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.
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]


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.
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]


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]

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 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]
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.
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.

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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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, ¶ 5.
[6]. Ben Charny, FCC to begin VoIP inquiry, CNET, November 6, 2003, at, ¶ 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 /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
[18]. See
[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 /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 /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 /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
[72]. See
[73]. Id. at ¶ 26.
[74]. Id. at ¶ 24.
[75]. See
[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
[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.
[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
[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
[145]. See infra
[146]. Ed Fletcher, Laws Aim to Collect Taxes for Online Buys, Sacramento Bee, October 11, 2003, available at, ¶ 10.
[147]. See Charny, supra note 6.