The Struggle to Tax the Cloud

As the economy shifts from one that relies on goods to one that relies on services, states are finding it hard to capture revenue from constantly evolving technologies like cloud computing.

Two years ago, Massachusetts took a bold step. The legislature passed a bill to tax the cloud. But they didn’t stop there. Lawmakers also levied taxes on other tech activities. While the cloud may be where the fastest growth is taking place, technology overall is an increasingly large part of a state’s economy. Massachusetts didn’t want to lose out on a chance to include it in its revenue base. Legislative analysts projected that the taxes would bring in $160 million a year.

But just two months after passing the “tech tax,” as it had become known, Massachusetts repealed it. Opposition from the state’s business forces rained down pressure on lawmakers. The new law, they claimed, was putting them out of business. “It got very bruising,” says Andrew Bagley, research and public affairs director of the antitax Massachusetts Taxpayers Foundation.

Meanwhile, the Department of Revenue struggled to provide guidance to business owners on whether the service they were providing was subject to the tax. Amy Pitter, director of the department at the time, admits the complexities and confusion surrounding the law were a burden. So the legislature voted to repeal it and then-Gov. Deval Patrick, who had proposed the law in the first place, signed its retraction.

Massachusetts is not alone in trying to expand its sales tax to include tech services. Like many states, the commonwealth was already taxing some parts of the technology sector. But unlike most states, Massachusetts tried to capture a larger and growing part of that sector’s economic activity. The law’s resounding failure illustrates the many difficulties states have faced in recent years when it comes to taxing technology and computer services.

Part of the problem harks back to a general issue that has been bedeviling sales-tax states for more than half a century: As the economy has shifted from one that primarily produced goods (which are taxable at point of sale) to one that provides services, states have struggled to find a way to add services to their sales tax base. The other challenge is more specific to the technology industry: Its products and services are so complex, changing so rapidly and constantly overlapping each other, that it is hard to get a handle on what it is that should be taxed. The recent emergence of cloud computing -- computer services that consumers and businesses use and pay for but don’t necessarily own -- adds an extra layer of difficulty.

What has resulted from the attempts by Massachusetts and other states to harness the high-tech service economy is a hodgepodge of approaches that lack consistency and are frustrating for both the states that write the bills and the businesses affected by those laws.

More