by Shana Dines
The economy is in a recession. Gas prices are up. Mortgages are foreclosing. But digital music sales are on the rise, with iTunes reportedly selling over 5 billion songs, to date.
Not surprisingly, politicians have begun viewing the billion-dollar industry as a potential revenue generator for the government through taxation.
Many states, including California, have tax laws that unintentionally protect digital downloads from taxing because of language written well before the internet was even envisioned. However, a growing number of states have started (or will soon start) taxing digital music downloads, either through reinterpretation of existing tax laws or by passing new laws.
Currently, there are 17 states that have recently enacted taxes on digital downloads. Nebraska passed a tax in April that will go into effect in October. The Nebraska tax is being levied on "the retail sale of digital audio works, digital audiovisual works, digital codes, and digital books delivered electronically."
It also clarifies "retail sale" to include the transfer of permanent right of use, rights of use that terminates on some condition, and right of use that is conditioned upon continued payments. This is meant to ensure the tax can be applied to most of the digital music retailers, despite their different DRM and payment plans.
Tennessee passed a statute with similar content in June, which will take effect in January of next year. Some of the large states that tax downloads are Texas, New Jersey, and Washington, as well as the District of Columbia.
The struggle over digital download taxes in California has been one of the most contentious and hard-fought. With a deficit of $8 million, the state should take all the tax increases it can get.
A bill proposed by Democratic Assemblyman Charles Calderon was defeated back in April. The bill would have taxed the download of all types of digital property and would have drawn in approximately $114 million in tax revenue, according to California Board of Equalization. Calderon is expected to pursue this bill further in the next legislative session.
In a state where physical retail sales, including CDs and DVDs are taxed so heavily, it seems logical that the digital equivalent be subject to similar taxation. The bill was supported by agencies representing various state and public employees, like teachers and firemen.
However, the bill's opponents, including many internet-based companies and the Motion Picture Association of America, criticized the proposal on numerous different grounds. The vice president of the MPAA, Vans Stevenson, foresees a tax on digital downloads as encouraging consumers to return to their bad habits of illegally downloading copyrighted material. NetChoice's executive director, Steve DelBianco, criticizes it as taxation of the "greenest way to buy music, movies, and software," something which should be encouraged.
Further, one member of the California Board of Equalization, Michelle Steel, warns that California retailers would be at a competitive disadvantage to out-of-state companies because of nexus. The legal concept of "nexus," which was reinforced by the U.S. Supreme Court in 1992, requires that a state may only tax a company that has a physical business presence within the state's borders. Therefore, a state tax on digital downloads would apply to California-based companies like Apple and Rhapsody, but not Amazon, whose warehouse is in Seattle. This incentive for businesses to leave California would end up reducing tax revenues in the form of corporate taxes.
From a procedural perspective, Calderon's bill was also criticized for trying to circumvent normal initiatives for new taxes. The bill had the California Board of Equalization setting the new tax policy, which only requires a simple majority, as opposed to standard legislation on new taxes, which needs two-thirds voter approval. Del Bianco of NetChoice is critical of this practice, saying that if legislatures want to increase taxes, they "have to do it in the daylight" where it is subject to public debate and not behind closed doors.