March 3, 1998


by Andy Oram
American Reporter Correspondent

CAMBRIDGE, MASS.—The Internet Tax Freedom Act is meant to open up an era in online commerce, but it could well spawn a new industry of political rhetoric. Taken exactly as written, the bill is a sensible step toward stabilizing a new area of tax law that lacks the precedents it needs. But we have to draw a line carefully between what the law actually does and what claims are made for it by some interpreters, both in support and in opposition.

Essentially, this law (S. 442 in the Senate; H.R. 1054 in the House) would keep states from putting a tax on “the Internet or interactive computer services.” You wouldn’t pay an extra tax for dialing up a service provider or for carrying out online transactions.

The law explicitly allows state and local governments to collect the same sales taxes from sales made over the Internet as they do from mail orders and other traditional services. Only special taxes on Internet use are prohibited—but the press often fails to understand the distinction.

So the effect of the law would really be to maintain the status quo for two years. During that time, the bill directs various Cabinet departments to come up with policy recommendations. The alternative to the bill would be to let individual states impose taxes anywhere they please on what they see as affluent online consumers. Trying to figure out what locality people are logging in from and what taxes are being imposed on each side of a transaction would place an unbearable burden on online commerce.

Despite press reports positing a conflict between the Internet Tax Freedom Act sponsors and the National Governors’ Association, their goals overlap substantially. Both sides want consistency and fairness, but (according to press reports) the NGA requests an awkward system for imposing a uniform nationwide sales taxes and sharing them among states.

Even while President Clinton explained accurately what was covered and excluded as he made his push for the bill before industry groups last week, one can’t fault him for some hype about its benefits to the economy. More eager commentators have heralded a “tax-free” commercial zone in cyberspace, thus feeding the fears of those who watch the impoverishment of local communities with alarm and remain suspicious of tax cuts.

Ironically, the bill does nothing to protect Internet service from what its providers and users are most worried about: charges for the use of telephone lines. One section of the House version does prohibit the FCC and states from regulating “the prices or charges paid by subscribers for interactive computer services.” But no such regulation has been suggested by anyone. Instead, what some telephone companies want is for the FCC to reclassify service providers in such a way that they pay charges currently imposed on the telephone companies. The law does nothing to prevent that.

Luckily, the FCC has shown no inclination to make such changes. But it is coming under pressure to make ISPs pay into the universal service fund. The fund has recently begun to be used to support Internet connections for schools, libraries, and health care providers. Several telephone companies think it’s only fair to make ISPs pay into the fund. (To my mind, it would be like forcing construction firms to pay for affordable low-cost housing.)

The federal government has also muddied the debate by introducing a more radical and comprehensive recommendation to the World Trade Organization. According to the New York Times, the U.S. wants indeed to remove taxes from Internet sales—but not on physically traded goods, only on goods and services that can be transmitted electronically such as software, movies, and video games.

So the governors do have reason to worry. Not from the Internet Tax Freedom Act, whose two-year morotarium will expire well before large-scale Internet sales become a reality and will give the country time to decide how to handle the new kinds of commerce. Rather, they have a real enemy in the forces of anti-tax hysteria hiding behind the bill.

Personally, I oppose special taxes on Internet service, because I think it would discourage low-income families from getting online. But the digital marketplace that many envision for the future may change the situation. If people really do download their Hollywood movies and video games, what is so precious about this service that it should be protected from taxes? The revenues may well go toward subsidizing basic services (virtual or physical) to the poor.

The Internet was originally designed and operated through federal taxes, and a good deal of research and new development (the “second-generation Internet”) still depends on government funding. So people who disparage taxes should ask whether we’d have an Internet at all if they got their way.

Instead of “no Internet taxes,” why doesn’t President Clinton promote e-commerce through “no Internet restrictions on the use of encryption”? I dare him to cross the country with that message! Where tax relief gives a small economic boost, unfettered encryption is critical for the explosive development of online sales, online contracts, and online negotiations and data exchange. Yet Clinton holds on to an outdated concept of encryption as a tool for espionage and crime, as I have reported in a CPSR analysis.

The world is displaying disturbingly contradictory trends. On the one hand, responsibilities are being devolved to local communities (schooling, welfare, etc.). On the other hand, these communities’ abilities to control funding are being reduced by national regulations and international trade agreements. The result is unfunded mandates—or in other words, nothing gets done.

Eventually the Internet will have to be integrated into tax regimes. And the medium being global, a solution will benefit from global discussion and coordination. But a policy of exempting all commerce will be destructive, unless property or income taxes are universally adjusted to make up the loss.

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