Thursday, June 30, 2005

Taxing our Telephones

Yesterday's BNA Daily Tax Report contains a small story with a potentially broad impact. Senator Rick Santorum and other members of the Senate Finance Committee introduced legislation to repeal the 3 percent federal excise tax on certain telephone communications. (See BNADTR, June 30, 2005).

The story of the excise tax on telephone communications illustrates how hard it is to kill a tax once it gets started. This tax traces back to the time of the Spanish-American War. The world of 1898 was quite different from our own, at least in the scope of telecommunication services. (Keep in mind that Alexander Graham Bell had been granted his first patent on the telephone in 1876, and thus it was quite remarkable that the invention was out for 22 years before the government started to tax it. Bell lived until 1922, which means he got to see his invention help people as well as raise money for the Federal Treasury.) According to the website, the "Great Idea Finder" the first telephone exchange began in 1877, and the first exchange linking major cities (NY and Boston) was not in place until 1883.

I don't have the data for 1898, but you can probably guess that telephone usage had not become ubiquitous then. And it was expensive, meaning not all folks could afford it. In fact, recall the election between Truman and Dewey in 1948 -- 50 years later -- when pollsters predicted a Dewey victory (famously recorded in newspaper headlines which, to the relief of President Truman, proved inaccurate). The reason cited for those polling errors was the reliance on voters with telephone service, which in those days apparently included more Republicans than Democrats. So, during this era, one would probably conclude that richer folks (which in my experience includes Democrats and Republicans alike) were paying this tax, while others were not.

Nowadays, the economic and social structure are different. Both Republican and Democrats have phones. In fact, just about everyone I know has a cell phone - even little kids. In fact, it seems that many days I can't even walk across campus and enjoy the sights and sounds of the outdoors without having to listen to people with cellphones on their ears chatting aimlessly to their remote friends, blissfully ignorant of the friends with whom they are walking.

The excise tax, which is 3 percent of charges for local phone service plus toll service with a charge that "varies in amount with the distance and elapsed transmission time" (See I.R.C. section 4252), is thus now hitting a large group of people. I notice it when I pay my phone bill and my cell bill. (OK, I have one, too. ) And this is the reason the movers of this bill don't want to keep it -- they say it is now "regressive". It may well be regressive in relation to income, but it is roughly proportional to usage. For this reason, I don't necessarily think it is a bad thing to tax telephone communications. It does raise a lot of revenue. (The cost of repeal is estimated at 67 billion over ten years, according to the BNA article.)

However, the tax base was already crumbling. Another lesson from the telephone tax is that the market moves quickly to get around these taxes, so that the tax writers have to move quickly. As telecommunications over the Internet has become possible, this contributed to some erosion. Moreover, the type of rate plans people have for long distance may also erode the base. A recent decision in the Claims Court awarded a refund of over a million dollars to Honeywell because the particulars of its rate plan did not fall within the requirements of the statute for taxing toll charges. See Honeywell v. United States, 64 Fed. Cl. 188 (Feb. 2005).

Though there may be some symbolism in getting rid of a conspicuous tax, taxes that fall on all citizens -- thus forcing everyone to bear some costs of the government -- may well be preferable to taxes that are targeted only toward selected groups. In this case, I don't think we will kill telecommunications with a tax, though I admit that the tax causes less of it. (See our previous discussion on taxing cosmetic surgery.)

If only we could tax the cell phone users who walk and talk, or worse, who talk and drive. Then I think we would be on to something we could all support. I could do with less of that.

Edward A. Morse

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