Down To Business: Note To Tax Collectors: Leave The Internet AloneDown To Business: Note To Tax Collectors: Leave The Internet Alone

As if to convene for some triannual Olympic celebration, the nation's legislators are debating--for the third time in six years--whether to extend the Internet tax moratorium first established in 1998.

The exemption was originally put in place at the cusp of the Internet revolution, prohibiting state and local governments from taxing Net connections, applying multiple taxes to any single e-commerce transaction, and otherwise levying taxes that discriminate against online business. The idea was to create an environment where the fledgling Internet, so critical to economic growth and social advancement, could live up to its fullest potential.

The Internet is still growing, and it's more vital with each passing day. So as the Nov. 1 expiration date for the latest three-year tax moratorium approaches, lawmakers should get on with a permanent tax ban rather than ruminate about how long to extend the temporary one or, worse, figure out ways to tax more kinds of Internet commerce.

One sensitive area for the pro-tax crowd is voice over IP. When the moratorium was extended in 2004, taxes on VoIP services, which were just starting to replace conventional circuit-switched phone services, were permitted because of government concerns about losing a big source of revenue. Critics of a permanent Internet tax ban now worry that those revenues will be lost for good as VoIP services get lumped over time with e-commerce transactions in the same tax-exempt bucket.

Yet some of the same politicians who oppose a permanent tax ban, which would spread the Internet to even more people at relatively low cost, are the ones who worry about the "digital divide" and how the United States is falling behind broadband-connected economies in Asia and Europe. Sen. Daniel Inouye, chairman of the Commerce, Science, and Transportation Committee, last month pulled the Internet Tax Freedom Extension Act from a list of bills to be voted on, saying that "further negotiations are warranted." Rather than kill the Internet cash cow, some lawmakers want to put it in a pen in the hopes they can milk it for additional tax revenue at some point down the road.

Other opponents to extending the moratorium maintain that it puts offline retailers at a disadvantage--the old unlevel playing field argument. I (wrongly) made this same point in a column seven years ago: Why should an Amazon.com, with a market cap that dwarfs most of its offline rivals, receive a government subsidy to compete with them?

Why? Because the distinction between online and offline retailer (or any other business, for that matter) gets smaller all the time. As the Cato Institute points out, small Main Street shops are experiencing an "economic renaissance" in part because their Web storefronts and commerce capabilities are bringing in more customers online and offline. "Subjecting small Internet businesses to the tender mercies of more than 6,500 (and potentially over 30,000) state and local taxing jurisdictions wouldn't level the playing field--it would put the mom-and-pops out of business," Cato analyst Aaron Lukas argues.

As for the revenue ramifications of extending the moratorium, don't ignore the property, sales, income, and other taxes that expanding Internet-dependent businesses and their employees pay. The moratorium doesn't stop governments from collecting those taxes, so if we undercut businesses with more onerous Internet taxes, watch as overall tax revenue takes a hit.

We sometimes forget that the Internet is still something of a commercial startup. Most companies have yet to figure out, much less fully exploit, its potential to reshape their businesses and industries. The Internet has grown so big so fast because the government (for the most part) has gotten out of the way as entrepreneurs and large businesses alike leveraged this unparalleled sales, marketing, connectivity, and collaboration medium. Don't get in the way now.

Rob Preston,
VP/Editor In Chief
[email protected]

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