States Target Internet and Telecom for Exorbitant Taxes

State governments are starving for more money to pay for their broken budgets. To feed the budgetary beast, state governments are imposing unusually high taxes on a sector of the economy that has been investing billions of dollars in innovation and job creation—the Internet and telecommunications sector.

State governments, as well as the federal and many local governments, have imposed numerous taxes and fees on wireless services such as mobile phones, and they are rising.

Scott Mackey, an economist at KSE Partners, authored a recent study on wireless taxes and fees in which he noted, “[W]ireless users now face a combined federal, state, and local tax and fee burden of 16.3 percent, a rate two times higher than the average retail sales tax rate and the highest wireless rate since 2005.”

Forty-eight states currently levy wireless taxes in excess of 11 percent, higher than those imposed on many other goods and services, including ones the government is trying to discourage people from using, such as gasoline and cigarettes. In some states, such as Nebraska, as much as a quarter of the mobile phone bill a consumer pays goes to taxes.

Wireless Not a Luxury

A recent report by Dan Rothschild of the Mercatus Center dismantles the arguments for high taxes on wireless. Rothschild argues raising taxes on wireless service undermines broadband expansion.

As taxes on goods and services rise, consumption declines, he notes. And if wireless service consumption declines, there is less capital for wireless service providers to invest in high-speed networks that will help make broadband deployment possible, a goal of the Obama administration’s National Broadband Plan.

Wireless is no longer a luxury item. Low-income families increasingly rely on wireless service as their primary means of communication. Thus, higher taxes will hit low-income families hardest.

Practical and Constitutional Checks

E-commerce is another tempting target for cash-strapped states.

The advent of the Web fostered an explosion in Internet retailing. After a healthy 12.6 percent increase to $176.2 billion in 2010, the market-research group Forrester predicts U.S. online retail sales will reach $278.9 billion in 2015. The staggering growth in e-commerce and the success of companies such as and eBay are too much for the states, and e-commerce companies’ brick-and-mortar rivals, to ignore.

But there are, thankfully, some practical and constitutional checks on efforts to tax the Internet. There is no national sales tax, and the Constitution’s Commerce Clause, according to the U.S. Supreme Court in its 1992 Quill decision, prevents the states from compelling out-of-state mail order and online retailers that lack a physical presence (“nexus”) in the state from collecting and remitting sales and use taxes. States and federal legislators are trying to devise ways to evade the Constitution’s limitations, however.

Congress is considering the Main Street Fairness Act, which would force online retailers to collect sales and use taxes. Several states have signed a compact—the Streamlined Sales and Use Tax Agreement—that harmonizes tax rules among member states to encourage greater tax collection. More recently, some states have adopted or are considering “Amazon taxes,” named for the most famous of the e-commerce retailers, which controversially claim nexus through in-state affiliate marketers that provide hyperlinks on a Web site to the out-of-state retailer.

Serious Negative Consequences

There are several problems with each of these proposals, which Adam Thierer, a senior fellow at the Mercatus Center, articulated in a recent column.

First, there are the high costs of compliance. By one estimate, small retailers (those with less than $1 million in sales) spend 17 cents on compliance for every dollar in sales tax collected. If a small retailer were subject to the approximately 8,000 state and local tax jurisdictions in the United States, the costs of compliance would be enormous.

Second, there is the threat to competitive federalism. A national sales tax regime could undermine the tax competition between states, which has yielded creative solutions to budget and economic problems.

Third, there are real doubts that these tax schemes would be effective in raising revenue. A study published last year by Jeffrey Eisenach and Robert Litan for Netchoice, an e-commerce trade association, found total uncollected sales and use taxes amounted to just $3.9 billion, less than .3 percent of total state and local tax revenues. In addition, several e-commerce companies have shut down their affiliates programs in states that adopt Amazon taxes, rather than be subject to the tax liability.

Instead of raising taxes on wireless service and finding creative ways around constitutional prohibitions on interstate taxation, states need to undertake broad tax reform to simplify the tax code, expand the tax base, and lower tax rates. Additionally, budget reform and spending reductions should be on the table.

If states continue on their current path, their efforts to target the telecommunications and Internet sectors could do serious damage to the broader economy.

In Depth: Cronyism

Cronyism in tax policy stifles innovation, hinders competition and introduces a deep temptation for corruption. The 2014 ALEC Center for State Fiscal Reform study, The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth, found that in the most recent year in which states published their respective tax expenditure…

+ Cronyism In Depth