'Fairness' works its way into Internet tax debate

Tax fights in Congress aren't only about taxes. They often involve issues of fairness. As well, they affect the cost, size, and role of government.

For instance, there's a political battle rumbling over Internet taxation. Congress is deciding whether to allow new levies on online-access services - or continue its tax moratorium. That moratorium expires this week.

So the Senate will decide soon whether to make permanent the 1998 Internet Tax Freedom Act or let it expire. The law has kept most states and localities from tacking fees onto Internet-access services, such as the $23.90 bill many pay monthly to America Online.

The House approved an extension bill Sept. 17, dubbed the Internet Tax Nondiscrimination Act of 2003. It enlarges the tax loophole, perhaps to include all telecommunications on the Internet. As a result, Internet telephone calls might be free of taxes now imposed on regular telephone service. Critics view that as unfair competition.

Nearly all legislation nowadays comes with glorious, ringing titles. The names aim to garner support. Who would dare vote against "freedom" or "non-discrimination?"

But such words can be deceptive.

Take that "Nondiscrimination Act." To its critics, the act actually discriminates in favor of the telecommunications industry by exempting it from state and local sales taxes, maybe even property taxes.

"We are putting up a heck of a fight against it," says one lobbyist for the states and municipalities. "It is something the states can ill afford."

The House bill ultimately could reduce state and local revenues by $2 billion to $9 billion a year, estimates the Multistate Tax Commission. Much would depend on how courts interpret the bill's wording.

The "Freedom" act was passed when Wall Street was overly excited about the Web and Internet entrepreneurs were flush with cash and lavish in political contributions. They hoped tax "freedom" would lead more Americans to sign up for Internet access - and perhaps even enhance their stock options.

The National Governors Association (NGA) is pushing for a simple extension of the act, fearing much larger losses from the House bill. An extension might cost states $80 million to $120 million in revenues each year.

Sen. Lamar Alexander (R) of Tennessee sees any extension as an interference in states' rights to tax.

Last month, the NGA joined with six other associations representing state legislatures, state governments, cities, mayors, counties, and city managers in writing a letter to the leaders of key congressional committees arguing that the "ambiguity" of the House bill "will only add to uncertainty for industry and consumers, encourage litigation, and unnecessarily expose state and local governments to unanticipated revenue losses."

All this prompted the Center on Budget and Policy Priorities, a liberal Washington think tank, to turn out a 34-page paper attacking the proposal.

With its concern for America's economic underdogs, the CBPP doesn't want states and cities to lose revenues for education, Medicaid, public transportation, and other public services.

And Internet users are relatively affluent, points out CBPP analyst Michael Mazerov. They can afford computers, possess credit cards often necessary to sign up for service, and could easily pay an extra dollar or two in taxes a month.

Conservatives reply that state revenues were bloated between 1994 and 2001. Spending grew anywhere from 4.5 to 8.3 percent a year. So the present squeeze in revenues serves a useful purpose in "taming the beast" - trimming government.

Some of the argument does come down to ideology, notes Scott Pattison, executive director of the National Association of State Budget Officers.

In many states, the extra revenues were used to boost K-12 education. "That's politically popular," Mr. Pattison says. "It becomes difficult to cut that."

Overall, states spend more money on K-12 education than anything else - 21.6 percent of their budgets. The next biggest category is also tough to cut: Medicaid (at 20.8 percent). The other big categories - higher education (11.2 percent) and public transportation (8.1 percent) - have their own constituencies. No other programs take more than 2 percent of the total.

Right now, states are financially squeezed. In fiscal 2003, 37 states cut their budgets by a total of nearly $14.5 billion, the largest cuts since 1979. Overall state spending grew 0.3 percent and is expected to shrink 0.1 percent in the present fiscal 2004.

Given that situation, states and localities are especially keen to see passage by Congress of another bill, the Simplified Sales and Use Tax Act, that would also affect Internet users. Here they are joined by most retailers, including the National Retail Federation. Its members encompass 1.4 million retail establishments.

The bill would allow states that have implemented a streamlined sales-tax system to collect sales tax from "remote sellers" - out-of-state merchants doing business over the Internet, by mail-order, or by telephone.

Prospects for the "Simplified" act are considered good for 2004. Right now, Congress is busy with spending bills.

For business, the act will level the playing field between "bricks and mortar" merchants and other sales outlets. That's vital, as Internet sales are booming.

For consumers, it will make the sales-tax system simpler. But their chances of tax-free bargains online will diminish.