Nicola Daniel
Senior Advisor to the Center for Financial Policy
at the University of Maryland’s RH Smith School of Business
Reining in the darker side of big tech companies has
been the battle cry of many economists, legislators, and
data privacy experts for over a decade. Why? Because big
tech’s scale and global reach have evolved to the point
where they undermine, if unintentionally, the foundation
of free markets and democratic institutions with their
market power and political advertising. Policymakers,
including Nobel Prize-winning economist Paul Romer,
think the U.S. needs to rewrite economic policy for the
big tech era.
Romer’s argument for taxing Facebook and similar companies
rests on the fact that they drive their business
through algorithms that increase user engagement and
revenues by actively encouraging anger and disagreements,
so they are manipulating users “in ways that
they don’t fully understand.” This is not how markets
usually work. As Romer explains, “When economists
defend the market, we have this very simple idea in
mind, where I as a buyer give something and get some
good back.” That doesn’t happen in this new market for
digital services, in which advertising becomes a “hidden
method of capturing compensation for these firms.”
Inspired by Paul Romer’s op-ed on digital taxation in
the New York Times, Maryland State Senate President
Bill Ferguson pushed through the first digital advertising
tax in the U.S. in February 2021. The tax runs up to
10% on revenues companies receive from selling digital
ads that target Maryland IP addresses. It defines digital
advertising as services delivered on any type of software,
website, or application that a person can access on a
device. These include banner advertising, search engine
advertising, and other comparable advertising services.
Such ads tailor content based on users’ demographics
and browsing history.
Firms with less than $100 million in annual global digital
ad revenue are exempt from the Maryland tax. This
high threshold is designed to target the largest internet
companies, such as Google, Twitter, and Facebook, which
account for roughly 59% of the $130 billion digital ad
revenue market in the U.S., according to research firm
eMarketer. The tax is projected to yield up to $250 million
annually and was enacted just one week after legislators
amended the state sales tax to include “digital products”
and software as a service (SaaS).1
For Maryland small businesses, residents, and the state’s
budget, this tax makes sense, as it helps to level the
playing field between digital behemoths and smaller
companies. There are four core reasons legislators pushed
the new digital advertising tax. First, a digital tax seeks
to remedy the problem of jurisdictional tax arbitrage,
which results from companies profiting from differences
in systems of taxation. Second, it addresses the
fact that generating profit from gargantuan data caches
incentivizes companies to invade consumers’ privacy
in unprecedented ways. Third, it replaces tax revenues
lost from other sources. Finally, it encourages healthy
competition and punishes monopolies.
1 The new law defines a digital product as “a product that is obtained
electronically by the buyer or delivered by means other than tangible
storage media through the use of technology having electronic, digital,
magnetic, wireless, optical, electromagnetic, or similar capabilities.”
The law also adds SaaS, subscriptions, streaming services and “digital
codes” as taxable transactions.
The Logic of Digital Advertising Taxes
1. Tax Arbitrage
A 2021 report from the U.S. Treasury notes that “although
US companies are the most profitable in the world, the
U.S. collects less in corporate tax revenues as a share of
GDP than almost any advanced economy” at 1% of U.S.
GDP versus 3.1% of Organization of Economic Cooperation
and Development (OECD) country GDP. Regulators
in Europe have been less forgiving of tax arbitrage than
the U.S. In one case, Apple, the world’s largest company
by market capitalization, was presented with a $15.2
billion tax bill after the European Commission ruled
that Apple’s deal with Irish tax authorities constituted
illegal state aid. The commission showed that the deal
allowed Apple to pay a maximum tax rate of just 1%.
In 2014, the tech firm paid tax at a rate of only 0.005%.
The usual corporate tax rate in Ireland is 12.5%.
Google points out that its advertising sales do not take
place in a specific country, but via an auction algorithm
that is operated by algorithms whose physical location
is undefined. Hence, online advertising should not be
taxed by jurisdiction, according to Google’s argument.
The Maryland tax refutes this logic by linking advertising
directly to the IP addresses of Maryland consumers.
IP addresses are not a foolproof method of locational
identification, as critics have argued. Nonetheless, digital
ad taxes significantly curtail the ability for corporations
to engage in jurisdictional tax arbitrage.
2. Data Privacy
A digital advertising tax recognizes that companies with
massive data caches like Google, benefit financially
from the volume of individual consumer data without
economically compensating the data subject. The digital
tax thus represents the interests of Maryland residents
who provide that digital data.
Big tech’s incursion into consumer privacy has been welldocumented
in books including The Age of Surveillance
Capitalism and An Ugly Truth, a 2021 book describing
Facebook’s internal drift toward greater invasiveness
based on the profit motive.
The digital tax also responds to the federal government’s
failure to regulate consumer data privacy. The
European Union (EU) has strictly protected consumer
data privacy since 2018 through the Global Data Privacy
Regulation (GDPR).
In contrast, U.S. regulators ineffectively encouraged
companies to self-regulate. When the Federal Trade
Commission (FTC) fined Facebook $5 billion for the
Cambridge Analytica data privacy breach in April 2019,
Facebook’s stock price soared because the fine was
negligible compared to what regulators might have
levied. Since then, Facebook broke its pledge to the FTC
to keep barriers between its Instagram and WhatsApp
applications, allowing it to glean more data on its users.
The GDPR grants consumers in Europe the right to
obtain information about the data companies store on
them, as well as the right to have their data deleted.
More importantly, it grants individuals the right to sue
firms. In 2020, Max Schrems, an Austrian lawyer, sued
Facebook through the Irish Data Protection regulator
and prevailed. This suit nullified the Privacy Shield
agreement between the U.S. and the EU that allowed
for data transfers between companies across the Atlantic,
and it is forcing the U.S. to ensure better privacy
measures for consumers. There are currently six data
privacy laws proposed in Congress. Only two of them
allow individuals the right to sue, whereas the other four
require regulators to take offenders to court, suggesting
less enforcement due to capacity constraints.
3. Replacing Lost Tax Revenue
Maryland needs to replace income lost by the shrinking
of once-robust sources. For example, gas taxes, which
were once a major source of state government revenue,
have drastically fallen with increased electric vehicle use.
COVID-19 worsened this trend as driving plummeted
nationwide by 38% in the initial months of the pandemic.
Maryland experienced a 6% decline in gas tax revenues
in 2020. Overall, Maryland expects a $673 million tax
revenue shortfall—3% of projected revenues—in 2021.
Meanwhile, online tech giants grabbed unprecedented
market share as social distancing accelerated the shift
toward digital platforms. Google’s revenues grew by $20
billion to $181.9 billion in 2020. Its year-end net profits
as of June 2021 stood at a staggering $122.73 billion.
Similarly, Facebook’s revenues grew by $15.4 billion
to $86 billion in 2020, with net profits of $29.1 billion.
The annual $250 million projected tax revenue boost
from the digital advertising tax goes a long way toward
plugging Maryland’s COVID-related shortfall while
scarcely affecting the profit margins of digital giants.
4. Discouraging Monopoly
Finally, the digital tax provides incentives for healthy
market competition from smaller companies because
the more advertising revenue a firm collects, the higher
its tax rate. If a firm splits itself, e.g., if Facebook were to
spin off Instagram, the total tax bill for the two firms as
separate entities would be smaller. These higher taxes
for larger entities also discourage the kind of growth
by acquisition that drives digital giants to acquire their
potential competitors only to kill them.
Firms seeking to avoid the tax can opt for a subscription
revenue model. Subscriptions conform to a more
traditional economic framework in which consumers pay
something to get access to something valuable and the
balance of supply and demand determines the market
price. The New York Times, for example, switched from
an ad-only revenue stream to a subscription-driven
revenue stream with resounding success. Today, The
New York Times is financially healthy and dominates
online news searches.
Global Digital Tax Trends
Will Maryland be joined by other states in imposing a
digital tax? Or will it be isolated and face pressure that
may force it to end this tax?
Maryland’s digital ad tax is part of a much larger national
and global trend. As of March 2021, 26 European countries
imposed unilateral digital taxes on services like
software subscriptions, video streaming, and audiobooks.
They targeted firms that have many users in Europe and
yet pay few taxes there. The U.S. protested, claiming that
the policy would disproportionately affect U.S.-based
tech companies.
The European taxes led to negotiations, spearheaded
by the OECD and the EU, seeking to harmonize digital
taxation. The OECD has led discussions among 137
jurisdictions to establish rules about where taxes should
be paid and how profits should be allocated. Because
U.S. firms are disproportionately affected by such taxes,
U.S. regulators have increasingly participated in discussions.
The negotiations have driven economic research
that has led to a greater convergence of attitudes toward
digital taxation between the U.S. and OECD countries.
Looking Ahead
Domestic legal challenges to Maryland’s digital tax
have surfaced. In February 2021, the U.S. Chamber of
Commerce filed a suit against Maryland to challenge
the digital advertising tax, arguing that it violates the
federal Internet Tax Freedom Act. Other plaintiffs have
followed. These challenges are likely to meet with some
success and will require modifications to the existing
law. As a result, the Maryland General Assembly passed
an emergency bill to delay the digital tax’s implementation
to 2022. However, the U.S. Senate testimony of
former Facebook employee Frances Haugen in October
2021 added fuel to the drive to take regulatory action
against the larger digital platforms on multiple fronts
and may well bolster the popularity of digital taxes.
Many states—including Texas, West Virginia, Massachusetts,
and New York—are following Maryland’s lead in
introducing digital tax legislation. The digital tax trend
is not likely to abate soon.
References
“Once Tech’s Favorite Economist, Now a Thorn in Its Side,” The New
York Times (May 20, 2021).
“Taxing digital advertising could help break up big tech,” MIT Technology
Review (June 14, 2021).
“Opinion | A Tax That Could Fix Big Tech,” The New York Times (May
5, 2019).
“Duopoly still rules the global digital ad market, but Alibaba and
Amazon are on the prowl,” Insider Intelligence Trends, Forecasts &
Statistics (May 10, 2021).
MadeInAmericaTaxPlan_Report.pdf (treasury.gov). See also “Trends
and Proposals for Corporate Tax Revenue,“ Congressional Research
Service, August 27, 2021.
Apple ordered to pay €13bn after EU rules Ireland broke state aid
laws | Tax avoidance | The Guardian.
Zuboff, Shoshanna (2019). The Age of Surveillance Capitalism. New
York, Hachette Book Group.
Frenkel, S. and C. Kang (2021). An Ugly Truth. New York, Harper
Collins, pp. 226.
“FTC Imposes $5 Billion Penalty and Sweeping New Privacy Restrictions
on Facebook,” Federal Trade Commission (July, 2019).
“Amazon fined record $887 million over EU privacy violations,” The
Verge (July 30, 2021).
“Gas Tax Revenue to Decline as Traffic Drops 38 Percent,” Tax Foundation.
org (March 31, 2021).
Motor Fuel Tax and Motor Carrier Tax IFTA Annual Report (marylandtaxes.
gov).
States Grappling With Hit to Tax Collections | Center on Budget and
Policy Priorities (cbpp.org).
source: Statista.com.
The nations include: Argentina, Austria, Costa Rica, Germany, Greece,
Hungary, India, Indonesia, Italy, Kenya, Malaysia, Mexico, Nigeria,
Pakistan, Paraguay, Poland, Sierra Leone, Spain, Taiwan, Tunisia,
Turkey, United Kingdom, Uruguay, Vietnam, Zimbabwe. Source:
americanactionforum.org.
“Maryland To Delay Controversial Digital Advertising Tax As The
Lawsuits Keep Coming,” Forbes (April 17, 2021).