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Report to Congressional Committees:
January 2006:
Internet Access Tax Moratorium:
Revenue Impacts Will Vary by State:
GAO-06-273:
GAO Highlights:
Highlights of GAO-06-273, a report to congressional committees:
Why GAO Did This Study:
According to one report, at the end of 2004, some 70 million U.S.
adults logged on to access the Internet during a typical day. As public
use of the Internet grew from the mid-1990s onward, Internet access
became a potential target for state and local taxation.
In 1998, Congress imposed a moratorium temporarily preventing state and
local governments from imposing new taxes on Internet access. Existing
state and local taxes were grandfathered. In amending the moratorium in
2004, Congress required GAO to study its impact on state and local
government revenues. This report’s objectives are to determine the
scope of the moratorium and its impact, if any, on state and local
revenues.
For this report, GAO reviewed the moratorium’s language, its
legislative history, and associated legal issues; examined studies of
revenue impact; interviewed people knowledgeable about access services;
and collected information about eight case study states not intended to
be representative of other states. GAO chose the states considering
such factors as whether they had taxes grandfathered for different
forms of access services and covered different urban and rural parts of
the country.
What GAO Found:
The Internet tax moratorium bars taxes on Internet access services
provided to end users. GAO’s interpretation of the law is that the bar
on taxes includes whatever an access provider reasonably bundles to
consumers, including e-mail and digital subscriber line (DSL) services.
The moratorium does not bar taxes on acquired services, such as high-
speed communications capacity over fiber, acquired by Internet service
providers (ISP) and used to deliver Internet access. However, some
states and providers have construed the moratorium as barring taxation
of acquired services. Some officials told us their states would stop
collecting such taxes as early as November 1, 2005, the date they
assumed that taxes on acquired services would lose their grandfathered
protection. According to GAO’s reading of the law, these taxes are not
barred since a tax on acquired services is not a tax on Internet
access. In comments, telecommunications industry officials continued to
view acquired services as subject to the moratorium and exempt from
taxation. As noted above, GAO disagrees. In addition, Federation of Tax
Administrators officials expressed concern that some might have a
broader view of what could be included in Internet access bundles.
However, GAO’s view is that what is included must be reasonably related
to providing Internet access.
The revenue impact of eliminating grandfathering in states studied by
the Congressional Budget Office (CBO) would be small, but the
moratorium’s total revenue impact has been unclear and any future
impact would vary by state. In 2003, when CBO reported how much states
and localities would lose annually by 2007 if certain grandfathered
taxes were eliminated, its estimate for states with grandfathered taxes
in 1998 was about 0.1 percent of those states’ 2004 tax revenues.
Because it is hard to know what states would have done to tax access
services if no moratorium had existed, the total revenue implications
of the moratorium are unclear. In general, any future moratorium-
related impact will differ by state. Tax law details and tax rates
varied among states. For instance, North Dakota taxed access service
delivered to retail consumers, and Kansas taxed communications services
acquired by ISPs to support their customers.
Simplified Model of Tax Status of Services Related to Internet Access:
[See PDF for image]
[A] Depends on state law.
[End of figure]
What GAO Recommends:
GAO is not making any recommendations in this report.
www.gao.gov/cgi-bin/getrpt?GAO-06-273.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact James R. White at (202)
512-9110 or whitej@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Objectives, Scope, and Methodology:
Internet Access Services, Including Bundled Access Services, May Not Be
Taxed, but Acquired Services May Be:
While the Revenue Impact of Eliminating Grandfathering Would Be Small,
the Moratorium's Total Revenue Impact Has Been Unclear and Any Future
Impact Would Vary by State:
External Comments:
Appendixes:
Appendix I: Bundled Access Services May Not Be Taxed, but Acquired
Services Are Taxable:
Bundled Services, Including Broadband Services, May Not Be Taxed:
Acquired Services May Be Taxed:
Appendix II: CBO's Methodology for Estimating Costs Relating to Taxing
Internet Access Services:
Appendix III: Case Study States' Taxation of Services Related to
Internet Access:
California:
Kansas:
Mississippi:
North Dakota:
Ohio:
Rhode Island:
Texas:
Virginia:
Appendix IV: Comments from Telecommunications Industry Officials:
Appendix V: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Summary of Case Study State Rough Estimates of 2004 Tax
Revenue from Acquired Services:
Table 2: Case Study State Officials' Rough Estimates of Taxes Collected
for 2004 Related to Internet Access:
Table 3: Characteristics Showing Variations among Case Study States:
Table 4: Characteristics of Case Study States:
Figures:
Figure 1: Hypothetical Internet Backbone Networks with Connections to
End Users:
Figure 2: Simplified Illustration of Services Purchased by Consumers:
Figure 3: Simplified Model of Tax Status of Services Related to
Internet Access:
Abbreviations:
AOL: America Online:
CBO: Congressional Budget Office:
DSL: digital subscriber line:
FTA: Federation of Tax Administrators:
ISP: Internet service provider:
POP: point of presence:
POTS: plain old telephone service:
VoIP: Voice over Internet Protocol:
Letter January 23, 2006:
The Honorable Ted Stevens:
Chairman:
The Honorable Daniel K. Inouye:
Co-Chairman:
Committee on Commerce, Science and Transportation:
United States Senate:
The Honorable Joe Barton:
Chairman:
The Honorable John D. Dingell:
Ranking Minority Member:
Committee on Energy and Commerce:
House of Representatives:
According to one study, at the end of 2004 some 70 million U.S. adults
logged on to the Internet during a typical day.[Footnote 1] As Internet
usage grew from the mid-1990s onward, state and local governments
imposed some taxes on it and considered more. Concerned about the
impact of such taxes, Congress extensively debated whether state and
local governments should be allowed to tax Internet access. The debate
resulted in legislation setting national policy on state and local
taxation of access.
In 1998, Congress enacted the Internet Tax Freedom Act,[Footnote 2]
which imposed a moratorium temporarily preventing state and local
governments from imposing new taxes on Internet access or multiple or
discriminatory taxes on electronic commerce. Existing state and local
taxes were "grandfathered," allowing them to continue to be collected.
Since its enactment, the moratorium has been amended twice, most
recently in 2004, when Congress included language requiring that we
study the impact of the moratorium on state and local government
revenues and on the deployment and adoption of broadband
technologies.[Footnote 3] Such technologies permit communications over
high-speed, high-capacity media, such as that provided by cable modem
service or by a telephone technology known as digital subscriber line
(DSL).[Footnote 4]
This report focuses on the moratorium's impact on state and local
government revenues. Its objectives are to determine (1) the scope of
the moratorium and (2) the impact of the moratorium, if any, on state
and local revenues. In determining any impact on revenues, the report
explores what would happen if grandfathering of access taxes on dial-up
and DSL services were eliminated, what might have happened in the
absence of the moratorium, and how the impact of the moratorium might
differ from state to state. This report does not focus on taxing the
sale of items over the Internet. A future report will discuss the
impact that various factors, including taxes, have on broadband
deployment and adoption.
To prepare this report, we reviewed the language of the moratorium, its
legislative history, and associated legal issues; examined studies of
revenue impact done by the Congressional Budget Office (CBO) and
others; interviewed representatives of companies and associations
involved with Internet access services; and collected information
through case studies of eight states. We chose the states to get a
mixture of those that did or did not have taxes grandfathered for
different forms of access services, did or did not have local
jurisdictions that taxed access services, had high and low state tax
revenue dollars per household and business entity with Internet
presence, had high and low percentages of households online, and
covered different urban and rural parts of the country. We did not
intend the eight states to represent any other states. In the course of
our case studies, state officials told us how they made the estimates
they gave us of tax revenues collected related to Internet access and
how firm these estimates were. We could not verify the estimates, and,
in doing its study, CBO supplemented estimates that it received from
states with CBO-generated information. Nevertheless, based on other
information we obtained, the state estimates we received appeared to
provide a sense of the order of magnitude of the dollars involved. We
did our work from February through December 2005 in accordance with
generally accepted government auditing standards. A later section of
this report contains a complete discussion of our objectives, scope,
and methodology.
Results in Brief:
The Internet tax moratorium bars taxes on Internet access, meaning
taxes on the service of providing Internet access. In this way, it
prevents services that are reasonably bundled as part of an Internet
access package, such as electronic mail and instant messaging, from
being subject to taxes when sold to end users. These tax-exempt
services also include DSL services bundled as part of an Internet
access package. Some states and providers have construed the moratorium
as also barring taxation of what we call acquired services, such as
high-speed communications capacity over fiber, acquired by Internet
service providers and used by them to deliver access to the Internet to
their customers. Because they believed that taxes on acquired services
are prohibited by the 2004 amendments, some state officials told us
their states would stop collecting them as early as November 1, 2005,
the date they assumed that taxes on acquired services would lose their
grandfathered protection. However, according to our reading of the law,
the moratorium does not apply to acquired services since, among other
things, a tax on acquired services is not a tax on "Internet access."
Nontaxable "Internet access" is defined in the law as the service of
providing Internet access to an end user; it does not extend to a
provider's acquisition of capacity to provide such service. Purchases
of acquired services are subject to taxation, depending on state law.
The revenue impact of eliminating grandfathering in states studied by
CBO would be small, but the moratorium's total revenue impact has been
unclear and any future impact would vary by state. In 2003, CBO
reported that states and localities would lose from more than $160
million to more than $200 million annually by 2008 if all grandfathered
taxes on dial-up and DSL services were eliminated, although part of
this loss reflected acquired services. It also identified other
potential revenue losses, although unquantified, that could have grown
in the future but that now seem to pose less of a threat. CBO's
estimated annual losses by 2007 for states that had grandfathered taxes
in 1998 were about 0.1 percent of the total 2004 tax revenues for those
states. Because it is difficult to know what states would have done to
tax Internet access services if no moratorium had existed, the total
revenue implications of the moratorium are unclear. The 1998 moratorium
was considered before connections to the Internet were as widespread as
they later became, limiting the window of opportunity for states to
adopt new taxes on access services. Although some states had already
chosen not to tax access services and others stopped taxing them, other
states might have been inclined to tax access services if no moratorium
were in place. In general, any future impact related to the moratorium
will differ from state to state. The details of state tax law as well
as applicable tax rates varied from one state to another. For instance,
North Dakota taxed access service delivered to retail consumers. Kansas
taxed communications services acquired by Internet service providers to
support their customers. Rhode Island taxed both access service
offerings and the acquisition of communications services. California
officials said their state did not tax these areas at all.
We are not making any recommendations in this report.
In oral comments on a draft of this report, CBO staff members said we
fairly characterized CBO information and suggested clarifications that
we have made as appropriate. Federation of Tax Administrators (FTA)
officials said that our legal conclusion was clearly stated and, if
adopted, would be helpful in clarifying which Internet access-related
services are taxable and which are not. However, they expressed concern
that the statute could be interpreted differently regarding what might
be reasonably bundled in providing Internet access to consumers. A
broader view of what could be included in Internet access bundles would
result in potential revenue losses much greater than we indicated.
However, as explained in appendix I, we believe that what is bundled
must be reasonably related to accessing and using the Internet. In
written comments, which are reprinted in appendix IV, company
representatives commented that the 2004 amendments make acquired
services subject to the moratorium and therefore not taxable, and that
the language of the statute and the legislative history support this
position. While we acknowledge that there are different views about the
scope of the moratorium, our view is based on the language and
structure of the statute.
Background:
As shown in figure 1, residential and small business users often
connect to an Internet service provider (ISP) to access the Internet.
Well-known ISPs include America Online (AOL) and Comcast. Typically,
ISPs market a package of services that provide homes and businesses
with a pathway, or "on-ramp," to the Internet along with services such
as e-mail and instant messaging. The ISP sends the user's Internet
traffic forward to a backbone network where the traffic can be
connected to other backbone networks and carried over long distances.
By contrast, large businesses often maintain their own internal
networks and may buy capacity from access providers that connect their
networks directly to an Internet backbone network. We are using the
term access providers to include ISPs as well as providers who sell
access to large businesses and other users. Nonlocal traffic from both
large businesses and ISPs connects to a backbone provider's network at
a "point of presence" (POP). Figure 1 depicts two hypothetical and
simplified Internet backbone networks that link at interconnection
points and take traffic to and from residential units through ISPs and
directly from large business users.
Figure 1: Hypothetical Internet Backbone Networks with Connections to
End Users:
[See PDF for image]
[End of figure]
As public use of the Internet grew from the mid-1990s onward, Internet
access and electronic commerce became potential targets for state and
local taxation. Ideas for taxation ranged from those that merely
extended existing sales or gross receipts taxes to so-called "bit
taxes," which would measure Internet usage and tax in proportion to
use. Some state and local governments raised additional tax revenues
and applied existing taxes to Internet transactions. Owing to the
Internet's inherently interstate nature and to issues related to taxing
Internet-related activities, concern arose in Congress as to what
impact state and local taxation might have on the Internet's growth,
and thus, on electronic commerce. Congress addressed this concern when,
in 1998, it adopted the Internet Tax Freedom Act, which bars state and
local taxes on Internet access, as well as multiple or discriminatory
taxes on electronic commerce.[Footnote 5]
Internet usage grew rapidly in the years following 1998, and the
technology to access the Internet changed markedly. Today a significant
portion of users, including home users, access the Internet over
broadband communications services using cable modem, DSL, or wireless
technologies. Fewer and fewer users rely on dial-up connections through
which they connect to their ISP by dialing a telephone number. By 2004,
some state tax authorities were taxing DSL service, which they
considered to be a telecommunications service, creating a distinction
between DSL and services offered through other technologies, such as
cable modem, that were not taxed.
Originally designed to postpone the addition of any new taxes while the
Advisory Commission on Electronic Commerce studied the tax issue and
reported to Congress, the moratorium was extended in 2001 for 2
years[Footnote 6] and again in 2004, retroactively, to remain in force
until November 1, 2007.[Footnote 7] The 2001 extension made no other
changes to the original act, but the 2004 act included clarifying
amendments. The 2004 act amended language that had exempted
telecommunications services from the moratorium. Recognizing state and
local concerns about their ability to tax voice services provided over
the Internet, it also contained language allowing taxation of telephone
service using Voice over Internet Protocol (VoIP). Although the 2004
amendments extended grandfathered protection generally to November
2007, grandfathering extended only to November 2005 for taxes subject
to the new moratorium but not to the original moratorium.
Objectives, Scope, and Methodology:
To determine the scope of the Internet tax moratorium, we reviewed the
language of the moratorium, the legislative history of the 1998 act and
the 2004 amendments, and associated legal issues.
To determine the impact of the moratorium on state and local revenues,
we worked in stages. First, we reviewed studies of revenue impact done
by CBO, FTA, and the staff of the Multistate Tax Commission and
discussed relevant issues with federal representatives, state and local
government and industry associations, and companies providing Internet
access services. Then, we used structured interviews to do case studies
in eight states that we chose as described earlier. We did not intend
the eight states to represent any other states.
For each selected state, we focused on specific aspects of its tax
system by using our structured interview and collecting relevant
documentation. For instance, we reviewed the types and structures of
Internet access service taxes, the revenues collected from those taxes,
officials' views of the significance of the moratorium to their
government's financial situation, and their opinions of any
implications to their states of the new definition of Internet access.
We also learned whether localities within the states were taxing access
services. When issues arose, we contacted other states and localities
to increase our understanding of these issues.
We discussed with state officials how they derived the estimates they
gave us of tax dollars collected and how firm these numbers were. We
could not verify the estimates, and CBO supplemented estimates that it
received from states. Nevertheless, based on other information we
obtained, the state estimates appeared to provide a sense of the order
of magnitude of the numbers compared to state tax revenues.
We did our work from February through December 2005 in accordance with
generally accepted government auditing standards.
Internet Access Services, Including Bundled Access Services, May Not Be
Taxed, but Acquired Services May Be:
The moratorium bars taxes on the service of providing access, which
includes whatever an access provider reasonably bundles in its access
offering to consumers. On the other hand, the moratorium does not
prohibit taxes on acquired services, referring to goods and services
that an access provider acquires to enable it to bundle and provide its
access package to its customers. However, some providers and state
officials have expressed a different view, believing the moratorium
barred taxing acquired services in addition to bundled access services.
Internet Access Services, Including Bundled Broadband Services, May Not
Be Taxed:
Since its 1998 origin, the moratorium has always prohibited taxing the
service of providing Internet access, including component services that
an access provider reasonably bundles in its access offering to
consumers. However, as amended in 2004, the definition of Internet
access contains additional words. With words added in 2004 in italics,
it now defines the scope of nontaxable Internet access as:
"a service that enables users to access content, information,
electronic mail, or other services offered over the Internet, and may
also include access to proprietary content, information, and other
services as part of a package of services offered to users. The term
'Internet access' does not include telecommunications services, except
to the extent such services are purchased, used, or sold by a provider
of Internet access to provide Internet access."[Footnote 8] (italics
provided):
As shown in the simplified illustration in figure 2, the items
reasonably bundled in a tax-exempt Internet access package may include
e-mail, instant messaging, and Internet access itself. Internet access,
in turn, includes broadband services, such as cable modem and DSL
services, which provide continuous, high-speed access without tying up
wireline telephone service. As figure 2 also illustrates, a tax-exempt
bundle does not include video, traditional wireline telephone service
referred to as "plain old telephone service" (POTS), or VoIP. These
services are subject to tax. For simplicity, the figure shows a number
of services transmitted over one communications line. In reality, a
line to a consumer may support just one service at a time, as is
typically the case for POTS, or it may simultaneously support a variety
of services, such as television, Internet access, and VoIP.
Figure 2: Simplified Illustration of Services Purchased by Consumers:
[See PDF for image]
[A] Traditional wireline telephone service, commonly referred to in the
communications industry as "plain old telephone service" (POTS).
[B] May become taxable if not capable of being broken out from other
services on a bill.
[End of figure]
Our reading of the 1998 law and the relevant legislative history
indicates that Congress had intended to bar taxes on services bundled
with access. However, there were different interpretations about
whether DSL service could be taxed under existing law, and some states
taxed DSL. The 2004 amendment was aimed at making sure that DSL service
bundled with access could not be taxed. See appendix I for further
explanation.
Acquired Services May Be Taxed:
Figure 3 shows how the nature and tax status of the Internet access
services just described differ from the nature and tax status of
services that an ISP acquires and uses to deliver access to its
customers. An ISP in the middle of figure 3 acquires communications and
other services and incidental supplies (shown on the left side of the
figure) in order to deliver access services to customers (shown on the
right side of the figure). We refer to the acquisitions on the left
side as purchases of "acquired services."[Footnote 9] For example,
acquired services include ISP leases of high-speed communications
capacity over wire, cable, or fiber to carry traffic from customers to
the Internet backbone.
Figure 3: Simplified Model of Tax Status of Services Related to
Internet Access:
[See PDF for image]
[A] "Sell acquired services" refers to selling services, either to a
separate firm or to a vertically-integrated affiliate.
[B] Depends on state law.
[End of figure]
Purchases of acquired services are subject to taxation, depending on
state law, because the moratorium does not apply to acquired services.
As noted above, the moratorium applies only to taxes imposed on
"Internet access," which is defined in the law as "a service that
enables users to access content, information, electronic mail, or other
services offered over the Internet.…" In other words, it is the service
of providing Internet access to the end user--not the acquisition of
capacity to do so--that constitutes "Internet access" subject to the
moratorium.
Some providers and state officials have construed the moratorium as
barring taxation of acquired services, reading the 2004 amendments as
making acquired services tax exempt. However, as indicated by the
language of the statute, the 2004 amendments did not expand the
definition of "Internet access," but rather amended the exception from
the definition to allow certain "telecommunication services" to qualify
for the moratorium if they are part of the service of providing
Internet access. A tax on acquired services is not a tax directly
imposed on the service of providing Internet access.
Our view that acquired services are not subject to the moratorium on
taxing Internet access is based on the language and structure of the
statute, as described further in appendix I. We acknowledge that others
have different views about the scope of the moratorium. Congress could,
of course, deal with this issue by amending the statute to explicitly
address the tax status of acquired services.
Some States Have Applied the Moratorium to Acquired Services:
As noted above, some providers and state officials have construed the
moratorium as barring taxation of acquired services. Some provider
representatives said that acquired services were not taxable at the
time we contacted them and had never been taxable. Others said that
acquired services were taxable when we contacted them but would become
tax exempt in November 2005 under the 2004 amendments, the date they
assumed that taxes on acquired services would no longer be
grandfathered.
As shown in table 1, officials from four out of the eight states we
studied--Kansas, Mississippi, Ohio, and Rhode Island--also said their
states would stop collecting taxes on acquired services, as of November
1, 2005, in the case of Kansas and Ohio whose collections have actually
stopped, and later for the others. These states roughly estimated the
cost of this change to them to be a little more than $40 million in
revenues that were collected in 2004. An Ohio official indicated that
two components comprised most of the dollar amounts of taxes collected
from these services in 2004: $20.5 million from taxes on
telecommunications services and property provided to ISPs and Internet
backbone providers, and $9.1 million from taxes for private line
services (such as high-capacity T-1 and T-3 lines) and 800/wide-area
telecommunications services that the official said would be exempt due
to the moratorium. The rough estimates in table 1 are subject to the
same limitations described in the next section for the state estimates
of all taxes collected related to Internet access.
Table 1: Summary of Case Study State Rough Estimates of 2004 Tax
Revenue from Acquired Services:
State: California; Collected taxes paid on acquired services: No;
2004 revenue from taxes paid on acquired services (dollars in
millions): $0.
State: Kansas; Collected taxes paid on acquired services: Yes;
2004 revenue from taxes paid on acquired services (dollars in
millions): $9-10.
State: Mississippi; Collected taxes paid on acquired services: Yes;
2004 revenue from taxes paid on acquired services (dollars in
millions): At most, $1.
State: North Dakota; Collected taxes paid on acquired services: No;
2004 revenue from taxes paid on acquired services (dollars in
millions): $0.
State: Ohio; Collected taxes paid on acquired services: Yes;
2004 revenue from taxes paid on acquired services (dollars in
millions): $32.3.
State: Rhode Island; Collected taxes paid on acquired services: Yes;
2004 revenue from taxes paid on acquired services (dollars in
millions): Insignificant compared to total telecommunications tax
revenues.
State: Texas; Collected taxes paid on acquired services: No;
2004 revenue from taxes paid on acquired services (dollars in
millions): $0.
State: Virginia; Collected taxes paid on acquired services: No;
2004 revenue from taxes paid on acquired services (dollars in
millions): $0.
Source: State officials.
Note: The next section contains a discussion of general limitations of
the state estimates of revenue from taxes.
[End of table]
While the Revenue Impact of Eliminating Grandfathering Would Be Small,
the Moratorium's Total Revenue Impact Has Been Unclear and Any Future
Impact Would Vary by State:
According to CBO data, grandfathered taxes in the states CBO studied
were a small percentage of those states' tax revenues. However, because
it is difficult to know which states, if any, might have chosen to tax
Internet access services and what taxes they might have chosen to use
if no moratorium had ever existed, the total revenue implications of
the moratorium are unclear. In general, any future impact related to
the moratorium will differ from state to state.
According to Information in CBO Reports, States Would Lose a Small
Fraction of Their Tax Revenues If Grandfathered Taxes on Dial-up and
DSL Services Were Eliminated:
In 2003, CBO reported how much state and local governments that had
grandfathered taxes on dial-up and DSL services would lose in revenues
if the grandfathering were eliminated. The fact that these estimates
represented a small fraction of state tax revenues is consistent with
other information we obtained. In addition, the enacted legislation was
narrower than what CBO reviewed, meaning that CBO's stated concerns
about VoIP and taxing providers' income and assets would have
dissipated.
CBO provided two estimates in 2003 that, when totaled, showed that no
longer allowing grandfathered dial-up and DSL service taxes would cause
state and local governments to lose from more than $160 million to more
than $200 million annually by 2008. According to a CBO staff member,
this estimate included some amounts for what we are calling acquired
services that, as discussed in the previous section, would not have to
be lost. CBO provided no estimates of revenues involved for governments
not already assessing the taxes and said it could not estimate the size
of any additional impacts on state and local revenues of the change in
the definition of Internet access. Further, according to a CBO staff
member, CBO's estimates did not include any lost revenues from taxes on
cable modem services. In October 2003, around the time of CBO's
estimates, the number of cable home Internet connections was 12.6
million, compared to 9.3 million home DSL connections and 38.6 million
home dial-up connections.
CBO first estimated that as many as 10 states and several local
governments would lose $80 million to $120 million annually, beginning
in 2007, if the 1998 grandfather clause were repealed. Its second
estimate showed that, by 2008, state and local governments would likely
lose more than $80 million per year from taxes on DSL service.[Footnote
10]
CBO's estimates resulted from systematic, detailed analyses of
information from state and national sources and involved assumptions to
deal with uncertainties. In arriving at these estimates, CBO asked each
state with grandfathered taxes for information on how much it collected
in taxes related to access services. In addition, it estimated each
state's access service-related taxes by using such data as the number
of Internet users in the state, the average fees that users paid to
providers, applicable state tax rates, expected amounts of dial-up
versus broadband usage, and estimates of possible noncompliance with
tax assessments. See appendix II for further information on the CBO
methodology and associated limitations. Rather than again doing what
CBO had done and gathering information on all 50 states, we tried to
supplement what we learned from CBO by exploring more in-depth
information in case studies of eight states.
The CBO numbers are a small fraction of total state tax revenue
amounts. For example, the $80 million to $120 million estimate for the
states with originally grandfathered taxes for 2007 was about 0.1
percent of tax revenues in those states for 2004--3 years earlier.
The fact that CBO estimates are a small part of state tax revenues is
consistent with information we obtained from our state case studies and
interviews with providers. For instance, after telling us whether
various access-related services, including cable modem service, were
subject to taxation in their jurisdictions, the states collecting taxes
gave us rough estimates of how much access service-related tax revenues
they collected for 2004 for themselves and their localities, if
applicable. (See table 2.) All except two collected $10 million or
less. Even the largest state tax amount reportedly collected in 2004
for Internet access revenues, excluding collections for localities--$50
million in Texas--was only about one-sixth of 1 percent of the state's
tax revenues for that year; the largest percentage for any of our case
study states was about 0.2 percent.
Table 2: Case Study State Officials' Rough Estimates of Taxes Collected
for 2004 Related to Internet Access:
State: California;
Estimated taxes collected (dollars in millions): N/A.
State: Kansas;
Estimated taxes collected (dollars in millions): $9-10.
State: Mississippi;
Estimated taxes collected (dollars in millions): At most, $1[A].
State: North Dakota;
Estimated taxes collected (dollars in millions): $2.4.
State: Ohio;
Estimated taxes collected (dollars in millions): $52.1.
State: Rhode Island;
Estimated taxes collected (dollars in millions): Less than $4.5[B].
State: Texas;
Estimated taxes collected (dollars in millions): $50[C].
State: Virginia;
Estimated taxes collected (dollars in millions): N/A.
Source: State officials.
Note: The accompanying text contains a discussion of general
limitations of the state estimates of revenue from taxes.
[A] According to a Mississippi official, although estimating a dollar
amount would be extremely hard, the state believes the amount collected
was at most $1 million.
[B] Rhode Island officials told us that taxes collected on access were
taxes paid on services to retail consumers, and Rhode Island did not
have an estimate for taxes collected on acquired services.
[C] Texas officials did not provide us with an estimate of taxes
collected for Texas localities.
[End of table]
The states made their estimates by assuming, for instance, that access
service-related tax revenues were a certain percentage of state
telecommunications sales tax revenues, by reviewing providers' returns,
or by making various calculations starting with census data. Most
estimates provided us were more ballpark approximations than precise
computations, and CBO staff expressed a healthy skepticism toward some
state estimates they received. They said that the supplemental state-
by-state information they developed sometimes produced lower estimates
than the states provided. According to others knowledgeable in the
area, estimates provided us were imprecise because when companies filed
sales or gross receipts tax returns with states, they did not have to
specifically identify the amount of taxes they received from providing
Internet access-related services to retail consumers or to other
providers. As discussed earlier, sales to other providers remain
subject to taxation, depending on state law. Some providers told us
they did not keep records in such a way as to be able to readily
provide that kind of information. Also, although states reviewed tax
compliance by auditing taxpayers, they could not audit all providers.
The dollar amounts in table 2 include amounts, where provided, for
local governments within the states. For instance, Kansas's total
includes about $2 million for localities and North Dakota's about
$400,000 for localities. In these states as well as in others we
studied, local jurisdictions were piggybacking on the state taxes,
although the local tax rates could differ from each other. For example,
according to a state official, in Kansas the state tax was 5.3 percent,
and the state collected an average of another 1.3 percent for local
jurisdictions. While we did encounter localities outside our case study
states that taxed access services under their own authority, almost all
the collections for local jurisdictions that we came across were
amounts collected by the states that were sent back to the localities.
State tax officials from our case study states who commented to us on
the impacts of the revenue amounts did not consider them significant.
Similarly, state officials voiced concerns but did not cite nondollar
specifics when describing any possible impact on their state finances
arising from no longer taxing Internet access services. However, one
noted that taking away Internet access as a source of revenue was
another step in the erosion of the state's tax base.[Footnote 11] Other
state and local officials observed that if taxation of Internet access
were eliminated, the state or locality would have to act somehow to
continue meeting its requirement for a balanced budget. At the local
level, officials told us that a revenue decrease would reduce the
amount of road maintenance that could be done or could adversely affect
the number of employees available for providing government services.
Because of the provisions in the enacted 2004 law, some unquantified
revenue losses noted by CBO in its 2003 study that could have grown to
be large no longer seem to pose the threat that some feared. For
example, CBO mentioned the possibility of state and local governments
being unable to tax customers' telephone calls over the Internet.
However, as enacted, the 2004 amendments differed from the version
reviewed by CBO and contained language excluding Internet-based
telephone service, known as VoIP, from the moratorium.[Footnote 12]
In addition, CBO expressed concern that providers could bundle products
containing content, such as books and movies, call the product Internet
access, and have the whole bundle be exempt from taxes. Although some
people we interviewed still feared bundled content and information
might become tax free, they and others indicated they were aware of no
court cases in which this argument has been asserted.[Footnote 13]
The 2004 amendments also included a provision specifically allowing
states to tax Internet providers' net income, capital stock, net worth,
or property value, addressing another concern raised by some parties.
Timing of Moratorium Might Have Precluded Many States from Taxing
Access Services, with Unclear Revenue Implications:
Because it is difficult to predict what states would have done to tax
Internet access services had Congress not intervened when it did, it is
hard to estimate the amount of revenue that was not raised because of
the moratorium. For instance, at the time the first moratorium was
being considered in 1998, the Department of Commerce reported Internet
connections for less than a fifth of U.S. households, much less than
the half of U.S. households reported 6 years later. Access was
typically dial-up. As states and localities saw the level of Internet
connections rising and other technologies becoming available, they
might have taxed access services if no moratorium had been in place.
Taxes could have taken different forms. For example, jurisdictions
might have even adopted bit taxes based on the volume of digital
information transmitted.
The number of states collecting taxes on access services when the first
moratorium was being considered in early 1998 was relatively small,
with 13 states and the District of Columbia collecting these taxes,
according to the Congressional Research Service. Five of those
jurisdictions later eliminated or chose not to enforce their tax. In
addition, not all 37 other states would have taxed access services
related to the Internet even if they could have. For example,
California had already passed its own Internet tax moratorium in August
1998.
Still, after the moratorium began, other states showed an interest in
taxing Internet access services. Although the 1998 act precluded those
jurisdictions from taxing Internet access, it included language stating
that access services did not include telecommunications services.
States seeking to take advantage of this provision taxed parts of DSL
service they considered a telecommunications service and not an
Internet access service. If taxing DSL service shows a desire to tax
access services in general, many states not taxing dial-up or cable
modem service[Footnote 14] might have done so but for the moratorium.
Given that some states never taxed access services while relatively few
Internet connections existed, that some stopped taxing access services,
and that others taxed DSL service, it is unclear what jurisdictions
would have done if no moratorium had existed. However, the relatively
early initiation of a moratorium reduced the opportunity for states
inclined to tax access services to do so before Internet connections
became more widespread.
Any Future Impact of the Moratorium Will Vary by State:
Although as previously noted the impact of eliminating grandfathering
would be small in states studied by CBO or by us, any future impact
related to the moratorium will vary on a state-by-state basis for many
reasons. State tax laws differed significantly from each other, and
states and providers disagreed on how state laws applied to the
providers. Appendix III summarizes information we gathered about our
case study states.
As shown in table 3, states taxed Internet access using different tax
vehicles imposed on diverse tax bases at various rates. The tax used
might be generally applicable to a variety of goods and services, as in
Kansas, which did not impose a separate tax on communications services.
There, the state's general sales tax applied to the purchase of
communications services by access providers at an average rate of 6.6
percent, combining state and average local tax rates. As another
example, North Dakota imposed a sales tax on retail consumers'
communications services, including Internet access services, at an
average state and local combined rate of 6 percent. Rhode Island
charged a 5 percent tax on companies' telecommunications gross
receipts.
Table 3: Characteristics Showing Variations among Case Study States:
State: California;
Type of tax[A]: N/A;
State tax rate (percentage): N/A;
Local tax rate (percentage): N/A.
State: Kansas;
Type of tax[A]: Sales;
Taxing acquired services: Yes;
State tax rate (percentage): 5.3;
Local tax rate (percentage): 1.3 on average.
State: Mississippi;
Type of tax[A]: Gross income;
Taxing acquired services: Yes;
State tax rate (percentage): 7.0;
Local tax rate (percentage): N/A.
State: North Dakota;
Type of tax[A]: Sales;
Taxing retail consumer Internet access services: Yes;
State tax rate (percentage): 5.0;
Local tax rate (percentage): 1.0-2.0.
State: Ohio;
Type of tax[A]: Sales;
Taxing retail consumer Internet access services: Yes;
Taxing acquired services: Yes;
State tax rate (percentage): 5.5;
Local tax rate (percentage): 1.0 on average;
Exemptions of customer types or payment amounts: Residential consumers.
State: Rhode Island;
Type of tax[A]: Gross receipts and sales;
Taxing retail consumer Internet access services: Yes[B];
Taxing acquired services: Yes;
State tax rate (percentage): 5.0, 6.0;
Local tax rate (percentage): N/A.
State: Texas;
Type of tax[A]: Sales;
Taxing retail consumer Internet access services: Yes;
State tax rate (percentage): 6.25;
Local tax rate (percentage): 2.0 limit;
Exemptions of customer types or payment amounts: First $25 of services.
State: Virginia;
Type of tax[A]: N/A;
State tax rate (percentage): N/A;
Local tax rate (percentage): N/A.
Source: State officials and laws.
[A] For purposes of this report, a reference to a sales tax includes
any ancillary use tax. Also for our purposes, the difference between a
sales and a gross receipts tax is largely a distinction without a
difference since the moratorium does not differentiate between them.
[B] Rhode Island retail consumers did not pay this tax directly, but
rather through the gross receipts tax paid by their providers.
[End of table]
Our case study states showed little consistency in the base they taxed
in taxing services related to Internet access. States imposed taxes on
different transactions and populations. North Dakota and Texas taxed
only services delivered to retail consumers. In a type of transaction
which, as discussed earlier, we do not view as subject to the
moratorium, Kansas and Mississippi taxed acquired communications
services purchased by access providers. Ohio and Rhode Island taxed
both the provision of access services and acquired services, and
California and Virginia officials told us their states taxed neither.
States also provided various exemptions from their taxes. Ohio exempted
residential consumers, but not businesses, from its tax on access
services, and Texas exempted the first $25 of monthly Internet access
service charges from taxation.
Some state and local officials and company representatives held
different opinions about whether certain taxes were grandfathered and
about whether the moratorium applied in various circumstances. For
example, some providers' officials questioned whether taxes in North
Dakota, Wisconsin, and certain cities in Colorado were grandfathered,
and whether those jurisdictions were permitted to continue taxing.
Providers disagreed among themselves about how to comply with the tax
law of states whose taxes may or may not have been grandfathered. Some
providers told us they collected and remitted taxes to the states even
when they were uncertain whether these actions were necessary; however,
they told us of others that did not make payments to the taxing states
in similarly uncertain situations. In its 2003 work, CBO had said that
some companies challenged the applicability of Internet access taxes to
the service they provided and thus might not have been collecting or
remitting them even though the states believed they should.
Because of all these state-by-state differences and uncertainties, the
impact of future changes related to the moratorium would vary by state.
Whether the moratorium were lifted or made permanent and whether
grandfathering were continued or eliminated, states would be affected
differently from each other.
External Comments:
We showed staff members of CBO, officials of FTA, and representatives
of telecommunications companies assembled by the United States Telecom
Association a draft of our report and asked for oral comments. On
January 5, 2006, CBO staff members, including the Chief of the State
and Local Government Unit, Cost Estimates Unit, said we fairly
characterized CBO information and suggested clarifications that we have
made as appropriate. In one case, we have noted more clearly that CBO
supplemented its dollar estimates of revenue impact with a statement
that other potential revenue losses could potentially grow by an
unquantified amount.
On January 6, 2006, FTA officials, including the Executive Director,
said that our legal conclusion was clearly stated and, if adopted,
would be helpful in clarifying which Internet access-related services
are taxable and which are not. However, they expressed concern that the
statute could be interpreted differently regarding what might be
reasonably bundled in providing Internet access to consumers. A broader
view of what could be included in Internet access bundles would result
in potential revenue losses much greater than we indicated. However, as
explained in appendix I, we believe that what is bundled must be
reasonably related to accessing and using the Internet. FTA officials
were also concerned that our reading of the 1998 law regarding the
taxation of DSL services is debatable and suggests that states
overreached by taxing them. We recognize that Congress acted in 2004 to
address different interpretations of the statute, and we made some
changes to clarify our presentation. We acknowledge there were
different views on this matter, and we are not attributing any improper
intent to the states' actions.
When meeting with us, representatives of telecommunications companies
said they would like to submit comments in writing. Appearing in
appendix IV, their comments argue that the 2004 amendments make
acquired services subject to the moratorium and therefore not taxable,
and that the language of the statute and the legislative history
support this position. In response, we made some changes to simplify
appendix I. That appendix, along with the section of the report on
bundled access services and acquired services, contains an explanation
of our view that the language and structure of the statute support our
interpretation.
We are sending copies of this report to interested congressional
committees and other interested parties. In addition, the report will
be available at no charge on GAO's Web site at [Hyperlink,
http://www.gao.gov].
If you or your staffs have any questions about this report, please
contact me at (202) 512-9110 or [Hyperlink, whitej@gao.gov]. Contact
points for our Offices of Congressional Relations and Public Affairs
may be found on the last page of this report. GAO staff who made major
contributions to this report are listed in appendix V.
Signed by:
James R. White:
Director, Tax Issues Strategic Issues:
Appendixes:
Appendix I: Bundled Access Services May Not Be Taxed, but Acquired
Services Are Taxable:
The moratorium bars taxes on the service of providing access, which
includes whatever an access provider reasonably bundles in its access
offering to consumers.[Footnote 15] On the other hand, the moratorium
does not bar taxes on acquired services.
Bundled Services, Including Broadband Services, May Not Be Taxed:
As noted earlier, the 2004 amendments followed a period of significant
growth and technological development related to the Internet. By 2004,
broadband communications technologies were becoming more widely
available. They could provide greatly enhanced access compared to the
dial-up access technologies widely used in 1998. These broadband
technologies, which include cable modem service built upon digital
cable television infrastructure as well as digital subscriber line
(DSL) service, provide continuous, high-speed Internet access without
tying up wire-line telephone service. Indeed, cable and DSL facilities
could support multiple services--television, Internet access, and
telephone services--over common coaxial cable, fiber, and copper wire
media.
The Internet Tax Freedom Act bars "taxes on Internet access" and
defines "Internet access" as a service that enables "users to access
content, information, electronic mail, or other services offered over
the Internet." The term Internet access as used in this context
includes "access to proprietary content, information, and other
services as part of a package of services offered to users." The
original act expressly excluded "telecommunications services" from the
definition.[Footnote 16] As will be seen, the act barred jurisdictions
from taxing services such as e-mail and instant messaging bundled by
providers as part of their Internet access package; however, it
permitted dial-up telephone service, which was usually provided
separately, to be taxed.
The original definition of Internet access, exempting
"telecommunications services," was changed by the 2004 amendment.
Parties seeking to carve out exceptions that could be taxed had sought
to break out and treat DSL services as telecommunications services,
claiming the services were exempt from the moratorium even though they
were bundled as part of an Internet access package. State and local tax
authorities began taxing DSL service, creating a distinction between
DSL and services offered using other technologies, such as cable modem
service, a competing method of providing Internet access that was not
to be taxed. The 2004 amendment was aimed at making sure that DSL
service bundled with access could not be taxed. The amendment excluded
from the telecommunications services exemption telecommunications
services that were "purchased, used, or sold by a provider of Internet
access to provide Internet access."
The fact that the original 1998 act exempted telecommunications
services shows that other reasonably bundled services remained a part
of Internet access service and, therefore, subject to the moratorium.
Thus, communications services such as cable modem services that are not
classified as telecommunications services are included under the
moratorium.
Acquired Services May Be Taxed:
As emphasized by numerous judicial decisions, we begin the task of
construing a statute with the language of the statute itself, applying
the canon of statutory construction known as the plain meaning rule.
E.g. Hartford Underwriter Insurance Co. v. Union Planers Bank, N.A.,
530 U.S. 1 (2000); Robinson v. Shell Oil Co., 519 U.S. 337 (1997).
Singer, 2A Sutherland Statutory Construction, §§ 46:1, 48A:11, 15-16.
Thus, under the plain meaning rule, the primary means for Congress to
express its intent is the words it enacts into law and interpretations
of the statute should rely upon and flow from the language of the
statute.
As noted above, the moratorium applies to the "taxation of Internet
access." According to the statute, "Internet access" means a service
that enables users to access content, information, or other services
over the Internet. The definition excludes "telecommunications
services" and, as amended in 2004, limits that exclusion by exempting
services "purchased, used, or sold" by a provider of Internet access.
As amended in 2004, the statute now reads as follows:
"The term 'Internet access' means a service that enables users to
access content, information, electronic mail, or other services offered
over the Internet….The term "Internet access" does not include
telecommunications services, except to the extent such services are
purchased, used, or sold by a provider of Internet access to provide
internet access." Section 1105(5).
The language added in 2004--exempting from "telecommunications
services" those services that are "purchased, used, or sold" by a
provider in offering Internet access--has been read by some as
expanding the "Internet access" to which the tax moratorium applies, by
barring taxes on "acquired services." Those who would read the
moratorium expansively take the view that everything acquired by
Internet service providers (ISP) (everything on the left side of figure
3) as well as everything furnished by them (everything in the middle of
figure 3) is exempt from tax.
In our view, the language and structure of the statute do not permit
the expansive reading noted above. "Internet access" was originally
defined and continues to be defined for purposes of the moratorium as
the service of providing Internet access to a user. Section 1105(5). It
is this transaction, between the Internet provider and the end user,
which is nontaxable under the terms of the moratorium.[Footnote 17] The
portion of the definition that was amended in 2004 was the exception:
that is, telecommunication services are excluded from nontaxable
"Internet access," except to the extent such services are "purchased,
used, or sold by a provider of Internet access to provide Internet
access." Thus, we conclude that the fact that services are "purchased,
used, or sold" by an Internet provider has meaning only in determining
whether these services can still qualify for the moratorium
notwithstanding that they are "telecommunications services;" it does
not mean that such services are independently nontaxable irrespective
of whether they are part of the service an Internet provider offers to
an end user. Rather, a service that is "purchased, used, or sold" to
provide Internet access is not taxable only if it is part of providing
the service of Internet access to the end user. Such services can be
part of the provision of Internet access by a provider who, for
example, "purchases" a service for the purpose of bundling it as part
of an Internet access offering; "uses" a service it owns or has
acquired for that purpose; or simply "sells" owned or acquired services
as part of its Internet access bundle.
In addition, we read the amended exception as applying only to services
that are classified as telecommunications services under the 1998 act
as amended. In fact, the moratorium defines the term
"telecommunications services" with reference to its definition in the
Communications Act of 1934,[Footnote 18] under which DSL and cable
modem service are no longer classified as telecommunications
services.[Footnote 19] Moreover, under the Communications Act, the term
telecommunications services applies to the delivery of services to the
end user who determines the content to be communicated; it does not
apply to communications services delivered to access service providers
by others in the chain of facilities through which Internet traffic may
pass. Thus, since broadband services are not telecommunications
services, the exception in the 1998 act does not apply to them, and
they are not affected by the exception.[Footnote 20]
The best evidence of statutory intent is the text of the statute
itself. While legislative history can be useful in shedding light on
the intent of the statute or to resolve ambiguities, it is not to be
used to inject ambiguity into the statutory language or to rewrite the
statute. E.g., Shannon v. United States 512 U.S. 573, 583 (1994). In
our view, the definition of Internet access is unambiguous, and,
therefore, it is unnecessary to look beyond the statute to discern its
meaning from legislative history. We note, however, that consistent
with our interpretation of the statute, the overarching thrust of
changes made by the 2004 amendments to the definition of Internet
access was to take remedial correction to assure that broadband
services such as DSL were not taxable when bundled with an ISP's
offering. While there are some references in the legislative history to
"wholesale" services, backbone, and broadband, many of these pertained
to earlier versions of the bill containing language different from that
which was ultimately enacted.[Footnote 21] The language that was
enacted, using the phrase "purchased, used, or sold by a provider of
Internet access" was added through the adoption of a substitute offered
by Senator McCain, 150 Cong. Rec. S4402, which was adopted following
cloture and agreement to several amendments designed to narrow
differences between proponents and opponents of the bill. Changes to
legislative language during the consideration of a bill may support an
inference that in enacting the final language, Congress intended to
reject or work a compromise with respect to earlier versions of the
bill. Statements made about earlier versions carry little weight.
Landgraf v. USI Film Products, 511 U.S. 244, 255-56 (1994). Singer, 2A
Sutherland Statutory Construction, § 48:4. In any event, the plain
language of the statute remains controlling where, as we have
concluded, the language and the structure of the statute are clear on
their face.
[End of section]
Appendix II: CBO's Methodology for Estimating Costs Relating to Taxing
Internet Access Services:
According to Congressional Budget Office (CBO) staff, CBO estimated
revenue losses to states and localities from changing how Internet
access was taxed by using two independent methodologies and comparing
their results. First, it collected information directly from the
states. Using data from the Federation of Tax Administrators and the
Multistate Tax Commission to identify states taxing access and their
related tax collections, CBO discussed with state officials what the
dollar amounts included and what they did not. It then reduced the
state loss estimates by various percentages to get a sense of the
ranges possible by assuming, for instance, that providers were not
always paying the taxes states thought they should pay.
To estimate from a second direction, CBO compiled its own state-by-
state information. It multiplied the number of Internet users by state
times an average access fee for each user times the state's applicable
tax rate. It then discounted each state total based on assumptions
about noncompliance with tax assessments.
To arrive at the number of users, according to CBO staff, CBO consulted
the Department of Commerce, the Federal Communications Commission, and
studies of Internet usage. From these sources, it obtained historical
numbers of users and trends that it could project showing the number of
users growing over time, and how usage was changing between dial-up and
high-speed.
Finally, according to the staff members, CBO gathered the other
information for its state-by-state estimate from other sources. It
obtained state tax rates from Council on State Taxation information and
computed a weighted average access fee after calling access providers
about their current rates. It assumed that any change in revenues
brought on by changes in technology and markets would offset each
other. It estimated noncompliance to cover both tax avoidance and
nexus[Footnote 22] issues by using indications it had of certain
Internet service providers not paying an access tax, considering their
market share, and assuming various percentages of tax not being paid.
CBO considered information from both the approaches it was using to get
a range for each state. It used these estimates to produce the part of
its analysis that it could quantify--the nationwide range of $80
million to $120 million beginning in 2007 for states with originally
grandfathered taxes and more than $80 million per year by 2008 for the
states taxing DSL. CBO did not give point estimates or ranges for
specific states, an appropriate choice given the uncertainties in the
methodologies used. Although the nationwide estimates should be used
with caution, they provide reasonable bases for comparisons with the
size of other revenue sources, such as that for overall receipts from
state taxes, and for informing policy makers about the relative size of
revenue losses related to the moratorium.
[End of section]
Appendix III: Case Study States' Taxation of Services Related to
Internet Access:
Table 4 and the following summaries show how our case study states
significantly differed from each other in how they taxed services
related to Internet access. State tax officials gave us much of the
following information in conversations and written communications, and
it represents their opinions of the application of the Internet Tax
Freedom Act and the 2004 amendments to their own unique state laws.
That said, the officials' comments are not necessarily binding and
reflect their interpretation of state law.
Table 4: Characteristics of Case Study States:
State: California;
Type of tax[A]: N/A;
State tax rate (percentage): N/A;
Local tax rate (percentage): N/A;
Roughly estimated 2004 state and local tax collections for all these
services (dollars in millions)[B]: N/A.
State: Kansas;
Taxed acquired services: Yes;
Type of tax[A]: Sales;
State tax rate (percentage): 5.3;
Local tax rate (percentage): 1.3 on average;
Roughly estimated 2004 state and local tax collections for all these
services (dollars in millions)[B]: $9-10.
State: Mississippi;
Taxed acquired services: Yes;
Type of tax[A]: Gross income;
State tax rate (percentage): 7.0;
Local tax rate (percentage): N/A;
Roughly estimated 2004 state and local tax collections for all these
services (dollars in millions)[B]: At most, 1.0.
State: North Dakota;
Taxed retail consumer dial-up Internet access services: Yes;
Taxed retail consumer cable-modem Internet access services: Yes;
Taxed retail consumer DSL Internet access services: Yes;
Type of tax[A]: Sales;
State tax rate (percentage): 5.0;
Local tax rate (percentage): 1.0-2.0;
Roughly estimated 2004 state and local tax collections for all these
services (dollars in millions)[B]: 2.4.
State: Ohio;
Taxed retail consumer dial-up Internet access services: Yes;
Taxed retail consumer cable-modem Internet access services: Yes;
Taxed retail consumer DSL Internet access services: Yes;
Taxed acquired services: Yes;
Type of tax[A]: Sales;
State tax rate (percentage): 5.5;
Local tax rate (percentage): 1.0 on average;
Roughly estimated 2004 state and local tax collections for all these
services (dollars in millions)[B]: 52.1.
State: Rhode Island;
Taxed retail consumer dial-up Internet access services: Yes[C];
Taxed retail consumer DSL Internet access services: Yes[C];
Taxed acquired services: Yes;
Type of tax[A]: Gross receipts and sales;
State tax rate (percentage): 5.0,; 6.0;
Local tax rate (percentage): N/A;
Roughly estimated 2004 state and local tax collections for all these
services (dollars in millions)[B]: Less than 4.5[D].
State: Texas;
Taxed retail consumer dial-up Internet access services: Yes;
Taxed retail consumer cable-modem Internet access services: Yes;
Taxed retail consumer DSL Internet access services: Yes;
Type of tax[A]: Sales;
State tax rate (percentage): 6.25;
Local tax rate (percentage): 2.0 limit;
Roughly estimated 2004 state and local tax collections for all these
services (dollars in millions)[B]: 50[E].
State: Virginia;
Type of tax[A]: N/A;
State tax rate (percentage): N/A;
Local tax rate (percentage): N/A;
Roughly estimated 2004 state and local tax collections for all these
services (dollars in millions)[B]: N/A.
Source: State officials and laws.
[A] For purposes of this report, a reference to a sales tax includes
any ancillary use tax. Also, for our purposes, the difference between a
sales and a gross receipts tax is largely a distinction without a
difference since the moratorium does not differentiate between them.
[B] See earlier text for a discussion of the limitations of the state
estimates of revenue from taxes.
[C] Rhode Island retail consumers did not pay this tax directly, but
rather through the gross receipts tax paid by their providers.
[D] According to Rhode Island officials, Rhode Island did not have an
estimate for taxes collected on acquired services.
[E] Texas officials did not provide us with an estimate of taxes
collected for Texas localities.
[End of table]
California:
According to a state official, California had no grandfathered taxes on
Internet access under any provision of the 2004 amendments. In
addition, she said that California had enacted its own Internet Tax
Freedom Act that generally prohibited imposing taxes on access starting
January 1, 1999. Under this act, local governments were prohibited,
with specified exceptions, from imposing any taxes on buying or using
Internet access or other online computer services. Expiring January 1,
2004, the law did, however, expressly permit imposing sales and use
taxes, utility user taxes, and other taxes of general application on
goods and services that included access services. At the time of our
contact in mid-2005, California officials were not aware of any state
law either authorizing or preventing the taxation of access.
Kansas:
According to a state Department of Revenue official, Kansas taxes on
acquired services were grandfathered under the 2004 amendments. The
state imposed a general sales tax of 5.3 percent (with, according to
the official, local governments adding an average of another 1.3
percent) that applied to telecommunications services bought by an ISP
and used to provide Internet access. ISPs paid sales tax on these
acquired services to other providers that then remitted the funds to
the state. According to the official, the state annually collected an
estimated $9 million to $10 million in revenue from this tax, including
about $2 million of local tax revenues. The $9 million to $10 million
was an unverified estimate based on conversations between the
Department of Revenue and telecommunications providers about the
providers' volume of sales to ISPs. It was derived by taking 10 percent
of the $98 million total telecommunications sales tax receipts that the
state collected in 2004. The approximately $8 million of state revenue
was about 0.15 percent of Kansas's total tax receipts of about $5.3
billion in 2004. According to the official, he expected Kansas to lose
this yearly revenue starting on November 1, 2005.
Mississippi:
According to Mississippi State Tax Commission officials, although the
state did not tax access that was purchased by retail consumers, its
tax on sales of telecommunications services to ISPs--services we are
categorizing as acquired services--was grandfathered under the 2004
amendments. Since before the 1998 Internet Tax Freedom Act, the state
collected a gross income tax on public utilities, including
telecommunications providers, which operated much as a sales tax would.
No sale-for-resale exemption applied to these services, according to
the officials, because under Mississippi law the ISP was not a reseller
of the same service; the ISP changed the service before selling it to
the retail consumer. The tax rate was 7 percent and, although officials
told us the amount of resulting revenue collections was extremely
difficult to calculate due to a lack of data, they believed the total
amount to be less than $1 million per year. This was about 0.02 percent
of Mississippi's 2004 tax revenues of about $5.1 billion. According to
the officials, telecommunications companies remitted sales tax
collected from ISPs to the state on a monthly basis. As there were no
local option sales taxes in Mississippi, the state was the only
Mississippi entity that taxed the telecommunications services.
North Dakota:
North Dakota Office of State Tax Commissioner officials maintained that
their state was grandfathered under the 2004 amendments, and as such
continued to tax retail consumer Internet access. The state imposed a
sales tax on communications services, which it applied to Internet
access. The tax rate was 5 percent and, according to the officials, led
to state revenue collections of about $2 million per year, which was
about 0.16 percent of North Dakota's approximately $1.2 billion in 2004
tax revenues. In addition, local rates of generally 1 percent provided
about another $400,000 in yearly collections for local jurisdictions.
Retail consumers were taxed on intrastate Internet access transactions,
whether through dial-up, cable modem, DSL, or wireless technologies.
ISPs collected the taxes and then transferred them to the state. To
determine the amount of tax revenue collected, state officials said
they reviewed each registered ISP and approximated how much income
resulted from providing Internet access. According to the officials,
the state's determinations were confirmed by subsequent state audits.
Ohio:
According to Ohio Department of Taxation officials, Ohio was
grandfathered to continue taxing business (but not residential)
purchases of Internet access and provider purchases of other services
to provide access. Ohio imposed a 5.5 percent sales tax on business
users of telecommunications and electronic information services,
supplemented, according to the officials, by an average 1 percent tax
for local jurisdictions. The same taxes also applied to acquired
services. Ohio also provided a 25 percent sales tax credit for
electronic information service providers, which meant that ISPs could
get a tax credit for the equipment that they purchased and used
primarily to provide Internet access.
Because Ohio taxed Internet access as part of electronic information
services for business users, it was difficult for state officials to
determine exactly how much tax was paid on Internet access. Officials
estimated that in 2004, the state collected $17 million in taxes paid
on Internet access services (including some research services) sold to
end users, and an additional $2.8 million from local taxes on those
same services. They derived these numbers using economic census data
and vendors' tax returns.
In addition, an Ohio official estimated collecting another $27.3
million in state taxes and $5 million in local taxes in 2004 from other
Internet access-related services that state officials said Ohio could
no longer tax starting in November 2005. The combined $32.3 million
state and local revenues for services not taxable in November 2005
included several components. The largest was $20.5 million on
telecommunications services and property provided to ISPs and Internet
backbone providers, for example, high-speed lines leased by an ISP from
a telecommunications provider. In arriving at this estimate, state
officials assumed that 10 percent of telephone and wireless services
would become tax exempt. The next largest component was $9.1 million
for private line services, such as T-1 and T-3 lines, and 800/wide-area
telecommunications-type services that an official said would be exempt
due to the moratorium. The state derived this number by assuming that
10 percent of the relevant services were attributable to Internet
customers. These services had become taxable as of July 1, 2003, when
Ohio repealed exemptions for them, but, according to state officials,
these services were becoming tax exempt again at November 1, 2005,
under the changed definition of Internet access.
The amount of Internet access-related state taxes that an Ohio official
said the state collected in 2004 was $44.3 million. This was the sum of
the $17 million from retail services and $27.3 million from acquired
services. This total amounts to about 0.2 percent of Ohio's
approximately $22.5 billion in tax collections for 2004. It does not
reflect a problem that Ohio officials expected from taxpayers bundling
services as Internet access services in order to avoid sales tax.
Although the officials said the size of the problem was unknown, they
assigned a $24 million sales tax loss to it for 2007, assuming it to be
similar in size to other annual tax losses that would start in November
2005.
Rhode Island:
State officials told us that Rhode Island was grandfathered under the
2004 amendments to tax Internet access through both a gross receipts
tax on ISPs and a sales tax on telecommunications services acquired by
ISPs. The gross receipts tax, in existence since 1942, was imposed on
any company charging a telecommunications access fee, with provisions
to prevent the same charges from being taxed twice. This tax was
assessed at a rate of 5 percent, and companies submitted an annual
return to the state and made estimated payments throughout the year.
According to state officials, Rhode Island did not tax companies
providing Internet access services via cable modem but did tax those
providing access services through dial-up, DSL, or wireless
technologies. Not knowing what part of reporting companies' gross
receipts came from providing Internet access, the officials could not
determine precisely how much revenue the state collected from Internet
access under the gross receipts tax. They did say that since Internet
access charges probably totaled less than 10 percent of annual
telecommunications gross receipts of $40 million to $45 million, the
amount of state revenue collected from taxing Internet access would be
less than $4.5 million. This would be about 0.19 percent of 2004 state
tax revenues that totaled about $2.4 billion.
The officials also said that Rhode Island would be affected by the new
definition of Internet access under the 2004 amendments as it applies
to the state sales tax, and thus to the taxation of acquired services.
The sales tax was imposed at a 6 percent rate on the purchase of
telecommunications services bought by ISPs to provide Internet access.
The sale/resale exemption did not apply because ISPs are considered to
be the "end users" of the services, as their own products differ from
the ones purchased. The officials did not think revenues from taxing
acquired services were significant compared to overall state
telecommunications tax revenues.
Texas:
An official with the Texas Comptroller of Public Accounts maintained
that his state had been permitted to tax retail consumer Internet
access for years, making Texas another one of the relatively few states
that continued to be grandfathered under the 2004 amendments. Because
Texas had no state income tax, a sales tax was its primary source of
revenue. In 1985, telecommunications were added to the services covered
by the sales tax, and in 1988, information services were added as well.
According to the official, the 6.25 percent sales tax rate led to state
revenue collections of about $50 million for 2004, which was about 0.16
percent of Texas's approximately $30.8 billion in tax revenues for
2004. Local jurisdictions typically imposed an extra one-quarter to 1
percent additional sales tax on Internet access, but the combined total
of state and local taxes could not exceed 8.25 percent. Texas exempted
from taxation the first $25 of Internet access charges incurred by a
customer when buying Internet access from an ISP. However, according to
the official, a corporate customer qualified for one $25 exemption
regardless of how many accounts it maintained. The sale-for-resale
exemption applied in Texas to services sold by a provider to an ISP for
resale purposes, so those acquired services were not taxable. Retail
consumers were taxed on intrastate Internet access transactions,
whether through dial-up, cable modem, DSL, wireless, or satellite
technologies. ISPs collected the taxes and then transferred them to the
state.
Virginia:
According to Virginia Department of Taxation officials, Virginia had no
taxes on Internet access grandfathered under the 2004 amendments. In
Virginia, ISPs were subject to taxes of general application, like
corporate income and gross receipts taxes imposed by the state or local
jurisdictions, but Internet access transactions were not taxable
transactions. According to the officials, Virginia's sales tax statutes
exempted ISPs from collecting sales tax, codifying then current state
practices. Virginia had exempted Internet access services from its
sales and use tax in April 1998. Acquired services were similarly not
taxable in Virginia.
[End of section]
Appendix IV: Comments from Telecommunications Industry Officials:
January 17, 2006:
James R. White:
Director, Tax Policy and Administration:
U.S. Governmental Accountability Office:
441 G. Street, N.W.
Washington, DC 20548:
Re: Draft GAO Report on the Impact of the Internet Tax
Nondiscrimination Act on State Tax Revenues:
Dear Mr. White:
Thank you for the opportunity to provide input on the Draft GAO Report
("Report") discussing the impact of the Internet Tax Nondiscrimination
Act ("ITNA") on state tax revenues. We appreciate the time and effort
put forth by GAO during the preparation of the Report and the
willingness of GAO staff to discuss pertinent issues with us.
Background:
The 2004 amendments to the Internet Tax Freedom Act ("ITFA") included
several significant changes to the federal statute. Notable among them
was a key clarification of the definition of "Internet access" to
exempt telecommunications services "purchased, used, or sold by a
provider of Internet access to provide Internet Access" from state
taxation. [NOTE 1] As a result of this legislative change, state and
local governments are prohibited from imposing taxes upon the
telecommunications services "purchased, used, or sold by a provider of
Internet access to provide Internet Access."
Congress intended to advance two related and equally compelling
purposes by clarifying the definition of Internet Access. The first
purpose was to prevent states from taxing Internet access differently
depending on how a provider assembles its service and delivers the
service to consumers. The second and related purpose was to prevent
states from taxing the wholesale purchase of "backbone" (i.e., the
underlying telecommunications services) by Internet access providers
used to provide Internet access. Both purposes were targeted at
eliminating discriminatory tax treatment of Internet access services
provided by various providers and technologies. The dual purposes that
underlie the change in definition of "Internet access" are supported in
both legislative history and the plain language of the statute.
NOTE:
[1] 47 U.S.C. § 151, note § 1105(5).
Legislative History:
In 2004, Congress included language in ITNA that specifically prevents
states from taxing telecommunications services that are "purchased,
used, or sold by a provider of Internet access to provide Internet
access." Language in the introduced versions of the House and Senate
ITNA bills varied slightly from the enacted version. Early versions of
the bills prevented states from taxing telecommunications services that
were merely "used to provide Internet access." [NOTE 2] The words
"purchased" and "sold" were added as the bills progressed through the
legislative process in Congress. Although the language used by Congress
may have evolved during the deliberative process, the legislative
intent of the language was clear and never changed. As the legislative
history detailed below demonstrates, it was the intent of Congress
throughout the process to protect both the providers and consumers of
Internet access from state and local tax burdens.
1. Committee Reports:
The House and the Senate Committee reports discussing the early version
of the language support the contention that the exemption for
telecommunications services provided in section 1105(5) of ITNA was
intended to exempt wholesale purchases of telecommunications services
that become a component part of Internet access service. The Senate
Commerce Committee report on the introduced version of S. 150 indicates
that it was the sponsors' clear intent from the outset to protect
wholesale purchases of backbone services from state taxes:
NOTE:
[2] S. 150, 108th Cong. (2004); H.R. 49 108th Cong. (2004).
[T]he Committee believes that the current definition of Internet access
under the Act requires clarification to ensure that States and
localities do not attempt to circumvent the moratorium on Internet
access taxes by taxing individual components of access such as
telecommunications services used to provide Internet access:
The Committee intends for the tax exemption for telecommunications
services to apply whenever the ultimate use of those telecommunications
services is to provide Internet access. Thus, if a telecommunications
carrier sells wholesale telecommunications services to an Internet
service provider that intends to use those telecommunications services
to provide Internet access, then the exemption would apply. [NOTE 3]
The House Committee on the Judiciary Report on H. 49 (which also
contained slightly different language at the time of the report than
was included in ITNA) also indicates a clear legislative intent to
protect the wholesale purchases from state taxes. The report noted that
the ITNA wholesale language clarified the exception to the definition:
while telecommunications services are not generally within the
definition of Internet access, to the extent they are used to provide
Internet access, they are subject to the moratorium. Transmission
services used to provide Internet access, whether at the wholesale or
retail level, constitute "Internet access." [NOTE 4]
Thus, Committees of both legislative bodies early on acknowledged the
overall goals of ITNA could not be achieved without protecting
wholesale purchases from state taxation. Both Committees concluded that
a tax on a provider's wholesale purchase of telecommunications services
used to assemble Internet access service would be passed on to the end
consumer and therefore should be prohibited.
2. Floor Debate:
The floor debate on ITNA also exemplifies the strong desire on the part
of its sponsors to prevent states from taxing wholesale purchases of
telecommunications services that are used to provide Internet access
services. Senator Allen's floor statement particularly illustrates this
point: "We wanted to stop those who found a loophole in the original
moratorium and started taxing the backbone of the Internet. They are
taxing that and, of course, ultimately the consumer has to pay for
those taxes. We wanted to stop that immediately." [NOTE 5] Some states
were taxing the backbone transmission services, or wholesale services,
as telecommunications services-such states justified taxation of such
backbone services by classifying such services as telecommunications
services. Moreover, responding to Senator Dorgan on the meaning of the
proposed words "purchased, used, or sold by a provider of Internet
access to provide Internet access," Senator Allen stated: "The simple
answer is we do not want the bandwidth being taxed. .. The point is,
though, that for the bandwidth, that actual transport, that should not
be taxed." [NOTE 6]
NOTES:
[3] S. Rep. No. 108-155, at 3 (2003).
[4] H. Rep. No. 108-234, at 10 (2003).
[5] 150 Cong. Rec. 54401 (April 27, 2004) (Statement of Sen. Allen).
[6] 150 Cong. Rec. 54461 (April 27, 2004) (Statement of Sen. Allen).
Further information from the floor debate shows that state officials
similarly interpreted the new ITNA language to be an exemption for the
wholesale purchase of telecommunications services that are used in the
provision of Internet access. Senator Alexander introduced two letters
from state officials during the floor debate on ITNA that interpret the
ultimate language of ITNA as protecting wholesale purchases from state
taxes. The Tennessee Tax Commissioner noted:
[The ITNA wholesale language] has the effect of exempting
telecommunication services that snake up the Internet backbone, the
`middle mile" telecommunications used by Internet Service Providers to
provide Internet access and the "last mile" telecommunications services
used to connect an end user to the Internet. [NOTE 7]
The National Governors Association also noted in a letter to Senator
Alexander that:
Not only would the [ITNA wholesale language] prohibit states and
localities from collecting taxes on DSL, it would also exempt all
telecommunications services used anywhere along the Internet from the
end-user all the way to and including the "backbone." [NOTE 8]
3. Congressional Research Service Report on the Internet Tax Bills:
In late 2003, the Congressional Research Service issued a report on all
of the Internet tax bills that were pending in the 108th Congress. The
report detailed each bill and summarized some of the key issues related
to the bill. When discussing ITNA and the debate surrounding the key
issues, the report clearly acknowledged that the ITNA language protects
the wholesale purchase from state taxes by stating: "[The ITNA
wholesale language] could also exempt from tax not only the
telecommunications or other services that connect the consumer to the
Internet but all of the telecommunications and other services that make
up the Internet backbone." [NOTE 9]
4. Enacted Text of ITNA Contrasted with Alexander-Carper Bill:
The progression of the bill and state opposition to an exemption for
wholesale purchases indicate that the clear legislative intent was to
include wholesale purchases in the exemption from taxes under ITNA.
While ITNA was being debated, state opposition led to the introduction
of the competing Carper/Alexander Bill that did not protect wholesale
purchase from taxes. Important language differences between the
Carper/Alexander Bill and ITNA as enacted support a conclusion that the
enacted ITNA provision protects wholesale purchases from state taxes.
NOTES:
[7] 150 Cong. Rec. 54639 (April 29, 2004) (Statement of Senator
Alexander submitting a letter from Lauren Chumley, Commissioner of
Revenue, State of Tennessee).
[8] 150 Cong. Rec. 54640 (April 29, 2004) (Statement of Senator
Alexander submitting a letter from the National Governor's
Association).
[9] Congressional Research Service, Internet Tax Bills in the 108th
Congress CRS-5 (November 10, 2003).
The relevant text of the enacted version of ITNA reads: "The term
`Internet access' does not include telecommunications services, except
to the extent such services are purchased, used or sold by a provider
of Internet access to provide Internet access." [Emphasis added.]
However, the relevant text of the Alexander-Carper Bill illustrates a
failed attempt to exclude a wholesale exemption from ITNA by changing
keywords of the bill: "The term `Internet access service' does not
include telecommunications services, except to the extent such services
are purchased, used or sold by an Internet access provider to connect a
purchaser of Internet access to the Internet access provider." [NOTE
10] [Emphasis added.] Furthermore, the presentations used to explain to
Members of Congress the differences between the Carper/Alexander bill
and ITNA support a conclusion that wholesale purchases of backbone
services are protected from state taxation by the enacted language of
ITNA. [NOTE 11]
The significance of these differences in language was not lost on those
state tax policy commentators who discussed the issue. For example, the
Center on Budget and Policy Priorities issued a detailed report
comparing the Alexander-Carper language to the ITNA language. The
report noted: "The proposed S. 150 would prohibit all state and local
taxation of both 'last mile' telecommunications services and the
`upstream' telecommunications services that constitute the underlying
infrastructure and `backbone' of the Internet." [NOTE 12]
2Additionally, "Whip Talking Points" used by the state and local
government representatives during the debate demonstrate that the
states interpreted the language as including wholesale purchases. [NOTE
13]
5. Importance of the Wholesale Exemption to the Industry:
A great deal of public testimony and comments on ITNA indicate that
concern over the taxation of the wholesale purchase of
telecommunications services was an important reason for the language
change. All segments of the communications and Internet access
industries were strong proponents for the inclusion of the wholesale
exemption in ITNA, as this exemption provides both clarity and equity
for all service providers, regardless of the ownership of the backbone.
Testimony by Mark Beshears, Assistant Vice President of State and Local
Tax, Sprint Corporation, stated that the taxation of wholesale
purchases is a "real world" problem associated with the older ITFA
language. [NOTE 14] In a prepared Statement, Steven K. Berry, Senior
Vice President for Government Affairs, Cellular Telecommunications &
Internet Association noted that "[i]t is unfortunate that legislation
designed to prevent multiple and discriminatory taxation of Internet
and Electronic Commerce specifically excludes the one service that is
absolutely vital to the functioning of the Internet-- the
telecommunications backbone-and the one service that is subject to one
of the highest discriminatory state and local tax burdens in the
country." [NOTE 15]
NOTES:
[10] S. 2084, 108th Cong. (2004).
[11] See Attachment 1.
[12] Center on Budget and Policy Priorities, The Alexander-Carper
Internet Access Tax Moratorium Bill, S. 2084: A True Compromise That
Substantially Broadens The Original Moratorium 4 (March 15, 2004).
[13] See, Attachment 2.
[14] Internet Tax Moratorium: Hearings on S. 150 before Senate Comm. on
Commerce, Science, & Transportation, 108th Cong. (July 16, 2003)
(statement of Mark Beshears, Assistant Vice President of State and
Local Tax, Sprint Corporation).
[15] Internet Tax Moratorium: Hearings on S. 150 before Senate Comm. on
Commerce, Science, & Transportation, 108th Cong. (July 16, 2003)
(statement of Steven K. Berry, Senior Vice President for Government
Affairs, Cellular Telecommunications & Internet Association).
6. Indications of Legislative Intent Contained in the GAO's Draft
Report:
The draft Report contains several observations that also support a
conclusion that ITNA prevents states from imposing tax on wholesale
purchases. For example, many states were very involved in the debate
over the wholesale purchase exclusion-either directly or through the
Multistate Tax Commission and Federation of Tax Administrators. The
draft Report recognizes that four of the eight study states have
acknowledged that they will discontinue taxing wholesale purchases on
November 1, 2005; two of the study states do not tax Internet access at
all, and it is unclear from the report whether any of the eight study
states will tax wholesale purchases. A number of states, including
Massachusetts, North Carolina, Louisiana, Kentucky and Mississippi,
have already interpreted the language as protecting the wholesale
purchase on November 1, 2005.
The draft Report also indicates that the CBO interpreted ITNA as
preventing a tax on wholesale purchases. Thus, the CBO--
contemporaneously with the debate on the scope of the bill-interpreted
the provision to exempt to wholesale purchases from state taxes.
Statutorv Construction:
Application of statutory construction principles in interpretation of
the ITNA provision also yields a conclusion that the language prevents
the taxation of any telecommunications services that are purchased,
used, or sold to provide Internet access.
1. Plain Reading:
A plain reading of the provision indicates that ITNA prevents a state
from taxing the wholesale purchase of telecommunications services used
to provide Internet access. The operative provision of ITNA provides
that "[n]o State or political subdivision thereof shall impose any of
the following taxes during the period beginning November 1, 2003, and
ending November 1, 2007: (1) Taxes on Internet access. . ." [NOTE 16]
ITNA defines Internet access to mean a service that enables users to
access content, information, electronic mail, or other services offered
over the Internet, and may also include access to proprietary content,
information, and other services as part of a package of services
offered to users. The term 'Internet access' does not include
telecommunications services, except to the extent such services are
purchased, used, or sold by a provider of Internet access to provide
Internet access. [NOTE 17]
Read together, these two provisions provide a clear exemption for any
telecommunications service that is purchased, used or sold by a
provider of Internet access to provide Internet access. Simply stated,
wholesale purchases of telecommunications services used by an Internet
service provider to provide Internet access is protected from state
taxation under ITNA. No other provision of ITNA alters this plain
interpretation. Neither the accounting rule in section 1106 that
addresses aggregated charges nor the specific mention of voice services
in section 1108 should change this interpretation.
NOTES:
[16] 47 U.S.C. § 151, note § 1101.
[17] 47 U.S.C. § 151, note § 1105(5) (emphasis added).
2. The Words "Purchased" and "Used" Must be Given Meaning:
The words "purchased, used, or sold" must be interpreted more broadly
than simply as a means to level the playing field between different
technologies and providers with respect to end-users (e.g., to tax end-
user DSL and cable broadband consistently). If the new language is
interpreted to only level the playing field with respect to the
ultimate consumer purchase, most of the new language would be rendered
moot. If the drafters had intended only to level the playing field,
they would not have included such a broad provision concerning
"purchased, used or sold by a provider of Internet access to provide
Internet access." Consistent tax treatment on the sale to the end-user
could have been accomplished by merely using the word "sold." The
Senate debate that focused on the Alexander-Carper alternative, which
is discussed above, supports this conclusion. The addition of the words
"purchased" and "used" can only be read to protect the wholesale
purchase from state taxes.
3. The Language Should be Interpreted Consistently with State
Transaction Tax Concepts:
ITNA preempts the state and local taxation of certain services;
consequently, much of the language in ITNA was crafted to be consistent
with phrases and concepts that are well grounded instate and local tax.
[NOTE 18] The words "purchased," "used," and "sold" are all terms of
art instate and local tax that should be accorded similar significance
in the context of ITNA. States presently use this same language to
exempt the wholesale purchase of all types of goods and services, and
it is logical to use the same language when describing an exemption
from taxation for the purchase of wholesale services used to provide
Internet access.
NOTE:
[18] See, e.g., Ala. Admin. Code § 810-6-5-.26.01; Cal. SBE Reg. §
1823; Fla. Stat. § 212.06(2)(k); Conn. Agencies Regs. § 12-410(5)-1;
D.C. Code § 47-2201; 111. Admin. Code § 160.101; NY Tax Law § 1115;
Ohio Rev. Code § 5741.01(C) & (D); 61 Pa Code § 31.13; S.D. Laws § 10-
45-6.1; Tern. Code § 67-6-507; 34 Tex. Admin. Code § 3.287:
The use of the phrase "purchased, used, or sold" parallels exemption
language used in existing state transactional tax provisions that
strive to prevent the pyramiding of taxes, which is an important tax
policy issue that Congress also addressed when considering ITNA In
theory,
the retail sales tax is designed to tax final consumption of goods and
services. In other words, the tax should be imposed only on the
purchase of taxable sales by households while exempting business
purchases. A report prepared for the Council on State Taxation supports
the theory that a pyramiding of the sales tax leads to unfavorable
results for consumers and other negative economic results. [NOTE 19]
The imposition of" . . . state and local sales taxes .. on a
significant portion of business-to-business sales .. results in
problems, including distortions in how firms operate, arbitrary and
hidden differences in effective sales tax rates on different goods and
services that distort consumer choices, violations of horizontal and
vertical equity principles, and detrimental effects on a state's
business competitiveness. Those problems are partially a result of the
pyramiding of the retail sales tax." Pyramiding causes the taxes paid
by businesses to be built into the price charged to the consumer; this
practice violates principles of equity and neutrality because some
forms of consumption are taxed more than others, depending on the
extent to which business inputs were subject to tax. "In some cases,
legislators have chosen to tax inputs purchased by firms, such as
healthcare providers [or Internet access providers], as an indirect way
to tax services that are intentionally exempted from direct sales
taxation for public policy (`equity') reasons." [NOTE 20]
These pyramiding principles are equally applicable when discussing the
ITNA wholesale language. Congress intended to limit the ability of
states to tax the ultimate purchase of Internet access by consumers.
The imposition of taxes at the wholesale level on telecommunications
services utilized to provide Internet access to consumers would
unquestionably result in a pyramiding of taxes borne by the ultimate
consumer.
NOTES:
[19] Robert Cline, John L. Mikesell, Thomas S. Neubig, Andrew Phillips,
Sales Taxation of Business Inputs: Existing Tax Distortions and the
Consequences ofExtending the Sales Tax to Business Services; 2005 State
Tax Today 29-1 (Jan. 28, 2005).
[20] Id.
4. The Language Should be Interpreted Consistently with the Recognized
Legislative Intent of Treating Like/Similar Services Equally:
One of Congress's primary purposes underlying the reenactment of ITNA
was to address the potential and existing inequities between the
states' taxation of dial-up Internet access and high-speed Internet
access (i.e., DSL and cable modem service). A critical inequity that
Congress identified in this regard could occur between facilities-based
telecommunications providers that could use their own network to
primarily provide Internet access services and non-facilities-based
providers that primarily procure their telecommunications services
necessary to provide Internet access to consumers. Congress was
concerned that providers that are able to primarily utilize their own
networks (i.e., the backbone) could have a competitive advantage to
those providers who are required to primarily purchase the
telecommunications backbone for Internet service from another entity.
Congress sought to correct this potential inequity regarding the
treatment of these wholesale service transactions to ensure that all
providers of Internet access would be subject to the same level of
taxation with respect to their purchase of wholesale services. Thus,
Congress' purpose cannot be fulfilled without reading ITNA to address
both the retail and wholesale purchase of telecommunications service.
Sincerely,
America Online Inc.;
AT&T Corp.;
BellSouth Corp.;
Comcast Corp.;
Level 3 Communications;
Sprint Nextel:
T-Mobile USA;
Verizon;
Verizon Wireless;
Time Warner Cable;
United States Telecom Association.
cc: Lawrence M. Korb;
Bert Japikse:
Accessing the Internet Via "Dial Up" Service Over a Phone Line:
[See PDF for image]
[End of figure]
Accessing the Internet Via Wireline Broadband Service:
[See PDF for image]
[End of figure]
Accessing the Internet Via Wireless Broadband Service:
[See PDF for image]
[End of figure]
Wi-Fi - A new revenue stream for state and local government?
[See PDF for image]
[End of figure]
Whip Talking Points:
State and local governments oppose S. 150 because it unnecessarily
expands the existing moratorium on Internet access tales to include
certain telecommunications services. The Multistate Tax Commission
estimates that this expansion will. cost state and local governments $4
to $8.75 billion annually. [NOTE: substitute/add state numbers if
available.]
The sponsors of S. 150 have proposed changes to the bill that they
claim address state and local concerns. The proposed changes do not
take care of problems identified by state and local governments and
should be opposed. Our best estimates are that the proposed changes
would still cost state and local governments $2 to $4 billion annually
[NOTE: Substirute/add state numbers if available.]
State and local government groups offered compromise language to
tighten. the definitions in the bill and to make the moratorium
permanent. That language mould have made telecommunications
transmissions from the consumer to the ISP tax free (and test the
state/locals hundreds of millions in revenues). The state/local offer
was rejected by the sponsors.
Because of the cost and uncertainty associated with both S. 150 and the
proposed Managers' amendment, NGA and others are pushing for a simple
extension of current lam until industry, Congress and state and local
government groups can produce language that is thoughtful and fiscally
fair.
Given the complexities of this issue and the potential cost to state
and local governments, would Senator ________ support an amendment on
the Senate floor to change S. 150 to a simple extension of the current
moratorium?
[End of section]
Appendix V: GAO Contact and Staff Acknowledgments:
GAO Contact:
James R. White (202) 512-9110:
Acknowledgments:
In addition to the contact named above, Michael Springer, Assistant
Director; Bert Japikse; Shirley A. Jones; Lawrence M. Korb; Walter K.
Vance; and Bethany C. Widick made key contributions to this report.
(450433):
FOOTNOTES
[1] Pew Research Center, Trends 2005 (Washington, D.C.: Jan. 25, 2005).
[2] Pub. L. 105-277, 112 Stat. 2681-719 (1998), 47 U.S.C. § 151 Note.
[3] Internet Tax Nondiscrimination Act, Pub. L. 108-435, § 7, 118 Stat.
2615, 2618 (2004).
[4] DSL is a high-speed way of accessing the Internet using traditional
telephone lines that have been "conditioned" to handle DSL technology.
[5] A tax is a multiple tax if credit is not given for comparable taxes
paid to other states on the same transaction; a tax is a discriminatory
tax if e-commerce transactions are taxed at a higher rate than
comparable nonelectronic transactions would be taxed, or are required
to be collected by different parties or under other terms that are more
disadvantageous than those that are applied in taxing other types of
comparable transactions. Generally, states and localities that tax e-
commerce impose comparable taxes on nonelectronic transactions. States
that have sought at one time to require that access providers collect
taxes due--a process that might been thought to have been
discriminatory--have backed away from that position. Moreover, although
interstate commerce may bear its fair share of state taxes, the
interstate commerce clause of the Constitution requires there to be a
substantial nexus, fair apportionment, nondiscrimination, and a
relationship between a tax and state-provided services that largely
constrains the states in imposing such taxes. Quill Corp. v. North
Dakota, 504 U.S. 298, 313 (1992). In any case, our report does not
focus on taxing the sale of items over the Internet.
[6] Internet Tax Nondiscrimination Act, 2001, Pub. L. 107-75, § 2, 115
Stat. 703.
[7] Internet Tax Nondiscrimination Act, 2004, Pub. L. 108-435, §§ 2 to
6A, 118 Stat. 2615 to 2618.
[8] 47 U.S.C. § 151 Note § 1105(5).
[9] Some have also used the term wholesale to describe acquired
services. For example, the New Millennium Research Council in Taxing
High-Speed Services (Washington, D.C., Apr. 26, 2004) said that
"wholesale services that telecommunications firms provide ISPs can
include local connections to the customer's premise, high-capacity
transport between network points and backbone services." We avoid using
the term, however, because it suggests a particular sales relationship
(between wholesaler and retailer) that may be limiting and misleading.
[10] The more than $80 million per year is the amount of revenue that
CBO expected state and local governments to collect on DSL service and
some acquired services by 2008. If the jurisdictions had recognized
that the reason for the 2004 amendments was largely moot, and if they
had not been collecting taxes on DSL service in the first place, they
would not have had part of the $80 million to lose.
[11] In the debate leading to the 2004 amendments' passage, critics had
expressed concern that the federal government was interfering with
state and local revenue-raising ability.
[12] In our case studies, we found that even though the 2004 amendments
did not affect the taxation of VoIP, some state and local officials
were still very concerned about VoIP's taxability. When questioned
about the impact of the moratorium on his state's financial situation,
one official noted that the state was more concerned about what will
happen with VoIP than about the current provisions of the 2004
amendments. Some local officials we interviewed were concerned that
legislation like the 2004 amendments is a step toward eroding their
ability to tax utilities such as telephone services. City officials
were apprehensive that additional legislation will "piggyback" on the
2004 amendments, exclude services from state taxation, and eventually
define VoIP as Internet access, having a severe, detrimental effect on
revenues.
[13] Also see the first footnote in appendix I.
[14] Care must be taken not to confuse cable television service and
cable modem service, which is used to deliver Internet access. Cable
television service providers may also provide cable modem service. Only
cable modem service is subject to the moratorium.
[15] Notwithstanding fears expressed by some during consideration of
the 2004 amendments, this does not mean that anything may be bundled
and thus become tax exempt. Clearly, what is bundled must be reasonably
related to accessing and using the Internet, including electronic
services that are customarily furnished by providers. In this regard,
it is fundamental that a construction of a statute cannot be sustained
that would otherwise result in unreasonable or absurd consequences.
Singer, 2A Sutherland Statutory Construction, § 45:12 (6th ed., 2005).
[16] The 1998 act defined Internet access as "a service that enables
users to access content, information, electronic mail, or other
services offered over the Internet, and may also include access to
proprietary content, information, and other services as part of a
package of services offered to users. Such term [Internet access] does
not include telecommunications services."
[17] As noted previously, the moratorium applies to "taxes on Internet
access." Related provisions defining a "tax on Internet access" for
purposes of the moratorium focus on the transaction of providing the
service of Internet access: such a tax is covered "regardless of
whether such tax is imposed on a provider of Internet access or a buyer
of Internet access." Section 1105(10).
[18] 47 U.S.C. §153(46).
[19] DSL and cable modem services are now referred to as "information
services with a telecommunications component," under the Communications
Act of 1934. See In the Matter of Appropriate Framework for Broadband
Access to the Internet over Wireline Facilities, FCC 05-150, (2005),
and related documents, including In the Matter of Communications
Assistance for Law Enforcement Act and Broadband Access and Services,
FCC 05-153, 2995 WL 2347773 (F.C.C.) (2005). Although FCC announced its
intention as early as February 15, 2002, to revisit its initial
classification of DSL service as a telecommunications service under the
Communications Act (In the Matter of Appropriate Framework for
Broadband Access to the Internet over Wireline Facilities, FCC 02-42,
17 F.C.C.R. 3019, 17 FCC Rcd. 3019), it was not until after the Supreme
Court's decision in National Cable & Telecommunications Ass'n v. Brand
X Internet Services, 125 S.Ct. 2688 (2005), that it actually did so.
[20] There was some awareness during the debate that the then pending
Brand X litigation ("Ninth Circuit Court opinion affecting DSL and
cable") could affect the law in this area. See comments by Senator
Feinstein, 150 Cong. Rec. S4666.
[21] For example, proponents of giving the statute a broader
interpretation cite S. Rep. 108-155, 108th Cong., 1ST Sess. (2003),
which includes the following statement.
"The Committee intends for the tax exemption for telecommunications
services to apply whenever the ultimate use of those telecommunications
services is to provide Internet access. Thus, if a telecommunications
carrier sells wholesale telecommunications services to an Internet
service provider that intends to use those telecommunications services
to provide Internet access, then the exemption would apply."
At the time the 2003 report was drafted, the sentence of concern in the
draft legislation read, "Such term [referring to Internet access] does
not include telecommunications services, except to the extent such
services are used to provide Internet access." As adopted, the wording
became, "The term 'Internet access' does not include telecommunications
services, except to the extent such services are purchased, used, or
sold by a provider of Internet access to provide Internet access." The
amended language thus focuses on the package of services offered by the
access provider, not on the act of providing access alone.
[22] A state may only require an Internet seller to collect taxes if
the seller has nexus, that is, a physical presence in the state.
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