FCC Claims Authority
to Tax Internet Telephony

(April 13, 1998)  The Federal Communications Commission released a lengthy report to Congress late on Friday that argues that "phone-to-phone" Internet telephony services constitute "telecommunications services" and should therefore be taxed to subsidize phone services in rural and low income areas, and other "universal service" programs.  The FCC Report also argues that self providers of Internet backbone are "telecommunications services."

The Report was prepared pursuant to a directive contained in §623(b)(1) of the CJS Appropriations Act passed last year.  It required the FCC to report to Congress by Friday, April 10, 1998 on: (1) its definitions of "telecommunications services," "information services," and other terms contained in the Telecommunications Act of 1996; (2) its application of these definitions to "mixed or hybrid" services; (3) its interpretation of who is required to contribute to "universal service"; (4) its interpretation of who is required to receive "universal service" support; and (5) the "75-25 rule".

The Report generally reaffirms the FCC's prior positions that ISPs are not common carriers, and that Internet access, and its associated functions, such as web browsing, email, ftp, Usenet newsgroups, and home pages, constitute "information services" rather than "telecommunications services".  However, the Report seeks to expand FCC authority by taking an unprecedented position on IP Telephony.  The Report states:

"We also consider below the regulatory status of various forms of "phone-to-phone" IP telephony service mentioned generally in the record. The record currently before us suggests that certain of these services lack the characteristics that would render them information services within the meaning of the statute, and instead bear the characteristics of telecommunications services, but we do not believe it is appropriate to make any definitive pronouncements in the absence of a more complete record focused on individual service offerings. To the extent we conclude that the services should be characterized as "telecommunications services," the providers of those services would fall within the 1996 Act's mandatory requirement to contribute to universal service mechanisms."  (Source: Report, ¶3.  See also¶¶83-93.)

However, the Report is merely a preliminary statement of the FCC's views on the subject.  It adds: "We do not believe, however, that it is appropriate to make any definitive pronouncements in the absence of a more complete record focused on individual service offerings."  (Source: ¶83.)  According to Rochelle Cohen, in Common Carrier Bureau, "the Report itself has not changed the FCC's rules."  However, "should it receive Petitions or Complaints with regard to IP telephony it would address those."

Critics of the FCC's approach argue that the Telecommunications Act of 1996 was intended to reduce federal regulatory control over the telecommunications industry, not to increase FCC regulatory authority to the computer and internet industry, and that the FCC's interpretation of the Act is incorrect.  Critics also worry that taxation and regulation of nascent technologies will discourage investment and development.   Finally, some argue that the FCC is developing new and expensive "universal service" programs that will result in an unreasonable tax burden on users.

Universal Service

The Telecommunications Act of 1996 continued the previous requirement that "telecommunications services" be taxes to subsidize services in rural areas and low income areas, also called "universal service".  47 USC 254(d) provides that:

Every telecommunications carrier that provides interstate telecommunications services shall contribute, on an equitable and nondiscriminatory basis, to the specific, predictable, and sufficient mechanisms established by the Commission to preserve and advance universal service.

However, the Act gave the FCC no authority to either tax or subsidize "information services."  In its Report the FCC claims authority to do both.  The FCC's Schools and Libraries program is subsidizing internet access, even though its mandate for this program, §254(h), only covers "telecommunications."   The Report of the FCC circumvents its lack of authority to tax internet activities by redefining certain internet functions to be "telecommunications services," and therefore subject to taxation.

Most of the money raised to subsidize "universal service" recipients is paid by long distance users and businesses.  In addition, since "Internet service providers are major users of telecommunications, they make substantial indirect contributions to universal service support in the charges they pay to their telecommunications suppliers." (Source: ¶4.)  But, the FCC wants more.

At issue is not merely funding the FCCs mandate to make telecommunications services available in rural and low income areas.  The FCC has recently engaged in two new, expensive, and perhaps illegal, programs which subsidize not only telecommunications, but internet access, for schools, libraries, and health care.  The FCC has just determined to tax telecommunications services $2.25 Billion per year for its Schools and Libraries program.

The FCC Report does acknowledge that it has an "outmoded system of universal service support".  (Source: ¶4.)

FCC Report in More Detail

The FCC Report is a massive 155 pages in hard copy, with 605 footnotes.  It measures 822 KB in PDF.  The Report is part history, part review of competing arguments, part policy analysis, part polemic, and part bureaucratic obfuscation.

The Telecommunications Act of 1996 provides that there are "telecommunications services", which fall under the FCC's regulatory authority, and "information services", which do not.  Neither IP telephony, web browsing, email, nor other internet functions, are mentioned in "universal service" section of the Act.  The Report therefore reviews in detail the history of the use of these terms and similar terms, as well as the legislative history of the the 1996 Act.

Telecommunications Act of 1934 gave the FCC regulatory authority over telecommunications, which was designated as "common carrier".   This included the power to regulate prices.  As both telecommunications and computer technologies advanced, the FCC published a decision in 1980, usually called "computer II," which created a dichotomy of "basic services" and "enhanced services."   It decided that the later are not subject to "common carrier" treatment.  Then in the 1982 MFJ, the Court ruled that the regional Bells created by the MFJ could provide "telecommunications services" but not "information services".  The Telecommunications Act of 1996 used these same terms.

The FCC Report states that in using the terms "telecommunications services" and "information services" "Congress intended the 1996 Act to maintain the Computer II framework," (Source: ¶45.) and maintain the two as mutually exclusive categories.

The Report continues its prior treatment of the Internet in concluding that Internet access services, such as web browsing, email, ftp, and home pages, constitute "information services".  It states:

We find that Internet access services are appropriately classed as information, rather than telecommunications, services. Internet access providers do not offer a pure transmission path; they combine computer processing, information provision, and other computer-mediated offerings with data transport.  (Source: ¶73.)

In contrast, the Report finds internet telephony to be different.  The Report draws a line between "phone-to-phone" and computer-to-computer" IP telephony.  Only the former are the target of FCC "telecommunications" treatment.  The Report explains the difference as follows:

"In the case of "computer-to-computer" IP telephony, individuals use software and hardware at their premises to place calls between two computers connected to the Internet. The IP telephony software is an application that the subscriber runs, using Internet access provided by its Internet service provider. The Internet service providers over whose networks the information passes may not even be aware that particular customers are using IP telephony software, because IP packets carrying voice communications are indistinguishable from other types of packets. As a general matter, Title II requirements apply only to the "provi[sion] " or "offering" of telecommunications. Without regard to whether "telecommunications" is taking place in the transmission of computer-to-computer IP telephony, the Internet service provider does not appear to be "provid[ing]" telecommunications to its subscribers."   (Source: ¶87.)

"Phone-to-phone" IP telephony services appear to present a different case. In using the term "phone-to-phone" IP telephony, we tentatively intend to refer to services in which the provider meets the following conditions: (1) it holds itself out as providing voice telephony or facsimile transmission service; (2) it does not require the customer to use CPE different from that CPE necessary to place an ordinary touch-tone call (or facsimile transmission) over the public switched telephone network; (3) it allows the customer to call telephone numbers assigned in accordance with the North American Numbering Plan, and associated international agreements; and (4) it transmits customer information without net change in form or content."  (Source: ¶88.)

Specifically, when an IP telephony service provider deploys a gateway within the network to enable phone-to-phone service, it creates a virtual transmission path between points on the public switched telephone network over a packet-switched IP network. These providers typically purchase dial-up or dedicated circuits from carriers and use those circuits to originate or terminate Internet-based calls. From a functional standpoint, users of these services obtain only voice transmission, rather than information services such as access to stored files. The provider does not offer a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information. Thus, the record currently before us suggests that this type of IP telephony lacks the characteristics that would render them information services within the meaning of the statute, and instead bear the characteristics of telecommunications services.   (Source: ¶89.)

Yet, the Report does not attempt to define the terms "computer" or "phone", or explain how, as technology advances, the two will be distinguished.   Nor does it offer an explanation of how users might be billed.

Since "phone-to-phone" IP telephony is a telecommunications service, the Report continues, it is subject to taxation to support "universal service" subsidies:

"With regard to universal service contributions, to the extent we conclude that certain forms of phone-to-phone IP telephony are interstate "telecommunications," and to the extent that providers of such services are offering those services directly to the public for a fee, those providers would be "telecommunications carriers." Accordingly, those providers would fall within section 254(d)'s mandatory requirement to contribute to universal service mechanisms." (Source: ¶92.)

However, the Report also leaves open the door for future "telecommunications" treatment for other Internet services.  The Report adds that:

"Although we conclude that Internet access is not a "telecommunications service," we acknowledge that there may be telecommunications services that can be provisioned through the Internet. We have singled out IP telephony services for discussion in this Report."  (Source: ¶101.)

Politics

The Federal Communications Commission is a "New Deal" era regulatory agency with around 2,000 employees.  While the 1996 Telecommunications Act was a deregulatory bill passed by a Republican Congress, the FCC is presided over by Clinton appointees.  It often favors continued and expanded regulation.

This issue also divides many in the telecom industry against elements of the internet industry; it also pits rural areas, which receive "universal service" subsidies, against urban areas.  To many rural legislators, the more things that contribute "universal service" subsidies, the more money the rural states stand to get.  Sen. Ted Stevens (R-AK) and Sen. Conrad Burns (R-MT), while both conservative Republicans, are two of the strongest proponents of expanding FCC regulatory powers.  They even argued that to the FCC that services provided by ISPs, including e-mail, should be treated as "telecommunications services".  (See, Report, ¶73.)

Also, FCC Commissioner Gloria Tristani is from New Mexico, another highly subsidized state.  The Tristani biography in the FCC website states that "one of her primary goals at the FCC is to preserve and enhance universal service ..."  In a speech in Albuquerque on April 9 she stated that:

Both upstart and established long distance carriers are moving traffic off the circuit-switched network and onto IP-based networks. If this trend continues, some have said the federal government will be left with less and less money to keep local rates affordable. If that is true, it would be bad news for residents of New Mexico ...

Of course, these "upstarts" see things differently:

We strongly support the goals of universal service, but the idea these emerging services should subsidize universal service via existing mechanisms amounts to suggesting the emerging personal computer industry should have helped make computing more affordable by subsidizing the distribution of mainframes.  (Letter to Al Gore from IP Telephony CEOs.)

Dissent

One of the five FCC Commissioners dissented - Harold Furchtgott-Roth.  He is an economist with degrees from M.I.T. and Stanford.  The other four are lawyers.   (See, Dissent of Furchtgott-Roth.)

Other Resources:

• Text of FCC Report in PDF.  (FCC website, 155 pages, 822 KB.)
• Text of FCC Report in WordPerfect 6.1.  (FCC website.)
• FCC Common Carrier Bureau contacts:  Melissa Waksman (lead drafter of the FCC Report) and Pam Gallant at (202) 418-7400.
• FCC News Media contact: Rochelle Cohen at (202) 418-0253.
• Office of Plans and Policy contact: Robert Pepper at (202) 418-2030.