Because Congress recognized that unnecessary and duplicative taxation could slow the growth of the Internet, it passed the Internet Tax Freedom Act (ITFA) in 1998 to prohibit states from imposing new taxes on Internet access. Just to be clear, the ITFA does not exempt online sales from taxation. Congress is considering separate legislation that rightly would give states the ability to require sellers of goods on the Internet to collect and remit sales taxes if they simplify their tax codes and implement common rules and definitions. The ITFA prohibits taxes on Internet service fees, whether the Internet Service Provider (ISP) is supplying dial-up, cable, digital subscriber line (DSL), fiber, satellite, or wireless Internet. It also ensures that taxes cannot be imposed on incidental services such as e-mail or instant messaging.
The original ITFA was renewed in 2001, and in 2004 Congress passed a slightly revised version called the Internet Tax Nondiscrimination Act which attempted to close a loophole that allowed states to classify DSL broadband service as a telecommunication service so that they could impose taxes. While the original law stated that the term “Internet access” excluded telecommunication services, Congress redefined the term to exclude telecommunication services “except to the extent such services are purchased, used, or sold by a provider of Internet access to provide Internet access.”
Unfortunately, all three versions of the ITFA contain a grandfather clause that allows those states and local jurisdictions that had implemented taxes on Internet access before 1998 to keep them. Eight “first mover” states can tax Internet access under the grandfather clause: Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, Washington and Wisconsin. The original intent was to give states with existing laws some time to adjust their tax codes to reflect the federal mandate. These states, not surprisingly, have still not done so.
The current Internet tax moratorium is set to expire November 1, 2014. A bipartisan bill sponsored by Sens. Ron Wyden (D-Ore.) and John Thune (R-S.D.) would make the moratorium permanent and eliminate the grandfather clause. Given the importance of the Internet to consumers and to economic growth, Congress should decide once and for all not to tax Internet access.
Castro is a senior policy analyst with the Information Technology and Innovation Foundation.