Six states are staring at a combined loss of nearly $1 billion in revenue in the 2021 fiscal year when they lose a grandfathered ability to tax internet service providers.
In three months, a half-dozen states will lose their authority under the 1998 Internet Tax Freedom Act (ITFA) to levy taxes on subscription fees charged by internet providers such as AT&T, Cable One, CenturyLink, Comcast and Verizon. The loss in revenue—roughly half attributable to Texas alone—comes at a moment all states face budget shortfalls, hard-hit by the coronavirus pandemic and related economic decline.
The law generally prohibits states and municipalities from taxing internet access, but a handful of “grandfathered states” were given temporary authority to administer taxes enacted before the tax freedom law. The ITFA has been controversial since its inception, as it leaves states unable to tax a primary feature of the digital economy.
The Center on Budget and Policy Priorities estimated the non-grandfathered states annually forgo more than $6.5 billion in state and local tax revenue because of the tax prohibition, and predicts this figure will “grow substantially.” While ITFA was framed as a strategy for supporting a nascent industry, that logic seems obsolete when 90% of Americans use the internet, according to the Pew Research Center.
“The internet doesn’t need protection,” said Scott Peterson, vice president of U.S. tax policy and government affairs at tax software company Avalara who also served as South Dakota’s sales tax director when the law was enacted. “There was always a question whether Congress could actually do this, but no state took the issue to court.”
Losses in the Shadow of Covid-19
Through eight congressional extensions, six states—Hawaii, New Mexico, South Dakota, Ohio, Texas, and Wisconsin—retained their taxing authorities for 22 years. The special taxing rights end for all states on July 1, leaving the grandfathered states with budget holes to fill at a time when every state is coping with significant revenue hits from the Covid-19 pandemic.
A review of state tax collection data reveals a combined loss of nearly $1 billion annually, or approximately 2% of total state sales tax collections in the six states, said Lucy Dadayan, a senior research associate with the Urban-Brookings Tax Policy Center.
“They knew this was coming,” said Dadayan. “In an ideal world, if we didn’t have the pandemic, this shouldn’t have a big impact on the states’ budgets because it’s a small share of overall taxes.”
Revenue officials in the affected states estimated annual losses of $500 million for Texas, up to $207 million for Ohio, at least $170 million for Wisconsin, $81 million for New Mexico, and $20-25 million for South Dakota. Revenue officials in Hawaii said the access tax was a smaller portion of their revenue portfolio, generating less than $1 million.
The Internet and Television Association, representing global internet providers and media companies, said the expiration “comes at a good time for consumers” forced to rely on internet access to work, learn, and communicate remotely during the public health crisis.
Going forward, the trade group said the permanent moratorium ensures consumers “are not charged unnecessary taxes on internet access that could slow adoption of broadband and prevent more consumers from experiencing all of the benefits that the internet offers.”
The ITFA has a curious history, said Richard Pomp, a law professor specializing in state and local tax issues at the University of Connecticut School of Law.
It began as a short-term moratorium on state and local taxation to promote a fledgling technology. The law had two major features, a prohibition on taxes aimed at internet access and a prohibition on discriminatory taxes targeting e-commerce such as bit taxes, bandwidth taxes or email taxes.
“The argument was that this was an infant industry that needed to be protected the way we use tariffs to protect infant industries,” Pomp said. “It was really speculation and ignorance at the time. No one really knew what the problems were going to be.”
The same arguments cropped up eight times as the tax freedom law came up for congressional renewal, Pomp said. Internet service providers lobbied Congress for extensions of the moratorium and grandfathered states lobbied for maintenance of their carve-outs. Non-grandfathered states and think tanks sought full repeal, characterizing ITFA as an unnecessary and unlawful imposition on states’ taxing authorities.
The Congressional Research Service found the moratorium raised various tax fairness questions.
The ITFA “likely improves lower income individuals’ ability to purchase internet access,” but “the blanket nature of the moratorium likely results in some economic waste,” the research service wrote in 2016. Additionally, it found the the moratorium “results in unequal application of state and local taxes to the provision of services.”
The internet companies ultimately won the day with enactment of the Trade Facilitation and Trade Enforcement Act in February 2016. That law made the moratorium permanent and created a June 30, 2020, sunset date for the grandfathered states.