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Monday, June 23, 2008

Taxing Digital Products - Let's Also Use the Technology to Modernize Collection

When today's forms of taxes were created decades ago, there wasn't any technology to consider in making computations and collection easy. But that is not true today. While some states are slowly modernizing their laws to address new ways of living an doing business that are partly due to changes in technology, the technology as a tool of tax compliance and administration is often overlooked.

Tennessee enacted various tax law changes which the governor signed on June 5, 2008, including expanding its sales tax to include most digital goods provided the tangible equivalent is something already subject to sales tax. [SB 4173 enacted as Public Chapter Number 1006]

"The retail sale, lease, licensing, or use of specified digital products
transferred to or accessed by subscribers or consumers in this state shall be
subject to the tax levied by this chapter on the sales price or purchase price
thereof at a rate equal to the rate of tax levied on the sale of tangible
personal property at retail by the provisions of § 67-6-202."

The law defines various types of digital goods and notes a few exemptions. To determine where the buyer resides, the new law provides:
"(g) The tax imposed by this section shall apply to retail sales in this state, indicated by the residential street address or the primary business street address of the subscriber or consumer."

Thus, Tennessee joins New Jersey, Nebraska and a few other states that have modernized their sales taxes to include today's forms of consumption, although they don't also address using the technology for collection ease. For equity reasons and continuation of the tax base, as forms of consumption progress beyond what yesterday's legislators ever envisioned, such as the digital equivalent of tangible goods, including software and music downloads, a state needs to update its laws.

First - why include digital downloads in the sales tax base? As a consumption tax, there is no reason to tax a song sold on a CD that you'll play in your CD player, but not one downloaded online onto your MP3 player or computer to listen to. The result in both situations is the same - you enjoy the music. And both forms are consumption which is what a sales tax is designed to tax.

One argument sometimes voiced about including digital downloads in the sales tax base is that you may not know the location of the buyer. But, unless the song is free (in which case it is unlikely to be taxed unless it was bundled with something else that is taxable), the consumer is using a credit card which includes their address. While the credit card user could have the card registered in a different state, it is unlikely and there are ways to still require the user to let the credit card company know where the cardholder is located.

Another argument against taxing digital goods is that it will hurt Internet companies. This is a distractor argument. The sales tax is paid by the consumer, although collected by the seller if the seller has a physical presence in the state (if not, the buyer pays use tax on their own). Will people stop buying digital downloads because of sales tax? It seems unlikely because if they really want the product, their alternative is to buy the taxable tangible equivalent. Also, retailers of tangible personal property have been collecting sales tax for decades and they seem to be able to remain in business. Certainly, moving something from being non-taxable to taxable is shocking at first, but people will get used to it. If the states that are modernizing their laws to comport with today's ways of consuming and doing business help explain why the change is needed - equity, fairness, neutrality, to keep state tax bases from eroding, consumers are more likely to understand. And, the sooner the states update their laws, the better because the longer the delay, they are really indirectly educating consumers that digital consumption is not subject to sales tax.

Many states with sales tax, added it in the 1930s when digital goods were not in existence. So, most laws were written to apply to the key type of consumption - tangible personal property. If states had originally written their laws to apply to consumption of goods without using the word "tangible", digital downloads would have been taxable from the start and I don't think consumers would have questioned it. After all, if you pay sales tax on your music CD, why wouldn't you also pay it when you download the music onto your MP3 player to enjoy.
Another issue sometimes raised is the cost to vendors of collecting the tax on digital items. This is also a distractor in that other vendors have been incurring costs for decades to collect sales tax on the tangible items they sell. I do think though that vendors should recieve some relief for these costs, something very few states do today. I also think this is an area where technology could be better used to collect the tax. Again, when sales taxes were enacted decades ago, the use of technology to collect the tax was primarily paper and pencil.

Better Use of Technology:

Today, the sales tax could be collected by the state tax agency at the same time the buyer's credit card is billed for the item. This would enable the state tax agency to get the money sooner, there would be no need for the vendor to file any reports and it would still be transparent in that the buyer would see the sales tax charge when they buy the item. Checks and balances could still be in place in that in auditing a vendor, the state agency would primarily review the system for charging to see that it works as intended and check a sample of transactions to be sure the collected tax was charged by the correct state tax agency.

This sales tax billing system could also be used for tangible goods. Whenever the credit card is charged, the sales tax portion gets charged by the state tax agency. The credit card or other payment card would just need to have the customer's state noted or they could be asked at the register (already, many stores ask for a zip code - apparently for marketing purposes).
Let's truly act like we're in the 21st century and not only modernize sales tax to apply to the digital equivalent of tangible consumption, but use technology to make it easier and more cost effective for vendors, consumers and state tax agencies.

[For further information, see my 21st Century Taxation website.]

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