Yesterday’s Taxes Stalk Tomorrow’s Telephones

Published December 1, 2006

Good news: The IRS will be refunding part of your federal telephone tax, now that the federal government recognizes the archaic distinctions among long-distance, local, and bundled phone services are wholly unworkable for tax purposes.

Bad news: Telephone taxes still lurk everywhere.

While one is being reduced, others are growing or being reinvented. These minor taxes could take advantage of both telecommunications reform and the future of Internet taxation–this tail is wagging more than one dog.

The fastest-growing telecommunications tax is the so-called Universal Service Fund (USF) fee, a spin-off from the days when rural telephone service was difficult to establish.

The FCC levies this tax, pursuant to deliberately vague legislative authority. Long after rural phone service was built out, the USF fee has been constantly reinvented to justify its existence–currently, as a slush fund for wiring schools, libraries, and more to the Internet.

Overspent Slush Fund

That slush fund is so overspent, overcommitted, and rife with fraud that it faces a $350 million shortfall. The shortfall is blamed on the erosion of fund revenue to new competitors not covered by the USF tax base, such as Internet telephony and cellular service, instead of on the real culprit: pork barrel politics.

The FCC has now ordered Voice over Internet Protocol (VoIP) services to contribute to the USF. It also has levied higher taxes on cellular service. So VoIP and cellular customers can welcome higher taxes on their bills.

This piecemeal approach isn’t good enough for Senate Commerce Committee Chairman Ted Stevens (R-AK), whose telecom reform package broadens and deepens the scope of USF taxes.

Meanwhile, the Senate’s hopes for repealing the local calls remainder of the Spanish-American War telephone tax, coupled with a permanent federal moratorium on Internet taxation, are on hold. A moratorium proposal by Sen. George Allen (R-VA) is tied up with Stevens’ reform package.

While the Senate Finance Committee has approved complete telephone tax repeal, this too has been a victim of congressional jockeying for position on tax cuts. It will pop up, if at all, during the post-election “lame duck” period.

Tempting Cash Cow

When the dust settles, will telecom taxes go up or down? The only sure thing is the FCC’s increase in USF taxes, because that’s already in force. But telecom is a tempting cash cow, one of the biggest growth areas in the U.S. economy.

A comparatively hands-off approach from government helped drive that growth. The government’s current schizophrenia on telecom tax policy is a consequence of a backward-looking insistence on squeezing new technologies and growing markets into the tax and regulation boxes devised for the early twentieth century. Surely, if telecom taxes are to be changed, they should be rethought from the ground up.

The only bright spot is that Congress clearly knows the public isn’t eager for more telecom taxes. When the House of Representatives approved an amendment supporting FCC authority to tax VoIP, it did so by voice vote. No one wanted to go on record as supporting higher telecom taxes.

The FCC, of course, is not directly accountable to any voters, anywhere. It is troubling that the USF– the tax most removed from taxpayer accountability–is the biggest telecom tax growth area.

Maybe we need to subsidize telecom services in remote areas. Maybe we even need to provide subsidies to libraries and schools, though 99 percent of schools are already wired. But should one set of telecom customers be required to subsidize another? Any public funding for USF-type slush funds should be open, honest, and direct, with hard numbers to justify the scheme.

The free market has tackled much more difficult challenges than providing cable, wired, wireless, and satellite services to rural America. A change in Washington’s telecom tax climate–as in clearing the air–is long overdue.

George Pieler ([email protected]) is a senior research fellow with the Institute for Policy Innovation.