Why digital services taxes are a ‘bad idea’


While only one U.S. state (Maryland) has enacted a tax on digital advertising and data mining – a tax that’s currently on appeal – many others are considering doing so according to a special report from Tax Notes State. The study weighs the theories behind digital services taxes (DSTs) and finds them severely deficient.  

Advocates of DSTs have advanced a range of arguments. DSTs could be seen as analogous to severance taxes on the extraction of natural resources, with the “mining” and usage of consumer data standing in for, say, oil and gas extraction. They have also been proposed as a kind of excess profit tax to balance digital platforms’ increasingly dominant market positions. But perhaps the most popular rationale is that DSTs can help tax authorities fill gaps in their consumption tax regimes. “The internet economy creates new and powerful digital business models that frustrate the ability of governments to appropriately exercise their taxing authority,” the Tax Notes State report indicates. “Accordingly, gaps open up in the consumption tax base that never previously existed, requiring novel consumption tax solutions.” 

What’s wrong with that idea? Plenty, the report argues:  

  • The Maryland DST, and similar legislation elsewhere, exclusively targets business activities. Digital advertising and data mining are intermediate inputs in the value creation chain and, as such (at least in the U.S. tax system), are traditionally and intentionally untaxed. Tax is applied only to the final good or service produced. DSTs result in “pyramiding” of taxes by imposing tax on the intermediate business inputs as well as consumer purchases. 
  • Pyramiding taxes for digital services brings even more complexity to what the report calls the “excessive cascading of sales tax already overwhelming state tax systems”. Sales tax exemptions for business inputs are already distributed unevenly across industries. For example, most states offer no exemptions for purchases of computer hardware, software and telecommunications services – all crucial inputs for digital companies. 
  • Administering DSTs is problematic. In business-to-business commerce, digital products are hard to define and can be consumed simultaneously in multiple jurisdictions and across national boundaries. Determining the taxable value of transactions can be challenging.  

Tax authorities considering consumption tax reforms should cross DSTs off their list, the report concludes. “At a time when we critically need to improve the efficiency and effectiveness of U.S. state sales tax systems, DSTs would take us another step backward, pushing state tax systems further from international norms of a well-designed consumption tax.”

Blog Author

Michael J. Bernard, Chief Tax Officer – Transaction Tax at Vertex Inc. Vertex's Chief Tax Office (CTO) provides insight regarding the impact of tax regulations, policy, enforcement, and emerging technology trends on global tax department operations.

Michael J. Bernard

Chief Tax Officer, Transaction Tax

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Michael Bernard is the Chief Tax Officer of Transaction Tax. In his role, he provides insight and thought leadership around tax department operations, U.S. indirect tax, tax risk management, and tax policy, as well as emerging tax trends. He is an executive-level tax attorney with a diverse portfolio of experience in corporate tax, administration, and finance, including a substantive knowledge of U.S. and international tax laws.

Prior to joining Vertex, Michael was in various tax leadership roles at Microsoft Corporation for 28 years, the most recent being Senior Director – Tax Counsel. Michael led teams in the following functional areas: direct and indirect tax controversy, sales and use, business license, property, tax IT, SOX, and telecommunications. He also co-led a corporate taxpayer advocacy group with the Washington Department of Revenue and was a Director on the Board of the Washington Research Council. Michael has also testified before administrative and lawmakers at both the federal and state level.

Michael earned both a J.D. and a Bachelor of Science in Business Administration from Creighton University. He is a part-time lecturer of Law in the LLM program at the University of Washington School of Law. Michael also served on the board of directors, executive committee, and chaired committees for The Tax Executives Institute (TEI) for nearly 25 years.

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