The Other Tax Battleground Of 2001: The Internet

Ever since the battle over Internet taxes began in 1996, the focus has been on whether states could impose levies on goods sold over the Net. From the beginning, most state and local officials agreed to a ban on taxing the monthly fees paid to Internet service providers (ISPs), such as AOL Time Warner Inc., believing that such a tax would cause a political firestorm. The only exceptions: a half-dozen states that had enacted such taxes before '96.

Now, with the moratorium on new Net taxes set to expire in October, that may be about to change. For the first time, governors want Congress to let states tax pricey Internet services. Their model is a Texas law signed in 1999 by, of all people, then-Governor George W. Bush.

The governors' beef: ISPs are starting to include such extras as long-distance phone calls, news, and music in their monthly fees. As taxable products get bundled into the fee, states face a shrinking tax base. "The ban on Net access taxes is really problematic," says Michael Mazerov, a tax analyst at the Center on Budget & Policy Priorities, a Washington think-tank. "The longer it lasts, the more it is going to impinge on traditional state taxation of telecommunications and other services."

The '99 Texas law, which clarified an earlier tax on information services, hits monthly Net fees above $25 with a state tax of 6.25%. Cities such as Dallas add an extra 2%. Total take: a modest $50 million. But the potential revenue nationwide would be much higher. Forrester Research Inc. estimates that households pay $12 billion a year in access charges. Nearly all dial-up customers pay $22 or less a month and thus would be exempt from tax. But subscribers to higher-price dial-up services set to be rolled out this summer could be hit, along with the 6 million broadband users whose fees average $40 a month.

But the idea of taxing such fees will run into heavy opposition in Congress. Says Senator Ron Wyden (D-Ore.): "There ought to be a ban on access taxes." Already, Wyden and Representative Christopher Cox (R-Calif.) say they would extend the e-tax moratorium for five more years and permanently bar all access taxes. Arguing that the battered Internet industry should be exempt from new taxes, the pair may also try to roll back those e-taxes already on the books.

TOUGH SELL. But governors and other e-tax backers see no reason why online merchants shouldn't have to collect the same sales taxes as Main Street retailers. Senator Byron Dorgan (D-N.D.) will soon offer a measure requiring sellers to collect taxes on e-commerce as long as the states agree to simplify existing tax regimes. Late last year, a group representing 35 states agreed to such a simplified system, which would uniformly define taxable products and ease paperwork.

Later this year, that plan may be considered in as many as a dozen statehouses, including those in Michigan, Minnesota, and Texas. It'll be a battle: Local businesses will bemoan any loss of tax exemptions on their products. And dot-coms, led by AOL, are likely to fight the streamlining efforts tooth and nail.

Two key players in the debate will be President Bush and Senate Commerce Committee Chairman John McCain (R-Ariz.). Despite his Texas experience, Bush favors extending the moratorium for up to seven years and would also ban taxes on access fees, says a spokesman. McCain, who early last year endorsed a permanent ban on all Net taxes, has been working on and off for months to forge a compromise between the states and e-tailers. So far, his efforts have gone nowhere.

Congress will likely extend the moratorium beyond October. But deciding how long it lasts and what gets taxed will be the year's other big tax brawl.

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