New York Gov. Paterson Proposes ‘iTunes Tax’

Published February 1, 2009

New York Gov. David Paterson (D) is proposing to close the state’s $15.4 billion budget gap this year by imposing nearly 100 new taxes and fees, including a tax on downloads of digital media such as music, books, games, and movies.

Dubbed the “iTunes tax,” critics call it a bad idea and say it’s unworkable, overly burdensome, and constitutionally suspect.
“Special taxes aimed at downloads and Web-based goods and services are tantalizing for politicians due to the spectacular growth of e-commerce, but have major workability issues and legal and constitutional problems,” said George Pieler, a senior fellow with the Institute for Policy Innovation in Lewisville, Texas.

Digital downloads have been exempt from sales tax in New York—and most other states—because unlike a CD, an MP3 music file is not a tangible good. Paterson’s proposal would change the definition of a tangible good, hiking the cost of a 99 cent song on Apple’s iTunes to $1.07.

Though Apple charges sales tax in 18 states, compliance largely depends on customer cooperation. New York would join New Jersey as the second state in the country to require through legislation the collection of a digital download tax.

Constitutional Questions

Many tax law experts say Paterson’s proposal has little chance to survive a constitutional challenge. The U.S. Supreme Court’s 1992 Quill v. North Dakota decision found a state violates the U.S. Constitution’s “commerce clause” if it forces a company with no physical presence in the state to collect its sales taxes.

Several online retailers are challenging the constitutionality of the so-called “Amazon tax” New York passed last year. Other retailers, such as Newegg and, have either ceased selling goods to customers in New York or have ignored the state’s call to collect sales taxes.

“Since New York’s tax authorities have been so aggressive in pushing the online tax envelope, they seem to be saying to the courts, ‘We dare you,’ with this latest plan,” said Pete Sepp, vice president for policy and communications at the National Taxpayers Union in Alexandria, Virginia. “The proposed tax clearly violates the spirit and intent of the Supreme Court’s decision. If it goes unchallenged, look for other states to try the same end-run.”

iTunes a Ripe Target

The situation is more complicated with a tax on iTunes downloads because Apple has 13 retail stores in New York state.

“Therefore, iTunes songs [would appear to fall] within New York’s jurisdiction and Apple can be forced to collect sales tax at the point of sale,” said Ryan Radia, a research associate for technology policy at the Competitive Enterprise Institute in Washington, DC. “Other online music retailers like Sellaband could not legally be required to collect sales taxes.”

“In the case of New York, I have not seen a coherent explanation of just how his plan would work, probably because the mechanics are being left open until they see if the concept flies politically,” Pieler added. “In theory, one could just piggyback on the state’s sales and use tax, putting the burden on the taxpayer to self-report. Not likely many would, though.”

Burden on Business

Taxes on digital downloads also create special burdens for businesses because of the nature of online commerce, experts say. Though Paterson’s proposal envisions tracking down customers through the mailing address of their credit cards, clever consumers could get around that by having bills mailed to a post office box in a tax-free state.

Tracking the location of customers and sales on the Internet is difficult because there is no real geographical “place” on the Web. A customer can live in Connecticut, download a song from California-based Apple from a coffee shop in New York, and have the sale routed through a server in yet another state.

Experts say even a corporate giant like Apple would incur enormous costs keeping track of such complex transactions—and smaller retailers might find the burden overwhelming.

“Small businesses would be heavily burdened in collecting the tax, and may very well decide not to do business in New York anymore—just as did with its New York affiliates,” Sepp said. “Given New York State’s recent actions to go after Amazon’s affiliates for online sales taxes, this latest move can certainly be seen as another attempt to expand government’s fiscal control over the Internet.”

Better to Cut Spending

Critics say Paterson’s new tax plan contradicts his earlier promise to find spending cuts—even “painful” ones—to close the state’s budget gap.

“Last year Paterson seemed to commit to spending restraint in the state, but when the smoke cleared, the specter of higher taxes didn’t vanish,” Sepp said. “Yes, his actions may have slowed the growth of state expenditures, but it’s important to remember that he hasn’t actually reversed decades of overspending.

“Taxes on telecommunications are already far higher than those falling on most other goods and services,” Sepp added.

Bad Timing for Economy

Experts also question the wisdom of raising taxes during a recession. President Barack Obama revised his initial spend-heavy economic package to include billions in tax cuts to help ease the burden on individuals and businesses.

“New York’s plan to tax digital goods is just a bad idea,” Radia said. “In this tough economic climate, state governments should be easing burdensome laws, not creating entirely new ones.”

James G. Lakely ([email protected]) is a research fellow of The Heartland Institute and managing editor of Infotech & Telecom News.