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The Digital State: Remarks on Telecommunications Taxes

Dr. Jeffrey A. Eisenach
Before the National Governors' Association
Sunday, February 21, 1999

GOVERNOR LEAVITT: I would like to introduce one of America’s true innovative thinkers, Dr. Jeffrey Eisenach, president of The Progress & Freedom Foundation. . . .

DR. EISENACH: Governor, thank you very much. I want to talk about four specific steps that you can take when you go back next week, to win the competition not only among the states, but what is really an international competition today among all of the countries of the world.

Let me mention briefly two things that go to the question of what I would call government infrastructure. The first of those is simply having your states learn to do business the way business is doing business today.

When businesses are making decisions about where to locate their operations, they are looking in part at states that do business the way they do business.

And they do business today electronically. They do business with one another online. The ability to file a regulatory form, the ability to submit a tax return, the ability for their workers and for citizens to be able to get permits or to learn about new legislation, to be able to do all of those things online is an essential part of any state government today in terms of being effective in the Digital Age. It will lower your costs, it has lots of advantages in that sense. But the big advantage is to your constituents and to your customers in both the business sector and in the consumer sector.

Now, each year at The Progress & Freedom Foundation we do a report that ranks the 50 states on how successful they are being in using digital technologies to bring new services and more consumer friendly services to businesses and to consumers. [Eisenach holds up a copy of The Digital State.] A copy of this is, I think, on your place in front of you.

And I should take a second to congratulate Washington State which has been the winner of that each of the last two years, and to congratulate the Governors' Association for putting in place a task force that I think began meeting yesterday under Governor Locke and Governor Geringer to look specifically at how to use digital technologies to improve the efficiency and delivery of services by state governments.

So that's number one.

And the second thing, and I'll also address it just very briefly, is legal infrastructure. Whether it's digital signature, or privacy, or encryption, all of the laws that we have in place to do business in an Industrial Age environment need to be re-looked at, updated, and in many cases new laws need to be put in place in order simply to permit digital commerce to take place. Digital signature is the most obvious example of that.

I won't talk about that at any length. I will refer you to one recent example of a lot of work I know that you are doing in your states, and that is a report that Governor Gilmore recently had submitted by the Virginia Information Technology Council which he recently appointed, which I think is an excellent guide to those issues and has some excellent recommendations for things that you can be doing.

The final thing I want to talk about is the most important.

The infrastructure of the 21st Century -- the digital infrastructure that we need now for any locality to be prosperous -- is the telecommunications infrastructure. Our telecommunications infrastructure today is the roads, the bridges, the railroads, the canals, the ports, the harbors, all of those things wrapped up into one. That's what the telecommunications infrastructure means to every locality to every state today.

And our telecommunications infrastructure today is not up to the task of supporting the Internet . There's a phrase that's in common usage today that represents this. It's called the "World-Wide Wait," and what it says is that when you log on to the Internet and try to get access to information, whether it's about state government or about products that you can purchase over the Internet, whether it's sending information back and forth between businesses in the form of electronic commerce, that information flows too slowly.

That is because we have too little of something called "bandwidth." We don't have big enough pipes. Bandwidth refers to how big the pipes are that carry that information down the line, that carry the information to and from the Internet . We have a bandwidth shortage in the United States today. And you see that bandwidth shortage every time you try to log on to the Internet with a 28.8 modem, 28.8 kilobits per second. 28.8 is too slow. 28.8 defines the World-Wide Wait.

So our challenge today is to build out the telecommunications infrastructure. And let me come back and just emphasize, it is a challenge equivalent to building the roads, the bridges, the railroads, the canals, the ports, the harbors that made our states and our country successful in the Industrial Age. It was because we succeeded in that, that we led the Industrial Revolution. And it is only if we success in solving the bandwidth crisis that we will be successful in leading the Digital Revolution. It is the fundamental challenge facing the growth of the digital economy today.

Two things you can do in that arena. One of them is complicated and hard and the other is remarkably simple. The complicated and hard thing goes to the issue of telecommunications deregulation.

Now, I would argue to you today that the telecommunications marketplace, the marketplace for broadband big pipes telecommunications for rapid delivery of data, is competitive. That marketplace is about as competitive as a marketplace can be. Indeed, it may be the most competitive marketplace that's ever existed in the world.

Technology has presented us with the answers through what's called DSL technology from the telephone companies, from cable modem technology from the cable companies, through wireless technology, through satellite technology. We now technologically have the ability to deliver broadband, big pipe, fast access, video access to the Internet anyplace in the United States, and to do so affordably.

Today, if you want that kind of access, you probably buy what's called a T-1 line from the telephone company. It will cost you somewhere between $1,000 and $2,000 a month. If you're a big business, you can afford that. If you're a small business or a consumer or a home-based business, you cannot afford that.

But through DSL technology, through cable model technology, through wireless technologies that same kind of bandwidth, those big pipes, are now available from all of those companies, and literally hundreds of companies at prices of $40 or $50 or $60 or $70 a month. That's what the Digital Revolution had done to the telecommunications industry in terms of collapsing prices.

Why can't you get it? Why are you still logging on to the 28.8 modem?

There are two reasons. The first is, we are still treating the telecommunications industry as if it were a natural monopoly in terms of deregulation. Deregulation has moved too slowly in too many places. There are a lot of reasons for that. I won't take time going into them, except to say that one area that you as governors can and should be focused on is speeding the process of deregulation. And what that means is speeding the process of access by competitors to the marketplace.

We have policies in place today that say to firms who are capable of providing cheap broad band access, you cannot come in, do not come into this market, you're prohibited from coming into this market. And there are all sorts of reasons for why that may have made sense once, or may have made sense in 1996 when we passed the Telecommunications Act. It does not make sense in 1999 and we need to change those things. That's hard, that's complicated, I understand that, but it is something that is worth focusing on.

The fourth and final thing that you can do is remarkably simple, and is in an area that you are all familiar with, that you work on every day, that you are currently thinking about as you put together budgets and prepare legislative agendas for your state legislatures back home. It is something as simple as taxation.

You will be surprised I think to hear that is approximately true that the four most highly taxed industries in the United States today are tobacco, alcohol, telecommunications and gasoline.

Now, we all understand why we tax tobacco. We all understand for similar reasons why we tax alcohol. We could argue about the levels, but we all understand why we do that. We all understand for some related and for some different reasons why we tax petroleum. There are some user fee aspects to that. We can all understand why we would have some higher than average taxes on those products.

But -- in a world in which building out the telecommunications infrastructure is policy goal Number One – why would we place discriminatory taxes on telecommunications? And we’re not talking about small taxes, either. We're talking about levels of taxation between 20 and 40 percent, depending on the state and the locality because many of these taxes are state and local taxes.

We're talking about a level of complexity that is just stunning. There are 38 different kinds of taxes paid by telecommunications companies just in the telephone business. And at The Progress & Freedom Foundation we've undertaken a major study on this. A big component of that study is simply to catalog all the taxes because there are taxes of every kind and shape.

One major telecommunications company in the United States -- you'll hear from its chairman I think this afternoon, Michael Armstrong -- AT&T pays, files 39,312 tax returns in the United States alone each and every year. That's one every three minutes of the business day. 39,000 tax returns for that one company, which is trying to do nothing other than deliver telecommunication services to Americans.

The tax structure that we have is not only too high, it's also regressive. Virtually all of the taxes that we levy on telecommunications providers are excise taxes or line taxes, line charges, equivalent of poll taxes. And so they go directly against our objective of making Internet access and the information revolution available to people regardless of their income.

Let me give you a sense of how big a problem this is. Let’s imagine that I go to the store this afternoon and buy my 11-year-old daughter a $600 personal computer, for her to use for her schoolwork. And I want my daughter to have broadband access to the Internet – access through a big pipe, so to speak – I would also purchase (let’s say) a DSL line from my telephone company. And let's imagine that that costs me $60 a month, which is about average as you look across the United States.

If I did that, I would be paying each month out of that $60 about $15 of it in taxes. Which is to say that over the course of a year I would pay $180 in taxes, and over the course of the three-year life of that computer I would pay approximately as much in telecommunications taxes as I paid for the computer. It's a de facto 100 percent tax rate. And I can pay those taxes, but many people cannot.

As we look at making the Internet and the computer revolution available to all, we ought to be looking not just at the level of taxes, but at their structure.

You know, these taxes that we have in place, they're an historical figment or a relic. And there are 45 states today that have special exemptions in their sales taxes for manufacturing firms that do business in their states, where if a manufacturing firm buys a new machine or a new piece of capital equipment, it doesn't pay sales tax on that new machine. It's exempted from that on the theory that it's going to pay property taxes on that machine or it's going to pay sale taxes or income taxes on the revenue that's generated from that machine. 45 states have an exemption for manufacturing equipment. Only 11 states that same exemption applying to telecommunications equipment.

The perversity sometimes is striking. In some states we have special exemptions of that kind for railroad equipment dating back to the late 19th Century when we realized that doing things to build out the industrial infrastructure was what we needed to do if we were going to be competitive in the industrial age.

Every one of you is in a position to go back and do something about that, starting early next week, and I encourage you to do so. Every state has a different regime, every locality has a different regime, so you've got to go back and look at your specific situation. But every one of you can look at the taxes that you're levying in effect on the Internet because that's what the telecommunications infrastructure is, and do something about that beginning tomorrow.

Let me close with a broader perspective. I spent yesterday in New Castle, Indiana, about a hundred miles west of my hometown of Dayton, Ohio, visiting with family. And as I was driving through this extremely rural agricultural area of eastern Indiana, I found myself reflecting on the fact that the industrial revolution was not altogether kind to little towns like New Castle.

The digital revolution is a different kettle of fish. As Michael Porter said, this is an opportunity for every area of our country to prosper independent of the old ties to capital and resources and location. This is an opportunity, probably more than any other technological change in human history, to lift all boats and lift all areas.

It is tempting to look at this as a problem. It is tempting to listen to the squeaky wheel and to see the digital revolution as a problem. Well, surely there are challenges, and surely there are issues that need to be raised and addressed. But as you think about the digital revolution, please think opportunity and pursue it as aggressively as you can. Thank you.


Two more governors and then we'll conclude this part of our program.

From Colorado, Governor Owens.

GOVERNOR OWENS: My question is for Dr. Eisenach. And, Jeff, you warned us about the dangers of taxing high tech. And we're about to vote on a resolution which would -- it's called "streamlining state sales tax systems." What it would really do is put us on record again in terms of favoring a way to tax the Internet . Do you have any comments for us prior to that vote?

DR. EISENACH: The issue that I think that has come out of the Internet Tax Freedom debate and Tax Freedom Act debate, and the specific resolution you're talking about, I'm not familiar with. But I think the principle that needs to be put in place there is one of non-discrimination. And really this Internet thing is new and because it's new it is threatening in some ways. And we need to be careful, I think, to look at the ways in which it's really new or which to the contrary it's really like old problems that we have dealt with before.

If I can make an analogy to this problem of online sales of beer, wine and liquor. We shouldn't, I would argue, treat that problem any differently from the way we would treat the problem of 800 number sales for beer, wine and liquor. Because over an 800 number you can't really verify the age, you have the same kind of level of security in that environment or anonymity in that environment as you have in an Internet environment.

I don't think we should reach out and say because the Internet is different and therefore a little bit scary, let's put restrictions on it that we wouldn't put in an 800 number environment. And I think the same thing really ultimately applies to this issue of sales taxes.

The larger issue on the sales tax base I think really goes to a much larger question of what are the most sensible tax bases for states in this new, much more mobile environment. And I think one question that states are going to have to deal with is the extent to which sales taxes are appropriate relative to income taxes, relative to property taxes.

One could make an argument, and I won't make it here in the time I have, but one could make an argument that sales taxes are the least efficient taxes for states to be collecting. And that over the long haul a move in the direction of income taxes and the direction of property taxes would make more sense as the base for state taxation policy. Even that, I think, just depends tremendously on the history in each and every state.

What we don't want to do under any circumstances is reach out and discriminatorily tax Internet sales or online sales. Nor do I think that we should be taxing the sales of what are digital goods. We don't want to be taxing a software sale that comes purely over the Internet. And that's a principle that I think the Clinton Administration has done an excellent job enunciating both in the domestic environment and in the international environment.

GOVERNOR CARPER: Thank you, sir.

The last question in this session is going to go to the Governor of New Hampshire, Governor Shaheen?


I think this question may be for Dr. Eisenach, but if others have perspective, please respond. There is currently a battle brewing in New Hampshire over our area code, and it's also becoming an issue at the national level, about whether it's better to go ahead and allow a new overlay and adopt new area codes or to change the way phone numbers are parceled out so we can maintain our area code for a longer period of time.

Now, it seems to me that eventually we're going to have to change the area code anyway. Do you have any perspective on whether it makes any difference how we do this?

DR. EISENACH: I think what makes a difference is to go through this process of what's essentially dramatically expanding the number of telephone numbers is to go through this process in a way that slows it down as little as possible and imposes as few costs as possible in the process.

I think the advantage of simply going to a new area code is that you have a one time switch over from current numbers to new numbers, and you can get through that process, do it once and have it behind you. But again I think that's one that varies tremendously depending on the locale and on the specific circumstances. But I think the key here is to get through it quickly and to impose as few costs on the process as possible.

More broadly, if I can just say briefly, distance doesn't matter any more. And one thing that's very important, you might walk through an airport and walk up to a 7-Eleven and you'll see these phone cards for sale, and they will have rates on them for what it costs to call various states and what it costs to call various countries.

One of the things that you'll notice as you look at those rates is that there is absolutely no correlation between how far the country is away from you, from the United States, and the rate and the permanent price that you'll pay for a phone call. It's very expensive to call Mexico, it's very cheap to call the United Kingdom.

And the difference there is nothing but the regulatory structure. The entire difference in those prices, one hundred percent of the difference in those prices, has nothing to do with distance, little to do with technology, and everything to do with the fact that the countries where it's expensive are still imposing natural-monopoly or even government-ownership telecommunications regimes on that industry.

So distance has really become irrelevant. And really the number of numbers in your phone number will presently become irrelevant because I'm convinced within three or four years we'll be saying to our computer "Call Governor Shaheen," and the number will be dialed kind of irrespective of what the phone is.

This transcript was produced from tapes provided by The Progress & Freedom Foundation.

It has been edited slightly for clarity.



The Progress & Freedom Foundation