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. Some state and local  governments raised additional tax revenues and applied existing taxes to  Internet transactions. Objectives, Scope, and Methodology

To determine the scope of the Internet tax moratorium, we reviewed the  language of the moratorium, the legislative history of the 1998 act and the  2004 amendments, and associated legal issues. Internet Access Services, Including Bundled Access Services, May Not Be Taxed, but Acquired Services May Be

The moratorium bars taxes on the service of providing access, which  includes whatever an access provider reasonably bundles in its access  offering to consumers. 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. A  tax on acquired services is not a tax directly imposed on the service of  providing Internet access. While the Revenue Impact of Eliminating Grandfathering Would Be Small, the Moratorium’s Total Revenue Impact Has Been Unclear and Any Future Impact Would Vary by State

According to CBO data, grandfathered taxes in the states CBO studied  were a small percentage of those states’ tax revenues. In general, any future impact related to the  moratorium will differ from state to state. According to Information in CBO Reports, States Would Lose a Small Fraction of Their Tax Revenues If Grandfathered Taxes on Dial-up and DSL Services Were Eliminated

In 2003, CBO reported how much state and local governments that had  grandfathered taxes on dial-up and DSL services would lose in revenues if  the grandfathering were eliminated. For instance, Kansas’s total includes about  $2 million for localities and North Dakota’s about $400,000 for localities. 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. 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. 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. 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. A broader view of what could be  included in Internet access bundles would result in potential revenue  losses much greater than we indicated. On the other hand, the moratorium does not bar  taxes on acquired services. 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. This was about 0.02 percent of Mississippi’s 2004 tax revenues of about   $5.1 billion.
Why GAO Did This Study

According to one report, at the end of 2004, some 70 million U.S. adults logged on to access the Internet during a typical day. As public use of the Internet grew from the 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. This report's objectives are to determine the scope of the moratorium and its impact, if any, on state and local revenues. For this report, GAO reviewed the moratorium's language, its legislative history, and associated legal issues; examined studies of revenue impact; interviewed people knowledgeable about access services; and collected information about eight case study states not intended to be representative of other states. GAO chose the states considering such factors as whether they had taxes grandfathered for different forms of access services and covered different urban and rural parts of the country.

What GAO Found

The Internet tax moratorium bars taxes on Internet access services provided to end users. GAO's interpretation of the law is that the bar on taxes includes whatever an access provider reasonably bundles to consumers, including e-mail and digital subscriber line (DSL) services. The moratorium does not bar taxes on acquired services, such as high-speed communications capacity over fiber, acquired by Internet service providers (ISP) and used to deliver Internet access. However, some states and providers have construed the moratorium as barring taxation of acquired services. Some officials told us their states would stop collecting such taxes as early as November 1, 2005, the date they assumed that taxes on acquired services would lose their grandfathered protection. According to GAO's reading of the law, these taxes are not barred since a tax on acquired services is not a tax on Internet access. In comments, telecommunications industry officials continued to view acquired services as subject to the moratorium and exempt from taxation. As noted above, GAO disagrees. In addition, Federation of Tax Administrators officials expressed concern that some might have a broader view of what could be included in Internet access bundles. However, GAO's view is that what is included must be reasonably related to providing Internet access. The revenue impact of eliminating grandfathering in states studied by the Congressional Budget Office (CBO) would be small, but the moratorium's total revenue impact has been unclear and any future impact would vary by state. In 2003, when CBO reported how much states and localities would lose annually by 2007 if certain grandfathered taxes were eliminated, its estimate for states with grandfathered taxes in 1998 was about 0.1 percent of those states' 2004 tax revenues. Because it is hard to know what states would have done to tax access services if no moratorium had existed, the total revenue implications of the moratorium are unclear. In general, any future moratorium-related impact will differ by state. Tax law details and tax rates varied among states. For instance, North Dakota taxed access service delivered to retail consumers, and Kansas taxed communications services acquired by ISPs to support their customers.