Telecommunications and the Tangle of Taxes.

State and local tax policy mustn't get lost in the dizzying pace of change in the telecommunications industry.

It is hailed as the key to economic freedom, prosperity and growth in the 21st century. It is the backbone of the digital revolution--without it, electronic commerce would not exist. Upstarts and Fortune 500 companies alike are in a knock-down-drag-out battle to control its future.

"It" is the nation's telecommunications network--the fiber optic cables, switches, routers, copper wires, satellites, and wireless communications towers and equipment. Wall Street has made hundreds of billions of dollars available to competing telecommunications companies to lay fiber, add switches and expand the cellular network. This expansion in the network--combined with new federal and state laws and regulations deregulating the industry--has led to an explosion of choices for many (but not all) consumers. And it has given the American electronic commerce industry an important head start over foreign competitors shackled with outdated telecommunications networks.

Now the industry is rushing to deploy a critical upgrade in this network--called "broadband." Broadband will dramatically increase the capacity of the pipe, allowing huge volumes of data to flow in and out of homes and businesses at speeds 100 times greater than the current network. The deployment of broadband will greatly expand the speed and efficiency of the Internet. It will open up many new educational, medical and commercial opportunities on the World Wide Web.

AT&T and the cable industry want to provide broadband through cable TV wires; the regional bell telephone companies want to "turbocharge" existing phone lines; and wireless providers are trying to perfect the technology to provide broadband access without wires. Cable companies, established telecos and others have invested billions on developing these technologies--some of which may be obsolete in a few years.

With the dizzying pace of change in the telecommunications industry, there is one important piece of the puzzle that is mired in the bygone era of Ma Bell: state and local tax policy. Many state and local tax statutes refer to industry structures that have ceased to exist. The result is a complex and burdensome tax system that costs the industry billions in compliance costs.

And the problem is only going to get worse as companies develop new technologies and new ways to market them. For example, some industry analysts are predicting free long distance by the end of the year as traditional providers try to compete with "free" Internet telephone services. How will states impose transaction taxes on services that are free? And as companies roll out new calling plans and services that bundle cable TV, Internet access, wireless and traditional telephone plans into a single bill, how will states administer taxes that impose different rates on these services?

Clearly, changing technology will force states to reform their tax structures.

THE MORASS

A new study by a consortium of telecommunications companies found that almost 11,000 state and local jurisdictions have some type of tax or fee on telecommunications providers or customers. A hypothetical company that operated in all of these jurisdictions would have to file more than 55,000 tax returns each year, according to the study. This compares with only 7,200 returns from a company selling other types of goods and services in all of these taxing jurisdictions.

In addition to the administrative costs imposed by heavy filing requirements, telecommunications companies face the difficult task of making sure that they are applying the right tax. Tax boundaries do not always follow zip code boundaries. Firms that collect the city tax when they should have collected the county tax can face penalties from the county and must file for a refund from the city, a costly and time consuming procedure that is often not worth the cost. Furthermore, the company can face class action lawsuits by customers if they collect the wrong tax.

Although such horror stories are infrequent, they bolster the industry's claim that legislatures in some states need to reform state and local telecommunications taxes.

The industry complains, too, about the burden of property taxes and consumption taxes imposed by state and local governments. The industry study also found that telecommunications companies and their customers pay, on average, effective tax rates of about 18 percent of charges. This compares with an average sales and use tax rate of about 6 percent on other goods and services.

This type of tax burden does not seem to mesh with policymakers' desire to ensure

Access to the Internet for residents and to lure telecommunications companies and electronic commerce companies into the states for economic development. Many state and local policy makers recognize that a modern, efficient telecommunications network is vital to economic competitiveness in the 21st century. Yet state and local governments persist in maintaining outdated and burden-some tax structures.

FEDERAL INVOLVEMENT?

While NCSL and other state organizations have been examining these issues for the last several years, they have been pushed aside by the loud and raging debate on taxation of Internet access and electronic commerce. North Dakota is one of the few states that has modernized its telecommunications tax structure.

However, this lack of attention to telecommunications tax reform might be about to change. One of the mandates of the federal Advisory Commission on Electronic Commerce is to examine the role of federal, state and local taxes on telecommunications providers. Several proposals have already emerged that would either force or encourage states to reform their tax systems.

Former California legislator Dean Andal, vice chairman of an elected board that administers sales and property taxes in California, and member of the federal E-Commerce Commission, has proposed federal legislation that would outlaw "discriminatory" property taxes on telecommunications companies. A similar federal law (the "4R Act") has been used by numerous railroad and pipeline companies to overturn state and local property valuation methods. The Andal proposal could result in lower property tax collections for schools, cities, and other local governments in 22 states.

Another proposal to the commission from the telecommunications industry stops short of calling for federal statutes to preempt state and local laws. However, it calls on states to reexamine their telecommunications tax policies with an eye toward reducing both the administrative burden and overall tax burden.

Whether the federal commission will recommend to Congress that it preempt state and local telecommunications taxes is far from certain. However, the additional scrutiny will put new pressure on states to reform telecommunications taxes.

OR STATE REFORM?

One state that is taking the lead on reform is Florida. Under the existing system, the industry faces as many as nine different state and local taxes imposed by 370 Florida jurisdictions. Providers must file as many as 4,700 tax returns each year.

In 1997, a government-industry task force recommended a dramatic reform that would replace those state and local taxes with a single, statewide "unified tax" with a single return filed with the state. Opposition from local governments and questions about implementation ultimately doomed that effort.

But in 1999, an industry coalition revived the debate with a scaled-back proposal that preserved the authority of localities to levy their own taxes. Companies, however, would be required to file a single statewide return instead of multiple local returns. The state would collect all taxes and forward funds to localities. Questions remain, but the industry is pushing its reform proposal in the current legislative session.

Florida's experience highlights some of the reasons why telecommunications tax reform is so difficult in the states. First of all, about one-third of the states tax telecommunications property at higher effective rates than other types of business property. Any effort to reduce this disparate tax treatment will reduce revenues for school districts and other local governments. Localities will put pressure on the legislature to make up these lost revenues.

Large cities are also concerned that they could be major losers in any reform efforts. Some cities interpreted a provision in the federal Telecommunications Reform Act of 1996 as allowing them to impose "right-of-way" fees of as much as 5 percent of gross receipts, and they rushed to impose such "fees." In some cities, taxes on telecommunications charges (not property taxes) are the second largest source of revenue, and any efforts to reduce these taxes will create fiscal headaches for them.

The potential for the Legislature to create winners and losers at the local level creates unease among some local government officials.

"In Florida, the key to success will be getting local governments to feel comfortable that they would be treated fairly under a new system," according to Florida Representative Luis Rojas, a key reform proponent.

Another obstacle to reform comes from the industry itself. In order to reform telecommunications taxes, businesses and governments need to agree on what telecommunications is. But the industry sometimes cannot agree. Internet service providers, who enjoy a federal moratorium on new state and local taxes, do not want to be considered telecommunications providers because they fear being subject to the morass of taxes described earlier. The cable television industry faces its own set of taxes and fees that are distinct from taxes on wireless and land-based communications services. Getting companies with disparate tax structures to agree to definitions--let alone reform--is a tough task.

In Florida, the industry was able to overcome this obstacle and agree on a set of reforms. "All of the disparate industry players had to accept tradeoffs. But the opportunity to achieve reform in a tax system as difficult as Florida's was an important incentive to cooperate," noted Susan Langston, executive director of the Florida Telecommunications Industry Association.

At the winter meeting of NCSL's Assembly on Federal Issues in December, delegates passed a resolution acknowledging the antiquated nature of state and local telecommunications taxes. The resolution asked NCSL's Executive Committee Task Force on State and Local Taxation of Telecommunications and Electronic Commerce to develop principles for state reform efforts and develop model legislation for states to consider next year.

NCSL's task force began working with industry and local governments on this task last month, in hopes of completing its work by the July annual meeting in Chicago. By then, the results of Florida's reform effort will be clear. Representative Rojas, himself a member of the NCSL task force, is hopeful that Florida's reform can serve as a model for successful reform in other states.

Scott Mackey is NCSL'S chief economist.