Tax Consequences of Net Neutrality

by on October 21, 2014 · 1 comment

Would the Federal Communications Commission expose broadband Internet access services to tax rates of at least 16.6% of every dollar spent on international and interstate data transfers—and averaging 11.23% on transfers within a particular state and locality—if it reclassifies broadband as a telecommunications service pursuant to Title II of the Communications Act of 1934?

As former FCC Commissioner Harold Furchtgott-Roth notes in a recent Forbes column, the Internet Tax Freedom Act only prohibits state and local taxes on Internet access.  It says nothing about federal user fees.  The House Energy & Commerce Committee report accompanying the “Permanent Internet Tax Freedom Act” (H.R. 3086) makes this distinction clear.

The law specifies that it does not prohibit the collection of the 911 access or Universal Service Fund (USF) fees. The USF is imposed on telephone service rather than Internet access anyway, although the FCC periodically contemplates broadening the base to include data services.

The USF fee applies to all interstate and international telecommunications revenues.  If the FCC reclassifies broadband Internet access as a telecommunications service in the Open Internet Proceeding, the USF fee would automatically apply unless and until the commission concluded a separate rulemaking proceeding to exempt Internet access.  The Universal Service Contribution Factor is not insignificant. Last month, the commission increased it to 16.1%.  According to Furchtgott-Roth,

At the current 16.1% fee structure, it would be perhaps the largest, one-time tax increase on the Internet.  The FCC would have many billions of dollars of expanded revenue base to fund new programs without, according to the FCC, any need for congressional authorization.

In another Forbes column, Steve Posiask discusses the possibility that reclassification could also trigger state and local taxes.  The committee report notes that if Congress allows the Internet access tax moratorium (which expires on Dec. 11, 2014) to lapse, states and localities could impose a crippling burden on the Internet.

In 2007, the average tax rate on communications services was 13.5%, more than twice the rate of 6.6% on all other goods and services. Some rates even exceed sin tax rates. For example, in Jacksonville, Florida, households pay 33.24% wireless taxes, higher than beer (19%), liquor (23%) and tobacco (28%). Moreover, these tax burdens fall heavier on low income households. They pay ten times as much in communications taxes as high income households as a share of income.  (citation omitted.)

For more information on state and local taxation of communications services, see, e.g., the report from the Tax Foundation on wireless taxation that came out this month.

The House committee report also notes that broadband Internet access is highly price-elastic, which means that higher taxes would be economically inefficient.

former White House Chief economist Austan Goolsbee authored a paper finding the average elasticity for broadband to be 2.75. Elasticity is a measure of price sensitivity and here indicates that a $1.00 increase in Internet access taxes would reduce expenditures on those services by an average of $2.75.  (citation omitted.)

Even if the Internet Tax Freedom Act is renewed by the lame duck Congress, the act isn’t exactly a model of clarity on this issue. The definition (see Sec. 1104) of “internet access service,” for example, specifically excludes telecommunications services.

INTERNET ACCESS.—The term ‘‘Internet access’’ means 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 does not include telecommunications services.

And the definition of “telecommunications service” (also in Sec. 1104) is the same one (by cross-reference) that the FCC may try to interpret as including broadband.

TELECOMMUNICATIONS SERVICE.—The term ‘‘telecommunications service’’ has the meaning given such term in section 3(46) of the Communications Act of 1934 (47 U.S.C. 153(46)) and includes communications services (as defined in section 4251 of the Internal Revenue Code of 1986).

When the Internet Tax Freedom Act was enacted in 1998, Congress took great pains to not jeopardize the pre-existing authority of state and local governments to levy substantial taxes on telecommunications carriers. Notwithstanding, state and local tax collectors have been fighting the moratorium ever since.  Their point of view was summarized by Michael Mazerov in The Hill as follows:

Beyond costing states the $7 billion a year in potential revenue to support education, healthcare, roads, and other services, the bill would violate an understanding between Congress and the states dating back to the 1998 Internet Tax Freedom Act (ITFA): that any ban on applying sales taxes to Internet access charges would be temporary and not apply to existing access taxes.

The House passed H.R. 3086 in July. The “Internet Tax Freedom Forever Act” (S. 1431) is pending in the Senate Finance Committee.  Even if Congress renews the Internet Tax Freedom Act but fails to clarify the definitions in current law, there is a distinct possibility that state and local tax collectors will test the limits of the law if and when the FCC rules that broadband is no different than a Title II telecommunications service.

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