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Busting Three Myths About the Internet Tax Freedom Act's 'Grandfather Clause'

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The Senate next week will likely consider its version of a bill to renew the Internet Tax Freedom Act (ITFA), a federal law prohibiting state and local governments from taxing the monthly Internet access subscription fee that households and businesses pay. The House voted earlier this week to make ITFA, which is due to expire on November 1, permanent.

ITFA was enacted in 1998 with strong bipartisan support, and it has always included a "grandfather clause" that allowed states and localities that were taxing Internet access to keep doing so. Despite its long history, there's widespread misunderstanding about the grandfather clause in the current debate about renewing ITFA. Here are the facts behind three widespread myths about that clause:

Myth: The House and Senate bills that would make ITFA permanent preserve the grandfather clause.

Fact: The House-approved bill and its Senate analog both effectively eliminate the grandfather clause. There has been confusion about this because both bills strike ITFA's November 1, 2014 expiration date with no mention of the grandfather clause. But the current law terminates the grandfather clause as of November 1, 2014, meaning that it expires as of that date unless policymakers explicitly extend it. Neither the House nor Senate bill does so.

Myth: Eliminating the grandfather clause would affect the revenues of only seven states that directly tax Internet access service.

Fact: Virtually every state, and thousands of local governments, would be at risk of losing revenue if the grandfather clause expires -- dollars they use to pay teachers and police, provide financial aid to state university students, repair roads, and provide many other critical services. That's because the clause not only preserves the pre-1998 direct taxes on Internet access service of Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin, it also preserves all pre-1998 taxes that could be considered indirect taxes on Internet access. That would include, for example, state and local taxes that Internet access providers pay on the things they buy in order to provide Internet service, such as computer servers, fiber-optic cable, or even gasoline for their vehicles. Almost all of these taxes existed before 1998, so the grandfather clause protects them from legal challenge. But if Congress eliminates the clause, Internet access providers could challenge these taxes in court as indirect taxes on Internet access service and therefore voided by ITFA. (For more on this issue, see pages 8-10 of my recent analysis.)

Myth: The grandfather clause was intended to give states time to phase out Internet access taxes, which they've had ample time to do.

Fact: The original 1998 committee reports on ITFA don't back up this claim. Such a rationale wouldn't have made sense anyway, because ITFA itself was supposed to be temporary. As the 1998 Senate Commerce Committee report said, ITFA was intended to be "a temporary moratorium on Internet-specific taxes [that] is necessary to facilitate the development of a fair and uniform taxing scheme." Lawmakers included the grandfather clause to protect the interests of states and localities that had already come to rely on Internet access tax revenues to fund services. If Congress had wanted to push the states taxing Internet access to phase out those taxes, it could have had the grandfather clause expire sooner than the overall moratorium in the original 1998 legislation or in any of the three subsequent renewals, but it didn't.

The facts make the case: If Congress extends ITFA, no matter for how long, the law must continue to include the grandfather clause.

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