Is it Time to Tax the Internet?

There is a law advancing in the Maryland legislature that would tax Internet advertising. The law, if enacted would collect taxes from online advertising done by Google, Facebook, and others. The tax would immediately be challenged in court due to our history of not taxing things related to the Internet.

The idea of not taxing the Internet began with the Internet Tax Freedom Act in 1998. That law grandfathered taxes imposed in 13 states on Internet access but prohibited it elsewhere. The law also prohibited local governments from imposing taxes on electronic commerce. The law imposed a 3-year moratorium on such taxes and was extended eight times until the tax prohibition was made permanent in the Trade Facilitation and Trade Enforcement Act in 2015.

There are other precedents for not taxing electronics commerce. For example, the Supreme Court ruled in 1967 that requiring remote vendors to collect sales taxes would impose an undue constraint on interstate commerce. The prohibition against sales taxes for out-of-state sellers was strengthened in 1992 in the Supreme Court’s ruling in Quill Corporation v. North Dakota that prohibited a state from collecting sales taxes unless a business has a physical presence in a state. These prohibitions were assumed to also apply to sales made over the Internet if the seller lived in a different state than the buyer.

However, such rulings change over time and the Supreme Court reversed the older decisions in 2018 in the case of South Dakota v Wayfair, Inc. The Court effectively ruled that states can require remote sellers of any kind, including online sellers to collect state sales taxes. Since that ruling, many states have imposed sales taxes on Internet sales.

Opponents of the tax on advertising say that the proposed law would violate the intent of the Internet Freedom Act to not tax electronic commerce. The application of a tax to advertising is different enough from a sales tax that the Supreme Court ruling won’t automatically apply. If the law is passed it will likely have to go to the Supreme Court. To a non-lawyer like me, it seems the issue is similar enough to sales taxes that there is a good chance that at tax on advertising would be allowed. Even if it allowed, such a tax has the significant challenge of identifying the advertising revenue that applies to a given state. For example, what portion of nationwide advertising for Ford trucks would apply to Maryland?

The Maryland law does freshly raise the question of whether it’s time to tax the Internet. The original Internet Tax Freedom Act was an attempt by Congress to protect the fledgling broadband business. It’s debatable if the growth of the Internet would have been slowed had there been a few dollars of taxes applied to broadband bills like were applied to landline telephone bills. But the new Internet companies were the darlings of Wall Street, and Congress decided to keep broadband products free from taxation.

The broadband tax that’s most needed is a surcharge on broadband to help fund the FCC’s Universal Service Fund. Many states also have similar funds. The USF is currently being funded by fees charged to landlines and cellphones. The purpose of the fund is currently to promote broadband for places that don’t have it. The fund will be paying for the $20.4 billion RDOF grants for rural broadband and the $9 billion 5G Fund grants to improve rural cellular coverage. It’s silly that we aren’t charging a small fee onbroadband users to help pay for rural broadband – everybody in the country benefits when there is broadband everywhere. I can’t fathom a justification for having landlines users pay for rural broadband but not broadband customers.

Congress is often mystifying. I can understand the initial ban against Internet taxes, although I don’t believe such taxes would have hampered the explosive growth of broadband. But I can’t think of any justification in 2015 for making the ban on Internet taxes permanent. Considering the huge problems that lack of rural broadband just caused during the COVID-19 crisis, there is no justification for not increasing the funding for the Universal Service Fund, and the easiest way to do so is to tax broadband customers.