Are Internet Taxes Good or Bad for Small Businesses?

The Beatles were so perturbed by the taxman's pervasiveness they wrote a song about it in 1966. It went something like this: "If you drive a car, I'll tax the street. If you take a walk, I'll tax your feet." In their day, it would seem, nothing escaped the taxman.

But today, if you were to buy that song over the Internet, it would be tax free. That's because Congress has held the taxman at bay for the past nine years. It first declared a moratorium on Internet taxation in 1998 and has extended it twice since then. The ban, however, is set to expire again next month, and a debate over its value is heating up on Capitol Hill.

The House Small Business Committee held a hearing on the subject on Wednesday (Oct. 3). It largely drew supporters of a bill that would make the moratorium permanent. Currently, it prevents state and local governments from imposing any kind of tax, whether it's on Internet services or goods sold over the Internet. But is that in the best interests of small businesses, not to mention the nation?

The question might seem academic. Nobody likes taxes. But two recent studies argue that the moratorium is misguided and that imposing taxes would have little effect on the growth of the Internet, e-commerce, or those who shop online.

The Center for Budget and Policy Priorities (CBPP), a nonpartisan organization that examines the effects of government policy on low-income households, claims in one of the studies that a permanent moratorium is actually more likely to be counterproductive to expanding Internet access, especially among underserved communities.

"State and local governments play a critical role in providing many low-income individuals with their first hands-on exposure to the Internet in public schools, libraries, and community centers," it states. "Depriving states and localities of revenue through a permanent [moratorium] would interfere with their ability to take these kinds of initiatives."

That position meshes with the findings of a second study by the Pew Internet & American Life Project, a subsidiary of the Pew Charitable Trust. It found that price was a statistically insignificant factor in decisions by households to purchase broadband Internet service.

"To be sure, more competition, lower prices, and greater availability of faster infrastructure will be welcomed by American consumers. By themselves, however, they are not likely to be enough to lure non-online users off the digital sidelines,” the Pew study noted.

When the moratorium was first enacted nine years ago, it was clearly meant to be temporary. The idea was to give Internet service providers and state and local officials time to come up with a uniform approach to Internet taxation. Back then, the Internet was also still a nascent service that may have needed tax incentives to grow. But that dynamic has changed.

The Pew survey, conducted in February, noted that it would likely take only nine years for high-speed Internet service to reach half the population. In contrast, it took 10 years for the compact disc player to reach 50 percent of consumers, 15 years for cell phones, and 18 years for color TV.

Overseas, every country that leads the United States in broadband deployment and usage currently taxes broadband service, "often at rates two to three times higher than the typical combined state and local sales tax rates," according to the CBPP study. "This demonstrates that reasonable, nondiscriminatory taxation of Internet access service is no barrier to healthy rates of deployment and household subscriptions," it concluded.

Domestically, states that had Internet taxes on the books in 1998 were grandfathered under the moratorium and allowed to continue imposing the levies. In those states, broadband service is comparable to states without taxes. The CBPP study notes that Verizon is rolling out its new fiber-optic Internet service in states that levy Internet taxes as well as those that don't. What's more, prices are about the same, although they are substantially higher in all cases than services offered in Europe, which are typically faster.

The point here is that substantial evidence exists to make a persuasive argument against continuing the moratorium. My major concern is that the debate will focus excessively on the issue of taxation, and not on the broader issues involving how broadband is being deployed in what amounts to a duopoly market.

If lawmakers intend to extend the moratorium, they need to tie it to specific commitments from service providers that address shortcomings in the current level of service. That includes providing a plan to lower costs and improve services to small businesses, as well as rural households and other underserved areas of the country.

After all, there is no such thing as a free lunch, and extending the moratorium (forget about making it permanent) without some guarantee of better service would be tantamount to a tax giveaway. And the nation can ill afford that.