As a way to supplement their traditional revenue sources, some states want to close what they think is a tax-free loophole where digital goods and services land.   In the last two years, some states like New York, Oklahoma,  and Illinois have proposed legislation to tax digital goods and services, but have backed off from or failed to pass the legislation. On the flipside, North Dakota and Washington D.C. are the only two states that expressly do not tax digital goods and services.

Now the Congress under H.R. 5649, known as the Digital Goods and Services Fairness Act of 2010, is weighing in. The bill was introduced this week and is aimed at counteracting states’ piecemeal and potentially predatory tax practices regarding digital goods and services. The bill first prohibits multiple or discriminatory taxing of the sale or use of digital goods or services. Second, consumers can only be charged their state’s retail sales tax on digital music, books, and videos.

Without this federal bill becoming law, there is nothing in place to ensure states and local governments do not impose discriminatory taxes on consumers, providers, and distributors. As it stands now consumers could end up paying multiple taxes on the same transaction. Also, there are no safeguards to protect against predatory tax rates like those of the wireless telephone service sector. Plus, taxing digital goods could drive consumers to download pirated content as a way to avoid paying sales tax.

Emerging areas of the digital market are something else to consider. Allowing states to continue enacting varying and confusing digital tax laws stifles the innovation and growth of the self e-publishing frontier. Unlike the established market of music artists who sell their songs through online retailers, or through their own online store, authors of books, short-stories, and private blogs not supported by traditional publishing enterprises, may balk at expanding into the digital market because they do not want to deal with the confusing and predatory state tax laws when selling their content online.

Differing state tax laws also harm businesses because they are at an economic disadvantage if they reside in a state that imposes a sales tax on digital products, but their out-of-state competitors do not. Local jobs will disappear when companies relocate to states like North Dakota where digital tax policies act as incentives to do business there. Plus small businesses will be hamstrung trying to navigate the varying state and local tax rates being applied to the sale of their digital product.

Ultimately, the last ten years has brought us economic growth and innovation in the delivery of digital goods and services. Letting states fill the holes in their budgets with revenues from taxes of digital goods and services will only slow down a vibrant and thriving marketplace. It is this digital marketplace that we should be cultivating and embracing as an opportunity to rebuild our economic footing, and we as consumers can continue to enjoy access to digital music, books, and movies when we reach for cell phones, computers, and e-readers.