America's independent, non-partisan advocate for overburdened taxpayers.

Letter


NTU Comments to FCC on Net Neutrality

April 26, 2010
By Andrew Moylan

Before the

Federal Communications Commission

Washington, D.C. 20554 

In the Matter of                                            

Preserving the Open Internet - GN Docket No. 09-191

Broadband Industry Practices - WC Docket No. 07-52

Reply Comments of the National Taxpayers Union

These comments are submitted pursuant to the Proposed Rulemaking on Preserving the Open Internet and Broadband Industry Practices by the National Taxpayers Union in reply to several proponents of so-called "net neutrality" regulations and the "National Broadband plan," which would give the Federal Communications Commission (FCC) vastly greater powers for establishing infrastructure for federal taxation of digital goods and services.

     1.  Recent Court Ruling States that Commission Lacks Legal Authority to Enact Net Neutrality Regulations

On April 6, 2010, the United States Court of Appeals for the District of Columbia ruled in the case of Comcast v. FCC that the Federal Communications Commission lacks the legal authority necessary to enact net neutrality regulations. In its decision, the Court was quite clear that the Commission does not have the power to enforce net neutrality regulations and that its legal defense of said authority was "flatly inconsistent" with previous cases.

While both parties agreed that the FCC lacked broad "express" regulatory discretion, the Commission argued that it derived its power from so-called "ancillary" jurisdiction. The Court roundly rejected that argument, stating that it would render current limits to the FCC's authority irrelevant and "virtually free the Commission from its congressional tether." Congress clearly did not intend to empower the Commission to regulate at its whim.

The Court's decision in the Comcast case makes it clear that, under the current regulatory regime, the FCC simply cannot legally enforce net neutrality rules.

     2.  Attempts to Reclassify Internet Services Under Title II Constitute End-Run Around Comcast Decision

Any attempt to change the Internet's regulatory structure from its current classification as a Title I information service should rightly be viewed with tremendous suspicion. The Internet has always been and should continue to be regulated under Title I. Proponents of the Title II "common carrier" service classification for the Internet betray a transparent motive that has little to do with consistent or streamlined rulemaking; they actually seek dramatically increased authority for the Commission to regulate the Internet.

The Internet has always been regulated under Title I, despite confusion deliberately engendered by net neutrality advocates. They claim that DSL was once regulated under Title II, but even that is only half true. Until 2005, DSL transport services were indeed regulated under Title II, owing to the traditional landline phone infrastructure that served as its backbone. But even before 2005, the Internet service components of DSL were always subject to Title I regulation. In any case, since that point, the Internet has very clearly been treated as a Title I "information service."

In fact, the Commission itself has firmly established time and again a position through declaratory rulings that the Internet is a Title I "information service." This consensus went unchallenged for years by parties on both sides of the ideological spectrum. Only when it became clear that net neutrality regulation was a legal impossibility under Title I did net neutrality proponents begin to seriously float the idea of reclassifying the Internet under Title II.

     3.  Net Neutrality Proponents Offer No Defense Against Property Rights Concerns

In NTU's January 14, 2010 comments, we stated that net neutrality could "threaten the Internet's ability to thrive by forbidding network providers from setting limits on the access of Internet content, applications, and services on the expensive infrastructure they have built." Free Press and other net neutrality proponents have offered no solution to this problem.

In its January 10 filing, Free Press discusses at considerable length the circumstances surrounding claims that such regulation would violate an Internet service provider's (ISP's) First Amendment rights (pages 134-141).[i]  They do not, however, include any discussion of the legitimate questions pursuant to a Fifth Amendment property rights claim.

Randolf J. May, President of the Free State Foundation, summarized the Fifth Amendment concerns well in recent testimony:

"[Net] neutrality mandates [raise] serious Fifth Amendment property rights issues under the Takings Clause. This is because the mandate to carry traffic that ISPs might otherwise choose not to carry, or to carry traffic at faster speeds than the service providers otherwise might prefer, or to refrain from charging more to those who impose greater capacity demands, is not costless. . . . Government mandates that impose such costs, but which, at the same time, restrict ISPs' freedom to recover such costs, implicate the ISP's property rights."

Proposed regulations would effectively commandeer control of private networks in pursuit of a "public purpose," in this case network neutrality, without any form of compensation. Net neutrality proponents have failed to prove that such regulation would be consistent with the Constitution and able to survive a legal challenge on Fifth Amendment grounds.

     4.  Proponents' Claims on Infrastructure Investment Ring Hollow

Contrary to most industry observers, Free Press argues at length that net neutrality regulations will not have the effect of reducing investment in Internet infrastructure. They claim that "[without] network neutrality, ISPs will have a strong incentive to reduce investment and make congestion commonplace in order to extract revenues from content providers willing to pay to avoid traffic delays." Free Press illogically assumes that companies wish to reduce infrastructure investment absent net neutrality regulations, despite mountains of evidence to the contrary.

This does not square with the ample evidence that competition between ISPs has largely been the story of the race to a bigger and better infrastructure. Industry analysts pay close attention to infrastructure investment news as a proxy for the future strength of a provider. Furthermore, the ISPs themselves are rushing not just to spend more on infrastructure, but to shout from the mountaintops about it.

As but one example, Verizon Wireless and AT&T Wireless have spent millions of dollars in a recent ad war about the relative size and strength of their mobile "3G" networks.[ii] This shows that a robust infrastructure is more than just a concern for bean-counters at the companies themselves, but a selling point for consumers as well. Furthermore, both broadband and wireless Internet services are highly competitive and thus not likely to engage in such price manipulation.

     5.  Broadband Plan's "National Framework" for Taxation Threatens to Raise Burdens on Consumers

The FCC's National Broadband Plan, released last month, offers the following statement:

"RECOMMENDATION 4.20: The federal government should investigate establishing a national framework for digital goods and services taxation.

The National Broadband Plan is focused on increasing beneficial use of the Internet, including e-commerce and new innovative business models. The current patchwork of state and local laws and regulations relating to taxation of digital goods and services (such as ring tones, digital music, etc.) may hinder new investment and business models. Entrepreneurs and small businesses in particular may lack the resources to understand and comply with the various tax regimes.

Recognizing that state and local governments pursue varying approaches to raising tax revenues, a national framework for digital goods and services taxation would reduce uncertainty and remove one barrier to online entrepreneurship and investment."

The best federal policy to "reduce uncertainty" and remove barriers to online entrepreneurship and investment would be to invoke the Interstate Commerce Clause and ban such taxes altogether. Establishing a national framework for digital goods taxation would undermine the U.S. Supreme Court's landmark decision in Quill v. North Dakota, which established that a company must have a physical presence in a state to be subject to taxation. Furthermore, it is a transparent attempt to gain more revenue for government without regard to sound and sensible principles of taxation.

Physical presence constitutes a business environment between a consumer and an in-state provider that the state or local government infrastructure might nominally facilitate. This relationship is, in essence, a quid pro quo: businesses charge their consumers in order to pay taxes to the relevant governments who provide the infrastructure and protection necessary to survive. For example, businesses pay property taxes to be sited and fuel taxes in order to transport physical goods. With digital goods, however, nothing is being transported over roads, no physical inventories exist beyond servers, and there isn't even any post-consumer content that requires disposal. Simply stated, there is no defensible taxable event and the federal government should not legitimize attempts to raise more revenue through unsound tax policy.

Those claiming that the federal government might impose a lower tax rate on such goods than might eventually be found in many states or localities are misguided. The Streamlined Sales and Use Tax Agreement has support from states precisely because it allows for flexibility in charging rates. Unfortunately, that leads back to the same complexity the Commission purports to address with the aforementioned "national framework." For this reason, it is clear that the only way for the federal government to simplify the taxation of digital goods would be to "round up" and impose the regime everywhere, including jurisdictions where taxes currently don't apply. That means higher levies for millions of Americans.

While it is plain that this maneuvering on digital goods taxation is intended to raise significant amounts of revenue, applying it solely to conventionally-defined consumer-based transactions is not likely to work. According to Census data, retail purchases of software, music, and video amounted to less than $6 billion in the most recent report available.[iii]  Downloaded music and video, as opposed to music and video ordered online and shipped by mail, is not likely to be worth much more. Most downloaded music is illegal, but much of that activity occurs overseas, so even if American law enforcement agencies were willing and able to concentrate on it, it would be unlikely to generate large returns. Legally downloaded music worldwide was worth less than $4 billion in 2008.[iv]

This means that digital goods taxes would be aimed at currently identifiable bases of taxation, namely business-to-business transactions.[v]  Such transactions already represent over 90 percent of all e-commerce, and much of it is already subject to sales and use tax. The Commission's "national framework" is likely to result in an additional tax on top of existing burdens, or at the very least higher rates borne by consumers.

     6.  Broadband Plan's Proposal to Bring Internet Connections into Universal Service Fund Is Potentially a Massive Tax Increase

In the National Broadband Plan's Recommendation 8.10, the FCC suggests expanding the Universal Service Fund (USF) in order to include broadband services as well. This would be a sizeable expansion in the base for this tax, leading to higher levies on consumers. It is also an underhanded way of circumventing the current Internet Tax Moratorium language, since it would not be considered "discriminatory" under the existing ban. This expansion would directly contravene Congressional intent expressed in Internet Tax Moratorium legislation.

While no concrete calculations are available, early estimates suggest that the Broadband Plan could increase costs on consumers by anywhere from $1 per month to as much as $10 per month.[vi] [vii]

Taxpayers take little comfort from the FCC's intention to eliminate wireline carriers from the USF by 2020. Similar promises have been made in the past, only to be broken. Perhaps the best example is the 3 percent telephone excise tax known as the "Spanish-American War Tax." Instituted in 1898 on what was then a luxury item, the tax was collected for more than a century after the end of the conflict and, contrary to popular belief, it has still not been repealed in its entirety. The portion attributable to local-only service still applies. Further, as witnessed with the digital television conversion subsidies and repeated extensions, there is no guarantee that promises of phasing out the USF for wireline carriers will occur.

In addition to many instances of fraud and abuse in the existing USF program, NTU has concerns that a large influx of money for broadband programs could lead to significant "mission creep." Rural electric cooperatives are an instructive model. Originally intended to expand electric power at low prices in rural communities, some have entered into exotic business lines such as propane sales and consumer loans. Taxpayers are right to worry that the USF subsidies for rural broadband services may also see significant "leakage" into unrelated projects.

The extension of USF taxes to Internet services may constitute the top of a very slippery slope. Most phone users, whether landline or wireless, are very familiar with the litany of taxes and fees that federal, state, and local governments impose. NTU is concerned that extending USF to broadband might encourage much higher overall burdens on Internet services.

Scott Mackey, an economist from Kimball Sherman Ellis in Vermont, has conducted some excellent work showing how federal USF charges on wireless services have contributed to extraordinarily high burdens on wireless consumers. This is instructive to a potential rise in Internet taxation. Mackey has shown that average combined state and local tax burdens on wireless services are nearly 50 percent higher than general sales and use taxes. [viii]  At least 28 percent of the excess burden is attributable to USF charges alone. If history is any guide, extending USF to broadband would set the stage for much higher costs on consumers.

Conclusion

For these and many other reasons, NTU urges the Commission to not forcibly reclassify the Internet in order to extend its regulatory authority, and to reject policies that would lead to even higher taxes on Internet consumers. No matter one's opinion on the net neutrality rule, most will agree that the Internet has so far been a tremendous success without the onerous regulatory and taxation burdens proposed. The Commission has an obligation to ensure that success continues by encouraging innovation and investment, not restricting and penalizing it.

Sincerely,

Andrew Moylan

Director of Government Affairs

 

Notes


[i] http://www.freepress.net/files/Free_Press_09-191_Comments.pdf

[ii] http://business-phone-service.tmcnet.com/topics/business-phone-service/articles/81722-att-verizon-ad-wars-continue.htm

[iii] http://www.census.gov/econ/estats/2007/table6.pdf

[iv] http://www.itfacts.biz/37-bln-of-digital-music-sold-in-2008/12441

[v] http://www.t2sa.org/wiki/revenue_losses_from_ecommerce/methodology/sales_and_use_tax_compliance

[vi] http://www.dslreports.com/shownews/What-You-Need-To-Know-About-The-National-Broadband-Plan-107389

[vii] http://www.fastnetnews.com/dslprime/42-d/2665-broadband-plan-4-am-tuesday

[viii] http://files.ctia.org/pdf/PostionPaper_Mackey_StateandLocalTax.pdf