Internet Tax Repeal Saves Consumers A Few Bucks, Costs Governments $1 Billion

Sep 15, 2020

Broadband coverage in South Dakota, with areas newly served since 2018 in bold.
Credit SD Public Utilities Commission

A tax on internet service ended this summer, resulting in modest savings for South Dakota consumers and big holes in government budgets.

Meanwhile, governments are spending billions to expand high-speed internet access across the country, even as politicians grow increasingly resistant to imposing any internet taxes or fees that could pay for the expansion.

Gov. Kristi Noem welcomed the tax repeal.

“It will provide permanent tax relief for South Dakota families and businesses who currently pay the government for simply accessing the internet,” she said last December in a budget speech.

For many South Dakotans, the relief amounts to a few dollars saved on monthly bills for internet service and mobile-phone data. Meanwhile, the six states that were collecting internet service taxes – including South Dakota – lost a combined $1 billion in annual revenue.

And for some people, the tax savings are already wiped out by other fee increases. Customers who bundle services with Sioux Falls-based Midco are an example. When the tax on internet service went away, the company raised a fee on cable TV service by $5 a month.

Midco customer Chris Nelson couldn’t help but notice the timing.

“I chuckled because it was literally simultaneous,” Nelson said.

Nelson is more than a consumer. He also has a hand in regulating telecom companies through his seat on the state Public Utilities Commission. He said nothing stops companies from raising fees or rates at the same time as a tax repeal.

A Midco spokeswoman responded with an emailed statement. It says the fee increase was for retransmission agreements with broadcasters. The statement says the fee has “no bearing on the taxes that were and are no longer being charged on internet service.”

Customers might also notice that although the tax on their bill went down, it may not have gone away completely. That’s because the tax still applies to equipment like modems, and to warranties and service contracts on that equipment.

And although data is no longer taxed on cell phones, other things still are, like activation fees, disconnect fees, texting, voicemail and other options that are still considered taxable sales and services.

$30 million revenue loss in SD

The path to repealing taxes on internet service began in 1998 when Congress passed a temporary ban. But South Dakota and some other states already had taxes in place, so Congress allowed those states to keep collecting their taxes.

As the years passed, Congress renewed the temporary ban and the grandfather clause multiple times.

Then, in 2016, Congress permanently banned internet taxes and set an expiration date of July 1, 2020, for the grandfather clause.

The legislation split South Dakota’s congressional delegation.

Sen. Mike Rounds voted against the bill. He said it took away revenue from state and local governments without allowing them to recoup their losses by collecting sales taxes from online retailers (that authority finally came in 2018, thanks to a U.S. Supreme Court decision in favor of South Dakota).

Sen. John Thune championed the bill. He said that unless Congress acted to make the temporary tax ban permanent, dozens of states that had never levied taxes on internet service could have suddenly begun doing so.

Then-Rep. Noem also voted in favor of the bill. Later, as governor (she was elected in 2018), she had to adjust South Dakota’s budget for the loss of $20 million in annual revenue when the tax on internet service expired this July 1.

The annual hit to city governments was $10 million. Rapid City alone figures it lost $1.4 million in annual revenue.

Broadband funding source imperiled

The zeal that some politicians show for repealing internet taxation is not shared by everyone in the telecom world.

Rich Coit is executive director of the South Dakota Telecommunications Association, which represents cooperatives, small commercial, municipal and tribal telecommunications companies.

“From our perspective as companies, it was a pass-through,” Coit said of the tax on internet service. “It definitely hurts the state not having that money. And it hurts localities as well. So we certainly were not fans of it, or opposed to it, I guess.”

Coit does have concerns about the broader implications of anti-tax politics surrounding the internet.

“There is a reluctance on the part of policymakers, congressional leaders, members of Congress, at the federal level in particular, to assess anything on the internet," Coit said. "There’s this fear of, ‘We don’t want to tax the internet.’”

And yet, seemingly everybody wants high-speed internet to their homes. And in rural states like South Dakota, it often requires government subsidies to extend high-speed internet service to isolated areas.

Noem herself has convinced South Dakota’s Legislature to commit $10 million in matching funds for broadband access in unserved or under-served pockets of South Dakota, and the most recent annual report on the federal government’s Universal Service Fund said it gave out $4 billion to expand broadband services in 2018.

The Universal Service Fund is not supported by taxes on internet service. Instead, it’s supported by a surcharge on phone calls people make to other states and countries.

The volume of those calls has been dropping for years, which leaves the Universal Service Fund in a weakened position. So the federal government has repeatedly increased the surcharge on those calls, most recently to 26.5 percent.

PUC Commissioner Nelson leads a group of state commissioners that helps oversee the fund. He said the commissioners recognize the need for a better long-term funding source. So, they want to apply the existing phone surcharge to internet service – in other words, something a lot like the tax that just went away.

Nelson said they’ve had no luck so far.

“The great opposition to that comes from folks that say, well, 'We can’t add any tax to the internet. We can’t ever put a fee on internet service.'”

-Seth Tupper is SDPB's business and economic development reporter.