The Internet Tax Freedom Act and the Internet Economy

October 27, 2014

The Internet Tax Freedom Act (ITFA), the moratorium on taxing internet access, was recently extended to December 11, 2014, from its initial expiration date of November 1, 2014. However, a number of important questions are left unanswered by lawmakers regarding its future.

Internet access and the internet economy—which are key drivers of productivity, equality, and economic growth—could see new taxes at the state and local level if Congress decides against an extension of the moratorium.

The Internet is Key to the U.S. Economy

We have previously discussed the importance and underlying rationale of ITFA, which prevents state and local governments from taxing internet access.

One key benefit of this moratorium is that it prevents a tax that may hinder the productivity and growth of the internet economy. A 2012 OECD report, for example, highlights the role of the internet as a cornerstone for economic growth:

“[T]he internet is becoming a key economic infrastructure revolutionising businesses and serving as a platform for innovation.”

Additionally, considering that the U.S internet economy is projected to grow at a compounded annual growth rate of 6.5 percent between 2010 and 2016 and is estimated to comprise 5.4 percent of U.S. GDP in 2016, taxing internet access is seemingly counterproductive.

Internet Taxes Could Slow Internet Access

The Internet Tax Moratorium first came to be in 1998. Since then, it has been extend three times, most recently in 2007.

During the internet tax moratorium, between 1997 and 2012, internet access increased significantly from 18 percent to 74.8 percent (chart 1). Undoubtedly, the fact that access was untaxed contributed to this rapid expansion.

An analysis by the Phoenix Center for Advanced Legal and Public Policy Studies shows approximately 20 million future internet connections could be lost—equal to four years of internet adoption—in the event ITFA is not extended.

It is also important to consider the fact that a reduction in the growth of internet access could have negative consequences for lower-educated people. According to U.S. Census data, only 40 percent of those with less than a high school education have access to the internet, while 92 percent of those with college degrees have access.

Allowing taxation that impedes internet access could harm those with lower levels of educational attainment.

Potential Outcomes for the Internet Tax Freedom Act

Although ITFA enjoys bipartisan support from legislators, its future remains uncertain. Three potential outcomes exist.

Temporarily Extend the Moratorium, Again

The first possible outcome is that the bill will be temporarily extended as it has been in the past, which seems the most likely outcome.

Combining the Internet Tax Freedom Act with the Marketplace Fairness Act

There is a group of Senators favoring a merger of ITFA with the Marketplace Fairness Act (MFA), in the Marketplace and Internet Tax Fairness Act (MITFA).

The Marketplace Fairness Act would allow any state to require sales tax collection by out-of-state retailers, given that the state simplifies its sales tax system. (More about that here).

This outcome seems unlikely given that there is resistance to the Marketplace Fairness Act. Senate Finance Committee Chairman Ron Wyden (D-OR) has said that the introduction of MITFA could slow the process on ITFA and an amendment in the form of the Permanent Internet Access Freedom Act (PITFA).

In a release, Sen. Wyden, who co-authored ITFA, said:

“I hope that the proponents of the Marketplace Fairness Act will face the facts and admit that they can’t achieve their goal by holding the internet economy hostage, so they’ll have to go about it any other way than tying it to ITFA. There is absolutely no way to reconcile the current MFA and ITFA.”

A Permanent Internet Tax Freedom Act

The third outcome is a permanent extension of the Internet Tax Freedom Act: The Permanent Internet Tax Freedom Act.

PITFA represents a permanent ban on taxing internet access and an elimination of the grandfathered ability to tax internet access currently allowed in seven states: Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin. These states are, under the grandfathered clause, allowed to tax internet access because they implemented a tax prior to October 1, 1998.

Rep. Bob Goodlatte (R-VA), who sponsored PITFA, stated the following after the bill was passed by voice vote in the House on July 15 earlier this year:

"This legislation prevents a surprise tax hike on Americans’ critical services this fall…It also maintains unfettered access to one of the most unique gateways to knowledge and engine of self-improvement in all of human history."

PITFA is currently awaiting Senate consideration after the November midterm elections.

The Internet Economy’s Importance is Evident but its Future Uncertain

Internet access and the internet economy are important drivers of productivity, equality, and economic growth. The ramifications of delaying implementation of robust policy, in support of internet access, could adversely affect specific groups and the economy as a whole. It is unlikely that ITFA is allowed to expire, but until Congress reassembles after the midterm elections, the future trajectory of the internet economy and ITFA is uncertain.

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