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Testimony:
Before the Committee on Commerce, Science and Transportation, U.S.
Senate:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 10:00 a.m. EDT:
Wednesday, May 23, 2007:
Internet Access Tax Moratorium:
Revenue Impacts Will Vary by State:
Statement of James R. White:
Director, Tax Issues:
Strategic Issues:
GAO-07-896T:
GAO Highlights:
Highlights of GAO-07-896T, a testimony before the Committee on
Commerce, Science and Transportation, U.S. Senate
Why GAO Did This Study:
According to one report, at the end of 2006, about 92 million U.S.
adults used the Internet on 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. The objectives of the resulting 2006 report were
to determine the scope of the moratorium and its impact, if any, on
state and local revenues. This testimony is based on that report (GAO-
06-273).
For the report, GAO reviewed the moratorium’s language, legislative
history, and associated legal issues; examined revenue impact studies;
interviewed people knowledgeable about access services; and collected
information about eight case study states not intended to represent
other states. GAO chose the states considering such factors as whether
they had taxes grandfathered for different forms of access services and
covered different 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 GAO when it was preparing its
report that 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.
Figure: Simplified Model of Tax Status of Services Related to Internet
Access:
[See PDF for Image]
Source: GAO and PhotoDisc (images).
[A] Depends on state law.
[End of figure]
What GAO Recommends:
GAO makes no recommendations in this testimony.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-896T].
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]
Chairman Inouye, Vice Chairman Stevens, and Members of the Committee:
I appreciate this opportunity to discuss the moratorium on taxing
access to the Internet. According to one study, at the end of 2006
about 92 million U.S. adults used the Internet on 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 year, bills have been introduced in both houses
of Congress to make the moratorium permanent.
My remarks today are based on the first of two reports we issued
responding to the mandate that we study the impact of the moratorium.
Issued in January 2006, that report focused on the moratorium's impact
on state and local government revenues.[Footnote 5] Its objectives were
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 explored 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.
The report did not focus on taxing the sale of items over the Internet.
A second report discussed the impact that various factors, including
taxes, have on broadband deployment and adoption.[Footnote 6]
To prepare the first 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 testimony contains a complete discussion of our objectives, scope,
and methodology.
Let me begin by summarizing the major points of the report:
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
when we were preparing our report that 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.
In oral comments on a draft of our January 2006 report, CBO staff
members said we fairly characterized CBO information and suggested
clarifications that we 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 the appendix,
we believe that what is bundled must be reasonably related to accessing
and using the Internet. In written comments, company representatives
disagreed with GAO by commenting 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.
We made no recommendations in the report, and we are not making any
recommendations in this testimony.
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]
Source: GAO and PhotoDisc (images).
[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 7]
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 8] and again in 2004, retroactively, to remain in force
until November 1, 2007.[Footnote 9] 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 10] (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]
Source: GAO and PhotoDisc (images).
[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 the appendix 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 11] 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]
Source: GAO and PhotoDisc (images).
[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 the appendix. 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: [Empty];
2004 revenue from taxes paid on acquired services (dollars in
millions): $0.
State: Kansas;
Collected taxes paid on acquired services: x;
2004 revenue from taxes paid on acquired services (dollars in
millions): 9- 10.
State: Mississippi;
Collected taxes paid on acquired services: x;
2004 revenue from taxes paid on acquired services (dollars in
millions): At most, 1.
State: North Dakota;
Collected taxes paid on acquired services: [Empty];
2004 revenue from taxes paid on acquired services (dollars in
millions): 0.
State: Ohio;
Collected taxes paid on acquired services: x;
2004 revenue from taxes paid on acquired services (dollars in
millions): 32.3.
State: Rhode Island;
Collected taxes paid on acquired services: x;
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: [Empty];
2004 revenue from taxes paid on acquired services (dollars in
millions): 0.
State: Virginia;
Collected taxes paid on acquired services: [Empty];
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
12]
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.
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. In this state 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.
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 13] 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.
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.
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.
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.
Table 3: Characteristics Showing Variations among Case Study States:
State: California;
Type of tax[A]: N/A;
Taxing retail consumer Internet access services: [Empty];
Taxing acquired services: [Empty];
State tax rate (percentage): N/A;
Local tax rate (percentage): N/A;
Exemptions of customer types or payment amounts: [Empty].
State: Kansas;
Type of tax[A]: Sales;
Taxing retail consumer Internet access services: [Empty];
Taxing acquired services: x;
State tax rate (percentage): 5.3;
Local tax rate (percentage): 1.3 on average;
Exemptions of customer types or payment amounts: [Empty].
State: Mississippi;
Type of tax[A]: Gross income;
Taxing retail consumer Internet access services: [Empty];
Taxing acquired services: x;
State tax rate (percentage): 7.0;
Local tax rate (percentage): N/A;
Exemptions of customer types or payment amounts: [Empty].
State: North Dakota;
Type of tax[A]: Sales;
Taxing retail consumer Internet access services: x;
Taxing acquired services: [Empty];
State tax rate (percentage): 5.0;
Local tax rate (percentage): 1.0-2.0;
Exemptions of customer types or payment amounts: [Empty].
State: Ohio;
Type of tax[A]: Sales;
Taxing retail consumer Internet access services: x;
Taxing acquired services: x;
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: x[B];
Taxing acquired services: x;
State tax rate (percentage): 5.0, 6.0;
Local tax rate (percentage): N/A;
Exemptions of customer types or payment amounts: [Empty].
State: Texas;
Type of tax[A]: Sales;
Taxing retail consumer Internet access services: x;
Taxing acquired services: [Empty];
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;
Taxing retail consumer Internet access services: [Empty];
Taxing acquired services: [Empty];
State tax rate (percentage): N/A;
Local tax rate (percentage): N/A;
Exemptions of customer types or payment amounts: [Empty].
Source: State officials and laws.
[A] For purposes of this testimony, 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 January 2006 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 made as appropriate. In one case, we 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 the appendix, 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. 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 the appendix. That appendix, along
with the section of the testimony on bundled access services and
acquired services, contains an explanation of our view that the
language and structure of the statute support our interpretation.
Mr. Chairman, Mr. Vice Chairman, and Members of the Committee, this
concludes my testimony. I would be happy to answer any questions you
may have at this time.
Contacts and Acknowledgments:
For further information, please contact James R. White on (202) 512-
9110 or whitej@gao.gov. Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this
testimony. Individuals who made key contributions to this testimony
include Michael Springer, Assistant Director; Edda Emmanuelli-Perez;
Lynn H. Gibson; Bert Japikse; Shirley A. Jones; Lawrence M. Korb; Donna
L. Miller; Walter K. Vance; and Bethany C. Widick.
[End of section]
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 14] 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 15] 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 16] 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 17] under which DSL and cable
modem service are no longer classified as telecommunications
services.[Footnote 18] 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 19]
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 20] 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.
FOOTNOTES
[1] Pew Internet & American Life Project, Daily Internet Activities
(Washington, D.C.: Jan. 11, 2007).
[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] GAO, Internet Access Tax Moratorium: Revenue Impacts Will Vary by
State, GAO-06-273 (Washington, D.C.: Jan. 23, 2006). See the report for
more details than this testimony provides about revenue impacts and for
more appendixes, including one showing comments from telecommunications
industry officials.
[6] GAO, Telecommunications: Broadband Deployment Is Extensive
throughout the United States, but It Is Difficult to Assess the Extent
of Deployment Gaps in Rural Areas, GAO-06-426 (Washington, D.C.: May 5,
2006).
[7] 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 have 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 did not focus
on taxing the sale of items over the Internet.
[8] Internet Tax Nondiscrimination Act, 2001, Pub. L. 107-75, § 2, 115
Stat. 703.
[9] Internet Tax Nondiscrimination Act, 2004, Pub. L. 108-435, §§ 2 to
6A, 118 Stat. 2615 to 2618.
[10] 47 U.S.C. § 151 Note § 1105(5).
[11] 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.
[12] 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.
[13] 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.
[14] 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).
[15] 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."
[16] 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).
[17] 47 U.S.C. §153(46).
[18] 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.
[19] 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.
[20] 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.
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