Permanent Internet Tax Freedom

by Tom Yamachika, President, Tax Foundation Hawaii

Since 1998, a federal law called the Internet Tax Freedom Act has blocked many States from taxing Internet access. In Hawaii, however, the law has been a non-event because the Act has a grandfather clause allowing any State that taxed Internet access at the time the Act was passed to continue doing so. Hawaii was one of fifteen states that were grandfathered.

Lately, this Act has been in the news because a deal has been reached in Congress to make the Act permanent, and to remove the grandfather clause starting in 2020. Although some of the original fifteen States that were allowed to tax the Internet decided to quit doing so on their own, Hawaii is one of the seven holdouts. Thus we will be impacted when the grandfather clause expires. According to the Washington-based Center for Budget and Policy Priorities, Hawaii stands to lose about $20 million a year from the ban, without considering the Honolulu surcharge (which would probably be another $2 million or so).

Amazingly, our Department of Taxation seems to be in denial over this development. The Department’s spokesperson recently told watchdog.org: “Generally, the companies that provide internet access would be subject to Hawaii’s Public Service Company tax, which is paid in lieu of, among other taxes, our general excise and real property tax and which could be preempted under the federal ban.” Although the Department has not done a full legal review and analysis on this issue, she suggested that Hawaii’s general excise tax might be considered an exception to the ban and “possibly could survive a preemption challenge” by the federal government. “However, to be safe, we would prefer to have the grandfather clause remain in place,” she said.

Wait a minute. The federal law actually says, “No State or political subdivision thereof may impose any of the following taxes ... (1) Taxes on Internet access. (2) Multiple or discriminatory taxes on electronic commerce.”

The State attempted to avoid a federal ban thirty years ago and lost. Federal law prohibited taxes on the gross receipts of airlines, but it did permit property taxes. We had been applying our Public Service Company Tax at 5.885% of passenger ticket fares and cargo charges, and we said it was a property tax, but measured as a percentage of gross receipts. The Supreme Court in a unanimous decision, Aloha Airlines v. Director of Taxation, 464 U.S. 7 (1983), basically said, “A tax measured by gross receipts is a gross receipts tax. We don’t care what you call it.”

Here, the federal law prohibits “taxes on Internet access.” It doesn’t say that certain kinds of taxes are prohibited, it says that taxes are prohibited. We can’t even pretend to qualify for the dodge that we tried to use with the airline tax ban, and the Supreme Court soundly squashed that argument anyway. Whichever tax now applies to Internet service, be it the Public Service Company Tax or the GET, is without question a tax. What could our bureaucrats be thinking? God help us if they try to say it can be imposed because it’s a user fee or some kind of regulatory assessment.

Instead of tilting at this windmill, the Department could be helpful. It could at least round up some information on what services are taxed and what aren’t. Before 2020, we would want to see meaningful conversations between the Department and the Internet service provider (ISP) industry, followed shortly by good, solid, substantive guidance that tells the industry what activities are subject to tax and what activities aren’t. Wrangling with Uncle Sam or the ISP’s about whether the ban applies seems doomed to failure and is certain to cost a lot to fight. Let’s deal with it in a more constructive way.