Is Maryland’s digital service tax innovative or insane?

Want to open Pandora’s Box? Talk to a tax professional about digital services taxes. In nearly every incarnation they have taken on, digital services taxes have proven controversial. Whether domestically, where at least half of the states in the U.S. have made waves by enacting digital provisions of some kind, to foreign governments like France nearly inciting a trade war with the U.S., digital taxes are not without their critics.

But Maryland’s proposal to tax digital ads has sailed right past controversial to land in the realm of is this really happening?

The structure of Maryland’s digital ad tax, which is the first major policy pitched by Senate President Bill Ferguson (D-Baltimore City) under his pledge to modernize the tax code, is unique. According to the Washington Post, the proposal would levy as much as a 10 percent excise tax on revenue companies receive from selling digital ads that target Maryland IP addresses.

At first blush, that may seem like the type of progressive-thinking tax that states should be leveraging. Not only does it ensure that ads that are targeted at users of Facebook, Google, Twitter and the like are taxed like any other ad buy, but legislative analysts estimate that Maryland’s plan could generate as much as $250 million per year for the state.

However, once you start to peel back the layers of enforcing this type of tax, the mechanics of it all seem incredibly complex and unwieldy.

Most notably, there’s the issue of enforcement. It’s one thing to itemize business expenses or show a company’s total gross revenues. But unlike those metrics that are easier to cross reference and confirm, states would have to rely on a huge data dump from technology companies to enforce this tax. Just how feasible is that? It’s hard to say.

It’s possible that there’s a path for auditors to check which IP addresses accessed certain ads, but without knowing the inner workings of how these companies collect this data, it’s possible that state enforcement officials would be shooting in the dark. Needless to say, enacting a tax without a clear path to enforcing it seems ill-advised.

Then there are the seemingly inevitable privacy issues. Technology companies have already been dogged by privacy concerns. Just as recently as last week, Facebook settled a lawsuit for $550 million in Illinois that carried serious privacy implications. Could a case be made that this type of tax violates similar individual privacy rights?

It’s possible. A tax aimed at IP addresses would undoubtedly require the tracking of geotags and location services. Many social media users sign over these rights when they agree to a site’s terms of service, but what if they opt out of location service tracking? Can a company still access those records if, say, a New York resident takes a weekend trip to Maryland, uses a Maryland-based WiFi connection, and receives targeted ads? That seems like a sticky legal situation waiting to happen.

Overall, this seems to violate the basic rules of good tax policy: equity and fairness. Tax law is not supposed to single out companies of a certain sector, size or profitability. It’s hard to imagine anyone making a case that this law doesn’t do exactly that. Tack on the very real enforcement, reporting and privacy concerns, and it seems like a perfect example of good intentions gone wrong with flawed execution.

Without communicating a thorough plan to both monitor and enforce, Maryland lawmakers are simultaneously creating a different avenue for avoidance and a huge source of confusion for companies that file in the state. Only time will tell how this will play out, but, if it does pass, don’t be surprised if the legacy of Maryland’s digital ad tax isn’t measured in revenue, but instead, in the avalanche of headaches it creates for tax professionals in its wake.