United States Government Accountability Office

GAO Testimony 

Before the Committee on Commerce, 

Science and Transportation, U.S. Senate

INTERNET ACCESS TAX 

MORATORIUM 

Revenue Impacts Will Vary 

by State 

Statement of James R. White 

Director, Tax Issues 

Strategic Issues 

For Release on Delivery

Expected at 10:00 a.m. EDT 

Wednesday, May 23, 2007

 

GAO-07-896T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

May 23, 2007

INTERNET ACCESS TAX MORATORIUM

Revenue Impacts Will Vary by State 

Highlights of GAO-07-896T, a testimony 

before the Committee on Commerce, 

Science and Transportation, U.S. Senate 

www.gao.gov/cgi-bin/getrpt?GAO-07-896T.

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. 

According to one report, at the end 

of 2006, about 92 million U.S. 

adults used the Internet on 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. The

objectives of the resulting 2006

report were to determine the scope 

of the moratorium and its impact, if 

any, on state and local revenues. 

This testimony is based on that

report (GAO-06-273). 

For the report, GAO reviewed the 

moratorium’s language, legislative

history, and associated legal issues; 

examined revenue impact studies; 

interviewed people knowledgeable 

about access services; and 

collected information about eight 

case study states not intended to

represent other states. GAO chose 

the states considering such factors 

as whether they had taxes 

grandfathered for different forms 

of access services and covered

different parts of the country. 

What GAO Recommends

GAO makes no recommendations 

in this testimony. 

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 

GAO when it was preparing its report that 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 

a

Depends on state law. 
Chairman Inouye, Vice Chairman Stevens, and Members of the Committee: 

I appreciate this opportunity to discuss the moratorium on taxing access 

to the Internet. According to one study, at the end of 2006 about 92 million 

U.S. adults used the Internet on 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 

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

digital subscriber line (DSL).4

 This year, bills have been introduced in both 

houses of Congress to make the moratorium permanent. 

My remarks today are based on the first of two reports we issued 

responding to the mandate that we study the impact of the moratorium. 

Issued in January 2006, that report focused on the moratorium’s impact on 

state and local government revenues.5

 Its objectives were to determine 

(1) the scope of the moratorium and (2) the impact of the moratorium, if 

 1

Pew Internet & American Life Project, Daily Internet Activities (Washington, D.C.: Jan.

11, 2007). 

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). 

4

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

have been “conditioned” to handle DSL technology. 

5

GAO, Internet Access Tax Moratorium: Revenue Impacts Will Vary by State, GAO-06-273 

(Washington, D.C.: Jan. 23, 2006). See the report for more details than this testimony 

provides about revenue impacts and for more appendixes, including one showing 

comments from telecommunications industry officials.

Page 1 GAO-07-896T 
any, on state and local revenues. In determining any impact on revenues, 

the report explored 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. The report did not focus on taxing the sale

of items over the Internet. A second report discussed the impact that 

various factors, including taxes, have on broadband deployment and 

adoption.6

To prepare the first 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 CBOgenerated 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 testimony contains a 

complete discussion of our objectives, scope, and methodology. 

Let me begin by summarizing the major points of the report:

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,

 6

GAO, Telecommunications: Broadband Deployment Is Extensive throughout the United

States, but It Is Difficult to Assess the Extent of Deployment Gaps in Rural Areas, 

GAO-06-426 (Washington, D.C.: May 5, 2006). 

Page 2 GAO-07-896T 
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 when we were preparing our report that their 

states would stop collecting them as early as November 1, 2005, the date 

they assumed that taxes on acquired services would lose their 

grandfathered protection. However, according to our reading of the law, 

the moratorium does not apply to acquired services since, among other 

things, a tax on acquired services is not a tax on “Internet access.” 

Nontaxable “Internet access” is defined in the law as the service of 

providing Internet access to an end user; it does not extend to a provider’s 

acquisition of capacity to provide such service. Purchases of acquired 

services are subject to taxation, depending on state law. 

The revenue impact of eliminating grandfathering in states studied by CBO 

would be small, but the moratorium’s total revenue impact has been 

unclear and any future impact would vary by state. In 2003, CBO reported 

that states and localities would lose from more than $160 million to more 

than $200 million annually by 2008 if all grandfathered taxes on dial-up and 

DSL services were eliminated, although part of this loss reflected acquired

services. It also identified other potential revenue losses, although 

unquantified, that could have grown in the future but that now seem to 

pose less of a threat. CBO’s estimated annual losses by 2007 for states that 

had grandfathered taxes in 1998 were about 0.1 percent of the total 2004 

tax revenues for those states. Because it is difficult to know what states 

would have done to tax Internet access services if no moratorium had 

existed, the total revenue implications of the moratorium are unclear. The 

1998 moratorium was considered before connections to the Internet were 

as widespread as they later became, limiting the window of opportunity 

for states to adopt new taxes on access services. Although some states had 

already chosen not to tax access services and others stopped taxing them, 

other states might have been inclined to tax access services if no 

moratorium were in place. In general, any future impact related to the 

moratorium will differ from state to state. The details of state tax law as 

well as applicable tax rates varied from one state to another. For instance, 

North Dakota taxed access service delivered to retail consumers. Kansas 

taxed communications services acquired by Internet service providers to 

support their customers. Rhode Island taxed both access service offerings 

Page 3 GAO-07-896T 
and the acquisition of communications services. California officials said 

their state did not tax these areas at all. 

In oral comments on a draft of our January 2006 report, CBO staff 

members said we fairly characterized CBO information and suggested 

clarifications that we 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 the appendix, we believe that what is 

bundled must be reasonably related to accessing and using the Internet. In 

written comments, company representatives disagreed with GAO by 

commenting 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. 

We made no recommendations in the report, and we are not making any 

recommendations in this testimony. 

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 

Background 

Page 4 GAO-07-896T 
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

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 

Page 5 GAO-07-896T 
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.7

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 years8

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

9

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 

 7

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 have 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 did not focus 

on taxing the sale of items over the Internet. 

8

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

9

Internet Tax Nondiscrimination Act, 2004, Pub. L. 108-435, §§ 2 to 6A, 118 Stat. 2615 to

2618. 

Page 6 GAO-07-896T 
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.

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. 

Objectives, Scope, 

and Methodology 

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 7 GAO-07-896T 
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 Access 

Services, May Not Be

Taxed, but Acquired 

Services May Be 

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.”10 (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. 

 1047 U.S.C. § 151 Note § 1105(5). 

Page 8 GAO-07-896T 
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 the appendix for further explanation. 

Page 9 GAO-07-896T 
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.”11 For example, acquired services include ISP leases of highspeed communications capacity over wire, cable, or fiber to carry traffic 

from customers to the Internet backbone. 

Acquired Services May Be 

Taxed 

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. 

 11Some 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 10 GAO-07-896T 
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 

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 the appendix. 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

Page 11 GAO-07-896T 
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

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

Source: State officials.

Note: The next section contains a discussion of general limitations of the state estimates of revenue 

from taxes. 

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. 

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 

Page 12 GAO-07-896T 
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. 

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 

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.12

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 

 12The 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 13 GAO-07-896T 
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. 

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

Related to Internet Access 

State 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

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 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 

Page 14 GAO-07-896T 
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. In this state 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. 

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.13 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. 

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. 

 13In 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 15 GAO-07-896T 
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. 

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. 

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. 

Page 16 GAO-07-896T 
Table 3: Characteristics Showing Variations among Case Study States 

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

Source: State officials and laws. 

a

For purposes of this testimony, 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 

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 

Page 17 GAO-07-896T 
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. 

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 January 2006 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 made 

as appropriate. In one case, we 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. 

External Comments 

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 the 

appendix, 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. 

Page 18 GAO-07-896T 
When meeting with us, representatives of telecommunications companies 

said they would like to submit comments in writing. 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 the appendix. That appendix, along with the 

section of the testimony on bundled access services and acquired services, 

contains an explanation of our view that the language and structure of the 

statute support our interpretation. 

Mr. Chairman, Mr. Vice Chairman, and Members of the Committee, this 

concludes my testimony. I would be happy to answer any questions you 

may have at this time. 

For further information, please contact James R. White on (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 

testimony. Individuals who made key contributions to this testimony 

include Michael Springer, Assistant Director; Edda Emmanuelli-Perez; 

Lynn H. Gibson; Bert Japikse; Shirley A. Jones; Lawrence M. Korb; 

Donna L. Miller; Walter K. Vance; and Bethany C. Widick. 

Contacts and 

Acknowledgments 

Page 19 GAO-07-896T 
Appendix I: Bundled A

Be Taxed

ccess Services May Not 

, but Acquired Services Are Taxable 

Page 20 GAO-07-896T 

Appendix I: 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.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.

The original definition of Internet access, exempting “telecommunications 

services,” was changed by the 2004 amendment. Parties seeking to carve 

 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 21 GAO-07-896T 

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 

“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). 
Appendix I: Bundled Access Services May Not 

Be Taxed, but Acquired Services Are Taxable 

Page 22 GAO-07-896T 

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. 

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 

 

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 23 GAO-07-896T 

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, 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 

 

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. 

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. 
Appendix I: Bundled Access Services May Not 

Be Taxed, but Acquired Services Are Taxable 

Page 24 GAO-07-896T 

“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. 

 “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. 

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