The Center's work on 'Taxes and the Economy' Issues


Congress Shouldn’t Renew Internet Tax Freedom Act Unless It’s Paired With the Marketplace Fairness Act

July 21, 2014 at 2:54 pm

The Internet Tax Freedom Act’s (ITFA) ban on state and local sales taxation of monthly Internet access fees costs state and local governments about $6.5 billion annually in forgone revenue, and the states and localities currently taxing access under ITFA’s “grandfather” provision would lose at least $500 million on top of that each year if the provision expired, as I’ve recently explained.  Despite these costs, the House last week approved making ITFA permanent while letting the grandfather clause expire.  A new bipartisan Senate bill, however, would help state and local governments make up for the lost revenue.

The Senate bill would pair a 10-year ITFA extension with the Marketplace Fairness Act (MFA).  The MFA would enable states and localities to receive a substantial share of the sales tax that is legally due on purchases of goods and services from Internet and catalog merchants like Amazon and L.L. Bean but that they can’t collect from the companies.

Due to 1967 and 1992 Supreme Court decisions, a state can require out-of-state companies to charge its sales tax only if they have a physical presence in the state like a store, warehouse, or sales force.  The tax is still legally due, and consumers are supposed to pay it directly to their state, but few people do.  Those lost revenues could help pay for schools, roads, police, and other critical state and local services, and they keep sales and income tax rates higher than they’d otherwise need to be.

MFA would authorize states to require out-of-state sellers with more than $1 million in nationwide interstate sales to charge the applicable taxes — provided that states simplify their sales taxes and give merchants free software that calculates the correct tax.

This change would allow state and local governments to collect as much as $23 billion in annual revenues that they are owed under current law.  That would help them maintain and possibly reinvest in public services they cut during the recent recession.  It would also help offset states’ and localities’ ITFA-related $7 billion revenue loss — lost dollars that will grow as more people subscribe to Internet service; others trade-up to faster, and therefore more expensive, service; and others cancel their taxable landline telephones and cable TV in favor of Internet-based alternatives like Skype and Netflix.

MFA’s long-overdue enactment would also:

  • Create a more level playing field for local store-based retailers.  Because combined state and local sales tax rates typically range between 5 and 10 percent, Internet retailers that don’t collect sales taxes outside their home states start out with a price advantage over their local competitors.  This makes it harder for Main Street merchants to create local jobs.  It also has a ripple effect on local economies, as depressed sales at the neighborhood book or musical instrument shop lead to fewer purchases by their owners and employees at the farmers’ market and dry cleaner. 
  • End the unfair sales tax treatment of consumers who don’t shop online.  Low-income people who lack the computers, Internet access, or credit cards needed to shop online pay more than their fair share of sales taxes because online shoppers can avoid these taxes. 

These are worthy goals, and Congress should have passed the MFA long ago to achieve them.  But if lawmakers decide to extend ITFA, it’s even more urgent that they also enact MFA.  Congress should not extend the moratorium without also enacting MFA.

Busting Three Myths About the Internet Tax Freedom Act’s “Grandfather Clause”

July 18, 2014 at 4:08 pm

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.

Finally, Signs of Momentum on Corporate Inversions

July 17, 2014 at 4:26 pm

First it was Pfizer.  Now it’s Walgreens.  These and a growing list of companies have made headlines as they consider shifting their headquarters overseas — so-called corporate “inversions” — so they can avoid paying taxes on past and future profits.  In reality, these companies are not going anywhere.  They will still rely on U.S. infrastructure and scientific research and our educated workforce.  They just don’t want to help pay for it.

These headlines beg for a swift policy response.  Reps. Sander Levin (D-MI), the top Democrat on the House Ways and Means Committee, and Chris Van Hollen (D-MD), the top Democrat on the House Budget Committee, have advanced a House proposal that would make it harder for U.S. companies to expatriate to avoid U.S tax and, consequently, save $19.5 billion over ten years.

There are now fresh signs of momentum as key players hint that they want to try to act quickly.  Specifically, Treasury Secretary Jacob Lew, in a letter to Senate Finance Committee Chairman Ron Wyden (D-OR), called for a “new sense of economic patriotism” and said “we should not be providing support for corporations that seek to shift their profits overseas to avoid paying their fair share of taxes.”  He called on Chairman Wyden to pursue anti-inversion legislation.  Chairman Wyden quickly signaled support for near-term action, as did Senate Majority Leader Harry Reid (D-NV).

Secretary Lew’s call for a new patriotism isn’t new.  In 2004, Congress took swift bipartisan action in response to a spate of corporate inversions. Then-Finance Committee Chairman Chuck Grassley (R-IA) and his committee issued a press release describing Congress’ legislative action:

‘This will hit the unpatriotic companies that dash and stash their cash,’ Grassley said. . . .

‘I still remember my disgust when I watched a video of an accounting firm partner hawking corporate expatriation as a ‘mega trend hot topic’ because of depressed stock prices [after the events of September 11, 2001],’ Grassley said. 

As the current uptick in inversions shows, corporate tax lawyers have found ways around the 2004 anti-inversion provisions.  Policymakers should approve legislation that strengthens the bipartisan response from a decade ago — and soon.  Waiting for corporate or international tax reform will only invite more tax avoidance-driven corporate exits.

Don’t Believe the Hype: Permanent “Bonus Depreciation” Not a Positive Step Toward Tax Reform

July 15, 2014 at 9:23 am

The House has voted to convert “bonus depreciation” — a large, temporary tax break that policymakers adopted during the recession that lets businesses take bigger upfront tax deductions for certain purchases such as machinery and equipment — into a permanent feature of the tax code at very substantial cost.  The Senate should not go along for two fundamental reasons.

First, as we have explained in a previous paper, permanent bonus depreciation is fiscally irresponsible — costing $276 billion over ten years, according to the Joint Tax Committee — and delivers relatively little economic benefit, even as a temporary measure.

Second, and our focus here: despite what some conservative champions suggest, permanent bonus depreciation would not represent a positive step toward tax reform.

Several conservative groups — including Americans for Prosperity and Americans for Tax Reform — claimed in a letter to lawmakers that “making bonus depreciation permanent would be a massive victory in the cause of tax reform.”  That’s because, they wrote, “[f]ull expensing, a dream of tax reformers going back to the original supply siders, would be within reach.”  Full expensing would enable businesses to deduct the full cost of these purchases in the year of purchase.

Supply-side dreaming should indeed be a wake-up call to Congress, for it suggests that bonus depreciation — or, full expensing — would come wrapped in a package with a host of other questionable items.

Americans for Prosperity, for instance, outlined a tax reform plan that not only embraced full expensing but also included:

  • Cutting the tax rate on corporations’ foreign profits essentially to zero; 
  • Repealing the estate tax; 
  • Eliminating all limits on contributions to retirement accounts, which would primarily benefit very affluent individuals; and 
  • Slashing the top income tax rate.  (Americans for Prosperity cited House Budget Committee Chairman Paul Ryan’s proposal to cut the top rate from 39.6 percent to 25 percent and Senator Rand Paul’s proposal to replace all tax brackets with a flat 17 percent rate.) 

These priorities have two common elements:  a very large drain on federal revenues and a very large tilt toward the nation’s wealthiest individuals.  This tax reform dream would be injurious to working and middle-class Americans, who would have to pay higher taxes to help make up for the massive revenue losses, face deep cuts in key programs — likely including programs such as Medicare — to accommodate the large revenue losses, or both.

Congress should make sure this doesn’t become a reality.  The Senate can start by declining to go along with the House’s irresponsible action on bonus depreciation.

Mazerov on the Risks of Permanently Banning Sales Taxes on Internet Access Charges

July 14, 2014 at 4:04 pm

Writing today in The Hill, I explain why policymakers should reject an effort to permanently bar states from applying their normal sales taxes to the monthly charges that households and businesses pay for Internet access.  Such a permanent ban, which the House is expected to consider this week, could cost states roughly $7 billion a year in potential revenue.

Here’s an excerpt:

For starters, the bill would strip Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin of at least $500 million in annual state and local revenue from their existing taxes on these charges.

Beyond costing states the $7 billion a year in potential revenue to support education, healthcare, roads, and other services, the bill would violate an understanding between Congress and the states dating back to the 1998 Internet Tax Freedom Act (ITFA):  that any ban on applying sales taxes to Internet access charges would be temporary and not apply to existing access taxes.

Enacted when Internet commerce was still in its infancy, ITFA sought to balance Congress’ desire to encourage development of the Internet against states’ and localities’ need to finance essential services.  Thus, it imposed only a temporary “moratorium” on new taxes on Internet access and protected existing taxes through a “grandfather” clause.

Congressional extensions of ITFA in 2001, 2004, and 2007 maintained those two key features.  This latest ITFA legislation, though, eliminates both — the first time Congress has seriously considered doing so.

Congress should end, not extend, the ban on state and local taxation of Internet access, as I explained in our recent paper.  As I point out in The Hill:

The Internet is no longer an infant industry needing protection from taxes that apply to other services for which Internet access is a close substitute.  Cable television service is widely taxed, for example, but if someone decides to pay Verizon $50 a month so that they can stream Netflix to their TV, ITFA bans the taxation of the access charge.  This unequal treatment doesn’t makes sense.

Read the full op-ed here.