Tech.gov: A Taxing Tale

Death and taxes--the only certainties in life. But the debate raging in Congress shows that although taxes may be certain, what gets taxed isn't.

Anush Yegyazarian, PC World

Got a question or comment? Write to Anush Yegyazarian.

I may grumble, but as a confirmed Internet addict, I always pay my monthly tithe to my ISP. It's of some small comfort to me that this bill doesn't include any taxes. (Don't we all pay enough?) But while basic Internet access will likely remain tax-free, other Internet-related services--for-pay digital video and music, voice over IP, and the like--may soon be taxed.

Worse, all that Amazon.com loot we're buying for the holiday season may also end up taxed come next year. You'll be stuck paying more, unless you live in a state that doesn't collect sales tax. Perhaps it's time for me to move closer to the family in sales-tax-free New Hampshire.

What Taxes?

The moratorium on Internet access taxes expired on November 1, despite efforts in Congress to have that ban extended or made permanent. The House of Representatives passed a permanent moratorium (H.R. 49). As of this writing, the Senate hasn't passed its version of the House legislation (S. 150). Why? The usual sticking point: details.

Detail 1: What the heck does "Internet access" mean? It should be clear enough, but apparently it isn't. Remember, we're dealing with legalese, in which "sky" requires a five-paragraph definition and "blue" must come with the appropriate visible wavelengths specified.

The only point that critics and supporters seem to agree on is that basic ISP service--connection to the Internet--shouldn't be taxed when it comes to individual consumers like you and me. Likewise, very few people, if any, favor taxes on individual e-mail messages.

Everything else, however, is up for grabs, including voice-over-IP services, which can save you beaucoup bucks on your phone bill (see the February issue of PC World for more on these services) and plain old broadband connections, such as DSL. Both of these services can be classified as telecommunications services--which, as my phone bill attests, definitely get the tax treatment, often by the state, local, and federal government.

Detail 2: What about the services bundled with Internet access? Every provider, from America Online to Earthlink to Microsoft, offers some sort of additional service--special spam filters, for example, or Web hosting, or file downloads. Some of these are free, others definitely not. Critics of the Internet tax moratorium claim that as the law was written, ISPs could bundle dry cleaning or car washes into their services and they'd have a pretty good case for not collecting taxes on them. There's also concern that if all Internet access taxes get banned, the government will lock itself out of potential revenue as the technology evolves.

The States' Story

Like many people, I've done lots of shopping on the Web. Not only is it convenient (e-tailers wrap and deliver, which means my gifts have some hope of getting there on time), but it's also generally tax-free. That makes me happy; but it doesn't particularly please state and local governments.

Depending on whom you ask, states have lost millions to billions of dollars in revenue because people like me haven't paid sales taxes. Technically, we're supposed to keep track of our online purchases, then pay those uncollected taxes when we file our state income taxes. (Does anyone do that?) The gloomy economy of the past few years hasn't helped matters.

States have banded together to simplify the sales tax code via the Streamlined Sales Tax Project. Nope, this won't mean we'll all pay one rate. Rather, it means states and local governments will agree on what, say, a marshmallow should be considered (food? candy? potential Ghostbusters menace?), among other things. That's so every store, whether online or brick-and-mortar, will know whether to collect tax on an item when it's sold, and won't have to keep up with over 7000 individual definitions and exceptions from each state or county.

The states involved in this effort agreed on a set of guidelines to settle these questions in November 2002. Since then, about 20 states have passed legislation to adopt the rules as law, with 22 others considering it.

Though this legislation doesn't require compliance from online retailers, major names like Target and Wal-mart are playing along. And if federal legislation supporting this initiative gets passed (H.R. 3184 and S. 1736, both introduced in October and currently in committee), all states would adopt the SSTP guidelines; and states that wanted to enforce sales tax collection would have even more muscle to do so.

To Tax or Not to Tax

I don't want to pay the government more money. In my opinion, it too often mismanages what it already gets. But there are services I value: schools, police, fire, environmental protection, and road upkeep, to name a few (though I could live without meter maids). These services might be affected if state and local governments don't get at least some revenue from Internet-related sales.

The Congressional Budget Office can't come up with an assessment of what would be lost to states if the Internet access tax moratorium were extended or made permanent and "access" were broadly defined. But the estimates they do have for currently taxed DSL services show some significant potential losses.

Many other services that might be affected are in their infancy. VoIP is a good example: Only 2 percent of businesses used it regularly in 2002, according to In-Stat/MDR. Boyd Peterson, vice president of consumers, media, and entertainment research at Yankee Group, says only about 100,000 consumers use it today. But the potential for rapid growth is huge if taxes aren't levied; and if major companies such as AT&T and Time Warner Cable continue to roll out services. Additional costs, such as taxes, could undermine these fledgling services, end up throttling telecomm competition, and keep prices high.

Online retail purchases in the third quarter of 2003 were less than 2 percent of total retail sales for the quarter, according to the Census Bureau. That's not insignificant in terms of dollars, but it's only a drop in the retail bucket.

Some taxes on certain Internet services may be justified. But I suspect that we'd all be better off if the General Accounting Office got some muscle to audit and enforce remedies on overspending or misused funds, and if we closed loopholes in the tax system we already have.