Pricing and Digital Goods

Today's announcement of a change in pricing on iTunes poses an interesting opportunity to test the argument sometimes made that applying a sales tax to digital consumption will hurt the industry.

There are a few arguments against applying sales tax to the consumption of digital goods such as software and music, although most states tax downloaded software and some tax other digital downloads (and the number is growing). So, certainly, it is possible to tax this type of consumption.

Two of the arguments I think I've heard most often as to why we cannot or should not tax digital goods are:

1. It will just increase the use tax gap. That is, digital goods don't need a storefront and the vendor can easily operate out of just one state. So, it is a kind of good that is likely to be purchased from a seller without a physical presence in the buyer's state. That non-present seller has no sales tax collection obligation in states where they have no physical presence. However, the buyer will need to self-assess and pay use tax on the purchase and buyers don't do a good job of this. But, this also seems like a weak argument against taxing digital goods and is really a use tax issue, not a "should the sales tax apply to more types of personal consumption" issue. There are ways to make it easier to collect use tax, such as giving taxpayers the option of computing an estimate of use tax using a table based on income (such as New York, Michigan, Maine and a few other states do). [For more on this topic - click here.]
2. A sales tax on digital goods, such as music, will hurt that industry. This also seems weak since we don't also hear people argue that sales tax on tangible goods has hurt WalMart or other retailers. Also, small vendors of digital goods likely have a taxable presence in just one state so would only have to collect tax from buyers that live in the same state. Larger vendors, such as Amazon, Tower and Apple, already collect tax in several states and collecting on digital items in those states would not be a significant burden. And, they would not have to collect in states where they have no physical presence.

With the announcement today that Apple iTunes was changing its pricing structure, the news stories have noted the potential concerns of customers. The Associated Press article, "Changes to Apple's iTunes prices take effect" by Jessica Mintz (4/8/09) states:

"it isn't clear music shoppers are swayed by a difference of a few cents if it means having to change their iPod/iTunes habit in any way."

Mintz also notes in her article that even though Amazon has been offering lower prices and a "simple software download" would allow a transfer of music to iTunes, Apple sells more music than Amazon.

So, let's see if iTunes' new pricing of 69 cents, 99 cents and $1.29, rather than only 99 cents, results in the sale of any $1.29 songs - a price much higher than 99 cents + 6 to 10 cents of sales tax (depending on the state). It all still seems like a good deal except for states, such as California, with 20th century sales tax systems that treat tangible goods as the only thing taxpayers consume.