Wireless phone taxes must go

Daniel Rothschild Director of State Projects, R Street Institute
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Throughout their 2011 legislative sessions, a number of states sought ways to simplify their tax systems, which have become increasingly byzantine and complex. Florida, for instance, raised the level at which its corporate tax applies, raking some 15,000 small business off the corporate tax rolls. Michigan repealed the much-maligned Michigan Business Tax and overhauled its corporate tax structure.

States that are interested in rationalizing their tax codes would do well to look at the way they tax wireless phone service. Though taxes paid amount to only a few dollars per household per month, these taxes are bad policy for a number of reasons: they’re economically inefficient, they run counter to other policy goals and they disproportionally affect lower-income households.

At their root, wireless taxes reflect bad economics. Taxes exist to raise revenue for necessary government functions, and all taxes raise the price to consumers of buying goods and services.

That is why economists of all political persuasions typically recommend adherence to the principle of tax neutrality, which holds that taxes should treat economic activities equally in order to have similar effects across consumers. In other words, taxes should be broadly applied at a low rate rather than applied to just a handful of goods at a high rate.

And make no mistake: cell phones are taxed at an inordinately high rate. The federal government charges a 5.5 percent fee on the voice portion of your cell phone bill to support the Universal Service Fund, which subsidizes phone service to low-income and rural households as well as schools and libraries. State and local governments tack on additional fees, averaging almost ten percent nationwide, ranging from a low of just 1.84 percent in Oregon to a staggering 18.64 percent in Nebraska.

As a result, cell phone service is taxed at an average combined rate of 15.4 percent, according to calculations by economist Scott Mackey. Compare this with sales taxes, which average just 6.83 percent nationally (in part because the federal government collects no sales tax). This rate is simply economically unjustifiable.

These high taxes disproportionately affect lower-income households. When policymakers enacted cell phone taxes, wireless telephony was seen as the exclusive domain of the wealthy and privileged — think of the stereotypical 1980s Wall Street executive holding a brick-sized cell phone to his cheek.

This is obviously no longer the case. In the last decade, the number of cell phones in the United States has almost tripled. By 2009, a quarter of American households had only cell phones and no land lines. And poor households are almost twice as likely as non-poor households to only have cell phones.

Moreover, Congress has made expanding high-speed Internet access a policy priority. But because cell phones increasingly also offer Internet access, taxing wireless telephony runs counter to that policy.

According to a 2010 survey by the Pew Internet and American Life Project, 40 percent of American cell phone users report using their cell phones to go online. Eighteen percent of African-American respondents and 16 percent of English-speaking Hispanic respondents said their cell phones were their only means of accessing the Internet.

Virtually everyone agrees that increasing access to the Internet — whether through cables to your desktop or wireless signals to your pocket — is a good thing. But taxing wireless phone service will have the opposite effect.

If states are serious about improving their tax codes, they would do well to consider scrapping excise taxes on cell phone service and to avoid adding any new taxes to wireless Internet or data services.

Daniel Rothschild is the managing director of the State and Local Policy Project at the Mercatus Center at George Mason University.