As the use of digital goods – such as applications, music, videos, and e-books – has become more prevalent, state and local governments have looked for ways to raise new revenue by taxing these purchases. In Utah, members of the state legislature are now considering increasing the state’s tax revenue base by imposing a new tax on streamed media services, such as Netflix. It is not yet certain what the exact sales tax rate would be on these purchases.
Most states impose sales tax only on transactions that involve tangible property, such as a car or computer, but many do not impose sales taxes on services or intangible property. Digital goods, which fall somewhere in between these older definitions, have been the subject of much debate. Experts disagree over whether such transactions involve tangible personal property or intangible information.
The majority of states have declared most prewritten software are tangible products, and are therefore subject to sales taxes, but lawmakers disagree about whether other digital goods should be reclassified as tangible products.
When a digital transaction involves multiple states, a consumer can end up paying multiple sales taxes. Continued uncertainty over the taxation of digital goods will further slow the development of digital technology. State legislators should avoid placing new burdensome taxes on digital goods and abide by the physical presence standard, the precedent set by the U.S. Supreme Court’s 1992 decision in Quill Corp. v. North Dakota. In that case, the Court determined a state must prove a company has a “substantial nexus” within a state before taxes can be imposed.
Digital goods were a key part of the Quill ruling. North Dakota argued Quill’s software being used in the state constituted a presence using state resources, but the Court ruled a real-world presence was needed before taxes could be imposed. Since this ruling, the nexus, or “physical presence,” standard has been an important taxpayer protection. While technology has advanced since 1992, the basic idea that digital downloads, which are simply transmitted electrons, should not be taxed hasn’t changed.
Allowing a state to tax digital goods would enable a dramatic expansion of states’ taxing powers. “States will see the Internet as a practically unlimited source of tax income by charging low rates on large numbers of transactions,” wrote John Nothdurft, The Heartland Institute’s government relations director, in a Heartland Policy Tip Sheet.
Digital goods taxes implemented in Chicago and Philadelphia have proven to be very unpopular. When Chicago imposed a 9 percent tax to digital entertainment in 2015, the public widely opposed the tax and a lawsuit was quickly filed by consumers, which remains pending.
If a digital goods tax were to be implemented, legislators could simplify the process by mandating that taxes on digital goods must be charged only by the state in which the consumer lives, a principle known as “origin-based taxation.”
The following documents examine digital goods taxes in greater detail.
Lawmakers Should Get with the Program and Stop Taxing Digital Goods
Jesse Hathaway writes in The Hill about Pennsylvania’s digital goods tax. “Instead of skirting federal law and trying to wring taxpayers dry, lawmakers in Pennsylvania and other states should ‘get with the program’ and stop hiking taxes on things consumers find enjoyable, such as Netflix and Hulu. Cutting spending and eliminating government waste and fraud is a much better way for lawmakers to balance their budgets, and it’s far more popular with voters than tax hikes on services enjoyed by consumers every day,” wrote Hathaway.
10 Principles of Telecom Policy
In this Heartland Institute Legislative Principles booklet, Hance Haney and George Gilder describe what Indiana and other innovation leaders have done and how other states can follow their lead to reap the rewards of new investment in telecommunications services.
Time to Tax Netflix? Some Cities, and a State, Think So
Elaine S. Povich of Pew Chartitable Trusts examines Netflix taxes and discusses how several cities and states are seeking to generate new revenue through taxes on digital goods.
Digital Downloads Should Be Protected from Discriminatory and Duplicate Taxes
Free State Foundation Research Fellow Seth Cooper argues the sourcing rules, nondiscriminatory provision, and requirement for clear statements of tax policy by state legislatures in the proposed Digital Goods and Services Tax Fairness Act would create a framework in which states can equitably collect revenues without burying digital goods and services under multiple state taxes.
Five Reasons Why the ‘iTunes’ Tax Is a Bad Idea
James Lakely of The Heartland Institute gives five reasons why imposition of a sales tax on Internet purchases will cause more harm than good, in an op-ed published in The New York Post.
The Internet Tax Solution: Tax Competition, Not Tax Collusion
Cato Institute’s Adam D. Thierer and Veronique de Rugy explain why Congress should resist calls to allow states to require online retailers to collect taxes on the sale of goods over the internet.
Research & Commentary: Taxing Cloud Computing
Cloud computing has fundamentally changed how consumers purchase and use software and computing services, by moving many of the functions online. Matthew Glans of The Heartland Institute argues state legislators should avoid placing new, burdensome taxes on cloud computing and abide by the physical presence standard. Otherwise, cloud service providers will be discouraged from setting up shop in-state or providing these services there.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.
The Heartland Institute can send an expert to your state to testify or brief your caucus; host an event in your state, or send you further information on a topic. Please don’t hesitate to contact us if we can be of assistance! If you have any questions or comments, contact John Nothdurft, Heartland’s director of government relations, at [email protected] or 312/377-4000.