District of Columbia – D.C. Proposal to Include Advertising in Sales Tax Won’t Work as Advertised

While some jurisdictions are exploring standalone taxes on digital advertising, D.C. Council Chair Phil Mendelson (D) has a more down-to-earth proposal: why not just include advertising in the sales tax base?

The obvious upside is that it doesn’t immediately raise any legal red flags and it takes advantage of a tax that already exists and with which the District of Columbia and other jurisdictions already have significant experience. But it turns out there are good reasons why advertising is almost always excluded from the sales tax, reasons which go both to core principles of taxation and practicalities about who could be taxed.

With a D.C. sales tax on advertising, if a Virginia company placed ads in D.C. markets, the transaction would not be subject to the D.C. sales tax on advertising, but if a D.C.-based company placed ads in Virginia, it would. How can that be?

The District’s sales tax, like most, is destination-sourced, meaning that a transaction is subject to tax in the jurisdiction where the good or service is received, not the one from which it came. This is relatively easy with the sale of tangible goods but trickier with services, where D.C., again like most of its peers, sources the service to where it is used or its benefit is received.

Fundamentally, sales taxes are not designed to tax intermediate transactions like advertising, and both their rationale and their fairness are called into question when they do. Advertising is a business input, whereas sales taxes are designed to fall on final transactions. Taxing inputs results in what is known as tax pyramiding, where the sales tax is embedded in the final price of the good or service multiple times over. Consumers should only pay the sales tax on the actual purchase price of a product, without being asked to cover embedded sales taxes as well, which can lead to considerably more than 100 percent of the value of a product being subject to sales tax.

The sales tax is intended as a tax on final consumption. When a company purchases advertising, it does not do so because its executives enjoy “consuming” advertising; it does so because they want to sell a product, which itself will be (or at least usually should be) subject to sales tax.

Sales tax sourcing rules do not work nearly as well when the tax is extended to intermediate transactions, because that’s not what sales taxes are for. Destination-based sales taxes do not have much of an impact on a business’s location decisions, because the tax is borne at the purchaser’s location, not that of the business. But when the business itself pays sales tax on its inputs (including advertising), the cost of doing business in that jurisdiction rises.

For more information visit: taxfoundation.org

Tax Foundation 
BY Jared Walczak
July 7, 2020