Fighting Recession through IT Tax Reform

While there are some holdout forecasters, the consensus is that the U.S. economy is in or on the threshold of serious recession that promises to halt the long trend of job creation, productivity gains, and per capita income growth Americans have enjoyed in recent years.  The prospect of economic distress has set off discussions of alternative remedial measures for state and local governments.   This ConsumerGram reviews broadly current economic dynamics, alternative courses of action and urges substantial tax reform in the information technology (IT) sector, which according to a broad consensus is one of the most highly leveraged sectors in the economy in its ability to create jobs, growth and wealth in other parts of the economy.  We conclude that IT tax reform would not only create consumer value and increase the efficiency of the economy, but also provide an important component of state and federal government efforts to offset the economic downturn. In short, telecom tax reform is a critical anti-recessionary measure. 

U.S. Economic Distress

Depending on whom you ask, we have been in a recession for a while, or are likely to be in one soon, or don’t worry, be happy, the economy is just sluggish and will return to its long term growth path.  All three positions were authoritatively represented recently in the financial press.  The definition of recession requires two consecutive quarters of negative growth in GDP.  Given the lag in collecting and analyzing macroeconomic data, it will be some time before the National Bureau of Economic Research, the widely recognized authority on the health of the economy, can render its learned judgment. 

 

That said, there is growing consensus that former Treasury Secretary Larry Summers, well-known investor Warren Buffett and economic seers from Goldman Sachs, Wells Fargo, Morgan Stanley, Merrill Lynch, and others are right to believe that the economy has already turned down.  “The debate should no longer be about whether there is or is not a recession, only about how deep it will be,” according to the chief economist of Global Insight Analysis.

 

What’s beyond question is that the collapse of the subprime market has gradually spread to infect broader credit markets including those for auto loans, credit cards, corporate debt and even student loans, and that the dollar continues its precipitous fall against other currencies.  JP Morgan last week described financial markets in the aggregate as issuing a market wide margin call demanding that the economic system “come up with cash it does not have!”  Handwringers among us were distressed to hear that the number of jobs fell by 80,000 in March, housing starts and values continue to slide, oil prices are at their highest but have not yet peaked, consumer spending is weakening, the ratio of inventories to sales (a bad sign for manufacturers) is rising, and, combined with increases in consumer and producer prices, the economy is flashing signs of “stagflation.” 

 

The more pessimistic among us are beginning to draw parallels between what is happening here – dramatically weakening currency, a credit crunch and problems in the banking sector, falling real asset values, diminished investment incentives and job creation initiatives — and the malaise that struck and lingered in the Japanese economy in the 1990s.   

 

Government Response

            Governments typically respond to declining employment and growth, slowing productivity improvements, and to other signs of weakness.  The menu of possible actions is long and diverse, and there are historical precedents for, or against, specific measures.  Notwithstanding the diversity, the main choices are straightforward: 

 

1 – Mix:  Share of government versus private decisions in directing resource use.  With history as a guide, we are obliged to choose among initiatives requiring more or less and different kinds of government intervention.  Broadly speaking, the choice is between government command and provision of private sector incentives.  The record of the past two decades speaks clearly and without equivocation that the trend toward less reliance on government regulations and more on private markets – competition, investment and innovation – has worked well and provides no basis for expecting that more economic regulation will improve future performance of the sector.  Regulation tends to redistribute jobs and wealth, not create them.    

 

2 – Reach:  Sectoral v. Universal Measures.  Traditional countercyclical policies have focused on measures with direct, economy wide incidence – the Kennedy tax reductions, stimulus from increases in government expenditure, as well as classical monetary policies directed at general credit conditions and the overall price level.  However, government has traditionally recognized that for different reasons, some sectors are more important than others.  That recognition extends to consensus that the information technology sector is particularly robust in its ability to generate or suppress economic welfare not only directly, but indirectly through external impacts on other sectors of the economy. 

 

3 – Targets: Investment, Innovation and Growth.  Several years ago there was a spirited debate among leading macroeconomists (Harvard’s Dale Jorgenson and MIT’s Robert Solow) and their followers about the sources of economic growth – whether it was investment or innovation.  In the light of historical perspective and data, it turns out that the debate was largely semantic or definitional.  Investment and technological change are multifaceted phenomena that are interwoven in several dimensions.  One might ask whether the Internet and the growth it has precipitated should be treated as investment or innovation.  Pick a side and you can get a well reasoned argument.  No matter, the science on the question of what constitutes the major sectoral contributor to investment, innovation and growth is unambiguously clear – it is the information and communications networks sector. 

 

the LEVERAGeD Role of the IT sector

Conclusions from dozens of studies and reports from academia, government and think tanks are unanimous in finding that investment and innovation in the IT sector have been, are, and will be major drivers of economic performance in different dimensions – good jobs, per capita income, economic growth, productivity, income redistribution, international competitiveness and environment preservation and restoration.  It is notable that there is virtually no dissent from the central conclusion that the IT sector warrants special treatment from government.

 

A recent study by the Information Technology and Innovation Foundation (ITIF) undertook to review the vast emerging literature and to catalog the range, depth and character of economic benefits of broadband and more generally of the “Information Technology Revolution.”  The Foundation’s analysts found solid empirical evidence that IT drives productivity growth in firms, industries, regions and economies; that productivity growth from IT takes numerous and surprising forms, including more productive workers, less material use, more efficient use of capital and other scarce resources, among other benefits. 

 

ITIF emphasized that investment in information networks boosts growth both directly and indirectly on both the demand side (larger markets) and supply side (better production technique and management decision-making).  Information networks help the economy run at closer to full capacity and avoid waste of underemployment.  They help dampen the business cycle and raise employment, while also enabling goods and services to be allocated more efficiently and thereby to create greater consumer welfare.  An important aspect of information networks are their contributions to higher quality, more diverse and less expensive services, enabled by quality monitoring, mass customization, specialization and other features.

Extraordinary Information Network Tax Burdens

The Heartland Foundation recently reviewed the literature and record describing the level and structure of taxation of the central platforms of the IT sector upon which all other Internet stakeholders – subscribers and providers of software, applications, and content – are dependent.   A summary of taxes paid as of mid-2007 is shown in the table below.   

 

 

            The table shows that taxes on these information network services are (on average) substantially higher than for retail sales more generally.  The Heartland study estimated that taxes, from all levels of government, on telephone and cable television subscribers exceeded 13%.  That rate is roughly twice the study’s estimate (6.61%) of the average general sales tax paid on other goods.  In some cities the rate for cable subscribers exceeds 20%; the rate for telco subscribers often exceeds 25% and reaches more than 30% in some US cities; and, the rate for wireless services is frequently above 15% and has reached more than 20% in one city.  The average household might save over $10.00 per month ($125.76 a year) if taxes and fees on cable television and phone calls reflected the same general sales tax rates imposed on clothing, sporting goods, and household products – some of which are not taxed at all in many states.  

         

   Taxes and fees on telephone calls and cable TV are often equal to, or surpass, “sin” taxes on “public nuisance” goods like liquor and tobacco that impose significant costs on society.  Tax experts estimate that taxes and fees paid by the average wireline telephone subscriber are higher than the average tax on beer in numerous US cities.  In Jacksonville, Florida, taxes and fees on wireline phone service exceed taxes on beer, liquor, and tobacco.  It is notable that taxes on telecom are regressive and burden rural, minority and senior citizens with lower incomes disproportionately by taking a larger share of their disposable income.    

 

Concluding Observations

            Users and providers of telecommunications networks and services are subjected to higher tax burdens than consumers in almost all other sectors.  The reasons are rooted no doubt in the history of the relation between government and network providers – a history that is marked monopoly, pervasive regulation of rates and services, and social compacts of sorts under which government granted special privileges to electronic communications providers, but also exacted some economic consideration in return.  The basis for that relationship has been eroded by technological and market change.  Competition has replaced monopoly; open entry has replaced government protection; technological dynamism has eroded historic stability; and, privileges accorded to regulated firms have been eroded.  Government has adapted to those changes through regulatory reform, but has not altered time worn tax practices that unduly burden the sector. 

 

Continued imposition of heavy tax burdens on the sector is particularly ironic, nay puzzling and inconsistent, in light of the increasing importance of electronic networks in creating economic value in other sectors of the economy – a fact that is recognized explicitly in the breadth and depth of programs designed to subsidize its growth.

 

Demands on state and local governments for services continue to rise and will certainly not abate in the face of the current economic distress.   However, as governments at the federal, state and local levels look for ways to offset recession-related economic distresses faced by citizens, taxpayers and consumers, they should resist short term temptations to tax as usual. 

 

Instead, governments might usefully reconsider the value of tax reforms, and in particular reducing taxes on sectors that are known to create economic opportunities and wealth economy-wide.  Reducing broadband taxes promises to be a good investment that will pay dividends in the form of jobs, productivity, income growth and community competitiveness. 

 

It would also be a valuable countercyclical device to offset growing economic distress.   

 

References 

1.       David Turek, Paul Bachman, Steven Titch and John Rutledge, “Taxes and Fees on Communication Services”, The Heartland Institute, May 2007, p. 2 and p. 41.

2.      Larry F. Darby, “Consumer Welfare, Capital Formation and Net Neutrality:  Paying for Next Generation Broadband Networks”, Released by The American Consumer Institute, June 6, 2006, p. 18.  Available at:  http://www.aci-citizenresearch.org/Net%20Neutrality%20Study.pdf.

3.      Robert D. Atkinson and Andrew S. McKay, “Understanding the Economic Benefits of the Information Technology Revolution”, Information Technology and Innovation Foundation, March 2007