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Analyzing the Internet Tax Freedom Act: GFOA strongly opposes a permanent extension of the Internet Tax Freedom Act, which was originally enacted to safeguard the Internet when it was a nascent industry.

GFOA has paid special attention to the Internet Tax Freedom Act (UFA) since it was introduced in 1998, in an effort to protect the tax bases and fiscal strength of state and local governments. GFOA's membership recognizes the crucial nature of Internet in a community; residential and commercial access to broadband helps attract and retain residents and businesses as well as enabling many municipal operations to revolutionize the delivery of public services. But providing the rights-of-way that allow customers to access the Internet comes at a price to local governments. The ITFA has been temporarily extended several times, allowing federal legislators to take an industry litmus test between each iteration in order to decide the appropriateness of the moratorium. The most recent ITFA would extend the moratorium permanently, an effort that would block local governments from an essential revenue stream generated by a utility that shows no signs of halting its evolution. GFOA strongly opposes a permanent extension of ITFA and has stepped up efforts during this Congressional session to educate elected officials about ITFA's direct and indirect fiscal effects of on local governments throughout the United States.

GROWTH OF THE INTERNET

The purpose of the original bill was to safeguard the Internet, then a nascent industry, from any costs that might harm its growth (1)--but of course the Internet has become an integral part of everyday life across diverse parts of society. Internet use has exploded with the help of the ARRA's federal Broadband Technology Opportunity Project grants and investments made by the Internet service provider industry. Together with the efforts of state and local government groups, these investments have resulted in an industry with a product so widely used that describing it as nascent is incompatible with the data provided by the service providers themselves. The internet is no longer a budding industry; it is a thriving industry with a service relied upon by the global community.

Service providers and analysts report astonishing statistics about the volume of data transmitted over the Internet now and what is expected in the near future. In a recent study, researchers found that a staggering 84 percent of American adults use the Internet to accomplish a host of tasks. (2) They will use the Internet so much that annual global IP traffic is projected to reach 2 zettabytes per year by 2019. (3) (To help understand the magnitude of this number, the report says that by 2019, the gigabyte equivalent of all movies ever made will be streamed every two minutes.) This isn't especially surprising, as more and more traditional cable television subscribers are moving on to streaming video. This creates a cycle--fewer people are paying for cable and satellite television, service decreases, and more people stream movies and television, increasing Internet traffic. (4)

Individuals, businesses, and governments across the globe are increasingly performing tasks online that were once done manually. The so-called Internet of Things is one of the latest iterations (e.g., wearable devices that track activity, sleep patterns, and other personal information). Local governments are finding new ways to participate in the Internet of Things as well (e.g., applications that provide real-time data-driven management across urban systems, including water, energy, waste, and transportation). Motivated by an investment of $160 million from the White House, smart cities are making an expansive effort to transform livability and technological communications throughout the United States. (5)

Local governments build critical infrastructure and simultaneously provide right-of-way for telecommunications providers to build the last mile of infrastructure to get the service to citizens. In contrast, Internet firms often decide whether or not to build critical infrastructure based on density rather than need, making sure their capital costs are covered. Governments can often recover these costs through franchise fees and right-of-way fees. Jurisdictions are doing everything in their power to keep up with this rapid expansion, including expedited permitting and finding ways to reduce costs that will otherwise delay private investment in broadband infrastructure. Federal initiatives also encourage coordination between the industry and local government to expand broadband penetration. The recently introduced Broadband Conduit Deployment Act of 2015 (H.R. 3805) would require states to evaluate the need for broadband conduits whenever they dig up roads for a federally funded project. Simply having that conduit already installed will significantly reduce the costs of broadband deployment for Internet service providers. (6)

The sheer size of the industry suggests that Internet companies would be able to weather fiscal challenges. Together, the four largest Internet service providers (Comcast, AT&T, Time Warner Cable, and CenturyLink) reported combined earnings of $224.8 billion in 2014. The wired world is doing quite well; it is no longer a nascent industry needing special preemptive federal tax protection to grow and prosper. To the contrary, as more services make the transition from telecommunications and cable to broadband, the scope of what the ITFA covers will greatly expand, even if the ITFA's current language remains unchanged. Over time, the ITFA will essentially exempt an entire--and enormously fast-growing and prosperous--sector of the economy from state and local taxation.

CONCERNS ABOUT THE LEGISLATION

Despite GFOA's continued efforts to inform and educate congressional leaders about the fiscal challenges ITFA places on local governments, the bill continues to progress. A House version of the permanent ITFA (H.R. 235) passed in July 2015. The track of the identical Senate version (S. 431) is still unclear thanks to Senate local government champions who feel strongly that if localities are forced to forego revenue from telecommunications tax, then that revenue should be replaced by some other form of revenue--in the form of the estimated $23 billion in use taxes generated by the Marketplace Fairness Act. While encouraged by this approach, GFOA would also like to see special consideration of local government finances as the Senate deliberates ITFA's place in the continuing resolution to fund the federal government beyond 2015.

One of GFOA's concerns about the effect the ITFA/MFA strategy could have on local governments regards the flow of funds. In many states, most or all of the sales tax revenue flows through the state first, and a portion of the revenue is then redistributed to the localities. On the other hand, in states that allow for telecommunications taxes, they are typically assessed and collected at the locality, allowing the revenue sources to stay local. Fundamentally, the legitimate taxation of telecommunications is a matter of state and local sovereignty. Financially, the legitimate taxation of telecommunications is a matter of $96 million to localities in Wyoming, $390 million in Illinois, $237 million in Tennessee, more than a billion in California and, as a grandfathered state, a loss of nearly $25 million to localities in North Dakota. These figures represent the telecommunications taxes foregone by the present moratorium.

If that analysis considers the definitions (or lack thereof) within the legislation, the financial impact on local governments intensifies. The permanent ITFA defines "taxes" broadly to include state and local right-of-way fees, cable franchise fees, and other fees in addition to prohibiting the inclusion of telecommunications/broadband services in local utility taxes. Cable television franchise fees were first used to compensate local governments for expenses associated with the installation of cable along government-owned rights-of-way and with the administrative expenses of local rate regulation and consumer protection. But a major change occurred in 1984 with the passage of the federal Cable Communications Policy Act. Local governments were limited to a maximum municipal franchise fee of five percent. This fee was continued under the Federal Telecommunications Act of 1996, which contained language allowing the fee to be extended to new technologies that compete with standard cable television delivery methods and also use public rights-of-way so municipalities might recoup some of their expanding costs. Franchise fees mean $658,000 in income for Maryville, Tennessee, more than $2 million for Aurora, Illinois, and nearly a half of a million dollars for Jackson, Wyoming.

The permanent ITFA also doesn't distinguish between the Internet and broadband, or a higher-speed Internet service delivered via fiber. As more services make the transition from telecommunications and cable to broadband, the scope of what the ITFA covers will greatly expand. To protect the tax bases and fiscal strength of state and local governments, GFOA will not support anything more than a short-term extension of the ITFA. We need more time to allow for the full scope of the transition from telecommunications/cable to broadband, and we need to more meaningfully assess the costs that would be imposed on state and local governments by ITFA preemption.

THE BIGGER PICTURE

When considering a permanent extension of the ITFA, Congress also needs to consider the challenge to localities' telecommunications tax bases caused by switching from cable television to Internet streaming. In the absence of franchise fees, right-of-way fees, and telecommunications taxes on the Internet, the citizens who have not yet transitioned their telecommunications to the Internet will be burdened with the costs of continued Internet expansion (e.g., the costs of the capital projects required, such as excavating roads in order to lay fiber or cable). Other telecommunications revenues like traditional telephone services must be taxed at a greater rate, meaning the poorer, largely rural consumers of telephone services will have to pay higher taxes, while wealthy, largely urban and suburban, consumers escape taxes by "cutting the cord" and moving all their communications services to broadband. Narrowing the tax base forces localities to concentrate on the tax base that remains. Likewise, at the business level, industries like retailers, manufacturers, and other general businesses, as well as utilities like electric, water and gas services, will have to pay higher taxes, while the enormously profitable broadband/telecommunications industry will not.

At its core, this legislation grants special privileges to the Internet industry and preempts state and local government taxing authority. The Constitution assigns certain responsibilities to the federal government and reserves the balance to the states, so when federal policies preempt the roles of state and local governments in areas of responsibility that legitimately belong to the states, they violate the principles of our federal system of government. Where the federal government has a legitimate policy concern, it should work with state and local governments, which are partners with the national government in our federal system. Any federal law preempting state and local taxing authority must have a sunset date, especially one like the Internet Tax Freedom Act (ITFA), which over time will exempt an entire sector of the economy from state and local taxation.

The states with the grandfather provision have the most to lose by a permanent extension. A permanent ITFA eliminates the protection for states that imposed such taxes before the act was enacted. These revenue figures range from $13 million in South Dakota to an estimated $358 million in Texas--revenues flowing directly to the local governments' public service delivery that would be completely eliminated by this legislation.

Finally, this legislation also brings about the potential for litigation. The sunset date in the current ITFA has acted as an effective restraint against aggressive litigation by the telecommunications industry, in attempts to use the act in ways that were clearly not intended. Such litigation will be significantly restrained if the industry knows that state and local officials might have an opportunity to alert members of Congress that the ITFA has been used in ways that were not intended, and that Congress is required to revisit the issue. If the moratorium becomes permanent, Internet companies would likely bring suit against municipalities that charge franchise and right-of-way fees, asking courts to determine the application of the extremely broad and very ambiguous language found in the act, particularly related to the definition of discriminatory taxation. The costs of expensive litigation against states and localities are always borne by the taxpayers. And if Congress approves a permanent moratorium, it will be without the means or the will to reexamine these negative effects on states and localities and their constituents.

CONCLUSIONS

GFOA strongly opposes a permanent extension of ITFA and has stepped up its efforts to educate elected officials about the act's direct and indirect fiscal effects on local governments throughout the United States. Congress will likely take up this legislation in late December 2015 while it considers the short-term continuing resolution of the long-term omnibus spending bill. Now is the time to get involved. GFOA continues to inform legislators that while it recognizes that Internet access is crucial to our communities, there is often a cost to local governments, and users of other telecommunications services have to make up the difference. The Internet service provider industry is well past its infancy, and a permanent extension of this legislation would have devastating effects on local governments. GFOA encourages its local government Congressional champions to do what is necessary to protect state and local sovereignty.

Notes

(1.) The initial bill protected the revenue stream of states that already taxed the service--North Dakota, South Dakota, Texas, Wisconsin, Ohio (for commercial customers), Hawaii, and New Mexico--which are still protected by this grandfather clause.

(2.) Andrew Perrin and Maeve Duggan, "Americans' Internet Access: 2000-2015," Pew Research, June 2015.

(3.) "The Zettabyte Era--Trends and Analysis," Cisco, May 2015. (www.cisco.com)

(4.) Tim Stenovec, "Streaming services really are convincing people to ditch cable, and it's only going to get worse," Business Insider, May 12, 2015.

(5.) Administration Announces New "Smart Cities" Initiative to Help Communities Tackle Local Challenges and Improve City Services, White House fact sheet, September 14, 2015.

(6.) Opening Statement of the Honorable Greg Walden Subcommittee on Communications and Technology Hearing on "Breaking Down Barriers to Broadband Infrastructure Deployment," October 28, 2015. (http://energycommerce.house.gov)

EMILY SWENSON BROCK is senior policy advisor in GFOA's Federal Liaison Center in Washington, D.C.
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Title Annotation:Federal Focus; Government Finance Officers Association
Author:Brock, Emily Swenson
Publication:Government Finance Review
Geographic Code:1USA
Date:Dec 1, 2015
Words:2289
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