| THE HIGH COST
OF TAXING TELECOM by Jeffrey A. Eisenach on 09/06/99 of Progress & Freedom Foundation Topic: Taxation | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| I Jeffrey A. Eisenach is president and co-founder of The Progress & Freedom Foundation. This paper was prepared for presentation to the Advisory Commission on Electronic Commerce, September 14, 1999. It presents preliminary results from an ongoing study of telecommunications taxation underway at The Progress & Freedom Foundation. All results are tentative and subject to further modification. The final study is due out in mid-2000. The views expressed here are his own and do not necessarily reflect those of The Progress & Freedom Foundation, its officers or Board of Directors. Introduction and Summary Driven by technological progress, the telecommunications industry is nearing the end of a 30-year transition from natural monopoly to competitive market. Public policy has recognized this change through substantial deregulation and creation of a legal framework designed to facilitate competition. Tax policy, however, has not kept pace with the changing nature of the telecommunications business. As a result, the telecommunications industry is subjected to a vast array of taxes that have no apparent justification in the modern era and can be explained solely as holdovers from all but forgotten era. Simply put, there are too many taxes on telecommunications services, and they are far too high. Taxes on telecommunications are, inevitably, taxes on the Internet. Whether through dial-up access or Digital Subscriber Lines (DSL), over cable modems or wireless ones, access to the Internet takes place over the telecommunications network. Thus, high telecommunications taxes slow the spread of Internet access and discourage deployment of the broadband networks needed for the next generation of Internet growth. They raise the costs of electronic commerce for every business, big or small, and raise the price of Internet access for every household, rich or poor. Their impact is probably greatest, however, on poor households, small businesses and rural communities. The convergence of previously separate telecommunications technologies – cable, telephone, satellite, wireless – into a single marketplace adds further urgency to the need for telecommunications tax reform. Each of these different industry sectors is subject to its own tax regime, meaning that the same service can be subject to very different tax treatment depending on the type of firm that offers it, and efforts to eliminate such consistencies are hampered by the extreme complexity of the system. This paper represents a first step in an effort to reassess and to recommend reforms in telecommunications taxes. It describes the current regime and presents very preliminary findings about the impact of current policies in terms of both economic efficiency and fairness. The paper concludes with a brief discussion of potential policy implications. Telecommunications Taxes in the United States Telecommunications services in the United States are subject to an almost incomprehensible array of taxes at the local, state and Federal levels. Indeed, there are so many taxing entities levying so many taxes, fees and other charges that there literally is no comprehensive data source from which a complete listing can be obtained. Nevertheless, it is possible to paint a fairly accurate picture of the overall level of telecommunications taxes. A major new study by the Committee on State Taxation (COST) provides a wealth of data on state and local taxation of telecommunications services. See Committee on State Taxation, 50-State Study and Report on Telecommunications Taxation (Washington, DC: Committee on State Taxation, 1999). This study will make possible far more sophisticated analyses of telecommunications taxes than have been possible in the past. While the study was not completed in time for its results to be incorporated in this paper, the author wishes to thank COST for an advance copy. Federal Taxes: The Federal government taxes telecommunications in three significant ways. First, it levies a three- percent excise tax on all telecommunications services. Second, it imposes fees on long-distance carriers that are used to subsidize the provision of telecommunications services, wiring and computer-related equipment at schools, libraries and rural health care centers. Third, it oversees a system of "access charges" through which long-distance phone carriers subsidize the below-cost provision of local telephone service to selected customers. Of these, only the first is universally agreed to be a "tax." While these are the three most significant Federal taxes, they are by no means the only ones. Telecommunications carriers pay a wide variety of regulatory fees, participate in extremely complex cross-subsidization programs, are subject to a number of unfunded mandates and face numerous unfavorable depreciation and related provisions. The Federal telecommunications excise tax (FET) adds three percent to the cost of every telecommunications bill. It covers both long distance and local telephone service for both residential and business customers. Revenues from the tax are treated as general revenues. The FET is projected to raise about $5 billion in FY 1999. As shown below, this makes it the third largest general revenue excise tax in the U.S. budget, just behind alcohol and tobacco. Nevertheless, the tax accounts for less than four tenths of one percent of Federal revenue. By comparison, the Office of Management and Budget estimates the FY 1999 Federal budget surplus at $99 billion. Table One: General Fund Excise Taxes Beginning in 1998, revenues from the excise tax on motor fuels were removed from general revenues and dedicated virtually entirely to the highway trust fund. At nearly $40 billion, the tax on motor fuels is far and away the largest Federal excise tax in terms of revenue raised. Source: Office of Management and Budget, Budget of the United States: Historical Tables (Washington: Government Printing Office, 1999).
Source: Office of Management and Budget The second major tax on telecommunications services is the tax levied on long distance carriers to support the Federal Communications Commission's "e-rate" program. In May 1999, the FCC voted to raise the annual amount of this tax by approximately $1 billion to $2.25 billion annually. See Federal Communications Commission, In re: Federal-State Board on Universal Service: Twelfth Order on Reconsideration in CC Docket No. 96-45 (May 27, 1999). See also Dissenting Statement of Commissioner Harold Furchtgott-Roth (August 5, 1999). The FCC has gone to great lengths to ensure that the charges associated with the e-rate are not seen by the public as taxes. [See, for example, In re: First report and Order and Further Notice of Proposed Rulemaking, Truth-in-Billing and Billing Format; CC Docket 98-170 (May 11, 1999). In this "truth in billing" proceeding, the FCC effectively prohibited long distance carriers which pay into the fund from including on their bills a line showing the portion being passed through to consumers.] All documents available at www.fcc.gov. These taxes are passed through by long distance carriers to individual customers, increasing monthly bills by just over $1 per month per line. The e-rate program has been roundly criticized by academic economists. See, for example, Jerry Hausman, Taxation by Telecommunications Regulation: The Economics of the E-Rate, (Washington: The AEI Press, 1998). The third major Federal tax levied on telecommunications services is the most ambiguous and controversial of all: It is the system of access charges imposed on long-distance carriers to compensate local carriers for use of the local facilities used to complete long distance calls. While a comprehensive analysis of the access charge system is far outside the scope of this paper, it is generally agreed that the charges are higher than can be justified by the economics of local access per se, and in fact are part of the "universal service" regime that holds prices for some customers below cost by raising prices on other customers. To the extent access charges represent de facto government mandated transfers from some customers to others, it is difficult to argue that they are not "taxes." State and Local Taxes: While Federal taxes on telecommunications services are both high and complex, state and local taxes are both much larger and far more complex. As shown in Table Two below, there are approximately 37 different types of taxes levied on telecommunications services by state and local governments in the United States. These include excise taxes, franchise fees, right of way charges, gross receipts taxes, license fees, 911 fees, public utility taxes and even special levies for programs such as poison control centers. In some cases these taxes apply to local telephone services only; in others they extend across state borders and apply to long distance services as well. Wireless services are often taxed differently from landline services, and – as discussed further below – telecommunications services offered by non-traditional carriers such as competitive local exchange carriers (CLECS) may in practice be taxed differently from the same services when offered by traditional carriers. Table Two: State and Local Telecommunications Taxes State Local/Municipal · Franchise Taxes · Sales & Use Taxes · Telecommunications Excise Taxes · Gross Receipts Taxes · License Fees · Utility Taxes, Utility User Taxes, PUC Fees · Rental/Lease Taxes · Utility Sales Taxes · Business & Occupation Taxes · Infrastructure Maintenance Fees · 911 Fees, Emergency Operation Charges, 911 Database Charges, 911 Equalization Surcharge · Intrastate Surcharge · High Cost Fund Surcharge · Relay Service, Communications Devices Surcharges, Universal Access Charges · Access Line Charges · Infrastructure Fund Reimbursement · Poison Control Surcharge (TX) · Public Utility Commission Fees · Universal Service Charges, Universal Lifeline Telecommunications Surcharge · Franchise Taxes · Sales & Use Taxes · Local 911 Tax · Excise Taxes · Telecommunications Taxes · Gross Receipts Taxes · License Fees · Utility Taxes · Access Line Tax · Rental/Lease Taxes · Telephone Relay Surcharge/Universal Lifeline Surcharge · Public Service Taxes · Utility Users Tax · Infrastructure Maintenance Fees · Right-of-Way Charges · 911 Fees · Business & Occupation Taxes · Teleconnect Fund Source: AT&T, The Progress & Freedom Foundation One important data base for analysis of telecommunications taxes is contained in a survey published annually by the Federal Communications Commission. The FCC survey reports on 21 types of actual taxes, fees and other charges appearing on local telephone bills for 95 communities in 41 states. The FCC data do not include taxes levied on long distance services, nor do they distinguish between taxes levied by state governments and those levied at the local level. However, they do make it possible to determine the overall level of Federal, state and local taxes on local phone bills in both absolute and percentage terms. Table Three below summarizes this FCC survey data for the 20 highest-tax major metropolitan areas for 1997, the last year for which the Commission has made available the disaggregated data required for our purposes. While data from its 1990-1997 surveys is posted on the FCC's Web site, Commission staff have refused without explanation repeated requests to make available the 1998 data needed to break out the various components of taxes and fees that make up local bills. We remain hopeful this data will be made available in the immediate future. It shows that taxes on local telephone service amount to as much as 35 percent of the total phone bill, accounting in some jurisdictions for over $4 per month, or as much as nearly $60 per year. For the 95 jurisdictions overall, taxes average just over $2 per month, or about 16 percent of the total local service bill. These figures are broadly consistent with those reported in the COST study, which found an overall average rate of 18 percent nationally, with the highest state-average rate approaching 30 percent. The FCC data also permit us to compare the relative magnitude of different types of taxes. As shown in Figure One (on the following page), state and local excise taxes account for over half (52 percent) of the taxes on a local telephone bill. State and local fixed fees add another four percent of the total, while 911 fees (also levied by state and local governments) make up yet another 22 percent. The Federal excise tax accounts for less than one fourth (22 percent) of the taxes on a local phone bill. TABLE THREE: Telecommunications Taxes in the Twenty Highest-Tax Cities Calculated based on data collected by the Federal Communications Commission. Listed cities include only those over 100,000 population. Weighted average includes all 95 cities in sample. Taxes include the Federal excise tax (3%), state and local excise taxes, state and local fixed taxes, 911 excise taxes and 911 fixed taxes appearing on local residential telephone bills. Additional taxes (e.g. franchise taxes, public utility taxes, property taxes, etc.) not shown on the customer's bill are not included, nor is the Federal Subscriber Line Charge. See 1999 Reference Book of Rates, Price Indices, and Expenditures for Telephone Service (Industry Analysis Division, Common Carrier Bureau, Federal Communications Commission, February 1999), Table 14.1. The disaggregated data used to calculate the figures in this table are posted on the FCC's Web site, at www.fcc.gov/Bureaus/Common_Carrier/Reports/FCC-State_Link/lec.html
Because these figures include only taxes that are imposed on local telephone service, they do not reflect the Federal "e-rate" tax (which is imposed on long-distance carriers and passed through to consumers on long-distance bills). Similarly, they do not account for the portion of the Federal excise tax applied to long distance charges, or whatever portion of Federally mandated access charges one might attribute to universal service and thus appropriately characterize as a tax. Even if these charges were included, however, they would not change the basic conclusion that emerges from Figure One: On average, states and localities tax telecommunications even more heavily than does the Federal government. Again, this conclusion is consistent with the findings of the COST study. The FCC data also permit an examination of the trend in telecommunications taxes over time. As shown in Figure Two below, the trend is towards significantly higher taxes. Since 1986, the average tax rate on local phone bills has risen from 10.7 percent to 17.6 percent. In dollar terms, taxes on the average monthly phone bill have risen by 62 percent during this period, from $1.51 in 1986 to $2.41 in 1998. Source: Federal Communications Commission, Trends in Telephone Service (February 1999), Table 14.1. The PFF estimates in Table Three above are based on a somewhat more conservative methodology than that used by the FCC to calculate the percentages in Figure Two above. Thus, the FCC estimates the average tax rate in 1997 as 17.4 percent, compared with PFF's 15.7 percent. In summary, telecommunications taxes in the United States are numerous, complex, and high relative to other goods and services – and getting higher. The High Cost of Taxing Telecom Economists and other policy analysts agree on three broad criteria by which tax policy should be judged: Efficiency, equity and enforceability. The efficiency criteria implies that taxes should reduce overall economic welfare as little as possible. The equity criteria suggests that taxes should contribute to (or at least not detract from) some generally accepted sense of fairness in the distribution of income and wealth. The enforceability criteria simply means that taxes ought to be designed in a way that minimizes the administrative and other costs of collecting them. In the pre-competition, pre-Internet world of plain old telephone service, telecommunications taxes probably looked relatively good by these traditional standards of tax analysis: · Efficiency: Historically, telecommunications taxes probably caused relatively small welfare losses. This is because the quantity of plain old telephone service (POTS) purchased (especially local service) was relatively insensitive to price (it was price inelastic), and thus unresponsive to any price increases caused by high tax rates. The demand for basic local telephone service is highly inelastic. See, for example, Hausman, 1999. So long as taxes did not produce large changes in the quantity or types of telecommunications services purchased, the misallocation of economic resources caused by telecommunications taxes was small. · Equity: Telecommunications taxes were part and parcel of a system of price regulation that provided significant subsidies for those at the lower end of the income spectrum or who, for whatever reason, were felt to deserve relatively low telephone prices. And, because telecommunications carriers were guaranteed a regulatory rate of return, neither they nor their shareholders suffered when taxes were raised. · Enforceability: Telecommunications taxes were levied on a single provider, the monopoly telephone company, which was sufficiently large and sophisticated to comply efficiently with even a fairly complex tax regime. To the extent there were ambiguities in the system, these could be worked out between the lawyers for the phone company and the tax collectors, probably in conjunction with the state regulators. As discussed in the Appendix, however, there are massive changes underway in the telecommunications marketplace. These changes turn the calculus of telecommunications taxes on its head. Whereas telecommunications taxes may once have been relatively desirable (as compared with other taxes), they are now arguably the most destructive taxes being levied on the American economy. The work now underway at The Progress & Freedom Foundation aims to present a complete analysis of the impact of telecommunications taxes, and the objective of this paper is not to anticipate or prejudge the results of that analysis. At the same time, it is already quite apparent that, in today's converged, digital, Internet-defined marketplace, telecommunications taxes do not hold up well to the scrutiny of the traditional analysis described above. Telecom Taxes and Economic Efficiency: From the perspective of tax analysis, the most significant change in telecommunications markets may lie in the changing nature of telecommunications demand. Whereas demand for POTS was relatively inelastic, demand for the vast array of new telecommunications products appears to be relatively price elastic. Technically, this means that a relatively small percentage change in the price of telecommunications products results in a relatively large percentage change in the quantity purchased. In practical terms, it means that telecommunications taxes may cause many people to purchase fewer telecommunications services than economic efficiency would require. Consider, perhaps most importantly, the market for broadband communications – i.e. for high-speed connections to the Internet. In the past, high-speed Internet access was available only through so-called "T-1" lines which, at $2,000 or more per month, were affordable only by large corporations or the very wealthy. Recently, however, two new technologies have emerged that make broadband access potentially affordable for virtually everyone. Digital Subscriber Line (or "DSL") technology allows a standard telephone line to be converted into a high-speed data line. Offered by the major telephone companies, as well as a growing cadre of competitive "CLECs" and "DLECs," DSL services are being offered in many areas of the country for $40-$60 per month. At the same time, Cable Modem technology is now offering very similar services at competitive prices. See Federal Communications Commission, Inquiry Concerning the Deployment of Advanced Telecommunications Capability (CC Docket 98-146, August 7, 1998). Making affordable broadband services available to all Americans is one of America's highest economic priorities. As FCC Chairman Bill Kennard put it in a recent speech, "despite all the technical advances and globalization, the formula for economic success has remained the same: economic prosperity relies on high-speed access to the critical network of information and commerce. That network is the Internet, and the type of access needed is broadband." Hon. William Kennard, "The Road Not Taken: Building a Broadband Future for America," Speech to the National Cable Television Association, June 16, 1999. The available evidence suggests that demand for broadband services is highly elastic – that is, sensitive to price. A recent study by Robert Crandall and Chuck Jackson, for example, estimated that only four million consumers would be willing to pay $70 per month for an upgrade from 56.6 kb/s Internet access to 1.1 Mb/s, but 20 million would pay $25. See Robert W. Crandall and Charles L. Jackson, Eliminating Barriers to DSL Service, unpublished manuscript, May 1998. Applying the available evidence on elasticities of demand for broadband services to current telecommunications tax rates yields disturbing results. Indeed, as shown in Table Four below, the available evidence suggests telecommunications taxes already are having a significant impact in slowing the adoption of high speed Internet access to American households. And, as the number of households with access to broadband services grows, this effect will grow in the future. Specifically, at the national average telecom tax rate of 16 percent, we estimate that at least 165,000 households, and perhaps as many as 2.9 million households, are being effectively priced out of the market for broadband Internet access in 1999. As the availability of broadband services spreads, and the number of potential customers grows, these estimates go up significantly over time. By 2002, at current tax rates, we estimate that between 1.2 million and 4.2 million households will be denied broadband Internet access by high telecommunications taxes. If telecommunications taxes were to continue to rise, the impact would grow more than proportionately. For example, a 20 percent tax burden (similar to current rates in Baltimore, Dallas, Los Angeles and Tampa) is estimated to reduce broadband penetration by approximately 11 percent. However, a 33 percent burden (similar to the current rate in Richmond, Virginia) reduces predicted broadband penetration by nearly 20 percent. Table Four: The Impact of Telecommunications Taxes on Broadband Penetration
Telecom Taxes and Equity: The equity consequences of telecommunications taxes are also being affected by the changing marketplace. As noted above, telecommunications taxes in the pre-competition, pre-digital environment were part and parcel of a regulatory regime that set virtually all prices at levels designed to ensure equity while offering a fair return to telephone companies. Thus, prices could be set in such as way as to offset the inherently regressive nature of fixed and excise (i.e. percentage) taxes on telecommunications. In a competitive environment, of course, such cross-subsidies are simply unsustainable, and indeed the Federal Communications Commission is moving gradually in the direction of reducing and/or eliminating such cross subsidies. For products, like POTS, where elasticities of demand are low and prices (even if allowed to rise to full cost) are affordable for most families, the impact of removing such cross subsidies should be relatively small. Again, however, the analysis is quite different when one considers the full impact of telecommunications taxes on products with high elasticities of demand. Returning again to the example in Table Four above, we have estimated the impact of current and possible future telecommunications taxes on the availability of at- home broadband Internet access for children. As shown in the table, we estimate that, at current tax rates, between 800,000 and 2.7 million children will be denied such access over the next three years. It should also be noted that these figures reflect the average impact of telecommunications taxes on all customers, assuming all are equally sensitive to price changes. This assumption is open to question, in at least two specific ways. First, households with lower incomes are likely to be more sensitive to changes in telecommunications prices than those with higher incomes. See, for example, U.S. Department of Commerce, Falling Through the Net (July 1999), p. 81. Thus, telecommunications taxes are likely to deny broadband access to proportionately more "poor" families (and their children) than to the rich. Second, because the costs of deploying broadband services in rural areas are higher and rural incomes are lower than the national average, it is also likely that high telecommunications taxes will have a greater impact on rural areas than on urban or suburban ones. Thus, telecommunications taxes contribute directly to the digital divide, whether it is expressed in terms of geography, income or both. Telecom Taxes and Enforceability: As discussed further in the Appendix, the emerging market for telecommunications services is the antithesis of a monopoly. As former White House Internet Advisor Ira Magaziner put it in a recent Progress & Freedom Foundation paper, "with the Internet and this new environment of convergence, we are going to have the greatest amount of competition the world has ever seen." The competition now breaking out in the telecommunications marketplace is of two types. First, it consists of numerous companies all competing to offer the same product in the same market. Thus, nearly all U.S. markets now have more than one company offering local telephone service, and most states have literally dozens of companies – many of them small and relatively young – offering telephone services in their states. An obvious implication of this sort of competition for telecommunications taxes is to increase administrative costs for both tax collectors and for the companies. And, because such costs are, in effect, fixed costs of entering new markets, they end up serving as barriers to entry, thereby reducing economic efficiency. The second type of competition is even more problematic for tax authorities: It is competition to offer new and different services, often through new and different means. It is here that the current tax regime begins simply to collapse. When, for example, is a service a "telecommunications service"? This used to be a pretty straightforward question: It was a telecommunications service if it was offered by the phone company. Then along came wireless (i.e. cellular) telephony. For the most part, wireless telephony was also treated as a telecommunications service. At about this same time, AT&T was broken up into its local and long-distance components. Could the states tax the long distance (interstate) part of the bill? As it turned out, under a 1989 Supreme Court decision, they could: Interstate calls were telecommunications services too. Once data services are added to the pot, however, the question becomes far more ambiguous. Is "Internet access" a telecommunications service? The answer, at the moment, is that no one knows for sure. Indeed, just two weeks ago, on August 25, 1999, the U.S. Court of Appeals for the District of Columbia granted the FCC's request to remand an August 1998 order determining that "advanced" telecommunications services are either "telephone exchange" or "telephone access" services. See Federal Communications Commission, "Comments Requested in Connection with Court Remand of August 1998 Advanced Services Order" (Public Notice, September 9, 1999). In other words, even the national authority on telecommunications policy – the FCC – isn't sure what counts as telecommunications anymore. In fact, the question of who should pay telecommunications taxes, and on what tax base, is certain to get more complex before it gets simpler. For example: The issues described below are illustrative of a vast array of questions now facing taxing authorities with respect to telecommunications taxes. For one thoughtful review of such issues, see Richard McHugh, Sales Taxation of Telecommunications Service in the State of Utah (Georgia State University School of Policy Studies, February 1997). · When telephone companies bundle Internet Service Provider services with DSL services, are those services taxable as telecommunications services? Or are they exempt from taxation under the moratorium imposed by the Internet Tax Freedom Act? Perhaps they are taxable only in part. If so, how should taxing authorities decide where to draw the line? · Does the answer to the above question change if the same service is provided by an Internet Service Provider using DSL lines leased from a telephone company? (The answer, apparently, is that it depends what state you are in, as some states in fact treat the two situations differently while others treat them the same.) · Is broadband Internet access offered by a cable television company a telecommunications service? What if the service is offered over telephone lines leased from a phone company? If it is offered over the cable company's own phone lines? The list of such questions could go on indefinitely – and, on the current path, it will, as each of these questions and literally thousands more will need to be decided by taxing authorities all across the U.S. It seems unlikely that the decisions they reach will be consistent with one another, forcing telecommunications providers to create increasingly complex compliance systems – or, again, to choose not to enter some markets in order to avoid the administrative burdens of doing so. In summary, applying the current, highly complex system of telecommunications taxes to the new, competitive telecommunications market will create serious problems of enforceability, imposing high compliance costs on both tax collectors and companies. Conclusions and Tentative Policy Implications The circumstances that made it possible to subject telecommunications services to a complex system of extremely high tax rates have changed. In fact, the same traditional tax policy analysis that suggests that telecommunications taxes were relatively efficient ways to raise revenue in the pre-competition, pre-Internet environment strongly suggests that they are quite costly and highly inefficient today. Policymakers need to re-examine the panoply of taxes currently applied to telecommunications with an eye towards both tax simplification and tax reduction. For states and localities, which together account for more than three-fourths of all telecom taxes, there is an urgent need to put such reforms in place at a pace consistent with the rapid development of the marketplace. In this case, at least, tax policy needs to be worked on "on Internet time." Appendix: The Changing Market for Telecommunications The market for telecommunications has changed dramatically in recent years. It has changed from a natural monopoly to a competitive market. It has changed from technologically homogenous and stable market to one with many competing and rapidly changing technologies. And, it has changed from a market that followed the overall economy to one that is, more than any other, leading it. For most of its history, the telecommunications industry has been thought of as a natural monopoly and regulated as a traditional public utility. During the 1970s and 1980s, however, technological progress began to transform the telecommunications marketplace into one in which competition was both possible and desirable. In the 1980s, digital switching technologies first made it economical to interconnect multiple long distance and wireless carriers to the local switching system. The results were the breakup of AT&T, the creation of the cellular telephone industry and the development of competitive markets for both long distance and wireless telephone services. Local telephone service, however, continued to be viewed as a natural monopoly and regulated as a public utility. By 1996, it was generally agreed that further technological progress was rapidly making competition possible not only in the long distance and wireless markets, but also in the market for local telephone service. Similarly, most policymakers agreed that, thanks largely to competition from direct satellite broadcasting, the market for cable television was also becoming competitive. Recognizing these changes, Congress passed Telecommunications Act of 1996, which ended rate regulation of cable television and initiated a transition to a competitive market for local telephone service. Importantly, the Telecommunications Act also called for an end to the use of hidden cross subsidies, concealed within regulated prices, that previously had kept some prices (e.g. rates for basic telephone services in rural areas) below cost while artificially raising others (e.g. rates for urban business customers). As Congress correctly recognized, a precondition for competition was that prices reflect the actual costs of providing services, and thus that any cross-subsidies be made explicit. One phenomenon the Telecommunications Act could not and did not anticipate was the explosive growth of the Internet and its impact on the telecommunications network. While growth of the Internet has slowed somewhat since 1995, it continues to grow by 50 percent or more per year, as measured by the number of Internet host computers (and faster by some other measures). See Erran Carmel, Jeffrey A. Eisenach and Thomas M. Lenard. The Digital Economy Fact Book (Washington: The Progress & Freedom Foundation, 1999). The Internet has resulted in very rapid growth in the volume of data travelling on the public switched telephone network, to the point that data traffic will soon exceed voice traffic. The resulting demand for data transport (especially for the high-capacity broadband transport needed to facilitate increasingly rich Internet-based applications and to support electronic commerce), combined with the competitive framework established by the Telecommunications Act, has led to an explosive growth in the number and the types of both telecommunications services and telecommunications providers. The impact of these changes on the nature of the telecommunications marketplace is quite profound. As former White House Internet advisor Ira Magaziner explains in a recent Progress & Freedom Foundation publication: With the Internet and this new environment of convergence, we are going to have the greatest amount of competition the world has ever seen. We are going to have telecom companies, computer companies, software companies, satellite companies, wireless companies, consumer electronics companies, and electric utilities all competing to build out this infrastructure, and the best thing we could do is let that competition take place and not try to regulate it or interfere with it. See Ira Magaziner, "Creating a Framework for Global Electronic Commerce," Future Insight 6.1, (Washington: The Progress & Freedom Foundation, July 1999). As Magaziner explains, technological convergence has brought previously separate sectors of the telecommunications industry into direct competition with one another. Most notably, the cable industry has become a major competitor in the market for telecommunications services of all kinds, especially broadband communications offered through cable modems. See Barbara Esbin, Internet Over Cable: Defining the Future in Terms of the Past (Office of Plans and Policy, Federal Communications Commission) OPP Working Paper No. 30, August 1998. See also These changes are no longer a matter of speculation. Indeed, in the first paragraph of its recently released restructuring proposal, the Federal Communications Commission states unequivocally that: In five years, we expect U.S. communications markets to be characterized predominantly by vigorous competition that will greatly reduce the need for direct regulation. The advent of Internet-based and other new technology-driven communication services will continue to erode the traditional regulatory distinctions between different sectors of the communications industry. A New FCC for the 21st Century (Federal Communications Commission, August 1999) The third major change – and the one that makes reform of telecommunications taxes so crucially important – is that the telecommunications sector has become the catalyst for overall macroeconomic growth. Indeed, most economists now agree that the information technology sector of the economy is responsible for a disproportionate share of American economic growth in recent years. Testifying before Congress in February 1998, for example, Federal Reserve Board Chairman Alan Greenspan stated that: [O]ur nation has been experiencing a higher growth rate of productivity – output per hour worked – in recent years. The dramatic improvements in computing power and communications and information technology appear to have been a major force behind this beneficial trend. Alan Greenspan, Monetary Policy Testimony and Report to Congress, February 24, 1998. More recently, the U.S. Department of Commerce has reported that the information technology sector of the economy (which includes telecommunications) – though making up less than 10 percent of total output and employment – is responsible for over 40 percent of growth in Gross Domestic Product. See U.S. Department of Commerce, The Emerging Digital Economy II (June 1999). These statistics highlight the importance of constructing a sensible public policy framework that permits and encourages continued growth in the telecommunications sector. Obviously, tax policy is an important part of any such framework. As discussed in the body of this paper, our current policies are a long way from meeting this standard. Publications on Related Topics Progress on Point series George A. Keyworth II and Jeffrey A.
Eisenach, "The FCC and the Telecommunications Act of 1996: Putting
Competition on Hold?" Progress on
Point 2.1, October
1996. Future Insight series George Gilder, George A. Keyworth II,
Alvin Toffler, "A Magna Carta for the Knowledge Age,"
Future Insight 1.2, August 1994. Monographs, Studies, Books, etc. George A. Keyworth II, Jeffrey A.
Eisenach, Thomas M. Lenard, David E. Colton, The Telecom Revolution: An American Opportunity
(Washington, DC: The Progress
& Freedom Foundation, May 1995). | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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