Don't Be Fooled, the Internet Is Already Taxed
Many people think that when the Internet Tax Freedom Act (ITFA) expires on December 11, this will open the door for the first time to the taxation of the Internet. Wrong. The Internet is already taxed, and taxation can continue even if IFTA is extended.
IFTA was first passed in 1998 to temporarily prevent taxes on Internet access from state and local governments. It has been extended in 2001, 2004, and 2007. It prevents non-grandfathered state and local governments from taxing Internet access. The bill was set to expire on November 1, 2014, but the date was pushed back to December 11, 2014, so that taxes would not rise on the Internet just before the November midterm elections. If it is not extended further, all states and localities will have additional opportunities to collect a sales tax on consumers' monthly Internet bills.
Seven states, including Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin, had their Internet access taxes grandfathered under the IFTA. These states collected an estimated $500 million in 2012. According to the Center for Budget and Policy Priorities, taxpayers living outside the grandfathered areas could have been taxed $6.5 billion in 2012.
But Americans who have smartphones and packages for service at home that include Internet are already paying taxes. If you don't believe it, just take a look at your phone bills. With smartphones proliferating, and broadband an increasingly important component of cell phone use, you are paying tax on your wireless Internet service. Then, you are paying taxes on your packages of phone/cable/Internet. Across the economy, these taxes add up to millions of dollars a year.
As a reality check, I started with my latest T-Mobile smartphone bill. I live in Maryland, not one of the grandfathered states under IFTA. Itemized on my T-Mobile bill are amounts for state and local sales tax, state and county 911, a universal service fee, and a utility use fee. In addition, I pay a separate T-Mobile fee for the Federal Universal Service Fund and yet another Regulatory Programs fee. These added up to $6.58.
Then, I checked my bill from RCN, the telecom company that provides my phone and Internet. Taxes, surcharges, and fees added up to $15.98. They include a Federal Subscriber Line Charge, a Federal Excise Tax, Federal Universal Service Fund (see, I have to pay this three times, twice to T-Mobile and once to RCN), a Gross Receipts Tax, a State 911 charge, and a Telecommunications Access Fee, a County 911 Surcharge, and a County Telephone Surcharge. The taxes on the two bills together add up to $22.56. If I subtract the Federal Subscriber Line Charge, which is not Internet-related, it comes to $14.06.
On average, large portions of wireless bills are currently taxed by the federal government for the federal Universal Service Fund at an average rate that tops 16 percent. Revenues from this tax are used for a variety of programs, including free phones to low-income individuals, sometimes known as "Obamaphones."
Determining tax jurisdiction for Internet services is not always easy. The landline has a billing address, the mobile phone does not. The billing address can be different from the residential address which differs from where the device is used. This has caused difficulty in taxing mobile services-which are also Internet services.
The Permanent Internet Tax Freedom Act (H.R. 3086), sponsored by House Judiciary Committee Chairman Bob Goodlatte (R-VA), would make permanent the Internet Tax Freedom Act. State and local governments would be prohibited from collecting certain types of Internet taxes. But they could still raise the taxes that are in place now.
The bill passed the House on July 15, but has yet to be taken up by the Senate. The Congressional Budget Office reports that enacting H.R. 3086 would have no effect on the federal budget, but beginning in late 2014, it would impose significant annual costs on some state and local governments because their revenue-raising ability would be constrained.
Though Democratic senators are trying to combine the extension with the more-controversial Marketplace Fairness Act, which would require online retailers to collect sales tax on goods and services sold over the Internet, the moratorium is separate. Some lawmakers have tried to merge the two bills for political reasons, but the bills are distinct. Without offsetting reductions in state sales tax rates, the Marketplace Fairness Act would raise sales taxes on Americans and add increasing complexity to online sales.
If the IFTA were not extended, some states would be tempted to tax Internet access in order to make up for budget shortfalls. Even though wireless and phone bills already partially tax the Internet, the end of IFTA might raise the level of taxation. Even low taxes on Internet bills could be a lucrative source of revenue. But taxing Internet access further has the potential to damage a growing, productive sector of the economy.
The National Governors Association believes that states should make their own decisions as to taxation due to federalism reasons. In a statement the group said, "This federal prohibition on state taxing authority is contrary to federalism and the sovereign authority of states to structure and manage their own fiscal systems."
On one hand, if a state wants to kill the goose that lays the golden eggs with Internet taxes, why should Congress prohibit it? Let the voters of that jurisdiction punish lawmakers for such a policy, if they object. On the other hand, Internet taxes could interfere with interstate commerce, and so the federal government could have an interest in keeping such taxes low.
Continuing to exempt Internet access from taxation means the government would be allowed to choose, or at least influence, marketplace winners and losers. If a state taxes cable television service, it might be considered unfair for Congress to exempt the monthly fee for Internet access that other people pay to be able to stream TV shows over the Internet. If a state taxes conventional text messages on a mobile phone, there is no justification for a lesser tax to send similar messages via email or Twitter. Why, for instance, should Skype have a lower tax rate than landlines and wireless phone calls?
Some observers have framed the debate on ITFA as preserving the Internet as a tax-free service. In reality, the Internet is already taxed, but often in distortionary ways. Allowing IFTA to expire might reduce some of these distortions.
