Tax Rules for the Information Superhighway

You’ve just flown to California from your home in Virginia. In California you decide to purchase a smartphone app from an app store that is based in Canada. The app developer is based in Oregon, but you downloaded the newly purchased app from a server in Connecticut. 

Which state gets to tax the download? Not easy, is it?

It’s easier to ask which state WANTS to tax the download, because the answer is: All of them. And there is nothing preventing multiple states from taxing the same Internet transaction.

This makes no sense, of course, and it’s one of the reasons the U.S. Constitution included the Commerce Clause to make sure that states aren’t doing things like this.

That’s why the Digital Goods & Services Tax Fairness Act is before Congress. The Act creates a structure that prohibits transactions from being taxed two and even three times by different jurisdictions; it creates a rule that determines “where” a given transaction takes place and thus determines taxing jurisdiction.

The approach makes sense, is consistent with the role of the federal government under the Commerce Clause, and protects consumers. So guess who’s opposed to it?

The states—or at least some of them—as represented by the Federation of Tax Administrators. Their justification is simply that the states need more revenue, and instead of doing the hard work of rethinking their tax systems to reflect a digital age, they keep trying to find new things to tax. People are downloading a lot of stuff? Let’s slap a tax on it.

But this attitude by the states has resulted in incoherent tax policy. States tax broadband access, and especially wireless access, at punitive tax rates as if they were trying to discourage adoption—much as they do alcohol and cigarettes. Some states tax mobile devices with taxes and fees totaling to 23 or 24 percent, and that’s before they get around to taxing the same transaction twice.

Pro-tax forces across the country see broadband as yet another goose to be plucked. Their counterproductive tax grab raises prices to consumers and drives at least some away from adopting broadband.

Greed for more revenue should not drive tax policy, but there’s no reason to expect self-restraint to kick in anytime soon. That’s why it’s necessary and appropriate for the federal government to lay down the rules of the digital road so that, if digital downloads are taxed, they are taxed once and only once by the appropriate jurisdiction.