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At Least One Tax-Break Repeal Effort Has Some Ooomph – Support Grows in Legislature to Extend Sales Tax to All Phone Service

111129 bell system phoneOLYMPIA, March 26.—The Washington Legislature is poised to end a sales-tax break that has been granted to residential telephone customers since 1983, and if it offers lawmakers a chance to declare victory in the war on loopholes this year, you probably won’t hear any argument from the telecom industry. Even though it’s way more complicated than that.

While it seems to be the only repeal of a tax exemption that has widespread support at this point, it’s really more of a rethinking of taxes for an important segment of the telecom industry. Talk about the deal seems to be surfacing with increasing frequency as lawmakers discuss their upcoming budget negotiations, a sign that key players are giving it the nod. But the idea didn’t come from the Legislature; it came from the telecom industry itself. It took a full year to percolate. And maybe most important — it helps the state dodge a billion-dollar bullet.

And lawmakers who know the story say they are relieved. As House Republican Leader Richard DeBolt, R-Chehalis, puts it, “We were going to lose.”

The telecom plan would eliminate a sales tax exemption for those who get their landline telephone service through traditional phone companies and cable operators. It means about $30 million a year in additional revenue for the state after the startup phase, and it keeps alive a handful of state telephone initiatives for the poor, the deaf and residents of rural areas.

The deal isn’t totally cooked – retailers still have a few problems. But traditional telephone companies, wireless companies and telephone providers say they found a way to compromise. Said Ron Main of the cable-industry Broadband Communications Association, “Out in the marketplace we are trying to beat each others’ brains out, and here we’re working on common issues – and that is what makes it all the more remarkable.”

Here’s what it’s all about.

On the Hook for a Billion

The telecom tax deal, sometimes described as the “telecommunications tax parity” issue, was prompted by a novel argument raised by a court case in 2007. Wireless provider Sprint told the Thurston County court so many customers were dropping their landline phones and replacing them with cell phones that really wireless service had become a new form of residential service. And so Sprint ought to get the same tax break the state provides to traditional phone companies.

Back in 1983, when the state extended sales taxes to phone service, it exempted the basic service portion of residential service, as a way to keep costs low and encourage “universal service.” State officials argued that the tax break was only meant for traditional phone companies. The case took four years to make it through Thurston County court. And when the court finally decided Sprint made good sense, all hell broke loose.  For one thing, the state faced a mighty big phone bill. If it stopped collecting sales taxes from cell phone companies for residential service and refunded all tax payments for the previous four years, as is standard in such tax cases, Washington was on the hook for a whopping $1 billion.

In Stall Mode

Solutions were just as tricky. The Department of Revenue asked the Legislature for a bill providing a retroactive clarification – going back some 28 years – stating that the sales tax break was never intended to be so expansive, and was only supposed to apply to traditional telephone companies. After 28 years, a retroactive clarification might have seemed a little like an annulment after a pregnancy, but it was an even bigger problem for cable companies. They hadn’t been charging sales tax, either, on their Internet-based VoIP (voice over Internet protocol) service. The bill meant they’d be on the hook for years of back taxes. They could point with some justification to conflicting advice from Revenue, while Revenue said they were wrong about it, and there was no way to include cell phones and exclude cable service, and after plenty of fuss and argument last year, and an unsuccessful attempt by cable companies to include a competing proposal in the budget deal – nothing much happened.

Since then, the state has settled with Sprint. The terms are undisclosed, but the ruling has been vacated, and the company continues to collect sales tax. Still, any other cell company can sue. Verizon filed a semi-related suit in January — it has to do with the taxability of landline flat-rate long-distance service; the company maintains only toll calls should be subject to sales tax, but because the case involves residential service the thought is that any court ruling might affect the cell phone sales tax issue as well. The Department of Revenue estimates that if a lawsuit on cell phone sales taxes makes it all the way through and the ruling goes in favor of the wireless companies, Washington could be on the hook for as much as $429 million in 2013-15 and $673.2 million in 2015-17.

Driven by Market Changes

Now here’s where things really get tricky: The market actually has changed, and if the state doesn’t do something to change the way it taxes phone service, big problems are around the corner. For years the state has financed telephone programs for the deaf, the poor and for emergency services by imposing taxes on traditional landline service. But if the business continues to decline, so does the revenue. The market trend is hardly a secret, but one measure, cited by the U.S. National Health Information Survey, indicates that the share of wireless-only households doubled between 2008 and 2011, from 17 to 34 percent, while the percentage of homes with a landline phone decreased from 79.1 percent to 63.6 percent. That doesn’t measure the number of households that disconnected traditional phone-company service and went with cable-company service as part of a bundled deal.

Meanwhile, the federal government is cutting back on a program that subsidizes rural telephone companies – federal money dries up in 2019. In Washington, that’s a loss of $8.8 million, and some rural providers maintain they won’t be viable if there isn’t a fix. In testimony to the House Finance Committee earlier this month, Dale Merten, chief operating office of Toledo Telephone, said without the subsidies, residential phone service will rise to $104 a month. Perhaps 90 percent of customers would terminate – and since system costs would stay the same, the few business customers that have to have landlines would pay perhaps $1,600.

How it Works

The proposal, embodied in Senate Bill 5422 and House Bill 1971, basically ties everything together. The sales tax exemption for residential landline service goes away, and all customers pay the same – wireless, cable, and traditional companies. The money goes into the state general fund. But a share of that money is earmarked for the deaf, the poor, and a new state program for underserved rural areas. 911 programs get their money as well. The state would be barred from going after cable companies for back taxes, and wireless companies would be barred from going after the state.

And after a year of rather contentious backroom argument, everyone in the biz seems to be singing the deal’s praises. Tax everyone the same, testified T-Mobile government affairs manager Jim Blundell. The state’s telecom tax structure fails to recognize that different segments of the business are now in direct competition, he said. “Lines began to blur, silos began to break down between industry niches, and today you have a situation where not only is T-Mobile competing against AT&T, Verizon and Sprint, but we are competing against landline carriers in the marketplace, we are competing against cable, we are competing against satellite carriers. So we have cross-platform competition that is robust, vibrant and meaningful, and yet tax policy has not caught up.”

Still to be resolved is an issue raised by retailers. Grocers and convenience store operators say they are unimpressed with a provision that would require them to collect and remit taxes when they sell prepaid phones. They ought to be compensated for their tax-collection costs, they say. And so the dickering continues.

All Four Corners

The telcom tax-parity issue, while not exactly a constant topic of conversation around the statehouse, seems to be coming up with increasing frequency – if you’re listening for it. For instance, at a news conference March 14 on the House Republican education budget proposal, budget-writer Gary Alexander, R-Olympia, described the sales tax break as a tax exemption his team is willing to end. Senate Republican Leader Mark Schoesler, R-Ritzville, whose district is served by those rural telephone companies, says the proposal corrects inequities in the telecom business. “There seems to be pretty broad support for it,” said Senate Democratic budget lead Jim Hargrove, D-Hoquiam.

And over on the House side, sponsor of the House bill is Finance Chairman Reuven Carlyle, D-Seattle. “We are trying to get a much simpler, much more consistent approach to taxation that is just a better reflection of the marketplace,” he said.