Kicking States While They’re Down

With state revenues still well below pre-recession levels, the last thing states need is new federal restrictions on state and local taxing authority — but that’s exactly what they’d get under several bills before Congress.

I’ve already described one such bill, which would make it much easier for corporations to shelter profits from state corporate income taxes.  The latest such bill to be introduced (the Digital Goods and Services Tax Fairness Act) would restrict states’ and localities’ ability to tax downloaded music, movies, and online services like photo storage and payroll processing.  Backed by a powerful lobbying coalition that includes the U.S. Chamber of Commerce, Amazon, Verizon, Comcast, and Time Warner, the bill threatens to:

• reduce state and local tax revenues even as states and localities struggle to fund critical services like education, health care, and public safety;
• seriously disrupt fundamental features of state and local sales taxation that extend far beyond the kinds of online goods and services covered by the bill; and
• open up major tax-avoidance opportunities for large multistate corporations selling physical goods online.

As one of our two analyses of the bill explains, the bill’s proponents claim that states and localities want to ease their current fiscal problems by imposing discriminatory taxes on digital goods and services, such as by taxing the sale of a digital book delivered online at a higher rate than the sale of a printed book.  They also claim that the bill is needed to stop taxation of digital goods and services by more than one state and more than one local government.  But they’ve presented no concrete examples of discriminatory or multiple taxation of digital goods and services, and in any event, the federal Internet Tax Freedom Act already bans “multiple or discriminatory taxes on electronic commerce.”

Moreover, as our companion analysis explains, the bill could cause a host of problems for states and localities, from interfering with sales taxes on physical goods to sparking widespread litigation.

Far from being discriminated against, digital goods and services often start out with an unfair 5-10 percent price advantage over their physical counterparts because they are exempt from sales taxes.  Almost every state with a sales tax imposes it on books, music, movies, software, and games delivered on physical media.  Many states also tax newspapers and magazines, cable and satellite TV service, pay-per-view movies, and satellite radio subscriptions.  Yet only a minority of states tax these same goods and services when they are sold in the form of a digital download or as a service delivered over the Internet.

In short, the bill is largely a solution in search of problem, and it could have large unintended consequences.  Given these facts, Congress shouldn’t enact it in its current form.