STATE DIGITAL SERVICES TAXES: A GOOD AND PERMISSIBLE IDEA (DESPITE WHAT YOU MIGHT HAVE HEARD).

• Author: Kim, Young Ran Christine

INTRODUCTION 743 I. UNPACKING THE PLATFORM ECONOMY 750 A. Defining Platforms 750 B. Distinctive Features of Multisided Platforms 751 1. Different User Groups and Network Effects 751 2. Two-Sided Market and Differing Pricing Mechanisms 752 3. Low Marginal Costs and Monopolies 754 4. Ease of Profit Shifting 756 C. What Has Happened at the International (and Federal) Level 757 D. What Has Hajipened at the State Level 759 II. POLICY ARGUMENTS IN FAVOR OF DIGITAL SERVICES TAXES (DSTS) 760 A. Fill out the Consumption Tax 763 B. Tax Economic Rents 767 C. Reduce an Externality/Other Regulatory Goals 770 D. Tax Base Diversity 772 E. Apportionment Diversity 773 III. LEGAL ANALYSIS OF DSTS: THE CASE OF MARYLAND'S DST 777 A. Basic Objection Based on the Internet Tax Freedom Act (ITFA) 778 1. Discrimination 778 2. Should the DST Be Preempted Because of a Concern with Stability? 782 3. Does the Presumption Against Preemption Apply to the ITFA? 784 4. Doesn't the Legislative History Indicate That a Tax on Just Digital Commerce Is Discriminatory? 785 5. Conclusion on ITFA 787 B. Dormant Commerce Clause Challenge: Extraterritorial Values 787 C. Foreign Affairs Doctrines 789 1. One-Voice Prong from the Dormant Commerce Clause 789 2. Foreign Affairs Preemption 792 3. Conclusion of Foreign Affairs Doctrines 793 D. Whither Murphy 793 IV. RESPONDING TO POLICY OBJECTIONS 796 A. Expand Sales Taxes 796 B. Difficulties of Taxing Barter Transactions 797 C. Economic Distortion by Tax Pyramiding 800 D. Regressive Tax Incidence 802 E. Use Corporate Income Taxes 806 CONCLUSION 807 APPENDIX 809 INTRODUCTION

How to tax the digital economy is a topic that has set the world's tax community aflutter. (1) This makes sense. Not only is the digital economy big (2) and growing, (3) but it operates differently than the traditional brick and mortar economy, putting a strain on international and national tax systems that were designed a century ago. (4) Accordingly, the Organization for Economic Co-operation and Development (OECD)/G20's global tax deal, joined by almost 140 countries in October 2021, proposes to reform the outdated tax rules for the digital economy. (5)

One challenge posed by the digital economy relates to which jurisdiction has the power to impose a tax on e-commerce transactions. A state or a country needs to establish sufficient nexus to a business in order to tax business activities associated with the state. Such a nexus traditionally required a physical presence, like an office within the taxing state, and thus a state could not tax income or consumption generated from remote sales by out-of-state businesses. This was not a big problem when a remote sale meant placing an order by phone. However, the rise of e-commerce has increased the magnitude of remote sales exponentially, punching a big hole in sales (consumption) tax bases around the world. What is needed is a shift to nexus based on significant economic presence. The recent OECD/G20's global tax deal provides for such a change of rules at the international level. (6) Within the United Sates, the states have generally already adopted substantial economic presence standards because the U.S. Supreme Court removed the main obstacle to them doing so in 2018 in a case called South Dakota v. Way fair, Inc. (7)

However, updating the nexus rules is not all that is necessary to update tax systems for the modern economy. Expanding the nexus rules allows states to tax traditional brick and mortar transactions (say buying a book) that have migrated to the internet. However, these rules do not help states tax new kinds of transactions made possible by the internet--and that should be subject to tax. We are particularly referring to transactions made possible by the digital platform economy, such as Google, Amazon, Facebook, and Apple. Digital platforms operate in a multisided market that connects multiple distinct user groups, (8) such as user-consumers and user-advertisers in Google (digital advertising platforms) or user-sellers and user-buyers in Amazon (online marketplace platforms). (9) Digital platforms provide the users with certain network benefits, meaning that the value of a product or service provided by a platform increases according to the number of others using it. (10) The platforms have proprietary technology that allows them to offer improved services as more users participate.

To illustrate the new tax problems in the platform economy, consider the hypothetical example of Mary. Mary, a single millennial lawyer living in Maryland, wants to purchase new business attire online. Mary is particularly interested in basic business casual, not too luxurious, and she begins "googling" key words like "business casual for women." For no explicit charge, Google shows search results, such as suits by J. Crew, Banana Republic, and H&M. Mary clicks only on J. Crew and skips other brands. For Google, the data it collects from Mary about "business casual for women" is information that it can, and does, monetize in order to provide its "free" service. So, it is not surprising that when Mary visits her favorite YouTube channel to watch a new video clip, YouTube shows an advertisement for J. Crew, which Mary is now more likely to click on or at least not to skip.

In sum, digital platforms (Google) sell user-advertisers (J. Crew) precisely targeted, individualized, and verifiable access to user-consumers (Mary). Their business practice relies on two-sided, mutually reen-forcing transactions. On one side, user-advertisers pay digital advertising platforms to place their ads in front of user-consumers. On the other, the platforms engage in a barter with user-consumers: exchanging services (e.g., social networking, search, maps, etc.) for the right to place targeted advertising in front of them and to collect enormous amounts of user data (e.g., where those users browse the web, how they use the platforms' services, or whether they click on an ad) including by installing small bits of tracking code on user-consumers' computers. (11) These transactions are often conducted simultaneously, and the success of the first side of the transaction depends at every step on the barter exchange (e.g., platforms simultaneously show a user-consumer a targeted ad, collect data about that users' activities, adapt ads in real time to increase chance of affecting user behavior, and get paid by the advertiser based on the user's activities).

Digital platforms create the same tax challenges regarding physical presence as more traditional e-commerce does (think buying a book through Amazon) because digital platforms are not bound by geographical location of service delivery. However, there is an additional tax problem created by digital platforms due to the features associated with operating in a two-sided market. First, unlike the traditional tax problems that involve two competing tax jurisdictions, digital platforms can involve three competing tax jurisdictions where platforms (Google in California), user-advertisers (J. Crew in New York), and user-consumers (Mary in Maryland) are located. Neither international nor multistate tax rules were designed with this structure in mind. (12) Second, the provision of data from Mary in Maryland in the barter transaction side of the platform generates extraordinary profits for platforms on the advertising side. (13) But the barter transactions are not recognized or taxed in any state, resulting in a large and growing gap in the sales (consumption) tax.

Digital advertising platforms collect an enormous amount of data about their user-customers--everything from a user's demographics and her friend network to her web history and geolocation relative to another user. (14) And this data is immensely valuable. Digital advertising platforms feed it all into sophisticated algorithms that allow them to precisely target users and command higher bids from advertisers. (15) So, user data is analogized as the new "oil" in the twenty-first century, (16) and it is reasonable for market states (Maryland) to expect to collect tax revenue from the platforms, especially from the barter transaction between platforms and its resident user-consumers (Mary).

In response to the perceived failure to tax the profits of very profitable providers of digital services, (17) several big market nations, in particular the United Kingdom, France, and other European countries, have imposed a special tax on digital services, called Digital Services Taxes (DSTs). (18) Heated debate and pushback from the United States ensued because the U.S. and the big tech firms argue that DSTs in effect target U.S. tech giants, and are thus discriminatory. (19) There is now a tentative agreement as part of the OECD/G20 global tax deal to address the digital economy, a framework that is meant to supersede individual national DSTs. The United States supports the new global tax deal, and in return, it successfully included a provision that participating countries are required to repeal their DSTs. (20) At the time of writing, however, the future of this tax deal, known as Pillar One, is very much in doubt. (21)

Meanwhile, in the United States, at least ten states have considered imposing DSTs, (22) and Maryland actually did so--over the Governor's veto. (23) Maryland's DST is modeled on European DSTs in that taxes are based on the platform's global annual gross revenue. (24) But the tax rate varies from 2.5% to 10% and narrows the scope to digital advertising platforms only. (25) To meet the tax threshold, a taxpayer must have $100 million of global annual gross revenue from all sources and at least $1 million annual gross revenues derived from digital advertising services in Maryland. (26)

However, before the tax became effective on January 1, 2022, Maryland immediately had its tax challenged in both federal and state court. (27) The plaintiffs in both cases make many arguments, but their strongest arguments...