October 2004

Sidebar: A Taxing Dilemma

Should VoIP be regulated, and, if so, when and by whom?

It’s an intriguing issue: Should companies providing a nascent technology that could someday be ubiquitous, be subject to all of the same taxes and regulations imposed on companies with mature technology? And, if so, who holds the reins and what’s the timetable?

States like California, Alabama, and Wisconsin are set on applying traditional telephone rules and taxes to Internet telephony companies. The regulators argue that VoIP is a telecommunications service no different than phone service and therefore should pay the same taxes and fees, as well as provide 911 services and access for the disabled, said Susan Kennedy, a member of the California Public Utilities Commission (PUC), in the San Jose Mercury News. She notes that state regulators believe that regulating VoIP would protect consumers and provide a level playing field. But, unlike many of her colleagues, Kennedy doesn’t feel that regulators have a justifiable argument, noting that “new technologies don’t develop on a level playing field.”

Already one state has been shot down on its attempt to regulate VoIP. Last fall Minneapolis federal judge Michael J. Davis permanently barred his state from applying traditional telephone rules to VoIP provider Vonage. That has left Vonage free to sell its service in Minnesota without having to obtain a telephone operator’s license or pay the 911 service fees.

While this was the first ruling of its kind, it doesn’t necessarily set a precedent for the other states. “The Minnesota decision will certainly be an important input to the decision making of other state regulators, but I think ‘precedent’ is too strong a word,” says Charles Golvin, senior analyst for Forrester Research. “Each state regulatory board strongly defends its own ability to dictate policy, so each will make its own decisions, which gives incumbents new opportunities to lobby each state PUC.”

It’s a confusing time. Some argue that, like the long-standing postponement of taxing Internet service, hands should be off VoIP to allow the technology to mature, see what direction it will take, and encourage more investment and uptake. “The argument ought to be that it’s a new, more efficient technology that we want to encourage for our economy to be competitive,” says Clyde Rettig, consulting director of Deloitte Consulting LLP’s Strategy and Operations Practice. “If you tax the advances of the technology, you inhibit its adoption.”

Others argue for a hands-off policy for a different reason, citing that VoIP is a data service, not a phone service and therefore shouldn’t be regulated or taxed like the traditional public telephone networks. That, in fact, was the basis of Judge Davis’ decision in Minneapolis. He explained that Vonage and other VoIP providers supply an “information service,” not unlike companies that sell Internet access, and that grouping those two providers together makes sense because VoIP calls travel across the Internet, not a telephone company’s network. Since Congress has mandated that information providers are to be unregulated to enable future development, VoIP should likewise be unregulated, he held.

Then there are those who don’t object to regulation per se, but are against it being done by the states. It’s the “patchwork quilt” theory of regulation that is objected to with the hope that the FCC will instead step in. “The FCC needs to get involved instead of having state-by-state regulations because it will make the market a mess,” notes In-Stat/MDR senior analyst Daryl Schoolar. “For one thing, there’s the issue of different rules being imposed by different states. For another, it’s using the mindset of the old telecom world on a new and very different kind of technology.”

Regulations Take Shape
Vonage, which filed suit against Minnesota’s PUC and won, is obviously delighted with the outcome, but completely expects that regulation will come at some point. They just hope it’s at the federal level by the FCC with a new framework created around VoIP, according to John Rego, Vonage’s CFO. He predicts that in the short-term there will be some form of moratorium prohibiting state regulation of VoIP. “This will probably be similar to the Internet Tax Freedom Act or some other form of state preemption by the FCC, similar to the way wireless regulation was handled in its early stages,” Rego says. “This will allow the FCC to create a full public record enabling them to institute the proper regulatory framework for a new technology like VoIP.”

In fact, last December, the FCC initiated a yearlong inquiry into the appropriate regulatory environment. Glenn Reynolds, vice president of federal regulatory issues for BellSouth, is hoping that the FCC will come to the conclusion that VoIP is fundamentally an interstate service and address it with “a minimal light regulatory hand.”

“But they also need to recognize that there are certain public policy obligations that should exist, such as public safety, that need to be applied on a nondiscriminatory, across-the-board basis,” he says.

“From a big picture, our position is that VoIP is changing all the rules,” notes Reynolds. “It really does affect all of the regulatory creations that have held up the public switched telephone network, particularly those dependent on subsidies for public policy purposes. It also upsets traditional thinking about who has market power. Anybody can get into this service. Look at a company like Vonage. They’re being quite successful in offering what is in effect a telephone service, and are able to sell this service irrespective of traditional phone companies.”

Companies like AT&T, however, see the issue from a different perspective — as a deregulatory opportunity. “We’ve got a deregulatory approach on this and hope that’s the way the FCC will go on this,” says Patrick Merrick, director of regulatory affairs for AT&T. “We see the distinction between data and voice blurring with voice increasingly becoming an IP application over the network.”

Because AT&T, MCI, Sprint, and other carriers have to pay access charges to the Bells for initiating or terminating a call, and wireless carriers and ISPs have still different compensation schemes, Merrick hopes that VoIP “finally drives the FCC to fix the patchwork quilt of compensation schemes.” And he’s not alone in his thinking. BellSouth’s Reynolds agrees. “In conjunction with figuring out appropriate regulatory schemes, the FCC needs to undertake a thorough evaluation of interstate subsidy provisions and get those subsidies out of there,” he says.

But, they disagree on the timing of FCC intercession. Reynolds explains that two of the largest companies of VoIP traffic are AT&T and MCI, not startups that need time to develop their businesses, and he cites public safety concerns of having unregulated services. “We don’t want to burden these guys with heavy regulations, but they’ve got to be willing to recognize public interest and public safety regulations, such as emergency 911 access. The FCC needs to find a way to make it applicable to VoIP because it’s a public obligation.”

Merrick, however, is in the camp of those who want to wait a while. “We want VoIP to mature a little more, to leave it alone until it’s more of a mainstay and the industry has a chance to sort out how it will work out.”

“VoIP holds tremendous promise,” Merrick says. “If VoIP is going to be a substitute for home telephone lines, it needs to mature and new services need to be allowed to develop. Customers will benefit in the long run.”

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