Internet Access Tax Moratorium: Revenue Impacts Will Vary by	 
State (23-MAY-07, GAO-07-896T). 				 
                                                                 
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).		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-896T					        
    ACCNO:   A69854						        
  TITLE:     Internet Access Tax Moratorium: Revenue Impacts Will Vary
by State							 
     DATE:   05/23/2007 
  SUBJECT:   Federal law					 
	     Internet						 
	     Municipal taxes					 
	     Policy evaluation					 
	     State taxes					 
	     Tax administration 				 
	     Tax law						 

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GAO-07-896T

   

     * [1]Background
     * [2]Objectives, Scope, and Methodology
     * [3]Internet Access Services, Including Bundled Access Services,

          * [4]Internet Access Services, Including Bundled Broadband Servic
          * [5]Acquired Services May Be Taxed
          * [6]Some States Have Applied the Moratorium to Acquired Services

     * [7]While the Revenue Impact of Eliminating Grandfathering Would

          * [8]According to Information in CBO Reports, States Would Lose a
          * [9]Timing of Moratorium Might Have Precluded Many States from T
          * [10]Any Future Impact of the Moratorium Will Vary by State

     * [11]External Comments
     * [12]Contacts and Acknowledgments

          * [13]Bundled Services, Including Broadband Services, May Not Be T
          * [14]Acquired Services May Be Taxed

     * [15]GAO's Mission
     * [16]Obtaining Copies of GAO Reports and Testimony

          * [17]Order by Mail or Phone

     * [18]To Report Fraud, Waste, and Abuse in Federal Programs
     * [19]Congressional Relations
     * [20]Public Affairs

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

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.^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 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.^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.^6

1Pew Internet & American Life Project, Daily Internet Activities
(Washington, D.C.: Jan. 11, 2007).

^2Pub. L. 105-277, 112 Stat. 2681-719 (1998), 47 U.S.C. S 151 Note.

^3Internet Tax Nondiscrimination Act, Pub. L. 108-435, S 7, 118 Stat.
2615, 2618 (2004).

^4DSL is a high-speed way of accessing the Internet using traditional
telephone lines that have been "conditioned" to handle DSL technology.

^5GAO, Internet Access Tax Moratorium: Revenue Impacts Will Vary by State,
[21]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.

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.

^6GAO, Telecommunications: Broadband Deployment Is Extensive throughout
the United States, but It Is Difficult to Assess the Extent of Deployment
Gaps in Rural Areas, [22]GAO-06-426 (Washington, D.C.: May 5, 2006).

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

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.^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^8
and again in 2004, retroactively, to remain in force until November 1,
2007.^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.

^7A 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.

^8Internet Tax Nondiscrimination Act, 2001, Pub. L. 107-75, S 2, 115 Stat.
703.

^9Internet Tax Nondiscrimination Act, 2004, Pub. L. 108-435, SS 2 to 6A,
118 Stat. 2615 to 2618.

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."^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.

^1047 U.S.C. S 151 Note S 1105(5).

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 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."^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

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

bDepends on state law.

^11Some 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.

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

                Collected taxes paid 2004 revenue from taxes paid on acquired 
State        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.^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.

^12The 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.

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, 1^a                                    
North Dakota 2.4                                             
Ohio         52.1                                            
Rhode Island Less than 4.5^b                                 
Texas        50^c                                            
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. 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.^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.

^13In 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.

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

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

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 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 [email protected] . 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.

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.^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."

^1Notwithstanding 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, S 45:12 (6th ed., 2005).

^2The 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."

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, SS 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.^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

^3As 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).

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.

^447 U.S.C. S153(46).

^5DSL 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.

^6There 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.

^7For 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.

(450601)

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www.gao.gov/cgi-bin/getrpt?GAO-07-896T .

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Highlights of [31]GAO-07-896T , a testimony before the Committee on
Commerce, Science and Transportation, U.S. Senate

May 23, 2007

INTERNET ACCESS TAX MORATORIUM

Revenue Impacts Will Vary by State

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.

[32]What GAO Recommends

GAO makes no recommendations in this testimony.

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.

Simplified Model of Tax Status of Services Related to Internet Access

^aDepends on state law.

References

Visible links
  21. http://www.gao.gov/cgi-bin/getrpt?GAO-06-273
  22. http://www.gao.gov/cgi-bin/getrpt?GAO-06-426
  31. http://www.gao.gov/cgi-bin/getrpt?GAO-07-896T
*** End of document. ***