October 20, 2003

MAKING THE INTERNET TAX FREEDOM ACT PERMANENT IN THE FORM CURRENTLY
PROPOSED WOULD LEAD TO A
SUBSTANTIAL REVENUE LOSS FOR STATES AND LOCALITIES
By Michael Mazerov

Summary

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On September 17th, the House of Representatives approved H.R. 49, the “Internet Tax Non-Discrimination Act of 2003.”  The Multistate Tax Commission estimates that the House bill (and its Senate counterpart) ultimately could reduce state and local revenues by $2 billion to $9 billion annually.[1]

If enacted into law, H.R. 49 would expand and make permanent a federally-imposed “moratorium” on state and local taxation of sales of “Internet access” services.  States and local governments would be permanently prohibited from charging sales taxes on the $10-$50 monthly charge that households and businesses pay to a company like America Online, or to the local phone or cable TV company, to be able to access the World Wide Web and send and receive e-mail.  The original moratorium had been established by the “Internet Tax Freedom Act” (ITFA) enacted in 1998 and later renewed through November 1, 2003.

In addition to making ITFA a permanent prohibition on state and local Internet access taxes, H.R. 49 makes two substantive changes in the law that could result in a much broader loss of revenue for states and localities.

The Senate counterpart to H.R. 49, S. 150, was approved by the Senate Committee on Commerce, Science and Transportation on July 31.  As amended in committee, S. 150 is identical to H.R. 49 except that the grandfather clause is not eliminated until October 1, 2006.   S. 150 was sequentially referred to the Committee on Finance, which is expected to discharge the bill on October 21st without marking it up.  It could then move to the floor of the Senate at any time.

Both H.R. 49 and S. 150 would result in substantial revenue losses for state and local governments.  The only difference is one of timing.  The immediate elimination of the grandfather clause by H.R. 49 would quickly inflict revenue losses on many states and localities in the midst of their worst fiscal crisis in decades.  S. 150 would have the same impacts, but in most cases they would be delayed for three years.

Where Is DSL Service
Taxed by State and/or
Local Governments?

Alabama
Alaska
Arizona
Colorado
Connecticut
D. of Columbia
Florida
Hawaii
Illinois
Indiana
Kansas
Kentucky
Louisiana
Minnesota
Mississippi
Missouri
New Hampshire
New Jersey
New Mexico
New York
North Carolina
Ohio
Rhode Island
South Carolina
Tennessee
Texas
Washington
Wisconsin

Source: Earthlink
 States in which Internet access taxes also are “grandfathered” are shown in bold.

Both bills would have the following impacts on state and local taxes almost immediately after the grandfather clause became inoperative:

Enactment of H.R. 49/S. 150 would have even more far-reaching implications for the ability of state and local governments to raise vital revenues over a five to ten year time horizon.

Not enough time remains before the November 1, 2003 expiration date of ITFA to permit careful consideration of these issues and careful drafting of changes to the law that would avoid unintended adverse impacts on the long-term fiscal health of state and local governments.  The best solution to this dilemma would be for Congress to extend ITFA in its current form for another six months to two years.  Unless an expiration date on the moratorium is maintained, Congress will not have an adequate incentive to revisit the law and address the unintended adverse consequences for states and localities that already are eminently foreseeable.

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End Notes:

[1]  Dan Bucks, Elliott Dubin, and Ken Beier, “Revenue Impact on State and Local Governments of Permanent Extension of the Internet Tax Freedom Act,” memorandum, September 4, 2003.  Available at www.mtc.gov/ITFA.htm.  The wide range in the MTC estimate is due to uncertainty regarding how courts would interpret which state and local taxes are prohibited by H.R. 49/S. 150.  The low end of the range assumes that the law would be interpreted to bar only telecommunications excise and sales taxes on “end-user” Internet access services and a limited set of Internet-related telecommunications services.  The upper end of the range assumes that a larger number of telecommunications services would be affected, and that the courts would also block the imposition of corporate income taxes, property taxes, and a few other business taxes on providers of Internet access and Internet-related telecommunications.

[ii]  AOL’s challenge to Tennessee’s tax on Internet access is also based in part on federal constitutional law, specifically, a claim that is has insufficient physical presence in the state to be subject to sales taxation.

[iii]  A “transactional tax” is one imposed on an individual sales transaction or the seller’s receipts from that transaction.