1998 was a lifetime ago in the world of technology. E-commerce was in its infancy, Mark Zuckerberg was a 14-year-old and Napster hadn’t yet been invented. But even then, many people rightly scoffed at the notion that the Internet was an “infant industry” requiring special protection from state taxes.
Congress, however, agreed the Internet required exclusions and enacted the “Internet Tax Freedom Act” (ITFA), which placed a moratorium on state and local sales taxes on Internet access (the monthly fee consumers pay for home Internet access) and prohibited all “multiple or discriminatory” taxes on sales of items purchased over the Internet. Since the ITFA expired in fall of 2001, Congress has extended the ITFA moratorium several times, and it is now set to expire in November of 2014.
If the “infant industry” argument was highly questionable in 1998, it’s utterly absurd now. From books to airline tickets, virtually everything consumers purchased in “brick and mortar” stores in 1998 is now available online. Internet access, while not yet omnipresent is widely accessible. Many traditional retailers are going under due to competition from companies such as Amazon.com. Sixteen years later, the infant of 1998 now has the car keys to the American economy.
Nonetheless, Sens. John Thune and Ron Wyden have cosponsored the “Internet Tax Freedom Forever” act, which would turn the moratorium into a permanent ban on Internet access taxes. A glowing Wyden press release claims the bill will “giv[e] online innovators and entrepreneurs the stability they need to grow their businesses.”
While other tax bills have deadlocked Congress, the Internet Tax Freedom Forever act has garnered 50 co-sponsors in the U.S. Senate. The most likely reason is Congress is playing with other people’s money. The fiscal impact of ITFA in 2014, as in 1998, falls entirely on state and local governments. So Wyden and Thune can breezily pre-empt an entire economic sector from tax without hurting the federal budget’s bottom line. But for state and local governments, the bill would represent a real hit on their ability to balance budgets in the long term.
Besides taking a bite out of state budgets, “Internet tax freedom” is simply bad policy. A sustainable sales tax should apply to personal consumption as universally as possible—and it’s especially vital that the tax apply to sectors that are growing most rapidly. By permanently exempting Internet access from sales taxes, the Thune-Wyden bill will make it more likely that state governments will have to hike the sales tax rate on all the other items subject to the tax to make up the revenue loss.
This year’s bill goes beyond simply turning a temporary bad idea into a permanent one. It would also eliminate a “grandfather clause” that allows nine states (Hawaii, New Hampshire, New Mexico, North Dakota, Ohio, South Dakota, Texas, Washington and Wisconsin), which had enacted taxes on Internet access before the original ITFA, to continue to levy these taxes. So in addition to choking off future state revenues, the Thune-Wyden bill would also put an immediate hit on budgets in the nine states that have been sheltered by the grandfather clause to date.
To be sure, state sales taxes have their flaws. They’re regressive, falling most heavily on low-income families, and are littered with special-interest exemptions. As we have argued elsewhere, shifting away from sales taxes and toward the progressive personal income tax is a sensible reform strategy for states. But a federal ban on internet access taxes is not a way to move this debate forward.