Weekly SSRN Tax Article Review And Roundup: Kim Reviews The Internet Tax Freedom Act At 25 By Hellerstein & Appleby

This week, Young Ran (Christine) Kim (Cardozo; Google Scholar) reviews Walter Hellerstein (Georgia) and Andrew Appleby (Stetson; Google Scholar), The Internet Tax Freedom Act at 25, 107 Tax Notes St. 7 (Jan. 2, 2023).

Policy on how to tax digital platforms, such as Google or Facebook, presents heated debate across the globe. Digital Services Taxes and Pillar One of the global tax deal are notable examples. Domestically, the debate occurs at the state and local tax level. At least ten states in recent years entertained imposing a Digital Advertising Tax, while Maryland did implement one. Maryland’s Digital Ad Tax has been challenged in courts, and the oral argument at the Maryland Supreme Court is scheduled for Friday, May 5, 2023. One of the main issues is whether the tax violates the Internet Tax Freedom Act (ITFA) by discriminating against the digital economy, as it taxes only digital advertising platforms and not traditional advertising. 

Darien Shanske (UC Davis; Google Scholar) and I published an article on the Maryland Digital Ad Tax, and we have recently filed an amicus brief with Reuven Avi-Yonah (Michigan; Google Scholar), David Gamage (Indiana Maurer; Google Scholar), Orly Mazur (SMU; Google Scholar), and Democracy Forward in support of Maryland. Hence, it makes sense for me to review a timely piece by Walter Hellerstein and Andrew Appleby, The Internet Tax Freedom Act at 25, 107 Tax Notes State 7 (2023) that reviews the legislative history of the ITFA and questions whether the law is fit for service in today’s digital economy.

The ITFA was enacted in 1998 to temporarily suspend the enactment of new state and local taxes on Internet access in order to encourage electronic commerce. Congress also created a committee to study the issues raised by such taxes, and to give legislative recommendations. After failing to adopt federal legislation and extending the ITFA four times, Congress finally made the act permanent in 2016.  

The ITFA prohibits three types of taxes: (1) taxes on internet access; (2) discriminatory taxes on electronic commerce; and (3) multiple taxes on electronic commerce. While Hellerstein and Appleby examine each category, they properly advise the reader to note that the technology, business models, and charges associated with access to and use of the internet have evolved dramatically since the ITFA’s original enactment.

I would like to direct the reader’s attention to the second category—discriminatory taxes on electronic commerce, which is one of the claims at issue in the Maryland tax case. Hellerstein and Appleby express their disappointment over a lower level state judge’s order invalidating the Maryland tax without providing reasoning. The order simply states that the Maryland tax “violates the Supremacy Clause of the United States Constitution and the Internet Tax Freedom Act because the Tax constitutes a discriminatory tax.” During the hearing preceding the order, the judge addressed the ITFA issue in a very cursory way. In finding that digital advertising is sufficiently similar to traditional advertising for ITFA purposes, the judge simply declared: “Puppies are puppies and advertising is advertising.” With all due respect, this is mere tautology and not legal reasoning. Similarly disappointed, Hellerstein and Appleby call for more analysis in addressing ITFA claims and note the following:

The digital advertising business model differs in meaningful ways from traditional advertising. Digital advertisers collect and monetize user data by using that data precisely to target advertisements and to track their effectiveness in real time. Indeed, the targeted nature of digital advertising, and thus its increased effectiveness, is why digital advertising providers can generate such enormous profits compared with the profits generated by traditional advertising providers.

I agree with this assessment, and it is one reason why I think the Maryland Supreme Court will reverse the lower court’s decision.

Further, Hellerstein and Appleby consider whether the ITFA is fit for service in today's digital economy. In particular, ITFA's second and third operative provisions, which prohibit discriminatory or multiple taxes on electronic commerce, arguably have outlived their originally intended purposes:

In the 2014 debate over ITFA’s status, those opposed to its extension stressed that ITFA was originally intended to incubate electronic commerce, not to provide an enduring advantage for electronic commerce over traditional commerce. They observed that the “Internet is no longer a nascent development in need of Federal tax protection to grow. It is now a prosperous sector of the global economy.” They also noted that by 2014, “one of the original goals of the ITFA — to foster electronic commerce by protecting it from multiple and discriminatory taxation — has already been met as evidenced by the explosion of commercial transactions over the Internet.”

Hellerstein and Appleby suggest that electronic commerce no longer merits legislative protection beyond what is already provided in the Constitution’s commerce and equal protection clauses, and Congress should repeal ITFA language that does not reflect the current state of internet commerce. Otherwise, the ITFA could undermine states' authority to enact their own legislative solutions to deal with the digital economy:

Congress appears increasingly concerned with large technology companies’ dominance, and it has been exploring various avenues to combat the effects of that dominance, including increased regulation and taxation. If Congress recognizes that the federal corporate net income tax does not adequately tax many of the key players in the digital economy, as Congress appeared to do when it enacted a corporate alternative minimum tax earlier this year, it arguably would be hypocritical to prohibit the states from undertaking their own efforts to tax the digital economy in a manner more consistent with contemporary economic reality.

I wholeheartedly agree with Hellerstein and Appleby's reflection on the ITFA. There are many other important issues that scholars and policymakers should ponder when considering how to tax digital platforms. Consider undue burden on interstate commerce, nondiscrimination between resident and nonresident taxpayers under the dormant Commerce Clause, an instrumental choice between income tax reform and consumption tax, and so on.

However, due to the ITFA, much of the discussion in the United States is focused on the degree of similarity between digital platforms and traditional commerce. Few courts have considered such questions: The Illinois Court of Appeals held that streaming services were not similar to live performances for purposes of ITFA, and suggested that ITFA applies only when the services are “identical.” The Washington Court of Appeals held that an online research library was not “equivalent” to research delivered by CD or email under the ITFA. It is time for the Maryland Supreme Court to conduct a more robust and persuasive “similarity” analysis regarding digital advertising platforms. When they do, they will find that digital advertising is so unique that it cannot be consider “similar” to traditional advertising under the ITFA.

But the best solution would be for Congress to repeal or amend the ITFA to tackle the current digital economy. Otherwise, as Hellerstein and Appleby observe, ITFA could continue to lead to distortion and litigation over states' reasonable ability to tax the digital economy, and we will continue to see cases like Apple challenging Chicago's streaming video tax and Texas's tax on iCloud storage service, all litigated under the vestigial banner of the ITFA. To be clear, just because I think that Maryland should triumph in the current litigation regarding the ITFA, it does not mean that it would not be much better for Maryland and all states to be spared the trouble. There are going to be hard cases that need to be litigated, such as whether a state tax rule imposes an 'undue burden.' But here, as I have explained—and I think Hellerstein and Appleby agree—the underlying rule the ITFA imposes is not "fit for service" and so all litigating about it is a waste of time and resources no matter the result. 

Here’s the rest of this week’s SSRN Tax Roundup:

• Benjamin Yost (Boston College) & Enshuai Yu (Boston College), Corner-Cutters: Personally Tax Aggressive Executives and Corporate Regulatory Violations (2023)
• Scott Dyreng (Duke), Robert Hills (Pennsylvania State), Christina Lewellen (North Carolina State) & Bradley P. Lindsey (Utah State), Endogeneity and the Economic Consequences of Tax Avoidance (2023)
• Katie Boylen (Wisconsin – Madison), Fabio B. Gaertner (Wisconsin – Madison) & Melissa Martin (Illinois Chicago), CEO Bonus Incentives for Domestic and Foreign Performance (2023)
• Di Wu (Nankai), Leonard F.S. Wang (Zhongnan) & Jie Ma (Zhongnan), Corporate Profit Tax and MNF's Transfer Pricing with Decentralized Delegation (2023)
• Andrew M. C. Smith (Victoria University of Wellington), Taxing the Gig Economy in New Zealand – Extending the Tax Net, Asia-Pacific Tax Bulletin (forthcoming 2023).
• Rangita de Silva de Alwis (Pennsylvania), Amani Michelle Carter Coutinho (Kirkland & Ellis) & Govind Nagubandi (healthPiper), Equitable Ecosystem: A Two-Pronged Approach to Equity in Artificial Intelligence, 29 Mich. Tech. L. Rev. 101 (forthcoming 2023)
• Robert W. McGee (Fayetteville State), How to Determine Your 'Fair Share' of Taxes: Ask Chatgpt (2023)
• Deus Mugabe (Godena Associates), Stay of Execution in Tax Matters in Uganda: a Case for a Departure from the Ordinary Rules of Civil Procedure in Stay of Execution Applications in Tax Matters (2023)