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Taxation, broadband adoption, and edge provider doo doo

Posted August 1st, 2014 in Broadband, capital, edge providers, Internet, taxes and tagged , , , by Alton Drew

Last week, the U.S House of Representatives gave edge providers a little love when the Republican-controlled chamber of Congress voted to make permanent a 1998 moratorium on Internet taxes.  The moratorium, scheduled to expire on 1 November 2014, prohibits states or their political subdivisions from imposing taxes on Internet access or from applying multiple or discriminatory taxes on electronic commerce.  The bill, H.R. 3086, is now in the U.S. Senate waiting for their review.

Needless to say, state and local governments have their underwear in a bunch over the bill.  According to congressional estimates, states and local governments stand to lose hundreds of millions of dollars annually should the moratorium become permanent.  For example, the Center on Budget and Policy Priorities argues that Congress has no business trying to boost the consumption of Internet access at the expense of state and local revenues.  The Internet, according to the Center, is no longer the nascent industry that needs exemption from taxation in order to grow and flourish.

States that may be particularly hit the hardest are the states who were taxing Internet transactions before the moratorium was put in place and right before the first Internet bubble popped. These states collect taxes under a grandfather clause in the moratorium and include Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin.  In addition, Tennessee, Washington, and New Hampshire may also collect taxes but currently do not do so.

The National League of Cities argues that current tax policy advantages online retailers at the expense not only of revenue collection by localities but of main street retailers as well.  In a statement released last June, the NLC argued that “Main Street retailers are the backbone of our local communities.  These Brick and mortar shops need Congress to end the special tax status for online retailers and allow for fair competition.”

While the arguments made by the critics tug at the heartstrings, or I should say, reverberate the fiscal purse strings, they fail to take into account Congress’ responsibility to regulate commerce, the impact a failure to make permanent the moratorium will have on capital flow to edge providers, the very drivers of the Internet eco-system, the incentives presented to edge providers to move offshore that increased taxes would create, and the negative impact Internet taxes would have on broadband access adopters, the very adopters that create the derived demand necessary for a flourishing Internet eco-system.

First, Constitutional Law 101.  The Congress has the power to regulate commerce among the states.  The Internet is the conduit through which electronic commerce traverses and given the redundancy and virtual characteristics of the protocol that pushes data across some 67,000 globally connected computer networks, I think it’s safe to say that, at least inside the United States, the U.S. Congress has the option of regulating the Internet in a manner that promotes the consumption of Internet access.

Second, Economics 101.  The real backbone of any economy, whether local, regional, or national are the consumers, not the retailers.  Demand for goods and services are derived from consumer demand and more and more consumers are demanding goods and services via the Internet and at speeds that only high-quality broadband networks can provide.  Kimberlee Morrison, in a post for SocialTimes, reports that e-commerce is a $220 billion industry driven by consumers that search online for products before either entering into brick-and-mortar stores to make a purchase or just purchasing online.

Chuck Jones, in a piece for Forbes.com, wrote last fall that mobile commerce or m-commerce is expected to grow to over $100 billion in sales in 2017, up rather appreciably from the estimated $47 billion in 2013.

In a sluggish recovery where 70% of gross domestic product is driven by personal consumption, why would municipalities and states want to retard the level of consumer spending online with taxes?  And given the overindexing of people of color that use mobile broadband to access services online, is imposing a tax on Internet sales good economic policy?

According to the Pew Research Center’s Internet Project, 92% of African American adults have a cell phone and 56% of black adults have a smartphone.  Mobile broadband access is the primary mode for accessing electronic commerce as evidenced by lower adoption rates among blacks for broadband at home.  Pew reports that while 87% of white Americans make use of the Internet, 80% of blacks are traveling the information superhighway.  The gap in broadband access is wider, where 74% of whites have adopted broadband at home while the percentage of blacks who are wired at home comes in at 62%.

But Internet taxation does not only impact consumption of e-commerce or broadband adoption by people of color.  It impacts providers of services on the edge.  On one extreme is Internet information and content provider Yahoo!, a multinational corporation based in Sunnyvale, California.  Yahoo! is known primarily as a search engine, providing consumers with financial, entertainment, and cultural content.

Taxation is a threat to Yahoo!’s bottom-line according to its most recent 10-K filing.   Yahoo! notes in their 10-K that they may have exposure to additional tax liabilities which could potentially impact their income tax provision, net income, and tax flow.  Newly enacted tax law could have a materially adverse impact on the company’s cash flow.  Yahoo! cites the possibility of several jurisdictions seeking to increase government revenues by either taxing Internet advertising revenues or by increasing general business taxes.

Smaller players would not be immune from this threat according to Melbourne, Florida-based entrepreneur, web designer, and software engineer Maurice Newton.  Mr. Newton puts it succinctly and colorfully.  “The tax is a big factor.  Some companies will even go offshore to save money.  The FCC is up to their ears in edge provider doo doo and the smoke will not clear for a long time.”

The U.S. Senate needs to follow the House’s lead and listen to Internet entrepreneurs, the industries larger players, and the consumers that use broadband to access services.  A permanent moratorium on taxing Internet access will keep businesses here in the U.S. while encouraging further broadband adoption.

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There is infrastructure. Then there is broadband infrastructure

Highways, airports, roads, bridges, harbors. All are part of the conduit that moves American commerce, getting goods and services from consumer to producer. They are part of the commonwealth, owned by municipalities, states, and the federal government. When commenters talk about building or renovating America’s infrastructure, these are typically the components they are referring to.

The financing of these components is usually done with tax revenue or revenue or bond issues paid back with tax revenues. Accounting wise, a municipality may have a specific fund established which accounts for the revenues dedicated to and expenditures resulting from an infrastructure project.

Broadband facilities tend to be mentioned in the same breath as the infrastructure components mentioned above. Broadband facilities, the “information superhighway”, carry digitized voice and data between our cell phones, lap tops, and tablets. Broadband facilities are described as the on ramp to electronic commerce, much like the on ramp to Interstate 20 at Joseph E. Lowery and Oak Street in the West End of Atlanta.

That’s about where the similarities end.

Unlike airports, highways, bridges and toll roads, the vast majority of broadband facilities are owned by private entities; Comcast, Verizon, Time Warner, and AT&T, to name a few. The vast majority of the capital used to build and deploy central offices, nodes, other packet switches, and cable is provided either from equity shareholders or creditors. Broadband providers go into the markets to buy the capital needed to meet the demand for facilities. The private versus public ownership of these facilities creates a dependence on the private sector for the financing. Price paid for capital, not government mandate, determines whether capital will be available to meet the consumer demand for broadband facilities.

Sometimes the consumer demand comes from geographical areas that make a business model very expensive to finance; specifically rural and insular areas. Terrain and climate raise challenges to broadband providers because in addition to the physical deployment of facilities, a business case must be made about the probability that consumers in rural and insular areas will be able to pay the higher than average cost of receiving broadband services. The price mechanism may preclude broadband providers from buying the investment capital needed to make the investment. The rational investor or underwriter may not buy into a rural or insular broadband business model.

Enter the irrational. Enter the Federal Communications Commission.

Driven by its interpretation of universal service as provided in the Communications Act, the FCC has over the past few decades implemented a universal service and inter-carrier compensation scheme designed to subsidize delivery of telecommunications services to the poor, underserved rural markets, and health care providers in underserved areas. Business customers were basically overcharged in order to subsidize residential customers. Interexchange companies paid originating and terminating fees to local exchange companies with these funds placed into a pot where LECs would receive a cut after certifying the expenses claimed were for providing telecommunications services.

The FCC, threw its Connect America Fund, has essentially modified the model so that funds go to broadband services versus the legacy plain old telephone service network prior universal service finds financed. To date, the FCC is still trying to get broadband companies to bite on the remaining $180 million in subsidies available during the first phase of CAF. Broadband providers leaving money on the table should be a red flag that something is wrong with this model.

What’s wrong with this model is that it does not take into account that the infrastructure belongs to private entities, entities that could borrow at near zero rates, but who do not finance infrastructure projects in unserved, rural, or insular areas because a strong business case cannot be made for it. The FCC and the Congress throw money at them anyway, hoping that the initiative will get broadband to the homes. In a free market, capitalist society where the method of production and delivery is held in private hands, this 1930s view of stimulation cannot work. What is needed is something more direct especially if government is to participate in stimulating broadband demand.

While it is good to see Mr. Genachowski and his Gang of Four act like supply-siders, what is needed for broadband deployment is a combination of demand stimulation and a “private equity” mindset on the part of government, in this case, the FCC.

First, Congress should get rid of language describing the methods of implementing universal service. Rather than extorting money from IXCs to fund universal service, Congress, via the FCC, should issue poor consumers vouchers to be used with the broadband provider of their choice. This voucher could reflect the difference between the average monthly amount paid for broadband in the consumer’s market area and what they pay for telephone service.

Second, Congress should establish a broadband infrastructure bank to be administered by the U.S. Department of Commerce. The infrastructure bank would be funded from general tax revenues and would lend funds to broadband providers who present innovative business plans for providing service in insular, rural, and urban unserved and under-served areas. Funds would be paid back to the infrastructure bank at some rate below prime. The infrastructure bank could also issue debt giving investors another avenue for hedging other investments. Profits would either be returned to the Treasury, reinvested in the voucher program, or go on to support broadband in schools and libraries.

The current universal service program is open to abuse, such as skewing most funding toward carriers that do not need the funds. It introduces additional government regulation for the purpose of financing broadband deployment by private actors when those actors could go into the markets and get financing themselves; financing based on the showing of a good business model. By requiring the showing of a good business model, broadband providers would be required to develop innovative technologies to provide service. Innovation will beget financing which begets the value added to a service, value that consumers will identify and demand.

Can we really hate on Amazon for trying to avoid taxes?

Posted August 3rd, 2011 in taxes and tagged , by Alton Drew

An article in The Wall Street Journal described the extent to which online retailers, such as Amazon, may have to go to in order to reduce their tax costs. States and localities are feeling the squeeze on their revenues due to the recession and want to pass the pain on to Amazon.com and other online retailers seeking to avoid collecting sale taxes.

Collecting sales taxes In all states, according to the article, would evaporate 1.4% of Amazon’s revenues. A loss of revenues is not good news for investors. Passing on sales taxes to consumers does not bode well for promoting use of broadband for commerce either.

Should Amazon have to pay taxes?

Posted March 14th, 2011 in Internet, taxes and tagged , , by Alton Drew

The state budget crisis is catching up to online retailers like Amazon. A report in The New York Times tells us about a new law in Illinois that compels Amazon to collect taxes from residents of Illinois that purchase Amazon’s products as a result of being directed to Amazon by one of its affiliates.

Affiliates are companies that place links to Amazon on their websites. The affiliates get paid a commission when a consumer links to Amazon via the affiliate’s site and makes a purchase.

I have to disclose that I have an affiliate arrangement with Amazon, so when I say this, I say it with the utmost authority: taxing Amazon is the fair thing to do. Every other American and every other brick-and-mortar store that has a website has to pay taxes on the income they generate. Amazon should pay its fair share as well.

Will there be a catastrophic impact on the use of the Internet? Of course not. We are Americans. We like to consume and we are used to paying taxes. This is not to say we would pay them without fussing and cussing, but my intuition tells me that the convenience of shopping online will offset any sensitivity to price change caused by Amazon having to raise prices a bit in order to collect sales taxes.