Congress Extends Internet Tax Freedom Act – Again!

On Friday, December 18, 2015, Congress passed and President Obama signed the $1.1 trillion funding bill that will keep the federal government running until September 30, 2016. This legislation includes a nine-month extension of the Internet Tax Freedom Act (ITFA). If Congress had failed to extend the ITFA, states and municipalities would have had the ability to tax Internet access.

Despite the good news of the nine-month extension, it is very important that the Senate pass the Permanent Internet Tax Freedom Act in the next nine months to avoid another close call with the ITFA expiration date at the end of September 2016. Congress has had to extend the ITFA a handful of times in the past two years. The House already passed its version of the bill back in June 2015. (See my blog from last week.)

Permanently banning taxes on Internet access would help keep the Internet affordable for all Americans. And it would lead to additional market-driven innovation, content choices, and economic growth. 

FCC Hits Consumers With New Year’s USF Tax Hike

Starting 2016, consumers must pay an 18.2% surcharge on part of their phone bills. The surcharges pay into the Universal Service Fund (USF), a multi-billion-dollar subsidy system.

Functionally, USF surcharges are taxes. But the FCC doesn't call them "taxes" because the rate is assessed and the money collected and spent outside the control and accountability of Congress. Apparently, labeling USF taxes "surcharges" is the FCC's way of dodging the constitutional maxim of "no taxation without representation."

USF surcharges appear as a line item on consumers' monthly bills for voice services. The surcharge rate – 18.2% – is assessed against the interstate long distance portion of those services. The money is remitted to an entity established by the FCC to administer the USF program. In 2014 alone, money paid into the USF program was given to:

          - voice providers in rural or high-cost areas -- $3.75 billion;
          - schools and libraries -- $2.27 billion;
          - health care facilities -- $193 million;
          - voice providers serving low-income consumers -- $1.6 billion.

Not to be overlooked are the expenses incurred by the FCC-established entity established to administer the USF program -- nearly $119 million in 2014.

Over the last several years the USF subsidy system has snowballed in size. 2014 USF disbursements total over $7.8 billion, marking a significant increase from 2000 USF spending of $4.0 billion. Corresponding to climbing USF subsidy spending are climbing USF surcharge rates. The following pair of charts shows the unmistakably upward march in the effective tax rate on consumers.

As further explained in my blog post, "USF Surcharge Hikes Hit Over-Taxed Wireless Consumers Hardest," the FCC generally treats 37.1% of a wireless consumer's calling plan as the interstate long distance portion subject to USF surcharges. Wireless consumers face a tax pile up from multiple state and local wireless taxes, fees, and surcharges. Often, wireless services are taxed at higher rates than general sales tax rates. Federal USF surcharges heighten the problem of wireless consumer over-taxation.

Plans for future increases in USF subsidies further heighten concerns for taxpaying consumers. For example, the E-Rate Modernization Order (2014) authorized a $1.5 billion annual increase in school-related subsidies. Consumers must ultimately pay for such USF subsidy increases. As the FCC looks to direct USF subsidies to certain broadband services and "experiments," Chairman Tom Wheeler has not ruled out the possibility of subjecting broadband consumers to USF surcharges – in effect, a USF "Internet tax."

Going forward, the FCC needs to make consumers a priority by reducing the burden of USF surcharges. It also needs to resist the bad idea of imposing USF surcharges on consumers of broadband services. For starters, the FCC must take steps to reduce the overall size of the USF program, especially the high cost fund. And it must resist the temptation to make grand new USF subsidy giveaways from the pockets of consumers.

Senate Should Immediately Pass the Permanent Internet Tax Freedom Act

The Internet tax moratorium is set to expire on Wednesday, December 16, 2015. Instead of Congress temporarily extending the moratorium as it has done several times in the past two years, the Senate should pass the Permanent Internet Tax Forever Act, which would permanently ban state and local taxes on Internet access. (See here, here, and here.) The House already passed its version of the bill back in June 2015. (See my June 2015 blog for more.)

Michael Powell, President and CEO of the National Cable and Telecommunications Association, Meredith Attwell Baker, President and CEO of CTIA - The Wireless Association, and Walter B. McCormick Jr., President and CEO of U.S. Telecom Association, sent a coalition letter to members of the Senate, urging them to support a permanent extension on the Internet Tax Freedom Act. The letter also discusses the important bipartisan history of this issue:

Over the nearly 17 years since ITFA was enacted, the Internet has become an engine for economic growth, opportunity, and inclusion while American consumers have been shielded from having their broadband access subject to the myriad of discriminatory taxes and fees that apply to traditional telecommunications services, often at rates twice that of general sales taxes—11.5% on average but as high as 17% in some places. Because of this bipartisan policy achievement, most Americans have never paid these taxes on their broadband access.

This success – begun during the Clinton Administration, and continued through the Bush Administration and thus far through the Obama Administration – is at risk because ITFA will expire this year unless Congress acts. Expiration would likely increase the cost of broadband access as it would become vulnerable to new onerous telecommunication taxes and fees, an imminent threat due to the Federal Communications Commission’s recent reclassification of broadband services as a Title II telecommunications service. At a time when promoting broadband adoption is a national priority, Congress should ensure that every American can afford to participate in the digital economy by making the expiring ban on Internet access taxation permanent.

As stated in the letter by these industry leaders, permanently banning taxes on Internet access would help keep the Internet affordable for all Americans and would lead to additional market-driven innovation, content choices, and economic growth. 

The Senate should act immediately to adopt the permanent ban on state and local taxes for Internet access!

Regulatory Uncertainty Harms Broadband Investment and the Economy

On November 30, 2015, in an article for the Wall Street Journal, Eric Morath reported that capital expenditures within the entire U.S. economy declined 3.8% through the first 10 months of 2015 compared to the same period in 2014. Mr. Morath reported that lower levels of investment in facilities and equipment have slowed U.S. productivity and output and that this slowdown is a key reason why the overall economy has not grown faster than 2% in recent years.

Mr. Morath gives a couple of reasons why companies are not investing as heavily as economists forecast just one year ago. Perhaps foremost, businesses have hesitated to commit to projects due to consumer demand that remains uneven. But, significantly, according to Mr. Morath, “concerns about the regulatory environment” is another reason for the investment decline.

“Concerns about the regulatory environment” is certainly worth considering with regard to investment in broadband facilities.

There does not seem to be uneven consumer demand in the broadband market. Indeed, demand is increasing rapidly. In fact, mobile data traffic is projected to increase seven-fold from 2015-2019. Consumers continue to use more data; acquire newer, more innovative devices and applications; and consume ever more content. The cost savings (in time and money) that Internet access provides consumers (through shopping, transportation, work, education, entertainment, and myriad other applications) generally more than offsets any nominal increase in the price of broadband service.

But while broadband Internet providers may not suffer from the lack of demand depressing other markets, they do confront an uncertain, more costly regulatory environment that likely affects their forward-looking capital investment decisions. The prospect of continuing Title II public utility-like regulation may well cause broadband providers to invest less than they otherwise would. It is often difficult to know with any precision how much a company would have invested absent concerns regarding costly regulations. But sometimes there are enough worrisome signs to suggest paying close attention – especially in the already current slow investment, slow growth economic environment.

As Free State Foundation Research Associate Michael Horney outlined in an October 2015 blog, Progressive Policy Institute economist Hal Singer found a $3.3 billion decline in broadband capital expenditures from the first half of 2014 to the first half of 2015. This decline correlated with the conduct of the FCC’s Open Internet proceeding and the resulting order imposing public utility-like regulation on the Internet service providers. And with regard to regulatory uncertainty and its potential adverse investment impact, it is worth acknowledging the inherent uncertainty created by the FCC’s new amorphous “general conduct standard.”

On November 5, 2015, Mr. Singer updated his earlier figures to include the first three quarters of both 2014 and 2015. He determined that capital expenditures for broadband fell year-over-year by $2.9 billion among wireline providers alone and by $2 billion if wireless providers are included in the sample.

In September 2015, Michael Mandel, the Progressive Policy Institute’s chief economic strategist, released a report, “U.S. Investment Heroes of 2015: Why Innovation Drives Investment,” ranking the top 25 companies according to their estimated domestic capital investment in their most recent fiscal year. Here is the key chart from that report.

As the chart shows, with respect to 2014 capital expenditures, four of the top 25 companies are broadband Internet providers that are now subject to Title II regulation.  AT&T and Verizon are the top two “investment heroes.” Both of these broadband providers decreased investment in the first three quarters of 2015 compared to 2014’s first three quarters.

Summing the capital expenditures of AT&T, Verizon, Comcast, and Time Warner Cable, these four major broadband providers invested $48.7 billion in 2014. In other words, over 28 percent of capital expenditures in Mr. Mandel’s top 25 ranking is attributable to these four broadband providers. So if the regulatory environment is having a negative effect on the broadband Internet provider “investment heroes,” as may well be the case, then it surely will adversely impact aggregate productivity and economic growth.

Moreover, if the regulatory environment is causing the nation’s largest broadband providers to curtail investment, it almost surely is doing the same with respect to the smaller ones.

The Court of Appeals for the D.C. Circuit just heard the appeal from the FCC’s Open Internet order. The ultimate fate, as a matter of law, of the FCC’s reclassification of Internet providers as telecommunications carriers subject to the Communications Act’s public utility-like regime remains up in the air. But, in the meantime, on the ground, it appears that the FCC’s action – the “concerns about the regulatory environment” as the Wall Street Journal reporter put it – already likely is negatively impacting the rate of investment.

Needless to say, as a matter of policy, this is not good for the overall economy or for those looking for jobs that a more robust economy might create.

Piracy and Malware Are Closely Related Problems

On December 3, 2015, I posted a blog about a new Interactive Advertising Bureau (IAB) study, which found that advertising fraud, piracy websites, and “malvertising” costs the U.S. digital marketing, advertising, and media industry $8.2 billion annually in potential revenue. The study also specifically found that illegal content costs advertising companies and digital marketing firms $2.4 billion annually in potential revenue.

This week, on December 8, the Trustworthy Accountability Group (TAG) announced a list of major advertisers who have pledged to require their advertising partners to take aggressive steps to help fight the $2.4 billion annual loss. Some of the big names include Allstate, American Express, Comcast, and Walmart. (See my February 2015 blog on TAG’s Brand Integrity Program Against Piracy.)

Also, on December 9, the Digital Citizens Alliance (DCA) released a new report entitled “Digital Bait.” The report found that one out of every three piracy websites contains malware. Additionally, consumers are 28 times more likely to receive malware from a website with illegal content than from a website with licensed content providers. The report also found that 45 percent of malware is delivered by “drive-by downloads,” which invisibly download malware onto a user’s computer without the user clicking on anything. Lastly, the report found that advertising revenue and sales of user information on piracy websites amounted to $70 million in revenue in 2015.

If it was not already clear, the IAB and DCA reports show that advertising fraud, piracy, and malware-related advertising are serious problems costing companies billions of dollars in potential revenue. However, it is encouraging to see voluntary initiatives from TAG and major advertisers that stand up against websites which facilitate illegal content.

It is necessary to diminish ad-supported piracy and advertising fraud to help ensure that content providers, artists, innovators, and marketers can earn a return on their creative works – thereby incentivizing more innovation, investment, and economic growth. 

IAB Study: Digital Fraud and Piracy Costs $8.2 Billion Annually

On December 1, 2015, the Interactive Advertising Bureau (IAB) released a new study entitled “What Is an Untrustworthy Supply Chain Costing the U.S. Digital Advertising Industry?” The study found that advertising fraud, piracy websites, and “malvertising” are costing the U.S. digital marketing, advertising, and media industry $8.2 billion annually.

Of the $8.2 billion annually, the losses are split into three categories:

• Advertisers lose $4.4 billion from invalid traffic, which induces systems to generate ad-related actions for purposes other than support of the delivery of the right ad at the right time to the right user.

• Infringed content represents a $2.4 billion loss for the digital marketing and media industry. Two billion dollars is lost revenue to content providers and $456 million is lost revenue to potential advertisers.

• The remaining $1.4 billion in losses come from “malvertising” (or malicious advertising) and the cost of fighting all these illegal activities. The $1.4 billion includes lost revenue from malware-related ad blocking ($781 million), lost revenue from search engine blacklisting when a website is impacted by malware ($57 million), and the cost of investigating illegal activities and documenting direct incidents ($423 million).

It is necessary to diminish ad-supported piracy and advertising fraud to help ensure that content providers, artists, innovators, and marketers can earn a return on their creative works – thereby incentivizing more innovation, investment, and economic growth.

Oyez! Oyez! Oyez!: The Court Hears the Open Internet Case

If you’re at all interested in communications law and policy, and you don’t know that the oral argument in the Open Internet case will be held this Friday, December 4, then…well, I won’t even say it.

In any event, I bet 95% of you reading this now, do know.

And you almost certainly know that I oppose the FCC’s action in February of this year adopting new mandates governing the practices of Internet service providers. I especially object to that part of the Commission’s order classifying Internet providers as common carriers under Title II of the Communications Act. This allows them to be regulated in much the same way as railroads in the 19^th Century or Ma Bell in the 20^th Century. Most, but not all, of the FSF-affiliated scholars share my opposition to various aspects of the FCC’s Open Internet order on either policy or legal grounds, or both.

Over the last decade – yes, that’s how long the “net neutrality” since rebranded “Open Internet” fight has been going on – Free State Foundation scholars have published literally hundreds of book chapters, law review articles, academic papers and shorter pieces and blogs on the subject. Trust me, literally means literally.

If you want to prep for the December 4 oral argument, you can find these pieces on our website under the Publications tab or on our blog site.

Here – especially for the benefit of busy reporters and our other friends in the press – I only want to highlight and link to a very few of our Free State Foundation papers published this year that address the FCC’s Open Internet order. Beneath the link to the entire work, there is an excerpt from each. Each of these pieces provides insights into various aspects of the FCC’s decision that may well be discussed this Friday.   

• Challenging the FCC’s Unlawful Open Internet Order, Justin (Gus) Hurwitz, August 13, 2015. (This Perspectives from FSF Scholars reviews an amicus curiae brief submitted by the International Center for Law and Economics and economics and administrative law scholars, including myself.)

“The brief’s basic argument is that the Order would expand the FCC’s authority far beyond what the Communications Act permits. This follows both because the FCC is asserting a massive expansion of its regulatory authority to encompass basically the entirety of the Internet, and because of the lengths to which the Commission must go in crafting its Order, picking and choosing among statutory provisions on the one hand and disclaiming various effects of the Order on the other. All in all, the brief demonstrates that the Commission has created a “Frankenorder” that bears no resemblance to Congressional intent.”

• Why Chevron Deference May Not Save the FCC’s Open Internet Order – Part II, Randolph J. May, May 4, 2015.

“As I discussed in Part I, a good case can be made that the Commission did not support adequately its reversal of policy regarding classification of Internet services, ‘when, for example, its new policy rests upon factual findings that contradict those which underlay its prior policy.’ And, as shown in Part II, it is arguable that President Obama’s explicit ‘asks,’ coupled with the agency’s abandonment of its primary proposal in the rulemaking notice, may cause courts to be less deferential than they otherwise would be if they consider political considerations to have trumped the Commission’s exercise of its supposed expertise. Either of these two lines of argument, separately, could mean the Commission’s order is not accorded Chevron deference or any deference, however denominated. Taken together, the chances that the FCC’s Open Internet order may not pass judicial muster are further increased.”

• Regulating Interconnection (Lightly!), Daniel A. Lyons, May 19, 2015.

“Of the many potential land mines lurking in the Open Internet order, perhaps the most surprising is the Commission’s assertion of jurisdiction over interconnection agreements….[T]he 2014 Notice of Proposed Rulemaking tentatively concluded that the Open Internet rules should not affect agreements for the exchange of traffic between networks. Although the Commission invited comments on this conclusion, Chairman Tom Wheeler explained during the comment period that interconnection is ‘not a net neutrality issue’ and a Commission spokesman clarified that ‘[p]eering and interconnection are not under consideration in the Open Internet proceeding.’…In part because of this about-face, the interconnection provisions may be one of the portions of the Open Internet order most vulnerable to reversal on judicial review.”

• The FCC, Still Lawless, Randolph J. May, November 23, 2015.

“The Commission delegated authority in the ‘Open Internet Order’ to its Enforcement Bureau staff to enforce the new general conduct rule. This open-ended provision leaves agency bureaucrats with virtually unbridled discretion to penalize regulated parties for conduct the parties have no way of knowing in advance is prohibited. It doesn’t take an expert steeped in the Magna Carta’s history or our American rule of law norms to understand the problematic nature of this essentially standardless rule, which by its very nature invites arbitrariness and favoritism in its exercise.”

• Net Neutrality, Administrative Procedure, and Presidential Overreach, Enrique Armijo, November 19, 2015.

“Correspondingly, in reviewing agency action under the APA, a court is obliged to ensure that the agency record before it is adequate for judicial review. If that record is inadequate – if some material basis for the agency’s decision is not in the record – the court must remand the agency’s rule. All of which begs a few questions: Are net neutrality-favoring arguments made in secret White House meetings relied upon by the Obama Administration, and relied upon in turn by an agency that adopts the Administration’s position in full, adequately public? How might the D.C. Circuit, which will be hearing oral arguments on the net neutrality rule on December 4, adequately consider the quality of the agency’s reasoning in such a case?

The FCC and its advocates would likely laugh off an argument that a reviewing court might deem this agency record inadequate, pointing to literally millions of comments from the public, and the largest docket in the FCC’s history. But the one comment that was indisputably the most important to the agency in promulgating its final net neutrality rule was the product of a clandestine process that was in many ways the opposite of the transparent one that the APA requires. Under the APA, just one needle supporting the agency’s final rule can sometimes be enough, regardless of the size of the haystack. But here, this particular needle is not in the haystack at all.”

[NOTE - Professor Armijo said this in his FSF Perspectives: “Regardless of which side of the merits of the net neutrality debate you happen to fall on – and, in the interest of disclosure, if pressed, I personally would likely conclude that some form of net neutrality rules are a net benefit for Internet users, a view in contrast to that expressed by most Free State Foundation scholars – you should find this level of politicization of an independent agency rulemaking deeply troubling.”]

*    *    *

The judicial appeal from the FCC’s Open Internet order certainly is one of the more important communications law and policy cases in the last half-century. The appeal involves fundamental questions regarding the extent of the FCC’s authority under the Communications Act to regulate in a public utility-like fashion important parts of the Internet ecosystem – the Internet service providers – and possibly the entire ecosystem, including the so-called “edge providers” like Google, Yahoo, and Facebook. And depending on the outcome of the judicial review, and the actions of a majority of present or future Commissioners, such regulation possibly could extend considerably beyond the messaging services of these Internet companies.

There are also important issues relating to compliance with Administrative Procedure Act requirements and the strictures of the First Amendment’s free speech guarantee.

In my view, the Open Internet order’s lawfulness ultimately may be determined by the Supreme Court. But, in the meantime, fasten your seatbelts: For come the morning of December 4, the U.S. Marshall will call out: “Oyez! Oyez! Oyez! All persons having business before this Honorable Court are admonished to draw near and give their attention, for the Court is now sitting. God save the United States and this Honorable Court."

Maryland Needs to Improve Its Business Tax Climate Ranking

On November 17, 2015, the nonpartisan Tax Foundation released its 2016 State Business Tax Climate Index co-authored by Jared Walczak, Scott Drenkard, and Joseph Henchman. Unfortunately, in this annual ranking, Maryland has not improved since the 2015 index was released. Indeed, it actually fell one place to No. 41. This slippage drops the state into the Tax Foundation’s “10 Worst Business Tax Climates” grouping.

As I have written several times earlier this year, Maryland Governor Larry Hogan, since taking office, has taken some concrete steps to improve the state’s business climate reputation – and, thus, Maryland’s competitive position among the states. But the governor needs more cooperation from Maryland’s General Assembly to effect the changes that would improve Maryland’s overall business climate, including its tax climate.

In developing its state rankings, the Tax Foundation examines the following five factors (with Maryland’s rank indicated): Corporate Tax (19); Individual Income Tax (45); Sales Tax (8); Unemployment Insurance Tax (28); and Property Tax (42). Sadly, Maryland’s rank did not improve in any category from 2015 to 2016. As stated, its overall ranking fell from 40 to 41.

I do not claim that rankings such as this are perfect. I do not even claim that this particular study necessarily tells the complete story about Maryland’s “business tax climate.” But the Tax Foundation’s study surely is useful as an indication that changes are needed if Maryland is to improve its business tax climate. As the study states: “While there are many ways to show how much is collected in taxes by state governments, the Index is designed to show how well states structure their tax systems, and provides a roadmap for improvement.” And with respect to the ten worst states in the ranking, the Tax Foundation says this of special relevance: “The states in the bottom 10 tend to have a number of afflictions in common: complex, non-neutral taxes with comparatively high rates.”

Of course, the rankings are not just for sport; they reflect real-world factors that influence businesses decisions that, in turn, impact jobs, investment, and a state’s overall economic prosperity. As the Tax Foundation recalled in this year’s study: “In 2010, Northrup Grumman chose to move its headquarters to Virginia over Maryland, citing the better business tax climate.” And as you can see from the map below, none of Maryland’s neighboring states rank in the “10 Worst Business Tax Climates.” Delaware, West Virginia, and Virginia, for example, rank significantly higher.

Aside from the Tax Foundation’s just-released business tax climate index ranking discussed here, Maryland recently has been ranked 37^th in overall fiscal health; 39^th in small business climate; and 45^th in individual income tax structure in various studies. Again, it is not necessary to claim infallibility for each of the various studies from which the rankings were derived in order to maintain that there is much room for improvement with respect to Maryland’s business climate and its overall fiscal health.

In the past several months, with the research assistance of my Free State Foundation colleague Michael Horney, I have published a series of blogs addressing various aspects of Maryland’s regulatory and business climate and its budgetary and fiscal situation. For convenience sake, here they are:

Maryland Needs to Improve Its Fiscal Health – July 9, 2015

Maryland Needs to Improve Its Regulatory Climate – July 13, 2015

Maryland's Small Business Regulatory Climate Ranks Poorly – July 22, 2015

Maryland Needs to Improve Its Regulatory Climate - Part II – August 23, 2015

Reforming Maryland Business Licensing Regime – October 5, 2015

Of course, Maryland’s national ranking in other important measures, such as education and household income, are higher. And its current unemployment ranking at 5.1% is right in the middle. So, the overall picture is by no means bleak.

But Governor Hogan is right to focus on improving Maryland’s business climate and its overall fiscal health. His actions this year to eliminate or reduce over 100 fees across state government, amounting to an estimated savings of approximately $51 million over five years, and to establish a commission to recommend elimination of unnecessary regulations are tangible steps in the right direction. Governor Hogan should continue on this course, and the legislature should support the change in direction towards a lower tax, more restrained spending, less regulatory environment that Maryland needs.