Commentary: Fixing The Phone Tax Mess Before It Gets Worse

Take a look at your phone bill. It's littered with taxes, charges, and fees that can easily add 30% to your monthly costs. Not only do they pump up the price, they cost companies a bundle to administer. Worst of all, they're unfair.

Call Aunt Gladys in Nebraska on your old-style phone, and the call is taxed. Use your computer and the Internet for the same call, and it's tax-free. It is time for industry and government to clean up this mess: get rid of some taxes, combine others, and make sure everyone who communicates by phone, computer, cable, or satellite pays the same levy.

Sure, some add-ons are junk fees charged by telecoms themselves. For instance, local phone companies stick customers with line charges. And long-distance service usually includes an extra local-access fee. But those are the result of ongoing industry squabbles, and they won't get sorted out until the telecom business gets completely deregulated.

TEXAS-SIZE. We can, however, fix the maze of taxes, which make up most of the extras. First, there is a 3% federal excise levy. Next, add state and local telecom taxes, which average over 14%--more than twice the typical 6% sales tax on other goods and services. In Chicago, for instance, customers pay the federal tax, a city excise tax, a state excise tax, a city infrastructure-maintenance tax, a state infrastructure-maintenance tax, a public utility commission fee, and a 911 fee (illustration)--adding up to a 20% rate. In some states, that number is even higher. In George W. Bush's Texas, the rate on telecom services is 28%. "The taxes just mount up," says Bell Atlantic Corp. tax counsel Mark Mullet.

These taxes are nightmares for telcos as well as consumers. In California, according to accountants Deloitte Touche Tohmatsu, there are 190 separate state and local telecommunications taxes and fees. One phone call in New York City can be subject to 11 different levies. AT&T estimates it had to file 99,000 state and local tax forms last year and says it spent $15 million on paperwork and other compliance costs. Nobody even knows how much is collected through this maze, though it is in the many billions of dollars.

Before telecom competition, such taxes were much less controversial. Says Michael Mazerov, a tax-policy expert at the Center on Budget Policy & Priorities: "They were designed when telecommunications was a monopoly, and they could just be passed through to customers in their rates."

Not anymore. As technology has changed, similar services are taxed in different ways. It just depends on the gizmo you're using. For example, an old-fashioned telephone call is subject to the federal excise tax. But instant messaging over the Net isn't. What about calls made using newfangled Internet Protocol telephony, in which calls are switched from phones to the Net to phones, or from computer to computer? Sometimes they're taxed, and sometimes they're not, depending on how the technology is used. Similarly, the cost of an ordinary phone line is taxed even if it's used just for a computer. The same is true of a DSL line. But a fiber-optic data line? Maybe not.

That's just the federal tax. Thousands of state and local governments have their own rules. The infrastructure-maintenance fee Illinois charges is a stark example: Ordinary phone customers pay it; cell-phone users don't. "What do all these taxes apply to?" asks Walter Nagel, senior tax counsel at MCI Worldcom Inc. "The answer is: Nobody really knows."

State and local governments and industry are working together to sort out one issue--taxation of wireless services. Now, if you make a call on a cellular phone while crossing from one state to another, each can tax its piece of the transmission. A bill in Congress would tax the service only at customers' billing address.

That's a good first step. Washington could take the next by abolishing its $5 billion-a-year excise tax--a relic of the Spanish-American War. When it was enacted a century ago, 3% of households had phones and it was a luxury tax. Today, government considers phone service so essential it subsidizes local access for the poor. So why is it taxed?

The state and local issue is dicier. Governments rely heavily on telecom-tax revenues. And many fees, such as the ones used to pay for the use of public rights-of-way, are certainly legitimate. But 190 different taxes in California? There has to be a better way.

SIMPLIFY. One solution would be to set a single rate on all telecommunications services no matter what the medium. DSL, cable, computers, handsets, cell phones--tax them all the same way. States could impose any rate they choose. But by taxing all services, governments could lower the rates and collect the same amount of money. And get rid of all these special fees. If people want 911 service, they should pay for it the same way they finance the ambulance their emergency call brings--through property, income, or sales taxes.

Persuading governments to simplify and eliminate taxes is only part of the challenge. Many companies love the current situation. For instance, an Internet provider that offers instant messaging now has a big advantage over rival telcos. Besides, industry sources suggest that many small telecom providers are not collecting these taxes, even when they should be.

With technology changing so fast, the old taxes just won't hold up. New telecom services will increasingly fall outside the traditional rules. Old Economy users will be stuck with a bunch of annoying and obsolete levies while the wired ones will go tax-free. A simple and fair tax system should protect state and local revenues while making sure that no technology gets a tax advantage over any other. We may not be able to settle the argument over Internet taxes anytime soon. But we should be able to fix this.

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