Will States Tax the Internet?

Published December 1, 2003

Since November 1, all bets are off concerning the taxing of the Internet.

A five-year federal moratorium has prevented states and localities from levying taxes on Internet dial-up or broadband connections, but cash-hungry states are now looking for revenue, and retailers have little reason to help consumers skirt taxation.

While the House in September passed a bill to continue the ban, the Senate failed to act on its version of the measure (S. 150), authored by Senator George Allen (R-Virginia). As a result, new Internet taxes could go into effect between the time Congress adjourns and returns in January or when states return to session.

Senator Ron Wyden (D-Oregon), one of the principal proponents of the moratorium, has accused some state and local officials of trying to change the definition of “Internet access” in order to find new ways to tax.

“In doing so, what it would do is give states and localities explicit permission to tax what Internet users do once they get on line,” Wyden said in an October 15 floor speech. “That would mean you could have games, music, magazines, newspapers, information services, financial services, research services, or other products or services, in effect, facing a barrage of new taxes,” Wyden warned.

“The phrase ‘you’ve got mail’ would be replaced with ‘you owe taxes,'” he quipped.

Senators Lamar Alexander (R-Tennessee) and Maria Cantwell (D-Washington), among others, have placed a procedural “hold” on the Senate bill amid concerns over state budget deficits.

Alexander called a no-tax plan sponsored by Wyden and Allen the “worst kind of unfunded mandate.”

“If you limit Tennessee’s ability to have a broad-based sales tax, then you are increasing the chances Tennessee has an income tax or a higher tax on medicine or food. Or higher college tuition for families to pay,” Alexander explained.

Taxpayer groups, including Americans for Tax Reform, are fighting for the moratorium to be continued. ATR President Grover Norquist said Internet taxes would hurt consumers. He contends backers of the hold are “supporting taxes on Internet access and e-mail, as well as double-taxation of a product or service bought over the Internet.”

Senator George Voinovich (R-Ohio) is insisting on changes to the moratorium. His home state stands to lose existing tax revenue from phone taxes, Voinovich believes, unless the bill’s language is clarified. The problem stems from an overly broad definition of telecommunications services that could encompass future Internet-based telephone services, he fears.

Ohio Governor Bob Taft, a fellow Republican, wrote Voinovich a letter estimating that extending the moratorium would cost the state $350 million, but such cost estimates vary. Nationwide, the Congressional Budget Office has estimated extending and expanding the moratorium would deprive states of $80 to $120 million in taxes annually. But the Multistate Tax Commission has said states are likely to forego between $4 billion and $9 billion in 2006 alone.

John Berthoud of the National Taxpayers Union (NTU) says it’s just politicians looking to tax their way out of a problem. “The bottom line is that these guys just want more money,” Berthoud said.

“Internet use is already taxed through the burdens that states and localities impose on phone and cable bills,” added NTU’s Paul Gessing. Congress shouldn’t allow new Internet access taxes or multiple-state taxation of a single item purchased online, Gessing believes, because “it amounts to double jeopardy.”

Another obstacle to be overcome is the differences in state and local taxation–there are almost 8,000 different tax-collecting jurisdictions in the United States.

As U.S. News reported: “Cough drops, for example, are taxable in Massachusetts but not in Maryland, while in Ohio a gift basket of fruit is not taxed though a crystal dish filled with candy is. Cloth diapers in Wisconsin? Tax exempt. Disposable ones? Taxable.”

States are promising more uniformity of product definitions and taxable vs. non-taxable items, and special software is becoming available that will instantly calculate taxes based on the zip code of the buyer.

Says Patti Freeman Evans of Jupiter Research, “Consumers are used to paying tax.” Albeit not on the Internet.

Christine Hall comes to CNSNews.com from Capitol Hill, having served as Rep. Mark Sanford’s Social Security policy analyst. Prior to that, she worked as a policy analyst on Steve Forbes’s Presidential campaign and also served as director of public affairs for the Seniors Coalition. CSNNews can be found on the web at http://www.CNSNews.com.