^{Democracy & Technology Blog} State and local tax collectors have ambitious plans for taxing Internet

The Senate Commerce Committee’s hearing Wednesday on the Internet tax moratorium demonstrates the necessity of making the ban on state and local taxation of Internet access services permanent. Another temporary extension simply guarantees opponents another chance to overturn it down the road, and creates the possibility they can win new concessions in the meantime.
The hearing showed than opponents are still determined to gut the moratorium. Harley Duncan, the Washington representative of state and local tax administrators, rehashed the old argument that the moratorium is unnecessary, because “the economic evidence is that state taxation of Internet access charges has little or nothing to do with the adoption of Internet services by consumers or the deployment of services by industry.” And he cites a new Government Accountability Office conclusion that taxing Internet access is “not a statistically significant factor influencing the adoption of broadband service at the 5 percent level. It was statistically significant at the 10 percent level.” Even assuming this conclusion is valid, it still doesn’t mean anything. Because once states and localities are allowed to impose taxes on Internet access, they won’t hold the line at 5 percent.
To get an idea what states and localities might do with Internet access, just consider what they do with telecommunications. Right now, for instance, Jeff Dircksen of the National Taxpayer Union & Foundation notes that the are pushing the combined tax burden on cellphone services above 20 percent.

Local and state governments believe wireless taxes, fees, and surcharges are a “cash cow” for the 21st Century. Yet, they fail to consider that the total wireless tax and fee burden can exceed 20 percent in some areas — a higher effective tax rate than the typical middle-class consumer pays on a 1040 federal income tax return.

Annabelle Canning with Verizon Communications points to a 1999 study by the Committee on State Taxation which found that consumers of telecommunications services paid effective state and local tax rates that were “more than twice those imposed on taxable goods sold by general business (13.74% vs. 6%).” She also cited a Heartland Institute conclusion that consumers of cable TV, wireless and wireline phone service paid an average of 13.5% in taxes, more than two times the 6.6% average sales tax rate.
The taxes on telecom, cable and wireless include franchise taxes, utility taxes, line access and right-of-way charges, 911 fees, relay charges, and maintenance surcharges, according to Dircksen. He notes that there are approximately 11,000 state and local governmental entities that could levy taxes or fees on telecommunication activities, according to the National Conference of State Legislatures. Canning mentioned that the typical communications service provider was required to file “seven to eight times as many tax returns compared to those filed by typical businesses (63,879 vs. 8,951 annually).”
This is how we can expect state and local government to handle the taxation of Internet access services if given the chance.
“Bundled” and “Acquired” Services
If Duncan can’t eliminate the moratorium, he’d like to gut it. In his Senate testimony, he suggested changing the definition of “Internet access” to make it clear that an Internet service provider cannot “bundle” other types of Internet services, content and information (some of which may be currently taxable) into a package of “Internet access” and claim that the state would be preempted from taxing any part of that package.
There is also a controversy over so-called “acquired” services. Basically, opponents want to apply the moratorium only to retail services while allowing wholesale services to be taxed. The effect is to allow taxation of the Internet backbone. Unfortunately, GAO has bought-off on this interpretation. Their testimony, which includes the following diagram, claims that the Internet tax moratorium did not apply to Internet backbone services (described as “acquired” services).

The bottom line is that the Internet tax moratorium helps keep the price consumers pay for broadband as low as possible, and affordability is usually a key factor when consumers make a purchasing decision. If we didn’t have the moratorium, we might be forced to consider subsidizing broadband to make it ubiquitous. Duncan’s testimony makes it clear that’s exactly what the tax administrators recommend.
Online Sales Taxes
States and localities are prohibited from taxing “remote sales” by virtue of a Supreme Court ruling, not the Internet Tax Moratorium. Duncan requested enactment of Federal legislation to authorize states to require remote sellers to collect sales and use taxes on goods and services sold into the state. The Supreme Court’s Bellas Hess rule has been around since 1967. State and local officials have been trying, without success, to overturn it ever since. If they were to ever succeed, they would surely discover that the Internet provides a lot of opportunities for tax avoidance and evasion. That would only lead to more regulation which would stifle innovation.
Policymakers have more serious things to talk about than debate these same issues every few years; that’s why Congress needs to make the Internet Tax Moratorium permanent.