Don’t Tax What You Want To Encourage!

In this season of political fervor and contention, consensus on anything of substance is rare.  Standing out is the virtually unanimous view that we as a nation should be taking all reasonable measures to spur development of broadband telecommunications networks.  The consensus is partially grounded in concerns about US broadband development vis-à-vis other countries, but in larger part by a shared conviction that broadband networks are highly leveraged in their ability to create value in other important sectors of the economy and to make the economy “greener.”  Nobody disputes that more widely available and faster broadband networks generate enormous external benefits – jobs, productivity, growth, and international competitiveness. 

 

            Support for adopting broadband policies reflects more consensus than ideas about what might be done to spur broadband development.   

 

            The handful countries that are arguably ahead of us have adopted approaches reflecting their unique geography, demographics, economic structure and political institutions.  A recent study by the widely respected, non partisan Information Technology & Innovation Foundation concluded that differing national policies are not the major source of global broadband development differences, but policy does matter – in particular policies designed to encourage broadband investment.

 

            A recent investment analysis by Bernstein Research a highly regarded Wall Street Investment Research firm analyzed in detail the economics of broadband network supply and demand.  Bernstein concluded that a “fiber to the home” network being constructed by one of the major Internet service providers would cost approximately $4,000 per connected home but bring in only about $3,200, yielding a negative net present value of nearly $800 per subscriber. 

 

            The Bernstein results are mirrored by others suggesting that a major barrier to broadband development by other companies and platforms (cable, wireless), outside metropolitan areas in particular, is the gap between expected revenue and expected cost.  As Bernstein put it, broadband is terrific product….for consumers, but not very attractive to earnings minded, risk averse investors.   

 

            What can be done to make the economics more attractive?  Managerial economics 101 and commonsense suggest lowering costs and increasing revenue for companies that build the networks.  And, here is where government can help.  The ITIF report on broadband policies of other countries made eleven recommendations the very first of which was to:

 

 “Enact more favorable tax policies to encourage investment in broadband networks, such as accelerated depreciation and exempting broadband services from federal, state and local taxation.” 

 

            In this context, the status quo is alarming.  Tax practices at the state and federal level combine to make telecommunications networks over which broadband services are provided the most highly taxed services in the Nation.  The average tax rate on wireless, wireline telco and cable TV services exceeds 13.5% and more than doubles those imposed on other services. 

 

            Telecom taxes are double-edged swords in slashing incentives to invest in broadband.  First, they reduce cash available for firms to invest and force firms to rely on external financing.  Cash sent to the government cannot be used to construct networks.  Secondly, part of the tax is reflected in higher charges to consumers.  This adds to inflation, but also suppresses demand, household penetration, and carrier revenue, which loop back to suppress both the incentive and ability of companies to invest. 

 

            Declining the temptation to tax broadband is important, but so to is relief from existing tax burdens on all telecom network facilities and services.  Broadband services are provided through multiservice, multi-user facilities that provide voice, video, data, and Internet services to users in different locations.  This is important from a policy perspective – and from a tax perspective in particular – since it implies that not only do broadband taxes matter, but that taxes on other non-broadband services provided over these multiservice, multi-user facilities will also reduce cash available for investment and raise prices, thereby discouraging companies from invest in such network facilities.  

 

            The broadband Internet is a network of networks located in different tax jurisdictions.  The result is a patchwork of taxes imposed on telecom networks willy-nilly and largely without regard to distant or collateral economic impacts.  

 

            The candidates agree that broadband is important, but have yet to recognize the destructive effect of taxing services from telecom networks that provide broadband services.

 

            The simple message from consumers is “don’t tax what you want to encourage!” 

 

 

Dr. Larry Darby, Senior Fellow and Board Director for the American Consumer Institute’s Center for Citizen Research, and former Chief at the Federal Communication Commission’s Common Carrier Bureau.  For more information, visit www.theamericanconsumer.org.

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