States Push for Net Taxes

Congress tries to hold the line despite slow economy.

Cash-starved states throughout the country are looking to the Internet as a source of new tax revenue, but the U.S. Congress, fearing that taxes will cut Internet use, is trying to hold them back.

States could reap revenue from the Internet in two ways: by taxing access and by taxing online retail sales. Access taxes are prohibited by a federal moratorium due to expire in November. Last week, a House panel voted to make the moratorium permanent, and senators called for an extension.

"Every year, we go through this complicated process and end up with a temporary extension," said Sen. John McCain, R-Ariz., chairman of the Senate Commerce Committee. "As we see the budget woes of states, we also see them understandably looking for sources of revenue."

Politics aside, the federal moratorium reflects widespread concern about the chilling impact of such taxes. "Additional taxation for accessing the Internet would clearly be a double tax," said Michael Schwedhelm, CIO at United Labor Bank, in Oakland, Calif., and an eWEEK Corporate Partner. "This would be akin to paying one tax for having cable TV service brought to your home and another whenever you turn the TV on."

Congress has extended the access tax moratorium twice, but it faces growing pressure from states in the sluggish economy. Most lawmakers who oversee technology are wary of Internet taxes, but other members of Congress may be more sympathetic to the states, ensuring a heated debate as the issue moves toward a vote.

Some states have begun sidestepping the ban by taxing access when it is bundled with other telephony services, said Mark Beshears, assistant vice president of State and Local Tax at Sprint Corp., in Overland Park, Kan. Beshears told Congress last week that in Florida and Illinois, Sprint is required to collect taxes on dedicated Internet access service, in violation of the federal ban. Sprint is urging Congress to create a uniform way for dealing with access packages.

ISPs recently raised access rates overseas in response to new taxes, and federal lawmakers want to prevent that from happening here. In Europe, America Online Inc. increased prices in response to a new value-added tax, and AOLs subscriptions leveled off, according to Joseph Ripp, vice chairman at AOL, in Dulles, Va.

As for Internet sales, a state can collect taxes only if the online retailer has a store or other facility located in the state. By edict of the U.S. Supreme Court, states cannot collect sales taxes on out-of-state online retailers until complex state tax structures are simplified.

Almost 40 states are working together to simplify their tax codes, and earlier this month, Virginia Gov. Mark Warner announced that he wants to collect taxes on remote sales. The states are lobbying Congress to authorize collecting such taxes in exchange for maintaining the access tax moratorium.

Many IT managers view online sales taxes as detrimental to the continued growth of the Internet as an engine of economic development. "A sales tax on e-business will only stunt development," said Nicholas Gass, IT manager at Color Kinetics Inc., in Boston. "States already tax the businesses in their domain. And what of the regulatory nightmare of trying to determine the location of an Internet consumer?"

The Senate Commerce Committee is expected to vote on the access tax moratorium by early next month, and lawmakers in both houses may address sales taxes later in the year.