Net Taxes: Here Comes a Battle Royal

With the moratorium on taxes for access now expired with no new deal, states will drive for far more expansive e-taxing authority next year

By Howard Gleckman

Congress has -- once again -- punted on whether to bar states from taxing Internet-access fees. But here's the latest twist: A deal banning Internet taxes once and for all was inadvertently done in by telecoms and their congressional allies. Instead of a permanent ban on such taxes, which Congress would have easily passed two months ago, lawmakers left town having agreed on nothing. The moratorium on such taxes has now expired. So, states are -- in theory, at least -- free to impose levies on Internet access.

That will set the stage for yet another battle over e-taxes next year. And that struggle could, for the first time, take the issue beyond the narrow question of taxing monthly Internet service provider (ISP) fees. It could open the door to the much bigger controversy over taxing all e-commerce.

Despite the common perception, the issue of the Internet tax moratorium has never involved online purchases of merchandise but only ISP services. The sales tax debate has always been lurking in the background, but it hasn't been included in any congressional legislation. Now that the moratorium has expired, the two may become inextricably linked in 2004.


  To understand why, it's important to know what happened this year on access taxes. Just as the antitax faction was poised for a big -- and surprisingly easy -- win, it got greedy. Congressional allies such as Senators George Allen (R-Va.) and Ron Wyden (D-Ore.) tried to slip in a provision that would have gone far beyond taxes on monthly ISP fees and, instead, tried to bar states from taxing a broad range of Internet-based telecom services, such as Internet telephony, or voice-over-IP (VOIP). That angered state governments. As telecom rapidly becomes Internet-based, they saw themselves potentially losing as much as $9 billion a year.

State and local officials had conceded the Net-access tax issue with barely a whimper. They had even agreed to expand the state tax ban to include broadband. But when Congress tried to extend the tax prohibition to all Internet services, such as VOIP, governors and mayors finally found their voice and put on a full-court press. With the support of several ex-governors now in Congress, such as senators Tom Carper (D-Del.) and Lamar Alexander (R-Ark.), they blocked any extension of the Internet tax moratorium, which expired in October.

At the same time, more than 30 states have been quietly working to simplify and streamline their sales tax laws. That's a crucial step in their plan to require e-tailers to collect sales tax on all goods they sell. For decades, mail-order and online sellers have avoided that responsibility, thanks to a series of Supreme Court rulings that barred states from forcing out-of-state retailers to collect sales taxes. The High Court blocked the practice, saying most sales-tax laws were too confusing for out-of-state sellers. But the court also said Congress could permit such collections if state sales taxes were simplified.


  Next year, having moved to end the confusion that bothered the court, the states will be back on Capitol Hill, pushing Congress to allow them to require online sellers to collect sales taxes. The proposal has already generated bipartisan support on Capitol Hill. And it has the backing of key retailers and commercial developers, who argue that if they and their tenants have to collect sales tax, so should online sellers.

Another complication concerns the rights of states to impose corporate income taxes and other levies on businesses that are located in many different jurisdictions. Some business groups may try to throw that issue into the mix next year as well. That would turn what started as a narrow debate on how to tax a modest $9.95 monthly Net-access fee into a major squabble about the fundamental rights of states to tax.

Had Congress enacted a permanent ban on Internet access taxes, those states pushing for broader sales tax collections would have had a high hill to climb next year. But by bungling the Internet tax curb and allowing the moratorium to expire, antitaxers have dug themselves a hole.

Now, supporters of states' right to collect sales tax will drive a harder deal: They'll give up the right to tax Internet access, but only if they get the authority to require online sellers to collect other sales taxes. And that would be a dramatic turn in the long-running saga of e-taxes.

Gleckman is a senior correspondent in BusinessWeek's Washington bureau. Follow his views in Washington Watch, only on BusinessWeek Online

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