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Declan McCullagh

Staff Writer, CNET

An influential congressional committee has dropped a political bombshell by suggesting that a tax originally created to pay for the Spanish American War could be extended to all Internet and data connections this year.

The committee, deeply involved in writing U.S. tax laws, unexpectedly said in a report Thursday that the 3 percent telecommunications tax could be revised to cover “all data communications services to end users,” including broadband; dial-up; fiber; cable modems; cellular; and DSL, or digital subscriber line, links.

Currently, the 3 percent excise tax applies only to traditional telephone service. But because of technological convergence and the dropping popularity of landlines, the Joint Committee on Taxation concluded in its review of tax law reforms that it might make sense to extend the 100-year old levy to new technologies. The committee did not take a position on whether Congress should approve such an extension and simply listed it as an “option.”

“We need to avoid starting down a path of overtaxing nascent forms of communication.”

–Jonathan Zuck, president, Association for Competitive Technology

“Cellular phones are being manufactured that may operate using VoIP through Wi-Fi access, as well as through more traditional means,” the tax committee’s report says. “As voice phone service migrates to using Internet Protocol, there may be no way to distinguish ‘packets’ of voice and ‘packets’ of data.” VoIP refers to voice over Internet Protocol, or making telephone calls through a broadband connection.

The congressional report comes not long after the Internal Revenue Service and Treasury Department said they were considering how the Spanish American War tax should be reinterpreted “to reflect changes in technology” used in “telephonic or telephonic quality communications.” Tech companies including Microsoft, Intel and Skype slammed that idea in a September letter, asking the IRS to “refrain from any attempt to extend the excise tax to VoIP services.”

The discussion in the tax committee’s report, however, ventures far beyond VoIP. “Extending the tax to all communications requires taxing Internet access, bandwidth capacity, and the transmission of cable and satellite television,” it says.

Technology trade associations were instantly critical. “We need to be careful in trying to stretch a taxation system this old to be a catchall for all modern technology,” said Jonathan Zuck, president of the Association for Competitive Technology. “We need to avoid starting down a path of overtaxing nascent forms of communication.”

Congress enacted the so-called “luxury” excise tax at 1 cent a phone call to pay for the Spanish American War back in 1898, when only a few thousand phone lines existed in the country. It was repealed in 1902, but was reimposed at 1 cent a call in 1914 to pay for World War I and eventually became permanent at a rate of 3 percent in 1990.

Thursday’s report, titled “Options to Improve Tax Compliance and Reform Tax Expenditures,” is a broad review of tax law and proposes a number of ways–such as reforming the taxation of overseas corporations–to boost the federal government’s bottom line by up to about $400 billion over the next decade.

It lists three different telecommunications tax options, one of which would cover all data communications. A second choice would extend the excise tax to cell phones and perhaps VoIP. The third would clearly levy the charge on VoIP, including Internet-only phone calls using services such as Skype that do not touch the public telephone network. “It is not necessary that the voice communications service provide” that capability, the report says.

James Maule, who teaches tax law at Villanova University and edits a related blog, said the more extreme taxation option may be a way for committee members to make the others “look a bit more palatable. There’s some psychology going on.”

“The odds of something happening in 2005 that amends the tax law is extremely high,” Maule said, referring to President Bush’s promise to revise the tax code. “I suspect that (one of these options) is going to be tacked on.”

A few years ago, the U.S. House of Representatives voted overwhelmingly to repeal the excise tax, but the Senate never acted on the measure.

Members of the Joint Committee on Taxation include Sens. Charles Grassley, R-Iowa; Orrin Hatch, R-Utah; Max Baucus, D-Mont.; John Rockefeller, D-W.Va.; and representatives Bill Thomas, R-Calif.; and Charles Rangel, D-N.Y.