Internet Access Tax Moratorium: Revenue Impacts Will Vary by State
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.