October 18, 2007
By Robert Atkinson, Anna Eshoo, (D-Calif.) and James L. Gattuso
In 1998, Congress passed the Internet Tax Freedom Act,
establishing a moratorium on all new taxes on Internet access. The
Internet has changed tremendously since then, with the number of
Americans online tripling and broadband use soaring from virtually
zero to over 50 percent. Experts disagree about whether this growth
is fast enough, or inclusive enough. But on one point there is
surprising consensus across the ideological spectrum: The Internet
tax moratorium has been a success. And letting it expire -- as it
will do this November unless Congress acts -- would be a step in
the wrong direction.
The importance of the Internet is hard to overestimate. It has
been a key driver of growth and productivity gains in the national
economy, with the U.S. economy almost $2 trillion larger than it
would be without the post-1995 IT revolution. And the economic
benefits are matched by the social benefits of the digital economy
-- in education, in health care, and in civic participation in
It is in this context that making permanent the moratorium is so
important. Unfortunately, there is considerable confusion about
what the proposed legislation does and does not do. To be clear,
the Internet Tax Freedom Act does not ban states from imposing
sales taxes on products purchased online, although states do face
practical difficulties in collecting sales taxes on out-of-state
Internet transactions. Nor does it preclude states from continuing
to tax (at relatively high levels) telephone and cable TV service,
even if those services are bundled with Internet access. What it
does do is ban the imposition of taxes on Internet access and
"multiple" or "discriminatory" taxes that states and localities
might impose because of the Internet's inherent cross-border
The idea of making the tax ban permanent, or even extending it for
another several years, has -- predictably -- been strongly opposed
by state tax collectors, who worry about the revenue losses. How
substantial these losses are is a matter of debate. The access fees
currently imposed under the grandfather clause constitute only 0.1
percent of the combined tax revenue for the nine states involved.
Potentially, the long-term revenue loss could be significantly
higher if states sought to impose the kinds of taxes on Internet
access that are now imposed on most other telecommunications
services. Some point to fees on cell phones -- which approach some
20 percent of the typical bill -- as a benchmark. For consumers,
however, tax levels of this magnitude are hardly reassuring, and
raising the price of broadband Internet access would make it harder
to close the digital divide.
State officials, nevertheless, call this an issue of federalism --
arguing that Washington shouldn't second-guess their tax policy
decisions. But in this case, there's a legitimate role for federal
rules. The Internet, by its nature, is an interstate -- in fact,
global -- network. States have an incentive to tax Internet access
because they receive all of the tax revenues as a benefit, but the
net social cost of lower rates of Internet access extends beyond
the states' borders to affect the entire nation. By reducing taxes
on Internet access, more consumers will be able to afford to go
online and take advantage of the benefits and cost-savings that
come with Internet access. The network effect of having more
citizens online creates positive externalities that translate into
economic benefits for the entire country. In this case, bad
policies in one state are borne not just by that state's citizens,
but by citizens of other states as well. This "political
externality" can be direct -- by taxing firms that are
disproportionately based out-of-state -- or indirect, by simply
slowing the growth of the Internet, and decreasing its benefits for
the whole country. In this case, federal intervention is not only
justified, it's necessary.
The ban on special taxes on the Internet has proven to be sensible
and successful. Rather than let it expire, policymakers should make
Eshoo is a member of the House Energy and Commerce
Committee; Atkinson is president of the Information Technology and
Innovation Foundation;James L. Gattuso is senior
research fellow in regulatory policy in the Roe Institute for
Economic Policy Studies at the Heritage Foundation.
First appeared in the The Hill
In 1998, Congress passed the Internet Tax Freedom Act, establishing a moratorium on all new taxes on Internet access. The Internet has changed tremendously since then, with the number of Americans online tripling and broadband use soaring from virtually zero to over 50 percent. Experts disagree about whether this growth is fast enough, or inclusive enough. But on one point there is surprising consensus across the ideological spectrum:
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Anna Eshoo, (D-Calif.)
James L. Gattuso
Senior Research Fellow in Regulatory Policy
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