House Committee OKs 5-Year Ban on New Internet Taxes

Acting with unusual speed and almost no debate, a key House committee Thursday unexpectedly approved a five-year extension of the moratorium on new taxes that target the Internet.

The highly controversial measure, attacked by traditional retailers and local tax authorities, was not even expected to be taken up this year. But Republican leaders have pushed the legislation forward, and an approval by the full House is widely expected.

Under current law, the tax moratorium would end in October 2001. The legislation approved Thursday by the House Judiciary Committee would extend the exemption until 2006. With the projected boom in the Internet, state and local jurisdictions would lose $8 billion in tax revenues annually by 2004, according to Forrester Research in Cambridge, Mass.

Internet retailers say they are subject to the same rules applying to mail-order firms, which collect sales taxes only in states in which they have operations. The current legislation would prevent states and localities from targeting Internet sales for additional taxes.

As Internet sales heat up, the issue is bound to grow in importance. In 1999, consumers spent about $20.3 billion online, according to Forrester. By 2004, an estimated 7% of U.S. retail sales will be made using the Net, compared with roughly 2% currently.

Originally, GOP leaders had talked of delaying debate on the moratorium until next year. But this week, sensing a political trump card, House Majority Leader Dick Armey (R-Texas) rallied his troops in hopes of winning the gratitude of taxpayers and the increasingly powerful high-tech industry as a presidential election year unfolds.

Thursday’s measure, approved by a 29-8 margin, is one of three Internet bills that Armey has vowed to push through the House as quickly as possible. The others include a bill to permanently prohibit any tax on Internet access and a second measure that would repeal the 3% telephone excise tax.

The three bills, which could reach the House floor as early as next week, are aimed at insulating consumers buying goods on the Internet from the kind of taxes they pay in stores on Main Street. The measures have met with such little resistance that even opponents say an extension of the Internet tax moratorium is all but inevitable in the House. The legislation faces more opposition in the Senate, although the political momentum of a strong House approval could improve prospects there.

But traditional retailers and some state officials say insulating the Internet from taxes is unfair and could result in the loss of billions of dollars in tax revenue to state and local governments.

Sales taxes are the single-largest source of revenue for most state and local governments--about $189 billion in 1998--and experts say the skyrocketing growth of e-commerce could take a huge bite out of state and city budgets. Some even predict that municipalities would have to cut back on basic services such as fire prevention.

“I think the action they’ve taken is hasty and unnecessary,” said Harley Duncan, executive director of the Federation of Tax Administrators, which represents state tax officials. “An issue of this magnitude should at least require a reasoned approach . . . and hearings. Too much is at stake.”

The committee’s vote comes a little more than a month after a blue-ribbon government and industry panel adopted a report asking Congress to extend a ban on new Internet taxes for five years.

The Clinton administration has taken a middle position, generally opposing any new taxes on the Internet but favoring some means to more efficiently collect state and local sales taxes. Clinton probably would sign a bill extending the moratorium on new taxes, unless it were significantly broadened.

Though the potential for significant tax revenue from such activity is small today, state tax experts say that will change. The advent of long-distance calling over the Internet, for instance, could one day rival the $90-billion market for long-distance dialing over ordinary telephone lines.

Frank Shafroth, director of state and federal relations at the National League of Cities, cited a University of Tennessee study forecasting losses even higher than other estimates. By 2003, he said, states could start losing as much as $20 billion annually in all categories of tax revenue if the Internet remains largely free of taxes.

“It concerns us that in many states, critical things like education are funded through sales taxes, so erosion of the sales tax base isn’t a good thing for society in general,” said Dan Nordstrom, chief executive of the online division of Nordstrom department stores. “It doesn’t matter much today, but the problem becomes more important as Internet channels become increasingly significant.”