Abolish Franchise Fees

Published February 1, 2006

“If there is an issue in replacing ‘franchise fees,'” Ray Gifford writes in the accompanying piece, “that is properly a tax policy question of whether localities should tax video services differently than any other good or service.”

Gifford succinctly cuts to the core of the video franchise fee issue for municipalities and towns: revenue enhancement.

Video franchise fees were born of the original monopoly nature of cable TV. In most communities, franchise fees exist largely independent of right-of-way fees, which are levied as compensation for use of public streets and underground conduit and other such physical plant. The reasoning for franchise fees was that, in return for the right to a captive market for a popular service–television–the cable provider would return a portion of its revenues to the community and be required to meet certain obligations, such as running cable past all homes in the community, providing free or discounted service to government buildings, schools, and libraries, and setting aside a channel for local public access.

The captive market cable companies once enjoyed is gone. In growing numbers, consumers are exercising other options to receive video entertainment: from direct broadcast satellite; from phone companies offering video over DSL or fiber; from content aggregators on the Internet who now provide programming in MPEG, PSP, and iPod formats within a legal digital rights management framework.

The Television Advertising Bureau, a trade group that represents advertising buyers, not cable companies, estimates cable companies lost 1.4 million subscribers in the 12 months ended November 2005. Using data from Nielsen Media Research, the group says alternative methods of video distribution reach more than 30 percent of the market.

The industry sees nothing but growth of these alternative channels. Apple, Google, Microsoft, Sony, and Starz all showcased Internet video initiatives at the Winter Consumer Electronics Show last month. This isn’t vaporware, either. Go to Apple’s iTunes or Starz’ Vongo.com sites today and you can download movies, TV shows, and other entertainment. Verizon Wireless touts video downloads in its advertising.

An Arbitrage Opportunity

All this raises questions: Who, if anyone, should be required to pay special fees for the “right” to offer video services via the Internet? Can municipalities even collect such fees? With so many options available for electronic video delivery, singling out two providers–the legacy cable and telephone companies–for a special tax is discriminatory and, further, invites arbitrage.

For example, under the new franchise law in Texas, if an AT&T customer were to download a movie from Starz as part of an AT&T branded service, that customer would pay a 5 percent franchise tax on that purchase. If, however, that same AT&T DSL customer downloads a movie from Starz’ Vongo service, which is marketed and billed separately from AT&T’s video service, no “franchise fee” would (or could) be assessed.

This adds up. For example, if our Texas viewer purchases an average of four on-demand video programs a week at $3 a piece, that adds up to $624 a year. If he purchases those on-demand videos from his cable or DSL provider, he pays 5 percent, or $31, more than he would if he downloaded them from a third-party content provider on the Web. That $31 amounts to the cost of 10 more downloads (almost another month’s worth of downloads for the movie buff). And since this amounts to a “use tax,” the heaviest users would be most inclined to avoid the extra fee.

It also isn’t simply a matter of extending the franchise regime to third-party providers like Vongo or even independent ISPs. Part and parcel of the franchise fee regime are state laws that require phone and cable companies to report revenues derived from the sale of video services. Third-party out-of-state content and service providers are under no such obligation.

The only reason municipalities extract franchise fees from telephone and cable companies is because they are easy marks. To do business, these companies require a physical presence in town and must manage third-party billing and accounting.

But with so many video options available from companies outside the regulatory framework, all franchise fees do now is penalize local co-branding, co-billing, and co-location of video delivery via the Internet (not to mention the corporation that desires to set up shop in your town and hire from the local labor pool). This is the last thing localities should be doing–especially as they clamor for greater broadband penetration and local investment.

The revenues local governments gain from video franchise fees may be difficult to part with. But reform serves a larger aim: the benefits of local broadband deployment. Franchise fees create an unnecessary cost burden on firms looking to expand not just service, but infrastructure. Tax something and you get less of it. Since right-of-way is paid for separately, franchise fees unnecessarily burden the builder. And this is cockeyed policy when the main goal is getting that broadband pipe in place as fast as possible.

Steven Titch ([email protected]) is senior fellow for information technology and telecom policy at The Heartland Institute and managing editor of IT&T News.