563 National Tax Journal Vol. LIII, No. 3, Part 1 Abstract - In addition to the usual range of local, state, and Fed- eral taxes, the telecommunications sector faces a number of specific taxes and tax–like fees not faced by other industries. There is clear evidence that these sector specific taxes fail to satisfy the usual cri- teria of fairness, efficiency, and simplicity and, with recent deregu- lation, increased competition, and technological innovation, which have dramatically altered the telecommunications sector, the fail- ings of these taxes will be exacerbated. INTRODUCTION T elecommunications has become one of the most dynamic sectors of the economy, propelled by technological in- novation and also competition fostered by the transition of the telecommunications industry from a regulated monopoly to a more competitive market. 1 The taxation of telecommu- nication services, however, has not kept pace with the tech- nological and regulatory changes that are rapidly blurring the lines between different telecommunication providers. Traditional telecommunications services often face the full range of federal, state, and local taxes imposed on other busi- nesses, as well as a broad array of taxes and tax–like fees that are levied only on them. Some of these are relics of the tele- communication industry’s regulated past, while others are rooted in the budgetary politics of the 1980s and early 1990s. Although the controversy surrounding the taxation of elec- tronic commerce has attracted attention in the press, there is also growing recognition that taxation of telecommunication services needs to be reformed. 2 This sentiment was most re- cently evident in widely reported debates of the Advisory Commission on Electronic Commerce. Despite disagreement The Tangled Web of Taxing Talk: Telecommunication Taxes in the New Millennium Joseph J. Cordes, Charlene Kalenkoski, & Harry S. Watson Department of Economics, The George Washington University, Washington, D.C. 20052 1 For a useful overview of recent developments in the telecommunications sector, see Council of Economic Advisers. 2 For example, see Martin Sullivan (1999); National Tax Association (1999). The National Governor ’s Association also recently issued a report acknowl- edging the complexity of the current tax structure for the telecommunica- tions industry, and calling on the states to undertake a thorough review of their telecommunications tax structure. See, Scott Paladino and Stacy Ma- zer (2000).
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The Tangled Web of Taxing Talk
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National Tax JournalVol. LIII, No. 3, Part 1
Abstract - In addition to the usual range of local, state, and Fed-eral taxes, the telecommunications sector faces a number of specifictaxes and tax–like fees not faced by other industries. There is clearevidence that these sector specific taxes fail to satisfy the usual cri-teria of fairness, efficiency, and simplicity and, with recent deregu-lation, increased competition, and technological innovation, whichhave dramatically altered the telecommunications sector, the fail-ings of these taxes will be exacerbated.
INTRODUCTION
Telecommunications has become one of the most dynamicsectors of the economy, propelled by technological in-
novation and also competition fostered by the transition ofthe telecommunications industry from a regulated monopolyto a more competitive market.1 The taxation of telecommu-nication services, however, has not kept pace with the tech-nological and regulatory changes that are rapidly blurringthe lines between different telecommunication providers.Traditional telecommunications services often face the fullrange of federal, state, and local taxes imposed on other busi-nesses, as well as a broad array of taxes and tax–like fees thatare levied only on them. Some of these are relics of the tele-communication industry’s regulated past, while others arerooted in the budgetary politics of the 1980s and early 1990s.
Although the controversy surrounding the taxation of elec-tronic commerce has attracted attention in the press, there isalso growing recognition that taxation of telecommunicationservices needs to be reformed.2 This sentiment was most re-cently evident in widely reported debates of the AdvisoryCommission on Electronic Commerce. Despite disagreement
The Tangled Web of Taxing Talk:Telecommunication Taxes in
the New Millennium
Joseph J. Cordes,Charlene Kalenkoski,& Harry S. WatsonDepartment ofEconomics, The GeorgeWashingtonUniversity,Washington, D.C.20052
1 For a useful overview of recent developments in the telecommunicationssector, see Council of Economic Advisers.
2 For example, see Martin Sullivan (1999); National Tax Association (1999).The National Governor’s Association also recently issued a report acknowl-edging the complexity of the current tax structure for the telecommunica-tions industry, and calling on the states to undertake a thorough review oftheir telecommunications tax structure. See, Scott Paladino and Stacy Ma-zer (2000).
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in the commission about the merits of tax-ing internet commerce, there was generalagreement on the desirability of reform-ing state and local telecommunicationtaxes and repealing the federal excise tax;3
and proposals to repeal the federal tele-communications excise tax have been in-troduced in the U.S. Congress.4
Although calls to reform state and lo-cal telecommunications taxes are rela-tively recent, proposals to repeal the fed-eral telephone excise tax predate the de-liberations of the Advisory Commissionon Electronic Commerce. In the 1980s, theTreasury Department issued a report rec-ommending that the tax (U.S. Departmentof the Treasury, 1987), which had its ori-gins as a temporary luxury tax to help fi-nance the Spanish American War, shouldbe allowed to expire as scheduled at theend of 1987.5
Despite the Treasury report, the federalcommunications excise tax was extendedin 1987 mainly because large and persis-tent budget deficits made it difficult, if notimpossible, to enact tax cuts. Similar bud-get pressures facing state and local gov-ernments in the late 1980s and early 1990salso led to increases in state and local tele-communications taxes and fees. Today,however, with sizable actual and projectedbudget surpluses at all levels of govern-ment, the fiscal equation has changed, andthe pace of technological change is creat-ing pressures to rethink the rationale forthe current array of taxes and fees that areimposed on telecommunication services.
This paper provides a brief overview ofthe current state of federal, state, and lo-cal taxation of telecommunication ser-
vices. We summarize the range of taxesand tax–like fees that are imposed on tele-phone services, and provide estimates ofthe total amount of taxes on telecommu-nications that are collected at the federal,state, and local levels. We then discusshow the current system measures upagainst the three–fold standard of fairness,administrative simplicity, and economicefficiency that is commonly used to evalu-ate alternative ways of raising govern-ment revenue.
TELECOMMUNICATION TAXES INTHE UNITED STATES
Telecommunication services in theUnited States are subject to three levels oftaxation: federal, state, and local. Underthe current system there are literally thou-sands of different taxing entities levyinghundreds of different types of taxes andfees.6
Federal Taxes and Charges
The oldest and most familiar telecom-munications tax is the 3 percent federalexcise tax that is levied on all telecommu-nications services. The tax was first lev-ied as a luxury tax during the Spanish–American War. Though scheduled toexpire at the end of 1987, the tax was re-newed and made permanent in the Rev-enue Reconciliation Act of 1990.
The federal communications (telecom-munications) excise tax (FET) is levied ata rate of 3 percent of the amount paid byindividuals and businesses for local andtoll (long distance) telephone (as well as
3 Elliot Zaret (2000). http://www.cnbc.com/.4 Legislation in the House of Representatives to repeal the tax has been introduced by Representatives Robert
Matsui (D., California) and Rob Portman (R., Oregon). Legislation in the Senate to repeal the tax has beenintroduced by Senators William Roth, (D., Delaware), John Breaux (D., Louisiana), Don Nickles, (R., Okla-homa), Frank Murkowski (R., Alaska), Connie Mack, (R., Florida), and Chuck Robb, (D., Virginia). As of thiswriting, the House had voted to abolish the Federal Telecommunications tax by a margin of 420 to 2.
5 U.S. Department of the Treasury (1987).6 One major telecommunications provider has estimated that complying with the current range of telecommu-
nications taxes and fees required it to file 39,000 different forms.
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telewriter services). Local telephone ser-vice is defined as “access to a local tele-phone system and the privilege of tele-phonic quality communication with sub-stantially all persons having telephone orradio telephone stations constituting apart of the local system;” toll telephoneservice is defined to be a “telephone qual-ity communication for which there is a tollcharge that varies with the distance andelapsed transmission time of each com-munication and the charge for which ispaid in the United States.”7 The “amountpaid” on which the excise tax is appliedincludes mandated federal charges, suchas the Federal Subscriber Line Charge, aswell as certain state and local fees such asright–of–way and 911 charges.
As may be seen from Table 1, amonggeneral excise taxes collected by the fed-eral government, the tax ranks second af-ter the federal tax on cigarettes in termsof tax collections. Roughly half of this to-tal is paid directly by consumers on theirphone bills.8 Based on information aboutannual expenditures for telecommunica-tion services from the Consumer Expen-diture Survey, the amount of FET directlypaid by households is estimated to range
from approximately $18 per year forhouseholds with incomes of less than$20,000 to $36 per year for householdswith incomes greater than $70,000.9
The other half of the FET is paid by busi-nesses. Although this portion of the FETis not directly paid by households, the bur-den of the “business half” of the FET isnonetheless ultimately borne by house-holds in their roles as business owners andemployees.
Federal Fees and Charges
In addition, Federal regulations man-date that telecommunication providersassess fees to defray the cost of subsidiz-ing certain types of service. Before 1996U.S. telecommunications policy relied ona complicated, implicit system of transfersamong various groups of telecommuni-cations users in order to promote “univer-sal service,” which is defined to be “thehighest level of telephone connectivity byindividuals.”10 These transfers were madethrough a pricing system in which tele-phone companies charged urban andbusiness users more than their share ofcosts to help offset the costs of servingrural and residential customers. Local tele-
TABLE 1FEDERAL EXCISE TAXES
Actual and Projected Revenue from Federal General Fund Excise Taxes: (billions of dollars)
Source: U.S. Congress, Joint Committee on Taxation, 1999, Table B.
7 Ibid., p. 8.8 See Julie–Ann Cronin (1999).9 See U.S. Department of Labor, at http://stats.bls.gov/csx/1998/Aggregate/income.pdf.
10 U.S. Congressional Budget Office (1998).
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phone service was also subsidized by pric-ing long distance service above its cost.Until 1996, this system of cross–subsidieswas financed outside the federal budgetthrough rates and charges assessed byprivate telephone companies.
The mechanism for financing these sub-sidies was changed by the Telecommuni-cations Act of 1996, which convertedmany of these implicit transfers into ex-plicit fees and charges that are now partof the federal budget. Accordingly, boththe Congressional Budget Office and theOffice of Management and Budget nowcount payments into the Universal ServiceFund as federal revenues and paymentsfrom the fund as federal outlays, so thatthe budgetary treatment of the feescharged to support universal service issimilar to the treatment of other federalfees and user charges.
In addition, the TelecommunicationsAct of 1996 also required the FCC to es-tablish a system for subsidizing the pro-vision of advanced telecommunicationservices—mainly in the form of enhancedinternet access—for schools, libraries, andsome rural health providers. Like Univer-sal Service, these subsides are financed bycharges imposed on telecommunicationcarriers, that in turn, are passed forwardto users of these services. The budgetarytreatment of these charges is similar to thatof fees and charges collected to defray thecost of providing universal services.
Technically, these fees and charges arenot treated as taxes in the federal budget;a recent federal court case has upheld thestatus of these charges as fees rather thantaxes. Normally, the legal distinction be-tween taxes and fees is based on whethera charge is levied for “purely private ben-efits” that are received by the parties thatpay the charges, in which case the chargeis a fee, or whether a charge confers “pub-
lic benefits that are independent of, ratherthan incidental to, private benefits,” inwhich case the charge would normally beconsidered to be a tax.11
An important exception to this prin-ciple, however, is that Congress may del-egate to agencies the authority to levy“charges that require private beneficiariesto pay for services that confer a publicbenefit,” provided the Congressional in-tent to do so is clear and the guidelinesfor setting charges are adequately set forthin the legislation.12 In this latter case, thelegal distinction between fees and taxesbecomes moot, and a charge that mayhave the economic attributes of a tax maynonetheless be treated as a fee.
Aside from its legal status, the chargethat finances subsidies for expandedinternet access in schools and libraries hasall of the economic attributes of an addi-tional tax on phone service. The universalservice charge may look less like an “over-all” tax on telecommunications servicesbecause it is a transfer from unsubsidizedto subsidized users of telecommunicationservices. Yet, for the vast majority of tele-phone users who pay the universal servicecharge without receiving the subsidy, itacts much like a tax (see footnote 35).
Hence, while existing federal telecom-munication charges are technically feesrather than taxes, for many telephone us-ers, they are economically equivalent toan additional federal tax on telecommu-nications. The Congressional BudgetOffice has projected that receipts and out-lays from all these fees and charges to-gether will rise to about $14 billion by theyear 2007, of which roughly four–fifthswill reflect charges and outlays associatedwith providing universal service, whilethe remaining fifth will reflect charges andoutlays associated with subsidizing en-hanced telecommunication services.13
11 U.S. Congressional Budget Office (1992).12 Ibid.13 U.S. Congressional Budget Office (1998).
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State and Local Taxes and Charges
It is much harder to characterize thescope of state and local telecommunica-tions taxation because of the multitude ofdifferent jurisdictions that collect theselevies. As shown in Table 2, there are up-wards of 20 different broad types of stateand local taxes and fee charges levied ontelecommunications providers; the rangeof specific state and local variation in thesecharges is almost as wide–ranging as thenumber of different taxing jurisdictionsthat assess these charges.
Until recently, it would have been ex-tremely difficult to summarize the breadthand depth of telecommunication taxes atthe state and local level because there wasno single source that provided a compre-hensive and coherent description of thescope of these taxes. However, data com-piled by the Committee on State Taxation(COST), allow one to paint a reasonably
complete picture of the range of taxes andfees that presently apply to telecommu-nications services.14
The purpose of the COST study is todescribe and compare the full range oftransactions taxes and charges levied ontelecommunications services as comparedwith comparable taxes levied on othergoods and services.15 The information onthese taxes and charges were compiled byrepresentatives of the tax departmentsfrom telecommunication companies thatare members of the COST Telecommuni-cations Task Force. The taxes and fees lev-ied by each state (and Washington, D.C.)were analyzed by one telecommunicationscompany, and subsequently reviewed bya second telecommunications company.
Property Taxes
In addition to providing informationabout transactions taxes on telecommu-nication services, the COST study also
TABLE 2STATE AND LOCAL TELECOMMUNICATION TAXES
State Taxes and Fees Local/Municipal Taxes and Fees
Database Charges, 911 Equalization Surcharge Local 911 tax, 911 feesIntrastate Surcharge Right of Way ChargesHigh Cost Fund SurchargeRelay Service, Communications Devices Surcharges,
Universal Access Charges Telephone Relay SurchargeAccess Line Charges Access Line TaxInfrastructure Fund ReimbursementPoison Control Surcharge (TX)Public Utility Commission Fees Public Service TaxesTeleconnect FundUniversal Service Charges, Universal Lifeline
14 Committee on State Taxation (1999).15 Two important earlier attempts to describe the range of state and local taxes faced by telecommunication
providers are: Karl Case (1992); and Richard McHugh (1996).
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provided information about whetherproperty owned by telecommunicationproviders is treated differently from prop-erty owned by general business. A de-tailed discussion of the relative tax treat-ment of telecommunication property isoutside the scope of this paper, but a briefsummary and discussion of the main find-ings of the COST study regarding the taxa-tion of telecommunication property is in-cluded in the appendix.
Should State and Local Fees Be Included in theTax Burden?
The COST study combines charges thatare legally designated as fees with thosethat are legally designated as taxes into asingle measure of the overall telecommu-nication tax burden. Thus, as in the caseof federal telecommunication fees, thequestion arises as to whether state andlocal charges that are legally designatedas fees are truly fees, or are economicallymore like taxes.
The issue again turns to whether thecharges in question are really assessed for“purely private benefits that are receivedby the parties that pay the charges,”—inwhich case they would be properlyviewed as fees or user charges and not astaxes—or whether state and local telecom-munication fees “confer public benefitsthat are independent of, rather than inci-dental to, private benefits”—in which casethey are taxes.
Determining when a charge that is lev-ied on a telecommunications provider“crosses the line” that divides fees fromtaxes is not easy. Nonetheless, many tele-communication charges do not appear tofinance specific services provided to tele-communication providers or their cus-tomers by state and local governments,but instead are either relics of the dayswhen telecommunication providers wereheavily regulated by state and local gov-ernments, or are charges that effectively
defray “public benefits.” Some of the is-sues that arise are illustrated by right–of–way charges and 911 fees.
Right–of–Way Charges
Right–of–way charges that are often as-sessed on telecommunication and cableproviders are intended to recoup costsassociated with laying telephone or cablelines under public streets. If such chargesare commensurate with the added costthat maintenance of the telecommunica-tion infrastructure imposes on the main-tenance of public roads, then a right–of–way charge could be appropriatelyviewed as a fee rather than a tax. If, how-ever, the charge is set at a level that ex-ceeds a reasonable estimate of these costs,or if these additional costs are defrayedfrom additional taxes levied on tele-communication providers but not otherbusinesses, then a case could be madethat at least some portion of a right–of–way charge that is labeled a fee is reallya tax.
911 Fees
Many states and localities charge a feefor 911 service. Again, the issue is whetherthe fee is set at a level commensurate withthe added public costs of responding to911 calls. Recently, a state legislative ana-lyst in Virginia uncovered evidence thatsome localities were using revenue fromthe 911 charge to pay for items other thanthe direct costs of providing 911 service,such as general outlays for equipment andstaffing in local police and fire depart-ments.16
As these two cases illustrate, the divid-ing line between what constitutes a truefee and what is a tax can be fuzzy. None-theless, as in the case of federal charges, areasonable case can be made for treatingmany, if not all, of the state and localcharges as economically equivalent totaxes, notwithstanding their legal status.
16 Holly Heyser (2000).
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Range and Complexity of State and LocalTelecommunication Taxes and Charges
One objective of the COST study was todocument the range and complexity ofstate and local telecommunication taxesand charges along the following dimen-sions: rates, base, frequency of remittancefilings (from a business to the state or lo-cal revenue authority), uniformity of base,number of jurisdictions, and uniformity oftax exemptions. The findings of the studyare summarized in Figure 1 and Figure 2.
As shown in Figure 1, one feature ofstate and local telecommunication taxesis their number and complexity. Whenspecific differences in these taxes and feesare taken into account, the COST studyindicates that there are over 300 separatestate and local taxes and fees that are ap-plied to almost 700 different tax bases. Inpart, this complexity reflects the fact thatmany state laws allow local jurisdictionsto specify a base for a particular tax or feethat differs from the base that applies tothe state and to other local jurisdictions.
Figure 1. Number of Taxes, Fees, and Tax and Fee Bases
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The complexity of collecting state andlocal taxes may be contrasted with trans-actions taxes imposed on general busi-nesses. As may be seen from Figure 2, tele-communications providers must maintainrecords for approximately the same num-ber of taxing jurisdictions as do other busi-nesses, but generally need to keep trackof more different kinds of transactionstaxes and charges. The upshot is that com-pliance with telecommunications taxesand fees requires the filing of over 55,000
different forms, compared with just over7,000 forms for companies providingother goods and services.
Average Burden of TelecommunicationTaxes
Translating information about the legalstructure of state and local telecommuni-cations taxes and fees into summary mea-sures of the average effective burden ofthese taxes and charges is difficult for two
Figure 2. Number or Jurisdictions and Tax Forms
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reasons. The sheer number of different stateand local taxes and fees is one complicat-ing factor. Another is that many of thesecharges are either levied in fixed amounts,e.g., so many cents per phone bill, or percall, or are capped, e.g., 20 percent of theamount billed up to some dollar limit.
A crude measure of the average effec-tive financial burden imposed by thesetaxes and fees is to first express the dollaramount of state and local taxes and/orfees that are fixed or capped as a percent-age of the monthly charge paid by house-holds for basic local service. These per-centages are then added to the percent-age rates of taxes or charges that arelevied on an ad valorem basis to arrive at ameasure of the overall burden as a per-centage of the basic monthly phone bill.17
Using this yardstick results in the mea-sures of “average burdens” shown in Table3, which ranks states by the burden of lo-cal and state telecommunication taxes andcharges as a percentage of the monthlycharge for basic service. Column 1 of Table3 shows the average burden that wouldresult if telecommunication services weretaxed at the same rate as other goods andservices; column 2 shows the average bur-den of the taxes, fees, and charges that areassessed on these services, as estimated byCOST; and column 3 presents the com-bined burden of state and local telecom-munication taxes, fees, and charges plusthe federal excise tax and the federal feefor enhanced internet access. Column 4 isthe estimated additional tax burden on
telecommunication taxes in each state re-sulting from the combined impact of stateand local taxes, fees, and charges and thefederal telecommunications tax and fed-eral fee for enhanced internet access.18
The average burdens reported in theCOST study indicate that millions ofAmerican households face substantialtaxes on their use of telecommunicationservices. Over two out of five householdslive in states where the average burden ofstate and local telecommunication taxes(excluding federal taxes and fees) can equalor exceed 20 percent of the basic monthlyphone bill; more than one–half of house-holds live in states where the combinedburden of state and local telecommunica-tions taxes and fees plus federal taxes andfees can be more than 20 percent; and al-most three of four households live in stateswhere the combined burden of federal,state, and local telecommunication taxesand fees can be more than 15 percent.19
The budgetary environment that pre-vailed in many states from the late 1980sinto the 1990s is one important reason forthe prevalence of relatively high rates ofstate and local taxation on telecommuni-cation services. During this period manystates faced with revenue shortfalls broad-ened their revenue base by expandingsales and use taxes to services. In the caseof telecommunication services these “newtaxes”were simply added on to existingtaxes and charges that had been collectedfrom telecommunication providers intheir status as regulated industries.20
17 The discussant of this paper correctly pointed out that the presence of charges that are fixed or capped causesthe measure of average burden in the COST study to overstate the percentage of the total phone bill that ispaid in state and local taxes and fees because the total bill can exceed the basic monthly charge by amountsthat vary, with factors such as the volume of long distance calls and the use of enhanced phone services. Thisfeature of the COST burden measures is taken into account when we estimate the amounts of revenue raisedfrom state and local telecommunication taxes.
18 Table 3 does not include the federal universal service charge, though the COST measures of average burdendo include state and local universal service charges.
19 In states where the tax rate of a particular tax varies among local jurisdictions , the COST study adopted theconvention of using the highest tax rate.
20 Data published by the FCC show that taxes as a percentage of the monthly phone bill increased steadily from1985 to 1999. See Jeff Eisenbach (1999). As suggested by a discussant of this paper, this trend could reflect acombination of rising taxes and falling costs for telephone services.
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TABLE 3AVERAGE BURDEN OF TAXES AND CHARGES ON TELECOMMUNICATION
SERVICES VS. GENERAL BUSINESS
Tax Rates (Percent)
Taxes and Charges as a % of Avg. Residential Genl. Business Phone Bill
State/Local + Fed. Excise Tax State/Local State/Local and Fees Tax Gap
Total Amount Paid in State and LocalTelecommunications Taxes, Fees, andCharges
Estimating the total amount of revenuecollected by state and local governmentsfrom the taxes and fees described aboveis complex because some of these taxesand charges apply only to revenue fromlocal calls, others to revenue from all in-trastate calls, and still others to all rev-enue. It is, however, possible to arrive ata rough estimate of the overall burden ofthese charges on consumers and busi-nesses.
According to FCC data, telecommuni-cation providers reported receiving justover $230 billion in revenue in 1997, whichtranslates into estimated total revenue inthe year 2000 of just under $270 billion, ifone assumes an annual growth rate in rev-enues of 5 percent per year. Roughly 45percent of this total comprised revenuefrom local calls, while revenue from all in-trastate calls (including local calls) madeup 55 percent of the total.21 As a roughfirst estimate, these data suggest that stateand local telecommunication taxes andfees may apply to about 50 percent of tele-communication revenue, or about $135billion in the year 2000.
Treating the average burdens shown inTable 3 as average tax rates, and multi-plying these tax rates by 50 percent of to-tal projected telephone revenue in eachstate, suggests that state and local telecom-munication taxes and charges will imposea total burden of $22 billion in 2000. Thisestimate equals roughly 8 percent of totaltelecommunication revenue.22
The Total Telecommunication Tax Burden
The estimates of the tax burdens fromfederal state and local telecommunicationtaxes and charges suggest that telecom-munication providers and their custom-ers will pay almost $30 billion ($7.9 bil-lion plus $22 billion) in federal excise taxesand fees and state and local taxes andcharges, not counting the impact of fed-erally–mandated fees for universal ser-vice. Roughly two–thirds of this amount,or $20 billion, is attributable to additionaltaxes and fees that are paid by telecom-munication providers and their custom-ers, and not other businesses.23
ASSESSING TELECOMMUNICATIONTAXES AS SOURCES OF REVENUE
From a broad tax policy perspective, thequestion is whether the existing panoplyof telecommunication taxes and fees is adesirable way of raising public revenueaccording to standard criteria that areused to judge the fairness and effective-ness of different forms of taxation. Beforeturning to this subject, however, it is help-ful to highlight some distinctive economiccharacteristics of telecommunication taxesand (tax–like) fees.
The Simple Welfare Economics ofTelecommunication Taxes
Figure 3 presents the standard partialequilibrium diagram of the incidence ofan excise tax. The basic conclusion is thatthe effect of imposing a constant per unitexcise tax of $t on good X is to impose a
21 According to information in the COST study, many state and local taxes and fees are limited to local and/orintrastate phone calls.
22 Case (1992) estimates that in 1991, telecommunication providers paid roughly 3.6 percent of total revenuein state and local sales and use taxes and gross receipts taxes. This percentage does not include state andlocal charges designated as fees, nor does it reflect any increase in taxes that has occurred between 1991 and2000.
23 This figure is calculated by multiplying the difference between the average telecommunication tax burdenand the average general tax burden shown for each state in the last column of Table 3 by 50 percent of totaltelecommunication revenue in each state and then adding this amount ($12 billion) to the estimated $7.9billion raised from the federal excise tax and enhanced internet access fee.
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total economic burden on consumers ofX equal to the direct tax payment of $Tplus an excess burden of $E.
The effects of taxes on telecommunica-tion services can differ from those of asimple excise tax for several reasons. Oneis that some taxes and (tax–like) fees areeither imposed as fixed charges or arecapped. A second difference is that theproduction technology of telecommunica-tions requires producers to incur substan-tial fixed costs in order to provide the ser-vice. These fixed costs are covered bycharging a price to consumers that ex-ceeds the marginal cost of service.24
Lastly, the consumer effectively makestwo decisions in acquiring telecommuni-cations services: whether to pay for accessto the service and, conditional on payingfor access, the amount of telecommunica-tion services to consume (e.g., volume oflong–distance calls, call–waiting, etc.).
Telecommunication taxes can thus affectthe decision to pay for access, or the deci-sion of how much to consume of services.The two–part decision facing the con-sumer is mirrored in the pricing structureof telecommunication services, whichtypically involves a charge for access tothe service, that does not vary with thelevel of usage, plus charges that vary withquality and level of service.
Figure 4 illustrates the effects of charg-ing a fixed charge, F. The fixed charge is aburden to the consumer. Depending on itsmagnitude, the fee could affect whether aconsumer chooses to pay for access, butconditional on the consumer’s decision topay for access, does not have a marginaleffect on how much of the taxed service isconsumed.
Figure 5 shows the implications ofcharging a price in excess of marginal cost.As in Figure 3, imposing an excise tax on
Figure 3. Simple Exise Tax
24 Jerry Hausman (1998).
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Figure 4. Fixed Telecom Charge
Figure 5. Effects of a Telecom Tax When Price Exceeds Marginal Cost
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the service imposes a direct burden of $T,and an excess burden on consumers of$EC. Unlike Figure 3 (where X is assumedto be priced at marginal cost), however,taxing the telecommunication service alsoimposes an excess burden on producersequal to loss in producer’s surplus, $EP,from the reduced consumption of the ser-vice.
Figure 5 can also be used to model theeffects of taxes and fees on access. Assumethat in order to have access to C, the con-sumer must pay an access charge of $A.Then, in the absence of taxes, the decisionof whether to pay for access will dependon whether the net benefits from access,measured by the consumer surplus $(B +T + EC) exceeds the access charge, $A: thatis, whether $(B + T + EC) – $A > 0.
Taxing telecommunication services re-duces the net benefit to $B, and causessome consumers to avoid paying for ac-cess. These consumers suffer a welfare lossequal to the net benefit they would haveenjoyed from access, which equals $(B +T + EC) – $A. In addition, the providers ofthe service lose the producers’ surplusthey could have earned on providing theservice, which equals $(D + EP).
Fairness
An important principle of public fi-nance is that taxes should distribute theburden of financing government fairly.Two broad principles of fairness in taxa-tion are generally used to judge the fair-ness of taxes: the benefit principle and theability–to–pay principle.25
Benefit Principle
The benefit principle holds that the bur-dens of raising public revenue should bedistributed according to the benefits thattaxpayers receive from the public goods
and services provided by government.One way of seeing to it that those whobenefit from specific public services alsopay for them is to assess fees and otherbeneficiary charges for the use of specificpublic services. Alternatively, one can taxgoods or activities whose use or conductbears some identifiable relation to benefitsreceived from government. For example,federal and state taxes on gasoline are seenas providing a rough kind of tax fairnessby distributing the burden of paying forpublic roads according to how muchpeople drive.26
The benefit principle provides no ratio-nale for a federal communications excisetax. There is no basis for presuming thattelecommunication providers and theircustomers derive distinctive benefits fromthe range of goods and services financedin the federal budget that would justifysubjecting telecommunication services toan additional layer of federal taxation notfaced by other businesses.
The justification on benefit principlegrounds for assessing state and local taxesand fees on telecommunication servicesabove and beyond those imposed on othergoods and services is mixed. The abilityto conduct business directly or indirectlydepends on a range of public goods andservices provided by state and local gov-ernments, such as a judicial system, policeand fire protection, roads, and schools.There is little evidence, however, that tele-communication providers and their cus-tomers impose special burdens on theseservices that justifies subjecting telecom-munication services to the current addi-tional layer of taxation not faced by otherbusinesses. Some fees, such as right–of–way charges and 911 fees, may be justifiedas beneficiary charges, but only to the ex-tent that the amount of such fees are com-mensurate with actual benefits received.
25 For an explanation of the benefit and the ability to pay principles, see the relevant entries in Joseph J. Cordes,Jane G. Gravelle, and Robert Ebel, eds., Encyclopedia of Taxation and Tax policy, Urban Institute Press, 1999.
26 Joseph J. Cordes, “Benefit Principle,” in Cordes, Gravelle, and Ebel (1999).
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Ability to Pay
The other widely–used principle of taxfairness is the ability–to–pay principle,which holds that tax burdens should bedistributed among taxpayers in line withtheir ability to pay taxes, as typically mea-sured by their annual income. This crite-rion is often applied in practice by mea-suring how the percentage tax burdenchanges as a taxpayer’s income rises. Atax is said to be regressive if the percent-age of income paid in tax falls as incomerises, proportional if the percentage of in-come paid in tax stays the same as incomerises, and progressive if the percentageincome paid in taxes rises as income rises.Many public finance scholars agree thattaxation on the basis of ability–to–pay re-quires that the tax burden be distributedat least somewhat progressively, and thereis even more widespread agreement thattax burdens should not be regressive.
As noted in a recent Treasury Depart-ment working paper on the distributionalanalysis of taxes, the overall distributionof the burden of taxes and charges on tele-communication services depends on theseparate distribution of the burden of theshare of telecommunication taxes andcharges that is paid by businesses, and theshare that is paid by individual consum-ers. In the case of telephone taxes andcharges that are paid by businesses, it isplausible to assume that the incidence ofthese taxes is comparable to a broad–
based consumption tax, that is borne byhouseholds in proportion to capital andlabor income.27
Telecommunication taxes and chargesthat are paid directly by households ontheir phone bills are distributed regres-sively with respect to income.28 As shownin Figure 6, the estimated share of telecom-munication taxes paid by households withannual incomes less than $40,000 exceedsthese households’ shares of total income—in some cases by a considerable mar-gin.29 Figure 6 also shows that the burdenof telecommunication taxes paid directlyby consumers is distributed more regres-sively than federal taxes on alcoholic bev-erages.30
Tax Simplicity
Society has an interest in keeping its taxsystem as simple as possible. Govern-ment, businesses, and individuals oftenmust spend considerable time and effortto administer and comply with taxes.Some of the time and money needed tocollect taxes is an unavoidable conse-quence of raising public revenue. It is alsowasteful, however, because scarce eco-nomic resources that could otherwise beused more productively are used to trans-fer resources to the government. It is thusconsidered good public policy to designrevenue systems that are relatively simpleto comply with and to administer.
27 Cronin (1999, pp. 27–31).28 As is the convention in distributional analyses done by the Treasury, the Joint Committee on Taxation, and the
Congressional Budget Office, the burden that is distributed to households is the “direct” cash burden of taxes,and does not include the excess burdens of telecommunication taxes. In the case of telecommunication taxes,including excess burden would have the effect of reducing the overall regressivity of these taxes because asubstantial portion of the excess burden is made up of lost producer’s surplus. The portion of the total taxburden that is borne by households would still be distributed regressively, however.
29 The shares of the tax burden shown in Figure 1 were derived by assuming that the burdens of the portion offederal excise taxes that are paid directly by consumers are borne in proportion to each household’s share ofspending on the taxed good. These spending shares, along with the income shares, are taken or derived fromdata reported on the Consumer Expenditure Survey, tabulated in Table 46, at http://stats.bls.gov/csx/1998/Aggregate/income.pdf.
30 This result is broadly consistent with the findings of a 1987 Congressional Budget Office study; the burden ofthe federal telephone excise tax is distributed at least as regressively as the burden of taxes on alcohol andtobacco. See U.S. Congress (1987). (As cited in U.S. Department of the Treasury, 1987.)
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Figure 6. Regressivity of Telecommunication Taxes
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As noted in the COST study, numerouscomplexities are involved in complyingwith the myriad of different telecommu-nication taxes and fees. As with any trans-actional tax, complying with telecommu-nication taxes and fees require that a num-ber of issues be addressed.31
• Where did the transaction take place?• In which taxing jurisdiction did the
transaction occur?• Which transactions are taxed in each
jurisdiction?• Which transactions or customers are
exempt from tax?• Does the taxing jurisdiction compen-
sate sellers for collecting transactionstaxes?
• Where does the tax that is collectedneed to be remitted?
• Has the tax been properly applied?
To some extent, these issues need to beconfronted by any business that is obli-gated to collect state and local sales anduse taxes; as acknowledged in the COSTstudy, these issues become even morecomplex for businesses that, like manytelecommunication providers, operate indifferent taxing jurisdictions.
Nonetheless, there are several features,both of the taxation of telecommunicationservices and the market for these services,that make dealing with these issues espe-cially complex for telecommunication pro-viders. One of these special factors is thenumber of different taxes that are appliedto the same type of transaction. As shownin Figure 1, there are 310 different formsof telecommunications and charges, lev-
ied on 687 different bases, as comparedwith 103 different general business taxeslevied on 184 different bases.
Estimating Compliance Costs
It is difficult to quantify the cost of taxcompliance, even in the case of generalbusiness taxes; there is no direct estimateof the cost of complying with the myriadof state and local telecommunication taxesand fees. A recent study by Ernst & Young(Cline and Neubig, 1999) indicates thatmulti–state retailers face costs of comply-ing with sales taxes that equal roughly8 percent of total revenue collected.32 Thisratio cannot, however, be applied directlyto telecommunication taxes, because theErnst & Young estimate includes adminis-trative costs attributable to credit card pur-chases that are quite important for sales butnot telecommunication taxes. When arough adjustment is made to remove thiscomponent of compliance costs, a crude es-timate is that a multi–state retailer facescompliance costs, other than those attrib-utable to credit purchases, equal to about2 percent of the total amount of revenuecollected. Thus, if complying with telecom-munication taxes and fees is as complex ascomplying with the retail sales tax, this es-timate suggests that the compliance costof raising revenue from these charges mayalso be about 2 percent of the revenue col-lected, or about $360 million.33
Drawing the Line Between Taxable andNontaxable Transactions
Other complexities arise from the paceof technological change that is rapidlychanging the nature of telecommunication
31 Council on State Taxation (1999, pp. 12–18).32 Washington State Department of Revenue (1998).33 A large phone company has estimated that it spends $15 million per year to comply with state and local
telecommunication taxes. See Howard Glickman (2000). If one assumed that this amount does not vary muchby company size, multiplying the $15 million estimate by the 18 telecom companies participating in the COSTstudy yields total estimated compliance costs of $270 million. The figure of $270 million is lower than theestimate presented in the text, but both estimates suggest that the costs of complying with state and localtelecommunication taxes and fees could run into the hundreds of millions of dollars.
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services, and the way in which these ser-vices are provided. In the 1980s, for ex-ample, it was still a relatively simple mat-ter to determine what was a telecommuni-cation service. It was a telecommunicationservice if it was offered by the phone com-pany. In the new millennium, however, theintertwining of data services, including butnot limited to Internet access, with tradi-tional telephone services raises importantand potentially difficult questions of whatis and is not a telecommunications service.
For example, in August of 1999, the U.S.Court of Appeals for the District of Co-lumbia granted the FCC’s request to re-mand an August 1998 order determiningthat “advanced” telecommunications ser-vices (including Internet access) are either“telephone exchange” or “telephone ac-cess” services, indicating that the FCC it-self may be uncertain. This uncertaintywas mirrored in the final report issued bythe National Tax Association’s Commu-nication and Electronic Commerce Project,which was unable to reach a consensuson how to define telecommunications ser-vices to reflect recent changes in the mar-ket for communications.34
The same uncertainties confronting theFCC confront the U.S. Treasury and staterevenue departments. For example, a fairlyimmediate question is raised about how totreat newly emerging broadband technolo-gies that allow a standard phone line to beconverted into a high–speed data line, e.g.,Digital Subscriber Line (DSL) technology.Like an additional phone line, a DSL lineallows the user to have simultaneous ac-cess to both Internet and telephone com-munications, but unlike a phone line, a DSLline allows the user much broader andmore rapid access to the Internet.
What portion of such a bundled serviceshould be subject to telecommunicationtaxes and fees? One possible answermight be that providers would need todevelop methods for apportioning themonthly bill between taxable and nontax-able usage. Yet the need for such appor-tionment raises new complexities.
Economic Efficiency
It is widely recognized that most taxesaffect how resources are allocated in themarketplace, and that this normally im-poses costs on the economy in excess of theamount of tax revenue that is collected.Telecommunication taxes exact such costsin two ways. One is by raising the price thatconsumers pay for telecommunication ser-vices. The other is by potentially affectingthe terms under which different providersof telecommunications services competewith each other in the marketplace.
Demand For Telephone Service and InternetAccess
Telecommunications taxes and chargesraise the price of telecommunication ser-vices to households and businesses com-pared with other goods and services. Mak-ing telecommunication services relativelymore expensive discourages the use ofsuch services compared with other, less–heavily–taxed, goods and services. Thisresponse of consumers prevents resourcesfrom being allocated between productionand consumption of telecommunicationservices and other goods and services inthe most efficient possible manner, andresults in an overall loss of economic well–being, termed excess burden, that exceedsthe amount of taxes collected.35 This situ-
34 National Tax Association (1999), section on telecommunication tax issues.35 As noted above, the average tax burdens calculated in the COST study include state and local universal service
fees. The fact that the revenue raised from these fees is ultimately used to lower the cost of telephone access forsome subscribers does not alter the fact that these charges impose an excess burden by driving a wedge betweenthe producer and consumer prices of telecommunication services. Moreover, the subsidy that is provided bythese taxes may result in an added excess burden by causing services to be provided that are valued at less thanthe social opportunity cost of providing these services. Universal charges are treated as taxes in Hausman (1998).
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ation may be contrasted with the case ofexcise taxes, which are intended to dis-courage people from consuming goodsthat are believed to be socially harmful,such as tobacco and, to a lesser extent, al-cohol.36
The 1987 Treasury Department studynoted that perhaps one of the most com-pelling arguments for the retaining thefederal telecommunications excise tax wasthe widely–held belief that demand fortelephone service as a consumption goodwas relatively unresponsive to changes inits price, so that any associated excess bur-den associated with telecommunicationtaxes was likely to be small. Yet, that re-port also noted that even though thisclaim had some validity, it was not a fullyaccurate description of the demand fortelephone service in the 1980s; it seemseven less applicable today in a rapidlychanging market offering services such asinternet access and wireless telephony inaddition to traditional telephone service.
Access to Basic Telephone Services
Although the estimated response issmall, studies of the demand for telephoneservice have found that the decision ofwhether or not to pay for basic telephoneaccess is sensitive to price. For example,elasticities reported by Taylor indicate thata 100 percent increase (decrease) in basicaccess charges would reduce (increase) thepercentage of households with telephonesby roughly 3 to 5 percentage points.37 Thelast column of Table 3 shows that federal,state, and local telecommunication taxesand fees impose an average added bur-den on telecommunication services ofroughly 10 percentage points.38 Thus,
multiplying this percentage by the accesselasticities reported by Taylor implies thateliminating the federal telecom tax andmaking the burden of state and local tele-communication taxes and fees commen-surate with other services would increasethe number of households with tele-phones by between 300,000 and 420,000.39
This estimate may seem like a relativelysmall number, but it needs to be put intocontext. As noted by Hausman (1998), theFCC was reluctant to increase the sub-scriber line charge in order to finance in-creased Internet access because it wouldreduce the number of households withtelephones by 39,000—a number that isless than a tenth of the estimated increasein telephone penetration.40 Moreover,FCC data also show that, not surprisingly,the vast majority of households withouttelephone access also tend to be lower–income households. Thus, even low priceelasticities for telephone access mean thatcurrent levels of taxation have a measur-able effect on the likelihood of telephoneaccess by low–income households.
Demand for Long Distance and Wireless
In addition, telecommunication taxesaffect a range of services whose demand,unlike the demand for basic access, hasbeen found to be fairly sensitive to price.One is long distance service, which hasconsistently been found to have a priceelasticity of demand that is on the orderof –0.7. Another is the demand for wire-less service, where the estimated priceelasticity is roughly –0.5.
Federal, state, and local telecommuni-cation taxes have a measurable effect onconsumer demand for wireless and long
36 See U.S. Congressional Budget Office (1990).37 Lester D. Taylor (1994).38 Because this estimate is an average of tax gaps that range from virtually zero to over 20 percentage points (see
Table 3), calculations using the ten percentage point figure are best thought of as producing rough orders ofmagnitude rather than precise estimates.
39 Taylor (1994, Chapter 5, Tables 3 and 7). Because the COST estimates include charges that finance universalservice subsidies, these estimates assume that these subsidies would be financed by other means.
40 Hausman (1998), supra, p. 45.
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distance services. Hausman has estimatedthat state and local telecommunicationtaxes exact economic costs in the form ofreduced production and consumption ofwireless service that average roughly $.50for each dollar of revenue raised, and thatthe federal fee to finance enhancedinternet access imposes an average excessburden of $.65 per dollar of revenueraised.41 These estimates suggest that theadditional layer of federal, state, and lo-cal taxes imposed on long distance ser-vices and wireless telephony could im-pose an excess burden of as much as $7billion.42
Internet Access
The effects of telecommunication taxeson access to the Internet are potentially asimportant as their effects on telephoneaccess and usage, but are also difficult toquantify at this point. Data compiled bythe FCC indicate that almost 19 millionhouseholds now have second phone lines,in addition to their primary lines. Cur-rently, the principle means of access to theInternet for many households is throughtraditional phone lines, and recent surveyevidence confirms that many, if not most,households are prompted to have theseextra lines as means of being able to ac-cess both the Internet and use the tele-phone at the same time. Thus, taxes as-sessed on second phone lines are a de–factotax on enhanced access to the internet.43
Recent estimates suggest that the priceelasticity of demand for second phone linesis roughly –0.5 at prices in the range of $20–25 per month. This elasticity suggests thatthe combined added burden of federal,state, and local telecommunication taxesreduces the number of households thathave second phone lines more than 5.0 per-cent or by roughly 1 million households.44
It is possible to make a rough calcula-tion of the excess burden that is associ-ated with reduced use of second phonelines. Let $TS be the taxes owed on a sec-ond phone line. If a household elects notto have a second phone line, it must bethe case that $TS > $NBS, where $NBS isthe value of the net benefits the householdreceives from having a second line. Thus,the added tax that a typical householdowes on a second phone line—which isroughly $40 per year—can be taken to bea rough upper bound estimate of the netbenefits foregone by households thatwould have paid for a second phone line.
In addition, if the amount charged fora second line exceeds its marginal cost,telecommunication providers lose con-sumer surplus equal to the difference be-tween the price charged for a second lineless its marginal cost. There are no esti-mates of the marginal cost of adding asecond phone line. Hausman states, how-ever, that the marginal cost of long dis-tance service is at most about 0.25 of theprice.45 If one assumes that this factor ap-
41 Hausman (1998; 1999). One reason why the average excess burden from taxing wireless and long distanceservices is so large is that prices faced by consumers for telephone services deviate from the marginal cost ofthose services by a fairly large margin.
42 This estimate was calculated as follows. FCC data indicate that roughly 15 percent of telecommunication rev-enue are attributable to wireless services, and 45 percent are attributable to long–distance service. These per-centages were then multiplied by $20 billion, which is the amount of the added tax burden imposed by thefederal telecommunication excise tax and internet access fee and state and local income taxes to yield theestimated added tax burden imposed on wireless services ($3 billion) and on long distance services ($9 billion).These amounts were then multiplied by the estimated average excess burden per dollar of revenue raised fromtaxing wireless services ($.50), and long distance services ($.65), to yield estimates of the total excess burdenfrom taxing wireless services ($1.5 billion), and long distance services ($5.9 billion). Total estimated excessburden from added federal, state, and local taxes imposed on telecommunication providers is thus $7.4 billion.
43 Taxes assessed on second lines are best viewed as a tax on enhanced Internet access rather than on Internetaccess per se, because individuals can choose to be connected to the Internet through a single phone line.
44 Paul N. Rappoport, Lester D. Taylor, and Donald Kridel (1999).45 Hausman (1998), supra.
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plies to the marginal cost of service on asecond phone line, then if the averagemonthly phone bill for basic access is ap-proximately $240 per year, a typical tele-communication provider may lose aproducer’s surplus of approximately $180per year on each second line that is notprovided because of taxes. Thus, overall,the estimated deadweight loss would beon the order of $200 per each secondphone line that is not provided. Multiply-ing this estimate by one million house-holds yields a total estimated excess bur-den of $200 million from raising revenueof some $760 million by the added taxesthat are imposed on second phone lines.This translates into an average excess bur-den of roughly $0.25 per dollar of revenueraised from taxing second lines.
There is also evidence that householddemand for new broadband technologies,such as the DSL lines mentioned above, isat least as sensitive to price as the demandfor second phone lines, mainly becauseindividuals seem to place a surprisinglylow value on time spent on the web.46 Ananalysis of survey data by Rappaport,Taylor, and Kridel (1999) yields an esti-mated price elasticity for faster Internetaccess that is on the order of –0.5 atmonthly subscription rates of $40 to $50per month, and –1.23 at monthly rates ofbetween $50 and $60, an amount at whichDSL services are now becoming availablein many areas.47
At this time, it is uncertain whetherbroadband technologies are likely to besubject to the full range of telecommuni-cation taxes, only some of these taxes, ornone. On one hand, since users must ac-cess DSL lines through existing phonelines, it could be argued that DSL linesprovide Internet access only, and hencewould not be subject to telecommunica-
tion taxes. On the other hand, many stateand local telecommunication taxes are lev-ied on the revenue earned by businessesthat are classified as telecommunicationproviders, without regard to the type ofservice that is offered, in which case suchtaxes would apply to DSL services. Fur-ther uncertainty may be created by a re-cent decision of the 9th U.S. Appeals Courtthat Internet access over cable broadbandlines is a telecommunications service un-der the Communications Act.48 In anyevent, the elasticities reported byRappoport, et. al. (1997) imply that if DSLlines were to be taxed at the same rate asexisting telephone lines, the demand forthese services would be on the order of10 to 15 percent lower than otherwise.49
Competitive Neutrality
The issue of how telecommunicationtaxes affect the playing field between dif-ferent providers may loom at least as largeas the question of whether and by howmuch existing telecommunications taxesreduce the use of long distance and wire-less services and slow the rate of internetaccess. A basic principle undergirding theTreasury Department’s landmark reformof the federal income tax in 1986 was thattax systems should be neutral, and avoidgiving a market advantage to some pro-ducers over others. It is hard to envision,however, how such competitive neutral-ity would be achieved in a world in which“traditional providers” of telecommuni-cations services, such as telephone com-panies, are subject to the full range of ex-isting federal, state, and local communi-cations taxes, while “new entrants” to themarket, such as cable providers or provid-ers of internet telephony are either sub-ject to none of these taxes or to differenttaxes.
46 Hal Varian (1999).47 Rappoport et al. (1999).48 Kumar et. al. (2000).49 See Eisenbach (1999).
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Indeed, unless the current system is re-formed and simplified, it would seem thatthose responsible for tax policy may findthemselves on the horns of a dilemma.The playing field between competing pro-viders could be leveled by imposing thecurrent, ineffective system of telecommu-nication taxation on “new” and “old”providers and/or technologies alike,which would potentially mean a signifi-cant, and somewhat hard to justify, in-crease in taxes collected on communica-tions services. This particular view wasechoed by some members of the NationalTax Association’s Electronic CommerceProject (1999), who expressed the concernthat broadening the definition of telecom-munications services to include nontradi-tional forms of electronic communicationswould simply subject these emerging ser-vices to the already tangled web of exist-ing telecommunications taxes and fees.50
Alternatively, competitive neutralityamong communication providers couldbe achieved by substantially loweringtaxes and fees on traditional telecommu-nication taxes and providers to enablethem to fairly compete with technologiesand/or providers that are not subject tothese taxes. Indeed, a similar issueprompted the Treasury Department to is-sue its 1987 report. At that time, the issuewas how to treat the growth of privatecommunication services, which enjoyedan exemption from the federal telecom-munications tax. The report noted changesin the tax law that would need to be madein order to reduce the differential tax treat-ment arising from the exemption of pri-vate communications service. Instead ofrecommending that an existing tax, thatby then had outlived its usefulness, beextended to a new area, however, the re-port recommended that the existing fed-eral telecommunication tax be abol-ished.51
SUMMARY AND CONCLUSIONS
In1987, the Treasury Department con-cluded that “there is no policy rationalefor retaining(the federal) communicationsexcise tax.” The basis for drawing this con-clusion in the case of the FET is at least asstrong today as it was in 1987; there aregood arguments for simplification andreform of state and local telecom taxes.
Perhaps the most important policy ra-tionale for keeping existing telecommuni-cation taxes is that “these taxes are alreadyin place, and are steady revenue raisers.”This argument had practical merit in the1980s when governments at all levels werefacing large and, at the time, growing bud-get deficits, but it is a less–compelling ra-tionale for retaining these taxes when notonly the federal budget, but also manystate and local budgets, have sizable cur-rent and projected budget surpluses.
Given that excise taxes play only a smallrole in the overall system of federal taxa-tion, there is a strong case for repealingthe FET. The issue is more complicated atthe state and local level. Since sales anduse taxes are important sources of stateand local tax revenues, there is a rationalefor taxing telecommunication services—but not more heavily and in a more cum-bersome manner than other goods andservices. State and local tax reform effortsshould thus focus both on simplifyingtelecommunication taxes and on reducingtheir burden to levels that are commen-surate with taxes levied on other goods.Achieving these goals will require thatstate governments work cooperatively notonly with local governments, but alsowith telecommunication providers.
Acknowledgments
The authors gratefully acknowledgeresearch support from the Progress andFreedom Foundation. The views in this
50 See National Tax Association (1999).51 U.S. Department of the Treasury (1987, pp. 2–3).
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paper are those of the authors and shouldnot be attributed to the Progress and Free-dom Foundation.
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Appendix: Taxation of TelecommunicationProperty
Table A-1 summarizes information in theCOST study on property taxation in states
where property owned by telecommunicationproviders is taxed differently than propertyowned by general businesses. The last columnshows where each of the states that taxes tele-communication property more heavily thangeneral business property rank in terms of theaverage burden of telecommunication transac-tions taxes and fees.
Although the focus of this paper is on theeffects of “transactions taxes” levied on tele-communication services, telecommunicationproviders also face a heavier property tax bur-den in some states. As shown in the table, tenstates tax real property owned by telecommu-nication providers more heavily than real prop-erty owned by general businesses, and 14 taxtangible property (e.g., equipment) moreheavily. In addition, in 15 states telecommuni-cation property is assessed by applying the unitvalue rule, which essentially uses the value ofthe business unit, instead of the cost of real andtangible property as the basis for assessingvalue. This practice has the economic effect ofincluding the value of intangible assets, suchas goodwill or even R&D know–how, in theproperty tax base.
Considered in isolation, the effect of taxingtelecommunication assets relatively moreheavily than other business capital would beto increase the effective tax rate that telecom-munication providers pay on each dollar ofprofit, which increases the cost of capital ontelecommunication investment. Whether tele-communication providers face a higher over-all cost of capital than other businesses, how-ever, depends not only on the comparativeproperty tax burdens faced by telecommuni-cation and other businesses but also on the com-parative burdens of federal and state corporateincome taxes.52
52 For a discussion of how property and other taxes on income and assets affect that tax rate and the cost ofcapital of businesses, see Jane G. Gravelle (1994).
