Cities are targeting cell phones and
the internet as new revenue sources
By Mayraj Fahim, Local government adviser*

18 June 2005: Cell phone and Internet sales taxes are becoming new technology income sources for governments looking to shore up their fiscal positions. Newspaper articles across the United States are reporting how state and local governments are seeking new technology-based revenue streams. As this is an era of rising costs, governments are looking to add income from sources previously left untapped - even non-governmental organizations (NGOs).

California - Land of confusion and universality | Taking it to court | International dimension | Internet sales taxes | Exceptions to the rule | Sales tax payment responsibility | Conclusion |

So it should come as no surprise to their constituents that cell phones and Internet sales will be targeted in these days of rising usage, and at a time when other traditional income sources are not as productive as before. These charges are also attractive, since the individual amounts to be paid are small enough not to create an outcry in the way that property tax rises excite opposition to the extent that it tends to curb the ability of governments to raise them. But collectively, the amounts are not insignificant. Hence, Baltimore, which added a cell phone tax, also raised the amount required to record deeds and expanded fees on utilities.

It is worth noting that cell phone subscribers paid almost $20 billion in federal, state and local taxes in 2004. Needless to say, as cell phone usage is rising fast, so will the revenue prospects of revenue-hungry state and local governments. It will become increasingly attractive for them in the course of time.

As reported in USA Today, a Federal Communications Commission report stated that over the past four years landline usage has decreased by 30 million users. Over the same period, cell phone subscribers rose by more than 70 million. Furthermore, according to the Telecommunications Industry Association, in 2004 cell phone revenue almost doubled between 2000 and 2004, with landline revenue dropping by $30 million. Moreover, with evolving technology, lawmakers are seeking to go beyond cell phones to telecommunications because this is where technological convergence is taking place.

As reported in The Los Angeles Times, some are considering a uniform tax for all telecommunications and the many ways of making a phone call today: land lines, cell phones, internet telephony, and high speed data and programming lines provided by satellites and cable. In this environment, individual states and local governments are developing their own routes as they respond to local dynamics. Baltimore, facing a difficult budget shortfall, would have lost 186 police officers, a reduction in fire department operations and less frequent garbage collections, before officials decided to avoid all this by tapping cell phones as an income source.

Baltimore decided on a charge of $3.50 on the city’s almost 300,000 cell phone subscribers. It further broadened this charge by applying it to land lines. In Springfield, Oregon, a five per cent charge on cell phone users was passed to finance a jail. In Virginia, Alexandria became the 31st of 39 of the state’s cities to approve a tax - one of $3 a month. One of the most expensive tax regions is Pennsylvania, where different levels of tax can add up to almost 20% of the mobile phone bill.

California - Land of confusion and universality
In California, mobile charges are the most extensively applied. By May, 2005, there were 160 local governments with a cell phone tax of varying ranges in place – with Los Angeles charging a 10% rate and San Francisco 7.5%. There is, however, much confusion over what the law relating to this issue actually says. An interesting article in the San Francisco Chronicle in May reported that Regulation 1585 of the state code on sales and use taxes specifies that all cell phones must be taxed at the full retail amount, regardless of the price paid as part of a special offer. But that is only one example of a confusing state of affairs resulting from inconsistent regulations, and the subject in general has even managed to confuse the state’s top tax lawyers.
Mobile companies refuse to accept government charging without challenging them first

Needless to say, cell phone companies who perceive that these taxes will reduce their business, and feel that such taxes will be an onerous burden, are fighting back. The arguments that providers put forward are wide-ranging. It is argued that this is a sales tax, and users are already paying sales taxes. It is also contended that the percentage of charges exceeds that of other services. Furthermore, it is maintained that a wireless phone is not a utility because it does not use public rights of way, as do landlines. It is also asserted that local units cannot charge for services that are received outside their jurisdiction. To battle the rising tide of local and state charges, the industry is funding a website – www.stopaddingtomybill.com – to lobby against what it perceives to be a threat to increasing usage of their facility.

Taking it to court
Some companies have gone further. In Oregon, the city of Eugene approved a 2% telecommunications tax in 1997. Qwest challenged this in court on the grounds that it did not wish to pass the burden on to consumers. In 1999, a Lane County court declared the tax invalid. The city appealed the ruling to the state Supreme Court, which upheld the tax and awarded the city $9.1 million. Qwest responded by taking the direct democracy route by putting a measure on November’s 2004 ballot that asks voters in Eugene whether or not they wish to repeal the tax.

Meanwhile, Portland, the largest city in the state, was in litigation with Qwest over a related issue: the city’s right to collect franchise fees. Qwest sued the city in 2001, withholding payment of millions of dollars in fees. When a federal District Court sided with the city in 2002, Qwest, paid the money back but appealed the case. The city’s Mayor, Vera Katz, had earlier asked the city attorney’s office to look into the cell phone tax option, but opted to pass because of the potential legal challenges. Nevertheless, the same spokesman added that the Mayor would be open to exploring the question again to adjust the inconsistencies in the fee structure

International dimension
As the battle rages in the US, the issue is relevant in other parts of the world. In April 2001 it was reported that the Serbian parliament had passed a resolution imposing new taxes on the ownership and usage of mobile phones. The new tax will be imposed at the rate of US$3 per month, with an additional sales tax of US$3 when a phone is sold.

Internet sales taxes - A related issue
It was noted by 2003 that many states were streamlining sales tax collection as a prelude to Internet sales tax enactment. In fact, more than 20 states supported Congressional legislation moving towards that end. Under the proposed Streamlined Sales and Use Tax Act, out-of-state merchants and online vendors would have been required to collect sales taxes on goods shipped to some states. The key issue was whether buyers lived in a state that has adopted the interstate sales and use tax program, called the Streamlined Sales and Use Tax Agreement.

Currently, more than 40 states, and the District of Columbia, impose sales and use taxes on purchases. Of these, 35 states have signed onto the interstate tax program, which streamlines more than 7,500 diverse sales tax laws in state and local jurisdictions. In 20 of these 35 states, the state legislatures have ratified the program and are ready to start taxing Internet purchases. By 2003 the program was voluntary so not all merchants were participating. Wal-Mart and Target were not among them, as they collected sales taxes for online purchases in the 20 interstate tax program states. Enactment of the Congress legislation would make it mandatory rather than voluntary.

The ten states that have not signed up were moving cautiously toward adoption, while continuing to study and analyze the issue. This group included California - the state where regulation on cell phone charges has confused even those whose business is in working with the law! Its complicated sales and use tax system was perhaps one of the reasons for feeling its way around this matter – though some would say the real reason was to protect the IT industry, which is such a high revenue generator for the state.
Some states see Internet sales in terms of usage and look to the customer’s responsibility.

Some Internet sales are subject to sales tax and consumers can have the responsibility of remitting unpaid sales taxes on online purchases directly to their state. In legal terms, this connection between sales and location is referred to as a "nexus" and was established by a US Supreme Court case Quill v. North Dakota, 504 U.S. 298 (1992).

Exceptions to the rule
Many big retailers with local stores can sell their products tax free over the Internet if they have separate legal subsidiaries managing their online business. Needless to say, the practice of establishing a separate legal entity mainly to escape sales taxes has antagonized those retailers whose customers must still pay tax. The issue becomes murkier when a company's online and offline entities experience customer interaction. For example, a consumer buys tax-free golf clubs from Sears.com and is allowed to return them offline to the local Sears store. Whether such entities are legally independent of each other is a matter that has to be tested in the courts. Many offline retailers view tax avoidance through online purchases as an unfair competitive advantage, especially in states where sales taxes are high. Large retailers whose Internet subsidiaries permit tax-free sales, but allow online purchases to be returned to their offline stores, particularly anger them.

Sales tax payment responsibility
If one resides in a state that collects a sales tax but avoids paying it on an Internet purchase, one may still be required to pay the tax to the state. This is termed a "use" tax rather than a sales tax. The rationale behind use taxes is that of a hole-filler to ensure that the state collects revenue on every taxable item purchased within its borders. But the onerous business of collecting use taxes on smaller purchases led states to focus on major items requiring a license, such as cars and boats.

Now, some states, including Connecticut, Maine, Nebraska, New Jersey and North Carolina, have changed their perspective in these lean times and are stepping up efforts to collect use taxes. Nevertheless, bureaucracy, complex tax rules and limited state resources are still a major barrier towards this end. Since state governments are losing substantial revenue, the collection of use taxes may become a priority if the federal government continues its ban on Internet e-commerce taxes that it put in place in the late 1990s.
Sales tax revenues currently amount to about $150 billion annually and make up approximately one-third of all state revenues. States not having a personal income tax, like Texas, are even more dependent on sales tax revenue.

Conclusion
Evolving technology, and the new revenue streams linked to it, has currently produced an inconsistent and confusing environment. But what is clear is that the tide is moving towards a governmental embracing of these new revenue streams. And, as revealed in the context of other subject matter, the local dynamic leads to individuality in the heterogeneous US system.

*Mayraj Fahim, the author of this article, is a local government adviser. Her occupational focus in local government has been in the areas of municipal finance in the United States and in municipal finance monitoring internationally. She also advises on local government reorganization in the United States and internationally. If you require further information on any points made in this article please email the editor, with 'Phone tax' in the subject line.