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March 1, 2000

Taxing Talk: The Telephone Excise Tax and the Universal Service Fees

Executive Summary

The charge on your phone bill doesn’t say “luxury tax” or “war tax,” but that’s what the federal telephone excise tax was when it was enacted in 1898 to fund the Spanish American war. Only the wealthy had telephones, the U.S. had no income tax at that time, and we relied on excise taxes to fund the war. So why do we still have the tax?

That is the question answered in the newly released Tax Foundation Background Paper No. 34, titled “Taxing Talk: The Telephone Excise Tax and Universal Service Fees.” Written by Stephen J. Entin, executive director and chief economist of the Institute for Research on the Economics of Taxation (IRET), the study narrates the checkered history of the federal telephone excise tax–one of the nation’s oldest taxes–as well as its companion, the “universal service program.”

The universal service program is another obscure line on your phone bill. Called “access fee” or “federal line charge” by your phone company, it is actually the federal government’s program to subsidize phone service in sparsely populated areas.

According to Entin, the federal telephone excise tax, the universal service program, and all its attendant taxes, charges, and subsidies violate basic economic principles and should be abolished because narrowly targeted federal excise taxes on particular goods and services distort prices, reducing economic efficiency and consumer satisfaction. The government should rely for its revenue on broadly based, less distorting taxes.

The Federal Telephone Excise Tax

Every war the U.S. fought during the 20th century was used as an excuse to raise or extend the federal telephone excise tax. It got as high as 10 percent in 1966 when President Johnson persuaded Congress that it was a good way to help pay for the Vietnam War. During the 1980s, the tax was scheduled to expire several times, but concern over budget deficits came to its rescue, and the Revenue Reconciliation Act of 1990 made the tax permanent at three percent.

Telephones are no longer a luxury, so its defenders have called it a user fee. Entin says it is by no definition a proper user fee that would fund telephone service. It deposits revenue right into the general fund, and Entin calls it “a pure money raiser.”

The Universal Service Program Entin decries the long-running “universal service program” that the government forces on telephone companies in an attempt to lower rates in sparsely populated areas. Enacted in the 1930s, it imposes numerous hidden charges and subsidies, boosting the price of service for some subscribers to hold down the price for others, without regard to the incomes of the people involved.

Where subsidies are deemed necessary, according to Entin, they should be provided through explicit outlays in the federal budget, readily visible for all to see, funded through general revenues, and based on individuals’ needs.

Legislative Action

The Advisory Commission on Electronic Commerce and its chairman Governor James Gilmore (R-VA) have proposed elimination of the federal telephone excise tax as part of a broader proposal to prevent or eliminate internet taxes.

Several bills in Congress–H.R. 2677 from Rep. Lynn Rivers (D-MI); H.R. 3011 from Rep. Tom Bliley (R-VA); S. 94 from Sen. John McCain (R-AZ); H.R. 692 from Rep. Thomas G. Tancredo (R-CO); H.R. 727 from Reps. Ron Klink (D-PA), J. W. Dickey (R-AR), Timothy Holden (D-PA), Robert Brady (D-PA), Gene Green (D-TX), and Philip S. English (R-PA); and S. 1004 /H.R. 1746 from Sen. Conrad Burns (R-MT) and Rep. W. J. Tauzin (R-LA)–have been introduced to repeal or scale back the telephone excise tax or the universal service line fees, and to make any fees that remain more visible to customers.

The improvements they suggest are worth noting, but none goes far enough, according to Entin. Keeping the telephone excise tax for any length of time for any purpose invites its permanent retention, and allowing the schools and libraries hook-up program to proceed risks establishing a new entitlement and interest group.

The universal service program itself needs to be replaced by a rational system of assistance that boosts the income of needy individuals rather than attempting to regulate the price of telephone services by geography, provider, and type of consumer.

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