For the first time since Congress enacted the Internet Tax Freedom Act (ITFA) in 1998, lawmakers are seriously considering permanently extending the moratorium on new state and local sales taxes on Internet access service and eliminating the “grandfather clause” exempting existing taxes — changes that could cost states $7 billion a year in potential annual revenue. Our new paper explains why Congress should do the opposite: allow all states to apply their normal sales tax to this service, just as they tax similar communication and entertainment services like long-distance telephone service and cable TV.
Even if Congress isn’t prepared to let ITFA lapse, there’s no justification for making the law permanent and eliminating the grandfather clause, as a bill that the House is expected to consider next week would do. Congress can achieve all of its major objectives by enacting another temporary extension that leaves the grandfather clause intact.
A temporary extension would ensure that no new states and localities tax Internet access. It also would continue ITFA’s ban on “discriminatory taxation” of Internet access service and other types of Internet commerce — for example, taxing these items at higher rates than other kinds of interstate communications or consumer purchases.
At the same time, another extension would avoid the problems that the House bill would cause, namely:
Congress first enacted ITFA when Internet commerce was still in its infancy and high-speed Internet access was just becoming available to individual households. Congress sought to balance state and local governments’ need to finance essential services against Congress’ desire to encourage the development of the Internet industry. Even then, Congress decided that striking that balance entailed grandfathering existing taxes and prohibiting new taxes on Internet access only temporarily.
There is no need to continue treating the Internet as an “infant industry” and exempting it from state and local taxes that other industries must pay. But even if Congress wishes to renew ITFA, surely its tax treatment should be no more favorable than in 1998 — a temporary exemption for taxes on Internet access service, with pre-1998 taxes still grandfathered.