There is one service free from state and local taxes that few people even know about because it is not a significant line-item on their internet bill. That is the taxation of internet access. In November, President Obama signed H.R. 719, the Continuing Appropriations Act, 2016. Buried in this legislation is an extension of the Internet Tax Freedom Act, which has been extended multiple times by Congress, usually at the last minute before it expired and usually for only a short period of time. The latest extension expires on December 11, 2015.
So what is this perpetually extended law all about? The Internet
Tax Freedom Act is a temporary moratorium preventing state and local governments from taxing Internet access or placing “discriminatory” taxes on e-commerce. Digital subscriber lines and Voice over Internet Protocol services are included in the tax ban. This law is not about making businesses collect sales taxes on internet sales, although it does limit state tax jurisdiction based on the location of remote computer servers. Rather, it is about state and local governments taxing internet access.
Seven States Grandfathered In
Currently, seven states tax Internet access because they were grandfathered in at the time the original Internet Tax Freedom law was passed. They include: Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin. According to the Congressional Research Service (CRS), these seven states collect a combined $563 million per year from taxes on Internet access.
No Win Situation for Congress
The law was first enacted in 1998, and Congress struggles each year to extend it. Consumers and businesses want Congress to continue to block yet another tax on needed services. State and local governments, on the other hand, are unhappy with their inability to apply taxes to Internet and non-Internet services equally, thereby increasing state and local revenues. As you can imagine, this is a no-win situation for Congress, so they maintain the status quo by renewing the ban periodically.
Skype v. Landline Calls
As CRS points out in a recent report, the ban provides a tax advantage to services offered through the Internet. For example, an individual who wants phone service can either buy regular landline service, which is usually subject to state and local sales taxes, or they can purchase Internet access and use a free service, like Skype, to make phone calls and avoid paying taxes. Opponents of the Act cite this inequitable treatment as a principal reason to allow it to expire.
Billions at Stake
One estimate suggests that the moratorium on Internet access taxes reduces potential state and local revenues by as much as $6.5 billion each year. As you can imagine, state and local governments are anxious to impose their sales taxes on the monthly payments that consumers make to their ISP, such as Comcast or AT&T, in exchange for access to the Internet. The moratorium prohibits taxes on Internet access services regardless of whether the tax is imposed on the consumer or the provider. The National Conference of State Legislatures yearly issues a position paper arguing that Congress should not extend the moratorium unless it at the same time requires businesses to collect sales taxes on all internet sales.