a

GAO

United States Government Accountability Office

Report to Congressional Committees

January 2006 INTERNET ACCESS 

TAX MORATORIUM

Revenue Impacts Will 

Vary by State

GAO-06-273
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

January 2006

INTERNET ACCESS TAX MORATORIUM

Revenue Impacts Will Vary by State 

Highlights of GAO-06-273, a report to 

congressional committees 

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 mid1990s 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 Recommends

GAO is not making any 

recommendations in this report. 

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. 

Simplified Model of Tax Status of Services Related to Internet Access 

Source: GAO and PhotoDisc (images).

Sell acquired 

services to ISP

Sells bundled 

access services

to end user

ISP End user

Providers of 

acquired services

Subject Tax exempt

to taxationa

a

Depends on state law. 

www.gao.gov/cgi-bin/getrpt?GAO-06-273.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact James R. White 

at (202) 512-9110 or whitej@gao.gov. 
Page i GAO-06-273 Internet Access Tax Moratorium

Contents

Letter 1

Results in Brief 3

Background 4

Objectives, Scope, and Methodology 7

Internet Access Services, Including Bundled Access Services, May 

Not Be Taxed, but Acquired Services May Be 8

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 13

External Comments 20

Appendixes

Appendix I: Bundled Access Services May Not Be Taxed, but Acquired 

Services Are Taxable 23

Bundled Services, Including Broadband Services, May Not Be 

Taxed 23

Acquired Services May Be Taxed 24

Appendix II: CBO’s Methodology for Estimating Costs Relating to Taxing 

Internet Access Services 28

Appendix III: Case Study States’ Taxation of Services Related to Internet 

Access 30

California 31

Kansas 31

Mississippi 31

North Dakota 32

Ohio 32

Rhode Island 33

Texas 34

Virginia 35

Appendix IV: Comments from Telecommunications Industry Officials 36

Appendix V: GAO Contact and Staff Acknowledgments 50

Tables Table 1: Summary of Case Study State Rough Estimates of 2004 Tax 

Revenue from Acquired Services 12

Table 2: Case Study State Officials’ Rough Estimates of Taxes 

Collected for 2004 Related to Internet Access 15

Table 3: Characteristics Showing Variations among Case Study 

States 19
Contents

Page ii GAO-06-273 Internet Access Tax Moratorium

Table 4: Characteristics of Case Study States 30

Figures Figure 1: Hypothetical Internet Backbone Networks with 

Connections to End Users 5

Figure 2: Simplified Illustration of Services Purchased by 

Consumers 9

Figure 3: Simplified Model of Tax Status of Services Related to 

Internet Access 11

Abbreviations

AOL America Online

CBO Congressional Budget Office

DSL digital subscriber line

FTA Federation of Tax Administrators

ISP Internet service provider

POP point of presence

POTS plain old telephone service

VoIP Voice over Internet Protocol

This is a work of the U.S. government and is not subject to copyright protection in the 

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Page 1 GAO-06-273 Internet Access Tax Moratorium

United States Government Accountability Office

Washington, D.C. 20548

A

January 23, 2006 Letr

The Honorable Ted Stevens

Chairman

The Honorable Daniel K. Inouye

Co-Chairman

Committee on Commerce, Science and Transportation

United States Senate

The Honorable Joe Barton

Chairman

The Honorable John D. Dingell

Ranking Minority Member

Committee on Energy and Commerce

House of Representatives

According to one study, at the end of 2004 some 70 million U.S. adults 

logged on to the Internet during 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

1

Pew Research Center, Trends 2005 (Washington, D.C.: Jan. 25, 2005).

2

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

3

Internet Tax Nondiscrimination Act, Pub. L. 108-435, § 7, 118 Stat. 2615, 2618 (2004).
Page 2 GAO-06-273 Internet Access Tax Moratorium

provided by cable modem service or by a telephone technology known as 

digital subscriber line (DSL).4

This report focuses on the moratorium’s impact on state and local 

government revenues. Its objectives are 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 explores 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. This report does not focus on taxing the sale of items over the 

Internet. A future report will discuss the impact that various factors, 

including taxes, have on broadband deployment and adoption. 

To prepare this 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 report contains a complete discussion of our 

objectives, scope, and methodology.

4

DSL is a high-speed way of accessing the Internet using traditional telephone lines that 

have been “conditioned” to handle DSL technology.
Page 3 GAO-06-273 Internet Access Tax Moratorium

Results in Brief 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 
Page 4 GAO-06-273 Internet Access Tax Moratorium

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.

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 
Page 5 GAO-06-273 Internet Access Tax Moratorium

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 

POP

POP

POP

POP

POP

New York

Denver

Seattle

Backbone A

Backbone B

Point of presence

Point of interconnection

Dallas

Atlanta

Los Angeles

Large business

and institutional 

users Large business

and institutional 

users

Residential, small 

business, and other users

ISP

ISP

Large business

and institutional

users

Residential, small 

business, and other

users

Chicago

San

Francisco

Source: GAO and PhotoDisc (images).
Page 6 GAO-06-273 Internet Access Tax Moratorium

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.5

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 years6

and again in 2004, retroactively, to remain in force until November 1, 2007.7 

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. 

5

A 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 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 does not focus on taxing the sale of 

items over the Internet.

6

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

7

Internet Tax Nondiscrimination Act, 2004, Pub. L. 108-435, §§ 2 to 6A, 118 Stat. 2615 to 2618.
Page 7 GAO-06-273 Internet Access Tax 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.
Page 8 GAO-06-273 Internet Access Tax Moratorium

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.”8

 (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.

8

47 U.S.C. § 151 Note § 1105(5).
Page 9 GAO-06-273 Internet Access Tax Moratorium

Figure 2: Simplified Illustration of Services Purchased by Consumers

a

Traditional wireline telephone service, commonly referred to in the communications industry as “plain 

old telephone service” (POTS).

b

May 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 appendix I for further explanation.

Source: GAO and PhotoDisc (images).

Home, business, or 

other user Tax-exemptb

Subject to taxation

Providers including

telephone, cable, 

and wireless

companies

Internet access

package

(may include e-mail, Internet 

access, and instant 

messaging)

Video

POTSa

VoIP
Page 10 GAO-06-273 Internet Access Tax Moratorium

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.”9

 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. 

9

Some 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.
Page 11 GAO-06-273 Internet Access Tax Moratorium

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.

b

Depends on state law.

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 

Examples of services

provided:

• E-mail

• Internet access

• Instant messaging

Examples of end users:

• Home

• Business

• Government

• Education

Source: GAO and PhotoDisc (images).

Sell acquired 

servicesa to ISP

Sells bundled 

access services

to end user

ISP End user

Examples of services

provided:

• Capacity over a medium 

 (copper wire, coaxial cable, 

 fiber, wireless, satellite)

• Hardware to connect to capacity 

 (modem or equivalent)

• Server capacity and other 

 capabilities to create own Web

 presence (e-mail, Web site, Web

 hosting, etc.)

Providers of 

acquired services

Subject Tax exempt

to taxationb
Page 12 GAO-06-273 Internet Access Tax Moratorium

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.

Table 1: Summary of Case Study State Rough Estimates of 2004 Tax Revenue from Acquired Services

State

Collected taxes paid on 

acquired services

2004 revenue from taxes paid on acquired services (dollars in 

millions)

California $0
Page 13 GAO-06-273 Internet Access Tax Moratorium

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 

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

(Continued From Previous Page)

State

Collected taxes paid on 

acquired services

2004 revenue from taxes paid on acquired services (dollars in 

millions)
Page 14 GAO-06-273 Internet Access Tax Moratorium

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.10

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. 

10The 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.
Page 15 GAO-06-273 Internet Access Tax Moratorium

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. 

Table 2: Case Study State Officials’ Rough Estimates of Taxes Collected for 2004 

Related to Internet Access

Source: State officials.

Note: The accompanying text contains a discussion of general limitations of the state estimates of 

revenue from taxes.

a

According to a Mississippi official, although estimating a dollar amount would be extremely hard, the 

state believes the amount collected was at most $1 million.

b

Rhode 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.

c

Texas 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-byState Estimated taxes collected (dollars in millions)

California N/A

Kansas $9-10

Mississippi At most, 1a

North Dakota 2.4

Ohio 52.1

Rhode Island Less than 4.5b

Texas 50c

Virginia N/A
Page 16 GAO-06-273 Internet Access Tax Moratorium

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 accessrelated 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.11 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.

11In 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. 
Page 17 GAO-06-273 Internet Access Tax Moratorium

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.12 

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.13 

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 

12In our case studies, we found that even though the 2004 amendments did not affect the 

taxation of VoIP, some state and local officials were still very concerned about VoIP’s 

taxability. When questioned about the impact of the moratorium on his state’s financial 

situation, one official noted that the state was more concerned about what will happen with 

VoIP than about the current provisions of the 2004 amendments. Some local officials we 

interviewed were concerned that legislation like the 2004 amendments is a step toward 

eroding their ability to tax utilities such as telephone services. City officials were 

apprehensive that additional legislation will “piggyback” on the 2004 amendments, exclude 

services from state taxation, and eventually define VoIP as Internet access, having a severe, 

detrimental effect on revenues.

13Also see the first footnote in appendix I.
Page 18 GAO-06-273 Internet Access Tax Moratorium

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 service14 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 

14Care must be taken not to confuse cable television service and cable modem service, 

which is used to deliver Internet access. Cable television service providers may also 

provide cable modem service. Only cable modem service is subject to the moratorium.
Page 19 GAO-06-273 Internet Access Tax Moratorium

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.

Table 3: Characteristics Showing Variations among Case Study States 

Source: State officials and laws.

a

For purposes of this report, 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.

b

Rhode 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 

State Type of taxa

Taxing retail 

consumer 

Internet access 

services

Taxing acquired 

services 

State tax rate 

(percentage)

Local tax rate 

(percentage)

Exemptions of 

customer types or 

payment amounts

California N/A N/A N/A

Kansas Sales x 5.3 1.3 on average

Mississippi Gross 

income

x 7.0 N/A

North Dakota Sales x 5.0 1.0-2.0

Ohio Sales x x 5.5 1.0 on average Residential 

consumers

Rhode Island Gross 

receipts and 

sales

xb x 5.0,

6.0

N/A

Texas Sales x 6.25 2.0 limit First $25 of services

Virginia N/A N/A N/A
Page 20 GAO-06-273 Internet Access Tax Moratorium

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 
Page 21 GAO-06-273 Internet Access Tax Moratorium

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 
Page 22 GAO-06-273 Internet Access Tax Moratorium

of this report. GAO staff who made major contributions to this report are 

listed in appendix V.

James R. White

Director, Tax Issues

Strategic Issues
Page 23 GAO-06-273 Internet Access Tax Moratorium

Appendix I

Bundled Access Services May Not Be Taxed, Apendxies

but Acquired Services Are Taxable ApendxiI

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. 

1

Notwithstanding 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, § 45:12 (6th ed., 2005).

2

The 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.”
Appendix I

Bundled Access Services May Not Be Taxed, 

but Acquired Services Are Taxable

Page 24 GAO-06-273 Internet Access Tax Moratorium

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. 

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 
Appendix I

Bundled Access Services May Not Be Taxed, 

but Acquired Services Are Taxable

Page 25 GAO-06-273 Internet Access Tax Moratorium

“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.

3

As 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).
Appendix I

Bundled Access Services May Not Be Taxed, 

but Acquired Services Are Taxable

Page 26 GAO-06-273 Internet Access Tax Moratorium

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

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, 

4

47 U.S.C. §153(46).

5

DSL 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. 

6

There 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.
Appendix I

Bundled Access Services May Not Be Taxed, 

but Acquired Services Are Taxable

Page 27 GAO-06-273 Internet Access Tax Moratorium

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, § 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.

7

For 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.
Page 28 GAO-06-273 Internet Access Tax Moratorium

Appendix II

CBO’s Methodology for Estimating Costs 

Relating to Taxing Internet Access Services ApendxiI

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 nexus1

 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 

1

A state may only require an Internet seller to collect taxes if the seller has nexus, that is, a 

physical presence in the state.
Appendix II

CBO’s Methodology for Estimating Costs 

Relating to Taxing Internet Access Services

Page 29 GAO-06-273 Internet Access Tax Moratorium

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.
Page 30 GAO-06-273 Internet Access Tax Moratorium

Appendix III

Case Study States’ Taxation of Services 

Related to Internet Access ApendxiI

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. 

Table 4: Characteristics of Case Study States 

Source: State officials and laws.

a

For purposes of this report, 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.

b

See earlier text for a discussion of the limitations of the state estimates of revenue from taxes.

c

Rhode Island retail consumers did not pay this tax directly, but rather through the gross receipts tax 

paid by their providers.

d

According to Rhode Island officials, Rhode Island did not have an estimate for taxes collected on 

acquired services.

e

Texas officials did not provide us with an estimate of taxes collected for Texas localities.

State

Taxed retail 

consumer 

dial-up 

Internet 

access 

services

Taxed retail 

consumer 

cablemodem 

Internet 

access 

services

Taxed retail 

consumer 

DSL Internet 

access 

services

Taxed 

acquired 

services

Type of 

taxa

State tax rate 

(percentage)

Local 

tax rate 

(percentage)

Roughly 

estimated 

2004 state 

and local tax 

collections 

for all these 

services 

(dollars in 

millions)b

California N/A N/A N/A N/A

Kansas x Sales 5.3 1.3 on average $9-10

Mississippi x Gross 

income

7.0 N/A At most, 1.0

North Dakota x x x Sales 5.0 1.0-2.0 2.4

Ohio x x x x Sales 5.5 1.0 on average 52.1

Rhode Island xc xc x Gross 

receipts 

and sales

5.0,

6.0

N/A Less than 4.5d

Texas x x x Sales 6.25 2.0 limit 50e

Virginia N/A N/A N/A N/A
Appendix III

Case Study States’ Taxation of Services 

Related to Internet Access

Page 31 GAO-06-273 Internet Access Tax Moratorium

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 
Appendix III

Case Study States’ Taxation of Services 

Related to Internet Access

Page 32 GAO-06-273 Internet Access Tax Moratorium

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. 
Appendix III

Case Study States’ Taxation of Services 

Related to Internet Access

Page 33 GAO-06-273 Internet Access Tax Moratorium

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 accessrelated 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 
Appendix III

Case Study States’ Taxation of Services 

Related to Internet Access

Page 34 GAO-06-273 Internet Access Tax Moratorium

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 
Appendix III

Case Study States’ Taxation of Services 

Related to Internet Access

Page 35 GAO-06-273 Internet Access Tax Moratorium

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.
Page 36 GAO-06-273 Internet Access Tax Moratorium

Appendix IV

Comments from Telecommunications 

Industry Officials ApendxiIV
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 37 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 38 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 39 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 40 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 41 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 42 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 43 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 44 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 45 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 46 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 47 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 48 GAO-06-273 Internet Access Tax Moratorium
Appendix IV

Comments from Telecommunications 

Industry Officials

Page 49 GAO-06-273 Internet Access Tax Moratorium
Page 50 GAO-06-273 Internet Access Tax Moratorium

Appendix V

GAO Contact and Staff Acknowledgments ApendxiV

GAO Contact James R. White (202) 512-9110

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. 

(450433)
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