Once, not so long ago, people got their entertainment on discs engraved with microscopic bumps, a computer version of braille. Stores like Blockbuster rented these plastic pucks, which people referred to as “DVDs.” Music, too, traveled around on platters of polycarbonate called “CDs.”
It was a bizarre but ultimately brief era when digital goods had physical heft. You could caress your copy of “Oops!… I Did It Again”; you could lend it to a friend; you could both weep over the shards after she dropped it in a terrible accident.
These days, your Britney albums are more likely to live on your computer’s hard drive as a collection of magnetic stripes. You can still cuddle this hard drive, but it’s really not the same thing. Right?
Some state governments would argue yes. Some state governments are confused. Some state governments still grappling with the idea of goods that have transcended the material plane. How do you regulate them? How do you tax them?
Though it’s been over a decade since Apple sold its first song on iTunes, there’s still a lot of murkiness concerning the metaphysics of, say, Miley Cyrus’s latest digital exclusive.
Alabama is the latest example of a state trying to reconcile reality with its behind-the-times tax code. In March, its Department of Revenue announced it would start taxing streaming services like Netflix and Spotify the same way it taxes rental stores that deal in physical discs.
The actual law, which hasn’t changed, says that the state will levy a 4 percent tax on rentals of “tangible personal property.” So in order to tax a Netflix subscription, Alabama’s tax collectors have been forced to argue that streaming movies are somehow exactly that — tangible.
To most people, “tangible” implies “touchable” — the word literally comes from the Latin for “to touch.”
But the law in Alabama (and several other states) provides a much looser definition. It’s anything “which may be seen, weighed, measured, felt, or touched, or is in any other manner perceptible to the senses.”
Here, state administrators see some leeway to shoehorn an old tax law into a new situation. The movies you stream from Netflix are certainly perceptible — so they should be taxable too, right?
Alabama could use the money. The state is in a terrible budget crisis. It doesn’t help that rental tax revenue has dwindled as people switch to streaming videos instead of renting them on pieces of plastic.
“I used to go to Blockbuster to rent movies, and I used to pay the rental tax,” said Alabama’s deputy co-commissioner of revenue, Joe Garrett. “I still rent movies, but now I go to Netflix or Amazon or some other kind of on-demand service. What we are saying is that those transactions are also subject to the rental tax.”
Garrett’s department estimates the state could get $5-10 million dollars by taxing streaming services — far from enough to close the estimated $700 million budget shortfall, but not a paltry sum either.
“This is an issue across the country,” he added. “Old-economy transactions that were subject to tax have been displaced by new-economy versions of those transactions.”
Garrett readily admits that the state may be stretching the law a little. “In a perfect world there would be an update to our legislation that would address new-economy versions of these products,” he said. “We don’t have that right now. So we have to operate with the law that we have, which is less than certain given the fact that it was written many years ago.”
Many argue that it’s only common sense to tax digital goods like their tangible counterparts. Everything is data nowadays. What difference does it make if your song arrives as data etched onto a CD or as data piped in from the Internet?
“In most cases, these tax exemptions exist not for any policy reason but rather because sales tax laws and regulations have not been updated to reflect the Internet age,” wrote Michael Mazerov in a 2012 paper for the Center on Budget and Policy Priorities.
Most states rely on sales taxes for a third or more of their revenue. Their laws refer pointedly to “tangible personal property,” a term that betrays the era in which most of these taxes were conceived.
Historically, the law has recognized two kinds of property, tangible and intangible. Things like patents, copyrights, and stocks are intangible. Things of physical substance are tangible. “Tangible personal property” refers to things you can take with you — bracelets or Pokémon cards, for instance; not land or buildings.
Many states have chosen to define digital downloads (like movies or MP3s) as a third kind of property, neither tangible nor intangible. That’s the position laid out in the Streamlined Sales and Use Tax Agreement, which about half of states have passed laws to participate in. The goal of this agreement is for states to coordinate on how to tax commerce between states, an issue that has become increasingly complicated with Internet sellers conducting business from thousands of miles away.
Getting everyone on the same page with digital products is a step in that direction. But weaving these new definitions into existing tax codes takes legislative effort (and some argue there may be unintended consequences).
So some state officials have moved ahead without waiting for lawmakers to get their act together. Tax collectors in places like Alabama argue that digital downloads are similar enough to tangible goods that they should be subject to the same traditional taxes.
“Technology innovates at a rate much, much faster than the states can deal with it — we all know how slow the legislative process is,” said Medha Parlikar, a product director at Avalara, a firm that helps companies calculate sales taxes in different states. “Many states are trying to [find] a place to fit electronic goods into their existing law because they haven’t come up with new laws yet.”
Streaming services like Netflix and Pandora complicate matters further. Since these movies and music aren’t permanently stored, should the sales tax even apply? Maybe these digital subscriptions are more like rental transactions, as Alabama and Arizona argue. Florida considers Netflix to be a communication service, taxing it like a phone utility. Texas, meanwhile, taxes it like a cable TV service.
Companies have tried to fight the encroaching taxation with mixed results. Idaho last year passed a law updating its definition of “tangible personal property” to include digital music, videos and books. This means that the sales tax now applies to those kinds of purchases. The Idaho Tax Commission ruled that Netflix subscriptions would also get hit with the tax, a decision that Netflix is disputing.
In Louisiana, administrators from Jefferson Parish recently lost a lawsuit over whether they could tax streaming video-on-demand and pay-per-view services. Like Alabama, Jefferson Parish levies a tax when people rent “tangible personal property.” Much of the argument went back to definition of “tangible.” Lawyers from cable company Cox argued that video streams aren’t really tangible property because they’re not stored permanently; the data is thrown out after it hits the screen, so there is not even temporary transfer of ownership.
In December, an appeals court agreed with Cox, ruling that streaming video was an untaxable service, not a taxable rental transaction. Last month, the state supreme court declined to take up the case, letting the decision stand.
These growing pains will only continue, says Brian Kirkell, a state tax expert at consulting firm McGladrey. “The economy that existed at the time that a lot of these sales tax laws came from was very much driven by sales of goods,” he said. “It wasn’t as heavy of a service economy and these transactions in intangibles didn’t really happen.”
That’s all changed, and tax laws have a lot of catching up to do. “Now tangible personal property is just one piece of the equation,” he said. “We’ve really become an economy that is heavily tied to transactions in intangibles and services.”
A few years ago, when e-books were becoming mainstream, many complained that they weren’t much cheaper than their regular, dead-tree counterparts. But printing costs were never a major part of a book’s price, not even for hardcovers. When you buy a book, you’re mostly paying for authors, editors, marketers, offices and red pens. When you buy a book, you’re really buying a labored-over collection of words.
Digitization has forced all of us, not just tax collectors, to confront the fact that movies and music and books have intrinsic value. The rest is just packaging. As technology continues to invent new ways for us to consume old media, Kirkell argues that it only makes sense to concentrate on the content, rather than how it is delivered to us.
“When I download music, and when I listen to music online, and when I buy a CD, ultimately I want the same thing,” Kirkell said.
“Shouldn’t that all be taxed in the exact same way?”