Last week, Zoom Video Communications announced that, come November, the company will start collecting and remitting local utility and communications taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es in California, New York, Maryland, and Virginia. The specific taxes and their rates vary depending on the state and locality in which the user is located. As an example, in California, the company will collect the Utility User Tax (UUT) and the Communication User Tax (CUT). The rate on these taxes ranges between 0.5 percent and 11 percent. Utility and communications taxes are excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. es, different from, and in most cases in addition to, the general sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. that many states, rightly, levy on online video call services.
Tax rates for communication and utility taxes in all 50 states can be found in the appendix of our yearly publication on wireless taxation (last year’s version here).
Utility taxes have been levied on private use of public utilities for over a century. The argument for levying these taxes is that companies using public utilities increase costs for the state or locality owning the resource, and often enjoy the benefit of regulatorily-guaranteed monopoly and the use of eminent domain. The tax allows them to recover the costs associated with that use. For example, in California, utility taxes are levied at rates varying by location on use of electricity, gas, water, sewer, telephone (including cell phone and long distance), sanitation, and cable television. And in New York City, utility taxes are levied on all utilities and vendors of utilities at rates varying by utility type. Traditionally, these taxes have been levied on communications services for companies with telephone poles and buried coax.
However, as technology has evolved way beyond conducting phone calls using telephone poles, states and localities have adjusted their tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. to include more modern technology, such as cell phone use and online video call services. Including online video calls in the tax base is especially suspect from a tax policy perspective, as, generally, excise taxes should be levied in an effort to address some negative externalityAn externality, in economics terms, is a side effect or consequence of an activity that is not reflected in the cost of that activity, and not primarily borne by those directly involved in said activity. Externalities can be caused by either production or consumption of a good or service and can be positive or negative. , limit consumption, or establish a user feeA user fee is a charge imposed by the government for the primary purpose of covering the cost of providing a service, directly raising funds from the people who benefit from the particular public good or service being provided. A user fee is not a tax, though some taxes may be labeled as user fees or closely resemble them. .
Unlike a sales tax, which is imposed on a broad range of consumption to fund general government, excise taxes (including utility taxes) are intended to address consumption that imposes unique social costs, or to create a user-pays system. They pay for roads or reduce and address the health costs associated with smoking, at least in theory. These externalities are what justifies a specific tax on select activities, above and beyond broad-based general taxes.
A “Zoom tax” fails these tests. Taxes originally created for utility companies that own telephone poles and buried cables, and which often have a government-protected regional monopoly, are inappropriate for software-as-a-service companies.
When it comes to online meeting and conference services, it is very hard to identify any negative externalities or any increased government costs related to use. In terms of discouraging consumption, it is highly unlikely that local governments desire that fewer people use video meeting software. We are left with the conclusion that these taxes are likely levied with the sole purpose of raising revenue.
If revenue is the goal, however, states and localities should focus on broad taxes with low rates. Excise taxes on communications services are rather narrow and, as illustrated by the emergence of online communications, subject to technological disruption resulting in a risk of highly volatile tax collections. As such, they should not be relied upon for general revenue. It is equally unclear why one particular use of broadband—video calls—would be subject to a special tax, while other uses are not.
Additionally, taxing online communications such as Zoom by location of the user also raises a number of issues. Historically levying a utility user tax on communication services was fairly straightforward as phone lines are plugged into a physical utility and wireless phone service pings a physical tower for service. Online calls are not so simple, however. For instance, it is unclear whether the taxing jurisdiction will be the home of the account holder or the home of the user. (These are not necessarily the same person as many company plans allow multiple users to initiate video calls.) The question is where the consumption takes place in the eye of the tax code.
This would be less of an issue if everyone were conducting video calls from their office buildings, but right now, due to the pandemic, millions of us are working outside our offices. As a result, the Zoom account holder may be located in New York City but have users in, for example, New Jersey or even New Mexico. If the location of the user is a determining factor, issues surrounding reliability of a user’s IP as a location tool may arise. Think about the problems arising from the use of VPNs (where a user connects to the internet via an out-of-state server). Using IP addresses could encourage tax avoidance by incentivizing companies to open accounts in states and localities with no or low taxes, or, even without avoidance, could introduce error and complexity.
Ultimately, utility taxes on online video calls have very little legitimacy as such calls cause no negative externalities, do not result in increased costs for state and local governments, and cannot easily be distinguished from any other use of internet services which is not subject to a special tax. As revenue tools, they risk being highly volatile due to their narrow design and risk of tax avoidance. Extending utility taxes, developed to tax services delivered with physical infrastructure (much of it in public rights-of-way), to online video conferencing is an enormous stretch, and one that cannot be justified by any reasonable theory about the purpose of excise taxes. Lawmakers would be well-advised to reconsider the appropriate tax base for utility taxes and to rely more on broad taxes with low rates for general revenue.
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