Flaws in Free Press’s Alternative Estimate of New State and Local Fees Attributable to Reclassification

In reply to a PPI study that I co-authored with Bob Litan, Free Press issued an alternative estimate of the annual consumer burden associated with reclassifying broadband as a Title II service. Free Press is not arguing over the fact of consumer injury; they are just quibbling over the extent of the damages. Whereas our study placed the estimate at $15 billion in new state and local fees for broadband consumers, Free Press arrives at a mere $4 billion in new fees. As their report states:

If the FCC reclassifies broadband access as a Title II service, it will also (based on precedent) declare that broadband is a purely interstate telecom service. Because broadband access is interstate and not intrastate, none of the intrastate taxes or special telecom fees would apply. The only taxes that could apply would be state sales taxes levied on interstate telecom services. Even if you used PPI’s fuzzy math, this would amount to approximately $4 billion in total, nowhere near the $15 billion sum Singer and Litan cite.

Free Press makes at least six erroneous claims in its reply (as well a few personal attacks on me and on PPI that I will ignore). This response is meant to set the record straight.

Claim 1: “Because broadband access is interstate and not intrastate, none of the intrastate taxes or special telecom fees would apply.”

While state utility commission regulatory authority is limited to intrastate services, state taxing authority has never been limited this way. Accordingly, the only state or local taxes in our analysis that could possibly be avoided if the FCC were to declare broadband to be an interstate service would be the state-based universal service fees adopted pursuant to state utility commissions. Yet these fees make up one component of several state-based charges and taking them out of the calculations does not materially reduce the fee burden on consumers. For example, in California, in addition to a “Universal Lifeline Telecom Service Surcharge,” telecom service providers are assessed a State 911 Surcharge, a Local 911 Surcharge, a Public Utility Commission Fee, a California Teleconnect Fund Fee, a Universal Lifeline Telecom Service Surcharge, and a Utility Users Tax.

Notwithstanding the fact that state-based universal service fees represent one of several state-based telecom fees, we don’t know whether the FCC would declare all broadband services to be interstate. For example, in a proceeding involving reciprocal compensation for dialup Internet traffic, the FCC held that such traffic was “jurisdictionally mixed and largely interstate in nature.” Thus, it’s speculative for Free Press to claim that the FCC would declare all broadband service to be interstate here.

Further, there are already a handful of states that assess universal service fees on interstate voice revenues, including South Carolina and Vermont. This suggests that, when push comes to shove, there is no ironclad protection from taxation if the state decides it wants to grab those revenues.

Free Press’s claim that state sales taxes are the only state taxes or fees that would survive if the FCC declares broadband to be an interstate service is simply wrong. To the extent that a state adopts any tax or fee under its general tax authority, from property taxes to gross receipts, rather than under the authority of a public utility commission, the hypothetical interstate designation affords zero protection. The reason that states haven’t been able to tax broadband services isn’t because of any FCC interstate classification, but because of a federal statute that has prohibited taxes by states on Internet access, a point I’ll address in a bit.

Claim 2: “PPI’s argument also ignores the possibility that the FCC and Congress could take additional steps to remove or limit any future taxes or fees.”

Litan and I conceive that the FCC could in theory forbear from assessing federal universal service on broadband revenues but that would be at odds with the fact that the FCC has effectively converted the focus of the universal service fund from voice to broadband. And the agency’s willingness to increase the E-Rate plan by $1.5 billion this year demonstrates the political forces at work to expand program demand. How could the FCC decline a similar infusion for its LifeLine program once it expands the assessment base to include broadband in light of its recent E-Rate decision? One can hear the lobbyists knocking at the door.

Claim 3: “Whether or not the FCC does [forbear], adding broadband into the USF mix wouldn’t impact the fund’s overall size.”

Litan and I conceive that reclassification by itself (absent the powerful political forces) does not imply an increase in program demand for the federal universal service fund (FUSF). Indeed, when calculating the new federal fees from reclassification, we conservatively assumed no increase in program demand. Adding broadband revenues to the mix, however, does alter the consumer burden in two important ways that are lost on Free Press.

First, whereas the FUSF is largely financed today by voice customers (long-distance in particular), the fund would be largely financed by broadband customers (which might be a different set of customers) if the FCC proceeds to reclassify broadband as a telecom service.

Second, and more importantly, whereas the fund is split fairly evenly between business and residential voice customers, the fund would be largely financed by consumer broadband customers under reclassification. Indeed, Litan and I estimate that the consumer burden would shift from 50 percent to 62 percent of the contribution base, as the consumer contribution (compared to business) of broadband revenues is proportionally greater than the consumer contribution of long-distance revenues.

Claim 4: “Just as the FCC can decline to extend USF assessments to retail broadband access at this time, it also has the authority to preempt states from doing so.”

It is not clear that the FCC has the authority to preempt states from taxing in whatever method the states see fit. Indeed, the FCC traditionally has been loathe to preempt states from acting in areas even where the agency has been given authority to act. Section 253 of the Act authorizes the FCC to preempt state laws that would impair a carrier from providing interstate or intrastate telecom services. It’s hard to see how assessing fees on broadband would impair any carrier from providing broadband services. At most, such fees would reduce broadband penetration by squeezing out marginal (price-sensitive) customers. But that’s a far cry from impairing entry by a provider.

Claim 5: “If Congress doesn’t renew this [Internet Tax Freedom] Act, which expires on Dec. 11, this all becomes moot: There will be new taxes no matter what the FCC does.”

If the Internet Tax Freedom Act (“ITFA”) is not renewed—that is, if nothing prevents the states from taxing broadband access—the states will be largely free to apply taxes to broadband access. As noted above, this has been the most important obstacle (besides reclassification) that has blocked states from grabbing a portion of broadband revenues. What Free Press fails to recognize, however, is that if the ITFA is not renewed and the FCC reclassifies broadband, then states will be encouraged to assess such taxes since the feds will have defined broadband as a telecom service on which states already have assessed taxes and fees.

Claim 6: “If Congress wants to renew this special exemption, making sure it applies to Internet access after the FCC reclassifies is a very easy legislative fix.”

Free Press admits that, as the ITFA is currently written, if the FCC were to reclassify broadband as a Title II service, a legislative fix is needed to ensure that the current protection would extend to telecom services. Stated differently, Free Press admits that the ITFA as currently written would not prevent these new taxes if broadband were reclassified. If there was any doubt on their views, Free Press estimated that the application of state taxes to broadband revenues would generate $4 billion per year, an admission that the ITFA offers no protection as written.

In regards to the likelihood of an amendment, the language of the ITFA has been roughly the same for more than 15 years. The notion that there could be changes to the ITFA to avoid this outcome is farfetched.

* * *

Free Press concludes that “If the FCC does nothing more than stick with precedent and designate broadband as an interstate telecom service, the average potential increase in taxes and fees per household would be far less than PPI estimates.” It seems like they have conceded the big issue: Free Press and PPI are now arguing over the extent of the pain inflicted on broadband customers. To reduce the estimate from $15 to $4 billion, however, Free Press has badly misconstrued the telecom landscape. Dialing back the vitriol in their response might permit them to think more clearly.

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