By Larry Jones
May 10, 2004

Ending six months of stalled negotiations, the Senate voted 93 - 3 April 29 to approve the Internet Tax Nondiscrimination Act (S.150), which would reinstate a moratorium that expired last November on state and local taxes on Internet access fees, as well as ban multiple and discriminatory taxes on electronic commerce. Although the debate got off to a shaky start with members offering unrelated amendments on the energy bill (see story on page 16), members voted to table those amendments and proceeded to considering S. 150, which was eventually adopted by an overwhelming majority.

Legislation adopted by the Senate would extend the moratorium for four years and allow state and local governments that imposed a tax on Internet access fees prior to the moratorium to continue collecting such taxes. While the bill broadens the definition of Internet access to exempt some telecommunications services from state and local taxes (such as wholesale Internet access sold between businesses), it makes clear that state and local governments may tax Voice over Internet Protocol (VoIP) or telephone calls made over the Internet. State and local officials expressed concerns that if these calls were included in the definition of exempt Internet access, it would result in significant revenue loss.

The four-year extension was offered as a compromise by Senator John McCain (AZ) after two key proposals — a permanent moratorium (the original version of S. 150) sponsored by Senators George Allen (VA) and Ron Wyden (OR) and a two-year extension (S. 2084) sponsored by Senators Lamar Alexander (TN) and Thomas Carper (DE) — fell short of generating enough support to pass on their own. The Allen-Wyden proposal, which is similar to a measure (H.R. 49) adopted by the House last year, received strong support from the telecommunications industry. In H.R. 49, the definition of Internet access is so broad that it is unclear whether state and local governments would be able to continue collecting taxes on traditional telecommunications services such as telephone and rights'of-way fees. Although the definition was modified in the Senate compromise, it would still exempt a number of telecommunications services from state and local taxes.

Concerned about the impact the original Allen-Wyden bill could have on state and local revenues, Senators Lamar Alexander (TN) and Thomas Carper (DE) offered an alternative (S. 2084) with strong backing from state and local governments. The Alexander-Carper alternative called for a two-year extension of the moratorium and a more narrow definition of Internet access. Unlike the Senate compromise, which would exempt most of the Internet network or the so called "backbone" from state and local taxes, the Alexander-Carper alternative would only exempt services involving the connection between the Internet service provider and the customer. And all forms of Internet access including telephone, cable, wireless and digital subscriber lines (DSL) would be covered by the moratorium.

Although Senators Allen, Wyden, Alexander and Carper met on numerous occasions to discuss a compromise, in the end they could not agree on the two most critical issuesÑthe length of the moratorium and the definition of Internet access. Since neither of their proposals generated enough support to pass, an overwhelming majority of Senators embraced the McCain alternative as a viable compromise. It provides for a temporary extension of the moratorium, grandfather clauses that will allow state and local governments that imposed a tax on Internet access fees before October 1, 1998 to continue collecting such taxes for four years, and the continuance of DSL tax collection for two more years.

During Senate floor considerations, Senator Diane Feinstein (CA) argued that the grandfather clauses in the McCain compromise should be the same for both Internet access and DSL. She offered an amendment to extend the two-year protection for DSL to four years, but Allen and Wyden argued against the extension that was eventually voted down by 59 - 37.

The compromise also includes the expanded definition of Internet access from the Allen-Wyden proposal, which would exempt a number of telecommunications services from state and local taxes. While the Conference and other state and local groups were not pleased with the definition, the grandfather clauses will give the 8 states (and local governments) with taxes on Internet access fees as well as the 27 states (and local governments) with taxes on DSL, time to phase out of such taxes and find new revenue streams.

Because the House and Senate have passed significantly different proposals, the leadership is now faced with the difficult task of discussing a final compromise. Under ordinary circumstances, conferees from both chambers would get together and take language from each bill to craft a final compromise that could be supported by the majority in both houses. But since the Senate failed to endorse the permanent moratorium and the expanded definition of Internet access in the House bill, it is very doubtful that the Senate will be able to agree on a compromise that moves in the direction of the House proposal. It is unclear at this time whether conferees will attempt to get together at all or if the House will be asked to consider the Senate bill as adopted. State and local groups will urge congressional leaders and members of both chambers to adopt the Senate compromise.