By Vikki Beatley, Principal
Utilities Users Tax (UUT) is a fascinating quagmire of rules and regulations. UUT is collected by 163 agencies in the State of California – 158 cities, one special district and four counties to be specific. UUT is collected on several different utility services which include telecommunications, video/cable, electricity, gas, water, sewer, various forms of refuse/sanitation and cogeneration in at least one agency. The annual revenue generated ranges from several hundred thousands to tens of millions. There are two primary drivers of the revenue: the rate charged (currently ranging from 1% to 11%) and the services on which the UUT is collected. The total annual revenue collected by local government agencies through UUT is approximately $1.8 billion per year (Utility User Tax Facts, 2021). Although the revenue ranges from agency to agency, on average UUT collections are approximately 15% of general fund revenues.
Surprisingly, this revenue source has very significant oversight from multiple agencies. Why the surprise? Well, let us spend a little bit of time reviewing the history. The Telecommunications Act of 1934, and the overhaul in 1996, is the basis for oversight specifically for the communications companies at the federal level. Without going into the incredibly boring minutiae of this relationship, the key thing to know is that the Federal Communications Commission (FCC) has oversight specific to interstate communications. Why does that matter?
The Telecommunications Act has two primary components, Title I and Title II, that regulate wire and radio communication services. Title II, otherwise known as Common Carrier (think Pacific Bell from days long ago), provides the guidelines from which companies operate in this classification. Title II is often referred to as telecommunication services (also commercial mobile services) and Title I is often referred to as information services. How the FCC classifies various services provided by communications companies has a significant impact on local government agency revenues. Okay, we are almost done with the boring stuff but to understand the dynamics we need to go a little deeper.
The Internet Tax Freedom Act, enacted in 1998, in part prohibited new taxes on internet access fees (Didn’t the Internet Tax Freedom Act (ITFA) Ban Taxes on Sales over the Internet?, 2019). The general purpose was to encourage use of the internet as something more than just an e-mail service. The law, which was extended in 2007, included a new definition for internet access which means “a service that enables users to connect to the Internet to access content, information, or other services” (Didn’t the Internet Tax Freedom Act (ITFA) Ban Taxes on Sales over the Internet?, 2019). This extension was in effect until 2014. This law was extended several times and the extension was made permanent in late 2016.
Another term that needs some explaining is “Net Neutrality”. This idea of Network Neutrality essentially meant that all data on the internet should be treated equally by corporations such as internet services providers (ISPs) and governments regardless of the “content, user, platform, application, or device” (Net Neutrality, 2021). These principles were adopted by the FCC in 2005. This categorized ISPs in the Title II/Common Carrier classification making them regulated and therefore taxable (think UUT revenue to local government). In late 2017, the FCC changed their stance and Net Neutrality ended (think loss of UUT revenue to local governments). This change was referred to as “The Open Internet”.
So, what happened? The FCC reclassified data (broadband internet access) to Title I/information services status which meant that it was no longer regulated as a common carrier and therefore no longer taxable. With this new classification, local government agencies saw a significant decline in UUT revenue. The FCC also reclassified voicemail and text messaging to information services which caused another decline in UUT revenue to local government.
As mentioned previously in this document, there is significant oversight with respect to communications companies. Not only is the FCC involved in the regulation of these businesses but so is the California Public Utilities Commission (CPUC). The CPUC regulates communications companies (with respect to intrastate activity) as well as other public utilities. The regulatory process at both the federal level and the state level operates in a legalistic, quasi-judicial, environment similar to courts.
Both Commissions approve applications for communications companies to operate. When applications to operate in the U.S. are approved, the company is assigned a unique identifier by the North American Numbering Plan Administrator (NANPA). Through the application process with the FCC, these companies must also declare their intent to operate in each of the 50 states.
Applications to operate in California go through a similar process with the CPUC. When applications are approved, the CPUC assigns a Certificate of Public Convenience and Necessity (CPCN), a Registration License, or a Wireless Identification Registration, which is essentially a permit to operate in California. Non-facilities-based (resellers) interconnected Voice over Internet Protocol (VoIP) operators are also required to register but are not assigned a CPCN. Now that some key background has been covered, we can move on to some of the issues that are presenting themselves in the current environment.
COVID-19 changed many things, including our use of voice communications. When our work environment shifted from the office to the home, we started talking to each other more via the telephone (landline and mobile phones) and the computer (virtual meetings). Generally speaking, voice activity drives the amount of UUT on telecommunications bills. However, even though voice communications over landlines, wireless, and VoIP increased, the UUT collections did not increase significantly. Although this outcome seems counter-intuitive, there are a couple of things to keep in mind.
First, many mobile phone users have switched to unlimited data plans from voice minutes/data plans. Even though these “bundled” plans are called out in most municipal codes, there are different methods by which providers can allocate plan dollars to voice related activities and services. While we may see minutes used on our mobile phone bills, we may not see any UUT being charged on those minutes in the billing cycle. The quick transition to virtual meetings through VoIP providers such as Zoom and Microsoft Teams is worth mentioning too. Local agencies are now seeing a spike in UUT revenues from companies that provide virtual meeting technologies. This is a trend that is expected to continue for quite some time.
The second significant change that has occurred over the last several years is the increase in video streaming services. Historically, Americans signed up with a traditional cable company to provide television services. More recently the number of cable subscribers has declined as more of us have opted into subscription services like Netflix, Hulu and the like. Many of these linear video (aka over-the-top) programming services are not currently collecting UUT from their users even though municipal codes have been updated to include specific language to capture these utility providers.
There are various lawsuits in other parts of the country specifically related to this topic and at least one has sided with local government in respect to UUT. The primary legal basis used by local governments is that the streaming companies should be treated like cable companies because they are using the existing physical infrastructure to deliver their services and therefore should be subject to the rules that govern franchise agreements. However, these streaming companies argue that they have no physical infrastructure and are therefore not technically in the public right of way. While there are no lawsuits in California, there is one provider, Sling TV LLC, that has been collecting and remitting UUT to local agencies.
Another issue that is important to understand relates to electric utility providers and more specifically to Southern California Edison (SCE). Over the last several years local agencies have seen a decline in the UUT revenue collected and remitted by SCE. Some of these reductions are directly related to the switch to solar power by many residents and businesses. Through various legislative actions, solar energy is currently exempt from UUT.
The bigger issue, being litigated by the City of Torrance, et al., pertains to SCE’s application of the California Climate Credit on utility bills. To provide some background, “The California Climate Credit is a credit bill that is part of California’s efforts to fight climate change. The credit is from a state government program that requires power plants, natural gas providers and other large industries that emit greenhouse gases to buy carbon pollution permits from auctions managed by the Air Resources Board. The credit on your electricity and natural gas bills is your share of the payments from the State’s program” (California Climate Credit, 2021).
In short, SCE chose to reduce the utility bill by the amount of the credit before applying the UUT. It is important to note that most municipal codes are written such that gross revenues, as defined, are subject to UUT. The effect of this practice reduces the revenue collected and remitted to local governments. The court, on appeal, has sided with local government, but there are still some potential legal challenges to the ruling.
What was for decades a truly stable source of local government revenue has been significantly impacted over the last several years. This is concerning because utility users taxes are instrumental to on-going municipal operations and continuity of service delivery to communities across California.
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