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Judge to decide if federal challenge to Maryland’s digital ad tax can continue

A federal challenge to Maryland’s first-in-the-nation digital advertising tax is in limbo after a state court found the tax unconstitutional last month.

U.S. District Judge Lydia Kay Griggsby must decide if the federal lawsuit can continue despite the state court decision.

Central to the federal challenge is the law’s “pass-through prohibition,” which bans digital advertising companies from passing on the cost of the tax directly to consumers. The U.S. Chamber of Commerce, which filed the federal lawsuit in early 2021, claims the prohibition is a restriction on companies’ speech that violates the First Amendment.

The lawyers for the defendants and the plaintiffs clashed in court Tuesday over whether the statute regulates speech or conduct.

Steven M. Sullivan, the state solicitor general who is representing the Maryland Comptroller’s Office in the lawsuit, argued the law simply restricts conduct. Companies may not directly charge customers in order to recover the money they pay out for the tax.

“There is a material difference between simply stating a price … and telling a customer you are legally responsible to pay this cost,” Sullivan said.

But the lawyer for the Chamber of Commerce, Michael B. Kimberly, said the legislation has already chilled speech. Companies are allowed to charge more to cover the tax, he said, but are prohibited from communicating with their customers about the reason for the new expense.

RELATED: Judge strikes down Md.’s digital advertising tax as unconstitutional

“What they don’t want to happen is for digital advertising companies to assign responsibility for increased prices to lawmakers having enacted a tax,” Kimberly said. “They think it’s OK for prices to go up and for these companies to recoup the charge, they just don’t want them talking about it on invoices.”

Before Griggsby reaches the First Amendment issue, she must decide if the case is now moot.

Anne Arundel County Circuit Court Judge Alison L. Asti struck down the tax in October, finding that the surcharge violated the U.S. Constitution’s prohibition on state regulation of interstate commerce and discriminated against certain online companies while not taxing others.

Asti found that the law violated the federal Internet Tax Freedom Act’s prohibition on discriminatory taxes on online services because Maryland does not similarly tax nondigital advertising. The judge granted summary judgment for Verizon and Comcast, which challenged the tax on digital ads in state court.

The decision was a blow to the law’s sponsors, who said the tax would raise about $250 million annually to expand early childhood education, raise teacher salaries and help struggling schools. Maryland lawmakers enacted the statute last year over Republican Gov. Larry Hogan’s veto.

The Maryland Attorney General’s Office has appealed the circuit court decision to the state’s Court of Special Appeals.

Sullivan noted that while the pass-through prohibition is not specifically before the Court of Special Appeals, the issue may still arise as the case proceeds.

“Judicial restraint has never been the hallmark of our appellate court,” he said, “so one cannot rule out in any particular appeal that the appellate court may wish to address, in some manner, any component of the case.”

Griggsby said Tuesday that she is concerned about stepping into the issue while it is pending before the state appellate court. She also said that it’s unclear whether the state can enforce the pass-through prohibition given that the tax itself has been struck down in state court.

“If there’s no tax, I’m not sure what we’re passing through,” she said.

Griggsby said she will rule on the mootness issue shortly. The parties agreed that if the judge finds the case moot, she should dismiss the complaint without prejudice so that it can be refiled.