THE DISPARITY BETWEEN HOW
TRADITIONAL PHONE COMPANIES AND INTERNET PHONE COMPANIES ARE REGULATED AND
TAXED: WHAT THE LEGISLATURE CAN DO TO PROTECT PUBLIC SERVICES AND TO SAVE
TRADITIONAL INDUSTRIES FROM INTERNET-BASED
COMPETITORS
I. INTRODUCTION
The internet has been left mostly free
from taxation and regulation since it’s rise to mainstream popularity in
the late 1990’s. In 1998, Congress enacted a moratorium on taxing
internet commerce by passing the Internet Tax Freedom
Act,
[1] which made it illegal to tax
Internet Service Providers (“ISP’s”) as well as to tax most
forms of electronic commerce.
[2]
Congress did this to “preserve the vibrant and competitive free market
that presently exists for the internet... unfettered by federal or state
regulation.”
[3] The Act was
extended in 2001 for two additional years, but it expired in November of 2003
and has yet to be extended.
[4] While
some feel it is imperative to keep the internet free from some forms of
taxation, there is growing debate over whether the government can continue to
forfeit this tax revenue.
[5] Because
online companies have replaced or infringed upon so many other tax-generating
industries, public policy may require that the legislature act to save public
services and protect traditional industry.
The Voice over Internet Protocol
(“VoIP”) industry illustrates how internet-based companies have the
potential to devastate traditional industries and deplete federal, state, and
local treasuries. VoIP technology turns a computer into a phone and requires
nothing more than an internet connection, a microphone, and
software.
[6] Until recently, the VoIP
industry posed little threat to traditional phone companies because call quality
was poor and most users did not have access to the broadband internet
connections that were required for making VoIP
calls.
[7] In addition, VoIP services
initially only allowed calls to be made from one computer to another
computer.
[8] The technology has since
advanced to allow calls from computers to traditional phones as well as (in some
cases) from traditional phone to traditional phone (with VoIP
adapter)
[9]. With broadband
connections becoming more common
[10]
and the quality of VoIP calls said to rival that of traditional phone
services,
[11] some experts believe
that VoIP could soon be poised to replace the traditional telecom
industry.
[12] Because other
traditional industries will likely soon face threats similar to that currently
posed by the VoIP industry, how the legislature deals with VoIP may determine
the rules by which future internet-based technologies will be allowed to
compete.
In October 2003, a Minnesota District Court dealt a major victory to
the VoIP industry by ruling that the Minnesota Public Utility Commission could
not regulate and tax VoIP companies as it does traditional telephone
companies.
[13] The opinion was
based primarily on the fact that VoIP services transmit voice calls over the
internet rather than over conventional phone
lines.
[14] Unlike companies
offering only VoIP services, the telecom industry is currently taxed by federal
and state authorities and regulated for purposes such as public safety and
universal access.
[15] Although
society stands to benefit from new, more efficient technology that can often be
offered at a cheaper cost, when allowed to exist unfettered by regulation or
taxation, society may stand to lose more than it gains from such companies.
This is because the public derives benefits both directly and indirectly from
the taxation and regulation imposed on VoIP and other traditional
industries.
[16] Access to the 9-1-1
emergency system, just to name one example, is the product of regulation. In
2003, federal excise taxes (of which telecom taxes are included) accounted for
4% of total federal tax revenue.
[17]
While the telecom excise tax alone accounts for only about five billion in
federal tax revenue each year,
[18]
state and local jurisdictions impose additional taxes on telecom services.
California, for example, imposes a 4.83% sales tax on intrastate
calls
[19] and local taxing
jurisdictions (cities and counties) in the state impose additional surcharges
and taxes ranging from zero to
11%.
[20] While taxing and
regulating the VoIP industry (once the transition is further along) may seem
like a logical response to this potential revenue and benefits shortfall,
similar taxes and regulations may be difficult to impose due to the online
nature of the VoIP industry.
This paper will address what steps must be
taken by the legislature to address the disparity between how traditional phone
companies and VoIP companies are treated for tax and regulatory purposes. It
will begin with a brief background of the telecom industry and the VoIP
industry, followed by an analysis of the Minnesota Court opinion (the first
court opinion on this issue).
[21]
Next, this paper will identify the specific legal issues that need to be
addressed. It will then discuss the tax and regulatory disparity, as it exists
under current law, and analyze how a change to existing law may affect the VoIP
and telecom industries, consumers, the general public, and the nation’s
treasuries. Finally, this paper will discuss the effects this treatment may
have on other industries and future internet-based technologies.
II. BACKGROUND
The telecommunications industry has been regulated since
shortly after Alexander Graham Bell’s invention of the telephone some 125
years ago.
[22] Mississippi was one
of the first states to regulate the industry by implementing “common
carrier” regulations that provided the terms and conditions whereby the
public could make use of their phone
services.
[23] In 1894, Bell’s
patents on the telephone expired and thousands of competitors began wiring the
nation,
[24] allowing the number of
daily calls to increase
exponentially.
[25] Bell’s
company, AT&T, only controlled forty-nine percent of local phone service by
1907.
[26] To the dislike of federal
authorities, AT&T began to buy out its rivals to defend against competition.
In the midst of antitrust threats, AT&T proposed what became known as the
“Kingsbury Commitment,” in which AT&T agreed to sell thirty
million dollars of its Western Union stock and to allow competitors to use its
vast network.
[27] The company also
promised that for every new local phone competitor it acquired, it would sell an
equal share of lines to other
rivals.
[28]
A. TELECOM INDUSTRY AS MONOPOLY
Even in the early days, AT&T marketed the telephone industry as a
“natural monopoly.”
[29]
As the dominant provider, AT&T benefited the most from the government
creating regulatory barriers against new companies entering the
market.
[30] The “natural
monopoly” theory was based on the idea that it was a waste of time and
money for multiple companies to build the infrastructure required to provide
telecom services.
[31] Since only a
few companies had access to these large, expensive infrastructures, it was
difficult for other companies to
compete.
[32] By 1925, telecom rates
were regulated across most of the nation, and competition was either discouraged
or explicitly prohibited.
[33]By
1934, telecommunications were so important that Congress passed the first
Communications Act and founded the Federal Communications Commission
(FCC).
[34] The Communications Act
recognized the importance of universal service by providing that communication
by wire and radio be made available "so far as possible, to all the people of
the United States ...a rapid, efficient, nationwide, and worldwide wire and
radio communication service with adequate facilities at reasonable
charges."
[35] Such a provision
resulted in some subscribers (in densely populated areas) paying marginally
higher prices for phone service so that those in rural areas could be offered
phone service at a price that average consumers could afford (often less than
actual cost).
[36] With few
exceptions, the FCC required that all Americans have telephone service and the
industry was regulated to ensure that this objective was
met.
[37] Congress also authorized
the FCC to impose service requirements at regulated
rates.
[38] In addition to this, any
deviations in product or service required government
approval.
[39] To a lesser extent,
these regulations still exist in the telecom
industry.
[40]Over time, it
became apparent that implementation of the “natural monopoly”
approach to the telecom industry had negative
consequences.
[41] Because telecom
companies were guaranteed a certain rate for their services they were not under
pressure to operate under an efficient business model and technological
advancement was not pursued
aggressively.
[42] Furthermore, this
approach led many to view competition as a threat –- much as VoIP is seen
by some as a threat despite the fact that it represents the possibility of a
cheaper, more efficient replacement for traditional telephone
service.
[43]After many decades
of regulating the industry as a pure monopoly, Congress passed the 1996
Telecommunications Act at a time when the telecom industry was becoming less
monopolistic due to technological advances that blurred the distinctions between
various types of communications.
[44]
The 1996 Act decreased industry regulations and was designed to encourage new
competition within the industry and persuade companies in the private sector to
upgrade the nation’s telephone
networks.
[45] The Act did not have
the expected effect because the FCC, to some extent, continued to regulate the
industry as if it was still a
monopoly.
[46] For example, even
after 1996, the FCC required established telephone companies (such as Verizon
and SBC) to lease their networks to new companies trying to become established
within the industry.
[47] Skeptics
argued that the prices fixed by the FCC for gaining access to these networks
were so low that companies new to the industry had no incentive to invest in
creating new networks.
[48] On the
other hand, companies leasing their networks to companies new to the industry
had no incentive to improve existing networks or to create new
ones.
[49] This is just one example
offered to illustrate the state of the telecom industry as it stands today.
Traditional phone companies are still taxed and regulated much like monopolistic
utility companies despite efforts on the part of the legislature to deregulate
the industry.
B. GROWTH OF THE INTERNET AND THE BIRTH OF VOIP
VoIP
companies first began offering services in the mid-1990’s, even before the
internet moratorium was imposed.
[50]
Early VoIP services were plagued by low quality calls resulting from new
technology and lack of broadband availability to most
consumers.
[51] With many of the
technological problems now addressed and access to broadband more
common,
[52] VoIP’s user base
has risen to levels at which the traditional phone companies can no longer
ignore.
[53] Perhaps even more
discomforting to the telecom industry than VoIP technology itself is the public
response to recently released VoIP services. Such enthusiasm suggests that VoIP
offers something to consumers that traditional phone services
lack.
[54]Consumers have mainly
been attracted to the low rates that VoIP companies can afford to offer partly
because the industry is unregulated and
untaxed.
[55] One regulation on
traditional phone companies, for example, requires they provide service even in
areas in which it is not profitable to do so—so that those living in
desolate areas of the country may also have telephone service. To meet this
requirement, the telecom industry has historically passed this expense on to
consumers—in the form of higher
rates.
[56] The VoIP industry is not
subject to this or other regulations, which is one of the reasons it can offer
consumers more competitively priced services.
Significant additional cost
savings are a result of the fact that VoIP technology is comparably efficient
and does not require an immense and expensive infrastructure to
operate.
[57] With VoIP, a user
speaks into the telephone or microphone and the sounds are broken down into ones
and zeros, sorted into packets of information, and then transmitted across the
worldwide network of fiber
lines.
[58] When these packets reach
their destination, they are reassembled and turned back into sounds, which is
identical to how an email message is
transmitted.
[59] In the regular
phone network, calls are transmitted over less efficient copper wires and the
phone companies must maintain dedicated connections between
users.
[60] Data transmitted using
VoIP just mixes in with all the other information being transmitted over the
internet.
[61]
C. VOIP SERVICES BEGIN TO FLOURISH
In August of 2003, two Swedish
entrepreneurs
[62] released a new
VoIP product called Skype.
[63]
Skype software allows users to communicate for free from one computer to
another, and the company plans to upgrade the program in 2004 to permit free
calls from computers to traditional
phones.
[64] Over one million users
downloaded the software within weeks of its initial
release,
[65] and the two founders
have said that their goal is to make Skype the “global telephone
company”.
[66] While the
calling service is free, the company hopes to eventually make money by offering
services like voice mail and call
waiting.
[67] Despite the
overwhelming public interest it has generated, some experts feel that
Skype’s greatest drawback is that it doesn’t currently offer
services that allow connections between traditional
phones.
[68] Without such
capabilities, some feel Skype can be nothing more than a niche product that can
never penetrate the mainstream telecom
market.
[69] This is based on the
fact that many consumers still do not have broadband internet connections and of
those that do, many would rather not use a computer to make a
call.
[70] Lack of broadband usage
will not likely be a factor for long. A study released in April of 2004 showed
that two out of every five home internet users in the U.S. now subscribe to
broadband.
[71] In the same month
that this study was released, President Bush called for universal broadband
access by 2007.
[72]New
Jersey-based Vonage, on the other hand, has received much publicity because of
the traditional manner in which it offers voice calls over the
internet.
[73] Vonage allows VoIP
calls to be made using traditional phones installed with special VoIP adapters,
which are hooked up to broadband
connections.
[74] Vonage has a
quickly growing subscriber base of about
130,000
[75] (still a small market
share) and offers users unlimited worldwide VoIP calling for as low as $39.99
per month.
[76] Services provided by
Vonage do not require either caller to be on a computer. While most Vonage
customers will likely have computers anyway, the belief, at least for now, may
be that most customers are more comfortable making phone calls using a
traditional telephone. Traditional phone companies recognize this and are
lobbying even more aggressively for regulations to be imposed on VoIP companies
that offer services using standard
phones.
[77] At the same time,
traditional telecom providers have also begun to offer VoIP services of their
own.
[78] One of the nation’s
largest telecom providers, AT&T, plans to offer a major digital voice
service to businesses in 2004.
[79]
The company has also experimented with a pilot program offering services to home
consumers in New Jersey.
[80]
Another major player in the industry, MCI, expects to have made a complete
transition to VoIP by 2005.
[81] In
2001, Sprint announced plans to convert its entire existing network to packet
switching,
[82] which is the type of
network required for VoIP calls.
[83]
Even companies not traditionally associated with the telecom industry plan to
get into the act. In December 2003, Time Warner Inc.’s cable TV unit and
Qwest Communications International Inc. announced plans to offer VoIP services
to consumers.
[84]
D. JUDICIAL ANALYSIS OF VOIP
The courts may ultimately determine if
VoIP companies should be regulated and taxed. Since the treatment of the VoIP
industry may determine how future internet-based industries are treated, it is
important to recognize how the judiciary has analyzed the VoIP industry. A
Minnesota Court is the only court to perform this analysis to
date.
[85] This court’s opinion
was issued in response to a complaint filed by the Minnesota Department of
Commerce (“MDOC”), which investigated Vonage’s
services.
[86] The complaint alleged
that Vonage failed to (1) obtain a proper certificate of authority required to
provide telephone service in Minnesota; (2) submit a required 911 service plan;
(3) pay 911 fees; and (4) file a
tariff.
[87] MDOC also requested
temporary relief, asserting that Vonage should be (1) prohibited from marketing
to potential customers; (2) required to notify its Minnesota customers regarding
the issues before the MPUC; and (3) required to submit a 911
plan.
[88] The court concluded that
Vonage’s activities fit within the definition of information
services—not telephony
services.
[89] Because this is the
only court to address this issue, the distinction the court drew between
information services providers and telephony services providers is critical to
the discussion of taxation and regulation of VoIP providers and future
technologies.
[90] The court
acknowledged that Vonage provided services that were closely related to
telecommunications services as defined by Congress, the courts, and the FCC (for
purposes of regulation).
[91] It
determined, however, that Vonage
used telecommunications services, rather
than provided them.
[92] Most
importantly, the Court recognized that the backbone of Vonage’s service
was the Internet.
[93] It analyzed
congressional intent by examining the Internet Tax Freedom Act, which stated,
“It is the policy of the United States...to preserve the vibrant and
competitive free market that presently exists for the internet and other
interactive computer services, unfettered by federal or state
regulation.”
[94] The court
felt the intentions of Congress were clear in the wording of this Act, but it
recognized that Congress’ intentions did not apply to VoIP unless VoIP
companies were classified as information providers as opposed to
telecommunications providers.
[95]
The court relied heavily on documents from the FCC in determining the
appropriate
classification.
[96]After
analyzing these documents, the court concluded that the intention of the
legislative and administrative bodies was to treat VoIP companies as providers
of information services. It’s holding affirms the carefully crafted
distinction the FCC and Congress appeared to have drawn between telecom
providers and information
providers.
[97] In an FCC report to
Congress on this issue in 1998, the Commission recognized that the relationship
that information services providers often have with providers of
telecommunications services should remain
distinguishable.
[98] The report
stated that when a company “offers transmission incorporating the
capability for generating, acquiring, storing, transforming, processing,
retrieving, utilizing, or making available information, it does not offer
telecommunications.”
[99]
Rather, the Commission believed, it offers an information service even though it
uses telecommunications to do
so.
[100] The FCC also appeared
to understand that information services would be built on top of existing
telecommunications services, but made it clear that such services were not to be
regulated like telecommunications
services.
[101] The Commission
recognized that the rapid and expansive growth of the internet and other
enhanced services (which the FCC believed VoIP to
be)
[102] was partially due to the
fact that such providers were not “common carriers” within the
meaning of the 1996 Telecommunications
Act.
[103] The FCC explained that
communications networks function as overlapping layers, with many providers
often leveraging a common
infrastructure.
[104] The
commission explained that “as long as the underlying market for provision
of transmission facilities is competitive or is subject to sufficient
pro-competitive safeguards, we see no need to regulate the enhanced
functionalities that can be built on top of those
facilities.”
[105] It felt
that Congress, by distinguishing telecommunications services from information
services and by stating that the internet should be free from state or federal
regulation, agreed with this
distinction.
[106] The Commission
stated “Congress intended to maintain a regime in which information
service providers are not subject to regulation as common carriers merely
because they provide their services ‘via
telecommunications.’”
[107]
The FCC concluded that regulations should be limited to the companies that
provide the underlying networks, since this is the area where competition does
not exist fully.
[108] As proof
that this policy works, the FCC noted evidence that competition was strong among
companies offering VoIP and other enhanced internet services in which regulation
did not exist.
[109] The court
rejected the argument made by the Minnesota Public Utilities Commission that
because Vonage’s customers make phone calls, Vonage’s services must
be telecommunications
services.
[110] The court called
this reasoning a “quacks like a duck” argument, and felt it
oversimplified the issue.
[111] It
ruled that what Vonage provides is essentially the enhanced functionality on top
of the underlying network, which the FCC explained should be left
alone.
[112] The court found no
statutory intent to regulate VoIP, and determined that unless Congress speaks
more clearly on this issue, Minnesota may not regulate an information services
provider such as Vonage as if it were a telecommunications
provider.
[113] III. THE LEGAL
PROBLEM
The tax and regulatory disparity between VoIP providers and telecom
providers will be carefully considered by the
FCC
[114] and other courts in
2004.
[115] The outcome of this
investigation will likely impact companies that will utilize internet-based
technologies in the future, as well as the traditional industries against which
they will compete. The main legal issue is whether the legislature can tax and
regulate VoIP companies in the same manner as it does telecom companies, despite
the fact that VoIP providers transmit data over the internet (instead of over
the traditional telephone
network)
[116] and despite the fact
that the FCC and Congress have determined VoIP companies to be providers of
information services as opposed to telecommunication
services.
[117] If it is determined
that it is not appropriate to tax and regulate the VoIP industry as a telecom
company, the secondary issue is how to tax and regulate it in a manner that is
both effective and enforceable.
- ANALYSIS
It can be argued that the general public benefits
both directly and indirectly from the taxes and regulations that are imposed
upon traditional telecommunications
providers.
[118] Regulations
provide for universal phone access, 911 emergency access, and other federally
mandated services,
[119] as well as
a host of programs and other services funded, at least in part, by the tax
revenue generated by the telecom
industry.
[120] Some may argue
that the cost paid by the consumer (in the form of taxes) is greater than the
benefits received in return. This argument, while valid, is not specific to
telecom taxation but applies to all forms of taxation. Many of the regulations
on the telecom industry, on the other hand, are imposed for purposes such as
public safety and national security. While it can also be argued that these
services are not worth the cost that the taxpayer pays (indirectly, in the form
of higher prices), the government has determined that every taxpayer is entitled
to them.
A. THE BENEFITS OF TAXATION AND REGULATION OF TELECOM
INDUSTRY
The transition to VoIP currently threatens far more than just the
traditional telecom industry.
[121]
This threat is more tangible when viewed in terms of the potential loss in
regulation-generated revenue.
[122]
In the United States, current regulations require that the average long-distance
provider pay roughly two cents per minute for the origination and completion of
domestic interstate calls on the networks of local phone
companies.
[123] Telecom providers
can pay over 30 times as much to terminate calls
abroad.
[124] In addition, telecom
companies are under federal mandate to contribute approximately 7.2 percent of
company revenues for the support of affordable universal telephone
service.
[125] When viewed in
terms of lost sales tax, the potential loss in revenue is also quite
significant. While the federal government only receives about five billion per
year in telecom tax revenue, when combined with the state and local taxes
imposed on telecom, the cumulative effect is quite substantial. Save a few
states that do not tax telephone services at all, state sales tax rates on
telecom range from 3% to 11%.
[126]
On top of that, many local taxing jurisdictions impose additional taxation on
telecom services. The City of Los Angeles, for example, taxes telecom services
at a rate of 10%.
[127] While the
amount of tax revenue lost to the VoIP industry alone may be viewed by some as
absorbable by the government, if and when future internet-based technologies
begin replacing other industries, the amount collectively lost in tax revenue
may be truly devastating. Again, this is why the manner in which the legislature
deals with the VoIP industry is so significant.
B. PURPOSE OF
REGULATION
One historical purpose for regulation has been to prevent the
interruption of the supply of a commodity or service when there were high social
costs associated with such an
interruption.
[128] The theory is
that regulation in these industries promotes extra reliability by encouraging
additional investment.
[129]
The traditional telecom industry has been regulated in the past because the
reliability of nationwide phone service has been viewed as a critical
requirement for achieving and maintaining a robust economy and providing peace
of mind to all citizens through a reliable means of communication. Another
reason it has been regulated is that the high equipment costs associated with
providing telecom services made the industry monopolistic. Understanding the
unique role of this industry, the government allowed the monopoly to exist at
the price of having some control over how it operated. The VoIP industry is
currently quite competitive and will never likely become monopolistic because of
the comparably low costs associated with offering this technology. Since few
depend on VoIP as their primary method of communicating, the costs to society of
service disruption are also currently quite low. Based on these facts, it
appears that the VoIP industry does not match the profile of an industry
historically the target of regulation.
Even if VoIP continues to grow in
popularity and consumers in mass numbers embrace this technology as their
primary method of communication, competition within the industry means it may
never find itself the target of regulations for the same reasons the telecom
industry has historically been regulated. Due to the large number of VoIP
providers, an interruption in VoIP service is unlikely to produce unusually high
social costs. If one VoIP provider fails, the customer has access to numerous
others offering comparable services. Since the VoIP user base will likely be
spread across different providers, the interruption of any one provider will
produce negligible social costs. If the entire broadband network on which VoIP
calls are made were to be interrupted, it may be argued that the costs to
society would be high. It is still unclear whether the broadband industry will
become more competitive or will ultimately be controlled by the local phone
company. Only once this is evident will it be possible to determine whether
disruptions in broadband service will result in such a high impact.
While
standard phone service is still arguably an important part of a well-functioning
economy, various alternative technologies have diminished the importance of the
standard telephone. The advancement of cellular technology is the most obvious
alternative to the traditional telephone. In the past decade, cellular signal
coverage has not only expanded to cover most populated areas in
America
,[130] but
competition has driven prices down so that even modest income families can
afford some form of wireless phone
service.
[131] So, if a business
meeting between someone in California and someone in New York is disrupted due
to an interruption in standard phone service, the effect is no longer as
dramatic. Under these circumstances, the two individuals simply take out their
cell phones and within seconds can proceed from the point at which they were
interrupted. The same meeting could also be continued over instant messaging,
email, video conference, or other alternative technologies that the internet has
made possible. As a result of these alternative technologies, it is arguable
whether disruption of telephone service would any longer produce results that
are especially high to society. The advancement of VoIP technology will
decrease the impact even further. The original purpose for regulating the
telecom industry is diminishing, and there may soon be little justification for
regulating it at all.
C. POSSIBLE SOLUTIONS
The legislature has a
difficult task ahead in determining the best approach for addressing the
disparity in taxation and regulation between the VoIP and telecom
industries.
[132] It must not only
determine if an internet-based industry can be effectively regulated and taxed,
but also how to enforce such requirements if imposed. This section will address
several possible solutions for accomplishing this objective and the potential
problems with each proposal.
1. REGULATE VOIP COMPANIES AS TELECOM
COMPANIES
Part of the survival strategy of traditional phone companies is to
push for taxation and regulation of VoIP companies to the same extent as telecom
companies.
[133] One dilemma is
that the judiciary has held that VoIP companies cannot be taxed and regulated as
telephone companies.
[134] Unless
other courts or the FCC (upon re-analysis) view this differently in the future,
the classification of VoIP providers as information services providers means the
VoIP industry will not be taxed and regulated in the same way as the telecom
industry. To address this disparity, the legislature may need to devise an
appropriate taxation and regulation plan specific to the VoIP
industry.
2. IMPLEMENT TAXATION AND REGULATIONS SPECIFIC TO VOIP
INDUSTRY
Another possible alternative is for the legislature to implement
taxes and regulations that are specific to the VoIP industry. Even if the
legislature devises a regulatory and tax strategy specific to the VoIP industry,
it will be challenging to enforce regulations on an industry that it is
internet-based. While traditional phone companies provide a visible service
with physical equipment and locations, VoIP calls are transmitted with the rest
of internet traffic and VoIP companies may not require any offices or unusual
equipment. If taxation and regulation of VoIP is to succeed, the government may
need to create and implement a client side technology that is capable of
identifying VoIP calls. The government could require that VoIP providers make
it’s customers install a VoIP tracking application—perhaps an
application that launches on a user’s hard drive when a VoIP client
application (such as Skype) is launched. This application would need to
indicate the start and end of a VoIP call before it leaves the user’s
machine or VoIP phone (since once the data goes into cyberspace, it may be
impossible to identify), then be able to send this information to a government
maintained database, from which a tax bill could be generated. Of course, some
VoIP plans do not even require the use of a PC. In these cases, the government
could decide to tax calling plans as opposed to individual calls. Like the
cellular industry, some VoIP companies offer users unlimited calling plans for a
set fee. While this is much easier for the government to reach, it creates
additional problems concerning what to do with companies providing VoIP services
free of charge. There is also the problem of what to do with open source
versions of VoIP client software that are bound to circulate on the internet.
These may be hard to prevent—and the government may need to frustrate
users into using credible, tax collecting versions of VoIP by uploading many
defective versions of VoIP software. The music industry has employed similar
tactics against illegal music downloaders and had some success.
3. TAX
INTERNET USAGE—NOT VOIP CALLS SPECIFICALLY
Instead of focusing on
taxing and regulating VoIP calls, another possible alternative is for the
legislature to tax and regulate the aspect of VoIP that can actually be
grasped—the internet. The expiration of the Internet Tax Freedom Act in
2003 allows jurisdictions to legally begin taxing consumers for internet access.
One way to eliminate the problems associated with determining how to tax VoIP
calls is to simply tax all internet users, regardless of what tasks they perform
while using the internet. While this may be politically unpopular right now,
such an approach would not require all internet traffic be monitored for
content—one of the primary obstacles to taxing VoIP calls. The problem
with this approach is that it is over inclusive; it imposes taxes on all
internet users (even those not using VoIP) just to reach those who are using
VoIP to make calls (although I am sure the legislators will come up with many
other reasons why
all internet users should be taxed). This would allow
those who make dozens of VoIP calls a day to pay the same in taxes as someone
who utilizes the internet for no other purpose than to check their stock
portfolio twice a week.
A slightly fairer approach would be to tax on the
basis of how much data each user transmits over the internet—regardless of
it’s content. Such a method would not be
as over inclusive since
tax amounts would at least correlate with the amount of internet usage. It may
still be difficult to determine how much each taxpayer owes since there may be
no effective method for determining how much data each user sends over the
internet. Reliable software can probably be produced to record how many packets
of data a user has sent or received over a period of time, but monitoring the
usage of every internet user may prove to be impossible or not
administrable.
Consumers may stand to lose regardless of which tax and
regulatory strategy is chosen. While the VoIP industry’s lower rates may
be partly due to tax and regulatory advantages over the traditional telecom
industry, the VoIP industry is also more technologically efficient than
traditional competitors. Because of this, the costs of VoIP services
really
are lower—they do just appear lower because of tax and regulatory
freedom. If the latter were accurate, then protection of traditional telecom
may be warranted since the public would stand to lose various services and would
receive little benefit in return (other than marginally lower rates—at
least in the short-term). Only the traditional telecom industry would benefit
from regulations imposed for this purpose. Because the public potentially
stands to benefit greatly from VoIP in the form of
truly lower rates, the
legislature may try to deal with both industries in a way that combines the best
of what both industries have to offer consumers--VoIP’s truly lower rates
and traditional telecom’s services and features.
4. DO NOT TAX NOR
REGULATE THE VOIP INDUSTRY
Another possible approach is to simply keep the
VoIP industry free from regulation and taxation. Until now, one of the primary
attractions to VoIP is the fact that it provides services that are comparable to
traditional phone companies for free or at a fraction of the
price.
[135] If taxation and
regulation were imposed on this industry, VoIP companies would almost certainly
have to transfer some of these costs to consumers, making VoIP services less
affordable and less attractive to potential
customers.
[136] Services that
exist only as a result of regulation are also likely to disappear. Valuable
public services that telecom companies are currently required to provide include
universal access for telephone
service,
[137] services that allow
authorities to immediately locate anyone who dials
9-1-1,
[138] and the ability to
wiretap phone lines to find suspected criminals or
terrorists.
[139] Taxation and
regulation may also diminish progress and discourage future innovation. Besides
being anti-capitalistic, such action by the legislature could kill the growth in
the industry and deprive the public of what appears to be a cheaper, more
efficient alternative to the old telephone
network.
[140] VoIP represents a
potential alternative to an outdated methodology, and imposing regulations on
VoIP reduces the incentive for others to improve upon this technology and allow
it to spread.
[141] The absence of
regulation has so far allowed VoIP services to flourish and advance. Apple
Computer, for example, has already created free iChat software that allows voice
and video calls to be made from one Mac to another. Regulating and taxing VoIP
companies may have a significant negative impact on future technologies as
well.
[142] Individuals and
corporations may feel less incentive to invest time and money to create
something from which society will benefit if the belief is that the government
may step in and regulate it once it becomes a threat to major corporations or a
certain way of life.
D. FUTURE TECHNOLOGIES AND THE THREAT TO OTHER
TRADITIONAL INDUSTRIES
As stressed throughout this comment, allowing VoIP to
flourish without taxation and regulation sets a troubling precedent for future
technologies to follow. As the number of broadband subscribers increases, new
internet-based technologies will be developed to compete directly with other
traditional industries. The cumulative effect of all online industries
remaining untaxed and unregulated may be devastating. When consumers acquire
goods and services online without paying sales tax, it may be argued that the
treasury does not really lose this tax revenue. While a consumer who uses a
free VoIP client (such as Skype) can make VoIP calls free from sales tax, the
money saved by not being charged for the call may in turn be spent on products
or services on which sales tax
will be assessed. This argument is
becoming less relevant because there are so many ways to purchase products and
services online and tax-free. A consumer who saves $50 a month by switching to
VoIP may be just as likely to spend it on legal music downloads (on which sales
tax is not imposed in most
states)
[143] as on products
purchased through traditional industries. In addition, taxes imposed on telecom
by various taxing jurisdictions are generally higher than on other goods and
services, so even if a consumer spends the money saved on telecom on other taxed
goods, these goods will probably be taxed at a much lower rate than telecom
services. States are aware of this dilemma and are scrambling to come up with a
simplified sales tax approach so that online retailers can reasonably be
expected to tax customers at the point of
sale.
[144] This objective is
proving to be difficult to achieve, as the more than 7,500 different taxing
jurisdictions have yet to reach a workable compromise.
E. ENCRYPTION AND
OTHER CHALLENGES OF ENFORCING THE TAX CODE
Even if the tax code is simplified
to make taxing and regulating VoIP possible, it may still be quite difficult to
enforce. With encryption becoming more advanced, it may be difficult to
distinguish between someone making a call over VoIP and someone sending an email
to their grandma. The two acts are identical once they are floating through
cyberspace, and determining if a user is involved in a transaction that is
subject to taxation might require the ability to spy on the PC of every taxpayer
to determine what it is they are doing. As mentioned earlier, the government
could require that businesses devise a method to collect these
taxes.
[145] Even if businesses
manage to create such a program, the online nature of the VoIP industry will
bring new challenges with regard to enforcement. For instance, it will probably
be difficult to prevent online hacks from altering their purchase location to
pay less in taxes or no taxes at all. This could be advantageous to the
taxpayer if only U.S. citizens are required to pay taxes or if tax rates vary
from one taxing jurisdiction to another.
Companies may also move all or
portions of their businesses to other countries to avoid imposing taxes on their
customers. While traditional businesses can do this as well, an online company
may not require offices or factories to operate and can likely be run just as
easily and effectively from a location outside of the United States. Even if
the legislature somehow passes a law to make foreign companies collect U.S.
sales tax on purchases made from the U.S., it will be difficult to enforce since
the transactions will occur entirely in cyberspace. The government is not
currently capable of monitoring every online business transaction made in the
U.S., and such internet transactions leave no paper trail that can be used
against the consumer as evidence of tax evasion.
F. CAN ANY ONLINE INDUSTRY
BE TAXED OR REGULATED EFFECTIVELY?
The difficulties in devising and enforcing
a regulatory and tax strategy for the VoIP industry illustrates the challenges
that taxing jurisdictions have and will continue to encounter when trying to tax
and regulate online industries. As more and more online technologies will
compete with traditional industries in the future, the loss in services and tax
revenue could reach truly shocking levels if the government does develop a
strategy for dealing with online industries. The Streamlined Sales Tax Project
is a step in the right direction for addressing the problem of online retail
sales made out of state. Twenty states, including California, have joined this
effort to create a sensible and enforceable method for collecting sales tax on
retail purchases made between consumers in one state and businesses in another
state.
[146] While this effort is
proving to be a challenge in itself, it will still not address the problems
associated with collecting sales tax on VoIP calls. In principle, it will be
difficult to collect sales tax on a service that is free (as some VoIP services
are). Regarding those who do pay for VoIP, it will be hard to enforce the
payment of taxes on something that cannot be seen. It will also likely be
impossible to collect taxes or regulate VoIP providers offering calling services
from other countries. Other online technologies are sure to follow in the
footsteps of VoIP so these issues are best addressed sooner rather than
later.
VII. CONCLUSION:
Less than a month after the ruling by the
Minnesota Court, the Federal Communications Commission decided to begin a
yearlong inquiry into the regulatory and tax disparity between traditional phone
service providers and VoIP
providers.
[147] Devising a tax and
regulatory model for the VoIP industry will likely be complicated, and enforcing
compliance may very well be impossible. The potential loss in tax revenue from
the VoIP threat alone has caught the attention of many at every level of
government. While some may perceive these revenue losses as absorbable, they
may be small when compared with the potential revenue shortfalls when more
online competitors begin replacing other traditional industries. If not
addressed soon, the effects of leaving all internet-based industries free from
taxation and regulation could be devastating. The legislature must deal with
this disparity in a manner in which the negative impact on the general public is
minimized. How it chooses to address this issue may determine how all
internet-based technologies will be treated in the
future.
1. 47 U.S.C. § 151(1998).
[2].
Id. at § 230(b)(2)(1998).
[3].
Id.
[4]. The moratorium expired
despite efforts on the part the President and many in Congress to extend it.
[5]. Ed Fletcher, Laws Aim to Collect Taxes
for Online Buys, Sacramento Bee, October 11, 2003,
available at
http://www.sacbee.com/content/politics/recall/story/7579498p-8520556c.html,
¶ 5.
[6]. Ben Charny, FCC to begin VoIP
inquiry, CNET News.com, November 6, 2003,
at
http://news.com.com/2100-7352-5103856.html,
¶ 4.
[7].
See Vonage, 290
F.Supp.2d at 994 n.1.
[8].
See
infra p. 9. Vonage is different from other VoIP providers in that it
offers VoIP services that work using traditional phone equipment. This service
requires an adapter that converts the data into internet packets.
[9].
See Vonage, 290 F.Supp.2d at
995.
[10].
Id. at 994
n.1.
[11]. Nicholas Thompson, To Whom May I
Direct Your Free Call?, N.Y. Times, October 12, 2003,
at
www.nytimes.com
/2003/10/12/business/yourmoney/12kaza.html, ¶
23.
[12].
Id. at ¶21. The
article quotes Berge Ayvazian, a senior research fellow at the Yankee Group as
saying "The big telecom companies worry that VoIP could completely undermine
their business within 12 months."
[13]. Vonage Holdings Corporation v.
Minnesota Public Utilities Commission, 290 F.Supp.2d 993
(D.Minn.2003).
[14].
Id. at
994.
[15].
Id. at ¶
7.
[16].
See infra pp.
14-15.
[17].
See
http://www.whitehouse.gov/omb/budget/fy2002/guide02.html
[18].
See
http://telephonyonline.com/ar/telecom_solution_house_proposal/.
[19]. James
E. Prieger, Terri A. Sexton, & Annette Nellen, The Taxation of
Telecommunication in California in the Information Age, California Policy
Research Center Brief, Vol. 15, No. 4, April
2003.
[20].
Id.
[21].
See Charny,
supra note 6, ¶ 5.
[22]. Adam D.
Thierer, Unnatural Monopoly: Critical Moments in the Development of the Bell
System Monopoly, 14 The Cato Journal 2, ¶ 8 (Fall 1994),
at
http://www.cato.org/pubs /journal/cjv14n2-6.html.
[23].
See
Von Alven,
supra note 13.
[24]. Ms.
Diane S. Katz, A Brief History of Telecom Regulation, (December 12, 2003),
available at
http://www.mackinac.org
/article.asp?ID=6033.
[25].
Id.
[26].
Id.
[27].
Id.
[28].
Id.
[29]. Ms.
Diane S. Katz, A Brief History of Telecom Regulation, (December 12, 2003),
available at
http://www.mackinac.org
/article.asp?ID=6033.
[30].
Id.
[31].
Id.
[32].
See
Thierer,
supra note 22, ¶
5.
[33].
Id. at ¶
32.
[34]. 47 U.S.C. § 151
(1934).
[35].
Id.
[36]. In
the Matter of Federal-State Joint Board on Universal Service (1998), 13 F.C.C.R.
11,830.
[37].
Id. at 11505.
[38].
See Katz,
supra note
29.
[39].
Id.
[40].
Id.
[41].
Id.
[42].
Id.
[43].
Id.
[44].
See
Universal Service Report (1998),
supra note 36. This breakdown is
largely attributed to the personal computer and it’s increasing multimedia
capabilities.
[45].
Id. at
11525.
[46]. 47 U.S.C.A. § 251(1996).
This Act explains the duties still imposed on telecom providers as a result of
the 1996 Telecommunications
Act.
[47].
Id. at §
251(a)(1996).
[48].
See Universal
Service Report (1998),
supra note
36.
[49].
See Katz,
supra note
29.
[50].
See Thompson,
supra
note 11, ¶ 23.
[51].
See
Vonage, 290 F.Supp.2d at 994
n.1.
[52].
Id.
[53].
See
Thompson,
supra note 11, ¶
24.
[54].
Id. at ¶
6.
[55]. Products such as Skype are free to
users, while Vonage offers unlimited calling plans starting at
$39.99.
[56]. James E. Prieger, Terri A.
Sexton, & Annette Nellen, The Taxation of Telecommunication in California in
the Information Age, California Policy Research Center Brief, Vol. 15, No. 4,
April 2003.
[57].
Infra p.
21.
[58].
See Thompson,
supra
note 11, ¶ 24.
[59].
Id.
[60].
Id.
[61].
Id.
[62].
Id.
Niklas Zennstrom and Janus Friis are the same two who created the popular music
swapping software Kazaa.
[63].
Id.
[64].
See Thompson,
supra
note 11, ¶ 24.
[65].
Id.
[66].
Id.
[67].
Id.
[68].
Id.
[69].
Id. at ¶
20.
[70].
Id. at ¶
18.
[71].
See
http://www.cnn.com/2004/TECH/internet/04/19/broadband.study.ap/index.html.
[72].
See
http://www.msnbc.msn.com/id/4609864/.
[73].
Id.
at ¶ 26.
[74].
Id. at ¶
24.
[75].
See
www.usatoday.com/money/industries/telecom/2004-03-05-vonage_x.htm.
[76].
Id.
[77].
See Thompson,
supra
note
11
.[78].
Id.
[79].
Id.[80].
Id.[81].
Id.[82].
Id.[83].
See
supra p. 6.
[84]. Brian Bergstein, Voice
Over Internet Going Mainstream... but it Will Take a While, Associated Press,
Dec 12, 2003, available at
http://reprints.msnbc.com/id/3693976/.
[85].
See
Charny,
supra note 6, ¶
5.
[86].
See Vonage, 290 F.Supp.2d at
994.
[87].
Id. at
995-996.
[88].
Id. at
996.
[89].
Id. at
994.
[90]. This distinction is discussed
infra pp. 11-14.
[91].
Infra
pp. 11-14.
[92].
See Vonage, 290
F.Supp.2d at 994.
[93].
Id. at
997.
[94]. 47 U.S.C. § 230(b);
see
also Zeran v. America Online, Inc., 129 F.3d 327, 330 (4th Cir. 1997)
(recognizing that “Congress acted to keep government regulation of the
Internet to a
minimum”).
[95]. Information providers
were free from regulation and taxation under the Internet Tax Freedom Act.
[96]. The main document the court analyzed
was the FFC’s report to Congress regarding universal service.
See
Universal Service Report (1998),
supra note 36 at
11,522.
[97]. These distinctions are
explained in this comment.
See infra pp.
12-14.
[98].
See Universal Service
Report (1998),
supra note 36 at
11,522.
[99].
Id. at
11830.
[100].
Id. at
11520.
[101].
Id. at
11546.
[102].
Supra p.
10.
[103].
See Universal Service
Report (1998),
supra note 36, at
11546.
[104].
Id.
[105].
Id.
at 11546. For public policy reasons, the legislature may determine that this
industry is no longer competitive and thus regulation may be appropriate.
[106].
Id.
[107].
Id.
at 11511.
[108].
Id. at
11546.
[109].
Id.
[110].
See Vonage, 290 F.Supp.2d
at
1001.
[111].
Id.
[112].
See
Universal Service Report (1998),
supra note 36, at
11546.
[113].
See Vonage, 290
F.Supp.2d at 1003.
[114].
See
Charny, supra note 6.
[115]. Suits are
pending in several other states, including
California.
[116].
Supra pp.
10-14.
[117]. This was at least the
conclusion drawn by the Minnesota Court.
See Vonage, 290
F.Supp.2d at 1003.
[118].
Supra
14-15
[119]. State requirements for
telecommunications carriers vary from jurisdiction to jurisdiction, but include
certification, tariff filing, and various reporting requirements and fees.
See Universal Service Report (1998),
supra note 28, at 11524.
[120].
See Supra
16-17
.[121].
Infra pp.
16-18.
[122].
Infra p.
17.
[123]. Chérie R. Kiser, Angela
F. Collins, Regulation on the Horizon: Are Regulators Poised to Address the
Status of IP Telephony? Cath. U.L.Rev 19
(2003).
[124].
Id.
[125].
Id.
[126]. http://www.bizsites.com/1999/AM99/utilities.html.
[127].
Id.
[128]. James
L. Johnston, A General Theory of Regulation and Deregulation, 152, In
(De)Regulation of Energy: Intersecting Business, Economics and Policy:
Conference Proceedings." 17th Annual North American Conference of the United
States Association for Energy Economics/ International Association for Energy
Economics, October 27-30, 1996, Boston, MA,
1996.
[129].
Id.
[130]. This
cellular coverage map indicates that every area in America has cellular
coverage, with the exception of some mountain ranges, valleys, and deserts.
See
http://www.mobile911alarms.com/911map.htm.
[131]. Björn
Wellenius,
Extending Telecommunications Beyond the Market, Toward
Universal Service in Competitive Environments, Public Policy for the Private
Sector, Note No. 206, March
2000.
[132]. The FCC is in the midst of a
yearlong inquiry into VoIP. Several states also have pending court cases.
See Charny,
supra note
6.
[133].
See Thompson,
supra
note 11.
[134]. As determined by the
Minnesota Court interpreting the intentions of the FCC and Congress.
See
Vonage 290 F.Supp.2d at
1001.
[135].
See Thompson,
supra
note 11.
[136].
Id. Article
states that many users are attracted to VoIP services because they are free.
Even services (such as Vonage) that are not free are cheaper than traditional
services.
[137].
See Universal
Service Report (1998),
supra note
28.
[138].
See Thompson,
supra
note
11.
[139].
Id.
[140].
See
supra p. 8.
[141].
Infra pp.
18-19.
[142].
Infra pp.
16-17.
[143]. The Apple iTunes Music Store
only charges sales tax where required by local law. As of 2004, only 13 states
required that sales tax be collected on internet music
downloads.
[144]. Veronique de Rugy,
Internet Tax: The New OPEC for Politicians, The CATO Institute, November 19,
2002,
available at
http://www.cato.org/dailys/11-19-02.html.
[145]. See
infra
[146]. Ed Fletcher, Laws Aim to
Collect Taxes for Online Buys, Sacramento Bee, October 11, 2003,
available
at
http://www.sacbee.com/content/politics/recall/story/7579498p-8520556c.html,
¶ 10.
[147].
See Charny, supra
note 6.