Why digital services taxes are a ‘bad idea’

While only one U.S. state – Maryland – has enacted a tax on digital advertising and data mining (a tax that’s currently on appeal), many others are considering doing so according to a special report from Tax Notes State. The study weighs the theories behind digital services taxes (DSTs) and finds them severely deficient.  

Advocates of DSTs have advanced a range of arguments. DSTs could be seen as analogous to severance taxes on the extraction of natural resources, with the “mining” and usage of consumer data standing in for, say, oil and gas extraction. They have also been proposed as a kind of excess profit tax to balance digital platforms’ increasingly dominant market positions. But perhaps the most popular rationale is that DSTs can help tax authorities fill gaps in their consumption tax regimes. “The internet economy creates new and powerful digital business models that frustrate the ability of governments to appropriately exercise their taxing authority,” the Tax Notes State report indicates. “Accordingly, gaps open up in the consumption tax base that never previously existed, requiring novel consumption tax solutions.” 

What’s wrong with that idea? Plenty, the report argues:  

• The Maryland DST, and similar legislation elsewhere, exclusively targets business activities. Digital advertising and data mining are intermediate inputs in the value creation chain, and as such (at least in the U.S. tax system) are traditionally and intentionally untaxed. Tax is applied only to the final good or service produced. DSTs result in “pyramiding” of taxes by imposing tax on the intermediate business inputs as well as consumer purchases. 
• Pyramiding taxes for digital services brings even more complexity to what the report calls the “excessive cascading of sales tax already overwhelming state tax systems.” Sales tax exemptions for business inputs are already distributed unevenly across industries. For example, most states offer no exemptions for purchases of computer hardware, software and telecommunications services – all crucial inputs for digital companies. 
• Administering DSTs is problematic. In business-to-business commerce, digital products are hard to define and can be consumed simultaneously in multiple jurisdictions and across national boundaries. Determining the taxable value of transactions can be challenging.  

Tax authorities considering consumption tax reforms should cross DSTs off their list, the report concludes. “At a time when we critically need to improve the efficiency and effectiveness of U.S. state sales tax systems, DSTs would take us another step backward, pushing state tax systems further from international norms of a well-designed consumption tax.”