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2006
STATE TAXATION OF INTERSTATE TELECOMMUNICATIONS SERVICES

HEARING

BEFORE THE

SUBCOMMITTEE ON
COMMERCIAL AND ADMINISTRATIVE LAW

OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

JUNE 13, 2006

Serial No. 109–120

Printed for the use of the Committee on the Judiciary
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Available via the World Wide Web: http://judiciary.house.gov

COMMITTEE ON THE JUDICIARY

F. JAMES SENSENBRENNER, Jr., Wisconsin, Chairman
HENRY J. HYDE, Illinois
HOWARD COBLE, North Carolina
LAMAR SMITH, Texas
ELTON GALLEGLY, California
BOB GOODLATTE, Virginia
STEVE CHABOT, Ohio
DANIEL E. LUNGREN, California
WILLIAM L. JENKINS, Tennessee
CHRIS CANNON, Utah
SPENCER BACHUS, Alabama
BOB INGLIS, South Carolina
JOHN N. HOSTETTLER, Indiana
MARK GREEN, Wisconsin
RIC KELLER, Florida
DARRELL ISSA, California
JEFF FLAKE, Arizona
MIKE PENCE, Indiana
J. RANDY FORBES, Virginia
STEVE KING, Iowa
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TOM FEENEY, Florida
TRENT FRANKS, Arizona
LOUIE GOHMERT, Texas

JOHN CONYERS, Jr., Michigan
HOWARD L. BERMAN, California
RICK BOUCHER, Virginia
JERROLD NADLER, New York
ROBERT C. SCOTT, Virginia
MELVIN L. WATT, North Carolina
ZOE LOFGREN, California
SHEILA JACKSON LEE, Texas
MAXINE WATERS, California
MARTIN T. MEEHAN, Massachusetts
WILLIAM D. DELAHUNT, Massachusetts
ROBERT WEXLER, Florida
ANTHONY D. WEINER, New York
ADAM B. SCHIFF, California
LINDA T. SÁNCHEZ, California
CHRIS VAN HOLLEN, Maryland
DEBBIE WASSERMAN SCHULTZ, Florida

PHILIP G. KIKO, Chief of Staff-General Counsel
PERRY H. APELBAUM, Minority Chief Counsel

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Subcommittee on Commercial and Administrative Law

CHRIS CANNON, Utah Chairman

HOWARD COBLE, North Carolina
TRENT FRANKS, Arizona
STEVE CHABOT, Ohio
MARK GREEN, Wisconsin
J. RANDY FORBES, Virginia
LOUIE GOHMERT, Texas

MELVIN L. WATT, North Carolina
WILLIAM D. DELAHUNT, Massachusetts
CHRIS VAN HOLLEN, Maryland
JERROLD NADLER, New York
DEBBIE WASSERMAN SCHULTZ, Florida

RAYMOND V. SMIETANKA, Chief Counsel
SUSAN A. JENSEN, Counsel
BRENDA HANKINS, Counsel
MIKE LENN, Full Committee Counsel
STEPHANIE MOORE, Minority Counsel

C O N T E N T S

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JUNE 13, 2006

OPENING STATEMENT
    The Honorable Chris Cannon, a Representative in Congress from the State of Utah, and Chairman, Subcommittee on Commercial and Administrative Law

    The Honorable Melvin L. Watt, a Representative in Congress from the State of North Carolina, and Ranking Member, Subcommittee on Commercial and Administrative Law

WITNESSES

Mr. Steven Rauschenberger, Assistant Republican Leader, Illinois Senate, and President, National Conference of State Legislatures, Springfield, IL
Oral Testimony
Prepared Statement

Mr. Stephen P. B. Kranz, Tax Counsel, Council on State Taxation (COST)
Oral Testimony
Prepared Statement

Mr. David Quam, Director, Office of State and Federal Relations, National Governors Association, Washington, DC
Oral Testimony
Prepared Statement

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Mr. Scott Mackey, Economist and Partner, Kimbell Sherman Ellis LLP, Montpelier, VT
Oral Testimony
Prepared Statement

LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING

    Prepared Statement of the Honorable Chris Cannon, a Representative in Congress from the State of Utah, and Chairman, Subcommittee on Commercial and Administrative Law

STATE TAXATION OF INTERSTATE TELECOMMUNICATIONS SERVICES

TUESDAY, JUNE 13, 2006

House of Representatives,
Subcommittee on Commercial
and Administrative Law,
Committee on the Judiciary,
Washington, DC.

    The Subcommittee met, pursuant to notice, at 3:07 p.m., in Room 2141, Rayburn House Office Building, the Honorable Chris Cannon (Chairman of the Subcommittee) presiding.

    Mr. CANNON. Good afternoon, ladies and gentlemen. This hearing of the Subcommittee on Commercial and Administrative Law will now come to order. I apologize for being a few minutes late. We just had a vote.
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    Every month, we'll receive at least one bill from a telecommunications company and some receive more. I know I do. These bills are for our home phone, cell phone, cable, DSL, cable Internet, and other services. Whenever I look at my bill, one thing I keep thinking is how much do I have to pay in taxes just to be able to communicate with others.

    In our increasing mobile society, communications services hold us together. These services allow us to keep in touch with our families while we are away from home. They allow us to communicate with our kids when they leave home. I personally e-mail or text message my son. It turns out to be the most convenient way to get more than three words out of him. And not often and they sometimes are ''u'' instead of ''y-o-u,'' but this is what life is about. With the touch of a button, we can contact them to find out how they are, find out how they are doing and then they ask us for more money. I was thinking we might be able to establish a filter for that.

    The innovations and expansion of communications have helped us become a more productive society and fueled our ability to lead the global economy. We should be finding ways to encourage innovation, not block it with excessive and discriminatory taxes. Higher taxes ensure that we will see less of the taxed service. Taxing telecommunications services stymies technological process by creating disincentives to purchase these services.

    Communication taxes have been applied piecemeal by local State and Federal Government over a long period of time, and many of these taxes were created while we still had essentially one company running communications in America. We now have competition from wireless, cable and others, but we still have not moved away from a complex tax system, even though we have a dynamic competitive industry.
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    Taxes on communications services are a jumble. The tax rates on communications are about at the point where these taxes are approaching the level of ''sin'' taxes. We want to encourage people to use communications, and we want all people to be able, not move the cost beyond what the poor amongst us can afford. The taxes fees and surcharges on a phone bill include: Relay center surcharges public right-of-way fees, gross receipts taxes, 911 fees, universal service funds, cost recovery surcharges, State sales tax, local sales tax and additional local taxes.

    It is easy to understand what some of these taxes fund such as the 911 fees, but other fees are not comprehensible such as the cost recovery surcharge found on the Virginia Verizon bill.

    In 2004, the regressive rate of State and local taxation on telecommunications services was 14.17 percent. States and localities have acknowledged there is a problem and that we need to reform. Today, we'll discuss this problem and what can be done to limit excessive taxation on telecommunications services and providers. This is just the beginning of the discussion. I expect future hearings on this issue, and I look forward to the testimony of the panel.

    Now without objection, the Chair will be authorized to recess the Committee at any point. Hearing none, so ordered.

    I further ask unanimous consent that Members have 5 legislative days to submit written statements and statements by interested parties for inclusion in today's record. Without objection, so ordered.
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    [The prepared statement of Mr. Cannon follows:]

PREPARED STATEMENT OF THE HONORABLE CHRIS CANNON, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF UTAH, AND CHAIRMAN, SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW

    Good afternoon ladies and gentlemen; this hearing of the Subcommittee on Commercial and Administrative Law will now come to order.

    Every month we all receive at least one bill from a telecommunications company, and some receive more, I know I do. These bills are for our home phone, cell phone, cable, DSL, cable internet, and other services. Whenever I look at my bill, the one thing I keep thinking is: How much do I have to pay in taxes, just to be able to communicate with others?

    In our increasingly mobile society, communications services hold us together. These services allow us to keep in touch with our families while we are away from home. They allow us to communicate with our kids when they leave home. With the touch of a button, we can contact them to find out how they are, find out what they are doing and for them to ask us for more money. Maybe we could establish a filter for this use!

    The innovations and expansion of communications have helped us become a more productive society and fueled our country's ability to lead the global economy. We should be finding ways to encourage innovation, not block it with excessive and discriminatory taxes. Higher taxes ensure that we will see less of the taxed service. Taxing telecommunications services stymies technological progress by creating disincentives to purchase these services.
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    Communication taxes have been applied piecemeal by local, state, and federal government over a long period of time. Many of these taxes were created when we still had essentially one company running telecommunications in America. We now have competition from wireless, cable and others, but we still have not moved away from a complex tax system even though we have a dynamic and competitive industry.

    Taxes on communications services are a jumble. The tax rates on communications are about at the point where these taxes approach the level of ''sin'' taxes. We want to encourage the use of communications by ALL people, not move the cost beyond what the poor amongst us can afford.

    The taxes, fees and surcharges, on a phone bill include: relay center surcharges, public right-of-way fees, gross receipts taxes, 911 fees, universal service funds, cost recovery surcharges, state sales tax, local sales tax and additional local taxes. It is easy to understand what some of these taxes fund, such as the 911 fees. But other fees are not comprehensible such as the cost recovery surcharge found on a Virginia Verizon bill.

    In 2004 the regressive rate of state and local taxation on telecommunications services was 14.17 percent. States and localities have acknowledged there is a problem and that we need reform. Today, we will discuss this problem and what has been done to limit excessive taxation on telecommunications services and providers.

    This is just the beginning of the discussion. I expect future hearings on this issue, and I look forward to the testimony of the panel.
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    Without objection, the Chair will be authorized to recess the committee at any point. Hearing none, so ordered.

    I further ask unanimous consent that Members have 5 legislative days to submit written statements and statements by interested parties for inclusion in today's record. Without objection, so orderd.

    I now yield to Mr. Watt, the Ranking Member of the Subcommittee, for an opening statement.

    Are there any Members wishing to make opening remarks?

    Mr. CANNON. I'd now like to recognize Mr. Watt, the Ranking Member of the Subcommittee, for an opening statement.

    Mr. WATT. Thank you, Mr. Chairman. Today's hearing and mark-up consider tax policies of significant importance to the effect that industries and also to the States and local governments that levy taxes and rely on revenues from those taxes. At the hearing on H.R. 1396, which we understand are marking up today one of the witnesses testified ''it is axiomatic that if had Congress intervenes in State and local taxation in a manner that establishes a favored group of taxpayers, then other taxpayers who feel that they are in the same position will come forward seeking the same favorite treatment.''

    Against the backdrop of any Federal legislation seeking to curtail or limit the States' taxing authority, are structural issues of federalism and constitutional considerations including due process, commerce clause, and equal protection. There are also very basic bread and butter issues: Funding of schools, revitalizing post hurricane devastated areas and paving streets. Things of that kind.
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    That said, I think that it is important that we take a serious look at the current state of State and Federal and local tax structures and the way they affect the telecommunications industry and the consumer. I believe the change is necessary in this area. I am also respectful of State sovereignty and hope that this and subsequent hearings will enlighten us on what role Congress can constructively make in assuring that the principles of tax efficiency, competitive neutrality and tax equity on which all stakeholders seem to agree are reflected in concrete policies and practices.

    One of my particular concerns about the discriminatory application of State and local taxes on the telecommunications industry is the disproportion of burdens such taxes may have on low fixed and middle income families and communities of color. As Chair of the Congressional Black Caucus, I have endeavored to support legislative initiatives that close the disparities that exist in various facets of American life. Telecommunications is no different. Indeed, in light of the pervasiveness and rapidity of technological advances, I believe that ensuring policies that promote growth, competition and access are fundamental to citizens of all economic background.

    Understand that we will hear from additional stakeholders at subsequent hearings. For example, a U.S. conference of mayors and other local entities not represented here today may have another variations on these issues and certainly a different perspective. And because I have always wanted to hear all the perspectives, I will certainly be supporting additional hearings so that everybody can express themselves.

    Thank you again, Mr. Chairman, for convening the hearing. I look forward to additional hearings on this issue and thank the witnesses in advance for their testimony, and I yield back the balance of my time.
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    Mr. CANNON. Thank you. I always appreciate your thoughtful comments. I want to apologize for the background communications while you are speaking. Just for the convenience of witnesses, we have a camera that is associated with whoever thinks he's going to be the first witness, and I am not sure who that is. Is that you, Mr. Rauschenberger? Okay. Great.

    Then, actually, for odd reasons we are going to introduce Mr. Mackey first and then we'll move across the dais. We'll start with you as the first witness.

    Scott Mackey is an economist and partner at Kimbell Sherman Ellis. He's worked with the States and major wireless telecommunications companies in their efforts to conform to the Mobile Telecommunications Sourcing Act. Mr. Mackey has been the chief economist for the National Council State Legislatures and represented NCSL on the Steering Committee on the NTA Telecommunications and Electronic Commerce Tax Project.

    Mr. Mackey earned his undergraduate degree in economics from Middlebury College and his MBA from the University of Colorado. Mr. Mackey, thank you for your appearance here today. We look forward to your testimony.

    Our next witness is David Quam, the Director of the Office of the State and Federal Relations for the National Governors Association. He works closely with the governors of Washington D.C. Representatives and the NGA's standing committees.

    Prior to joining the NGA, Mr. Quam was the Director of International Affairs and General Counsel for the International Anti-Counterfeiting Coalition, Inc. He was also Majority Counsel for the U.S. Senate Subcommittee on the Constitution, Federalism and Property Rights for the Committee on the Judiciary.
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    And Mr. Quam received his undergraduate degree from Duke University and his J.D. from Vanderbilt University, and we appreciate you coming to testify today.

    Our next witness is Stephen Kranz, Tax Counsel for the Council on State Taxation. He's responsible for following and responding to State tax developments around the country for COST. Mr. Kranz is a regular contributor to COST's publications and COST's State Study and Report on Telecommunications Taxation. He's also a frequent speaker on State and local tax topics around the country.

    Prior to joining COST, Mr. Kranz established the Office of the Chief Counsel while working at the District of Columbia's Office of Tax and Revenue. He spent 6 years as a trial attorney in the Honors Program of the United States Department of Justice, Tax Division and he is the current chair of the District of Columbia Bar's State and Local Tax Committee. And Mr. Kranz, welcome. We appreciate your time.

    Our final witness is, or in this case, the first witness today is Senator Steven Rauschenberger. Senator Rauschenberger was elected to the Illinois Senate in 1992. He is now the assistant Republican leader and specializes in eliminating State and local discriminatory tax schemes, as well as immigration, Medicaid, and welfare reform.

    Would you like to come to Utah? Take some of the arrows for the next few days?

    He is President of the National Counsel of State Legislatures through August of this year and previously served as co-chair of NCSL's Executive Committee Taskforce on State and Local Taxation of Telecommunications and Electronic Commerce.
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    During his time in office, Senator Rauschenberger has been an advocate in the interests of taxpayers.

    Senator Rauschenberger, we thank you for coming here to Washington to discuss these issues with us today. It is nice to see you today and appreciate your involvement in the topic, which is very important. I extend to each of you my warm regards and appreciation for your willingness to participate in today's hearing. In light of the fact that your written statements will be included in the hearing record, I request that you limit your oral remarks to about 5 minutes.

    We have a lighting system that starts with a green light that goes for 4 minutes, then it turns yellow and at 5 minutes it turns red. It is my habit to tap my pencil just to get a little bit of attention at that point. Sometimes we have a lot of people in these hearings, maybe people who are still wandering back from votes. When that's the case, we try to keep it more tightly at 5 minutes because everybody needs a chance to ask questions, but this is not a fixed thing, unless people ask questions that I don't like then I get tougher with the gavel. That's not true, we have never had a problem with that, I don't think.

    On the other hand, we would like to explore a bit in discussion and with questions, and so to finish up your thoughts, we'll move on. And after you've presented your remarks I will, based upon the time of arrival of Members of the Committee will be offered the opportunity to ask questions.

    Now, pursuant to the Chairman of the Judiciary Committee, I need to ask you to stand and raise your right hand and take the oath.
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    [Witnesses sworn.]

    Mr. CANNON. The record should reflect that all of the witnesses answered in the affirmative.

    You may be seated.

    And then we are going to start with you, Mr. Rauschenberger; is that not correct? You are recognized for 5 minutes.

STATEMENT OF STEVEN RAUSCHENBERGER, ASSISTANT REPUBLICAN LEADER, ILLINOIS SENATE, AND PRESIDENT, NATIONAL CONFERENCE OF STATE LEGISLATURES, SPRINGFIELD, IL

    Mr. RAUSCHENBERGER. Good afternoon, Chairman Cannon, and Ranking Member Watt and Members of the Subcommittee on Commercial and Administrative Law. I truly appreciate the opportunity to be here to testify before you today and I am very appreciative of the fact that you are taking up what I think is a very important issue to my children, to my constituents, and ultimately, to the United States.

    I am State Senator Steve Rauschenberger from Illinois. I am President this year of the National Conference of State Legislatures. With me today in the audience is State Senator Leticia Van de Putte of Texas and NCSL's President-elect. Senator Van de Putte and I have made telecommunications tax reform one of NCSL's major priorities and I am pleased that she could join me here today to see the testimony and see how I did in my first testimony before the Judiciary Committee.
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    New technology convergence and competition in telecommunications makes it critical to simplify and reform State and local taxes to ensure a level playing field and to enhance economic development and avoid discrimination among telecommunications providers.

    For almost 100 years until 1984, telephone service was a highly regulated industry in which consumers did not have a choice of provider. Phone companies were subject to tax under statutes applicable to public utilities, and such taxes in the form of gross receipts, franchise and other industry. Specific taxes were passed on to customers as part of the regulatory rate setting scheme. Many monopoly phone companies had no reason to, and normally did not, oppose these taxes. In the 1990's, many States began efforts to deregulate local markets and to open these markets to competition to improve consumer choice and, hopefully, lower prices. In the Telecommunications Act of 1996, Congress further opened local markets. In most States, the deregulation of the industry was not accompanied by corresponding elimination, simplification, or restructuring of the old monopolistic tax system that's based on silos and technology. Innovation and convergence of existing technologies are radically expanding what telecommunication services are; blurring the distinction between telephone and Internet services; between cable wireless and satellite communications; between long distance and local service; and, between telephone and other forms of communications.

    Many of these new technologies are capable of delivering telecommunications or telecommunications-like services. As a result, similar services can be delivered by networks that are taxed very differently and for a growing number of new technologies, these services are free from State and local taxation. This uneven governmental treatment at the State and local level, while not intentional, has led to competitive barriers, discouraged market investment and infrastructure development that is crucial to the future and impacted the rollout of advance telecommunications service throughout the United States.
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    Imposing these higher tax burdens on telecommunications services provided by some telecommunication providers while imposing lower or even no tax burdens on similar services sold by nontraditional providers, places governments in the position of picking winners and losers in the market place.

    Under the legacies of the former monopolistic structure, State and local tax burdens on telecommunications companies and their customers are significantly above those imposed in other types of industries and service. The Council on State Taxation, COST, found that the average rate of State and local taxes for telecommunications services was around 14.1 percent, compared with only an average of about 6 percent for general business taxes.

    No reasonable policy maker can continue to justify this discriminatory tax regime on communication services. At a time when we talk about how important it is to have everyone ubiquitously connected to the network and to have access to high speed communications, for us to allow a—a discriminatory tax regime is not realistic.

    You need to know that NCSL has been working for almost a decade on reforming State telecommunication taxes. The three principles that I want to highlight that we believe and have pressed hard for are tax efficiency by State and local governments; we've pushed hard for competitive neutrality in State and local public policy; and, for tax fairness between technologies.

    Telecommunications tax reform is much easier said than done. States face a tremendous barrier in overcoming inertia, in persuading local governments in municipalities to accept the risks of a new tax regime which may lower rates but broaden their tax base. But if we are going to have the kind of advanced deployment of telecommunication services in networks that we all believe are the future for the United States, we are going to have to take those kind of risks.
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    I think the fact that this Subcommittee is taking this issue up, helps provide impetus and encourages State and local decision makers to stay focused on the task. The threat over time that there may be deadlines from the Federal Government serves as a stimulus which will help bring State and local government decision makers together.

    You know, I've worked thoughtfully and watched the telecommunications industry cooperate with my task force for nearly a decade as we tried to build consensus and we have had some progress. I am going to get into it in questions where States had acted on their own.

    But I don't think we have another decade to thoughtfully wait for enlightened State public policy makers to find their way on their own. So the very fact that you're convening this, that you are discussing this, you are making people aware that the Congress is concerned about equity and taxation, are making sure we send the right kind of messages. I'll be happy to answer any questions you have.

    Thank you.

    [The prepared statement of Mr. Rauschenberger follows:]

PREPARED STATEMENT OF SENATOR STEVEN RAUCHENBERGER

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    Mr. CANNON. Thank you, Mr. Rauschenberger. It's always a pleasure to hear from you.

    Mr. Kranz.

STATEMENT OF STEPHEN P.B. KRANZ, TAX COUNSEL, COUNCIL ON STATE TAXATION (COST)

    Mr. KRANZ. Thank you, Mr. Chairman, for the invitation to participate in today's hearing.

    As you said during the introductory remarks, my name is Steve Kranz. I am Tax Counsel with the Council on State Taxation, also known as COST. COST is a trade association that represents about 600 of the Nation's largest taxpayers, including companies from every industry segment and particularly those companies in the telecom and cable and technology arena which have been asked, and, in fact, forced by State and local laws to collect the taxes that we are discussing today.

    COST's mission is to preserve and promote equitable and nondiscriminatory taxation, and as the 2004 State study and report on telecommunications taxation, which COST prepared, points out telecommunications and communications taxation is anything but. In fact, it is inequitable and discriminatory.

    We have forced a square peg of a monopoly form of tax administration, left over from the days of telecom regulation, into the round hole of free market telecom service providers. The result is a system that's broken and in desperate need of repair.
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    COST has studied and commented on the tax structure facing telecommunications providers since 1999, has put on a number of those studies and can describe the landscape in really 2 words: Oppressively burdensome. We have a system of telecom taxation that violates every tenet of good tax policy, creates an untenable burden for telecom providers and more importantly for their customers. We ask telecom companies to collect tax from their customers under a set of rules that are so complicated no one can do the job correctly. We ask companies to collect tax from their customer at rates that make one think the product they're selling should be kept behind the counter of a convenience store and only sold to customers who are over the age of 18.

    While a small number of States have made progress, as State Senator Rauschenberger has indicated, by improving their particular tax systems, the overall burden, as you see by looking at the 1999, the current study, has not significantly changed. In fact, the overall tax rate that is imposed by State and local governments continues to increase.

    Telecom customers are taxed at a rate more than double the rate on goods sold by a normal or general business. Second, the accounting burden that's imposed by State and local tax authorities is astounding. Companies are required to file almost 50,000 tax returns a year if they do business nationwide.

    Looking in further detail at the results of the telecom study. In 2004, as I said, the rate that was imposed on telecom services was double that was imposed on goods sold at a K-Mart. The average rate on telecom was over 14 percent, while the average rate on sales of goods was about 6 percent. This difference is something you can see in many of the States across this country. Eighteen States have rates on telecommunications in excess of 15 percent. Nine of those States tax telecom services at rates exceeding 20 percent.
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    Turning to the accounting burden that is created by this system. I mentioned 50,000 tax returns a day. That's a big number. And if you break it down, it is over 190—I am sorry—50,000 and tax returns per year broken down is over 190 tax returns per business day, almost one every 2 1/2 minutes. I don't know how much time it takes you to do your tax return or whether you do it, but it takes a long time to prepare tax returns and these companies are required to spend phenomenal resources filing those returns on a daily basis.

    On a State-by-State level, when you look at the study, 18 States require companies to file more than a thousand tax returns per year. Of those, 6 States require more than 3,000 tax returns per year. Looking at your phone bill, as you said Mr. Chairman, you can see the complexity on its face. In Maryland, for example, there are 7 separate line items, different taxes that are imposed. In Washington State, there are 10 separate line items of tax imposed, and in New York, there are 12. Each of these line items requires a company to calculate, collect and remit tax information and dollars from consumers on a monthly basis.

    In conclusion, while the phone bill gives you a snapshot, the 50-State study gives you a thorough picture of the complexity of the issue that exists out there. The difference in rates that is imposed on telecom companies and the administrative and accounting burden that results from the various impositions.

    Mr. Chairman, and Members of the Subcommittee, thank you again for giving me the opportunity to testify. I hope that you provide—that you find the information and the COST study useful as you consider this difficult problem. And I'd be happy to respond to any questions that you'd have.
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    Mr. CANNON. Thank you, Mr. Kranz.

    [The prepared statement of Mr. Kranz follows:]

PREPARED STATEMENT OF STEPHEN P. B. KRANZ

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    Mr. CANNON. We want to acknowledge the presence of Mr. Coble from North Carolina and the gentlelady from Florida, Ms. Wasserman Shultz, who have joined us for the hearing.

    And Mr. Quam, you are recognized for 5 minutes.

STATEMENT OF DAVID QUAM, DIRECTOR, OFFICE OF STATE AND FEDERAL RELATIONS, NATIONAL GOVERNORS ASSOCIATION, WASHINGTON, DC

    Mr. QUAM. Thank you, Chairman Cannon, Ranking Member Watt, Members of the Committee. My name is David Quam. I am the Director of Federal Relations for the National Governors' Association and greatly appreciate the opportunity to testify here today.

    Telecommunications tax reform has been a major issue for the governors over the past year. As I am sure we'll discuss, the NGA was essential in trying to pull together industry and State and local officials together last year to have a discussion about what could be done regarding the status of State and local taxes on telecommunications, and really, it's a communications issue. Not just telecommunications, but all the different communications mediums which are now competing against one another.
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    I'll talk a little bit about those reforms, but first, there are four main points that I'd like to get across to the Committee today. First and foremost is that issues and responsibility for State and local taxations should be left to State and local officials. Ultimately, this is about State and local revenues, and State and local taxes and governors and State legislatures are very concerned with both those revenues and control of those tax systems.

    Second, an acknowledgement that changes do need to be made. Communications technology has evolved far beyond the existing State tax systems and a failure to act on behalf of States will only create increasing disparities among competitors and threaten long term revenues for State and local governments.

    Third, States are working to reform their taxes. Perhaps not at the speed that some in industry would like, but States are working very actively to try to modernize their tax systems, reduce administrative burden, and, in some cases, reduce rates.

    Finally, that Congress can best support State tax modernization by ultimately avoiding Federal action that will restrict the ability of States to craft meaningful reforms. Again, this gets back to the principle of federalism because we're talking about State and local taxes. Reforms and solutions really need to come from State and local governments.

    The discussions that NGA hosted were quite comprehensive, and, I should say, quite difficult.

    NGA and members of the big seven organizations, including NCSL, the National League of Cities, the Conference of Mayors, the Association of Counties, and others, joined together with representatives from the telecommunications industry, from the Internet industry, and cable and satellite television. All of the major players who are currently involved in communications—in the communications industry to try to discuss what could be done. First, what are the problems associated with State and local taxation. Second what are the principles for reforms for the different groups and, third, could consensus be developed to create some sort of solution that could be enacted by State and local governments.
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    A couple of key points became clear during those discussions. First, of course, that the current system of taxation is complex and does not completely reflect today's market for communications services. Several State taxation systems continue to tax communications based on the technology used to provide them rather than the service. It is these silos that often create disparities between new competitors in the market place.

    Second, industry regards certain, if not most, State and local tax practices and requirements as barriers to their ability to compete in an ever-increasing competitive market place. This is best summed up by one of the participants who said, ''in my estimation the real problem here is that there are 49 too many States.'' I think that's summed up where industry was coming from with regard to State and local taxation.

    Another industry observation from a non-telecom: ''Nobody wants to be a telecommunication company.'' If you look at the tax burden and some of the regulatory burdens, anybody out side of that rubric would like to remain out there.

    Third, every one wants to preserve their own competitive advantage. If a statute allows you a business model that gives you a competitive advantage over another member, you are going to want to preserve the status quo. These are all obstacles for reform. From the State standpoint, local and State officials are committed to competition and encouraging innovation. There is no governor that wouldn't want more broadband access in their State. However, State sovereignty also has to mean something, and at its core, that is the ability to structure State and local revenue systems, regulate businesses and protect and promote the public interest.

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    And finally, for State and local governments, revenues do matter. Any reform that simply shifts cost to States away from States is going the create more problems than it ultimately solves. And so anything that is just a simple tax cut without more comprehensive reforms, creates difficulties.

    As I said before, States are working to reform their systems. The COST study, which we've heard about, cites simplification reform in Florida, Illinois, Ohio, Tennessee, and Utah as having decreased the number of tax returns that a telecommunications provider must file by over 18,000.

    More recent reforms in Missouri and Virginia have gone even further. Virginia is a particularly interesting example—having just passed, it will take effect this year. The back story on Virginia's new tax, one that combined several different communications industries to broaden the base and lower the rate, is that it involved all levels of government negotiations between the governors office, State and local government, and different industry groups.

    Finally, States have also supported wide ranging telecommunications tax reforms as part of the streamlined sales and use tax agreement. This is the State-based voluntary agreement. Under that agreement, States are required to adopt uniformed definitions in administrative rules in return for collecting taxes from revoked vendors that volunteered to participate in the agreement. The governing board recently adopted new definitions that will require States participating to adopt those definitions into their State laws for purposes of sales tax. So there is considerable reform going on at the State level.

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    When State and local government went into the discussions that we held with industry. And I should say that ultimately they did not prove fruitful because of some of the conflicts we had between revenue neutrality and competitive neutrality.

    There were several different principles that were important to State and local government. First and foremost, reform should be technology neutral focusing on the service rather than the technology used to provide the service. Second, reform should be revenue neutral, hence one of the problems during our discussions. That's debated over 20 billion annually telecommunications taxes not only support general revenues, but are often allocated at the local level to pay for specific purposes ranging from education to improving public safety systems.

    The potential to significantly reduce State and local tax revenues is one of the primary difficulties with simply subscribing to a request that telecommunications industry be treated just like a general business. As the COST study asserts, and assuming the numbers are correct, and Steve, I'll give you the benefit of the doubt—the telecom tax rate stands at 14.17 percent compared to only 6.12 percent for general business. Mandating a reduction on telecommunications rates to those of general business with the effort required of 51 percent increase.

    Third, the Federal Government should not pre-empt State and local taxing authority. Fourth, the role of State and local government in serving public interest obligations must be maintained in any sort of reforms. And fifth, reform can not happen over night.

    The complexity of State and local tax systems does not lend itself to an immediate or one-size-fits-all solution. Reform should incorporate the interest of all affected parties and allow for sufficient transition time to fully implement comprehensive reform.
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    I'll be happy to take any questions from the Committee.

    [The prepared statement of Mr. Quam follows:]

PREPARED STATEMENT OF DAVID QUAM

    Chairman Cannon, Ranking Member Watt, distinguished members of the committee, my name is David Quam and I am the Director of Federal Relations for the National Governors Association (NGA). I appreciate the opportunity to appear before you today on behalf of NGA to discuss issues related to the taxation of communications services at the state and local level.

OVERVIEW

    Last year NGA embarked on an ambitious effort to develop consensus between representatives of the communications industry and state and local officials regarding the future of state and local taxation of communications services. For over eight months participants representing the wireline and wireless telecommunications sectors, cable and satellite television and state and local governments met to examine the issues raised by the current systems of taxation, formulate principles for reform, and if possible, craft a consensus for promoting changes that could benefit industry, government and consumers.

    Through those discussions several points became clear:

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 The current system of taxation is complex and does not completely reflect today's market for communications services.

 Industry views certain state and local tax practices and requirements as barriers to their ability to compete in an increasingly competitive marketplace.

 State and local government officials are committed to encouraging innovation and deployment of communications services while also protecting the public interest and providing for the needs of their citizens.

    The last two points proved the most difficult to reconcile. From the industry perspective, the days of monopoly service have given way to a competitive and evolving marketplace. Traditional state and local tax laws, which are generally based on the technology used to deliver communications services, distort the marketplace by disproportionately favoring one industry over another. The solution proposed by the telecommunication industry was to end specific telecommunications taxes and treat telecommunications service providers like a ''general business.''

    In contrast, state and local officials recognized the need to modernize existing tax laws, but stressed that reform also must reflect government's responsibility to protect the public interest and remain cognizant of the need for state and local governments to balance their budgets and structure their revenue systems.

    In the end, these competing interests prevented consensus, but they also made it clear that the complexity of state and local tax systems requires that long-term comprehensive solutions evolve from states—not the federal government. The ability of states to structure their revenue systems is a core element of sovereignty that must be respected by the federal government. Congress therefore can best support state tax modernization by avoiding federal action that will restrict the ability of states to craft meaningful reforms.
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BACKGROUND

    In 2000, NGA's Center for Best Practices issued a paper calling for Governors and state legislators to ''reexamine the state and local tax treatment of the telecommunications industry.'' (''Telecommunications Tax Policies: Implication for the Digital Age,'' NGA Center for Best Practices, 2000). The report concluded that existing state and local tax systems were ill-suited for the modern telecommunications marketplace, stating:

''[S]tate and local telecommunications tax systems are not competitively neutral. In many cases, the current tax structure favors some segments of the industry over others. In other instances, the tax burden on the telecommunications industry is greater than that of other industries. In either case, telecommunications companies are not competing on a level playing field. The current tax system forces these companies to compete not only on the basis of economic factors, but also on the basis of the tax differential among them.''

    The report went on to recommend that state policymakers review their state telecommunications taxes with goals of increasing tax efficiency, competitive neutrality, tax equity and administrative simplicity. Importantly, however, the report recognized that many of its reforms are not revenue neutral and that the fiscal impacts of any changes on state and local government ''need to be a major focus of any proposals.''

STATE TELECOMMUNICATIONS TAX REFORMS

    Since 2000, several states have taken up the mantel of telecommunications tax reform. As noted in the Council on State Taxation's 2004 State Study and Report on Telecommunications Taxation (COST Study), simplification reforms in Florida, Illinois, Ohio, Tennessee and Utah decreased the number of tax returns that a telecommunications provider must file by 18,610. More recent reforms in Missouri and Virginia have gone even further. The Missouri law, which will take effect Aug. 28, 2006, expands the municipal tax base by making it clear that providers of cell phone and other wireless telecommunications are subject to the same tax as wired telecommunications. In return, the state (rather than municipalities) will collect the tax and apply a new 5 percent ceiling to all municipalities by 2010.
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    Virginia's new communications tax law is even more comprehensive, streamlining existing state and local taxes into a statewide, flat-rate structure and eliminating local cable-franchising fees. Beginning January 1, 2007, the commonwealth will collect the tax and disburse rebates to municipalities on a share basis reportedly equal to what they now gather from the existing tax structure. In addition, a statewide rights-of-way use fee will be applied to all cable-TV service lines in the same way it is currently applied on all local exchange telephone lines. Supporters of the law maintain the new measure will raise approximately the same amount of revenue that municipal authorities now receive from local taxes and franchise fees. The standardized rate is distributed evenly among communication services resulting in reductions in the monthly phone bill for most residential customers.

    States have also supported wide-ranging telecommunications tax reforms as part of the Streamlined Sales and Use Tax Agreement. Under the Agreement, states are required to adopt uniform definitions and administrative rules in return for collecting sales taxes from remote vendors that volunteer to participate in the Agreement. The Governing Board (the governing body for the Agreement) recently adopted uniform definitions for telecommunications services that will require changes to the tax laws of the Agreement's member states. The benefits of the Streamlined Agreement—central collection; uniform definitions, customer remedy procedures and sourcing rules; and notification of and limitations on local rate and boundary changes—represent critical reforms that will significantly reduce complexities and ease providers' administrative requirements.

OPENING A DIALOGUE

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    While states worked individually to modernize their tax systems, it was the debate over how to best extend the federal Internet access tax moratorium that underscored the need for states and local governments to work with communications providers to address state tax issues.

    A key part of the extension debate was how to level the perceived tax disparities between telecommunication and cable broadband offerings and address the rise of new Internet-based services such as Voice-over-Internet-Protocol. Those industry sectors not subject to the moratorium argued for their inclusion to promote competitive neutrality. Those subject to the moratorium argued to preserve their exempt status; and those outside the moratorium fought to prevent the transfer of any additional tax responsibility to their industry. The debate illustrated the difficulties states face in modernizing their tax systems to make them competitively neutral: industry sectors that stand to gain from reform support state efforts; industries with an existing competitive advantage due to state or federal restrictions fight to maintain the status quo.

    Following passage of the extension, NGA called for an open a dialogue between state and local elected officials and industry representatives to examine current taxation practices, compare principles and priorities for reform, and determine whether any consensus exists for modernizing state and local communications taxes.

    State and local government associations worked together to develop key principles to help guide discussions with industry. First, reforms should be technology neutral, focusing on the service provided rather than the technology used to provide the service. Such a change would decrease discriminatory tax treatment between competing service providers and allow for greater certainty for new entrants.
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    Second, reforms should be revenue neutral for state and local governments. Estimated at over $20 billion annually, telecommunications taxes not only support general revenues, but are often allocated at the local level to pay for specific purposes ranging from education to improving public safety systems. The potential to significantly reduce state and local revenues is one of the primary difficulties with simply subscribing to the demand of the telecommunications industry to be taxed like ''general business.'' The COST study asserts that the average effective rate of state and local transaction taxes for telecommunications services is 14.17%, compared to only 6.12% for general business. Mandating a reduction of telecommunications rates to those of general businesses would therefore require a 51% decrease in state and local tax rates. Actual revenue losses would likely exceed the $6.987 billion difference estimated in a November 2001 study prepared by Ernst & Young LLP for the Telecommunications State and Local Tax Coalition.

    Third, the federal government should not preempt state and local taxing authority. Governments at the federal, state and local level have long recognized that communications services play a unique and critical role in modern society that may require different regulatory and tax treatment from those imposed on general businesses. Furthermore, state and local jurisdictions are generally required to balance their budgets. A federally mandated reduction of more than $7 billion in telecommunications tax revenue would require spending cuts or revenue increases to cover the loss. The ability of states to structure their revenue systems to fund government services is a core element of state sovereignty that should not be undermined by federal authorities.

    Fourth, the role of state and local government in preserving public interest obligations should be maintained. The responsibility of managing public-rights-of-way, funding public safety infrastructure, providing consumer protection and promoting universal service are critical state and local functions. Reforms to state and local tax systems should not undermine government's ability to carry out its responsibilities to protect the public interest.
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    Fifth, reform cannot happen overnight. The complexity of state and local tax systems does not lend itself to an immediate or one-size-fits-all solution. Reform should incorporate the interests of all affected parties and allow for sufficient transition time to fully implement comprehensive reforms.

CONCLUSION

    A modern communications infrastructure that provides high-quality, reliable, and affordable communications services is essential to the economic competitiveness of states and the nation. Recent technological advancements in communications services are fundamentally changing the manner and means by which consumers communicate with one another. These changes have led to the development of new services, greater competition and increased consumer choice. Technological advancements also pose challenges for states, which generally tax communications services based on the technology used to provide the service rather than the service itself. Left unchanged, these laws will create inequities between competing service providers and diminish state communication tax bases as new technologies evolve beyond existing laws.

    Although NGA's efforts to develop consensus recommendations for reform were not immediately successful, Governors continue to support state efforts to modernize their tax systems in a manner that promotes innovation and competition, encourages investment, preserves state authority, provides necessary resources and advance the public interest.

    Mr. CANNON. Thank you. We've got a bill for a vote. We have a couple of votes, but I think we have time, Mr. Mackey, for your testimony and we will come back and do questioning afterward.
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STATEMENT OF SCOTT R. MACKEY, ECONOMIST AND PARTNER, KIMBELL SHERMAN ELLIS LLP, MONTPELIER, VT

    Mr. MACKEY. Thank you, Mr. Chairman, Representative Watt, and Members of the Committee. As you said in your introduction, Mr. Chairman, I have looked at this issue from both sides now. I've worked with the wireless industry for the last 5 years, specifically trying to address the discriminatory and excessive State and local tax burdens, and also, when I was at NCSL I was working on it too. I think—seeing it from both sides—it is clear that the problem, as defined on both sides, is the same. Everyone acknowledges there is a problem, and of course, the stumbling block is how to solve it.

    I am going to focus on something that you, Mr. Chairman, and Representative Watt mentioned in your opening statements, which is the economic impact of some of these taxes. I'm going to talk specifically in my short time about consumers and about the overall economy, because these taxes and the tax systems that we've allowed to sort of become institutionalized really have impacts that—broadly on the national economy and on consumers that don't get a lot of attention but perhaps really should.

    On the first point concerning consumers. Everybody in the State and local world knows that consumption taxes are regressive, and I think what you see with telecommunication taxes is you have a layering effect of one regressive tax on top of another regressive tax on top of another, you know, where you have multiple taxes at the State and local level all being layered on the consumer. And as a result, you have sort of a very regressive tax system on our people on fixed incomes and our low income households. When you have average effective rates of 15 percent—as has been talked about in the COST study—obviously a tax on telecommunications and other communications services is going to have a much bigger impact on somebody with a lower income than a higher income.
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    A troubling trend recently is some jurisdictions actually imposing flat rate taxes. For instance, in the City of Baltimore, where the city imposed a $3.50 per line tax on wireless and wireline phone lines. Well, obviously, at $3.50 as a percentage of a $25 cheapest plan you can get is a lot higher than $3.50 on a $100 plan. And the impact can be even magnified in households where you have families—at least in the wireless side, for instance, you have, you know, buy your first phone and sign up for a second or third line for only $10 more a month. Well, the marginal rate on some of those second and third lines is 40 percent if you are only paying $10 more and you are adding $3.50 in tax plus 5 percent tax.

    So we really have a situation where the regressive nature of these consumption taxes is really, really magnified in the area of communication services tax.

    Now consumers are burdened, but consumers are also wage earners. They're also out there trying to earn a living. And the other point I wanted to make is the economic impact of these communication services taxes really affect the whole economy because, as others speakers have alluded to, we've moved from a monopoly structure where there wasn't choice, there wasn't competition for consumers. Taxes were buried in the bills and essentially taxes didn't matter. You were buying plain vanilla communication services and the tax that you pay really wasn't going to affect what you were buying. Now we are in a situation where consumers have choices of providers, choices of technology. And they're really—more and more of their dollars are being spent not so much on plain vanilla communication services, but on other things: downloads and things like that.

    So what you are seeing is consumers are a lot more price sensitive today than they were in the monopoly era. And when you impose taxes of 15 percent and as high as 20 percent and more in some States, what you have is a real impact on consumers' purchasing choices. One study that looked only at wireless, but a lot of it, I think, is true for other communication services as well, found that every 1 percent increase in the price is going to reduce consumer demand by between 1.1 and 1.3 percent. So you can imagine a system where you have tax burdens that are 9 percent—7 to 9 percent higher than what you buy at the store. That's going to translate into a 10 to 12 percent reduction—in consumer expenditures on communications.
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    So what does that mean to the economy? Well, obviously the communications companies—wireless, wireline, cable—are investing huge amounts of money to push advanced communications network broadband out to more consumers so they can compete with each other and get into everybody's business. And obviously this benefits consumers because the more competition there is, you are going be able to get a better deal. And what we are finding is that these taxes that have an impact on how much revenue, you know, cash flow from operations—that these companies have available to invest back in their networks. And these are not insignificant amounts of money. In the wireless side, it's 20 billion a year. I am sure it is higher, even higher in cable and wireline telecom as well. And this is how these advance communications networks are going to be built: by the private sector investing money to get these services out there.

    Now, the reason this is important is because study after study has showed that there are huge productivity benefits to the U.S. economy when we can get these networks out there and get businesses and consumers and everybody using them to be more productive. In fact, a study that was recently done by Ovum and Indepen found that 80 percent of the productivity gains in the year 2004 were estimated to come from information technology and communications.

    So obviously, the more money that companies have to invest in networks, there is going to be more productivity benefits that are going to accrue to everybody. And when we talk about the revenue concern that the local governments have, those are real concerns. But there is also the possibility that we can create a bigger pie and have people spend more on services if we didn't have some of these discriminatory taxes that are going to result in more tax revenues coming in for everybody, higher incomes, and all of the positive things that we saw in the '90's with the Internet and the growth of e-commerce.
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    So these taxes do matter to the economy. And you know, to the extent that these tax structures are retarding investment in advanced communication services, that's a problem.

    And I'll just sum up with a simple maxim that if you want more of something, subsidize it, if you want less of something, tax it. And unfortunately, we are taxing our way to slower broadband deployment, less investment by the private sector in advanced communication services. And we're doing that at a time when State and local governments and their economic development people are very serious about wanting to get this out there. On the one hand, we have these tax structures that are retarding investments and in some areas we actually have subsidization going on to try to get more of it.

    These taxes really do have an impact directly on the consumer as a purchaser, but also the overall economy and affect it that way. So it is a very important issue, and it is great that this Committee is looking at it because of these national implications of what we are doing, and I know you have a vote. I look forward to the question period, and I thank you.

    [The prepared statement of Mr. Mackey follows:]

PREPARED STATEMENT OF SCOTT R. MACKEY

[Note: Image(s) not available in this format. See PDF version of this file for complete hearing record.]
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    Mr. CANNON. We will recess for about 20 minutes. Long enough to go over and vote. Then when I get back, we'll restart. So we will be recessed for a bit. Thank you.

    [Recess.]

    Mr. CANNON. The Subcommittee will come to order. All this technology going on here. Modern communications are fixed to the floor and worse, we have noise from the floor.

    I think—Steve, do you want to stay for a question?

    Thank you. We have another briefing going on elsewhere, so I think we'll do questions. I'll ask you questions and we will be a little less formal here, but I'd like to get up to that briefing as well.

    I apologize for that, the interruption. That's sort of what happens in Committee. But we had some really interesting discussion, and what I'd like to do is just get comments from the various perspectives on this issue. Historically, the richest guys in town were the guys who had the telephones first and they got to call each other and the maids got to call the maids in other houses. You had somebody who actually physically pulled the plug and put it in so you connect to the circuit. And so we taxed people pretty heavily on telecommunications because it was a luxury.

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    The world has changed around us now. We don't—not only do we not have plugs, but we don't have circuits any more. We have the Internet and communication on the Internet.

    I am wondering if given the regressive nature, and certainly you'll testify on this, but I'd like to focus on the regressive nature of the tax as telecommunications has become so common. Is that not something that ought to concern us significantly. We'll start Steve, with you and go down the panel.

    Mr. RAUSCHENBERGER. Absolutely it should. The aggressive nature of telecommunications taxes is a problem. Because the rate's high. Because consumption tends to, on traditional phone lines, tends to be more concentrated in less affluent socio-economic groups. And the other thing that we didn't touch on but I think has been stated—the concept emerging since the '20's and the '30's, the 1920's and 1930's in the United States of a ubiquitous network where everybody's connected. The value of the network is, in large measure, because everybody is on it. I mean having a phone system that only connects half of the Members of Congress is less valuable to everybody. So these extraordinarily high taxes also discourages some people from being on the network.

    Mr. CANNON. Thank you. That's a remarkably important insight and I appreciate that. I don't mean to interrupt, particularly, but if you could add to the commentary. You might, in particular, want to talk about this. It seems to me the wonderful thing about America is we have upward mobility. The ideas of Americans that we have is that rights come from God, individuals delegate those rights to Government, and we protect those rights through the rule of law. And in that environment, it doesn't matter who your poppi was, you know. It doesn't matter where you were born or the color of your skin. What matters is your initiative and your intellect and other talents.
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    And so in America, we have this upward mobility that's created by a system. No other country—I mean, there's been stories about China for instance, where they would seek out the smartest kids in the country, bring them into the bureaucracy and the bureaucracy is what actually maintained and developed upward mobility but it was very, very limited. Whereas in America, any kid can fail his test here and there and not do well, but finally get some initiative and make something out of himself.

    It seems to me that telecommunications is like a key factor in letting that kid get an education, assert himself, connect himself and move up. And am I missing something here but isn't that an important part of it?

    Mr. RAUSCHENBERGER. I would agree. I would again say the danger we have in not dealing with this traditional silo tax and regulatory scheme and simply avoiding doing it because it's uncomfortable. It causes us to rethink how we do municipal taxation or rethink how we do State taxation. There's no long-term benefit to the United States or to any municipality or State not reforming these.

    So that's why—if you are going to have a network of exchange of information, if intellectual property is going to be one of the cornerstones of my children and your children, and the United States has to build on as we compete in an ever-increasing flattened world. We need to make sure our networks are ubiquitous, that they're low costs, that they're broad based and they're well distributed, and our tax policy today does not—you know, I believe in the sovereign States.

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    I am a States' rights person. We need to work with the municipalities and the States to make sure we do this right. But we do need leadership on some issues from Congress to help set time frames.

    Mr. CANNON. And when you talk about a ubiquitous network what you're talking about there is not only the whole system where you better but the ability of kids or individuals to emerge in the system. The record should reflect that Senator Rauschenberger is nodding his head in the affirmative on that. Thank you.

    Mr. Kranz, or Mr. Quam——

    Mr. QUAM. I'd be happy to take that. I think you definitely hit on an issue I think everybody here recognizes in that we have a legacy problem that our tax laws are not keeping up with some of the technological evolutions that we've seen. Some of which have been evolutionary, if not revolutionary, just in the last 6 years. The Internet, in particular, is now the cornerstone in communications. This is no longer just wireline and pack switches and that type of thing. And so States do need to reform and take a look at the regressivity of some of the taxes and the entire tax system as a whole. However, one of the things I pointed out in my testimony—one of the things that was critical during our discussions, was bringing everybody to the table.

    Again, this is not telecommunications anymore, this is all communication services. You have what has traditionally been defined not as telecommunication—telecom now offering telecom type services. So if you are talking about reform of the tax system, and again, States are really beginning to look at reform at the State level where you can broaden the base and lower that rate and possibly address some of these legacy issues. You need to get rid of some of the restrictions that prevent States from being able to broaden that base so that you can craft a solution that really works at the State level.
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    I go back to the example in Virginia. Again, during that process, which took a number of years, they reached out to local government groups, all sorts of different industry groups. Crafted a bill, established a rate, ran the tax numbers to see if the revenues would be sufficient to make municipalities whole and get the revenues that the State needed, and also meet some of the competitive neutral aspects that they were after. When it didn't, they went back out, tried to bring, you know, talk to other industries, brought them in to the point where you have a very comprehensive bill that really could revolutionize State and local tax structures in Virginia.

    Now, it's important to note that that model can't be used everywhere. Not every State is going to have the options that Virginia did as far as moving taxes, increasing them some places, lowering them in others. But the dialogue at the State level, State and local level, and I would argue at the Federal level, has got to be now, not about telecommunications taxes but about communications, the entire industry. Ultimately, reforms should be future proof, and I want to borrow a phrase from one of my friends in telecom that said if we do that right, you get to reforms where the next new entrant and the next new thing fits seamlessly in there and provides opportunities for everybody to use that technology and taxation is no longer picking and choosing winners and losers, but it is also meeting the needs of State and local government.

    Mr. MACKEY. Just briefly, Mr. Chairman. I absolutely agree that we ought to be concerned with the regressivity. As you mentioned, obviously, the networks are ubiquitous, but you also have, you know, the demographics are changing in terms of who's using and purchasing a lot of these services, and you alluded to it in your opening statement about the kids doing the text messages back and forth and you having to try to keep up with your kids doing it.
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    I mean, we have got a lot of young people, a lot of people on fixed incomes staying connected through this technology in a lot of different ways, not just through voice. So it's absolutely important and critical that we look at it. So I would agree 100 percent.

    One other thing, if I can tie it back to something I said earlier, to the extent that—and this relates to the prices that folks pay for communications services. To the extent that we have tax policies that slow the emergence of competing networks so that we have one provided by a cable company and one provided by a landline company and one provided by a wireless company, and others all able to provide broadband, to the extent we slow that, consumers are denied the benefits of competition, which are also going to lower the price that consumers have to pay for those services.

    So there's the impact of the regressive taxes and slowing of investments that's going to bring lower prices for everybody as well.

    Mr. CANNON. Thank you. I have another couple of questions, but my time has expired.

    Mr. Watt.

    Mr. WATT. Mr. Chairman, I always like these hearings because we spend all that time arguing about things that I think everybody already agrees on. Taxes are too high, taxes shouldn't be regressive, taxes are unfair, State to State is inconsistent. I think pretty much everybody on the panel said that in one way or another.
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    The point I am wrestling with, I don't even disagree with any of that, is how the Federal Government gets there from here and what our standing is to be setting a standard. And so I guess my devil's advocate question, not to try to get to a different conclusion than you all—I mean, Senator Rauschenberger said that we need to do something to provide incentives to, quote, enlighten State public policymakers. Recognizing that there are some enlightened State public policymakers, the problem is it sounds to me like they are all moving in the direction and all of a sudden the Federal Government is getting ready to do something preemptive, or runs that risk.

    So I am trying to figure out how we don't stifle those enlightened State public policymakers, but don't overstep our bounds at the same time, because if you accept the notion that interstate commerce—and this is one of those—telecommunications, I guess, is interstate commerce—but if you accept the notion that the Federal Government can preempt, and the next step is going to be no taxes on telecommunications, I don't know how you get off that slippery slope. I don't know how you get from the notion that you can do this on interstate telecommunications, but there is still some intrastate, and I'm not sure what authority we have as Congress to do this.

    So I'm going to encourage you all—I'm going to stop talking and encourage you all to have a discussion about some of the things that we need to be focusing on, not the things that we all agree on. Everybody will tell you taxes are too high, but I'm sure Senator Rauschenberger is not going to tell you that the State doesn't have the authority to set its own tax structure, and I'm sure the local government is not going to tell you that we've got to at least have some revenue coming from somewhere if we're going to provide local services. And at some point we've got to come to grips with who has responsibility and authority to make these assessments, and you all keep talking about providing incentives, or speeding up, but I haven't heard anybody say where you think we ought to get off, because once the Federal Government gets on, we don't have much of a history of getting off of anything.
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    That's my question. Whoever wants to answer it.

    Mr. RAUSCHENBERGER. Congressman, thank you for asking that question. Two quick observations. Enlightened legislators, State legislators, is not the same as military intelligence. Sometimes it really does exist. I think State public policy is moving in the right direction, but so are the glaciers in Greenland.

    I think at risk here is the speed that we need to understand that we operate today 16th- and 17th-century Governmental models which served the public well——

    Mr. WATT. The States are operating under those same models. The Federal Government is still operating under some of those same models, too. So that doesn't answer my question.

    Mr. RAUSCHENBERGER. Which is why public policy falls behind.

    I would make three recommendations to you. First of all, I think preemption is a dangerous place to go, but if the Federal Government or the Congress were to consider putting out there a set of guidelines and recommendations to States, much like they did with the Mobile Sourcing Act where there was a requirement that States over a period of time act to modernize their sourcing rules or they lost the ability to levy those taxes. In the end, we had 50-State compliance because people had time to react to it. It set an agenda for State legislators.

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    I would also recommend that as this Committee looks at it, you need to consider defining communication services broadly enough that State legislatures can broadly tax all communications services at a lower rate rather than focusing on some technologies. The concept that Voice Over Internet Protocol or Internet speech ought to somehow be treated differently than wireline communications is not something I think is in the public's best interest in the long run.

    I think also I would recommend, whatever you do, that you allow sufficient time frame, keeping in mind that some State legislatures still only meet every other year. I would argue 4 to 6 years at the minimum, is the shortest time period to mandate to work with the States to modernize because some legislatures don't meet often enough.

    The last thing I would urge you to consider in this short laundry list is the understanding that States are going to have a difficult time mitigating the impact on local governments. So giving States resources to work with; for example, I have always believed that the best opportunity to actually get telecommunication tax reform done at the States, is simultaneous with modernization of State sales taxes in the streamline bill where there's resources from the modernization of the sales tax occurring simultaneous with the loss of revenue in telecommunications. So we can improve both those tax systems.

    Mr. KRANZ. Mr. Chairman, Representative Watt, I think if you take the problems we've described and break them down into two separate pieces, the tax rate burden and the discrimination that occurs there and the administrative or, as I call it, the accounting burden, those two problems can be solved with very different solutions. And the rate burden, the discrimination, there are models out there, the 4R Acts that Congress passed, preventing States from discriminating against transportation companies in their taxing positions. There's a markup later this afternoon on a bill that would prevent States from discriminating in natural gas pipelines.
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    That's the kind of Federal solution that could be crafted here, and my job isn't to advocate any solution. Our study is intended to discuss the lay of the land out there.

    On the administrative or accounting burden, a solution could be fashioned at the Federal level similar to what State Senator Rauschenberger mentioned in the streamline bill. There Congress can provide a carrot incentivizing the States to get to a simpler world.

    Those are possibilities that I think should be considered. I know that our friends at the State level don't want Federal solutions to these problems, but I do agree that the icebergs in Greenland are moving faster.

    Mr. QUAM. Mr. Watt, I am going to, surprise, surprise, disagree with some of my panelists. Having the Federal Government somehow proscribe a solution here or preempt the States in coming out and asking for that as a potential solution seems to be saying, please help States—please save us from ourselves.

    The last time I checked, States and local officials, they answer to voters, and they are subject to elections, and they are making those decisions. That's ultimately where State and local tax decisions need to remain.

    In my testimony I mentioned that one of the biggest things Congress could do in this field, because States are reforming taxes, is support modernization by just avoiding Federal action that will restrict the ability of States to craft meaningful reforms.

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    I get back to one of the best ways to ultimately allow States to reduce rates, if that is an ultimate goal, is to be able to broaden the base and create some tax equity and some competitive neutrality among competitors. I think that is a worthy goal, but a goal that has to be pursued at States.

    Finally, I think Senator Rauschenberger is right on the mark with regard to streamlined. The streamlined bill has been a remarkable effort by States on a volunteer basis to modernize sales tax systems, to address an incredibly complex systems of sales tax laws, find agreement and work together in a sovereign way, because it's States making State decisions and working together and ultimately having the Federal Government support that effort and partner with States I think will be a large step forward with regard to taxes and promoting that type of simplification, administrative simplifications.

    Mr. MACKEY. Mr. Chairman, Mr. Watt, just briefly. The problem is I think if we just say just leave it to the States, I mean, we have a history of about 10 years where everyone has said there is a problem, and we've had, as others have said, very little movement.

    I absolutely agree that the federalism issues are very tricky, and you guys are drawing that line, but, I mean, Congress is uniquely, I hope, positioned to look at the broader economic issues of balancing federalism between the national economy and some of the impacts that some of these taxes are having on our ability as a Nation to compete globally and to get the networks out as quickly as possible. That is a difficult balancing act. Certainly if this were an easy thing for States to do, more would have done it.

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    I guess the problem from the communications industry side is just that it's difficult and frustrating when everyone agrees that there's a problem, and there is not much action or no action, or, I guess, one State moves to fix it.

    That's the dilemma that we face, and we're glad that you guys are having this hearing so we can talk about some of these issues, and you can weigh where you come out on that balancing act.

    Mr. CANNON. Thank you. Without objection, we'll go to a second round of questioning.

    Mr. Watt just asked pretty much my second question that I wanted to talk about. Let me refine it now a little bit, because I am highly reluctant to preempt States. On the other hand, there are some issues that really cry out in our constitutional environment for Federal national policy.

    I think, Mr. Mackey, you talked about the value of the network, in fact, several talked about the value of the network, being more valuable as more people get involved, and to the degree that that network becomes a huge national asset. And, in fact frankly, the foundation for the wealth not only of America, but for the rest of the world, it seems to me that that cries out for national policy in a world where any given State can distort that network fairly substantially.

    Does anyone want to comment on that with particularity? If you say it, it's better in the record than if I say it.
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    Mr. RAUSCHENBERGER. Let me say again, whether you are talking about the first intercontinental rail system, the movement toward standard gauges for railroads in America, or the National Highway System where States surrendered small parts of their State sovereignty—we all agreed lane width would be 13 1/2 feet, yellow paint would separate oncoming lanes of traffic—those networks have always had more value because there was consistency and leadership at the Federal level. No governor and no mayor is in a position not to see from 30,000 feet the value and the importance of being part of a ubiquitous, seamless network.

    For Congress to set a 6- or an 8-year reasonable deadline requiring States and local governments to reform and bring their tax system into compliance so they don't discriminate against a particular type of technology does not seem to me to be overly intrusive. I don't think any of us are suggesting here that we manage the network from the Federal Congress.

    We're talking about what everybody agrees is clearly a discriminatory taxing system that's affecting this network, which we all agree has value. I think your point is on target.

    Mr. QUAM. Mr. Chairman, I see a fundamental difference between sort of highways and railroads and the role they played and the network they served when they were being built and what we look at today. You're absolutely right, the value of network is absolutely proportional to the number of people on it, no question about it.

    No one would say, however, that the wireless industry has somehow not been successful in the last 10 years when you look at the number of subscribers. No one would argue that some of the large Bell companies who are investing in fiberoptics and broadband and aggressively going out there aren't competing and competing well and competing at the highest levels. The COPE Act itself is about establishing market-based reforms to increase that competition.
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    When you're talking about the railroads and the highways and a national presence, that was needed in some sense just to get the roads built, just to get them across the States. We have networks in place right now; I can go buy a roaming plan, and my phone will work anywhere in the United States. That's a pretty robust network.

    The question becomes, Mr. Watt, I think you said yourself, the commerce clause gives Congress very wide authority, and arguably communications is interstate, and we give Congress wide authority to come and interfere with State and local taxation. However, the question has got to be should Congress interfere with that. I think the 10th amendment ultimately means that's got to be a very high bar to cross.

    Mr. WATT. I think the question is where you draw the line.

    Mr. QUAM. I think that's absolutely right.

    Mr. WATT. That's really the question. What you're doing is making the case for a Federal taxing system. That's probably more understandable than the argument you're making. I don't see—I don't see a compelling Federal argument to provide an incentive to do this in 6 years. I see a more competitive, compelling argument that the Federal Government could take it over completely and say don't tax it. That's what we did with the Internet.

    But you're on a slippery slope, and I'm just suggesting that you need to be careful, and even there I don't know how you say to a State and local government you can't tax local phone calls, local communication. That's not——
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    Mr. CANNON. That's my next question. You're asking exactly the questions that I think need to be asked, but can I just add a little bit? We have already decided not to tax the Internet, and we are talking about being neutral to technology. So, how do we tax telecommunication systems when you have a system that we're already agreed on a national level, with some exceptions, not to tax?

    There's been some talk, I think that's where you're headed, and I'd like to get the opinions of these folks. Should we tax the telephone number? Because if you tax a telephone number, people will go to URLs, and that will clog a system that people have come to enjoy. In other words, if you are going to be technologically neutral, don't you need Federal leadership; and secondly, don't you need to get away from taxation entirely of a system that is fundamental?

    We tax gasoline. We don't tax, except in cases like Utah, and they are under the process of thinking about being stupid on this point—we don't tax except generally speaking through gasoline taxes.

    Doesn't it make some sense to not tax communications because that's the only way you are going to be technologically neutral; and secondly, don't you need Federal leadership to actually do that?

    Mr. WATT. Except you should know for the Chairman it makes sense not to tax anything.

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    Mr. CANNON. Very little.

    Let's start with Mr. Mackey and move back, because, Steve, you may want the last word on this one.

    Mr. MACKEY. That's a policy question that people would argue about. I think what the industry is seeking on behalf of its customers is fairness, and fairness defined as we're not seeking to be exempt from all taxes. We feel like the services that the communications services industry provides, which, after all, are moving more and more away from plain vanilla talking on a telephone and more toward a lot of digital goods and other types of services that are really no different than sometimes what you buy at a store, whether you buy a CD in a store or download it onto your phone or onto your computer at home—we think that the industry would argue that fairness means being taxed like general business. Now, from an economic development maybe you can make the argument that the rate should be zero. This industry, communications industry, has been subject to a discriminatory burden for so long that we just want to get to where general business is. And we think there are significant economic benefits to the economy of doing that that, as I said earlier, will generate some money at local governments to help them fill in some of what they think they are losing.

    Mr. CANNON. Mr. Mackey, do you know how many users Skype has today? Last I heard, it was 28 million, but it's probably doubled since then, 30, 40 million. Does anybody know? In other words, we have something like 98 million landlines, something like 100 million cell phones. Skype is now in the ballpark of those. They are not taxed.

    So I appreciate the fact that you're willing to take the stripes of the normal tax burden here, but the normal tax burden is not going to be normal for a year or 2 longer.
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    Mr. MACKEY. I'll quickly follow up. To the extent you maintain the high rates, you are just driving everyone to the type of system you're talking about with them.

    Mr. CANNON. Pushing the envelope a bit because I want some feedback, we are rapidly becoming a system where not only is the discriminatory tax outrageous, counterproductive, but any tax is going to be marginalized by technology. So don't we need Federal leadership on probably a quicker scale than you are suggesting, Senator Rauschenberger, to deal with this issue so America maintains its leadership and expands at a rate unencumbered? And, of course, it does create a problem for States; I'm not suggesting it does not.

    Mr. QUAM. Mr. Chairman, it won't be surprising that I'm going to be contrary.

    Mr. CANNON. When you disagree, would you tell me what we do about taxing VOIP? I think taxing a phone number is silly. That's probably what we do in the Senate with the COPE Act. I think it's a stop-gap, and I hope the States think about how we get away from that quickly enough so we don't distort the system. That's what I'd really like to hear from you. What do we do to tax Skype in a way that is not counterproductive to the development of the Internet and communications services generally?

    Mr. QUAM. Right now, and somebody can tell me if I'm wrong, I believe Skype is a free service. Some of it is. So it's more or less a free service. So forgetting the tax, you also have a free service compared to other communications. So there are a lot of economic factors involved in why Skype might be growing the way it is.
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    More importantly, I want to get back to an important key point, and this is the hearing and what you're talking about is State and local taxation, it's not Federal taxation. The Federal Government certainly can and should be a leader with regard to Federal tax policy. I don't think the Federal Government has to lead when it comes to State and local tax policy.

    Mr. CANNON. Would you deal with the issue of the national policy toward telecommunications, communications, Internet, all the bundle of things? In other words, if you say historically we don't have a right to deal with local taxation of particular items, well, we have constitutional issues that we've developed over a long period of time, but we are not talking in a context. Now we're talking about a future in which communication can be virtually free, and that means free of taxes and in some cases free of even cost other than the access to the bandwidth.

    The question in my area is now selling mostly bandwidth and other things that go along with bandwidth. That's where they view their financial future. And whatever services, whether that's telecommunication or television, cable content or video conferencing, they just want to get money—in other words, the industry is saying we want value for what we provide, we don't care what it is that you do.

    So telecommunications, if you take an arbitrary identifier like a telephone number, becomes an obstruction to the development that might otherwise just happen, and the States are in the middle of that, and we're looking at that from a national policy view.

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    What do we do to distance ourselves in the areas of innovation and communication? That's what I think I need to hear from you, not that the States have rights, because they do. But what do we do as a country so we go in the right direction, and what is the most important economic force in the world today?

    Mr. QUAM. I get back to, again, the point that was made when we gathered all of our players for the discussion. That was an issue I talked about before, and that is future-proofing, which is really what you're talking about, the vision for the future that will allow for the growth of new technologies, new entrants, new paradigms really, and how do those match up with Government responsibilities, ultimately.

    The Federal Government certainly has a role in planning Federal policy to do that. I don't disagree. Do I have the answers? No. I don't think anybody in this room does, but it could be one heck of a debate.

    My issue remains that at the end of the day States do have rights, States do have responsibilities, States do have public interest that they need to enforce, and sovereignty means something, and revenues do matter.

    To the extent that the Federal Government interferes with those State tax systems, I think that's a very high bar to cross. Establishing a national standard with national resources, absolutely, that's Congress's prerogative. But when you cross into the State line, and I think we can be good partners, and States can be innovators and will be innovators moving forward.

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    Mr. CANNON. Mr. Kranz, you have something to say?

    Mr. KRANZ. The communication companies are inevitably in a national playing field. Whether they're traditional telecom companies, cable companies, the Skype or the Vonage that are selling communication services online, they are in a national playing field, and I think we've identified—and I hate to use the phrase, but we've identified two nonlevel portions of that playing field, and one is communication companies competing with other communication companies and the disparity in treatment there. That requires a solution.

    The bigger problem that is addressed and I think the traditional communication companies are very concerned about is the difference between tax treatment of communication companies and general business, and that's where you have the huge disparities in rates and where there is a need for Federal solution or Federal guidance that says you can't discriminate, States and localities, you can't discriminate against these communication companies.

    And as you said, Mr. Chairman, it's no wonder that consumers are being driven to other solutions, but you eliminate the discrimination that's imposed, and the drive is not going to be there.

    Mr. CANNON. Thank you.

    Mr. RAUSCHENBERGER. I think we either voluntarily or involuntarily at some point surrender some of our freedom for the security that government offers. We surrender some of our resources for government to spend on common purposes. I think tax systems work best if they're simple, broad-based and low-rate. I would argue the solution that we ultimately need to get to for State taxation is a low rate, fair, broad-based consumption tax, a modernized sales tax across the States where States still have the sovereign right to decide what they want to exempt from taxation and the right to set their own rates.
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    The solution for telecommunication services, the solution for cable services, the solution for the service that we don't know about yet is simply to define it into the consumption tax base. Make a decision later if you want to exempt it.

    I know we're not supposed to talk about that other bill, but really fundamental to solving a lot of these problems is to quit treating telecommunications as if it's something different. It's not Twinkies, it's the expenditure of funds. We ought not to at the State level or the local level charge two to two and a half times a tax penalty simply because we've historically done it.

    If you think of the tax system in the United States, you think of a three-legged milk stool is what I tell people. On the one leg, you tax wealth through the property taxes in the United States, mostly in the States. You tax productivity through income taxes. And the third leg of that stool is sales taxes or consumption taxes.

    The solution, I think, in the long run that doesn't discriminate between technologies, doesn't pick favorites in companies is to move all of those services into the base of the consumption tax and make public policymakers who want to argue that they shouldn't be in the consumption tax base argue why they ought to be exempted or taxed at a higher rate.

    Mr. CANNON. Thank you. I appreciate your time here today. This is an issue that I think is remarkably important. I might point out that State revenues are at an all-time high in part because of the technology boom and in part because of Federal tax cuts. Lots of things are happening here.
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    This seems to me to be the time States ought to be figuring out to rationalize what they're doing. In part, that ought to include allowing the driving force, which I think has been the Internet, or the network, let's say, more broadly, the opportunity for people to enter with a low threshold to get over, and that ultimately keeping that threshold low for every node on the Internet is probably pretty vital.

    This is a complicated area, we recognize it, and we appreciate your input on it, and I suspect we'll have more hearings as we pursue the issue. Again, thank you all for coming. We are now adjourned.

    We had a markup scheduled, but because of the briefing on Iraq, we don't have a quorum, and so we are going to adjourn the Committee; not just the hearing, but the full Committee. Thank you all.

    [Whereupon, at 5:02 p.m., the Subcommittee was adjourned.]