The anti-tax ethos of the Internet ran headlong this year into two of the most powerful rallying cries in Washington: "states' rights" and "tax fairness."
Congress was widely expected to renew the Internet tax moratorium before it expired on Nov. 1. The five-year-old law barred states and local governments from taxing the fees consumers pay for Internet service.
But in what turned out to be a major miscalculation, backers of the moratorium's renewal moved to expand the range of telecommunications services covered by the ban, prompting a surprisingly vocal reaction from state capitals and a handful of key lawmakers in Congress that ultimately derailed the issue for the rest of 2003. The failure to renew the moratorium was all the more surprising given that it was one of the few items on the congressional to-do list that had strong bipartisan support.
The House of Representatives went on record in September with its approval of a permanent ban on any kind of Internet access -- including DSL and cable. The House's move to make clear that any form of Internet service would be exempt under the moratorium was backed by the telecommunications industry, which is increasingly concerned by some states' desire to tax broadband services.
But when the issue came up in the Senate in November, Republicans Lamar Alexander (Tenn.) and George Voinovich (Ohio) objected. Defining their objections in terms of fairness to the states, the lawmakers said their two states alone could lose millions of dollars in tax revenue if the House version of the moratorium bill passed. According to a September study by the Multistate Tax Commission, a permanent ban on all Internet access taxes could reduce state and local revenue collections by $8.75 billion annually by 2006.
Alexander and Voinovich criticized a provision in the House bill that would strip the rights of 10 states -- including Ohio and Tennessee -- to continue taxing Internet access since they already had such taxes on the books when the moratorium first took effect in 1998. That change could cost those states $120 million over three years, they said.
"We don't want to tax Internet access, but what is really being proposed is more of a tax break for large telecom companies," said Arkansas Gov. Mike Huckabee (R). "The way state budgets are now, any amount of revenue we might lose now or in the future is a lot of money."
Critics also said that the expanded moratorium legislation could make all kinds of Internet services tax-exempt, including movie and music downloads. Internet-based telephone calls also could wind up being tax-free under the ban.
But the telecommunications lobby said the change is necessary because dozens of states and local governments tax DSL Internet connections like regular telephone service. That, the industry said, is an extra cost that prevents money-conscious consumers from adopting broadband Internet service in heavy numbers -- itself causing an economic dent.
"It is an interpretation problem with the states. Some states are not applying the [moratorium] in a technology-neutral way and are reading in a way that has led them to tax DSL," said Broderick Johnson, a lobbyist for AT&T.