Are taxes on the way for Net access?

A federal moratorium on Internet access taxes has expired, leaving state governments free to levy new taxes on Americans' dial-up, wireless and broadband connections.

Declan McCullagh
Declan McCullagh Former Senior Writer
Declan McCullagh is the chief political correspondent for CNET. You can e-mail him or follow him on Twitter as declanm. Declan previously was a reporter for Time and the Washington bureau chief for Wired and wrote the Taking Liberties section and Other People's Money column for CBS News' Web site.
4 min read
A federal moratorium on Internet access taxes expired over the weekend, leaving state governments free to levy new taxes on Americans' dial-up, wireless and broadband connections to the Net.

The U.S. Senate last week considered a proposal to broaden the ban and make it permanent. But state officials objected, arguing the proposed alterations to the moratorium could let voice over IP (VoIP) and telephone services, digital cable TV, and other converging technologies go untaxed and so cost state and local governments billions of dollars in lost revenue.

Senate Majority Leader Bill Frist said last week that the debate on the bill, which has 11 cosponsors, would resume no earlier than Thursday. A representative for Frist said Monday the debate is likely to take place Thursday and Friday. The U.S. House of Representatives voted on Sept. 17 for a slightly different bill that also would make the moratorium permanent.

One highly contested phrase in the bill is stalling its progress in the Senate. The phrase says that states may no longer tax telecommunications services (such as those for telephones, cell phones and pagers) to the extent that "such services are used to provide Internet access."

The National Governors Association, an influential lobbying group, and its Senate allies fear that that wording would prevent state governments from cashing in on a mammoth source of revenue, as emerging technologies like VoIP and Wi-Fi telephones gain acceptance and more and more handheld devices include Internet access features.

The Senate debate comes at a time when technological convergence has already made traditional regulatory classifications porous and unwieldy. The former Baby Bells--Verizon Communications, SBC Communications, Qwest Communications International and BellSouth--are currently regulated for services carried on their phone lines, such as voice and broadband Internet. However, cable companies such as Comcast and Cox Communications, which enjoy less regulation, are beginning to pull in more and more phone subscribers for their coaxial networks.

Citing states' rights, Sen. Lamar Alexander, R-Tenn., warned in a floor speech on Oct. 22 that "the bill has the potential to exempt telephone and cable companies from a broad array of state and local taxes that could amount to an unfunded mandate on state and local governments of up to $9 billion a year."

"Some say...that the Internet is too important to carry its fair share of the taxes," Alexander said. "Is access to the Internet more important than food? If not, then why not limit the state sales tax on food, medicine, electricity, natural gas, water, corporations generally, car tags, telephones, cable TV? They are all in interstate commerce. Let us limit the tax on all of them from Washington, D.C."

Unpicking the language
Supporters of the tax ban dismiss that argument as scaremongering, saying the controversial phrase is necessary to update the original 1998 law, called the Internet Tax Freedom Act, to reflect the times.

"That is so incorrect an interpretation," Carol Guthrie, a spokeswoman for Sen. Ron Wyden, D-Ore., said. Wyden is sponsoring the tax ban with George Allen, R-Va. "The senators have made it so clear that their intent is not to exempt telecommunications services from taxes," Guthrie said. "What is taxed now as a telecommunications service will continue to be taxed. The senators have no intention of touching that."

Guthrie added: "Now folks have cable modems and DSL service, and it's simply necessary to clarify that those forms of Internet access are protected as well. This is simply treating Internet access the same, regardless of the medium that is used. This is not a reach into exempting telecommunications services from taxes."

To buttress her argument, Guthrie pointed to an Oct. 28 alert from the National Conference of State Legislatures. It carefully avoids taking any position on whether or not the moratorium should be extended, but says if Congress does act, "NCSL believes that all providers of access should be treated similarly, regardless of the medium that is used to provide Internet access."

The position of the National Governors Association is not as nuanced: Its members are steadfastly opposed to the current language of the tax ban, S.150.

David Quam, the NGA's director of state-federal relations, said: "We feel that voice over IP is implicated in this, but more broadly, telecommunications services (are) traditionally a taxable event by state and local governments. S.150 is a gigantic expansion of the moratorium because it wants to take all the telecommunications transmissions used for Internet access and make them a nontaxable event."

"There's a real risk that the future of telecommunications becomes tax free," Quam said. "When you read this language, it's clear that it could be interpreted (in many different ways). If I'm using a telephone line for dial-up 50 percent of the time, why don't I get it 50 percent tax-free? These are the vague definitions that cause us such great concern with S.150."

The NGA also opposes the House bill, which has similar language. In principle, though, Quam said that the NGA would support a second extension of the current moratorium that did not broaden its scope.

This debate is only limited to Internet access fees and does not affect sales taxes paid on purchases made over the Internet. Currently, e-commerce retailers are only required to collect sales taxes if a buyer lives in a state where the business has a physical presence, such as an office or a retail outlet. State legislators want to change current law, but are a long way from persuading Congress to do so.