A Crossroads for Telecom Taxes

State and local revenue bases are threatened as more companies offer communication services via the untaxable Internet.
by | February 2005

The long-promised bundling of services over the Internet is starting to happen. Music, movies, e-mails and phone calls will be coming through the same wires into people's homes. That may be good news for consumers, but it stands to make a mess of state and local tax policy.

At the present time, state and local governments pull in $18 billion a year in telecom taxes, the bulk of which are levied on hard-line telephone companies at rates as high as 18 percent. Meanwhile, other companies offer competing services through different wires. Those services are untaxed and likely to remain so for now. Congress extended the moratorium on Internet access fees in November, and that same month, the Federal Communications Commission ruled that a Voice over Internet Protocol is exempt from state regulation.

In response, state and local government groups are negotiating feverishly with companies across the communications sector to try to flatten or streamline existing tax rates and end some competitive disadvantages. The goal is to have all sides agree to a detailed set of principles in time for the National Governors Association's winter meeting in Washington, which opens on February 21. It's an ambitious timetable, considering that there are major disagreements not only between different sectors of the communications business but also between the state and local organizations.

Virginia Governor Mark Warner, this year's NGA chairman, seems well suited for the task of leading the effort, having co-founded telecommunications companies, including Nextel, before entering politics. At a December summit between the major state and local groups and about 20 communications companies, Warner made it clear that his goal was to lower the monopolistic tax rates on old-fashioned telephony.

But the only way Warner can see to lower current rates on telephone companies is to make the sectors that are currently tax-free share the burden. Representatives for city interests share that view. "This is not a fledgling industry anymore," argues Marilyn Mohrman-Gillis, director of policy and federal relations at the National League of Cities. "This is a robust and thriving industry that needs to share in broad-based support of state and local government services."

Communication companies are less than thrilled with the idea, though, and as negotiations with state and local interests continue, some of the cable and Internet companies are taking their case to Congress, looking for a permanent exemption from taxes.

Meanwhile, the state groups face a challenge in placating the fears of local governments, which rely more heavily on telecom taxes. Warner contends that any telecom tax simplification has to leave states in the driver's seat, since they are more unified than all the local governments companies now have to deal with. But mayors are understandably nervous that states would soon be up to their familiar trick of holding on to funds they are supposed to pass through to the local level.

It's not clear yet whether the ultimate goal is model legislation for states or a package the groups can present to Congress. If they can achieve consensus, it should be an easy sell. Some of the same companies and state and local organizations reached an agreement on cell phone regulation, for example, to which Congress was happy to give its blessing a few years ago. And there are jurisdictional issues--some VoIP providers are located overseas--that would require a federal solution.

"My experience with federal lawmakers is, if there's an opportunity for them not to tackle difficult policy issues where there are divergent views, but instead have a negotiated process take place," says Mohrman-Gillis, "most of the time they're happy to defer to that process."


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