Because of quirks in many state laws, sales taxes may be levied on CDs sold in storefronts but not on iTunes and other digital downloads. It's a situation that recession-weary, tax-hungry politicians are hoping to change.
A growing number of states are considering laws to tax digital goods, such as iTunes songs, Amazon MP3s, or electronic books. Yet at a time when governments say they want to encourage broadband adoption and the development of a low-carbon economy, opponents say taxing digital goods sends exactly the wrong message.
Mississippi is one of the latest states to write into law a tax on digital products. The measure, which was adopted mid-March and goes into effect July 1, imposes a sale and use tax on specified digital products--including digital audio-visual works such as movies, digital audio works such as ringtones, and digital books.
Republican Gov. Haley Barbour endorsed the legislation via Twitter. "On HB 1461, I support this bill and here's why: This bill will treat Internet sales like catalog sales making it a level playing field," he said on March 11.
Including Mississippi, at least 18 states claim they have the authority to, and more are likely to join them.
On March 12, a bill was introduced in the North Carolina general assembly "to modernize the sales and use tax statutes by treating music, movies, books, and computer software that are delivered electronically the same as those that are purchased in a tangible medium."
A digital goods tax measure was also introduced in the Minnesota House of Representatives in late March. The bill could raise the state more than $8.2 million in 2010 through 2013, according to the Minnesota Department of Revenue (PDF).
States such as Washington and Vermont are also considering such measures, according to Stephen Kranz, an attorney at the Sutherland law firm who represents companies in the digital media industry.
The idea isn't popular everywhere. Ato tax digital goods in New York died this month when it was left it out of the state budget.
Rob Atkinson, the president of the Information Technology and Innovation Foundation, said that policy makers should distinguish between digital goods and digital services in their tax laws.
"A service would be someone designing your Web site for you," Atkinson said. "Whether they design it from a thousand miles away or in your office is irrelevant. On the other hand, if someone is buying (music online), it should be treated in the same way as a physical analog in the economy."
"I don't think most policy makers think about it that way," he added.
The Washington state bill would clearly tax digital services as well as what's typically considered digital goods, Kranz said. The Streamlined Sales Tax Project, a multistate effort to develop uniform standards for taxation, adopted in 2007 a specific definition of digital products, along with procedures for how they should be taxed.
Location, location, location
A uniform definition across states would make the taxes less burdensome to merchants, Atkinson said.
"There has to be some easy to use plug-in software...so each seller doesn't have to go through this accounting nightmare," of determining the taxes due in each state, he said.
However, some proposed laws such as Minnesota's would not apply to online merchants based outside the state, Kranz said. That's because under the legal concept of "nexus," a state generally may only tax a company that has a physical business presence within the state's borders--though a state may apply a "use tax" for goods coming into the state from elsewhere.
Those states that are not including a use tax in their proposals are "'discriminating against their own digital community," Kranz said. "If I'm a consumer and I have a choice between two Web sites and one charges tax and one doesn't, which one do you think I'm going to purchase from?"
In fact, North Dakota Gov. John Hoeven on March 19 signed into law a measure to explicitly exempt digital goods from taxes for that reason.
"I think it's important we send a message to the world of digital products that this is a state that's favorable to their interests," Dwight Cook, the state senator who introduced the tax exemption bill,in January.
The tech industry has also beenfor the government to promote the use of information and communications technology as a means of creating a more energy efficient economy--a goal that may be undermined by digital goods taxes, according to some.
"The digital economy is growing fast, and the tiny carbon footprint of downloads is something that benefits all of us," said Steve DelBianco, executive director of NetChoice. "Digital downloads are the most environmentally responsible way to get movies, music and software, and tax policy is one the ways we promote environmentally sound decisions."
Digital goods taxes may be particularly unappealing to consumers on April 15, DelBianco said.
"Writing a fat tax check is particularly painful when your home (value) and savings have declined so deeply, and the idea of facing new taxes on digital goods makes that pain last all year long," he said.