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

“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.”  (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.
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.”  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.
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.

	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.
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.
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.  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.
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.
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 service 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.
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.

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.  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.  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, §§ 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. “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.  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, under which DSL and cable modem service are no longer classified  as telecommunications services.  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.
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.  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, § 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

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 nexus 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 Access

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.

	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

GAO Contact and Staff Acknowledgments

	GAO Contact

	Acknowledgments

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.

Summary:
Why GAO Did This Study

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 Found

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.