From: Brian Wingfield, USC Law
Published August 29, 2007 08:07 PM

A Permanent Ban On Internet Taxes?

WASHINGTON, D.C. - By all accounts, it's fairly safe to say that Congress is not going to allow state and local taxes on Internet service, at least for the next several years.


A bill proposed by Sens. Tom Carper, D-Del., Lamar Alexander, R-Tenn., and others would extend the current tax ban until at least 2011. Other bills in both the House of Representatives and Senate, including a measure sponsored by Sen. Ron Wyden, D-Ore., would make the moratorium permanent. Previously, there had been some speculation that Congress would let the current ban expire on Nov. 1, but with so many bills in play, that no longer seems to be the case.


However, when lawmakers return from their summer recess next month, Capitol Hill will be abuzz with a debate over whether to keep the Web indefinitely tax free--and it boils down to a good old-fashioned American debate over states' rights.


Traditionally, Congress has steered away from interfering with the ability of states and localities to tax their constituents. One notable exception was the 1998 Internet Tax Freedom Act, which prevented localities from imposing new taxes on Internet service providers. (Several states already had Web taxes in place, and Congress left them alone.) Since then, the law has been renewed several times.


But organizations such as the National Governors Association (NGA) and the U.S. Conference of Mayors are worried that the changing nature of the Internet prevents states and municipalities from collecting revenue that's due to them.


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"The original moratorium was supposed to be temporary," says David Quam, director of federal relations for the NGA. "Any time that Washington interferes with state and local revenues, it harms the state's ability to control its own destiny."


The groups are especially concerned about the definition of "Internet access," which determines whether a technology can be taxed locally. Telecommunications services have been subject to taxes; other services, like e-mail, remain tax free. But NGA believes that companies have found a loophole in the law by bundling together their services and then offering them over the Net in order to avoid taxes.


"We are using a 1998 definition of 'Internet access' in a 2007 world, and the two just don't match up," says Quam.


But his group is facing a powerful (and wealthy) opposition and momentum seems to be building to make the tax ban permanent. An umbrella group called Don't Tax Our Web--which has support from Google (nasdaq: GOOG - news - people ), Amazon.com (nasdaq: AMZN - news - people ), Corning (nyse: GLW - news - people ) and the National Association of Manufacturers, among other organizations--is pushing for an indefinite tax-free Internet.


"Companies have to be able to plan, they have to have a sense of what their costs will be," says Broderick Johnson, a spokesman for the umbrella group. "The problem with a temporary moratorium is that it certainly sends a signal that this may expire."


And regarding the state vs. federal question, Johnson says that for nearly a decade, it has been Congress' policy that the Internet is "not burdened by state and local taxes."


While the debate has focused on Internet access, states are also concerned that they are losing money because e-commerce transactions are typically not subject to sales taxes. Why should the corner bookstore be taxed, they ask, when an online bookseller gets to hawk their wares virtually tax free?


But there's clearly another reason for supporting the permanent federal moratorium. Tech and wireless companies know that if they can get such a ban in place now, it will literally take an act of Congress to allow states and localities on the Web further down the road.


"If we get [a permanent tax moratorium] in place, it's certainly harder to undo as opposed to going through this process again in four years," says Joe Farren, a spokesman for CTIA-The Wireless Association, the industry group that represents companies like T-Mobile USA, Verizon Wireless and Sprint Nextel (nyse: S - news - people ).


The Bush administration is also looking to influence the debate. Earlier this month, Treasury Secretary Henry Paulson and Commerce Secretary Carlos Gutierrez sent a letter to key leaders of Congress, notably House Speaker Nancy Pelosi, D-Cal., and Senate Majority Leader Harry Reid, D-Nev., urging them to support the permanent Internet tax ban.


Keeping the Net tax free they say, would "help ensure that consumers have affordable access to the Internet ” and strengthen the foundations of electronic commerce as a vital and growing part of our economy."


Give the nod to the administration and the tech coalition for showing its muscle. There's even a good chance that permanent moratorium might become law.


But even if they don’t get a permanent moratorium, they’re not likely going to complain about an extension--at least for the next four years.


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