Congressional gridlock threatens to tax the Internet

Since enactment of the Telecommunications Act of 1996, promoting the deployment and adoption of advanced communications services, in particular high-speed Internet service (or broadband), has been a formal policy goal of the United States. Billions have been spent to encourage deployment and adoption, and billions more will be spent each year as a result of Universal Service reform, Rural Utilities Service grants and loans, and other programs. Some progress has been made, but more is needed. However, should Congress fail to extend (or, even better, make permanent) the Internet Tax Freedom Act (ITFA) this November, much of this progress could be quickly erased.

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By way of background, when the Internet was in its nascency, Congress sought to encourage adoption by keeping prices affordable. To do so, Congress passed the ITFA, which imposed a three-year moratorium on the imposition of (new) state and local taxes on Internet access. Given that state and local governments aggressively and discriminatorily tax communications services, the moratorium aimed to reduce prices significantly and, consequently, encourage adoption. Since 1998, this moratorium has been extended three times, and is due to expire again in November 2014. While there is generally broad bipartisan support to extend — if not make permanent — the ITFA's moratorium, given congressional gridlock, there are no guarantees.

With November 2014 rapidly approaching, the question policymakers now need to ask themselves is how a failure to extend the ITFA will affect these efforts to expand broadband adoption? Using both economic theory and empirical evidence, it is possible to make some predictions about the economic effects of failing to extend the ITFA. It isn't pretty.

States and municipalities aggressively tax communications services, typically levying taxes well in excess of sales taxes. Under plausible assumptions, allowing states and municipalities to tax Internet connections would have a significant adverse impact on adoption rates. In fact, for fixed connections (e.g., cable modem, DSL and fiber), a 5 percent effective tax rate would undo the last four years' adoption gains, while a effective tax rate of 10 percent would reverse six years of fixed-line growth. In other words, a failure to extent the IFTA would take the country back to adoption rates in 2008, unwinding significant and sometimes costly progress.

Failure to extend the ITFA would also adversely affect wireless adoption. While wireless service adoption has been growing rapidly in the last few years, imposing state and local taxes on wireless broadband connections could easily reset the adoption rate to levels seen two or three years ago.

All told, under plausible conditions, we could be looking at a total loss of between 30 to 60 million broadband connections should Congress fail to extend or make permanent the ITFA, thereby reducing the economic and social benefits of broadband connectivity. Higher prices are also likely to negatively impact lower income households.

But there is more bad news:

For example, while the Organisation for Economic Co-operation and Development's (OECD) broadband rankings are no longer used by most analysts as a policy-relevant measure of relative adoption, it should be noted that the fall in adoption caused by a failure to extend (or make permanent) the tax moratorium is also likely to lower the United States' rank in broadband adoptions per capita. For fixed-line connections, a loss of 5 million connections (which is plausible) would lower the U.S. one spot in the OECD's rankings. At the higher end, a loss of 13.5 million fixed lines would force the U.S. to fall from a rank of 16 to 21. For wireless, a plausible loss of 30 million lines (a 10 percent drop in adoption) would move the U.S. from the seventh to the ninth spot in the OECD's rankings of mobile broadband adoption.

The international aspects of failing to renew the ITFA do not end with lowering the United States' place in OECD rankings for broadband adoption, however. Over the years, some have argued that U.S. broadband prices are "too high" relative to the rest of the world. While these studies have generally been discredited, one cannot dispute the fact that the imposition of state and local taxes will cause U.S. broadband prices to rise vis-a-vis the rest of the world.

Moreover, great effort has been extended to ensure that the Internet stays free from foreign government control (including the ability to "tax" the Internet”). However, if the U.S. fails to extend the ITFA, then the U.S. might look a bit hypocritical in future negotiations regarding Internet governance. Clearly then, allowing the ITFA to lapse — and, by extension, explicitly condoning the ability of state and local governments to tax the Internet at will — is not a positive example of American exceptionalism.

It is axiomatic that taxes reduce consumption. Given that a key policy goal of the U.S. government for the last 20 years has been to increase broadband adoption — a goal to which we have allocated billions of dollars over the years— choosing now to reduce broadband consumption by letting the ITFA expire is an odd and counterproductive policy.

Ford is the chief economist of the Phoenix Center for Advanced Legal & Economic Public Policy Studies, a non-profit 501(c)(3) research organization that studies broad public-policy issues related to governance, social and economic conditions, with a particular emphasis on the law and economics of the digital age. A full copy of Ford's formal analysis, "Should the Internet Tax Moratorium be Made Permanent?," may be downloaded free from the Phoenix Center's webpage here.