    Internet Access Tax Moratorium: Revenue Impacts Will Vary by
    State (23-JAN-06, GAO-06-273).

    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.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-06-273
        ACCNO:   A45508
      TITLE:     Internet Access Tax Moratorium: Revenue Impacts Will Vary
    by State
         DATE:   01/23/2006
      SUBJECT:   Federal law
    	     Internet
    	     Municipal taxes
    	     Policy evaluation
    	     State taxes
    	     Tax administration
    	     Tax law

    ******************************************************************
    ** This file contains an ASCII representation of the text of a  **
    ** GAO Product.                                                 **
    **                                                              **
    ** No attempt has been made to display graphic images, although **
    ** figure captions are reproduced.  Tables are included, but    **
    ** may not resemble those in the printed version.               **
    **                                                              **
    ** Please see the PDF (Portable Document Format) file, when     **
    ** available, for a complete electronic file of the printed     **
    ** document's contents.                                         **
    **                                                              **
    ******************************************************************
    GAO-06-273

         * Report to Congressional Committees
              * January 2006
         * INTERNET ACCESS TAX MORATORIUM
              * Revenue Impacts Will Vary by State
         * Contents
              * Results in Brief
              * Background
              * Objectives, Scope, and Methodology
              * Internet Access Services, Including Bundled Access Services, May
                Not Be Taxed, but Acquired Services May Be
                   * Internet Access Services, Including Bundled Broadband
                     Services, May Not Be Taxed
                   * Acquired Services May Be Taxed
                   * Some States Have Applied the Moratorium to Acquired Services
              * 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 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
                   * Timing of Moratorium Might Have Precluded Many States from
                     Taxing Access Services, with Unclear Revenue Implications
                   * Any Future Impact of the Moratorium Will Vary by State
              * External Comments
         * 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
         * CBO's Methodology for Estimating Costs Relating to Taxing Internet
           Access Services
         * Case Study States' Taxation of Services Related to Internet Access
              * California
              * Kansas
              * Mississippi
              * North Dakota
              * Ohio
              * Rhode Island
              * Texas
              * Virginia
         * Comments from Telecommunications Industry Officials
         * GAO Contact and Staff Acknowledgments

    Report to Congressional Committees

    January 2006

    INTERNET ACCESS TAX MORATORIUM

    Revenue Impacts Will Vary by State

    Contents

    Tables

    Figures

    January 23, 2006 Letter

    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.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,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.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).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

    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.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 years6 and
    again in 2004, retroactively, to remain in force until November 1, 2007.7
    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

    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

    aTraditional wireline telephone service, commonly referred to in the
    communications industry as "plain old telephone service" (POTS).

    bMay become taxable if not capable of being broken out from other services
    on a bill.

    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."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

    a"Sell acquired services" refers to selling services, either to a separate
    firm or to a vertically-integrated affiliate.

    bDepends on state law.

    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     Collected taxes paid 2004 revenue from taxes paid on acquired
                    on acquired services      services (dollars in millions)
    California                        $0
    Kansas       x                    9-10
    Mississippi  x                    At most, 1
    North Dakota                      0
    Ohio         x                    32.3
    Rhode Island x                    Insignificant compared to total
                                         telecommunications tax revenues
    Texas                             0
    Virginia                          0

    Source: State officials.

    Note: The next section contains a discussion of general limitations of the
    state estimates of revenue from taxes.

    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.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           Estimated taxes collected (dollars in millions)
    California          N/A
    Kansas              $9-10
    Mississippi         At most, 1a
    North Dakota        2.4
    Ohio                52.1
    Rhode Island        Less than 4.5b
    Texas               50c
    Virginia            N/A

    Source: State officials.

    Note: The accompanying text contains a discussion of general limitations
    of the state estimates of revenue from taxes.

    aAccording to a Mississippi official, although estimating a dollar amount
    would be extremely hard, the state believes the amount collected was at
    most $1 million.

    bRhode 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.

    cTexas officials did not provide us with an estimate of taxes collected
    for Texas localities.

    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.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.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.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 service14 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    Type of   Taxing   Taxing   State tax    Local tax   Exemptions
                     taxa    retail  acquired     rate         rate     of customer
                            consumer services (percentage) (percentage)  types or
                            Internet                                      payment
                             access                                       amounts
                            services
    California  N/A                        N/A          N/A
    Kansas      Sales             x        5.3          1.3 on
                                                           average
    Mississippi Gross             x        7.0          N/A
                   income
    North       Sales    x                 5.0          1.0-2.0
    Dakota
    Ohio        Sales    x        x        5.5          1.0 on       Residential
                                                           average      consumers
    Rhode       Gross    xb       x        5.0,         N/A
    Island      receipts
                   and                        6.0
                   sales
    Texas       Sales    x                 6.25         2.0 limit    First $25
                                                                        of services
    Virginia    N/A                        N/A          N/A

    Source: State officials and laws.

    aFor 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.

    bRhode Island retail consumers did not pay this tax directly, but rather
    through the gross receipts tax paid by their providers.

    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 http://www.gao.gov .

    If you or your staffs have any questions about this report, please contact
    me at (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 report. GAO staff who made major contributions to this report are
    listed in appendix V.

    James R. White Director, Tax Issues Strategic Issues

    Bundled Access Services May Not Be Taxed, but Acquired Services Are
    Taxable Appendix I

    The moratorium bars taxes on the service of providing access, which
    includes whatever an access provider reasonably bundles in its access
    offering to consumers.1 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.2 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, S:S: 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 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.3 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
    1934,4 under which DSL and cable modem service are no longer classified as
    telecommunications services.5 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.6

    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.7 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, S: 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.

    CBO's Methodology for Estimating Costs Relating to Taxing Internet Access
    Services Appendix II

    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 nexus1 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.

    Case Study States' Taxation of Services Related to Internet AccessAppendix
    III

    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     Taxed      Taxed     Taxed    Taxed   Type of   State tax    Local tax     Roughly
                 retail    retail     retail  acquired   taxa       rate         rate      estimated
                consumer  consumer   consumer services          (percentage) (percentage) 2004 state
                dial-up  cable-modem   DSL                                                 and local
                Internet  Internet   Internet                                                 tax
                 access    access     access                                              collections
                services  services   services                                               for all
                                                                                             these
                                                                                           services
                                                                                          (dollars in
                                                                                          millions)b
    California                                         N/A      N/A          N/A          N/A
    Kansas                                    x        Sales    5.3          1.3 on       $9-10
                                                                             average
    Mississippi                               x        Gross    7.0          N/A          At most,
                                                       income                             1.0
    North       x        x           x                 Sales    5.0          1.0-2.0      2.4
    Dakota
    Ohio        x        x           x        x        Sales    5.5          1.0 on       52.1
                                                                             average
    Rhode       xc                   xc       x        Gross    5.0,         N/A          Less than
    Island                                             receipts                           4.5d
                                                       and      6.0
                                                       sales
    Texas       x        x           x                 Sales    6.25         2.0 limit    50e
    Virginia                                           N/A      N/A          N/A          N/A

    Source: State officials and laws.

    aFor 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.

    bSee earlier text for a discussion of the limitations of the state
    estimates of revenue from taxes.

    cRhode Island retail consumers did not pay this tax directly, but rather
    through the gross receipts tax paid by their providers.

    dAccording to Rhode Island officials, Rhode Island did not have an
    estimate for taxes collected on acquired services.

    eTexas officials did not provide us with an estimate of taxes collected
    for Texas localities.

    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.

    Comments from Telecommunications Industry Officials Appendix IV

    GAO Contact and Staff Acknowledgments Appendix V

    James R. White (202) 512-9110

    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)

    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.

    Highlights of GAO-06-273 , a report to congressional committees

    January 2006

    INTERNET ACCESS TAX MORATORIUM

    Revenue Impacts Will Vary by State

    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 Recommends

    GAO is not making any recommendations in this report.

    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

    aDepends on state law.
    *** End of document. ***