Congress moves to resolve internet tax debate

For years, state and federal lawmakers have wrestled with whether–and how–to impose taxes on internet access fees and online purchases. Now, Congress is considering two measures that could bring these issues closer to a resolution.

House lawmakers on Sept. 17 passed a bill that would keep connections to the internet tax-free on a permanent basis. One week later, Rep. Ernest Istook, R-Okla., introduced a bill to help states collect sales taxes on purchases made online.

The issues cut two ways for schools, which increasingly rely on the internet for their purchases and other day-to-day operations.

Collecting and processing sales taxes from businesses and consumers would result in increased expenses for online merchants. And even though most schools don’t pay sales taxes, these operating increases ultimately would be passed on to schools and other consumers in the form of higher prices.

Opponents of taxes on internet connections also argue that such taxes would curb the growth of home internet access. For schools, this means some parents might be asked to pay too much for home access, possibly reducing the number of households where students can go online after school.

On the other hand, internet sales taxes and taxes on internet access fees would provide some welcome relief for cash-strapped states, many of which are being forced to dip into their education budgets to offset soaring deficits.

Taxes on internet access

H.R. 49., passed with bipartisan support, would make permanent a ban on taxing internet connections. A temporary ban on these taxes, first enacted in 1998, ran out Nov. 1.

New language in the bill clarifies that all types of internet access–ranging from dial-up connections and high-speed DSL to cable modems-cannot be taxed.

“This bill would broaden access to the internet, expand consumer choice, promote certainty and growth in the IT [information technology] sector of our economy, and encourage the deployment of broadband services at lower prices,” said Rep. Chris Cannon, R-Utah.

Rep. Christopher Cox, R-Calif., described the original moratorium as “something of an experiment” and declared it a success. Keeping internet access tax-free will give more people access, he said.

“It’s just a little bit too expensive for a lot of people,” Cox said. “A nick here, and a little bit of nickels and dimes here, would add up to a serious amount of taxation for most people.”

Currently, nine states-Hawaii, New Hampshire, North Dakota, Ohio, South Dakota, Tennessee, Texas, Wisconsin, and Washington-are allowed to impose a communications tax on internet connections, because these states had such taxes in place before Congress first approved the moratorium in 1998.

If H.R. 49 becomes law, however, these states stand to lose $80 million to $120 million a year in lost tax revenue, according to the National Conference of State Legislatures (NCSL).

Several Texas Democrats opposed the bill, including Rep. Gene Green, who said the bill would cost Texas $45 million a year in lost revenue.

“I don’t need to remind my colleagues of the fiscal crisis that our states are currently finding ourselves in, including the state of Texas,” Green said.

A similar Senate bill would give states that tax internet connections three years to phase them out and find new sources of revenue.

NCSL spokesman Neal Osten said states also worry that a permanent moratorium will lead to confusion when telecommunications companies develop new technologies never contemplated by the law. When the moratorium was first introduced, he noted, cell phones were a novelty and DSL service had no consumer market.

In fact, some state officials say the bill could have the unintentional effect of freeing the telecommunications industry from virtually all taxes.

The Multistate Tax Commission, an organization of state tax officials, says the bill’s language is too broad and eventually could exempt the telecommunications industry from all state and local taxes, as telecommunication companies gradually start using internet technology to deliver all of their services.

The commission says the bill’s language could leave telecommunications businesses free from sales, excise, income, and property taxes, and that states stand to lose between $4 billion and $9 billion a year by 2006.

Lawmakers who wrote the bill said they look at the same words and see a different meaning.

“I think they are discussing a problem that does not exist,” said Rep. Melvin Watt, D-N.C. “It’s hard for me to box with a shadow.”

Watt and other members of the House Judiciary Committee added the language to ensure that consumers who use broadband get the same treatment as those who use slower, dial-up connections. They also wanted to give future technology equal footing with current means of access.

Watt said he shared the language with several state and local organizations and remains open to new ideas. But so far, he said, no one has proposed better language.

State tax officials and federal lawmakers do not question each others’ motives. Both sides say internet access must remain tax-free to make the technology available to the most consumers for the best price. They split over how telecommunications industry lawyers and courts will interpret the bill.

If courts decided to interpret the law to mean that services delivered through the internet should be free of state and local taxes, the Multistate Tax Commission said consumers will lose.

“All those consumers are also taxpayers,” said Dan Bucks, the commission’s executive director. He said consumers would see their income taxes, sales taxes, or property taxes rise to make up the lost revenue.

Internet sales taxes

Congress also is being asked to decide whether to let states begin collecting sales taxes via internet retailers or preserve the mostly tax-free world of virtual shopping.

Lawmakers backing the effort by state and local governments to collect taxes on internet purchases prepared legislation for introduction Sept. 25 that would give congressional approval for the voluntary system.

The effort, known as the Streamlined Sales Tax Project, imposes no new taxes, it just helps states capture the taxes already due, said Rep. Ernest Istook, R-Okla., who is sponsoring the legislation. “This is not about changing taxes. It’s about simplifying them,” he said.

The internet has remained a mostly tax-free shopping zone since the Supreme Court ruled that states can’t force a business to collect sales taxes unless it has a store or other physical presence in the state.

Although 45 states require buyers to pay taxes on internet purchases, few states enforce those laws.

State and local governments have been working with businesses since 2000 to organize an easier way to collect the taxes. They have simultaneously established a simpler set of tax rules that keep businesses from having to adapt to the different tax customs of every state and local government.

So far, 20 states-Arkansas, Iowa, Indiana, Kansas, Kentucky, Minnesota, Nebraska, Nevada, North Carolina, North Dakota, Ohio, Oklahoma, South Dakota, Tennessee, Texas, Utah, Vermont, Washington, West Virginia, and Wyoming-have adopted the new rules to align their laws with the tax agreement. Another four states- New Hampshire, New Jersey, Pennsylvania, and Wisconsin-plan to pass similar provisions this fall.

The National Governors Association estimates that sales taxes make up one-third of state tax revenue, and state and local governments fear that tax collections will decline as shoppers turn to the internet more often.

“Preserving local authority is critical to the ability of local government to provide fundamental services on which our citizens depend, especially at a time when local governments have been squeezed by so many fiscal pressures,” said Karen J. Anderson, mayor of Minnetonka, Minn.

The federal government has taken note of the budgetary pressure on states. Congress this year approved a $20 billion payment to help states weather a stormy economy. Istook said federal help gradually draws power to Washington, though, and he would rather see the states make their own decisions about how to raise and spend tax money.

He predicted most House lawmakers would agree. “The votes are here in the House,” he said.

Traditional brick-and-mortar retailers also have their eyes on lost money. They say they stand to lose money as shoppers turn to tax-free internet purchases.

In 2001, researchers at the University of Tennessee estimated that states were losing about $13.5 billion in revenue as a result of non-taxable internet commerce–a figure many expect will climb as more and more consumers shop online.

See these related links:

National Conference of State Legislatures

Multistate Tax Commission

House Judiciary Committee

Streamlined Sales Tax Project

National Governors Association

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