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    States Have Chance to Tax Internet After Moratorium Expires

    BY Kelley Beaucar Vlahos
    12/22/2003
    by Kelley Beaucar Vlahos on 12/22/03.

    WASHINGTON — The World Wide Web (search) has been left vulnerable to new levies by states and local governments now free from an Internet tax moratorium (search) Congress failed to renew before adjourning for the year.

    The ban on taxes that prevents state lawmakers from imposing a utility fee much like that imposed for phone or cable TV use expired Nov. 1.

    The House passed a measure on Sept. 17 to make the ban permanent, but a companion bill sponsored in the Senate by Ron Wyden, D-Ore., and George Allen, R-Va., was stalled on procedural grounds before senators left for the winter recess earlier this month.

    Even with the moratorium temporarily lifted, officials on Capitol Hill say it is unlikely -- at least for now -- that states will jump on the chance to tax the Internet.

    "The best obstacle to new taxes are voters, and governors and state and county executives and local councils have to answer to those voters," said David Quam, director of state and federal relations for the National Governors Association (search). "That's not going to go away, whether the moratorium is passed or not."

    "We do not see local and state governments running out to impose new taxes," said Rep. Rick Boucher, D-Va., and co-chair of the Congressional Internet Caucus (search). He called much of the hand-wringing over the tax issue "a tempest in a teapot."

    But that does not mean that both sides aren't embroiled in the thick of a policy fight.

    Governors and state legislatures have lobbied Congress heavily to allow them to tax high-speed Digital Subscriber Line (search) (DSL) access or the new roll-out of Voice over Internet Protocol (search) (VoIP), which would allow users to make phone calls over the Internet.

    "We're very, very concerned about the prospect of making this moratorium permanent," said Michael Mazerov, senior policy analyst with the Center on Budget and Policy Priorities (search).

    Mazerov said that if VoIP is considered a safe haven from taxes, telecommunications companies could easily shift their business to the Internet, leaving the old, taxable system behind and governments at a loss over how to make up lost revenues.

    "There is little doubt that this legislation would make it impossible for states to extend their telecommunications tax to Voice Over Internet," he said. "It is very worrisome."

    But Rep. Christopher Cox, R-Calif., who sponsored the House legislation as well as the original moratorium in the Internet Tax Freedom Act (search) of 1998, said allowing local municipalities and state governments to tax access -- whether it be regular dial-up, broadband DSL or cable modem -- would increase the digital divide, hurt small businesses and deter people from exploring the Internet.

    "It would be a huge mistake to allow governments worldwide to set up tollbooths on the information highway," Cox said in a recent taping for an Orange County cable television talk show.

    According to a Pew Internet and American Life study, as of March 2003, an estimated 31 million people in the United States -- roughly 16 percent -- use high-speed, or broadband, access to the Internet from home. Of those, 28 percent got their high-speed access through DSL while 67 percent had cable modem access.

    Even with the moratorium, the Internet is not completely free of access taxes. Ten states, grandfathered because they were among 13 states that already had laws in place at the time the 1998 legislation passed, continue to collect taxes on Internet access. The Congressional Budget Office said in a recent report that those states stand to lose between $80 million and $120 million annually if the grandfather clause expires.

    Mazerov and Quam say at least 27 states and local governments already had been taxing consumers on DSL access through their phone companies, claiming the service falls under telecommunications, rather than Internet access. By their count, those governments stand to lose an estimated $9 billion in the next few years if they are no longer allowed to collect that tax.

    "Ideally, I don't think there is a valid rationale for state and local governments being prevented by the federal government from taxing Internet service, as long as it's not done in a discriminatory manner," Mazerov said.

    But supporters of the moratorium say states will have to make up the revenue somewhere else and suggest that keeping the ban will help states in the long run by maintaining a business incentive.

    Pointing to recent Department of Commerce reports that show state revenues increasing for the sixth straight quarter, one House Republican aide added that states may be exaggerating bad times in order to justify a call for new taxes.

    "You are talking about small fractions of one percent of the total revenue of the states here," said the aide, who asked not to be identified. "When you compare that to the incredible benefits one gets from increased productivity on the Internet, we just don't think it makes sense to tax this."

    Unlike the Cox bill, which makes the moratorium permanent and nixes the grandfather clause, amendments to the Senate legislation extend the moratorium instead for another two years and don't touch the grandfather clause for three years. In return, DSL services are placed under tax-free protection -- a compromise that tax ban opponents say they can live with, for now.

    Meanwhile, not everyone is confident that governments won't take advantage of the current stalemate to impose new taxes.

    "We're pretty frantic right now," said Chris Kinnan, a spokesman for Citizens for a Sound Economy, which is against any taxes on Internet access. "We think it's in everyone's best interest to prevent local and state governments from meddling in restrictive ways."