Internet Taxes Take Center Stage in Senate

Internet taxes (search) are taking the Senate floor by storm this week, with lawmakers debating which methods of Internet access should be taxed, if any.

Lawmakers on Monday voted 74-11 to push ahead on a proposal to retain the moratorium on World Wide Web connection taxes, and on which methods of accessing the Internet should be tax-free for good.

Congressional aides say the issue may get "messy."

"Our hope is that we can come up with a clear plan that protects the consumer and that especially that will bridge a lot of gaps out there," said John Reid, spokesman for Sen. George Allen (search), R-Va., who is sponsoring one of the bills under debate.

"The best-case scenario would be if there was some kind of compromise and everyone could go to the floor with an agreement on the bill and it be passed and that be it," added Alexia Poe, a spokeswoman for Sen. Lamar Alexander (search), R-Tenn., who is sponsoring an alternative bill.

But staffers admit it's unlikely likely to be that easy.

"It's a toss-up right now as to who wins on the floor," said one congressional aide.

President Bush even weighed in on the debate Monday, when he urged Congress to permanently ban taxes consumers pay on high-speed Internet hook-ups called broadband.

The original Internet Tax Freedom Act (search), which was enacted in 1998 and extended in 2001, was designed to encourage the adoption of Internet services while the medium was still in its infancy. It exempted from taxation the fees that consumers pay to Internet service providers (search) like AOL and EarthLink.

But that was the age of dial-up, so the law didn't specifically say that states were prohibited from collecting taxes on services like DSL, which was introduced after the ban. DSL uses phone lines, which are subject to taxation under federal law. Cable-modem service cannot be taxed.

The act also prohibits multiple taxes on companies that do business over the Internet and bans "discriminatory" taxes on Web-based businesses located outside of a buyer's state. The aim was to avoid those companies from being treated differently than regular Main Street businesses.

Since November, when the moratorium lapsed, lawmakers have been fighting over what step to take next.

Among the two bills under consideration is one sponsored by Allen and Sen. Ron Wyden, D-Ore., that would permanently extend the moratorium and prohibit taxes on all types of high-speed Internet services offered over DSL or other future telecommunications services. Final passage of Allen's bill could come as early as Tuesday or Wednesday.

The sponsors argue that consumers shouldn't have to pay more taxes by hooking up to the Web in some ways and not others.

"You already pay taxes on phone lines to get the Internet … you shouldn't have to pay double taxes just because you're using that same line for Internet access," said Wyden spokeswoman Carol Guthrie. "It would be as though you bought a carton of milk and you'd have to pay taxes on it when you put it in your cereal and when you put it in your coffee."

Under this bill, states that previously taxed certain forms of Internet access would have to phase out the taxes.

The alternative offered by Alexander and Sen. Tom Carper, D-Del., extends the same moratorium for two years, banning states from taxing individual users of DSL, but allows a tax on some business transactions that take place during the delivery of DSL service. States that were already collecting access taxes could continue to do so for two more years.

"Senator Alexander is very supportive of the Internet and advancements of new technology," Poe said. "He does not feel that it's Congress' place to give the telecom industry (search) basically a tax break, a huge tax break, and send the bill to state and local governments. The other side argues we're trying to add taxes, and that's not accurate. We are preserving the status quo."

Critics say the Alexander-Carper bill will do more to harm businesses and that many Internet service providers like MSN, EarthLink and AOL will bear the brunt of the cost.

"Consumers will never see a tax on their bill ... what they will see is that their bill will almost double when ISPs have to pass on the costs to the taxes added to the ISP lines, to the back hall or the back line of their services," said Dave McClure, spokesman for the Consumer Internet Access Coalition (search).

"They don't have room to eat this stuff … this is going to put thousands of small ISPs out of business," he said.

With the technology and Internet industry constantly evolving, Allen and Wyden say it's even more imperative to avoid loopholes where states could tax future means of accessing the Net.

"It'd be like saying don't tax hamburgers and we all agree, and someone says 'Well, you said the hamburger but not the bun so we'll tax the bun … the taxes have started on the bun, we think that violated the spirit of the agreement on the first place," Reid said. "We'd like to beat back the tax dogs that will look at any hole in the fence to get them, to take another bite of [consumers'] money."

But Poe responded: "Allen and Wyden say this is a loophole; state and local governments say this is a permissible tax under the moratorium."

Critics of Allen-Wyden also say that definition of "access" is so broad that it will allow telecom companies to sneak out of taxes that they currently owe.

The Congressional Budget Office (search) estimates that about 10 states and several local jurisdictions in Colorado, Ohio, South Dakota, Texas, Washington and Wisconsin are currently collecting access taxes that total between $80 million and $120 million a year. They were taxing those services before the original ban was enacted.

CBO also estimates that states that currently tax DSL would lose $40 million to $75 million per year.

"For states, every dollar out is a dollar that has to be found somewhere else, whether it's spending cuts or raising taxes, neither of which are very popular," said David Quam, director of state-federal relations at the National Governors Association (search), which argues that states should be able to tax all sales equally. "Alexander-Carper is a true compromise for all parties."

But McClure called that measure "nothing more than a cheap grab for consumers' wallets."

Aides said the two sides seem willing to compromise on whether Internet telephone service, specifically, should be taxable.

What's throwing another wrench in the process is a proposal introduced last week by Sen. John McCain, R-Ariz., that, according to a briefing paper obtained by, would extend the expired moratorium for four years but would exclude traditional phone service and Internet phone service from the tax ban. It would temporarily allow states already taxing some access to continue doing so.

But aides in Alexander, Carper, Allen and Wyden's office said they have not yet seen the actual language of the proposal, so chances that it's a cure-all are slim.