Reclassification Could Be Costly for Consumers

As a means to establish and promulgate new Internet rules, commonly referred to as net neutrality regulations, the Federal Communications Commission (FCC) appears to be on the verge of reclassifying Internet services from a less-regulated “information service” to a much stricter public utility-style “common carrier telecommunications service.” The regulatory capture of the Internet service industry has led FCC Commissioner Pia to raise concerns that these new regulations would prevent broadband offerings that could lower consumer prices, allow for government price regulation, invite regulatory micromanagement of broadband services, offer new class-action litigation opportunities to trial attorneys, and result in new taxes and fees that will ultimately increase consumer prices by $11 billion, according to one estimate.

You would think that higher consumer prices would be a concern to the FCC, since higher prices would discourage consumer adoption of broadband services. How ironic this is, considering that the FCC has long stressed the need to improve broadband available and affordability, and suggested that lagging adoption would justify regulatory intervention. How would higher prices achieve the FCC’s goals?

Why then open the doors to taxing broadband services? Could it be that controlling the Internet is more important to the FCC than helping consumers?

FCC Says the “Order will Not Impose” New Taxes

There has been some pushback by some pro-regulation advocates stating that the tax effect from reclassification would be zero, because: 1) the Internet Tax Freedom Act prevents new taxes on Internet access; 2) the Internet is an interstate service, which prevents state and local governments from taxing the service; and 3) the FCC could decide not to include universal service fund taxes on Internet services. The FCC Chairman seems in total agreement with this position, stating that “the order will not impose, suggest or authorize any new taxes or fees.”

These statements are factually incorrect. Reclassifying broadband services to a “common carrier” telecommunications service will – without any doubt whatsoever – expose these services to existing (not to mention potentially new) public utility and regulated telecommunications taxes. Did the FCC lie to the American people?

Internet Freedom Act Only Prevents Access Taxes

As to the Internet Freedom Act, it expires again on October 1st of this year, which would open the door to a host of new Internet access taxes that will not be addressed here. Avoiding these Internet taxes is reason enough for the moratorium to be made permanent, and a bill has been introduced to do just that. However, even if the tax moratorium becomes permanent, some taxation of Internet services would occur once reclassification occurs. This is because the moratorium applies to access taxes, but excludes income taxes, capital stock taxes, net worth taxes, property taxes and some fees.

In other words, as important as it is to make the moratorium permanent, that alone would not prevent taxation if broadband services are reclassified. Reclassification will lead to some immediate tax increases and open the doors for potentially new taxes – all because broadband services can be deemed a regulated telecommunications service, a common carrier service, or a public utility service.  This means that, if taxes rise, then so will consumer prices. The following identifies specific areas where broadband taxes can and will increase, even if the Internet moratorium is made permanent:

1. Tangible Property Subject to Higher Public Utility Taxes

Assuming that the Internet tax moratorium becomes permanent and if Internet services are reclassified as a common carrier service, states that tax the property and equipment of public utilities and regulated telecommunications services (and they typically tax this property at higher rates compared to other businesses and services) will now be able to tax the property of broadband service providers.  In other words, some states – like North Carolina, which defines a public service company to include companies regulated by the FCC – could immediately tax a service provider without having to pursue the more challenging course of securing legislative change. The result would be a significant increase in property taxes affecting wireless telecommunications, cable and other ISP providers immediately after reclassification occurs. Taxing broadband providers does not spare consumers these costs.

2. Intangible Property Subject to Higher Taxes

In addition, if states consider “intangible” property as taxable (such as Oregon), wireless providers may see their tangible broadband property and equipment taxed, but also the value of their spectrum, which is worth well over a hundred billion dollars. It should be repeated that many states levy higher property tax rates on utility and regulated telecommunications services, compared to other business property. As a result, taxing property will severely discourage broadband investment, and taxing spectrum will discourage auction participation and proceeds. Less investment and higher costs do not bode well for Internet consumers.

3. Mixed Use Can Broaden the Tax Base

Another major risk is that state and local governments will not discern what portion of a broadband provider’s plant and equipment is solely used for Internet connectivity. They might simply designate all of the firm’s property as “mixed use” and subject it to the full taxation as regulated telecommunications property. Therefore, broadband providers that provide video services, information services and other lines of business (such as applications and cloud computing services) could have their tangible and intangible property for other lines of businesses taxed at higher rates and under a broader base, exposing the entire business to these higher costs. These new costs will flow through to consumers in the form of higher prices.

4. Universal Service Taxes Are Certain

On another topic, the FCC says that federal universal service fees will not apply to broadband services, but later the Chairman’s proposal notes that reclassifying “bolsters universal service fund support for broadband service in the future through partial application of Section 254.” The current fund uses total interstate telecommunications revenues as its tax base, which means broadband (an interstate service) would eventually be subject to these fees. Just as FCC Commissioner Pai points this out, and there is no sugarcoating it, these universal service fees are coming and consumers will be on the hook to pay for it.

5. Privilege Taxes Are Likely

As in the case with universal service fees, the Internet tax moratorium does not prevent some other fees from being assessed onto broadband services, such as fees for state universal service, E-911, state and local Rights-of-Way, and those taxes imposed for a specific privilege, service or benefit. For example, if reclassification occurs, a state could tax broadband service providers for the “privilege to operate” in the state, just as it does for other utility or regulated telecommunications services. This means that broadband service providers could be subject to various fees and taxes, not unlike the telecommunications gross receipts taxes currently levied in Mississippi, Maryland and elsewhere.

6. Taxing Interstate Services Are Possible

The notion that states can’t take federal services is also mistaken. Interstate services are not exempt from state taxation, provided that “intrastate” traffic is estimated, according to a Supreme Court ruling on the wireline side, as well as federal law on the wireless side. That could lead to a whole host of new state taxes and state traffic studies on broadband providers, not unlike those imposed in the days of “Ma Bell.” All of this becomes possible, when broadband is a de facto regulated telecommunications service.

Conclusion: FCC Disingenuous with the Facts

So, did the FCC lie to the American People? At the very least, the FCC’s claim that reclassification of broadband services would not impose or authorize new taxes is a dishonest representation of the facts. While the ruling would mean that the FCC would not be directly imposing or ordering new taxes onto broadband providers or consumers, reclassification would open the doors for some existing taxes, as well the new taxes in the foreseeable future – even if the Internet Tax Moratorium becomes permanent.

The FCC was warned about these tax implications and their effects on consumers, but they have chosen to ignore it and pretend that it won’t happen. Instead, the majority appears ready to side with groups that want communications and the media to be government-owned and controlled.

With all of the immensely talented lawyers and economists at the “expert agency,” you would think they would not gloss over the empirical evidence. The fact is that the FCC’s reclassification of broadband services will raise consumer prices and this will reduce broadband demand by more than net neutrality would ever hope to create. The effects of higher prices and demand repression guarantee a reduction in consumer welfare.

If these regulations are not in the public’s interest, than whose interest do they serve?  Shame on the FCC.

Steve Pociask is president of the American Consumer Institute, a nonprofit educational and research institute.  While he has also been a member of the FCC’s Consumer Advisory Committee, the positions expressed here are solely his own. For more information about the Institute, visit Twitter — @consumerpal