. The question is, does that discriminate within the intent of ITFA?

I would say that in making this argument, that it is discriminatory. You don’t want too narrow an interpretation of what offline advertising is. That’s just an invitation to more and more litigation. Let’s get that issue resolved once and say, “Advertising is advertising, and if you’re going to tax online, you have to tax offline. If you don’t, there’s discrimination.”

But if you take too narrow an approach to what is offline advertising, then you’re just opening the door to more and more litigation as every taxpayer that is different from every other taxpayer comes forward with its form of offline advertising and says, “OK, well, so and so lost because they were viewed as engaging in a form of advertising that was not similar enough to online advertising. My facts are different.”

You want stability into your law. You just don’t want a holding to be so narrow that it becomes unstable and just invites more and more litigation. To me, that’s an argument for a broad interpretation of offline advertising.

If that leads to discrimination and Congress is unhappy, they can change it. They can amend the act to make it clearer as to what it is they intended. They’re the arbiters. They’re higher than the Supreme Court in this case.

If you have a court, Supreme Court perhaps, that says, “Look, advertising is advertising. This DST of Maryland’s is discriminatory.” If Congress is happy with that, then Maryland has a decision to make. It drops its DST or it expands its tax to reach offline advertising.

Lauren Loricchio: You kind of mentioned the two lawsuits already that have been filed to challenge Maryland’s tax. There’s one that was filed by four trade associations in federal court, and I was wondering what you think of the legal arguments in that lawsuit.

Richard D. Pomp: The one at federal court has a tricky argument to make. As you know, but maybe not everyone who is listening, there’s something called the Tax Injunction Act, a federal statute, whose goal is to really keep these tax cases out of federal court if you have a speedy and efficient remedy in the state courts, which you typically do.

In order to get around the Tax Injunction Act, the litigants in the federal court have to argue that what Maryland imposed is not a tax. It’s a penalty, it’s a fee, it’s something other than a tax. Therefore the Tax Injunction Act doesn’t apply. But for them to make their violation of the ITFA, they have to argue that what Maryland has imposed is a tax. It is not impossible for something to be a tax for one purpose and not a tax for another purpose. That’s not logically impossible.

It is not dead on arrival for the litigants to say, “Look for the Tax Injunction Act, we don’t have a tax in front of us within the meaning of the Tax Injunction Act, and therefore we can proceed in federal court. In federal court, you can hear our argument that violates the Internet Tax Freedom Act because for purposes of that statute, it is a tax.”

But you’ve got to walk this line, and it may strike a judge as perhaps inconsistent, although logically it’s not inconsistent at all. But it means delving into the statutory history of what the Tax Injunction Act was intended to do and why the DST is not a tax within the legislative history of the Tax Injunction Act. It just calls for a little clever and creative lawyering, not certainly in short supply in this business.

In state court, that issue is avoided because the Tax Injunction Act has no relevance whatsoever. There is a difference there.

Lauren Loricchio: Two tax law professors filed an amicus brief in support of Maryland in the federal case. They argue that the tax is not discriminatory for the purposes of ITFA because digital advertising is different from traditional advertising. What do you think of their arguments?

Richard D. Pomp: Yeah, of course it’s different. I mean, that’s not an epiphany. 

The question is, just because it’s different, does that mean it’s not discriminatory? Could Congress really have added this nondiscrimination provision only to have it undercut because offline is different from online?

They knew offline was going to be different from online, even if they couldn’t exactly predict what form online was going to take. But they passed this because they knew they were dealing with a new way of doing things different from the traditional way of doing things. To say online is different from offline is simply to say we have a new way of doing something versus our old traditional way of doing it.

I don’t think Congress intended for that to defeat a discrimination argument. That at least was not my sense when I was at Treasury working on this.

We’ll see though. Analytically, it’s not a new argument. We face this all the time, and you revert back to legislative intent. What did the drafts persons intend by this? Then appeal to others’ values. One would be stability in the law. For me, that’s kind of the game changer on this. You want stability.

Their brief is very good of course. Both of them are very sharp. But what they don’t address is if they’re right, that in this particular situation there’s some offline advertising that is going to be different enough from online advertising to beat back a discrimination claim. There may be other litigants with offline advertising that moves the needle closer to online advertising. It can’t be identical by definition, but it might be closer to online than someone else. You just don’t want to keep hearing these cases.

Lauren Loricchio: There are a couple other proposals out there. There’s one in New York that would impose an excise tax on the collection of data as an alternative to a digital advertising tax. I was wondering what you think of that proposal.

Richard D. Pomp: These are fresh ideas that are free, I think, of the constitutional defects that entirely infect almost every turn in the Maryland statute. They raised a lot of money with a fairly low rate and they have that virtue.

Unfortunately, they are being proposed at a time when the atmosphere is such that they’re no longer really getting the reception that they might have if they were in a state that was running major deficit and desperate for every dollar they can get.

But look, there’s a gestation period. All new ideas have a gestation period and you’ve got to start the clock running. I think at some point we will revisit this idea or maybe other countries will find it intriguing.

Lauren Loricchio: Do you expect Maryland will prevail in the litigation? Do you expect other states will try to emulate Maryland’s law?

Richard D. Pomp: I expect they will not prevail. Therefore they ought to be amenable to a plea by the White House to back off. If I were them, and if I really thought I was going to lose, and maybe they don’t think that, but that’s my evaluation. If they were to share that and think that they were going to lose, Biden is offering them a way out.

Now, I say that, I suspect he’s offering them a way out. I can’t imagine that calls have not been made or will be made from the White House to Maryland. I would accept that if I were Maryland. Ride out into the sunset as a good corporate citizen.

Lauren Loricchio: Well, thank you, Professor Pomp, for joining us on the podcast. We really appreciate it.

Richard D. Pomp: Thank you, Lauren. Always nice chatting with you.