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Think Tank: Keep Internet Tax Moratorium Temporary

A Washington think tank issued a report Monday calling for Congress to continue to make the Internet moratorium on access taxes temporary, claiming new legislation to make the moratorium permanent creates an uncertain revenue impact on states and an unfair tax advantage for those who can afford high-speed Internet services.

The U.S. House of Representatives on Sept. 17 passed a bill to make the current moratorium, which expires on Nov. 1, permanent, and similar legislation in the Senate may be voted on as early as this week. The original moratorium was established by the Internet Tax Freedom Act (ITFA) enacted for three years in 1998 and renewed by Congress for another two years in 2001.

Opponents to a permanent ban say the House and Senate bills make substantive changes to the current law that could eventually cost states as much as $9 billion annually in taxes, including eliminating a grandfather clause that preserves state and local taxes on Internet access "imposed and actually enforced prior to October 1, 1998," and an expanded definition of "Internet access" to prevent states from taxing telecommunications services "used to provide Internet access."

The Congressional Budget Office (CBO) estimates that repealing the grandfather clause would result in revenue losses for the 10 states exempted totaling between $80 million and $120 million annually beginning in 2004.

More controversial is the language change in both proposed bills to expand the coverage of Internet access to DSL service, which is defined under current law as a telecommunications service and subject to sales and excise taxes.

According to the Center on Budget and Policy Priorities, a Washington policy group working at the federal and state levels on fiscal policy and public programs that affect low and moderate income families and individuals, in at least 27 states and the District of Columbia, the state and/or local governments would lose revenues they currently are receiving from sales and excise taxes levied on DSL telephone service.

"The change is a reversal of commitments made to state and local governments at the time ITFA was enacted; the legislative history of the Act makes clear that state and local governments were to be allowed to tax telecommunications services underlying the Internet at all levels of this 'network of networks,'" the Center's Monday report states.

Despite that commitment, according to the report, the "House Judiciary Committee and the Senate Commerce Committee reports on the bills both state explicitly that the reversal of earlier policy preserving these telecommunications taxes is intended."

The CBO was unable to estimate the amount state and local revenue losses that would result from this change because telecommunications companies are not required to maintain records categorizing their sales by type of customer, making it impossible to distinguish sales of high-speed telephone lines to Internet access providers from sales of similar services to other business customers.

However, the CBO did state, "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."

The Center on Budget and Policy Priorities report claims no state or local government would be permitted to tax DSL service in the future under the language changes in the proposed bills. As a result of this prohibition, the report states, consumers who choose to lease a second regular voice telephone line to access the Internet would be subject to all applicable state and local taxes, while those who purchase more expensive DSL service, which permits simultaneous use of the Internet and a voice telephone, would not be subject to taxes.

"The ban on state and local taxation of telecommunications services used to provide Internet access would effectively eliminate billions of dollars worth of taxes on voice telephone service as the provision of that service is migrated to the Internet -- a process that is well underway," the report states. "Within a decade there is likely to be no administrable distinction between 'Internet access' and voice telecommunication for many users who will use their high-speed Internet connections to make phone calls as well. This trend will shift the burden of telecommunications taxes to less affluent segments of the population who will remain subject to the various taxes levied on 'plain old telephone service.'"

The Center concludes, "Not enough time remains before the November 1, 2003, expiration date of ITFA to permit careful consideration of these issues and careful drafting of changes to the law that would avoid unintended adverse impacts on the long-term fiscal health of state and local governments. The best solution to this dilemma would be for Congress to extend ITFA in its current form for another six months to two years."

The report claims that unless an expiration date on the moratorium is maintained, "Congress will not have an adequate incentive to revisit the law and address the unintended adverse consequences for states and localities that already are eminently foreseeable."