Free Ride on the Internet

State lawmakers pay particular attention to Congress whenever its votes affect state tax revenues. They do this partly from self-interest and partly because Congress seems to pay so little attention itself. A new moratorium on taxing Internet-access services, scheduled for consideration in the Senate tomorrow, worries governors and legislators not for what it says explicitly but for the effect it may have, now and, more importantly, in five or six years.

The previous tax moratorium ended Nov. 1, but would be added permanently under S. 150, the Internet Tax Nondiscrimination Act, and would prohibit state and local government from taxing Internet access to content, electronic mail or other services offered over the Internet. The tax exemption also applies to access “to proprietary content, information and other services as part of a package of services offered to users,” including telecommunication services that provide Internet access. The states want to know what would happen when packages offering phone service, books, movies and music are offered as part of an access package; they fear it would mean that those “other services as part of a package” would also be tax exempt.

This exemption would not affect taxes on traditional phone service, but the states look ahead to voiceover Internet services (already available in Portland), bundling of new services and the bill’s squishy definition of what constitutes Internet access and see more revenue slipping away. How much this would cost the states is difficult to predict because states cannot say how much of their tax revenue would come from technologies such as voice transmission during the next decade. But the Congressional Budget Office examined the bill and concluded, “Depending on how the language altering the definition of what telecommunications services are taxable is interpreted, that language also could result in substantial revenue losses for states and local governments.”

Risking substantial losses to state and local governments through permanent tax protection for the telecommunications industry while the option exists of temporarily extending the current definitions of Internet access is difficult to understand – except for the intense lobbying by the industry.

Both Sens. Olympia Snowe and Susan Collins support this measure, though the Maine Revenue Service estimates S. 150 would cost Maine more than $35 million annually and among its many changes is the removal of an exemption to the tax moratorium for intrastate telephone calls. The revenue service fears, justifiably, that the telecommunications industry would interpret any rule changes in the most aggressive manner possible, turning a simple tax advantage for a young industry into a permanent means to remove its many services from state tax bases.

State organizations estimate the potential cost of S. 150 as high as $9 billion annually, which many in Congress dispute. But no one disputes that the bill would remove the grandfathered access taxes in 10 states worth, according the CBO, between $80 million and $120 million annually. These costs should remind the Senate of its Unfunded Mandates Reform Act, passed in 1995. That act, supported by Sen. Snowe, states that it is “not in order for the Senate or the House of Representatives” to consider any bill that increases costs to the states at the level being considered under S. 150.

Unfortunately, Congress has gotten into the habit of passing along such costs. While Sen. Collins led a fight to include $20 billion to the states in added Medicaid funding, other federal polices since fiscal year 2002 through FY 2005 reduce state revenues by $185 billion. The expansion of an exemption for Internet access services would make the problem even worse. Maine senators would do far better to support a straightforward, two-year extension rather than singling out one ever-expanding industry to shield permanently from taxation.