CBPP: Digital Goods Act Will Limit Tax Collection

Identical bills proposed by House and Senate lawmakers to provide rules of the road for taxing digital goods and services would immediately and significantly reduce state and local tax collections, the Center on Budget and Policy Priorities warns in a report.

The CBPP also said the bills, entitled the “Digital Goods and Services Tax Fairness Act of 2011,” would restrict the ability of state and local governments to levy sales and gross receipts taxes on fast-growing categories of consumer and business purchases.

Rep. Lamar Smith, R-Tex., chairman of the House Judiciary Committee, and Sens. Ron Wyden, D-Ore., and Jon Thune, R-N.D., introduced the bills last May. They were designed to protect digital goods and services, like mobile smartphones and cloud computing, from multiple and discriminatory taxes at the state and local level.

But Michael Mazerov, author of the CBPP report, said that, if enacted, the bills “would further undermine state and local governments’ already-shaky finances.”

He said revenue losses from the bills would grow over time as more types of entertainment, information and business-to-business services shift to online technologies. He added that the legislation would have far-reaching negative implications for states and localities and ultimately undermine funding for education, health care and other state and local services.

Mazerov describes four provisions that would adversely affect state and local tax collections. The bills would repeal existing sales taxes imposed on computer software sold and delivered online. They would define downloaded software as a digital good rather than a tangible product that could be taxed.

In addition, the legislation’s proposed “sourcing rule” for digital goods and services would promote corporate tax avoidance by allowing otherwise taxable business purchases of these products to escape taxation completely, the report noted.

Mazerov said the bill would create a “large, unwarranted tax break for many online purchases by preventing state and local governments from continuing to impose sales taxes on the full retail price of items sold by online 'intermediaries.’ ”

Lastly, Mazerov said the bill would reduce revenue because it bars states from taxing digital goods and services that are used to produce other digital goods and services, also known as sales-for-resale exemptions.

Aides to Smith rebuffed the think tank’s report. “Contrary to CBPP’s assertions, the Digital Goods and Services Tax Fairness Act does nothing to impair a state or locality from imposing a sales tax on digital goods at the same rate and in the same manner as its sales tax is applied to tangible goods or services,” a House Judiciary Committee aide said.

“In fact, under the bill, a state or locality that currently does not impose a sales tax on digital goods today could actually decide to impose one on digital goods in the future, which presumably would result in net revenue gains.”

The aide said the committee has not yet scheduled a markup on the bill.

Wyden said: “Without this bill, there may be a rush to impose discriminatory and duplicative taxes on the digital economy that will stifle growth and the jobs that come along with it. That is not a good outcome for states and the overall economy.”

Several state and local groups like the National League of Cities oppose the bill, claiming the measure could disrupt fundamental features of state and local sales taxation and open up tax-avoidance opportunities for large multistate corporations during a time of fiscal stress.

“We appreciate the objective, but certainly the devil is in the details,” said Lars Etzkorn, program director for federal relations for the NLC. “The bill provides a loophole by not paying taxes for business-to-business sales. They are gaming the system in order to undermine state and local authorities to tax.”

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