Testimony – State Taxation of Interstate Telecommunications Services (David Quam)

Chairman Cannon, Ranking Member Watt, distinguished members of the committee, my name is David Quam and I am the Director of Federal Relations for the National Governors Association (NGA). I appreciate the opportunity to appear before you today on behalf of NGA to discuss issues related to the taxation of communications services at the state and local level.

Last year NGA embarked on an ambitious effort to develop consensus between representatives of the communications industry and state and local officials regarding the future of state and local taxation of communications services. For over eight months participants representing the wire-line and wireless telecommunications sectors, cable and satellite television and state and local governments met to examine the issues raised by the current systems of taxation, formulate principles for reform, and if possible, craft a consensus for promoting changes that could benefit industry, government and consumers.

Through those discussions several points became clear:

  • The current system of taxation is complex and does not completely reflect today’s market for communications services.
  • Industry views certain state and local tax practices and requirements as barriers to their ability to compete in an increasingly competitive marketplace.
  • State and local government officials are committed to encouraging innovation and deployment of communications services while also protecting the public interest and providing for the needs of their citizens.

The last two points proved the most difficult to reconcile. From the industry perspective, the days of monopoly service have given way to a competitive and evolving marketplace. Traditional state and local tax laws, which are generally based on the technology used to deliver communications services, distort the marketplace by disproportionately favoring one industry over another. The solution proposed by the telecommunication industry was to end specific telecommunications taxes and treat telecommunications service providers like a “general business.”

In contrast, state and local officials recognized the need to modernize existing tax laws, but stressed that reform also must reflect government’s responsibility to protect the public interest and remain cognizant of the need for state and local governments to balance their budgets and structure their revenue systems.

In the end, these competing interests prevented consensus, but they also made it clear that the complexity of state and local tax systems requires that long-term comprehensive solutions evolve from states — not the federal government. The ability of states to structure their revenue systems is a core element of sovereignty that must be respected by the federal government. Congress therefore can best support state tax modernization by avoiding federal action that will restrict the ability of states to craft meaningful reforms.

In 2000, NGA’s Center for Best Practices issued a paper calling for Governors and state legislators to “reexamine the state and local tax treatment of the telecommunications industry.” (“Telecommunications Tax Policies: Implication for the Digital Age,” NGA Center for Best Practices, 2000). The report concluded that existing state and local tax systems were ill-suited for the modern telecommunications marketplace, stating:

“[S]tate and local telecommunications tax systems are not competitively neutral. In many cases, the current tax structure favors some segments of the industry over others. In other instances, the tax burden on the telecommunications industry is greater than that of other industries. In either case, telecommunications companies are not competing on a level playing field. The current tax system forces these companies to compete not only on the basis of economic factors, but also on the basis of the tax differential among them.”

The report went on to recommend that state policymakers review their state telecommunications taxes with goals of increasing tax efficiency, competitive neutrality, tax equity and administrative simplicity. Importantly, however, the report recognized that many of its reforms are not revenue neutral and that the fiscal impacts of any changes on state and local government “need to be a major focus of any proposals.”

State Telecommunications Tax Reforms
Since 2000, several states have taken up the mantel of telecommunications tax reform. As noted in the Council on State Taxation’s 2004 State Study and Report on Telecommunications Taxation (COST Study), simplification reforms in Florida, Illinois, Ohio, Tennessee, and Utah decreased the number of tax returns that a telecommunications provider must file by 18,610. More recent reforms in Missouri and Virginia have gone even further. The Missouri law, which will take effect Aug. 28, 2006, expands the municipal tax base by making it clear that providers of cell phone and other wireless telecommunications are subject to the same tax as wired telecommunications. In return, the state (rather than municipalities) will collect the tax and apply a new 5 percent ceiling to all municipalities by 2010.

Virginia’s new communications tax law is even more comprehensive, streamlining existing state and local taxes into a statewide, flat-rate structure and eliminating local cable-franchising fees. Beginning January 1, 2007, the commonwealth will collect the tax and disburse rebates to municipalities on a share basis reportedly equal to what they now gather from the existing tax structure. In addition, a statewide rights-of-way use fee will be applied to all cable-TV service lines in the same way it is currently applied on all local exchange telephone lines. Supporters of the law maintain the new measure will raise approximately the same amount of revenue that municipal authorities now receive from local taxes and franchise fees. The standardized rate is distributed evenly among communication services resulting in reductions in the monthly phone bill for most residential customers.

States have also supported wide-ranging telecommunications tax reforms as part of the Streamlined Sales and Use Tax Agreement. Under the Agreement, states are required to adopt uniform definitions and administrative rules in return for collecting sales taxes from remote vendors that volunteer to participate in the Agreement. The Governing Board (the governing body for the Agreement) recently adopted uniform definitions for telecommunications services that will require changes to the tax laws of the Agreement’s member states. The benefits of the Streamlined Agreement – central collection; uniform definitions, customer remedy procedures and sourcing rules; and notification of and limitations on local rate and boundary changes – represent critical reforms that will significantly reduce complexities and ease providers’ administrative requirements.

Opening a Dialogue
While states worked individually to modernize their tax systems, it was the debate over how to best extend the federal Internet access tax moratorium that underscored the need for states and local governments to work with communications providers to address state tax issues.

A key part of the extension debate was how to level the perceived tax disparities between telecommunication and cable broadband offerings and address the rise of new Internet-based services such as Voice-over-Internet-Protocol. Those industry sectors not subject to the moratorium argued for their inclusion to promote competitive neutrality. Those subject to the moratorium argued to preserve their exempt status; and those outside the moratorium fought to prevent the transfer of any additional tax responsibility to their industry. The debate illustrated the difficulties states face in modernizing their tax systems to make them competitively neutral: industry sectors that stand to gain from reform support state efforts; industries with an existing competitive advantage due to state or federal restrictions fight to maintain the status quo.

Following passage of the extension, NGA called for an open a dialogue between state and local elected officials and industry representatives to examine current taxation practices, compare principles and priorities for reform, and determine whether any consensus exists for modernizing state and local communications taxes.

State and local government associations worked together to develop key principles to help guide discussions with industry. First, reforms should be technology neutral, focusing on the service provided rather than the technology used to provide the service. Such a change would decrease discriminatory tax treatment between competing service providers and allow for greater certainty for new entrants.

Second, reforms should be revenue neutral for state and local governments. Estimated at over $20 billion annually, telecommunications taxes not only support general revenues, but are often allocated at the local level to pay for specific purposes ranging from education to improving public safety systems. The potential to significantly reduce state and local revenues is one of the primary difficulties with simply subscribing to the demand of the telecommunications industry to be taxed like “general business.” The COST study asserts that the average effective rate of state and local transaction taxes for telecommunications services is 14.17%, compared to only 6.12% for general business. Mandating a reduction of telecommunications rates to those of general businesses would therefore require a 51% decrease in state and local tax rates. Actual revenue losses would likely exceed the $6.987 billion difference estimated in a November 2001 study prepared by Ernst & Young LLP for the Telecommunications State and Local Tax Coalition.

Third, the federal government should not preempt state and local taxing authority. Governments at the federal, state and local level have long recognized that communications services play a unique and critical role in modern society that may require different regulatory and tax treatment from those imposed on general businesses. State and local jurisdictions must also balance their budgets. A federal mandate restricting state taxation of telecommunications to a general business level would represent an unwarranted restriction on states’ sovereign authority to structure their own revenue systems and force states to either cut spending or increase revenues to cover the loss.

Fourth, the role of state and local government in preserving public interest obligations should be maintained. The responsibility of managing public-rights-of-way, funding public safety infrastructure, providing consumer protection and promoting universal service are critical state and local functions. Reforms to state and local tax systems should not undermine government’s ability to carry out its responsibilities to protect the public interest.

Fifth, reform cannot happen overnight. The complexity of state and local tax systems does not lend itself to an immediate or one-size-fits-all solution. Reform should incorporate the interests of all affected parties and allow for sufficient transition time to fully implement comprehensive reforms.

A modern communications infrastructure that provides high-quality, reliable, and affordable communications services is essential to the economic competitiveness of states and the nation. Recent technological advancements in communications services are fundamentally changing the manner and means by which consumers communicate with one another. These changes have led to the development of new services, greater competition and increased consumer choice. Technological advancements also pose challenges for states, which generally tax communications services based on the technology used to provide the service rather than the service itself. Left unchanged, these laws will create inequities between competing service providers and diminish state communication tax bases as new technologies evolve beyond existing laws.

Although NGA’s efforts to develop consensus recommendations for reform were not immediately successful, Governors continue to support state efforts to modernize their tax systems in a manner that promotes innovation and competition, encourages investment, preserves state authority, provides necessary resources and advance the public interest.