State Policy Update: Startups watch as state digital ad tax saga unfolds

Engine
4 min readAug 11, 2022

By Jennifer Weinhart, Policy Manager, Engine Advocacy & Foundation

In a series of State Policy Updates, we are exploring how state initiatives are impacting the innovation happening in startup ecosystems across the country. While much of Engine’s work centers on policy advocacy and education in the federal landscape, state-based policymakers impact startup formation and growth through their own work. We’re tracking what’s working for startups, what’s falling short, and what federal policymakers can learn from their state-level counterparts.

Tax laws are changing at the state level that could lead to higher costs for startups. Earlier this year, Maryland, after passing and implementing a state digital advertising tax after a years-long battle with advertising tech companies, conceded that taxed companies can effectively pass down the cost of the ad tax to their customers — including individual consumers and startups. While the outcome of the case has yet to be decided, startups should continue to pay attention as other states eye similar proposals that could impact business for them too.

Digital advertising taxes, like Maryland’s tax, generally apply an excise tax to gross revenue resulting from digital advertising. These taxes typically target large technology companies that often provide low-cost advertising services to customers. The calculation of the tax itself is complex, as digital advertisers structure their fees in different ways, and is largely discriminatory. Under Maryland’s tax, for example, the tax rate a company is subject to depends on global revenues — leading larger companies to face higher rates and the tax to be based on non-Maryland revenues. Given this discrimination against interstate commerce, the law is potentially unconstitutional. And because print advertising, for example, isn’t typically subject to a similar tax questions remain as to whether the tax is in violation of the Internet Tax Freedom Act, which prohibits taxes that discriminate between offline activities and electronic commerce.

Maryland’s tax on gross revenues from digital advertising services, which was first adopted in March of 2020 and went into effect in January, is being challenged in both state and federal court. Plaintiffs in both the state and federal cases argue that the ad tax violates the commerce clause and the due process clause of the Constitution, in addition to the Internet Tax Freedom Act. And plaintiffs in the federal case argued that the law constitutes a penalty in order to get standing in a federal court, thanks to the antiquated Tax Injunction Act — though the court ultimately disagreed. Only the challenge to the “pass-through prohibition” in the law — which prevents affected businesses from passing along the tax to consumers — was allowed to proceed in federal court.

However, the U.S. Chamber of Commerce and Maryland Attorney General Frosh later reached an agreement regarding the “pass-through prohibition” in the law. That agreement would allow taxed companies from passing on the cost of the tax to customers, including startups, so long as any increase in billing appears as an increase to overall billing, as opposed to a separate surcharge on a customer’s bill. As a result, startups and other consumers may ultimately begin paying more for services provided by companies that provide digital advertising. Attorney General Frosh confirmed that the provision does not in fact restrict what taxpayers can say to consumers about higher charges because of the tax.

In recent years a number of states have followed Maryland’s lead in an effort to boost revenues by taxing the digital services of large technology companies. Legislators in Massachusetts, for example, introduced a bill last year to pass a similar tax on banner advertising, interstitial advertising, search engine advertising, and other comparable services. And New Mexico has introduced guidance regarding taxation of digital advertising under their existing gross receipts tax, which was recently expanded. The new rules are set to become effective in October, but state officials expect the tax to face less scrutiny than the Maryland tax, arguing it is not discriminatory and shouldn’t run afoul of the Internet Tax Freedom Act because New Mexico already taxes broadcast and print advertising services.

Some critics of the tech industry believe the taxes are a way to punish large digital platforms for the user-generated content they host. Others view state digital advertising taxes as a parallel to efforts on the international stage to tax the digital services of mostly American, large technology companies. Though digital services taxes have largely been suspended as the world awaits adoption of a global minimum tax, taxed companies have indicated that the new taxes would result in increased costs for consumers.

Startups should watch as the challenges to these taxes make their way through state legislatures and the courts. Digital advertising taxes aren’t the only measures states are considering. Other states are considering taxes on income from the sale of user data, and others still have considered taxation targeting social media advertising. These measures may or may not directly apply to startups depending on the state and the tax, but they can all ultimately pose a threat, as startups depend on the low-cost services of other platforms and marketplaces.

Engine is a non-profit technology policy, research, and advocacy organization that bridges the gap between policymakers and startups. Engine works with government and a community of thousands of high-technology, growth-oriented startups across the nation to support the development of technology entrepreneurship through economic research, policy analysis, and advocacy on local and national issues.

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Engine

Engine is the voice of startups in government. We are a nonprofit that supports entrepreneurship through economic research, policy analysis, and advocacy.