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.
Listen to the first episode in the series: The Fight Over Maryland’s Digital Advertising Tax, Part 1
For additional coverage, read these articles in Tax Notes:
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This episode is sponsored by SafeSend. For more information, visit safesend.com.
This episode is sponsored by the UC Irvine School of Law’s Graduate Tax Program. For more information, visit https://ce.uci.edu/?utm_source=TNM&utm_medium=podcast&utm_campaign=2022taxnote.
***
Credits
Host: David D. Stewart
Executive Producers: Jasper B. Smith, Paige Jones
Showrunner and Audio Engineer: Jordan Parrish
Guest Relations: Christa Goad
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.
Listen to the first episode in the series: The Fight Over Maryland’s Digital Advertising Tax, Part 1
For additional coverage, read these articles in Tax Notes:
Follow us on Twitter:
**
This episode is sponsored by SafeSend. For more information, visit safesend.com.
This episode is sponsored by the UC Irvine School of Law’s Graduate Tax Program. For more information, visit https://ce.uci.edu/?utm_source=TNM&utm_medium=podcast&utm_campaign=2022taxnote.
***
Credits
Host: David D. Stewart
Executive Producers: Jasper B. Smith, Paige Jones
Showrunner and Audio Engineer: Jordan Parrish
Guest Relations: Christa Goad
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.
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(ITFA).
David D. Stewart:Alright, 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:So 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. And the question is whether it's even going to survive the Biden administration. Because 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 DSTs(digital service taxes). I would think, and I'm only speculating, but I would think calls should be made, 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. And so 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:Well for our 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. And 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. And so Congress seems to be on the same page as the White House, that there seems to be this concerted effort to force the 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, and then Maryland had the same objective. And so 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 digital services taxes. And 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 suits? Makes no sense at all. And 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. And they knew there were two suits pending. I think they probably got a little gun-shy. And this is before there was this international movement to eliminate, or at least hold in abeyance DSTs. So 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:I wonder, 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. I mean we could get into the problems, to start off with the rates structure: you have this tremendous notch effect in the rate structure, and we always avoid notch effects when we draft if at all possible. So what do I mean by that? Well, if your total global revenue is between$100 million and$1 billion, the rate is 2.5 percent. If your total global revenue is between$1 billion and$5 billion, the rate doubles to 5 percent. So if you make, if your total global revenue is$1,000,000,001, their rate jumps from 2.5 percent to 5 percent, 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, so let's assume 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. So you have, let's say$1 billion of global revenue, which is the same as your Maryland digital advertising. That tax would be$25 million. That's 2.5 percent times$ 1 billion. Now suppose the taxpayer receives$1 more in total revenue, so now it has$1,000,000,001, and we'll assume that's all Maryland advertising revenue. The total tax now would double to$50 million, 5 percent times 1,000,000,001. So that extra$1 of revenue generates an additional tax of$25 million. I mean, that is as large a notch effect as I have ever seen and 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. So 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. So 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. So 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. And 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 percent. 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 percent. So 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. And that is an aspect of this tax that I've never seen before. And normally, if your out of state activities increase in a state corporate income tax, your tax goes down, it doesn't go up. So we have a very odd feature and 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. So you can't tax the online activity and not the offline activity. That's paraphrasing in a nutshell, that's what the Internet Tax Freedom Act prohibits. So the question now is, Maryland is taxing online advertising and not taxing some forms of offline advertising. Is that discriminatory or not?
Lauren Loricchio:And do you think it is?
Richard D. Pomp:I think it is. I happen to have worked on the Internet Tax Freedom Act 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 the Internet Tax Freedom Act? And 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. What you really want is to say, basically,"advertising is advertising and of course online, in many aspects, is more efficient than offline or else you wouldn't be doing it." So obviously it has advantages, but it's advertising. And 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 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." Boy, 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. And 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 arbitrators, they're the higher than the Supreme Court in this case. But if they're happy, if you have a court that says, Supreme Court perhaps, that says,"look, advertising is advertising, this DST of Maryland is discriminatory." And 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 inefficient remedy in the state courts, which you typically do, and the goal is really to keep this state tax cases in state courts. In order to get around the Tax Injunction Act, the litigants in the federal court has 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. And therefore the Tax Injunction Act doesn't apply. But for them to make their violation of the Internet Tax Freedom Act, 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. And so 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 and 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 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 you're in state court, so the Tax Injunction Act has no relevance whatsoever. So there is a difference there.
Lauren Loricchio:Two tax law professors filed an amicus brief i n s upport o f 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, of course it's different. So the question is, just because it's different, does that mean it's not discriminatory? Could Congress really have asked this non-discrimination provision only the to have it undercut because offline is different from online? I mean, 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. So 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. And 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. So, I mean, 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? And then appeal to others values and one would be stability in the law. And for me, that's kind of the game changer on this. You want stability and their brief is very good of course, both of them are very sharp. So you expect a very good brief, 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. And you just don't want to keep hearing these cases.
Lauren Loricchio:There's another couple of their 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:Yeah. These are fresh ideas that are free, I think, of the constitutional defects that entirely infect almost every turn in the Maryland statute. So they avoid that. 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, and this idea that's being proposed in New York, 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 running. And so 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? And do you expect other states will try to emulate Maryland's law?
Richard D. Pomp:I expect they will not prevail. And therefore they ought to be amenable to a plea by the White House to back off. So 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. So 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.
David D. Stewart:And now, coming attractions. Each week, we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?
Paige Jones:Thanks, Dave. In Tax Notes Federal, Robert Kane examines the case Pope& Talbot and argues that the IRS has inappropriately relied on it in two rulings addressing the calculation of section 311 gain on distributions of partnership equity. Mindy Herzfeld summarizes possible U.S. options for implementing pillar 1 of the OECD’s plan for a new international tax framework. In Tax Notes State, Walter Hellerstein and Andrew Appleby consider the question whether Wayfair applies retroactively in light of the Supreme Court’s case law and a recent Oregon Tax Court opinion. Ronald Fisher reviews the widespread decline of effective state individual income tax rates and decreasing reliance on income taxes for revenue since the year 2000. In Tax Notes International, three tax professionals examine the relationship between cryptocurrencies and legal tender, outline the key taxable events, and explain how treating cryptocurrencies as assets subjects them to various taxes. Gert Greve argues that the allocation of taxing rights to a source country based on the physical presence of production factors is no longer a fair and appropriate system, given the digitalization of the global economy. In Featured Analysis, Nana Ama Sarfo looks at how select countries are thinking about tax as a lever for recovery from the COVID-19 pandemic. And finally, on the Opinions page, Joseph Thorndike rejects the proposal to impose an excess profits tax on COVID-19 vaccine manufacturers. Robert Goulder and Joseph Thorndike debate the merits and necessity of the capital gains preference, all in five minutes.
David D. Stewart:That's it for this week. You can follow me online@TaxStew, that's S-T-E-W. And be sure to follow@TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.