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June 1, 2006
The Phone Tax: Gone but Never Forgotten
Joseph J. Thorndike

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The Phone Tax: Gone but Never Forgotten

Joseph J. Thorndike is a contributing editor with Tax Analysts. E-mail: Joe_Thorndike@tax.org.


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It's not easy to work the Spanish-American War into casual conversation, much less news coverage. But journalists had a chance recently when federal officials announced the end of the federal excise tax on telephone calls. An item from Marketwatch.com was typical:

    Last week the Treasury Department announced it would stop collecting the 3 percent federal excise tax on long-distance telephone service that Americans have been paying since 1898, when the tax was first levied to help finance the Spanish-American War.

That juxtaposition of past and present makes for a good lead, especially when offered with the appropriate tone of incredulity. Unfortunately, it's also misleading. The telephone tax was certainly an anachronism, out of step with modern markets and technology; it richly deserves the oblivion it seems to have found.

But the telephone tax was not some forgotten vestige of a long- ago war. Indeed, it has been very well -- and very regularly -- remembered. Over the years, lawmakers have repealed and revived it numerous times, ignoring both popular complaint and experts' disdain. Its survival is a testament to the famous adage: An old tax is a good tax.

In his excellent history of the telephone tax, Louis Alan Talley of the Congressional Research Service chronicled the uneven odyssey of the unpopular levy. "The history shows that the tax has been intermittent," he observed in his 2000 study. (For the study, see Doc 2000-14017 or 2000 TNT 97-32.) As advertised by its modern-day antagonists, the tax first appeared during the Spanish- American War. And in the decades since, its legislative fortunes have been linked -- often, but not always -- to military and economic crises. But the tax has come and gone repeatedly.

In 1898 lawmakers enacted the telephone tax as an emergency war measure. Originally they considered a graduated rate structure: 1 cent on calls costing less than 25 cents, 2 cents on calls costing from 25 cents to $1, 5 cents on calls costing from $1 to $5, and 10 cents on any call costing more than $5. Ultimately they thought better of the idea, adopting instead a flat-rate tax of 1 cent on any long-distance call costing more than 15 cents.

As with any new tax, there was considerable debate over administrative issues. In a rush of patriotism and administrative expediency, some phone companies promised to pick up the tab: The New England Telephone and Telegraph Company and the New York Telephone Company took out advertisements to assure customers that charges for long-distance calls would be unaffected.

The telephone tax expired in 1902, more than three years after the war ended. But 12 years later, lawmakers revived it to pay for new defense spending. Alarmed by the new war in Europe, U.S. political leaders introduced a range of new taxes to fund President Wilson's rearmament program. Like most other levies in the Emergency Internal Revenue Tax Act of 1914, the telephone tax was a duplicate of its 1898 predecessor, imposing a 1-cent tax on every phone call costing more than 15 cents. It was set to expire after one year, but lawmakers extended it until 1916.

The tax then lapsed, briefly. In 1917 Congress imposed a new, much heavier tax. "Fifteen cents worth of telephone conversations, after today, will cost 20 cents," reported The Washington Post, "the extra nickel being the war tax under the new revenue law." In 1919 the tax edged higher, and for the first time lawmakers used graduated rates: 5 cents on every call costing between 14 cents and 50 cents, and 10 cents for calls above that amount.

Throughout the war years, lawmakers and journalists worried that the telephone tax would be hard to administer in the modern world of mass communication. Telephone use was growing rapidly, and phone companies struggled to track, collect, and remit the phone tax revenue. But those problems paled beside a more prosaic, mechanical difficulty: How could the tax be collected on calls made from pay phones?

At first, callers were expected to drop an extra penny in the slot, but compliance was uncertain and enforcement impossible given existing machinery. Eventually, many phone companies modified their phones to include a special tax slot, with pennies (and later nickels) dropping into a separate coffer.

[Image omitted] After the end of the Great War, lawmakers pondered wholesale tax reform, including the elimination of many excise taxes like the phone levy. In 1921 Republican Sen. Reed Smoot suggested a comprehensive plan that included repealing the telephone tax. "The big feature of the measure is its repeal of 30 of the so-called nuisance taxes which are generally regarded as obnoxious and annoying to the people," he declared. His plan failed, but the phone tax expired in 1924.

In 1932 economic emergency prompted Congress to adopt a new version of the telephone tax. Desperate for revenue, lawmakers imposed excises on a wide range of goods and services, including communications. Critics were unhappy. "Under this section every voice over a long-distance telephone will become sweet music to the White House," wrote H.I. Phillips in The Washington Post. "Uncle Sam is going to put a levy on all messages except those sent by smoke signal."

Since 1932, the telephone tax has been a fixture of federal finance, reauthorized at least 29 times, according to Talley. The extensions were often for just a year or two, with lawmakers paying lip service to the tax's temporary nature. But in 1941 Congress broadened the tax for the first time to reach local service, while also raising rates. Again, war prompted new interest in the levy, which saw further increases after the United States' entry into World War II. In 1943 it reached an all-time high: 15 percent on local calls and 25 percent on long-distance calls costing more than 24 cents. Wartime legislators promised to eliminate the tax six months after the end of hostilities, but somehow never got around to it.

In 1947 Congress reauthorized the tax indefinitely. The Treasury Department was lukewarm at best about the idea. The tax served to keep phone rates high, according to department experts, since it would probably be passed on to consumers as long as phone systems were operating at close to capacity. The tax also unfairly burdened those with a greater need for communication services relative to other forms of consumption. But Treasury officials also noted that the tax was productive and easily administered. Apparently the latter arguments won over most lawmakers.

Still, critics of the phone tax continued their campaign. "Of all the plagues of taxes we Americans have to contend with, many of them hidden in the multitudinous costs of living, one of the most irritating and unjust, and boldly featured on our monthly bills, is the 15 percent United States tax that burdens our costs for telephone service," complained one reader of The New York Times in 1949. "This is a gross abuse of the taxing powers and should be corrected pronto." According to a 1953 Gallup poll, the phone tax was the nation's most unpopular excise, beating out the levies on railroad tickets and cosmetics.

In the 1950s lawmakers reduced the tax, and in 1959 they slated it for termination. Many state officials were eyeing the levy for their own purposes, and President Eisenhower was reportedly sympathetic. But once again, revenue needs trumped good intentions, and Congress decided to keep the tax for itself.

Critics thought the jurisdictional struggle for the phone tax missed the point. As The Wall Street Journal observed, "there's another party on this line who's got a right to speak his piece. And that's the taxpayer who has paid this phone tax ever since it was first enacted in World War II -- which ended almost 15 years ago." But the short-term extensions of the federal levy kept coming, every year between 1960 and 1966. The tax was again scheduled for extinction -- and again rescued from the fiscal dustbin to help balance the books.

This story goes on. And on, and on, and on. Experts continued to counsel repeal. In the late 1980s, Treasury officials suggested that the phone tax be allowed to lapse, once and for all. But Congress wasn't listening. "When the 1988 Treasury study came out, it was like the proverbial tree falling in an unpopulated forest with no sound being heard," recalled Gene Steuerle, who headed Treasury's Office of Tax Analysis in the late 1980s. The Reagan administration recommended extending the tax, hardly bothering to explain the decision. "But it was understood at the time," Steuerle later wrote, "that in a period of large deficits and continual deficit-reducing legislation, maintaining an old tax was politically more acceptable than enacting some new one."

And that, in a nutshell, explains the longevity of the telephone excise tax. Lawmakers are always reluctant to part with a productive, well-tolerated source of revenue. As Steuerle notes, an old tax is almost always a good tax, at least for those trying to pay the bills.

[Image omitted] A few months ago, a reporter asked me if the federal tax system included other levies like the phone tax: old provisions that linger on the books, all but forgotten after their supposedly temporary enactment. The answer is no: There are no other forgotten taxes, and the phone tax itself doesn't fit the model. It is not a vestige of the Spanish-American War any more than the income tax is a vestige of the Civil War.