The Digital Goods and Services Tax Fairness Act (H.R. 1860) was introduced May 12, 2011 and would prohibit state and local governments from imposing taxes on certain sales of digital goods and services that are taxable under current law. The stated intention of H.R. 1860 is to promote neutrality, simplicity, and fairness in the taxation of electronic goods and services. But good intentions are not enough.
As a threshold matter, the proposed legislation arguably exceeds Congress' enumerated powers.
Commerce Clause. The Supreme Court has substantially narrowed its interpretation of the scope of the commerce power in recent years. In this regard, the Court has emphasized the importance of distinguishing between national matters and matters that are truly local. State and local taxation is a local matter insofar as revenue needs and tax issues vary among jurisdictions. The states are in the better position to identify issues with their tax systems and implement remedial measures.
14th Amendment. State action is a necessary prerequisite to the exercise of Congress' Section 5 power. It does not appear that Congress has made any factual findings of actual incidences of discriminatory taxation. To be sure, preventative rules are sometimes necessary, but even then, they must be appropriately tailored to reach the perceived threat in order to pass constitutional muster. The restrictions imposed on states' taxing rights by this legislation are too great in comparison to the threat of discriminatory taxation.
Even if Congress has authority to enact this legislation, the focus on tangible versus intangible is misplaced. A sales tax is best summarized as a tax on consumption. In this respect, there are two basic precepts to the sales tax: (1) all personal consumption should be taxed; and (2) all business inputs should be exempt. Yet, the inquiry as to whether the thing being conveyed is tangible or intangible says nothing about personal consumption or business inputs. Not only does this legislation focus on the wrong issue, but it also explicitly contravenes the established principle that business inputs should not be taxed. See Sec. 5(2)(B) (specifying business location as tax address for sourcing purposes when item is delivered to a business); Sec. 5(2)(F) (indicating that advertising services are sales taxable).
Moreover, although the proposed legislation apparently seeks to "promote neutrality, simplicity, and fairness in the taxation of digital goods and services," it will actually do the opposite. A "digital good" includes a variety of downloadable content - e.g., software, music albums, films, e-books, photography. Significantly, the downloaded content is no different than the content acquired through off-the-shelf software, CDs, DVDs, traditional books, or traditional photos. Yet, these items would be subject to a special federal tax regime under the proposed legislation. Such disparity is not neutral, simple, or fair. The substance of the transaction rather than the form of delivery should govern tax consequences. In this respect, the focus should be on consumption.
To be sure, risks of multiple taxation remain even when the focus is on consumption. However, States are competent to deal with these issues, and the drafters of this bill would agree according to Section 8 (expressing States' competency to deal with multiple taxation in international context). In the e-commerce environment, the issues of multiple taxation are similar domestically and internationally. So if Congress has faith in the States' ability to handle the issue on an international level, then the States are certainly competent to handle the issue domestically.