Spring 2004

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This article appeared in The Bond Buyer on March 19, 2004. It is reprinted with permission.

Failing to make the lapsed Internet access tax moratorium permanent might help boost sagging state and local treasuries a little bit, but it would be a colossal public policy blunder that would harm the nation’s consumers and the Internet itself, while crippling the Internet service industry, according to an Internet tax law expert who is lobbying for a permanent ban.

Extending the moratorium indefinitely is the right thing for Congress to do because it would prevent “a complex labyrinth” of taxes and regulations resembling the nation’s current telephone tax system from “growing like a vine around Internet access” and “strangling” Internet access, said attorney Lee E. Goodman.

Goodman was an adviser to former Virginia Gov. James S. Gilmore 3d when he was chairman of the Advisory Commission on Electronic Commerce. The congressionally created commission’s April 2000 majority report, which states and localities have strongly denounced ever since, urged that the moratorium, designed to keep online access inexpensive for all, be made permanent.

Goodman, who is now in the private sector working for the District of Columbia-based law firm of Wiley Rein & Fielding LLP, where he represents Time Warner Inc. and its affiliates, AOL and Time Warner Cable, said in recent interviews that the ban should be made permanent both to protect consumers and to prevent bureaucratic red tape from swallowing up Internet service companies.

Six years ago, federal lawmakers enacted the moratorium that lapsed on Nov. 1 as part of the Internet Tax Freedom Act, in order to prevent cumbersome taxes and regulations like those that govern the nation’s interstate telephone system from stifling the future growth of the Internet and the industries around it, Goodman said.

In particular, the law was intended to protect Internet service providers from the network of taxes and regulations that 7,600 different state and local taxing jurisdictions impose on companies providing interstate telephone service, he said. Goodman said that can amount to having to file about 70,000 tax returns with those authorities annually.

Lawmakers, armed with the knowledge that the nation’s telephone tax system was “complicated and burdensome,” Goodman said, deliberately sought to create a different kind of legal regime to govern the Internet service industry.

Goodman credited the moratorium with making the U.S. dominant in the world in the digital content, services, and software markets. “We can go the way Europe has gone by imposing taxes on all digital content, services, and software,” as some U.S. lawmakers are now urging, “or we can continue to promote easy consumer access through tax policy,” he said.

Goodman elaborated on this point, saying that U.S. policymakers currently considering competing bills to extend the moratorium need only look at Europe to see how policy missteps can stifle an industry. “Look at the United Kingdom, France, and Germany, which have a complex system of value-added taxes burdening Internet access service,” he said.

The three countries have 700 Internet service providers among them, he said. “In the United States, we have 7,000 Internet service providers, and one reason we do is because we have kept Internet access service free of regulatory and tax burdens to date.”

Opening the door to taxing the Internet and Internet access will ultimately harm the U.S. economy and make it less competitive, Goodman argues.

CONSUMERS TRUMP GOVERNMENTS

He noted that the Constitution’s Interstate Commerce Clause was enacted to prevent individual states from imposing their tariffs, taxes, or other regulatory burdens on the transportation or importation of goods from one state into another, as they had in the days before the Constitution. Since 1942, Congress has intervened in state tax affairs at least 10 times in order to protect interstate commerce and promote the national good over parochial interests, he said.

With state and local governments seeking to tax Web pages, filtering software, e-mail software, online stock quotes, and sports news, in addition to taxing Internet access and myriad Internet-related activities, Congress should act now, Goodman said. “Congress has every reason to step in to promote a national policy of ubiquitous Internet access for all Americans,” he said.

But legislation Goodman supports that would make the ban permanent has stalled in Congress because state and local government advocates claim its enactment could cause them to miss out on billions of dollars in future taxes related to the telecommunications industry. One such bill, sponsored by Senators George Allen, R-VA, and Ron Wyden, D-OR., was approved by the Senate Commerce Committee on July 31, but has not yet come to the Senate floor.

On the House side, a similar bill introduced by Representative Christopher Cox, R-CA, that also would prohibit the taxes forever, sailed through that chamber in September. The Allen-Wyden bill would repeal in 2006 a grandfather clause in the statute that allows the 11 states with the power to tax Internet access services to retain that power. Cox’s bill would eliminate the grandfather clause immediately.

Goodman and his allies say that state and local claims are grossly exaggerated and that the real impact of a permanent moratorium on states and localities would be minuscule, pointing to a Congressional Budget Office analysis that forecast that states would miss out on between $80 million and $120 million a year if the permanent ban were enacted.

Goodman also said he is skeptical of claims that permanently extending the moratorium would jeopardize the repayment of municipal bonds.

“Bond issues to date have been based on certain tax bases, and those bases have not included this new area of activity called Internet access – either because it didn’t yet exist, or because there was already the ITFA moratorium in place, and it is therefore not accurate for the other side to say that bond issuers have somehow relied on revenues related to Internet access,” he said.

Goodman also took aim at the compromise legislation sponsored by Senators Lamar Alexander, R-TN, and Tom Carper, D-DE, that would extend the ban to November 1, 2005. States and localities back the bill, arguing that more time is needed to grapple with the issues and that the temporary extension provided in that bill would provide more time for a consensus to emerge on all the highly complex regulatory and fiscal questions related to the Internet.

But Goodman said those arguments are nonsense. The bill, which is supported by the National Governors Association, the National Association of Counties, and other state and local advocacy groups, is “a Trojan-horse plan for full-blown taxes on the Internet within two years,” said Goodman.

Final resolution of the issue will be even more difficult to achieve in late 2005, because by then the states collecting Internet access taxes under the grandfather clause will be even less likely to want to give up those revenues, especially if they grow over time, he said.

Goodman also said the fact that Alexander is leading the effort for the compromise extension of the ban to 2005 puzzled him. For it was Alexander, Goodman noted, who invoked states’ rights and railed against the moratorium on the Senate floor just months ago.

On October 22, Alexander criticized “unfunded mandates” such as the ban and urged his colleagues to “let the moratorium on access to the Internet die a well-deserved and natural death when it expires on November 1,” according to the Congressional Record. Yet less than two weeks after the statute lapsed, Alexander unveiled a plan, which he introduced as legislation on February 12, to reinstate the ban and extend it to November 1, 2005.