Unstable revenue sources make unsustainable tax reform
Sustainable tax reform depends upon sustainable revenue sources. And while Platte Institute has been critical of a state-local tax swap because it uses state funds to subsidize local spending, it’s also worth clarifying that not all state funding sources are created equally.
Regardless of Platte’s position on tax swaps, no tax reform should be built upon an unstable or unpredictable revenue source. In short, the state should not replace a stable revenue source with an unstable revenue source.
The sales tax is a stable revenue source, and is notably more stable than the individual or corporate income tax. That’s one reason why economists agree that the sales tax base should even be extended to include more final retail services. Yet extending the sales tax to include digital advertisements, as proposed in LB 1354, might be illegal altogether. A similar tax is being credibly challenged in Maryland on multiple fronts. Nebraska should avoid building any tax code changes on revenue that might be illegal to collect.
Maryland instituted a digital advertisements tax in 2021 over the veto of then-Governor Larry Hogan. Since then, the state has been in and out of court due to a fleet of legal challenges.
Starting with the most straightforward argument, technology companies believe that the federal Internet Tax Freedom Act (ITFA) pre-empts that state tax. State governments cannot act on issues pre-empted or defined by the federal government, which is what the ITFA does. The ITFA says that online activity cannot be taxed in a way that offline activity is not taxed. In other words, if billboards and other forms of ads aren’t hit with a tax, then neither can digital ads. Nebraska’s law effectively exempts the taxation of offline ads by only applying the tax by a $1 billion national revenue threshold, which captures only a handful of online platforms.
The Maryland ad tax is also being challenged as a First Amendment violation. The tax treats online speech (digital ads) more harshly than offline speech (broadcast and news), thus treating speech differently across different media. Both state and federal courts are analyzing Maryland’s law for First Amendment violations, with a state court already ruling it illegal on 1A grounds.
Tech companies also allege other violations of due process and the commerce clause because the tax only applies to companies that generate a certain amount of tax revenues ($1 billion) outside the jurisdiction that enacts the law. The tax also favors Nebraska’s-based advertisers over outside advertisers, which is not allowed in the open system of commerce between the states.
Setting aside these legal issues, it’s also not a good idea to tax business inputs. Advertising services are business inputs, i.e. things businesses buy in order to produce and sell their goods and services. A tax on advertising can effectively be passed along to businesses and consumers. Furthermore, taxing business inputs causes a spiral of taxation upon goods and services before they are ever consumed by a retail purchaser. This spiral of taxation, or “tax pyramiding,” swells the cost of goods and services in a way that you cannot see transparently. This results in unseen taxation through high prices for goods and services.
A tax code built upon legally-dubious revenue sources is built upon sand. Nebraska should not make any form of tax relief contingent upon a new tax on digital advertisements that might disappear with the next court ruling. The digital ad tax should be thrown out of consideration altogether.