July 20, 2004

by Michael Mazerov

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The Senate Commerce Committee is scheduled to mark up S. 2281, the “VOIP Regulatory Freedom Act of 2004” on July 22.  Sponsored by Senator John Sununu, S. 2281 would limit the application of existing federal and state telecommunications regulations to new “voice over Internet protocol” (VOIP) technologies.  In a variety of ways, these technologies use the Internet itself or the Internet’s underlying “language” to carry telephone calls.  As is the case with e-mail and World Wide Web “pages,” VOIP breaks voice phone calls into small digital “packets” that are transmitted over various public and private telecommunications networks and then reassembled into voice at the receiving end.

S. 2281 does not address only regulatory issues, however.  Section 7 of the proposed legislation provides that “No state or political subdivision [thereof] shall impose any tax, fee, surcharge, or other charge for the purpose of generating revenues for governmental purposes on the offering or provision of a VOIP application.”  This is a major problem because it is widely anticipated that all or nearly all voice communication eventually will be transmitted using Internet protocol-based technologies.  If enacted into law, this language would:

Whatever the Congress may ultimately decide about the appropriate federal and state regulatory treatment of VOIP services, there is no need to dictate a ban on state and local taxation now.  There is no evidence that state and local governments are seeking to discriminate against VOIP services; they simply wish to apply the same categories of taxes that apply to traditional phone calls and telecommunications providers to VOIP services and providers.  Cellular telecommunications grew extremely rapidly in the 1980s and 1990s without a federal ban on state and local taxation, and, to the extent that VOIP is perceived to fulfill consumer wants and needs, it can similarly expect to enjoy rapid growth — state and local taxation notwithstanding.[3]

If the Commerce Committee wishes to align S. 2281 with the policy expressed in S. 150 that preserves the authority of states and localities to tax VOIP services, the best course of action would be to strip Section 7 from the bill and substitute explicit language like that contained in S. 150 that preserves both taxes on the sale of VOIP services and taxes on the property and profits of VOIP providers.  Merely eliminating Section 7 is not sufficient, because language elsewhere in the bill preventing state and local government “burdens” on VOIP could be construed as banning taxation.  This could lead VOIP providers to challenge the legality of most state and local taxes on VOIP services, even if no specific ban on state and local taxation were included.

If the Commerce Committee is not prepared to add language to S. 2281 explicitly preserving the taxability of VOIP services and providers, however, it could simply delete Section 7.  This would likely ensure the continued collection of most state and local taxes applicable to VOIP services until such time as litigation answered the question as to whether the regulatory provisions of S. 2281 independently banned state and local taxes.

End Notes:

[1] Letter to Senator Lamar Alexander from CBO Director Douglas Holtz-Eakin regarding S. 150, the “Internet Tax Nondiscrimination Act,” dated February 13, 2004.

[2] The sponsors of S. 150, the pending “Internet Tax Non-discrimination Act,” were willing to acknowledge that state and local taxes imposed on the profits and property of Internet access providers could be considered indirect taxation of the Internet access service itself, and they accepted the inclusion in the bill of an explicit provision preserving such taxes.

[3] This is not to say that there may not be an appropriate role for Congress at some point in the future in regulating how states and localities tax VOIP services.  The growth of mobile telecommunications engendered certain ambiguities and inconsistencies in state and local taxation that proved troublesome for the industry and state/local governments alike.  These were resolved through the joint industry-government development and ultimate approval by Congress of the Mobile Telecommunications Sourcing Act (MTSA), which provides for a place of primary use-based system of taxing cellular phone calls and other mobile communications.  No significant evidence has yet emerged that the advent of VOIP raises tax administration questions beyond those already addressed by the MTSA, but should such questions arise in the future it could be appropriate for Congress to address them.