The Senate is expected to vote soon on continuing a moratorium on state and local taxes of Internet access, and the specifics of what passes could mean hundreds of millions of dollars gained or lost to Kentucky’s state budget.
The moratorium, known as the Internet Tax Freedom Act (ITFA), passed originally in 1998, has been extended several times since then and is set to expire again on November 1. ITFA bars states from imposing sales taxes and telecommunications excise taxes on the fees paid by households and businesses for wired and mobile Internet access.
The original legislation was intended to be temporary, and it grandfathered in states that already had taxes on Internet access. According to a recent report, Kentucky loses about $80 million a year in revenue because of this ban. The ban gives an unfair advantage to Internet-based services against competing communications and entertainment services that are typically taxed like long-distance telephone service and cable TV. Kentucky’s telecommunications tax, which applies to such services, brought in $64 million to the state last year.
The lost revenue from this ban is only likely to grow as more people subscribe to Internet service, get faster and more expensive service, or cancel now-taxed services like telephone and cable TV in favor of Internet-based alternatives (like Skype for phone calls, Spotify for music and Netflix for movies).
There’s no evidence that taxes on Internet access are a deterrent to household subscriptions. If anything, banning taxes on Internet access contributes to worsening the digital divide by limiting public dollars to libraries, schools and community centers where many low-income people get their first exposure to the Internet.
While unfortunately Congress looks likely to extend the moratorium, the terms of the extension still matter greatly for Kentucky’s budget. One version of the extension links it with the Marketplace Fairness Act (MFA), a bill that passed the Senate in May 2013. The MFA empowers states to require Internet and catalog retailers with more than a million dollars in annual sales to collect and remit sales taxes on purchases of goods or services made remotely or online. Right now, those taxes are legally owed to states, but consumers rather than retailers are obligated to turn the revenue over if the seller doesn’t have a physical presence in a state. Many consumers don’t know that, so compliance is low.
As we’ve previously written, the MFA levels the playing field between online and bricks-and-mortar businesses and addresses the unfairness in taxation of consumers that don’t shop online, who tend to be lower-income. The MFA would result in an estimated $130 to $200 million more per year for Kentucky’s budgetary needs. The proposal that links the MFA and the ITFA also extends the moratorium on Internet access taxes only temporarily.
A second version, which recently passed the House and has been introduced in the Senate, worsens the situation by ignoring the MFA and making the moratorium permanent so that states could never collect taxes on Internet access subscriptions. The proposal also threatens other taxes that existed before the law was passed in 1998 that could be considered “indirect” taxes on Internet access—such as taxes on purchases that Internet access providers make—that had also been grandfathered in previously.
Kentucky Senators Mitch McConnell and Rand Paul both voted against the MFA last year. McConnell is also a co-sponsor of the Senate bill that would make the ban on Internet access taxes permanent.
A changing economy makes it harder for Kentucky to collect the revenue it needs to fund K-12 education, public safety, health care and other services that would move the state forward. One cause is Congress’s limits on states’ ability to keep their tax codes up to date. In the long-run, Internet access should be treated just like other telecommunications services when it comes to taxation. For now, linking the MFA to an extension of the moratorium on Internet access taxes would provide needed help to Kentucky’s budget, while turning the moratorium into a permanent ban will only it make it worse.