Stateline Story

Billions at Stake in Internet Tax Debate

  • March 19, 2004
  • By Pamela Prah

Most people yawn and get that cloudy, glazed-eye look when discussing the Internet and taxes. State lawmakers, on the other hand, see a vibrant shade of green--as in money--when discussing ways to convert Internet commerce into sorely needed tax dollars for state coffers.

Billions of dollars of potential revenue float through cyberspace in the form of Internet transactions, but only a small fraction currently can be taxed by states. No wonder that state lawmakers are pushing Congress, which has the power to regulate interstate commerce, for the okay to tap into the vast tax potential in cyberspace.

The most lucrative prize would be the go-ahead to slap a state sales tax on online purchases, which most consumers now consider to be tax-free.

States see a treasure trove of up to $45 billion a year in potential taxes on online purchases, which are growing at a far faster rate than retail sales in stores where sales tax routinely is added to each bill. But it is highly unlikely that anything will happen on taxing Internet salesat least this yearbecause it's too politically explosive and unpopular for Congress to take up in this short, election-year session.

Instead, Congress is more likely to take action on a related Internet issue that will determine whether states can tax the $10-to-$50-a-month charge that computer users pay to an Internet-access provider such as America Online, or to the local phone or cable company, to reach the World Wide Web and send and receive e-mail.

With at least $200 million a year in state taxes at stake, plus the future ability of states to tax phone calls made over the Internet, the so-called "Internet access" issue pits the nation's governors against the powerful high-tech community.

Governors are lobbying against a bill (S 150) by Virginia's former governor, U.S. Sen. George Allen (R), that would bar states from taxing Internet access, robbing 10 states of $120 million a year they already collect in access taxes and 27 states of up to $80 million in taxes on DSL lines.

Instead, the nation's governors strongly favor a competing measure (S 2084) by former governors and now U.S. Sens. Lamar Alexander (R-Tenn.) and Tom Carper (D-Del.) that would buy everyone time to sort out the emerging technologies and services to spring from cyberspace and whether and how to tax them.

The Alexander-Carper bill would extend for two years a moratorium imposed by Congress in 1998 that bars Internet access taxes in all but 10 states. Those states - Colorado, Hawaii, New Hampshire, New Mexico, North Dakota, Ohio, South Dakota, Texas, Washington and Wisconsin were exempted from the moratorium because they already had taxes in place, according to Michael Mazerov, senior fellow with the Center on Budget and Policy Priorities.

One of the main reasons Congress is likely to act this year is because the moratorium expired last November, leaving the high-tech industry jittery that more states could jump in with new taxes.

"We wouldn't be surprised to see some action by the states to try and get around the expired moratorium within the next few months. It's imperative that a moratorium be reinstated and extended as quickly as possible," said Joe Rubin, executive director of technology and e-commerce for the U.S. Chamber of Commerce.

The long-term fear for governors is that Congress, through the Allen proposal, could write tax policy on Internet access in such a way it eventually wipes out $20 billion in taxes that states and localities currently collect on local and long-distance telephone services. That's because more carriers are using technology that allows people to go online to make phone calls. By some estimates, most business calls will be made over the Internet by the end of the decade, potentially costing states billions of dollars in taxes on phone calls.

"I want to make sure that ... we have a definition of Internet access' that doesn't become so broad that, in the rush to protect the Internet industry, we end up wiping out a whole series of other telecommunications taxes," Virginia Gov. Mark Warner (D) told Stateline.org during the National Governors Association recent winter meeting in Washington. Before becoming governor, Warner came from the high-tech community, helping to create more than 70 telecommunications and information technology companies.

Even though there are millions of dollars at stake, the National Conference of State Legislatures is staying out of the fight over Internet access taxes. Instead, state legislators are targeting as a top priority the longer-term and far more lucrative issue of winning permission from Congress to start collecting sales taxes on items bought online.

"This is more important (than the Internet access tax) because it involves more money," said Neal Osten, who specializes in communications and interstate commerce for the NCSL.

Internet purchases jumped 25 percent in the fourth quarter to a record $17.2 billion, rising four times as fast as all retail sales, the Commerce Department said in February. By 2006, states could lose $45 billion a year in sales tax from online purchases, according to a 2001report from the Center for Business and Economic Research at the University of Tennessee.

States have a long way to go before they can start charging sales tax on all online purchases. Twenty states have started the process by passing model legislation under the NCSL's "Streamlined Sales Tax Project" that rewrites their tax codes to uniformly define what and how online purchases would be taxed. Before states can collect, however, a U.S. Supreme Court decision requires that Congress pass a law allowing states to charge sales taxes on interstate online transactions.

But Congress has yet to even hold a hearing on the legislation, the first step in the arduous path to enacting a law. Sources on and off Capitol Hill all but rule out action this year.

States argue that they're not trying to impose a new tax but simply collect state sales tax on purchases made on a computer screen instead of on Main Street. "This is enforcing a tax that is already owed. This is making sure that one of the major revenue bases for state and local government is not allowed to collapse," said U.S. Rep. Ernest Ishtook (R-Okla.), the lead sponsor of a bill HR 3184 that would give the states the green light.

Currently people who buy online are supposed to fill out a form from the state declaring how much they bought and then pay their state the sales tax that is due. "I'm pleased to say that we have almost a half-dozen people who do that," joked U.S. Sen. Mike Enzi (R-Wyo.), the lead sponsor of the Senate measure S 1736 to allow Internet sales taxes.

In the meantime, states are trying another tactic to collect from online sales. At least a dozen states have separate lines on their state income tax forms that ask specifically about online purchases and include instructions for payments. But the payout is paltry, often netting states less than a $1 million a year. Michigan appears to be the most effective, collecting $2.9 million in 1999 from more than 64,000 taxpayers.

Tags: Economy