In 1997, senators warned that letting state and local governments tax the internet would be like having “30,000 different pairs of hands reaching into” the pockets of every American who tried to do business online. Congress passed the Internet Tax Freedom Act (ITFA) in bipartisan fashion the next year, extended it several times, and made it permanent in 2016 with little opposition. The logic was clear: a patchwork of internet taxes would strangle a technology that had enormous promise. That logic has not changed, but the political coalition that once enforced it is showing serious cracks.
ITFA, codified at 47 U.S.C. § 151 (note), sought to resolve several important issues. At its core, ITFA prevents state and local governments from adding new taxes on internet access or any taxes that discriminate against electronic commerce. NTU and NTUF were early champions of the reform. The late John Berthoud, who served as president of both organizations, argued that the law would give “a fair shake for all businesses, whether they’re located on Main Street or Cyber Street.” Tax neutrality is another major concern: taxing digital transactions differently from their analog equivalents distorts markets without correcting any market failure. With sound tax policy principles guiding the way, a lasting bipartisan consensus developed to protect taxpayers using new technologies.
ITFA has been a success: the internet changed from a tool for shopping and letter writing to a major source of socialization and job opportunities. The internet is now available on demand at all times through cell phones and other devices.
That consensus behind the principles-based ITFA reform is now fraying. Legislators at both the state and federal levels are concocting new ways to single out internet-based activity for special taxes, both to punish unwanted behavior as covert “sin taxes” and to boost government revenues that can no longer keep pace with spending increases. Proposals include taxes on digital advertising, video streaming, online prediction markets, and more. Some of these ideas have actually passed legislatures, as with Maryland’s digital advertising tax and a slate of new taxes in Illinois targeting online activity.
These policies not only introduce complexity and economic distortion—the exact issues that ITFA sought to preempt—but also face legal challenges. Legal scholars have flagged that Maryland’s digital advertising tax violates ITFA, and five years and counting of litigation have followed. The economic costs fell not on the large platforms the law targeted, but ultimately on average consumers. Taxes that target transaction volume, such as Illinois’s cryptocurrency transaction and prediction market taxes, will be incredibly cumbersome to calculate. Chicago is also proving to be an example of online taxes becoming distortionary, having raised its streaming tax to 10.25% alongside a new Social Media Amusement Tax on consumer data. As NTUF has documented, Chicago now taxes a Netflix subscription at more than six times the rate of a DVD rental.
The newest version of this impulse is a tax on compute, which is a direct levy on the processing power behind artificial intelligence training, web browsing, and virtually all other online activities. Proponents offer two justifications: to slow the spread of AI, and to fund compensation for displaced workers. Neither survives scrutiny.
Taxing compute is the equivalent of taxing steel during the Industrial Revolution: it does not deter downstream displacement, it simply relocates it, slows productivity gains, and encourages research in other jurisdictions (like China) that face no such constraint.
ITFA establishes a broad prohibition on taxing the internet, and deliberately so: the complexity and neutrality concerns that motivated it apply as much today as they did in 1997. What the law attempts to discourage is discrimination: singling out digital channels for treatment that is not imposed on real-world equivalents. The current wave of proposals to tax online activity clearly violates the law as it is written.
The targets are bigger now and the political arguments more sophisticated, but neither changes the underlying economics or logic, and neither justifies what amounts to a quiet unraveling of a quarter-century of bipartisan consensus.