As I and others have recently noted, if the Federal Communications Commission reclassifies broadband Internet access as a “telecommunications” service, broadband would automatically become subject to the federal Universal Service tax—currently 16.1%, or more than twice the highest state sales tax (California–7.5%), according to the Tax Foundation.
Erik Telford, writing in The Detroit News, has reached a similar conclusion.
U.S. wireline broadband revenue rose to $43 billion in 2012 from $41 billion in 2011, according to one estimate. “Total U.S. mobile data revenue hit $90 billion in 2013 and is expected to rise above $100 billion this year,” according to another estimate. Assuming that the wireline and wireless broadband industries as a whole earn approximately $150 billion this year, the current 16.1% Universal Service Contribution Factor would generate over $24 billion in new revenue for government programs administered by the FCC if broadband were defined as a telecommunications service.
The Census Bureau reports that there were approximately 90 million households with Internet use at home in 2012. Wireline broadband providers would have to collect approximately $89 from each one of those households in order to satisfy a 16.1% tax liability on earnings of $50 billion. There were over 117 million smartphone users over the age of 15 in 2011, according to the Census Bureau. Smartphones would account for the bulk of mobile data revenue. Mobile broadband providers would have to collect approximately $137 from each of those smartphone users to shoulder a tax liability of 16.1% on earnings of $100 billion.
The FCC adjusts the Universal Service Contribution Factor quarterly with the goal of generating approximately $8 billion annually to subsidize broadband for some users. One could argue that if the tax base increases by $150 billion, the FCC could afford to drastically reduce the Universal Service Contribution Factor. However, nothing would prevent the FCC from raising the contribution factor back up into the double digits again in the future. The federal income tax started out at 2%.
The FCC is faced with the problem of declining international and interstate telecommunications revenues upon which to impose the tax—since people are communicating in more ways besides making long-distance phone calls—and skeptics might question whether the FCC could resist the temptation to make vast new investments in the “public interest.” For example, at this very moment the FCC is proposing to update the broadband speed required for universal service support to 10 Mbps.
What Role Will the States Play?
Another interesting question is how the states will react to this. There is a long history of state public utility commissions and taxing authorities acting to maximize the scope of state regulation and taxes. Remember that telecommunications carriers file tax returns in every state and local jurisdiction—numbering in the thousands.
In Smith v. Illinois (1930), the United States Supreme Court ruled that there has to be an apportionment of telecommunication service expenses and revenue between interstate and intrastate jurisdictions. The Communications Act of 1934 is scrupulously faithful to Smith v. Illinois.
In 2003, Minnesota tried to regulate voice over Internet Protocol (VoIP) services the same as “telephone services.” The FCC declined to rule whether VoIP was a telecommunication service or an information service, however it preempted state regulation anyway when it concluded that it is “impossible or impractical to separate the intrastate components of VoIP service from its interstate components.” The FCC emphasized
the significant costs and operational complexities associated with modifying or procuring systems to track, record and process geographic location information as a necessary aspect of the service would substantially reduce the benefits of using the Internet to provide the service, and potentially inhibit its deployment and continued availability to consumers.
The U.S. Court of Appeals for the Eighth Circuit agreed with the FCC in 2007. Unfortunately, this precedent did not act as a brake on the FCC.
In 2006—while the Minnesota case was still working it’s way through the courts—the FCC was concerned that the federal Universal Service Fund was “under significant strain”; the commission therefore did not hesitate to establish universal service contribution obligations for providers of fixed interconnected VoIP services. The FCC had no difficulty resolving the problem of distinguishing between intrastate and interstate components: It simply took the telephone traffic percentages reported by long-distance companies (64.9% interstate versus 35.1% intrastate) and applyed them to interconnected VoIP services. Vonage Holdings Corp., the litigant in the Minnesota case (as well as in the subsequent Nebraska case, discussed below), did not offer fixed interconnected VoIP Service, so it was unaffected.
Before long, Nebraska tried to require “nomadic” interconnected VoIP service providers (including Vonage) to collect a state universal service tax on the intrastate portion (35.1%) of their revenues. Following the Minnesota precedent, the Eighth Circuit rejected the Nebraska universal service tax.
Throughout these legal and regulatory proceedings, the distinction between “fixed” and “nomadic” VoIP services was observed. According to the Nebraska court,
Nomadic service allows a customer to use the service by connecting to the Internet wherever a broadband connection is available, making the geographic originating point difficult or impossible to determine. Fixed VoIP service, however, originates from a fixed geographic location. * * * As a result, the geographic originating point of the communications can be determined and the interstate and intrastate portions of the service are more easily distinguished.
Nebraska argued that it wasn’t impossible at all to determine the geographic origin of nomadic VoIP service—the state simply used the customer’s billing address as a proxy for where nomadic services occurred. If Nebraska had found itself in a more sympathetic tribunal, it might have won.
The bottom line is that the FCC has been successful so far in imposing limits on state taxing authority—at least within the Eighth Circuit (Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota and South Dakota)—but there are no limits on the FCC.
Reclassifying broadband Internet access as a telecommunications service will have significant tax implications. Broadband providers will have to collect from consumers and remit to government approximately $24 billion—equivalent to approximately $89 per household for wireline Internet access and approximately $137 per smartphone. The FCC could reduce these taxes, but it will be under enormous political pressure to collect and spend the money. States can be expected to seek a share of these revenues, resulting in litigation that will create uncertainty for consumers and investors.