Article by Erik Smith. Published on Tuesday, November 29, 2011 EST.

Department of Revenue Would ‘Clarify’ a 1983 Law and Force Sprint to Pay Sales Tax – but Cable Landline Customers Would Have to Pay, Too

The Department of Revenue says a 1983 tax break was intended only for old-style landline phones.

By Erik Smith

Staff writer/ Washington State Wire

OLYMPIA, Nov. 29.—There’s been plenty of talk lately about court decisions that force the state to pay big bucks, but you probably haven’t heard about the biggest one of all – a bell-ringer of a ruling in Thurston County Superior Court earlier this year that could cost state and local governments a billion dollars.

            That’s not a typo. That’s a billion, with a “b.”

            The court ruled in April that a vintage-1983 law that exempts local phone service from sales tax applies to cell phone companies. That means big money in an age when residential customers are ditching landline phones in favor of wireless service. But if the ruling is upheld at the appeals-court level, it means state and local governments are on the hook for enormous refunds, and they stand to lose hundreds of millions of dollars every year. Lawmakers are pondering a bill that aims to fix that problem but creates a new one all its own. It will force nearly a million cable telephone customers to start paying a tax they never have paid before, and it will put cable companies at a disadvantage as they compete to provide local telephone service. Cable providers call it a great big disconnect.

            In a special session where lawmakers already face a $2 billion shortfall, House Bill 2128 is getting emergency treatment. The measure got a hearing in the House Ways and Means Committee on opening day and a quick vote sent it sailing to the House floor. But it’s safe to say the battle has just begun. Cable companies say the measure is unfair, and they’re pushing an amendment that includes them out. “It’s a big hunk of money, and the Department of Revenue says we can’t lose it,” said Ron Main, lobbyist for the Broadband Communications Association of Washington. “We don’t have a problem with that. But this bill goes too far.”

            It’s not as if customers can tell a difference between service provided through a pair of twisted copper wires and service that comes through a modem and a coaxial cable, Main says. You still pick up the receiver and you hear a dial tone. You can’t take the phone with you. So why should cable customers have to pay an extra nine or ten-percent tax when traditional phone-company customers don’t?

            “Clarifying” a Decades-Old Law

            Back in 1983, when the Legislature imposed the sales tax on phone service, no one had even heard of the Internet, of course, and cell phones were new on the market. They cost a thousand dollars or more, and the per-minute and roaming charges were so astronomical that only the wealthiest could afford them. Nearly all commercial and residential customers were served by the traditional landlines offered by Ma Bell and its local competitors. In the interest of keeping costs low and promoting “universal service,” the Legislature exempted customers “subscribing to a residential class of phone service.”

            Things are different now, and it’s not so easy to tell the difference. In 2007, wireless provider Sprint filed suit in Thurston County Superior Court, arguing that cell phones have become so pervasive in the residential market that they ought to get the same treatment.

            The problem is that cell phone providers have been charging sales tax all along. And if the state can’t impose the tax, it also has to provide four years of refunds – the maximum allowed by state law. That’s an enormous hit. The impact on the current two-year budget would be $739 million, and in 2013-15, it would be another $331 million. Because local governments have been getting a share of sales tax revenue as well, they would be on the hook, too – the hit this budget cycle would be about $280 million, and they would lose about $130 million every two years thereafter.

            Lawmakers could solve the problem by passing a new tax on cell phone service and making it retroactive. But that isn’t so easily done. A new tax would require a two-thirds vote of the Legislature, because of the provisions of Initiative 1053, approved by voters last year. That is an all-but-impossible political hurdle.

So the Department of Revenue has come up with a rather convoluted solution. Its bill aims to “clarify” the 1983 law. HB 2128 says the Legislature of 28 years ago never intended the exemption to be applied to new forms of telephone service – it was always supposed to be limited to the traditional phone companies that are regulated by the state Utilities and Transportation Commission. The bill declares that “the Department of Revenue has consistently restricted the residential service exemption to local telephone service provided under a regulatory tariff.”

Trouble is, that really isn’t the way things happened.

            Cable Companies Hit This Year

Cable companies have been offering dial-up phone service through their broadband Internet modems for about a decade. Right now 800,000 Washington residents are served by voice-over-Internet-protocol systems, better known as VoIP. Cable companies assumed from the start that they fell under the same rules that apply to traditional phone companies, Main said, and so they have been paying the same taxes and fees, for things like 911 emergency service. They also took the same exemptions. And a close reading of the 1983 law seems to support that position. Nowhere does the law limit the tax break to companies that are subject to UTC regulation, and certainly the cable companies are offering a residential class of phone service, in any modern meaning of the term.

But as the Thurston County case was working its way through the courts, the Department of Revenue published a new interpretation of the law, Main said, perhaps in anticipation of having to run a bill like this one. It said the exemption was limited to old-style telephone service. Once the ruling came down, Comcast was hit with an audit that concluded it was liable for sales tax.

Industry-wide, the bill is somewhere between $20 million and $22 million a year. That means higher bills for cable customers. And because DOR can seek four years of back taxes, that’s another $80 million hit. “We have no way of collecting, so they are basically taken out of our pockets,” Main said.

Comcast lobbyist Rhonda Weaver said it’s not right that cable companies should be hit with a tax bill when traditional phone companies, providing the same landline service, don’t have to pay. “Passage of this bill would result in a competitive imbalance between our services and those provided by the incumbent [traditional telephone companies],” she complained.

            Is it a New Tax?

The bill whizzed out of the Ways and Means Committee Monday on a party-line vote, though members acknowleged that it might need a bit more work before it reaches the governor’s desk. There was a notable absence at the hearing: None of the state’s cell phone companies were represented. So Sprint didn’t tell the story that carried the day in court, that cell phones these days are taking the place of sales-tax-exempt landline phones, and they deserve the same tax break.

And the bill raises a question. Its aim might be to avoid creating a new tax, and it might be that the cable companies were caught in the middle. But by “clarifying” the law so that cable companies have to pay a tax they never did before, does the bill create a new tax anyway? So is a two-thirds vote required?

Your support matters.

Public service journalism is important today as ever. If you get something from our coverage, please consider making a donation to support our work. Thanks for reading our stuff.