Twenty years ago, your only option for buying a book or a getting a CD of your favorite music was to head to a Borders or Best Buy. You would find what you were looking for, take it to the counter, pay for it, and that would be the end of it. No complications. Today, millions of songs, movies, books, apps, and other digital items are downloaded over the Internet through outlets such as iTunes or Amazon. These are called digital goods. It’s commonplace to purchase something over the Internet that you’ll never be able to physically touch. In just a short amount of time, the market for media has shifted drastically. Today, digital revenue for Netflix has reached $1.5 billion in sales for 2011, 31% of music albums were downloaded instead of purchased in a store, and sales of e-books now outpace sales of books on paper, according to Amazon. Of course, this way of purchasing items has a lot of advantages—the convenience of never leaving your home, no limited stock of items that brick and mortar stores are bound by, and the ability to keep all of your media on a tiny device such as a computer, iPod or Kindle. But with this added convenience comes some added complications.

Currently, there are no guidelines or rules for how these digital goods are taxed, and what jurisdictions have the right to tax them. So right now you could potentially be taxed in a variety of different ways when purchasing digital goods. Let’s say for example you download a movie from Amazon. You might live in Chicago, Amazon is headquartered in California, and maybe their servers from which the download originated are located in Oregon. Which state is able to levy a tax? It’s not completely clear. Right now, theoretically, all three states and the respective municipalities might be able to levy a tax on that download, hitting the consumer with a huge tax bill through multiple tax jurisdictions. 

The question arises, of course, over why digital items need to be taxed at all. Tangible products, like those purchased from Amazon, aren’t levied a tax. And as we showed in previous posts, the app economy is booming, and creating thousands of new jobs. Would imposing more taxes on these digital goods hamper the growth and innovation we’ve seen in this sector?

Many groups are urging action on this issue. Americans for Tax Reform (ATR), a free-market advocacy group, points out that the issue of taxing digital goods can often put states at a competitive disadvantage. Some states are exempting digital goods from taxation, while others are imposing it. Taxing digital goods can often discourage high tech startups from locating to a particular area, which according to ATR, is why states like Ohio, Minnesota, and California have all rejected imposing digital taxes. The Download Fairness Coalition is a group hoping to take away some of this disparity. They’ve proposed Congress enact a framework that would set guidelines for which states are allowed to tax digital goods.  The lack of a national framework for how items are taxed could be hampering e-commerce, according to the group.

Congress could soon act on the proposed guidelines. A bipartisan bill has been introduced into both chambers of Congress. Known as The Digital Goods and Services Tax Fairness Act, it’s sponsored by Senators Thune (R-SD) and Wyden (D-OR) in the Senate, and Congressman Lamar Smith (R-TX) and Congressman Steve Cohen (D-TN) in the House. There’s a chance the Senate could be moving on this bill as soon as mid-March. There’s a lot riding on the digital economy—the thousands of jobs being created, the commerce that’s taking place that’s helping to drive the economy—so Congress must be eager to act. The bill would attempt to identify which states or entities would have the power to tax these digital goods, along with other measures meant to clarify and ease the regulatory burden on many e-commerce companies. When unemployment is still hovering above 8%, Congress must feel compelled to act, as the digital economy is one of the few bright spots in an otherwise dismal array of industries feeling the pain of the poor economy.

Zack Christenson writes on digital and tech issues for the American Consumer Institute