How should tech firms be taxed? Maryland is the latest test case

The sales tax got its start in the Great Depression.

Short on revenue, the first US states launched the policy and process for collecting a percentage on products sold. Others followed: Maryland in the 1940s, Pennsylvania in the 1950s and Virginia in the 1960s. All started with only physical products. 

Two big trends over the last 50 years upended sales tax strategy. For one, in addition to products, we also buy and sell services (from haircuts to consulting), and we now spend about as much on both, per the Federal Reserve. 

Secondly, the internet and software challenged what we mean by products. Generations of policymakers have debated whether software providers should be taxed at the state and local levels.

Most recently, as part of an agreement with Gov. Wes Moore, the Maryland House of Delegates passed a bill that would require certain business-service providers to pay a tax, timed with a $3 billion state budget shortfall. But this has happened before, in states around the country. 

Memorably, in Pennsylvania, an online sales tax was eventually introduced in the 2010s, but the state’s “tech tax” on digital services was avoided after organizing from Pennsylvania’s two largest tech lobbying groups: the Pittsburgh Tech Council and PACT. Now, the Maryland Tech Council, which is part of the same national organization, may be following the same playbook. 

That playbook: Remind policymakers that tech businesses are easier to relocate than retailers, and argue that tech jobs are valuable to have in part because of their multiplier effects. These points are packaged with standard guidance: Tax what you want less of, and avoid taxing what you want more of.

This was compelling in the 2010s. But has the argument lost its punch post-pandemic?

A higher share of tech jobs are done away from office than nearly any other industry, including more international hiring, and about half of the newest crop of tech startups are fully remote, according to a recent Technical.ly analysis. With the end of the cheap-money era, many tech firms have retreated from public life — fewer are hosting and sponsoring the community events and do-goodery that Technical.ly chronicled back then. 

Post-pandemic, state and local governments are shifting to attracting and retaining people first, before companies. If tech firms are also less engaged in public life, and not necessarily hiring locally, why wouldn’t they be expected to shoulder the burden of investing in the places they’re a part of?

It helps to benchmark across locations. Maryland, for example, is considered a high-tax state, per a comprehensive Tax Foundation assessment, though so are economically powerful states such as Massachusetts, California and New York. That’s true when looking more narrowly at tech-related taxes too.

For ease, let’s put various “tech taxes” into three categories:

• Online transactions of physical goods: Following the 2018 Supreme Court ruling in South Dakota v. Wayfair, Inc., most jurisdictions see ecommerce as no different than a physical retailer when it comes to sales tax (from Amazon to a small retailer).
• Online transactions of digital goods: Most states (41) tax digital products, and nearly half tax SaaS companies specifically. 
• Purchases of digital services: This is the least defined category, and it includes the current Maryland example. States handle a range of services very differently: about half tax some business services, but fewer include software development.

The term “tech business” describes a wide range of companies: from loss-making software startups and experimental hardware companies to ecommerce and digital media companies to consulting firms and contract development shops. Once considered magical, they’re all increasingly treated like other parts of the economy. 

The trend seems clear that after decades of uncertainty, these various tech categories are being treated more and more like the traditional economy: Individual transactions being taxed, in addition to any corporate tax that 40+ states impose. Tax consultants are advising ever more complicated strategies to combat this.

Software and IT consulting firms, which sell digital services, are expected to generate net profit margins well over 10%, after relatively high salaries and few physical assets. More than any breakthrough invention, most business services firms sell their processes and people. High tax places like Maryland often have good public schools and other amenities that brainy people like.

High taxes isn’t the full criticism; Instead the question is whether taxes are too high relative to the services someone receives in return. Business services, like software and web development consultancies, won’t likely drive many residents to move if they relocate. These companies will exist wherever the most talented people are. Worry more about population trends — that should be Maryland’s bigger concern.